Form 10-Q (First Quarter 2007)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(Mark
One)
[X]
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the
quarterly period ended March
31, 2007
or
[
]
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the
transition period
from to
Commission
File Number: 0-24960
COVENANT
TRANSPORT, INC.
(Exact
name of registrant as specified in its charter)
Nevada
|
|
88-0320154
|
(State
or other jurisdiction of incorporation
|
|
(I.R.S.
Employer Identification No.)
|
or
organization)
|
|
|
|
|
|
400
Birmingham Hwy.
|
|
|
Chattanooga,
TN
|
|
37419
|
(Address
of principal executive offices)
|
|
(Zip
Code)
|
423-821-1212
(Registrant's
telephone number, including area code)
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days.
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act (Check
one):
Large
accelerated filer [ ]
|
Accelerated
filer [ X ]
|
Non-accelerated
filer [ ]
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date (May 7, 2007).
Class
A
Common Stock, $.01 par value: 11,662,420 shares
Class
B
Common Stock, $.01 par value: 2,350,000 shares
PART
I
FINANCIAL
INFORMATION
|
|
|
Page
Number
|
|
|
|
Item
1.
|
Financial
Statements
|
|
|
|
|
|
Consolidated
Condensed Balance Sheets as of March 31, 2007 (Unaudited) and December
31,
2006
|
|
|
|
|
|
Consolidated
Condensed Statements of Operations for the three months ended March
31,
2007 and 2006 (Unaudited)
|
|
|
|
|
|
Consolidated
Condensed Statements of Equity and Comprehensive Loss for the three
months
ended March 31, 2007 (Unaudited)
|
|
|
|
|
|
Consolidated
Condensed Statements of Cash Flows for the three months ended March
31,
2007 and 2006 (Unaudited)
|
|
|
|
|
|
Notes
to Consolidated Condensed Financial Statements (Unaudited)
|
|
|
|
|
Item
2.
|
Management's
Discussion and Analysis of Financial Condition and Results of
Operations
|
|
|
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures about Market Risk
|
|
|
|
|
Item
4.
|
Controls
and Procedures
|
|
PART
II
OTHER
INFORMATION
|
|
|
Page
Number
|
|
|
|
Item
1.
|
Legal
Proceedings
|
|
|
|
|
Item
1A.
|
Risk
Factors
|
|
|
|
|
Item
6.
|
Exhibits
|
|
|
|
|
PART
1 -
FINANCIAL INFORMATION
ITEM
1. FINANCIAL
STATEMENTS
CONSOLIDATED CONDENSED
BALANCE SHEETS
(In
thousands, except share data)
|
|
ASSETS
|
|
March
31, 2007
(unaudited)
|
|
December
31, 2006
|
|
Current
assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
4,305
|
|
$
|
5,407
|
|
Accounts
receivable, net of allowance of $1,395 in 2007 and $1,491 in
2006
|
|
|
71,092
|
|
|
72,581
|
|
Drivers'
advances and other receivables, net of allowance of $2,631 in
2007
and $2,598 in 2006
|
|
|
5,568
|
|
|
4,259
|
|
Inventory
and supplies
|
|
|
4,774
|
|
|
4,985
|
|
Prepaid
expenses
|
|
|
13,717
|
|
|
11,162
|
|
Assets
held for sale
|
|
|
26,487
|
|
|
22,581
|
|
Deferred
income taxes
|
|
|
19,836
|
|
|
16,021
|
|
Income
taxes receivable
|
|
|
7,198
|
|
|
6.371
|
|
Total
current assets
|
|
|
152,977
|
|
|
143,367
|
|
|
|
|
|
|
|
|
|
Property
and equipment, at cost
|
|
|
349,491
|
|
|
349,663
|
|
Less
accumulated depreciation and amortization
|
|
|
(78,149
|
)
|
|
(74,689
|
)
|
Net
property and equipment
|
|
|
271,342
|
|
|
274,974
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
|
36,210
|
|
|
36,210
|
|
Other
assets, net
|
|
|
20,337
|
|
|
20,543
|
|
Total
assets
|
|
$
|
480,866
|
|
$
|
475,094
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Securitization
facility
|
|
$
|
49,981
|
|
$
|
54,981
|
|
Checks
outstanding in excess of bank balances
|
|
|
8,597
|
|
|
4,280
|
|
Current
maturities of acquisition obligation
|
|
|
333
|
|
|
333
|
|
Accounts
payable and accrued expenses
|
|
|
30,425
|
|
|
30,521
|
|
Current
portion of insurance and claims accrual
|
|
|
16,715
|
|
|
20,097
|
|
Total
current liabilities
|
|
|
106,051
|
|
|
110,212
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
|
114,500
|
|
|
104,900
|
|
Insurance
and claims accrual, net of current portion
|
|
|
15,469
|
|
|
18,002
|
|
Deferred
income taxes
|
|
|
55,920
|
|
|
50,685
|
|
Other
long-term liabilities
|
|
|
2,342
|
|
|
2,451
|
|
Total
liabilities
|
|
|
294,282
|
|
|
286,250
|
|
|
|
|
|
|
|
|
|
Commitments
and contingent liabilities
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Stockholders'
equity:
|
|
|
|
|
|
|
|
Class
A common stock, $.01 par value; 20,000,000 shares authorized;
13,469,090
and 13,469,090 shares issued; 11,662,420 and 11,650,690
shares
outstanding as of March 31, 2007 and December 31, 2006,
respectively
|
|
|
135
|
|
|
135
|
|
Class
B common stock, $.01 par value; 5,000,000 shares authorized;
2,350,000
shares issued and outstanding
|
|
|
24
|
|
|
24
|
|
Additional
paid-in-capital
|
|
|
92,065
|
|
|
92,053
|
|
Treasury
stock at cost; 1,806,670 shares and 1,818,400 shares as of March
31,
2007 and December
31, 2006, respectively
|
|
|
(21,443
|
)
|
|
(21,582
|
)
|
Retained
earnings
|
|
|
115,803
|
|
|
118,214
|
|
Total
stockholders' equity
|
|
|
186,584
|
|
|
188,844
|
|
Total
liabilities and stockholders' equity
|
|
$
|
480,866
|
|
$
|
475,094
|
|
The
accompanying notes are an integral part of these consolidated condensed
financial statements.
CONSOLIDATED
CONDENSED STATEMENTS OF OPERATIONS
FOR
THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006
(In
thousands, except per share data)
|
|
Three
months ended March 31,
(unaudited)
|
|
|
|
2007
|
|
2006
|
|
Revenue:
|
|
|
|
|
|
Freight
revenue
|
|
$
|
143,542
|
|
$
|
129,434
|
|
Fuel
surcharge revenue
|
|
|
22,850
|
|
|
22,091
|
|
Total
revenue
|
|
$
|
166,392
|
|
$
|
151,525
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
Salaries,
wages, and related expenses
|
|
|
67,422
|
|
|
58,642
|
|
Fuel
expense
|
|
|
45,990
|
|
|
41,915
|
|
Operations
and maintenance
|
|
|
9,598
|
|
|
8,497
|
|
Revenue
equipment rentals and purchased transportation
|
|
|
15,461
|
|
|
14,678
|
|
Operating
taxes and licenses
|
|
|
3,879
|
|
|
3,302
|
|
Insurance
and claims
|
|
|
6,255
|
|
|
8,226
|
|
Communications
and utilities
|
|
|
2,115
|
|
|
1,591
|
|
General
supplies and expenses
|
|
|
5,682
|
|
|
4,304
|
|
Depreciation
and amortization, including gains and losses on
disposition
of equipment
|
|
|
12,734
|
|
|
10,000
|
|
Total
operating expenses
|
|
|
169,136
|
|
|
151,155
|
|
Operating
income (loss)
|
|
|
(2,744
|
)
|
|
370
|
|
Other
(income) expenses:
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
3,032
|
|
|
1,144
|
|
Interest
income
|
|
|
(115
|
)
|
|
(137
|
)
|
Other
|
|
|
(82
|
)
|
|
(53
|
)
|
Other
expenses, net
|
|
|
2,835
|
|
|
954
|
|
Loss
before income taxes
|
|
|
(5,579
|
)
|
|
(584
|
)
|
Income
tax expense (benefit)
|
|
|
(3,509
|
)
|
|
300
|
|
Net
loss
|
|
$
|
(2,070
|
)
|
$
|
(884
|
)
|
|
|
|
|
|
|
|
|
Loss
per share:
|
|
|
|
|
|
|
|
Basic
and diluted loss per share:
|
|
$
|
(0.15
|
)
|
$
|
(0.06
|
)
|
|
|
|
|
|
|
|
|
Basic
and diluted weighted average common shares outstanding
|
|
|
14,005
|
|
|
13,985
|
|
The
accompanying notes are an integral part of these consolidated condensed
financial statements.
CONSOLIDATED
CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY
AND
COMPREHENSIVE LOSS
FOR
THE THREE MONTHS ENDED MARCH 31, 2007
(Unaudited
and in thousands)
|
|
Common
Stock
|
|
Additional
Paid-In
|
|
Treasury
|
|
Retained
|
|
Total
Stockholders'
|
|
Comprehensive
|
|
|
|
Class
A
|
|
Class
B
|
|
Capital
|
|
Stock
|
|
Earnings
|
|
Equity
|
|
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances
at December 31, 2006
|
|
$
|
135
|
|
$
|
24
|
|
$
|
92,053
|
|
$
|
(21,582
|
)
|
$
|
118,214
|
|
$
|
188,844
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance
of restricted stock to
non-employee
directors from
treasury
stock
|
|
|
-
|
|
|
-
|
|
|
12
|
|
|
139
|
|
|
-
|
|
|
151
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative
impact of change in
accounting
for uncertainties in
income
taxes (FIN 48 - see Note 6)
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(341
|
)
|
|
(341
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(2,070
|
)
|
|
(2,070
|
)
|
|
(2,070
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
loss for three
months
ended March 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(2,070
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances
at March 31, 2007
|
|
$
|
135
|
|
$
|
24
|
|
$
|
92,065
|
|
$
|
(21,443
|
)
|
$
|
115,803
|
|
$
|
186,584
|
|
|
|
|
The
accompanying notes are an integral part of these consolidated condensed
financial statements.
CONSOLIDATED
CONDENSED STATEMENTS OF CASH FLOWS
FOR
THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006
(In
thousands)
|
|
Three
months ended March 31,
(unaudited)
|
|
|
|
2007
|
|
2006
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
Net
loss
|
|
$
|
(2,070
|
)
|
$
|
(884
|
)
|
Adjustments
to reconcile net loss to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
Provision
for losses on accounts receivable
|
|
|
165
|
|
|
158
|
|
Depreciation
and amortization
|
|
|
12,393
|
|
|
10,140
|
|
Amortization
of deferred financing fees
|
|
|
65
|
|
|
20
|
|
Deferred
income taxes (benefit)
|
|
|
1,079
|
|
|
(1,020
|
)
|
Stock
based compensation expense
|
|
|
151
|
|
|
4
|
|
Loss
(gain) on disposition of property and equipment
|
|
|
341
|
|
|
(140
|
)
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Receivables
and advances
|
|
|
30
|
|
|
15,965
|
|
Prepaid
expenses and other assets
|
|
|
(2,556
|
)
|
|
2,299
|
|
Inventory
and supplies
|
|
|
239
|
|
|
(55
|
)
|
Insurance
and claims accrual
|
|
|
(5,915
|
)
|
|
(3,455
|
)
|
Accounts
payable and accrued expenses
|
|
|
(878
|
)
|
|
3,962
|
|
Net
cash flows provided by operating activities
|
|
|
3,044
|
|
|
26,994
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Acquisition
of property and equipment
|
|
|
(23,988
|
)
|
|
(44,227
|
)
|
Proceeds
from disposition of property and equipment
|
|
|
11,269
|
|
|
14,542
|
|
Payment
of acquisition obligation
|
|
|
(83
|
)
|
|
-
|
|
Net
cash flows used in investing activities
|
|
|
(12,802
|
)
|
|
(29,685
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Exercise
of stock options
|
|
|
-
|
|
|
192
|
|
Excess
tax benefits from exercise of stock options
|
|
|
-
|
|
|
16
|
|
Change
in checks outstanding in excess of bank balances
|
|
|
4,317
|
|
|
-
|
|
Proceeds
from issuance of debt
|
|
|
22,000
|
|
|
10,000
|
|
Repayments
of debt
|
|
|
(17,400
|
)
|
|
(10,000
|
)
|
Debt
refinancing costs
|
|
|
(261
|
)
|
|
-
|
|
Net
cash provided by financing activities
|
|
|
8,656
|
|
|
208
|
|
|
|
|
|
|
|
|
|
Net
change in cash and cash equivalents
|
|
|
(1,102
|
)
|
|
(2,483
|
)
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at beginning of period
|
|
|
5,407
|
|
|
3,618
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at end of period
|
|
$
|
4,305
|
|
$
|
1,135
|
|
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 preparing financial
statements, it is necessary for management to make assumptions and estimates
affecting the amounts reported in the consolidated condensed financial
statements and related notes. These estimates and assumptions are
developed based upon all information available. Actual results could
differ from estimated amounts. 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, 2006 consolidated condensed balance sheet was derived from the
Company's audited balance sheet as of that date. These consolidated condensed
financial statements and notes thereto be read in conjunction with the
consolidated condensed financial statements and notes thereto included in the
Company's Form 10-K for the year ended December 31, 2006. 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 (Loss)
Comprehensive
earnings (loss) generally include all changes in equity during a period except
those resulting from investments by owners and distributions to owners.
Comprehensive loss for the three month periods ended March 31, 2007 and 2006
equaled net loss.
Note
3. Segment
Information
The
Company has 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 the Company's transportation service offerings and
subsidiaries 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, the Company has not presented separate financial
information for each of its service offerings and subsidiaries as the condensed
consolidated financial statements present the Company's one reportable segment.
The Company generates 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 Loss per
Share
The
Company applies the provisions of SFAS No. 128,
Earnings per Share,
which
requires it 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 ended March 31,
2007
and 2006, excludes all unexercised shares, since the effect of any assumed
exercise of the related options would be anti-dilutive.
The
following table sets forth for the periods indicated the calculation of net
loss
per share included in the consolidated condensed statements of
operations:
(in
thousands except per share data)
|
|
Three
months ended
March
31,
|
|
|
|
2007
|
|
2006
|
|
Numerator:
|
|
|
|
|
|
Net
loss
|
|
$
|
(2,070
|
)
|
$
|
(884
|
)
|
Denominator:
|
|
|
|
|
|
|
|
Denominator
for basic earnings per share - weighted-
average
shares
|
|
|
14,005
|
|
|
13,985
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
Employee
stock options
|
|
|
-
|
|
|
-
|
|
Denominator
for diluted earnings per share -
adjusted
weighted-average shares and assumed
conversions
|
|
|
14,005
|
|
|
13,985
|
|
Net
loss per share:
|
|
|
|
|
|
|
|
Basic
and diluted loss per share:
|
|
$
|
(0.15
|
)
|
$
|
(0.06
|
)
|
Note
5. Share-Based
Compensation
Prior
to
May 23, 2006, the
Company
had four
stock-based compensation plans. On May 23, 2006, upon the recommendation of
the
Company's Board
of
Directors, its
stockholders approved the Covenant Transport, Inc. 2006 Omnibus Incentive Plan
("2006 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. The 2006 Plan permits annual
awards of shares of the Company's Class A common stock to executives, other
key
employees, and non-employee directors
under
various types of options, restricted stock awards, or other equity instruments.
The
number of shares available for issuance under the 2006 Plan is 1,000,000 shares
unless adjustment is determined necessary by the Committee as the result of
dividend or other distribution, recapitalization, stock split, reverse stock
split, reorganization, merger, consolidation, split-up, spin-off, combination,
repurchase or exchange of Class A common stock, or other corporate transaction
in order to prevent dilution or enlargement of benefits or potential benefits
intended to be made available. At March 31, 2007, 440,466 of these
1,000,000 shares were available for award under the 2006 Plan. No participant
in
the 2006 Plan may receive awards of any type of equity instruments in any
calendar-year that relates to more than 250,000 shares of the Company's Class
A
common stock. No awards may be made under the 2006 Plan after May 23, 2016.
The
Company has a policy of issuing treasury stock to satisfy all share-based
incentive plans.
Effective
January 1, 2006, the
Company
adopted
SFAS No. 123R, Share-Based
Payment
("SFAS
No. 123R") using the modified prospective method. Under this 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
compensation expense for the three months ended March 31, 2007 and 2006 was
approximately $151,000 and $4,000, respectively, and is included in salaries,
wages, and related expenses within the consolidated condensed statements of
operations. As a result of the acceleration of vesting of all outstanding
unvested stock options on August 31, 2005, there was no cumulative effect of
initially adopting SFAS No. 123R.
The
following tables summarize our stock option activity for the three months ended
March 31, 2007:
|
|
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
|
|
|
1,287
|
|
$
|
13.98
|
|
|
68
months
|
|
$
|
685
|
|
Options
granted
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
Options
exercised
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
Options
forfeited
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
Options
expired
|
|
|
(1
|
)
|
$
|
15.30
|
|
|
|
|
|
|
|
Outstanding
at end of period
|
|
|
1,286
|
|
$
|
13.98
|
|
|
65
months
|
|
$
|
599
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at end of period
|
|
|
1,178
|
|
$
|
14.07
|
|
|
61
months
|
|
$
|
599
|
|
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. No options were
granted during the three months ended March 31, 2007 or 2006.
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 the Company's 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
Company issues performance-based restricted stock awards whose vesting is
contingent upon meeting certain earnings-per-share targets selected by the
Compensation Committee. Determining the appropriate amount to expense is based
on likelihood of achievement of the stated targets and requires judgment,
including forecasting future financial results. This estimate is revised
periodically based on the probability of achieving the required performance
targets and adjustments are made as appropriate. The cumulative impact of any
revision is reflected in the period of change.
The
following tables summarize the Company's restricted stock award activity for
the
three months ended March 31, 2007:
|
|
Number
of
stock
awards
|
|
Weighted
average
grant
date
fair value
|
|
Unvested
at January 1, 2007
|
|
|
456,984
|
|
$
|
12.65
|
|
Granted
|
|
|
-
|
|
|
-
|
|
Vested
|
|
|
-
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
-
|
|
Unvested
at December 31, 2006
|
|
|
456,984
|
|
$
|
12.65
|
|
As
of
March 31, 2007, the Company had no unrecognized compensation expense related
to
stock options or restricted stock awards which is probable to be recognized
in
the future.
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.
In
July
2006, the FASB issued Interpretation No. 48 ("FIN 48"), Accounting
for Uncertainty in Income Taxes.
The
Company was required to adopt the provisions of FIN 48, effective January 1,
2007. As a result of this adoption, the Company recognized additional tax
liabilities of $0.3 million with a corresponding reduction to beginning retained
earnings as of January 1, 2007. As of January 1, 2007, the Company had a $2.8
million liability recorded for unrecognized tax benefits, which includes
interest and penalties of $0.5 million. The Company recognizes interest and
penalties accrued related to unrecognized tax benefits in tax expense. If
recognized, $2.0 million of unrecognized tax benefits would impact the Company's
effective tax rate.
As
previously disclosed, the IRS completed their audit fieldwork of the Company's
2003 and 2004 federal tax returns and has proposed the disallowance, with which
the Company has agreed, of approximately $350,000 of costs related to the
November 2003 stock offering. During the three months ended June 30, 2006,
the
Company recorded all of the $0.1 million of income tax expense related to this
proposed disallowance of tax benefits. Additionally, the IRS proposed to
disallow the tax benefits associated with insurance premium payments made to
Volunteer Insurance Limited ("Volunteer"), the Company's wholly-owned captive
insurance subsidiary, for the 2003 and 2004 years. Due to receiving the
favorable resolution of the 2001 and 2002 IRS audit on this issue, for which
the
Closing Agreement received from the IRS 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, we vigorously
defended our position related to this proposed disallowance of tax benefits.
On
October 5, 2006, we filed an official Statement of Appeal with the IRS Appeals
Office. Prior to adoption of FIN 48, we had approximately $0.9 million recorded
as a contingent tax liability to fully reserve for the potential tax benefits
of
the post-2004 fiscal years, as required by SFAS No. 5, Accounting
for Contingencies.
Upon
adoption of FIN 48 on January 1, 2007, we reduced the contingent tax liability
related to this transaction to approximately $0.4 million. On March 29, 2007,
following conferences with the IRS, the IRS Appeals Officer recommended the
IRS'
conceding of this case related to this issue. Based on the IRS Appeals Officer's
recommendation to concede the IRS' position, the Company revised its measurement
of this issue at March 31, 2007 resulting in recognition of the approximate
$0.4
million of income tax benefit for the three months ended March 31, 2007 which
remained as a contingent tax liability upon adoption of FIN 48 at January 1,
2007.
The
Company is subject to United States Federal income tax examinations for the
tax
years 2003 and forward. The Company files in numerous state tax jurisdictions
with varying statutes of limitations. Except related to the outcome of the
captive insurance matter discussed in the above paragraph, there were no
material changes to the total amount of unrecognized tax benefits for the three
months ended March 31, 2007.
Note
7. Derivative
Instruments
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.
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 determined using the straight-line method over the estimated useful lives
of
the assets. Depreciation of revenue equipment is the
Company's
largest
item of depreciation. The
Company
generally depreciates
new
tractors (excluding day cabs) over five years to salvage values of 7% to 33%
and
new trailers over seven years to salvage values of 22% to 39%. The
Company
annually
reviews
the
reasonableness of its
estimates regarding useful lives and salvage values of its
revenue
equipment and other long-lived assets based upon, among other things,
its
experience with similar assets, conditions in the used revenue equipment market,
and prevailing industry practice. Changes in the
useful
life or salvage value estimates, or fluctuations in market values that are
not
reflected in the
Company's
estimates, could have a material effect on its
results
of operations. Gains and losses on the disposal of revenue equipment are
included in depreciation expense in the
consolidated condensed statements of operations.
Note
9. Securitization
Facility and
Long-Term Debt
Long-term
debt and our securitization facility consisted of the following at March 31,
2007 and December 31, 2006:
(in
thousands)
|
|
March
31, 2007
|
|
December
31, 2006
|
|
|
|
|
|
|
|
Securitization
Facility
|
|
$
|
49,981
|
|
$
|
54,981
|
|
|
|
|
|
|
|
|
|
Borrowings
under Credit Facility
|
|
$
|
114,500
|
|
$
|
104,900
|
|
Total
long-term debt
|
|
|
114,500
|
|
|
104,900
|
|
Less
current maturities
|
|
|
-
|
|
|
-
|
|
Long-term
debt, less current portion
|
|
$
|
114,500
|
|
$
|
104,900
|
|
In
December 2006, the
Company
entered
into a second amended and restated revolving credit agreement, (the "Credit
Facility") with a group of banks. The Credit Facility matures in December 2011.
Borrowings under the Credit Facility 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
0.625% and 1.625% based on cash flow coverage (the applicable margin was 1.25%
at March 31, 2007). At March 31, 2007, the
Company
had
borrowings outstanding under the Credit Facility totaling $114.5 million with
a
weighted average interest rate of 6.724%. The Credit Facility is guaranteed
by
the Company and all of its subsidiaries except CVTI Receivables Corp. ("CRC")
and Volunteer.
The
Credit Facility has a maximum borrowing limit of $200.0 million with an
accordion feature which permits an increase up to a maximum borrowing limit
of
$275.0 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 $100.0
million. The Credit Facility is secured by a pledge of the stock of most of
the
Company's subsidiaries. A commitment fee, which is adjusted quarterly between
0.125% and 0.35% per annum based on cash flow coverage, is due on the daily
unused portion of the Credit Facility. At March 31, 2007 and December 31, 2006,
the
Company
had
undrawn letters of credit outstanding of approximately $60.1 million. As of
March 31, 2007, the
Company
had
approximately $25.4 million of available borrowing capacity.
In
December 2000, the
Company
entered
into an accounts receivable securitization facility (the "Securitization
Facility"). On a revolving basis, the
Company
sells
its interests in its
accounts
receivable to CRC, a wholly-owned, bankruptcy-remote, special-purpose subsidiary
incorporated in Nevada. CRC sells a percentage ownership in such receivables
to
unrelated financial entities. The
Company
can
receive up to $70.0 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 is
shown as
a current liability because the term, subject to annual renewals, is 364 days.
As of March 31, 2007 and December 31, 2006, the
Company
had
$50.0 million and $55.0 million outstanding, respectively, with weighted average
interest rates of 5.3% for both dates, respectively. CRC does not meet the
requirements for off-balance sheet accounting; therefore, it is reflected in
the
consolidated condensed financial statements.
The
Credit Facility 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
March 31, 2007.
Note
10. Acquisition
On
September 14, 2006, the
Company
acquired
100% of the outstanding stock of Star Transportation, Inc. ("Star"), a
short-to-medium haul dry van regional truckload carrier based in Nashville,
Tennessee. The acquisition included 614 tractors and 1,719 trailers. The total
purchase price of approximately $40.1 million has been allocated to tangible
and
intangible assets acquired and liabilities assumed based on their fair market
values as of the acquisition date in accordance with SFAS No. 141, "Business
Combinations". Star's operating results have been accounted for in the Company's
consolidated results of operations since the acquisition date.
The
following table summarizes the Company's estimated fair value of the assets
acquired and liabilities assumed at the date of acquisition:
(In
thousands) |
|
|
|
|
|
|
|
Current
assets
|
|
$
|
10,970
|
|
Property
and equipment
|
|
|
62,339
|
|
Deferred
tax assets
|
|
|
275
|
|
Other
assets -
Interest rate swap
|
|
|
252
|
|
Identifiable
intangible assets:
|
|
|
|
|
Tradename
(4-year estimated useful life)
|
|
|
920
|
|
Noncompetition
agreement (7-year useful life)
|
|
|
1,000
|
|
Customer
relationships
(20-year estimated useful life)
|
|
|
3,490
|
|
Goodwill
|
|
|
24,655
|
|
Total
assets
|
|
$
|
103,901
|
|
|
|
|
|
|
Current
liabilities
|
|
$
|
13,181
|
|
Long-term
debt, net of current maturities
|
|
|
36,298
|
|
Deferred
tax liabilities
|
|
|
14,361
|
|
Total
liabilities
|
|
$
|
63,840
|
|
|
|
|
|
|
Total
purchase price
|
|
$
|
40,061
|
|
The
total
purchase price of $40.1 million includes purchase price consideration paid
to
the selling shareholders of Star, or their respective escrow agents, totaling
$38.8 million and $0.3 million of acquisition-related costs, as well as an
additional 3-year acquisition obligation note payable totaling $1.0 million
to
one of the selling shareholders of Star related to her 7-year noncompetition
agreement.
The
following pro forma financial information reflects our summarized consolidated
condensed results of operations for the three months ended March 31, 2006 as
if
the acquisition of Star had taken place on January 1, 2006. The pro forma
financial information is not necessarily indicative of the results as it would
have been if the acquisition had been effected on the assumed date and is not
necessarily indicative of future results:
(in
thousands, except per share data)
|
|
Three
months ended
March
31, 2006
|
|
Pro
forma revenues
|
|
$
|
174,740
|
|
Pro
forma net income
|
|
$
|
436
|
|
Pro
forma basic and diluted earnings per share
|
|
$
|
0.03
|
|
Note
11. Recent
Accounting Pronouncements
In
February 2007, the Financial Accounting Standards Board ("FASB") issued SFAS
No.
159, The
Fair Value Option for Financial Assets and Financial
Liabilities
(SFAS
159). SFAS No. 159 permits entities to choose to measure certain financial
assets and liabilities at fair value. Unrealized gains and losses on items
for
which the fair value option has been elected are reported in earnings. SFAS
No.
159 is effective for fiscal years beginning after November 15, 2007.
The
Company is
currently assessing the expected impact of SFAS No. 159 in
the
consolidated condensed financial statements.
In
September 2006, the FASB issued SFAS No. 157, Fair
Value Measurements.
This
Statement defines fair value, establishes a framework for measuring fair value
in generally accepted accounting principles (GAAP), and expands disclosures
about fair value measurements. The provisions of SFAS No. 157 are effective
as
of the beginning of the first fiscal year that begins after November 15, 2007.
The
Company
does not
believe the adoption of SFAS No. 157 will have a material impact in
the
consolidated condensed financial statements.
In
July
2006, the FASB issued FIN 48 which clarifies the accounting for uncertainty
in
income taxes recognized in the financial statements in accordance with SFAS
No.
109,
Accounting for Income Taxes.
FIN 48
provides guidance on 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, disclosures, and transition. FIN 48 is effective for fiscal
years beginning after December 15, 2006. The
Company
adopted
the provisions of FIN 48 as of January 1, 2007. As
a
result of this adoption, the Company recognized additional tax liabilities
of
$0.3 million with a corresponding reduction to beginning retained earnings
as of
January 1, 2007 (See Note 6).
Note
12. Commitments
and Contingencies
From
time
to time,
the
Company is
a party
to ordinary, routine litigation arising in the ordinary course of business,
most
of which involves claims for personal injury and property damage incurred in
connection with the transportation of freight. The
Company
maintains insurance to cover liabilities arising from the transportation of
freight for amounts in excess of certain self-insured retentions. In
management's
opinion,
the
Company's
potential exposure under pending legal proceedings is adequately provided for
in
the accompanying consolidated condensed financial statements.
Financial
risks which potentially subject the
Company
to
concentrations of credit risk consist of deposits in banks in excess of the
Federal Deposit Insurance Corporation limits. The
Company's
sales
are generally made on account without collateral. Repayment terms vary based
on
certain conditions. The
Company
maintains reserves which it
believes
are adequate to provide for potential credit losses. The majority of
its
customer
base spans the United States. The
Company monitors
these risks and believes the risk of incurring material losses is
remote.
The
Company
uses
purchase commitments through suppliers to reduce a portion of its
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.
Except
for certain historical information contained herein, this report contains
"forward-looking statements" within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and Section 27A of the
Securities Act of 1933, as amended that involve risks, assumptions, and
uncertainties that are difficult to predict. All statements, other than
statements of historical fact, are statements that could be deemed
forward-looking statements, including without limitation: any
projections of revenues, earnings, cash flows, profit margins, capital
expenditures, or other financial items; any statement of plans, strategies,
and
objectives of management for our business realignment or future operations;
any
statements concerning proposed acquisition plans, new services or developments;
any statements regarding future economic or competitive conditions or
performance; and any statements of belief and any statement of assumptions
underlying any of the foregoing. Words such as "believe," "may," "could,"
"expects," "hopes," "anticipates," and "likely," and variations of these words,
or similar expressions, are intended to identify such forward-looking
statements. Actual events or results could
differ
materially from those
discussed in forward-looking statements. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed in the
section entitled "Item 1A. Risk Factors," set forth in our form 10-K for the
year ended December 31, 2006, as supplemented in Part II below.
All
such
forward-looking statements speak only as of the date of this Form 10-Q. You
are
cautioned not to place undue reliance on such forward-looking statements. The
Company expressly disclaims any obligation or undertaking to release publicly
any updates or revisions to any forward-looking statements contained herein
to
reflect any change in the Company's expectations with regard thereto or any
change in the events, conditions, or circumstances on which any such statement
is based.
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 five major transportation service
offerings: Expedited long haul service, Refrigerated service, Dedicated service,
Covenant regional solo-driver service, and Star 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 also generate
revenue through a subsidiary that provides freight brokerage
services.
On
September 14, 2006, we acquired 100% of the outstanding stock of Star
Transportation, Inc. ("Star"),
a
short-to-medium haul dry van regional truckload carrier based in Nashville,
Tennessee. Star's operating results have been accounted for in the Company's
consolidated condensed financial statements since the acquisition date. Star's
total revenue for the three months ended March 31, 2007 was $23.6 million,
representing approximately 14.2% of our consolidated total revenue.
For
the
three months ended March 31, 2007, total revenue increased $14.9 million, or
9.8%, to $166.4 million from $151.5 million in the 2006 period. Freight
revenue, which excludes revenue from fuel surcharges, increased $14.1 million,
or 10.9%, to $143.5 million in the 2007 period from $129.4 million in
the 2006 period. We experienced a net loss of $2.1 million, or $0.15 per share,
for the first three months of 2007, compared with a net loss of $0.9 million,
or
$0.06 per share, for the first three months of 2006.
For
the
three months ended March 31, 2007, our average freight revenue per tractor
per
week, our main measure of asset productivity, increased 1.8%, to $2,992 compared
to $2,938 in the same period of 2006. The increase was primarily generated
by a
0.8% increase in average freight revenue per total mile, and a 1.2% increase
in
average miles per tractor, offset by a 0.4% increase in non-revenue miles.
Weighted average tractors increased 7.6% to 3,686 in the 2007 period from 3,426
in the 2006 period, primarily as a result of the Star acquisition. The freight
market was very competitive during the first quarter of 2007, with significant
pressure on freight rates, soft demand for capacity, and a material increase
in
the re-bidding of service requirements by customers. In addition, severe winter
weather affected equipment utilization in February and early March of
2007.
Our
after-tax costs on a per-mile basis increased 2.6%, or $.035 per mile, compared
with the first three months of 2006. The
main
factors were a $.034 per mile increase in compensation expense, (driven
primarily by increases in driver pay from the better retention of experienced
drivers, and office salaries in the growth of our brokerage subsidiary and
severance payments and additional headcount related to our realignment efforts),
a $.014 per mile increase in net fuel expense associated with increasing fuel
prices and a less effective fuel surcharge program due to an increase in broker
freight, a $.009 per mile increase in general supplies and expenses, (primarily
related to the increase in building rent resulting from our building sale
leaseback transaction in April 2006), a $0.018 per mile increase in depreciation
and amortization expense (resulting primarily from the acquisition of tangible
and intangible assets of Star and a reduction in gain on sale of revenue
equipment), and a $0.017 per mile increase in interest expense related to the
additional debt from the September 2006 acquisition of Star. These increases
were partially offset by a $.026 per mile decrease in our insurance and claims
expense (resulting from positive claims experience), as well as a $.037 per
mile
decrease in income tax expense.
During
2005, we began the formal realignment of our business into 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. In addition, we added the Star Regional
solo-driver service offering with our acquisition of Star. Our freight brokerage
operation is also managed and operated as a separate subsidiary.
For
the
three months ended March 31, 2007, 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 March 31, 2006:
•
|
Expedited
long haul service. We increased the fleet by approximately 13%, primarily
through the January 2007 assimilation of the former Covenant Refrigerated
service offering's team-driver trucks into this service offering.
We
expanded the length of haul to reflect a renewed focus on transcontinental
loads. Average freight revenue per total mile has remained basically
flat
with last year, although the length of haul has expanded about
5%.
|
|
|
•
|
Refrigerated
service. In January 2007, we assimilated the single-driver trucks
from our
former Covenant Refrigerated service offering into our Southern
Refrigerated Transport ("SRT") service offering. The addition of
the
unprofitable Covenant Refrigerated operations into SRT resulted in
a
deterioration of SRT's performance, primarily due to a significant
increase in freight from freight brokers to keep trucks loaded and
to
migrate the Covenant Refrigerated trucks to the SRT lanes. We expect
SRT
to gradually reduce its dependency on broker freight throughout the
year.
|
|
|
•
|
Dedicated
service. We increased the fleet by approximately 6% and kept the
average
length of haul and miles per truck relatively flat. Average freight
revenue per total mile increased almost 3%. As of March 31, 2007,
we have
renegotiated 83% of the Dedicated service offering's contracts with
more
favorable terms, and we expect to negotiate most of the remainder
during
the next few quarters. We also addressed a problem on one dedicated
fleet
that temporarily idled about 50 trucks, but we believe this has been
solved. Although we have expectations for meaningful improvement
for the
rest of the year, the soft freight environment has begun to impact
the
dedicated arena and more customers are attempting to take advantage
of the
soft freight market. On the other hand, the bid pipeline for dedicated
business continues to look very promising.
|
|
|
•
|
Covenant
regional solo-driver service. We decreased the fleet by approximately
500
trucks or 46%, decreased the length of haul by approximately 14%
to 512
miles, and increased miles per truck by almost 16% compared with
the first
quarter of 2006. Average freight revenue per total mile remained
flat. The
freight mix within our regional service offering changed substantially,
as
we have worked to reposition several hundred tractors around freight
centers and driver domiciles. We have reduced our dependence on brokered
freight and believe the network is beginning to stabilize, represented
by
an approximate 14% increase in average freight revenue per tractor
per
week compared with the first quarter of 2006. Substantial additional
improvements are needed for this service offering to become
profitable.
|
|
|
•
|
Star
regional solo-driver service. On
September 14, 2006, we acquired 100% of the outstanding stock of
Star, a
short-to-medium haul dry van regional truckload carrier based in
Nashville, Tennessee. Star's total revenue for the quarter ended
March 31,
2007 totaled approximately $23.6 million. Soft freight demand in
the
southeast affected Star, which had to rely on brokered freight to
keep its
trucks moving.
|
|
|
•
|
Brokerage
freight service. Late
in the first quarter of 2006, we initiated our freight brokerage
operation
and hired a Vice President and General Manager of this separate subsidiary
operating as Covenant Transport Solutions, Inc. The brokerage operation
has helped us continue to serve customers when we lacked capacity
in a
given area or when the load has not met the operating profile of
one of
our service offerings. This service has been useful as we continue
to
realign trucks between service offerings and subsidiaries and in
the
management of our freight mix toward preferred lanes. Since inception,
the
loads and revenues provided by this operation have grown each
quarter.
|
At
March
31, 2007, we had $186.6 million in stockholders' equity and $164.5 million
in
balance sheet debt for a total debt-to-capitalization ratio of 46.9% and a
book
value of $13.32 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. We 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. 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. The variable 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.
Our
business realignment presents numerous challenges and may result in volatile
financial performance or periods of unprofitable results. Fluctuations in
results may be ongoing as major activities within the realignment are expected
to continue throughout 2007. Our primary goal for 2007 is to improve our
operating ratio by 100 to 200 basis points versus the full year of 2006. Due
to
slower than anticipated freight volumes and the resulting concern regarding
capacity supply and demand in the marketplace, this goal for 2007 may be
difficult to achieve, although we have not formally changed that goal. Our
expectation is that the combination of 1) the downsizing of the Covenant
regional solo-driver service offering during the second half of 2006, 2)
reallocating non-performing assets from the Covenant refrigerated service
offering to SRT and Covenant's expedited long haul service offering which
occurred in January 2007, 3) aggressively improving Covenant's dedicated service
offering's profitability as contracts expire, and 4) reducing overhead and
capital costs in all non-performing areas, should produce earnings improvement
during the second half of 2007, assuming an improvement in freight demand and
little increase in industry-wide trucking capacity leads to a more favorable
operating environment.
Revenue
Equipment
We
operate approximately 3,693 tractors and 9,524 trailers. Of our tractors, at
March 31, 2007, approximately 2,743 were owned, 806 were financed under
operating leases, and 144 were provided by independent contractors, who own
and
drive their own tractors. Of our trailers, at March 31, 2007, approximately
2,494 were owned and approximately 7,030 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.
During
2006, we replaced approximately 2,000 tractors, or approximately 55% of our
Company-owned tractor fleet. This is a substantially greater percentage than
the
number of tractors we would normally have replaced and resulted in a substantial
increase over normal replacement capital expenditures. We increased 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
March
31,
|
|
|
|
Three
Months Ended
March
31,
|
|
|
2007
|
|
2006
|
|
|
|
2007
|
|
2006
|
Total
revenue
|
|
100.0%
|
|
100.0%
|
|
Freight
revenue (1)
|
|
100.0%
|
|
100.0%
|
Operating
expenses:
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
Salaries,
wages, and related
expenses
|
|
40.5
|
|
38.7
|
|
Salaries,
wages, and related
expenses
|
|
47.0
|
|
45.3
|
Fuel
expense
|
|
27.6
|
|
27.7
|
|
Fuel
expense (1)
|
|
16.1
|
|
15.3
|
Operations
and maintenance
|
|
5.8
|
|
5.6
|
|
Operations
and maintenance
|
|
6.7
|
|
6.6
|
Revenue
equipment rentals and
purchased
transportation
|
|
9.3
|
|
9.7
|
|
Revenue
equipment rentals and
purchased
transportation
|
|
10.8
|
|
11.3
|
Operating
taxes and licenses
|
|
2.3
|
|
2.2
|
|
Operating
taxes and licenses
|
|
2.7
|
|
2.6
|
Insurance
and claims
|
|
3.8
|
|
5.4
|
|
Insurance
and claims
|
|
4.4
|
|
6.4
|
Communications
and utilities
|
|
1.3
|
|
1.0
|
|
Communications
and utilities
|
|
1.5
|
|
1.2
|
General
supplies and expenses
|
|
3.4
|
|
2.8
|
|
General
supplies and expenses
|
|
4.0
|
|
3.3
|
Depreciation
and amortization
|
|
7.7
|
|
6.6
|
|
Depreciation
and amortization
|
|
8.9
|
|
7.7
|
Total
operating expenses
|
|
101.6
|
|
99.8
|
|
Total
operating expenses
|
|
101.9
|
|
99.7
|
Operating
income (loss)
|
|
(1.6)
|
|
0.2
|
|
Operating
income (loss)
|
|
(1.9)
|
|
0.3
|
Other
expense, net
|
|
1.7
|
|
0.6
|
|
Other
expense, net
|
|
2.0
|
|
0.7
|
Loss
before income taxes
|
|
(3.4)
|
|
(0.4)
|
|
Loss
before income taxes
|
|
(3.9)
|
|
(0.5)
|
Income
tax expense (benefit)
|
|
(2.1)
|
|
0.2
|
|
Income
tax expense (benefit)
|
|
(2.4)
|
|
0.2
|
Net
loss
|
|
(1.2)%
|
|
(0.6)%
|
|
Net
loss
|
|
(1.4)%
|
|
(0.7)%
|
(1)
|
Freight
revenue is total revenue less fuel surcharge revenue. Fuel surcharge
revenue is shown netted against the fuel expense category ($22.9
million
and $22.1 million in the three months ended March 31, 2007 and 2006,
respectively).
|
COMPARISON
OF THREE MONTHS ENDED MARCH 31, 2007 TO THREE MONTHS ENDED MARCH 31,
2006
For
the
quarter ended March 31, 2007, total revenue increased $14.9 million, or 9.8%,
to
$166.4 million from $151.5 million in the 2006 period. Total revenue
includes $22.9 million and $22.1 million of fuel surcharge revenue in the 2007
and 2006 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.
On
September 14, 2006, we acquired 100% of the outstanding stock of Star
Transportation, Inc. ("Star"), a short-to-medium haul dry van regional truckload
carrier based in Nashville, Tennessee. Star operates primarily in the
southeastern United States, with shipments concentrated from Texas across the
Southeast to Virginia, and an average length of haul of approximately 432 miles.
We are operating Star as a separate subsidiary, continuing with substantially
the same personnel, customers, lanes and terminal locations as it had prior
to
our acquisition. The
acquisition included 614 tractors and 1,719 trailers. Star's operating results
have been accounted for in the Company's results of operations since the
acquisition date. Star's total revenue for the quarter ended March 31, 2007
totaled approximately $23.6 million, which is included in our consolidated
condensed statements of operations for the quarter ended March 31, 2007. Star's
cost structure is similar to that of our additional operating subsidiaries,
and
therefore has a minimal impact on expenses as a percentage of freight revenue
on
the following discussion and analysis of revenues and costs of our consolidated
entities.
Freight
revenue increased $14.1 million, or 10.9%, to $143.5 million in the three months
ended March 31, 2007, from $129.4 million in the same period of 2006.
Utilization at the beginning of the quarter was seasonally strong, and then
weather conditions and the competitive environment worsened. As a result,
average freight revenue per tractor per week, our main measure of asset
productivity, increased 1.8%, to $2,992 in the first three months of 2007
compared to $2,938 in the same period of 2006 as average freight revenue per
loaded mile increased 1.1% and average miles per tractor increased 1.2%. An
increase in volume from freight brokers increased our rates because fuel
surcharges are not separately stated in the generally lower broker rates and
instead are included in freight revenue per mile. Weighted average tractors
increased 7.6% to 3,686 in the 2007 period from 3,426 in the 2006 period.
Excluding the acquisition of Star, we continued 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 $8.8 million, or 15.0%, to $67.4 million
in the 2007 period, from $58.6 million in the 2006 period. As a percentage
of
freight revenue, salaries, wages, and related expenses increased to 47.0% in
the
2007 period, from 45.3% in the 2006 period. The increase was largely
attributable to improved driver retention that resulted in higher wages for
more
experienced drivers, salaries for personnel in our growing non-asset based
brokerage subsidiary, and additional office salaries and severance payments
related to our business realignment. Driver pay increased $5.8 million to $46.1
million in the 2007 period, from $40.3 million in the 2006 period.
This
resulted in increased driver pay on a cost per mile basis of 14.4% in the 2007
period over the 2006 period. Our payroll expense for employees, other than
over-the-road drivers, as well as our employee benefits, increased $3.0 million
to $21.4 million in the 2007 period from $18.4 million in the 2006 period.
These
non-driver payroll expenses increased to 14.9% of freight revenues in the 2007
period from 14.2% of freight revenues in the 2006 period.
Fuel
expense, net of fuel surcharge revenue of $22.9 million in the 2007 period
and
$22.1 million in the 2006 period, increased $3.3 million, or 16.7%, to $23.1
million in the 2007 period, from $19.8 million in the 2006 period. As a
percentage of freight revenue, net fuel expense increased to 16.1% in the 2007
period from 15.3% in the 2006 period. Diesel fuel prices increased sharply
toward the end of the 2007 quarter. Fuel surcharges amounted to $0.21 per total
mile in both the 2007 and 2006 periods, respectively. In the 2007 period, we
had
a lower surcharge collection rate due primarily to the increase in freight
obtained through brokers. Our total miles increased about 9% while our fuel
surcharge revenue only increased 3% with a resulting net effect being that
our
fuel expense, net of surcharge increased approximately $.014 per mile. 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 $1.1 million to $9.6 million in the
2007
period from $8.5 million in the 2006 period. As a percentage of freight revenue,
operations and maintenance remained essentially constant at 6.7% in the 2007
period and 6.6% in the 2006 period.
Revenue
equipment rentals and purchased transportation increased $0.8 million, or 5.3%,
to $15.5 million in the 2007 period, from $14.7 million in the 2006 period.
As a
percentage of freight revenue, revenue equipment rentals and purchased
transportation expense decreased to 10.8% in the 2007 period from 11.3% in
the
2006 period. Payments to third-party transportation providers from our brokerage
subsidiary were $1.7 million in the 2007 period, compared to zero in the 2006
period, before we began operating our brokerage subsidiary. Tractor and trailer
equipment rental and other related expenses decreased $0.4 million, to $9.6
million compared with $10.0 million in the same period of 2006. We had financed
approximately 806 tractors and 7,030 trailers under operating leases at March
31, 2007, compared with 1,241 tractors and 7,138 trailers under operating leases
at March 31, 2006. Payments to independent contractors decreased $0.3 million,
or 6.4%, to $4.4 million in the 2007 period from $4.7 million in the 2006
period, mainly due to a slight decrease in the independent contractor
fleet.
Operating
taxes and licenses increased $0.6 million, or 17.5%, to $3.9 million in the
2007
period from $3.3 million in the 2006 period. As a percentage of freight revenue,
operating taxes and licenses remained essentially constant at 2.7% in the 2007
period versus 2.6% in the 2006 period.
Insurance
and claims, consisting primarily of premiums and deductible amounts for
liability, physical damage, and cargo damage insurance and claims, decreased
$1.9 million, or 24.0%, to approximately $6.3 million in the 2007 period from
approximately $8.2 million in the 2006 period. As a percentage of freight
revenue, insurance and claims decreased to 4.4% in the 2007 period from 6.4%
in
the 2006 period. The decrease was due to a reduction in our casualty claims
accrual resulting from several quarters of improved safety results that have
changed our actuarial estimate of unpaid claims. Consistent with the 2006
period, we recorded a $1.0 million rebate from our insurance carrier due to
management's issuing a contractual release to the insurance provider, related
to
achieving certain monetary claim targets for our casualty policy in the policy
year ended February 28, 2007. For the remainder of 2007, assuming continued
positive claims experience, we expect insurance and claims expense should be
in
the range of 7.5 to 8.5 cents per mile.
In
general, for casualty claims, we have insurance coverage up to $50.0 million
per
claim. For the 2006 period and through February 28, 2007, we were 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 resulted in total self-insured retention of up to $4.0 million
until the $2.0 million aggregate threshold was reached. We
renewed our casualty program as of February 28, 2007.
Subsequent to the renewal, we are self-insured for personal injury and property
damage claims for amounts up to the first $4.0 million. 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, and any increase in frequency or severity of claims could adversely
affect our financial condition and results of operations.
Communications
and utilities expense increased to $2.1 million in the 2007 period from $1.6
million in the 2006 period. As a percentage of freight revenue, communications
and utilities remained essentially constant at 1.5% and 1.2% in the 2007 and
2006 periods, respectively.
General
supplies and expenses, consisting primarily of headquarters and other terminal
facilities expenses, increased $1.4 million to $5.7 million in the 2007 period
from $4.3 million in the 2006 period. As a percentage of freight revenue,
general supplies and expenses increased to 4.0% in the 2007 period from 3.3%
in
the 2006 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.
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 Facility 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 is being amortized ratably over the life
of
the lease and recorded as an offset to building rent on our consolidated
condensed statements of operations.
Depreciation
and amortization, consisting primarily of depreciation of revenue equipment,
increased $2.7 million, or 27.3%, to $12.7 million in the 2007 period from
$10.0
million in the 2006 period. As
a
percentage of freight revenue, depreciation and amortization increased to 8.9%
in the 2007 period from 7.7% in the 2006 period. The increase related to several
factors including an increase in the number of owned tractors and trailers
in
the 2007
period,
a softer market for used equipment resulting in a loss of $0.3 million in the
2007 period compared to a gain of $0.1 million in the 2006 period, and increased
amortization expense of $0.3 million related to the identifiable intangibles
acquired with our Star acquisition on September 14, 2006. Partially
offsetting these increases was a decrease of $0.2 million in depreciation
expense for the 2007 period resulting from the April 2006 sale leaseback
transaction involving our Chattanooga facility as compared to the 2006 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 $1.9 million, to $2.8 million
in the 2007 period from $0.9 million in the 2006 period. The increase relates
primarily to increased net interest expense of $1.9 million resulting from
the
additional borrowings related to the Star acquisition.
Our
income tax benefit was $3.5 million for the 2007 period compared to income
tax
expense of $0.3 million for the 2006 period. 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.
In
addition, we received a net tax benefit compared with the 2006 period because
the 2006 period had included a disallowance of $0.1 million relating to
nondeductible offering expenses and because we reversed a contingent tax accrual
effective March 31, 2007 based on the recommendation by an IRS appeals officer
that the IRS concede a case in our favor. This concession resulted in
recognition of approximately $0.4 million of income tax benefit for the three
months ended March 31, 2007.
Primarily
as a result of the factors described above, we experienced net losses of $2.1
million and $0.9 million in the 2007 and 2006 periods, respectively.
As
a
result of the foregoing, our net loss as a percentage of freight revenue
deteriorated to (1.4%) in the 2007 period from (0.7%)
in
the
2006 period.
LIQUIDITY
AND CAPITAL RESOURCES
Our
business requires significant capital investments over the short-term and the
long-term. In recent years, we have financed our capital requirements with
borrowings under our Securitization Facility and Credit Facility, cash flows
from operations, and long-term operating leases. Our primary sources of
liquidity at March 31, 2007, were funds provided by operations, proceeds from
the sale of used revenue equipment, proceeds under the Securitization Facility
and borrowings under our Credit Facility, each as defined in Note 9 to our
consolidated condensed financial statements contained herein, and operating
leases of revenue equipment. We believe our sources of liquidity are adequate
to
meet our current and projected needs for at least the next twelve months. On
a
longer term basis, based on anticipated future cash flows, current availability
under our Credit Facility 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 $3.0 million in the 2007 period and $27.0
million in the 2006 period. Our cash from operating activities was lower in
2007
primarily due to less efficient collection of receivables, which resulted in
an
approximately $16.0 million reduction in cash from operating activities in
the
2007 period. In addition, during the 2007 period, we paid one year of prepaid
casualty insurance premiums equaling $4.0 million, while in the 2006 period
all
of our prepaid casualty insurance premiums had been paid as part of a two-year
policy that began in 2005.
Net
cash
used in investing activities was $12.8 million in the 2007 period and $29.7
million in the 2006 period in each case relating primarily to net purchases
of
property and equipment. Assuming that we proceed as planned with minimal new
tractor and trailer purchase activity during 2007, that we dispose of assets
held for sale during 2007 at expected prices, and that we do not complete any
business acquisitions, we expect our capital expenditures, net of proceeds
of
dispositions, to drop to a range of $10 million to $15 million for 2007 from
$100 million in 2006.
Net
cash
provided by financing activities was $8.7 million in the 2007 period, as we
borrowed additional funds primarily to fund the exercise of purchase options
available at the end of certain revenue equipment leases. Net cash provided
by
financing activities was $0.2 million in the 2006 period. At March 31, 2007,
the
Company had outstanding balance sheet debt of $164.5 million, primarily
consisting of $114.5 million drawn under the Credit Facility and approximately
$50.0 million from the Securitization Facility. Interest rates on this debt
range from 5.3% to 6.7%.
We
have a
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 were purchased under this plan during the
first quarter of 2007. At March 31, 2007, there were 1,154,100 shares still
available to purchase under the guidance of this plan. The stock repurchase
plan
expires June 30, 2007.
Material
Debt Agreements
In
December 2006, we entered into our Credit Facility with a group of banks. The
Credit Facility matures in December 2011. Borrowings under the Credit Facility
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 0.625% and 1.625% based on cash flow
coverage (the applicable margin was 1.250% at March 31, 2007). At
March
31, 2007, the
Company
had
borrowings outstanding under the Credit Facility totaling $114.5 million with
a
weighted average interest rate of 6.724%. The Credit Facility is guaranteed
by
the Company and all of its subsidiaries except CVTI Receivables Corp. ("CRC")
and Volunteer.
The
Credit Facility has a maximum borrowing limit of $200.0 million with an
accordion feature which permits an increase up to a maximum borrowing limit
of
$275.0 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 $100.0
million. The Credit Facility is secured by a pledge of the stock of most of
the
Company's subsidiaries. A commitment fee, which is adjusted quarterly between
0.125% and 0.35% per annum based on cash flow coverage, is due on the daily
unused portion of the Credit Facility. At March 31, 2007 the
Company
had
undrawn letters of credit outstanding of approximately $60.1 million. At March
31, 2007, the
Company
had
approximately $25.4 million of available borrowing capacity.
In
December 2000, we entered into an accounts receivable securitization facility
(the "Securitization Facility"). On a revolving basis, we sell our interests
in
our accounts receivable to CRC, a wholly-owned, bankruptcy-remote,
special-purpose subsidiary incorporated in Nevada. CRC sells a percentage
ownership in such receivables to unrelated financial entities. We can receive
up
to $70.0 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
March
31, 2007 and December 31, 2006, the
Company
had
$50.0 million and $55.0 million outstanding, respectively, with weighted average
interest rates of 5.3% for both dates, respectively. CRC does not meet the
requirements for off-balance sheet accounting; therefore, it is reflected in
the
consolidated condensed financial statements.
The
Credit Facility 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 of
the
Credit Facility and Securitization Facility as of March 31, 2007.
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 March
31,
2006, we had financed approximately 806 tractors and 7,030 trailers under
operating leases. Vehicles held under operating leases are not carried on our
consolidated
condensed balance
sheets,
and
lease payments in respect of such vehicles are reflected in our consolidated
condensed statements
of
operations in
the
line item "Revenue equipment rentals and purchased transportation." Our revenue
equipment rental expense was $9.4 million for the 2007 period, compared to
$10.0
million for the 2006 period. The total amount of remaining payments under
operating leases as of March 31, 2007, was approximately
$159.3
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 March 31, 2007, the maximum amount of
the
residual value guarantees was approximately $33.1 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 substantially 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 as relevant to the
circumstances. Such decisions include the selection of applicable accounting
principles and the use of judgment in their application, the results of which
impact reported amounts and disclosures. Changes in future economic conditions
or other business circumstances may affect the outcomes of our estimates and
assumptions. Accordingly, actual results could differ from those anticipated.
A
summary of the significant accounting policies followed in preparation of the
consolidated condensed financial statements is contained in Note 1 of the
consolidated financial statements contained in our annual report on Form 10-K
for the fiscal year ended December 31, 2006. 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:
Revenue
Recognition - Revenue, drivers' wages and other direct operating expenses are
recognized on the date shipments are delivered to the customer. Revenue includes
transportation revenue, fuel surcharges, loading and unloading activities,
equipment detention, and other accessorial services.
Depreciation
of Revenue Equipment - Depreciation
is determined using the straight-line method over the estimated useful lives
of
the assets and was approximately $11.3 million on tractors and trailers in
the
first three months of 2007. 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 7% to 33% and new trailers over seven
years
to salvage values of 22% to 39%. 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. Gains and losses on the
disposal of revenue equipment are included in depreciation expense in our
consolidated condensed statements 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.
Assets
Held for Sale - Assets
held for sale include property and revenue equipment no longer utilized in
continuing operations which is available and held for sale. Assets held for
sale
are no longer subject to depreciation, and are recorded at the lower of
depreciated book value plus the related costs to sell or fair market value
less
selling costs. We periodically review the carrying value of these assets for
possible impairment. We expect to sell these assets within twelve
months.
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 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 March 31, 2007, no such charge had been
recorded. However, we are continuing to evaluate this investment for impairment
as our evaluation of the value of this investment had been steadily declining
over the last few fiscal quarters until recent cash flow improvements steadied
this decline in recent months. As such,
we do
not currently believe that an impairment charge will be warranted in the near
term. We will continue to evaluate this investment for impairment on a quarterly
basis. Also, during the first quarter of 2005, the Company loaned Transplace
approximately $2.7 million. The 6% interest-bearing note receivable matures
January 2009,
an
extension of the original January 2007 maturity date.
Based
on the borrowing availability of Transplace, we do not believe there is any
impairment of this note receivable.
Accounting
for Business Combinations - In
accordance with business combination accounting, we allocate the purchase price
of acquired companies to the tangible and intangible assets acquired, and
liabilities assumed based on their estimated fair values. We engage third-party
appraisal firms to assist management in determining the fair values of certain
assets acquired. Such valuations require management to make significant
estimates and assumptions, especially with respect to intangible assets.
Management makes estimates of fair value based upon historical experience,
as
well as information obtained from the management of the acquired companies
and
are inherently uncertain. Unanticipated events and circumstances may occur
which
may affect the accuracy or validity of such assumptions, estimates or actual
results. In certain business combinations that are treated as a stock purchase
for income tax purposes, we must record deferred taxes relating to the book
versus tax basis of acquired assets and liabilities. Generally, such business
combinations result in deferred tax liabilities as the book values are reflected
at fair values whereas the tax basis is carried over from the acquired company.
Such deferred taxes are initially estimated based on preliminary information
and
are subject to change as valuations and tax returns are finalized.
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. 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 substantially 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.
In
July
2006, the FASB issued Interpretation No. 48 ("FIN 48"), Accounting
for Uncertainty in Income Taxes.
The
Company was required to adopt the provisions of FIN 48, effective January 1,
2007. As a result of this adoption, the Company recognized additional tax
liabilities of $0.3 million with a corresponding reduction to beginning retained
earnings as of January 1, 2007. As of January 1, 2007, the Company had a $2.8
million liability recorded for unrecognized tax benefits, which includes
interest and penalties of $0.5 million. The Company recognizes interest and
penalties accrued related to unrecognized tax benefits in tax expense. If
recognized, $2.0 million of unrecognized tax benefits would impact the Company's
effective tax rate.
Deferred
income taxes represent a substantial liability on our consolidated balance
sheets
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. Based
on
forecasted income, no
valuation reserve has been established at March 31, 2007, because 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. Should our tax
positions be challenged, different outcomes could result and could have a
significant impact on the amounts reported through our consolidated condensed
statements
of
operations.
Performance-based
Employee Stock Compensation - Effective
January 1, 2006, we adopted the fair value recognition provisions of SFAS
No. 123R, under which we estimate compensation expense that is recognized
in our consolidated statements of operations for the fair value of employee
stock-based compensation related to grants of performance-based stock options
and restricted stock awards. This estimate requires various subjective
assumptions, including probability of meeting the underlying performance-based
earnings per share targets and estimating forfeitures. If any of these
assumptions change significantly, stock-based compensation expense may differ
materially in the future from the expense recorded in the current
period.
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. In addition, new emissions control regulations
and increases in commodity prices, wages of manufacturing workers, and other
items have resulted in higher tractor prices. The cost of fuel also has risen
substantially over the past three years, although we believe at least some
of
this increase 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 since the first round of
additional regulation in 2002. As of March 31, 2007, we are not operating any
tractors with the 2007-compliant engines, and our substantial "pre-buy" in
2006
has reduced our need to acquire new tractors in the near-term. Compliance with
the 2007 standards 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 as the regulations impact our business through new tractor purchases.
Fluctuations
in the price or availability of fuel, as well as hedging activities, surcharge
collection, the percentage of freight we obtain from freight brokers, 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 the first quarter of 2007 were 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.
ITEM
3. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We
experience various market risks, including changes in interest rates and fuel
prices. We do not enter into derivatives or other financial instruments for
trading or speculative purposes, or when there are no underlying related
exposures.
COMMODITY
PRICE RISK
From
time-to-time we may enter into derivative financial instruments to reduce our
exposure to fuel price fluctuations. In accordance with SFAS 133, we adjust
any
derivative instruments to fair value through earnings on a monthly basis. As
of
March 31, 2007, we had no derivative financial instruments to reduce our
exposure to fuel price fluctuations.
INTEREST
RATE RISK
Our
market risk is also affected by changes in interest rates. Historically, we
have
used a combination of fixed-rate and variable-rate obligations to manage our
interest rate exposure. Fixed-rate obligations expose us to the risk that
interest rates might fall. Variable-rate obligations expose us to the risk
that
interest rates might rise. Currently, all of our borrowing is under
variable-rate agreements.
Our
variable rate obligations consist of our Credit Facility and our Securitization
Facility. Borrowings under the Credit Facility, provided there has been no
default, are based on the banks' base rate, which floats daily, or LIBOR, which
accrues interest based on one, two, three, or six month LIBOR rates plus an
applicable margin that is adjusted quarterly between 0.75% and 1.25% based
on a
consolidated leverage ratio, which is generally defined as the ratio of
borrowings, letters of credit, and the present value of operating lease
obligations to our earnings before interest, income taxes, depreciation,
amortization, and rental payments under operating leases. The applicable margin
was 1.25% at March 31, 2007. At March 31, 2007, we had variable borrowings
of
$114.5 million outstanding under the Credit Facility.
Our
Securitization Facility carries a variable interest rate based on the commercial
paper rate plus an applicable margin of 0.44% per annum. At March 31, 2007,
borrowings of approximately $50.0 million had been drawn on the Securitization
Facility. Assuming variable rate borrowings under the Credit Facility
and
Securitization Facility at March 31, 2007 levels, a one percentage point
increase in interest rates could increase our annual interest expense by
approximately $1.6 million.
ITEM
4. CONTROLS
AND PROCEDURES
As
required by Rule 13a-15 and 15d-15 under the Securities Exchange Act of 1934,
as
amended (the "Exchange Act"), we have carried out an evaluation of the
effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the period covered by this report. This evaluation
was carried out under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer.
Based upon that evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that our controls and procedures were effective as of the
end
of the period covered by this report. There were no changes in our internal
control over financial reporting that occurred during the period covered by
this
report that have materially affected or that are reasonably likely to materially
affect our internal control over financial reporting.
Disclosure
controls and procedures are controls and other procedures that are designed
to
ensure that information required to be disclosed in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized, and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms. Disclosure controls and procedures include
controls and procedures designed to ensure that information required to be
disclosed in our reports filed under the Exchange Act is accumulated and
communicated to management, including our Chief Executive Officer, as
appropriate, to allow timely decisions regarding disclosures.
We
have
confidence in our internal controls and procedures. Nevertheless, our
management, including our Chief Executive Officer and Chief Financial Officer,
does not expect that our disclosure procedures and controls or our internal
controls will prevent all errors or intentional fraud. An internal control
system, no matter how well-conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of such internal controls are met.
Further, the design of an internal control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all internal
control systems, no evaluation of controls can provide absolute assurance that
all our control issues and instances of fraud, if any, have been
detected.
PART
II
OTHER
INFORMATION
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LEGAL
PROCEEDINGS
From
time to time we are a party to routine litigation arising in the
ordinary
course of business, 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.
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RISK
FACTORS
While
we attempt to identify, manage, and mitigate risks and uncertainties
associated with our business, some level of risk and uncertainty
will
always be present. Our Form 10-K for the year ended December 31,
2006, in
the section entitled Item
1A. Risk Factors,
describes some of the risks and uncertainties associated with our
business. These risks and uncertainties have the potential to materially
affect our business, financial condition, results of operations,
cash
flows, projected results, and future prospects. In addition to the
risk
factors set forth on our Form 10-K, we believe that the following
additional issues, uncertainties, and risks, should be considered
in
evaluating our business and growth outlook:
We
may not be able to renew Dedicated service offering contracts on
the terms
and schedule we expect.
As
part of the plan to improve profitability and increase the average
freight
revenue per tractor per week in our Dedicated service offering, we
are
attempting to renew and negotiate contracts covering the Dedicated
fleet.
The current freight environment has resulted in increased competition
for
these contracts, which has in turn placed more pressure on rates.
If
contract renewals do not proceed on an acceptable basis, we may not
be
successful in executing this plan on the terms and schedule we expect.
We
may not be able to cause the performance of Star Transportation,
Inc. to
return to historical levels.
The
profitability of our Star Transportation subsidiary has declined
substantially since we acquired Star in September 2006. We believe
the
primary factor has been lack of freight demand in the southeast U.S.,
where Star's operations are concentrated. However, other factors
may be
contributing, as well. We may not be able to cause Star to operate
at its
former level of profitability. If we do not, our financial results
may
suffer and we could be forced to write-down all or a portion of the
goodwill associated with the Star acquisition.
We
may not be able to successfully integrate the former operations of
our
Covenant Refrigerated service offering into our SRT and Expedited
Long-Haul operations.
In
the first quarter of 2007, we reallocated the assets formerly operated
by
our Covenant Refrigerated service offering to our SRT and Expedited
long
haul service offerings. The Covenant Refrigerated service offering
had
produced significant losses, and absorbing these operations adversely
affected the results in our SRT and Expedited long haul service offerings.
Particularly in the SRT service offering, we were forced to rely
on
freight from freight brokers to haul adequate loads and to move the
trucks
to lanes where SRT operates. Improving SRT's results will require
reducing
the percentage of freight derived from freight brokers. We may not
be
successful in reducing our dependency on broker freight or in returning
our SRT and Expedited long haul service offerings to their historical
levels of profitability.
|
|
EXHIBITS
|
|
|
Exhibit
Number
|
Reference
|
Description
|
3.1
|
(1)
|
Restated
Articles of Incorporation
|
3.2
|
(1)
|
Amended
Bylaws dated September 27, 1994
|
4.1
|
(1)
|
Restated
Articles of Incorporation
|
4.2
|
(1)
|
Amended
Bylaws dated September 27, 1994
|
|
#
|
Covenant
Transport, Inc. 2007 Named Executive Bonus Program, dated February
28,
2007
|
|
#
|
Certification
pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant
to
Section 302 of the Sarbanes-Oxley Act of 2002, by David R. Parker,
the
Company's Chief Executive Officer
|
|
#
|
Certification
pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant
to
Section 302 of the Sarbanes-Oxley Act of 2002, by Joey B. Hogan,
the
Company's Chief Financial Officer
|
|
#
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002, by David R. Parker, the Company's
Chief
Executive Officer
|
|
#
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002, by Joey B. Hogan, the Company's Chief
Financial Officer
|
References:
|
|
(1)
|
Incorporated
by reference from Form S-1, Registration No. 33-82978, effective
October
28, 1994.
|
#
|
Filed
herewith.
|
SIGNATURE
Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
|
COVENANT
TRANSPORT, INC.
|
|
|
|
|
Date:
May 9, 2007
|
By:
|
/s/
Joey B. Hogan
|
|
|
Joey
B. Hogan
|
|
|
Executive
Vice President and Chief Financial Officer,
|
|
|
in
his capacity as such and on behalf of the
issuer.
|
31