-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VZbYPmctGNxuFTPO3NfK6Bav69AVyMn52FJpE3opLXCNNlGUSr3eIik6aWRAzTV9 Tnz7m8yEYmc0uRA4NtE7+A== 0001008886-02-000084.txt : 20021114 0001008886-02-000084.hdr.sgml : 20021114 20021114141031 ACCESSION NUMBER: 0001008886-02-000084 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020930 FILED AS OF DATE: 20021114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COVENANT TRANSPORT INC CENTRAL INDEX KEY: 0000928658 STANDARD INDUSTRIAL CLASSIFICATION: TRUCKING (NO LOCAL) [4213] IRS NUMBER: 880320154 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-24960 FILM NUMBER: 02824075 BUSINESS ADDRESS: STREET 1: 400 BIRMINGHAM HIGHWAY CITY: CHATTANOOGA STATE: TN ZIP: 37419 BUSINESS PHONE: 4238211212 MAIL ADDRESS: STREET 1: 400 BIRMINGHAM HIGHWAY CITY: CHATTANOOGA STATE: TN ZIP: 37419 10-Q 1 form10qr1.txt COVENANT TRANSPORT FORM 10-Q 3RD QTR 2002 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 0-24960 Covenant Transport, Inc. (Exact name of registrant as specified in its charter) Nevada 88-0320154 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 400 Birmingham Hwy. Chattanooga, TN 37419 (423) 821-1212 (Address, including zip code, and telephone number, including area code, of registrant's principal executive office) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO __ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date (October 28, 2002). Class A Common Stock, $.01 par value: 12,024,733 shares Class B Common Stock, $.01 par value: 2,350,000 shares Page 1 PART I FINANCIAL INFORMATION Page Number Item 1. Financial Statements Condensed Consolidated Balance Sheets as of December 31, 2001 and September 30, 2002 (Unaudited) 3 Condensed Consolidated Statements of Operations for the three months and nine months ended September 30, 2001 and 2002 (Unaudited) 4 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2001 and 2002 (Unaudited) 5 Notes to Condensed Consolidated Financial Statements (Unaudited) 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk 20 Item 4. Controls and Procedures 20
PART II OTHER INFORMATION Page Number Item 1. Legal Proceedings 21 Items 2, 3, 4, and 5. Not applicable 21 Item 6. Exhibits and Reports on Form 8-K 21
Page 2 ITEM 1. FINANCIAL STATEMENTS COVENANT TRANSPORT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands except share data) December 31, 2001 September 30, 2002 (unaudited) ----------------------- ----------------------- ASSETS Current assets: Cash and cash equivalents $ 383 $ 1,132 Accounts receivable, net of allowance of $1,623 in 2001 and $1,800 in 2002 62,540 65,076 Drivers' advances and other receivables 4,002 5,453 Inventory and supplies 3,471 3,126 Prepaid expenses 11,824 9,241 Deferred income taxes 6,630 5,953 Income taxes receivable 4,729 4,729 ----------------------- ----------------------- Total current assets 93,579 94,710 Property and equipment, at cost 369,069 384,434 Less accumulated depreciation and amortization 137,533 156,989 ----------------------- ----------------------- Net property and equipment 231,536 227,445 Other 24,667 22,538 ----------------------- ----------------------- Total assets $ 349,782 $ 344,693 ======================= =======================
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt 20,150 - Securitization facility 48,130 50,130 Accounts payable 7,241 7,334 Accrued expenses 17,871 19,732 Insurance and claims accrual 11,854 18,340 ----------------------- ----------------------- Total current liabilities 105,246 95,536 Long-term debt, less current maturities 29,000 23,000 Deferred income taxes 53,634 53,634 ----------------------- ----------------------- Total liabilities 187,880 172,170
Commitments and contingencies Stockholders' equity: Preferred stock, $.01 par value, 5,000,000 shares authorized; no shares issued and outstanding - - Class A common stock, $.01 par value; 20,000,000 shares authorized; 12,680,483 and 12,996,233 shares issued and 11,708,983 and 12,024,733 shares outstanding as of 2001 and 2002, respectively 127 130 Class B common stock, $.01 par value; 5,000,000 shares authorized; 2,350,000 shares issued and outstanding as of 2001 and 2002 24 24 Additional paid-in-capital 79,832 84,422 Other comprehensive (loss) income (748) 355 Treasury stock, at cost; 971,500 shares as of 2001 and 2002 (7,935) (7,935) Retained earnings 90,602 95,527 ----------------------- ----------------------- Total stockholders' equity 161,902 172,523 ----------------------- ----------------------- Total liabilities and stockholders' equity $ 349,782 $ 344,693 ======================= ======================= The accompanying notes are an integral part of these consolidated financial statements.
Page 3 COVENANT TRANSPORT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2002 (In thousands except per share data) Three months ended September Nine months ended September 30, 30, (unaudited) (unaudited) --------------------------------- ------------------------------ 2001 2002 2001 2002 Freight revenue $ 138,057 $ 135,275 $ 411,069 $ 403,135 Fuel and accessorial surcharges 7,209 5,948 21,990 14,619 --------------------------------- ------------------------------ Total revenue $ 145,266 $ 141,223 $ 433,059 $ 417,754 Operating expenses: Salaries, wages, and related expenses 59,674 55,315 185,490 169,647 Fuel expense 26,153 24,077 80,192 70,223 Operations and maintenance 10,369 10,697 29,063 29,824 Revenue equipment rentals and purchased transportation 16,696 14,711 50,935 44,368 Operating taxes and licenses 3,619 3,165 10,994 10,357 Insurance and claims 7,991 7,840 19,309 22,844 Communications and utilities 1,995 1,567 5,645 5,103 General supplies and expenses 3,357 3,579 10,355 10,727 Depreciation, amortization and impairment charge, including gains (losses) on disposition of equipment (1) 10,465 11,492 30,410 37,466 --------------------------------- ------------------------------ Total operating expenses 140,319 132,443 422,393 400,559 --------------------------------- ------------------------------ Operating income 4,947 8,780 10,666 17,195 Other (income) expenses: Interest expense 1,756 868 6,441 2,802 Interest income (44) (18) (252) (52) Other 1,010 738 990 949 --------------------------------- ------------------------------ Other (income) expenses, net 2,722 1,588 7,179 3,699 --------------------------------- ------------------------------ Income before income taxes 2,225 7,192 3,487 13,496 Income tax expense 1,380 3,581 1,859 7,682 --------------------------------- ------------------------------ Income before extraordinary loss on early extinguishment of debt 845 3,611 1,628 5,814 Extraordinary loss on early extinguishment of debt, net of income tax benefit - - - 890 --------------------------------- ------------------------------ Net income $ 845 $ 3,611 $ 1,628 $ 4,924 ================================= ============================== Net income per share: Income before extraordinary loss on early extinguishment of debt $ 0.06 $ 0.25 $ 0.12 $ 0.41 Extraordinary loss, net of income tax benefit - - - (0.06) --------------------------------- ------------------------------ Total basic earnings per share: $ 0.06 $ 0.25 $ 0.12 $ 0.35 ================================= ============================== Income before extraordinary loss on early extinguishment of debt $ 0.06 $ 0.25 $ 0.11 $ 0.40 Extraordinary loss, net of income tax benefit - - - (0.06) --------------------------------- ------------------------------ Total diluted earnings per share: $ 0.06 $ 0.25 $ 0.11 $ 0.34 ================================= ============================== Weighted average shares outstanding 14,009 14,317 13,975 14,171 Adjusted weighted average shares and assumed conversions outstanding 14,233 14,704 14,230 14,465 (1) Includes a $3.3 million pre-tax impairment charge in the first quarter of 2002, which is reflected in the nine month period ended September 30, 2002. The accompanying notes are an integral part of these condensed consolidated financial statements.
Page 4 COVENANT TRANSPORT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2002 (In thousands) Nine months ended September 30, (unaudited) -------------------------------------------- 2001 2002 Cash flows from operating activities: Net income $ 1,628 $ 4,924 Adjustments to reconcile net income to net cash provided by operating activities: Provision for losses on accounts receivables 185 672 Extraordinary loss on early extinguishment of debt, net of tax - 890 Depreciation, amortization and impairment of assets (1) 29,517 35,805 Provision for losses on guaranteed residuals - 324 Deferred income tax expense 310 676 Equity in earnings of affiliate 1,016 - Income tax benefit from exercise of stock options - 746 Loss on disposition of property and equipment 15 1,661 Changes in operating assets and liabilities: Receivables and advances 7,049 (2,999) Prepaid expenses 2,745 2,583 Tire and parts inventory (565) 345 Accounts payable and accrued expenses 9,604 10,090 ------------------ ----------------- Net cash flows provided by operating activities 51,504 55,717 Cash flows from investing activities: Acquisition of property and equipment (53,955) (40,244) Acquisition of business (564) - Proceeds from disposition of property and equipment 17,086 6,867 ------------------ ----------------- Net cash flows used in investing activities (37,433) (33,377) Cash flows from financing activities: Checks in excess of bank balances 1,325 - Deferred costs (94) - Exercise of stock options 883 3,847 Proceeds from issuance of long-term debt 49,000 54,000 Repayments of long-term debt (66,418) (79,438) ------------------ ----------------- Net cash flows used in financing activities (15,304) (21,591) ------------------ ----------------- Net change in cash and cash equivalents (1,233) 749 Cash and cash equivalents at beginning of period 2,287 383 ------------------ ----------------- Cash and cash equivalents at end of period $ 1,054 $ 1,132 ================== ================= (1) Includes a $3.3 million pre-tax impairment charge in 2002. The accompanying notes are an integral part of these consolidated financial statements.
Page 5 COVENANT TRANSPORT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 1. Basis of Presentation The condensed consolidated financial statements include the accounts of Covenant Transport, Inc., a Nevada holding company, and its wholly-owned subsidiaries ("Covenant" or the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation. The financial statements have been prepared, without audit, in accordance with accounting principles generally accepted in the United States of America, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the accompanying financial statements include all adjustments which are necessary for a fair presentation of the results for the interim periods presented, such adjustments being of a normal recurring nature. Certain information and footnote disclosures have been condensed or omitted pursuant to such rules and regulations. The December 31, 2001 Condensed Consolidated Balance Sheet was derived from the audited balance sheet of the Company for the year then ended. It is suggested that these condensed consolidated financial statements and notes thereto be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Form 10-K for the year ended December 31, 2001. 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 with the current period's classification. In the past, the Company has reported revenue net of fuel surcharges and accessorial revenue and has netted amounts against the related expense items. Effective January 1, 2002, the Company is now including those items in revenue in its Statement of Operations. The prior period Statement of Operations has been conformed with the reclassification. Note 2. Basic and Diluted Net Income per Share The following table sets forth for the periods indicated the calculation of net income per share included in the Company's Condensed Consolidated Statements of Income: Three months ended Nine months ended September 30, September 30, 2001 2002 2001 2002 (in thousands except per share data) Numerator: Income before extraordinary loss on early extinguishment of debt $ 845 $ 3,611 $ 1,628 $ 5,814 Extraordinary loss, net of income tax benefit - - - 890 ---------- ---------- ---------- ---------- Net income $ 845 $ 3,611 $ 1,628 $ 4,924 Denominator: Denominator for basic earnings per share - weighted-average shares 14,009 14,317 13,975 14,171 Effect of dilutive securities: Employee stock options 224 387 255 294 ---------- ---------- ---------- ---------- Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions 14,233 14,704 14,230 14,465 ========== ========== ========== ========== Net income per share: Income before extraordinary loss on early extinguishment of debt $ 0.06 $ 0.25 $ 0.12 $ 0.41 Extraordinary loss, net of income tax effect - - - (0.06) ---------- ---------- ---------- ---------- Total basic earnings per share: $ 0.06 $ 0.25 $ 0.12 $ 0.35 ========== ========== ========== ========== Income before extraordinary loss on early extinguishment of debt $ 0.06 $ 0.25 $ 0.11 $ 0.40 Extraordinary loss, net of income tax effect - - - (0.06) ---------- ---------- ---------- ---------- Total diluted net income per share: $ 0.06 $ 0.25 $ 0.11 $ 0.34 ========== ========== ========== ==========
Page 6 Note 3. 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, and the effect of the per diem pay structure for drivers. Note 4. Investment in Transplace Effective July 1, 2000, the Company combined its logistics business with the logistics businesses of five other transportation companies into a company called Transplace, Inc. ("TPC"). TPC operates a global transportation logistics service and is developing programs for the cooperative purchasing of products, supplies, and services. In the transaction, Covenant contributed its logistics customer list, logistics business software and software licenses, certain intellectual property, intangible assets totaling approximately $5.1 million, and $5.0 million in cash for the initial funding of the venture. In exchange, Covenant received 12.4% ownership in TPC. Upon completion of the transaction, Covenant ceased operating its own transportation logistics and brokerage business, which consisted primarily of the Terminal Truck Broker, Inc. business acquired in November 1999. The contributed operation generated approximately $5.0 million in net brokerage revenue (gross revenue less purchased transportation expense) received on an annualized basis. Initially, the Company accounted for its 12.4% investment in TPC using the equity method of accounting. During the third quarter of 2001, TPC changed its filing status to a C corporation and as a result, management determined it was appropriate to account for its investment using the cost method of accounting. Note 5. Goodwill and Other Intangible Assets Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, which requires the Company to evaluate goodwill and other intangible assets with indefinite useful lives for impairment on an annual basis, with any resulting impairment recorded as a cumulative effect of a change in accounting principle. Goodwill that was acquired in purchase business combinations completed before July 1, 2001, is no longer amortized after January 1, 2002. Furthermore, any goodwill that is acquired in a purchase business combination completed after June 30, 2001, will not be amortized. During the second quarter of 2002, the Company completed its evaluation of its goodwill for impairment and determined that there was no impairment. At September 30, 2002, the Company has $11.0 million of goodwill. Had goodwill not been amortized in previous years, the Company's net income and net income per share would have been as follows for the three and nine months ended September 30, 2001: Three months ended Nine months ended September 30, 2001 September 30, 2001 ----------------------- ---------------------- (in thousands except per share data) Net income as reported $ 845 $1,628 Add back goodwill amortization 62 186 ----------------------- ---------------------- Adjusted net income $ 907 $1,814 ======================= ====================== Basic earnings per share: As reported $0.06 $0.12 Goodwill amortization - 0.01 ----------------------- ---------------------- As adjusted $0.06 $0.13 ======================= ====================== Diluted earnings per share As reported $0.06 $0.11 Goodwill amortization - 0.02 ----------------------- ---------------------- As adjusted $0.06 $0.13 ======================= ======================
Note 6. Derivative Instruments and Other Comprehensive Income In 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of SFAS Statement No. 133, an amendment of SFAS Statement No. 133, and SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment of SFAS Statement 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. Page 7 The Company adopted SFAS No. 133 effective January 1, 2001, but had no instruments in place on that date. During the first quarter of 2001, the Company entered into two $10 million notional amount cancelable interest rate swap agreements to manage the risk of variability in cash flows associated with floating-rate debt. Due to the counter-parties' imbedded options to cancel, these derivatives did not qualify, and are not designated as hedging instruments under SFAS No. 133. Consequently, these derivatives are marked to fair value through earnings, in other expense in the accompanying statement of operations. At September 30, 2002, the fair value of these interest rate swap agreements was a liability of $1.7 million. The Company uses purchase commitments through suppliers to reduce a portion of its cash flow exposure to fuel price fluctuations. At September 30, 2002, the notional amount for fixed price normal purchase commitments for 2002, 2003 and 2004 is approximately 9.3 million gallons in the remainder of 2002, approximately 37.5 million gallons in 2003 and approximately 3.6 million gallons in 2004. In addition, during the third quarter of 2001, the Company entered into two heating oil commodity swap contracts to hedge its cash flow exposure to diesel fuel price fluctuations on floating rate diesel fuel purchase commitments. These contracts are considered highly effective in offsetting changes in anticipated future cash flows and have been designated as cash flow hedges under SFAS No. 133. Each calls for 3.0 million gallons of fuel purchases at a fixed price of $0.695 and $0.629 per gallon before fuel taxes, respectively, through December 31, 2002. These fuel hedge contracts were effective for the quarter and nine months ended September 30, 2002. At September 30, 2002, the cumulative fair value of these heating oil contracts was an asset of $0.6 million, which was recorded in accrued expenses with the offset to other comprehensive income, net of taxes. All changes in the fuel derivatives' fair values were determined to be effective for measurement and recognition purposes. The entire amount of gains and losses is expected to be recognized in earnings within the next three months. The derivative activity as reported in the Company's financial statements for the nine months ended September 30, 2002, was (in thousands): Net derivative liability at December 31, 2001 $ (1,932) Changes in statements of operations: Loss on derivative instruments that do not qualify as hedging instruments: Beginning liability balance (726) Loss in value (925) ----------- Ending derivative liability balance $ (1,651) =========== Changes in other comprehensive income (loss) relating to fuel hedge contracts that qualify as cash flow hedges: Beginning other comprehensive income (loss) (748) Gain in value 1,780 Change in deferred taxes relating to other comprehensive income (677) ----------- Ending other comprehensive income 355 ----------- Deferred taxes 218 ----------- Ending derivative asset balance, gross 573 =========== Net derivative liability at September 30, 2002 $ (1,078) =========== The following is a summary of comprehensive income for the nine months ended September 30, 2001 and 2002. (in thousands) 2001 2002 ---------- ---------- Net income $ 1,628 $ 4,924 Other comprehensive income - Unrealized gain on cash flow hedging derivatives, net of taxes (99) 1,103 ---------- ----------- Comprehensive income $ 1,529 $ 6,027 =========== ========== Page 8 Note 7. Impairment of Equipment and Change in Estimated Useful Lives During 2001, the market value of used tractors was significantly below both historical levels and the carrying values on the Company's financial statements. The Company extended the trade cycle of its tractors from three years to four years during 2001, which delayed any significant disposals into 2002 and later years. The market for used tractors did not improve by the time the Company negotiated a tractor purchase and trade package with Freightliner Corporation for calendar years 2002 and 2003 covering the sale of model year 1998 through 2000 tractors and the purchase of an equal number of replacement units. The significant difference between the carrying values and the sale prices of the used tractors combined with the Company's less profitable results during 2001 caused the Company to test for asset impairment under applicable accounting rules. In the test, the Company measured the expected undiscounted future cash flows to be generated by the tractors over the remaining useful lives and the disposal value at the end of the useful life against the carrying values. The test indicated impairment, and during the fourth quarter of 2001 and the first quarter of 2002, the Company recognized pre-tax charges of approximately $15.4 million and $3.3 million, respectively, to reflect an impairment in tractor values. The charges related to the Company's approximately 2,100 model year 1998 through 2000 in-use tractors. The Company incurred a loss of approximately $324,000 on guaranteed residuals for leased tractors in the first quarter of 2002, which was recorded in revenue equipment rentals and purchased transportation in the accompanying statement of operations. The Company accrued this loss from January 1, 2002, to the date the tractors were purchased off lease in February 2002. The approximately 1,400 model year 2001 tractors were not affected by the impairment charges. The Company has evaluated the 2001 model year tractors for impairment and determined that such units were not impaired. These units are not expected to be disposed of for 24 to 36 months following December 31, 2001. The Company adjusted the depreciation rate of these model year 2001 tractors to approximate its recent experience with disposition values and expectation for future disposition values. The Company also increased the lease expense on its leased units since it expects to purchase the leased tractors at the end of the three-year leases and operate them for the last year of its four-year trade cycle. Although management believes the additional depreciation and lease expense will bring the carrying values of the model year 2001 tractors in line with future disposition values, the Company does not have trade-in agreements covering those tractors. These assumptions represent management's best estimate and actual values could differ by the time those tractors are scheduled for trade. Management estimates the impact of the change in the estimated useful lives and depreciation on the 2001 model year tractors to be approximately $1.5 million pre-tax or $.06 per share annually. Note 8. Long-term Debt and Securitization Facility Long-term debt consisted of the following at December 31, 2001, and September 30, 2002: December 31, September 30, 2001 2002 --------------------------------------- (in thousands) Borrowings under $120 million credit agreement $ 26,000 $ 20,000 10-year senior notes 20,000 - Notes to unrelated individuals for non-compete agreements 150 - Note payable to former SRT shareholder, bearing interest at 6.5% with interest payable quarterly 3,000 3,000 Total long-term debt 49,150 23,000 Less current maturities 20,150 - Long-term debt, less current maturities $ 29,000 $ 23,000
In December 2000, the Company entered into a credit agreement (the "Credit Agreement") with a group of banks with maximum borrowings of $120 million, which matures December 13, 2003. The Credit Agreement provides a revolving credit facility with borrowings limited to the lesser of 90% of the net book value of eligible revenue equipment or $120 million. Letters of credit are limited to an aggregate commitment of $20 million. The Credit Agreement is collateralized by an agreement which includes pledged stock of the Company's subsidiaries, inter-company notes, and licensing agreements. A commitment fee is charged on the daily unused portion of the facility and is adjusted quarterly between 0.15% and 0.25% per annum based on the consolidated leverage ratio. At September 30, 2002, the fee was 0.20% per annum. The Credit Agreement is guaranteed by all of the Company's subsidiaries except CVTI Receivables Corporation ("CRC"). The Credit Agreement includes a "security agreement" such that the Credit Agreement may be collateralized by virtually all assets of the Company if a covenant violation occurs. As of September 30, 2002, the Company had borrowings under the Credit Agreement in the amount of $20.0 million with a weighted average interest rate of 2.8% and outstanding letters of credit of approximately $19.2 million. The Company had borrowing availability of $80.8 million under the Credit Agreement. Page 9 On March 15, 2002, the Company retired its $20 million in senior notes due October 2005 with an insurance company with borrowings from the Credit Agreement. The term agreement required payments of interest semi-annually in arrears with principal payments due in five equal annual installments beginning October 1, 2001. Interest accrued at 7.39% per annum. The Company incurred a $0.9 million after-tax extraordinary loss ($1.4 million pre-tax) to reflect the early extinguishment of this debt in the first quarter of 2002. At September 30, 2002 and December 31, 2001, the Company had outstanding letters of credit of approximately $19.2 and $12.6 million, respectively. Maturities of long term debt at September 30, 2002 were as follows (in thousands): 2002 $ - 2003 20,000 2004 3,000 In December 2000, the Company entered into a $62 million revolving accounts receivable securitization facility (the "Securitization Facility"). On a revolving basis, the Company sells its interests in its accounts receivable to CRC, a wholly-owned bankruptcy-remote special purpose subsidiary. CRC sells a percentage ownership in such receivables to an unrelated financial entity. The transaction does not meet the criteria for sale treatment under SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities and is reflected as a secured borrowing in the financial statements. The Company can receive up to $62 million of proceeds, subject to eligible receivables and will pay a service fee recorded as interest expense, as defined in the agreement. The Company will pay commercial paper interest rates plus an applicable margin on the proceeds received. The Securitization Facility includes certain significant events that could cause amounts to be immediately due and payable. The proceeds received are reflected as a current liability on the consolidated financial statements because the committed term, subject to annual renewals, is 364 days. As of September 30, 2002 and December 31, 2001, the Company had received $50.1 million and $48.1 million, respectively, in proceeds, with a weighted average interest rate of approximately 1.8%. The Credit Agreement and Securitization Facility contain certain restrictions and covenants relating to, among other things, dividends, tangible net worth, cash flow, acquisitions and dispositions, and total indebtedness and are cross-defaulted. As of September 30, 2002, the Company was in compliance with the Credit Agreement and Securitization Facility. Note 9. Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 provides new guidance on the recognition and measurement of an asset retirement obligation and its associated asset retirement cost. It also provides accounting guidance for legal obligations associated with the retirement of tangible long-lived assets. SFAS No. 143 is effective for the Company's fiscal year beginning in 2003 and the Company is still evaluating the impact on the Company's consolidated financial statements. In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 provides new guidance on the recognition of impairment losses on long-lived assets to be held and used or to be disposed of and also broadens the definition of what constitutes discontinued operations and how the results of discontinued operations are to be measured and presented. SFAS No. 144 is effective for the Company's fiscal year beginning in 2002 and is not expected to materially change the methods used by the Company to measure impairment losses on long-lived assets. In April 2002, the Financial Accounting Standards Board issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that statement, SFAS No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. This statement also rescinds SFAS No. 44, Accounting for Intangible Assets of Motor Carriers. This statement amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. In addition, this statement amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. SFAS No. 145 is generally effective for the Company's fiscal year beginning in 2003 with earlier application encouraged. The Company has evaluated the impact that this standard will have on its consolidated financial statements and it will impact presentation of the loss from early extinguishment of debt. Page 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The condensed consolidated financial statements include the accounts of Covenant Transport, Inc., a Nevada holding company, and its wholly-owned subsidiaries ("Covenant" or the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation. Except for the historical information contained herein, the discussion in this quarterly report contains forward-looking statements that involve risk, assumptions, and uncertainties that are difficult to predict. Statements that constitute forward-looking statements are usually identified by words such as "anticipates," "believes," "estimates," "projects," "expects," or similar expressions. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based upon the current beliefs and expectations of the Company's management and are subject to significant risks and uncertainties. Actual results may differ from those set forth in the forward-looking statements. The following factors, among others, could cause actual results to differ materially from those in forward-looking statements: excess capacity in the trucking industry; decreased demand for the Company's services or loss of one or more major customers; surplus inventories; recessionary economic cycles and downturns in customers' business cycles; strikes or work stoppages; increases or rapid fluctuations in fuel prices, interest rates, fuel taxes, tolls, and license and registration fees; increases in the prices paid for new revenue equipment; the resale value of the Company's used equipment and the price of new equipment; increases in compensation for and difficulty in attracting and retaining qualified drivers and owner-operators; increases in insurance premiums or deductible amounts or claims relating to accident, cargo, workers' compensation, health, and other matters; seasonal factors such as harsh weather conditions that increase operating costs; competition from trucking, rail, and intermodal competitors; regulatory requirements that increase costs or decrease efficiency; and the ability to identify acceptable acquisition candidates, consummate acquisitions, and integrate acquired operations. Readers should review and consider the various disclosures made by the Company in its press releases, stockholder reports, and public filings, as well as the factors explained in greater detail in the Company's annual report on Form 10-K. The Company's freight revenue before fuel surcharges and accessorial revenue decreased 1.9%, to $403.1 million in the nine months ended September 30, 2002, from $411.1 million during the same period of 2001. The Company's revenue was affected by a 3.8% decrease in weighted average number of tractors partially offset by a 4.1% increase in revenue per tractor per week. The Company has elected to constrain the size of its fleet until fleet production and profitability improve. The Company recognized an approximately $3.3 million pre-tax impairment charge and an approximately $0.9 million after-tax extraordinary loss to reflect the early extinguishment of debt in the first quarter of 2002. Excluding the impairment charge and extraordinary loss, the Company's net income improved to $7.8 million during the first nine months of 2002 compared to $1.6 million during the 2001 period. Including the impairment charge and the extraordinary loss, the Company's net income was $4.9 million for the nine months ended September 30, 2002. Covenant reduced the number of teams in its operations during 2001 and into 2002 to better match the demand for expedited long-haul service. The single driver fleets generally operate fewer miles per tractor and experience a greater percentage of non-revenue miles. The additional expenses and lower productive miles are expected to be offset by generally higher revenue per loaded mile and the reduced employee expense of compensating only one driver. The Company's operating statistics and expenses are expected to continue to shift in future periods with the mix of single and team operations. The Company continues to obtain revenue equipment through its owner-operator fleet and finance equipment under operating leases. Over the past two years, it has become more difficult to retain owner-operators due to challenging operating conditions. The Company's owner-operator fleet decreased to an average of 350 in the first nine months of 2002 compared to an average of 371 in the 2001 period. Owner-operators provide a tractor and a driver and are responsible for all operating expenses in exchange for a fixed payment per mile. The Company does not have the capital outlay of purchasing the tractor. The Company continues to use operating leases as a method of financing its equipment. As of September 30, 2002, the Company had financed approximately 636 tractors and 2,631 trailers under operating leases as compared to 995 tractors and 1,932 trailers under operating leases as of September 30, 2001. The payments to owner-operators and the financing of equipment under operating leases are recorded in revenue equipment rentals and purchased transportation and as a result, expenses associated with owned equipment, such as interest and depreciation, are not incurred, and for owner-operator tractors, driver compensation, fuel, and other expenses are not incurred. Because obtaining equipment from owner-operators and under operating leases effectively shifts financing expenses from interest to "above the line" operating expenses, the Company evaluates its efficiency using net margin rather than operating income. The Company's tractor leases generally run for a term of three years. With the company's tractor trade cycle currently at approximately four years, the Company has been purchasing the leased tractors at the expiration of the lease term, although there is no commitment to purchase the tractors. To date the purchases have been financed through the Company's line of credit. The tractors are then accounted Page 11 for as owned equipment. Trailer leases generally run for a term of seven years with the first leases expiring in 2005. The Company has not determined whether it anticipates purchasing trailers at the end of these leases. The following table sets forth the percentage relationship of certain items to freight revenue: Three Months Ended Nine Months Ended September 30, September 30, --------------------------------- -------------------------------- 2001 2002 2001 2002 ---------------- ---------------- --------------- --------------- Freight revenue (1) 100.0% 100.0% 100.0% 100.0% Operating expenses: Salaries, wages, and related expenses (1) 42.2 39.5 44.2 40.8 Fuel expense (1) 15.0 15.2 15.4 15.4 Operations and maintenance (1) 7.2 7.5 6.8 7.0 Revenue equipment rentals and purchased transportation 12.1 10.9 12.4 11.0 Operating taxes and licenses 2.6 2.3 2.6 2.6 Insurance and claims 5.8 5.8 4.7 5.7 Communications and utilities 1.4 1.2 1.4 1.3 General supplies and expenses 2.5 2.6 2.5 2.7 Depreciation and amortization (2) 7.6 8.5 7.4 9.3 ---------------- ---------------- --------------- --------------- Total operating expenses 96.4 93.5 97.4 95.8 ---------------- ---------------- --------------- --------------- Operating income 3.6 6.5 2.6 4.2 Other (income) expense, net 2.0 1.2 1.7 0.9 ---------------- ---------------- --------------- --------------- Income before income taxes 1.6 5.3 0.8 3.3 Income tax expense 1.0 2.6 0.5 1.9 ---------------- ---------------- --------------- --------------- Income before extraordinary loss on early extinguishment of debt 0.6 2.7 0.4 1.4 Extraordinary loss on early extinguishment of debt, net of income tax benefit - - - 0.2 ---------------- ---------------- --------------- --------------- Net income 0.6% 2.7% 0.4% 1.2% ================ ================ =============== ===============
(1) Freight revenue is total revenue less fuel surcharge and accessorial revenue. In this table, fuel surcharge and accessorial revenue are shown netted against the appropriate expense category. (Salaries, wages, and related expenses, $1.4 million and $1.9 million in the three months ended September 30, 2001, and 2002, respectively. Fuel expense, $5.4 million and $3.5 million in the three months ended September 30, 2001, and 2002, respectively. Operations and maintenance, $0.4 million and $0.6 million in the three months ended September 30, 2001, and 2002, respectively. Salaries, wages, and related expenses, $3.9 million and $5.1 million in the nine months ended September 30, 2001, and 2002, respectively. Fuel expense, $16.8 million and $8.0 million in the nine months ended September 30, 2001, and 2002, respectively. Operations and maintenance, $1.2 million and $1.5 million in the nine months ended September 30, 2001, and 2002, respectively.) (2) Includes a $3.3 million pre-tax impairment charge or 1.2% of revenue in the nine months ended September 30, 2002. COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2002 TO THREE MONTHS ENDED SEPTEMBER 30, 2001 Freight revenue (total revenue before fuel surcharge and accessorial revenue) decreased $2.8 million (2.0%), to $135.3 million in the three months ended September 30, 2002, from $138.1 million in the same period of 2001. The Company's revenue was affected by a 2.6% decrease in weighted average number of tractors partially offset by a 1.6% increase in revenue per tractor per week to $2,819 in the 2002 period from $2,774 in the 2001 period. Weighted average tractors decreased to 3,639 in the 2002 period from 3,738 in the 2001 period. The Company has elected to constrain the size of its tractor fleet until fleet production and profitability improve. Salaries, wages, and related expenses, net of accessorial revenue of $1.9 million in the 2002 period and $1.4 million in the 2001 period, decreased $4.8 million (8.3%), to $53.4 million in the 2002 period, from $58.3 million in the 2001 period. As a percentage of freight revenue, salaries, wages, and related expenses decreased to 39.5% in the 2002 period, from 42.2% in the 2001 period. Wages for over the road drivers as a percentage of freight revenue decreased to 27.8% in the 2002 period from 30.0% in the 2001 period. The decrease was largely attributable to the Company utilizing a larger percentage of single-driver tractors, with only one driver per tractor to be compensated, implementing changes in its pay structure and implementing a per diem pay program for its drivers during August 2001. The Company's payroll expense for employees other than over the road drivers increased to 7.3% of freight revenue in the 2002 Page 12 period from 6.9% of freight revenue in the 2001 period. Health insurance, employer-paid taxes, workers' compensation, and other employee benefits decreased to 5.8% in the 2002 period from 6.4% in the 2001 period, partially due to paying lower taxes due to lower payroll amounts and improving claims experience in the Company's health insurance plan. Fuel expense, net of fuel surcharge revenue of $3.5 million in the 2002 period and $5.4 million in the 2001 period, decreased $0.2 million (1.0%), to $20.6 million in the 2002 period, from $20.8 million in the 2001 period. As a percentage of freight revenue, net fuel expense remained relatively constant at 15.2% in the 2002 period and 15.0% in the 2001 period. Fuel surcharges amounted to $.033 per loaded mile in the 2002 period compared to $.048 per loaded mile in the 2001 period. Fuel costs may be affected in the future by the Company's fuel hedging and volume purchase commitments from time-to-time and the collectibility of fuel surcharges, as well as by lower fuel mileage if government mandated emissions standards effective October 1, 2002 result in less fuel efficient engines. Operations and maintenance consist primarily of vehicle maintenance, repairs and driver recruitment expenses. Net of accessorial revenue of $0.6 million in the 2002 period and $0.4 million in the 2001 period, operations and maintenance increased $0.2 million (2.0%), to $10.1 million in the 2002 period, from $10.0 million in the 2001 period. As a percentage of freight revenue, operations and maintenance increased to 7.5% in the 2002 period, from 7.2% in the 2001 period. The Company extended the trade cycle on its tractor fleet from three years to four years, which resulted in an increase in the number of required repairs. Revenue equipment rentals and purchased transportation decreased $2.0 million (11.9%), to $14.7 million in the 2002 period, from $16.7 million in the 2001 period. As a percentage of freight revenue, revenue equipment rentals and purchased transportation decreased to 10.9% in the 2002 period from 12.1% in the 2001 period. The decrease was the result of lower lease expense during the quarter (3.1% of freight revenue in 2002 compared to 4.3% of freight revenue in 2001). As of September 30, 2002, the Company had financed approximately 636 tractors and 2,631 trailers under operating leases as compared to 995 tractors and 1,932 trailers under operating leases as of September 30, 2001. The lease expense per tractor will increase in future periods. See Note 7 to the Condensed Consolidated Financial Statements. Owner-operator expense, which also is included in this expense category, remained essentially constant at 7.8% of freight revenue in the 2002 and 2001 periods. Owner-operators are independent contractors, who provide a tractor and driver and cover all of their operating expenses in exchange for a fixed payment per mile. Accordingly, expenses such as driver salaries, fuel, repairs, depreciation, and interest normally associated with Company-owned equipment are consolidated in revenue equipment rentals and purchased transportation when owner-operators are utilized. Operating taxes and licenses decreased $0.5 million (12.5%), to $3.2 million in the 2002 period, from $3.6 million in the 2001 period. As a percentage of freight revenue, operating taxes and licenses decreased to 2.3% in the 2002 period, from 2.6% in the 2001 period. Insurance and claims, consisting primarily of premiums and deductible amounts for liability, physical damage, and cargo damage insurance and claims, decreased $0.2 million (1.9%), to $7.8 million in the 2002 period from $8.0 million in the 2001 period. As a percentage of freight revenue, insurance remained constant at 5.8% of freight revenue in the 2002 and 2001 periods. The Company addressed an industry-wide increase in insurance rates by adopting an insurance program with significantly higher deductible exposure that is partially offset by lower premium rates. The deductible amount increased from $5,000 in 2000, to $250,000 in 2001, to $500,000 in March of 2002, to $1.0 million in November of 2002. On July 15, 2002, the Company obtained binders for excess insurance coverage up to $50.0 million with a $500,000 aggregate deductible for liability, physical damage, and cargo claims per incident. During the third quarter, the Company sought replacement excess coverage after the insurance agent failed to produce proof of insurance on the policies for which the Company had obtained binders as of July 15, 2002. The replacement coverage is for an aggregate $4.0 million of insurance coverage with a $1.0 million aggregate deductible for liability, physical damage, and cargo claims per incident. The new policy increases the Company's exposure for claims both within the deductible limit and in excess of the maximum coverage. The Company's premium expense will decrease by approximately 40%. The Company intends to pursue its legal rights against the insurance agent and its errors and omissions policy. The Company accrues the estimated cost of the uninsured portion of pending claims. These accruals are based on management's evaluation of the nature and severity of the claim and estimates of future claims development based on historical trends. Insurance and claims expense will vary based on the frequency and severity of claims, the premium expense, and the level of self insured retention. Communications and utilities expense decreased $0.4 million (21.5%), to $1.6 million in the 2002 period, from $2.0 million in the 2001 period. As a percentage of freight revenue, communications and utilities decreased to 1.2% in the 2002 period, from 1.4% in the 2001 period. General supplies and expenses, consisting primarily of headquarters and other terminal facilities expenses, increased $0.2 million (6.6%), to $3.6 million in the 2002 period, from $3.4 million in the 2001 period. As a percentage of freight revenue, general supplies and expenses remained essentially constant at 2.6% and 2.5% of freight revenue in the 2002 and 2001 periods, respectively. Depreciation and amortization, consisting primarily of depreciation of revenue equipment, increased $1.0 million (9.8%), to $11.5 million in the 2002 period from $10.5 million in the 2001 period. As a percentage of freight revenue, depreciation and amortization increased to 8.5% in the 2002 period from 7.6% in the 2001 period. The Company has increased the annual depreciation expense on Page 13 the 2001 model year tractors to approximate the Company's recent experience with disposition values and expectation for future disposition values. In addition, depreciation expense is expected to rise in the future as the cost of new tractors has increased and the residual value has decreased. Depreciation and amortization expense is net of any gain or loss on the disposal of tractors and trailers. Loss on the disposal of tractors and trailers was approximately $0.3 million in the 2002 period compared to approximately $0.1 million in the 2001 period. Amortization expense relates to deferred debt costs incurred and covenants not to compete from five acquisitions. Goodwill amortization ceased beginning January 1, 2002, in accordance with SFAS No. 142, and the Company will evaluate goodwill and certain intangibles for impairment, annually prospectively beginning in 2002. During the second quarter of 2002, the Company completed its analysis of goodwill for impairment and concluded there was no impairment. The favorable impact of goodwill no longer being amortized was approximately $75,000 for the three months ended September 30, 2002. Other expense, net, decreased $1.1 million (41.6%), to $1.6 million in the 2002 period, from $2.7 million in the 2001 period. As a percentage of freight revenue, other expense decreased to 1.2% in the 2002 period from 2.0% in the 2001 period. The decrease was the result of lower debt balances and more favorable interest rates. Included in the other expense category are interest expense, interest income, and the pre-tax non-cash losses related to the accounting for interest rate derivatives under SFAS 133, which amounted to $0.7 million in the 2002 period and $0.9 million in the 2001 period. The Company's income tax expense for the 2002 period was $3.6 million or 49.8% of income before taxes. The Company's income tax expense for the 2001 period was $1.4 million or 62.0% of income before taxes. The effective tax rate is different from the expected combined tax rate due to permanent differences related to a per diem pay structure implemented during the third quarter of 2001. Due to the nondeductible portion of per diem expenses, the Company's tax rate will fluctuate in future periods as income fluctuates. Primarily as a result of the factors described above, net income increased $2.8 million (327.3%), to $3.6 million in the 2002 period (2.7% of revenue) from $0.8 million in the 2001 period (0.6% of revenue). As a result of the foregoing, the Company's net margin increased to 2.7% in the 2002 period from 0.6% in the 2001 period. COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2002 TO NINE MONTHS ENDED SEPTEMBER 30, 2001 Freight revenue (total revenue before fuel surcharge and accessorial revenue) decreased $7.9 million (1.9%), to $403.1 million in the nine months ended September 30, 2002, from $411.1 million in the same period of 2001. The Company's revenue was affected by a 3.8% decrease in weighted average tractors partially offset by a 4.1% increase in revenue per tractor per week, to $2,796 in the 2002 period from $2,685 in the 2001 period. Weighted average tractors decreased to 3,679 in the 2002 period from 3,823 in the 2001 period. The Company has elected to constrain the size of its tractor fleet until fleet production and profitability improve. Salaries, wages, and related expenses, net of accessorial revenue of $5.1 million in the 2002 period and $3.9 million in the 2001 period, decreased $17.0 million (9.4%), to $164.6 million in the 2002 period, from $181.6 million in the 2001 period. As a percentage of freight revenue, salaries, wages, and related expenses decreased to 40.8% in the 2002 period, from 44.2% in the 2001 period. Wages for over the road drivers as a percentage of freight revenue decreased to 28.5% in 2002 from 31.5% in 2001. The decrease was largely attributable to the Company utilizing a larger percentage of single-driver tractors, with only one driver per tractor to be compensated, implementing changes in its pay structure and implementing a per diem pay program for its drivers during August 2001. The Company's payroll expense for employees other than over the road drivers increased to 7.1% of freight revenue in the 2002 period from 6.7% of freight revenue in the 2001 period. Health insurance, employer-paid taxes, workers' compensation, and other employee benefits decreased to 6.5% of freight revenue in the 2002 period from 6.9% of freight revenue in the 2001 period, partially due to paying lower taxes due to lower payroll amounts and improving claims experience in the Company's health insurance plan. Fuel expense, net of fuel surcharge revenue of $8.0 million in the 2002 period and $16.8 million in the 2001 period, decreased $1.1 million (1.8%), to $62.2 million in the 2002 period, from $63.3 million in the 2001 period. As a percentage of freight revenue, net fuel expense remained constant at 15.4% in the 2002 and 2001 periods. Fuel surcharges amounted to $.024 per loaded mile in the 2002 period compared to $.050 per loaded mile in the 2001 period. Fuel costs may be affected in the future by the Company's fuel hedging and volume purchase commitments from time-to-time and the collectibility of fuel surcharges, as well as by lower fuel mileage if government mandated emissions standards effective October 1, 2002, result in less fuel efficient engines. Operations and maintenance consist primarily of vehicle maintenance, repairs and driver recruitment expenses. Net of accessorial revenue of $1.5 million in the 2002 period and $1.2 million in the 2001 period, operations and maintenance increased $0.4 million (1.5%), to $28.3 million in the 2002 period, from $27.9 million in the 2001 period. As a percentage of freight revenue, operations and maintenance increased to 7.0% in the 2002 period, from 6.8% in the 2001 period. The Company extended the trade cycle on its tractor fleet from three years to four years, which resulted in an increase in the number of required repairs. Revenue equipment rentals and purchased transportation decreased $6.6 million (12.9%), to $44.4 million in the 2002 period, from $50.9 million in the 2001 period. As a percentage of freight revenue, revenue equipment rentals and purchased transportation Page 14 decreased to 11.0% in the 2002 period from 12.4% in the 2001 period. The decrease was the result of a smaller fleet of owner-operators during 2002 (an average of 350 in 2002 compared to an average of 371 in 2001) and lower lease payments during the nine month period (3.4% of freight revenue in the 2002 period compared to 4.1% of freight revenue in the 2001 period). The smaller fleet resulted in lower payments to owner-operators (7.6% of freight revenue in 2002 compared to 8.3% of freight revenue in 2001). Owner-operators are independent contractors, who provide a tractor and driver and cover all of their operating expenses in exchange for a fixed payment per mile. Accordingly, expenses such as driver salaries, fuel, repairs, depreciation, and interest normally associated with Company-owned equipment are consolidated in revenue equipment rentals and purchased transportation when owner-operators are utilized. As of September 30, 2002, the Company had financed approximately 636 tractors and 2,631 trailers under operating leases as compared to 995 tractors and 1,932 trailers under operating leases as of September 30, 2001. The lease expense per tractor will increase in future periods. See Note 7 to the Condensed Consolidated Financial Statements. Operating taxes and licenses decreased $0.6 million (5.8%), to $10.4 million in the 2002 period, from $11.0 million in the 2001 period. As a percentage of freight revenue, operating taxes and licenses remained constant at 2.6% in the 2002 and 2001 periods. Insurance and claims, consisting primarily of premiums and deductible amounts for liability, physical damage, and cargo damage insurance and claims, increased $3.5 million (18.3%), to $22.8 million in the 2002 period from $19.3 million in the 2001 period. As a percentage of freight revenue, insurance increased to 5.7% in the 2002 period from 4.7% in the 2001 period. The increase is a result of an industry-wide increase in insurance rates, which the Company addressed by adopting an insurance program with significantly higher deductible exposure that is partially offset by lower premium rates. The deductible amount increased from $5,000 in 2000, to $250,000 in 2001, to $500,000 in March of 2002, to $1.0 million in November of 2002. On July 15, 2002, the Company obtained binders for excess insurance coverage up to $50.0 million with a $500,000 aggregate deductible for liability, physical damage, and cargo claims per incident. During the third quarter, the Company sought replacement excess coverage after the insurance agent failed to produce proof of insurance on the policies for which the Company had obtained binders as of July 15, 2002. The replacement coverage is for an aggregate $4.0 million of insurance coverage with a $1.0 million aggregate deductible for liability, physical damage, and cargo claims per incident. The new policy increases the Company's exposure for claims both within the deductible limit and in excess of the maximum coverage. The Company's premium expense will decrease by approximately 40%. The Company intends to pursue its legal rights against the insurance agent and its errors and omissions policy. The Company accrues the estimated cost of the uninsured portion of pending claims. These accruals are based on management's evaluation of the nature and severity of the claim and estimates of future claims development based on historical trends. Insurance and claims expense will vary based on the frequency and severity of claims, the premium expense, and the level of self insured retention. Communications and utilities expense decreased $0.5 million (9.6%), to $5.1 million in the 2002 period, from $5.6 million in the 2001 period. As a percentage of freight revenue, communications and utilities remained essentially constant at 1.3% and 1.4% in the 2002 and 2001 periods, respectively. General supplies and expenses, consisting primarily of headquarters and other terminal facilities expenses, increased $0.4 million (3.6%), to $10.7 million in the 2002 period, from $10.4 million in the 2001 period. As a percentage of freight revenue, general supplies and expenses increased to 2.7% in the 2002 period, from 2.5% in the 2001 period. Depreciation, amortization and impairment charge, consisting primarily of depreciation of revenue equipment, increased $7.1 million (23.2%), to $37.5 million in the 2002 period from $30.4 million in the 2001 period. As a percentage of freight revenue, depreciation and amortization increased to 9.3% in the 2002 period from 7.4% in the 2001 period. The increase is the result of a $3.3 million pre-tax impairment charge, increased depreciation expense and losses on the sale of equipment. The impairment charge is related to approximately 327 model year 1998 through 2000 in use tractors. See "Impairment of Tractor Values and Future Expense" below for additional information. The Company's approximately 1,400 model year 2001 tractors were not affected by the charge. The Company has increased the annual depreciation expense on the 2001 model year tractors to approximate the Company's recent experience with disposition values and expectation for future disposition values. In addition, depreciation expense is expected to rise in the future as the cost of new tractors has increased and the residual value has decreased. Depreciation and amortization expense is net of any gain or loss on the disposal of tractors and trailers. Loss on the disposal of tractors and trailers was approximately $1.6 million in the 2002 period compared to a $16,000 loss in the 2001 period. Amortization expense relates to deferred debt costs incurred and covenants not to compete from five acquisitions. Goodwill amortization ceased beginning January 1, 2002, in accordance with SFAS No. 142, and the Company will evaluate goodwill and certain intangibles for impairment, annually prospectively beginning in 2002. During the second quarter of 2002, the Company tested its goodwill for impairment and found no impairment. The positive impact of goodwill no longer being amortized was approximately $230,000 for the nine months ended September 30, 2002. Other expense, net, decreased $3.5 million (48.5%), to $3.7 million in the 2002 period, from $7.2 million in the 2001 period. As a percentage of freight revenue, other expense decreased to 0.9% in the 2002 period from 1.7% in the 2001 period. The decrease was the result of lower debt balances and more favorable interest rates. Included in the other expense category are interest expense, interest income, and the pre-tax non-cash losses related to the accounting for interest rate derivatives under SFAS No. 133, which amounted to $0.9 million in the 2002 and 2001 periods. Page 15 The Company's income tax expense for the nine months ended September 30, 2002 was $7.7 million or 56.9% of income before taxes. The Company's income tax expense for the 2001 period was $1.9 million or 53.3% of income before taxes. The effective tax rate is different from the expected combined tax rate due to permanent differences related to a per diem pay structure implemented during the third quarter of 2001. Due to the nondeductible effect of per diem, the Company's tax rate will fluctuate in future periods as income fluctuates. Primarily as a result of the factors described above, net income increased $3.3 million (202.6%), to $4.9 million in the 2002 period (1.2% of revenue) from $1.6 million in the 2001 period (0.4% of revenue). As a result of the foregoing, the Company's net margin increased to 1.2% in the 2002 period from 0.4% in the 2001 period. LIQUIDITY AND CAPITAL RESOURCES Historically, the Company's growth has required significant capital investments. The Company historically has financed its expansion requirements with borrowings under a line of credit, cash flows from operations, long-term operating leases, and borrowings under installment notes payable to commercial lending institutions and equipment manufacturers. The Company's primary sources of liquidity at September 30, 2002, were funds provided by operations, proceeds under the Securitization Facility (as defined below), borrowings under its primary credit agreement, which had maximum available borrowing of $120.0 million at September 30, 2002 (the "Credit Agreement") and operating leases of revenue equipment. The Company believes its sources of liquidity are adequate to meet its current and projected needs for at least the next twelve months. Net cash provided by operating activities was $55.7 million in the 2002 period and $51.5 million in the 2001 period. The 2001 period included an unusually large collection of receivables that had resulted from billing problems during 2000. In 2002, there was an increase in depreciation and amortization which included a $3.3 million pre-tax impairment charge as well as an increase in claims accruals as the Company increased its self insured retention amounts. Net cash used in investing activities was $33.4 million in the 2002 period and $37.4 million in the 2001 period. Net cash used in investing activities in 2002 related to the purchase of tractors, which were previously financed through operating leases, and the acquisition of new revenue equipment (net of trade-ins) using proceeds from the Credit Agreement. In 2001, approximately $15 million was related to the financing of the Company's headquarters facility, which was previously financed through an operating lease that expired in March 2001. The Company financed the facility using proceeds from the Credit Agreement. The Company agreed to purchase and trade approximately 1,000 tractors during 2002, of which approximately half of the trade package was completed during the third quarter of 2002. The Company expects to complete the trade package during the fourth quarter of 2002 and also will purchase approximately 300 trailers during the fourth quarter. The Company expects capital expenditures, primarily for revenue equipment (net of trade-ins) to be approximately $30.0 million in the fourth quarter of 2002 and approximately $80 million in 2003, in each case exclusive of acquisitions. Net cash used in financing activities was $21.6 million in the 2002 period and $15.3 million in the 2001 period. At September 30, 2002, the Company had outstanding debt of $73.1 million, primarily consisting of $50.1 million in the Securitization Facility and $20.0 million drawn under the Credit Agreement. Interest rates on this debt range from 1.8% to 6.5%. During the first quarter of 2002, the Company prepaid the remaining $20.0 million in previously outstanding 7.39% ten year private placement notes with borrowings from the Credit Agreement. In conjunction with the prepayment of the borrowings, the Company recognized an approximate $0.9 million after-tax extraordinary loss to reflect the early extinguishment of debt. In December 2000, the Company entered into the Credit Agreement with a group of banks, which matures December 2003. Borrowings under the Credit Agreement are based on the banks' base rate or LIBOR and accrue interest based on one, two, or three month LIBOR rates plus an applicable margin that is adjusted quarterly between 0.75% and 1.25% based on cash flow coverage. At September 30, 2002, the margin was 1.00%. The Credit Agreement is guaranteed by the Company and all of the Company's subsidiaries except CVTI Receivables Corp ("CRC"). The Credit Agreement has a maximum borrowing limit of $120.0 million. Borrowings related to revenue equipment are limited to the lesser of 90% of net book value of revenue equipment or $120.0 million. Letters of credit are limited to an aggregate commitment of $20.0 million. The Credit Agreement includes a "security agreement" such that the Credit Agreement may be collateralized by virtually all assets of the Company if a covenant violation occurs. A commitment fee, that is adjusted quarterly between 0.15% and 0.25% per annum based on cash flow coverage, is due on the daily unused portion of the Credit Agreement. As of September 30, 2002, the Company had borrowings under the Credit Agreement in the amount of $20.0 million with a weighted average interest rate of 2.8% and the Company had borrowing availability of $80.8 million under the Credit Agreement. Page 16 In December 2000, the Company entered into a $62 million revolving accounts receivable securitization facility (the "Securitization Facility"). On a revolving basis, the Company sells its interests in its accounts receivable to CRC, a wholly-owned bankruptcy-remote special purpose subsidiary incorporated in Nevada. CRC sells a percentage ownership in such receivables to an unrelated financial entity. The Company can receive up to $62 million of proceeds, subject to eligible receivables, and will pay a service fee recorded as interest expense, based on commercial paper interest rates plus an applicable margin of 0.41% per annum and a commitment fee of 0.10% per annum on the daily unused portion of the Facility. The Securitization Facility is collateralized by the receivables of CRC. 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. The transaction did not meet the criteria for sale treatment under SFAS No. 140 and is reflected as a secured borrowing in the financial statements. As of September 30, 2002, there were $50.1 million in borrowings outstanding. The Credit Agreement and Securitization Facility contain certain restrictions and covenants relating to, among other things, dividends, tangible net worth, cash flow, acquisitions and dispositions, and total indebtedness. These agreements are cross-defaulted. CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make decisions based upon estimates, assumptions, and factors it considers 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 management's estimates and assumptions. Accordingly, actual results could differ from those anticipated. A summary of the significant accounting policies followed in preparation of the financial statements is contained in Note 1 of the financial statements contained in the Company's annual report on Form 10-K. Other footnotes describe various elements of the financial statements and the assumptions on which specific amounts were determined. The Company's critical accounting policies include the following: Revenue Recognition - Freight revenue, drivers' wages and other direct operating expenses are recognized on the date shipments are delivered to the customer. Property and Equipment - Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Revenue equipment has been depreciated over five to eight years with salvage values ranging from 18% to 48%. Gains or losses on disposal of revenue equipment are included in the caption entitled depreciation, amortization and impairment charge in the statements of operations. Impairment can be impacted by management's estimate of the property and equipment's useful lives. Impairment of Long-Lived Assets - Long-lived assets to be disposed of are reported at the lower of the carrying value or the fair value less costs to sell. The Company evaluates the carrying value of long-lived assets held for use for impairment losses by analyzing the operating performance and future cash flows for those assets, whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Company adjusts the carrying value of the underlying assets if the sum of expected undiscounted cash flows is less than the carrying value. Impairment can be impacted by management's projection of future cash flows, the level of cash flows and salvage values, the methods of estimation used for determining fair values and the impact of guaranteed residuals. Insurance and Other Claims - The Company's insurance program for liability, workers' compensation, group medical, property damage, cargo loss and damage, and other sources involves self insurance with high risk retention levels. In 2001, the Company adopted an insurance program with significantly higher deductibles. The deductible amount increased from $5,000 in 2000, to $250,000 in 2001, to $500,000 in March of 2002, to $1.0 million in November of 2002. On July 15, 2002, the Company obtained binders for excess insurance coverage up to $50.0 million with a $500,000 aggregate deductible for liability, physical damage, and cargo claims per incident. During the third quarter, the Company sought replacement excess coverage after the insurance agent failed to produce proof of insurance on the policies for which the Company had obtained binders as of July 15, 2002. The replacement coverage is for an aggregate $4.0 million of insurance coverage with a $1.0 million aggregate deductible for liability, physical damage, and cargo claims per incident. The new policy increases the Company's exposure for claims both within the deductible limit and in excess of the maximum coverage. The Company's premium expense will decrease by approximately 40%. The Company intends to pursue its legal rights against the insurance agent and its errors and omissions policy. The Company accrues the estimated cost of the uninsured portion of pending claims. These accruals are based on management's evaluation of the nature and severity of the claim and estimates of future claims development based on historical trends. Insurance and claims expense will vary based on the frequency and severity of claims, the premium expense and the level of self insured retention. Derivative Instruments and Hedging Activities - From time-to-time, the Company engages in activities that expose it to market risks, including the effects of changes in interest rates and fuel prices. Financial exposures are managed as an integral part of the Company's risk management program, which seeks to reduce potentially adverse effects that the volatility of the interest rate and fuel markets may Page 17 have on operating results. Hedging activities could defer the recognition of losses to future periods. All derivatives are recognized on the balance sheet at their fair values. The Company also formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair-value hedge, the Company continues to carry the derivative on the balance sheet at its fair value, and no longer adjusts the hedged asset or liability for changes in fair value. The adjustment of the carrying amount of the hedged asset or liability is accounted for in the same manner as other components of the carrying amount of that asset or liability. When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the Company continues to carry the derivative on the balance sheet at its fair value, removes any asset or liability that was recorded pursuant to recognition of the firm commitment from the balance sheet and recognizes any gain or loss in earnings. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the Company continues to carry the derivative on the balance sheet at its fair value, and gains and losses that were accumulated in other comprehensive income are recognized immediately in earnings. In all other situations in which hedge accounting is discontinued, the Company continues to carry the derivative at its fair value on the balance sheet, and recognizes any changes in its fair value in earnings. The Company does not regularly engage in speculative transactions, nor does it regularly hold or issue financial instruments for trading purposes. Lease Accounting - The Company leases a significant portion of its tractor and trailer fleet using operating leases. Substantially all of the leases have residual value guarantees under which the Company must insure that the lessor receives a negotiated amount for the equipment at the expiration of the lease. In accordance with SFAS No. 13, Accounting for Leases, the rental expense under these leases is reflected as an operating expense under "revenue equipment rentals and purchased transportation." Operating leases are carried off balance sheet in accordance with SFAS No. 13. Contractual Obligations and Commitments - The Company had commitments outstanding related to equipment, debt obligations, and diesel fuel purchases as of January 1, 2002. Contractual commitments changed during the first quarter of 2002 as a result of the payoff of senior notes with proceeds from the Credit Agreement, and the purchase of 327 tractors off lease in February, 2002. The Company had commitments to acquire revenue equipment for approximately $154 million at December 31, 2001. These purchases are expected to be financed by debt, proceeds from sales of existing equipment, and cash flows from operations. The Company has the option to cancel such commitments with 60 days notice. The following table sets forth the Company's contractual cash obligations and commitments as of January 1, 2002. Payments Due By Period There- (in thousands) Total 2002 2003 2004 2005 2006 after --------------------------------------------------------------------------------------- Long Term Debt $49,150 $20,150 $26,000 $3,000 $ - $ - $ - Short Term Debt 48,130 48,130 - - - - - Operating Leases 68,517 20,137 15,393 7,944 7,151 6,789 11,103 Lease residual value guarantees 55,153 15,720 19,562 - 423 2,348 17,100 Purchase Obligations: Diesel fuel 68,147 31,427 36,720 - - - - Equipment 153,698 72,298 81,400 - - - - --------------------------------------------------------------------------------------- Total Contractual Cash Obligations $442,795 $207,862 $179,075 $10,944 $7,574 $9,137 $28,203 =======================================================================================
INFLATION AND FUEL COSTS Most of the Company's 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 drivers. Innovations in equipment technology and comfort along with government-mandated emissions standards and an increase in Page 18 market prices generally have resulted in higher new tractor prices, and there has been an industry-wide increase in wages paid to attract and retain qualified drivers. The Company historically has limited the effects of inflation through increases in freight rates and certain cost control efforts. In addition to inflation, fluctuations in fuel prices can affect profitability. Fuel expense comprises a larger percentage of revenue for Covenant than many other carriers because of Covenant's long average length of haul. Most of the Company's contracts with customers contain fuel surcharge provisions. Although the Company historically has been able to pass through most long-term increases in fuel prices and taxes to customers in the form of surcharges and higher rates, increases in fuel expense usually are not fully recovered. In the fourth quarter of 1999, fuel prices escalated rapidly and have remained high throughout most of 2000, 2001, and into 2002. This has increased the Company's cost of operating. 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. The Company's 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 the Company's ability to satisfy some of that requirement. The seasonal shortage typically occurs between May and August because California produce carriers' equipment is fully utilized for produce during those months and does not compete for shipments hauled by the Company's dry van operation. During September and October, business increases as a result of increased retail merchandise shipped in anticipation of the holidays. IMPAIRMENT OF TRACTOR VALUES AND FUTURE EXPENSE During 2001, the market value of used tractors was significantly below both historical levels and the carrying values on the Company's financial statements. The Company extended the trade cycle of its tractors from three years to four years during 2001, which delayed any significant disposals into 2002 and later years. The market for used tractors did not improve by the time the Company negotiated a tractor purchase and trade package with Freightliner Corporation for calendar years 2002 and 2003 covering the sale of model year 1998 through 2000 tractors and the purchase of an equal number of replacement units. The significant difference between the carrying values and the sale prices of the used tractors combined with the Company's less profitable results during 2001 caused the Company to test for asset impairment under applicable accounting rules. In the test, the Company measured the expected undiscounted future cash flows to be generated by the tractors over the remaining useful lives and the disposal value at the end of the useful life against the carrying values. The test indicated impairment, and during the fourth quarter of 2001, and the first quarter of 2002, the Company recognized pre-tax charges of approximately $15.4 million and $3.3 million, respectively, to reflect an impairment in tractor values. The charges related to the Company's approximately 2,100 model year 1998 through 2000 in-use tractors. The approximately 1,400 model year 2001 tractors were not affected by the impairment charges. The Company has evaluated the 2001 model year tractors for impairment and determined that such units were not impaired. These units are not expected to be disposed of for 24 to 36 months following December 31, 2001. The Company has adjusted the depreciation rate of its owned model year 2001 tractors to approximate its recent experience with disposition values and expectation concerning future disposition values. The Company also increased the lease expense on its leased units since it expects to purchase the leased tractors at the end of the three-year leases and operate them for the last year of its four-year trade cycle. Although management believes the additional depreciation will bring the carrying values of the model year 2001 tractors in line with future disposition values, the Company does not have trade-in agreements covering those tractors. See Note 7 to the Condensed Consolidated Financial Statements. These assumptions represent management's best estimate and actual values could differ by the time those tractors are scheduled for trade. Management estimates the impact of the change in the estimated useful lives and depreciation on the 2001 model year tractors to be approximately $1.5 million pre-tax or $.06 per share annually. Because of the adverse change from historical purchase prices and residual values, the annual expense per tractor on model year 2003 and 2004 tractors is expected to be higher than the annual expense on the model year 1999 and 2000 units being replaced. Management expects the increase in depreciation expense to be approximately one-half cent per mile pre-tax during the first year and grow to approximately one cent per mile pre-tax as all of these new units are delivered. By the time the model year 2001 tractors are traded and the entire fleet is converted, management expects the total increase in expense to be approximately one and one-half cent pre-tax per mile. If the tractors are leased instead of purchased, the references to increased depreciation would be reflected as additional lease expense. Page 19 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to market risks from changes in (i) certain commodity prices and (ii) certain interest rates on its debt. COMMODITY PRICE RISK Prices and availability of all petroleum products are subject to political, economic, and market factors that are generally outside the Company's control. Because the Company's operations are dependent upon diesel fuel, significant increases in diesel fuel costs could materially and adversely affect the Company's results of operations and financial condition. Historically, the Company has been able to recover a portion of short-term fuel price increases from customers in the form of fuel surcharges. The price and availability of diesel fuel can be unpredictable as well as the extent to which fuel surcharges could be collected to offset such increases. For the first nine months of 2002, diesel fuel expenses net of fuel surcharge represented 15.5% of the Company's total operating expenses and 15.4% of freight revenue. The Company uses purchase commitments through suppliers to reduce a portion of its exposure to fuel price fluctuations. At September 30, 2002, the national average price of diesel fuel as provided by the U.S. Department of Energy was $1.438 per gallon. At September 30, 2002, the notional amount for purchase commitments during 2002 was 9.3 million gallons. At September 30, 2002, the price of the notional 9.3 million gallons would have produced approximately $2.1 million of income to offset fuel expense if the price of fuel remained the same as of September 30, 2002. At September 30, 2002, a ten percent increase in the price of fuel would produce an additional $1.3 million of income to offset fuel expense. At September 30, 2002, a ten percent change in the price of fuel would increase or decrease the gain on fuel purchase commitments by approximately $1.3 million. In addition, during the third quarter of 2001, the Company entered into two heating oil commodity swap contracts to hedge its exposure to diesel fuel price fluctuations. These contracts are considered highly effective and each calls for 1.5 million gallons of fuel purchases at fixed prices of $0.695 and $0.629 per gallon, respectively, through the remainder of 2002. At September 30, 2002 the cumulative fair value of these heating oil contracts was an asset of $0.6 million, which was recorded in accrued expenses with the offset to other comprehensive loss, net of taxes. The Company does not enter into contracts with the objective of earning financial gains on price fluctuations, nor does it trade in these instruments when there are no underlying related exposures. INTEREST RATE RISK The Credit Agreement, provided there has been no default, carries a maximum variable interest rate of LIBOR for the corresponding period plus 1.25%. During the first quarter of 2001, the Company entered into two $10 million notional amount interest rate swap agreements to manage the risk of variability in cash flows associated with floating-rate debt. At September 30, 2002, the Company had drawn $20 million under the Credit Agreement, which was subject to the interest rate swaps that fixed the interest rates at 5.16% and 4.75% plus the applicable margin per annum. The swaps expire January 2006 and March 2006. These derivatives are not designated as hedging instruments under SFAS No. 133 and consequently are marked to fair value through earnings. At September 30, 2002, the fair value of these interest rate swap agreements was a liability of $1.7 million. As of September 30, 2002, the Company had no variable rate borrowings outstanding; therefore each one-percentage point increase or decrease in LIBOR would have no affect on the Company's pre-tax interest expense. The Company does not trade in derivatives with the objective of earning financial gains on price fluctuations, on a speculative basis, nor does it trade in these instruments when there are no underlying related exposures. ITEM 4. CONTROLS AND PROCEDURES Within 90 days prior to the date of this report, an evaluation was performed under the supervision and with the Company's management, including its Chief Executive Officer and its Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including its Chief Executive and Chief Financial Officer, concluded that the Company's disclosure controls and procedures were effective as of September 30, 2002. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to September 30, 2002, including any corrective actions with regard to significant deficiencies and material weaknesses. Page 20 PART II OTHER INFORMATION Item 1. Legal Proceedings. None Items 2, 3, 4 and 5. Not applicable Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits Exhibit Number Reference Description 3.1 (1) Restated Articles of Incorporation. 3.2 (1) Amended Bylaws dated September 27, 1994. 4.1 (1) Restated Articles of Incorporation. 4.2 (1) Amended Bylaws dated September 27, 1994. 10.1 (1) 401(k) Plan filed as Exhibit 10.10. 10.2 (2) Outside Director Stock Option Plan, filed as Exhibit A. 10.3 (3) Amendment No. 1 to the Outside Director Stock Option Plan, filed as Exhibit 10.11. 10.4 (4) Credit Agreement by and among Covenant Asset Management, Inc., Covenant Transport, Inc., Bank of America, N.A., and each other financial institution which is a party to the Credit Agreement, dated December 13, 2000, filed as Exhibit 10.9. 10.5 (4) Loan Agreement dated December 12, 2000, among CVTI Receivables Corp., and Covenant Transport, Inc., Three Pillars Funding Corporation, and SunTrust Equitable Securities Corporation, filed as Exhibit 10.10. 10.6 (4) Receivables Purchase Agreement dated as of December 12, 2000, among CVTI Receivables Corp., Covenant Transport, Inc., and Southern Refrigerated Transport, Inc., filed as Exhibit 10.11. 10.7 (5) Clarification of Intent and Amendment No. 1 to Loan Agreement dated March 7, 2001, among CVTI Receivables Corp., Covenant Transport, Inc., Three Pillars Funding Corporation, and SunTrust Equitable Securities Corporation, filed as Exhibit 10.12. 10.8 (6) Incentive Stock Plan, Amended and Restated as of May 17, 2001, filed as Appendix B. 10.9 (7) Amendment No. 1 to Credit Agreement dated August 28, 2001, among Covenant Asset Management, Inc., Covenant Transport, Inc., Bank of America, N.A., and each other financial institution which is a party to the Credit Agreement, filed as Exhibit 10.11. - -----------------------------------------------------------------------------------------------------------------------------------
Previously filed as an exhibit to and incorporated by reference from: 1) Form S-1, Registration No. 33-82978, effective October 28, 1994. 2) Schedule 14A, filed April 13, 2000. 3) Form 10-Q for the quarter ended September 30, 2000. 4) Form 10-K for the year ended December 31, 2000. 5) Form 10-Q for the quarter ended March 31, 2001. 6) Schedule 14A, filed April 5, 2001. 7) Form 10-Q/A, filed July 30, 2002. (b) A Form 8-K was filed on August 12, 2002, with respect to the certification requirements of 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Page 21 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COVENANT TRANSPORT, INC. Date: November 14, 2002 /s/ Joey B. Hogan --------------------------------- Joey B. Hogan Senior Vice President and Chief Financial Officer, in his capacity as such and on behalf of the issuer. CERTIFICATIONS I, David R. Parker, certify that: 1. I have reviewed this quarterly report on Form 10-Q for the quarterly period ended September 30, 2002, of Covenant Transport, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures for the registrant and we have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board or directors: a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize, and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were Page 22 significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ David R. Parker ---------------------------------------- David R. Parker Chief Executive Officer I, Joey B. Hogan, certify that: 1. I have reviewed this quarterly report on Form 10-Q for the quarterly period ended September 30, 2002, of Covenant Transport, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures for the registrant and we have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board or directors: a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize, and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ Joey B. Hogan ---------------------------------------- Joey B. Hogan Chief Financial Officer Page 23 -----END PRIVACY-ENHANCED MESSAGE-----