| COVENANT TRANSPORT INC ITEM 1A RISK FACTORS Factors That May Affect Future Results Our future results may be affected by a number of factors over which we have little or no control |
| The following issues, uncertainties, and risks, among others, should be considered in evaluating our business and growth outlook |
| Our business is subject to general economic and business factors that are largely out of our control, any of which could have a materially adverse effect on our operating results |
| Our business is dependent on a number of factors that may have a materially adverse effect on our results of operations, many of which are beyond our control |
| Some of the most significant of these factors include excess tractor and trailer capacity in the trucking industry, declines in the resale value of used equipment, strikes or other work stoppages, increases in interest rates, fuel taxes, tolls, and license and registration fees, and rising costs of healthcare |
| We also are affected by recessionary economic cycles, changes in customers &apos inventory levels, and downturns in customers &apos business cycles, particularly in market segments and industries, such as retail and manufacturing, where we have a significant concentration of customers, and regions of the country, such as California, Texas, and the Southeast, where we have a significant amount of business |
| Economic conditions may adversely affect our customers and their ability to pay for our services |
| Customers encountering adverse economic conditions represent a greater potential for loss, and we may be required to increase our allowance for doubtful accounts |
| In addition, it is not possible to predict the effects of actual or threatened terrorist attacks, efforts to combat terrorism, military action against any foreign state, heightened security requirements, or other related events |
| Such events, however, could negatively impact the economy and consumer confidence in the United States |
| Such events could also have a materially adverse effect on our future results of operations |
| We may not be successful in improving or maintaining our profitability |
| During 2005 we adopted a strategic plan designed to improve our profitability |
| The plan generally involves organizing our operations around four distinct service offerings |
| Within each service offering we expect changes to items such as the customer base, rate structure, routes served, driver domiciles, management, reporting structure, and operating procedures |
| These changes, and others that we did not expect, will present significant challenges, including, but not limited to, the following: • Developing management depth to oversee the service offerings and also manage regional terminals within the service offerings; • Adapting our personnel to new strategies, policies, and procedures, including more distributed decision making; • Maintaining customer relationships and freight volumes while changing routes, pricing, and other aspects of our operations; • Maintaining a sufficient number of qualified drivers while changing routes, policies, procedures, and management structures; • Controlling headcount and expenses generally during a transition that may entail a period of duplication of some functions; and • Improving or eliminating processes, functions, services, or other items that are identified as substandard |
| We self-insure for a significant portion of our claims exposure, which could significantly increase the volatility of, and decrease the amount of, our earnings |
| Our future insurance and claims expense could reduce our earnings and make our earnings more volatile |
| We self-insure for a significant portion of our claims exposure and related expenses |
| We accrue amounts for liabilities based on our assessment of claims that arise and our insurance coverage for the periods in which the claims arise, and we evaluate and revise these accruals from time-to-time based on additional information |
| We do not currently maintain directors and officers &apos insurance coverage, although we are obligated to indemnify them against certain liabilities they may incur while serving in such capacities |
| Because of our significant self-insured amounts, we have significant exposure to fluctuations in the number and severity of claims and the risk of being required to accrue or 10 _________________________________________________________________ [36]TABLE OF CONTENTS pay additional amounts if the claims prove to be more severe than originally assessed |
| Historically, we have had to adjust our reserves on several occasions, and future adjustments may occur |
| We maintain insurance above the amounts for which we self-insure with licensed insurance carriers |
| Our insurance and claims expense could increase when our current coverages expire, or we could raise our self-insured retention |
| Although we believe our aggregate insurance limits are sufficient to cover reasonably expected claims, it is possible that one or more claims could exceed those limits |
| Insurance carriers recently have been raising premiums for many businesses, including trucking companies |
| As a result, our insurance and claims expense could increase, or we could find it necessary to again raise our self-insured retention or decrease our aggregate coverage limits when our policies are renewed or replaced |
| Our operating results and financial condition may be adversely affected if these expenses increase, if we experience a claim in excess of our coverage limits, if we experience a claim for which we do not have coverage, or if we have to increase our reserves again |
| Ongoing insurance requirements could constrain our borrowing capacity |
| The increase in our self-insured retention has caused our outstanding undrawn letters of credit in favor of insurance companies to increase |
| We expect outstanding letters of credit to increase in the future |
| Outstanding letters of credit reduce the available borrowings under our credit agreement, which could negatively affect our liquidity should we need to increase our borrowings in the future |
| We operate in a highly competitive and fragmented industry, and numerous competitive factors could impair our ability to maintain or improve our profitability |
| These factors include: • We compete with many other truckload carriers of varying sizes and, to a lesser extent, with less-than-truckload carriers, railroads, and other transportation companies, many of which have more equipment and greater capital resources than we do |
| • Many of our competitors periodically reduce their freight rates to gain business, especially during times of reduced growth rates in the economy, which may limit our ability to maintain or increase freight rates or maintain significant growth in our business |
| • Many customers reduce the number of carriers they use by selecting "e core carriers "e as approved service providers, and in some instances we may not be selected |
| • Many customers periodically accept bids from multiple carriers for their shipping needs, and this process may depress freight rates or result in the loss of some business to competitors |
| • The trend toward consolidation in the trucking industry may create other large carriers with greater financial resources and other competitive advantages relating to their size |
| • Advances in technology require increased investments to remain competitive, and our customers may not be willing to accept higher freight rates to cover the cost of these investments |
| • Competition from non-asset-based logistics and freight brokerage companies may adversely affect our customer relationships and freight rates |
| • Economies of scale that may be passed on to smaller carriers by procurement aggregation providers may improve their ability to compete with us |
| We derive a significant portion of our revenue from our major customers, the loss of one or more of which could have a materially adverse effect on our business |
| A significant portion of our revenue is generated from our major customers |
| Generally, we do not have long term contractual relationships with our major customers, and our customers may not continue to use our services or continue to use our services at the same levels |
| For some of our customers, we have entered into multi-year contracts, and the rates may not remain advantageous |
| A reduction in or termination of our services by one or more of our major customers could have a materially adverse effect on our business and operating results |
| 11 _________________________________________________________________ [37]TABLE OF CONTENTS Increases in driver compensation or difficulty in attracting and retaining qualified drivers could adversely affect our profitability |
| Like many truckload carriers, we experience substantial difficulty in attracting and retaining sufficient numbers of qualified drivers, including independent contractors |
| In addition, due in part to current economic conditions, including the higher cost of fuel, insurance, and tractors, the available pool of independent contractor drivers has been declining |
| Because of the shortage of qualified drivers, the availability of alternative jobs, and intense competition for drivers from other trucking companies, we expect to continue to face difficulty increasing the number of our drivers, including independent contractor drivers |
| The compensation we offer our drivers and independent contractors is subject to market conditions, and we may find it necessary to continue to increase driver and independent contractor compensation in future periods |
| In addition, we and our industry suffer from a high turnover rate of drivers |
| Our high turnover rate requires us to continually recruit a substantial number of drivers in order to operate existing revenue equipment |
| If we are unable to continue to attract and retain a sufficient number of drivers, we could be required to adjust our compensation packages, let trucks sit idle, or operate with fewer trucks and face difficulty meeting shipper demands, all of which would adversely affect our growth and profitability |
| We operate in a highly regulated industry, and increased costs of compliance with, or liability for violation of, existing or future regulations could have a materially adverse effect on our business |
| Our operations are regulated and licensed by various US, Canadian, and Mexican agencies |
| Our company drivers and independent contractors also must comply with the safety and fitness regulations of the United States DOT, including those relating to drug and alcohol testing and hours-of-service |
| Such matters as weight and equipment dimensions are also subject to US and Canadian regulations |
| We also may become subject to new or more restrictive regulations relating to fuel emissions, drivers &apos hours-of-service, ergonomics, or other matters affecting safety or operating methods |
| Other agencies, such as the Environmental Protection Agency, or EPA, and the Department of Homeland Security, or DHS, also regulate our equipment, operations, and drivers |
| Future laws and regulations may be more stringent and require changes in our operating practices, influence the demand for transportation services, or require us to incur significant additional costs |
| Higher costs incurred by us or by our suppliers who pass the costs onto us through higher prices could adversely affect our results of operations |
| The DOT, through the Federal Motor Carrier Safety Administration Act, or FMCSA, imposes safety and fitness regulations on us and our drivers |
| New rules that limit driver hours-of-service were adopted effective January 4, 2004, and then modified effective October 1, 2005 |
| The rules effective October 1, 2005, did not substantially change the existing rules but are likely to create a moderate reduction in the amount of time available to drivers in longer lengths of haul, which could reduce equipment productivity in those lanes |
| The FMCSA is studying rules relating to braking distance and on-board data recorders that could result in new rules being proposed |
| We are unable to predict the effect of any rules that might be proposed, but we expect that any such proposed rules would increase costs in our industry, and the on-board recorders potentially could decrease productivity and the number of people interested in being drivers |
| In the aftermath of the September 11, 2001 terrorist attacks, federal, state, and municipal authorities have implemented and continue to implement various security measures, including checkpoints and travel restrictions on large trucks |
| The Transportation Security Administration, or TSA, of the DHS has adopted regulations that require determination by the TSA that each driver who applies for or renews his license for carrying hazardous materials is not a security threat |
| This could reduce the pool of qualified drivers, which could require us to increase driver compensation, limit our fleet growth, or let trucks sit idle |
| These regulations also could complicate the matching of available equipment with hazardous material shipments, thereby increasing our response time on customer orders and our non-revenue miles |
| These security measures could negatively impact our operating results |
| Some states and municipalities have begun to restrict the locations and amount of time where diesel-powered tractors, such as ours, may idle, in order to reduce exhaust emissions |
| These restrictions could force us to alter our drivers’ behavior, purchase on-board power units that do not require the engine to idle, or face a decrease in productivity |
| 12 _________________________________________________________________ [38]TABLE OF CONTENTS We have significant ongoing capital requirements that could affect our profitability if we are unable to generate sufficient cash from operations and obtain financing on favorable terms |
| The truckload industry is capital intensive, and our policy of operating newer equipment requires us to expend significant amounts annually |
| For the past few years, we have depended on cash from operations, our credit facilities, and operating leases to fund our revenue equipment |
| If we elect to expand our fleet in future periods, our capital needs would increase |
| We expect to pay for projected capital expenditures with cash flows from operations, borrowings under our line of credit, proceeds under our financing facilities, and operating leases of revenue equipment |
| If we are unable to generate sufficient cash from operations and obtain financing on favorable terms in the future, we may have to limit our growth, enter into less favorable financing arrangements, or operate our revenue equipment for longer periods, any of which could have a materially adverse effect on our profitability |
| We currently have trade-in or fixed residual agreements with certain equipment suppliers concerning the substantial majority of our tractor fleet |
| If the suppliers refuse or are unable to meet their financial obligations under these agreements, or if we decline to purchase the relevant number of replacement units from the suppliers, we may suffer a financial loss upon the disposition of our equipment |
| Fluctuations in the price or availability of fuel, as well as hedging activities, surcharge collection, and the volume and terms of diesel fuel purchase commitments, may increase our costs of operation, which could materially and adversely affect our profitability |
| Diesel fuel prices fluctuate greatly due to economic, political, and other factors beyond our control |
| Fuel also is subject to regional pricing differences and often costs more on the West Coast, where we have significant operations |
| From time-to-time we have used hedging contracts and volume purchase arrangements to attempt to limit the effect of price fluctuations |
| If we do hedge, we may be forced to make cash payments under the hedging arrangements |
| The absence of meaningful fuel price protection through these measures, fluctuations in fuel prices, or a shortage of diesel fuel, could materially and adversely affect our results of operations |
| We may not make acquisitions in the future, or if we do, we may not be successful in our acquisition strategy |
| We made nine acquisitions between 1996 and 2000, including four between September 1999 and August 2000 |
| Accordingly, acquisitions have provided a substantial portion of our growth |
| We may not be successful in identifying, negotiating, or consummating any future acquisitions |
| If we fail to make any future acquisitions, our growth rate could be materially and adversely affected |
| Any acquisitions we undertake could involve the dilutive issuance of equity securities and/or incurring indebtedness |
| In addition, acquisitions involve numerous risks, including difficulties in assimilating the acquired companyapstas operations, the diversion of our managementapstas attention from other business concerns, risks of entering into markets in which we have had no or only limited direct experience, and the potential loss of customers, key employees, and drivers of the acquired company, all of which could have a materially adverse effect on our business and operating results |
| If we make acquisitions in the future, we may not be able to successfully integrate the acquired companies or assets into our business |
| Our operations are subject to various environmental laws and regulations, the violation of which could result in substantial fines or penalties |
| We are subject to various environmental laws and regulations dealing with the hauling and handling of hazardous materials, fuel storage tanks, air emissions from our vehicles and facilities, engine idling, and discharge and retention of storm water |
| We operate in industrial areas, where truck terminals and other industrial activities are located, and where groundwater or other forms of environmental contamination have occurred |
| Our operations involve the risks of fuel spillage or seepage, environmental damage, and hazardous waste disposal, among others |
| We also maintain above-ground bulk fuel storage tanks and fueling islands at two of our facilities |
| A small percentage of our freight consists of low-grade hazardous substances, which subjects us to a wide array of regulations |
| Although we have instituted programs to monitor and control environmental risks and promote compliance with applicable environmental laws and regulations, if we are involved in a spill or other accident involving hazardous substances, if there are releases of hazardous substances we transport, or if we are found to be in violation of applicable laws or regulations, we could be subject to liabilities, including substantial fines or penalties or civil and criminal liability, any of which could have a materially adverse effect on our business and operating results |
| 13 _________________________________________________________________ [39]TABLE OF CONTENTS Regulations limiting exhaust emissions became effective in 2002 and become progressively more restrictive in 2007 and 2010 |
| Engines manufactured after October 2002 generally cost more, produce lower fuel mileage, and require additional maintenance compared with earlier models |
| We expect additional cost increases and possibly degradation in fuel mileage from the 2007 engines |
| These adverse effects, combined with the uncertainty as to the reliability of the newly designed diesel engines and the residual values of these vehicles, could increase our costs or otherwise adversely affect our business or operations |
| Increased prices, reduced productivity, and restricted availability of new revenue equipment may adversely affect our earnings and cash flows |
| We have experienced higher prices for new tractors over the past few years, partially as a result of government regulations applicable to newly manufactured tractors and diesel engines, in addition to higher commodity prices and better pricing power among equipment manufacturers |
| More restrictive EPA emissions standards for 2007 will require vendors to introduce new engines, and some carriers may seek to purchase large numbers of tractors with pre-2007 engines, possibly leading to shortages |
| Our business could be harmed if we are unable to continue to obtain an adequate supply of new tractors and trailers for these or other reasons |
| As a result, we expect to continue to pay increased prices for equipment and incur additional expenses and related financing costs for the foreseeable future |
| Furthermore, the new engines are expected to reduce equipment productivity and lower fuel mileage and, therefore, increase our operating expenses |
| We have agreements covering the terms of trade-in and/or repurchase commitments from our primary equipment vendors for disposal of a substantial portion of our revenue equipment |
| The prices we expect to receive under these arrangements may be higher than the prices we would receive in the open market |
| We may suffer a financial loss upon disposition of our equipment if these vendors refuse or are unable to meet their financial obligations under these agreements, if we fail to enter into definitive agreements that reflect the terms we expect, if we fail to enter into similar arrangements in the future, or if we do not purchase the required number of replacement units from the vendors |
| Our substantial indebtedness and operating lease obligations could adversely affect our ability to respond to changes in our industry or business |
| As a result of our level of debt, operating lease obligations, and encumbered assets: • Our vulnerability to adverse economic conditions and competitive pressures is heightened; • We will continue to be required to dedicate a substantial portion of our cash flows from operations to operating lease payments and repayment of debt, limiting the availability of cash for other purposes; • Our flexibility in planning for, or reacting to, changes in our business and industry will be limited; • Our profitability is sensitive to fluctuations in interest rates because some of our debt obligations are subject to variable interest rates, and future borrowings and lease financing arrangements will be affected by any such fluctuations; • Our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, or other purposes may be limited; and • We may be required to issue additional equity securities to raise funds, which would dilute the ownership position of our stockholders |
| Our financing obligations could negatively impact our future operations, our ability to satisfy our capital needs, or our ability to engage in other business activities |
| We also cannot assure you that additional financing will be available to us when required or, if available, will be on terms satisfactory to us |
| 14 _________________________________________________________________ [40]TABLE OF CONTENTS Our revolving credit facility contains restrictive and financial covenants, and we may be unable to comply with these covenants |
| A default could result in the acceleration of all of our outstanding indebtedness, which could have an adverse effect on our financial condition, liquidity, results of operations, and the price of our common stock |
| Our credit facilities and our other financing arrangements contain covenants that impose certain restrictions and require us to maintain specified financial ratios |
| If we fail to comply with any of these covenants, we will be in default, which could cause cross-defaults under other loans or agreements |
| A default, if not waived by our lenders, could cause our debt and other obligations to become immediately due and payable |
| To obtain waivers of defaults, we may incur significant fees and transaction costs |
| If waivers of defaults are not obtained and acceleration occurs, we may be unable to borrow sufficient additional funds to refinance the accelerated debt |
| Even if new financing is made available to us, it may not be available on commercially acceptable terms |
| If we are unable to retain our key employees, our business, financial condition, and results of operations could be harmed |
| We are highly dependent upon the services of the following key employees: David R Parker, our Chairman of the Board, Chief Executive Officer, and President; Joey B Hogan, our Executive Vice President and Chief Financial Officer; Michael W Miller, our Executive Vice President and Chief Operating Officer; Jeffrey S Paulsen, our Senior Vice President and General Manager; Jeffrey D Taylor, our Vice President and General Manager; and Jeffery D Acuff, our Vice President and General Manager |
| We currently do not have employment agreements with any of them |
| We do maintain key-man life insurance on David Parker |
| The loss of any of their services could negatively impact our operations and future profitability |
| We must continue to develop and retain a core group of managers if we are to realize our goal of improving our profitability |
| Our Chief Executive Officer and President and his wife control a large portion of our stock and have substantial control over us, which could limit your ability to influence the outcome of key transactions, including changes of control |
| Our Chairman of the Board, Chief Executive Officer, and President, David Parker, and his wife, Jacqueline Parker, beneficially own approximately 38prca of our outstanding Class A common stock and 100prca of our Class B common stock |
| On all matters with respect to which our stockholders have a right to vote, including the election of directors, each share of Class A common stock is entitled to one vote, while each share of Class B common stock is entitled to two votes |
| All outstanding shares of Class B common stock are owned by the Parkers and are convertible to Class A common stock on a share-for-share basis at the election of the Parkers or automatically upon transfer to someone outside of the Parker family |
| This voting structure gives the Parkers approximately 47prca of our outstanding votes |
| The Parkers are able to effectively control decisions requiring stockholder approval, including the election of our entire board of directors, the adoption of extension of anti-takeover provisions, mergers, and other business combinations |
| This concentration of ownership could limit the price that some investors might be willing to pay for the Class A common stock, and could allow the Parkers to prevent or delay a change of control, which other stockholders may favor |
| The interests of the Parkers may conflict with the interests of other holders of Class A common stock, and they may take actions affecting us with which you disagree |
| Seasonality and the impact of weather affect our operations and profitability |
| Our tractor productivity decreases during the winter season because inclement weather impedes operations, and some shippers reduce their shipments after the winter holiday season |
| Revenue can also be affected by bad weather and holidays, since revenue is directly related to available working days of shippers |
| At the same time, operating expenses increase, with fuel efficiency declining because of engine idling and harsh weather creating higher accident frequency, increased claims, and more equipment repairs |
| We can also suffer short-term impacts from weather-related events such as hurricanes, blizzards, ice storms, and floods that could harm our results or make our results more volatile |