Frozen Food Express Industries 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007
[ ] 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 1-10006
FROZEN FOOD EXPRESS INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)
Registrant's telephone number, including area code (214) 630-8090
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: Yes [ ] No [ X ]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act: Yes [ ] No [ X ]
Indicate by check mark whether the registrant (l) 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 by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ X ] Non-accelerated filer [ ] Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ]
The aggregate market value of 15,969,049 shares of the registrant’s $1.50 par value common stock held by non-affiliates as of June 30, 2007 was approximately $161,926,000 million (based upon $10.14 per share).
As of February 29, 2008, the number of outstanding shares of the registrant’s common stock was 16,650,992.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Annual Report to Stockholders for the year ended December 31, 2007 and Proxy Statement for use in connection with its Annual Meeting of Stockholders to be held on May 14, 2008, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after December 31, 2007, are incorporated by reference in Part III (Items 10, 11, 12, 13 and 14).
ITEM 1. Business.
Frozen Food Express Industries, Inc. is a publicly-owned motor carrier with core operations in the transport of temperature-controlled products and perishable goods including food products, health care products and confectionary items. Service is offered in over-the-road and intermodal modes for temperature-controlled truckload and less-than-truckload, as well as dry truckload. We also provide brokerage, or logistics services, as well as dedicated fleets. We were incorporated in Texas in 1969, as successor to a company formed in 1946. Our principal office is located at 1145 Empire Central Place, Dallas, Texas 75247-4305. References to “we” or “us”, unless the context requires otherwise, include Frozen Food Express Industries, Inc. and our subsidiaries, all of which are wholly-owned. Our services are further described below:
- TRUCKLOAD LINEHAUL SERVICE: This service provides for the shipment of a load, typically weighing between 20,000 and 40,000 pounds and usually from a single shipper, which fills the trailer. Normally, a truckload shipment has a single destination, although we are also able to provide multiple deliveries. According to industry publications and based on 2006 revenue (the most recent year for which data is available), we are one of the largest temperature-controlled, truckload carriers in North America.
- DEDICATED FLEETS: In providing certain truckload services, we contract with a customer to provide service involving the assignment of specific trucks and drivers to handle certain of the customer's transportation needs. Frequently, we and our customers anticipate that dedicated fleet logistics services will lower the customer's transportation costs and improve the quality of service.
- LESS-THAN-TRUCKLOAD ("LTL") LINEHAUL SERVICE: This service provides for the shipment of a load, typically consisting of up to 30 shipments, each weighing as little as 50 pounds or as much as 20,000 pounds, from multiple shippers destined to multiple receivers. Our temperature-controlled LTL operation is the largest in the United States and the only one offering regularly scheduled nationwide service. In providing refrigerated LTL service, multi-compartment trailers enable us to haul products requiring various levels of temperature control as a single load.
- BROKERAGE: Our brokerage operation helps us to balance the level of demand in our core trucking business. Orders for shipments to be transported for which we have no readily available transportation assets are assigned to other unaffiliated motor carriers through our brokerage service. We establish the price to be paid by the customer and we invoice the customer. Accordingly, we also assume the credit risk associated with the transaction. Our brokerage service also pays the other motor carrier and earns a margin on the difference.
- OTHER: During the last four months of 2005, many of our resources were engaged in providing relief to the regions affected by Hurricanes Katrina and Rita. We provided dedicated fleet services, which contributed revenue of $5.7 million in 2005 and $500 thousand for similar services in 2006. No such revenue was generated during 2007. We also provided temperature-controlled trailers, which were rented on a per-day basis for storage and transportation of perishable items. Such hurricane-related trailer rentals generated revenue of $3.2 million during the final three months of 2005 and $2.2 million for rentals that continued into 2006.
The following table summarizes and compares the components of our revenue for each of the years in the five-year period ended December 31, 2007 (in millions):
Additional information regarding our business is presented in the Notes to Consolidated Financial Statements included in Item 8 and in Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of this Annual Report on Form 10-K.
We offer nationwide services to nearly 10,000 customers, none of which accounted for more than 10% of total revenue during each of the past five years. Revenue from international activities was less than 10% of total revenue during each of the past five years.
Our temperature-controlled and non-temperature-controlled ("dry") trucking operations serve nearly 10,000 customers in the United States, Mexico and Canada. Temperature-controlled shipments account for about 75% of our total revenue. Our customers are involved in a variety of products including food products, pharmaceuticals, medical supplies and household goods. Our customer base is diverse in that our 5, 10 and 20 largest customers accounted for 22%, 32% and 42%, respectively, of our revenue during 2007. None of our markets are dominated by any single competitor. We compete with several thousand other trucking companies. The principal methods of competition are price, quality of service and availability of equipment needed to satisfy customer requirements.
Temperature-Controlled Trucking:> The products we haul include meat, ice, poultry, seafood, processed foods, candy and other confectionaries, dairy products, pharmaceuticals, medical supplies, fresh and frozen fruits and vegetables, cosmetics, film and Christmas trees. In the temperature-controlled market, it may be necessary to keep freight frozen, as with ice; to keep freight cool, as with candy; or to keep freight from freezing, for example, when delivering fresh produce or flowers to Minnesota during winter. The common and contract hauling of temperature-sensitive cargo is highly fragmented and comprised primarily of carriers generating less than $50 million in annual revenue. Industry publications report that only twelve other temperature-controlled carriers generated $100 million or more of revenue in 2006, the most recent year for which data is available. In addition, many major food companies, food distribution firms and grocery chain companies transport a portion of their freight with their own fleets ("private carriage").
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High-volume shippers frequently seek to lower their cost structures by reducing their private carriage capabilities by turning to common and contract carriers ("core carriers") for their transportation needs. As core carriers continued to improve their service capabilities through such means as satellite communications systems and electronic data interchange, some shippers abandoned their private carriage fleets in favor of common or contract carriage.
Non-Temperature-Controlled Trucking: Our non-temperature-controlled (“dry”) trucking fleet conducts business under the name American Eagle Lines ("AEL"). AEL accounts for about 35% of our truckload linehaul revenue. AEL serves the dry truckload market throughout the United States and Canada. Also, during 2007, about 10% of the truckload shipments transported by our temperature-controlled fleets were of dry commodities.
Intermodal: > In providing our truckload linehaul service, we often engage railroads to transport shipments between major cities. In such an arrangement (called "intermodal" service), loaded trailers are transported to a rail facility and placed on flat cars for transport to their destination. On arrival, we pick up the trailer and deliver the freight to the consignee. Intermodal service is generally less costly than using one of our own trucks for such movements, but other factors also influence our decision to utilize intermodal services.
The management of a number of factors is critical to a trucking company's growth and profitability, including:
Employee-Drivers:> We maintain an active driver recruiting program. Driver shortages and high turnover can reduce revenue and increase operating expenses through reduced operating efficiency and higher recruiting costs. Since 2002, our operations have periodically been affected by driver shortages. At various times, we have not been able to attract and retain a sufficient number of qualified drivers.
For much of 2003, the labor market remained soft, and we experienced less difficulty in attracting qualified employee-drivers than in 2002. From 2003 into the first part of 2007, the economy has improved and our ability to attract such drivers has been negatively impacted. During 2007 and into 2008, the economy has weakened and driver retention has improved. If the economy strengthens during 2008, the availability of qualified drivers could continue to diminish. Effective April 2006, we implemented a general rate increase of $0.02 per mile, an increase of about 6%, for all employee-drivers.
During 2007, our employee-driver turnover rate was approximately 90%, depending on a number of factors, as compared to industry averages exceeding 120% during the same period. If we can retain a driver through the fairly difficult first six- to twelve-month period, we usually have the opportunity to retain them for the long-term. For example, the average tenure for all of our drivers at the end of 2007 was 3.4 years, but for trainees, the average tenure was 2.5 months. Among drivers who have been with us for at least one year, the average tenure was 5.6 years.
Owner-Operators:> We actively seek to expand our fleet with equipment provided by owner-operators, who act as independent contractors. Owner-operators provide tractors and drivers to pull our loaded trailers. Each owner-operator pays for the drivers' wages, fuel, equipment-related expenses and other transportation expenses and receives either a portion of the revenue from each load or a guaranteed rate per mile. At the end of 2007, we had contracts for 412 owner-operator tractors in our truckload operations and 162 in our LTL operations. Of the 412 truckload tractors, 264 were owned by us and leased to the involved owner-operators.
The percent of linehaul truckload and LTL revenue generated from shipments transported by owner-operators during each of the last five years is summarized below:
To compensate owner-operators for the use of their trucks, we pay them commissions that are based either upon the amount of revenue we earn from the shipments they transport or upon the miles their trucks travel to haul our freight. Freight hauled by an owner-operator is transported under operating authorities and permits issued to us by various state and federal agencies. We, and not the owner-operator, are accountable to the customers for any problems encountered related to the shipment. We, and not the owner-operator, have sole discretion as to the price the customer will pay for the service, and owner-operators may decline to haul specific loads for any reason, including their belief that their revenue-based commission will not be to their satisfaction. Further, we, and not the owner-operator, are 100% at risk for credit losses should the customer fail to pay us for the service. For these reasons, revenue from shipments hauled by owner-operators is recorded as gross of owner-operator commissions, rather than as an agent net of such commissions.
Fuel:> Our average cost per gallon of fuel doubled between 2003 and 2007, including an increase of approximately 14% in 2006, and an increase of 7% during 2007, each as compared to the prior year. Through February of 2008, the cost per gallon of fuel has increased an additional 19% over that of 2007. Owner-operators are responsible for all costs associated with their equipment, including fuel. Therefore, the cost of such fuel is not a direct expense of ours. Fuel price fluctuations result from many external market factors that cannot be influenced or predicted by us.
In most years states increase fuel and road use taxes. Our recovery of future increases or realization of future decreases in fuel prices and fuel taxes, if any, will continue to depend upon competitive freight market conditions.
We do not hedge our exposure to volatile energy prices. We are able to mitigate the impact of such volatility by adding fuel surcharges to the basic rates for the services we provide. Surcharges are designed to, but often do not, fully offset the increased fuel expenses we incur when prices escalate rapidly.
Though we will continue to add fuel surcharges whenever possible, there can be no assurance that we can add them in an amount sufficient to minimize the impact of fuel prices on our results of operations.
Factors that could prevent us from fully recovering fuel cost increases include the competitive environment, deadhead (empty) miles, tractor engine idling and fuel to power our trailer refrigeration units. Such fuel consumption often cannot be attributed to a particular load and therefore, there is no incremental revenue to which a fuel surcharge may be applied. Also, our fuel surcharges are computed by reference to federal government indices that are released weekly for the preceding week. When prices are rising, our fuel cost in a given week is more than the price indicated by the government reports for the preceding week. Accordingly, we are unable to recover the excess of the current week's actual price to the preceding week's indexed price.
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The Environmental Protection Agency (“EPA”) has mandated lower emission standards for newly manufactured tractor engines. We scheduled our new equipment purchases to accommodate these new standards to allow adequate testing of the new engines. The 2007 EPA-compliant engines are equipped with a diesel particulate filter and will require more costly ultra-low-sulfur diesel (ULSD) fuel. ULSD fuel costs approximately $0.04 to $0.05 more per gallon.
Risk Management:> Liability for accidents is a significant concern in the trucking industry. Exposure can be large and occurrences can be unpredictable. The cost and human impact of work-related injury claims can also be significant. We maintain a risk management program designed to minimize the frequency and severity of accidents and to manage insurance coverage and claims expense.
Our risk management program is founded on the continual enhancement of safety in our operations. Our safety department conducts programs that include driver education and over-the-road observation. All drivers must meet or exceed specific guidelines relating to safety records, driving experience and personal standards, including a physical examination and mandatory drug testing.
Drivers must also complete our training program, which includes tests for motor vehicle safety and over-the-road driving. They must have a current commercial driving license before being assigned to a tractor. Student drivers undergo a more extensive training program with an experienced instructor-driver. In accordance with federal regulations, we conduct drug tests on all driver candidates and maintain a continuing program of random testing for use of such substances. Applicants who test positive for drugs are turned away and drivers who test positive for such substances are immediately disqualified.
As of December 31, 2007, our liability insurance provides for a $3 million deductible for each occurrence. We are fully insured between $3 million and $5 million per occurrence. The insurance company and we share in losses on a 75%/25% basis between $5 million and $10 million per occurrence. Accordingly, our maximum exposure for a $10 million insured loss is $4.25 million. We are fully insured for liability exposures between $10 million and $50 million. Our liability insurance policies will expire in mid-2008, at which time these coverage levels may change. Insurance premiums do not significantly contribute to our operating costs, primarily because we carry large deductibles under our policies of liability insurance.
Because of our retained liability, a series of very serious traffic accidents, work-related injuries or unfavorable developments in the outcomes of existing claims could materially and adversely affect our operating results. Claims and insurance expense can vary significantly from year to year. Reserves representing our estimate of ultimate claims outcomes are established based on the information available at the time of an incident. As additional information regarding the incident becomes available, any necessary adjustments are made to previously recorded amounts. The aggregate amount of open claims, some of which involve litigation, is significant.
During December, 2007, a major ice storm hit the mid-section of the United States. One of our trucks was involved in a chain-reaction accident on an icy bridge. Due to various factors and events that occurred relative to this incident, we established a significant reserve for the outcome of this event.
We engage the services of an independent actuarial firm to analyze our claims history and to establish reasonable estimates of our claims reserves. In addition, the actuarial firm provided us procedures with which to establish appropriate claims reserves in future periods.
Customer Service>: Major shippers continue to require increasing levels of service and rely on their core carriers to provide transportation and logistics solutions, such as providing the shipper real-time information about the movement and condition of any shipment.
Temperature-controlled truckload service requires a substantially lower capital investment for terminals and lower costs for shipment handling and information management than does LTL. At the end of 2007, our truckload tractor fleet consisted of 1,271 tractors owned or leased by us and 412 tractors contracted to us by owner-operators, making us one of the seven largest temperature-controlled truckload carriers in North America.
We conduct operations involving "dedicated fleets". In such an arrangement, we contract with a customer to provide service involving the assignment of specific trucks to handle the transportation needs of a specific customer. Frequently, we and our customers anticipate that dedicated fleet logistics services will lower the customer's transportation costs and improve the quality of the service the customer receives. We continuously improve our capability to provide and to market our dedicated fleet services. About 9% of our company-operated truckload fleet is now engaged in dedicated fleet operations.
Temperature-controlled LTL trucking is service and capital intensive. LTL freight rates are higher than those for truckload and are based on mileage, weight, commodity type, trailer space, and pick-up and delivery locations. Temperature-controlled LTL trucking requires a system of terminals capable of temporarily holding refrigerated and frozen products. Our LTL terminals are strategically located in or near New York City, Philadelphia, Atlanta, Lakeland (Florida), Miami, Chicago, Memphis, Dallas, Salt Lake City, Modesto (California) and Los Angeles. Some of these LTL terminals also serve as truckload driver centers where company-operated, truckload fleets are based. Additional truckload operations are based in our Ft. Worth, Texas facility.
Information Management:> Information management is essential to a successful temperature-controlled trucking operation. On a typical day, our LTL system handles about 6,000 shipments - about 4,000 on the road, 1,000 being delivered and 1,000 being picked up. In 2007, our LTL operation handled almost 280,000 individual shipments.
Our truckload fleets use computer and satellite technology to enhance efficiency and customer service. The satellite-based communications system provides automatic hourly position updates of each truckload tractor and permits real-time communication between operations personnel and drivers. Dispatchers relay pick-up, delivery, weather, road and other information to the drivers while shipment status and other information is relayed by the drivers to our computers via the satellite.
International Operations:> Service to and from Canada is provided using tractors from our fleets. We partner with Mexico-based trucking companies to facilitate freight moving both ways across the southern United States border. Freight moving from Mexico is hauled in our trailers to the border by the Mexico-based carrier, where the trailers are exchanged. Southbound shipments work much the same way. This arrangement has been in place for more than ten years.
In February, 2007, the United States Department of Transportation (“DOT”) announced a new program to allow United States-based trucks into Mexico for the first time ever and to change how some Mexico-based trucks may operate within the United States. Regarding the ability of Mexican trucks to operate within the United States, the DOT has put in place a rigorous inspection program to ensure the safe operation of Mexico-based trucks crossing the border. Mexican trucking companies that may be allowed to participate in this program will be required to have insurance with a U.S. licensed firm and meet all U.S. safety standards. Companies that meet these standards will be allowed to make international pick up and deliveries only and will not be able to move goods from one U.S. city for delivery to another.
We do not expect to change our manner of dealing with freight to or from Mexico. Although we serve customers in Mexico, less than 10% of our consolidated linehaul revenue during 2007 involved international shipments, all of which was billed in United States currency.
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We operate premium company-owned tractors in order to help attract and retain qualified employee-drivers, promote safe operations, minimize maintenance and repair costs and assure dependable service to our customers. We believe the higher initial investment for our equipment is recovered through more efficient vehicle performance offered by such premium tractors and improved resale value. Repair costs are mostly recovered through manufacturers' warranties, but routine and preventative maintenance is our expense.
When we put a new truck into service, we and the manufacturer typically agree that the manufacturer will purchase that truck from us at the end of the truck’s service life, typically after 42 months.
Changes in the size of our fleet depend upon acquisitions, if any, of other motor carriers, developments in the nation's economy, demand for our services and the availability of qualified drivers. Continued emphasis will be placed on improving the operating efficiency and increasing the utilization of the fleet through enhanced driver training and retention and reducing the percentage of empty, non-revenue producing miles. Due to the current softness in customer demand for our services, we do not plan to add trucks to our company-operated, truckload fleet during 2008.
The federal government has required new technology for truck engines. The new technology is designed to reduce emission from diesel engines. Our cost of new trucks increased 12.5% largely due to the new engines. The newer engines are also more costly to maintain over the service life of the trucks. In order to delay the purchase price increase, the additional maintenance expenses and other uncertainties involved with the new technology engines, we took delivery during late 2006 and early 2007 of 720 trucks without the new technology, and retired a number of older 2003 and 2004 model trucks from service. In late 2007, we placed 34 trucks with the EPA compliant engines in service, and expect to add another 518 as replacements for older tractors in 2008. Because we retired older equipment with our pre-purchase strategy, we did not have an excess number of trucks sitting idle, as did many other companies who purchased the old-technology trucks.
Our trucking operations are regulated by the DOT. The DOT generally governs matters such as safety requirements, registration to engage in motor carrier operations, certain mergers, insurance, consolidations and acquisitions. The DOT conducts periodic on-site audits of our compliance with its safety rules and procedures. Our most recent audit, which was completed in March of 2008, resulted in a rating of "satisfactory", the highest safety rating available. A "conditional" or "unsatisfactory" DOT safety rating could have an adverse effect on our business, as some of our contracts with customers require a satisfactory rating and our qualification to self-insure our liability claims would be impaired.
During 2005, the Federal Motor Carrier Safety Administration ("FMCSA") began to enforce changes to the regulations which govern drivers' hours of service. Hours of Service ("HOS") rules issued by the FMCSA, in effect since 1939, generally limit the number of consecutive hours and consecutive days that a driver may work. The new rules reduced by one hour the number of hours that a driver may work in a shift, but increased by one hour the number of hours that a driver may drive during the same shift. Drivers often are working at a time they are not driving. Duties such as fueling, loading and waiting to load count as part of a driver's shift that are not considered driving. Under the old rules, a driver was required to rest for at least eight hours between shifts. The new rules increased that to ten hours, thereby reducing the amount of time a driver can be "on duty" by two hours.
Because of the two additional hours of required rest period time and the amount of time our drivers spend loading and waiting to load, we believe the new rules have reduced our productivity and may negatively impact our profitability during 2008 and beyond. Accordingly, we are seeking pricing concessions from our customers to mitigate the impact on our profitability.
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. We have plans to equip all of our truckload linehaul tractors with on-board power units that do not require the engine to idle by the end of 2008. In the meantime, these restrictions could force us to alter our drivers’ behavior, accelerate the purchase of the on-board power units or face a decrease in productivity.
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 required vendors to introduce new engines. Additional EPA-mandated emission standards will become effective for newly manufactured trucks beginning in January 2010. Our business could be harmed if we are unable to continue to obtain an adequate supply of new tractors and trailers. We expect to continue to pay increased prices for equipment. At December 31, 2007, only 2% of our tractor fleet was comprised of tractors with pre-2007 engines that meet EPA-mandated clean air standards. By year-end 2008, approximately one-third of our fleet will have the new engines. We are also subject to regulation by various state regulatory agencies with respect to certain aspects of our operations. State regulations generally involve safety and the weight and dimensions of equipment.
Our temperature-controlled truckload operations are somewhat affected by seasonal changes. The growing seasons for fruits and vegetables in Florida, California and Texas typically create increased demand for trailers equipped to transport cargo requiring refrigeration. Our LTL operations are also impacted by the seasonality of certain commodities. LTL shipment volume during the winter months is normally lower than other months. Shipping volumes of LTL freight are usually highest during July through October. LTL volumes also tend to increase in the weeks preceding holidays such as Thanksgiving, Christmas and Easter when significant volumes of food and candy are shipped. Severe winter driving conditions can be hazardous and impair all of our trucking operations from time to time.
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The number of our employees, none of whom are subject to collective bargaining arrangements, as of December 31, 2007 and 2006 was as follows:
This report contains information and forward-looking statements that are based on management's current beliefs and expectations and assumptions we made based upon information currently available. Forward-looking statements include statements relating to our plans, strategies, objectives, expectations, intentions and adequacy of resources and may be identified by words such as "will", "could", "should", "believe", "expect", "intend", "plan", "schedule", "estimate", "project" and similar expressions. These statements are based on our current expectations and are subject to uncertainty and change.
Although we believe the expectations reflected in such forward-looking statements are reasonable, actual results could differ materially from the expectations reflected in such forward-looking statements. Should one or more of the risks or uncertainties underlying such expectations not materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those we expect.
Factors that are not within our control that could cause actual results to differ materially from those in such forward-looking statements include demand for our services and products, and our ability to meet that demand, which may be affected by, among other things, competition, weather conditions and the general economy, the availability and cost of labor and owner-operators, our ability to negotiate favorably with lenders and lessors, the effects of terrorism and war, the availability and cost of equipment, fuel and supplies, the market for previously-owned equipment, the impact of changes in the tax and regulatory environment in which we operate, operational risks and insurance, risks associated with the technologies and systems we use and the other risks and uncertainties described in Item 1A, Risk Factors of this report and risks and uncertainties described elsewhere in our filings with the Securities and Exchange Commission (“SEC”).
INTERNET WEB SITE
We maintain a web site, www.ffex.net, on the Internet where additional information about our company is available. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, press releases, earnings releases and other reports filed with and furnished to the SEC, pursuant to Section 13 or 15(d) of the Exchange Act are available, free of charge, on our web site as soon as practical after they are filed.
We have adopted a Code of Business Conduct and Ethics for our Board of Directors, our Chief Executive Officer, principal financial and accounting officers and other persons responsible for financial management and our employees generally. We also have charters for the Audit Committee, Compensation Committee, and Nominating Committee of our Board of Directors. Copies of the foregoing documents may be obtained on our website as noted in the above paragraph, and such information is available in print to any shareholder who requests it.
The annual, quarterly, special and other reports we file with and furnish to the SEC are available at the SEC's Public Reference Room, located at 100 F Street, NE, Room 1580, Washington, D.C. 20549. Information may be obtained on the operation of the Public Reference Room by calling the SEC at 1-800-732-0330. The SEC also maintains a web site at www.sec.gov. The SEC site also contains information we file with and furnish to the agency.
ITEM 1A. Risk Factors>.
There are numerous factors that affect our business and our operating results, many of which are beyond our control. The following is a description of significant factors that might cause our future operating results to differ materially from those currently expected. The risks described below are not the only risks facing us. Additional risks and uncertainties not specified herein, not currently known to us or currently deemed to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
We are subject to general economic factors and business risks that are beyond our control, any of which could significantly reduce our operating margins and income. > Recessionary economic cycles, changes in customers' business activity and outlook and excess tractor or trailer capacity in comparison with shipping demands could impact our operations. Economic conditions that decrease shipping demand or increase the supply of tractors and trailers generally available in the transportation sector of the economy can exert downward pressure on our equipment utilization, thereby decreasing asset productivity. Economic conditions also may harm 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 uncollectible accounts.
We are also subject to increases in costs that are outside of our control that could materially reduce our profitability if we are unable to increase our rates sufficiently. Such cost increases include, but are not limited to, declines in the resale value of used equipment, increases in interest rates, fuel prices, taxes, tolls, license and registration fees, insurance, revenue equipment, and wages and health care for our employees.
In addition, we cannot predict the effects on the economy or consumer confidence of actual or threatened armed conflicts or terrorist attacks, efforts to combat terrorism, military action against a foreign state or group located in a foreign state, or heightened security requirements. Enhanced security measures could impair our operating efficiency and productivity and result in higher operating costs.
Future insurance and claims expense could reduce our earnings. > Our future insurance and claims expense might exceed historical levels, which could reduce our earnings. We self-insure significant portions of our claims exposure resulting from work-related injuries, auto liability, general liability, cargo and property damage claims, as well as employees' health insurance. We reserve currently for anticipated losses and expenses. We periodically evaluate and adjust our claims reserves to reflect our experience. However, ultimate results usually differ from our estimates.
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We maintain insurance above the amounts for which we self-insure. Although we believe the aggregate insurance limits should be sufficient to cover reasonably expected claims, it is possible that one or more claims could exceed our aggregate coverage limits. Insurance carriers have raised premiums for many businesses, including trucking companies. As a result, our insurance and claims expense could increase, or we could raise our self-insured retention when our policies are renewed. If these expenses increase, if we experience a claim in excess of our coverage limits, or if we experience a claim for which coverage is not provided, results of our operations and financial condition could be materially and adversely affected.
Higher fuel prices could reduce our income. > We are subject to risk with respect to purchases of fuel for use in our tractors and refrigerated trailers. Fuel prices are influenced by many factors that are not within our control. Because our operations are dependent upon diesel fuel, significant increases in diesel fuel costs could materially and adversely affect our results of operations and financial condition unless we are able to pass increased costs on to customers through rate increases or fuel surcharges. Historically, we have sought to recover increases in fuel prices from customers through fuel surcharges. Fuel surcharges that can be collected have not always fully offset the increase in the cost of diesel fuel in the past and there can be no assurance that fuel surcharges that can be collected will offset the increase in the cost of diesel fuel in the future.
We will have significant ongoing capital requirements which could negatively impact our growth and profitability. > The trucking industry is capital intensive, and replacing older equipment requires significant investment. If we elect to expand our fleet in future periods, our capital needs would increase. We expect to pay for our capital expenditures with cash flows from operations, leasing and borrowings under our revolving credit facility. If we are unable to generate sufficient cash from operations and obtain financing on favorable terms, we may need to limit our growth, enter into less favorable financing arrangements or operate our revenue equipment for longer periods, any of which could impact our profitability.We rely on our key management and other employees and depend on recruitment and retention of qualified personnel; difficulty in attracting or retaining qualified employee-drivers and independent contractors who provide tractors for use in our business could impede our growth and profitability. > A small number of key executives manage our business. Their departure could have a material adverse effect on our operations. In addition, our performance is primarily dependent upon our ability to attract and retain qualified drivers. Our independent contractors are responsible for paying for their own equipment, labor, fuel, and other operating costs. Significant increases in these costs could cause them to seek higher compensation from us or other opportunities. Competition for employee-drivers continues to increase. If a shortage of employee-drivers occurs, or if we were unable to continue to sufficiently contract with independent contractors, we could be forced to limit our growth or experience an increase in the number of our tractors without drivers, which would lower our profitability. During April 2006, we increased our employee-driver pay scale by about 6%. We could be required to further adjust our driver compensation, which could impact our profitability if not offset by a corresponding increase in the rates we charge for our services.
Reductions in service by the railroads or increases in railroad rates can impact our intermodal operations, which could reduce our income.> Our intermodal operations are dependent on railroads, and our dependence on railroads may increase if we expand our intermodal services. In most markets, rail service is limited to a few railroads or even a single railroad. Any reduction in service by the railroads may increase the cost of the rail-based services we provide and reduce the reliability, timeliness and overall attractiveness of our rail-based services. Railroads are relatively free to adjust their rates as market conditions change. That could result in higher costs to our customers and impact our ability to offer intermodal services. There is no assurance that we will be able to negotiate replacement of or additional contracts with railroads, which could limit our ability to provide this service.
Interruptions in the operation of our computer and communications systems could reduce our income. > We depend on the efficient and uninterrupted operation of our computer and communications systems and infrastructure. Our operations and those of our technology and communications service providers are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure, terrorist attacks, Internet failures, computer viruses and other events beyond our control. In the event of a system failure, our business could experience significant disruption. To mitigate this risk, we have established an off-site facility where our data and processing functions are replicated.
Changes in the availability of or the demand for new and used trucks could reduce our growth and negatively impact our income. > More restrictive federal emissions standards for 2007 model year trucks require new technology diesel engines. 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. The new engines are also expected to reduce equipment productivity, increase fuel consumption and be more expensive to maintain.
We have a conditional commitment from our principal tractor vendor regarding the amount that we will be paid on the disposal of most of our tractors. We could incur a financial loss upon disposition of our equipment if the vendor cannot meet its obligations under these agreements.
We are subject to various environmental and zoning laws and regulations, and costs of compliance with and liabilities for violations of existing or future regulations could significantly increase our costs of doing business. > We operate in industrial areas, where truck terminals and other industrial facilities are located, and where groundwater or other forms of environmental contamination may have occurred. Our operations involve the risks of fuel spillage, environmental damage and hazardous waste disposal, rezoning and eminent domain, among others. If we are involved in a spill or other accident involving hazardous substances, if one of our properties is rezoned, if a governmental agency should assert a right involving eminent domain or if we are found to be in violation of applicable laws or regulations, such an event could significantly increase our cost of doing business. Additionally, under specific environmental laws, we could be held responsible for all of the costs relating to any contamination at our past or present terminals and at third-party waste disposal sites.
We operate in an industry subject to extensive government regulations, and costs of compliance with and liability for violation of existing or future regulations could significantly increase our costs of doing business. > Our operations are overseen by various agencies. Our drivers must comply with federal safety and fitness regulations, including those relating to drug and alcohol testing and hours of service. Such matters as weight and equipment dimensions are also the subject of federal and state regulations. We are also governed by federal and state regulations regarding fuel emissions, and other matters affecting safety or operations. Future laws and regulations may be more stringent and may influence the demand for transportation services, may require us to make changes in our operating practices, or may 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.
We may not be able to improve our operating efficiency rapidly enough to meet market conditions.> Because the markets in which we operate are highly competitive, we must continue to improve our operating efficiency in order to maintain or improve our profitability. Although we have been able to improve efficiency and reduce costs in the past, there is no assurance that we will continue to do so in the future. In addition, the need to reduce ongoing operating costs may result in significant up-front costs to reduce workforce, close or consolidate facilities, or upgrade equipment and technology.
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An extended disruption of vital infrastructure could negatively impact our business, results of operations and financial condition.> Our operations depend upon, among other things, our infrastructure, including equipment and facilities. Extended disruption of vital infrastructure by fire, power loss, natural disaster, telecommunications failure, computer hacking or viruses, technology failure, terrorist activity or the domestic and foreign response to such activity, or other events outside of our control could have a materially adverse impact on the transportation services industry as a whole and on our business, results of operations, cash flows, and financial condition in particular. Our business recovery plan may not work as intended or may not prevent significant interruptions of our operations.
Our operations could be adversely affected by a work stoppage at locations of our customers.> Although none of our employees are covered by a collective bargaining agreement, a strike or other work stoppage at a customer could negatively affect our revenue and earnings and could cause us to incur unexpected costs to redeploy or deactivate assets and personnel.
We operate in a competitive and somewhat fragmented industry. Numerous factors could negatively impair our growth and profitability and impair our ability to compete with other carriers and private fleets.
We are subject to anticipated future increases in the statutory federal tax rate. >An increase in the statutory rate would increase our tax expense. In addition, our net deferred tax liability is stated net of offsetting deferred tax assets. The assets consist of anticipated future tax deductions for items such as personal and work-related injuries and bad debt expenses which have been reflected on our financial statements but which are not yet tax deductible. At current federal tax rates, we will need to generate sufficient future taxable income in order to fully realize our deferred tax assets. Due to probable tax rate increases in the future, we would be required to adjust our deferred tax liabilities at that time to reflect higher federal tax rates.
Other Risks Related to Our Business. >Other risk factors include, but are not limited to, changes in the mix of our services, changes in legislation applicable to us, changes in market demand or our business strategies, potential litigation and claims arising in the normal course of business, credit risk of customers and other risk factors.
The following tables set forth certain information regarding our revenue equipment at December 31, 2007 and 2006:
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Approximately three-fourths of our trailers are insulated and equipped with refrigeration units capable of providing the temperature control necessary to handle perishable freight. Trailers that are used primarily in LTL operations are equipped with movable partitions permitting the transportation of goods requiring maintenance of different temperatures. We also operate a fleet of non-refrigerated trailers in our "dry freight" truckload operation. Company-operated trailers are primarily 102 inches wide. Truckload trailers used in dry freight linehaul operations are 53 feet long. Linehaul temperature-controlled operations are conducted with both 48- and 53-foot refrigerated trailers.
Our general policy is to replace our company-operated, heavy-duty tractors after 42 months, subject to cumulative mileage and condition. Our refrigerated and dry trailers are usually retired after seven or ten years of service, respectively. Occasionally, we retain older equipment for use in local delivery operations.
At December 31, 2007, in addition to a number of smaller rented recruiting and sales offices around the United States, we maintained terminal or office facilities of 10,000 square feet or more in or near the cities listed below. Lease terms range from one month to twelve years. We expect that our present facilities are sufficient to support our operations. We also own three properties in Texas that we lease to W&B Service Company, L. P. (“W&B”), an entity in which we hold a minority ownership interest.
*Facilities are part of an industrial park in which we share acreage with other tenants.
Most of our terminals serve as satellite offices for our brokerage operation, FFE Logistics, Inc. (“FFEL”). In other markets, FFEL also leases small sales offices. FFEL has also expanded from one office at the end of 2006 to twelve as of December 31, 2007.
During 2007, we learned that the (owned) terminal near Newark and the (leased) facility near Los Angeles have been targeted for eminent domain proceedings by the cities in which they are located. We are currently working with the appropriate authorities to accommodate our need to sell the New Jersey property and vacate the premises in an orderly fashion. We have owned the New Jersey property for about 20 years, and it is not subject to any liens. When we sell the property to a user that meets the standards of the city, we project that we will realize a substantial gain and receive cash for the full sales price. We are currently searching for a new location in the northern and central sections of New Jersey. We currently are planning to lease, rather than own, the new facility. This matter should be concluded during 2008.
With regard to the leased southern California location, the city in which it is located has informed the property owner and us that it plans to construct a water tower and pumping station on the property. Our lease expires late in 2011, and we do not expect the city to take action until at least that time. We are currently looking for a replacement facility, which we intend to lease on a long-term basis.
ITEM 3. Legal Proceedings.
We are party to routine litigation incidental to our business, primarily involving claims for personal injury, property damage, work-related injuries of employees and cargo losses incurred in the ordinary and routine highway transportation of freight. As of December 31, 2007, the aggregate amount of reserves for such claims on our consolidated balance sheet was nearly $21.7 million. We also primarily insure for employee health care claims. We maintain excess insurance programs and accrue for expected losses in amounts designed to cover liability resulting from such claims.
On January 4, 2006, Owner Operator Independent Drivers Association, Inc., Warrior Transportation, Roy Clark, and Gregory Colvin d/b/a Wolverine Trucking, Inc. filed a lawsuit in the U.S. District Court for the Northern District of Texas, Dallas Division, on behalf of themselves and all others similarly situated against our principal operating subsidiary FFE Transportation Services, Inc. (“FFE”). Plaintiffs alleged that FFE’s Independent Contractor Agreements (“ICA”) violated the federal Truth in Leasing Regulations that govern the content of agreements, such as the ICAs, between independent drivers and trucking companies. Plaintiffs seek certification of a class consisting of every contractor who signed an ICA with FFE since January 4, 2002. According to Plaintiffs, FFE violated the regulations by deducting amounts from the proposed class members’ escrow accounts to pay obligations that were not specified with particularity. Plaintiffs further alleged that FFE improperly deducted certain fees and charges from proposed class members' compensation at the time of payment. Plaintiffs also allege improper forced purchases in violation of the regulations. Plaintiffs seek damages, interest, costs and attorneys’ fees, as well as declaratory and injunctive relief.
On June 15, 2007, the Court denied Plaintiffs’ motion for class certification, leaving only the Plaintiffs’ individual claims for adjudication. The trial of those claims has been set for July 28, 2008. Plaintiffs have indicated an interest in settling the remaining claims. If the matter is not settled, FFE intends to vigorously contest Plaintiffs' claims.
On January 8, 2008, a shareholders’ derivative action was filed in the District Court of Dallas County, 192nd District, entitled James L. and Eleanor A. Gayner, Individually and as Trustees of The James L. & Eleanor 81 UAD 02/04/1981 Trust, Derivatively On Behalf of Frozen Food Express Industries, Inc. v. Stoney M. Stubbs, Jr., et al. This action alleges that certain of our current and former officers and directors breached their respective fiduciary duties in connection with our equipment lease arrangements with certain related-parties, which were terminated in September 2006. The shareholders seek, putatively on our behalf, an order that the lease arrangements were null and void from their origination, an unspecified amount of damages, the imposition of a constructive trust on any benefits received by the defendants as a result of their alleged wrongful conduct, and recovery of attorneys’ fees and costs. A special litigation committee (“SLC”) consisting solely of independent directors has been created to investigate the claims in the derivative action. As permitted by Texas law, we have requested the derivative action be stayed while the SLC conducts its investigation, which request has been opposed by the plaintiffs. The Court has not ruled on the Company’s request to stay the action.
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ITEM 5. Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.
Market for Registrant's Common Equity and Related Shareholder Matters.
During each of the five quarters ended December 31, 2007, we paid a cash dividend of $0.03 per share. Our Board of Directors intends to continue to declare such dividends on a quarterly basis in the future, subject to provisions in our credit agreement that may restrict our ability to do so without first obtaining consent from our lenders. We have not set any pre-established guidelines as to the per-share or aggregate quarterly amount of such dividends relative to net income or any other measurement.
As of March 7, 2008, we had approximately 3,000 beneficial shareholders, including participants in our retirement plans. Our $1.50 par value common stock trades on the Global Select Market tier of the Nasdaq Stock Market under the symbol FFEX. Information regarding our common stock is as follows:
Issuer Purchases of Equity Securities
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The following graph compares the cumulative total shareholder return on our common stock for the last five years to the S&P 500 Index and the Hemscott Industry Group Index #774- Trucking Companies (assuming the investment of $100 in our common stock, the S&P 500 Index and the Hemscott Industry Index on December 31, 2002 and reinvestment of all dividends).
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ITEM 6. Selected Financial Data.
The following unaudited data for each of the years in the five-year period ended December 31, 2007 should be read in conjunction with our Consolidated Financial Statements and Notes thereto included at Item 8 of this report and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in Item 7. The historical information is not necessarily indicative of future results or performance:
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
We are principally a motor-carrier, also commonly referred to as a trucking company. We offer various transportation services to customers in the United States, Canada and Mexico. Our services primarily involve the over-the-road movement of freight. In the United States, we sometimes arrange for the use of railroads to transport our loaded trailers between major cities. Most of our revenue is from service which is order-based, meaning that we separately bill our customers for each shipment. A minority of our revenue is from services which are asset-based, meaning that we bill our customer for the use of a truck and driver or the use of a trailer for a period of time, without regard to the number of shipments hauled. We also refer to such truck and driver asset-based service as "dedicated fleets", because the trucks and drivers involved are dedicated for use by a specific customer on a full-time basis.
Order-based services are either truckload or LTL. Our trailers are designed to carry up to 40,000 pounds of freight. Shipments weighing 20,000 pounds or more are truckload, while smaller shipments are classified as LTL.
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Customers let us know that they have shipments requiring transportation, and inform us as to any special requirements, such as an identification of the type of product to be shipped, the origin and destination of the load and the expected time by which delivery must occur. We inform our customers of our availability to haul the freight and of the price we will charge. If these fit with the needs of the customer, we pick up the freight.
Shipments have three stages: pick-up, linehaul and delivery. The linehaul stage is over-the-road and involves longer distances. Most of our truckload shipments will have all of these stages performed by the same truck and trailer.
LTL shipments typically involve different trucks and trailers for each of the three stages, including the linehaul stage, as the freight moves within our network of terminals. For example, an LTL truck bound from Los Angeles to Dallas may carry shipments destined for Dallas, Chicago and Atlanta. Once the truck arrives in Dallas, the freight will be sorted and sent out from Dallas on different trucks to Chicago and Atlanta with other LTL shipments that originated in Dallas or arrived there on trucks from other areas of the country. The freight destined for Dallas will be delivered by the city fleet. A linehaul load of LTL typically weighs 25,000 to 35,000 pounds and is comprised of between 5 and 30 individual shipments.
We are the only company that provides nation-wide, temperature-controlled LTL service. Other such LTL providers tend to operate on a regional basis. Our LTL trucks operate according to published schedules. That enables our customers to know when we will arrive to pick up or deliver a shipment. We rarely haul “dry” LTL freight.
We operate under four primary brand names, FFE Transportation Services ("FFE"), Lisa Motor Lines ("LML"), AEL and FFE Logistics, Inc. (“FFEL”). FFE and LML specialize in products that require temperature control. All of our LTL service is provided by FFE.
Most shipments require the maintenance of a temperature between minus 10 degrees and plus 60 degrees Fahrenheit. Examples include perishable food, beverages, candy, pharmaceuticals, photographic supplies and electronics. Other products require maintenance of a warm temperature in the colder months to prevent freezing while in transit, such as nursery stock and liquid products. FFE conducts all of our LTL business, and also has significant order-based and asset-based truckload operations. LML has specialized in order-based truckload operations, but in the second half of 2007 has focused more on asset-based dedicated fleet operations. AEL serves the market for order-based and asset-based truckload activities that do not require temperature control. FFE Logistics is our brokerage service, negotiating third-party truckload transportation of both dry and refrigerated freight.
The assets we must have for temperature-controlled service are costly to acquire and maintain. The rates we charge for our temperature-controlled services are usually higher than other companies who offer no temperature-controlled services. Many products that require protection from the heat during the warmer months of the year do not require protection during the colder months. Therefore, during the warmer months, demand for our temperature-controlled truckload and LTL services expands. Demand for our LTL service also swells in the weeks before a holiday, when retailers are stocking extra food and candy to meet the seasonal demands of their customers.
There are several companies that provide national temperature-controlled truckload services. We know of no other company providing nationwide LTL temperature-controlled service. The vast majority of trucking companies that are nationwide in scope, such as our AEL brand, offer only truckload service with no temperature control. Therefore, the markets that are served by AEL tend to be very price-competitive and generally lack the level of seasonality present in our FFE and LML operations. Because consumer demand for products requiring temperature control is often less sensitive to economic cycles, linehaul revenue from FFE and LML tends to be less volatile during such cycles.
The trucking business is highly competitive. During 2006, the last year for which data is available, there were several thousand companies operating in all sectors of the trucking business in the United States. Among those, the top five companies offering primarily temperature-controlled services collectively generated 2006 revenue of $2.6 billion. The next 20 such companies collectively generated revenues of $2.2 billion. In 2006, we ranked third in terms of revenue generated among all temperature-controlled motor carriers.
We have nearly 10,000 active customers for our trucking business. We generally collect payment for our services between 30 and 50 days after our service is provided.
Trucking companies of our size face challenges to be successful. Costs for labor, maintenance, fuel and insurance typically change every year. Fuel prices can increase or decrease quite rapidly. Due to the high level of competitiveness, it is often difficult to pass these rising costs on to our customers. Over the past few years, many trucking companies have ceased operations, resulting in a reduced number of alternatives and increasing the awareness among customers that price increases for trucking services are likely.
The capacity of the trucking industry to haul freight increased during 2006. Over the same time, customer demand for such services diminished. One result was increased industry-wide downward pressure on the rates truckers can charge for their services. Although there can be no assurance this supply/demand imbalance will be corrected in the near-term, such situations have occurred periodically in the past, and are likely to recur in the future.
During the latter part of 2005, many of our resources were engaged in providing relief to the regions affected by Hurricanes Katrina and Rita. We provided dedicated fleet services in these hurricane relief efforts, which contributed revenue of $5.7 million during 2005 and $500 thousand during 2006, respectively. We also provided refrigerated trailers, which were rented on a per-day basis for storage and transportation of perishable items. Such hurricane-related trailer rentals generated $3.2 million of revenue during 2005 and $2.2 million in 2006.
During 2007, the commodities we hauled most frequently included the following:
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In last year’s annual report, we outlined a few areas that we expected to explore during 2007. Below is a comparison of what we said then and what the current status is:
In April of 2008, we are convening our first customer advisory board. The board will be comprised of up to ten key customers who will meet with our senior management team twice per year. We will use what we learn from the board to stay abreast of market conditions and competitive environments and to help us shape our strategic initiatives going forward. We consider customer insight invaluable in determining how we shape our future plans.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have made several critical accounting estimates. These require a more significant amount of management judgment than the other accounting policies we employ. Our critical accounting policies are as follows:
Revenue and Expense Recognition:> We recognize revenue and all estimated direct operating expenses such as fuel and labor on the date we pick up shipments from our customers. In 1991, the Emerging Issues Tax Force ("EITF") of the Financial Accounting Standards Board promulgated Issue 91-9, Revenue and Expense Recognition for Freight Services in Process ("EITF 91-9"). In 2001, the Securities and Exchange Commission issued Staff Accounting Bulletin 101, Revenue Recognition in Financial Statements ("SAB 101"), which provides that EITF 91-9 determines the revenue and expense recognition methods that may be used in our industry. Therefore, according to EITF 91-9 and SAB 101, our manner of recognizing revenue and expenses for freight in process is acceptable.
The other methods generally defer the recognition of revenue and expenses to as late as the date on which delivery of the shipments is completed. We have consistently utilized our manner of revenue and expense recognition since we began operations in 1946. Because our consolidated financial statements contain accruals for revenue and all associated estimated direct expenses as of the beginning and the end of each reporting period, if we were to change our manner of recognizing revenue and associated estimated direct expenses to one of the other methods allowed by EITF 91-9 and SAB 101, our results of operations would not be substantially affected. In such an event, each period's revenue and expenses would be adjusted to include revenue and expense amounts from freight in process at the beginning of the period and to exclude revenue and expense amounts from freight in process at the end of the same period. These amounts would essentially offset one another from period to period, resulting in minimal impact to our revenue, operating income, net income or net loss.
Revenue from equipment rental is recognized on a per-day basis over the term of the associated rental agreements.
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Personal and Work-Related Injuries:> The trucking business involves risk of injury to our employees and to the public. Prior to 2002, we retained the first $500 thousand and $1 million of these risks, respectively, on a per occurrence basis. Since mid-2005, our liability policies have contained a $3 million deductible for each occurrence. As of December 31, 2007, we are fully insured between $3 million and $5 million per occurrence. The insurance company and we share 75%/25% in losses between $5 million and $10 million per occurrence. Accordingly, our maximum exposure for a $10 million insured loss is $4.25 million. We are fully insured for liability exposures between $10 million and $50 million. Our public liability insurance policies will expire in mid-2008, at which time these coverage levels may change. Since 2005, our retention for work-related injuries has been $1 million. For work-related injuries, our retention for Texas-based employees is $500 thousand. For employees based elsewhere, our retention is $1 million.
Due to our large public liability and work-related injury retentions, the potential adverse impact a single occurrence can have on our results is significant. When an event involving potential liability occurs, our internal staff of risk management professionals determines the range of most probable outcomes. Based on that, we record a reserve in our financial statements during the period in which the event occurred. As additional information becomes available, we increase or decrease the amount of this reserve. We also maintain additional reserves for public liability and work-related injury events that may have been incurred but have not yet been reported. As of December 31, 2007, our reserves for personal injury, work-related injury, cargo and other claims against us aggregated nearly $21.7 million. If we were to change our estimates of those reserves up or down by 10% in the aggregate, the impact on our 2007 net loss would have been about $1.4 million, and net loss per share of common stock would have been impacted by $0.08.
Estimate of Uncollectible Accounts:> We extend trade credit to our customers. We also establish a reserve to represent our estimate of accounts that will not ultimately be collected. Once we conclude that a specific invoice is unlikely to be paid by the customer, we charge the invoice against the reserve. We estimate the amount of our bad debt reserve based on the composite age of our receivables and historical trends regarding such uncollectible amounts. Significant changes in our collection experience could impact our profits and financial condition. As of December 31, 2007, our reserve for uncollectible accounts was $1.3 million. If our estimate were to change by 10%, our 2007 net loss would have been impacted by about $130 thousand or $0.01 per share of common stock.
Depreciation:> Property and equipment are stated at cost. Depreciation on property and equipment is calculated by the straight-line method over the estimated useful life, which ranges from two to 30 years, down to an estimated salvage value of the property and equipment. We periodically review the reasonableness of our estimates regarding useful lives and salvage values of our revenue equipment and other long-lived assets based upon, among other things, our experience with similar assets, conditions in the used revenue equipment market, and prevailing industry practice. Changes in our useful life or salvage value estimates, or fluctuations in market values that are not reflected in our estimates, could have a material effect on our results of operations.
Income Taxes:> Our net deferred tax liability position of $8.5 million is stated net of offsetting deferred tax assets. The assets consist of anticipated future tax deductions for items such as personal and work-related injury and bad debt expenses which have been reflected on our financial statements but which are not yet tax deductible. In total, our deferred tax assets as of December 31, 2007 were about $11.5 million. At current federal tax rates, we will need to generate about $33 million in future taxable income in order to fully realize our deferred tax assets.
We believe it probable that we will generate sufficient taxable income in 2008 and beyond to realize the remainder of our deferred tax assets. If our expectation of such realizability changes, we may be required to establish a valuation allowance on our balance sheet. That could diminish our net income in future periods.
RESULTS OF OPERATIONS
For 2007, our operating results did not meet our expectations. Most industry observers expected the weak customer demand for trucking services in 2006 would improve during the latter part of the year. We shared those expectations, which went unmet. For 2007, our pre-tax loss approached $10 million, a result we find unacceptable. As we enter 2008 with uncertain economic conditions, we do not have the same level of expectations we had a year ago. We will continue to focus on those areas that have shown recent signs of promise from a revenue, as well as a margin, perspective, such as our dedicated fleet, intermodal and brokerage (or “logistics”) service offerings. On the expense side, some of our 2007 loss came from expenses that were unexpected going into the year, such as accidents and the rapidly-escalating price of fuel.
Other expenses are more controllable, and we intend to address many of those during 2008. During 2007, for example, we incurred employee severance-related expenses of approximately $1.0 million. Having separated those employees should help us lower our salaries, wages and related expenses between $2 and $3 million during 2008. Other changes we have made should help to reduce non-driver payroll costs, such as the deferral of all merit increases until the final third of the year and a reduction in our 401(k) match. Previously, all non-driver employees were reviewed on their individual anniversary dates, so the absence of merit increases during the first two thirds of 2008 will help reduce costs. We believe that reviewing all employees at the same time will enable us to more effectively evaluate relative performance among the employees and allocate our salary adjustments accordingly. With regard to our 401(k), we have reduced our maximum employer match, from 2% to 1%, and advised our employees that we will consider restoring the 2% level after we have experienced at least two consecutive quarters with an operating profit.
We have also implemented new approval processes across the board to better control other expenses, including, but not limited to, employee traveling expenses, the use of overnight delivery services and how we use vendors vs. employees to deliver our LTL freight in major metropolitan areas. A new, rigorous budgeting process is in effect for 2008, and our line managers know how they are expected to perform.
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Revenue>: Our revenue is derived from five types of transactions:
Truckload and LTL linehaul revenue is order-based and earned by transporting cargo for our customers using tractors and trailers that we control by ownership, long-term leases or by agreements with independent contractors (sometimes referred to as “owner-operators”). We operate fleets that focus on refrigerated or “temperature-controlled” LTL, on truckload temperature-controlled shipments and on truckload non-refrigerated, or “dry”, shipments. Over 90% of our LTL linehaul shipments must be temperature-controlled to prevent damage to the cargo. Of the shipments transported by our temperature-controlled fleets during 2007, about 10% were dry commodities.
Our dedicated fleet operation consists of fleets of tractors and trailers that haul freight only for a specific customer. Dedicated fleet revenue is asset-based. Customers typically pay us weekly for this type of service.
During the fourth quarter of 2005, we provided refrigerated trailers, which were rented on a per-day basis, for storage and transportation of perishable items in regions affected by Hurricanes Rita and Katrina. Such hurricane-related trailer rentals generated $3.2 million of revenue during 2005 and $2.2 million during 2006. Income from equipment rental also includes amounts we charge to independent contractors for the use of trucks we own and lease to the owner-operator.
During the last four months of 2005, many of our resources were engaged in providing relief to the regions affected by Hurricanes Katrina and Rita. We provided dedicated fleet services, which contributed revenue of $5.7 million.
The rates we charge for our freight services include fuel surcharges. In periods when the price we incur for diesel fuel rises, we increase our surcharges in an effort to recover the increase from our customers. The opposite is true when fuel prices decline. Using fuel surcharges to offset rising fuel costs is an industry-wide practice.
The following table summarizes and compares the significant components of revenue and presents our operating ratio and revenue per truck per week for each of the years in the three year period ended December 31, 2007:
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The following table summarizes and compares selected statistical data relating to our freight operations for each of the years in the three-year period ended December 31, 2007:
The following table summarizes and compares the makeup of our fleets between company-provided tractors and tractors provided by owner-operators as of December 31, 2007, 2006 and 2005:
During 2006, the capacity of the trucking industry to haul freight expanded for a number of reasons. During that same time, customer demand for such services decreased. This supply/demand imbalance continued throughout 2007. One result was increased industry-wide downward pressure on the rates truckers were able to charge for their services. Although there can be no assurance this imbalance will be corrected in the near-term, such cycles have occurred in the past and are likely to recur in the future. Most participants in and observers of the trucking industry do not expect the current imbalance to last beyond mid-2008. When comparing 2007 results to 2006 this imbalance is the primary reason for the declines we experienced.
Truckload linehaul revenue decreased by $25.1 million (10.6%) during 2007 as compared to 2006. During 2006, such revenue decreased by $25.7 million (9.8%) as compared to 2005. For most of 2005, the demand for linehaul trucking service was strong. Trucks available to provide such service were relatively scarce. The result was that shippers were willing to pay extra for service during 2005, as compared to the years before and after 2005.
Revenue from our dedicated fleet service for 2007 declined by $3.2 million (15.2%), as compared to 2006, and was $10.4 million (33.0%) less than during 2005. Over half of the 2006 decline in dedicated-fleet revenue was from decreased activity connected to the recovery efforts for Hurricanes Katrina and Rita during the last four months of 2005.
LTL linehaul revenue for the years ended December 31, 2007 and 2006 decreased by $2.4 million (1.8%) and $1.4 million (1.1%), respectively, each as compared to the immediately preceding year.
Our truckload linehaul revenue per loaded mile for 2007 was $1.45, 2.0% below 2006, and 4.6% less than 2005. We averaged 969 and 954 loaded miles per truckload shipment for 2007 and 2006, respectively. However, due primarily to the lower level of customer demand for such services, the number of such shipments declined by 10% during 2007, as compared to 2006.
During 2007, the number of LTL shipments increased by 2.4%, while the average weight of such shipments did not change appreciably. The increase in LTL volume, measured by shipments and weight per shipment, was offset by a decline in the average revenue per hundredweight, from $15.43 during 2006 to $14.85 during 2007.
LTL operations offer the opportunity to earn higher revenue on a per-mile and per-hundredweight basis than do truckload operations, but the level of investment and fixed costs associated with LTL activities significantly exceed those of truckload activities. Accordingly, as LTL revenue fluctuates, many costs remain fixed, leveraging the impact from such revenue fluctuations on our operating income. During 2007 and 2006, as LTL activity and revenue fluctuated, many LTL related costs remained static.
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We continuously assess the performance of our LTL operations. As a result, we periodically alter the frequency at which we service locations where freight volumes have declined and change the mix of our company-operated vs. independent contractor-provided trucks in order to more closely match our operating costs to the level of our LTL revenue.
Linehaul and dedicated fleet revenue-per-truck-per-week was $3,233 during 2007, $3,352 during 2006 and $3,579 during 2005. The 2006 and 2007 declines from 2005 are reflections of the impact of the hurricane-relief revenue generated in 2005 and general softness in the marketplace.
During 2006, the number of trucks in our company-operated fleet decreased by 19 to 1,588 as of year-end. As of December 31, 2007, there were 1,501 tractors in our company-operated fleet, a decrease of 87 tractors as compared to 1,588 at the end of 2006.
Continued emphasis will be placed on improving the efficiency and the utilization of our fleets through enhanced driver training and retention, by reducing the percentage of non-revenue-producing miles, by extending the average loaded miles per shipment and through expansion of dedicated fleet operations.
During 2005, the Transportation Security Administration (“TSA”), the federal agency that regulates motor-carrier safety, began to enforce new Hours of Service ("HOS") rules, which limit the number of hours truck drivers may work and drive in a shift. Time in a shift spent by a driver fueling, loading and unloading and waiting to load or unload freight count as non-driving work hours. The old HOS rules were introduced in 1939, and the new rules are intended by the government to reflect more closely the equipment and roads in use today, as compared to the 1930’s.
The new rules generally expand from 10 to 11 the number of hours that a person can drive an over-the-road truck in a shift, but reduce from 15 to 14 the number of hours such a person can work during the same shift. Also, under the old HOS rules, time spent in the middle of a shift waiting to load or unload did not count as hours worked, but such time does count as hours worked under the new HOS rules. The new rules also extend from 8 to 10 the number of hours that drivers must rest between on-duty shifts.
In order to compensate our drivers and offset other expenses from diminished asset utilization, we are seeking payment from our customers through such methods as rate increases and detention fees. Such detention fees are designed to motivate our customers to expedite the loading and unloading of their freight, thereby maximizing the number of hours that our drivers can drive during a work shift.
Our truckload fleets use satellite technology to enhance efficiency and customer service. Location updates of each tractor are provided by this network and we exchange dispatch, fuel and other information with the driver by way of satellite.
Recent high operating expenses, particularly for maintenance and fuel, have resulted in a sharp decline in the number of independent contractors providing equipment to the trucking industry. Our ability to mitigate this industry-wide trend by expanding our company-operated fleets has been constrained by an industry-wide lack of drivers qualified to operate the equipment.
During the latter half of 2006, we began to re-focus on our brokerage operation as a potential source of growth. At the end of 2006 and early in 2007, we brought in new management to devise and implement plans to achieve that potential. This business enables us to better adjust our ability to transport loads offered to us but for which we have no available equipment by engaging unaffiliated trucking companies to haul the freight. The brokerage bills the customer and pays the third-party trucking company.
Revenue from our brokerage increased by $3.1 million (24.8%) and decreased by $3.1 million (19.9%) during 2007 and 2006, respectively, each as compared to the immediately preceding year. Despite the revenue turn-around, the narrow margins inherent to this type of business and the start-up costs associated with its expansion and turn-around, this business was not profitable in 2007. Thus, we have decided to curtail additional expansion of the brokerage until we attain profitability. We expect to do that by mid-year, and to resume expansion strategies in the third and fourth quarters of 2008.
Operating Expenses:> Changes in the proportion of revenue from truckload versus LTL shipments, as well as in the mix of company-provided versus independent contractor-provided equipment and in the mix of leased versus owned equipment, contribute to variations among operating and interest expense.
The following table summarizes and compares, as a percentage of revenue, our major operating expenses for each of the years in the three-year period ended December 31, 2007:
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Salaries, Wages and Related Expenses>: Salaries, wages and related expenses decreased by $1.7 million (1.3%) during 2007 and declined by $3.0 million (2.2%) during 2006, each as compared to the immediately preceding year. The following table summarizes and compares the major components of these expenses for each of the years in the three-year period ended December 31, 2007 (in millions):
Employee truckload linehaul drivers are typically paid a certain rate per mile. During non-recessionary economic periods, we typically have difficulty attracting qualified employee-drivers for our truckload linehaul operations. Such shortages increase costs of employee-driver compensation, training and recruiting. Significant resources are continually devoted to recruiting and retaining qualified employee-drivers and to improving their job satisfaction. During 2007 and 2006, the supply of qualified drivers continued to tighten. With increasing frequency and magnitude, our competitors often increase their employee-driver pay scales. We monitor such events and consider increases should the need arise. Consequently, we increased our employee-driver pay per mile in April 2006 by approximately 6%. The impact of this was mitigated by the presence of fewer trucks in our fleet. Changes in the number of miles traveled by employee-driven trucks contribute to changes in driver salaries and per-diem expenses.
Drivers hauling LTL typically earn a higher wage than do their truckload counterparts. LTL wages are based on a number of factors including the amount of on-duty time, miles driven, hundredweight hauled and in-route stops to load and unload freight.
Early in 2007, we completed the consolidation of our truckload dispatch and truck manager functions into one centralized facility located near Dallas. Previously, these tasks were performed out of several offices in the regions where freight originated or was set for delivery. During 2006, we decided the former structure was not cost-effective from a managerial or communications perspective. We started the consolidation in October 2006. The result has been that more work now gets done with fewer people, and the quality of data input and communications has improved. Errors in data input create problems with 'downstream' needs for accurate information, such as planning for the next load, getting the driver home, billing the load, paying the driver correctly, collections and accounting.
As the size of our fleets declined during 2007 and 2006, we noted that we needed fewer non-driver employees to support our business. Also, over the past few years, we have been able to automate certain back-office functions that were previously performed manually. To address the problem of having too many non-driver employees, during June 2007 we offered all such employees incentives to voluntarily end their employment with us. When comparing the years 2007 and 2006, non-driver salaries (excluding severance pay) increased by $100 thousand (.3%) and decreased by $2.3 million (5.7%), respectively. The 2007 year included severance pay related to voluntary separation payments we made to terminated employees. At $1.0 million, severance pay in 2007 was twice that of 2006. However, we project the effect of these payments will be to reduce future non-driver salaries, wages and related expenses by about $3.0 million on an annual basis. We will continue to implement strategies to eliminate, consolidate and automate remaining back-office processes in order to further reduce our non-driver staff.
We sponsor bonus and incentive programs for our employees and management. Bonus payments are generally based on our operating ratio (operating expenses divided by revenue), adjusted for certain items. For 2007, 2006 and 2005, non-driver salaries expense included bonuses aggregating approximately $126 thousand, $1.5 million, and $4.4 million, respectively, which contributed to increased non-driver salaries in 2006 and the decrease during 2007.
We also sponsor a 401(k) wrap plan which enables employees to defer a portion of their current salaries to their post-retirement years. Because the wrap plan's assets are held by a grantor, or “rabbi” trust, we are required to include the wrap plan's assets and liabilities in our consolidated financial statements. As of December 31, 2007, such assets included approximately 86 thousand shares of our common stock, which are classified as treasury stock in our consolidated balance sheets. The trust also holds assets other than our common stock. Such investments are included in "other assets" in our consolidated balance sheets.
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We are required to value all of the assets and liabilities of the wrap plan at market value on our balance sheets, but we are precluded from reflecting the treasury stock portion of the wrap plan's assets at market value. When the market value of our common stock rises, we experience upward pressure on non-driver salaries and wage expense. The opposite is true when our common stock price falls. The price of our common stock fell during both 2007 and 2006. The effect of those changes resulted in a decrease of $150 thousand during 2007 and a $300 thousand decrease in 2006 in salaries, wages and related expenses, each as compared to the immediately preceding year. Also, during 2007, our Executive Bonus and Phantom Stock Plan was partially denominated in 105 thousand “phantom” shares of our stock, the liability for which is also determined by the value of our stock. During 2006, the plan contained 166 thousand such shares. That resulted in a further reduction of $270 thousand of non-driver salaries and wage expense during 2007 and a reduction of $450 thousand during 2006, each as compared to the immediately preceding year.
Costs associated with work-related injuries rose by $1.0 million (33.3%) during 2007 as compared to 2006 and decreased by $1.3 million (30.2%) in 2006 as compared to 2005. Injuries incurred by drivers are the primary contributor to this expense. The number of our employee-drivers dropped by about 7% between 2006 and 2007, but our loss experience for work-related injuries worsened. Of the 2007 increase, $500 thousand was related to a single claim. No other work-related injury claim during the three years ended December 31, 2007 exceeded $200 thousand.
We share the cost of health insurance with our employees. For the past several years, we have experienced annual health insurance cost increases. Since 2005 and through 2007, we repeatedly increased both the amounts employees pay to participate and the amount of medical costs that must be borne by our employees. This helped us mitigate the rate at which our costs have increased. During the latter half of 2007, we commenced a number of programs designed to reduce our expenses for employee health insurance. Employees have the option, in exchange for a reduced premium, to participate in a “wellness program” that offers free testing for various indicators of health risks, as well as personal coaching to help resolve such problems. In connection with the wellness program, we have encouraged weight-loss through a “biggest loser” program, in which teams of employees compete for prizes awarded for the largest percentage weight loss. Also, early in 2008, we began an audit of all participating dependents of our enrolled employees, and have identified several who will no longer be eligible to participate. It is too early to determine what, if any, impact these initiatives will have on our expenses, particularly for drivers, who are on the road most of the time and unable to participate. We will continue to customize the wellness effort to address such issues.
Purchased Transportation:> Purchased transportation expense declined by $639 thousand (.6%) during 2007 and $10.4 million (8.3%) during 2006, each as compared to the immediately preceding year. The following table summarizes our purchased transportation expense for each of the years in the three-year period ended December 31, 2007, by type of service (in millions):
Purchased transportation expense related to linehaul services decreased by $5.4 million (6.2%) during 2007 and $8.2 million (8.6%) during 2006, each as compared to the immediately preceding year.
Independent contractors provide tractors and drivers to pull our loaded trailers. Each pays for the drivers' wages, fuel, taxes, equipment-related expenses and other transportation expenses and receives either a portion of our revenue from each load or a rate for each mile driven while hauling our freight. Independent-contractor-provided equipment generated 24%, 24% and 26% of our truckload linehaul revenue during 2007, 2006 and 2005, respectively. At December 31, 2007 and 2006, there were 412 and 460 independent-contractor-provided tractors in our truckload fleet, respectively. At the end of 2005, there were 515 such tractors. As the number of these trucks fluctuates, so does the amount of revenue generated and miles traveled by such units.
Purchased transportation expense for truckload linehaul service has continued to decline since 2005, dropping by $6.3 million (13.6%) and $3.0 million (6.1%) during 2007 and 2006, respectively, each as compared to the prior year. This reflects an industry-wide shortage of trucks provided by independent contractors. Due in part to that shortage, we continue to explore alternatives, including intermodal providers to transport freight that might otherwise be hauled by independent-contractor-provided equipment.
Purchased transportation expense related to LTL linehaul services decreased by $1.6 million (4.6%) during 2007 and $4.0 million (10.3%) during 2006. This resulted from changes in the amount of LTL freight transported by independent-contractor-provided equipment relative to equipment we provided.
When fuel prices escalate, as they have for several years, we add fuel surcharges to the rates we bill our customers. Independent contractors are responsible for payment for the fuel used by their trucks in transporting freight for our customers. For shipments that are transported by independent contractors, we pass through to the contractor any fuel surcharges that will be paid by the customer. Fuel prices have doubled in the past two years. This practice added $18.8 million, $16.9 million and $14.5 million, to our purchased transportation expense during 2007, 2006 and 2005, respectively.
In providing our truckload linehaul service, we often engage railroads to transport shipments between major cities. In such an “intermodal” arrangement, loaded trailers are transported to a rail facility and placed on flat cars for transport to their destination. On arrival, we pick up the trailer and deliver the freight to the consignee. Intermodal service is generally less costly than using one of our own trucks for such movements, but other factors also influence our decision to utilize intermodal services. During 2007, the number of intermodal truckload shipments increased by 81.9%, but decreased by 27.3% in 2006, each as compared to the immediately preceding year.
Purchased transportation expenses related to our intermodal service providers increased by $2.5 million (39.7%) during 2007. Such expenses declined by $1.2 million (16.0%) during 2006. Management was hired to grow our intermodal revenue and has been successful in negotiating directly with the railroads. This avoids the cost of fees associated with third-party brokers and improved our cost structure by 18% per load when comparing year-to-date 2007 to the same period of 2006.
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Our brokerage helps us to balance the level of demand in our core trucking business. Orders for shipments to be transported for which we have no readily available assets to provide the service are assigned to other unaffiliated motor carriers through our brokerage. We establish the price and we invoice the customer. We also assume the credit risk associated with the transaction. Our brokerage also negotiates the fee payable to the other motor carrier.
When we book an order in our brokerage, we arrange for an unaffiliated trucking company to haul the freight. We set the price to be paid by the customer and bear the risk should the customer fail to pay us for the shipment. We determine which trucking company will haul the load and negotiate with them the fee we will pay, which represents brokerage purchased transportation expenses. Purchased transportation expense associated with our brokerage operation increased by $2.8 million (27.5%) and declined by $4.5 million (30.6%) during 2007 and 2006, respectively, each as compared to the immediately preceding year, and in line with declining levels of associated revenues.
During the latter half of 2007, we began to re-focus on our brokerage operation as a potential source of growth. At the end of 2006 and early in 2007, we brought in new management to devise and implement plans to achieve that potential.
Fuel:> Fuel expense decreased by $3.4 million (3.9%) during 2007 and increased by $6.6 million (8.1%) during 2006, each as compared to the immediately preceding year. Fuel expenses represent the cost of fuel to transport freight with company-operated equipment. During 2007, 2006 and 2005, our fuel expenses were $84.3 million, $87.8 million and $81.2 million, respectively. The following table summarizes and compares the relationship between fuel expense and freight linehaul revenue during each of the years in the three year period ended December 31, 2007 (dollar amounts in millions):
A significant percentage of our freight is transported with equipment provided by independent contractors. Independent contractors are responsible for all of their own operating expenses, including fuel. The amounts we pay independent contractors are classified as purchased transportation expense (see “Purchased Transportation”). In times when fuel prices are high, and to the extent we are able to obtain fuel surcharges from our customers, we compensate independent contractors on a load-by-load basis for their increased fuel expense. Such additional compensation is also classified as purchased transportation expense. Accordingly, our fuel expenses exclude the fuel expense incurred by our independent-contractor-provided fleets.
Most of the increases in our fuel expense were related to the increases in price of diesel fuel for our company-operated fleet of tractors and trailers. During 2005, our average price per gallon of diesel fuel increased by about 34.1%, as compared to 2004. During 2007 and 2006, the average price of diesel fuel increased by an additional 6.9% and 13.5%, respectively, each as compared to the preceding year. Compared to the 2004 level, the cumulative three-year increase in fuel cost per gallon was 62.6%. During the first two months of 2008, not quite nine weeks, the price we paid per gallon of fuel increased by 8.3%.
Because fuel surcharges do not fully compensate us or our independent contractors for the increased fuel costs, fuel price volatility impacts our profitability. We have implemented a number of strategies that mitigate, but do not eliminate, the impact of such volatility. Pursuant to the contracts and tariffs by which our freight rates are determined, those rates in most cases automatically fluctuate as diesel fuel prices rise and fall because of the fuel surcharges.
Factors that prevent us from fully recovering fuel cost increases include the competitive environment, the presence of deadhead (empty) miles, tractor engine idling and fuel to power our trailer refrigeration units. Such fuel consumption often cannot be attributable to a particular load and, therefore, there is no revenue to which a fuel surcharge may be applied. Also, our fuel surcharges are computed by reference to federal government indices that are released weekly for the preceding week. When prices are rising, the price we incur in a given week is more than the price the government reports for the preceding week. Accordingly, we are unable to recover the excess of the current week's actual price over the preceding week's indexed price.
With regard to fuel expenses for company-operated equipment, we attempt to further mitigate the impact of fluctuating fuel costs by operating more fuel-efficient tractors and aggressively managing fuel purchasing. We use computer software to optimize our routing and fuel purchasing. The software enables us to select the most efficient route for a trip. It also assists us in deciding on a real-time basis how much fuel to buy at a particular fueling station. We have decided that all new trucks will include opti-idle, an idle reduction technology, which should further reduce our exposure to rising fuel costs.
Supplies and Expenses>: Supplies and expenses decreased by $4.2 million (7.2%) during 2007 and $3.8 million (6.1%) during 2006, each as compared to the immediately preceding year. The following table summarizes and compares the major components of supplies and expenses for each of the years in the three-year period ended December 31, 2007 (in millions):
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Fleet repairs and maintenance expenses represented approximately 81% and 95% of the decrease in our total supplies and expenses during 2007 and 2006, respectively, each as compared to the immediately preceding year. During 2007, expenses for tractor repair and maintenance decreased by $1.7 million, and trailer repair expenses decreased by $1.5 million, each as compared to 2006.
With regard to tractor repairs, during 2002 we agreed with our primary tractor manufacturer to extend our tractor replacement cycle from 36 months up to 48 months, thereby causing our tractor fleet to consist of older vehicles. Older, high mileage vehicles typically are more expensive to maintain than newer, low mileage vehicles. As of December 31, 2007, 2006 and 2005, 26%, 13% and 17%, respectively, of the tractors in our company-operated fleets were more than three years old. During the year ended December 31, 2007, the number of trucks in our company-operated fleets decreased by 5.5% to 1,501, and the number of such trucks that are more than three years old increased by 172 units to 379.
During the two-year period ended December 31, 2007, the number of trailers in our fleets increased by 3.2% to 4,046 and the number of such trailers that are more than five years old increased by 38% to 1,245. Older tractors and trailers are more costly to maintain.
Tire expense decreased by $0.8 million (13.8%) during 2007 and increased by $0.5 million (9.4%) during 2006, each as compared to the immediately preceding year. We have changed certain of our tire management and purchasing practices in order to reduce such expenses.
Driver recruiting expenses declined by $400 thousand during 2007, as compared to 2006, which was $1.1 million more than 2005. This was related to our continuing efforts to recruit qualified employee-drivers and engage qualified owner-operators. In an improving economy, the number of persons available to work in our industry typically declines, which usually results in more intensive recruiting efforts.
Revenue Equipment Rent and Depreciation>: The total of revenue equipment rent expense and depreciation expense decreased by $628 thousand and $38 thousand during 2007 and 2006, respectively, each as compared to the immediately preceding year. These fluctuations were due in part to changes in the use of leasing to finance our fleet. Equipment rental includes a component of interest-related expense that is classified as non-operating expense when we incur debt to acquire equipment. Equipment rent and depreciation also are affected by the replacement of less expensive, older model company-operated tractors and trailers with more expensive new equipment.
More restrictive EPA emissions standards for 2007 require vendors to introduce new engines for the trucks they sell. Additional EPA mandated emission standards will become effective for newly manufactured trucks beginning in January 2010. During 2007 and 2006, we accelerated our acquisition of pre-2007 engines. We expect to incur increased prices for additional tractors in the future, which will cause increased costs for rental expense or depreciation. At December 31, 2007, 100% of our tractor fleet was comprised of tractors with pre-2007 engines that meet EPA-mandated clean air standards.
We estimate the new engine technology increased the cost to acquire such trucks by about $7,500 per truck. We project that, if our fleet at the beginning of 2011 were to be the same size as it was at the end of 2007, and if the EPA-mandated engine were the only factor affecting the cost of new tractors in the interim, the total of our depreciation and rental expense for 2011 would be about $7.5 million more than it was during 2007. We expect to recover these costs by increasing our rates and using APUs (auxiliary power units).
Our tractors are equipped with a “sleeper” compartment behind the seats. The sleeper contains limited essentials for a driver when he is not on duty, such as a mattress, AC power outlets, a small refrigerator, etc. In order to provide power to those devices and to cool or heat the air for the comfort of the driver, it is necessary to idle the tractor engine in order to generate the required electricity. While idling, the tractor consumes about one gallon of fuel per hour.
APUs are small, diesel powered devices that are not designed to power the truck while it is in motion, but can provide the power needed for the sleeper while the truck is parked. APUs consume about one gallon of fuel every four hours.
Besides the fuel cost benefit of APUs, these devices will result in fewer hours that the primary diesel engine is idling over the truck’s service life. This should reduce maintenance costs by extending the interval between routine maintenance events, as well as between major overhauls. The end-of-life resale value of our tractors may also improve due to fewer hours the engine was used during its service life.
At the end of 2007, 191 of our company-owned units had APUs installed. We will continue to evaluate the performance and effectiveness of the APUs in order to determine the cost-effectiveness of expanding this program.
Claims and Insurance:> Claims and insurance expenses increased by $2.5 million (13.8%) during 2007 and decreased by $1.6 million (8.2%) during 2006, each as compared to the immediately preceding year. The following table summarizes and compares the major components of claims and insurance expenses for each of the years in the three-year period ended December 31, 2007 (in millions):
Losses related to work-related injuries are included in salaries, wages and related expenses as are employee-related insurance costs.
During December 2007, a major ice storm hit the mid-section of the United States. One of our trucks was involved in a chain-reaction accident on an icy bridge. Due to various factors related to this event that occurred relative to this incident, we established a significant reserve for the outcome of this event which was the primary factor in the increase in 2007.
From June 1, 2004 through May 2005, we retained the first $3 million of our liability risk, our insurance company assumed the risk in full between our $3 million deductible and $5 million, and the insurance company and we shared the risk equally between $5 million and $10 million for each occurrence. As of December 31, 2007, our deductible was $3 million for each occurrence. Losses between $5 million and $10 million are shared 25% by us and 75% by the insurer. We are fully insured for losses for each occurrence between $10 million and $50 million.
We have accrued for our estimated costs related to our liability claims. When an incident occurs, we record a reserve for the estimated outcome. We engage the services of independent actuaries to help us improve the process by which we estimate the amount of our work-related and public liability claims reserves. Such estimates address the amount of the claims' settlements as well as legal and other fees associated with attaining such settlements. As additional information becomes available, adjustments are made.
Our liability insurance policies will expire in mid-2008, at which time these coverage levels may change. Insurance premiums do not significantly contribute to our operating costs, primarily because we carry large deductibles under our policies of liability insurance.
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Accrued claims liabilities include all reserves for over the road accidents, work-related injuries, self-insured employee medical expenses and cargo losses. The actuarial reports for 2007 provided us with factors we use to estimate expected costs associated with claims development and claims handling expenses. It is probable the estimates we have accrued at any point in time will change in the future.
Claims and insurance expenses can vary significantly from year to year. The amount of open claims is significant. There can be no assurance these claims will be settled without a material adverse effect on our financial position or our results of operations.
Gain on Sale of Property and Equipment:> Such gains were $3.1 million in the year ended December 31, 2007, $3.4 million during 2006 and $4.7 million during 2005. The periodic amount of such gains depends primarily upon conditions in the market for previously-owned equipment and on the quantity of retired equipment sold.
We usually pre-arrange the retirement sales value when we accept delivery of a new tractor. Fluctuations in the market value of our leased equipment do not impact the pre-arranged retirement value of tractors presently in our fleet, but softness in the market for used equipment could diminish future pre-arranged retirement values. That may require us to increase the amount of depreciation and rental expense we incur in 2008 and beyond.
We do not expect used equipment market prices to alter our current depreciation or rental expense related to trailers, but changes in the trailer market values could impact the amount of gains on sale of trailers in future periods.
Other and Miscellaneous Expense: > The following table summarizes and compares the major components of miscellaneous expenses for each of the years in the three-year period ended December 31, 2007 (in millions):
During 2007, 2006 and 2005, we incurred approximately $400 thousand, $1.0 million and $1.2 million, respectively, in expenses and professional fees associated with our efforts to comply with the internal control provisions of the Sarbanes-Oxley Act of 2002. For 2006, professional fees (legal, audit and Sarbanes-Oxley) include approximately $2.1 million for fees associated with the investigation commissioned by the Audit Committee of the Board of Directors, which was concluded during the second quarter of 2006.
Loss or Income from Continuing Operations:> Income from operations decreased by $22.1 million during 2007 and decreased by $18.1 million during 2006, each as compared to the immediately preceding year.
Interest and Other (Income) Expense: The sale of a life insurance investment for $6.1 million resulted in a gain of $3.8 million during 2005. We sold the remainder of our life insurance investment in 2006 for $7.1 million, with a corresponding gain of $5.1 million. The decline in interest expense from 2006 to 2007 and the increases in interest income between 2005 and 2006 and between 2006 and 2007 were primarily related to the receipt and investment of the cash from the sale of the life insurance investment, which was used to pay down our debt. In addition, the debt of a variable interest entity was accruing interest expense during 2005 and 2006, but not in 2007.
Equity in earnings of limited partnership for 2007 and 2006 was from our 20% equity interest in W&B. We account for that investment by the equity method of accounting.
Pre-Tax and Net (Loss) Income: > For 2007, we incurred a pre-tax loss of $9.9 million as compared to pre-tax income of $17.7 million for 2006 and $33.7 million for 2005. During 2007, we realized an income tax benefit of $2.3 million. During 2006 and 2005, we incurred income tax expense of $6.5 million and $12.9 million, respectively. During 2007, 2006 and 2005 we reported net (loss) income of ($7.7) million, $11.2 million and $20.4 million, respectively.
Our marginal tax rate for federal and state taxes has been about 37% since 2003, but our effective income tax rate (provision for or benefit from a percent of pre-tax income) was 22.8%, 36.6% and 38.4% for 2007, 2006 and 2005, respectively. During 2007, we experienced a $2.3 million income tax benefit, created by the pre-tax loss. This rate is impacted by the presence of non-taxable income and non-tax deductible expenses in our pre-tax income. During a year when we have pre-tax income, non-taxable income reduces the effective tax rate and non-deductible costs increase the effective rate. The opposite is true when there is a pre-tax loss.
During 2006 and 2005, we had non-taxable gains from the sale of a life insurance policy of nearly $5.1 million and $3.8 million, respectively, but the downward impact of those gains on our effective tax rate was more than offset by the upward impact of non-deductible expenses. The largest of our non-deductible expenses are associated with travel expenses and per-diem travel allowances for our employee-drivers.
During 2007, our current federal tax benefit was $2.8 million. We will also receive a tax benefit of $333 thousand from stock options that were exercised during the year. Because we paid significant federal income taxes during 2005 and 2006, federal law allows us to “carryback” our 2007 tax benefit and receive a refund from taxes we incurred and paid for those prior years. We intend to do so during the first half of 2008.
Since 2005, our effective income tax rate did not vary significantly from statutory rates for federal income taxes, which remained at 35% since 2005 and through 2007. Differences between pre-tax income for financial reporting purposes and taxable income for income tax purposes can impact the effective tax rate. Income that is not taxable (such as the 2006 and 2005 gains from the sale of a life insurance investment) reduces taxable income as compared to pre-tax income and results in a lower effective tax rate. Conversely, financial-reporting expenses that are not tax deductible increase taxable income as compared to pre-tax income and results in a higher effective tax rate. For 2005 through 2007, the effect of such non-taxable income and non-deductible expense largely offset one another, resulting in effective tax rates that were between 22% and 39%, including provision for state income taxes.
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During 2005, we implemented a 'per-diem' expense reimbursement plan for our employee-drivers. Under such a plan, when drivers are away from home overnight while performing their duties, they need not collect and retain receipts for their meals and incidental expenses. Rather, we classify a portion of their pay as a 'per-diem' expense reimbursement. Per-diem payments are not subject to payroll withholding taxes nor are they subject to the payroll taxes we incur on the wages we pay, such as FICA and unemployment tax. Under IRS regulations, however, we were allowed to deduct only 75% of our per-diem expenses on our 2007 and 2006 tax returns. For 2008 and beyond, we will be able to deduct 80% of our per-diem expenses. The inclusion of this expense for financial reporting purposes vs. the exclusion for income tax purposes affects our effective tax rate.
We do not expect to have future non-taxable income of the magnitude that we saw in 2006 and 2005, but we do expect to have substantial per-diem payments to our employee-drivers beyond 2007. For 2006, the impact of both the life insurance gain and the per-diem expenses on our effective rate were both about 9%, in opposite directions. The level of the impact depends on the monetary amount of the non-taxable expense or income relative to the amount of pre-tax income for financial reporting purposes. With no expected non-taxable income in an amount sufficient to offset expenses that are not tax deductible, we expect our effective tax rate for years when we are profitable to significantly exceed the statutory federal rate.
Discontinued Operations: During 2005, we sold the principal operating assets of our former non-freight business to the management of that business. In connection with that transaction, we provided financial assistance to the buyers and we retained 20% ownership in the buyer's entity. We sold our remaining 20% interest in 2006. Accounting principles generally accepted in the United States of America required that we continue to consolidate the financial statements of the buyer until that point when we sold our entire equity interest. The business we sold is a distributor of after-market vehicle air conditioning parts and supplies. During 2006, our consolidated revenue from this business was $9.7 million (2.0%). Income from discontinued operations for 2006 was $23 thousand compared to a loss of $283 thousand in 2005.
LIQUIDITY AND CAPITAL RESOURCES
Debt and Working Capital>: Cash from our revenue is typically collected between 30 and 50 days after the service has been provided. We continually seek to accelerate our collection of accounts receivable to enhance our liquidity and minimize our debt. Our freight business is highly dependent on the use of fuel, labor, operating supplies and equipment provided by owner-operators. We are typically obligated to pay for these resources within seven to fifteen days after we use them, so our payment cycle is a significantly shorter interval compared to our collection cycle. This disparity between cash payments to our suppliers and cash receipts from our customers can create the need for borrowed funds to finance our working capital, especially during the peak time of our fiscal year.
Our primary needs for capital resources are to finance working capital, expenditures for property and equipment and, from time to time, acquisitions. Working capital investment typically increases during periods of sales expansion when higher levels of receivables occur.
As of December 31, 2007, we had a $50 million secured line of credit pursuant to a revolving credit agreement with two commercial banks, which will expire in 2010. Borrowings under the agreement are secured by our accounts receivable. In addition, we have the option to provide the banks with liens on a portion of our truck and trailer fleets to cover borrowings and letters of credit in excess of the amount that can be borrowed against accounts receivable.
We may elect to borrow at a daily interest rate based on the bank’s prime rate or for specified periods of time at fixed interest rates which are based on the London Interbank Offered Rate in effect at the time of a fixed rate borrowing. Interest is paid monthly. At December 31, 2007, no money was borrowed against this facility and $5.0 million was being used as collateral for letters of credit. Accordingly, at December 31, 2007, approximately $45.0 million was available under the agreement.
The agreement contains a pricing “grid” in which increased levels of profitability and cash flows or reduced levels of indebtedness can reduce the rates of interest expense we incur. The new agreement permits, with certain limits, payments of cash dividends, repurchases of our stock and increased levels of capital expenditures. The amount we may borrow under the facility may not exceed the lesser of $50 million, as adjusted for letters of credit and other debt as defined in the agreement, a borrowing base or a multiple of a measure of cash flow as described in the agreement. Loans and letters of credit will become due upon the expiration of the agreement.
The credit agreement contains several restrictive covenants, including:
As of December 31, 2007, we were in compliance with all of our restrictive covenants and we project that our compliance will remain intact during 2008.
Cash Flows: Compared to 2005, cash provided by operating activities declined by $9.0 million in 2006, in line with the $9.2 million decline in net income between those years.
During 2007, we incurred a net loss of $7.7 million which is a $18.9 million decline in our operating results. Our cash provided by operating activities declined in 2007 by $8.5 million, as compared to 2006.
During 2006 and 2005, our net income included gains from the sale of property and equipment and life insurance transactions, net of income tax, of $7.4 million and $6.8 million, respectively. Such gains during 2007 were $2.1 million. The cash we received from equipment sales and life insurance is included in cash flows from investing activities, so the gains from those transactions are subtracted from net income or loss in calculating cash flows from operating activities. The changes in the amount of such transactions represented 62% of the decrease in cash provided by operating activities for 2007, as compared to 2006.
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Our 2007 net loss created a tax-loss “carryback” of approximately $3 million, the amount of which is included in other current assets on our 2007 balance sheet. We intend to file for and collect that overpayment during the first half of 2008. Of the $12 million increase in other current assets during 2006, about $6 million was related to an overpayment of our federal income taxes for that year, which was refunded to us during 2007. Accordingly, the $3 million carryback created in 2007 and the collection of the 2006 overpayment of $6 million together served to generate operating cash flows of $3 million during 2007.
Cash used in investing activities, which include the proceeds from the sales of retired equipment and investments discussed above, was $6.3 million during 2007, $16.0 million during 2006 and $20.3 million during 2005. For 2007, most of our $6.3 million cash used in investing activities was related to the replacement of retired tractors and trailers. We also received a $2.1 million payment by collecting the remaining balance on a note due to us from a business we sold in 2001. Net of the life insurance and other transactions, cash used in investing activities for 2006 and 2005 was $25.2. million and $26.5 million, respectively, almost all of which was related to the replacement of tractors and trailers during those years, net of cash we received from the sale of the equipment we replaced.
Cash used in financing activities for 2007, 2006 and 2005 was $13.3 million, $6.3 million and $1.8 million, respectively. Of the $7 million increase during 2007, $4.9 million (70%) was used to reduce our debt to zero. We use our credit facility periodically during the year to finance our operations and equipment purchases. When we sold the life insurance investment on December 31, 2006, much of the cash did not arrive by wire at our bank in time to fully repay our debt, which we did on January 2, 2007. We used the remainder of the cash for financing activities during 2007 to pay $2.1 million in dividends to our shareholders. During 2007, 2006 and 2005, respectively, we spent $8.0 million, $10.7 million and $3.9 million to repurchase shares of our stock.
Contractual Obligations and Commitments>: The table below sets forth information as to the amounts of our contractual obligations and commitments as well as the years in which they become due (in millions):