UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [Mark one] [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2005 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-14690 WERNER ENTERPRISES, INC. (Exact name of registrant as specified in its charter) NEBRASKA 47-0648386 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 14507 FRONTIER ROAD 68145-0308 POST OFFICE BOX 45308 (Zip Code) OMAHA, NEBRASKA (Address of principal executive offices) Registrant's telephone number, including area code: (402) 895-6640 _________________________________ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No --- --- As of July 29, 2005, 79,427,338 shares of the registrant's common stock, par value $.01 per share, were outstanding.
INDEX TO FORM 10-Q PAGE ---- PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Statements of Income for the Three Months Ended June 30, 2005 and 2004 3 Consolidated Statements of Income for the Six Months Ended June 30, 2005 and 2004 4 Consolidated Condensed Balance Sheets as of June 30, 2005 and December 31, 2004 5 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2004 6 Notes to Consolidated Financial Statements as of June 30, 2005 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk 25 Item 4. Controls and Procedures 26 PART II - OTHER INFORMATION Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 27 Item 4. Submission of Matters to a Vote of Security Holders 27 Item 6. Exhibits 28 PART I FINANCIAL INFORMATION Item 1. Financial Statements. The interim consolidated financial statements contained herein reflect all adjustments which, in the opinion of management, are necessary for a fair statement of the financial condition, results of operations, and cash flows for the periods presented. The interim consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. Operating results for the three-month and six-month periods ended June 30, 2005, are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. In the opinion of management, the information set forth in the accompanying consolidated condensed balance sheets is fairly stated in all material respects in relation to the consolidated balance sheets from which it has been derived. These interim consolidated financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2004. 2
WERNER ENTERPRISES, INC. CONSOLIDATED STATEMENTS OF INCOME <TABLE> <CAPTION> Three Months Ended (In thousands, except per share amounts) June 30 - --------------------------------------------------------------------------- 2005 2004 - --------------------------------------------------------------------------- (Unaudited) <S> <C> <C> Operating revenues $ 485,789 $ 411,115 --------------------------- Operating expenses: Salaries, wages and benefits 141,332 134,296 Fuel 78,064 50,105 Supplies and maintenance 39,921 34,802 Taxes and licenses 29,465 27,428 Insurance and claims 21,838 20,022 Depreciation 40,539 35,644 Rent and purchased transportation 90,342 71,201 Communications and utilities 5,134 4,450 Other (2,974) (1,824) --------------------------- Total operating expenses 443,661 376,124 --------------------------- Operating income 42,128 34,991 --------------------------- Other expense (income): Interest expense 2 4 Interest income (822) (551) Other 46 57 --------------------------- Total other expense (income) (774) (490) --------------------------- Income before income taxes 42,902 35,481 Income taxes 17,607 13,861 --------------------------- Net income $ 25,295 $ 21,620 =========================== Earnings per share: Basic $ .32 $ .27 =========================== Diluted $ .31 $ .27 =========================== Dividends declared per share $ .040 $ .035 =========================== Weighted-average common shares outstanding: Basic 79,415 79,233 =========================== Diluted 80,692 80,891 =========================== </TABLE> 3
WERNER ENTERPRISES, INC. CONSOLIDATED STATEMENTS OF INCOME <TABLE> <CAPTION> Six Months Ended (In thousands, except per share amounts) June 30 - --------------------------------------------------------------------------- 2005 2004 - --------------------------------------------------------------------------- (Unaudited) <S> <C> <C> Operating revenues $ 941,051 $ 797,395 --------------------------- Operating expenses: Salaries, wages and benefits 281,554 267,608 Fuel 145,692 95,857 Supplies and maintenance 76,675 67,696 Taxes and licenses 58,243 54,940 Insurance and claims 45,038 39,529 Depreciation 80,176 70,629 Rent and purchased transportation 172,909 134,351 Communications and utilities 10,576 8,998 Other (4,777) (2,063) --------------------------- Total operating expenses 866,086 737,545 --------------------------- Operating income 74,965 59,850 --------------------------- Other expense (income): Interest expense 6 6 Interest income (1,787) (1,086) Other 73 94 --------------------------- Total other expense (income) (1,708) (986) --------------------------- Income before income taxes 76,673 60,836 Income taxes 31,457 23,648 --------------------------- Net income $ 45,216 $ 37,188 =========================== Earnings per share: Basic $ .57 $ .47 =========================== Diluted $ .56 $ .46 =========================== Dividends declared per share $ .075 $ .060 =========================== Weighted-average common shares outstanding: Basic 79,383 79,414 =========================== Diluted 80,754 81,116 =========================== </TABLE> 4
WERNER ENTERPRISES, INC. CONSOLIDATED CONDENSED BALANCE SHEETS <TABLE> <CAPTION> (In thousands, except share amounts) June 30 December 31 - --------------------------------------------------------------------------- 2005 2004 - --------------------------------------------------------------------------- (Unaudited) <S> <C> <C> ASSETS Current assets: Cash and cash equivalents $ 51,057 $ 108,807 Accounts receivable, trade, less allowance of $8,590 and $8,189, respectively 198,789 186,771 Other receivables 11,760 11,832 Inventories and supplies 10,152 9,658 Prepaid taxes, licenses and permits 8,279 15,292 Current deferred income taxes 18,791 - Income taxes receivable 7,672 768 Other current assets 17,466 18,128 --------------------------- Total current assets 323,966 351,256 --------------------------- Property and equipment 1,477,085 1,374,649 Less - accumulated depreciation 540,833 511,651 --------------------------- Property and equipment, net 936,252 862,998 --------------------------- Other non-current assets 15,043 11,521 --------------------------- $1,275,261 $1,225,775 =========================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 53,789 $ 49,618 Insurance and claims accruals 64,985 55,095 Accrued payroll 19,280 19,579 Income taxes payable 9,082 475 Current deferred income taxes - 15,569 Other current liabilities 17,607 17,230 --------------------------- Total current liabilities 164,743 157,566 --------------------------- Insurance and claims accruals, net of current portion 87,301 84,301 Deferred income taxes 207,424 210,739 Commitments and contingencies Stockholders' equity: Common stock, $.01 par value, 200,000,000 shares authorized; 80,533,536 shares issued; 79,419,695 and 79,197,747 shares outstanding, respectively 805 805 Paid-in capital 105,588 106,695 Retained earnings 730,294 691,035 Accumulated other comprehensive loss (361) (861) Treasury stock, at cost; 1,113,841 and 1,335,789 shares, respectively (20,533) (24,505) --------------------------- Total stockholders' equity 815,793 773,169 --------------------------- $1,275,261 $1,225,775 =========================== </TABLE> 5
WERNER ENTERPRISES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> Six Months Ended (In thousands) June 30 - --------------------------------------------------------------------------- 2005 2004 - --------------------------------------------------------------------------- (Unaudited) <S> <C> <C> Cash flows from operating activities: Net income $ 45,216 $ 37,188 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 80,176 70,629 Deferred income taxes (37,675) 142 Gain on disposal of property and equipment (6,039) (5,396) Tax benefit from exercise of stock options 1,260 973 Other long-term assets (311) 403 Insurance claims accruals, net of current portion 3,000 7,000 Changes in certain working capital items: Accounts receivable, net (12,018) (1,014) Other current assets 349 7,391 Accounts payable 4,171 2,249 Other current liabilities 18,142 4,943 -------------------------- Net cash provided by operating activities 96,271 124,508 -------------------------- Cash flows from investing activities: Additions to property and equipment (208,640) (118,306) Retirements of property and equipment 55,979 45,282 Decrease in notes receivable 2,087 1,754 -------------------------- Net cash used in investing activities (150,574) (71,270) -------------------------- Cash flows from financing activities: Dividends on common stock (5,552) (3,975) Repurchases of common stock (263) (14,178) Stock options exercised 1,868 1,948 -------------------------- Net cash used in financing activities (3,947) (16,205) -------------------------- Effect of exchange rate fluctuations on cash 500 (178) Net increase (decrease) in cash and cash equivalents (57,750) 36,855 Cash and cash equivalents, beginning of period 108,807 101,409 -------------------------- Cash and cash equivalents, end of period $ 51,057 $ 138,264 ========================== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 6 $ 6 Income taxes $ 65,999 $ 24,632 Supplemental schedule of non-cash investing activities: Notes receivable issued upon sale of revenue equipment $ 5,298 $ 2,052 </TABLE> 6
WERNER ENTERPRISES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) Comprehensive Income Other than its net income, the Company's only other source of comprehensive income (loss) is foreign currency translation adjustments. Other comprehensive income (loss) from foreign currency translation adjustments was $549 and ($273) (in thousands) for the three-month periods and $500 and ($178) (in thousands) for the six-month periods ended June 30, 2005 and 2004, respectively. (2) Long-Term Debt As of June 30, 2005, the Company has two credit facilities with banks totaling $75.0 million which expire May 16, 2007 and October 22, 2005 and bear variable interest based on the London Interbank Offered Rate ("LIBOR"), on which no borrowings were outstanding. As of June 30, 2005, the credit available pursuant to these bank credit facilities is reduced by $35.5 million in letters of credit the Company maintains. Each of the debt agreements require, among other things, that the Company maintain a minimum consolidated tangible net worth and not exceed a maximum ratio of total funded debt to earnings before interest, income taxes, depreciation, amortization and rentals payable as defined in the credit facility. Although the Company had no borrowings pursuant to these credit facilities as of June 30, 2005, the Company remained in compliance with these covenants at June 30, 2005. On April 29, 2005, the Company renewed the $50.0 million bank credit facility, extending the maturity date from May 16, 2006 to May 16, 2007 and increasing the amount of the minimum consolidated tangible net worth requirement to $500.0 million plus 50% of annual net income. (3) Commitments As of June 30, 2005, the Company has commitments for net capital expenditures of approximately $127.0 million. 7
(4) Earnings Per Share Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. The difference between basic and diluted earnings per share for all periods presented is due to the common stock equivalents that are assumed to be issued upon the exercise of stock options. The computation of basic and diluted earnings per share is shown below (in thousands, except per share amounts). <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30 June 30 ------------------------ ---------------------- 2005 2004 2005 2004 ------------------------ ---------------------- <S> <C> <C> <C> <C> Net income $ 25,295 $ 21,620 $ 45,216 $ 37,188 ======================== ====================== Weighted-average common shares outstanding 79,415 79,233 79,383 79,414 Common stock equivalents 1,277 1,658 1,371 1,702 ------------------------ ---------------------- Shares used in computing diluted earnings per share 80,692 80,891 80,754 81,116 ======================== ====================== Basic earnings per share $ .32 $ .27 $ .57 $ .47 ======================== ====================== Diluted earnings per share $ .31 $ .27 $ .56 $ .46 ======================== ====================== </TABLE> Options to purchase shares of common stock which were outstanding during the periods indicated above, but were excluded from the computation of diluted earnings per share because the option purchase price was greater than the average market price of the common shares, were: <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30 June 30 ------------------------ ---------------------- 2005 2004 2005 2004 ------------------------ ---------------------- <S> <C> <C> <C> <C> Number of shares under option 39,500 - - - Range of option purchase prices $19.26-$19.84 - - - </TABLE> (5) Stock Based Compensation At June 30, 2005, the Company has a nonqualified stock option plan. The Company granted 20,000 and 787,000 stock options during the three-month periods and 39,500 and 787,000 options during the six-month periods ended June 30, 2005 and 2004, respectively. The Company applies the intrinsic value based method of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its stock option plan. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The Company's pro forma net income and earnings per share (in thousands, except per share amounts) would have been as indicated below had the fair value of all option grants been charged to salaries, wages, and benefits expense in accordance with Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation. 8
<TABLE> <CAPTION> Three Months Ended Six Months Ended June 30 June 30 ---------------------- -------------------- 2005 2004 2005 2004 ---------------------- -------------------- <S> <C> <C> <C> <C> Net income, as reported $ 25,295 $ 21,620 $ 45,216 $ 37,188 Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects 457 557 905 911 ---------------------- -------------------- Net income, pro forma $ 24,838 $ 21,063 $ 44,311 $ 36,277 ====================== ==================== Earnings per share: Basic - as reported $ .32 $ .27 $ .57 $ .47 ====================== ==================== Basic - pro forma $ .31 $ .27 $ .56 $ .46 ====================== ==================== Diluted - as reported $ .31 $ .27 $ .56 $ .46 ====================== ==================== Diluted - pro forma $ .31 $ .26 $ .55 $ .45 ====================== ==================== </TABLE> The maximum number of shares of common stock that may be optioned under the Stock Option Plan is 20,000,000 shares, and the maximum aggregate number of options that may be granted to any one person is 2,562,500 options. (6) Related Party Transactions The Company owns a one-third interest in an entity that operates a motel located nearby one of the Company's terminals with which the Company has committed to rent a guaranteed number of rooms to be used by the Company's employees, primarily its drivers. On June 30, 2005, the Company sold .783 acres of land to this entity for approximately $90,000, in accordance with the exercise of a purchase option clause contained in a separate agreement entered into by the Company and the entity in April 2000. The Company realized a gain of approximately $55,000 on the transaction. (7) Segment Information The Company has two reportable segments - Truckload Transportation Services and Value Added Services. The Truckload Transportation Services segment consists of five operating fleets that have been aggregated since they have similar economic characteristics and meet the other aggregation criteria of SFAS No. 131. The medium-to-long haul Van fleet transports a variety of consumer, non-durable products and other commodities in truckload quantities over irregular routes using dry van trailers. The Regional short-haul fleet provides comparable truckload van service within five geographic areas. The Dedicated Services fleet provides truckload services required by a specific company, plant, or distribution center. The Flatbed and Temperature-Controlled fleets provide truckload services for products with specialized trailers. Revenues for the Truckload Transportation Services segment include non-trucking revenues of $3.5 million and $3.6 million for the three-month periods and $7.0 million and $6.5 million for the six-month periods ended June 30, 2005 and 2004, respectively, representing the portion of shipments delivered to or from Mexico where the Company utilizes a third-party carrier and revenues generated in a few dedicated accounts where the services of third-party carriers are used to meet customer capacity requirements. The Value Added Services segment, which generates the majority of the Company's non- trucking revenues, provides freight brokerage, intermodal services, and freight transportation management. 9
The Company generates other revenues related to third-party equipment maintenance, equipment leasing, and other business activities. None of these operations meet the quantitative threshold reporting requirements of SFAS No. 131. As a result, these operations are grouped in "Other" in the tables below. "Corporate" includes revenues and expenses that are incidental to the activities of the Company and are not attributable to any of its operating segments. The Company does not prepare separate balance sheets by segment and, as a result, assets are not separately identifiable by segment. The Company has no significant intersegment sales or expense transactions that would result in adjustments necessary to eliminate amounts between the Company's segments. The following tables summarize the Company's segment information (in thousands of dollars): <TABLE> <CAPTION> Revenues -------- Three Months Ended Six Months Ended June 30 June 30 ---------------------- --------------------- 2005 2004 2005 2004 ---------------------- --------------------- <S> <C> <C> <C> <C> Truckload Transportation Services $ 427,136 $ 369,564 $ 829,499 $ 720,224 Value Added Services 55,555 38,986 105,715 72,353 Other 1,919 1,505 3,818 3,060 Corporate 1,179 1,060 2,019 1,758 ---------------------- --------------------- Total $ 485,789 $ 411,115 $ 941,051 $ 797,395 ====================== ===================== Operating Income ---------------- Three Months Ended Six Months Ended June 30 June 30 ---------------------- --------------------- 2005 2004 2005 2004 ---------------------- --------------------- Truckload Transportation Services $ 39,803 $ 33,986 $ 70,987 $ 58,334 Value Added Services 1,916 1,169 3,909 2,098 Other 815 574 1,671 1,249 Corporate (406) (738) (1,602) (1,831) ---------------------- --------------------- Total $ 42,128 $ 34,991 $ 74,965 $ 59,850 ====================== ===================== </TABLE> 10
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. This report contains historical information, as well as forward- looking statements that are based on information currently available to the Company's management. The forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company believes the assumptions underlying these forward- looking statements are reasonable based on information currently available; however, any of the assumptions could be inaccurate, and therefore, actual results may differ materially from those anticipated in the forward-looking statements as a result of certain risks and uncertainties. These risks include, but are not limited to, those discussed in the section of this Item entitled "Forward-Looking Statements and Risk Factors" and in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", of the Company's Annual Report on Form 10-K for the year ended December 31, 2004. Caution should be taken not to place undue reliance on forward-looking statements made herein, since the statements speak only as of the date they are made. The Company undertakes no obligation to publicly release any revisions to any forward-looking statements contained herein to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events. Overview: The Company operates in the truckload sector of the trucking industry, with a focus on transporting consumer nondurable products that ship more consistently throughout the year. The Company's success depends on its ability to efficiently manage its resources in the delivery of truckload transportation and logistics services to its customers. Resource requirements vary with customer demand, which may be subject to seasonal or general economic conditions. The Company's ability to adapt to changes in customer transportation requirements is a key element in efficiently deploying resources and in making capital investments in tractors and trailers. Although the Company's business volume is not highly concentrated, the Company may also be affected by the financial failure of its customers or a loss of a customer's business from time-to-time. Operating revenues consist of trucking revenues generated by the five operating fleets in the Truckload Transportation Services segment (medium/long-haul van, dedicated, regional short-haul, flatbed, and temperature-controlled) and non-trucking revenues generated primarily by the Company's Value Added Services ("VAS") segment. The Company's Truckload Transportation Services segment also includes a small amount of non-trucking revenues for the portion of shipments delivered to or from Mexico where it utilizes third-party carriers, and for a few of its dedicated accounts where the services of third-party carriers are used to meet customer capacity requirements. Non-trucking revenues reported in the operating statistics table include those revenues generated by the VAS segment, as well as the non-trucking revenues generated by the Truckload Transportation Services segment. Trucking revenues accounted for 87% of total operating revenues in second quarter 2005, and non-trucking and other operating revenues accounted for 13%. Trucking services typically generate revenue on a per-mile basis. Other sources of trucking revenue include fuel surcharges and accessorial revenue such as stop charges, loading/unloading charges, and equipment detention charges. Because fuel surcharge revenues fluctuate in response to changes in the cost of fuel, these revenues are identified separately within the operating statistics table and are excluded from the statistics to provide a more meaningful comparison between periods. Non-trucking revenues generated by a fleet whose operations are part of the Truckload Transportation Services segment are included in non-trucking revenue in the operating statistics table so that the revenue statistics in the table are calculated using only the revenues generated by company-owned and owner- operator trucks. The key statistics used to evaluate trucking revenues, excluding fuel surcharges, are revenues per tractor per week, the per-mile rates charged to customers, the average monthly miles generated per tractor, the percentage of empty miles, the average trip length, and the number of tractors in service. General economic conditions, seasonal freight patterns in the trucking industry, and industry capacity are key factors that impact these statistics. 11
The Company's most significant resource requirements are qualified drivers, tractors, trailers, and related costs of operating its equipment (such as fuel and related fuel taxes, driver pay, insurance, and supplies and maintenance). The Company has historically been successful mitigating its risk to increases in fuel prices by recovering additional fuel surcharges from its customers; however, there is no assurance that current recovery levels will continue in future periods. The Company's financial results are also affected by availability of drivers and the market for new and used revenue equipment. Because the Company is self-insured for cargo, personal injury, and property damage claims on its revenue equipment and for workers' compensation benefits for its employees (supplemented by premium-based coverage above certain dollar levels), financial results may also be affected by driver safety, medical costs, the weather, the legal and regulatory environment, and the costs of insurance coverage to protect against catastrophic losses. A common industry measure used to evaluate the profitability of the Company and its trucking operating fleets is the operating ratio (operating expenses expressed as a percentage of operating revenues). The most significant variable expenses that impact the trucking operation are driver salaries and benefits, payments to owner-operators (included in rent and purchased transportation expense), fuel, fuel taxes (included in taxes and licenses expense), supplies and maintenance, and insurance and claims. Generally, these expenses vary based on the number of miles generated. As such, the Company also evaluates these costs on a per-mile basis to adjust for the impact on the percentage of total operating revenues caused by changes in fuel surcharge revenues, per-mile rates charged to customers, and non-trucking revenues. As discussed further in the comparison of operating results for second quarter 2005 to second quarter 2004, several industry-wide issues, including high fuel prices, a challenging driver recruiting market, and uncertainty regarding possible changes to the hours of service regulations, could cause costs to increase in future periods. The Company's main fixed costs include depreciation expense for tractors and trailers and equipment licensing fees (included in taxes and licenses expense). Depreciation expense has been affected by the new engine emission standards that became effective in October 2002 for all newly purchased trucks, which have increased truck purchase costs. The trucking operations require substantial cash expenditures for tractors and trailers. The Company has maintained a three-year replacement cycle for company-owned tractors. These purchases are currently funded by net cash from operations, as the Company repaid its last remaining debt in December 2003. Non-trucking services provided by the Company, primarily through its VAS division, include freight brokerage, intermodal, freight transportation management, and other services. During 2005, VAS is expanding its service offerings to include multimodal, which is a blend of truck and rail intermodal services. Unlike the Company's trucking operations, the non- trucking operations are less asset-intensive and are instead dependent upon information systems, qualified employees, and the services of other third- party providers. The most significant expense item related to these non- trucking services is the cost of transportation paid by the Company to third-party providers, which is recorded as rent and purchased transportation expense. Other expenses include salaries, wages and benefits and computer hardware and software depreciation. The Company evaluates the non-trucking operations by reviewing the gross margin percentage (revenues less rent and purchased transportation expense expressed as a percentage of revenues) and the operating margin. The operating margins for the non-trucking business are generally lower than those of the trucking operations, but the returns on assets are substantially higher. 12
Results of Operations: The following table sets forth certain industry data regarding the freight revenues and operations of the Company for the periods indicated. <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30 % June 30 % -------------------- -------------------- 2005 2004 Change 2005 2004 Change ------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Trucking revenues, net of fuel surcharge (1) $371,612 $341,966 8.7% $729,478 $671,699 8.6% Trucking fuel surcharge revenues (1) 51,967 24,016 116.4% 92,903 41,987 121.3% Non-trucking revenues, including VAS (1) 59,065 42,639 38.5% 112,742 78,892 42.9% Other operating revenues (1) 3,145 2,494 26.1% 5,928 4,817 23.1% --------- -------- -------- -------- Operating revenues (1) $485,789 $411,115 18.2% $941,051 $797,395 18.0% ========= ======== ======== ======== Operating ratio (consolidated) (2) 91.3% 91.5% -0.2% 92.0% 92.5% -0.5% Average monthly miles per tractor 10,199 10,254 -0.5% 10,066 10,144 -0.8% Average revenues per total mile (3) $1.389 $1.318 5.4% $1.391 $1.309 6.3% Average revenues per loaded mile (3) $1.578 $1.482 6.5% $1.579 $1.476 7.0% Average percentage of empty miles 11.99% 11.03% 8.7% 11.88% 11.36% 4.6% Average trip length in miles (loaded) 566 588 -3.7% 569 584 -2.6% Total miles (loaded and empty) (1) 267,547 259,384 3.1% 524,393 513,337 2.2% Average tractors in service 8,744 8,432 3.7% 8,682 8,434 2.9% Average revenues per tractor per week (3) $3,269 $3,119 4.8% $3,231 $3,063 5.5% Total tractors (at quarter end) Company 7,820 7,520 7,820 7,520 Owner-operator 930 930 930 930 --------- -------- -------- -------- Total tractors 8,750 8,450 8,750 8,450 Total trailers (at quarter end) 24,090 22,920 24,090 22,920 (1) Amounts in thousands. (2) Operating expenses expressed as a percentage of operating revenues. Operating ratio is a common measure in the trucking industry used to evaluate profitability. (3) Net of fuel surcharge revenues. </TABLE> The following table sets forth the revenues, operating expenses, and operating income for the Truckload Transportation Services segment. Revenues for the Truckload Transportation Services segment include non- trucking revenues of $3.5 million and $3.6 million for the three-month periods and $7.0 million and $6.5 million for the six-month periods ended June 30, 2005 and 2004, respectively, as described on page 11. <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30 June 30 ----------------------------- ----------------------------- Truckload Transportation Services 2005 2004 2005 2004 -------------- -------------- -------------- -------------- (amounts in 000's) $ % $ % $ % $ % - ------------------ -------------- -------------- -------------- -------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Revenues $427,136 100.0 $369,564 100.0 $829,499 100.0 $720,224 100.0 Operating expenses 387,333 90.7 335,578 90.8 758,512 91.4 661,890 91.9 -------- -------- -------- -------- Operating income $ 39,803 9.3 $ 33,986 9.2 $ 70,987 8.6 $ 58,334 8.1 ======== ======== ======== ======== </TABLE> Higher fuel prices and higher fuel surcharge collections have the effect of increasing the Company's consolidated operating ratio and the Truckload Transportation Services segment's operating ratio. Eliminating 13
this sometimes volatile source of revenue provides a more consistent basis for comparing the results of operations from period to period. The following table calculates the Truckload Transportation Services segment's operating ratio using total operating expenses, net of fuel surcharge revenues, as a percentage of revenues, excluding fuel surcharges. <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30 June 30 ----------------------------- ----------------------------- Truckload Transportation Services 2005 2004 2005 2004 -------------- -------------- -------------- -------------- (amounts in 000's) $ % $ % $ % $ % - ------------------ -------------- -------------- -------------- -------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Revenues $427,136 $369,564 $829,499 $720,224 Less: trucking fuel surcharge revenues 51,967 24,016 92,903 41,987 -------- -------- -------- -------- Revenues, net of fuel surcharge 375,169 100.0 345,548 100.0 736,596 100.0 678,237 100.0 -------- -------- -------- -------- Operating expenses 387,333 335,578 758,512 661,890 Less: trucking fuel surcharge revenues 51,967 24,016 92,903 41,987 -------- -------- -------- -------- Operating expenses, net of fuel surcharge 335,366 89.4 311,562 90.2 665,609 90.4 619,903 91.4 -------- -------- -------- -------- Operating income $ 39,803 10.6 $ 33,986 9.8 $ 70,987 9.6 $ 58,334 8.6 ======== ======== ======== ======== </TABLE> The following table sets forth the non-trucking revenues, operating expenses, and operating income for the VAS segment. Other operating expenses for the VAS segment primarily consist of salaries, wages and benefits expense. VAS also incurs smaller expense amounts in the supplies and maintenance, depreciation, rent and purchased transportation (excluding third-party transportation costs), communications and utilities, and other operating expense categories. <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30 June 30 ----------------------------- ----------------------------- 2005 2004 2005 2004 -------------- -------------- -------------- -------------- Value Added Services (amounts in 000's) $ % $ % $ % $ % - --------------------------------------- -------------- -------------- -------------- -------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Revenues $ 55,555 100.0 $ 38,986 100.0 $105,715 100.0 $ 72,353 100.0 Rent and purchased transportation expense 50,405 90.7 35,318 90.6 95,571 90.4 65,559 90.6 -------- -------- -------- -------- Gross margin 5,150 9.3 3,668 9.4 10,144 9.6 6,794 9.4 Other operating expenses 3,234 5.9 2,499 6.4 6,235 5.9 4,696 6.5 -------- -------- -------- -------- Operating income $ 1,916 3.4 $ 1,169 3.0 $ 3,909 3.7 $ 2,098 2.9 ======== ======== ======== ======== </TABLE> Three Months Ended June 30, 2005 Compared to Three Months Ended June 30, - --------------------------------------------------------------------------- 2004 - ---- Operating Revenues Operating revenues increased 18.2% for the three months ended June 30, 2005, compared to the same period of the prior year. Excluding fuel surcharge revenues, trucking revenues increased 8.7% due primarily to a 5.4% increase in average revenues per total mile, excluding fuel surcharges, and a 3.7% increase in the average number of tractors in service, offset by a 0.5% decrease in average monthly miles per tractor. Average revenues per total mile, excluding fuel surcharges, increased due to customer rate increases secured during late 2004 and early 2005 and, to a lesser extent, a 3.7% decrease in the average loaded trip length due to growth in the Company's dedicated fleet. The Company grew its dedicated fleet by 6% in second quarter 2005 compared to second quarter 2004. Dedicated fleet business tends to have lower miles per trip, a higher empty mile percentage, a higher rate per loaded mile, and lower miles per truck. The growth in dedicated business had a corresponding effect on these same operating statistics, as reported above, for the entire Company. 14
In the third and fourth quarter of 2004, the Company's sales and marketing team met with customers to negotiate annual rate increases to recoup the significant cost increases in fuel, driver pay, equipment, and insurance and to improve the Company's operating margin. Most of the Company's non-dedicated contractual business renews in the latter part of third quarter and fourth quarter, and these contractual rate increases contributed to the pricing improvement in second quarter 2005 compared to second quarter 2004. There are several inflationary cost pressures impacting truckload carriers. While the Company has taken several actions to limit or delay these cost increases, management will be seeking freight rate increases during the upcoming contract renewal period to recoup unavoidable cost increases. For most of second quarter 2005, freight demand exceeded the Company's available truck capacity. While freight demand improved from April to June 2005, as anticipated due to the seasonal patterns in the trucking industry, demand during second quarter 2005 was not as strong as the abnormally strong freight market of second quarter 2004. This caused an increase in empty miles from 73 miles per trip to 77 miles per trip. Fuel surcharge revenues, which represent collections from customers for the higher cost of fuel, increased to $52.0 million in second quarter 2005 from $24.0 million in second quarter 2004 in response to higher average fuel prices in second quarter 2005. The Company's fuel surcharge programs are designed to recoup the higher cost of fuel from customers when fuel prices rise and automatically provide customers with the benefit of lower costs when fuel prices decline. These programs have historically enabled the Company to recover a significant portion of the fuel price increases. As discussed further under the "Operating Expenses" heading, the strength of the Company's fuel surcharge programs helped to limit the impact of higher fuel costs, including higher owner-operator fuel reimbursements and the effect of fuel mile per gallon ("mpg") degradation for trucks with post October-2002 engines, to two cents per share in second quarter 2005. These surcharge programs automatically adjust depending on the Department of Energy ("DOE") weekly retail on-highway diesel prices. Typical programs specify a base price per gallon when surcharges can begin to be billed. Above this price, the Company bills a surcharge rate per mile when the price per gallon falls in a bracketed range of fuel prices. When fuel prices increase, fuel surcharges recoup a lower percentage of the incrementally higher costs due to the impact of inadequate recovery for empty miles not billable to customers, out-of-route miles, truck idle time, and "bracket creep". "Bracket creep" occurs when fuel prices approach the upper limit of the bracketed range, but a higher surcharge rate per mile cannot be billed until the fuel price per gallon reaches the next bracket. Also, the DOE survey price used for surcharge contracts changes once a week while actual fuel prices change more frequently. Because collections of fuel surcharges typically trail fuel price changes, rapid fuel price increases cause a temporarily unfavorable effect of fuel costs increasing more rapidly than fuel surcharge revenues. This effect typically reverses if fuel prices fall. VAS revenues increased 42.5% to $55.6 million for the three months ended June 30, 2005 from $39.0 million for the three months ended June 30, 2004 due to the Company's continued focus on growing the volume of business generated by this segment. VAS revenues consist primarily of freight brokerage, intermodal, freight transportation management, and other services. The Company expects to continue to capitalize on the sophisticated service, management, and technology advantages of its logistics service offerings. During 2005, VAS began offering multimodal services, which provide for the movement of freight using a combination of truck and rail intermodal services. Operating Expenses Operating expenses, expressed as a percentage of operating revenues, were 91.3% for the three months ended June 30, 2005, compared to 91.5% for the three months ended June 30, 2004. Because the Company's VAS business operates with a lower operating margin and a higher return on assets than the trucking business, the growth in VAS business in second quarter 2005 compared to second quarter 2004 affected the Company's overall operating ratio. As explained above, the significant increase in fuel expense and related fuel surcharge revenues also affected the operating ratio. The 15
tables on pages 13 and 14 show the operating ratios and operating margins for the Company's two reportable segments, Truckload Transportation Services and Value Added Services. The following table sets forth the cost per total mile of operating expense items for the Truckload Transportation Services segment for the periods indicated. The Company evaluates operating costs for this segment on a per-mile basis to adjust for the impact on the percentage of total operating revenues caused by changes in fuel surcharge revenues, which provides a more consistent basis for comparing the results of operations from period to period. <TABLE> <CAPTION> Three Months Ended Increase Six Months Ended Increase June 30 (Decrease) June 30 (Decrease) ---------------------- -------------------- 2005 2004 per Mile 2005 2004 per Mile ------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Salaries, wages and benefits $.517 $.507 $.010 $.525 $.511 $.014 Fuel .291 .192 .099 .277 .186 .091 Supplies and maintenance .144 .128 .016 .145 .126 .019 Taxes and licenses .110 .105 .005 .111 .107 .004 Insurance and claims .081 .077 .004 .085 .077 .008 Depreciation .147 .136 .011 .148 .134 .014 Rent and purchased transportation .149 .138 .011 .147 .134 .013 Communications and utilities .019 .017 .002 .020 .017 .003 Other (.010) (.006) (.004) (.012) (.003) (.009) </TABLE> Owner-operator costs are included in rent and purchased transportation expense. Owner-operator miles as a percentage of total miles were 12.8% in second quarter 2005 compared to 12.7% in second quarter 2004. Owner- operators are independent contractors who supply their own tractor and driver and are responsible for their operating expenses including fuel, supplies and maintenance, and fuel taxes. Because the change in owner- operator miles as a percentage of total miles was minimal, there was essentially no shift in costs to the rent and purchased transportation category from other expense categories. Attracting and retaining owner- operator drivers has continued to be difficult due to the challenging operating conditions. Salaries, wages and benefits for non-drivers increased in second quarter 2005 compared to second quarter 2004 to support the growth in the VAS segment. The increase in salaries, wages and benefits per mile of 1.0 cent for the Truckload Transportation Services segment is primarily the result of increased student driver pay, higher driver pay per mile, and an increase in the number of maintenance employees, offset by lower workers' compensation. Because of the challenging driver recruiting market, discussed below, the Company is training more student drivers as an alternative source of drivers. On August 1, 2004, the Company's previously announced two cent per mile pay raise became effective for company solo drivers in its medium-to-long-haul van division, representing approximately 25% of total company drivers. The Company has recovered this pay raise through its customer rate increase negotiations, which occurred in third and fourth quarter 2004. The Company renewed its workers' compensation insurance coverage, and for the policy year beginning April 2005, the Company continues to maintain a self-insurance retention of $1.0 million per claim and is responsible for an annual aggregate amount of $1.0 million for claims above $1.0 million and below $2.0 million. The Company's premium rates for this coverage did not change from the prior policy year. The driver recruiting market remains extremely challenging. By placing more emphasis on training drivers, increasing the frequency of driver home time, providing drivers with a newer truck, and maximizing driver productivity within the federal hours of service regulations, the Company is obtaining an adequate number of drivers to maintain its current fleet size. However, the supply of qualified truck drivers remains constrained due to alternative jobs that are becoming available with a solid economy and inadequate demographic growth for the industry's targeted 16
driver base over the next several years. The Company expects the tight driver market will make it very difficult to add meaningful truck capacity in the near future. The Company instituted an optional per diem reimbursement program for eligible company drivers (approximately half of total non-student company drivers) beginning in April 2004. This program increases a company driver's net pay per mile, after taxes. As a result, driver pay per mile was slightly lower before considering the factors above that increased driver pay per mile, and the Company's effective income tax rate was higher in second quarter 2005 compared to second quarter 2004. The Company expects the cost of the per diem program to be neutral, because the combined driver pay rate per mile and per diem reimbursement under the per diem program is about one cent per mile lower than mileage pay without per diem reimbursement, which offsets the Company's increased income taxes caused by the nondeductible portion of the per diem. The per diem program increases driver satisfaction through higher net pay per mile. The Company anticipates that the competition for qualified drivers will continue to be high and cannot predict whether it will experience shortages in the future. If such a shortage were to occur and additional increases in driver pay rates were necessary to attract and retain drivers, the Company's results of operations would be negatively impacted to the extent that corresponding freight rate increases were not obtained. Fuel increased 9.9 cents per mile for the Truckload Transportation Services segment due to higher average diesel fuel prices and more trucks with post-October 2002 engines. Average fuel prices in second quarter 2005 were 51 cents a gallon, or 45%, higher than in second quarter 2004, and were 19 cents a gallon higher than in first quarter 2005. Fuel expense had a two cent negative impact on earnings per share in second quarter 2005 compared to second quarter 2004, after considering fuel surcharge collections and the cost impact of owner-operator fuel reimbursements (which is included in rent and purchased transportation expense) and lower miles per gallon due to truck engine emissions changes. Company data continues to indicate that the fuel mpg decrease for trucks with post- October 2002 engines (68% of the Company fleet as of June 30, 2005 compared to 23% as of June 30, 2004) is a reduction of approximately 5%. As the Company continues to replace older trucks in its fleet with trucks with the post-October 2002 engines, fuel cost per mile is expected to increase further due to the lower mpg. Shortages of fuel, increases in fuel prices, or rationing of petroleum products can have a materially adverse effect on the operations and profitability of the Company. The Company is unable to predict whether fuel price levels will continue to increase or decrease in the future or the extent to which fuel surcharges will be collected from customers. As of June 30, 2005, the Company had no derivative financial instruments to reduce its exposure to fuel price fluctuations. Diesel fuel prices recently increased in June and July. Assuming fuel prices remain at price levels at the date of this filing throughout the remainder of third quarter 2005, the negative impact of fuel expense on earnings for third quarter 2005 compared to third quarter 2004 is estimated to be in the range of approximately two cents to three cents per share. If fuel prices average ten cents per gallon higher than current price levels throughout the remainder of third quarter 2005, the negative impact of fuel expense on earnings for third quarter 2005 compared to third quarter 2004 is estimated to be in the range of three cents to four cents per share. Supplies and maintenance for the Truckload Transportation Services segment increased 1.6 cents on a per-mile basis in second quarter 2005 due primarily to increases in repair expenses for trucks to be sold by the Company's Fleet Truck Sales subsidiary. Higher over-the-road equipment repairs, driver recruiting costs (including driver travel and lodging and driver physicals), and higher toll expense related to state toll rate increases also contributed to a smaller portion of the increase. Over-the- road ("OTR") repairs increased as a result of the increase in dedicated- fleet trucks, which typically do not have as much maintenance performed at company terminals. The Company includes the higher cost of OTR maintenance when establishing pricing for dedicated customers. 17
Taxes and licenses for the Truckload Transportation Services segment increased 0.5 cents per total mile due primarily to the effect of the fuel mpg degradation for trucks with post-October 2002 engines on the per-mile cost of federal and state diesel fuel taxes. Insurance and claims for the Truckload Transportation Services segment increased 0.4 cents on a per-mile basis due primarily to negative development on existing liability insurance claims. For the policy year beginning August 1, 2004, the Company became responsible for the first $2.0 million per claim with an annual aggregate of $3.0 million for claims between $2.0 million and $3.0 million, and the Company became fully insured (i.e., no aggregate) for claims between $3.0 million and $5.0 million. For claims in excess of $5.0 million and less than $10.0 million, the Company is responsible for the first $5.0 million of claims. The increased Company retention from $500,000 to $2.0 million is due to changes in the trucking insurance market and is similar to increased claim retention levels experienced by other truckload carriers. The Company maintains liability insurance coverage with reputable insurance carriers substantially in excess of the $10.0 million per claim. Effective August 1, 2005, the Company's self-insured aggregate for claims between $2.0 million and $3.0 million will decrease to $2.0 million. The Company expects its liability insurance premiums for the policy year beginning August 1, 2005 to be approximately the same as the previous policy year. Depreciation expense for the Truckload Transportation Services segment increased 1.1 cents on a per-mile basis in second quarter 2005 due primarily to higher costs of new tractors with the post-October 2002 engines. As of June 30, 2005, approximately 68% of the company-owned truck fleet consisted of trucks with the post-October 2002 engines compared to 23% at June 30, 2004. As the Company continues to replace older trucks in its fleet with trucks with the post-October 2002 engines, depreciation expense is expected to increase. Rent and purchased transportation consists mainly of payments to third- party carriers in the VAS and other non-trucking operations and payments to owner-operators in the trucking operations. As shown in the VAS statistics table on page 14, rent and purchased transportation expense for the VAS segment increased in response to higher VAS revenues. These expenses generally vary depending on changes in the volume of services generated by the segment. As a percentage of VAS revenues, VAS rent and purchased transportation expense increased to 90.7% in second quarter 2005 compared to 90.6% in second quarter 2004. Rent and purchased transportation for the Truckload Transportation Services segment increased 1.1 cents per total mile in second quarter 2005 as higher fuel prices necessitated higher reimbursements to owner-operators for fuel. The Company's customer fuel surcharge programs do not differentiate between miles generated by Company-owned trucks and miles generated by owner-operator trucks; thus, the increase in owner-operator fuel reimbursements is included with Company fuel expenses in calculating the per-share impact of higher fuel prices on earnings. The Company has experienced difficulty recruiting and retaining owner-operators for over two years because of challenging operating conditions. However, the Company has historically been able to add company-owned tractors and recruit additional company drivers to offset any decreases in owner-operators. If a shortage of owner-operators and company drivers were to occur and increases in per mile settlement rates became necessary to attract and retain owner-operators, the Company's results of operations would be negatively impacted to the extent that corresponding freight rate increases were not obtained. Payments to third-party carriers used for portions of shipments delivered to or from Mexico and by a few dedicated fleets in the truckload segment decreased by 0.2 cents per mile, offsetting the overall increase for the Truckload Transportation Services segment. Other operating expenses for the Truckload Transportation Services segment decreased 0.4 cents per mile in second quarter 2005. Gains on sales of assets, primarily trucks, are reflected as a reduction of other operating expenses and are reported net of sales-related expenses, including costs to prepare the equipment for sale. Gains on sales of assets increased to $3.6 million in second quarter 2005 from $3.4 million in second quarter 2004 due to increased unit sales of trucks as the Company is attempting to keep its fleet as new as possible, partially offset by a 18
slightly lower average gain per truck. The Company's wholly-owned subsidiary, Fleet Truck Sales, is one of the largest domestic class 8 truck sales companies in the United States. Fleet Truck Sales opened its 17th truck sales location during second quarter 2005. The Company's goal is to sell a majority of its used equipment through its Fleet Truck Sales network. Other operating expenses also include bad debt expense and professional services fees. The remaining decrease in other operating expenses in second quarter 2005 is due primarily to a reduction in computer consulting fees as some consultants were hired by the Company, resulting in a reduction in other operating expenses, but an increase in salaries, wages and benefits expense. The Company's effective income tax rate (income taxes expressed as a percentage of income before income taxes) increased to 41.0% for the three- month period ended June 30, 2005 from 39.1% for the three-month period ended June 30, 2004 due to an increase in non-deductible expenses for tax purposes related to the implementation of a per diem pay program for student drivers in fourth quarter 2003 and a per diem pay program for eligible company drivers in April 2004. Six Months Ended June 30, 2005 Compared to Six Months Ended June 30, 2004 - ------------------------------------------------------------------------- Operating Revenues Operating revenues increased by 18.0% for the six months ended June 30, 2005, compared to the same period of the previous year. Excluding fuel surcharge revenues, trucking revenues increased 8.6%, due primarily to a 6.3% increase in average revenues per total mile, excluding fuel surcharges, and a 2.9% increase in the average number of tractors in service, offset by a 0.8% decrease in average monthly miles per tractor. Average revenues per total mile, excluding fuel surcharges, increased primarily due to customer rate increases secured during late 2004 and early 2005. VAS revenues increased by $33.4 million (46.1%) due to ongoing growth in the segment, and fuel surcharge revenues increased by $50.9 million (121.3%) due to higher average diesel fuel prices for the first six months of 2005 as compared to the same period of 2004. Operating Expenses Operating expenses, expressed as a percentage of operating revenues, were 92.0% for the six months ended June 30, 2005, compared to 92.5% for the same period of the previous year. Because the Company's VAS business operates with a lower operating margin and a higher return on assets than the trucking business, the growth in VAS business in the first six months of 2005 compared to the first six months of 2004 affected the Company's overall operating ratio. As explained earlier, the significant increase in fuel expense and related fuel surcharge revenues also affected the operating ratio. The tables on pages 13 and 14 show the operating ratios and operating margins for the Company's two reportable segments, Truckload Transportation Services and Value Added Services. Owner-operator miles as a percentage of total miles were 12.8% and 12.5% for the six months ended June 30, 2005 and 2004, respectively. Because the change in owner-operator miles as a percentage of total miles was minimal, there was essentially no shift in costs to the rent and purchased transportation category from other expense categories. Salaries, wages and benefits for non-drivers increased to support the growth in the VAS segment. Salaries, wages and benefits for the Truckload Transportation Services segment increased 1.4 cents on a per-mile basis due to higher driver pay per mile and an increase in the number of maintenance employees, offset by lower workers' compensation. Fuel increased 9.1 cents per mile due to higher fuel prices. Average fuel prices for the first six months of 2005 were 48 cents a gallon, or 45%, higher than the first six months of 2004. Supplies and maintenance increased 1.9 cents per mile due to higher driver recruiting costs (including driver travel and lodging, 19
driver advertising, and driver physicals), increases in the cost of over- the-road repairs and repairs on trucks sold by the Company's Fleet Truck Sales subsidiary, and higher toll costs due to state toll rate increases. Insurance increased 0.8 cents on a per-mile basis primarily to negative development on existing liability insurance claims. Depreciation increased 1.4 cents per mile due to higher costs of new tractors as the Company replaces tractors with pre-October 2002 engines with tractors that have the new EPA-compliant engines at a higher cost. Rent and purchased transportation for the Truckload Transportation Services segment increased 1.3 cents per mile as higher fuel prices necessitated higher reimbursements to owner-operators for fuel. Rent and purchased transportation expense for the VAS segment increased in response to higher VAS revenues. Other operating expenses decreased 0.9 cents per mile due to the Company selling more used trucks to third parties and recognizing additional gains, net of sales-related expenses, including costs to prepare the equipment for sale. The Company's effective income tax rate was 38.9% for the six months ended June 30, 2004 (38.5% for first quarter 2004 and 39.1% for second quarter 2004). The rate increased to 41.0% for the six months ended June 30, 2005, related to the implementation of per diem pay programs for student drivers and eligible company drivers. Liquidity and Capital Resources: During the six months ended June 30, 2005, the Company generated cash flow from operations of $96.3 million, a 22.7% decrease ($28.2 million) in cash flow compared to the same six-month period a year ago. The decrease in cash flow from operations is due primarily to larger federal income tax payments in the first six months of 2005 compared to the same period of 2004 and an increase in days sales in accounts receivable, offset by higher net income and higher depreciation expense for financial reporting purposes related to the higher cost of the post-October 2002 engines. Deferred taxes decreased by $37.7 million during the six months ended June 30, 2005 related to the reversal of certain tax strategies implemented in 2001 due to recent tax law changes and lower income tax depreciation in 2005 due to the bonus depreciation which expired on December 31, 2004. In second quarter 2005, the Company made federal income tax payments of $22.5 million related to the tax strategies and $25.6 million representing its first and second quarter 2005 estimated tax payments, and expects income tax payments for the remaining two quarterly tax payment dates of 2005 to be higher than those in the comparable periods of 2004 due to the reversal of deferred tax liabilities related to equipment depreciation. The cash flow from operations and existing cash balances enabled the Company to make net property additions, primarily revenue equipment, of $152.7 million, pay common stock dividends of $5.6 million, and repurchase common stock of $0.3 million. Based on the Company's strong financial position, management foresees no significant barriers to obtaining sufficient financing, if necessary. Net cash used in investing activities for the six-month period ended June 30, 2005 increased by $79.3 million, from $71.3 million for the six- month period ended June 30, 2004 to $150.6 million for the six-month period ended June 30, 2005. The large increase was due primarily to the Company purchasing more tractors in the first six months of 2005. As of June 30, 2005, the Company has committed to property and equipment purchases, net of trades, of approximately $127.0 million. The average age of the Company's truck fleet is 1.44 years at June 30, 2005 compared to 1.71 years as of June 30, 2004. The Company intends to continue to keep its fleet as new as possible in advance of the federally mandated engine emission standards which are required for all newly- manufactured trucks beginning in January 2007. As such, capital expenditures are expected to be higher throughout the remainder of 2005 as compared to 2004. The Company intends to fund these capital expenditure commitments through existing cash on hand and cash flow from operations. Equipment may be purchased through financing if management determines that financing is advantageous or necessary for the Company. Net financing activities used $3.9 million and $16.2 million during the six months ended June 30, 2005 and 2004, respectively. The Company paid dividends of $5.6 million in the six-month period ended June 30, 2005 20
and $4.0 million in the six-month period ended June 30, 2004. The Company increased its quarterly dividend rate by $.01 per share beginning with the dividend paid in July 2004 and by $.005 per share beginning with the dividend paid in July 2005. Financing activities also included common stock repurchases of $0.3 million and $14.2 million in the six-month periods ended June 30, 2005 and 2004, respectively. From time to time, the Company has repurchased, and may continue to repurchase, shares of its common stock. The timing and amount of such purchases depends on market and other factors. The Company's Board of Directors has authorized the repurchase of up to 3,965,838 shares. As of June 30, 2005, the Company had purchased 182,038 shares pursuant to this authorization and had 3,783,800 shares remaining available for repurchase. Management believes the Company's financial position at June 30, 2005 is strong. As of June 30, 2005, the Company has $51.1 million of cash and cash equivalents, no debt, and $815.8 million of stockholders' equity. As of June 30, 2005, the Company has no equipment operating leases, and, therefore has no off-balance sheet equipment debt. The Company maintains $35.5 million in letters of credit as of June 30, 2005. These letters of credit are primarily required as security for insurance policies. As of June 30, 2005, the Company has $75.0 million of credit pursuant to credit facilities, on which no borrowings were outstanding. The credit available under these facilities is reduced by the $35.5 million in letters of credit. Off-Balance Sheet Arrangements: The Company does not have arrangements that meet the definition of an off-balance sheet arrangement. Regulations: The Federal Motor Carrier Safety Administration ("FMCSA") of the U.S. Department of Transportation issued a final rule on April 24, 2003, that made several changes to the regulations that govern truck drivers' hours of service ("HOS"). The new rules became effective on January 4, 2004. On July 16, 2004, the U.S. Circuit Court of Appeals for the District of Columbia rejected the new hours of service rules for truck drivers, because it said the FMCSA had failed to address the impact of the rules on the health of drivers as required by Congress. In addition, the judge's ruling noted other areas of concern including the increase in driving hours from 10 hours to 11 hours, the exception that allows drivers to split their required rest periods, the new rule allowing drivers to reset their 70-hour clock to 0 hours after 34 consecutive hours off duty, and the decision by the FMCSA not to require the use of electronic onboard recorders to monitor driver compliance. On September 30, 2004, the extension of the federal highway bill signed into law by the President extended the previously vacated 2003 hours of service rules, effective immediately, for one year or whenever the FMCSA develops a new set of regulations, whichever comes first. On January 24, 2005, the FMCSA re-proposed its April 2003 HOS rules, adding references to how the rules would affect driver health, but making no changes to the regulations. The public comment period ended on March 10, 2005. The federal highway bill approved by Congress on July 29, 2005 did not codify the current hours of service regulations as Federal Law. Thus, the FMCSA is expected to announce its new regulations prior to the September 30, 2005, deadline previously established by Congress. If new regulations are issued by the FMCSA, indications are that the rules may be different than the current rules, and litigation is likely to follow. Beginning in January 2007, a new set of more stringent engine emissions standards mandated by the Environmental Protection Agency ("EPA") will become effective for all newly manufactured trucks. The Company intends to continue to keep its fleet as new as possible in advance of the new standards. The Company expects that the engines produced under the 2007 standards will be less fuel-efficient and have a higher cost than the current engines. In addition, all truckload carriers will be required to use new ultra-low sulfur fuel for all of the existing trucks in their fleet beginning in mid-2006. Fuel supply and delivery issues may cause the price per gallon of the new ultra-low sulfur fuel to be higher compared to current fuel, and preliminary estimates are that the new ultra-low sulfur 21
fuel will cause an approximate 1% to 3% decline in fuel miles per gallon. To gain a better understanding of the impact of these items, the Company expects to begin testing a few January 2007 compliant test engines using ultra-low sulfur fuel in third quarter 2005. The Company also expects to begin testing the ultra-low sulfur fuel on existing company trucks in third quarter 2005 to determine the impact on fuel mile per gallon. Critical Accounting Policies: The most significant accounting policies and estimates that affect our financial statements include the following: * Selections of estimated useful lives and salvage values for purposes of depreciating tractors and trailers. Depreciable lives of tractors and trailers range from 5 to 12 years. Estimates of salvage value at the expected date of trade-in or sale (for example, three years for tractors) are based on the expected market values of equipment at the time of disposal. Although the Company's current replacement cycle for tractors is three years, the Company calculates depreciation expense for financial reporting purposes using a five-year life and 25% salvage value. Depreciation expense calculated in this manner continues at the same straight-line rate, which approximates the continuing declining market value of the tractors, in those instances in which a tractor is held beyond the normal three-year age. Calculating depreciation expense using a five-year life and 25% salvage value results in the same annual depreciation rate (15% of cost per year) and the same net book value at the normal three-year replacement date (55% of cost) as using a three-year life and 55% salvage value. The Company continually monitors the adequacy of the lives and salvage values used in calculating depreciation expense and adjusts these assumptions appropriately when warranted. * The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. An impairment loss would be recognized if the carrying amount of the long-lived asset is not recoverable, and it exceeds its fair value. For long-lived assets classified as held and used, if the carrying value of the long-lived asset exceeds the sum of the future net cash flows, it is not recoverable. The Company does not separately identify assets by operating segment, as tractors and trailers are routinely transferred from one operating fleet to another. As a result, none of the Company's long-lived assets have identifiable cash flows from use that are largely independent of the cash flows of other assets and liabilities. Thus, the asset group used to assess impairment would include all assets and liabilities of the Company. Long-lived assets classified as held for sale are reported at the lower of their carrying amount or fair value less costs to sell. * Estimates of accrued liabilities for insurance and claims for liability and physical damage losses and workers' compensation. The insurance and claims accruals (current and long-term) are recorded at the estimated ultimate payment amounts and are based upon individual case estimates, including negative development, and estimates of incurred-but-not-reported losses based upon past experience. The Company's self-insurance reserves are reviewed by an actuary every six months. * Policies for revenue recognition. Operating revenues (including fuel surcharge revenues) and related direct costs are recorded when the shipment is delivered. For shipments where a third-party provider is utilized to provide some or all of the service and the Company is the primary obligor in regards to the delivery of the shipment, establishes customer pricing separately from carrier rate negotiations, generally has discretion in carrier selection, and/or has credit risk on the shipment, the Company records both revenues for the dollar value of services billed by the Company to the customer and rent and purchased transportation expense for the costs of transportation paid by the Company to the third-party provider upon 22
delivery of the shipment. In the absence of the conditions listed above, the Company records revenues net of expenses related to third-party providers. * Accounting for income taxes. Significant management judgment is required to determine the provision for income taxes and to determine whether deferred income taxes will be realized in full or in part. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. When it is more likely that all or some portion of specific deferred income tax assets will not be realized, a valuation allowance must be established for the amount of deferred income tax assets that are determined not to be realizable. A valuation allowance for deferred income tax assets has not been deemed to be necessary due to the Company's profitable operations. Accordingly, if the facts or financial circumstances were to change, thereby impacting the likelihood of realizing the deferred income tax assets, judgment would need to be applied to determine the amount of valuation allowance required in any given period. Management periodically evaluates these estimates and policies as events and circumstances change. Together with the effects of the matters discussed above, these factors may significantly impact the Company's results of operations from period to period. Accounting Standards: In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 153, Exchanges of Nonmonetary Assets. This Statement amends the guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions. APB Opinion No. 29 provided an exception to the basic measurement principle (fair value) for exchanges of similar assets, requiring that some nonmonetary exchanges be recorded on a carryover basis. SFAS No. 153 eliminates the exception to fair value for exchanges of similar productive assets and replaces it with a general exception for exchange transactions that do not have commercial substance, that is, transactions that are not expected to result in significant changes in the cash flows of the reporting entity. The provisions of SFAS No. 153 are effective for exchanges of nonmonetary assets occurring in fiscal periods beginning after June 15, 2005. As of June 30, 2005, management believes that SFAS No. 153 will have no significant effect on the financial position, results of operations, and cash flows of the Company. In December 2004, the FASB revised SFAS No. 123 (revised 2004), Share- Based Payments. SFAS No. 123(R) eliminates the alternative to use APB Opinion No. 25's intrinsic value method of accounting (generally resulting in recognition of no compensation cost) and instead requires a company to recognize in its financial statements the cost of employee services received in exchange for valuable equity instruments issued, and liabilities incurred, to employees in share-based payment transactions (e.g., stock options). The cost will be based on the grant-date fair value of the award and will be recognized over the period for which an employee is required to provide service in exchange for the award. In April 2005, the Securities and Exchange Commission ("SEC") adopted a rule amending the compliance dates for SFAS No. 123(R). Under the new SEC rule, the provisions of the revised statement are to be applied prospectively by the Company for awards that are granted, modified, or settled in the first fiscal year beginning after June 15, 2005. Additionally, the Company would recognize compensation cost for any portion of awards granted or modified after December 15, 1994, that is not yet vested at the date the standard is adopted, based on the grant-date fair value of those awards calculated under SFAS No. 123 (as originally issued) for either recognition or pro forma disclosures. When the Company adopts the standard on January 1, 2006, it will be required to report in its financial statements the share- based compensation expense for reporting periods in 2006. As of June 30, 2005, management believes that adopting the new statement will have a negative impact of approximately one cent per share for the year ending December 31, 2006, representing the expense to be recognized for the unvested portion of awards which were granted prior to June 30, 2005, and cannot predict the earnings impact of awards that may be granted after that 23
date. (See Note 5 of the Notes to Consolidated Financial Statements under Part I, Item 1 of this Form 10-Q, which shows the pro forma effect of SFAS No. 123, as originally issued.) In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections. This Statement replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of all voluntary changes in accounting principle and changes required by an accounting pronouncement when the pronouncement does not include specific transition provisions. This Statement requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impracticable to do so. The provisions of SFAS No. 154 are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. As of June 30, 2005, management believes that SFAS No. 154 will have no significant effect on the financial position, results of operations, and cash flows of the Company. Forward-Looking Statements and Risk Factors: The following risks and uncertainties, as well as those listed in Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2004, may cause actual results to differ materially from those anticipated in the forward-looking statements included in this Form 10-Q: The Company is sensitive to changes in overall economic conditions that impact customer shipping volumes. Future weakness in the economy and consumer demand could result in reduced freight demand, which, in turn, would impact the Company's growth opportunities, revenues, and profitability. Other economic conditions that may affect the Company include employment levels, business conditions, fuel and energy costs, interest rates, and tax rates. At times, there have been shortages of drivers and owner-operators in the trucking industry. Improvement in the general unemployment rate can lead to further difficulty in recruiting and retention. The market for recruiting drivers became more difficult in fourth quarter 2003 and continued through second quarter 2005. The Company anticipates that the competition for company drivers and owner-operators will continue to be high and cannot predict whether it will experience shortages in the future. If such a shortage was to occur and additional increases in driver pay rates and owner-operator settlement rates became necessary to attract and retain drivers and owner-operators, the Company's results of operations would be negatively impacted to the extent that corresponding freight rate increases were not obtained. Diesel fuel prices have increased eight consecutive quarters and high prices continue through July 2005. To the extent the Company cannot recover the higher cost of fuel through general customer fuel surcharge programs, the Company's results would be negatively impacted. Shortages of fuel, further increases in fuel prices, or rationing of petroleum products could have a materially adverse impact on the operations and profitability of the Company. As discussed above, the United States Circuit Court of Appeals for the District of Columbia vacated the new hours of service regulations in their entirety on July 16, 2004, and on September 30, 2004, the previously vacated 2003 rules were extended for a one-year period or until the FMCSA develops a new set of regulations. On January 24, 2005, the FMCSA re- proposed its April 2003 HOS rules, adding references to how the rules would affect driver health, but making no changes to the regulations. No ruling on the FMCSA's proposal has been made as of the date of this filing. The Company cannot predict what rule changes, if any, will result from the court's ruling, nor the extent of the proposed rule's effect on the operations and profitability of the Company. 24
The Company self-insures for liability resulting from cargo loss, personal injury, and property damage as well as workers' compensation. This is supplemented by premium-based insurance with licensed insurance companies above the Company's self-insurance level for each type of coverage. To the extent that the Company were to experience a significant increase in the number of claims, the cost per claim, or the costs of insurance premiums for coverage in excess of its retention amounts, the Company's operating results would be negatively affected. Effective October 1, 2002, all newly manufactured truck engines must comply with the engine emission standards mandated by the EPA. As of June 30, 2005, approximately 68% of the company-owned truck fleet consisted of trucks with post-October 2002 engines. The Company has experienced an approximate 5% reduction in fuel efficiency to date and increased depreciation expense due to the higher cost of the new engines. The Company anticipates continued increases in these expense categories as regular tractor replacements increase the percentage of company-owned trucks with post-October 2002 engines. As discussed above, a new set of more stringent emissions standards mandated by the EPA will become effective for newly manufactured trucks beginning in January 2007, and all truckload carriers will be required to use new ultra-low sulfur fuel for all of the existing trucks in their fleet beginning in mid-2006. Fuel supply and delivery issues may cause the price per gallon of the new ultra- low sulfur fuel to be higher compared to current fuel, and preliminary estimates are that the new ultra-low sulfur fuel will cause an approximate 1% to 3% decline in fuel miles per gallon. The Company is unable to predict the ultimate impact these new regulations will have on its operations, financial position, results of operations, and cash flows. Item 3. Quantitative and Qualitative Disclosures About Market Risk. The Company is exposed to market risk from changes in commodity prices, foreign exchange rates, and interest rates. Commodity Price Risk The price and availability of diesel fuel are subject to fluctuations due to changes in the level of global oil production, seasonality, weather, and other market factors. Historically, the Company has been able to recover a majority of fuel price increases from customers in the form of fuel surcharges. The Company has implemented customer fuel surcharges programs with most of its revenue base to offset most of the higher fuel cost per gallon. The Company cannot predict the extent to which higher fuel price levels will continue in the future or the extent to which fuel surcharges could be collected to offset such increases. As of June 30, 2005, the Company had no derivative financial instruments to reduce its exposure to fuel price fluctuations. Foreign Exchange Rate Risk The Company conducts business in Mexico and Canada. Foreign currency transaction gains and losses were not material to the Company's results of operations for second quarter 2005 and prior periods. To date, all foreign revenues are denominated in U.S. dollars, and the Company receives payment for freight services performed in Mexico and Canada primarily in U.S. dollars to reduce foreign currency risk. Accordingly, the Company is not currently subject to material foreign currency exchange rate risks from the effects that exchange rate movements of foreign currencies would have on the Company's future costs or on future cash flows. 25
Interest Rate Risk The Company had no debt outstanding at June 30, 2005. Interest rates on the Company's unused credit facilities are based on the London Interbank Offered Rate ("LIBOR"). Increases in interest rates could impact the Company's annual interest expense on future borrowings. Item 4. Controls and Procedures. As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures, as defined in Exchange Act Rule 15d-15(e). Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in enabling the Company to record, process, summarize and report information required to be included in the Company's periodic SEC filings within the required time period. There have been no changes in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. The Company has confidence in its internal controls and procedures. Nevertheless, the Company's management, including the Chief Executive Officer and Chief Financial Officer, does not expect that the internal controls or disclosure procedures and controls will prevent all errors or intentional fraud. An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of such internal controls are met. Further, the design of an internal control system must reflect the fact that there are resource constraints, and the benefits of controls must be relative to their costs. Because of the inherent limitations in all internal control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. 26
PART II OTHER INFORMATION Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. On December 29, 1997, the Company announced that its Board of Directors had authorized the Company to repurchase up to 4,166,666 shares of its common stock. On November 24, 2003, the Company announced that its Board of Directors approved an increase to its authorization for common stock repurchases of 3,965,838 shares. The December 29, 1997 repurchase authorization of 4,166,666 shares was completed in 2004. As of June 30, 2005, the Company had purchased 182,038 shares pursuant to the November 24, 2003 authorization and had 3,783,800 shares remaining available for repurchase. The Company may purchase shares from time to time depending on market, economic, and other factors. The authorization will continue until withdrawn by the Board of Directors. No shares of common stock were repurchased during the second quarter of 2005 by either the Company or any affiliated purchaser. Item 4. Submission of Matters to a Vote of Security Holders. The Annual Meeting of Stockholders of Werner Enterprises, Inc. was held on May 10, 2005 for the purpose of electing three directors for three- year terms, voting on a proposed amendment to the Company's Articles of Incorporation, and considering a stockholder proposal regarding board inclusiveness. Proxies for the meeting were solicited pursuant to Section 14(a) of the Securities Exchange Act of 1934, and there was no solicitation in opposition to management's nominees. Of the 79,420,150 shares entitled to vote, stockholders representing 75,392,867 shares (94.9%) were present in person or by proxy. The stockholders elected the three directors standing for re-election. The voting tabulation was as follows: Shares Shares Voted Voted "FOR" "ABSTAIN" ---------- --------- Gary L. Werner 71,892,108 3,500,759 Gregory L. Werner 73,123,833 2,269,034 Michael L. Steinbach 73,817,288 1,575,579 The stockholders approved the amendment to Article X of the Company's Articles of Incorporation regarding the number of classes of directors and the number of directors in each class. The voting tabulation was as follows: Shares Shares Shares Voted Voted Voted "FOR" "AGAINST" "ABSTAIN" ---------- ---------- --------- Articles of Incorporation Amendment 47,190,652 28,169,697 32,516 27
The stockholders voted against the stockholder proposal regarding board inclusiveness. The voting tabulation was as follows: Shares Shares Shares Voted Voted Voted "FOR" "AGAINST" "ABSTAIN" --------- ---------- --------- Board Inclusiveness 3,824,269 61,836,894 3,244,879 Item 6. Exhibits. Exhibit 3(i)(A) Revised and Amended Articles of Incorporation (Incorporated by reference to Exhibit 3 to Registration Statement on Form S-1, Registration No. 33-5245) Exhibit 3(i)(B) Articles of Amendment to Articles of Incorporation (Incorporated by reference to Exhibit 3(i) to the Company's report on Form 10-Q for the quarter ended May 31, 1994) Exhibit 3(i)(C) Articles of Amendment to Articles of Incorporation (Incorporated by reference to Exhibit 3(i) to the Company's report on Form 10-K for the year ended December 31, 1998) Exhibit 3(i)(D) Articles of Amendment to Articles of Incorporation (filed herewith) Exhibit 3(ii) Revised and Restated By-Laws (Incorporated by reference to Exhibit 3(ii) to the Company's report on Form 10-Q for the quarter ended June 30, 2004) Exhibit 10.1 Non-Employee Director Compensation (filed herewith) Exhibit 31(i)(A) Rule 13a-14(a)/15d-14(a) Certification (filed herewith) Exhibit 31(i)(B) Rule 13a-14(a)/15d-14(a) Certification (filed herewith) Exhibit 32.1 Section 1350 Certification (filed herewith) Exhibit 32.2 Section 1350 Certification (filed herewith) 28
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. WERNER ENTERPRISES, INC. Date: August 1, 2005 By: /s/ John J. Steele ------------------------ ------------------------------------- John J. Steele Senior Vice President, Treasurer and Chief Financial Officer Date: August 1, 2005 By: /s/ James L. Johnson ------------------------ ------------------------------------- James L. Johnson Vice President, Controller and Corporate Secretary 29