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KNX > SEC Filings for KNX > Form 10-K on 28-Feb-2014All Recent SEC Filings




Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations

Cautionary Note Regarding Forward-Looking Statements

Item 7, as well as other items of this Annual Report, contains certain
statements that may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and such statements are subject to the safe harbor created by those sections and the Private Securities Litigation Reform Act of 1995, as amended. All statements, other than statements of historical or current fact, are statements that could be deemed forward-looking statements, including without limitation: any projections of earnings, revenues, or other financial items; any statement of plans, strategies, and objectives of management for future operations; any statements concerning proposed new services or developments; any statements regarding future economic conditions or performance; and any statements of belief and any statement of assumptions underlying any of the foregoing. In this Item 7, statements related to expected tractor trade-ins, expected sources of working capital and funds for acquiring revenue equipment, expected capital expenditures, future asset utilization, future capital requirements, future trucking capacity, future consumer spending, expected freight demand and volumes, future rates, planned driver pay and related costs, future depreciation and amortization, expected tractor and trailer fleet age, future purchased transportation expense, and our expected liquidity position, among others, are forward-looking statements. Such statements may be identified by their use of terms or phrases such as "believe," "may," "could," "expects," "estimates," "projects," "anticipates," "plans," "intends," and similar terms and phrases. Forward-looking statements are based on currently available operating, financial, and competitive information. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, which could cause future events and actual results to differ materially from those set forth in, contemplated by, or underlying the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section entitled "Item 1A. Risk Factors," set forth above. Readers should review and consider the factors discussed in "Item 1A. Risk Factors," along with various disclosures in our press releases, stockholder reports, and other filings with the Securities and Exchange Commission.

All such forward-looking statements speak only as of the date of this Annual Report. You are cautioned not to place undue reliance on such forward-looking statements. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in the events, conditions, or circumstances on which any such statement is based.


Business Overview

We offer a broad range of truckload transportation and logistics services with one of North America's largest tractor fleets, operated through a nationwide network of service centers, and contractual access to thousands of third-party capacity providers. We have grown substantially by increasing the geographic reach of our service center network and by expanding the breadth of our services. Our Asset-Based segment provides truckload transportation, including dedicated services, of various products, goods, and materials for our diverse customer base through our Dry Van, Refrigerated, and Drayage operating units. The Brokerage and Intermodal operating units of our Non-Asset-Based segment provide a multitude of shipment solutions, including additional sources of truckload capacity and alternative transportation modes, and by utilizing our vast network of third-party capacity providers and rail partners, as well as certain logistics, freight management, and other non-trucking services. Our objective is to operate our Asset-Based and Non-Asset-Based business with industry-leading margins and growth, while providing safe, high-quality, cost-effective solutions for our customers.

The main factors that affect our results are industry-wide economic factors, such as freight demand, truckload and rail intermodal capacity, fuel prices, the number of tractors we operate, our revenue per tractor (which includes primarily our revenue per total mile and our number of miles per tractor), freight volumes brokered to third-party capacity providers (including our rail partners), driver and independent contractor recruitment and retention, and our ability to control costs on a company-wide basis. Our success depends on our ability to efficiently and effectively manage our resources in providing transportation and logistics solutions to our customers in light of such factors. We evaluate the growth opportunities for each of our Asset-Based and Non-Asset-Based businesses based on customer demand and supply chain trends, availability of drivers and third-party capacity providers, expected returns on invested capital, expected net cash flows, and our company-specific capabilities.

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Recent Consolidated Results of Operations and Year-End Financial Condition

Our consolidated results of operations for the year ended December 31, 2013, compared to the year ended December 31, 2012, were as follows:

Total revenue increased 3.5%, to $969.2 million from $936.0 million;
Net income attributable to Knight increased 8.1%, to $69.3 million from $64.1 million; and
Net income attributable to Knight per diluted share increased 7.6%, to $0.86 from $0.80.

During the first half of 2013, freight demand began softer than expected and then improved during the normal seasonal peaks. A constrained driver market, new hours-of-service regulations, and relatively weak demand impacted the third quarter negatively when compared to 2012, however, in the fourth quarter we experienced a more favorable environment with a strong seasonal improvement.

In 2013, our Asset-Based segment operated an average of 4,017 tractors, a decrease of 79 tractors from a year ago. Productivity, as measured by average annual revenue per tractor, before fuel surcharge, increased 0.8% in 2013. This improvement was attributable to expansion of our freight mix and contract pricing as the truckload freight market continued a slow recovery. Shipments serviced by our Non-Asset-Based segment increased as we continued increasing the number of customers utilizing our Non-Asset-Based services, which further contributed to the increased revenue and net income realized in 2013.

In 2013, we returned $19.4 million to our shareholders in the form of quarterly cash dividends and also reduced our debt by $42.0 million. We ended the year with $992,000 of cash and $551.5 million of shareholders' equity. In 2013, we generated $138.5 million in cash flow from operations and used $85.4 million for capital expenditures net of equipment sales.

Since inception, we have been profitable through multiple economic cycles. We view the difficult cycles as opportunities to gain market share from competitors that do not have the financial staying power to survive the cycles. These difficult cycles also provide valuable experience to our managers that will help us develop the leaders to grow our business profitably.

Our liquidity is not materially affected by off-balance sheet transactions. See the discussion under "Off-Balance Sheet Transactions" under Item 7 to Part I of this Annual Report for a description of our off-balance sheet transactions.

Consolidated Revenue and Expenses

We primarily generate revenue by transporting freight for our customers in our Asset-Based segment or arranging for the transportation of customer freight in our Non-Asset-Based segment. Our operating revenue is reported under "Results of Operations" under Item 7 to Part I of this Annual Report and categorized as (i) Asset-Based revenue, net of fuel surcharge, (ii) Asset-Based fuel surcharge revenue, and (iii) Non-Asset-Based revenue. Asset-Based revenue, net of fuel surcharge, and Asset-Based fuel surcharge revenue is largely generated by the trucking services provided by our three Asset-Based operating units (Dry Van, Refrigerated, and Drayage), whereas Non-Asset-Based revenue is mostly generated by the logistics services provided by our two Non-Asset-Based operating units (Brokerage and Intermodal). We also provide logistics, freight management and other non-trucking services, such as used equipment sales and leasing to independent contractors and third-parties through our Non-Asset-Based business.

The operating revenue and operating expenses of our Asset-Based and Non-Asset-Based segments are similarly affected by certain factors that generally relate to, among other things, overall economic conditions in the United States, customer inventory levels, specific customer demand, the levels of truckload and rail intermodal capacity, and availability of qualified drivers, independent contractors, and third-party capacity providers.

To lessen our risk to fuel price fluctuations in our Asset-Based segment, we have a fuel surcharge program under which we obtain from our customers additional fuel surcharges that generally recover a majority, but not all, of the increased fuel costs; however, we cannot ensure whether current recovery levels will continue in the future. In discussing our overall and segment-based results of operations, because changes in fuel costs typically cause fuel surcharge revenue to fluctuate, we identify Asset-Based fuel surcharge revenue separately and omit fuel surcharge revenue from our statistical calculations. We believe that omitting this sometimes volatile source of revenue provides a more meaningful comparison of our operating results from period to period.

Prior to fourth quarter 2013, we aggregated our Asset-Based and Non-Asset-Based segments in accordance with relevant accounting guidance regarding segment reporting. We recently reevaluated our segment reporting because

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of evolving events and changes to our business and determined that separate segment reporting of our Asset-Based business and Non-Asset-Based business is appropriate. Please refer to Note 11 to the consolidated financial statements for more information regarding segment reporting.

Asset-Based Strategy and Segment Information

Our Asset-Based operating strategy is to achieve a high level of asset utilization within a highly disciplined operating system while maintaining strict controls over our cost structure. To achieve these goals, we operate primarily in high-density, predictable freight lanes in select geographic regions and attempt to develop and expand our customer base around each of our service centers by providing multiple truckload services for each customer. This operating strategy allows us to take advantage of the large amount of freight transported in regional markets. Our service centers enable us to better serve our customers and work more closely with our driving associates. We operate a premium modern fleet to appeal to drivers and customers, reduce maintenance expenses and driver and equipment downtime, and enhance our fuel and other operating efficiencies. We employ technology in a cost-effective manner to assist us in controlling operating costs and enhancing revenue.

Asset-Based revenue is generated by our Dry Van, Refrigerated, and Drayage operating units. Generally, we are paid a predetermined rate per mile or per load for our Asset-Based trucking services. Additional revenues are generated by charging for tractor and trailer detention, loading and unloading activities, dedicated services, and other specialized services, as well as through the collection of fuel surcharges to mitigate the impact of increases in the cost of fuel. The main factors that affect our Asset-Based revenue are the revenue per mile we receive from our customers, the percentage of miles for which we are compensated, and the number of loaded miles we generate with our equipment.

Effectively controlling our expenses is an important element of maximizing our profitability. The most significant expenses of our Asset-Based segment are primarily variable and include fuel and fuel taxes, driver-related expenses (such as wages, benefits, training, and recruitment) and costs associated with independent contractors (which are primarily included in purchased transportation expense recorded on the "Purchased transportation" line of our consolidated statements of income). Expenses that have both fixed and variable components include maintenance expense (which includes costs for replacement tires for our revenue equipment) and our total cost of insurance and claims. These expenses generally vary with the miles we travel but also have a controllable component based on safety, fleet age, efficiency, and other factors. The main fixed costs for our Asset-Based segment are the acquisition and depreciation of long-term assets (such as revenue equipment and service centers) and the compensation of non-driver personnel.

The primary measure we use to evaluate the profitability of our Asset-Based segment is operating ratio, measured both on a GAAP basis (operating expenses expressed as a percentage of revenue) and on a non-GAAP basis that many in our industry use (operating expenses, net of Asset-Based fuel surcharge revenue, expressed as a percentage of Asset-Based revenue, excluding Asset-Based fuel surcharge revenue). We believe the second method allows us to more effectively compare periods while excluding the potentially volatile effect of changes in fuel prices. The tables below compare our operating ratio using both methods.

GAAP Presentation:              2013                        2012                        2011
Asset-Based (amounts
in thousands)              $               %           $               %           $                  %
Revenue                 $ 822,188                   $ 836,357                   $ 785,989
Operating expenses        716,021          87.1       733,344          87.7       691,006          87.9
Operating income        $ 106,167                   $ 103,013                   $  94,983

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The following table sets forth the Asset-Based segment adjusted operating ratio (non-GAAP) as if fuel surcharges are excluded from total revenue and instead reported as a reduction of operation expenses, excluding intersegment activity.

Non-GAAP Presentation:                            2013                         2012                     2011
Asset-Based (amounts in thousands)            $              %              $            %           $           %
Revenue                                $    822,188                   $    836,357              $  785,989
Less: Asset-Based fuel surcharge           (177,386 )                     (183,885 )              (168,913 )
Less: Intersegment transactions(1)             (120 )                         (112 )                   (82 )
Revenue, net of fuel surcharge and          644,682                        652,360                 616,994
intersegment transactions(1)
Operating expenses                          716,021                        733,344                 691,006
Less: Asset-Based fuel surcharge           (177,386 )                     (183,885 )              (168,913 )
Less: Intersegment transactions(1)             (120 )                         (112 )                   (82 )
Operating expenses, net of fuel
surcharge and intersegment                  538,515        83.5            549,347     84.2        522,011     84.6
Operating income                       $    106,167                   $    103,013              $   94,983

(1) These items represent non-GAAP financial measures and are not substitutes for, and should be considered in addition to, the GAAP financial measures presented in the previous table.

When evaluating Asset-Based revenue, we consider the following key operating statistics for each period: (i) average revenue per tractor per week; (ii) average length of haul (miles with loaded trailer cargo); (iii) average percentage of empty miles (miles without trailer cargo); and (iv) average number of tractors and trailers in operation. The following table sets forth certain key operating statistics and certain other statistical data of the Asset-Based segment for the indicated periods.

                                                  2013          2012          2011
Average revenue per tractor (1)              $ $160,186     $ 158,978     $ 157,076
Average length of haul                           479            482            483
Non-paid empty mile percent                     10.6%          10.6%          10.6%
Average tractors in operation during period     4,017          4,096          3,908
Average trailers in operation during period     9,405          9,195          8,907

(1) Average revenue per tractor is based on revenue net of intersegment elimination, and does not include fuel surcharge revenue.

Our Asset-Based segment requires substantial capital expenditures for purchases of new revenue equipment. We fund these purchases with cash flows from operations and financing available under our existing line of credit. We operated an average of 4,017 tractors in 2013, of which 3,537 were company-owned tractors. The average age of our company-owned tractor fleet was 1.9 years at December 31, 2013, which we expect to maintain in 2014. We also operated an average of 9,406 trailers in 2013, with an average age of 5.4 years as of December 31, 2013. We expect the average age of our trailers to decrease slightly in 2014 as we refresh our fleet. Our net property, plant, and equipment at December 31, 2013 was $591.8 million, most of which relates to our Asset-Based segment.

Our capital expenditures can also affect depreciation expense. Asset-Based depreciation relates primarily to our owned tractors, trailers, auxiliary power units, ELDs and other communication units, and other similar assets. Changes to this fixed cost are generally attributed to increases or decreases to company-owned equipment and fluctuations in new equipment purchase prices, which have historically been precipitated in part by new or proposed federal and state regulations (such as the 2007 and 2010 EPA engine emissions requirements and the California trailer efficiency requirements). Depreciation can also generally be affected by the cost of used equipment that we sell or trade and the replacement of older used equipment. Our management periodically reviews the condition, average age, and reasonableness of estimated useful lives and salvage values of our equipment and considers such factors in light of our experience with similar assets, used equipment market conditions, and prevailing industry practice. Total Asset-Based segment depreciation and amortization expense was approximately $81.0 million in 2013.

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Non-Asset-Based Strategy and Segment Information

Non-Asset-Based revenue is generated primarily by our Brokerage and Intermodal operating units. We also provide logistics, freight management and other non-trucking services to our customers through our Non-Asset-Based business. We are generally paid a predetermined rate per mile or per load for arranging freight transportation for our customers and providing other Non-Asset-Based services. Additional revenue is generated by offering specialized logistics solutions (including, but not limited to, origin management, surge volumes, disaster relief, special projects, and other logistics needs). Our Non-Asset-Based revenue is mainly affected by the rates we obtain from customers, the freight volumes we ship through our third-party capacity providers, and our ability to secure qualified third-party capacity providers to transport customer freight. Increases in shipments serviced by our Brokerage and Intermodal operating units and continued increases in the number of customers utilizing our Non-Asset Based services contributed to the improved productivity and revenue realized in 2013.

Our Non-Asset-Based segment is less asset-intensive and is instead dependent upon talented non-driver personnel, modern and effective information technology, and qualified third-party capacity providers. The most significant expense of our Non-Asset-Based segment, which is primarily variable, is the cost of purchased transportation that we pay to third-party capacity providers (including our rail partners) (which is included in the "Purchased transportation" line of our consolidated statements of income). This expense generally varies depending upon truckload and rail capacity, availability of third-party capacity providers, rates charged to customers, and current freight demand and customer shipping needs. Other Non-Asset-Based operating expenses are generally fixed and primarily include the compensation and benefits of non-driver personnel (included in salaries, wages and benefits expense recorded on the "Salaries, wages and benefits" line of our consolidated statements of income) and depreciation and amortization expense.

The following table sets forth the Non-Asset-Based segment revenue, other operating expenses, and operating income.

                                       2013                    2012                   2011
Non-Asset-Based (amounts in         $           %           $          %           $          %
Revenue                        $ 151,194               $ 105,794              $  86,449
Other operating expenses         143,452      94.9       100,540     95.0        81,411     94.2
Operating income               $   7,742               $   5,254              $   5,038

The following table sets forth the Non-Asset-Based revenue, operating expenses, and operating income, excluding intersegment transactions.

                                        2013                     2012                     2011
Non-Asset-Based (amounts in
thousands)                         $            %           $            %           $            %
Revenue                        $ 151,194                $ 105,794                $  86,449
Less: Intersegment
transactions                      (4,025 )                 (6,003 )                 (6,157 )
Revenue excluding intersegment
transactions                     147,169                   99,791                   80,292
Operating expenses               143,452                  100,540                   81,411
Less: Intersegment
transactions                      (4,025 )                 (6,003 )                 (6,157 )
Operating expenses excluding
intersegment transactions        139,427       94.7        94,537       94.7        75,254       93.7
Operating income               $   7,742                $   5,254                $   5,038

We primarily measure the Non-Asset-Based segment's profitability by reviewing the gross margin percentage (revenue, less purchased transportation expense, expressed as a percentage of revenue) and the operating income percentage. The gross margin percentage can be affected by customer rates and the costs of securing third-party capacity providers. Our third-party capacity providers are generally not subject to long-term or predetermined contracted rates, and our operating results could be affected if the availability of third-party capacity providers or the rates for such providers change in the future. The following table lists the gross margin percentage for our Brokerage and Intermodal businesses.

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                                     2013         2012       2011
Brokerage gross margin percent (1)  13.3 %      13.6  %     11.7  %
Intermodal gross margin percent(1)  10.7 %      12.0 %       8.2 %

(1) Gross margin percentage is based on revenue net of intersegment elimination.

Our Non-Asset-Based segment does not require significant capital expenditures and is not asset-intensive like our Asset-Based segment. Rather, our Non-Asset-Based segment depends on effective usage of information systems and technology that enable us to efficiently arrange for the transportation of our customers' freight and remain resourceful and responsive in meeting customer shipping needs. As our Non-Asset-Based services evolve, we may incur costs to upgrade, integrate, or expand our information systems and technology, but we do not expect that costs for such improvements will require significant capital expenditures in the future. Total Non-Asset-Based segment depreciation and amortization expense was approximately $5.1 million in 2013, which is primarily attributed to equipment leased to third parties.

Trends and Outlook

We have created a service network with financial accountability, a modern tractor fleet, access to thousands of third-party capacity providers, and the capability of providing multiple transportation service offerings and modes to customers in North America. We believe our operating strategies are contributing factors to our revenue and earnings growth.

In 2013, we continued to produce consolidated revenue growth. This growth was driven by our less capital-intensive operations such as Brokerage and Intermodal in the Non-Asset-Based segment. In these businesses we continue to gain market share, build out our team, source additional capacity, and strategically align our service offerings with the supply chain needs of our customers. We expect our investment in providing multiple solutions for our customers will continue to lead to additional revenue opportunities across all of our lines of business.

In 2014, we expect truckload freight demand to improve based on our expectation of a moderately growing economy. In addition, we expect that the new hours-of-service rules, the pending ELD mandate, and other regulations, including CSA, could result in a reduction in effective trucking capacity to serve increased demand. An expanding United States economy could create alternative employment opportunities for drivers we wish to hire. Reduced hours of operation and driver shortages could negatively impact equipment utilization, even in a stronger demand environment. In such an environment, we believe carriers that are well-positioned to develop and retain drivers, withstand supply and demand fluctuations, and provide safe, dependable, and high-quality service to customers will have opportunities to increase freight rates and market share. We believe domestic and global economic and political conditions present the most direct challenges to improved freight demand. These threats include the possibility that rising energy prices, an inability of the United States government to timely and adequately address fiscal issues, currency fluctuations, or other factors outside our control could reduce consumer spending or industrial investment, thus negatively affecting freight volumes.

Several issues impacting the trucking industry could also cause our costs to increase in 2014. These issues include driver and independent contractor . . .

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