UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2006
Commission File No. 000-22490
 
FORWARD AIR CORPORATION
(Exact name of registrant as specified in its charter)

 
Tennessee
  
62-1120025
  
 
(State or other jurisdiction
of incorporation or organization)
  
(I.R.S. Employer Identification No.)
  
         
 
430 Airport Road
      
 
Greeneville, Tennessee
  
37745
  
 
(Address of principal executive offices)
  
(Zip Code)
  

(423) 636-7000
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 
Common Stock, $0.01 par value
  
The NASDAQ Stock Market LLC
  
 
(Title of class)
  
(Name of exchange on which registered)
  

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes x  No ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ¨  No x
 
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer x
Accelerated filer ¨
Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)  Yes ¨  No x

The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2006 was approximately $1,277,374,667 based upon the $40.73 closing price of the stock as reported on The NASDAQ Stock Market LLC on that date. For purposes of this computation, all directors and executive officers of the registrant are assumed to be affiliates. This assumption is not a conclusive determination for purposes other than this calculation.

The number of shares outstanding of the registrant’s common stock, $0.01 par value per share, as of February 21, 2007 was 30,406,692.

DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the proxy statement for the 2007 Annual Meeting of Shareholders are incorporated by reference into Part III of this report.
 
Table of Contents

Forward Air Corporation
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35
 
F-2
   
Exhibit Index  
2

Introductory Note

This Annual Report on Form 10-K for the fiscal year ended December 31, 2006 (the “Form 10-K”) contains “forward-looking statements,” as defined in Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are statements other than historical information or statements of current condition and relate to future events or our future financial performance. Some forward-looking statements may be identified by use of such terms as “believes,” “anticipates,” “intends,” “plans,” “estimates,” “projects” or “expects.” Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. The following is a list of factors, among others, that could cause actual results to differ materially from those contemplated by the forward-looking statements: economic factors such as recessions, inflation, higher interest rates and downturns in customer business cycles, our inability to maintain our historical growth rate because of a decreased volume of freight moving through our network or decreased average revenue per pound of freight moving through our network, increasing competition and pricing pressure, surplus inventories, loss of a major customer, the creditworthiness of our customers and their ability to pay for services rendered, our ability to secure terminal facilities in desirable locations at reasonable rates, the inability of our information systems to handle an increased volume of freight moving through our network, changes in fuel prices, claims for property damage, personal injuries or workers’ compensation, employment matters including rising health care costs, enforcement of and changes in governmental regulations, environmental and tax matters, the handling of hazardous materials, the availability and compensation of qualified independent owner-operators and freight handlers needed to serve our transportation needs and our inability to successfully integrate acquisitions. As a result of the foregoing, no assurance can be given as to future financial condition, cash flows or results of operations. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Part I

Business

We were formed as a corporation under the laws of the state of Tennessee on October 23, 1981. We are a leading provider of time-definite surface transportation and related logistics services to the North American deferred air freight market. We offer our customers scheduled surface transportation of cargo as a cost effective, reliable alternative to air transportation. We transport cargo that must be delivered at a specific time, but is less time-sensitive than traditional air freight. This type of cargo is frequently referred to in the transportation industry as deferred air freight. We operate through a network of 81 terminals located on or near airports in the United States and Canada, including a central sorting facility in Columbus, Ohio and nine regional hubs serving key markets. Our typical shipment consists of a pallet-load of freight, often consisting of electronics, telecommunications equipment, machine parts, trade show exhibit materials or medical equipment. During 2006, our average shipment weighed over 720 pounds. We utilize a flexible source of capacity made up of owner-operators and, to a lesser extent, other surface transportation providers, which results in a largely variable cost operating model with low capital requirements.
 
We also offer our customers an array of logistic and other services including: exclusive-use vehicles (commonly referred to as truck brokerage); dedicated fleets; local pick-up and delivery; warehousing; customs brokerage; and shipment consolidation, deconsolidation and handling. These services are critical to our air freight forwarder customers, which are businesses that arrange transportation of cargo for third parties, that do not provide these logistics services themselves or that prefer to use one provider for all of their surface transportation needs.
 
We market our services primarily to air freight forwarders, integrated air cargo carriers, and passenger and cargo airlines. To serve this market, we offer customers a very high level of service with a focus on on-time, damage-free deliveries. We serve our customers by locating terminals on or near airports and maintaining regularly scheduled transportation service between major cities. We either receive shipments at our terminals or pick up shipments directly from our customers and transport them by truck (i) directly to the destination terminal; (ii) to our Columbus, Ohio central sorting facility; or (iii) to one of our nine regional hubs, where they are unloaded, sorted and reloaded. After reloading the shipments, we deliver them to the terminals nearest their destinations and then, if requested by the customer, on to a final designated site. We ship freight directly between terminals when justified by the volume of shipments. During 2006, approximately 20.8% of the freight we handled was for overnight delivery, approximately 60.6% was for delivery within two to three days and the balance was for delivery in four or more days. We generally do not market our services directly to shippers (where such services might compete with our freight forwarder customers). Also, because we do not place significant size or weight restrictions on shipments, we generally do not compete directly with integrated air cargo carriers such as United Parcel Service, Federal Express and DHL Worldwide in the overnight delivery of small parcels. In 2006, our five largest customers accounted for approximately 27.6% of our operating revenue and no single customer accounted for more than 10.0% of our operating revenue.
3
 
Our Industry

As businesses minimize inventory levels, perform manufacturing and assembly operations in multiple locations and distribute their products through multiple channels, they have an increased need for expedited delivery services. Expedited shipments are those shipments for which the customer requires delivery the next day or within two to three days, usually by a specified time or within a specified time window. The Colography Group, Inc., an independent industry market research and consulting firm, estimates that the total U.S. expedited cargo market, including domestic air, domestic ground parcel, domestic less-than-truckload and U.S. air export will generate $107.6 billion in revenue in 2007. Also according to The Colography Group, Inc., the U.S. domestic air freight market accounts for approximately $37.5 billion, or 34.9%, of this market. Approximately 14.1%, of that market is made up of heavyweight overnight and deferred air freight, which is the portion of the market within which we primarily compete.

Shippers with expedited delivery requirements have four principal alternatives to transport freight: freight forwarders; integrated air cargo carriers; less-than-truckload carriers; and passenger and cargo airlines.

 
•
Freight forwarders obtain requests for shipments from customers, make arrangements for transportation of the cargo by a third-party carrier and usually arrange for both delivery from the shipper to the carrier and from the carrier to the recipient.

 
•
Integrated air cargo carriers provide pick-up and delivery services primarily using their own fleet of trucks and provide transportation services generally using their own fleet of aircraft.

 
•
Less-than-truckload carriers also provide pick-up and delivery services through their own fleet of trucks. These carriers operate terminals where freight is unloaded, sorted and reloaded multiple times in a single shipment. This additional handling increases transit time, handling costs and the likelihood of cargo damage.

 
•
Passenger or cargo airlines provide airport-to-airport service, but have limited cargo space and generally accept only shipments weighing less than 150 pounds.

Although expedited air freight is usually transported by aircraft, freight forwarders often elect to transport cargo by truck, especially for shipments requiring deferred delivery. Generally, the cost of shipping freight, especially heavy freight, by truck is substantially less than shipping by aircraft. We believe there are several trends that are increasing demand for lower-cost truck transportation of expedited air freight. These trends include:

 
•
Increased Outsourcing of Logistics Management to Third-Party Logistics Providers. Air freight forwarders are playing an increasingly important role in logistics management. As the growing emphasis on just-in-time processes has added to the complexity of logistics management, companies are finding it more advantageous to outsource their logistics management functions to third parties. According to the Council of Supply Chain Management Professionals, the United States’ third-party logistics market grew at a compound annual rate of approximately 17.1% between 1995 and 2005. In contrast to integrated air cargo carriers and less-than-truckload carriers that are focused on utilizing their own fixed-cost assets, air freight forwarders can select from various transportation modes and suppliers to meet their customers’ shipping requirements, thereby serving their customers less expensively. In addition, air freight forwarders generally handle shipments of any size and offer customized shipping options, unlike most integrated air cargo carriers and less-than-truckload carriers.

 
•
Integrated Air Cargo Carriers’ Focus on Overnight Freight. Integrated air cargo carriers that transport heavy freight are targeting their marketing efforts at higher yielding overnight freight in order to better utilize their high fixed-cost infrastructures. As a result, these carriers are outsourcing deferred freight to surface transportation providers like us.

 
•
Reduced Airline Cargo Capacity. Since the 1980’s, when the domestic airlines eliminated many of their all-cargo aircraft, growth in demand for air cargo services has generally outpaced the growth of aircraft cargo capacity. Airlines have decreased fleet sizes and are utilizing smaller aircraft, including more regional jets, in many markets. The short supply of air cargo space has resulted in increased demand for surface transportation of cargo.

4
 
Competitive Advantages

We believe that the following competitive advantages are critical to our success as a leading provider of time-definite surface transportation services and related logistics services to the deferred air freight market in North America:

 
•
Focus on the Deferred Air Freight Market. We focus on providing time-definite surface transportation and related logistics services to the deferred air cargo industry. We believe that our focused approach has enabled us to provide a higher level of service in a more cost-effective manner than our competitors.

 
•
Expansive Network of Terminals and Sorting Facilities. We have built a network of terminals and sorting facilities throughout the United States and Canada located on or near airports. We believe it would be difficult for a competitor to duplicate our network without the expertise and strategic facility locations we have acquired and without expending significant capital and management resources. Our network enables us to provide regularly scheduled service between most markets with low levels of freight damage or loss, all at rates generally significantly below air freight rates.

 
•
Concentrated Marketing Strategy. We provide our services mainly to air freight forwarders, integrated air cargo carriers, and passenger and cargo airlines rather than directly serving shippers. We do not place significant size or weight restrictions on shipments and, therefore, we do not compete with delivery services such as United Parcel Service, Federal Express and DHL Worldwide in the overnight small parcel market. We believe that our customers prefer to purchase their transportation services from us because, among other reasons, we generally do not market our services to their shipper customers and, therefore, do not compete directly with them for customers.

 
•
Superior Service Offerings. Our published schedule for transit times with specific cut-off and arrival times generally provides our customers with the predictability they need. In addition, our network of terminals allows us to offer our customers later cut-off times, a higher percentage of direct shipments (which reduces damage and lost time caused by additional sorting and reloading) and shorter delivery times than most of our competitors.

 
•
Flexible Business Model. Rather than owning and operating our own trucks, we purchase most of our transportation requirements from owner-operators or truckload carriers. This allows us to respond quickly to changing demands and opportunities in our industry and to generate higher returns on assets because of our low capital requirements.

 
•
Comprehensive Logistic and Other Service Offerings. We offer an array of logistic and other services including: exclusive-use vehicles (commonly referred to as truck brokerage), dedicated fleet, warehousing, customs brokerage and shipment consolidation and handling. In addition, during 2006 we introduced our new pick-up and delivery service called Forward Air Complete™, whereby we arrange for cargo to be picked up from and/or delivered to a customer-designated site. These services are an essential part of many of our customers’ transportation needs and are not offered by many of our competitors.

 
•
Leading Technology Platform. We are committed to using information technology to increase the volume of freight we can handle in our network, improve visibility of shipment information and reduce our operating costs. Our technology allows us to provide our customers with electronic bookings and real-time tracking and tracing of shipments while in our network, complete shipment history, proof of delivery, estimated charges and electronic bill presentment. We continue to enhance our systems to permit us and our customers to access vital information through both the Internet and electronic data interchange.

 
•
Technology Advances. We have continued to invest in information technology to the benefit of our customers and our business processes. In 2006, we substantially completed the development and installation of our Terminal Automation Program (“TAP”), a new wireless application for our Company-operated terminals. The new system enables individual operators to perform virtually all data entry from our terminal floor locations. The new system provides immediate shipment updates, resulting in increased shipment accuracy and improved data timeliness. We believe that the TAP system not only will reduce operational manpower compared to our previous operation, but also will improve our on-time performance. Additionally, in order to support our new Forward Air Complete service offering,  we developed and installed a web-based system, which coordinates activities between our customers, operations personnel and external service providers.

5

Growth Strategy

Our growth strategy is to take advantage of our competitive strengths in the deferred air freight market in order to increase our profits and shareholder returns. Principal components of our growth strategy include efforts to:

 
•
Increase Freight Volume from Existing Customers. Many of our customers currently use us for only a portion of their overall transportation needs. In addition, many of our air freight forwarder customers are growing rapidly, and we expect that they will have a greater need for our services as their businesses grow. We will continue to market directly to these customers to capture additional freight volume. We also believe that there is significant potential for increased freight volume from passenger and cargo airlines, as well as from the integrated air cargo carriers.

 
•
Develop New Customers. We continue to actively market our services to potential new air freight forwarder customers, such as international freight forwarders. We believe air freight forwarders may move away from integrated air cargo carriers because those carriers charge higher rates, and away from less-than-truckload carriers because those carriers provide less reliable service and compete for the same customers as do the air freight forwarders. In addition, we believe our comprehensive North American network and related logistics services are attractive to domestic and international airlines.

 
•
Improve Efficiency of Our Transportation Network. We constantly seek to improve the efficiency of our network without changing our infrastructure or incurring significant capital expenditures. Regional hubs and direct shuttles improve our efficiency by reducing the number of miles freight must be transported and reducing the number of times freight must be handled and sorted. As the volume of freight between key markets increases, we intend to continue to add direct shuttles. In 2006, we substantially completed a project to expand our national hub in Columbus, Ohio.  The new expanded Columbus, Ohio facility is 125,000 square feet with 168 trailer doors. This premier facility can unload, sort and load upwards of 3.7 million pounds in five hours. In addition to the expansion, we process-engineered the freight sorting in the expanded building to improve handling efficiencies. The benefits will include reductions in the distance each shipment moves in the building to speed up the transfer process, less handling of freight to further improve service integrity and flexibility to operate multiple sorts at the same time.

 
•
Expand Logistic and Other Services. We continue to expand our logistic and other services to increase revenue and improve utilization of our terminal facilities and labor force. Because of the timing of the arrival and departure of cargo, our facilities are underutilized during certain portions of the day, allowing us to add logistics services without significantly increasing our costs. Therefore, we have added a number of services in the past few years, such as exclusive-use transportation services, dedicated fleet, warehousing, customs brokerage and shipment consolidation and handling services. In 2006, we introduced Forward Air Complete, our new pick-up and delivery service. These services directly benefit our existing customers and increase our ability to attract new customers, particularly those air freight forwarders that cannot justify providing the services directly. These services are not offered by many transportation providers with whom we compete and are attractive to customers who prefer to use one provider for all of their transportation needs.

 
•
Enhance Information Systems. We are committed to the continued enhancement of our information systems in ways that will continue to provide us competitive service advantages and increased productivity. We believe our enhanced systems assist us in capitalizing on new business opportunities with existing customers and developing relationships with new customers because of the customer-friendly, cost-saving features our systems provide, including our real-time tracking and tracing of shipments and electronic bill presentment.

 
•
Pursue Strategic Acquisitions. We intend to continue to evaluate acquisitions that can increase our penetration of a geographic area, add new customers or increase freight volume. In addition, we expect to explore acquisitions that may enable us to offer additional logistics services. Since our inception, we have acquired certain assets of nine of our competitors that met one or more of these criteria.

Operations

We receive freight from air freight forwarders, integrated air cargo carriers and passenger and cargo airlines at our terminals, which are located on or near airports in the United States and Canada. We also pick up freight from customers at designated locations via our new Forward Air Complete service. We consolidate and transport these shipments by truck through our network to our terminals nearest the ultimate destinations of the shipments. We operate regularly scheduled service to and from each of our terminals through our Columbus, Ohio central sorting facility or through one of our nine regional hubs. We also operate regularly scheduled shuttle service directly between terminals where the volume of freight warrants bypassing the Columbus, Ohio central sorting facility or a regional hub. When a shipment arrives at our terminal nearest its destination, the customer arranges for the shipment to be picked up and delivered to its final destination. Through our Forward Air Complete service, we will also deliver the freight for the customer to its final destination.

6

Terminals

Our network consists of terminals located in the following 81 cities:

City
  
Airport Served
  
City
  
Airport Served
Albany, NY
  
ALB
  
Louisville, KY
  
SDF
Albuquerque, NM
  
ABQ
  
Memphis, TN
  
MEM
Atlanta, GA
  
ATL
  
McAllen, TX*
  
MFE
Austin, TX
  
AUS
  
Miami, FL
  
MIA
Baltimore, MD
  
BWI
  
Milwaukee, WI
  
MKE
Baton Rouge, LA*
  
BTR
  
Minneapolis, MN
  
MSP
Birmingham, AL*
  
BHM
  
Mobile, AL*
  
MOB
Blountville, TN*
  
TRI
  
Nashville, TN
  
BNA
Boston, MA
  
BOS
  
Newark, NJ
  
EWR
Brownsville, TX*
  
BRO
  
Newburgh, NY
  
SWF
Buffalo, NY
  
BUF
  
New Orleans, LA
  
MSY
Charleston, SC
  
CHS
  
New York, NY
  
JFK
Charlotte, NC
  
CLT
  
Norfolk, VA
  
ORF
Chicago, IL
  
ORD
  
Oklahoma City, OK
  
OKC
Cincinnati, OH
  
CVG
  
Omaha, NE*
  
OMA
Cleveland, OH
  
CLE
  
Orlando, FL
  
MCO
Columbia, SC*
  
CAE
  
Pensacola, FL*
  
PNS
Columbus, OH
  
CMH
  
Philadelphia, PA
  
PHL
Corpus Christi, TX*
  
CRP
  
Phoenix, AZ
  
PHX
Dallas/Ft. Worth, TX
  
DFW
  
Pittsburgh, PA
  
PIT
Dayton, OH*
  
DAY
  
Portland, OR
  
PDX
Denver, CO
  
DEN
  
Raleigh, NC
  
RDU
Detroit, MI
  
DTW
  
Richmond, VA
  
RIC
El Paso, TX
  
ELP
  
Rochester, NY
  
ROC
Greensboro, NC
  
GSO
  
Sacramento, CA
  
SMF
Greenville, SC
  
GSP
  
Salt Lake City, UT
  
SLC
Hartford, CT
  
BDL
  
San Antonio, TX
  
SAT
Harlingen, TX*
  
HRL
  
San Diego, CA
  
SAN
Harrisburg, PA*
  
MDT
  
San Francisco, CA
  
SFO
Houston, TX
  
IAH
  
Seattle, WA
  
SEA
Huntsville, AL*
  
HSV
  
St. Louis, MO
  
STL
Indianapolis, IN
  
IND
  
Syracuse, NY
  
SYR
Jackson, MS*
  
JAN
  
Tampa, FL
  
TPA
Jacksonville, FL
  
JAX
  
Toledo, OH*
  
TOL
Kansas City, MO
  
MCI
  
Tucson, AZ*
  
TUS
Knoxville, TN*
  
TYS
  
Tulsa, OK
  
TUL
Lafayette, LA*
  
LFT
  
Washington, DC
  
IAD
Laredo, TX*
  
LRD
  
Montreal, Canada*
  
YUL
Las Vegas, NV
  
LAS
  
Ottawa, Canada*
  
YOW
Little Rock, AR
  
LIT
  
Toronto, Canada
  
YYZ
Los Angeles, CA
  
LAX
        

*
Denotes an independent agent location.

Independent agents operate 22 of our locations. These locations typically handle lower volumes of freight relative to our company-operated facilities.

7

Direct Service and Regional Hubs

We operate direct terminal-to-terminal services and regional overnight service between terminals where justified by freight volumes. We currently provide regional overnight service to many of the markets within our network. Direct service allows us to provide quicker scheduled service at a lower cost because it allows us to minimize out-of-route miles and eliminate the added time and cost of handling the freight at our central or regional hub sorting facilities. Direct shipments also reduce the likelihood of damage because of reduced handling and sorting of the freight. As we continue to increase volume between various terminals, we intend to add other direct services. Where warranted by sufficient volume in a region, we utilize larger terminals as regional sorting hubs, which allows us to bypass our Columbus, Ohio central sorting facility. These regional hubs improve our operating efficiency and enhance customer service. We operate regional hubs in Atlanta, Charlotte, Dallas/Ft. Worth, Kansas City, Los Angeles, New Orleans, Newburgh, Orlando and San Francisco.

Shipments

The average weekly volume of freight moving through our network was approximately 32.2 million pounds per week in 2006. During 2006, our average shipment weighed over 720 pounds and shipment sizes ranged from small boxes weighing only a few pounds to large shipments of several thousand pounds. Although we impose no significant size or weight restrictions, we focus our marketing and price structure on shipments of 200 pounds or more. As a result, we typically do not directly compete with integrated air cargo carriers in the overnight delivery of small parcels. The table below summarizes the average weekly volume of freight moving through our network for each year since 1990.

Year
Average Weekly Volume in Pounds
 
(In millions)
1990
1.2
1991
1.4
1992
2.3
1993
3.8
1994
7.4
1995
8.5
1996
10.5
1997
12.4
1998
15.4
1999
19.4
2000
24.0
2001
24.3
2002
24.5
2003
25.3
2004
28.7
2005
31.2
2006
32.2

Logistic and Other Services

Customers increasingly demand more than the movement of freight from their transportation providers. To meet these demands, we continually seek ways to customize our logistics services and add new services. Logistic and other services increase our profit margins by increasing our revenue without corresponding increases in our fixed costs.

Our logistic and other services allow customers to access the following services from a single source:

 
•
exclusive-use vehicles, commonly referred to as truck brokerage;

 
•
dedicated fleets;

 
•
customs brokerage, such as assistance with U.S. Customs and Border Protection (“U.S. Customs”) procedures for both import and export shipments;

 
•
warehousing, dock and office space; and

 
•
shipment consolidation and handling, such as shipment build-up and break-down and reconsolidation of air or ocean pallets or containers.

8
 
These services are critical to many of our air freight forwarder customers that do not provide logistics services themselves or that prefer to use one provider for all of their surface transportation needs.

Customers and Marketing

Our wholesale customer base is primarily comprised of air freight forwarders, integrated air cargo carriers and passenger and cargo airlines. Our air freight forwarder customers vary in size from small, independent, single facility companies to large, international logistics companies such as SEKO Worldwide, AIT Worldwide Logistics, DHL Danzas, UPS Supply Chain Solutions and Pilot Air Freight. Because we deliver dependable service, integrated air cargo carriers such as UPS Cargo and DHL Worldwide Express use our network to provide overflow capacity and other services, including shipment of bigger packages and pallet-loaded cargo. Our passenger and cargo airline customers include British Airways, KLM, United Airlines and Virgin Atlantic.

We market our services through a sales and marketing staff located in major air cargo transportation markets of the United States. Senior management also is actively involved in sales and marketing at the national account level and supports local sales initiatives. We have a strong commitment to strategically supporting the wholesale air cargo industry and focus on air freight forwarders, integrated air cargo carriers and passenger and cargo airlines that have time-sensitive shipping needs requiring customized services. We also participate in air cargo trade shows and advertise our services through direct mail programs and through the Internet via www.forwardair.com. The information contained on our website is not part of this filing.

Technology and Information Systems

Our technology allows us to provide our customers with real-time tracking and tracing of shipments throughout the transportation process, complete shipment history, proof of delivery, estimated charges and electronic bill presentment. In addition, our customers are able to electronically transmit bookings to us from their own networks and schedule transportation and obtain tracking and tracing information. We continue to enhance our systems to permit our customers to obtain this information both through the Internet and through electronic data interchange. We have invested and expect to continue investing management and financial resources on maintaining and upgrading our information systems in an effort to increase the volume of freight we can handle in our network, improve the visibility of shipment information and reduce our operating costs. The ability to provide accurate, real-time information on the status of shipments is increasingly important and our efforts in this area could result in both competitive service advantages and increased productivity throughout our network. We believe our continuing technical enhancements will assist us in capitalizing on new business opportunities, capturing additional freight from existing customers, and attracting new customers.

In 2006, we fully implemented TAP, a new program, in our continuing effort to automate and improve terminal operations, and a new website to support our new Forward Air Complete service offering. TAP enables operation personnel to perform data entry from our terminal floor locations. This greatly reduces the need for data entry personnel and provides immediate shipment updates. The result is increased shipment accuracy and improved data timeliness. We believe the TAP system will improve our ability to provide accurate, real-time information, and will result in both competitive service advantages and increased productivity throughout our network. The Forward Air Complete website coordinates activities between our customers, operations personnel and external service providers. We believe that the TAP system, Forward Air Complete website and other technical enhancements will assist us in capitalizing on new business opportunities and could encourage customers to increase the volume of freight they send through our network.

Purchased Transportation

We contract for most of our transportation services on a per mile basis from owner-operators. The owner-operators own, operate and maintain their own tractors and employ their own drivers. Our freight handlers load and unload our trailers for hauling by owner-operators between our terminals.

We seek to establish long-term relationships with owner-operators to assure dependable service and availability. Historically, we have experienced significantly higher than industry average retention of owner-operators. We have established specific guidelines relating to safety records, driving experience and personal evaluations that we use to select our owner-operators. To enhance our relationship with the owner-operators, our per mile rates are generally above prevailing market rates. In addition, we typically offer our owner-operators and their drivers a consistent work schedule. Usually, schedules are between the same two cities, improving quality of work life for the owner-operators and their drivers and, in turn, increasing driver retention.

As a result of efforts to expand our logistics and other services, seasonal demands and volume surges in particular markets, we also purchase transportation from other surface transportation providers to handle overflow volume. Of the $146.7 million incurred for purchased transportation during 2006, we purchased 62.4% from owner-operators and 37.6% from other surface transportation providers.

9
 
Competition

The air freight transportation industry is highly competitive and very fragmented. Our competitors include regional trucking companies that specialize in handling deferred air freight and national and regional less-than-truckload carriers. To a lesser extent, we compete with integrated air cargo carriers and passenger and cargo airlines. We believe competition is based on service, primarily on-time delivery, flexibility and reliability, as well as rates. We offer our services at rates that generally are significantly below the charge to transport the same shipment to the same destination by air. We believe we have an advantage over less-than-truckload carriers because we deliver faster, more reliable service between many cities.

Seasonality

Historically, our operating results have been subject to seasonal trends when measured on a quarterly basis. The first quarter has traditionally been the weakest and the third and fourth quarters have traditionally been the strongest. Typically, this pattern has been the result of factors such as climate, national holidays, customer demand and economic conditions. Additionally, a significant portion of our revenue is derived from customers whose business levels are impacted by the economy.

Employees

As of December 31, 2006, we had 1,225 full-time employees, 464 of whom were freight handlers. Additionally as of that date, there were 709 part-time employees, of whom the majority were freight handlers. None of our employees are covered by a collective bargaining agreement. We recognize that our workforce, including our freight handlers, is one of our most valuable assets. The recruitment, training and retention of qualified employees are essential to support our continued growth and to meet the service requirements of our customers.

Risk Management and Litigation

Under U.S. Department of Transportation (“DOT”) regulations, we are liable for property damage and personal injuries caused by owner-operators while they are operating on our behalf. We currently maintain liability insurance coverage that we believe is adequate to cover third-party claims. We have a self-insured retention of $0.5 million per occurrence for each vehicle and general liability claim. We may also be subject to claims for workers’ compensation. We maintain workers’ compensation insurance coverage that we believe is adequate to cover such claims. We have a self-insured retention of approximately $0.3 million for each such claim, except in Ohio, where we are a qualified self-insured with an approximately $0.4 million self-insured retention. We could incur claims in excess of our policy limits or incur claims not covered by our insurance.

From time to time, we are a party to litigation arising in the normal course of our business, most of which involve claims for personal injury, property damage related to the transportation and handling of freight, or workers’ compensation. We do not believe that any of these pending actions, individually or in the aggregate, will have a materially adverse effect on our business, financial condition or results of operations.

Regulation

The DOT and various state agencies have been granted broad powers over our business. These entities generally regulate such activities as authorization to engage in property brokerage and motor carrier operations, safety and financial reporting. We are licensed through our subsidiaries by the DOT as a motor carrier and as a broker to arrange for the transportation of freight by truck. Our domestic customs brokerage operations are licensed by U.S. Customs. We are subject to similar regulation in the Dominion of Canada.

Service Marks

Through one of our subsidiaries, we hold federal trademark registrations or applications for federal trademark registration, associated with the following service marks: Forward Air, Inc.®, North America’s Most Complete Roadfeeder Network®, Forward Air ™  and Forward Air Complete™. These marks are of significant value to our business.

10
 
Website Access

We file reports with the Securities and Exchange Commission (the “SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q and other reports from time to time. We are an electronic filer and the SEC maintains an Internet site at www.sec.gov that contains these reports and other information filed electronically. We make available free of charge through our website our Code of Ethics and our reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Our website address is www.forwardair.com. Please note that this website address is provided as an inactive textual reference only. The information provided on the website is not part of this report, and is therefore not incorporated by reference unless such information is otherwise specifically referenced elsewhere in this report.

Risk Factors

In addition to the other information in this Form 10-K and other documents we have filed with the SEC from time to time, the following factors should be carefully considered in evaluating our business. Such factors could affect results and cause results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, us. Some or all of these factors may apply to our business.

Our business is subject to general economic and business factors that are largely out of our control, any of which could have a materially adverse effect on our results of operations.

Our business is dependent upon a number of factors that may have a materially adverse effect on the results of our operations, many of which are beyond our control. These factors include increases or rapid fluctuations in fuel prices, capacity in the trucking industry, insurance premiums, self-insured retention levels and difficulty in attracting and retaining qualified owner-operators and freight handlers. Our profitability would decline if we were unable to anticipate and react to increases in our operating costs, including purchased transportation and labor, or decreases in the amount of revenue per pound of freight shipped through our system. As a result of competitive factors, we may be unable to raise our prices to meet increases in our operating costs, which could result in a materially adverse effect on our business, results of operations and financial condition.

Economic conditions may adversely affect our customers and the amount of freight available for transport. This may require us to lower our rates, and this may also result in lower volumes of freight flowing through our network. Customers encountering adverse economic conditions represent a greater potential for loss, and we may be required to increase our reserve for bad-debt losses.

Our results of operations may be affected by seasonal factors. Volumes of freight tend to be lower in the first quarter after the winter holiday season. In addition, it is not possible to predict the short or long-term effects of any geopolitical events on the economy or on customer confidence in the United States, or their impact, if any, on our future results of operations.

In order to continue growth in our business, we will need to increase the volume and revenue per pound of the freight shipped through our system.

Our continued growth depends in significant part on our ability to increase the amount and revenue per pound of the freight shipped through our network. The amount of freight shipped through our network and our revenue per pound depend on numerous factors, many of which are beyond our control, such as economic conditions and our competitors’ pricing. Therefore, we cannot guarantee that the amount of freight shipped or the revenue per pound we realize on that freight will increase or even remain at current levels. If we fail to increase the volume of the freight shipped through our network or the revenue per pound of the freight shipped, we may be unable to maintain or increase our profitability.

Because a portion of our network costs are fixed, we will be adversely affected by any decrease in the volume or revenue per pound of freight shipped through our network.

Our operations, particularly our network of hubs and terminals, represent substantial fixed costs. As a result, any decline in the volume or revenue per pound of freight we handle may have an adverse effect on our operating margin and our results of operations. Typically, we do not have contracts with our customers and we cannot guarantee that our current customers will continue to utilize our services or that they will continue at the same levels. The actual shippers of the freight moved through our network include various manufacturers and distributors of electronics, telecommunications equipment, machine parts, trade show exhibit materials and medical equipment. Adverse business conditions affecting these shippers or adverse general economic conditions are likely to cause a decline in the volume of freight shipped through our network.

11
 
We operate in a highly competitive and fragmented industry, and our business will suffer if we are unable to adequately address downward pricing pressures and other factors that may adversely affect our operations and profitability.

The freight transportation industry is highly competitive, very fragmented and historically has had few barriers to entry. Our principal competitors include regional trucking companies that specialize in handling deferred air freight and national and regional less-than-truckload carriers. To a lesser extent, we compete with integrated air cargo carriers and passenger airlines. Our competition ranges from small operators that compete within a limited geographic area to companies with substantially greater financial and other resources, including greater freight capacity. We also face competition from air freight forwarders who decide to establish their own networks to transport deferred air freight. We believe competition is based on service, primarily on-time delivery, flexibility and reliability, as well as rates. Many of our competitors periodically reduce their rates to gain business, especially during times of economic decline. In the past several years, several of our competitors have reduced their rates to unusually low levels that we believe are unsustainable in the long-term, but that may materially adversely affect our business in the short-term. These competitors may cause a decrease in our volume of freight, require us to lower the prices we charge for our services and adversely affect both our growth prospects and profitability.

Claims for property damage, personal injuries or workers’ compensation and related expenses could significantly reduce our earnings.

Under DOT regulations, we are liable for property damage and personal injuries caused by owner-operators while they are operating on our behalf. We currently maintain liability insurance coverage that we believe is adequate to cover third-party claims. We have a self-insured retention of $0.5 million per occurrence for each vehicle and general liability claim. We may also be subject to claims for workers’ compensation. We maintain workers’ compensation insurance coverage that we believe is adequate to cover such claims. We have a self-insured retention of approximately $0.3 million for each such claim, except in Ohio, where we are a qualified self-insured with an approximately $0.4 million self-insured retention. We could incur claims in excess of our policy limits or incur claims not covered by our insurance. Any claims beyond the limits or scope of our insurance coverage may have a material adverse effect on us. Because we do not carry “stop loss” insurance, a significant increase in the number of claims that we must cover under our self-insurance retainage could adversely affect our profitability. In addition, we may be unable to maintain insurance coverage at a reasonable cost or in sufficient amounts or scope to protect us against losses.

We have grown and may grow, in part, through acquisitions, which involve various risks, and we may not be able to identify or acquire companies consistent with our growth strategy or successfully integrate acquired businesses into our operations.

We have grown through acquisitions and we intend to pursue opportunities to expand our business by acquiring other companies in the future. Acquisitions involve risks, including those relating to:

 
•
identification of appropriate acquisition candidates;

 
•
negotiation of acquisitions on favorable terms and valuations;

 
•
integration of acquired businesses and personnel;

 
•
implementation of proper business and accounting controls;

 
•
ability to obtain financing, on favorable terms or at all;

 
•
diversion of management attention;

 
•
retention of employees and customers; and

 
•
unexpected liabilities.

Acquisitions also may affect our short-term cash flow and net income as we expend funds, potentially increase indebtedness and incur additional expenses. If we are not able to identify or acquire companies consistent with our growth strategy, or if we fail to successfully integrate any acquired companies into our operations, we may not achieve anticipated increases in revenue, cost savings and economies of scale, and our operating results may actually decline.

12
 
We may have difficulty effectively managing our growth, which could adversely affect our results of operations.

Our growth plans will place significant demands on our management and operating personnel. Our ability to manage our future growth effectively will require us to regularly enhance our operating and management information systems and to continue to attract, retain, train, motivate and manage key employees. If we are unable to manage our growth effectively, our business, results of operations and financial condition may be adversely affected.

If we fail to maintain and enhance our information technology systems, we may lose orders and customers or incur costs beyond expectations.

We must maintain and enhance our information technology systems to remain competitive and effectively handle higher volumes of freight through our network. We expect customers to continue to demand more sophisticated, fully integrated information systems from their transportation providers. If we are unable to maintain and enhance our information systems to handle our freight volumes and meet the demands of our customers, our business and results of operations will be adversely affected. If our information systems are unable to handle higher freight volumes and increased logistics services, our service levels and operating efficiency may decline. This may lead to a loss of customers and a decline in the volume of freight we receive from customers.

Our information technology systems are subject to risks that we cannot control.

Our information technology systems are dependent upon global communications providers, web browsers, telephone systems and other aspects of the Internet infrastructure that have experienced significant system failures and electrical outages in the past. While we take measures to ensure our major systems have redundant capabilities, our systems are susceptible to outages from fire, floods, power loss, telecommunications failures, break-ins and similar events. Despite our implementation of network security measures, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. The occurrence of any of these events could disrupt or damage our information technology systems and inhibit our internal operations, our ability to provide services to our customers and the ability of our customers to access our information technology systems. This may result in the loss of customers or a reduction in demand for our services.

If we have difficulty attracting and retaining owner-operators or freight handlers, our results of operations could be adversely affected.

We depend on owner-operators for most of our transportation needs. In 2006, owner-operators provided 62.4% of our purchased transportation. Competition for owner-operators is intense, and sometimes there are shortages of available owner-operators. In addition, we need a large number of freight handlers to operate our business efficiently. During periods of low unemployment in the areas where our terminals are located, we may have difficulty hiring and retaining a sufficient number of freight handlers. If we have difficulty attracting and retaining enough qualified owner-operators or freight handlers, we may be forced to increase wages and benefits, which would increase our operating costs. This difficulty may also impede our ability to maintain our delivery schedules, which could make our service less competitive and force us to curtail our planned growth. If our labor costs increase, we may be unable to offset the increased labor costs by increasing rates without adversely affecting our business. As a result, our profitability may be reduced.

A determination by regulators that our independent owner-operators are employees rather than independent contractors could expose us to various liabilities and additional costs.

At times, the Internal Revenue Service, the Department of Labor and state authorities have asserted that owner-operators are “employees,” rather than “independent contractors.” One or more governmental authorities may challenge our position that the owner-operators we use are not our employees. A determination by regulators that our independent owner-operators are employees rather than independent contractors could expose us to various liabilities and additional costs including, but not limited to, employment-related expenses such as workers’ compensation insurance coverage and reimbursement of work-related expenses.

We operate in a regulated industry, and increased costs of compliance with, or liability for violation of, existing or future regulations could have a material adverse effect on our business.

The DOT and various state agencies have been granted broad regulatory powers over our business, and we are licensed by the DOT and U.S. Customs. If we fail to comply with any applicable regulations, our licenses may be revoked or we could be subject to substantial fines or penalties and to civil and criminal liability.

13
 
We are also subject to various environmental laws and regulations dealing with the handling of hazardous materials. Our operations involve the risks of fuel spillage or seepage. If we are involved in a spill or other accident involving hazardous substances, our business and operating results may be adversely affected. Changes to current environmental laws or regulations may increase our operating costs and adversely affect our results of operations.

The transportation industry is subject to legislative and regulatory changes that can affect the economics of our business by requiring changes in operating practices or influencing the demand for, and the cost of providing, transportation services. Heightened security concerns in the aftermath of the September 11, 2001 terrorist attacks may continue to result in increased regulations, including the implementation of various security measures, checkpoints or travel restrictions on trucks.

In addition, there may be changes in applicable federal or state tax or other laws or interpretations of those laws. If this happens, we may incur additional taxes, as well as higher workers’ compensation and employee benefit costs, and possibly penalties and interest for prior periods. This could have an adverse effect on our results of operations.

We are dependent on our senior management team, and the loss of any such personnel could materially and adversely affect our business.

Our future performance depends, in significant part, upon the continued service of our senior management team. We cannot assure you that we can retain these employees. The loss of the services of one or more of these or other key personnel could have a material adverse effect on our business, operating results and financial condition. We must continue to develop and retain a core group of management personnel and address issues of succession planning if we are to realize our goal of growing our business. We cannot assure you that we will be able to do so.

If our employees were to unionize, our operating costs would likely increase.

None of our employees are currently represented by a collective bargaining agreement. However, we have no assurance that our employees will not unionize in the future, which could increase our operating costs and force us to alter our operating methods. This could have a material adverse effect on our operating results.

Our shareholder rights plan, charter and bylaws and provisions of Tennessee law could discourage or prevent a takeover that may be considered favorable.

We have a shareholder rights plan that may have the effect of discouraging unsolicited takeover proposals. The rights issued under the shareholder rights plan would cause substantial dilution to a person or group that attempts to acquire us on terms not approved in advance by our Board of Directors. In addition, our shareholder rights plan, charter and bylaws and provisions of Tennessee law may discourage, delay or prevent a merger, acquisition or change in control that may be considered favorable. These provisions could also discourage proxy contests and make it more difficult for shareholders to elect directors and take other corporate actions. Among other things, these provisions:

•
authorize us to issue preferred stock, the terms of which may be determined at the sole discretion of our Board of Directors and may adversely
affect the voting or economic rights of our shareholders; and

•
establish advance notice requirements for nominations for election to the Board of Directors and for proposing matters that can be acted
on by shareholders at a meeting.

Our shareholder rights plan, charter and bylaws and provisions of Tennessee law may discourage transactions that otherwise could provide for the payment of a premium over prevailing market prices for our common stock, $0.01 par value per share, and also could limit the price that investors are willing to pay in the future for shares of our common stock.

Unresolved Staff Comments

None.

14

Properties

Properties and Equipment
 
Management believes that we have adequate facilities for conducting our business, including properties owned and leased. Management further believes that in the event replacement property is needed, it will be available on terms and at costs substantially similar to the terms and costs experienced by competitors within the transportation industry.
 
We lease our 37,500 square foot headquarters in Greeneville, Tennessee from the Greeneville-Greene County Airport Authority. The initial lease term ended in 2006 and has two ten-year and one five-year renewal options. We timely notified the Greeneville-Greene County Airport Authority of our intent to renew the lease for an additional ten years, which will run through 2016. The extension was signed in January 2007.
 
We own our Columbus, Ohio central sorting facility. During 2006 we completed a $5.5 million expansion of this facility.  The new expanded Columbus, Ohio facility is 125,000 square feet with 168 trailer doors. This premier facility can unload, sort and load upwards of 3.7 million pounds in five hours. In addition to the expansion, we process-engineered the freight sorting in the expanded building to improve handling efficiencies. The benefits will include reductions in the distance each shipment moves in the building to speed up the transfer process, less handling of freight to further improve service integrity and flexibility to operate multiple sorts at the same time.
 
During the fourth quarter of 2002, the City of Atlanta filed a Petition for Condemnation and Declaration of Taking for a terminal facility owned by Transportation Properties, Inc. and leased by Forward Air, Inc., two of our wholly owned subsidiaries. The condemnation was filed in connection with the fifth runway airport expansion project at Atlanta Hartsfield-Jackson International Airport. According to the 2002 condemnation petition, the City of Atlanta took ownership of the property and building and deposited $2.6 million into the Registry of the Superior Court of Clayton County, Georgia (the “Court”) as compensation to Transportation Properties, Inc. We filed a protest to the City of Atlanta’s evaluation of the property and building and also challenged the method of condemnation it utilized. Prior to December 2003, the City of Atlanta destroyed the condemned building in conjunction with the runway expansion project. On or about December 30, 2003, the Court ruled that the City of Atlanta’s method of condemnation was improper and returned ownership of the land to us.
 
During January 2004, the City of Atlanta filed a second condemnation petition to obtain title to the land. In connection with this second petition, the City of Atlanta deposited an additional $1.3 million into the Registry of the Court, which was the City of Atlanta’s estimated fair market value of the land. The City of Atlanta petitioned the Court and was granted the right to withdraw the original $2.6 million escrow balance it paid into the Court as part of the first petition for condemnation. We and our outside counsel believed that the December 30, 2003 ruling by the Court and the City of Atlanta’s actions subsequent to the first condemnation gave rise to additional theories of recovery. We challenged the method of condemnation set forth in the second petition and the withdrawal of the original $2.6 million escrow balance. Additionally, we had claims for damages arising from the City of Atlanta’s destruction of the Company’s building during the wrongful possession of the property by the City of Atlanta. As of December 31, 2004, we had received the $1.3 million escrow into cash and had a $1.3 million receivable for the difference in the original $2.6 million escrow and actual $1.3 million in escrow received.
 
In the second quarter of 2005, an agreement was reached with the City of Atlanta to settle the dispute. In the settlement, the City of Atlanta paid us approximately $2.7 million, which represents payment of the receivable of $1.3 million along with additional pre-tax gain of approximately $1.4 million, included in other income, net. The cash received is net of attorney’s fees.
 
In July 2003, we relocated our Atlanta operations into a new 63,550 square foot Atlanta terminal facility. The initial lease term for this terminal facility expires in June 2008.
 
As part of our plan to acquire three new sites in key gateway cities, we entered into an agreement on July 10, 2006 to purchase real property and to construct a new terminal near Chicago, Illinois. On September 14, 2006, we entered into an agreement to purchase real property and to construct a new regional hub near Atlanta, Georgia. In addition, during February 2007 we purchased 36.7 acres of land in Irving, Texas on which we will build a new regional hub. Completion of the new terminal and regional hubs will occur throughout 2007.
 
We lease and maintain terminals in 57 additional cities located at or near various airports in the United States and Canada. Lease terms are typically for three to five years. The remaining 22 terminals are agent stations operated by independent agents who handle freight for us on a commission basis.
 
We own the majority of trailers we use to move freight through the Forward Air network. Substantially all of our trailers are 53’ long, some of which have specialized roller bed equipment required to serve air cargo industry customers. The average age of our owned trailer fleet was approximately 2.5 years at December 31, 2006.

15
 
Legal Proceedings

From time to time, we are a party to ordinary, routine litigation incidental to and arising in the normal course of our business, most of which involve claims for personal injury, property damage related to the transportation and handling of freight, or workers’ compensation. We do not believe that any of these pending actions, individually or in the aggregate, will have a material adverse effect on our business, financial condition or results of operations.

Submission of Matters to a Vote of Security Holders

During the fourth quarter of the fiscal year ended December 31, 2006, no matters were submitted to a vote of security holders through the solicitation of proxies or otherwise.

Executive Officers of the Registrant

Pursuant to Instruction 3 to Item 401(b) of Regulation S-K of the Securities Act and General Instruction G(3) to Form 10-K, the following information is included in Part I of this report. The ages listed below are as of December 31, 2006.

The following are our executive officers:

Name
  
Age
  
Position
Bruce A. Campbell
  
55
  
President and Chief Executive Officer
Rodney L. Bell
  
44
  
Chief Financial Officer, Senior Vice President and Treasurer
Craig A. Drum
  
51
  
Senior Vice President, Sales
Matthew J. Jewell
  
40
  
Senior Vice President, General Counsel and Secretary
Chris C. Ruble
  
44
  
Senior Vice President, Operations

There are no family relationships between any of our executive officers. All officers hold office at the pleasure of the Board of Directors.

Bruce A. Campbell has served as a director since April 1993, as President since August 1998 and as Chief Executive Officer since October 2003. Mr. Campbell was Chief Operating Officer from April 1990 until October 2003 and Executive Vice President from April 1990 until August 1998. Prior to joining us, Mr. Campbell served as Vice President of Ryder-Temperature Controlled Carriage in Nashville, Tennessee from September 1985 until December 1989. Mr. Campbell also serves as a director of Greene County Bancshares.
 
Rodney L. Bell began serving as Chief Financial Officer, Senior Vice President and Treasurer in June 2006. Mr. Bell, who is a Certified Public Accountant, was appointed Chief Accounting Officer in February 2006 and continued to serve as Vice President and Controller, positions held since October 2000 and February 1995, respectively. Mr. Bell joined the Company in March 1992 as Assistant Controller after serving as a senior manager with the accounting firm of Adams and Plucker in Greeneville, Tennessee.
 
Craig A. Drum has served as Senior Vice President, Sales since July 2001 after joining us in January 2000 as Vice President, Sales for our Internet and technology service and support subsidiary. In February 2001, Mr. Drum was promoted to Vice President of National Accounts. Prior to January 2000, Mr. Drum spent most of his 24-year career in air freight with Delta Air Lines, Inc., most recently as the Director of Sales and Marketing - Cargo.

Matthew J. Jewell has served as Senior Vice President and General Counsel since July 2002. In October 2002, he was also appointed Secretary. From July 2002 until May 2004, Mr. Jewell was also the Senior Vice President, General Counsel and Secretary of Landair Corporation. From January 2000 until joining us in July 2002, Mr. Jewell was a partner with the law firm of Austin & Sparks, P.C. Mr. Jewell was an associate at Dennis, Corry & Porter, L.L.P. from July 1991 to December 1998 and a partner from January 1999 to January 2000.

Chris C. Ruble has served as Senior Vice President, Operations since October 2001. He was a Regional Vice President from September 1997 to October 2001 and a regional manager from February 1997 to September 1997, after starting with us as a terminal manager in January 1996. From June 1986 to August 1995, Mr. Ruble served in various management capacities at Roadway Package System, Inc.

16


Part II

Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

Our common stock, $0.01 par value per share (“Common Stock”), trades on The NASDAQ Global Select Stock Market™ under the symbol “FWRD.” The following table sets forth the high and low sales prices for the Common Stock as reported by The NASDAQ Global Select Stock Market™ for each full quarterly period within the two most recent fiscal years. All prices have been restated to reflect a three-for-two stock split declared in February 2005.
 
2006
  
High
  
Low
First Quarter
$39.49
  
$31.01
Second Quarter
$41.05
  
$35.04
Third Quarter
$43.67
  
$30.26
Fourth Quarter
$37.58
  
$28.86

2005
  
High
  
Low
First Quarter
$30.37
  
$25.67
Second Quarter
$30.00
  
$22.02
Third Quarter
$36.86
  
$28.13
Fourth Quarter
$40.93
  
$32.58
 
There were approximately 377 shareholders of record of our Common Stock as of February 21, 2007.
 
On February 15, 2005, our Board of Directors declared a three-for-two stock split of our Common Stock to be effected in the form of a stock dividend to shareholders of record as of March 18, 2005. Common Stock issued and additional paid-in capital have been restated to reflect the split for all periods presented. All common share and per share data included in the consolidated financial statements and notes thereto have been restated to give effect to the stock split.

During each of the three months ended March 31, 2006, June 30, 2006, September 30, 2006 and December 31, 2006, dividends of $0.07 per share were declared on our Common Stock then outstanding. The quarterly dividends were paid on March 31, 2006, June 9, 2006, September 8, 2006 and December 8, 2006. During the three months ended March 31, 2005, June 30, 2005, September 30, 2005 and December 31, 2005, dividends of $0.06 per share were declared on our Common Stock then outstanding. The 2005 quarterly dividends were paid on April 18, 2005, June 3, 2005, September 2, 2005 and January 3, 2006. Subsequent to December 31, 2006, our Board of Directors declared a cash dividend of $0.07 per share that will be paid on March 30, 2007 to shareholders of record at the close of business on March 15, 2007. We expect to continue to pay regular quarterly cash dividends, though each subsequent quarterly dividend is subject to review and approval by the Board of Directors.

There are no material restrictions on our ability to declare dividends. 

None of our securities were sold during fiscal year 2006 without registration under the Securities Act.

17

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information as of December 31, 2006 with respect to shares of our Common Stock that may be issued under existing equity compensation plans, including the 1992 Amended and Restated Stock Option and Incentive Plan (the “1992 Plan”), the 1999 Stock Option and Incentive Plan (the “1999 Plan”), the Non-Employee Director Stock Option Plan (the “NED Plan”), the 2000 Non-Employee Director Award (the “2000 NED Award”), the 2005 Employee Stock Purchase Plan (the “ESPP”) and the 2006 Non-Employee Director Stock Plan (the “2006 NED Plan”). All shares and prices have been restated to reflect a three-for-two stock split declared in February 2005. Our shareholders have approved each of these plans.

Equity Compensation Plan Information

Plan Category
    
Number of Securities to be Issued upon Exercise of Outstanding Options, Warrants and Rights
    
Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights
    
Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a))
 
   
(a) 
    
(b)
 
  
(c)
 
Equity Compensation Plans Approved by Shareholders
    
1,714,877
 (1)
$
21.36
 (2)
  
2,362,991
 (3)
Equity Compensation Plans Not Approved by Shareholders
    
--
    
--
    
--
  
Total
    
1,714,877
 
$
21.36
    
2,362,991
  

(1)
Includes 57,005 shares of Common Stock issuable upon the exercise of options under the 1992 Plan. The 1992 Plan expired November 12, 2002. No additional options may be granted under the 1992 Plan.
(2)
Includes the weighted-average exercise price of options outstanding under the 1992 Plan. Excludes purchase rights accruing under the ESPP, which has a shareholder-approved reserve of 500,000 shares. Under the ESPP, each eligible employee may purchase up to 2,000 shares of Common Stock at semi-annual intervals each year at a purchase price per share equal to 90.0% of the lower of the fair market value of the Common Stock at close of (i) the first trading day of an option period or (ii) the last trading day of a option period.
(3)
Includes shares available for future issuance under the ESPP. As of December 31, 2006, an aggregate of 479,079 shares of Common Stock were available for issuance under the ESPP.
 
18
 
Stock Performance Graph
 
The following graph compares the percentage change in the cumulative shareholder return on our Common Stock with The NASDAQ Trucking and Transportation Stocks Index and The NASDAQ Global Select Stock Market™ Index commencing on the last trading day of December 2001 and ending on the last trading day of December 2006. The graph assumes a base investment of $100 made on December 31, 2001 and the respective returns assume reinvestment of all dividends. The comparisons in this graph are required by the SEC and, therefore, are not intended to forecast or necessarily be indicative of any future return on our Common Stock.
 
 
 
 
2001
 
2002
 
2003
 
2004
 
2005
 
2006
 
Forward Air Corporation
 
$100
 
$ 57
 
$  81
 
$132
 
$163
 
$129
 
NASDAQ Trucking and Transportation Stocks Index
 
  100
 
 102
 
 146
 
 187
 
 195
 
  227
 
NASDAQ Stock Market Index
 
  100
 
   69
 
 103
 
 112
 
 115
 
  126
 
 
Issuer Purchases of Equity Securities
 
The following table provides information with respect to purchases we made of shares of our Common Stock during each month in the quarter ended December 31, 2006.
 
Period
    
Total Number of Shares Purchased
    
Average Price Paid per Share
    
Total Number of Shares Purchased as Part of Publicly Announced Program
    
Maximum Number of Shares that May Yet Be Purchased Under the Program (1)
 
October 1-31, 2006
    
--
    
--
    
--
    
--
  
November 1-30, 2006
    
--
    
--
    
--
    
--
  
December 1-31, 2006
    
100,000
  
$
29.48
    
1,386,673
    
1,613,327
  
Total
    
100,000
  
$
29.48
    
1,386,673
    
1,613,327
  

(1)
On November 17, 2005, we announced that our Board of Directors approved a stock repurchase program for up to 3.0 million shares of our Common Stock with a term expiring November 18, 2008.
19

Selected Financial Data

The following table sets forth our selected financial data. The selected financial data should be read in conjunction with our consolidated financial statements and notes thereto, included elsewhere in this report.

 
  
Year ended December 31
     
2006
    
2005
    
2004
    
2003
    
2002
  
 
(in thousands, except per share data)
                                 
Income Statement Data:
                                
Operating revenue
  
$
352,758
 
$
320,934
 
$
282,197
 
$
241,517
 
$
226,072
  
Income from operations
    75,396    
67,437
    
53,598
    
40,182
    
32,737
  
Operating margin (1)
     21.4
%
  
21.0
%
  
19.0
%
  
16.6
%
  
14.5
%
Net income
    48,923    
44,909
    
34,421
    
25,815
    
21,616
  
Net income per share: (2)
                                
Basic
  
$
1.57
 
$
$1.41
 
$
1.07
 
$
0.81
 
$
0.67
  
Diluted
  
$
 1.55  
$
$1.39
 
$
1.05
 
$
0.79
 
$
0.65
  
                                 
Cash dividends declared per common share (2)
  
$
0.28
 
$
0.24
 
$
--
 
$
--
 
$
--
  
                                 
Balance Sheet Data (at end of period):
                                
Total assets
  
$
213,014
 
$
212,600
 
$
214,553
 
$
175,087
 
$
145,511
  
Long-term obligations, net of current portion
     796    
837
    
867
    
907
    
935
  
Shareholders’ equity
     185,227    
178,816
    
181,003
    
147,708
    
118,346
  
 
(1)
Income from operations as a percentage of operating revenue.
(2)
Restated to reflect a three-for-two stock split declared in February 2005.

20

Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Overview and Executive Summary
 
We are a leading provider of time-definite surface transportation and related logistics services to the North American deferred air freight market. We offer our customers scheduled surface transportation of cargo as a cost-effective, reliable alternative to air transportation. We transport cargo that must be delivered at a specific time, but is less time-sensitive than traditional air freight. This type of cargo is frequently referred to in the transportation industry as deferred air freight. We operate through a network of 81 terminals located on or near airports in the United States and Canada, including a central sorting facility in Columbus, Ohio and nine regional hubs serving key markets.
 
In addition, during 2006 we introduced our new pick-up and delivery service called Forward Air Complete whereby we arrange for cargo to be picked up from and/or delivered to a customer-designated site. Through offering Forward Air Complete we expect to increase tonnage through our network by attracting new customers or shipments from existing customers that require door-to-door service. Revenue from the roll out of Forward Air Complete was $1.3 million during the year ended December 31, 2006.
 
Trends and Developments
 
During the year ended December 31, 2006 our logistics business experienced significant growth while the growth rate for our airport-to-airport business slowed over the last half of the year. The growth rate of our logistics business is driven by our added capacity and continuing efforts to promote and expand the business, as well as by our enhanced technology. During the year ended December 31, 2006, the one-year anniversary of our May 28, 2005 acquisition of certain assets of U.S. Xpress Enterprises, Inc. (“USX”) occurred bringing an anticipated slowing of the airport-to-airport tonnage and revenue growth. In anticipation of this slowing, we began a number of initiatives focused on continued growth of our airport-to-airport business as well as overall revenue growth. These initiatives include the implementation of Forward Air Complete, our partnership with DHL Global Forwarding to be their primary ground transportation provider and new strategic business initiatives with United Airlines and Pilot Air Freight.
 
 Also, during the year ended December 31, 2006 we completed a project to expand our national hub in Columbus, Ohio.  The new expanded Columbus, Ohio facility is 125,000 square feet with 168 trailer doors. This premier facility can unload, sort and load upwards of 3.7 million pounds in five hours. In addition to the expansion, we process-engineered the freight sorting in the expanded building to improve handling efficiencies. The benefits will include reductions in the distance each shipment moves in the building to speed up the transfer process, less handling of freight to further improve service integrity and flexibility to operate multiple sorts at the same time.
 
Risk Factors
 
A summary of factors which could affect results and cause results to differ materially from those expressed in any forward-looking statements made by us, or on our behalf, are further described under the caption “Risk Factors” in the Business portion of our 2006 Form 10-K.

21
Results of Operations

The following table sets forth our historical financial data for the years ended December 31, 2006 and 2005 (in millions):

 
    
2006
    
2005
    
Change
    
% Change
  
Operating revenue:
                      
Airport-to-airport
$
 299.6
$
276.9
$
 22.7 8.2 %
Logistics
     32.1     24.4     7.7     31.6  
Accessorial
     21.0     19.6     1.4     7.1  
Total operating revenue
     352.7     320.9     31.8     9.9  
Operating expenses:
                          
Purchased transportation
     146.7     132.9     13.8     10.4  
Salaries, wages and employee benefits
     74.4     68.1     6.3     9.3  
Operating leases
     14.5     13.5     1.0    
7.4
  
Depreciation and amortization
     8.9     8.9     --     --  
Insurance and claims
     6.0     5.2     0.8     15.4  
Other operating expenses
     26.8     24.9     1.9     7.6  
Total operating expenses
     277.3     253.5     23.8     9.4  
Income from operations
     75.4     67.4     8.0     11.9  
Total other income
     3.1     3.8     (0.7 )    (18.4 )
Income before income taxes
     78.5     71.2     7.3     10.3  
Income taxes
     29.6     26.3     3.3     12.5  
Net income
  
$
 48.9  
$
44.9
  
 $
 4.0     8.9
%
 
The following table sets forth our historical financial data for the years ended December 31, 2005 and 2004:
 
 
    
2005
 
 
2004
 
 
Change
 
 
% Change
  
Operating revenue:
                          
Airport-to-airport
  
$
 276.9  
$
238.4
  
$
 38.5     16.1
%
Logistics
     24.4     24.1     0.3     1.2  
Accessorial
     19.6     19.7     (0.1 )   (0.5 )
Total operating revenue
     320.9     282.2     38.7     13.7  
Operating expenses:
                          
Purchased transportation
     132.9     118.4     14.5     12.2  
Salaries, wages and employee benefits
     68.1     62.7     5.4     8.6  
Operating leases
     13.5     12.8     0.7     5.5  
Depreciation and amortization
     8.9     6.8     2.1     30.9  
Insurance and claims
     5.2     5.4     (0.2 )    (3.7 ) 
Other operating expenses
     24.9     22.5     2.4     10.7  
Total operating expenses
     253.5     228.6     24.9     10.9  
Income from operations
     67.4     53.6     13.8     25.7  
Total other income
     3.8     1.1     2.7     245.5  
Income before income taxes
     71.2     54.7     16.5     30.2  
Income taxes
     26.3     20.3     6.0     29.6  
Net income
  
$
 44.9  
$
34.4
  
$
 10.5     30.5
%
 
22
 
The following table shows the percentage relationship of expense items to operating revenue for the years ended December 31, 2006, 2005 and 2004:
 
     
2006
 
 
2005
 
 
2004
  
Operating revenue:
    
 
 
  
 
 
  
 
 
Airport-to-airport
     84.9     86.3 %   84.5 %
Logistics
     9.1     7.6     8.5  
Accessorial
     6.0     6.1     7.0  
Total operating revenue
     100.0 %   100.0 %   100.0 %
Operating expenses:
                    
Purchased transportation
     41.6    
41.4
    
42.0
  
Salaries, wages and employee benefits
    
21.1
    
21.2
    
22.2
  
Operating leases
    
4.1
    
4.2
    
4.5
  
Depreciation and amortization
    
2.5
    
2.8
    
2.4
  
Insurance and claims
    
1.7
    
1.6
    
1.9
  
Other operating expenses
    
7.6
    
7.8
    
8.0
  
Total operating expenses
    
78.6
    
79.0
    
81.0
  
Income from operations
    
21.4
    
21.0
    
19.0
  
Other income, net
    
0.9
    
1.2
    
0.4
  
Income before income taxes
    
22.3
    
22.2
    
19.4
  
Income taxes
    
8.4
    
8.2
    
7.2
  
Net income
     13.9 %  
14.0
%
  
12.2
%
 
Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
 
Operating revenue increased by $31.8 million, or 9.9%, to $352.7 million for the year ended December 31, 2006 from $320.9 million for the year ended December 31, 2005. Airport-to-airport revenue, which is the largest component of our operating revenue, increased $22.7 million, or 8.2%, to $299.6 million, accounting for 84.9% of our total operating revenue during the year ended December 31, 2006 compared to 86.3% for the year ended December 31, 2005. Airport-to-airport revenue decreased as a percentage of total operating revenue is the result of the significant growth of our logistics revenue, which is discussed below. The 8.2% increase in airport-to-airport revenue was driven by an increase in tonnage and an increase in average revenue per pound. Tonnage that transited our network increased by 2.2% in the year ended December 31, 2006 compared with the year ended December 31, 2005. The increase in tonnage is a result of positive trends among our customer base and the acquisition of certain assets of USX on May 28, 2005.  These positive trends were offset by a decline in shipping demand during the last half of 2006, as demonstrated by the 3.0% decline in our average weight per shipment, despite a 5.3% increase in total shipments. Our airport-to-airport business is priced on a per pound basis and the average revenue per pound, including the impact of fuel surcharges, increased 5.9% for the year ended December 31, 2006 versus the year ended December 31, 2005. Average revenue per pound increased primarily as a result of rate increases implemented in March 2006 and increased fuel surcharges to offset rising fuel costs.
 
Our logistics revenue, which is primarily truckload brokerage and priced on a per mile basis, increased $7.7 million, or 31.6%, to $32.1 million, accounting for 9.1% of our total operating revenue during the year ended December 31, 2006 compared to 7.6% for the year ended December 31, 2005. Logistics revenue increased despite the loss of a significant customer in the second half of 2005 who accounted for approximately $1.6 million in logistics revenue during the year ended December 31, 2005. The increase in logistics revenue is primarily attributable to our ability to capture a larger percentage of truckload opportunities as a result of our increased access to sufficient capacity through third-party transportation providers. During the year ended December 31, 2006, we increased the number of miles driven to support our logistics revenue by 32.6%. The increase in miles driven is a result of our continued efforts to grow our logistics business and obtain additional customers. The average revenue per mile of our logistics business, including the impact of fuel surcharges, decreased 0.9% for the year ended December 31, 2006 versus the year ended December 31, 2005. The decrease in our revenue per mile is primarily a result of a change in the mix of business offset by increased fuel surcharges to offset rising fuel costs.
 
Accessorial revenue, which includes Forward Air Complete, warehousing services and terminal handling and accounts for our final component of operating revenue, increased $1.4 million, or 7.1% to $21.0 million for the year ended December 31, 2006 from $19.6 million for the year ended December 31, 2005. The increase in accessorial revenue is attributable to the 2006 introduction of Forward Air Complete and increases in other accessorial charges for special shipping needs, offset by decreases in terminal handling fees due to the customer loss discussed in logistics revenue.
 
 
Purchased transportation increased by $13.8 million, or 10.4%, to $146.7 million for the year ended December 31, 2006 from $132.9 million for the year ended December 31, 2005. The increase in purchased transportation is primarily attributable to an increase of approximately 9.5% in miles driven and an approximate 0.9% increase in the total cost per mile for the year ended December 31, 2006 versus the year ended December 31, 2005. As a percentage of total operating revenue, purchased transportation increased to 41.6% during the year ended December 31, 2006 compared to 41.4% in the same period of 2005. For the year ended December 31, 2006, purchased transportation costs for our airport-to-airport network decreased to 39.4% of airport-to-airport revenue for the year ended December 31, 2006 versus 40.0% for the year ended December 31, 2005. The proportionate improvement resulted from better load factors, or more revenue per mile, for the year ended December 31, 2006. For the year ended December 31, 2006, logistics purchased transportation costs represented 71.0% of logistics revenue versus 70.3% for the year ended December 31, 2005. The increase resulted from lower logistics revenue per mile discussed above and a 0.1% increase in our logistics cost per mile. Logistics cost per mile increased as a result of the use of more third-party transportation providers as opposed to our less costly fleet of owner-operators offset by lower third-party transportation provider rates due to our increased capacity and utilization. Accessorial purchased transportation costs as a percentage of accessorial revenue increased to 28.2% of accessorial revenue for the year ended December 31, 2006 from 25.1% for the year ended December 31, 2005. The increase as a percentage of revenue is primarily attributable to a change in the revenue mix resulting from the implementation of Forward Air Complete and the customer loss discussed in the analysis of logistics revenue.
 
Salaries, wages and employee benefits were 21.1% of operating revenue for the year ended December 31, 2006 compared to 21.2% for the same period of 2005. The decrease in salaries, wages and employee benefits as a percentage of operating revenue is attributable to operating efficiencies gained during the year. Salaries and wages, including payroll taxes, and workers’ compensation insurance and expenses, which increased by $3.9 million, or 6.2%, declined 0.7% as a percentage of revenue. Salaries and wages and workers’ compensation insurance and expenses increased to meet the additional demands of the increased tonnage through our network and increased logistics and other services provided to our customers, but declined as a percentage of revenue due to operating efficiencies gained during the year as a result of TAP and other management initiatives. This decrease as a percentage of revenue was offset by a $2.4 million, or 0.6% as a percentage of operating revenue, increase in health care costs due to increased participants in our health care plan, as well as a larger number of high dollar claims. Also, during 2006 we implemented Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payments(“SFAS 123R”), and issued non-vested shares of Common Stock to certain key employees. As a result we recognized $1.3 million, or 0.4% of operating revenue, in share-based compensation that is included in salaries, wages and employee benefits for the year ended December 31, 2006. However, this increase was offset by the year ended December 31, 2005 including a $1.3 million dollar, or 0.4% of operating revenue, charge resulting from the decision by our Board of Directors to accelerate the vesting of all of our outstanding and unvested stock options to employees, officers and non-employee directors in the fourth quarter of 2005.
 
Operating leases, the largest component of which is facility rent, were 4.1% of operating revenue for the year ended December 31, 2006 compared with 4.2% for the year ended December 31, 2005. The decrease in operating leases as a percentage of operating revenue was attributable to the increase in operating revenue as operating lease expenses increased $1.0 million, or 7.4%, from the year ended December 31, 2005 to the year ended December 31, 2006. The increase is attributable to expansion of certain facilities resulting in higher facility rent.
 
Depreciation and amortization expense as a percentage of operating revenue was 2.5% for the year ended December 31, 2006 compared to 2.8% for the year ended December 31, 2005. Depreciation and amortization expense was $8.9 million for the year ended December 31, 2006 and 2005. The decrease in depreciation and amortization expense as a percentage of operating revenue was attributable to the increase in operating revenue as depreciation and amortization remained consistent year over year. Depreciation decreased $1.1 million year over year due to the year ended December 31, 2005 including increased depreciation from the accelerated depreciation of trailers sold in the third and fourth quarters of 2005. Also, depreciation decreased $0.8 million due to several assets becoming fully depreciated during 2006. These decreases were offset by amortization expense increasing during the year ended December 31, 2006 by $0.5 million, or by five additional months of amortization, due to the purchase of certain assets of USX on May 28, 2005. The decreases were also offset by increased depreciation on new trailers and tractors purchased during late 2005 and 2006, as well the depreciation on our new TAP system which was fully implemented during 2006.
 
Insurance and claims were 1.7% of operating revenue for the year ended December 31, 2006 compared to 1.6% for the year ended December 31, 2005 . The increase in insurance and claims is primarily the result of higher insurance premiums, offset by improved claims experience during the year ended December 31, 2006. Additionally, during the year ended December 31, 2005, an independent third party performed an actuary study of our loss development factor for vehicle liability claims. The results of the study caused us to lower our loss development reserve for vehicle liability claims.
 
 
Other operating expenses were 7.6% of operating revenue for the year ended December 31, 2006 compared to 7.8% for the year ended December 31, 2005. The decrease in other operating expenses as a percentage of operating revenue was attributable to the increase in operating revenue as other operating expenses increased $1.9 million, from the year ended December 31, 2005 to the year ended December 31, 2006. The $1.9 million increase in other operating expenses is primarily attributable to a $0.7 million decrease in the gain on the sale of trailers due to the replacement of approximately half of the trailers in our fleet during 2005. The remaining increase in total other operating expenses is attributable to increases in volume related operating expenses, such as fuel, tires, and station handling fees.
 
Income from operations increased by $8.0 million, or 11.9%, to $75.4 million for the year ended December 31, 2006 compared with $67.4 million for the same period in 2005. The increase in income from operations was primarily a result of the increase in operating revenue and operating expenses decreasing as a percentage of revenue.
 
Other income, net was $3.1 million, or 0.9% of operating revenue, for the year ended December 31, 2006 compared with $3.8 million, or 1.2% of operating revenue, for the year ended December 31, 2005. The decrease in other income in total dollars and as a percentage of operating revenue was attributable to the year ended December 31, 2005 including the $1.4 million gain from our lawsuit settlement with the City of Atlanta regarding property we owned adjacent to the Atlanta Hartsfield-Jackson International Airport. This decrease was offset by higher interest income earned during the year ended December 31, 2006 due to higher yields and average investment balances. The decrease was further offset by 2006 including a $0.3 million gain on the recovery of escrow funds related to a 2001 asset purchase.
 
The combined federal and state effective tax rate for the year ended December 31, 2006 was 37.7% compared to a rate of 37.0% for the year ended December 31, 2005. The increase in the effective tax rate was primarily due to a decrease in tax-exempt interest income as a percentage of our total income before taxes.
 
As a result of the foregoing factors, net income increased by $4.0 million, or 8.9%, to $48.9 million for the year ended December 31, 2006 compared with $44.9 million for the year ended December 31, 2005.
 
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

Operating revenue increased by $38.7 million, or 13.7%, to $320.9 million for 2005 from $282.2 million in 2004. Airport-to-airport, which is the largest component of our operating revenue, increased $38.5 million to $276.9 million, accounting for 86.3% of our total operating revenue. The increase in airport-to-airport revenue was driven, in part, by the acquisition of certain assets of USX in the second quarter of 2005. During 2005, we experienced an 8.2% increase in tonnage that transited our network as the result of a stronger economy and positive trends among our customer base. Our airport-to-airport business is priced on a per pound basis and the average revenue per pound including the impact of fuel surcharges increased 5.0% for 2005 versus 2004 primarily as the result of a rate increase implemented during the year. Our logistics revenue, which is primarily truckload brokerage and priced on a per mile basis, increased $0.3 million to $24.4 million in 2005. During the year, we decreased the number of miles driven to support our logistics revenue by 4.4% while increasing the revenue per mile including the impact of fuel surcharges charged by 5.8%. Accessorial revenue, which includes warehousing services and terminal handling and accounts for our final component of operating revenue, decreased $0.1 million to $19.6 million, a 0.4% decrease from 2004.
 
Purchased transportation decreased to 41.4% of operating revenue in 2005 versus 42.0% in the same period of 2004. The decrease in purchased transportation as a percentage of operating revenue was primarily attributed to a year over year improvement in tonnage transported through the airport-to-airport network and revenue per pound that allowed us to operate our network more efficiently in 2005 versus 2004. During the year, we increased the amount we spent for purchased transportation by $14.5 million, an increase of 12.2%. For 2005, purchased transportation costs for our airport-to-airport network represented 40.0% of airport-to-airport revenue versus 40.6% in 2004. During this period, we were able to increase both the volume and revenue per pound of freight, which enabled us to operate the airport-to-airport network more efficiently. These increases were offset, in part, by an increase in the number of miles needed to operate our system as well as an increase in the average rate per mile paid. For 2005, logistics purchased transportation costs represented 70.2% of logistics revenue versus 69.4% last year.

Salaries, wages and employee benefits were 21.2% of operating revenue in 2005 compared to 22.2% for the same period of 2004. The decrease in salaries, wages and employee benefits as a percentage of operating revenue was primarily attributed to a year over year improvement in operating revenue that allowed us to operate our network more efficiently in 2005 versus 2004. This includes a $1.3 million dollar, or 0.4% of operating revenue, charge resulting from the decision to accelerate the vesting of Common Stock options in the fourth quarter of 2005. Additionally, as a percentage of revenue, the amounts spent on health care decreased 0.3%, offset by a 0.1% increase in workers’ compensation expenses.
 
Operating leases, the largest component of which is facility rent, were 4.2% of operating revenue in 2005 compared to 4.5% in the same period of 2004. The decrease in operating leases as a percentage of operating revenue between periods was primarily attributable to an increase in operating revenue as the dollar amount in this category increased between the two periods.

25
 
Depreciation and amortization expense as a percentage of operating revenue was 2.8% in 2005 compared to 2.4% in the same period of 2004. The increase in depreciation and amortization expense as a percentage of operating revenue was partially attributable to an increase in amortization associated with the purchase of certain intangible assets from USX. Additionally, there was increased depreciation resulting from the accelerated depreciation of trailers sold during the third and fourth quarters.
 
Insurance and claims were 1.6% of operating revenue in 2005 compared to 1.9% in the same period of 2004. The decrease as a percentage of operating revenue was driven by an increase in operating revenue as insurance expenses and claims expenses as a percentage of operating revenue decreased by 0.2% and 0.1%, respectively. We are self-insured for each auto liability claim in the amount of $500,000.
 
Other operating expenses were 7.8% of operating revenue in 2005 compared to 8.0% in the same period of 2004. Other operating expenses as a percentage of operating revenue decreased primarily as the result of a 0.2% gain from the sale of trailers, as well as a 0.1% decrease in corporate expenses. These decreases were offset, in part, by a 0.1% increase in terminal and operating expenses.

Income from operations increased by $13.8 million, or 25.7%, to $67.4 million for 2005 compared with $53.6 million for the same period in 2004. The increase in income from operations was primarily a result of the increase in operating revenue, including fuel surcharges, which was offset in part by increases in variable costs associated with operating the network.

Other income, net was $3.8 million, or 1.2% of operating revenue, in 2005 compared to $1.1 million, or 0.4%, for the same period in 2004. The increase in other income in total dollars and as a percentage of operating revenue was attributable to the year ended December 31, 2005 including the $1.4 million gain from our lawsuit settlement with the City of Atlanta regarding property we owned adjacent to the Atlanta Hartsfield-Jackson International Airport. The remaining increase in other income, net resulted from higher interest income attributed to higher yields on balances in available-for-sale securities during 2005.

The combined federal and state effective tax rate for 2005 was 37.0% of pre-tax income compared to a rate of 37.0% for the same period in 2004.

As a result of the foregoing factors, net income increased by $10.5 million, or 30.5%, to $44.9 million for 2005 compared to $34.4 million for the same period in 2004.
 
Discussion of Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We continuously evaluate our critical accounting policies and estimates, including those related to collectibility of accounts receivable, self-insurance loss reserves, income taxes, share-based compensation, and valuation of goodwill. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our financial position and results of operations may be significantly different when reported under different conditions or when using different assumptions in the application of such policies. In the event estimates or assumptions prove to be different from actual amounts, adjustments are made in subsequent periods to reflect more current information.
 
      We believe the following critical accounting policies require significant judgments and estimates in the preparation of our consolidated financial statements.

Allowance for Doubtful Accounts

We evaluate the collectibility of our accounts receivable based on a combination of factors. In circumstances in which management is aware of a specific customer’s inability to meet its financial obligations to us (for example, bankruptcy filings or accounts turned over for collection or litigation), we record a specific reserve for these bad debts against amounts due to reduce the net recognized receivable to the amount we reasonably believe will be collected. For all other customers, we recognize reserves for these bad debts based on the length of time the receivables are past due. Specifically, amounts that are 90 days or more past due are reserved at 50.0%. If circumstances change (i.e., we experience higher than expected defaults or an unexpected material adverse change in a customer’s ability to meet its financial obligations to us), the estimates of the recoverability of amounts due to us could be reduced by a material amount. Accounts are written off after all means of collection, including legal action, have been exhausted.

26
 
Allowance for Revenue Adjustments

Our allowance for revenue adjustments consists of amounts reserved for billing rate changes that are not captured upon load initiation. These adjustments generally arise: (i) when the sales department contemporaneously grants small rate changes (“spot quotes”) to customers that differ from the standard rates in the system; (ii) when freight requires dimensionalization or is reweighed resulting in a different required rate; (iii) when billing errors occur; and (iv) when data entry errors occur. When appropriate, permanent rate changes are initiated and reflected in the system. We monitor the manual revenue adjustments closely through the employment of various controls that are in place to ensure that revenue recognition is not compromised and that fraud does not occur. During 2006, average revenue adjustments per month were approximately $0.2 million, on average revenue per month of approximately $29.6 million (less than 1.0% of monthly revenue). In order to estimate the allowance for revenue adjustments related to ending accounts receivable, we prepare an analysis that considers average monthly revenue adjustments and the average lag for identifying and quantifying these revenue adjustments. Based on this analysis, we establish an allowance for approximately 40-80 days (dependent upon experience in the last twelve months) of average revenue adjustments, adjusted for rebates and billing errors. The lag is periodically adjusted based on actual historical experience. Additionally, the average amount of revenue adjustments per month can vary in relation to the level of sales or based on other factors (such as personnel issues that could result in excessive manual errors or in excessive spot quotes being granted). Both of these significant assumptions are continually evaluated for validity.
 
Self-Insurance Loss Reserves
 
Given the nature of our operating environment, we are subject to vehicle and general liability, workers’ compensation and health insurance claims. To mitigate a portion of these risks, we maintain insurance for individual vehicle and general liability claims exceeding $0.5 million and workers’ compensation claims and health insurance claims exceeding approximately $0.3 million, except in Ohio, where we are a qualified self-insured with an approximately $0.4 million self-insured retention. The amount of self-insurance loss reserves and loss adjustment expenses is determined based on an estimation process that uses information obtained from both company-specific and industry data, as well as general economic information. The estimation process for self-insurance loss exposure requires management to continuously monitor and evaluate the life cycle of claims. Using data obtained from this monitoring and our assumptions about the emerging trends, management develops information about the size of ultimate claims based on its historical experience and other available market information. The most significant assumptions used in the estimation process include determining the trend in loss costs, the expected consistency in the frequency and severity of claims incurred but not yet reported to prior year claims, changes in the timing of the reporting of losses from the loss date to the notification date, and expected costs to settle unpaid claims. Management also monitors the reasonableness of the judgments made in the prior year’s estimation process (referred to as a hindsight analysis) and adjusts current year assumptions based on the hindsight analysis. Additionally, we utilize an actuary to evaluate open vehicle liability claims and estimate the ongoing development exposure.
 
Income Taxes

The Company accounts for income taxes using the liability method, whereby deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to be recovered or settled.
 
Valuation of Goodwill

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we conduct an annual impairment test of goodwill at the end of the second quarter of each year based on judgments regarding the market value of our Common Stock, ongoing profitability and cash flow of the underlying assets. Changes in strategy or market conditions could significantly impact these judgments and require adjustments to recorded asset balances. For example, if we had reason to believe that our recorded goodwill had become impaired due to decreases in the fair market value of the underlying business, we would have to take a charge to income for that portion of goodwill that we believe is impaired. The annual impairment test was conducted and it did not result in any impairment charges.
 
Share-Based Compensation
 
Prior to January 1, 2006, as permitted by SFAS No. 123, Accounting for Stock Based Compensation (“SFAS 123”), as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, we accounted for share-based payments to employees using Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. As such, we generally recognized no compensation cost for employee stock options as options granted had exercise prices equal to the fair market value of our Common Stock on the date of grant. We also recorded no compensation expense in connection with our employee stock purchase plan as the purchase price of the stock paid by employees was not less than 85% of the fair market value of our Common Stock at the beginning and at the end of each purchase period.


27
 
Effective January 1, 2006, we adopted SFAS 123R and elected the modified prospective transition method. Under the modified prospective transition method, awards that are granted, modified, repurchased or canceled after the date of adoption should be measured and accounted for in accordance with SFAS 123R. Share-based awards that are granted prior to the effective date should continue to be valued in accordance with SFAS 123 and stock option expense for unvested options must be recognized in the statement of operations. On December 31, 2005, our Board of Directors accelerated the vesting of all of our outstanding and unvested stock options awarded to employees, officers and non-employee directors under our stock option award plans. As a result of the acceleration of the vesting of our outstanding and unvested options in 2005, there was no additional compensation expense recognized during the year ended December 31, 2006 related to options granted prior to January 1, 2006.

Prior to the implementation of SFAS 123R, we utilized stock options as our sole form of share-based awards. During the year ended December 31, 2006, we granted non-vested shares of Common Stock (“non-vested shares”) to key employees. The non-vested shares’ fair values were estimated using opening market prices for the business day of the grant. The share-based compensation for the non-vested shares is recognized, net of estimated forfeitures, ratably over the requisite service period, or vesting period, of three years. Forfeitures have been estimated based on our historical experience, but will be adjusted for future changes in forfeiture experience. We estimate the forfeitures of dividends paid on non-vested shares and record expense for the estimated forfeitures in accordance with SFAS 123R.

Under the ESPP, which has been approved by shareholders, we are authorized to issue shares of Common Stock to our employees. These shares may be issued at a price equal to 90% of the lesser of the market value on the first day or the last day of each six-month purchase period. Common Stock purchases are paid for through periodic payroll deductions and/or up to two large lump sum contributions. As the ESPP does not qualify as non-compensatory under the requirements of SFAS 123R, we recognize share-based compensation on the date of purchase based on the difference between the purchase date fair market value and the employee purchase price.

Prior to the adoption of SFAS 123R, we presented all tax benefits for tax deductions resulting from the exercise of stock options as operating cash flows on our statements of cash flows. SFAS 123R requires the cash flows resulting from the tax benefits for tax deductions in excess of the compensation expense recorded for those options (excess tax benefits) to be classified as financing cash flows. Accordingly, we classified excess tax benefits as financing cash inflows rather than as operating cash inflows on our statement of cash flows for the year ended December 31, 2006.
 
SFAS 123R also requires companies to calculate an initial “pool” of excess tax benefits available at the adoption date to absorb any unused deferred tax assets that may be recognized under SFAS 123R. The pool includes the net excess tax benefits that would have been recognized if we had adopted SFAS 123 for recognition purposes on its effective date. We have elected to calculate the pool of excess tax benefits under the alternative transition method described in Financial Accounting Standards Board (“FASB”) Staff Position No. FAS 123(R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards, which also specifies the method we must use to calculate excess tax benefits reported on the statement of cash flows.
 
Impact of Recent Accounting Pronouncements
 
During June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109)” (“FIN 48”), which is effective for us on January 1, 2007. This interpretation was issued to clarify the accounting for uncertainty in income taxes recognized in the financial statements by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The guidance prescribed in FIN 48 establishes a recognition threshold of more likely than not that a tax position will be sustained upon examination. The measurement attribute of FIN 48 requires that a tax position be measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. We are continuing to evaluate the impact of FIN 48 on our consolidated financial statements as a result of on-going litigation between taxing authorities and entities that are not related to us in certain tax jurisdictions in which we file. The results of this litigation may materially impact the financial statement recognition of tax positions taken in certain state income tax returns. Upon initial adoption, as specified by FIN 48 any required cumulative effect adjustment will be charged to retained earnings.
 
During September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which is effective for fiscal years beginning after November 15, 2007 with early adoption encouraged. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS 157 does not require any new fair value measurements. However, the application of SFAS 157 could change current practice. We plan to adopt SFAS 157 on January 1, 2008, but the implementation of SFAS 157 is not expected to have a significant impact on our financial position or results of operations.
 
28
 
Liquidity and Capital Resources
 
We have historically financed our working capital needs, including capital purchases, with cash flows from operations and borrowings under our bank line of credit. Net cash provided by operating activities totaled approximately $52.5 million for the year ended December 31, 2006 compared to approximately $51.2 million in the same period of 2005. The increase in cash provided by operating activities was primarily generated from the increase in our net income and decreases in our income taxes receivable. These increases were offset by the reclassification of cash provided by tax deductions in excess of the compensation expense recorded for options, which due to the implementation of SFAS 123R is now recorded in financing cash flows.
 
Net cash provided by investing activities was approximately $0.8 million for the year ended December 31, 2006 compared with approximately $3.1 million provided by investing activities in the same period of 2005. Investing activities consisted primarily of the purchase and sale or maturities of available-for-sale securities, payments and deposits for expanded or new facilities and the purchase of operating equipment and management information systems during the year ended December 31, 2006. The decrease in cash provided by investing activities was the result of a $15.3 million decrease in net cash provided by the sale and purchasing of available-for-sale-securities. Also, the year ended December 31, 2005 included $2.8 million in cash provided by the settlement of our lawsuit with the City of Atlanta regarding property we owned adjacent to the Atlanta Hartsfield-Jackson International Airport. These decreases in cash provided were offset by $12.8 million in cash used for the acquisition of USX during the year ended December 31, 2005. Additionally, cash paid for capital expenditures and deposits, net of proceeds from the disposal of property and equipment, decreased $2.7 million.
 
Net cash used in financing activities totaled approximately $45.4 million for the year ended December 31, 2006 compared with approximately $54.1 million used in financing activities for the same period of 2005. The decrease in cash used in financing activities was primarily attributable to a $12.3 million decrease in cash used for the repurchase of our Common Stock. Also, cash used for financing activities improved due to the implementation of SFAS 123R and the $2.0 million benefit resulting from the requirement to classify tax deductions in excess of the compensation expense recorded for options as financing cash flows as opposed to operating cash flows. Offsetting these improvements in cash flow, during the year ended December 31, 2006 we received approximately $1.6 million less in proceeds from the exercise of stock options than during 2005. In addition, positive movements in cash used in financing activities were offset by a $1.0 million increase in cash dividends paid, a $1.5 million decrease in borrowings from our line of credit and a $1.5 million increase in payments on our line of credit.
 
During 2006, we substantially completed the project to expand our national hub in Columbus, Ohio and continue to execute our plan to acquire three sites in key gateway cities for construction of new terminals and regional hubs. For the national hub expansion, we have paid approximately $5.5 million through December 31, 2006. In addition, during 2006 we entered into an agreement to purchase real property and to construct a terminal near Chicago, Illinois for $22.1 million. A deposit of $3.3 million was paid to the sellers upon execution of the agreement. Also, in 2006 we entered into an agreement to purchase real property and to construct a new regional hub near Atlanta, Georgia for $14.8 million.  A deposit of $1.5 million was paid to the sellers upon execution of the agreement.  For both the Chicago and Atlanta agreements, the remainder of the purchase prices will be paid upon completion of each project, which we estimate will occur during the first half of 2007. In addition, during February 2007 we purchased 36.7 acres of land in Irving, Texas for $3.1 million.  The land will be used to build a new regional hub. We expect to spend up to $15 million to complete this regional hub by the end of 2007. 

On July 25, 2002, we announced that our Board of Directors approved a stock repurchase program for up to 3.0 million shares of Common Stock, which we completed in the third quarter of 2005. On November 17, 2005, we announced that our Board of Directors approved a subsequent stock repurchase program for an additional 3.0 million shares of Common Stock (the “2005 Repurchase Plan”). During the year ended December 31, 2006, we repurchased 1,302,695 shares of Common Stock under the 2005 Repurchase Plan for $41.7 million, or $32.03 per share.
 
On February 15, 2005, our Board of Directors declared a three-for-two stock split of our Common Stock to be effected in the form of a stock dividend to shareholders of record as of March 18, 2005. Common Stock issued and additional paid-in capital have been restated to reflect the split for all years presented. All common share and per share data have been restated to give effect to the stock split.
 
During the three months ended March 31, 2006, June 30, 2006, September 30, 2006 and December 31, 2006, dividends of $0.07 per share were declared on Common Stock then outstanding. The quarterly dividends were paid on March 31, 2006, June 9, 2006, September 8, 2006 and December 8, 2006. During the three months ended March 31, 2005, June 30, 2005, September 30, 2005 and December 31, 2005, dividends of $0.06 per share were declared on Common Stock then outstanding. The 2005 quarterly dividends were paid on April 18, 2005, June 3, 2005, September 2, 2005 and January 3, 2006. Subsequent to December 31, 2006, our Board of Directors declared a cash dividend of $0.07 per share that will be paid on March 30, 2007 to shareholders of record at the close of business on March 15, 2007. We expect to continue to pay regular quarterly cash dividends, though each subsequent quarterly dividend is subject to review and approval by the Board of Directors.
 
 
Management believes that our available cash, investments, expected cash generated from future operations and borrowings under available credit facilities will be sufficient to satisfy our anticipated cash needs for at least the next twelve months.
 
Off-Balance Sheet Arrangements
 
At December 31, 2006, we had letters of credit outstanding from a bank totaling $4.4 million required by our workers’ compensation and vehicle liability insurance providers.
 
Contractual Obligations and Commercial Commitments

Our contractual obligations and other commercial commitments as of December 31, 2006 (in thousands) are summarized below:

Contractual Obligations
  
Payment Due Period
   
Total 
    
Less Than 1 Year
    
2-3 Years
 
 
4-5 Years
 
 
After 5 Years
  
Capital lease obligations
  
$
 1,217  
$
89
  
$
178
  
$
178
  
$
772
  
Real estate purchase commitments    
32,088
    
32,088
    
--
    
--
    
--
  
Operating leases
    
28,698
    
11,127
    
13,248
    
4,224
    
99
  
Total contractual cash obligations
  
$
62,003
  
$
43,304
  
$
13,426
  
$
4,402
  
$
871
  

As of December 31, 2006, we had a commitment to acquire 77 new forklifts for approximately $1.1 million during 2007. We can cancel the order for 25, or approximately $0.4 million, of these forklifts by March 30, 2007. This commitment is expected to be funded by proceeds from the sale of existing equipment and cash flows from operations.
 
We believe that our available cash, available-for-sale securities, cash expected to be generated from future operations and available borrowings under lines of credit, will be sufficient to satisfy these cash needs for at least the next twelve months.
 
Related Party Transactions
 
Scott M. Niswonger, Chairman of the Board until May 2005, owns a majority interest in Landair Transport, Inc. (“Landair”). Matthew J. Jewell, our Senior Vice President and General Counsel, served in these same capacities with Landair until May 2004. During 2004, we purchased approximately $0.2 million of truckload transportation services from Landair, which have been included in purchased transportation in our consolidated statements of income. No transportation services were purchased from Landair during 2006 and 2005.

During 2004, we provided various operational and administrative services to Landair. We charged Landair approximately $0.2 million during 2004 for these services. These amounts have been included as a reduction of salaries, wages and employee benefits in our consolidated statements of income for 2004. Landair provided various operational and administrative services to us and charged approximately $0.1 million during the year ended December 31, 2004 for these services. These charges have been included in salaries, wages and employee benefits in our consolidated statements of income. No operational and administrative services were provided during 2006 and 2005.

Until September 2005, we had a sublease with Landair pursuant to which we sublet to Landair a portion of our headquarters in Greeneville, Tennessee that is leased from the Greeneville-Greene County Airport Authority. We sublet the facility to Landair for consideration based upon the cost of such facility to us and an agreed-upon percentage of usage. Sublease rental income charged to Landair in 2005 and 2004 was less than $0.1 million in both years. These amounts are included in sublease rental income disclosed in our consolidated statements of income.

Transactions with Sky Night, LLC
 
Sky Night, LLC (“Sky Night”) is a limited liability corporation owned by Mr. Niswonger, Chairman of the Board until May 2005. During 2006, 2005 and 2004 we purchased air transportation services from Sky Night. Air charter expense totaled $0.1 million in 2006, 2005 and 2004, respectively.

During 2001, we entered into an agreement to sublease hangar space at our Greeneville, Tennessee headquarters to Sky Night. The initial term of the sublease was for 12 months. Currently, the hangar space is being sublet on a month-to-month basis.
 
30
 
Forward-Looking Statements

This report contains “forward-looking statements,” as defined in Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements are statements other than historical information or statements of current condition and relate to future events or our future financial performance. Some forward-looking statements may be identified by use of such terms as “believes,” “anticipates,” “intends,” “plans,” “estimates,” “projects” or “expects.” Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. The following is a list of factors, among others, that could cause actual results to differ materially from those contemplated by the forward-looking statements: economic factors such as recessions, inflation, higher interest rates and downturns in customer business cycles, our inability to maintain our historical growth rate because of a decreased volume of freight moving through our network or decreased average revenue per pound of freight moving through our network, increasing competition and pricing pressure, surplus inventories, loss of a major customer, the creditworthiness of our customers and their ability to pay for services rendered, our ability to secure terminal facilities in desirable locations at reasonable rates, the inability of our information systems to handle an increased volume of freight moving through our network, changes in fuel prices, claims for property damage, personal injuries or workers’ compensation, employment matters including rising health care costs, enforcement of and changes in governmental regulations, environmental and tax matters, the handling of hazardous materials, the availability and compensation of qualified independent owner-operators and freight handlers needed to serve our transportation needs and our inability to successfully integrate acquisitions. As a result of the foregoing, no assurance can be given as to future financial condition, cash flows or results of operations. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
 
Quantitative and Qualitative Disclosures About Market Risk
 
Except for capital lease obligations totaling $0.8 million, we had no long-term debt at December 31, 2006. Accordingly, our exposure to market risk related to debt is not significant.

We are also exposed to changes in interest rates from our available-for-sale securities. As a result of the regularly reset interest rates to market rates on the available-for-sale securities we own, a material adverse effect to the fair market value of the investments is unlikely.
 
Financial Statements and Supplementary Data

The response to this item is submitted as a separate section of this report.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Controls and Procedures

Disclosure Controls and Procedures

We maintain controls and procedures designed to ensure that we are able to collect the information required to be disclosed in the reports we file with the SEC, and to process, summarize and disclose this information within the time periods specified in the rules of the SEC. Based on an evaluation of our disclosure controls and procedures as of the end of the period covered by this report conducted by management, with the participation of the Chief Executive Officer and Chief Financial Officer, the Chief Executive Officer and Chief Financial Officer believe that these controls and procedures are effective to ensure that we are able to collect, process and disclose the information we are required to disclose in the reports we file with the SEC within the required time periods.

Management’s Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rules 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance to management and the Board of Directors regarding the preparation and fair presentation of financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

31
 
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we assessed the effectiveness of our internal control over financial reporting as of December 31, 2006. In making this assessment, management used the framework set forth by the Committee on Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated Framework. Based on our assessment, we believe, as of December 31, 2006, that our internal control over financial reporting was effective based on those criteria.

Management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2006, has been audited by Ernst & Young LLP, the independent registered public accounting firm who also audited our consolidated financial statements. Ernst & Young LLP’s attestation report on management’s assessment of our internal control over financial reporting appears below.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the fourth quarter of 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
.

32

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders
Forward Air Corporation

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Forward Air Corporation maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Forward Air Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that Forward Air Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Forward Air Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Forward Air Corporation as of December 31, 2006 and 2005, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006 and our report dated February 26, 2007 expressed an unqualified opinion thereon.

 
/s/ Ernst & Young LLP
Nashville, Tennessee
  
February 26, 2007
  

33

Other Information

Not applicable.
Part III

Directors, Executive Officers and Corporate Governance

The information required by this item with respect to our directors is incorporated herein by reference to our proxy statement for the 2007 Annual Meeting of Shareholders (the “2007 Proxy Statement”). The 2007 Proxy Statement will be filed with the SEC not later than 120 days subsequent to December 31, 2006.

Pursuant to Item 401(b) of Regulation S-K, the information required by this item with respect to our executive officers is set forth in Part I of this report.

Executive Compensation

The information required by this item is incorporated herein by reference to the 2007 Proxy Statement.

Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

The information required by this item is incorporated herein by reference to the 2007 Proxy Statement.

Certain Relationships and Related Transactions, and Director Independence 

The information required by this item is incorporated herein by reference to the 2007 Proxy Statement.

Principal Accounting Fees and Services

The information required by this item is incorporated herein by reference to the 2007 Proxy Statement.

Part IV

Exhibits, Financial Statement Schedules

(a)(1) and (2)
List of Financial Statements and Financial Statement Schedules.

The response to this portion of Item 15 is submitted as a separate section of this report.

(a)(3)
List of Exhibits.

The response to this portion of Item 15 is submitted as a separate section of this report.

(b)
Exhibits.

The response to this portion of Item 15 is submitted as a separate section of this report.

(c)
Financial Statement Schedules.

The response to this portion of Item 15 is submitted as a separate section of this report.

34

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.
 
 
 
 
 
Forward Air Corporation
 
Date:  February 27, 2007
 
By:   
/s/ Bruce A. Campbell
 
 
 
Bruce A. Campbell
President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 

Signature
 
Title
 
Date
 
 
 
 
 
 
 
 
 
 
/s/ Richard W. Hanselman
 
Chairman of the Board
 
February 27, 2007
Richard W. Hanselman
 
 
 
 
 
 
 
 
 
 
 
 
 
 
/s/ Bruce A. Campbell
 
President, Chief Executive Officer
 
February 27, 2007
Bruce A. Campbell
 
and Director
 
 
 
 
(Principal Executive Officer)
 
 
 
 
 
 
 
/s/ Rodney L. Bell
 
Chief Financial Officer, Senior Vice
 
February 27, 2007
Rodney L. Bell
 
President and Treasurer
 
 
 
 
(Principal Financial and Accounting Officer)
 
 
 
 
 
 
 
/s/ C. Robert Campbell
 
Director
 
February 27, 2007
C. Robert Campbell
 
 
 
 
 
 
 
 
 
 
 
 
 
 
/s/ C. John Langley, Jr.
 
Director
 
February 27, 2007
C. John Langley, Jr.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
/s/ G. Michael Lynch
 
Director
 
February 27, 2007
G. Michael Lynch
 
 
 
 
 
 
 
 
 
 
 
 
 
 
/s/ Ray A. Mundy
 
Director
 
February 27, 2007
Ray A. Mundy
 
 
 
 
 
 
 
 
 
 
 
 
 
 
/s/ B. Clyde Preslar
 
Director
 
February 27, 2007
B. Clyde Preslar
 
 
 
 
 
35

Annual Report on Form 10-K

Item 8, Item 15(a)(1) and (2), (a)(3), (b) and (c)

List of Financial Statements and Financial Statement Schedule

Financial Statements and Supplementary Data

Certain Exhibits

Financial Statement Schedule

Year Ended December 31, 2006

Forward Air Corporation

Greeneville, Tennessee

F-1

Forward Air Corporation

Form 10-K — Item 8 and Item 15(a)(1) and (2)

Index to Financial Statements and Financial Statement Schedule

The following consolidated financial statements of Forward Air Corporation are included as a separate section of this report:

 
Page No.
F-3
F-4
F-6
F-7
F-8
F-9

The following financial statement schedule of Forward Air Corporation is included as a separate section of this report.

S-1

All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.

F-2

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders
Forward Air Corporation

We have audited the accompanying consolidated balance sheets of Forward Air Corporation as of December 31, 2006 and 2005, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Forward Air Corporation at December 31, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with United States generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

As discussed in Note 1 to the consolidated financial statements, in 2006 the Company changed its method of accounting for share-based compensation.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Forward Air Corporation’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2007 expressed an unqualified opinion thereon.

 
/s/ Ernst & Young LLP
Nashville, Tennessee
  
February 26, 2007
  

F-3

Forward Air Corporation

Consolidated Balance Sheets
 
   
December 31
  
     
2006
 
 
2005
  
 
(In thousands, except share data)
               
Assets
              
Current assets:
              
Cash
  
$
8,231
  
$
332
  
Short-term investments
    
61,650
    
79,000
  
Accounts receivable, less allowances of $860 in 2006 and $922 in 2005
    
48,486
    
45,763
  
Income taxes receivable
    
3,403
    
5,179
  
Inventories
    
501
    
567
  
Prepaid expenses and other current assets
    
4,114
    
4,455
  
Deferred income taxes
    
1,178
    
1,438
  
Total current assets
    
127,563
    
136,734
  
               
Property and equipment:
              
Land
    
2,611
    
2,611
  
Buildings
    
12,367
    
8,051
  
Equipment
    
82,646
    
77,165
  
Leasehold improvements
    
3,566
    
3,259
  
Total property and equipment
    
101,190
    
91,086
  
Accumulated depreciation and amortization
    
47,875
    
43,864
  
Net property and equipment
    
53,315
    
47,222
  
Goodwill and other acquired intangibles:
              
Goodwill
    
15,588
    
15,588
  
Other acquired intangibles, net of accumulated amortization of $2,019 in 2006 and $744 in 2005
    
10,731
    
12,007
  
Total net goodwill and other acquired intangibles
    
26,319
    
27,595
  
Other assets
    
5,817
    
1,049
  
Total assets
  
$
213,014
  
$
212,600
  

F-4

Forward Air Corporation

Consolidated Balance Sheets (continued)
 
   
 December 31
  
     
2006
 
 
2005
  
 
(In thousands, except share data)
               
Liabilities and shareholders’ equity
              
Current liabilities:
              
Accounts payable
  
$
7,949
  
$
12,640
  
Accrued payroll and related items
    
3,117
 
  
3,262
  
Insurance and claims accruals
     3,265    
4,381
Payables to owner-operators
     2,128     1,779  
Collections on behalf of customers
     1,347     1,572  
Other accrued expenses
    
1,287
    
788
  
Short-term debt
    
--
    
1,504
  
Current portion of capital lease obligations
    
40
    
38
  
Total current liabilities
    
19,133
    
25,964
  
               
Capital lease obligations, less current portion
    
796
    
837
  
Other long-term liabilities     1,271    
--
  
Deferred income taxes
    
6,587
    
6,983
  
Commitments and contingencies (Note 9)              
               
Shareholders’ equity:
              
Preferred stock, $0.01 par value:
              
Authorized shares - 5,000,000
              
No shares issued
    
--
    
--
  
Common stock, $0.01 par value:
              
Authorized shares - 50,000,000
              
Issued and outstanding shares - 30,372,082 in 2006 and 31,360,842 in 2005
    
304
    
314
  
Additional paid-in capital
    
--
    
--
  
Accumulated other comprehensive income
    
--
    
--
  
Retained earnings
    
184,923
    
178,502
  
Total shareholders’ equity
    
185,227
    
178,816
  
Total liabilities and shareholders’ equity
  
$
213,014
  
$
212,600
  


The accompanying notes are an integral part of these consolidated financial statements.

F-5

Forward Air Corporation

Consolidated Statements of Income
 
   
Year ended December 31
  
     
2006
 
 
2005
 
 
2004
  
 
(In thousands, except per share data)
Operating revenue
  
$
352,758
  
$
320,934
  
$
282,197
  
                     
Operating expenses:
                    
Purchased transportation
    
146,721
    
132,912
    
118,425
  
Salaries, wages and employee benefits
    
74,448
    
68,086
    
62,728
  
Operating leases
    
14,458
    
13,486
    
12,791
  
Depreciation and amortization
    
8,934
    
8,947
    
6,817
  
Insurance and claims
    
5,967
    
5,202
    
5,382
  
Other operating expenses
    
26,834
    
24,864
    
22,456
  
Total operating expenses
    
277,362
    
253,497
    
228,599
  
Income from operations
    
75,396
    
67,437
    
53,598
  
                     
Other income (expense):
                    
Interest expense
    
(81
)
  
(104
)
  
(55
)
Other, net
    
3,229
    
3,904
    
1,127
  
Total other income
    
3,148
    
3,800
    
1,072
  
Income before income taxes
    
78,544
    
71,237
    
54,670
  
Income taxes
    
29,621
    
26,328
    
20,249
  
Net income
  
$
48,923
  
$
44,909
  
$
34,421
  
                     
Income per share:
                    
Basic
  
$
1.57
  
$
1.41
  
$
1.07
  
Diluted
  
$
1.55
  
$
1.39
  
$
1.05
  
Dividends declared per share
  
$
0.28
  
$
0.24
  
$
--
  


The accompanying notes are an integral part of these consolidated financial statements.

F-6

Forward Air Corporation

Consolidated Statements of Shareholders’ Equity
 
   
Common Stock
    
Additional Paid-in Capital
    
Retained Earnings
    
Accumulated Other Comprehensive Income (Loss)
    
Total Shareholders’ Equity
  
     
Shares
    
Amount
                          
 
(In thousands)
  
Balance at December 31, 2003
    
32,245
  
$
322
  
$
37,410
  
$
109,975
  
$
1
  
$
147,708
  
Net income for 2004
    
--
    
--
    
--
    
34,421
    
--
    
34,421
  
Unrealized gain on securities available for sale, net of $2 tax
    
--
    
--
    
--
    
--
    
3
    
3
  
Comprehensive income
                                  
34,424
  
Exercise of stock options
    
588
    
6
    
7,097
    
--
    
--
    
7,103
  
Common stock issued under employee stock purchase plan
    
14
    
--
    
250
    
--
    
--
    
250
  
Common stock repurchased under stock repurchase plan
    
(449
)
  
(4
)
  
(11,384
)
  
--
    
--
    
(11,388
)
Income tax benefit from stock options exercised
    
--
    
--
    
2,906
    
--
    
--
    
2,906
  
Balance at December 31, 2004
    
32,398
    
324
    
36,279
    
144,396
    
4
    
181,003
  
Net income for 2005
    
--
    
--
    
--
    
44,909
    
--
    
44,909
  
Unrealized loss on securities available for sale, net of ($2) tax
    
--
    
--
    
--
    
--
    
(4
)
  
(4
)
Comprehensive income
                                  
44,905
  
Exercise of stock options
    
643
    
6
    
6,206
    
--
    
--
    
6,212
  
Common stock issued under employee stock purchase plan
    
11
    
1
    
293
    
--
    
--
    
294
  
Acceleration of vesting of stock options
    
--
    
--
    
1,300
    
--
    
--
    
1,300
  
Dividends ($0.24 per share)
    
--
    
--
    
--
    
(7,668
)
  
--
    
(7,668
)
Common stock repurchased under stock repurchase plan
    
(1,690
)
  
(17
)
  
(49,108
)
  
(3,135
)
  
--
    
(52,260
)
Cash paid for fractional shares in 3-for-2 stock split
    
(1
)
  
--
    
(44
)
  
--
    
--
    
(44
)
Income tax benefit from stock options exercised
    
--
    
--
    
5,074
    
--
    
--
    
5,074
  
Balance at December 31, 2005
    
31,361
 
 
314
 
 
--
 
 
178,502
 
 
--
 
 
178,816
  
Net and comprehensive income for 2006
    
--
    
--
    
--
     48,923    
--
     48,923  
Exercise of stock options
     305     3     4,359    
--
    
--
     4,362  
Common stock issued under employee stock purchase plan
     9    
--
     268    
--
    
--
     268  
Share-based compensation
--
--
 1,307
--
--
 1,307
Dividends ($0.28 per share)
    
--
    
--
    
--
     (8,694 )  
--
     (8,694 )
Common stock repurchased under stock repurchase plan
     (1,303 )    (13 )  
(7,901
 )   (33,808 )    --     (41,722 ) 
Income tax benefit from stock options exercised
    
--
    
--
    
1,967
    
--
     --     1,967  
Balance at December 31, 2006
     30,372  
$
 304  
$
 --  
$
 184,923  
$
 --  
$
 185,227  
 
The accompanying notes are an integral part of these consolidated financial statements.

F-7
Forward Air Corporation

Consolidated Statements of Cash Flows
   
Year ended December 31
  
     
2006
 
 
2005
 
 
2004
  
 
(In thousands)
Operating activities:
                    
Net income
  
$
48,923
 
$
44,909
 
$
34,421
  
Adjustments to reconcile net income to net cash provided by operating activities:
                  
Depreciation and amortization
   
8,934
    
8,947
    
6,817
  
Share-based compensation
     1,307     1,300     --  
Atlanta condemnation settlement gain
    
--
 
  
(1,428
 )  
--
  
Other non-cash charges
    
--
    
274
    
--
  
Gain on sale of property and equipment
    
(42
)
  
(728
 )  
--
  
Provision for (recovery) loss on receivables
    
(223
)
  
(121
)
  
161
  
Provision for revenue adjustments
    
2,095
    
2,100
    
1,848
  
Deferred income taxes
    
(136
)
  
(48
)
  
1,511
 
Tax benefit of stock options exercised
     (1,967 )  
5,074
    
2,906
  
Changes in operating assets and liabilities:
                    
Accounts receivable
   
(6,516
)
  
(7,438
)
  
(8,886
)
Inventories
   
66
 
  
(145
)
  
(23
 )
Prepaid expenses and other current assets
   
341
 
  
(705
)
  
(1,081
)
Accounts payable and accrued expenses
   
(4,058
 )  
615
    
4,262
  
Income taxes
    
3,743
 
  
(1,374
)
  
(4,521
 )
Net cash provided by operating activities
   
52,467
    
51,232
    
37,415
  
                     
Investing activities:
                    
Proceeds from disposal of property and equipment
    3,665    
2,804
    
9
  
Purchases of property and equipment
    (15,454
)
  
(22,077
)
  
(11,200
)
Deposits in escrow for construction of new terminals     (4,793
)
   --     --  
Proceeds from sales or maturities of available-for-sale securities
   
229,330
    
229,865
    
232,496
  
Purchases of available-for-sale securities
   
(211,980
)
  
(197,265
)
  
(273,916
)
Acquisition of business
     --
 
  
(12,750
 )  
--
  
Proceeds from Atlanta condemnation settlement/release of amounts held in escrow
    
--
    
2,765
    
1,260
  
Other
   
26
 
  
(242
)
  
(94
 )
Net cash provided by (used in) investing activities
    
794
    
3,100
 
  
(51,445
)
                     
Financing activities:
                    
Payments of capital lease obligations     (39
)
  
(31
)
  
(30
)
(Payments) borrowings on line of credit     (1,504 )  
1,504
     --  
Proceeds from exercise of stock options
   
4,362
    
5,938
    
7,103
  
Payments of cash dividends
     (8,694
)
  
(7,668
)
  
--
  
Cash paid for fractional shares in 3-for-2 stock split
     --    
(44
)
  
--
  
Proceeds from common stock issued under employee stock purchase plan
    268     294    
250
  
Repurchase of common stock
    (41,722
)
  
(54,071
)
  
(9,577
)
Tax benefit of stock options exercised     1,967     --     --  
Net cash used in financing activities
   
(45,362
)
  
(54,078
)
(2,254
)
Net increase (decrease) in cash
   
7,899
    
254
 
  
(16,284
 )
Cash at beginning of year
     332    
78
    
16,362
  
Cash at end of year
 
$
8,231
 
$
332
 
$
78
  
Common stock repurchase liabilities included in accounts payable
  
$
 --
 
$
--
 
$
1,811
 
Uncollected proceeds from disposal of property and equipment in accounts receivable
  
$
 49  
$
 1,970  
 $
 --  
 
The accompanying notes are an integral part of these consolidated financial statements.
F-8

FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(In thousands, except share and per share data)

1.
Accounting Policies

Basis of Presentation and Principles of Consolidation

The accompanying consolidated financial statements of the Company include Forward Air Corporation and its subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.

The Company operates a comprehensive national network for the time-definite surface transportation of deferred air freight. The Company provides its transportation services through a network of terminals located at or near airports in the United States and Canada. The Company’s customers primarily consist of air freight forwarders, domestic and international airlines and integrated air cargo carriers. The Company’s operations involve receiving shipments at its terminals or picking up shipments directly from customers and transporting them by truck.  The shipments are delivered to the terminals nearest their destinations and then, if requested by the customer, on to final designated sites. These activities constitute a single business segment as defined by the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosure about Segments of an Enterprise and Related Information.

Use of Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Significant areas requiring management estimates include the following key financial areas:

Allowance for Doubtful Accounts

The Company evaluates the collectibility of its accounts receivable based on a combination of factors. In circumstances in which management is aware of a specific customer’s inability to meet its financial obligations to the Company (for example, bankruptcy filings, accounts turned over for collection or litigation), the Company records a specific reserve for these bad debts against amounts due to reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers, the Company recognizes reserves for these bad debts based on the length of time the receivables are past due. Specifically, amounts that are 90 days or more past due are reserved at 50.0%. If circumstances change (i.e., the Company experiences higher than expected defaults or an unexpected material adverse change in a customer’s ability to meet its financial obligations to the Company), the estimates of the recoverability of amounts due to the Company could be reduced by a material amount. Accounts are written off after all means of collection, including legal action, have been exhausted.

Allowance for Revenue Adjustments

The Company’s allowance for revenue adjustments consists of amounts reserved for billing rate changes that are not captured upon load initiation. These adjustments generally arise: (1) when the sales department contemporaneously grants small rate changes (“spot quotes”) to customers that differ from the standard rates in the system; (2) when freight requires dimensionalization or is reweighed resulting in a different required rate; (3) when billing errors occur; and (4) when data entry errors occur. When appropriate, permanent rate changes are initiated and reflected in the system. The Company monitors the manual revenue adjustments closely through the employment of various controls that are in place to ensure that revenue recognition is not compromised and that fraud does not occur. During 2006, average revenue adjustments per month were approximately $175, on average revenue per month of approximately $29,571 (less than 1.0% of monthly revenue). In order to estimate the allowance for revenue adjustments related to ending accounts receivable, the Company prepares an analysis that considers average monthly revenue adjustments and the average lag for identifying and quantifying these revenue adjustments. Based on this analysis, the Company establishes an allowance for approximately 40-80 days (dependent upon experience in the last twelve months) of average revenue adjustments, adjusted for rebates and billing errors. The lag is periodically adjusted based on actual historical experience. Additionally, the average amount of revenue adjustments per month can vary in relation to the level of sales or based on other factors (such as personnel issues that could result in excessive manual errors or in excessive spot quotes being granted). Both of these significant assumptions are continually evaluated for validity.

F-9

FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006

1.
Accounting Policies (Continued)

Self-Insurance Loss Reserves

Given the nature of the Company’s operating environment, the Company is subject to vehicle and general liability, workers’ compensation and health insurance claims. To mitigate a portion of these risks, the Company maintains insurance for individual vehicle and general liability claims exceeding $500 and workers’ compensation claims and health insurance claims exceeding $250, except in Ohio, where for workers’ compensation we are a qualified self-insured with a $350 self-insured retention. The amount of self-insurance loss reserves and loss adjustment expenses is determined based on an estimation process that uses information obtained from both company-specific and industry data, as well as general economic information. The estimation process for self-insurance loss exposure requires management to continuously monitor and evaluate the life cycle of claims. Using data obtained from this monitoring and the Company’s assumptions about the emerging trends, management develops information about the size of ultimate claims based on its historical experience and other available market information. The most significant assumptions used in the estimation process include determining the trend in loss costs, the expected consistency in the frequency and severity of claims incurred but not yet reported to prior year claims, changes in the timing of the reporting of losses from the loss date to the notification date, and expected costs to settle unpaid claims. Management also monitors the reasonableness of the judgments made in the prior year’s estimation process (referred to as a hindsight analysis) and adjusts current year assumptions based on the hindsight analysis. Additionally, the Company utilizes an actuary to evaluate open claims and estimate the ongoing development exposure.

Revenue Recognition

Operating revenue and related costs are recognized as of the date shipments are completed. No single customer accounted for more than 10.0% of operating revenue in 2006, 2005 or 2004.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash and cash equivalents.

Available-For-Sale Securities

Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported in other comprehensive income. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity computed under the effective interest method. Such amortization is included in other income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in other income. The cost of securities sold is based on the specific identification method. Interest on securities classified as available-for-sale is included in other income in the consolidated statements of income.

Inventories

Inventories of tires, replacement parts, supplies, and fuel for equipment are stated at the lower of cost or market utilizing the FIFO (first-in, first-out) method of determining cost. Inventories of tires and replacement parts are not material in the aggregate. Replacement parts are expensed when placed in service, while tires are capitalized and amortized over their expected life. Replacement parts and tires are included as a component of other operating expenses in the consolidated statements of income.
 
Property and Equipment

Property and equipment are stated at cost. Expenditures for normal repair and maintenance are expensed as incurred. Depreciation of property and equipment is calculated based upon the cost of the asset, reduced by its estimated salvage value, using the straight-line method over the estimated useful lives as follows:

Buildings
30-40 years
Equipment
3-10 years
Leasehold improvements
Lesser of Useful Life or Initial Lease Term
 
F-10
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006
 
1.
Accounting Policies (Continued)
 
Depreciation expense for each of the three years ended December 31, 2006, 2005 and 2004 was $7,659, $8,203 and $6,817, respectively.
 
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Impairment is recognized on assets classified as held and used when the sum of undiscounted estimated cash flows expected to result from the use of the asset is less than the carrying value. If such measurement indicates a possible impairment, the estimated fair value of the asset is compared to its net book value to measure the impairment charge, if any. When the criteria have been met for long-lived assets to be classified as held for sale, the assets are recorded at the lower of carrying value or fair market value (less selling costs).
 
Operating Leases
 
Certain operating leases include rent increases during the initial lease term. For these leases, the Company recognizes the related rental expenses on a straight-line basis over the term of the lease, which includes any rent holiday period, and records the difference between the amounts charged to operations and amount paid as rent as a rent liability.

Goodwill and Other Intangible Assets

Goodwill is recorded at cost based on the excess of purchase price over the fair value of assets acquired. Under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, goodwill and intangible assets with indefinite lives are not amortized but are subject to annual impairment tests in accordance with the statement. Other intangible assets are amortized over their useful lives. The Company completed the required annual impairment test of goodwill during each of the second quarters of 2006, 2005 and 2004, and determined that goodwill had not been impaired. Any subsequent impairment losses will be reflected in income from operations in the consolidated statements of income.

The definite-lived intangible assets of the Company resulting from the acquisition of certain assets of U.S. Express Enterprises, Inc. (“USX”) and the related amortization are described in Note 2, Acquisition of Business.

Software Development

Costs related to software developed or acquired for internal use are expensed or capitalized and then amortized in accordance with the American Institute of Certified Public Accountants Statement Of Position No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The Company uses a five-year straight line amortization for the capitalized amounts of software development costs.

Income Taxes

The Company accounts for income taxes using the liability method, whereby deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to be recovered or settled.
 
Income Per Share

The Company calculates income per share in accordance with SFAS No. 128, Earnings Per Share (“SFAS 128”). Under SFAS 128, income per basic share excludes any dilutive effects of options, warrants and convertible securities. Income per diluted share includes any dilutive effects of options, warrants and convertible securities, and uses the treasury stock method in calculating dilution. All income per share data included in the consolidated financial statements and notes thereto have been restated to give effect to a three-for-two stock split declared in February 2005 (see Note 5).
 
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006

1.
Accounting Policies (Continued)
 
Comprehensive Income

Comprehensive income includes any changes in the equity of the Company from transactions and other events and circumstances from non-operational sources. Unrealized gains and losses on available-for-sale securities are included in other comprehensive income for all years presented.

Share-Based Payments
 
Prior to January 1, 2006, as permitted by SFAS No. 123, Accounting for Stock Based Compensation (“SFAS 123”), as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, the Company accounted for share-based payments to employees using Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. As such, the Company generally recognized no compensation cost for employee stock options as options granted had exercise prices equal to the fair market value of our common stock on the date of grant. The Company also recorded no compensation expense in connection with our employee stock purchase plan as the purchase price of the stock paid by employees was not less than 85% of the fair market value of our common stock at the beginning and at the end of each purchase period.

Effective January 1, 2006, the Company adopted SFAS No. 123(R), Share-Based Payments (“SFAS 123R”), and elected the modified prospective transition method. Under the modified prospective transition method, awards that are granted, modified, repurchased or canceled after the date of adoption should be measured and accounted for in accordance with SFAS 123R. Share-based awards that are granted prior to the effective date should continue to be valued in accordance with SFAS 123 and stock option expense for unvested options must be recognized in the statement of operations. On December 31, 2005, the Company’s Board of Directors accelerated the vesting of all outstanding and unvested stock options awarded to employees, officers and non-employee directors under the Company’s stock option award plans. The primary purpose of the accelerated vesting of these options was to eliminate future compensation expense that the Company would otherwise have recognized in its statement of operations with respect to these unvested options upon the adoption of SFAS 123R. As a result of the acceleration of the vesting of the Company’s outstanding and unvested options in 2005, there was no additional compensation expense recognized during the year ended December 31, 2006 related to options granted prior to January 1, 2006.

Prior to the implementation of SFAS 123R, the Company utilized stock options as the sole form of share-based awards. During the year ended December 31, 2006, the Company granted non-vested shares of common stock (“non-vested shares”) to key employees. The non-vested shares’ fair values were estimated using opening market prices for the business day of the grant. The share-based compensation for the non-vested shares is recognized, net of estimated forfeitures, ratably over the requisite service period, or vesting period, of three years. Forfeitures have been estimated based on historical experience, but will be adjusted for future changes in forfeiture experience. The Company estimates the forfeitures of dividends paid on non-vested shares and records expense for the estimated forfeitures in accordance with SFAS 123R.

Under the 2005 Employee Stock Purchase Plan (the “ESPP”), which has been approved by shareholders, the Company is authorized to issue shares of common stock to our employees. These shares may be issued at a price equal to 90% of the lesser of the market value on the first day or the last day of each six-month purchase period. Common stock purchases are paid for through periodic payroll deductions and/or up to two large lump sum contributions. As the ESPP does not qualify as non-compensatory under the requirements of SFAS 123R, the Company recognizes share-based compensation on the date of purchase based on the difference between the purchase date fair market value and the employee purchase price.
 
Prior to the adoption of SFAS 123R, the Company presented all tax benefits for tax deductions resulting from the exercise of stock options as operating cash flows on its statements of cash flows. SFAS 123R requires the cash flows resulting from the tax benefits for tax deductions in excess of the compensation expense recorded for those options (excess tax benefits) to be classified as financing cash flows. Accordingly, the Company classified excess tax benefits as financing cash inflows rather than as operating cash inflows on its statement of cash flows for the year ended December 31, 2006.
 
SFAS 123R also requires companies to calculate an initial “pool” of excess tax benefits available at the adoption date to absorb any unused deferred tax assets that may be recognized under SFAS 123R. The pool includes the net excess tax benefits that would have been recognized if the Company had adopted SFAS 123 for recognition purposes on its effective date. The Company has elected to calculate the pool of excess tax benefits under the alternative transition method described in FASB Staff Position No. FAS 123(R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards, which also specifies the method the Company must use to calculate excess tax benefits reported on the statement of cash flows.
 
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006

1.
Accounting Policies (Continued)
 
If the Company had adopted SFAS 123R in the prior periods the amount of compensation cost that would have been recognized during the years ended December 31, 2005 and 2004, would have approximated the following:
 
 
    
2005
    
2004
  
Net income, as reported
  
$
44,909
  
$
34,421
  
Pro forma compensation expense, net of tax
    
(12,579
)
  
(2,658
)
Pro forma net income
  
$
32,330
  
$
31,763
  
Pro forma net income per share:
          
Basic
  
$
1.02
  
$
0.98
  
Diluted
  
$
1.00
  
$
0.96
  
 
The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 2005 and 2004, respectively: risk-free interest rates of 4.0% and 3.7%; dividend yields of 0.8% and 0.0%; volatility factors of the expected market price of the common stock of 0.4 and 0.4; and a weighted-average expected life of the option of seven years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company’s stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options.
 
Recently Issued Accounting Pronouncements
 
During June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109)” (“FIN 48”), which is effective for the Company on January 1, 2007. This interpretation was issued to clarify the accounting for uncertainty in income taxes recognized in the financial statements by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The guidance prescribed in FIN 48 establishes a recognition threshold of more likely than not that a tax position will be sustained upon examination. The measurement attribute of FIN 48 requires that a tax position be measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The Company is continuing to evaluate the impact of FIN 48 on its consolidated financial statements as a result of on-going litigation between taxing authorities and entities that are not related to the Company in certain tax jurisdictions in which the Company files. The results of this litigation may materially impact the financial statement recognition of tax positions taken in certain state income tax returns. Upon initial adoption, as specified by FIN 48 any required cumulative effect adjustment will be charged to retained earnings.
 
During September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which is effective for fiscal years beginning after November 15, 2007 with early adoption encouraged. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS 157 does not require any new fair value measurements. However, the application of SFAS 157 could change current practice. The Company plans to adopt SFAS 157 on January 1, 2008, but the implementation of SFAS 157 is not expected to have a significant impact on our financial position or results of operations.
 
Reclassifications
 
Certain reclassifications have been made to prior-year financial statements to conform to the 2006 presentation. These reclassifications had no effect on net income as previously reported.
 
F-13
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006
 
2.
Acquisition of Business
 
On May 28, 2005, the Company acquired certain assets of the airport-to-airport operations of USX for $12,750 in cash. In connection with the purchase, the Company acquired the airport-to-airport customer list of USX and USX agreed not to compete in the airport-to-airport market for a period of ten years. The purchase price allocation in accordance with SFAS No. 141, Business Combinations, is acquired intangible assets with a total value of $12,750 (majority of the allocation to the non-compete agreement). The acquired intangible assets will be amortized over a period of ten years. The Company began amortizing the assets on a straight-line basis during June 2005 and recorded amortization expense of approximately $1,275 and $744 for the years ended December 31, 2006 and 2005, respectively. Ongoing annual amortization expense will be $1,275 for the next five years and throughout the life of the assets. The results of operations of the USX airport-to-airport operations are included in the consolidated income statement for the year ended December 31, 2006, but only the results of operations from May 28, 2005 through December 31, 2005 are included in the consolidated income statement for the year ended December 31, 2005.
 
The airport-to-airport business had been reported by USX as a part of the Xpress Global Systems (“XGS”) business segment. XGS had total revenue for the year ended December 31, 2004 of approximately $159,000, of which an estimated $57,000 was attributable to the airport-to-airport operations. The XGS segment reported an operating loss of approximately $5,000 for the year ended December 31, 2004. USX did not account for the related expenses of the airport-to-airport operations separately within the XGS segment and, accordingly, the USX operating profit or loss attributable to the airport-to-airport operations is not known.
 
3.
Investments

The Company had a total of $61,650 and $79,000 in available-for-sale securities as of December 31, 2006 and 2005, respectively. The Company’s investments consist of state municipal bonds (often referred to as auction rate securities). The Company has the option to go to auction every 7-35 days with the auction rate securities, but the stated maturities of the investments are longer-term. The Company had interest income of $2,973, $2,476 and $1,143 for each of the years ended December 31, 2006, 2005 and 2004, respectively, on its investments.

Securities are classified as available for sale when the Company does not intend to hold the securities to maturity nor regularly trade the securities.

The following is a summary of available-for-sale securities at December 31, 2006 and 2005:

 
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
December 31, 2006
                          
Available-for-sale securities
  
$
61,650
 
$
--
 
$
--
 
$
61,650
 
                           
December 31, 2005
                          
Available-for-sale securities
  
$
78,999
 
$
1
 
$
--
 
$
79,000
 
 
The gross realized gains (losses) on sales of available-for-sale securities totaled $0 for each of the years ended December 31, 2006, 2005 and 2004, respectively. The net adjustments to unrealized holding gains (losses) on available-for-sale securities included in other comprehensive income totaled $0, ($4) and $3 in 2006, 2005 and 2004, respectively. Realized gains and losses are recorded based on the specific identification of securities sold.

The net carrying value and estimated fair value of debt securities at December 31, 2006 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because the Company has the intent and ability to sell prior to stated maturity without penalty (via auction).

F-14
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006
 
3.
Investments (Continued)
 
   
Cost
    
Fair Value
  
Debt securities:
              
Contractual maturity within one year
  
$
--
 
$
--
 
Contractual maturity after one year through five years
    
8,400
    
8,400
  
Contractual maturity after five years through ten years
    
700
    
700
  
Contractual maturity after ten years
    
52,550
    
52,550
  
Total debt securities with contractual maturities
  
$
61,650
 
$
61,650
 
 
4.
Credit Facilities and Long-Term Debt

The Company has a $20,000 unsecured working capital line of credit facility with a Tennessee bank. On May 25, 2006, the Company amended the unsecured working capital line of credit facility to extend the maturity date to April 30, 2008. Interest rates for advances under the facility vary from LIBOR plus 1.0% to 1.9% based upon covenants related to total indebtedness and cash flows, (6.4% and 5.3% at December 31, 2006 and 2005, respectively). The agreement contains certain covenants and restrictions, none of which are expected to significantly affect our operations or ability to pay dividends. As of December 31, 2006 and 2005, the Company had $0 and $1,504 outstanding under the line of credit facility, respectively. At December 31, 2006 and 2005, the Company had $15,615 and $14,196 of available borrowing capacity outstanding under the line, respectively, and had utilized $4,385 and $4,300 of availability for outstanding letters of credit, respectively.
 
Interest payments during 2006, 2005 and 2004 were $81, $104 and $55, respectively, none of which were capitalized.
 
5.
Shareholders’ Equity and Stock Options
 
Preferred Stock — The Board of Directors is authorized to issue, at its discretion, up to 5,000,000 shares of preferred stock, par value $0.01. The terms and conditions of the preferred shares are to be determined by the Board of Directors. No shares have been issued to date.
 
Common Stock Split— On February 15, 2005, the Board of Directors declared a three-for-two stock split of the common stock to be effected in the form of a stock dividend to shareholders of record as of March 18, 2005. Common stock issued and additional paid-in capital have been restated to reflect the split for all years presented. All common share and per share data included in the consolidated financial statements and notes thereto have been restated to give effect to the stock split.
 
Cash Dividend — Prior to February 15, 2005, the Company had never declared a cash dividend. During each quarter of 2006, the Company’s Board of Directors declared a cash dividend of $0.07 per share of common stock. During each quarter of 2005, the Company’s Board of Directors declared a cash dividend of $0.06 per share of common stock. On February 12, 2007, the Company’s Board of Directors declared a $0.07 per share dividend that will be paid in the first quarter of 2007. The Company expects to continue to pay regular quarterly cash dividends, though each subsequent quarterly dividend is subject to review and approval by the Board of Directors.

Repurchase of Common Stock — On July 25, 2002, the Company announced that its Board of Directors approved a stock repurchase program for up to 3,000,000 shares of common stock (the “2002 Repurchase Plan”). During the third quarter of 2005, the Company completed the repurchase of the shares authorized under the 2002 Repurchase Plan. For the year ended December 31, 2005, the Company repurchased 1,558,350 shares of common stock, under the 2002 Repurchase Plan for $49,049, or $31.47 per share.
 
On November 17, 2005, the Company announced that its Board of Directors approved a stock repurchase program for up to 3,000,000 shares of common stock (the “2005 Repurchase Plan”). For the year ended December 31, 2006, the Company repurchased 1,302,695 shares of common stock under the 2005 Repurchase Plan for $41,722, or $32.03 per share. For the year ended December 31, 2005, the Company repurchased 83,978 shares of common stock under the 2005 Repurchase Plan for $3,210, or $38.23 per share.

F-15
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006
 
5.
Shareholders’ Equity and Stock Options (Continued)
 
Share-Based Compensation — At December 31, 1998, the Company had reserved 4,500,000 shares of common stock under the 1992 Amended and Restated Stock Option and Incentive Plan (the “1992 Plan”). As of February 2004, the Company had reserved 4,500,000 common shares under the 1999 Stock Option and Incentive Plan, resulting in a total of 9,000,000 shares being reserved under the Plans. Options issued under the Plans have eight to ten-year terms and originally vested over a one to five year period. As of November 12, 2002, no additional options may be granted under the 1992 Plan resulting in the cancellation of 57,000 options available for grant under the 1992 Plan. On December 31, 2005, the Company's Board of Directors accelerated the vesting of all of the Company's outstanding and unvested stock options awarded to employees, officers and non-employee directors under the Company's stock option award plans.
 
The following table summarizes the Company’s employee stock option activity and related information for the years ended December 31, 2006, 2005 and 2004:

     
2006
    
2005
    
2004
  
   
Options (000)
    
Weighted-Average Exercise Price
    
Options (000)
 
  
Weighted-Average Exercise Price
    
Options (000)
 
  
Weighted-Average Exercise Price
  
Outstanding at beginning of year
    
1,957
  
$
23
 
 
1,443
 
$
15
 
 
1,476
 
$
15
  
Granted/converted
   
--
    
--
    
985
    
29
    
326
    
19
  
Exercised
   
(476
)
  
23
    
(443
)
   9    
(333
)
  
17
  
Forfeited
   
(6
)
  
34
    
(28
)
   22    
(26
)
  
19
  
Outstanding at end of year
 
 
1,475
 
$
23
 
 
1,957
 
$
23
 
 
1,443
 
$
15
 
Exercisable at end of year
  
 
1,475
 
$
23
 
 
1,957
 
$
23
 
 
783
 
$
12
 
Options available for grant
    
1,192
          
1,315
          
2,273
        
Average aggregate intrinsic value      
$
 18,381                  
 
          
Weighted-average fair value of options granted during the year
  
$
--
 
 
 
 
$
12.79
 
 
 
 
$
9.49
 
 
 
  
 
 
The following table summarizes information about stock options outstanding as of December 31, 2006:
 
Range of Exercise Price
  
 Number Outstanding (000)
 
  
Weighted-Average Remaining Contractual Life
    
Weighted-Average Exercise Price
  
 Number Exercisable (000)
 
  
Weighted-Average Exercise Price
  
$
4.17 — 4.95
  
68
 
    
2.0 years
  
$
 4
 
68
 
 
$
4
 
 
11.33 — 15.87
  
226
 
    
5.9 years
    
14
  
226
 
    
14
  
17.60 — 24.94
  
402
 
    
6.0 years
     20  
402
 
    
20
  
28.97 — 32.46
  
779
      
8.1 years
     29  
779
       29  
$
4.17 — 32.46
  
1,475
 
    
6.9 years
  
$
23
 
1,475
 
 
$
23
 
 
 
F-16
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006
 
5.
Shareholders’ Equity and Stock Options (Continued)
 
Each May from 1995 to 2005 options have been granted to the non-employee directors of the Company.  The options have terms of ten years and are fully exercisable. At December 31, 2006, 111,875 options were outstanding and will expire in July 2010 through May 2015 unless a non-employee director resigns or is not re-elected, in which event the options expire 90 days after the option holder is no longer a non-employee director.  During the year ended December 31, 2006, 2,500 options with a weighted-average exercise price of $20.20 were exercised.  At December 31, 2006, the total aggregate intrinsic value of these options was $1,513 and the weighted-average exercise price and remaining contractual term were $22.13 and 6.7 years, respectively.  
 
During the year ended December 31, 2006, the Company granted 129,350 non-vested shares of common stock (“non-vested shares”), respectively, to key employees with a weighted-average fair value of $36.09. During the year ended December 31, 2006, employees forfeited 13,750 non-vested shares with a weighted-average fair value of $36.17 per share. Share-based compensation expense of $1,175 was recognized in salaries, wages and employee benefits during the year ended December 31, 2006. Estimated dividend forfeitures on non-vested shares recorded to share-based compensation during the year ended December 31, 2006 were $5. The total tax benefit related to this share-based expense was $443 for the year ended December 31, 2006. Total compensation cost, net of estimated forfeitures, related to the non-vested shares not yet recognized in earnings was $2,827 at December 31, 2006. 
 
On May 23, 2006, the Company’s shareholders approved the Company’s 2006 Non-Employee Director Stock Plan (the “2006 Plan”). The 2006 Plan is designed to better enable the Company to attract and retain well-qualified persons for service as directors of the Company. Under the 2006 Plan, on the first business day after each Annual Meeting of Shareholders, each non-employee director will automatically be granted an award of 2,250 non-vested shares of the Company’s common stock. The non-vested shares will become vested and non-forfeitable in equal annual installments over three years. Each director may elect to defer receipt of the shares under a non-vested share award until the director terminates service on the Board of Directors. If a director elects to defer receipt, the Company will issue deferred stock units to the director which does not represent actual ownership in shares and the director will not have voting rights or other incidents of ownership until the shares are issued. However, the Company will credit the director with dividend equivalent payments in the form of additional deferred stock units for each cash dividend payment made by the Company. After approval of the 2006 Plan, 11,250 non-vested shares and 2,250 deferred stock units were issued to the Company’s non-employee directors with a weighted-average fair value of $36.27. Share-based compensation expense of $82 was recognized in salaries, wages and employee benefits during the year ended December 31, 2006. The total tax benefit related to the share-based expense was $31 for the year ended December 31, 2006. Total compensation cost, net of estimated forfeitures, related to the non-vested shares and deferred stock units not yet recognized in earnings was $338 at December 31, 2006. No unvested shares issued under the 2006 Plan were forfeited during the year ended December 31, 2006.
 
Under the ESPP, the Company is authorized to issue up to a remaining 479,079 shares of common stock to employees of the Company. For the year ended December 31, 2006, participants under the plan purchased 9,237 shares at an average price of $28.54. The weighted-average fair value of each purchase right under the ESPP granted for the year ended December 31, 2006, which is equal to the discount from the market value of the common stock at the end of each six month purchase period, was $4.90 per share. Share-based compensation expense of $45 was recognized in salaries, wages and employee benefits, during the year ended December 31, 2006. The total tax benefit related to this share-based expense was $17 for the year ended December 31, 2006.
 
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006
 
5.
Shareholders’ Equity and Stock Options (Continued)
 
Income Per Share— The following table sets forth the computation of income per basic and diluted share:

     
2006
    
2005
    
2004
  
Numerator:
                    
Numerator for income per basic and diluted share - net income
  
$
48,923
 
$
44,909
 
$
34,421
  
                     
Denominator:
                    
Denominator for income per basic share - weighted-average shares (in thousands)
    
31,091
    
31,847
    
32,310
  
Effect of dilutive stock options and non-vested shares (in thousands)
    
430
    
572
    
630
  
Denominator for income per diluted share - adjusted weighted-average shares (in thousands)
    
31,521
    
32,419
    
32,940
  
Income per basic share
  
$
1.57
 
$
1.41
 
$
1.07
  
Income per diluted share
  
$
1.55
 
$
1.39
 
$
1.05
 

The number of options and non-vested shares that could potentially dilute income per basic share in the future, but that were not included in the computation of income per diluted share because to do so would have been anti-dilutive for the periods presented, were approximately 105,000, 3,000 and 30,000 in 2006, 2005 and 2004, respectively.
 
6.
Income Taxes

The provision for income taxes consists of the following:

     
2006
 
 
2005
 
 
2004
  
Current:
                   
Federal
  
$
25,663
 
$
22,706
 
$
16,598
  
State
    
4,094
    
3,670
    
2,140
  
     
29,757
    
26,376
    
18,738
  
Deferred:
                    
Federal
    
(57
)
  
(50
 )  
1,224
 
State
     (79 )  
2
    
287
 
     
(136
)
  
(48
 )  
1,511
 
   
$
29,621
 
$
26,328
 
$
20,249
  
 
The tax benefits associated with the exercise of stock options during the years ended December 31, 2006, 2005 and 2004 were $1,967, $5,074 and $2,906, respectively, and are reflected as an increase in additional paid-in capital in the accompanying consolidated statements of shareholders’ equity.
 
In addition to the provision for income taxes included in the accompanying consolidated statements of income, a deferred tax provision (benefit) of approximately $0, ($2) and $2 is included in other comprehensive income for the years ended December 31, 2006, 2005 and 2004, respectively.
 
F-18
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006
 
6.
Income Taxes (Continued)
 
The historical income tax expense differs from the amounts computed by applying the federal statutory rate of 35.0% to income before income taxes as follows:

     
2006
 
 
2005
 
 
2004
  
Tax expense at the statutory rate
  
$
27,490
 
$
24,933
 
$
19,134
  
State income taxes, net of federal benefit
    
2,839
    
2,386
    
1,578
  
Meals and entertainment
    
233
    
207
    
195
  
Tax-exempt interest income
    
(1,005
)
  
(872
)
  
(419
)
Other
    
64
 
  
(326
)
  
(239
)
   
$
29,621
 
$
26,328
 
$
20,249
  
 
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax liabilities and assets are as follows:

   
December 31
  
     
2006
 
 
2005
  
Deferred tax assets:
              
Accrued expenses
 
$
1,917
 
$
2,032
 
Allowance for doubtful accounts
    
351
    
353
  
Non-compete agreements
     260    
95
  
Acceleration of option vesting
    
854
    
476
  
Net operating loss carryforwards
    
408
    
530
  
Total deferred tax assets
    
3,790
    
3,486
  
Valuation allowance
     (408
)
  
(408
)
Total deferred tax assets, net of valuation allowance
   
3,382
    
3,078
  
               
Deferred tax liabilities:
              
Tax over book depreciation
   
5,943
    
6,054
  
Research and development expenses
   
12
    
180
  
Prepaid expenses deductible when paid
     1,090    
948
  
Other
    
1,746
    
1,441
  
Total deferred tax liabilities
    
8,791
    
8,623
  
Net deferred tax liabilities
  
$
(5,409
)
$
(5,545
)
 
The balance sheet classification of deferred income taxes is as follows:

   
December 31
  
     
2006
 
 
2005
  
Current assets
 
$
1,178
 
$
1,438
  
Noncurrent liabilities
   
(6,587
)
  
(6,983
)
   
$
(5,409
)
$
(5,545
)

Total income tax payments, net of refunds, during fiscal years 2006, 2005 and 2004 were $26.019, $22,476 and $20,389, respectively.

F-19
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006

6.
Income Taxes (Continued)
 
At December 31, 2006 and 2005, the Company had state net operating loss carryforwards of $8,425 and $12,117, respectively, that will expire between 2013 and 2024. The use of these state net operating losses is limited to the future taxable income of separate legal entities. As a result, the valuation allowance has been provided for certain state loss carryforwards. The valuation allowance was unchanged during 2006. Based on expectations of future taxable income, management believes that it is more likely than not that the results of operations will generate sufficient taxable income to realize the deferred tax assets after giving consideration to the valuation allowance.
 
7.
Leases

In September 2000, the Company entered into an agreement with the Rickenbacker Port Authority (“Rickenbacker”) to lease a building located near the Company’s Columbus, Ohio hub facility. At the inception of the lease, the Company made a $2,004 loan to Rickenbacker. The lease agreement has a ten-year initial term, with two five-year renewal options. The present value of the future minimum lease payments of $836 (at December 31, 2006) is included in capital lease obligations in the accompanying consolidated balance sheets. Because the lease met the criteria for classification as a capital lease, the leased building was recorded in property and equipment at $3,015 (which represents the present value of minimum lease payments, including the $2,004 initial payment), as it is less than the fair value at the inception date. The building is being depreciated over the initial lease term.

SFAS No. 13, Accounting for Leases, requires that a lease meet one or more of four specified criteria in order to be classified as a capital lease. With respect to the Rickenbacker lease, it was classified as a capital lease since the present value of the minimum lease payments, including the initial $2,004 payment, exceeded 90.0% of the fair value of the property at lease inception.

Property and equipment include the following amounts for assets under capital leases:

   
December 31
  
     
2006
 
 
2005
  
Buildings
  
$
3,015
 
$
3,015
  
Less accumulated amortization
    
1,066
    
888
  
   
$
1,949
 
$
2,127
  

Amortization of assets under capital leases is included in depreciation and amortization expense.

The Company leases certain facilities under noncancellable operating leases that expire in various years through 2012. Certain of these leases may be renewed for periods varying from one to ten years. 
 
Sublease rental income, including amounts from related parties (see Note 8), was $622, $447 and $323 in 2006, 2005 and 2004, respectively, and was included in operating revenue in the accompanying consolidated statements of income. The Company expects to receive aggregate future minimum rental payments under noncancellable subleases of approximately $185.
 
F-20
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006
 
7.
Leases (Continued)
 
Future minimum rental payments under capital leases and noncancellable operating leases with initial or remaining terms in excess of one year consisted of the following at December 31, 2006:

 
    
Capital Leases
  
Operating Leases
  
Fiscal Year
            
2007
  
 $
89
  
 $
11,127
  
2008
    
89
    
8,197
  
2009
    
89
    
5,051
  
2010
    
89
    
2,977
  
2011
    
89
    
1,247
  
Thereafter
    
772
    
99
  
Total minimum lease payments
  
$
1,217
 
$
28,698
  
Amounts representing interest
    
381
        
Present value of net minimum lease payments
(including current portion of $40)
  
$
836
        

8.
Transactions With Related Parties

Transactions with Landair Transport, Inc.
 
Scott M. Niswonger, Chairman of the Board of the Company until May 2005, owns a majority interest in the parent company of Landair Transport, Inc. (“Landair”). Matthew J. Jewell, our Senior Vice President and General Counsel, served in these same capacities with Landair until May 2004. During 2004, the Company purchased approximately $200 of truckload transportation services from Landair, which have been included in purchased transportation in the consolidated statements of income. No transportation services were purchased from Landair during 2006 and 2005.

During 2004, the Company provided various operational and administrative services to Landair. The Company charged Landair approximately $200 during 2004 for these services. These amounts have been included as a reduction of salaries, wages and employee benefits in the accompanying consolidated statements of income for 2004. Landair provided various operational and administrative services to the Company and charged it approximately $93 during the year ended December 31, 2004 for these services. These charges have been included in salaries, wages and employee benefits in the accompanying consolidated statements of income. No operational and administrative services were provided during 2006 and 2005.

Until September 2005, the Company had a sublease with Landair pursuant to which the Company sublet to Landair a portion of the headquarters of the Company in Greeneville, Tennessee that is leased from the Greeneville-Greene County Airport Authority. The Company sublet the facility to Landair for consideration based upon the cost of such facility to the Company and an agreed-upon percentage of usage. Sublease rental income charged to Landair in 2005 and 2004 was approximately $17 and $25, respectively. These amounts are included in sublease rental income disclosed in Note 7.
 
Transactions With Sky Night, LLC
 
During 2006, 2005 and 2004, we purchased air transportation services from Sky Night, LLC (“Sky Night”), a limited liability corporation owned by Scott M. Niswonger. The air charter expense totaled approximately $143, $105 and $86 in 2006, 2005 and 2004, respectively, and is included in other operating expenses in the accompanying consolidated statements of income.

During 2001, the Company entered into an agreement to sublease hangar space at its Greeneville, Tennessee headquarters to Sky Night. The initial term of the sublease was for 12 months. Currently, the hangar space is being sublet on a month-to-month basis. Sublease rental income charged to Sky Night was approximately $35 in 2006, 2005 and 2004.
 
F-21
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006
 
9.
Commitments and Contingencies
 
The primary claims in the Company’s business are workers’ compensation, property damage, vehicle liability and medical benefits. Most of the Company’s insurance coverage provides for self-insurance levels with primary and excess coverage which management believes is sufficient to adequately protect the Company from catastrophic claims. In the opinion of management, adequate provision has been made for all incurred claims up to the self-insured limits, including provision for estimated claims incurred but not reported.
 
The Company estimates its self-insurance loss exposure by evaluating the merits and circumstances surrounding individual known claims and by performing hindsight analysis to determine an estimate of probable losses on claims incurred but not reported. Such losses could be realized immediately as the events underlying the claims have already occurred as of the balance sheet dates.
 
Because of the uncertainty of the ultimate resolution of outstanding claims, as well as uncertainty regarding claims incurred but not reported, it is possible that management’s provision for these losses could change materially in the near term. However, no estimate can currently be made of the range of additional loss that is at least reasonably possible.
 
Site Expansion
 
On July 10, 2006, as part of the Company’s plan to acquire three new sites in key gateway cities, the Company entered into an agreement to purchase real property and to construct a new terminal near Chicago, Illinois for $22,105. A deposit of $3,316 was paid to the sellers upon execution of the agreement. The remainder of the purchase price will be paid upon completion of the new terminal, which the Company estimates will occur during the first quarter of 2007. The deposit is included in noncurrent other assets.
 
In addition, on September 14, 2006, the Company entered into an agreement to purchase real property and to construct a new regional hub near Atlanta, Georgia for $14,776. A deposit of $1,477 was paid to the sellers upon execution of the agreement. The remainder of the purchase price will be paid upon completion of the new regional hub, which the Company estimates will occur in the second quarter of 2007. The deposit is included in noncurrent other assets.
 
The Company plans to fund these expenditures through cash and short-term investments currently on the balance sheet, cash provided by operating activities and/or borrowings under the credit facility.
 
Contractual Obligations and Commercial Commitments
 
As of December 31, 2006, the Company had a commitment to acquire 77 new forklifts for approximately $1,114 during 2007. The Company can cancel the order for 25, or $357, of these forklifts by March 30, 2007. This commitment is expected to be funded by proceeds from the sale of existing equipment and cash flows from operations.
 
Atlanta Terminal Condemnation
 
During the fourth quarter of 2002, the City of Atlanta filed a Petition for Condemnation and Declaration of Taking for a terminal facility owned by Transportation Properties, Inc. and leased by Forward Air, Inc., two of the Company’s wholly owned subsidiaries. The condemnation was filed in connection with the fifth runway airport expansion project at Atlanta Hartsfield-Jackson International Airport. According to the 2002 condemnation petition, the City of Atlanta took ownership of the property and building and deposited $2,600 into the Registry of the Superior Court of Clayton County, Georgia (the “Court”) as compensation to Transportation Properties, Inc. The Company filed a protest to the City of Atlanta’s evaluation of the property and building and also challenged the method of condemnation it utilized. Prior to December 2003, the City of Atlanta destroyed the condemned building in conjunction with the runway expansion project. On or about December 30, 2003, the Court ruled that the City of Atlanta’s method of condemnation was improper and returned ownership of the land to the Company.
 
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006
 
9.
Commitments and Contingencies (Continued)
 
During January 2004, the City of Atlanta filed a second condemnation petition to obtain title to the land. In connection with this second petition, the City of Atlanta deposited an additional $1,261 into the Registry of the Court, which was the City of Atlanta’s estimated fair market value of the land. The City of Atlanta petitioned the Court and was granted the right to withdraw the original $2,600 escrow balance it paid into the Court as part of the first petition for condemnation. The Company and its outside counsel believed that the December 30, 2003 ruling by the Court and the City of Atlanta’s actions subsequent to the first condemnation gave rise to additional theories of recovery. The Company challenged the method of condemnation set forth in the second petition and the withdrawal of the original $2,600 escrow balance. Additionally, the Company had claims for damages arising from the City of Atlanta’s destruction of the Company’s building during the wrongful possession of the property by the City of Atlanta. As of December 31, 2004, the Company had received the $1,261 escrow into cash and had a $1,339 receivable for the difference in the original $2,600 escrow and actual $1,261 in escrow received.
 
In the second quarter of 2005, an agreement was reached with the City of Atlanta to settle the dispute. In the settlement, the City of Atlanta paid the Company approximately $2,765, which represents payment of the receivable of $1,339 along with additional pre-tax gain of approximately $1,426, included in other income, net. The cash received is net of attorney’s fees.

10.
Employee Benefit Plan
 
The Company has a retirement savings plan (the “401(k) Plan”). The 401(k) Plan is a defined contribution plan whereby employees who have completed 90 days of service, a minimum of 1,000 hours of service and are age 21 or older are eligible to participate. The 401(k) Plan allows eligible employees to make contributions of 2.0% to 80.0% of their annual compensation. Employer contributions were made at 25.0% during 2006, 2005 and 2004 of the employee’s contribution up to a maximum of 6.0% for all periods presented of total annual compensation except where government limitations prohibit.

Employer contributions vest 20.0% after two years of service and continue vesting 20.0% per year until fully vested. The Company’s matching contributions included in operations for 2006, 2005 and 2004 were approximately $365, $256 and $203, respectively.

11.
Financial Instruments

Off Balance Sheet Risk

At December 31, 2006, the Company had letters of credit outstanding totaling $4,385 as required by its workers’ compensation and vehicle liability insurance providers.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash investments and trade accounts receivable. The Company does not generally require collateral from its customers. Concentrations of credit risk with respect to trade accounts receivable are limited due to the large number of entities comprising the Company’s customer base and their dispersion across many different industries.

Fair Value of Financial Instruments

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

Investments: The carrying amount for investments in available-for-sale securities was reported in the consolidated balance sheet at fair market value.

Accounts receivable and accounts payable: The carrying amounts reported in the balance sheet for accounts receivable and accounts payable approximate their fair value.

F-23
 
FORWARD AIR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2006
 
11.
Financial Instruments (Continued)
 
Long- and short-term debt: The fair value of the Company’s capital lease obligations is estimated using discounted cash flow analyses, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements, and does not differ materially from the carrying amount.
 
12.
Subsequent Event
 
During February 2007, the Company purchased 36.7 acres of land in Irving, Texas for $3,100.  The land will be used to build a new regional hub. The Company expects to spend up to $15 million to complete this regional hub by the end of 2007.
 
13.
Quarterly Results of Operations (Unaudited)

The following is a summary of the quarterly results of operations for the years ended December 31, 2006 and 2005:
 
 
2006
 
    
March 31
    
June 30
 
 
September 30
 
 
December 31
  
Operating revenue
  
$
82,330
 
$
86,779
 
$
90,441
 
$
93,208
 
Income from operations
    
16,956
    
19,767
    
19,788
    
18,885
  
Net income
    
11,008
    
13,021
    
12,725
    
12,169
  
                           
                           
Net income per share:
                          
Basic
  
$
0.35
 
$
0.41
 
$
0.41
 
$
0.40
 
Diluted
  
$
0.35
 
$
0.41
 
$
0.41
 
$
0.40
 
 
 
2005
 
    
March 31
    
June 30
 
 
September 30
 
 
December 31
  
Operating revenue
  
$
69,533
 
$
77,488
 
$
84,841
 
$
89,072
  
Income from operations
    
13,381
    
16,791
    
18,669
    
18,595
  
Net income
    
8,693
    
11,954
    
12,065
    
12,197
  
                           
                           
Net income per share:
                          
Basic
  
$
0.27
 
$
0.37
 
$
0.38
 
$
0.39
  
Diluted
  
$
0.27
 
$
0.37
 
$
0.38
 
$
0.38
  

 
 

F-24

Forward Air Corporation

Schedule II — Valuation and Qualifying Accounts

Col. A
    
Col. B
  
Col. C
  
Col. D
 
 
Col. E
 
       
Additions 
            
Description
    
Balance at Beginning of Period
    
(1)
Charged to Costs and Expenses
    
(2)
Charged to Other Accounts-Describe
    
Deductions-Describe
    
Balance at End of Period
  
 
(In thousands)
 Year ended December 31, 2006:                                
 Allowance for doubtful accounts
  
$
 637  
$
(223
 ) 
$
--
  
$
(210
)(2)  
 $
624
  
 Allowance for revenue adjustments (1) 
     285    
2,095
    
--
    
2,144
  (3)  
236
  
      922    
1,872
    
--
    
1,934
   
860
  
Year ended December 31, 2005:
                                
Allowance for doubtful accounts
  
$
826
  
$
(121
)
$
--
  
$
68
   (2)
$
637
  
Allowance for revenue adjustments (1) 
    
246
    
2,100
    
--
    
2,061
   (3)
  
285
  
     
1,072
    
1,979
    
--
    
2,129
   
922
  
Year ended December 31, 2004:
                                
Allowance for doubtful accounts
 
$
943
  
$
161
  
$
--
  
$
278
   (2)
$
826
  
Allowance for revenue adjustments (2)
    
320
    
1,848
    
--
    
1,922
   (3)
  
246
  
     
1,263
    
2,009
    
--
    
2,200
   
1,072
  


___________________

(1)
Represents an allowance for adjustments to accounts receivable due to disputed rates, accessorial charges and other aspects of previously billed shipments.
(2)
Uncollectible accounts written off, net of recoveries.
(3)
Adjustments to billed accounts receivable.

S-1

EXHIBIT INDEX

 No.
  
Exhibit
     
 3.1
  
Restated Charter of the registrant (incorporated herein by reference to Exhibit 3 to the registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 28, 1999 (File No. 0-22490))
     
 3.2
  
Amended and Restated Bylaws of the registrant (incorporated herein by reference to Exhibit 3.2 to the registrant’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004 filed with the Securities and Exchange Commission on November 2, 2004 (File No. 0-22490))
     
 4.1
  
Form of Landair Services, Inc. Common Stock Certificate (incorporated herein by reference to Exhibit 4.1 to the registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 27, 1993 (File No. 0-22490))
     
 4.2
  
Form of Forward Air Corporation Common Stock Certificate (incorporated herein by reference to Exhibit 4.1 to the registrant’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1998 filed with the Securities and Exchange Commission on November 16, 1998 (File No. 0-22490))
     
 4.3
  
Rights Agreement, dated May 18, 1999, between the registrant and SunTrust Bank, Atlanta, N.A., including the Form of Rights Certificate (Exhibit A) and the Form of Summary of Rights (Exhibit B) (incorporated herein by reference to Exhibit 4 to the registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 28, 1999 (File No. 0-22490))
     
10.1*
  
Forward Air Corporation 2005 Employee Stock Purchase Plan (incorporated herein by reference to the registrant’s Proxy Statement filed with the Securities and Exchange Commission on April 20, 2005 (File No. 0-22490))
     
10.2*
  
Amended and Restated Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the period ended June 30, 1995 filed with the Securities and Exchange Commission on August 14, 1995 (File No. 0-22490))
     
 
     
10.4
  
Air Carrier Certificate, effective August 28, 2003 (incorporated herein by reference to Exhibit 10.5 to the registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003 filed with the Securities and Exchange Commission on March 11, 2004 (File No. 0-22490))
     
10.5*
  
Non-Employee Director Stock Option Plan (incorporated herein by reference to Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the period ended June 30, 1995 filed with the Securities and Exchange Commission on August 14, 1995 (File No. 0-22490))
     
10.6*
  
Amendment to the Non-Employee Director Stock Option Plan (incorporated herein by reference to Exhibit 10.7 to the registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003 filed with the Securities and Exchange Commission on March 11, 2004 (File No. 0-22490))
     
10.7
  
Amended and Restated Loan and Security Agreement, dated as of September 10, 1998, between First Tennessee Bank National Association and the registrant (incorporated herein by reference to Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the period ended September 30, 1998 filed with the Securities and Exchange Commission on November 16, 1998 (File No. 0-22490))
   
10.8
  
Modification Agreement (to Amended and Restated Loan and Security Agreement), dated as of June 18, 2002, among the registrant, First Tennessee Bank National Association, FAF, Inc., Forward Air, Inc. and Transportation Properties, Inc. (incorporated herein by reference to Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the period ended June 30, 2002 filed with the Securities and Exchange Commission on August 14, 2002 (File No. 0-22490))

 
10.9
  
Letter Agreement, dated May 17, 2005, between the registrant and First Tennessee Bank National Association extending the maturity date of the registrant’s $20.0 million Master Secured Promissory Note under the Amended and Restated Loan and Security Agreement, dated as of September 10, 1998, as modified by Modification Agreement, dated as of June 18, 2002 (incorporated herein by reference to Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the period ended June 30, 2005 filed with the Securities and Exchange Commission on August 9, 2005 (File No. 0-22490))
     
10.10
  
Letter Agreement, dated as of May 25, 2006, between the registrant and First Tennessee Bank National Association extending the maturity date of the registrant’s $20.0 million Master Secured Promissory Note under the Amended and Restated Loan and Security Agreement, dated as of September 10, 1998, as modified by Modification Agreement, dated as of June 18, 2002 and by Letter Agreement, dated May 17, 2005 (incorporated herein by reference to Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the period ended June 30, 2006 filed with the Securities and Exchange Commission on August 4, 2006 (File No. 0-22490))
     
10.11*
  
Employment Agreement dated January 24, 2006, between Forward Air Corporation and Bruce A. Campbell, including Exhibit A, Restrictive Covenants Agreement entered into contemporaneously with and as part of the Employment Agreement (incorporated herein by reference to Exhibit 99.1 to the registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 26, 2006 (File No. 0-22490))
     
10.12*
  
Form of Incentive Stock Option Agreement under the registrant’s Amended and Restated Stock Option and Incentive Plan, as amended, and 1999 Stock Option and Incentive Plan, as amended, for grants prior to February 12, 2006 (incorporated herein by reference to Exhibit 10.12 to the registrant’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2005 filed with the Securities and Exchange Commission on March 22, 2006 (File No. 0-22490))
     
10.13*
  
Form of Non-Qualified Stock Option Agreement under the registrant’s Non-Employee Director Stock Option Plan, as amended, for grants prior to February 12, 2006 (incorporated herein by reference to Exhibit 10.13 to the registrant’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2005 filed with the Securities and Exchange Commission on March 22, 2006 (File No. 0-22490))
     
10.14*
  
1999 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the period ended March 31, 1999 filed with the Securities and Exchange Commission on May 17, 1999 (File No. 0-22490))
     
10.15*
  
Amendment to the 1999 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.14 to the registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003 filed with the Securities and Exchange Commission on March 11, 2004 (File No. 0-22490))
     
10.16*
  
Non-Qualified Stock Option Agreement dated August 21, 2000 between the registrant and Ray A. Mundy (incorporated herein by reference to Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the period ended September 30, 2000 filed with the Securities and Exchange Commission on November 6, 2000 (File No. 0-22490))
     
10.17
  
Forward Air Corporation Section 125 Plan (incorporated herein by reference to Exhibit 10.18 to the registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 filed with the Securities and Exchange Commission on March 15, 2002 (File No. 0-22490))
     
10.18*
  
Form of Option Restriction Agreement between the registrant and each executive officer regarding certain restrictions on transferability of accelerated stock options granted under the registrant’s 1999 Stock Option and Incentive Plan, as amended (incorporated herein by reference to Exhibit 10.18 to the registrant’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2005 filed with the Securities and Exchange Commission on March 22, 2006 (File No. 0-22490))
     
10.19*
  
Form of Restricted Stock Agreement for an award of restricted stock under the registrant’s 1999 Stock Option and Incentive Plan, as amended, granted on or after February 12, 2006 (incorporated herein by reference to Exhibit 10.19 to the registrant’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2005 filed with the Securities and Exchange Commission on March 22, 2006 (File No. 0-22490))
     
10.20*
  
2006 Non-Employee Director Stock Plan (incorporated by reference to Appendix A of the registrant’s Proxy Statement filed with the Securities and Exchange Commission on April 24, 2006 (File No. 22490))
 
   
10.21*
  
Form of Non-Employee Director Restricted Stock Agreement for an award of restricted stock under the registrant's 2006 Non-Employee Director Stock Plan (incorporated by reference to Exhibit 99.2 to the registrant's Registration Statement on Form S-8 filed with the Securities and Exchange Commission on May 19, 2006 (File No. 22490))
     
10.22*
  
Schedule of Non-Employee Director Compensation effective May 24, 2006 (incorporated herein by reference to Exhibit 99.1 to the registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 23, 2006 (File No. 0-22490))
     
10.23
  
Agreement of Purchase and Sale, dated as of July 10, 2006, among AMB Property II, L.P., Headlands Realty Corporation and Forward Air, Inc. (incorporated herein by reference to Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006 filed with the Securities and Exchange Commission on August 4, 2006  (File No. 0-22490))
     
10.24
  
Agreement of Purchase and Sale, dated as of September 14, 2006, by and between Headlands Realty Corporation and Forward Air, Inc. (incorporated herein by reference to Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2006 filed with the Securities and Exchange Commission on November 3, 2006 (File No. 0-22490))
     
14.1
  
Code of Ethics (incorporated herein by reference to Exhibit 14.1 to the registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003 filed with the Securities and Exchange Commission on March 11, 2004 (File No. 0-22490))
     
21.1
  
Subsidiaries of the registrant (incorporated herein by reference to Exhibit 21.1 to the registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000 filed with the Securities and Exchange Commission on April 2, 2001 (File No. 0-22490))
     
 
     
 
     
 
     
 
     
 
______________

*Denotes a management contract or compensatory plan or arrangement.