This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read together with "Business" in Part I, Item 1 of this Annual Report, as well as the consolidated financial statements and accompanying footnotes in Part II, Item 8 of this Annual Report. This discussion contains forward-looking statements as a result of many factors, including those set forth under Part I, Item 1A. "Risk Factors" and Part I "Cautionary Note Regarding Forward-looking Statements" of this Annual Report, and elsewhere in this report. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from those discussed.
Overview
Total revenue for 2020 increased by$34.7 million to$1.7 billion as compared to 2019. The increase was primarily a result of a 23.1% increase in Brokerage revenue to$228.8 million , a 1.6% increase in average revenue miles per tractor per week, a 0.6% increase in average revenue per mile, partially offset by a 0.5% decrease in average tractors and a$46.0 million decrease in fuel surcharge revenue. Excluding the impact of fuel surcharge revenue, revenue increased$80.7 million to$1.6 billion , an increase of 5.3% as compared to the prior year. Operating income for 2020 was$43.6 million compared to$26.1 million in 2019. We delivered a 97.5% operating ratio for the year which is an improvement relative to the 98.5% operating ratio reported in 2019. Our profitability increased as a result of increased revenue miles per tractor of 1.6%, a$0.013 increase in revenue per mile combined with lower fuel costs and other expenses associated with the exit of our OTR student driver program, partially offset by increased equipment costs and a decrease in our Brokerage segment gross margin to 8.5% compared to 12.9% in the prior year. We are continuing to focus on our driver centric initiatives, such as increased miles and modern equipment, to both retain the professional drivers who have chosen to partner with us and attract new professional drivers to our team. During the second quarter of 2020 we launched our digital fleet, Variant, which is largely recruited, planned, dispatched and managed using artificial intelligence and digital platforms. Variant is a completely new paradigm for operating trucks in an OTR environment that is provided to the driver through a proprietary app-based driver experience. We developed the concept as a hypothesis in 2018 based in part on the business models of the digital freight brokerages. As digital brokers began to enter the market utilizing cutting edge technology and a new operating model, we believed there was an opportunity to take this approach and apply it to our asset based business in order to drive improved profitability and growth. During 2019, we began building our technology leadership and teams to construct the necessary databases, applications, and processes to launch a pilot fleet with a small number of trucks in the fourth quarter of 2019. The test proved successful and we expanded the pilot fleet to approximately 100 trucks in the first quarter of 2020. Given the positive results of the first quarter pilot we moved to a full production model, scaling the business to approximately 700 trucks at the end of 2020. Phase one of our plan is to convert a total of 900 OTR solo trucks, with the lowest returns, to our Variant platform by the end of the first quarter of 2021. Phase two of our plan will be to convert an additional 600 trucks over the balance of the year. While the conversion will not be linear, we expect our margins to expand further. We believe that we can further scale this platform while maintaining these positive results and continuing to further enhance the capabilities of this new technology. We will continue to focus on implementing and executing our initiatives that we expect will continue to drive sustainable improved performance over time. While we believe our margins will expand as we continue to convert more of our trucks to our Variant platform, we also see tremendous growth opportunity given the highly fragmented nature of theU.S. trucking market. Our Variant business model directly addresses our drivers' frustrations as our model delivers higher utilization and pay which has directly contributed to a significant drop in turnover. During 2020, we purchased a small business with a technology platform and an experienced and talented team. Their approach to the brokerage business is to utilize a digital framework for handling transactions which we expect to be scalable. Importantly, we believe this platform will enable our team to continue scaling the business and drive a high level of growth in the years to come. Our team processed 62.1% of our Brokerage transactions digitally in the fourth quarter of 2020. As we drive more volume over our digital platform, we believe our Brokerage segment will become much more scalable and allow us to profitably drive growth as we look to the years ahead. Looking to the year ahead, our baseline assumptions for 2021 include an overall favorable market for carriers as we expect increasing inventory re-stocking, tight trucking capacity, and relatively benign cost inflation outside of driver-related and Page 34 Table of Contents insurance premium expenses. These conditions combined with a continued shortage of drivers are expected to be supportive of the market and rates. As a result, we expect contract rates in our OTR division in 2021 to increase on average by 10-15% with the driver shortage likely extending the cycle as we believe there could be up to 200,000 fewer drivers in the market compared to 2019. Our Management's Discussion and Analysis of Financial Condition and Results of Operations included in this document generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this document can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 .
Reportable Segments
Our business is organized into two reportable segments, Truckload and Brokerage. Our Truckload segment offers truckload services, including OTR trucking and dedicated contract services. Our OTR service offering transports a full trailer of freight for a single customer from origin to destination, typically without intermediate stops or handling pursuant to short-term contracts and spot moves that include irregular route moves without volume and capacity commitments. Tractors are operated with a solo driver or, when handling more time-sensitive, higher-margin freight, a team of two drivers. Our dedicated contract service offering provides similar freight transportation services, but with contractually assigned equipment, drivers and on-site personnel to address customers' needs for committed capacity and service levels pursuant to multi-year contracts with guaranteed volumes and pricing. Our Brokerage segment is principally engaged in non-asset-based freight brokerage services, where loads are contracted to third-party carriers.
Truckload Segment
In our Truckload segment, we generate revenue by transporting freight for our customers in our OTR and dedicated contract service offerings. Our OTR service offering provides solo and expedited team services through one-way movements of freight over routes throughoutthe United States . While we primarily operate in the eastern half ofthe United States , we provide services into and out ofMexico . InJanuary 2019 , we sold our interest inXpress Internacional . Even following our sale ofXpress Internacional , we continue to have business to and fromMexico through a variable cost model using third party carriers. The revenue from such model is generated inthe United States . Our dedicated contract service offering devotes the use of equipment to specific customers and provides services through long-term contracts. Our Truckload segment provides services that are geographically diversified but have similar economic and other relevant characteristics, as they all provide truckload carrier services of general commodities and durable goods to similar classes of customers. We are typically paid a predetermined rate per load or per mile for our Truckload services. We enhance our revenue by charging for tractor and trailer detention, loading and unloading activities and other specialized services. Consistent with industry practice, our typical customer contracts (other than those contracts in which we have agreed to dedicate certain tractor and trailer capacity for use by specific customers) do not guarantee load levels or tractor availability. This gives us and our customers a certain degree of flexibility to negotiate rates up or down in response to changes in freight demand and trucking capacity. In our dedicated contract service offering, which comprised approximately 41.5% of our Truckload operating revenue, and approximately 42.0% of our Truckload revenue, before fuel surcharge, for 2020, we provide service under contracts with fixed terms, volumes and rates. Dedicated contracts are often used by our customers with high-service and high-priority freight, sometimes to replace private fleets previously operated by them. We expect to grow our dedicated business as a percentage of our average tractors. Generally, in our Truckload segment, we receive fuel surcharges on the miles for which we are compensated by customers. Fuel surcharge revenue mitigates the effect of price increases over a negotiated base rate per gallon of fuel; however, these revenues may not fully protect us from all fuel price increases. Our fuel surcharges to customers may not fully recover all fuel increases due to engine idle time, out-of-route miles and non-revenue generating miles that are not generally billable to the customer, as well as to the extent the surcharge paid by the customer is insufficient. The main factors that affect fuel surcharge revenue are the price of diesel fuel and the number of revenue miles we generate. Although our surcharge programs vary by customer, we generally attempt to negotiate an additional penny per mile charge for everyfive-cent increase in theU.S. Department of Energy's (the "DOE") national average diesel fuel index over an agreed baseline price. Our fuel surcharges are billed on a lagging basis, meaning we typically bill customers in the current week based on a Page 35 Table of Contents previous week's applicable index. Therefore, in times of increasing fuel prices, we do not recover as much as we are currently paying for fuel. In periods of declining prices, the opposite is true. Based on the current status of our empty miles percentage and the fuel efficiency of our tractors, we believe that our fuel surcharge recovery is effective. The main factors that affect our operating revenue in our Truckload segment are the average revenue per mile we receive from our customers, the percentage of miles for which we are compensated and the number of shipments and miles we generate. Our primary measures of revenue generation for our Truckload segment are average revenue per loaded mile and average revenue miles per tractor per period, in each case excluding fuel surcharge revenue. In our Truckload segment, our most significant operating expenses vary with miles traveled and include (i) fuel, (ii) driver-related expenses, such as wages, benefits, training and recruitment and (iii) costs associated with independent contractors (which are primarily included in the "Purchased transportation" line item). Expenses that have both fixed and variable components include maintenance and tire expense and our total cost of insurance and claims. These expenses generally vary with the miles we travel, but also have a controllable component based on safety, fleet age, efficiency and other factors. Our main fixed costs include vehicle rent and depreciation of long-term assets, such as revenue equipment and service center facilities, the compensation of non-driver personnel and other general and administrative expenses. Our Truckload segment requires substantial capital expenditures for purchase of new revenue equipment. We use a combination of operating leases and secured financing to acquire tractors and trailers, which we refer to as revenue equipment. When we finance revenue equipment acquisitions with operating leases, we record an operating lease right of use asset and an operating lease liability on our consolidated balance sheet, and the lease payments in respect of such equipment are reflected in our consolidated statement of comprehensive income (loss) in the line item "Vehicle rents." When we finance revenue equipment acquisitions with secured financing, the asset and liability are recorded on our consolidated balance sheet, and we record expense under "Depreciation and amortization" and "Interest expense." Typically, the aggregate monthly payments are similar under operating lease financing and secured financing. We use a mix of finance leases and operating leases with individual decisions being based on competitive bids, tax projections and contractual restrictions. We expect our vehicle rents, depreciation and amortization and interest expense will be impacted by changes in the percentage of our revenue equipment acquired through operating leases versus equipment owned or acquired through finance leases. Because of the inverse relationship between vehicle rents and depreciation and amortization, we review both line items together. Approximately 26% of our total tractor fleet was operated by independent contractors atDecember 31, 2020 . Independent contractors provide a tractor and a driver and are responsible for all of the costs of operating their equipment and drivers, including interest and depreciation, vehicle rents, driver compensation, fuel and other expenses, in exchange for a fixed payment per mile or percentage of revenue per invoice plus a fuel surcharge pass-through. Payments to independent contractors are recorded in the "Purchased transportation" line item. When independent contractors increase as a percentage of our total tractor fleet, our "Purchased transportation" line item typically will increase, with offsetting reductions in employee driver wages and related expenses, net of fuel (assuming all other factors remain equal). The reverse is true when the percentage of our total fleet operated by company drivers increases.
Brokerage Segment
In our Brokerage segment, we retain the customer relationship, including billing and collection, and we outsource the transportation of the loads to third-party carriers. For this segment, we rely on brokerage employees to procure third-party carriers, as well as information systems to match loads and carriers. Our Brokerage segment revenue is mainly affected by the rates we obtain from customers, the freight volumes we ship through our third-party carriers and our ability to secure third-party carriers to transport customer freight. We generally do not have contracted long-term rates for the cost of third-party carriers, and we cannot assure that our results of operations will not be adversely impacted in the future if our ability to obtain third-party carriers changes or the rates of such providers increase. The most significant expense of our Brokerage segment, which is primarily variable, is the cost of purchased transportation that we pay to third-party carriers, and is included in the "Purchased transportation" line item. This expense generally varies depending upon truckload capacity, availability of third-party carriers, rates charged to customers and current freight demand and customer shipping needs. Other operating expenses are generally fixed and primarily include the Page 36 Table of Contents
compensation and benefits of non-driver personnel (which are recorded in the "Salaries, wages and benefits" line item) and depreciation and amortization expense.
The key performance indicator in our Brokerage segment is gross margin percentage (which is calculated as brokerage revenue less purchased transportation expense expressed as a percentage of total operating revenue). Gross margin percentage can be impacted by the rates charged to customers and the costs of securing third-party carriers.
Our Brokerage segment does not require significant capital expenditures and is not asset-intensive like our Truckload segment.
Results of Operations Revenue
We generate revenue from two primary sources: transporting freight for our customers (including related fuel surcharge revenue) and arranging for the transportation of customer freight by third-party carriers. We have two reportable segments: our Truckload segment and our Brokerage segment. Truckload revenue, before fuel surcharge and truckload fuel surcharge are primarily generated through trucking services provided by our two Truckload service offerings (OTR and dedicated contract). Brokerage revenue is primarily generated through brokering freight to third-party carriers. Our total operating revenue is affected by certain factors that relate to, among other things, the general level of economic activity inthe United States , customer inventory levels, specific customer demand, the level of capacity in the truckload and brokerage industry, the success of our marketing and sales efforts and the availability of drivers, independent contractors and third-party carriers. A summary of our revenue generated by type for the periods indicated is as follows: Year Ended December 31, 2020 2019 (in thousands) Revenue, before fuel surcharge$ 1,619,199 $ 1,538,450 Fuel surcharge 122,902 168,911 Total operating revenue$ 1,742,101 $ 1,707,361
The primary factors driving the increases in total operating revenue and revenue, before fuel surcharge, were increased volumes and pricing in our Brokerage segment, increased miles per tractor in our Truckload segment, increased miscellaneous revenues offset by decreased fuel surcharge revenues.
A summary of our revenue generated by segment for the periods indicated is as follows: Year EndedDecember 31, 2020 2019 (in thousands)
Truckload revenue, before fuel surcharge
122,902 168,911 Total Truckload operating revenue 1,513,276 1,521,494 Brokerage operating revenue 228,825 185,867 Total operating revenue$ 1,742,101 $ 1,707,361 InJanuary 2019 , we sold our interest inXpress Internacional . Even following our sale ofXpress Internacional , we continue to have business to and fromMexico through a variable cost model using third party carriers. The revenue from such model is generated inthe United States . Page 37 Table of Contents
The following is a summary of our key Truckload segment performance indicators, before fuel surcharge, for the periods indicated.
Year EndedDecember 31, 2020 2019
Over the road
Average revenue per tractor per week
$ 1.976 $ 1.949
Average revenue miles per tractor per week 1,847 1,825 Average tractors
3,675 3,712
Dedicated
Average revenue per tractor per week
$ 2.363 $ 2.375
Average revenue miles per tractor per week 1,728 1,687 Average tractors
2,735 2,727
Consolidated
Average revenue per tractor per week
$ 2.135 $ 2.122
Average revenue miles per tractor per week 1,796 1,767 Average tractors
6,410 6,439 The primary factors driving the changes in Truckload revenue, were a 1.6% increase in average revenue miles per tractor and a 0.6% increase in revenue per loaded mile primarily due to a greater than 23.0% increase in spot rates partially offset by an approximate 3.1% decrease in our contractual rates, and an increase of$12.6 million in miscellaneous revenue partially offset by a 0.5% decrease in average available tractors. Fuel surcharge revenue decreased by$46.0 million , or 27.2%, to$122.9 million , compared with$168.9 million in 2019. TheDOE national weekly average fuel price per gallon averaged approximately$0.50 per gallon lower for 2020 compared to 2019. The decrease in fuel surcharge revenue primarily relates to decreased fuel prices partially offset by a 1.5% increase in revenue miles compared to 2019. The key performance indicator of our Brokerage segment is gross margin percentage (brokerage revenue less purchased transportation expense expressed as a percentage of total operating revenue). Gross margin percentage can be impacted by the rates charged to customers and the costs of securing third-party carriers. The following table lists the gross margin percentage for our Brokerage segment for the years endedDecember 31, 2020 and 2019. Year Ended December 31, 2020 2019 Gross margin percentage 8.5 % 12.9 %
The primary factors driving the increase in Brokerage revenue were a 16.2% increase in load count combined with a 6.0% increase in average revenue per load. We experienced a decrease in our gross margin to 8.5% in 2020, compared to 12.9% in 2019. The decrease in gross margin was due to the increase in cost per load of 11.3% exceeding the 6.0% increase in revenue per load as compared to 2019. During the fourth quarter of 2020, our Brokerage revenue grew 41.0% compared to the prior year fourth quarter as we improved our mix of business towards the spot market and away from contract pricing in order to achieve a better balance in our business.
Operating Expenses
For comparison purposes in the discussion below, we use total operating revenue and revenue, before fuel surcharge when discussing changes as a percentage of revenue. As it relates to the comparison of expenses to revenue, before fuel surcharge, we believe that removing fuel surcharge revenue, which is sometimes a volatile source of revenue affords a more consistent basis for comparing the results of operations from period-to-period.
Individual expense line items as a percentage of total operating revenue also are affected by fluctuations in the percentage of our revenue generated by independent contractor and brokerage loads.
Page 38 Table of Contents
Salaries, wages, and related expenses
Salaries, wages and benefits consist primarily of compensation for all employees. Salaries, wages and benefits are primarily affected by the total number of miles driven by company drivers, the rate per mile we pay our company drivers, employee benefits such as health care and workers' compensation, and to a lesser extent by the number of, and compensation and benefits paid to, non-driver employees. The following is a summary of our salaries, wages and benefits for the periods indicated: Year Ended December 31, 2020 2019 (dollars in thousands) Salaries, wages and benefits$ 556,507 $ 530,801 % of total operating revenue 31.9 % 31.1 % % of revenue, before fuel surcharge 34.4 % 34.5 % The increase in absolute dollar terms was due primarily to$14.6 million of higher driver wages due in part to a 2.7% increase in company driver miles, increased Dedicated driver pay per mile partially offset by decreased OTR driver pay per mile due to the suspension of our OTR student program during the second quarter of 2020. Our office wages increased$17.2 million due in part to a 7.4% increase in headcount as we continue to invest in our ongoing digital initiatives. During 2020, our group health and workers' compensation expense decreased approximately 13.3%, due to decreased group health claims expense and positive trends in our workers' compensation claims compared to 2019. In the near term, we believe salaries, wages and benefits will increase as a result of a tight driver market, wage inflation and higher healthcare costs. As a percentage of revenue, we expect salaries, wages and benefits will fluctuate based on our ability to generate offsetting increases in average revenue per total mile and the percentage of revenue generated by independent contractors and brokerage operations, for which payments are reflected in the "Purchased transportation" line item.
Fuel and fuel taxes
Fuel and fuel taxes consist primarily of diesel fuel expense and fuel taxes for our company-owned and leased tractors. The primary factors affecting our fuel and fuel taxes expense are the cost of diesel fuel, the miles per gallon we realize with our equipment and the number of miles driven by company drivers. We believe that the most effective protection against net fuel cost increases in the near term is to maintain an effective fuel surcharge program and to operate a fuel-efficient fleet by incorporating fuel efficiency measures, such as auxiliary heating units, installation of aerodynamic devices on tractors and trailers and low-rolling resistance tires on our tractors, engine idle limitations and computer-optimized fuel-efficient routing of our fleet. The following is a summary of our fuel and fuel taxes for the periods indicated: Year Ended December 31, 2020 2019 (dollars in thousands) Fuel and fuel taxes$ 136,677 $ 189,174 % of total operating revenue 7.8 % 11.1 % % of revenue, before fuel surcharge 8.4 % 12.3 % To measure the effectiveness of our fuel surcharge program, we calculate "net fuel expense" by subtracting fuel surcharge revenue (other than the fuel surcharge revenue we reimburse to independent contractors, which is included in purchased transportation) from our fuel expense. Our net fuel expense as a percentage of revenue, before fuel surcharge, is affected by the cost of diesel fuel net of surcharge collection, the percentage of miles driven by company
tractors and our percentage Page 39 Table of Contents of non-revenue generating miles, for which we do not receive fuel surcharge revenues. Net fuel expense as a percentage of revenue, before fuel surcharge, is shown below: Year EndedDecember 31, 2020 2019 (dollars in thousands)
Total fuel surcharge revenue$ 122,902
31,585
46,862
Company fuel surcharge revenue$ 91,317 $ 122,049 Total fuel and fuel taxes$ 136,677 $ 189,174 Less: company fuel surcharge revenue 91,317
122,049 Net fuel expense$ 45,360 $ 67,125 % of total operating revenue 2.6 % 3.9 %
% of revenue, before fuel surcharge 2.8 %
4.4 %
During 2020, the decrease in net fuel expenses was primarily the result of a 24.4% decrease in the average fuel price per gallon, a 5.4% increase in average miles per gallon, partially offset by a$30.7 million decrease in company fuel surcharge revenue as compared to 2019. In the near term, our net fuel expense is expected to fluctuate as a percentage of total operating revenue and revenue, before fuel surcharge, based on factors such as diesel fuel prices, the percentage recovered from fuel surcharge programs, the percentage of uncompensated miles, the percentage of revenue generated by independent contractors, and the percentage of revenue generated by team-driven tractors (which tend to generate higher miles and lower revenue per mile, thus proportionately more fuel cost as a percentage of revenue).
Vehicle Rents and Depreciation and Amortization
Vehicle rents consist primarily of payments for tractors and trailers financed with operating leases. The primary factors affecting this expense item include the size and age of our tractor and trailer fleets, the cost of new equipment and the relative percentage of owned versus leased equipment. Depreciation and amortization consists primarily of depreciation for owned tractors and trailers. The primary factors affecting these expense items include the size and age of our tractor and trailer fleets, the cost of new equipment and the relative percentage of owned equipment and equipment acquired through debt or finance leases versus equipment leased through operating leases. We use a mix of finance leases and operating leases to finance our revenue equipment with individual decisions being based on competitive bids and tax projections. Gains or losses realized on the sale of owned revenue equipment are included in depreciation and amortization for reporting purposes. Vehicle rents and depreciation and amortization are closely related because both line items fluctuate depending on the relative percentage of owned equipment and equipment acquired through finance leases versus equipment leased through operating leases. Vehicle rents increase with greater amounts of equipment acquired through operating leases, while depreciation and amortization increases with greater amounts of owned equipment and equipment acquired through finance leases. Because of the inverse relationship between vehicle rents and depreciation and amortization, we review both line items together.
The following is a summary of our vehicle rents and depreciation and amortization for the periods indicated:
Year Ended December 31, 2020 2019 (dollars in thousands) Vehicle rents$ 86,684
102,827
94,337
Vehicle rents and depreciation and amortization of property and equipment$ 189,511 $ 174,401 % of total operating revenue 10.9 % 10.2 % % of revenue, before fuel surcharge 11.7 %
11.3 % Page 40 Table of Contents The increase in vehicle rents was primarily due to increased trailers financed under operating leases compared to 2019. The increase in depreciation and amortization, net of (gains) losses on sale of property, is primarily due to an increase in loss on sale of property and equipment of$8.9 million compared to 2019. This increase in our loss was partially the result of a$2.7 million gain related to the sale of our Laredo terminal and a$1.2 million gain related to a sale leaseback transaction both of which were recognized in 2019. Looking forward to 2021, excluding any change in our percentage allocation of owned versus leased equipment due to available financing terms, we expect to spend approximately$130.0 to$150.0 million in net capital expenditures which will keep the average age of our equipment relatively constant. This amount could expand to fund additional profitable growth opportunities. The balance of our equipment procurement will be funded through operating leases.
Purchased Transportation
Purchased transportation consists of the payments we make to independent contractors, including fuel surcharge reimbursements paid to independent contractors, in our Truckload segment, and payments to third-party carriers in our Brokerage segment.
The following is a summary of our purchased transportation for the periods indicated: Year Ended December 31, 2020 2019 (dollars in thousands) Purchased transportation$ 516,196 $ 481,589 % of total operating revenue 29.6 % 28.2 % % of revenue, before fuel surcharge 31.9 % 31.3 % The increase in purchased transportation reflected a 16.2% increase in our Brokerage load count, an 11.3% increase in cost per Brokerage load partially offset by a 32.6% decrease in fuel surcharge paid to independent contractors and a 1.3% decrease in independent contractor miles as compared to 2019. Because we reimburse independent contractors for fuel surcharges we receive, we subtract fuel surcharge revenue reimbursed to them from our purchased transportation. The result, referred to as purchased transportation, net of fuel surcharge reimbursements, is evaluated as a percentage of total operating revenue and as a percentage of revenue, before fuel surcharge, as shown below: Year Ended December 31, 2020 2019 (dollars in thousands) Purchased transportation$ 516,196
31,585
46,862
Purchased transportation, net of fuel surcharge reimbursement$ 484,611 $ 434,727 % of total operating revenue 27.8 % 25.5 % % of revenue, before fuel surcharge 29.9 %
28.3 %
The increase in purchased transportation reflected a 16.2% increase in our Brokerage load count, an 11.3% increase in cost per Brokerage load partially offset by a 1.3% decrease in independent contractor miles as compared to 2019. This expense category will fluctuate with the number and percentage of loads hauled by independent contractors and third-party carriers, as well as the amount of fuel surcharge revenue passed through to independent contractors. If industry-wide trucking capacity continues to tighten in relation to freight demand, we may need to increase the amounts we pay to third-party carriers and independent contractors, which could increase this expense category on an absolute basis and as a percentage of total operating revenue and revenue, before fuel surcharge, absent an offsetting increase in revenue. We continue to actively attempt to expand our Brokerage segment and recruit independent contractors. Our success in growing our lease-purchase program and independent contractor drivers have contributed to increased purchased transportation expense. If we are successful in continuing these efforts, we would expect this line item to increase as a percentage of total operating revenue and revenue, before fuel surcharge. Page 41 Table of Contents
Operating Expenses and Supplies
Operating expenses and supplies consist primarily of ordinary vehicle repairs and maintenance costs, driver on-the-road expenses, tolls and driver recruiting and training costs. Operating expenses and supplies are primarily affected by the age of our company-owned and leased fleet of tractors and trailers, the number of miles driven in a period and driver turnover. The following is a summary of our operating expenses and supplies for the periods indicated: Year EndedDecember 31, 2020 2019 (dollars in thousands)
Operating expenses and supplies
7.7 % 8.3 % % of revenue, before fuel surcharge 8.2 % 9.2 % The primary factors driving the decrease in operating expenses and supplies was decreased trailer maintenance combined with decreased expenses related to the suspension of our OTR student driver training program during the second quarter of 2020 partially offset by increased advertising costs for driver recruiting.
Insurance Premiums and Claims
Insurance premiums and claims consists primarily of retained amounts for liability (personal injury and property damage), physical damage and cargo damage, as well as insurance premiums. The primary factors affecting our insurance premiums and claims are the frequency and severity of accidents, trends in the development factors used in our actuarial accruals and developments in large, prior year claims. The number of accidents tends to increase with the miles we travel. With our significant retained amounts, insurance claims expense may fluctuate significantly and impact the cost of insurance premiums and claims from period-to-period, and any increase in frequency or severity of claims or adverse loss development of prior period claims would adversely affect our financial condition and results of operations.
The following is a summary of our insurance premiums and claims expense for the periods indicated: Year EndedDecember 31, 2020 2019 (dollars in thousands)
Insurance premiums and claims
5.0 % 5.2 % % of revenue, before fuel surcharge 5.4 % 5.8 % Insurance premiums and claims decreased primarily due to decreased physical damage claims primarily as a result of reduced frequency partially offset by increased auto liability premiums as compared to 2019. We renewed our liability insurance policies effectiveSeptember 1, 2020 and as a result of the challenging insurance market our premiums increased approximately 30% while our coverage limits decreased to$75.0 million from$300.0 million per occurrence. We continue to believe we have an opportunity to reduce our claims expense over time as a result of (1) having completed the installation of event recorders in 2018, (2) the successful launch of our redeveloped driver training facilities, (3) our decision to implement hair follicle testing for all of our drivers in the fourth quarter of 2019, and (4) the successful launch of Variant, our digital fleet, which is currently experiencing fewer preventable accidents per million miles than our OTR legacy fleet combined with the suspension of our OTR student program. During the second half of 2020 we experienced approximately 35% fewer preventable accidents than we did in the comparable prior year period which we believe contributed greatly to our lower insurance and claims expense despite higher premiums. Although a decrease in frequency in claims reduced our expense during the year, to the extent we have an increase in severity these savings could be partially or fully offset. Page 42 Table of Contents
General and Other Operating Expenses
General and other operating expenses consist primarily of legal and professional services fees, general and administrative expenses and other costs.
The following is a summary of our general and other operating expenses for the periods indicated: Year EndedDecember 31, 2020 2019 (dollars in thousands)
General and other operating expenses
3.2 % 3.1 % % of revenue, before fuel surcharge 3.4 % 3.4 %
General and other expenses increased primarily due to increased terminal rents related to the sale leaseback transaction executed in the fourth quarter of 2019.
Impairment of Equity Method Investments and Note Receivable
During 2019, we converted$5.0 million of Arnold receivables to a note receivable and advanced an additional$2.0 million . In the fourth quarter of 2019, we recorded an impairment charge of$6.8 million as the collectability of the note was remote. During the first quarter of 2020, we sold our interest in Arnold and recorded a$2.0 million loss on the sale.
Interest
Interest expense consists of cash interest, amortization of original issuance discount and deferred financing fees.
The following is a summary of our interest expense for the periods indicated: Year EndedDecember 31, 2020 2019 (in thousands)
Interest expense, excluding non-cash items$ 17,757 $ 21,000 Original issue discount and deferred financing amortization 1,090
635 Interest expense, net$ 18,847 $ 21,635 For 2020, interest expense decreased$2.8 million , primarily due to decreased borrowings and lower average interest rates as compared to 2019. InJanuary 2020 , we entered into a new$250.0 million revolving Credit Facility paying off our higher interest rate existing credit facility.
LIQUIDITY AND CAPITAL RESOURCES
Overview
Our business requires substantial amounts of cash to cover operating expenses as well as to fund capital expenditures, working capital changes, principal and interest payments on our obligations, lease payments, letters of credit to support insurance requirements and tax payments when we generate taxable income. Recently, we have financed our capital requirements with borrowings under our Credit Facility, cash flows from operating activities, direct equipment financing, operating leases and proceeds from equipment sales. We make substantial net capital expenditures to maintain a modern company tractor fleet, refresh our trailer fleet and strategically expand our fleet. During 2021, we currently plan to replace owned tractors with new owned tractors as they reach approximately 475,000 to 575,000 miles. Additionally, we expect to replace our tractor lease maturities with a mix of owned and leased replacements as we convert a portion of our leased tractors to owned. Our mix of owned and leased equipment may vary over time due to tax treatment, financing options and flexibility of terms, among other factors. Page 43 Table of Contents We believe we can fund our expected cash needs, including debt repayment, in the short-term with projected cash flows from operating activities, borrowings under our Credit Facility and direct debt and lease financing we believe to be available for at least the next 12 months. Over the long-term, we expect that we will continue to have significant capital requirements, which may require us to seek additional borrowings, lease financing or equity capital. We have obtained a significant portion of our revenue equipment under operating leases, which are not reflected as net capital expenditures but are recorded as operating lease liabilities on our balance sheet. The availability of financing and equity capital will depend upon our financial condition and results of operations as well as prevailing market conditions.
Sources of Liquidity
Credit Facility
OnJanuary 28, 2020 , we entered into the Credit Facility and contemporaneously with the funding of the Credit Facility paid off obligations under our then existing credit facility and terminated such facility. The Credit Facility is a$250.0 million revolving credit facility, with an uncommitted accordion feature that, so long as no event of default exists, allows the Company to request an increase in the revolving credit facility of up to$75.0 million . The Credit Facility is a five-year facility scheduled to terminate onJanuary 28, 2025 . Borrowings under the Credit Facility are classified as either "base rate loans" or "eurodollar rate loans". Base rate loans accrue interest at a base rate equal to the highest of (A) the Federal Funds Rate plus 0.50%, (B) the Agent's prime rate, and (C) LIBOR plus 1.00% plus an applicable margin that was set at 0.50% throughJune 30, 2020 and adjusted quarterly thereafter between 0.25% and 0.75% based on the ratio of the daily average availability under the Credit Facility to the daily average of the lesser of the borrowing base or the revolving credit facility. Eurodollar rate loans accrue interest at LIBOR plus an applicable margin that was set at 1.50% throughJune 30, 2020 and adjusted quarterly thereafter between 1.25% and 1.75% based on the ratio of the daily average availability under the Credit Facility to the daily average of the lesser of the borrowing base or the revolving credit facility. The Credit Facility includes, within its$250.0 million revolving credit facility, a letter of credit sub-facility in an aggregate amount of$75.0 million and a swingline sub-facility in an aggregate amount of$25.0 million . An unused line fee of 0.25% is applied to the average daily amount by which the lenders' aggregate revolving commitments exceed the outstanding principal amount of revolver loans and aggregate undrawn amount of all outstanding letters of credit issued under the Credit Facility. The Credit Facility is secured by a pledge of substantially all of the Company's assets, excluding, among other things, any real estate or revenue equipment financed outside the Credit Facility. Borrowings under the Credit Facility are subject to a borrowing base limited to the lesser of (A)$250.0 million ; or (B) the sum of (i) 87.5% of eligible billed accounts receivable, plus (ii) 85.0% of eligible unbilled accounts receivable (less than 30 days), plus (iii) 85.0% of the net orderly liquidation value percentage applied to the net book value of eligible revenue equipment, plus (iv) the lesser of (a) 80.0% the fair market value of eligible real estate or (b)$25.0 million . The Credit Facility contains a single springing financial covenant, which requires a consolidated fixed charge coverage ratio of at least 1.0 to 1.0. The financial covenant is tested only in the event excess availability under the Credit Facility is less than the greater of (A) 10.0% of the lesser of the borrowing base or revolving credit facility or (B)$20.0 million . Based on excess availability as ofDecember 31, 2020 , there was no fixed charge coverage ratio requirement. The Credit Facility includes usual and customary events of default for a facility of this nature and provides that, upon the occurrence and continuation of an event of default, payment of all amounts payable under the Credit Facility may be accelerated, and the lenders' commitments may be terminated. The Credit Facility contains certain restrictions and covenants relating to, among other things, dividends, liens, acquisitions and dispositions, affiliate transactions, and other indebtedness.
See Notes 9 and 10 to the accompanying consolidated financial statements for additional disclosures regarding our debt and leases, respectively.
Page 44 Table of Contents Cash Flows Our summary statements of cash flows for the periods indicated are set forth in the table below: Year EndedDecember 31, 2020 2019 (in thousands)
Net cash provided by operating activities
(111,603) (81,630) Net cash used in financing activities (39,468) (38,108) Operating Activities For 2020, we generated cash flows from operating activities of$150.9 million , an increase of$47.1 million compared to 2019. The increase was due primarily to a$29.9 million increase in net income adjusted for noncash items, combined with a$30.9 million increase in our operating liabilities partially offset by increased operating assets. Our operating liabilities increased$30.9 million during 2020 as compared to 2019, due in part to the deferred payroll taxes in conjunction with the Coronavirus Aid, Relief and Economic Security Act enactedMarch 2020 , combined with increased accounts payable and accrued wages and benefits related to timing of payments offset by decreased claims and insurance accruals. Our increase in net income adjusted for noncash items was due in part to increased average revenue miles per tractor, increased revenue per mile, decreased net fuel expense and decreased interest expense offset by decreases in our Brokerage gross margin. Investing Activities
For 2020, net cash flows used in investing activities were$111.6 million , an increase of$30.0 million compared to 2019. This increase is primarily the result of decreased proceeds of$31.6 million related to a terminal sale and a sale leaseback transaction during the fourth quarter of 2019. Our net equipment purchases as compared to 2019 decreased slightly while our technology capital expenditures increased as we continue to invest in our digital initiatives. We expect our net capital expenditures for calendar year 2021 will approximate$130.0 million to$150.0 million to execute our equipment replacement strategy and will be financed with cash from operations, borrowings on the Credit Facility and secured debt financing. If our growth strategy gains momentum, we may need to increase our capital expenditures to fund additional profitable growth opportunities.
Financing Activities
For 2020, net cash flows used in financing activities were$39.5 million , compared to$38.1 in 2019. During 2020, our debt repayments in excess of debt borrowings were$37.1 million compared to$29.9 million in 2019. During 2019, we purchased the remaining 10% of Total Transportation for$8.7 million .
Working Capital
As ofDecember 31, 2020 , we had a working capital deficit of$92.8 million , representing a$44.0 million decrease in our working capital fromDecember 31, 2019 . When we analyze our working capital, we typically exclude balloon payments in the current maturities of long-term debt and current portion of operating lease liabilities as these payments are typically either funded with the proceeds from equipment sales or addressed by extending the maturity of such payments. We believe this facilitates a more meaningful analysis of our changes in working capital from period-to-period. Excluding balloon payments included in current maturities of long-term debt and current portion of operating lease liabilities as ofDecember 31, 2020 , we had a working capital deficit of$56.5 million , compared with a working capital deficit of$23.6 million atDecember 31, 2019 . The decrease in working capital was primarily the result of increased accounts payable and accrued wages and benefits combined with decreased assets held for sale, partially offset by increased customer and other receivables. Accrued wages and benefits increased primarily due to the current portion of deferred payroll taxes. Working capital deficits are common to many trucking companies that operate by financing revenue equipment purchases through borrowing or finance leases and who use operating leases. When we finance revenue equipment through borrowing or finance leases, the principal amortization scheduled for the next twelve months is categorized as a current liability, although the revenue equipment is classified as a long-term asset. Consequently, each purchase of revenue equipment financed with borrowing or finance leases decreases working capital. Similarly, our operating lease right of use assets are Page 45 Table of Contents classified as long-term, while a portion of the corresponding lease liabilities are classified as a current liability. We believe a working capital deficit has little impact on our liquidity. Based on our expected financial condition, net capital expenditures, results of operations, related net cash flows, installment notes, and other sources of financing, we believe our working capital and sources of liquidity will be adequate to meet our current and projected needs and we do not expect to experience material liquidity constraints in the foreseeable future.
Contractual Obligations and Commercial Commitments
The table below summarizes our contractual obligations as ofDecember 31, 2020 : Payments Due by Period Less than More than 1 year 1 3 years 3 5 years 5 years Total (in thousands)
Longterm debt obligations(1)$ 112,381 $ 165,831 $ 74,956 $ 35,165 $ 388,333 Finance lease obligations(2) 4,081 2,846 296 - 7,223 Operating lease obligations(3) 87,842 139,681 49,737 44,196 321,456 Purchase obligations(4) 121,160 - - - 121,160
Total contractual obligations(5)
124,989
Including interest obligations on long-term debt, excluding fees. The table (1) assumes long-term debt is held to maturity and does not reflect events
subsequent to
(2) Including interest obligations on finance lease obligations.
We lease certain revenue and service equipment and office and service center
facilities under long-term, non-cancelable operating lease agreements
expiring at various dates through
terms are generally three to five years for tractors and five to eight years
for trailers. The lease terms and any subsequent extensions generally
represent the estimated usage period of the equipment, which is generally (3) substantially less than the economic lives. Certain revenue equipment leases
provide for guarantees by us of a portion of the specified residual value at
the end of the lease term. The maximum potential amount of future payments
(undiscounted) under these guarantees is approximately
revenue equipment is covered by repurchase or trade agreements between us and
the equipment manufacturer.
We had commitments outstanding at
other equipment. The revenue equipment commitments are cancelable, subject to (4) certain adjustments in the underlying obligations and benefits. These
purchase commitments are expected to be financed by operating leases,
long-term debt, proceeds from sales of existing equipment and cash flows from
operating activities.
(5) Excludes deferred taxes and long or short-term portion of self-insurance
claims accruals.
Off-Balance Sheet Arrangements
The Company has letters of credit of
The Company had cancelable commitments outstanding at
INFLATION
Inflation in the price of revenue equipment, tires, diesel fuel, health care, operating tolls and taxes and other items has impacted our operating costs over the past several years. A prolonged or more severe period of inflation in these or other items would adversely affect our results of operations unless freight rates correspondingly increase. Historically, the majority of the increase in fuel costs has been passed on to our customers through a corresponding increase in fuel Page 46 Table of Contents surcharge revenue, making the impact of the increased fuel costs on our results of operations less severe. Inflation related to other costs is not directly covered from our customers through a surcharge mechanism. Because these potential cost increases would be relatively consistent across the industry, we would expect corresponding rate increases generally to offset these increased costs over time. If these and other costs escalate and we are unable to recover such costs timely with effective fuel surcharges and rate increases, it would have an adverse effect on our operations and profitability.
CRITICAL ACCOUNTING POLICIES
In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial position in the preparation of our financial statements in conformity with GAAP. Actual results could differ significantly from those estimates under different assumptions and conditions. We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require management's most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. See Note 2 of the accompanying consolidated financial statements for additional information about our critical accounting policies and estimates. Income Taxes Significant management judgment is required in determining our provision for income taxes and in determining whether deferred tax assets will be realized in full or in part. Deferred tax assets and liabilities are measured using enacted tax rates that are expected to apply to taxable income in years in which the temporary differences are expected to be recovered or settled. When it is more likely than not that all or some portion of specific deferred tax assets, such as state tax credit carry-forwards or state net operating loss carry-forwards will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that are determined to be not realizable. The determination of the combined tax rate used to calculate our provision for income taxes for both current and deferred income taxes also requires significant judgment by management. We value the net deferred tax asset or liability by using enacted tax rates that we believe will be in effect when these temporary differences are recovered or settled. We use the combined tax rates at the time the financial statements are prepared since more accurate information is not available. If changes in the federal statutory rate or significant changes in the statutory state and local tax rates occur prior to or during the reversal of these items or if our filing obligations were to change materially, this could change the combined rate and, by extension, our provision for income taxes. We account for uncertain tax positions in accordance with ASC 740, Income Taxes and record a liability when such uncertainties meet the more likely than not recognition threshold.
Property and Equipment
Property and equipment are carried at cost. Depreciation of property and equipment is computed using the straight-line method for financial reporting purposes and accelerated methods for tax purposes over the estimated useful lives of the related assets (net of estimated salvage value or trade-in value). We generally use estimated useful lives of three to five years for tractors and ten or more years for trailers with estimated salvage values ranging from 25% to 50% of the capitalized cost. The depreciable lives of our revenue equipment represent the estimated usage period of the equipment, which is generally substantially less than the economic lives. The residual value of a substantial portion of our equipment is covered by repurchase or trade agreements between us and the equipment manufacturer. Periodically, we evaluate the useful lives and salvage values of our revenue equipment and other long-lived assets based upon, but not limited to, our experience with similar assets including gains or losses upon dispositions of such assets, conditions in the used equipment market and prevailing industry practices. Changes in useful lives or salvage value estimates, or fluctuations in market values that are not reflected in our estimates, could have a material impact on our financial results. Further, if our equipment manufacturer does not perform under the terms of the agreements for guaranteed trade-in values, such non-performance could have a materially negative impact on financial results. We review our property and equipment whenever events or circumstances indicate the carrying amount of the asset may not be recoverable. An impairment loss equal to the excess of carrying amount over fair value would be recognized if the carrying amount of the asset is not recoverable. Page 47 Table of Contents
Claims and Insurance Accruals
Claims and insurance accruals consist of estimates of cargo loss, physical damage, group health, liability (personal injury and property damage) and workers' compensation claims and associated legal and other expenses within our established retention levels. Claims in excess of retention levels are generally covered by insurance in amounts we consider adequate. Claims accruals represent the uninsured portion of pending claims including estimates of adverse development of known claims, plus an estimated liability for incurred but not reported claims and the associated expense. Accruals for cargo loss, physical damage, group health, liability and workers' compensation claims are estimated based on our evaluation of the type and severity of individual claims and historical information, primarily our own claims experience, along with assumptions about future events combined with the assistance of independent actuaries in the case of workers' compensation and liability. Changes in assumptions as well as changes in actual experience could cause these estimates to change in the near future. Workers' compensation and liability claims are particularly subject to a significant degree of uncertainty due to the potential for growth and development of the claims over time. Claims and insurance reserves related to workers' compensation and liability are estimated by a third-party actuary and we refer to these estimates in establishing the reserve. Liability reserves are estimated based on historical experience and trends, the type and severity of individual claims and assumptions about future costs. Further, in establishing the workers' compensation and liability reserves, we must take into account and estimate various factors, including, but not limited to, assumptions concerning the nature and severity of the claim, the effect of the jurisdiction on any award or settlement, the length of time until ultimate resolution, inflation rates in health care and in general, interest rates, legal expenses and other factors. Our actual experience may be different than our estimates, sometimes significantly. Changes in assumptions made in actuarial studies could potentially have a material effect on the provision for workers' compensation and liability claims. Additionally, if any claim were to exceed our coverage limits, we would have to accrue for and pay the excess amount, which could have a material adverse effect on our financial condition, results of operations and cash flows.
Recent Accounting Pronouncements
See Note 2 of the accompanying consolidated financial statements for information about recent accounting pronouncements.
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