PAMT CORP (PAMT) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Business Overview
The Company's administrative headquarters are in Tontitown, Arkansas. From this location we manage operations conducted through our wholly owned subsidiaries based in various locations around the United States, Mexico, and Canada. The operations of these subsidiaries can generally be classified into either truckload services or brokerage and logistics services. This designation is based primarily on the ownership of the asset that performed the freight transportation service. Truckload services are performed by Company divisions that generally utilize Company- owned trucks, long-term contractors, or single-trip contractors to transport loads of freight for customers, while brokerage and logistics services coordinate or facilitate the transport of loads of freight for customers and generally involve the utilization of single-trip contractors. Both our truckload operations and our brokerage/logistics operations have similar economic characteristics and are impacted by virtually the same economic factors as discussed elsewhere in this Report. All of the Company's operations are in the motor carrier segment.
For both operations, substantially all of our revenue is generated by transporting freight for customers and is predominantly affected by the rates per mile received from our customers, equipment utilization, and our percentage of non-compensated miles. These aspects of our business are carefully managed and efforts are continuously underway to achieve favorable results. Truckload services revenues, excluding fuel surcharges, represented 67.0%, 76.9% and 82.7% of total revenues, excluding fuel surcharges for the twelve months ended December 31, 2021, 2020 and 2019, respectively.
The main factors that impact our profitability on the expense side are costs incurred in transporting freight for our customers. Currently, our most challenging costs include fuel, driver recruitment, training, wage and benefit costs, independent broker costs (which we record as purchased transportation), insurance and claims, and maintenance and capital equipment costs.
In discussing our results of operations we use revenue, before fuel surcharge (and operating supplies and expense, net of fuel surcharge), because management believes that eliminating the impact of this sometimes volatile source of revenue allows a more consistent basis for comparing our results of operations from period to period. During 2021, 2020 and 2019, approximately $65.9 million, $47.8 million and $74.7 million, respectively, of the Company's total revenue was generated from fuel surcharges. We also discuss certain changes in our expenses as a percentage of revenue, before fuel surcharge, rather than absolute dollar changes. We do this because we believe the high variable cost nature of certain expenses makes a comparison of changes in expenses as a percentage of revenue more meaningful than absolute dollar changes.
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Results of Operations - Truckload Services
The following table sets forth, for truckload services, the percentage relationship of expense items to operating revenues, before fuel surcharges, for the periods indicated. Operating supplies and expenses are shown net of fuel surcharges.
| Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | ||||||||||
| Operating revenues, before fuel surcharge | 100.0 | % | 100.0 | % | 100.0 | % | ||||||
| Operating expenses: | ||||||||||||
| Salaries, wages and benefits | 30.6 | 35.3 | 34.5 | |||||||||
| Operating supplies and expenses, net of fuel surcharge | 8.3 | 10.7 | 6.5 | |||||||||
| Rent and purchased transportation | 24.3 | 23.2 | 28.3 | |||||||||
| Depreciation | 12.5 | 16.5 | 15.0 | |||||||||
| Insurance and claims | 4.4 | 2.6 | 9.8 | |||||||||
| Other | 2.5 | 3.6 | 3.6 | |||||||||
| (Gain) Loss on sale or disposal of property | (0.3 | ) | 0.1 | 0.0 | ||||||||
| Total operating expenses | 82.3 | 92.0 | 97.7 | |||||||||
| Operating income | 17.7 | 8.0 | 2.3 | |||||||||
| Non-operating income (expense) | 1.9 | (0.5 | ) | 1.5 | ||||||||
| Interest expense | (1.4 | ) | (2.2 | ) | (2.1 | ) | ||||||
| Income before income taxes | 18.2 | % | 5.3 | % | 1.7 | % |
2021 Compared to 2020
For the year ended December 31, 2021, truckload services revenue, before fuel surcharges, increased 27.3% to $429.6 million as compared to $337.5 million for the year ended December 31, 2020. The increase relates primarily to a 34.6% increase in our rate per loaded mile, from $1.91 for the year ended December 31, 2020 to $2.58 for the year ended December 31, 2021 and to temporary plant shutdowns in early 2020 experienced by some of our major customers due to COVID-19.
Salaries, wages and benefits decreased from 35.3% of revenues, before fuel surcharges, during 2020 to 30.6% of revenues, before fuel surcharges, during 2021. The percentage-based decrease relates primarily to the interaction of expenses with fixed-cost characteristics, such as general and administrative wages, maintenance wages, and operations wages with the increase in revenues for the periods compared.
Operating supplies and expenses decreased from 10.7% of revenues, before fuel surcharges, during 2020 to 8.3% of revenues, before fuel surcharges, during 2021. The decrease relates primarily to a decrease in the average surcharge-adjusted fuel price paid per gallon of diesel fuel, due to increased fuel surcharge collections from customers, and to for the year ended December 31, 2021 compared to December 31, 2020. The decrease also relates to the interaction of expenses with fixed-cost characteristics, such as rents, driver training schools and operating taxes and licenses.
Rent and purchased transportation increased from 23.2% of revenues, before fuel surcharges, during 2020 to 24.3% of revenues, before fuel surcharges, during 2021. The increase was primarily due to an increase in the rates paid to third-party owner-operators for the year ended December 31, 2021 compared to the year ended December 31, 2020.
Depreciation decreased from 16.5% of revenues, before fuel surcharges, during 2020 to 12.5% of revenues, before fuel surcharges, during 2021. The decrease relates primarily to the interaction of an increase in operating revenues with the fixed-cost nature of depreciation expense.
Insurance and claims increased from 2.6% of revenues, before fuel surcharges, during 2020 to 4.4% of revenues, before fuel surcharges, during 2021. This increase relates primarily to an increase in accident and legal reserves, recognized in 2021 as compared to 2020 and to an increase in the premiums paid for auto liability and cargo insurance.
Other expenses decreased from 3.6% of revenues, before fuel surcharges, during 2020 to 2.5% of revenues, before fuel surcharges, during 2021. This decrease relates primarily to a decrease in outside professional services expenses in 2021 as compared to 2020.
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Non-operating income increased from a loss of 0.5% of revenues, before fuel surcharges, during 2020 to a gain of 1.9% of revenues, before fuel surcharges, during 2021. This increase resulted primarily from an increase in the market value of our marketable equity securities portfolio at December 31, 2021 as compared to December 31, 2020.
The truckload services division operating ratio, which measures the ratio of operating expenses, net of fuel surcharges, to operating revenues, before fuel surcharges, improved to 82.3% for 2021 from 92.0% for 2020.
2020 Compared to 2019
For the year ended December 31, 2020, truckload services revenue, before fuel surcharges, decreased 7.2% to $337.5 million as compared to $363.6 million for the year ended December 31, 2019. The decrease relates primarily to temporary plant shutdowns in early 2020 experienced by some of our major customers due to COVID-19, and to a decrease in the average number of trucks in service from 2,075 during 2019 to 2,004 during 2020. These decreases were partially offset by a 3.9% increase in our rate per loaded mile, from $1.84 for the year ended December 31, 2019 to $1.91 for the year ended December 31, 2020
Salaries, wages and benefits increased from 34.5% of revenues, before fuel surcharges, during 2019 to 35.3% of revenues, before fuel surcharges, during 2020. The percentage-based increase relates primarily to an increase in amounts expensed for group health insurance expense and workers compensation claims expense. Also contributing to the percentage-based increase was the interaction of expenses with fixed-cost characteristics, such as general and administrative wages, maintenance wages, and operations wages with a decrease in revenues for the periods compared. In addition, the proportion of total miles driven by company drivers increased as the number of company drivers increased year-over-year.
Operating supplies and expenses increased from 6.5% of revenues, before fuel surcharges, during 2019 to 10.7% of revenues, before fuel surcharges, during 2020. The increase relates primarily to an increase in the proportion of total miles driven by company drivers for the year ended December 31, 2020 compared to December 31, 2019. This increase in miles driven by company drivers has the effect of increasing our net operating supplies and expenses while decreasing the Rent and purchased transportation category, as fuel surcharge revenue generated from transportation services performed by owner-operators is reflected as a reduction in net operating supplies and expenses, while fuel surcharges paid to owner-operators for their services is reported along with their base rate of pay in the Rent and purchased transportation category.
Rent and purchased transportation decreased from 28.3% of revenues, before fuel surcharges, during 2019 to 23.2% of revenues, before fuel surcharges, during 2020. The decrease was primarily due to a reduction in the proportion of total miles driven by owner-operators for the year ended December 31, 2020 compared to the year ended December 31, 2019.
Depreciation increased from 15.0% of revenues, before fuel surcharges, during 2019 to 16.5% of revenues, before fuel surcharges, during 2020. The increase relates primarily to the interaction of a decrease in operating revenues with the fixed-cost nature of depreciation expense. Also contributing to the increase was an increase in the average number of trailers owned by the company and to a general increase in truck and trailer replacement costs. During 2020, the average number of company-owned trailers increased by 634 as compared to 2019.
Insurance and claims decreased from 9.8% of revenues, before fuel surcharges, during 2019 to 2.6% of revenues, before fuel surcharges, during 2020. This decrease relates primarily to the negative impact, recognized in 2019, of the settlement of a lawsuit which claimed that the Company was in violation of minimum wage laws with regard to certain activities performed by employee drivers and for a lawsuit brought against the Company by certain individuals who asserted that they were misclassified as owner-operators. In addition, the Company became self-insured for certain lower layers of auto liability claims commencing September 1, 2019. During the first nine months of 2019, the Company paid for auto liability insurance coverage in these lower levels through various third-party insurance carriers. The decision to self-insure these layers reduced insurance premium costs from that point through to the annual renewal date of September 1, 2020.
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Non-operating income decreased from a gain of 1.5% of revenues, before fuel surcharges, during 2019 to a loss of 0.5% of revenues, before fuel surcharges, during 2020. This decrease resulted primarily from a decrease in the market value of our marketable equity securities portfolio at December 31, 2020 as compared to December 31, 2019.
The truckload services division operating ratio, which measures the ratio of operating expenses, net of fuel surcharges, to operating revenues, before fuel surcharges, improved to 92.0% for 2020 from 97.7% for 2019.
Results of Operations - Logistics and Brokerage Services
The following table sets forth, for logistics and brokerage services, the percentage relationship of expense items to operating revenues, before fuel surcharges, for the periods indicated. Brokerage operations occur specifically in certain divisions; however, brokerage operations occur throughout the Company in similar operations having substantially similar economic characteristics. Rent and purchased transportation, which includes costs paid to third-party carriers, are shown net of fuel surcharges.
| Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | ||||||||||
| Operating revenues, before fuel surcharge | 100.0 | % | 100.0 | % | 100.0 | % | ||||||
| Operating expenses: | ||||||||||||
| Salaries, wages and benefits | 4.6 | 5.0 | 5.8 | |||||||||
| Rent and purchased transportation | 82.5 | 86.5 | 86.4 | |||||||||
| Insurance and claims | 0.0 | 0.1 | 0.1 | |||||||||
| Other | 1.6 | 1.7 | 2.4 | |||||||||
| Total operating expenses | 88.7 | 93.3 | 94.7 | |||||||||
| Operating income | 11.3 | 6.7 | 5.3 | |||||||||
| Non-operating income (expense) | 1.0 | 0.0 | 0.8 | |||||||||
| Interest expense | (0.8 | ) | (1.1 | ) | (1.1 | ) | ||||||
| Income before income taxes | 11.5 | % | 5.6 | % | 5.0 | % |
2021 Compared to 2020
For the year ended December 31, 2021, logistics and brokerage services revenues, before fuel surcharges, increased 108.6% to $211.7 million as compared to $101.5 million for the year ended December 31, 2020. The increase was primarily related to a 69.5% increase in the number of loads carried for customers during 2021 as compared to 2020, coupled with a 23.1% increase in revenue per load.
Salaries, wages and benefits decreased from 5.0% of revenues, before fuel surcharges, in 2020 to 4.6% of revenues, before fuel surcharges, in 2021. The decrease relates primarily to the effect of higher revenues without a corresponding increase in those wages with fixed cost characteristics, such as general and administrative wages.
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Rent and purchased transportation decreased from 86.5% of revenues, before fuel surcharges, in 2020 to 82.5% of revenues, before fuel surcharges, in 2021. The decrease results from paying third-party carriers a smaller percentage of customer revenue.
The logistics and brokerage services division operating ratio, which measures the ratio of operating expenses, net of fuel surcharges, to operating revenues, before fuel surcharges, improved to 88.7% for 2021 from 93.3% for 2020.
2020 Compared to 2019
For the year ended December 31, 2020, logistics and brokerage services revenues, before fuel surcharges, increased 33.6% to $101.5 million as compared to $75.9 million for the year ended December 31, 2019. The increase was primarily related to a 36.0% increase in the number of loads carried for customers during 2020 as compared to 2019.
Salaries, wages and benefits decreased from 5.8% of revenues, before fuel surcharges, in 2019 to 5.0% of revenues, before fuel surcharges, in 2020. The decrease relates primarily to the effect of higher revenues without a corresponding increase in those wages with fixed cost characteristics, such as general and administrative wages.
Rent and purchased transportation increased from 86.4% of revenues, before fuel surcharges, in 2019 to 86.5% of revenues, before fuel surcharges, in 2020. The increase results from paying third-party carriers a larger percentage of customer revenue.
The logistics and brokerage services division operating ratio, which measures the ratio of operating expenses, net of fuel surcharges, to operating revenues, before fuel surcharges, improved to 93.3% for 2020 from 94.7% for 2019.
Results of Operations - Combined Services
2021 Compared to 2020
Income tax expense was approximately $26.0 million in 2021, resulting in an effective rate of 25.4%, as compared to approximately $5.6 million, or an effective tax rate of 23.8% in 2020. The effective tax rate is impacted by the effect of state taxes and other factors.
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In determining whether a tax asset valuation allowance is necessary, management, in accordance with the provisions of Accounting Standards Codification (“ASC”) 740-10-30, weighs all available evidence, both positive and negative to determine whether, based on the weight of that evidence, a valuation allowance is necessary. If negative conditions exist which indicate a valuation allowance might be necessary, consideration is then given to what effect the future reversals of existing taxable temporary differences and the availability of tax strategies might have on future taxable income to determine the amount, if any, of the required valuation allowance. As of December 31, 2021, management determined that the future reversals of existing taxable temporary differences and available tax strategies would generate sufficient future taxable income to realize its tax assets and therefore a valuation allowance was not necessary.
The Company recognizes a tax benefit from an uncertain tax position only if it is more likely than not that the position will be sustained on examination by taxing authorities, based on the technical merits of the position. As of December 31, 2021, an adjustment to the Company’s consolidated financial statements for uncertain tax positions has not been required as management believes that the Company’s tax positions taken in income tax returns filed or to be filed are supported by clear and unambiguous income tax laws. The Company recognizes interest and penalties related to uncertain income tax positions, if any, in income tax expense. During 2021 and 2020, the Company has not recognized or accrued any interest or penalties related to uncertain income tax positions.
The Company and its subsidiaries are subject to U.S. and Canadian federal income tax laws as well as the income tax laws of multiple state jurisdictions. The major tax jurisdictions in which we operate generally provide for a deficiency assessment statute of limitation period of three years and as a result, the Company’s tax years 2018 and forward remain open to examination in those jurisdictions.
The combined net income for all divisions was $76.5 million, or 11.9% of revenues, before fuel surcharge, for 2021 as compared to the combined net income for all divisions of $17.8 million or 4.1% of revenues, before fuel surcharge, for 2020. Diluted earnings per share increased to $6.69 for the year ended December 31, 2021 from $1.55 for the year ended December 31, 2020.
2020 Compared to 2019
Income tax expense was approximately $5.6 million in 2020, resulting in an effective rate of 23.8%, as compared to approximately $2.2 million, or an effective tax rate of 21.9% in 2019. The effective tax rate is impacted by the existence of partially non-deductible meal and incidental expense per-diem payments to company drivers. Per-diem payments may cause a significant difference in the Company’s effective tax rate from period-to-period as the proportion of non-deductible expenses to pre-tax net income increases or decreases.
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In determining whether a tax asset valuation allowance is necessary, management, in accordance with the provisions of ASC 740-10-30, weighs all available evidence, both positive and negative to determine whether, based on the weight of that evidence, a valuation allowance is necessary. If negative conditions exist which indicate a valuation allowance might be necessary, consideration is then given to what effect the future reversals of existing taxable temporary differences and the availability of tax strategies might have on future taxable income to determine the amount, if any, of the required valuation allowance. As of December 31, 2020, management determined that the future reversals of existing taxable temporary differences and available tax strategies would generate sufficient future taxable income to realize its tax assets and therefore a valuation allowance was not necessary.
The Company recognizes a tax benefit from an uncertain tax position only if it is more likely than not that the position will be sustained on examination by taxing authorities, based on the technical merits of the position. As of December 31, 2020, an adjustment to the Company’s consolidated financial statements for uncertain tax positions has not been required as management believes that the Company’s tax positions taken in income tax returns filed or to be filed are supported by clear and unambiguous income tax laws. The Company recognizes interest and penalties related to uncertain income tax positions, if any, in income tax expense. During 2020 and 2019, the Company has not recognized or accrued any interest or penalties related to uncertain income tax positions.
The Company and its subsidiaries are subject to U.S. and Canadian federal income tax laws as well as the income tax laws of multiple state jurisdictions. The major tax jurisdictions in which we operate generally provide for a deficiency assessment statute of limitation period of three years and as a result, the Company’s tax years 2017 and forward remain open to examination in those jurisdictions.
The combined net income for all divisions was $17.8 million, or 4.1% of revenues, before fuel surcharge, for 2020 as compared to the combined net income for all divisions of $7.9 million or 1.8% of revenues, before fuel surcharge, for 2019. Diluted earnings per share increased to $3.09 for the year ended December 31, 2020 from $1.34 for the year ended December 31, 2019.
Liquidity and Capital Resources
Our business has required, and will continue to require, a significant investment in new revenue equipment. Our primary sources of liquidity have been funds provided by operations, proceeds from the sales of revenue equipment, borrowings under our lines of credit, installment notes and investment margin account, and issuances of equity securities.
During 2021, we generated $101.7 million in cash from operating activities compared to $67.6 million and $84.3 million in 2020 and 2019, respectively. Investing activities generated $9.3 million in cash during 2021 compared to using $32.7 million and $62.3 million in 2020 and 2019, respectively. The cash used for investing activities relates primarily to the purchase of revenue equipment such as trucks and trailers. Financing activities used $92.8 million in cash during 2021 compared to using $34.9 million during 2020 and $22.0 million during 2019. See the Consolidated Statements of Cash Flows in Item 8 of this Report.
Our primary use of funds is for the purchase of revenue equipment. We typically use installment notes, our existing lines of credit on an interim basis, proceeds from the sale or trade of equipment, and cash flows from operations to finance capital expenditures and repay long-term debt. During 2021 and 2020, we utilized cash on hand, installment notes, and our lines of credit to finance revenue equipment purchases of approximately $51.9 million and $106.9 million, respectively.
We often finance the acquisition of revenue equipment through installment notes with fixed interest rates and terms ranging from 36 to 84 months. At December 31, 2021, the Company’s subsidiaries had combined outstanding indebtedness under such installment notes of $222.3 million. These installment notes are payable in monthly installments, ranging from 36 monthly installments to 84 monthly installments, at a weighted average interest rate of 2.81%. At December 31, 2020, the Company’s subsidiaries had combined outstanding indebtedness under such installment notes of $250.6 million. These installment notes were payable in monthly installments, ranging from 36 to 84 months at a weighted average interest rate of 3.30%.
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In order to maintain our truck and trailer fleet count, it is often necessary to purchase replacement units and place them in service before trade units are removed from service. The timing of this process often requires the Company to pay for new units without any reduction in price for trade units. In this situation, the Company later receives payment for the trade units as they are delivered to the equipment vendor and have passed vendor inspection. During the twelve months ended December 31, 2021 and 2020, the Company received approximately $22.4 million and $14.8 million, respectively, for units delivered for trade.
During 2021, we maintained a revolving line of credit with a borrowing limit of $60.0 million. Under this credit facility, amounts outstanding under the line bear interest at LIBOR (with a floor of 0.5%, determined as of the first day of each month) plus 1.25% (1.75% at December 31, 2021), are secured by our trade accounts receivable and mature on July 1, 2024. The credit facility also establishes an “unused fee” of 0.25% if average borrowings are less than $18.0 million. At December 31, 2021 outstanding advances on the line of credit were approximately $0.4 million, including approximately $0.3 million in letters of credit, with availability to borrow $59.6 million.
In February 2022, we borrowed $35.5 million under a term loan secured by our real estate. This term loan bears interest at a fixed rate of 2.95%, with principal and interest payable monthly, and matures on January 1, 2032. The loan is secured by mortgages and assignments of rents on the Company’s principal office and four terminal locations.
Trade accounts receivable increased from $77.7 million at December 31, 2020 to $121.9 million at December 31, 2021. The increase relates to a general increase in freight revenue and fuel surcharge revenue, which flows through the accounts receivable account, during the fourth quarter of 2021 as compared to the freight revenue and fuel surcharge revenue generated during the fourth quarter of 2020.
Marketable equity securities at December 31, 2021 increased approximately $11.5 million as compared to December 31, 2020. The increase resulted from purchases of marketable equity securities of approximately $6.4 million and an increase in the market value of the portfolio of approximately $8.2 million, offset by sales of marketable equity securities of $3.1 million. At December 31, 2021, the remaining marketable equity securities have a combined cost basis of approximately $29.4 million and a combined fair market value of approximately $39.4 million. The Company has developed a strategy to invest in securities from which it expects to receive dividends that qualify for favorable tax treatment, as well as appreciate in value. During 2021, the Company received dividends of approximately $1.4 million. The holding term of these securities depends largely on the general economic environment, the equity markets, borrowing rates, and the Company's cash requirements.
Revenue equipment at December 31, 2021, which generally consists of trucks, trailers, and revenue equipment accessories such as Qualcomm™ satellite tracking units and auxiliary power units, decreased approximately $71.6 million as compared to December 31, 2020. The decrease relates primarily to a delay in the trade-in or used trade trucks in exchange for the new replacement trucks. These delayed trades were disposed when payment was received during 2021, which reduced the balance in the Revenue equipment category.
Accounts payable decreased from $46.1 million at December 31, 2020 to $43.4 million at December 31, 2021. This decrease was primarily attributable to the decrease in amounts accrued for fixed asset purchases from $9.1 million at the end of 2020 to $0.3 million at the end of 2021. Accounts payable accruals can vary significantly at the end of each reporting period depending on the timing of the actual date of payment in relation to the last day of the reporting period.
Accrued expenses and other liabilities decreased from $26.6 million at December 31, 2020 to $14.1 million at December 31, 2021. The decrease was primarily related to the use of available cash to pay off the majority of the balance on the Company’s investment margin account.
Current maturities of long term-debt and long-term debt fluctuations are reviewed on an aggregate basis as the classification of amounts in each category are typically affected merely by the passage of time. Current maturities of long-term debt and long-term debt, on an aggregate basis, at December 31, 2021, decreased approximately $63.8 million as compared to December 31, 2020. The decrease relates primarily to the use of available cash to pay down the borrowings on our revolving line of credit and other installment notes.
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For 2022, we expect to purchase 400 new trucks and 1,000 trailers while continuing to sell or trade equipment that has reached the end of its life cycle, which we expect to result in net capital expenditures of approximately $95.1 million. Management believes we will be able to finance our existing needs for working capital over the next twelve months, as well as acquisitions of revenue equipment and any other asset acquisitions or capital transactions during such period, with cash balances, cash flows from operations, and borrowings believed to be available from financing sources. We will continue to have significant capital requirements over the long-term, which may require us to incur debt or seek additional equity capital. The availability of additional capital will depend upon prevailing market conditions, the market price of our common stock and several other factors over which we have limited control, as well as our financial condition and results of operations. Nevertheless, based on our anticipated future cash flows and sources of financing that we expect will be available to us, we do not expect that we will experience any significant liquidity constraints in the foreseeable future.
Inflation
Inflation has an impact on most of our operating costs. Over the past three years, the effect of inflation has been minimal. If the current rate of inflation persists, inflation, coupled with supply chain issues and international events could continue to result in increased costs for drivers, employee wages, equipment, fuel and other costs.
Adoption of Accounting Policies
See “Item 8. Financial Statements and Supplementary Data, Note 1 to the Consolidated Financial Statements – Accounting Policies, Recent Accounting Pronouncements.”
Critical Accounting Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to adopt accounting policies and make significant judgments and estimates that impact the amounts reported in our consolidated financial statements and accompanying notes. Therefore, the reported amounts of assets, liabilities, revenue, expenses, and associated disclosures of contingent assets and liabilities are affected by judgments and estimates. In some cases, there are alternative assumptions, policies, or estimation techniques that could be used. Management evaluates its assumptions, policies, and estimates on an ongoing basis, utilizing historical experience, and other methods considered reasonable in the particular circumstances. Nevertheless, actual results may differ significantly from our estimates and assumptions, and it is possible that materially different amounts would be reported using differing estimates or assumptions. Management considers our critical accounting estimates to be those that require more significant judgments and estimates when we prepare our consolidated financial statements.
Note 1 in Part II, Item 8 of this Annual Report describes the Company's accounting policies. The following discussion of accounting estimates should be read in conjunction with Note 1, as it provides additional insight into critical accounting estimates. Our critical accounting estimates include the following:
Depreciation and Amortization. Depreciation of trucks and trailers is calculated by the straight-line method over the assets’ estimated useful lives, which generally range from three to ten years, down to an estimated salvage value at the end of the assets’ estimated useful lives. Management must use its judgment in the selection of estimated useful lives and salvage values for purposes of this calculation. In some cases, the Company has agreements in place with certain manufacturers whereby salvage values are guaranteed by the manufacturer. In other cases, where salvage values are not guaranteed, estimates of salvage value are based on the expected market values of equipment at the time of disposal.
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The depreciation of trucks and trailers over their estimated useful lives and the determination of any salvage value also require management to make judgments about future events. Therefore, the Company’s management periodically evaluates whether changes to estimated useful lives or salvage values are necessary to ensure these estimates accurately reflect the economic reality of the assets. This periodic evaluation may result in changes in the estimated lives and/or salvage values used by the Company to depreciate its assets, which can affect the amount of periodic depreciation expense recognized and, ultimately, the gain or loss on the disposal of an asset. Future changes in our estimated useful life or salvage value estimates, or fluctuations in market value that are not reflected in current estimates, could have a material effect on the Company’s consolidated financial statements.
Claims accruals. The Company is self-insured for health and workers' compensation benefits up to certain stop-loss limits. Such costs are accrued based on known claims and an estimate of incurred but not reported (IBNR) claims. IBNR claims are estimated using historical lag information and other data either provided by outside claims administrators or developed internally. Actual claims payments may differ from management’s estimates as a result of a number of factors, including evaluation of severity, increases in legal or medical costs, and other case-specific factors. The actual claims payments are charged against the Company’s recorded accrued claims liabilities and have been historically reasonable with respect to the estimates of the liabilities made under the Company’s methodology. However, the estimation process is generally subjective, and to the extent that future actual results materially differ from original estimates made by management, adjustments to recorded accruals may be necessary which could have a material effect on the Company’s consolidated financial statements. Based upon our 2021 health and workers' compensation expenses, a 10% increase in both claims incurred and IBNR claims would increase our annual health and workers' compensation expenses by approximately $0.5 million.
On September 1, 2020, the Company elected to become self-insured for certain layers of auto liability claims in excess of $2.0 million. The Company specifically reserves for claims that are expected to exceed $2.0 million when fully developed, based on the facts and circumstances of those claims.