0000928658 COVENANT LOGISTICS GROUP, INC. false --12-31 Q3 2020 4,408 1,440 753 692 - - 0.01 0.01 40,000,000 40,000,000 16,211,918 14,784,214 16,165,145 16,165,145 0.01 0.01 5,000,000 5,000,000 2,350,000 2,350,000 2,350,000 2,350,000 1,427,704 0 12 821 226 652 56 185 2 5 1.0 5 7 10 0 0 408 10.0 4 21 2.8 3.7 1.9 3.3 0 0 1.8 2.5 0.0 0.0 1 0.4 0.4 0.4 0 0.1 49 1.2 0 0 42.5 0 0 As of September 30, 2020 we have a $1.0 million current liability related to employee separation costs. We expect to incur additional employee separation costs in the fourth quarter of 2020 related to this restructuring activity, but do not have enough information to quantify at this time. Excludes the nine months ended September 30, 2020. 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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2020

or

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                        to

 

Commission File Number: 0-24960

CVENLOGO2.JPG  

COVENANT LOGISTICS GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Nevada

88-0320154

(State or other jurisdiction of incorporation

(I.R.S. Employer Identification No.)

or organization)

 
   

400 Birmingham Hwy.

 

Chattanooga, TN

37419

(Address of principal executive offices)

(Zip Code)

 

423-821-1212

(Registrant's telephone number, including area code)

 

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

 

Title of each class Trading Symbol(s) Name of each exchange on which registered
$0.01 Par Value Class A common stock CVLG The NASDAQ Global Select Market

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes ☒

No ☐

 

Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes ☒

No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ☐

  

Accelerated filer ☒

Non-accelerated filer   ☐

Smaller reporting company ☒

 

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes ☐

No ☒


Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date (October 30, 2020).

 

Class A Common Stock, $.01 par value: 14,784,214 shares

Class B Common Stock, $.01 par value: 2,350,000 shares

 

Page 1

 

 
 

TABLE OF CONTENTS

 

PART I

FINANCIAL INFORMATION

   

Page

Number

Item 1.

Financial Statements

 
     
 

Condensed Consolidated Balance Sheets as of September 30, 2020 and December 31, 2019 (unaudited)

Page 3
     
 

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2020 and 2019 (unaudited)

Page 4
     
 

Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2020 and 2019 (unaudited)

Page 5
     
 

Condensed Consolidated Statements of Stockholders' Equity for the three and nine months ended September 30, 2020 and 2019 (unaudited)

Page 6
     
 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2020 and 2019 (unaudited)

Page 7
     
 

Notes to Condensed Consolidated Financial Statements (unaudited)

Page 8
     

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

Page 22
     

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Page 38
     

Item 4.

Controls and Procedures

Page 39
 

PART II

OTHER INFORMATION

   

Page

Number

     

Item 1.

Legal Proceedings

Page 40
     

Item 1A.

Risk Factors

Page 41
     

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Page 41
     

Item 3.

Defaults Upon Senior Securities

Page 41
     

Item 4.

Mine Safety Disclosures

Page 41
     

Item 5.

Other Information

Page 41
     

Item 6.

Exhibits

Page 42

 

Page 2

 

  

 

PART I

FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

 

COVENANT LOGISTICS GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

   

September 30, 2020

   

December 31, 2019

 
   

(unaudited)

       

ASSETS

               

Current assets:

               

Cash and cash equivalents

  $ 13,734     $ 43,591  

Accounts receivable, net of allowance of $4,408 in 2020 and $1,440 in 2019

    89,161       81,205  

Drivers' advances and other receivables, net of allowance of $753 in 2020 and $692 in 2019

    18,098       8,507  

Inventory and supplies

    3,296       4,210  

Prepaid expenses

    6,777       11,707  

Assets held for sale

    43,141       12,010  

Income taxes receivable

    5,083       5,403  

Other short-term assets

    414       1,132  
Current assets of discontinued operations     21,094       86,620  

Total current assets

    200,798       254,385  
                 

Property and equipment, at cost

    527,715       725,383  

Less: accumulated depreciation and amortization

    (140,487 )     (208,180 )

Net property and equipment

    387,228       517,203  
                 

Goodwill

    42,518       42,518  

Other intangibles, net

    25,670       29,615  

Other assets, net

    67,619       37,919  
                 

Total assets

  $ 723,833     $ 881,640  

LIABILITIES AND STOCKHOLDERS' EQUITY

               

Current liabilities:

               

Checks outstanding in excess of bank balances

  $ -     $ 592  

Accounts payable

    21,933       19,500  

Accrued expenses

    42,926       31,840  

Current maturities of long-term debt

    15,067       54,377  

Current portion of finance lease obligations

    5,964       7,258  
Current portion of operating lease obligations     17,478       19,460  

Current portion of insurance and claims accrual

    22,895       21,800  
Other short-term liabilities     824       185  
Current liabilities of discontinued operations     20,226       6,245  

Total current liabilities

    147,313       161,257  
                 

Long-term debt

    89,347       200,177  

Long-term portion of finance lease obligations

    13,190       26,010  
Long-term portion of operating lease obligations     25,635       40,882  

Insurance and claims accrual

    49,629       20,295  

Deferred income taxes

    72,672       80,330  

Other long-term liabilities

    11,251       2,578  

Total liabilities

    409,037       531,529  

Commitments and contingent liabilities

    -       -  

Stockholders' equity:

               

Class A common stock, $.01 par value; 40,000,000 shares authorized; 16,211,918 shares issued and 14,784,214 outstanding as of September 30, 2020; and 16,165,145 shares issued and outstanding as of December 31, 2019

    173       173  

Class B common stock, $.01 par value; 5,000,000 shares authorized; 2,350,000 shares issued and outstanding

    24       24  

Additional paid-in-capital

    142,896       141,885  
Treasury stock at cost; 1,427,704 and no shares as of September 30, 2020 and December 31, 2019, respectively     (17,446 )     -  

Accumulated other comprehensive loss

    (2,839 )     (1,014 )

Retained earnings

    191,988       209,043  

Total stockholders' equity

    314,796       350,111  

Total liabilities and stockholders' equity

  $ 723,833     $ 881,640  

 

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

 

Page 3

 

 

 

COVENANT LOGISTICS GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE three and nine months ended September 30, 2020 and 2019

(In thousands, except per share data)

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

(unaudited)

   

(unaudited)

 
   

2020

   

2019

   

2020

   

2019

 

Revenues

                               

Freight revenue

  $ 196,217     $ 197,377     $ 565,362     $ 583,950  

Fuel surcharge revenue

    14,613       23,082       47,971       70,882  

Total revenue

  $ 210,830     $ 220,459     $ 613,333     $ 654,832  
                                 

Operating expenses:

                               

Salaries, wages, and related expenses

    78,812       83,687       235,964       238,281  

Fuel expense

    18,061       28,812       59,264       85,858  

Operations and maintenance

    11,912       14,742       36,956       44,814  

Revenue equipment rentals and purchased transportation

    58,604       50,428       151,677       146,267  

Operating taxes and licenses

    2,979       3,170       9,555       9,719  

Insurance and claims

    13,317       14,050       40,491       35,755  

Communications and utilities

    1,306       1,790       4,657       5,268  

General supplies and expenses

    7,673       7,584       27,568       21,493  

Depreciation and amortization

    13,428       20,817       51,274       61,230  
Gain on disposition of property and equipment, net     (2,073 )     (751 )     (7,048 )     (959 )
Impairment of long lived property, equipment, and right-of-use assets     -       -       26,569       -  

Total operating expenses

    204,019       224,329       636,927       647,726  

Operating income (loss)

    6,811       (3,870 )     (23,594 )     7,106  

Interest expense, net

    1,935       2,198       5,917       6,048  

Income from equity method investment

    (1,176 )     (2,138 )     (971 )     (7,548 )

Income (loss) before income taxes

    6,052       (3,930 )     (28,540 )     8,606  

Income tax expense (benefit)

    1,339       112       (7,000 )     3,645  
Income (loss) from continuing operations     4,713       (4,042 )     (21,540 )     4,961  
Income from discontinued operations, net of tax     2,788       853       4,485       2,354  

Net income (loss)

  $ 7,501     $ (3,189 )   $ (17,055 )   $ 7,315  
                                 
Basic income (loss) per share:                                

Income (loss) from continuing operations

  $ 0.28     $ (0.22 )   $ (1.24 )   $ 0.27  
Income from discontinued operations     0.16       0.05       0.26       0.13  
Net income (loss)(1)   $ 0.44     $ (0.17 )   $ (0.98 )   $ 0.40  
Diluted income (loss) per share:                                
Income (loss) from continuing operations   $ 0.27     $ (0.22 )   $ (1.24 )   $ 0.27  
Income from discontinued operations     0.16       0.05       0.26       0.13  
Net income (loss)(1)   $ 0.43     $ (0.17 )   $ (0.98 )   $ 0.39  

Basic weighted average shares outstanding

    17,134       18,458       17,435       18,426  

Diluted weighted average shares outstanding

    17,267       18,458       17,435       18,620  

 

(1) Sum of the individual amounts may not add due to rounding.

 

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

 

Page 4

 

 

 

COVENANT LOGISTICS GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

FOR THE three and nine months ended September 30, 2020 and 2019

(Unaudited and in thousands)

 

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2020

   

2019

   

2020

   

2019

 
                                 

Net income (loss)

  $ 7,501     $ (3,189 )   $ (17,055 )   $ 7,315  
                                 

Other comprehensive income (loss):

                               
                                 

Unrealized loss on effective portion of cash flow hedges, net of tax of $12 and $821 in 2020 and $226 and $652 in 2019, respectively

    (34 )     (596 )     (2,398 )     (1,720 )
                                 

Reclassification of cash flow hedge losses (gains) into statement of operations, net of tax of ($56) and ($185) in 2020 and ($2) and $5 in 2019, respectively

    163       5       541       (14 )
                                 

Unrealized holding (loss) gain on investments classified as available-for-sale

    (4 )     26       33       47  

Total other comprehensive income (loss)

    125       (565 )     (1,824 )     (1,687 )
                                 

Comprehensive income (loss)

  $ 7,626     $ (3,754 )   $ (18,879 )   $ 5,628  

 

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

 

Page 5

 

 

 

COVENANT LOGISTICS GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

FOR THE three and nine months ended September 30, 2020 and 2019

(Unaudited and in thousands)

 

   

For the Three and Nine Months Ended September 30, 2020

 
                                   

Accumulated

                 
                   

Additional

           

Other

           

Total

 
   

Common Stock

   

Paid-In

   

Treasury

   

Comprehensive

   

Retained

   

Stockholders'

 
   

Class A

   

Class B

   

Capital

   

Stock

   

Loss

   

Earnings

   

Equity

 

Balances at December 31, 2019

  $ 173     $ 24     $ 141,885     $ -     $ (1,014 )   $ 209,043     $ 350,111  

Net loss

    -       -       -       -       -       (2,213 )     (2,213 )
Other comprehensive loss     -       -       -       -       (2,350 )     -       (2,350 )

Share repurchase

    -       -       -       (17,515 )     -       -       (17,515 )

Stock-based employee compensation expense

    -       -       466       -       -       -       466  

Issuance of restricted shares, net

    -       -       (6 )     -       -       -       (6 )

Balances at March 31, 2020

  $ 173     $ 24     $ 142,345     $ (17,515 )   $ (3,364 )   $ 206,830     $ 328,493  
Net loss     -       -       -       -       -       (22,343 )     (22,343 )

Other comprehensive income

    -       -       -       -       400       -       400  
Share repurchase     -       -       -       29       -       -       29  
Stock-based employee compensation expense     -       -       355       -       -       -       355  
Issuance of restricted shares, net     -       -       (43 )     40       -       -       (3 )
Balances at June 30, 2020   $ 173     $ 24     $ 142,657     $ (17,446 )   $ (2,964 )   $ 184,487     $ 306,931  
Net income     -       -       -             -       7,501       7,501  
Other comprehensive income     -       -       -             125       -       125  
Stock-based employee compensation expense     -       -       298             -       -       298  
Issuance of restricted shares, net     -       -       (59 )           -       -       (59 )
Balances at September 30, 2020   $ 173     $ 24     $ 142,896     $ (17,446 )   $ (2,839 )   $ 191,988     $ 314,796  

 

   

For the Three and Nine Months Ended September 30, 2019

 
                                   

Accumulated

                 
                   

Additional

           

Other

           

Total

 
   

Common Stock

   

Paid-In

   

Treasury

   

Comprehensive

   

Retained

   

Stockholders'

 
   

Class A

   

Class B

   

Capital

   

Stock

   

Income (Loss)

   

Earnings

   

Equity

 

Balances at December 31, 2018

  $ 171     $ 24     $ 142,177     $ -     $ 204     $ 200,566     $ 343,142  

Net income

    -       -       -       -       -       4,433       4,433  

Other comprehensive loss

    -       -       -       -       (432 )     -       (432 )

Stock-based employee compensation expense

    -       -       1,262       -       -       -       1,262  

Issuance of restricted shares, net

    1       -       (669 )     -       -       -       (668 )

Balances at March 31, 2019

  $ 172     $ 24     $ 142,770     $ -     $ (228 )   $ 204,999     $ 347,737  
Net income     -       -       -       -       -       6,071       6,071  
Other comprehensive loss     -       -       -       -       (690 )     -       (690 )
Stock-based employee compensation expense reversal     -       -       (1,433 )     -       -       -       (1,433 )
Issuance of restricted shares, net     -       -       -       -       -       -       -  
Balances at June 30, 2019   $ 172     $ 24     $ 141,337     $ -     $ (918 )   $ 211,070     $ 351,685  
Net loss     -       -       -       -       -       (3,189 )     (3,189 )
Other comprehensive loss     -       -       -       -       (565 )     -       (565 )
Stock-based employee compensation expense     -       -       597       -       -       -       597  
Issuance of restricted shares, net     -       -       (94 )     -       -       -       (94 )
Balances at September 30, 2019   $ 172     $ 24     $ 141,840     $ -     $ (1,483 )   $ 207,881     $ 348,434  

 

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

 

Page 6

 

 

 

COVENANT LOGISTICS GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE nine months ended September 30, 2020 and 2019

(Unaudited and in thousands)

 

    Nine Months Ended September 30,  
   

2020

   

2019

 
Cash flows from operating activities:                

Net (loss) income

  $ (17,055 )   $ 7,315  

Adjustments to reconcile net (loss) income to net cash provided by operating activities:

               

Provision for accounts receivable

    3,211       13  

Reversal of gain on sales to equity method investee

    (77 )     (7 )

Depreciation and amortization

    51,281       61,250  
Impairment of property and equipment     26,569       -  

Amortization of deferred financing fees

    154       110  

Deferred income tax (benefit) expense

    (7,138 )     4,632  

Income tax benefit arising from restricted share vesting and stock options exercised

    81       4  

Stock-based compensation expense

    1,120       426  

Income from equity method investment

    (971 )     (7,548 )
Return on investment in affiliated company     -       1,225  

Gain on disposition of property and equipment

    (7,019 )     (2,137 )
Gain on disposition of reportable segment     (3,720 )     -  

Return on investment in available-for-sale securities

    -       (4 )

Changes in operating assets and liabilities:

               

Receivables and advances

    (72,413 )     (9,099 )

Prepaid expenses and other assets

    5,756       (977 )

Inventory and supplies

    914       (111 )
Insurance and claims accrual     30,428       539  

Accounts payable and accrued expenses

    13,836       (15,828 )

Net cash flows provided by operating activities

    24,957       39,803  
                 
Cash flows from investing activities:                
Purchase of available-for-sale securities     (319 )     (1,380 )

Acquisition of property and equipment

    (63,614 )     (129,403 )

Proceeds from disposition of reportable segment

    108,375       -  

Proceeds from disposition of property and equipment

    86,555       31,235  

Net cash flows provided by (used in) investing activities

    130,997       (99,548 )
                 

Cash flows from financing activities:

               

Change in checks outstanding in excess of bank balances

    (592 )     (664 )

Proceeds from issuance of notes payable

    65,457       102,796  

Repayments of notes payable

    (215,750 )     (30,538 )

Repayments of finance lease obligations

    (17,372 )     (4,232 )

Proceeds under revolving credit facility

    1,091,966       1,257,755  

Repayments under revolving credit facility

    (1,091,966 )     (1,247,942 )

Payment of minimum tax withholdings on stock compensation

    (68 )     (762 )
Common stock repurchased     (17,486 )     -  

Net cash flows (used in) provided by financing activities

    (185,811 )     76,413  
                 

Net change in cash and cash equivalents

    (29,857 )     16,668  
                 
Cash and cash equivalents at beginning of period     43,591       23,127  
Cash and cash equivalents at end of period   $ 13,734     $ 39,795  

 

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

 

Page 7

 

 

COVENANT LOGISTICS GROUP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Note 1.

Significant Accounting Policies

 

Basis of Presentation

 

On July 1, 2020, the stockholders of Covenant Transportation Group, Inc. approved the amendment to the organization’s Articles of Incorporation to change the Company’s name to Covenant Logistics Group, Inc. All references herein reflect the change of name to Covenant Logistics Group, Inc.

 

The condensed consolidated financial statements include the accounts of Covenant Logistics Group, Inc., a Nevada holding company, and its wholly owned subsidiaries. References in this report to "we," "us," "our," the "Company," and similar expressions refer to Covenant Logistics Group, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X promulgated under the Securities Act of 1933. In preparing financial statements, it is necessary for management to make assumptions and estimates affecting the amounts reported in the condensed consolidated financial statements and related notes. These estimates and assumptions are developed based upon all information available. Actual results could differ from estimated amounts. In the opinion of management, the accompanying financial statements include all adjustments that are necessary for a fair presentation of the results for the interim periods presented, such adjustments being of a normal recurring nature.

 

Certain information and footnote disclosures have been condensed or omitted pursuant to such rules and regulations. The December 31, 2019, condensed consolidated balance sheet was derived from our audited balance sheet as of that date. Our operating results are subject to seasonal trends when measured on a quarterly basis; therefore operating results for the nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. These condensed consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes thereto included in our Form 10-K for the year ended December 31, 2019. Results of operations in interim periods are not necessarily indicative of results to be expected for a full year.

 

Change in Estimates

 

The Company reviews the estimated useful lives and salvage values of its assets on an ongoing basis, based upon, among other things, our experience with similar assets, conditions in the used revenue equipment market, and prevailing industry practice. During the second quarter of 2020, the Company adjusted the useful lives of certain intangible finite-lived assets, including the Landair trade name and non-compete agreement, and certain revenue equipment held under operating leases as the result of management changes, a change in the branding of the organization, and the forward looking use of these assets. These changes are being treated as a change in accounting estimate, which during the nine months ended September 30, 2020, resulted in an increase in depreciation and amortization expense of approximately $3.2 million, or a $2.2 million, or $0.13, per diluted share decrease to net income.

 

 

Risks and Uncertainties

 

In March 2020, the World Health Organization declared the COVID-19 outbreak a global pandemic, and the President of the United States declared the COVID-19 a national emergency. In view of the rapidly changing business environment, unprecedented market volatility and heightened degree of uncertainty resulting from COVID-19, we are currently unable to fully determine its future impact on our business. However, we are continuing to monitor the progression of the pandemic, further government response and development of treatments and vaccines and their potential effect on our financial position, results of operations, cash flows and liquidity. These events could have an impact in future periods on certain estimates used in the preparation of our third quarter financial results, including, but not limited to impairment of goodwill, other intangible assets and other long-lived assets, income tax provision and recoverability of certain receivables. Should the pandemic continue for an extended period of time, the impact on our operations could have a material adverse effect on our financial condition, results of operations, cash flows and liquidity.

 

Our insurance program includes multi-year policies with specific insurance limits that may be eroded over the course of the policy term. If that occurs, we will be operating with less liability coverage insurance at various levels of our insurance tower. For the current policy period ( April 1, 2018 to March 31, 2021), aggregate limits available in the coverage layer $9.0 million in excess of $1.0 million are estimated to be fully eroded based on current claims expense accruals, which could lead to volatility in our insurance and claims expense. As a result, any increases to existing claims, and/or new claims filed prior to March 31, 2021, may require additional expense accruals. Due to developments, we may experience additional expense accruals, increased insurance and claims expenses, which could have a material adverse effect on our business, financial condition, and results of operations. We maintain insurance to cover liabilities arising from the transportation of freight for amounts in excess of certain self-insured retentions. In management's opinion, our potential exposure under pending legal proceedings is adequately provided for in the accompanying condensed consolidated financial statements. Due to these developments, we may experience additional expense accruals, increased insurance and claims expenses, and greater volatility in our insurance and claims expenses, which could have a material adverse effect on our business, financial condition, and results of operations.

 

Page 8

 

On July 8, 2020, we sold a portfolio of accounts receivable, contract rights, and associated assets consisting of approximately $103.3 million in net funds employed (the “Portfolio”) previously held by Transport Financial Services ("TFS"), a division of Covenant Transport Solutions, LLC, an indirect wholly owned subsidiary of the Company, to a subsidiary of Triumph Bancorp, Inc. ("Triumph") for approximately $122.3 million, consisting of $108.4 million in cash and $13.9 million in Triumph stock, plus an earn-out opportunity of up to $9.9 million. After the transaction closed, the Company and Triumph became involved in a dispute over the nature of approximately $66.0 million of the assets included in the Portfolio. The dispute was resolved on September 23, 2020 with an amendment of the purchase agreement and related funding arrangements that reduced the purchase price of the Portfolio to approximately $108.4 million, representing the cash amount received by us at closing. Additionally, the earnout opportunity was terminated and we are required to sell the Triumph stock we received at closing and will deliver the net proceeds to Triumph. In October 2020, the Company sold the Triumph stock acquired as part of the amended purchase agreement for $28.1 million and remitted the proceeds to Triumph upon settlement. The amended purchase agreement resulted in a gain on the sale of the Portfolio of $3.7 million, net of related expenses.

 

The amended purchase agreement specifically identified approximately $62.0 million accounts within the Portfolio, which related to advances on services that had not yet been performed, were placed in a loss sharing pool to be repaid with proceeds other than those generated from ordinary working capital factoring. To the extent losses on covered accounts are incurred, we will indemnify Triumph on a dollar for dollar basis for up to the first $30.0 million of losses, and on a 50% basis for up to the next $30.0 million of losses, for total indemnification exposure of up to $45.0 million.

 

To date no indemnification obligations have been required to be funded and the Company and Triumph are cooperating to manage the covered accounts and assist the clients with, among other things, operational improvements in an attempt to minimize losses on the covered accounts. We have not recorded a liability for our indemnification obligations as of September 30, 2020, as we lack the information necessary to determine a probable amount. We will record liabilities, if any, when they become probable and capable of estimation. The accrual of material liabilities and payment of amounts with respect to the indemnification obligations could create volatility in our reported future financial results and could have an adverse effect on our results of operations, cash flows, available liquidity, and total indebtedness.

 

Property and Equipment

 

Property and equipment is stated at cost less accumulated depreciation. Depreciation for book purposes is determined using the straight-line method over the estimated useful lives of the assets, while depreciation for tax purposes is generally recorded using an accelerated method. Depreciation of revenue equipment is our largest item of depreciation. We have historically depreciated new tractors over five years to salvage values of approximately 15% of their cost. We generally depreciate new trailers over seven years for refrigerated trailers and ten years for dry van trailers to salvage values of approximately 25% of their cost. We review, at least annually, the reasonableness of our estimates regarding useful lives and salvage values of our revenue equipment and other long-lived assets based upon, among other things, our experience with similar assets, conditions in the used revenue equipment market, and prevailing industry practice. Changes in the useful life or salvage value estimates, or fluctuations in market values that are not reflected in our estimates, could have a material effect on our results of operations.

 

Recent Accounting Pronouncements

 

Accounting Standards not yet adopted

 

In June 2016, FASB issued ASU 2016-13, Financial Instruments - Measurement of Credit Losses on Financial Instruments, which will require an entity to measure credit losses for certain financial instruments and financial assets, including trade receivables. Under this update, on initial recognition and at each reporting period, an entity will be required to recognize an allowance that reflects the entity’s current estimate of credit losses expected to be incurred over the life of the financial instrument. This update will be effective for our annual reporting period beginning January 1, 2023, including interim periods within that reporting period. Early adoption is permitted. We are currently evaluating the impacts the adoption of this standard will have on the consolidated financial statements.

 

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Note 2.

Income (Loss) Per Share

 

Basic income (loss) per share excludes dilution and is computed by dividing earnings available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted income (loss) per share reflects the dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in our earnings. There were 133,000 and 261,000 shares issuable upon conversion of unvested restricted shares for the three months ended  September 30, 2020 and September 30, 2019, respectively, and approximately 216,000 shares and 194,000 shares issuable upon conversion of unvested restricted shares for the nine months ended September 30, 2020 and September 30, 2019, respectively. Of such shares, 261,000 shares and 216,000 shares for the three months ended September 30, 2019 and the nine months ended September 30, 2020, respectively, were not included in the computation of the diluted loss per share for the same periods as the inclusion would have been anti-dilutive due to the net loss. There were no outstanding stock options at September 30, 2020 or September 30, 2019. Income per share is the same for both Class A and Class B shares.

 

The following table sets forth, for the periods indicated, the calculation of net income (loss) per share included in the condensed consolidated statements of operations:

 

(in thousands except per share data)

 

Three Months Ended

   

Nine Months Ended

 
   

September 30,

   

September 30,

 
   

2020

   

2019

   

2020

   

2019

 

Numerators:

                               
Income (loss) from continuing operations   $ 4,713     $ (4,042 )   $ (21,540 )   $ 4,961  
Income from discontinued operations     2,788       853       4,485       2,354  

Net income (loss)

  $ 7,501     $ (3,189 )   $ (17,055 )   $ 7,315  

Denominator:

                               

Denominator for basic income (loss) per share – weighted-average shares

    17,134       18,458       17,435       18,426  

Effect of dilutive securities:

                               

Equivalent shares issuable upon conversion of unvested restricted shares

    133       -       -       194  

Denominator for diluted income (loss) per share adjusted weighted-average shares and assumed conversions

    17,267       18,458       17,435       18,620  
                                 

Basic income (loss) per share:

                               

Income (loss) from continuing operations

  $ 0.28     $ (0.22 )   $ (1.24 )   $ 0.27  
Income from discontinued operations     0.16       0.05       0.26       0.13  
Net income (loss)(1)   $ 0.44     $ (0.17 )   $ (0.98 )   $ 0.40  
Diluted income (loss) per share:                                
Income (loss) from continuing operations   $ 0.27     $ (0.22 )   $ (1.24 )   $ 0.27  
Income from discontinued operations     0.16       0.05       0.26       0.13  
Net income (loss)(1)   $ 0.43     $ (0.17 )   $ (0.98 )   $ 0.39  

 

(1Sum of the individual amounts may not add due to rounding.

Page 10

 

 

 

Note 3.

Discontinued Operations

 

As of June 30, 2020, our Factoring reportable segment was classified as discontinued operations as it: (i) was a component of the entity, (ii) met the criteria as held for sale, and (iii) had a material effect on the Company's operations and financial results. On July 8, 2020, we closed on the disposition of substantially all of the operations and assets of TFS, which included substantially all of the assets and operations of our Factoring reportable segment. The sale consisted primarily of $103.3 million of net accounts receivable, which included $108.7 million of gross accounts receivable, less advances and rebates of $5.4 million. 

 

We have reflected the former Factoring reportable segment as discontinued operations in the condensed consolidated statements of operations for all periods presented. Prior periods have been adjusted to conform to the current presentation.

 

The following table summarizes the results of our discontinued operations for the three and nine months ended September 30, 2020 and 2019:

(in thousands)   Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2020     2019     2020     2019  
Total revenue   $ 142     $ 2,455     $ 5,397     $ 6,561  
Operating expenses     (3,601 )     515       (2,571 )     1,327  
Operating income     3,743       1,940       7,968       5,234  
Interest expense     -       794       1,948       2,073  
Income before income taxes     3,743       1,146       6,020       3,161  
Income tax expense     955       293       1,535       807  
Net income from discontinued operations, net of tax    $ 2,788     $ 853     $ 4,485     $ 2,354  

 

Operating expenses for the three and nine months ended September 30, 2020 include the $3.7 million gain on disposition of the Factoring segment Portfolio.

 

Interest expense not directly attributable to or related to other operations has been allocated to discontinued operations in a manner consistent with debt needed to finance the net average funds employed by the Factoring reportable segment, multiplied by the Company’s weighted average interest rate.

The following table summarizes the major classes of assets and liabilities included as discontinued operations as of  September 30, 2020 and December 31, 2019:

(in thousands)

 

September 30, 2020

   

December 31, 2019

 

Current assets:

               

Accounts receivable, net of allowance of $0 in 2020 and $408 in 2019

  $ -     $ 86,620  
Other short-term assets     21,094       -  

Current assets of discontinued operations

    21,094       86,620  
                 

Current liabilities:

               

Accounts payable

    20,226       6,245  

Current liabilities of discontinued operations

  $ 20,226     $ 6,245  

 

In accordance with the amended purchase agreement, $19.6 million was recorded as an asset and liability for the fair market value of the Triumph stock received that is payable to Triumph. In October 2020, the Company sold the Triumph stock acquired as part of the amended purchase agreement for $28.1 million and remitted the proceeds to Triumph upon settlement.

 

The net cash flows for operating activities related to discontinued operations provided $10.0 million and used $25.9 million for the nine months ended September 30, 2020 and 2019, respectively. There were $108.4 million investing and no financing cash flows related to discontinued operations for the nine months September 30, 2020 and no investing or financing cash flows related to discontinued operations for the same period in 2019.

 

The following unaudited summary information is presented on a consolidated pro forma basis as if the Factoring assets were sold as of January 1, 2019.

 

(in thousands)   Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2020     2019     2020     2019  
Total revenue   $ 210,830     $ 220,459     $ 613,333     $ 654,832  
Income (loss) from continuing operations     4,713       (4,042 )     (21,540 )     4,961  
Income (loss) per basic share from continuing operations   $ 0.28     $ (0.22 )   $ (1.24 )   $ 0.27  
Income (loss) per diluted share from continuing operations   $ 0.27     $ (0.22 )   $ (1.24 )   $ 0.27  

 

Refer to Note 1, “Significant Accounting Policies” of the accompanying condensed consolidated financial statements for further information about the amended TFS purchase agreement. 

 

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Note 4.

Segment Information

 

Until the second quarter of 2020, we had four reportable segments, Highway Services, Dedicated, Managed Freight, and Factoring. As discussed in Note 3, our Factoring reportable segment was classified as discontinued operations as of June 30, 2020. As of September 30, 2020, the segment formerly known as Highway Services is now reflected as Expedited, given the change in business mix surrounding the exit of the majority of the solo-refrigerated business in the second quarter of 2020. In addition, given management changes and growth, we have reported Warehousing as a separate reportable segment from Managed Freight. We believe the updated reportable segments reflect our service offerings, strategic direction, and how management, including our chief operating decision makers, monitors our performance.

 

Our four reportable segments are as follows:

 

 

Expedited: The Expedited segment primarily provides truckload services to customers with high service freight and delivery standards, such as 1,000 miles in 22 hours, or 15-minute delivery windows. Expedited services generally require two-person driver teams on equipment either owned or leased by the Company.

 

 

Dedicated: The Dedicated segment provides customers with committed truckload capacity over contracted periods using equipment either owned or leased by the Company.

 

 

Managed Freight: The Managed Freight segment includes our brokerage and transport management services (“TMS”). Brokerage services provide logistics capacity by outsourcing the carriage of customers’ freight to third parties. TMS provides comprehensive logistics services on a contractual basis to customers who prefer to outsource their logistics needs. 

 

 

Warehousing: The Warehousing segment provides day-to-day warehouse management services to customers who have chosen to outsource this function.

 

The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies in our 2019 Form 10-K. Substantially all intersegment sales prices are market based. We evaluate performance based on operating income of the respective business units.

 

The following table summarizes our total revenue by our four reportable segments, as used by our chief operating decision makers in making decisions regarding allocation of resources etc., for the three and nine months ended September 30, 2020 and 2019:

 

(in thousands)

 

Three Months Ended

   

Nine Months Ended

 
   

September 30,

   

September 30,

 
   

2020

   

2019

   

2020

   

2019

 

Revenues:

                               

Expedited

  $ 78,410     $ 87,674     $ 244,347     $ 265,664  

Dedicated

    71,104       87,284       218,833       257,362  

Managed Freight

    47,594       33,339       112,695       95,725  

Warehousing

    13,722       12,162       37,458       36,081  

Total revenues

  $ 210,830     $ 220,459     $ 613,333     $ 654,832  

 

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Note 5.

Income Taxes

 

Income tax expense in both 2020 and 2019 varies from the amount computed by applying the federal corporate income tax rates of 21% to income before income taxes, primarily due to state income taxes, net of federal income tax effect, adjusted for permanent differences, the most significant of which is the effect of the per diem pay structure for drivers. Drivers who meet the requirements to receive per diem receive non-taxable per diem pay in lieu of a portion of their taxable wages. This per diem program increases our drivers' net pay per mile, after taxes, while decreasing gross pay, before taxes. As a result, salaries, wages, and related expenses are slightly lower and our effective income tax rate is higher than the statutory rate. Generally, as pre-tax income increases, the impact of the driver per diem program on our effective tax rate decreases, because aggregate per diem pay becomes smaller in relation to pre-tax income, while in periods where earnings are at or near breakeven the impact of the per diem program on our effective tax rate is significant. Due to the partially nondeductible effect of per diem pay, our tax rate will fluctuate in future periods based on fluctuations in earnings.

 

Our liability recorded for uncertain tax positions as of  September 30, 2020 has increased by less than $0.2 million since December 31, 2019.

 

The net deferred tax liability of $72.7 million primarily relates to differences in cumulative book versus tax depreciation of property and equipment, partially off-set by net operating loss carryovers and insurance claims that have been reserved but not paid. The carrying value of our deferred tax assets assumes that we will be able to generate, based on certain estimates and assumptions, sufficient future taxable income in certain tax jurisdictions to utilize these deferred tax benefits. If these estimates and related assumptions change in the future, we may be required to establish a valuation allowance against the carrying value of the deferred tax assets, which would result in additional income tax expense. On a periodic basis, we assess the need for adjustment of the valuation allowance. Based on forecasted taxable income resulting from the reversal of deferred tax liabilities, primarily generated by accelerated depreciation for tax purposes in prior periods, and tax planning strategies available to us, a valuation allowance has been established at September 30, 2020, for $0.4 million related to certain state net operating loss carryforwards. If these estimates and related assumptions change in the future, we may be required to modify our valuation allowance against the carrying value of the deferred tax assets.

 

On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The CARES Act, among other things, includes provisions for refundable payroll tax credits, deferral of employer-side social-security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations, and technical corrections to tax depreciation methods for qualified improvement property. Although the Company is still assessing the impact of the legislation, we do not expect there to be a material income tax impact to our consolidated financial statements at this time.

 

 

Note 6.

Restructuring and Cost Savings Initiatives

 

In the second quarter of 2020, we made significant changes to our operational business units, overhead structure and branding strategy in an effort to streamline our business in a manner that we believe will allow us to significantly lower our fixed costs, pay down debt and produce consistent acceptable margins. These changes include (i) a reduction in our fleet of tractors and refrigerated trailers, which have historically produced unacceptable or unprofitable operating income, (ii) reallocation of our operating fleet toward our more profitable expedited, dedicated and irregular route operations, (iii) the sale of our Hutchins, Texas terminal and discontinued use of our Texarkana, Arkansas terminal, (iv) changes to key management and reductions to headcount, (v) the closure and early termination of our leased office space in Chattanooga, Tennessee that our brokerage group occupied, (vi) the installation of new operational processes allowing us to abandon or discontinue the use of a number of peripheral information technology infrastructure and applications and (vii) a change in our branding strategy to focus on one company name, phasing out the use of the Landair trade name.

 

Although the significant majority of restructuring and cost savings initiatives were completed in the second quarter of 2020, we incurred additional costs in the third quarter of 2020 and anticipate additional costs in the fourth quarter of 2020, as we continue to optimize our fleet profile and management team.

 

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In the second quarter of 2020 we discontinued the use of a significant amount of property and equipment, including assets owned and held under operating leases. We adjusted the carrying value of the owned property and equipment down to fair market value less estimated costs of disposal and classified them as available held for sale as of June 30, 2020. We expect to sell all the assets within the next twelve months. We terminated the lease agreement on a leased office facility in Chattanooga, TN during the second quarter of 2020 and recognized the related loss on the termination of the right of use asset and the abandonment of leasehold improvements within the impairment of property and equipment line item of the condensed consolidated statement of operations. The following table provides a summary of the asset groups impaired, amount of the impairment and a description of the valuation technique used to determine fair value. We believe that these impairment activities are substantially complete. Accordingly, we incurred no additional charges during the third quarter of 2020 and do not expect to incur additional charges in connection with this activity.  

 

(in thousands)

 

Description

  Three months ended September 30, 2020  

Nine months ended September 30, 2020

  Segment(s) Impacted

Value Determination

Revenue equipment

  $ -   $ 16,779   Expedited and Dedicated

Third Party Market Appraisal

Terminal facility, leasehold improvements, and equipment, Texarkana, AR

    -     7,319   Expedited and Dedicated

Third Party Market Appraisal

Leased office facility, Chattanooga, TN

    -     2,236   Managed Freight

Loss on ROU Asset and Leasehold Improvements

Training and orientation center, Chattanooga, TN

    -     235   Expedited and Dedicated

Quoted Market Price

Impairment of right-of-use asset, long lived properties, and equipment

  $ -   $ 26,569      

 

Other restructuring related gains and charges incurred during the three and nine-months ended September 30, 2020 are summarized in the table below. Unless noted below, we believe that these other restructuring related gains and charges are substantially complete. Accordingly, we do not expect to incur additional charges in connection with this activity.

 

(in thousands)

 

    Three months ended   Nine months ended      

Description

  September 30, 2020  

September 30, 2020

  Segment(s) Impacted

Statement of Operations Line Item

Gain on sale of Hutchins, TX terminal

  $ -   $ (5,712 ) Expedited and Dedicated

Gain on disposition of property and equipment, net

Employee separation costs (1)     1,000     2,791   Expedited, Dedicated and Managed Freight Salaries, wages, and related expenses

Abandonment of information technology infrastructure and applications

    -     1,048   Expedited and Dedicated Gain on disposition of property and equipment, net
Change in useful life/abandonment of intangible assets     -     1,331   Dedicated, Managed Freight, and Warehousing Depreciation and amortization
Abandonment of revenue equipment held under operating leases     -     825   Expedited and Dedicated Revenue equipment rentals and purchased transportation
Contract exit costs and restructuring related costs and professional fees     -     695   Expedited and Dedicated

General supplies and expenses

Total

  $ 1,000   $ (978 )    

 

(1) As of September 30, 2020, we have a $1.6 million current liability related to employee separation costs. We expect to incur less than $1.0 million of additional employee separation costs in the fourth quarter of 2020 related to this restructuring activity.

 

Page 14

 
 

Note 7.

Debt

 

Current and long-term debt and lease obligations consisted of the following at  September 30, 2020 and December 31, 2019:

 

(in thousands)

 

September 30, 2020

   

December 31, 2019

 
   

Current

   

Long-Term

   

Current

   

Long-Term

 

Borrowings under Credit Facility

  $ -     $ -     $ -     $ -  
Borrowings under the Draw Note     -       -       -       -  

Revenue equipment installment notes; weighted average interest rate of 2.8% at September 30, 2020, and 3.7% at December 31, 2019, due in monthly installments with final maturities at various dates ranging from October 2020 to October 2024, secured by related revenue equipment

    13,939       67,528       53,431       177,514  

Real estate notes; interest rate of 1.9% at September 30, 2020 and 3.3% at December 31, 2019 due in monthly installments with a fixed maturity at August 2035, secured by related real estate

    1,128       21,819       1,093       22,670  

Deferred loan costs

    -       -       (147 )     (7 )

Total debt

    15,067       89,347       54,377       200,177  

Principal portion of finance lease obligations, secured by related revenue equipment

    5,964       13,190       7,258       26,010  

Principal portion of operating lease obligations, secured by related revenue equipment

    17,478       25,635       19,460       40,882  

Total debt and lease obligations

  $ 38,509     $ 128,172     $ 81,095     $ 267,069  

 

We and substantially all of our subsidiaries are parties to the Credit Facility with Bank of America, N.A., as agent (the "Agent") and JPMorgan Chase Bank, N.A. (together with the Agent, the "Lenders"). On October 23, 2020, we amended and extended the Credit Facility (the “Eighteenth Amendment”). The Credit Facility is a $110.0 million revolving credit facility (increased from $95.0 million by the Eighteenth Amendment), with an uncommitted accordion feature that, so long as no event of default exists, allows us to request an increase in the revolving credit facility of up to $50.0 million subject to Lender acceptance of the additional funding commitment. The Credit Facility includes a letter of credit sub facility in an aggregate amount of $105.0 million (increased from $95.0 million by the Eighteenth Amendment) and a swing line sub facility in an aggregate amount equal to the greater of $10.0 million or 10% of the Lenders' aggregate commitments under the Credit Facility from time-to-time. The Credit Facility matures in October 2025 (extended from September 2021 by the Eighteenth Amendment).

 

Borrowings under the Credit Facility are classified as either "base rate loans" or "LIBOR loans." Base rate loans accrue interest at a base rate equal to the greater of the Agent’s prime rate, the federal funds rate plus 0.5%, or LIBOR plus 1.0%, plus an applicable margin ranging from 0.25% to 0.75% (decreased from a range of 0.5% to 1.0% by the Eighteenth Amendment); while LIBOR loans accrue interest at LIBOR, plus an applicable margin ranging from 1.25% to 1.75% (decreased from a range of 1.5% to 2.0% by the Eighteenth Amendment). The applicable rates are adjusted quarterly based on average pricing availability. The unused line fee is the product of 0.25% times the average daily amount by which the Lenders' aggregate revolving commitments under the Credit Facility exceed the outstanding principal amount of revolver loans and the aggregate undrawn amount of all outstanding letters of credit issued under the Credit Facility. The obligations under the Credit Facility are guaranteed by us and secured by a pledge of substantially all of our assets, with the notable exclusion of any real estate or revenue equipment pledged under other financing agreements, including revenue equipment installment notes and finance leases.

 

Borrowings under the Credit Facility are subject to a borrowing base limited to the lesser of (A) $110.0 million (increased from $95.0 million by the Eighteenth Amendment), minus the sum of the stated amount of all outstanding letters of credit; or (B) the sum of (i) 87.5% (increased from 85% by the Eighteenth Amendment) of eligible accounts receivable, plus (ii) the least of (a) 85% of the appraised net orderly liquidation value of eligible revenue equipment, (b) 100% (increased from 95% by the Eighteenth Amendment) of the net book value of eligible revenue equipment, (c) 40.9% (increased from 35% by the Eighteenth Amendment) of the Lenders' aggregate revolving commitments under the Credit Facility, or (d) following the Eighteenth Amendment, $45.0 million, plus (iii) the lesser of (a) $10.4 million (as of the date of the Eighteenth Amendment) or (b) 80% (increased from 75% by the Eighteenth Amendment) of the appraised fair market value of eligible real estate, as reduced by a periodic amortization amount. We had no outstanding borrowings under the Credit Facility as of September 30, 2020, undrawn letters of credit outstanding of approximately $36.7 million, and available borrowing capacity of $58.3 million. As of September 30, 2020, there were no outstanding base rate or LIBOR loans. Based on availability as of September 30, 2020 and 2019, there was no fixed charge coverage requirement.

 

Page 15

 

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. If an event of default occurs under the Credit Facility and the Lenders cause, or have the ability to cause, all of the outstanding debt obligations under the Credit Facility to become due and payable, this could result in a default under other debt instruments that contain acceleration or cross-default provisions. The Credit Facility contains certain restrictions and covenants relating to, among other things, debt, dividends, liens, acquisitions and dispositions outside of the ordinary course of business, and affiliate transactions. Failure to comply with the covenants and restrictions set forth in the Credit Facility could result in an event of default. 

 

In connection with the TFS Settlement, on September 23, 2020, TBK Bank, SSB, as lender and agent for Triumph (“TBK Bank”), provided the Company with a $45 million line of credit (the “Draw Note”), the proceeds of which are to be used solely to satisfy our indemnification obligations under the TFS Settlement. We may borrow pursuant to the Draw Note until September 23, 2025. Any amount outstanding under the Draw Note will accrue interest at a per annum rate equal to one and one-half (1.5) percentage points over LIBOR, provided, however, that LIBOR shall be deemed to be at least 0.25%.  Accrued interest is due monthly and the outstanding principal balance is due on September 23, 2026. To secure our obligations under the TFS Settlement and the Draw Note, we pledged certain unencumbered revenue equipment with an estimated net orderly liquidation value of $60 million. The Draw Note includes usual and customary events of default for a facility of this nature and provides that, upon occurrence and continuation of an event of default, payment of all amounts payable under the Draw Note may be accelerated.

 

Pricing for the revenue equipment installment notes is quoted by the respective financial affiliates of our primary revenue equipment suppliers and other lenders at the funding of each group of equipment acquired and include fixed annual rates for new equipment under retail installment contracts. The notes included in the funding are due in monthly installments with final maturities at various dates ranging from  October 2020 to October 2024. The notes contain certain requirements regarding payment, insuring of collateral, and other matters, but do not have any financial or other material covenants or events of default except certain notes totaling $60.3 million are cross-defaulted with the Credit Facility. Additional borrowings from the financial affiliates of our primary revenue equipment suppliers and other lenders are expected to be available to fund new tractors expected to be delivered in 2020, while any other property and equipment purchases, including trailers, are expected to be funded with a combination of available cash, notes, operating leases, finance leases, and/or from the Credit Facility.

 

In April 2020, in an effort to improve our liquidity during the COVID-19 pandemic, we executed a modification to certain of our revenue equipment installment notes, exercising an option to make interest only payments for a period of 90 days, extending the due date of $177.3 million of debt by three months.

 

In August 2015, we financed a portion of the purchase of our corporate headquarters, a maintenance facility, and certain surrounding property in Chattanooga, Tennessee by entering into a $28.0 million variable rate note with a third party lender. The note contains certain restrictions and covenants that are usual and customary for a note of this nature. Failure to comply with the covenants and restrictions set forth in the note could result in an event of default. Concurrently with entering into the note, we entered into an interest rate swap to effectively fix the related interest rate to 4.2%. The note contains certain restrictions and covenants that are usual and customary for a note of this nature. Failure to comply with the covenants and restrictions set forth in the note could result in an event of default. For the second quarter ended June 30, 2020, we obtained a waiver from the third-party lender for a financial covenant that we did not comply with. Absent the waiver we would have been in default under our covenants. For the third quarter ended September 30, 2020, there was an amendment to the calculation of the covenant and we were in compliance with the calculation as stated in the amendment. We expect to be in compliance with our debt covenants for the next 12 months. 

 

Page 16

 
 
 

Note 8.

Lease Obligations

 

The finance leases in effect at  September 30, 2020 terminate from  October 2020 through  January 2024 and contain guarantees of the residual value of the related equipment by us.

 

 A summary of our lease obligations at September 30, 2020 and 2019 are as follows:

 

(dollars in thousands)

 

Three Months Ended

   

Three Months Ended

   

Nine Months Ended

   

Nine Months Ended

 
   

September 30, 2020

   

September 30, 2019

   

September 30, 2020

   

September 30, 2019

 

Finance lease cost:

                               

Amortization of right-of-use assets

  $ 1,018     $ 1,406     $ 3,023     $ 4,225  

Interest on lease liabilities

    284       210       808       644  

Operating lease cost

    5,734       6,167       19,782       17,824  

Variable lease cost

    44       -       358       -  
                                 

Total lease cost

  $ 7,080     $ 7,783     $ 23,971     $ 22,693  
                                 

Other information

                               

Cash paid for amounts included in the measurement of lease liabilities:

                               

Operating cash flows from finance leases

    1,018       1,146       3,023       3,589  

Operating cash flows from operating leases

    5,778       6,167       20,140       17,824  

Financing cash flows from finance leases

    284       210       808       644  

Right-of-use assets obtained in exchange for new finance lease liabilities

    1,131       -       3,258       -  

Right-of-use assets obtained in exchange for new operating lease liabilities

    122       20,096       2,759       26,421  

Weighted-average remaining lease term—finance leases

 

1.8 years

                         

Weighted-average remaining lease term—operating leases

 

2.5 years

                         

Weighted-average discount rate—finance leases

    4.2 %                        

Weighted-average discount rate—operating leases

    5.2 %                        

 

During the three and nine months ended September 30, 2020 we recognized $0.0 million and approximately $2.2 million, respectively, of impairment expense related to a leased office facility in Chattanooga, TN held under an operating lease and $0.0 million and approximately $0.8 million, respectively of additional revenue equipment and purchased transportation expense related to the abandonment of revenue equipment held under an operating lease. As of  September 30, 2020 and December 31, 2019, right-of-use assets of $41.7 million and $58.8 million for operating leases and $50.6 million and $35.6 million for finance leases, respectively, are included in net property and equipment in our condensed consolidated balance sheets. Operating lease right-of-use asset amortization is included in revenue equipment rentals and purchased transportation, communication and utilities, and general supplies and expenses, depending on the underlying asset, in the condensed consolidated statement of operations. Amortization of finance leased assets is included in depreciation and amortization expense in the condensed consolidated statement of operations.

 

Our future minimum lease payments as of September 30, 2020, are summarized as follows by lease category:

 

(in thousands)

 

Operating

   

Finance

 
2020 (1)   $ 5,177     $ 6,654  

2021

    18,543       7,590  

2022

    15,523       5,456  

2023

    6,762       29  

2024

    28       -  

Thereafter

    9       -  

Total minimum lease payments

  $ 46,042     $ 19,729  

Less: amount representing interest

    (2,929 )     (575 )

Present value of minimum lease payments

  $ 43,113     $ 19,154  

Less: current portion

    (17,478 )     (5,964 )

Lease obligations, long-term

  $ 25,635     $ 13,190  

 

(1) Excludes the nine months ended September 30, 2020.

 

Page 17

 
 
 

Note 9.

Stock-Based Compensation

 

Our Third Amended and Restated 2006 Omnibus Incentive Plan, as amended (the "Incentive Plan") governs the issuance of equity awards and other incentive compensation to management and members of the board of directors. On  July 1, 2020, the stockholders, upon recommendation of the board of directors, approved the Second Amendment (the “Second Amendment”) to our Third Amended and Restated 2006 Omnibus Incentive Plan (the "Incentive Plan"). The Second Amendment (i) increased the number of shares of Class A common stock available for issuance under the Incentive Plan by an additional 1,900,000 shares, (ii) added a fungible share reserve feature, under which shares subject to stock options and stock appreciation rights will be counted as one share for every share granted and shares subject to all other awards will be counted as 1.80 shares for every share granted, (iii) added a double-trigger vesting requirement upon a change in control, (iv) eliminated the Compensation Committee’s discretion to accelerate vesting, except in cases involving death or disability, (v) increased the maximum award granted or payable to any one participant under the Incentive Plan for a calendar year from 200,000 shares of Class A common stock or $2,000,000, in the event the award is paid in cash, to 500,000 shares of Class A common stock or $4,000,000, in the event the award is paid cash, (vi) re-set the date through which awards  may be made under the Incentive Plan to  June 1, 2030, and (vii) made other miscellaneous, administrative and conforming changes.

 

The Incentive Plan permits annual awards of shares of our Class A common stock to executives, other key employees, consultants, non-employee directors, and eligible participants under various types of options, restricted stock awards, or other equity instruments. As of  September 30, 2020, there were 2,515,193 shares remaining of the 4,200,000 shares available for award under the Incentive Plan. No participant in the Incentive Plan may receive awards of any type of equity instruments in any calendar year that relates to more than 500,000 shares of our Class A common stock or $4,000,000, in the event the award is paid in cash. No awards may be made under the Incentive Plan after June 1, 2030. To the extent available, we have issued treasury stock to satisfy all share-based incentive plans.

 

Included in salaries, wages, and related expenses within the condensed consolidated statements of operations is the net reversal of approximately $0.2 million and the recognition of $0.7 million of stock-based compensation expense for the three and nine months ended September 30, 2020, respectively, and the recognition of $0.6 million and $1.1 million of stock-based compensation expense for the three and nine months ended September 30, 2019, respectively. All stock compensation expense recorded in 2020 and 2019 relates to restricted shares, as no unvested options were outstanding during these periods. An additional $0.4 million of stock-based compensation was recorded in general supplies and expenses in the condensed consolidated statements of operations for each of the three and nine month periods ended  September 30, 2020 and 2019, respectively, as this amount relates to the issuance of restricted stock to non-employee directors.

 

The Incentive Plan allows participants to pay the federal and state minimum statutory tax withholding requirements related to awards that vest or allows participants to deliver to us shares of Class A common stock having a fair market value equal to the minimum amount of such required withholding taxes. To satisfy withholding requirements for shares that vested through September 30, 2020, certain participants elected to forfeit receipt of an aggregate of 5,119 shares of Class A common stock at a weighted average per share price of $14.15 based on the closing price of our Class A common stock on the dates the shares vested in 2020, in lieu of the federal and state minimum statutory tax withholding requirements. We remitted less than $0.1 million to the proper taxing authorities in satisfaction of the employees' minimum statutory withholding requirements.

 

 

Note 10.

Commitments and Contingencies

 

From time-to-time, we are a party to ordinary, routine litigation arising in the ordinary course of business, most of which involves claims for personal injury and property damage incurred in connection with the transportation of freight.

 

Our subsidiary Covenant Transport, Inc. (“Covenant Transport”) is a defendant in a lawsuit filed on November 9, 2018, in the Superior Court of Los Angeles County, California. The lawsuit was filed on behalf of Richard Tabizon (a California resident and former driver) who is seeking to have the lawsuit certified as a class action. The complaint asserts that the time period covered by the lawsuit is from October 31, 2014 to the present and alleges claims for failure to properly pay drivers for rest breaks, failure to provide accurate itemized wage statements and/or reimbursement of business related expenses, unlawful deduction of wages, failure to pay proper minimum wage and overtime wages, failure to provide all wages due at termination, and other related wage and hour claims under the California Labor Code. Since the original filing date, the case has been removed from the Los Angeles Superior Court to the U.S. District Court in the Central District of California and subsequently the case was transferred to the U.S. District Court in the Eastern District of Tennessee where the case is now pending. Covenant Transport intends to vigorously defend itself in this matter. We do not currently have enough information to make a reasonable estimate as to the likelihood, or amount of a loss, or a range of reasonably possible losses as a result of this claim, as such there have been no related accruals recorded as of  September 30, 2020

 

On February, 28 2019, Covenant Transport was named in a separate (but related) lawsuit filed in the Superior Court of Los Angeles County, California requesting civil penalties under the California Private Attorneys’ General Act for the same underlying wage and hour claims at issue in the putative class action case noted above. On August 1, 2019, the Los Angeles Superior Court entered an order staying the action pending completion of the earlier-filed action that is pending in the United States District Court for the Eastern District of Tennessee. Covenant Transport intends to vigorously defend itself in this matter. We do not currently have enough information to make a reasonable estimate as to the likelihood, or amount of a loss, or a range of reasonably possible losses as a result of this claim, as such there have been no related accruals recorded as of September 30, 2020.

 

Page 18

 

On August 2, 2018, Curtis Markson, et al. (collectively, “Markson”), filed a putative class action case in United States District Court, Central District of California generically claiming that five (5) specified trucking companies (including our subsidiary Southern Refrigerated Transport, Inc.) entered into a "no poaching conspiracy" in which they agreed not to solicit or hire employees in California who were "under contract" with a fellow defendant. The allegations center around new drivers in California who received their commercial driver's license through driving schools associated with, or paid for by, one of the named defendants, in exchange for agreeing to drive for that defendant carrier for a specified amount of time (typically 8-10 months). Over the ensuing 1820 months, the Plaintiffs added more trucking companies as co-defendants in the lawsuit, including Covenant Transport on April 23, 2020. The lawsuit claims that the named defendants sent letters to one another, providing notice of "under contract" status, if these new California drivers were hired by another defendant carrier prior to the driver completing their contractual obligations. Plaintiffs contend that these notifications evidence a collusive agreement by the named defendants to restrain competition among trucking companies in California and suppress wages. Southern Refrigerated Transport, Inc. and Covenant Transport, Inc. are vigorously defending themselves against these claims. We do not currently have enough information to make a reasonable estimate as to the likelihood, or amount of a loss, or a range of reasonably possible losses as a result of this claim, as such there have been no related accruals recorded as of September 30, 2020.

 

Refer to Note 1, “Significant Accounting Policies” of the accompanying condensed consolidated financial statements for information about our insurance program.

 

Based on our present knowledge of the facts and, in certain cases, advice of outside counsel, management believes the resolution of open claims and pending litigation, discussed above, taking into account existing reserves, is not likely to have a materially adverse effect on our condensed consolidated financial statements, however, any future liability claims would impact this analysis.

 

We had $36.7 million and $35.2 million of outstanding and undrawn letters of credit as of September 30, 2020 and December 31, 2019, respectively. The letters of credit are maintained primarily to support our insurance programs. Additionally, we had $45.0 million of availability on a line of credit from Triumph solely to fund any indemnification owed to Triumph in relation to the sale of TFS.

 

 

Note 11.

Equity Method Investment

 

We own a minority investment in Transport Enterprise Leasing, LLC ("TEL"). TEL is a tractor and trailer equipment leasing company and used equipment reseller. We have not guaranteed any of TEL's debt and have no obligation to provide funding, services, or assets. TEL’s majority owners are generally restricted from transferring their interests in TEL, other than to certain permitted transferees, without our consent. We sold no tractors or trailers to TEL during the nine-months ended September 30, 2020 and 2019, and we received $6.3 million and $7.1 million, respectively, for providing various maintenance services, certain back-office functions, and for miscellaneous equipment. We recognized a net reversal of previously deferred gains totaling less than $0.1 million for the nine-months ended September 30, 2020 and 2019, representing 49% of the gains on units sold to TEL less any gains previously deferred and recognized when the equipment was subsequently sold to a third party. Deferred gains, totaling $0.1 million and $0.2 million at  September 30, 2020 and 2019, respectively, are being carried as a reduction in our investment in TEL. At  September 30, 2020 and  December 31, 2019, we had accounts receivable from TEL of $0.8 million and $1.2 million, respectively, related to cash disbursements made pursuant to our performance of certain back-office and maintenance functions on TEL’s behalf.

 

We have accounted for our investment in TEL using the equity method of accounting, and thus our financial results include our proportionate share of TEL's 2020 net income through September 30, 2020, or $1.0 million. We received no equity distribution from TEL during the nine-months ended September 30, 2020 and $1.2 million during the three and nine months ended September 30, 2019. Our investment in TEL, totaling $33.0 million and $32.4 million, as of  September 30, 2020 and December 31, 2019, respectively, is included in other assets in the accompanying condensed consolidated balance sheets.

 

See TEL's summarized financial information below:

 

(in thousands)

 

As of September 30,

   

As of December 31,

 
   

2020

   

2019

 

Total Assets

  $ 337,699     $ 374,591  

Total Liabilities

    279,543       318,743  

Total Equity

  $ 58,156     $ 55,848  

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30,

   

September 30,

 
   

2020

   

2019

   

2020

   

2019

 

Revenue

  $ 22,984     $ 30,709     $ 72,202     $ 82,683  

Cost of Sales

    2,748       6,302       10,332       17,213  

Operating Expenses

    15,184       16,634       51,708       42,775  

Operating Income

    5,052       7,773       10,162       22,695  

Net Income

  $ 2,729     $ 4,585     $ 2,308     $ 14,452  

 

Page 19

 
 
 

Note 12.

Goodwill and Other Assets

 

On July 3, 2018, we acquired 100% of the outstanding stock of Landair Holdings, Inc., a Tennessee corporation (“Landair”). Landair is a dedicated and for-hire truckload carrier, as well as a supplier of transportation management, warehousing and logistics inventory management services. Landair’s results have been included in the consolidated financial statements since the date of acquisition. Landair’s trucking operations’ results are reported within our Dedicated reportable segment, while Landair’s logistics operations’ results are reported within our Managed Freight and Warehousing reportable segments.

 

As a result of management compensation structure changes and a change in the branding strategy of the organization, the Company revised the estimated remaining useful life of the Landair trade name to 15 months as of June 30, 2020. At the end of its useful life, the Landair trade name will have a residual value of $0.5 million. The non-compete agreement with a former Landair executive was terminated during the second quarter of 2020. These changes resulted in additional amortization of none and $1.3 million during the three and nine months ended  September 30, 2020, or a $1.0 million, or $0.06 per diluted share, decrease in net income. The remaining useful lives as adjusted are included in the summary of other intangible assets below.

 

As of  September 30, 2020 and December 31, 2019, we had goodwill of $42.5 million.

 

A summary of other intangible assets as of  September 30, 2020 and  December 31, 2019 is as follows:

 

(in thousands)

 

September 30, 2020

 
   

Gross intangible assets

   

Accumulated amortization

   

Net intangible assets

   

Remaining life (months)

 

Trade name:

                               

Dedicated

  $ 2,402     $ (896 )   $ 1,506          

Managed Freight

    999       (373 )     626          
Warehousing     999       (373 )     626          

Total trade name

    4,400       (1,642 )     2,758       12  

Non-Compete agreement:

                               

Dedicated

    914       (914 )     -          

Managed Freight

    130       (130 )     -          
Warehousing     356       (356 )     -          

Total non-compete agreement

    1,400       (1,400 )     -       -  

Customer relationships:

                               

Dedicated

    14,072       (2,638 )     11,434          

Managed Freight

    1,692       (318 )     1,374          
Warehousing     12,436       (2,332 )     10,104          

Total customer relationships:

    28,200       (5,288 )     22,912       117  

Total other intangible assets

  $ 34,000     $ (8,330 )   $ 25,670          

 

(in thousands)

 

December 31, 2019

 
   

Gross intangible assets

   

Accumulated amortization

   

Net intangible assets

   

Remaining life (months)

 

Trade name:

                               

Dedicated

  $ 2,402     $ (240 )   $ 2,162          

Managed Freight

    999       (100 )     899          
Warehousing     999       (100 )     899          

Total trade name

    4,400       (440 )     3,960       162  

Non-Compete agreement:

                               

Dedicated

    914       (274 )     640          

Managed Freight

    130       (39 )     91          
Warehousing     356       (107 )     249          

Total non-compete agreement

    1,400       (420 )     980       42  

Customer relationships:

                               

Dedicated

    14,072       (1,759 )     12,313          

Managed Freight

    1,692       (213 )     1,479          
Warehousing     12,436       (1,554 )     10,883          

Total customer relationships:

    28,200       (3,525 )     24,675       126  

Total other intangible assets

  $ 34,000     $ (4,385 )   $ 29,615          

 

The above intangible assets have a weighted average remaining life of 106 months as of September 30, 2020, compared to 128 months as of December 31, 2019, as a result of the change in estimated useful life as discussed above. The expected amortization of these assets for the remainder of 2020 and the next five successive years is as follows:

 

   

(in thousands)

 

2020 (1)

  $ 1,152  

2021

    4,043  

2022

    2,350  

2023

    2,350  

2024

    2,350  
2025     2,350  

Thereafter

    10,575  

 

(1) Excludes the nine months ended September 30, 2020.

 

Page 20

 

 

Note 13.

Equity

 

On February 10, 2020, the Company announced that the Board approved the repurchase of up to $20.0 million worth of the Company's outstanding common stock. The program was suspended on March 26, 2020, with approximately $2.5 million worth of the shares remaining authorized for purchase. There were 1.4 million shares repurchased in the open market for $17.5 million during the three months ended March 31, 2020. There were no changes to the stock repurchase program during the three months ended September 30, 2020. The Company has the ability to reinstate the stock repurchase program as circumstances warrant based on market conditions, cash flow requirements, securities law limitations, and other factors.

 

 

Note 14.

Liquidity

 

Our business requires significant capital investments over the short-term and the long-term. We generally finance our capital requirements with borrowings under our Credit Facility, cash flows from operations, long-term operating leases, finance leases, secured installment notes with finance companies, and proceeds from the sale of our used revenue equipment. We had working capital (total current assets less total current liabilities) of $53.5 million and $93.1 million at September 30, 2020 and December 31, 2019, respectively. Based on our expected financial condition, net capital expenditures, and results of operations and related net cash flows, we believe our working capital and sources of liquidity will be adequate to meet our current and projected needs for at least the next year.

 

As of September 30, 2020, we had no borrowings outstanding, undrawn letters of credit outstanding of approximately $36.7 million, and available borrowing capacity of $58.3 million under the Credit Facility. Additionally, we had $45.0 million of availability on a line of credit from Triumph solely to fund any indemnification owed to Triumph in relation to the sale of TFS. Fluctuations in the outstanding balance and related availability under our Credit Facility are driven primarily by cash flows from operations and the timing and nature of property and equipment additions that are not funded through notes payable, as well as the nature and timing of collection of accounts receivable, payments of accrued expenses, and receipt of proceeds from disposals of property and equipment.

 

During the first half of 2020, in response to the uncertainty of the upcoming economic environment as a result of COVID-19 and as part of our strategic focus to reduce overhead costs, we took measures to preserve our liquidity, including capital reductions, financing, cost reduction, and working capital actions. During 2020, we have paid down approximately $175.6 million of debt and lease obligations. If needed, we have other potential flexible sources of liquidity that we can leverage, such as currently unencumbered owned revenue equipment.

 

 

Note 15.

Subsequent Events

 

On October 23, 2020, we amended the Credit Facility to increase the size of the facility from $95 million to $110 million, extend the term through October 2025, improve the pricing by 25 basis points across the grid and improve various other terms and conditions, while incurring no amendment fees or similar bank fees related to the amendment. 

 

In October 2020, the Company sold the Triumph stock acquired as part of the amended purchase agreement for $28.1 million and remitted the proceeds to Triumph upon settlement.

 

Page 21

 
 
 

ITEM 2.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The condensed consolidated financial statements include the accounts of Covenant Logistics Group, Inc., a Nevada holding company, and its wholly owned subsidiaries. References in this report to "we," "us," "our," the "Company," and similar expressions refer to Covenant Logistics Group, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

 

This report contains certain statements that may be considered forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and such statements are subject to the safe harbor created by those sections and the Private Securities Litigation Reform Act of 1995, as amended. All statements, other than statements of historical or current fact, are statements that could be deemed forward-looking statements, including without limitation: any projections of earnings, revenues, or other financial items; any statement of plans, strategies, and objectives of management for future operations; any statements concerning proposed new services or developments; any statements regarding future economic conditions or performance; and any statements of belief and any statements of assumptions underlying any of the foregoing. In this Form 10-Q, statements relating to future reclassification of losses arising from derivative instruments and the performance of counterparties to such instruments, future impact of accounting standards, future third-party transportation provider expenses, future tax rates, expenses, and deductions, expected freight demand and volumes and trucking industry conditions, including the size and impact of “peak” season, potential results of a default and testing of our fixed charge covenant under the Credit Facility or other debt agreements, expected sources of working capital and liquidity (including our mix of debt, finance leases, and operating leases as means of financing revenue equipment), expected capital expenditures, allocations, and requirements, future customer relationships, expected debt reduction, including future interest expense, future driver market conditions, expected cash flows, expected operating income, future investments in and growth of our segments and services, expected adjusted operating ratio, future trucking capacity, future rates and prices, future utilization, future depreciation and amortization, future salaries, wages, and related expenses, including driver compensation and the impact of our cost saving measures, expected net fuel costs, strategies for managing fuel costs, the effectiveness and impact of, and cash flows relating to, our fuel hedging contracts and fuel surcharge programs, future fluctuations in operations and maintenance expenses, expected effects and mix of our solo and team operations, future fleet size, management, and upgrades, the market value of used equipment, including equipment subject to operating or finance leases relative to our payment obligations under such operating leases (including residual value guarantees and the proceeds from the sale thereof), the anticipated impact of our investment in TEL, the future impact of our restructuring activities, strategic plan, and other strategic initiatives, anticipated levels of and fluctuations relating to insurance, claims, and litigation expenses, , including the erosion of available limits in our aggregate insurance policies and possible additional expense to reinstate certain insurance policies, the impact of the material weakness identified in our internal control over financial reporting, our disposition of the assets of TFS, including any future indemnification obligations related to the TFS Portfolio, and the anticipated impact of the COVID-19 outbreak or other similar outbreaks, among others, are forward-looking statements.  -looking statements may be identified by the use of terms or phrases such as "believe," "may," "could," "would," "will," "expects," "estimates," "projects," "anticipates," "plans," " outlook," "focus," "seek," "potential," "continue," "goal," "target," "objective," "intends," derivations thereof, and similar terms and phrases. Such statements are based on currently available operating, financial, and competitive information. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, which could cause future events and actual results to differ materially from those set forth in, contemplated by, or underlying the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the sections entitled "Item 1A. Risk Factors," set forth in this Form 10-Q, in our Form 10-K for the year ended December 31, 2019, our Form 10-Q for the quarter ended March 31, 2020, as amended, and our Form 10-Q for the quarter ended June 30, 2020. Readers should review and consider the factors discussed in "Item 1A. Risk Factors," set forth in this Form 10-Q, in our Form 10-K for the year ended December 31, 2019, our Form 10-Q for the quarter ended March 31, 2020, as amended, and our Form 10-Q for the quarter ended June 30, 2020, along with various disclosures in our press releases, stockholder reports, and other filings with the Securities and Exchange Commission.

 

All such forward-looking statements speak only as of the date of this Form 10-Q. You are cautioned not to place undue reliance on such forward-looking statements. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in the events, conditions, or circumstances on which any such statement is based.

 

Executive Overview

 

We were pleased with the progress on executing our strategic plan, which is focused on growing our more consistent and profitable freight commitments, improving margins, improving return on capital, and managing leverage at a reasonable level. Compared with the third quarter of 2019, revenue before fuel surcharges was essentially constant, we reduced our tractor fleet nearly 18%, and profitability improved sharply. Additionally, we have paid down approximately $175.6 million of debt and obligations under operating leases over the past year. On an adjusted earnings per share basis, the third quarter of 2020 was second best of any third quarter in the past decade and third best of any quarter overall in the past five years. Nevertheless, we are in the early stages of implementing our plan, and we expect ups and downs as we work toward implementing lasting changes.

 

The following is a summary of infrequent and non-cash transactions that occurred during the third quarter of 2020:

 

Gain item:

 

  Gain on sale of TFS

$  3.7 million

   

Expense items:

 

  Employee separation costs

$  1.0 million

  Insurance policy erosion and reinstatement costs $  4.4 million
  Intangible asset amortization $  1.2 million

Net third quarter expense adjustment

$  2.9 million

 

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As of June 30, 2020, our Factoring segment was classified as discontinued operations as it: (i) was a component of the entity, (ii) met the criteria as held for sale, and (iii) had a material effect on the Company's operations and financial results. On July 8, 2020, we closed on the disposition of substantially all of the operations and assets of TFS, a division of Covenant Transport Solutions LLC, an indirect wholly owned subsidiary of the Company, which included substantially all of the assets and operations of our Factoring segment. Beginning with the period ended June 30, 2020, we have reflected the former Factoring segment as discontinued operations in the condensed consolidated statements of operations for all periods presented. Prior periods have been adjusted to conform to the current presentation. 

 

Additional items of note for the  third quarter of  2020 include the following:
 
 

Total revenue of $210.8 million, a decrease of 4.4% compared with the third quarter of 2019, and freight revenue (which excludes revenue from fuel surcharges) of $196.2 million, a decrease of 0.6% compared with the third quarter of 2019;

     
 

Operating income of $6.8 million, compared with operating loss of $3.9 million in the third quarter of 2019;

     
 

Net income of $7.5 million, or $0.43 per diluted share, compared with net loss of $3.2 million, or $0.17 per diluted share, in the third quarter of 2019. Net income from continuing operations of $4.7 million, or $0.27 per diluted share, compared to $4.0 million net loss from continuing operations or $0.22 per diluted share, in the third quarter of 2019. Net income from discontinued operations of $2.8 million, or $0.16 per diluted share, compared to net income from discontinued operations of $0.9 million, or $0.05 per diluted share, in the third quarter of 2019.

     
 

With available borrowing capacity of $58.3 million under our Credit Facility at September 30, 2020, we do not expect to be required to test our fixed charge covenant in the foreseeable future;

     
 

Our Managed Freight reportable segment’s total revenue increased to $47.6 million in the 2020 quarter from $33.3 million in the 2019 quarter and the segment had an operating income of $2.1 million in the 2020 quarter compared to operating income of $0.5 million in the 2019 quarter; 

     
 

Our equity investment in TEL provided $1.2 million of pre-tax earnings in the third quarter of 2020 and provided $2.1 million in the third quarter of 2019;

     
 

Since December 31, 2019, total indebtedness, net of cash, decreased by $151.7 million to $152.9 million; and 

     
 

Stockholders' equity and tangible book value at September 30, 2020, were $314.8 million and $246.6 million, respectively.

 

COVID-19

 

In March 2020, the World Health Organization declared COVID-19 a global pandemic. The outbreak of COVID-19 has resulted in governmental authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place orders, increased border and port controls and closures, and shutdowns.

 

During the second quarter, we increased our reserves for uncollectible accounts receivable by approximately $2.6 million as a result of the bankruptcy of one customer and the heightened risk we have on certain of our retail related customers as a result of COVID-19. There were no additional COVID-19 related reserves in the third quarter. Local, state and national governments continue to emphasize the importance of transportation and have designated it as an essential service. The health and safety of our team members and the community is our first priority, as such, we've put certain measures into place, including remote work arrangements, enforced social distancing and increased sanitation protocols, among others.

 

We believe we have sufficient liquidity to satisfy our cash needs, however we continue to evaluate and act, as necessary to maintain sufficient liquidity to ensure our ability to operate during these unprecedented times. However, the extent to which COVID-19 could impact our operations, financial condition, liquidity, results of operations, and cash flows is highly uncertain and will depend on future developments. We will continue to evaluate the nature and extent of these potential impacts to our business.

 

Outlook

As we look to the fourth quarter of 2020, we are focused on delivering superior service to our customers in what is expected to be a robust peak shipping season with limited trucking capacity.  Similar to the third quarter of 2020, our reduced fleet size and more focused and committed model provides limited capacity to “flex up” and take advantage of the peak spot market to the same extent we did in prior years.  However, we expect fourth quarter 2020 volumes and pricing to be favorable and to support sequential margin improvement. For the fourth quarter of 2020, adjusted operating ratio is expected to improve slightly compared with the 93.2% adjusted operating ratio generated in the third quarter of 2020.

 

In 2021 and beyond, our focus will be continued execution of our strategic plan, which consists of steadily and intentionally growing the percentage of our business generated by our Dedicated, Managed Freight, and Warehousing segments, reducing unnecessary overhead, and improving our safety, service, and productivity. This will be a gradual process of diversifying our customer base with less seasonal and cyclical exposure, improving legacy contracts, and investing in systems, technology, and people to support the growth of these previously under-invested areas.  As we undertake this multiyear effort, I would like to remind investors that our goal is to improve our earnings and returns in a manner that is sustainable and less susceptible to upward and downward market forces.  The gradual improvements we expect will be offset at times by short term forces.  For example, in 2021, we expect underlying progress on efficiency and cost control, improved contract pricing, and improved safety.  These benefits are expected to be offset to some extent by the return of certain cost pressures. Over time, we expect to exit the plan a stronger, more profitable, more predictable business with the opportunity for significant and sustained value creation. Adjusted operating ratio for the full year of 2021 is expected to improve compared with adjusted operating ratio for the full year of 2020 but deteriorate compared with the 93.2% adjusted operating ratio achieved in the third quarter of 2020.

 

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Non-GAAP Reconciliation

 

In addition to operating ratio, we use "adjusted operating ratio" as a key measure of profitability. Adjusted operating ratio is not a substitute for operating ratio measured in accordance with GAAP. There are limitations to using non-GAAP financial measures. Adjusted operating ratio means operating expenses, net of fuel surcharge revenue, excluding amortization of intangibles, and significant unusual items, divided by total revenue, less fuel surcharge revenue. We believe the use of adjusted operating ratio allows us to more effectively compare periods, while excluding the potentially volatile effect of changes in fuel prices, amortization of intangibles, and significant unusual items. Our Board and management focus on our adjusted operating ratio as an indicator of our performance from period to period. We believe our presentation of adjusted operating ratio is useful because it provides investors and securities analysts the same information that we use internally to assess our core operating performance. Although we believe that adjusted operating ratio improves comparability in analyzing our period-to-period performance, it could limit comparability to other companies in our industry, if those companies define adjusted operating ratio differently. Because of these limitations, adjusted operating ratio should not be considered a measure of income generated by our business or discretionary cash available to us to invest in the growth of our business. Management compensates for these limitations by primarily relying on GAAP results and using non-GAAP financial measures on a supplemental basis.

 

Operating Ratio

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 

GAAP Operating Ratio:

 

2020

   

OR %

   

2019

   

OR %

   

2020

   

OR %

   

2019

   

OR %

 

Total revenue

  $ 210,830             $ 220,459             $ 613,333             $ 654,832          

Total operating expenses

    204,019       96.8 %     224,329       101.8 %     636,927       103.8 %     647,726       98.9 %

Operating income (loss)

  $ 6,811             $ (3,870 )           $ (23,594 )           $ 7,106          
                                                                 

Adjusted Operating Ratio:

 

2020

   

Adj. OR %

   

2019

   

Adj. OR %

   

2020

   

Adj. OR %

   

2019

   

Adj. OR %

 

Total revenue

  $ 210,830             $ 220,459             $ 613,333             $ 654,832          

Fuel surcharge revenue

    (14,613 )             (23,082 )             (47,971 )             (70,882 )        

Freight revenue (total revenue, excluding fuel surcharge)

    196,217               197,377               565,362               583,950          
                                                                 

Total operating expenses

    204,019               224,329               636,927               647,726          

Adjusted for:

                                                               

Fuel surcharge revenue

    (14,613