Notes to Condensed Consolidated Financial Statements (unaudited)

September 30, 2020

NOTE A: BASIS OF PRESENTATION

Unless the context otherwise requires, all references in this Quarterly Report on Form 10-Q to “P.A.M.,” the “Company,” “we,” “our,” or “us” mean P.A.M. Transportation Services, Inc. and its subsidiaries.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In management’s opinion, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation have been included. The consolidated balance sheet at December 31, 2019 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Operating results for the three and nine-month period ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. For further information, refer to the consolidated financial statements and the footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2019.

NOTE B: RECENT ACCOUNTING PRONOUNCEMENTS

In March 2020, the FASB issued Accounting Standards Update No. 2020-04, (“ASU 2020-04”), Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. ASU 2020-04 was issued to provide optional guidance for a limited period of time to ease the potential burden in accounting for reference rate reform on financial reporting. ASU 2020-04 is effective as of March 12, 2020 through December 31, 2022. The Company has evaluated the provisions of this standard and determined that it is applicable to our line of credit and investment margin account. The London Interbank Offered Rate (“LIBOR”) is the basis for interest charges on outstanding borrowings for both our line of credit and investment margin account. The scheduled discontinuation of LIBOR is not expected to materially alter any provisions of either of these debt instruments, except for the identification of a replacement reference rate. The Company has evaluated the new guidance and does not expect it to have a material impact on its financial condition, results of operations, or cash flows.

In June 2016, the FASB issued ASU No. 2016-13, (“ASU 2016-13”), Accounting for Credit Losses (Topic 326). ASU 2016-13 requires the use of an “expected loss” model on certain types of financial instruments. The standard also amends the impairment model for available-for-sale debt securities and requires estimated credit losses to be recorded as allowances instead of reductions to the amortized cost of the securities. For smaller reporting companies, ASU 2016-13 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2022, with early adoption permitted. The adoption of this guidance on January 1, 2020 did not have a material impact on the Company’s financial condition, results of operations, or cash flows.

NOTE C: REVENUE RECOGNITION

The Company has a single performance obligation, to transport our customer’s freight from a specified origin to a specified destination. The Company has the discretion to choose to self-transport or to arrange for alternate transportation to fulfill the performance obligation. Where the Company decides to self-transport the freight, the Company classifies the service as truckload services, and where the Company arranges for alternate transportation of the freight, the Company classifies the service as brokerage and logistics services. In either case, the Company is paid a rate to transport freight from its origin location to a specified destination. Because the primary factors influencing revenue recognition, including performance obligation, customer base, and timing of revenue recognition, are the same for both of its service categories, the Company utilizes the same revenue recognition method throughout its operations.

Company revenue is generated from freight transportation services performed utilizing heavy truck trailer combinations. While various ownership arrangements may exist for the equipment utilized to perform these services, including Company owned or leased, owner-operator owned, and third-party carriers, revenue is generated from the same base of customers. Contracts with these customers establish rates for services performed, which are predominantly rates that will be paid to pick up, transport and drop off freight at various locations. In addition to transportation, revenue is also awarded for various accessorial services performed in conjunction with the base transportation service. The Company also has other revenue categories that are not discussed in this note or broken out in our condensed consolidated statements of operations due to their immaterial amounts.

In fulfilling the Company’s obligation to transport freight from a specified origin to a specified destination, control of freight is transferred to us at the point it has been loaded into the driver’s trailer, the doors are sealed and the driver has signed a bill of lading, which is the basic transportation agreement that establishes the nature, quantity and condition of the freight loaded, the responsibility for invoice payment and the pickup and delivery locations. Our revenue is generated, and our customer receives benefit, as the freight progresses towards delivery locations. In the event our customer cancels the shipment at some point prior to the final delivery location and re-consigns the shipment to an alternate delivery location, we are entitled to receive payment for services performed for the partial shipment. Shipments are generally conducted over a relatively short time span, generally one to three days; however, freight is sometimes stored temporarily in our trailer at one of our drop yard locations or at a location designated by a customer. Our revenue is categorized as either Freight Revenue or Fuel Surcharge Revenue, and both are earned by performing the same freight transportation services, as discussed further below.

Freight Revenue – revenue generated by the performance of the freight transportation service, including any accessorial service, provided to customers.

Fuel Surcharge Revenue – revenue designed to adjust freight revenue rates to an agreed-upon base cost for diesel fuel. Diesel fuel prices can fluctuate widely during the term of a contract with a customer. At the point that freight revenue rates are negotiated with customers, a sliding scale is agreed upon that approximately adjusts diesel fuel costs to an agreed-upon base amount. In general, as fuel prices increase, revenue from fuel surcharge increases, so that diesel fuel cost is adjusted to the approximate base amount agreed upon.

Revenue is recognized over time as the freight progresses towards its destination and the transportation service obligation is fulfilled. For loads picked up during the reporting period, but delivered in a subsequent reporting period, revenue is allocated to each period based on the transit time in each period as a percentage of total transit time. There are no assets or liabilities recorded in conjunction with revenue recognized, other than Accounts Receivable and Estimated Credit Losses.

NOTE D: MARKETABLE EQUITY SECURITIES

The Company’s investments in marketable securities consist of equity securities with readily determinable fair values. The cost of securities sold is based on the specific identification method, and interest and dividends on securities are included in non-operating income.

Marketable equity securities are carried at fair value, with gains and losses in fair market value included in the determination of net income. The fair value of marketable equity securities is determined based on quoted market prices in active markets, as described in Note J.

The following table sets forth market value, cost, and unrealized gains on equity securities as of September 30, 2020 and December 31, 2019.

The following table sets forth the gross unrealized gains and losses on the Company’s marketable securities as of September 30, 2020 and December 31, 2019.

The following table shows the Company’s net realized gains during the three and nine months ending on September 30, 2020 and 2019, respectively, on certain marketable equity securities.

For the quarter ended September 30, 2020, the Company recognized dividends received of approximately $314,000 in non-operating income in its condensed consolidated statements of operations. For the quarter ended September 30, 2019, the Company recognized dividends received of approximately $348,000 in non-operating income in its condensed consolidated statements of operations.

For the nine months ended September 30, 2020, the Company recognized dividends received of approximately $946,000 in non-operating income in its condensed consolidated statements of operations. For the nine months ended September 30, 2019, the Company recognized dividends received of approximately $931,000 in non-operating income in its condensed consolidated statements of operations.

The Company’s equity securities are periodically used as collateral against any outstanding margin account borrowings. As of September 30, 2020, and December 31, 2019, the Company had outstanding borrowings of approximately $12,705,000 and $7,474,000, respectively, under its margin account. Margin account borrowings are used for the purchase of marketable equity securities and as a source of short-term liquidity and are included in accrued expenses and other liabilities on our balance sheets.

Our marketable equity securities portfolio had a net unrealized pre-tax loss in market value of approximately $498,000 during the third quarter of 2020, and a net unrealized pre-tax gain in market value of approximately $133,000 during the third quarter of 2019, which were reported as non-operating income for the respective periods.

NOTE E: STOCK-BASED COMPENSATION

The Company maintains a stock incentive plan (the “Plan”) under which incentive and nonqualified stock options and other stock awards may be granted. Under the Plan, 750,000 shares are reserved for the issuance of stock awards to directors, officers, key employees, and others. The stock option exercise price and the restricted stock value under the Plan shall not be less than 85% of the fair market value of the Company’s common stock on the date the award is granted. The fair market value is determined by the closing price of the Company’s common stock, on its primary exchange, on the same date that the option or award is granted.

In January 2020, the Company granted 7,000 shares of common stock to certain key employees. These stock awards have a grant date fair value of $56.45 per share, based on the closing price of the Company’s stock on the date of grant, and vest on the fourth anniversary date in January 2024.

In March 2020, the Company granted 2,608 shares of common stock to non-employee directors. These stock awards have a grant date fair value of $30.75 per share, based on the closing price of the Company’s stock on the date of grant, and vested immediately.

In April 2020, the Company granted 242 shares of common stock to a new non-employee director upon his election to the board of directors. This stock award has a grant date fair value of $41.40 per share, based on the closing price of the Company’s stock on the date of grant, and vested immediately.

In August 2020, the Company granted 13,332 shares of common stock to certain key employees. These stock awards have a grant date fair value of $30.25 per share, based on the closing price of the Company’s stock on the date of grant, and vests on the fourth anniversary date in August 2024. During August 2020, the Company also granted 40,000 shares of common stock to the Company’s Chief Executive Officer which have a grant date fair value of $35.37 per share, based on the closing price of the Company’s stock on the date of grant. This award will vest in installments of 5,000 shares each in 2022, 2023, 2024 and 2027, and 10,000 shares each in 2025 and 2026.

The total grant date fair value of stock vested during the first nine months of 2020 was approximately $636,000. Total pre-tax stock-based compensation expense, recognized in salaries, wages and benefits during the first nine months of 2020, was approximately $430,000 and includes approximately $90,000 recognized as a result of the grant of shares to each non-employee director. The recognition of stock-based compensation expense decreased both diluted and basic earnings per common share by approximately $0.06 during the first nine months of 2020. As of September 30, 2020, the Company had stock-based compensation plans with total unvested stock-based compensation expense of approximately $2,318,000, which is being amortized on a straight-line basis over the remaining vesting period. As a result, the Company expects to recognize approximately $130,000 in additional compensation expense related to unvested stock awards during the remainder of 2020 and to recognize approximately $513,000, $513,000, $358,000, $271,000, $200,000, $200,000 and $133,000 in additional compensation expense related to unvested stock awards during the years 2021, 2022, 2023, 2024, 2025, 2026 and 2027, respectively.

The total grant date fair value of stock vested during the first nine months of 2019 was approximately $685,000. Total pre-tax stock-based compensation expense recognized in salaries, wages and benefits during the first nine months of 2019 was approximately $736,000 and includes approximately $100,000 recognized as a result of the grant of shares to each non-employee director during the first nine months of 2019. The recognition of stock-based compensation expense decreased both diluted and basic earnings per common share by approximately $0.09 during the first nine months of 2019. As of September 30, 2019, the Company had stock-based compensation plans with total unvested stock-based compensation expense of approximately $1,228,000, which was being amortized on a straight-line basis over the remaining vesting period.

A summary of the status of the Company’s non-vested restricted stock as of September 30, 2020 and changes during the nine months ended September 30, 2020, is as follows:

NOTE F: SEGMENT INFORMATION

The Company follows the guidance provided by ASC Topic 280, Segment Reporting, in its identification of operating segments. The Company has determined that it has a total of two operating segments whose primary operations can be characterized as either Truckload Services or Brokerage and Logistics Services; however, in accordance with the aggregation criteria provided by FASB ASC Topic 280, the Company has determined that the operations of the two operating segments can be aggregated into a single reporting segment, motor carrier operations. Truckload Services revenues and Brokerage and Logistics Services revenues, each before fuel surcharges, were as follows:

NOTE G: TREASURY STOCK

The Company’s stock repurchase program has been extended and expanded several times, most recently in April 2017, when the Board of Directors reauthorized 500,000 shares of common stock for repurchase under the initial September 2011 authorization. During the nine months ended September 30, 2020, the Company repurchased 49,755 shares of its common stock at an aggregate cost of approximately $1,793,134 under this program.

The Company accounts for Treasury stock using the cost method. As of September 30, 2020, 5,957,018 shares were held in the treasury at an aggregate cost of approximately $158,630,000.

NOTE H: EARNINGS PER SHARE

Basic earnings per share is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by adjusting the weighted average number of shares of common stock outstanding by common stock equivalents attributable to dilutive restricted stock. The computation of diluted earnings per share does not assume conversion, exercise, or contingent issuance of securities that would have an anti-dilutive effect on earnings per share. The computations of basic and diluted earnings per share were as follows:

NOTE I: INCOME TAXES

The Company and its subsidiaries are subject to U.S. and Canadian federal income tax laws as well as the income tax laws of multiple state jurisdictions. The major tax jurisdictions in which the Company operates generally provide for a deficiency assessment statute of limitation period of three years, and as a result, the Company’s tax years 2016 and forward remain open to examination in those jurisdictions.

In determining whether a tax asset valuation allowance is necessary, management, in accordance with the provisions of ASC 740-10-30, weighs all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is necessary. If negative conditions exist which indicate a valuation allowance might be necessary, consideration is then given to what effect the future reversals of existing taxable temporary differences and the availability of tax strategies might have on future taxable income to determine the amount, if any, of the required valuation allowance. As of September 30, 2020, management determined that the future reversals of existing taxable temporary differences and available tax strategies would generate sufficient future taxable income to realize its tax assets and therefore a valuation allowance was not necessary.

The Company recognizes a tax benefit from an uncertain tax position only if it is more likely than not that the position will be sustained on examination by taxing authorities, based on the technical merits of the position. As of September 30, 2020, an adjustment to the Company’s condensed consolidated financial statements for uncertain tax positions has not been required as management believes that the Company’s tax positions taken in income tax returns filed or to be filed are supported by clear and unambiguous income tax laws. The Company recognizes interest and penalties related to uncertain income tax positions, if any, in income tax expense. During the nine months ended September 30, 2020 and 2019, the Company has not recognized or accrued any interest or penalties related to uncertain income tax positions.

The Company’s effective income tax rates were 18.33% and 22.9% for the nine months ended September 30, 2020 and 2019, respectively. Our effective tax rate for the nine months ended September 30, 2020 differs from amounts computed by applying the United States federal statutory rates to pre-tax income primarily due to state income taxes and the tax benefits related to stock compensation.

NOTE J: FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company’s financial instruments consist of cash and cash equivalents, marketable equity securities, accounts receivable, trade accounts payable, and borrowings.

The Company follows the guidance for financial assets and liabilities measured on a recurring basis. This guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date and also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

The Company utilizes the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

At September 30, 2020, the following items are measured at fair value on a recurring basis:

The Company’s investments in marketable securities are recorded at fair value based on quoted market prices. The carrying value of other financial instruments, including cash, accounts receivable, accounts payable, and accrued liabilities approximate fair value due to their short maturities.

The carrying amount for the line of credit approximates fair value because the line of credit interest rate is adjusted frequently.

For long-term debt other than the lines of credit, the fair values are estimated using discounted cash flow analyses, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. The carrying value and estimated fair value of this other long-term debt at September 30, 2020 was as follows:

The Company has not elected the fair value option for any of its financial instruments.

NOTE K: NOTES PAYABLE

During the first nine months of 2020, the Company’s subsidiaries entered into installment obligations totaling approximately $43.9 million for the purpose of purchasing revenue equipment and $17.6 million for the purchase of a terminal. These obligations are payable in monthly installments and are recorded in long term debt and current maturities on the condensed consolidated balance sheets. The terms of these obligations vary from 36 months for trucks, to 84 months for trailers, and to 10 years for the terminal.

NOTE L: LITIGATION

The Company is not currently a party to any pending legal proceeding which management believes to be material to the financial statements of the Company. The Company maintains liability insurance against risks arising out of the normal course of its business.

We were a defendant in a collective- and class-action lawsuit which was filed on December 9, 2016, in the United States District Court for the Western District of Arkansas. The plaintiffs, who included current and former employee drivers who worked for the Company during the period of December 9, 2013, through December 31, 2019, alleged violations under the Fair Labor Standards Act and the Arkansas Minimum Wage Law including “failure to pay minimum wage during orientation, failure to pay minimum wage to team drivers after initial orientation, failure to pay minimum wage to solo-drivers after initial orientation, failure to pay for compensable travel time, Comdata card fees, unlawful deductions, and breach of contract.” The plaintiffs were seeking actual and liquidated damages to include court costs and legal fees. During July 2020, the United States District Court for the Western District of Arkansas granted final approval of a $16.5 million settlement reached with the plaintiffs and the settlement payment was disbursed by the Company during August 2020. Management has determined that the loss under this claim will not be covered by existing insurance policies.

On March 31, 2020, the United States District Court for the Western District of Arkansas dismissed the collective- and class-action lawsuit filed against the Company on May 29, 2019 by plaintiffs who were independent contractors alleging violations under the Fair Labor Standards Act and the Arkansas Minimum Wage Law. The plaintiffs, through their attorneys, alleged “misclassification as independent contractors, payment on the basis of miles without regard to the number of hours worked, improper deductions, and failure to pay minimum wage.” The dismissal of this lawsuit resulted when the Company and plaintiffs reached a settlement agreement and the Company paid approximately $421,000, plus legal fees. Legal reserve accruals in excess of the amount outlined in the settlement agreement were reversed during the first nine months of 2020, resulting in a reduction in accrued expenses and other liabilities in the Company’s condensed consolidated balance sheets.

The Company’s participation in the settlements of the above matters does not constitute an admission by the Company of any fault or liability, and the Company does not admit any fault or liability.

NOTE M: LEASES

Adoption of ASU 2016-02

The Company currently leases shop, office and parking spaces in various locations in the United States and Mexico. The initial term for the majority of these leases is one year or less, with an option for early cancellation and an option to renew for subsequent one- month periods. These leases can be terminated by either party by providing notice to the other party of the intent to cancel or to not extend. Relatively short lease durations for these properties are intended to provide flexibility to the Company as changing operational needs and shifting opportunities often result in cancellation or non-renewal of these leases by the Company or the lessor.

The initial lease term for certain shop and office locations is for periods ranging from one to five years with early cancellation options. The Company prefers that leases include early cancellation provisions to prevent becoming locked into long-term leases that become operationally unjustified and to allow the flexibility to pursue more cost-effective options for similar properties if they become available. These leases often include the option to extend for additional periods, which may or may not be exercised. Based on historical experience, the Company does not always extend these leases, sometimes exercises the option to cancel leases early and sometimes lessors choose to cancel leases or not extend.

The Company adopted ASU 2016-02 and related amendments on January 1, 2019 utilizing the modified retrospective approach and elected to apply the practical expedients outlined above. This election allowed the Company to continue to recognize lease expense for operating leases for which the initial term was twelve months or less, or for which it is reasonably likely that early cancellation provisions will be exercised, on a straight-line basis over the remaining term of the leases.

The Company leases trucks to owner-operators under our lease-to-own program. We also lease dock space to a related party at our Laredo, Texas terminal. We have reviewed these operating leases and determined that the adoption of ASU 2016-02 did not require a change to our financial statements, as our method of accounting for related assets and lease revenue is consistent with the provisions of the new standard.

Because the Company’s historical method of accounting for leases is consistent with the provisions of ASU 2016-02, the adoption of ASU 2016-02 on January 1, 2019 did not have a material impact on the Company’s financial condition, results of operations, or cash flows.

Right-of-Use Leases

Following the Company’s adoption of ASU 2016-02 and related amendments on January 1, 2019, the Company entered into operating leases which include initial terms ranging from three to five years and which do not include an option for early cancellation. In accordance with the provisions of ASC Topic 842, these leases resulted in the recognition of right-of-use assets and corresponding operating lease liabilities, respectively, valued at $1.7 million as of September 30, 2020. These assets and liabilities are recognized based on the present value of future minimum lease payments over the lease term at commencement date, using the Company’s incremental borrowing rate as of the respective dates of lease inception, as the rate implicit in each lease is not readily determinable. The right-of-use assets are recorded in other assets, and the lease liability is recorded in accrued expenses and other liabilities and in other long-term liabilities on our condensed consolidated balance sheet. Lease expense is recorded on a straight-line basis over the lease term and is recorded in rent and purchased transportation in our condensed consolidated statements of operations. While these lease agreements may contain provisions to extend after the initial term for an additional five years, the Company is not reasonably certain these extension options will be exercised. Therefore, potential lease payments that might occur under this extension period are not included in amounts recorded in our condensed consolidated balance sheets as of September 30, 2020.

Scheduled amounts and timing of cash flows arising from future right-of-use operating lease payments at September 30, 2020, are:

Cash Flows

No new right-of-use assets were recognized as a non-cash asset addition that resulted from new operating lease liabilities during the three months ended September 30, 2020. Cash paid for amounts included in the present value of operating lease liabilities was $0.1 million during the three months ended September 30, 2020 and is included in operating cash flows. Cash paid for amounts included in the present value of operating lease liabilities was $0.4 million during the nine months ended September 30, 2020 and is included in operating cash flows.

Lessor Disclosures under ASC Topic 842

The Company leases trucks to owner-operators under operating leases, which generally have a term of up to five years and include options to purchase the truck at the end of the lease. In the event that an independent contractor defaults on their lease, the Company generally leases the truck to another independent contractor.

As of September 30, 2020, the gross carrying value of trucks underlying these leases was $53.4 million and accumulated depreciation was $24.6 million. Depreciation is calculated on a straight-line basis over the estimated useful life of the equipment, down to an estimated salvage value. In most cases, the Company has agreements in place with certain manufacturers whereby salvage values are guaranteed by the manufacturer. In other cases, where salvage values are not guaranteed, estimates of salvage value are based on the expected market values of equipment at the time of disposal. During the quarter ended September 30, 2020, the Company incurred $1.4 million of depreciation expense for these assets. During the nine months ended September 30, 2020, the Company incurred $4.9 million of depreciation expense for these assets.

The Company leases dock space to a related party at our Laredo, Texas terminal and warehouse and office space to an unrelated lessee at a second Laredo, Texas terminal. The dock space and the warehouse and office space leased are depreciated in conjunction with the structures and improvements for the entire Laredo terminals on a straight-line basis over the estimated useful life of the assets. Lease income is recorded as a component of non-operating income in our condensed consolidated statements of operations. As of September 30, 2020, the gross carrying value of the buildings underlying these leases was $13.7 million and accumulated depreciation was $1.2 million. During the quarter ended September 30, 2020, the Company incurred $0.1 million of depreciation expense for the portions of these buildings that are subject to lease. During the nine months ended September 30, 2020, the Company incurred $0.2 million of depreciation expense for the portions of these buildings that are subject to lease.

NOTE N: EFFECT OF COVID-19 PANDEMIC

The rapid spread 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. These measures and the public health concerns resulting from the outbreak have severely disrupted economic and commercial activity. The resulting impact on domestic and global supply chains has caused slowdowns and reduced freight demand for transportation companies such as ours. Because we have a significant concentration of customers within the automotive industry, our freight volumes and revenues have been significantly affected by the closure of North American automotive manufacturing facilities beginning in late March. Our automotive customers resumed operations during the second quarter; however, the extent to which production will return to pre-pandemic levels remains uncertain. Any additional delays or interruptions of automotive production and other consumer activity affecting our customers, as well as any future wave of the virus or other similar outbreaks could further adversely affect our business. In addition, the implementation of measures to protect the health and safety of our employees, customers, vendors and the general public may disrupt our ability to efficiently manage personnel and operations and to recruit and retain driver and non-driver personnel, which could have a material adverse effect on our operating results. Further, negative financial results, an economic downturn or uncertainty, or a tightening of credit markets caused by COVID-19 or other similar outbreaks could have a material adverse effect on our liquidity and our ability to effectively meet our short- and long-term financial obligations.

NOTE O: NONCASH INVESTING AND FINANCING ACTIVITIES

The Company financed approximately $43.9 million in equipment purchases during the first nine months of 2020 utilizing noncash financing.