Landstar System Inc Q4 FY2020 Earnings Call

Good morning and welcome to Landstar System Incorporated Year-end 2020 Earnings Release Conference Call. All lines will be in a listen-only mode until the formal question-and-answer session. Today's conference call is being recorded. If you have any objections, you may disconnect at this time. Joining us today from Landstar are Jim Gattoni, President and CEO; Rob Brasher, Vice President and Chief Commercial Officer; Joe Beacom, Vice President and Chief Safety and Operations Officer. Now I would like to turn the call over to Mr. Jim Gattoni. Sir, you may begin.

Thank you, Missy. Good morning and welcome to Landstar's 2020 Fourth Quarter Earnings Conference Call. Before we begin, let me read the following statement. The following is a Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. Statements made during this conference call that are not based on historical facts are forward-looking statements. During this conference call, we may make statements that contain forward-looking information that relates to Landstar's business objectives, plans, strategies and expectations. Such information by nature is subject to uncertainties and risks, including, but not limited to, the operational, financial and legal risks detailed in Landstar's Form 10-K for the 2019 fiscal year, described in the section Risk Factors and other SEC filings from time to time. These risks and uncertainties could cause actual results or events to differ materially from historical results or those anticipated. Investors should not place undue reliance on such forward-looking information, and Landstar undertakes no obligation to publicly update or revise any forward-looking information. I believe it is safe to say 2020 was a year like no other. The economic and social disruption caused by the COVID-19 pandemic had unprecedented impacts on many sectors of the U.S. economy. Consumer spending on travel and entertainment along with other service-related expenditures shifted to spending on goods, while U.S. manufacturing was adversely impacted by the pandemic and still has not fully recovered. To conclude this rollercoaster of a year, Landstar achieved numerous all-time quarterly financial records in the 2020 fourth quarter. This remarkable turnaround from the adverse financial impact that COVID-19 had on our 2020 second quarter financial results was mostly due to significant consumer demand driving our van truckload business. Fourth quarter performance was also favorably impacted by an improvement in U.S. manufacturing compared to the 2020 third quarter. In fact, the fourth quarter was the only quarter of 2020 where revenue from transportation services hauled via unsided platform equipment exceeded the corresponding prior year quarter. At Landstar, the swings in financial performance caused by the pandemic were more dramatic than during any other time in the company's history. Second quarter gross profit decreased from the 2020 first quarter by almost 21% due to the sudden adverse impact COVID-19 had on the U.S. economy and actions taken by Landstar to provide additional financial support to the company's network of agents and BCOs. This was the first time in the company's history that gross profit decreased sequentially from the seasonally softer first quarter to the second quarter. Our second quarter performance was followed by substantial sequential quarterly growth in gross profit, which increased 42% from the 2020 second quarter to the third quarter and 13% from the third quarter to the fourth quarter. This gross profit growth was led by significant sequential increases beginning in June in month-to-month truck revenue per load and above-normal month-to-month increases in the number of loads hauled via truck. These sequential increases in revenue per load and the number of loads hauled via truck that began in June and continued through fiscal year-end drove our record quarterly financial performance in the 2020 fourth quarter. Also, as described in Landstar's 2020 fourth quarter earnings press release that we issued yesterday, these sequential trends drove our fourth quarter financial results to far exceed both the fourth quarter financial guidance we first presented in our 2020 third quarter earnings release on October 21st and the updated financial guidance provided on November 17th via Form 8-K filed with the SEC. Our updated guidance issued on November 17th indicated our expectation that revenue and diluted earnings per share in the fourth quarter would be slightly above the high end of our initial guidance issued on October 21st of $1.2 billion and $1.42, respectively. Actual revenue in the 2020 fourth quarter was $1.296 billion, and diluted earnings per share was $1.70. Revenue exceeded the high end of our guidance by $96 million as growth in the month-to-month trends in revenue per load and the number of loads hauled via truck exceeded our already high expectations. The increased revenue drove gross profit growth that contributed approximately $0.17 to the increase in diluted earnings per share over the high end of the guidance. The additional increase in diluted earnings per share compared to guidance was due to lower net costs, primarily insurance and claims during the quarter than expected, plus a $0.05 favorable impact from a lower than expected effective income tax rate. As it pertains to monthly trends, October closed with truck revenue per load 15% above October 2019 and the number of loads hauled via truck 10% above October 2019. As we moved through the fourth quarter, truck rates and volume continued to strengthen compared to the corresponding prior year period. November-December revenue per load on loads hauled via truck increased 17% and 18% over November and December 2019, respectively. And the number of loads hauled via truck in November and December increased 13% and 15% respectively compared to the same months of 2019. Overall, revenue per load on loads hauled via truck in the 2020 fourth quarter exceeded the 2019 fourth quarter by 17% and the number of loads hauled via truck exceeded the 2019 fourth quarter by 13%. The strength in demand for Landstar services provided via van equipment during the 2020 fourth quarter further strengthened from the already strong demand we experienced during the 2020 third quarter. In the 2020 fourth quarter, demand for services provided by unsided equipment also improved as compared to the third quarter with load volume and revenue per load on loads hauled via unsided equipment each exceeding the 2019 fourth quarter. As noted previously, the fourth quarter was the only quarter of 2020 where the number of loads hauled and revenue per load on loads hauled via unsided platform equipment each exceeded the corresponding prior year quarter. Even as demand for unsided platform services improved in the fourth quarter, overall demand for transportation services provided via van equipment continued to significantly outpace demand for services provided by unsided equipment. More specifically, the number of loads hauled via van equipment in October, November and December were 13%, 16% and 17% above October, November and December 2019. Revenue per load on loads hauled via van equipment in October increased 23% over October 2019 and increased 25% in both November and December over November and December 2019. The number of loads hauled via unsided equipment in October was about equal to October 2019. In November and December 2020, they were 8% and 12% above November and December 2019. The revenue per load on loads hauled via unsided equipment in October, November and December exceeded prior year by 6%, 4% and 5% respectively. In comparing the 2020 fourth quarter to the 2019 fourth quarter, demand for our services fluctuated significantly by industry sector. The sectors behind the revenue growth in the 2020 fourth quarter were the same sectors that drove revenue growth in the company's 2020 third quarter over the 2019 third quarter. The growth in revenue was driven by strength in consumer durables, automotive parts, building products and substitute line haul services, where Landstar provides truckload transportation services to LTL and parcel carriers between their hubs. The boom in home improvement and renovations helped growth in the building products sector, while new business awards outside the big three automotive manufacturers partly contributed to the automotive parts performance. Growth in new and existing accounts resulted in increased revenue in the consumer durable sector. Consumer demand for e-commerce drove the growth in substitute line haul services. Revenue from the machinery and metals sector, both of which are typically serviced using unsided equipment, improved compared to what we experienced in the 2020 third quarter. Revenue from the machinery sector in the 2020 fourth quarter was about equal to the 2019 fourth quarter, a significant improvement from the 12% decrease in the 2020 third quarter compared to the 2019 third quarter. Likewise, revenue from the metals sector was 3% above the 2019 fourth quarter, a significant improvement from a decrease of 12% in the 2020 third quarter compared to the 2019 third quarter. While certain sectors of the U.S. economy appeared strong and others lagged, the efforts of our agents to expand their business with new and existing customers across a broad array of sectors was critical in driving the company's strong fourth quarter performance. As to truck capacity, we continue to track qualified owner-operators to the model. We ended the year with a record 10,991 trucks, 420 more than at the end of the 2020 third quarter and 748 more than December 2019. BCO utilization, or loads per BCO per week, was slightly above seasonal norms. BCO utilization in the 2020 fourth quarter increased approximately 4% compared to the 2019 fourth quarter. Record BCO truck count and the increased BCO utilization led to a record number of quarterly loadings hauled by BCO capacity in the 2020 fourth quarter. Also, as demand increased, we saw an increased number of third-party carriers haul loads for Landstar. Active truck broker carrier count, defined as carriers who have hauled a Landstar load in the past 180 days, increased from approximately 41,000 in the 2020 third quarter to an all-time record of 46,000 in the 2020 fourth quarter. Approved and active third-party carrier count continues at an all-time high. As it relates to third-party carriers, the inflection in demand that began in August resulted in a sudden tightening of truck capacity that drove an increase in the rate of purchased transportation paid to third-party truck carriers. In the 2020 fourth quarter, revenue per load increased approximately 18%, while gross profit per load increased approximately 5% on truckloads hauled by third-party carriers as compared to the 2019 fourth quarter. The exceptional finish to fiscal year 2020 was partly due to very strong demand during the holiday peak season. Beginning in early November, overwhelming demand for e-commerce tightened truck capacity driving rates and volumes higher at the end of the year. Although I expect strong demand to continue through the 2021 first quarter, the impact of the year-end spike in e-commerce on truck rates and volume is expected to subside. Therefore, I expect quarter-over-prior-year quarter growth in truck rates and volume in the 2021 first quarter compared to the 2020 first quarter to be somewhat below the exceptional growth rates of the 2020 fourth quarter, although similar to the strong growth experienced in October 2020 over October 2019 prior to the spike in e-commerce. As a result, we expect truck revenue per load in the 2021 first quarter to exceed the 2020 first quarter in a mid-teen percentage range. We also currently expect the number of loads hauled via truck in the 2021 first quarter to exceed the 2020 first quarter in the high single-digit percentage range. As such, I expect first quarter revenue to be in the range of $1.100 billion to $1.150 billion. Based on that range of revenue, I anticipate diluted earnings per share to be in the range of $1.55 to $1.65. Landstar's business model, with access to a substantial number of truck capacity providers including both our BCO owner-operators and third-party carriers combined with the expertise and experience of the agent family and the geographic distribution of our over 1,200 agents throughout the U.S. and Canada, drives exceptional performance in most environments. The 2020 fourth quarter was no different. I just want to touch on a couple of line items within the P&L. Gross profit increased 23% to $182.4 million compared to $148.7 million in 2019. Gross profit margin was 14.1% of revenue in the 2020 fourth quarter and 14.9% in the 2019 fourth quarter. The 80 basis point decrease in gross profit margin was mostly attributable to a 220 basis point increase in the rate of transportation paid to third-party truck brokerage carriers, partly offset by a 140 basis point decrease in the rate of commissions paid to agents on that revenue. Gross profit margin in the 2020 fourth quarter was also lower than the 2019 fourth quarter due to mix, as a percent of revenue from fixed-margin business decreased compared to prior year. Other operating costs were $7.4 million in the 2020 fourth quarter compared to $8.7 million in 2019. This decrease was primarily due to a decreased provision for contractor bad debt. Insurance and claim costs were $21.2 million in the 2020 fourth quarter compared to $25.1 million in 2019. Total insurance and claim costs were 3.8% of BCO revenue in the 2020 period and 5.7% of BCO revenue in the 2019 period. The decrease in insurance and claims as compared to 2019 was primarily due to decreased net unfavorable development of prior year claims, decreased severity of current year claims during 2020, as well as decreased frequency during the 2020 period, partly offset by an increase in insurance premiums primarily for commercial trucking liability coverage. Selling, general and administrative costs were $42.9 million in the 2020 fourth quarter compared to $38.2 million in 2019. The increase in SG&A was mostly attributable to increased stock-based compensation expense, an increase in the provision for bonuses under the company's incentive compensation plans and increased wages, partly offset by decreased travel and entertainment costs and decreased event costs. In the 2020 fourth quarter, stock compensation and the provision for incentive compensation was $3.6 million. Stock compensation and the provision for incentive compensation were both insignificant in the 2019 fourth quarter. Depreciation and amortization was $11.6 million in the 2020 fourth quarter compared to $11.4 million in 2019. Operating income was $84.4 million, or 46.3% of gross profit in the 2020 fourth quarter, or $66.5 million or 44.7% of gross profit in 2019. Operating income increased 27% year-over-year. Excluding the $15.5 million one-time cost to buy out certain incentive commission arrangements with several agents, operating income and operating margin in the 2020 fourth quarter would have achieved all-time quarterly records. The effective income tax rate was 22% in the 2020 fourth quarter compared to 23.8% in 2019. The effective income tax rate was favorably impacted in both periods by resolutions of certain tax items and tax benefits resulting from equity compensation arrangements. Looking at our balance sheet, we ended the quarter with cash and short-term investments of $291 million. Cash flow from operations for 2020 was $211 million, compared to $308 million in fiscal year-end 2019. The decrease in cash flow from operations is mostly due to the spike in revenue to end 2020, driving year-end net receivables (accounts receivable less accounts payable) up. As it relates to full year 2021, the company does not provide revenue and earnings guidance beyond the upcoming quarter due to the unpredictable nature over extended periods of time in the U.S. spot market in which it primarily operates. However, as it relates to full year 2021, certain costs and cost savings that took place in 2020 mostly due to the COVID-19 pandemic are not expected to recur. During 2020, the company paid $50 per load as pandemic relief to BCOs and independent agents for all loads hauled via BCO during April and May, which resulted in a total one-time cost of $12.6 million. Additionally, the company recorded a $2.6 million charge at Landstar Metro related to the impairment of customer intangibles and a $15.5 million charge for the buyout of certain legacy agent incentive commission arrangements. The termination of those commission arrangements should result in a tailwind in commissions to agents in 2021 as compared to 2020 of approximately $10 million. The company also estimates that it had cost savings due to cancellation of events, travel and entertainment, BCO training and recruiting costs and various other savings totaling about $7 million in 2020. Overall, we estimate the aggregate impact of all these one-time items equals a net $13.7 million, providing a nice tailwind heading into 2021. As most of you know, several years ago we began the process of transforming our technology infrastructure. That plan includes an overall overhaul of Landstar's technology systems and involves changes to our network architecture, hardware, software and how data is stored and accessed to provide a more flexible, agile platform. Most of all, the transformation involves the delivery of new and upgraded tools that we make available to the company's network of small and large business owners. The new platform allows us to move to a plug-and-play environment, where we can build or buy tools that make sense for the business. Over the past few years, we have delivered a pricing tool to the agent family, automated the customer credit and trailer request process, provided a data analytics tool to the agents to help them better manage their business, delivered a freight visibility application, consolidated our applications used by the BCO network to a single mobile app called LandstarOne and improved our load and truck search features. We also continue to move forward on replacing our legacy operating system with a new transportation management system. During 2020 we established Landstar Blue, a company-owned and operated transportation company that will allow us to further design and develop tools that ultimately benefit the company's network of agents and capacity providers. During 2021, our recent investments in the company's technology ecosystem will add approximately $5 million to depreciation in 2021 over 2020. Additionally, as we continue to invest in new enhanced tools, I expect to incur approximately $5 million in costs related to continuation of our technology plan along with $2 million in IT wage increases as we transform the IT team with new skill sets. Overall, the incremental cost for the continuation of the company's technology transformation in 2021 is expected to be about $12 million. 2021 is setting up well for Landstar's operating conditions that contributed to our record quarterly performance in the 2020 fourth quarter and appear to be carrying through to January. We begin 2021 with a record number of BCO trucks and approved third-party carriers. Demand remains strong for van service; I believe demand for unsided platform service has turned the corner. Overall, strong demand and easy year-over-year comparisons through the first half of 2021 should result in first half revenue and earnings well above the first half of 2020. As we move to the back half of the year, we anticipate year-over-year comparisons may become a bit challenging due to our record finish to 2020, and the expectation of a normal spot market cycle, which would suggest softening truckload pricing in mid- to late-summer 2021. Nevertheless, from a longer-term perspective, Landstar expects to grow gross profit in the mid single-digit percentage range, pass 70% of that growth to operating income and increase diluted earnings per share in a high single to low double-digit percentage range. Ultimately, those expectations should result in an annual operating margin of 50% or more within a period of three to four years. Regardless of the environment, Landstar's network of small and large business owners provide the expertise to satisfy shipper demand in almost every sector in every geographic region in North America, sourcing capacity of varying equipment types, while Landstar provides the tools and financial support to empower their success. The strength and resiliency of Landstar's light asset-based variable cost business model proves itself over and over; 2020 is shaping up to be another great year. And with that, Missy, we are ready to take questions.

Thank you very much. At this time, we will begin the question-and-answer session. Operator instructions: if you would like to ask a question, press star one. Our first question is from Jack Atkins of Stephens. Your line is now open.

Great. Good morning and congratulations on a great quarter, guys.

Thanks, Jack. Well, first of all, Jack, you know my position on positive news: I'm more of a pessimist than an optimist, so I will go with normal business cycles. So, just my thoughts on 2021, which are actually a little bit different than a lot of the commentary out there that this is going to continue through the year. Right now the strong trends have continued right through January, and there's no indication they won't continue in the short term, at least through the first half of the year that I see. But when I look at things that are occurring in the industry like the increase in truck orders and wage increases to drivers, to me that was the reaction to the significant spike in spot rates. And when talking about contracts, people are talking about contract rates being up in the low double digits next year. So I do feel that we're just—I'm not saying the demand is going to go away, but I think there'll be a shift later in the year from spot to contract like we've historically seen. That's my opinion, and I've forced my guys here to believe in it, but I'm not sure they all believe it. I see all the things indicating that it's going to be a normal spot cycle where you see the significant climb similar to 2017 into 2018 and then slowing down into 2019. I just think it happened faster this time. Clearly this thing went from June to December: if you look at what happened at rates, we were growing about 5% sequentially month to month until we hit November and that was like 2.5% to 3%. So, under my view, there's nothing indicating right now, Jack, that we are going to slow down other than my expectation of normal cycles based on what I've seen occurring with the increased orders and increased wages to truck drivers and contract rates coming up to offset the pain of the high spot rates.

Understood. Okay, got you. Makes sense. And then I guess for my follow-up question with the new administration in place in Washington and a Democratic-controlled House and Senate, how are you guys thinking about potential regulatory changes around owner-operators, the potential for maybe an AB5-like bill that we saw in California to either be a national mandate or move into other states in the Northeast or Midwest?

Yes. Clearly, we've been watching that for quite a while. In California we can deal with that at a state-by-state level. If you recall back at the end of 2019, we were saying that we probably have to either move probably 300 to 400 BCOs out of California or just have them not freight in California. But if it became a national issue, we'd have to look at it a little differently. There are options that we have: they could drive on our motor carrier authority, they could drive independently. There are certain things you can do, but until we know exactly what the rule is you don't know what actions we need to take. Is it wage and hour laws? Is it health and benefits? Is it stuff like that? Watching how AB5 transpires gives us a little comfort that they wouldn't necessarily mandate that at a national level because if you see what's going on there's a considerable number of exceptions to that rule, and it got voted down by the public. So I would hope there'd be a little bit of, I don't want to call it common sense, but a little review into what independent contractors want. Our independent contractors want to be on their own. They want to drive when they want, where they want and haul what they want. The reason they do it is because they're small business owners, and I think the U.S. should focus on this as an opportunity for people to run their small businesses and it shouldn't be taken away. But we have our eyes on it; we always have. It's always been something we watch. I think this administration may cause a little disruption, but nothing so adverse that it will disrupt the operations of Landstar. Into the future there might be some adverse financial impact if they come up with a dependent contractor concept.

But just following up on that briefly though, Jim, with your access to third-party broker carriers as well—not just the BCOs—you've got a lot of options in terms of how you source capacity. So no matter what comes, you'll be able to effectively access capacity in the market. Is that the message?

Yes. Absolutely. Our systems are all designed to do it regardless of whether they're BCOs or not.

Okay. That’s great. Thanks for the time.

Yes.

Thank you so much. Our next question is from Allison Landry of Credit Suisse. Your line is now open.

Good morning. Thanks. I wonder if you could speak to your expectations for insurance costs when you come up for renewal of the coverage this year? Any sort of incremental cost headwind you're anticipating? And then maybe just the other side of that question: are you seeing an easier time getting BCO carriers and attracting them to the platform as a result of higher insurance costs?

Okay. I'll answer the first question about the premiums, and I'll pass the next question to Joe about recruiting BCOs as a result of higher insurance costs. On the premium side, we renew on May 1 as you know. So we have a renewal coming up in a couple of months. There is talk that we're going to see another 25% to 50% increase in commercial trucking liability coverage, which you're talking like $4 million, but there are things we can do. We have significant coverage where our limits are pretty high, probably higher than most of the industry, and I think there are things we can do within our layers come May 1 to reduce that 25% to 50% increase. It's hard to commit right now whether it's going to be an increase, but I don't believe it's that much. We went from $8 million to $22 million on net coverage May 1, 2020. I'm talking maybe $4 million more, but I think what we can get—we may reduce that below $4 million. We might even be even by the time we renew on May 1, but we will probably just end up taking a little more risk at the high levels of insurance. So it's certainly well managed going into May 1 and I'll have a better answer probably for you at the end of the first quarter. And with that I'll let Joe respond to recruiting trucks as BCOs.

Yes, Allison. We don't get a sense that the increase in BCO net count is really a function of insurance. It really hasn't been as much of an addition as it has been our retention levels. I think that's a function of the processes, the technology and all the things we have in place to keep small business owners productive in the system. So I don't sense that the BCO growth is a function of insurance. On the carrier side, with the growth in approved carriers and active carriers, insurance—while we believe it to be a factor and I don't know to what extent it's hit that population yet—I do think over time if insurance rates impact those small carriers, that could be a potential BCO recruiting opportunity down the road.

Okay. That was really helpful. Thanks. And then just as a follow-up question, I apologize if I missed this earlier, but could you give us your expectations for CapEx for 2021? And maybe how much of that is slated for technology?

Good question. I think technology is about $18 million and then trailers about $40 million to $50 million, which really gets funded through capital leases, so it doesn't show up as a cash CapEx expense.

Got it. Thank you, guys.

Thank you so much. Our next question is from Todd Fowler of KeyBanc Capital Markets. Your line is now open.

Great. Thanks. Hey, good morning, Jim. Just a couple of questions on the mix of business. Can you talk a little bit about the inflection you saw on the unsided business in the fourth quarter—November and December showed nice volume growth—specifically where you were seeing that? And then with your first quarter volume guidance, the up high single-digits, do you have a breakout between what you're expecting on the van side and the unsided side in that number?

Well, speaking to the guidance, we had a 13% volume increase fourth quarter over fourth quarter. The majority was on the van side, and a little bit was on the flatbed side. The slowdown I'm referring to is on the van side, so you'd pull that back from what I think was 17% down somewhat. The flatbed side was running maybe around 3%. I didn't anticipate much of an increase in van growth over the prior year's first quarter. We kind of anticipate a similar kind of growth that we had fourth quarter over fourth quarter for the flatbed coming into the first quarter, which got me to the high single digits. Rob can probably speak to the flatbed trends in the fourth quarter.

Yes, Todd, this is Rob. We really saw it in automotive, building materials and consumer durables. The automotive industry was disrupted, so we started picking up a lot of ground there on the unsided side from automotive. Building materials benefited from new housing starts and remodels and big-box retailers needing support. Consumer durables, driven by consumer spending and e-commerce, also picked up. As production picked up, we saw demand increase. So, if you look at building materials, consumer durables and automotive, that's where we picked up in the fourth quarter and where we expect momentum moving forward.

Okay. Good. That helps, Rob. That seems like those are all markets that should have some tailwind as we move into the first half of 2021. Jim, maybe just a follow-up. It's been a while since we've talked about substitute line haul. Can you refresh us on how that business is priced? Does it come through close to a spot rate, or is it priced a little differently? How do you think about the sustainability of that? E-commerce trends should be favorable for a while; does some of that business at some point shift to more of a contract, or do you think the business is pretty sustainable as we move into the second half of 2021? Thanks.

I think it's a combination of both. One of the larger organizations we haul for coordinates with us over the summer; we lock up rates and get an allotted amount of miles. So there's a big contracted piece, but there's also a big ad hoc piece that we haul as well. What really drove it was the excess: we get our allotted miles and then the e-commerce surge filled the ad hoc requests. When we were talking in the third quarter, we started seeing substitute line haul pick up in August, which typically starts about mid-November. At the front end it was ad hoc leading into November, and then we started running more traditional contract, agreed-upon rate dedicated line business. Most of the growth out of that was ad hoc. Through the first quarter, dispatch truckload volumes the last two weeks of the year were up over 20%, which speaks to the peak holiday season and that substitute line haul business. I expect that to subside in the first quarter, though some of it carried into January. I do expect it to slow down a little. Looking to next year, if you have that same type of demand, it will be a tough comp in the fourth quarter next year because carriers learn how to manage e-commerce spikes and they assign more contract business each year, which tends to slow the ad hoc, higher-priced mix. So I think you'll see a transition throughout the year: elevated compared to normal, but not to the peak-season extent.

Got it. Okay. That makes a ton of sense. I'll turn it over and get back in the queue. Thanks for the time this morning. Congratulations.

Sure, Todd.

Thank you so much. Our next question is from Jordan Alliger of Goldman Sachs. Your line is now open.

Hi. Question: I heard your commentary around supply-demand and price in the second half of 2021. Since the industrial/flatbed markets tend to lag relative to the consumer side, does the same commentary apply on price for flatbed? Can you talk to the dynamic around that versus the more consumer-oriented demand business?

Yes. I would think flatbed strength on pricing would lag; we didn't see the same strong increases in pricing on flatbed this year because demand wasn't as high. As manufacturing picks up, which tightens the flatbed market, you'll see a cycle up on pricing. But you won't likely see the same level of growth that we saw on the van side; the van rate increases were incredible from June through December. I expect increases in flatbed pricing if manufacturing tightens, but not near the level of what we saw in van. My view is that as the economy opens, consumer demand may moderate and manufacturing-related demand will help offset some of that seasonality in the back half of the year.

Great. Thanks so much.

Thank you so much. Our next question is from Scott Group of Wolfe Research. Your line is now open.

Hey. Thanks. Good morning, guys.

Good morning.

So Jim, I thought I heard you mention that you think you'll get to a 50% operating margin in a few years. You guys were there in the last two quarters. Why do you think you'll step back and then eventually get there in a few years?

Yes. Because we're seasonally softer in the first quarter, you have to take that into consideration. If you look at the year, we ran some pro formas. This year we're about 45% to 46%. We were at 49.7% in 2018 when we had about $667 million in gross profit and $340 million in costs. This year we probably had about $340 million of cost below the gross profit line, but the gross profit was really soft. The reason I'm projecting three to four years to reach a 50% operating margin is the pressure from insurance, which I think will continue to creep up a little bit not necessarily from premiums but from claim costs increasing, and our technology spend as I laid out where we're going to spend about $12 million in incremental costs in 2021. If we grow gross profit faster than the mid single digits, we can get there faster. There are some levers on costs but not that many. So, three to four years is a manageable timeframe assuming mid single-digit gross profit growth. If you exceed that growth, you can get there quicker.

Okay. I don't know there's an easy answer here, but how have you thought about a potential infrastructure bill? Any rules of thumb on what it could mean for Landstar?

It's hard because we've seen promises of infrastructure bills before and there's no historical benchmark. Any infrastructure bill that tightens the flatbed market would help pricing within the flatbed because flatbed is 30% to 35% of our business. I don't think we'll be directly involved hauling roadwork materials in the way heavy equipment contractors might be; we don't haul a lot of road materials. We might haul equipment into construction, but it's not our routine nature to be doing roadwork freight. So I wouldn't expect a large direct impact, but it could indirectly tighten flatbed markets and be positive for pricing.

Okay. All right. Thank you, guys.

Yeah.

Thank you so much. Our next question is from Stephanie Benjamin of Truist. Your line is now open.

Hi. Good morning. I appreciate you walking through some of the major technology investments that you laid out over the last couple of years and also providing the color on the incremental roughly $12 million cost expected in 2021. Can you maybe talk through what the 2021 incremental dollars are going towards? Thanks.

Yes. Four or five years ago we started transitioning our old operating system, which is an IBM model from the 80s, into a new more flexible TMS. That's a large component of our investment. Our plan is to roll out to about 80% of the agent base on that system this year. We continue to focus on user experience for customers, agents and capacity. We've been upgrading and consolidating tools into portals: an agent portal and a capacity portal to give access to a single source for trucks, available loads, pricing tools and so forth. That's part of the big investment next year—hopefully we have some portals rolled out for the agent family and by the end of the year the capacity portal may roll into the following year. We also own about 13,000 trailers and have been monitoring the trailer fleet manually; we're beta-testing a trailer pool management system which is automated so agents can manage their trailer pools within their drop-and-hook locations. Our track and visibility tool is another area of investment: it's easy to track BCOs because they all have ELDs, but we need an aggregator to help aggregate all the small carriers we use. So we're building that for third-party broker carriers to make track and visibility seamless for all types of capacity. There's many pieces to improve user experience and to move off the old IBM system. We aren't 100% done but are making significant progress.

That's helpful. And then just a second question: you gave revenue growth by industries served and showed strong growth in many categories. Can you speak to whether there were any new customer wins or share gains that contributed to some of that growth, or was it more general e-commerce trends and recovery in the industrial economy?

We did have customer wins, but given our business model the top 100 customers only make up about 40% of our business, so a new customer may add $4 million or $5 million to a quarter that had $1.2 billion in revenue—it's hard to move the needle. The growth was mostly category-driven: consumer durables, building products and automotive. Agents did a good job expanding relationships during slow periods and attacking markets where freight was. There were some notable new awards in automotive parts outside the Big Three, but overall it was more the sector trends and our agents expanding business rather than one or two large customers moving the needle.

Great. Thank you so much.

Thank you. Our next question is from Bascome Majors of Susquehanna. Your line is now open.

Thanks for taking my question. Jim, I don't think in the guidance you gave the expected range of the net revenue margin or gross margin for the quarter. Did you give it?

I did not in the prepared comments. I'd say gross profit margin in the first quarter guide is around 14.8% to 15%.

Thank you for that. And whatever level you want to answer this at, it would be helpful to understand how the business continues to evolve cyclically after that strong second half in the dry van business. What parts are still outperforming normal seasonality or incrementally recovering when you look at patterns you normally observe? Is the dry van just tracking seasonality at very high levels now, or are there other parts that have started to cool down cyclically? Any framing—van versus flatbed or industry verticals—would be helpful.

I'm trying to think of something that's starting to drag a little. Through the first several weeks of January the substitute line haul continued above seasonal trends and we're seeing improvement in machinery and metals similar to the fourth quarter. I'm not feeling a significant drag from demand right now. The month-to-month growth that was unbelievable has slowed a little from December to January and we're slightly above seasonal norms on rate and volume, but I don't see a material drag across sectors. Rob, do you have anything to add?

Bascome, it's more of a shift than a drag. The pandemic changed where people work and spend, which benefited building materials and consumer durables as people renovate and work from home. Automotive had disruption but we've seen recoveries. As things stabilize, construction-related and manufacturing demand could increase flatbed opportunities. A lot depends on how the vaccine and return-to-work trends progress. Manufacturing and construction could provide more lift in the back half of the year.

Okay. Thank you both for that detailed answer. Very helpful.

Thank you so much. Our next question is from Amit Mehrotra of Deutsche Bank. Your line is now open.

Thanks. Jim, I hope you and the team are doing well. I want to ask about yield trends versus what load board data indicates and how to think about those moving together over time. There could be a lag given some stickier parts of your book of business. If I remember correctly, your yields held in longer back in 2019 versus what the spot market was doing. Help us think about that dynamic, especially if there's a slower period later this year into 2022 as some supply comes on.

I think historically agents tend to lag the market reaction a bit. When conditions shift rapidly, agents don't increase or decrease pricing as quickly, so you generally see a month-or-two lag in pricing for us. Public load boards tend to show higher highs than we see because a lot of that is premium freight and the mix is different. Our prices are a bit elevated in our BCO business—drop-and-hook, premium freight—so when comparing to load boards, it's a different spot market world. And there's a lag in our agents' reaction time compared to market boards.

So a little more muted in volatility and lagged. Second, structurally we've seen spot rates at all-time highs and orders inflect later in the cycle than before even though spot rates were higher earlier. Does that support the argument that the hurdle rate to order a new unit is higher now due to structural changes like insurance and regulation, or is this cycle not materially different from prior cycles?

I'm a believer that this happened faster. Because it happened faster, it took manufacturers and operators a couple of months to order trucks. Spot pricing climbed very quickly from May into late summer and autumn, and it took two to three months for orders to respond. I don't think the structural dynamics of the spot versus contract cycles have materially changed; it was just an accelerated climb this time. There are structural factors like the drug and alcohol clearinghouse that put drivers on the sideline and insurance increases that can have real impact beyond spot market rates. Those could change capacity in the marketplace even if trucks are ordered; driver availability and claims trends matter a lot.

Yes. And relatedly, where are these orders coming from beyond replacement? Are they from independent owner-operators or other pockets of capacity?

Amit, my view is the large order numbers are beyond replacement. Some of that is make-up from the second quarter when orders and production were down. The lag happened because people wanted to see if the recovery and higher spot rates were sustainable. Once the environment sustained for a few months, orders went up. The challenge now is sourcing drivers when you get the trucks and manufacturers meeting production demand. I don't think the hurdles to entry are greater per se; they were just unusual due to freight demand and uncertainty. People were cautious until they saw sustained demand.

Got it. Thank you very much. Appreciate your time.

Thank you so much. We still have a few more questions in queue. The next is from Scott Schneeberger of Oppenheimer. Your line is now open.

Thanks very much. Good morning. First, on the automotive end market—it sounds like strength was largely in automotive parts and outside the big three manufacturers. Was that correct? Anything unique heading into 2021 in this end market that's noteworthy?

Yes, Scott. We do a great deal of business with the Big Three, and there was major disruption there, which is not a secret. We did land a sizable award from a non-Big Three customer that continues to be a large customer for us. We're primarily hauling components and parts to support manufacturing rather than finished vehicles. As the automotive supply chain stabilizes, we expect a mix of contracted business and premium ad hoc freight. I don't see any unusual trends beyond the recovery and normalization of production driving demand.

Great, thanks. Second question: you've had special dividends in prior years and then $2 special dividends in December 2019 and 2020. What's your return of capital policy going forward? Should we expect continued specials, more buybacks, or any M&A activity?

I wouldn't expect much change in strategy. There's nothing on the M&A horizon right now; we're focused on the core business and technology investments. Our philosophy has been to prefer buybacks historically. During 2020, we did buybacks in the first quarter totaling a bit over $100 million at average prices around $100 to $105. We don't chase the stock higher when buying. We typically evaluate our cash balance at year-end and market conditions 12 to 18 months out and decide whether to do buybacks or a special dividend. It's not automatic every December; it depends on cash and outlook. If we're active in the market during the year, that's a good indicator for December, but not guaranteed.

Great. Thanks. Appreciate the color.

Thank you so much. We'll take the last question from Todd Fowler of KeyBanc Capital Markets. Your line is now open.

Great. Thanks for taking the follow-up. Real quickly, I had a couple housekeeping questions. First, can you share what you have penciled in for full-year SG&A for 2021 and any expected quarterly cadence? I don't think you're having a big agent convention this year, so that might affect timing.

Without the agent convention muddying up numbers, you're typically a little lighter in the first quarter. The big factors are stock compensation and incentive compensation. Assuming we hit targets, you won't see a lot of quarter-to-quarter variation in SG&A; that assumes evenly distributed stock and incentive compensation. If we exceed targets, that will move it. Typically, in the third and fourth quarters we give raises that are worth a couple of million dollars, so you may see SG&A increase by $1 million to $2 million in the third and fourth quarters versus the first two quarters. Overall, you're probably looking at SG&A around 44% to 45% of gross profit, with a little higher depending on tech spend and some additional stock comp expense.

Okay. That helps for modeling. And you mentioned 45% to 46% operating margins penciled in for the year; first quarter guidance looks above that range. Can you talk about how that's trending through the year? Is the expectation that you'll start higher and end the full year around that range due to assumptions on spot rates and timing of tech spend?

Yes. Some of the tech spend and depreciation kicks in after the first quarter, so that will affect the full-year margin mix. I'm not saying we can't do 50% in 2021—if gross profit growth is faster than mid single digits, we could get there. The assumption underlying the three-to-four-year 50% goal is mid single-digit gross profit growth. If we grow faster, we'll get there sooner.

Yes, great. Appreciate that. Thanks so much for the time.

All right, Todd. Thank you. I look forward to speaking with you again on our 2021 first quarter earnings conference call, currently scheduled for April 22. Enjoy the rest of your day.

Thank you so much and that concludes today's conference call. Thank you all for joining the conference. Have a good morning. Please disconnect your lines at this time.