Earnings Call Transcript - LSTR Q2 2020

Operator, Operator

Good morning, and welcome to Landstar System Incorporated, Second Quarter 2020 Earnings Release Conference Call. If you have any objections, you may disconnect at this time. Joining us today from Landstar are Jim Gattoni, President and CEO; Kevin Stout, Vice President and CFO; 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. Gattoni. Sir, you may begin.

Jim Gattoni, President and CEO

Thank you, Missy. 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 is, by nature, 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. Through the end of Landstar's first quarter, the COVID-19 pandemic began to have a significant adverse impact on the US economy. The rapid decline in industrial output that began in mid-March accelerated into April and carried through most of the second quarter. Although conditions in the industrial markets Landstar serves improved somewhat in June, the 2020 second quarter experienced the most significant and rapid reduction of US industrial output in decades. The company's truckload volume began to experience the adverse economic impact caused by the pandemic in late March when state and local governments began to issue shelter in place mandates and manufacturing facilities started to close. Several weeks later, as truck capacity began to loosen due to the severe reduction in demand, revenue per load on loads hauled via truck began to rapidly deteriorate. These conditions persisted through April, and most of May, followed by relative volume and pricing improvement in June that has continued into the first few weeks of July. At the beginning of the crisis, the response to the pandemic generated a high demand for perishable consumer goods and much-needed medical supplies, while the US manufacturing sector began closing facilities and furloughing workers. The speed at which the freight environment deteriorated at the end of the first quarter was like nothing experienced in the history of the company. In the second week of April, Landstar's dispatched truckload volume reached a peak decrease of almost 27% below the same week of 2019, yet only four weeks prior, it was actually 1% above the comparable prior year week. A few weeks later, the downturn in revenue per load on loads hauled via truck peaked at almost 13% below the same week of 2019. The peak decrease in volume in the second week of April reflected the extensive closure of automotive plants and suppliers throughout the United States. To provide some additional context, automotive sector loadings, which typically contribute approximately 8% of the total Landstar revenue, experienced a decrease in dispatch volume of over 83% in the second week of April compared to the same week of the prior year. Other large declines in load volume during that week were seen in our other top commodity sectors with building products, machinery, metals, and consumer durables down 28%, 36%, 40%, and 20% respectively. Those five commodity groups in general contributed 56% of loadings in the 2020 week compared to 63% of the company's loadings in the 2019 week. Since the peak decrease in truckload volume in the second week of April, both the number of loads and revenue per load on loads hauled via truck have shown significant improvement. In June, the number of loads hauled via truck was 9% below June 2019, and revenue per load on loads hauled via truck was 6% below prior year June. Thankfully, Landstar's variable cost business model is highly resilient to rapid expansion and contractions in demand for freight transportation services. In the 2020 first quarter earnings release, we described the impact on earnings under a scenario where revenue was assumed to decrease from 20% to 30% compared to the 2019 second quarter. Under that hypothetical scenario, we said we would anticipate diluted earnings per share to be in a range of $0.70 to $0.85. That diluted earnings per share estimate did not reflect several expenses that took place in the second quarter. First and foremost, we implemented a pandemic relief incentive program for Landstar BCOs and agents. As we discussed during our first quarter earnings conference call on April 23rd, 2020, under this program for every load delivered by a BCO in April, Landstar would pay $50 to the BCO hauling the load and $50 to the agent dispatching the load. The program was implemented in an effort to reduce the financial burden imposed by the impact of the pandemic on our BCOs and agents and to supplement what we expected to be an increase in empty miles for BCOs as they looked to drive further to access freight opportunities. As the impact of the pandemic on freight markets became increasingly difficult in April, we received tremendous positive feedback on the importance of this program in fortifying our network and ultimately extended this relief effort through the month of May. Overall, the cost of this program was $12.6 million or $0.25 per diluted share in the 2020 second quarter. Second, the scenario we described did not account for asset impairment charges related to the company's Mexico operation of $2.6 million or $0.05 per diluted share. This impairment charge primarily related to intangible assets associated with our intra-Mexico business that were acquired as part of a small acquisition we made in Mexico several years ago. Third, we did not anticipate insurance premiums would increase beginning in May at a rate of approximately $1.1 million per month or $0.05 per diluted share in the 2020 second quarter. As you may be aware, recent annual premium increases to insure commercial auto liability for trucking companies have exceeded 200% in some cases. Landstar renews its insurance policies each year on May 1. For the policy period May 1, 2020 to April 30, 2021, Landstar's aggregate premium expense payable to third-party insurance companies for commercial auto liability coverage increased over 175% compared to the premiums we paid for the May 1, 2019 to April 30, 2020 policy period. This increase in our premiums will continue to be an additional headwind to us throughout the rest of the year. Overall, after taking into account these three items, the 2020 second quarter earnings aligned with what we anticipated under a scenario that involved the 20% to 30% reduction in revenue. Beyond this financial impact, the COVID-19 pandemic has had tremendous operational impact on our business. The health and well-being of our members of our network, the company's over 1,200 employees, 10,000 BCOs, 1,200 agents and their staffs, and over 25,000 customers, and 54,000 other third-party capacity providers have always been part of our safety-first culture and will remain a priority during these complex times. During March, it became clear that Landstar needed to address potentially unprecedented operational challenges that could result from the pandemic. As an essential business, we took actions to ensure our freight continued to be delivered safely and on-time, while we maintained appropriate measures and protocols consistent with applicable guidelines provided by health authorities and various government agencies, as well as customers. As it relates to the health and safety of our employees and business continuity, we successfully transitioned almost 1,000 of our more than 1,200 employees to work at home. We continue to operate with over 80% of our employees working remotely. The transition to remote work was and continues to be highly successful even though remote work was new to almost the entire Landstar employee base. As it pertains to the company's transportation network, we expected that the sudden decrease in demand in late March caused by industry closures and shelter-at-home orders would result in the disruption in the daily routines of many of our company's BCOs and agents. We implemented the pandemic relief incentive program I already spoke about to help our BCOs and agents. We also emphasize open and ongoing communication with our BCOs and agents to keep everyone informed and working together throughout the downturn. We believe our support efforts through the crisis greatly contributed to maintaining the health of the Landstar network. In the midst of the pandemic, BCO utilization in April and May or loads for BCO per week were at the lowest April and May utilization rates in over ten years. Even during that challenging operating environment, BCO turnover during April and May was slightly better than historical trends. In June, continuing into July, BCO utilization significantly improved, but remained somewhat below historical levels. Nevertheless, BCO truck count grew by 187 trucks during the second quarter from 10,112 at the end of March to 10,299 at the end of June. On the agent front, the majority of the agents within our network also operate variable cost business models that help protect them from the sudden significant shifts in market conditions. Agent turnover within our existing agent base continues to be very low. Recruiting productive agents, however, has become increasingly difficult in this environment due to the inability to personally interact with prospects and the sharp downturn in freight demand. During the 2020 second quarter, we did not purchase any shares of the company's common stock, consistent with what I said during our 2020 first quarter earnings conference call, we believe it is prudent to conserve cash until the duration and depth of the crisis becomes clear. Although the level of industrial output has stabilized in the back half of June and the first weeks of July, any adverse government or industry action to mitigate the increased spread of coronavirus could disrupt the recent market improvements. Until we have sustained stability in freight demand and economic performance, we'll continue to be prudent in our usage of cash. You will note, though, that we announced in our earnings release that our Board increased Landstar's regular quarter dividend by $0.25 per share or 13.5% over the amount of the company's regular quarterly dividend declared following each of the prior four quarters. There is no question that we remain in a highly uncertain environment due to the coronavirus pandemic and the possibility that economic conditions could again rapidly deteriorate due to the spiking number of cases, government actions, and business closures and bankruptcies. Nevertheless, based on the current trends, our 2020 third quarter revenue guidance assumes that the industrial output will remain stable, and truck capacity tightening on a sequential basis were more readily available throughout the quarter compared to the prior year quarter. Consistent with the recent trends in truck rate and volume, we expect the number of loads hauled and revenue per load on loads hauled via truck to each be below the 2019 third quarter in a mid-single-digit percentage range. As such, we expect revenue in the 2020 third quarter to be in a range of $885 million to $935 million. Our earnings guidance also assumes third quarter gross profit margin will be in a range of 15.2% to 15.4% similar to the gross profit margin of the 2020 second quarter prior to giving effect to the $12.6 million pandemic incentive we paid in the aggregate in April and May. Our third quarter guidance reflects as well insurance and claims costs at 4.8% of estimated BCO revenue for the quarter. Over the past several quarters, we have seen the cost of insurance and claims increase as a percent of BCO revenue due to the increased cost of settling individual claims. As I previously discussed, Landstar experienced an increase of over 175% in its annual commercial auto liability premiums beginning in May. This increase to the fixed cost component of our insurance and claims cost on an annual basis added approximately 80 basis points to the 4% historical average we previously used to estimate insurance and claims cost as a percent of BCO revenue. Based on these assumptions, our estimate of 2020 third quarter diluted earnings per share will be in a range of $1.11 to $1.17. When we take a longer-term view of the possible impact of Landstar on the economic downturn associated with the COVID-19 pandemic, we believe the resilience of our light asset base variable cost business model will continue to generate outstanding returns over time relative to the overall environment. The significant percentage of our cost tied directly to revenue somewhat insulates the Landstar business model from significant downturns in freight and typically generates positive cash flow throughout most business cycles. We continue to believe Landstar is well positioned with a strong balance sheet and expect positive cash flow generation throughout the cycle. In the past 20 years, Landstar's model has generated positive free cash flow every year but one and positive earnings in every year. In the first half of 2020, Landstar generated $178 million of free cash flow, including $84.6 million of which was generated in the 2020 second quarter. Although 2020 has become a challenging year, we remain confident in our model, not only to endure through tough times like these but also to come charging back as business conditions improve. And here is Kevin to provide additional commentary on the 2020 second quarter financials.

Kevin Stout, Vice President and CFO

Thanks, Jim. Jim has covered certain information on our 2020 second quarter. So I will cover various other second quarter financial information included in the press release. Gross profit defined as revenue less the cost of purchased transportation and commissions to agents was $113.1 million and represented 13.7% of revenue in the 2020 second quarter, compared to $158 million or 15.1% of revenue in 2019. Included in the 2020 second quarter is the impact of approximately $12.6 million paid to BCOs and agents in April and May under the company's previously disclosed pandemic relief incentive program. Excluding the effect of these payments, gross profit in the 2020 second quarter was approximately $125.7 million or 15.3% of revenue. The cost of purchased transportation was 77.1% of revenue in the 2020 second quarter versus 76.5% in 2019. Excluding the cost of these payments under the pandemic relief incentive program to BCOs, the cost of purchased transportation was 76.4% of revenue in the 2020 quarter. The PT rate paid to truck brokerage carriers in the 2020 second quarter was 37 basis points lower than the rate paid in the 2019 second quarter. Commissions to agents as a percentage of revenue were 9.1% in the 2020 second quarter compared to 8.4% in the 2019 second quarter. Excluding the cost of payments under the pandemic relief incentive program to agents, commissions to agents as a percentage of revenue was also 8.4% in the 2020 second quarter. Other operating costs were $7.4 million in the 2020 second quarter compared to $9.9 million in 2019. This decrease was primarily due to decreased trailing equipment rental costs, decreased BCO recruiting costs, decreased contractor bad debt, and increased gains on sales of trailing equipment. Insurance and claims costs were $19.8 million in the 2020 second quarter compared to $16.3 million in 2019. Total insurance and claims costs for the 2020 quarter were 5.2% of BCO revenue compared to 3.4% in 2019. The increase in insurance and claims expense compared to the prior year was primarily due to increased insurance premiums incurred in 2020 for commercial trucking liability coverage following the company's May 1, 2020 insurance renewal, increased net unfavorable development of prior year's claims, and increased severity of current year claims in the 2020 period, partially offset by reduced frequency and BCO miles in the 2020 period. The impact of the May 1 insurance renewal will add approximately $3.4 million to the fixed portion of insurance expense in both the company's third and fourth quarters. Selling, general and administrative costs were $40.6 million in the 2020 second quarter compared to $41.3 million in 2019. The decrease in selling, general and administrative costs compared to prior year was attributable to decreased agent convention costs and decreased stock-based compensation expense, partially offset by an increased provision for incentive compensation and increased provision for customer bad debt, and increased costs related to the company's technology initiatives. Stock compensation expense was $570,000 and $1.4 million in the 2020 and 2019 second quarters respectively. The provision for incentive compensation was $2 million in the 2020 second quarter compared to $873,000 in the 2019 second quarter. Quarterly SG&A expense as a percent of gross profit increased from 26.1% in the prior year to 35.9% in 2020. Depreciation and amortization was $11.5 million in the 2020 second quarter compared to $11 million in 2019. This increase was primarily due to increased IT-related depreciation. The impairment of intangible and other assets charges, totaling $2,582,000 during the 2020 period was due to the impact of negative macroeconomic trends in Mexico on customer-related intangible assets acquired in September, 2017, resulting in current financial projections relating to these intangible assets being substantially below those originally anticipated at the acquisition date. Operating income was $32.2 million, or 28.4% of gross profit in the 2020 quarter versus $80.9 million or 51.2% of gross profit in 2019. Operating income decreased 60% year-over-year. Excluding the impact of the pandemic relief incentive payments to BCOs and agents, operating income was $44.8 million, approximately 45% below the 2019 second quarter operating income. The effective income tax rate was 22.3% in the 2020 second quarter compared to 23.8% in 2019. The effective income tax rate was impacted by excess tax benefits relating to vesting of equity awards to employees in both periods and by higher-than-anticipated state tax refunds in the 2020 period. Looking at our balance sheet, we ended the quarter with cash and short-term investments of $282 million. Year-to-date cash flow from operations for the 2020 second quarter was $198 million, and cash capital expenditures were $20 million. There are currently 1,821,000 shares available for purchase under the company's stock purchase program. Back to you, Jim.

Jim Gattoni, President and CEO

Thanks, Kevin. With that, Missy, we will open to questions.

Operator, Operator

Thank you so much. At this time, we will begin the question-and-answer session. Our first question is from Scott Group of Wolfe Research. Your line is now open.

Scott Group, Analyst

Hey, thanks. Good morning, guys. So Jim, I wanted to ask about some of the yield trends. So we're seeing obviously spot rates have turned nicely positive, and even some of the TLs are talking about their yields turning positive in the third quarter. Why do you think you were still down mid-single digits? Do you think that your visibility to that is getting better as the quarter plays out, or maybe looking out into next quarter? Just some perspective there.

Jim Gattoni, President and CEO

Sequentially, Scott, if you look at the historical trends, when you move through April, May, and June and into July. Sequentially, we are improving better if you looked over the last five years. So pricing is getting better from a trend standpoint when you move month to month. So the pressure of prior years, I think as you know, our agents tend to be a little bit slower in reacting to market conditions as opposed to what happens in different types of companies that run more company store operations and have the centralized power to move rates within that organization, where our agents are out there making their own decisions running their own business, so they tend to be a little slower. So I think that's where you see our pricing drop off, it was a little bit lagged. Our pricing drop-off, and we were at the end of April talking about the first quarter and what we were seeing. Our pricing hadn't really been that affected yet. And then a couple of weeks later, it started to drop off. I think what you're going to see, on the similar side, you'll see us climb a little bit slower, and we didn't project any acceleration of growth into our forecast for the third quarter. We just kind of trended along the path that was taken to June and July, which generally is a bit slower to react than most of the other brokerage companies.

Scott Group, Analyst

And then in July, are you seeing any difference in van versus flat pricing?

Jim Gattoni, President and CEO

Well, it's hard; we don't have over the last couple of weeks it's hard for us to take one week carve out of information like that. So it's really hard to talk about individual, whether it's van or flat that are customer-type information, it's really just general trends combined van and flat.

Scott Group, Analyst

Okay. How are you viewing net operating margins as we progress in the cycle? They haven't been this low in quite some time. Do you believe that if we experience another cycle, those margins could return to the mid to high 40 levels?

Jim Gattoni, President and CEO

I think one significant challenge will be the 175% rise in our fixed insurance costs. We have some plans, possibly in 2021, to explore options that could help mitigate some of that increased expense. If we can return to the growth levels we had in 2017 and 2018, I believe we could achieve operating margins in the high 40s. Our objective is to reach high 40% to potentially 50% operating margins. This won't happen this year, and it will depend on economic conditions in 2021, but in the long term, we are definitely aiming to get back there.

Scott Group, Analyst

Okay. And then last one from me. The BCO count ticked up a little bit sequentially. Do you think that continues again in the third quarter?

Joe Beacom, Vice President and Chief Safety and Operations Officer

Yeah, Scott, this is Joe. I do think we'll see some growth in the third quarter. I think conditions are again improving and I think our growth to this point has been very retention-oriented. So, we see a lot of things working pretty well there. So, yes, I think some modest growth in the third quarter would be what we would expect.

Operator, Operator

Thank you so much. Our next question is from Ravi Shanker of Morgan Stanley, your line is now open.

Christine Hofmeister, Analyst

Hey, this is Christine on for Ravi, thanks for taking my question. Maybe circling back to sort of the earlier comments on end markets. I know you called out autos as sort of being a headwind in 2Q and some of the other commodity end markets. But how has that trended as you guys have moved into July? Has autos pretty much entirely come back or how are those moving as we head into 3Q?

Rob Brasher, Vice President and Chief Commercial Officer

Hey, Christine, this is Rob. Actually in the flatbed markets, if you kind of look, we've had some struggles I guess I should say with government and that had kind of stop quarter, in March it wasn't lifted until late May. So we looked to come back on that. We also don't know what's going on with Aerospace and Automotive. In automotive, both direct automotive and indirect, we serve a lot of industries that service the automotive, that doesn't necessarily go down as automotive steel. I think it's kind of at an all-time low since 2008. We've seen plant shutdowns and import shutdowns, heavy equipment, oil and gas machinery. So kind of those first three government aerospace, automotive steel, we look for those to start coming back. So we will look to start getting gains and have already seen gains, especially in automotive in the third quarter.

Christine Hofmeister, Analyst

Got it. Okay. That makes sense. And that's helpful. Maybe switching gears to some of the technology initiatives. I believe, you know, on the last conference call, you had indicated that the rollout was maybe even better than expected during some of the productivity gains from working from home. I was wondering if we could get an update on sort of the current tech program in terms of rollout and then looking down the line, further out, what's sort of the next gen of technology initiatives for Landstar?

Rob Brasher, Vice President and Chief Commercial Officer

When we discuss our initiatives, we are focusing on automating the entire order to cash cycle. This includes elements like tracking visibility tools, streamlining our credit process, and managing trailers. All these components are part of our technology transformation that we have been working on for three to four years. The productivity of our IT team has exceeded our projections for this quarter, especially compared to what they achieved while working from home. Recently, we began rolling out our new tracking and visibility tool, which is significantly more advanced than the previous version; this rollout started two weeks ago. We are also in Phase II of our pricing tool, which allows agents to generate quick and direct quotes for shippers. We plan to continue our spending at a level similar to two or three years ago, increasing our budget by about $8 million to $10 million annually. We are maintaining that investment in new technologies as we develop our modular system, moving away from our old legacy platform.

Operator, Operator

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

Bascome Majors, Analyst

Yeah, thanks for taking my question. I was hoping that you could help a little bit on some of the SG&A and other cost items, particularly with some of the noise around the agent convention typically being 2Q, but being canceled this year, any thoughts on maybe where the annual accrual for incentive comp is right now, along with stock comp expense versus what would be in a more typical year and thoughts on how the pacing of some of these operating cost items will go in the second half. Thank you.

Kevin Stout, Vice President and CFO

This is Kevin. Regarding the MICP accrual, we are accumulating for a one-time payment of $8 million annually, which breaks down to $2 million per quarter, so we are roughly halfway accrued for 2020. I anticipate that the SG&A in Q3 will be quite similar to Q2. Additionally, we are increasing our spending on technology initiatives, with an annual additional cost between $8 million to $12 million, likely leaning towards the higher end this year.

Operator, Operator

Thank you so much. We have several questions on queue. And our next question is from Jack Atkins of Stephens. Your line is now open.

Jack Atkins, Analyst

Okay, great. Good morning, everybody. Thanks for taking my questions. So just going back to the capacity side of things for a moment, the BCO count ticked up sequentially, but your third-party broker carrier count actually ticked down. So I was just curious what you guys are seeing out there from a capacity perspective, I mean do you feel like capacity has come out of the truckload market? You know, maybe it's temporary, maybe it's more permanent. Any sort of comments you could maybe provide around that?

Joe Beacom, Vice President and Chief Safety and Operations Officer

Yes, this is Joe. I have a few comments. I believe it's partly a utilization issue. If you're a BCO at Landstar and your utilization is low because you're not currently active, or you're classified as a high-risk BCO, you won't necessarily be removed from our count. On the other hand, if you're a carrier and the loads we have available for third-party boards decrease due to a dip in demand and a sluggish economy, and your insurance expires while you're unable to haul loads for us, then you will be taken out of the count. That's just how we account for it. Carriers are removed from the count if they are not active, while BCOs may remain in the count even if they are not immediately active. This reflects the different accounting methods for these two capacity types. More broadly, I consider our BCO population a reliable indicator of industry trends. As our results show, we are increasing the capacity count, although utilization has declined for obvious reasons. Many small carriers are likely less active, possibly due to high-risk drivers or other challenges. Aside from well-known bankruptcies, it is tough to determine if these carriers are exiting the market for good. They face similar insurance challenges, albeit of a different nature than ours, and it's hard to make any definite conclusions until conditions improve. However, we have not observed any significant decline in the population of carriers operating ten trucks or fewer, which is primarily who we work with.

Jack Atkins, Analyst

Okay. That's helpful, Joe. Thank you. And I guess just back to the insurance comment, Jim that you made earlier. Are there some things that you guys can do to incentivize BCOs to maybe install safety equipment that can help sort of lower your potential insurance costs? I'm just curious if maybe you could expand on that for a moment, because we have seen some fairly steady inflation in that line over the last couple of years. And maybe if you could just expand on sort of some of the initiatives that maybe you'll be rolling out next year, I think it'd be helpful for folks.

Joe Beacom, Vice President and Chief Safety and Operations Officer

Yeah, Jack this is Joe, I'll kind of give you our thoughts on the technology because there has been a lot of conversation and generally about truck technology and where it's going. You really have to look at the BCO fleet itself, and most of the truck technology that's out there, the collision avoidance technology, assisted break technology is really only applicable in trucks that are 2017 and newer and the majority of our BCO fleet have trucks that are older than 2017. So, really not a candidate for much of that technology that you hear about, unlike some of the company iron large publicly traded companies who rotate their fleet every three years or so. Most of our BCO fleet is not a candidate for much of that, but there are some other technologies whether it be alerts and those kinds of things that we're looking at that can be more of an aftermarket application. That's kind of where we're headed and focused to see what we can do to implement something like that in 2021.

Jack Atkins, Analyst

Okay, that's great. One last question if I could just on peak season expectations, obviously it's been an extremely volatile market here over the last six months, seven months, but what are your customers telling you about their expectations around peak season? I know in the past you guys have had a little bit more e-commerce exposure and obviously e-commerce has been growing very rapidly here over the last several quarters. But is there a thought that maybe the increased adoption of e-commerce combined with peak season could be a good guide for Landstar in the fourth quarter? How are you guys thinking about that, what are you hearing from your customers?

Rob Brasher, Vice President and Chief Commercial Officer

Hey, Jack. This is Rob. Yeah. A lot of the customers that we deal with that handle e-commerce, they're expecting big years; their business has obviously improved through this pandemic in some degree or another, and we are seeing direct effect of that. That being said, a lot of the customers we talked to, they feel that as business comes back, things are improving and things look good moving into the future. But, they don't know what the future of the pandemic is. They don't know what the future of their plant closures or openings are. Everybody is kind of influx right now. So the sentiment right this second is, things look good and improving into the third and fourth, but there is still that unknown that's kind of sitting above everyone.

Operator, Operator

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

Todd Fowler, Analyst

Great. Thanks, and good morning. Jim, on the gross profit margin expectations for 3Q to be pretty consistent with 2Q, if you exclude the agent and BCO bonus, yeah, I would think with revenue per load going up a little bit that, that would help gross profit margins. Is the offset there that you're expecting a little bit more compression on the brokered loads, or is there something else going on where gross profit percent is going to be relatively flat sequentially 3Q versus 2Q?

Jim Gattoni, President and CEO

Yeah, it's pretty much exactly what you described as I think we're going to see a little bit tighter capacity coming out of the weakness of April and May. So you're going to get a little more compression on the broker side. But I think utilization of BCO will go up. So it will be improved BCO utilization driving the gross profit margin up a little bit, while we're getting pressure on the third-party truck side. It's the net of the two.

Todd Fowler, Analyst

Got it. Okay, that makes sense. And then to your comment about the challenges right now in recruiting agents. Can you remind us, I think that every year, new agent recruitment contributes, I think it's a couple of hundred basis points to top line growth. Can you talk a little bit about that? And then, what would your expectation be, is this something that you know, as long as we're in this environment it's going to be a challenge? Or do you have things in place where maybe there is a pause right now and you could see that start to pick up and get back to more of a normalized level later this year?

Jim Gattoni, President and CEO

Previously, we mentioned that new agent revenue would account for about 3% of our total revenue when we were a $2 billion to $3 billion company. Now that we've reached $4 billion, much of our growth is driven by our existing agents, and our main focus is to support their growth while also bringing in new agents. Our objective has been to increase new agent revenue by approximately $100 million each year. However, given the recent challenges stemming from the pandemic and our recruitment efforts, we don't expect to reach that $100 million mark this year. Rob can provide more insights on recruitment and the impact of the pandemic.

Rob Brasher, Vice President and Chief Commercial Officer

Recruiting continues to be our primary focus. From an advertising and leads perspective, we're currently maintaining the same rate as in 2019. However, 2019 wasn't a strong year either. The impact stems from the transition following 2018, as many in the industry were comfortable and financially stable, but towards the end of 2019, as those resources dwindled, they reassessed their position in the market, only to face a pandemic. While our numbers indicate interest, we are still working on transitioning those customers, and despite the incoming numbers, revenue has not yet materialized. We expect it to improve as the situation stabilizes and the economy recovers.

Jim Gattoni, President and CEO

Okay, that makes sense. And I guess that just shows that I go back a little bit too far on the percentage piece. So the last one, Jim, I wanted to ask is, on the balance sheet, I understand the uncertainty in the environments right now, but obviously the cash balance has grown. What are you looking for as far as capital deployment, and how do you think about the cash balance relative to the uncertainty, and maybe you could just put a few parameters around some of the metrics that you're looking at before you either consider buying back stock, and I know you took up the dividend, but something along the lines of how you're thinking about the balance sheet in this environment. Thanks. If we look back to mid-March and through our first quarter release in April, it was clear that no one could predict the outcome of the pandemic. It made sense to be cautious and monitor our cash balances and customer receivables. We work with many small customers who may pose a higher risk compared to larger ones. Assessing the potential risks to our balance sheet from receivables was quite unpredictable at that time. Today, assuming that we maintain stable output and industrial production, we've moved past those concerns from March and April, and our level of caution has decreased somewhat. However, we are still only about five or six weeks into a more stable pattern of freight flows and industrial production, especially with discussions from some governments about potential shutdowns. I don’t foresee manufacturing halting, but I remain concerned about consumer confidence, unemployment levels, and their potential impact over the next three to six months. It is certainly better than it was at the end of April, but I worry about keeping our cash balance stable. We continue to monitor the stability of our loadings and conduct internal forecasts to assess market conditions. We evaluate business and consumer confidence, as well as our internal trends, particularly in the automotive sector. We need to know if consumers will return to automotive purchases at the normal rate of approximately $17 million. These are the factors we consider before utilizing cash, especially regarding our buyback program. Therefore, we intend to maintain a cautious approach until we emerge further from this economic cycle.

Operator, Operator

Thank you so much. Our next question is from Jason Seidl of Cowen & Company. Your line is now open.

Adam Kramer, Analyst

This is Adam on for Jason. I want to ask a little bit about capacity, but in light of the PPP loans. I think there are kind of two schools of thought here, one is that as these loans come up that carriers, well particularly smaller carriers who received these loans will kind of run into financial trouble and may exit the market. But the other school of thought is that kind of the government stimulus in general is maybe keeping people at home, maybe a little bit less motivated to go out there and kind of get back to work. I wanted to ask about your thoughts with regards to the stimulus, regards to the PPP loans and how you think that may affect capacity in the couple of months and quarters?

Joe Beacom, Vice President and Chief Safety and Operations Officer

Yeah, Adam, this is Joe. We don’t have a lot of information about the BCOs or small carriers and how much they are using the PPP loans. Generally, for those who participated, it has been a good way to navigate a challenging period. As conditions improve, I hope it's been sufficient for them to sustain themselves. However, that remains one of the key questions. We lack significant visibility into our BCO and carrier populations to determine if that has happened. I hope the recovery we're beginning to see continues to the point where the need for such support diminishes, but even that is uncertain.

Adam Kramer, Analyst

Okay, got that. And then, I also wanted to ask a little bit about some of the end markets. I know we've talked about some of the end markets that really struggled during the pandemic, like autos. I want to ask a little bit about some of the end markets that actually saw more strength during the pandemic, I mean, food, consumer products types of categories. How have those levels for those categories trended kind of since coming off the trough, and kind of what do you think what happened kind of in terms of those categories in the coming months?

Jim Gattoni, President and CEO

One of our more stable categories is Hazmat since all of our BCOs are certified to transport it. Although it was down, the decline was not as significant compared to other commodity groups, and we’re seeing steady performance in Hazmat. Foodstuffs, while not a large part of our overall revenue, remained flat to slightly up throughout April and early May, being one of the few categories that showed this trend. Overall, most of our commodities experienced a decline of about 25% in revenue in April. The most affected categories included automotive, machinery, and metals, which saw drops greater than 23%. However, consumer durables, foodstuffs, and some energy, particularly wind, performed better than the 23% decline. Overall, most of the major commodity groups contributed to that 23% drop in revenue and loadings during April.

Operator, Operator

Thank you so much. Our next question is from Ben Hartford of Baird. Your line is now open.

Ben Hartford, Analyst

Good morning. I wanted to revisit the BCO concept, and the program in April and May seemed successful. However, we can't observe the utilization of the BCOs within those numbers. Since you decided to terminate the program in late May, I'm curious about how the utilization of the BCO count in the network changed in June. I believe someone, possibly Jim, mentioned a focus on improving that utilization. Is there any way to incentivize it? Can you do more than what was done in April and May to ensure improvement? I'm interested in how the utilization trend might develop beyond the visible count.

Jim Gattoni, President and CEO

Normally, we track loads per BCO per week, and under typical circumstances, it averages between 1.6 and 1.8 loads. In April, however, it dropped to 1.4, which is the lowest we've seen in the last decade. Starting from April, considering our BCO network, many of them establish routines and build relationships with agents, adhering to a weekly schedule. When we noted a 20% decrease in revenue and loadings, those who had established routines faced the challenge of seeking out spot business and increased empty miles. Joe mentioned the utilization impact, where some drivers, particularly those at higher risk for COVID, temporarily parked their trucks. Additionally, other factors contributed to reduced utilization. The figure went from 1.4 in April to approximately 1.5 in May, still significantly below historical averages, but it rebounded to about 1.7 in June. This indicates a return towards normal trends, though still slightly below normal levels. I don't think a program akin to pandemic relief is necessary now; that program aimed to support drivers financially during the downturn and keep them engaged while they experienced reduced mileage and more empty miles. We're optimistic that utilization will continue to rise, especially with the resurgence in the automotive sector, as many BCOs are involved in that business, which was previously down by 85%. As this improves, we expect them to engage more with our spot market. Additionally, industrial manufacturing has been recovering for the past six weeks, contributing to increased utilization, and we anticipate this trend will persist throughout the quarter. The return of rates and the availability of loads should motivate BCOs to re-engage. Some drivers may still be hesitant due to health concerns, particularly those averaging in their early 50s. We have drivers who remain in our accounts but are not currently hauling. All these factors play a role, but we have seen positive momentum in utilization trends going into June and July.

Kevin Stout, Vice President and CFO

Hey, Ben, maybe the year-over-year by month percentage changes on that utilization would help. April, negative 18, May, negative 16, and then June, negative 4.

Ben Hartford, Analyst

Okay, that is helpful. Thanks, Kevin. What is that historical low level? Is there a 10-year average as a point of reference?

Kevin Stout, Vice President and CFO

I would say that you're looking at somewhere between 90 to 95 loads annually is what they haul.

Ben Hartford, Analyst

Okay. That's great. And then the sequential improvement in that count. Do you attribute that to the program in April and May? Obviously, it's a little bit counter to what happens when we're in, quote unquote recessionary periods with account following. What do you attribute that sequential improvement to? I don't know if you touched on that earlier.

Joe Beacom, Vice President and Chief Safety and Operations Officer

Yeah, Ben, this is Joe, it’s really been a retention-driven growth in the BCO count. I do attribute part of it to the incentive, and I think the gesture as much as the dollars, and I think also the realization that they want to stay in the industry, they want to run their own business, but they want to have a home and somebody who takes care of them in certain respects, that's Landstar. I think that's part of it. I think you've got owner operators either on their own authority. We see some significant challenges as a result of just the general environment, the COVID and the insurance that might come our way. I think with the slow down, you've seen owner operators who were attached to other company-owned fleets as kind of a flex capacity, and they weren't seeing any business so they see Landstar as an environment where they have an equal opportunity to run their business. I think all three of those really help us in any environment. But I think it helped us particularly well in the second quarter.

Kevin Stout, Vice President and CFO

That's great. What are you assuming for a tax rate in the back half of the year? 24.2% is our best guess on that.

Operator, Operator

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

Stephanie Benjamin, Analyst

Hi, good morning. I wanted to touch a little bit on the revenue guidance that you gave, maybe if you could just speak to what you would expect to see in the market, either from a capacity standpoint or maybe some improvement with some end markets to kind of reach the low or high end of that guidance, just any color you can provide on what's baked in there would be helpful. Thank you.

Jim Gattoni, President and CEO

I think we touched on it a little bit. We expect some margin pressure on the top line and gross profit. We anticipated that capacity would tighten slightly as the industrial economy began to improve about four to six weeks ago. From this perspective, we expect a margin squeeze on third-party trucks, but we foresee increased truck usage. Regarding our top line guidance, we discussed whether to release it at all due to current uncertainties, particularly concerning the virus resurgence and potential community shutdowns. However, we believe that the industrial community will remain stable. We based our projections on trends observed in July without factoring in any anticipated increase in industrial production. When we mention mid-single digits, we're simply using the trends from the past four to five weeks to project through the quarter as we would in a typical year. If the industrial economy performs better than it did in the last few weeks, we might reach the high end of our range. Conversely, if the government reintroduces stricter shelter-in-place orders or if the industrial economy begins to decline again, we could end up closer to the low end. So our expectations are primarily based on recent trends from the past six weeks.

Operator, Operator

Thank you so much. Our next question is from Scott Schneeberger of Oppenheimer. Your line is now open.

Scott Schneeberger, Analyst

Thank you very much. I just wanted to go back to the end markets and talk a bit to the bottom of the slide in other that's creeping up toward the quarter in the business slowly, and I'm guessing it's kind of more by default, but could you speak to a little bit about the puts and takes in there and then the follow-up on that is, you mentioned wind farms in the second quarter. Just curious what that can do in the energy vertical in the second half. Thanks.

Jim Gattoni, President and CEO

Yeah, I think that the other is primarily FAK, right it's freight all kinds where the agents just putting in a catch all where it's miscellaneous freight all kinds other, there's not a specific category that's greater than like 3% of that category. So it's really general environment. There are a lot of small customers, a lot of different types of commodities within there. So that one is really driven by general economic mostly conditions in industrial, the industrial components could be imports exports, but it's a catch all of various commodity groupings.

Scott Schneeberger, Analyst

Thanks, Jim. In the wind, anything interesting in the second half there?

Kevin Stout, Vice President and CFO

Yeah, last year was our best year on the wind and it was about, let's say $87 million, $88 million. Year-to-date this year, it's about $40 million. So we're close to our best year ever on the wind.

Scott Schneeberger, Analyst

Thank you, Jim. I'm interested in the size and timing of capital expenditures for the remainder of the year. You mentioned earlier that IT is progressing well, and I'm curious about the spending in that area. We are in a strong position with cash, so I would like to know what the next steps will be.

Jim Gattoni, President and CEO

Yeah, the capex year-to-date is $20 million. We've got elevated IT spend in there. Typically we run $8 million to $12 million or $8 million to $10 million annually on cash capex, but again this year all the increase was due to increased technology spend.

Operator, Operator

Thank you so much. Our last question on queue is from Bruce Chan of Stifel. Your line is now open.

Bruce Chan, Analyst

Good morning, gents. I appreciate the time. Just a couple left here on my list. Kevin, on the dividend, it's nice to see the increase there and obviously it seems like that rotation in shareholder return vehicle is a little bit more of a tactical decision. But is there anything more to read from that as far as the Board's appetite for maybe climbing toward a certain yield bogey?

Kevin Stout, Vice President and CFO

No. In July, each year, we typically increase the dividend, and it's usually in the 10% range, I guess, on average. So slightly higher this year, we went from $0.185 to $0.21 quarterly. But no, there is nothing to read into that.

Jim Gattoni, President and CEO

I would say that we still prefer the buyback program and dividends, valuing the flexibility that buybacks offer compared to being obligated to a large dividend. As Kevin mentioned, since we began our dividend program in 2004, we've consistently increased it every third quarter. This year's increase was slightly larger than usual, reaching $0.025, making it one of the biggest increases we've had, but it aligns with our historical approach. Our main focus remains on the buyback program and the flexibility it provides.

Bruce Chan, Analyst

Okay, great. Fair enough. And then just a last one here circling back to Mexico. I mean, I know that that's a pretty small portion of your revenue, but just want to see, given some of the changes going on, if you have any visibility on whether there has been increased capacity needs as a result of some of the near-shoring efforts?

Jim Gattoni, President and CEO

I don't think we've observed any significant increase in capacity due to near-shoring. It's a topic that's being discussed as a potential outcome from trade discussions and the current situation with China, but it seems more likely to be a future consideration. So, there hasn't been any new business specifically linked to near-shoring. However, cross-border business has been affected by the virus, but it's starting to reopen, and we hope it will remain strong for the rest of the year.

Operator, Operator

Thank you so much. At this point, we do not have any more questions on queue. You may continue.

Jim Gattoni, President and CEO

Thank you as always for your attention. We wish you and your family to stay healthy and safe and I look forward to speaking with you again on our 2020 third quarter earnings conference call currently scheduled for October 22nd. Have a good day.

Operator, Operator

Thank you so much, and that concludes today’s conference call. Have a good morning. Please disconnect your lines at this time.