Landstar System, Inc. (NASDAQ:LSTR) Q4 2023 Earnings Call Transcript

Landstar System, Inc. (NASDAQ:LSTR) Q4 2023 Earnings Call Transcript February 1, 2024

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Operator: Good morning, and welcome to Landstar System Incorporated’s Year End 2023 Earnings Release Conference Call. All lines will be in a listen-only mode until the formal question-and-answer session. Today’s 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; Jim Todd, Vice President and CFO; 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.

Jim Gattoni: Thank you, Bob. Good morning and welcome to Landstar’s 2023 fourth quarter earnings conference call. Before we begin, let me read the following statement. The following is the 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 statement. 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 include but not limited to the operational, financial and legal risks detailed and Landstar’s Form 10-K for the 2022 fiscal year described in the section risk factors and other SEC filings from time-to-time.

These risks 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 unless or undertakes no obligation to publicly update or revise any forward-looking at information. The freight environment throughout the 2023 fourth quarter reflected soft demand and readily available truck capacity. These freight market conditions were consistent with what Landstar experienced during the first three quarters of 2023. The 2023 fourth quarter also included an abnormally soft peak season by historical standards. Nevertheless, even with a weak peak season, Landstar performed mostly in line with the 2023 fourth quarter guidance we issued in our third quarter earnings release on October 25.

We provided revenue guidance of $1,225 million to $1,275 million. Actual revenue came in at $1,204 million, about 2% below the low end of our guidance. We also issued earnings per share guidance of $1.62 to $1.70, actual earnings per share in the 2023 fourth quarter was $1.62 slightly above the low end of the guidance. It is worth noting again that the 2023 performance continues to significantly outpace pre-pandemic levels. 2023 fourth quarter revenue was 21% over the 2019 fourth quarter revenue and earnings per share exceeded the 2019 fourth quarter by approximately 28%. Before diving into further detail on Landstar’s performance in the 2023 fourth quarter, please note I will mention of normal seasonal patterns or normal trends. For purpose of today’s conference call, normal seasonal patterns and normal trends refer to Landstar’s sequential revenue, load count, pricing, or other trends for monthly or quarterly periods from 2015 to 2019 and excludes our historical results from 2020, 2021, and 2022 due to the highly unusual dynamics reflected in those metrics during the pandemic-driven freight cycle.

Overall truck revenue was $1,085 million in the 2023 fourth quarter, 29% below the 2022 fourth quarter and a 22% decrease in load volume and a 10% decrease in revenue per load. It should be noted that the 2022 fourth quarter included 14 weeks, whereas the 2023 fourth quarter included 13 weeks. Excluding the estimated truck load volume from the extra week in the 2022 fourth quarter, truck load volume decreased an estimated 19% in the 2023 fourth quarter compared to the 2022 fourth quarter. As we entered the 2023 fourth quarter, the number of loads hauled via truck in early October was trending below normal seasonal patterns. The below normal trends in the number of loads hauled via truck started in the 2022 second quarter as each sequential quarter-to-quarter change in truck load count from the 2022 second quarter through the 2022 fourth quarter was below normal seasonal patterns due to the soft consumer demand for the types of freight we haul and a slow U.S. manufacturing sector.

Based on normal seasonal patterns, truck load volume typically increases slightly from the third quarter to the fourth quarter in a given year. From the 2022 third quarter to the 2023 fourth quarter, truck load volume decreased 6%, a significant underperformance compared to normal seasonal patterns. As to pricing, truck revenue per load was trending reasonably in line with normal seasonal patterns through mid-October. However, revenue per load on loads hauled via trucks softened after the first few weeks of October and trended seasonally below normal patterns from September to October, October to November, and November to December. We attribute that negative pattern primarily to the abnormally soft peak season. We look at BCO revenue per mile as a barometer of the rate environment as this metric mostly excludes the impact of rising and falling fuel costs.

During the 2023 fourth quarter, revenue per mile on BCO van equipment remained fairly stable from October to December, whereas revenue per mile on BCO unsided platform equipment softened through the quarter. BCO revenue per mile on van equipment and on unsided equipment, which in both cases excludes fuel surcharges were 17% and 14% higher in December 2023 compared to the December 2019, respectively. However, based on industry data from ATRI’s, the cost to operate a truck excluding fuel costs was approximately 20% greater in 2022 than in 2019. In other words, the increase in rates since December 2019 likely has not kept up over that period with the increase in cost to operate a truck. We continue to believe that rates in the spot market will stay relatively higher than 2019 levels given the significant amount of additional cost to operate a truck today.

In terms of revenue by equipment type in the 2023 fourth quarter, revenue hauled via van equipment, unsided/platform equipment, power only, and less in truck load, revenue all experienced revenue declines from the 2022 fourth quarter. Revenue hauled via van equipment was 29% below the 2022 fourth quarter, mostly on soft demand on the consumer freight we haul. Revenue hauled via unsided platform equipment was 20% below the 2022 fourth quarter, mostly due to a slow U.S. manufacturing sector. Other truck transportation revenue, which is primarily comprised of power only revenue, was significantly favorably impacted by increased demand for substitute line haul services during the pandemic and without 51% compared to the 2022 fourth quarter. Unsurprisingly, demand for substitute line haul services was significantly softer throughout 2023 compared to 2022.

Less in truck load revenue decreased 26% compared to the 2022 fourth quarter and a 15% decrease in load volume and a 13% decrease in pricing. Our rail, air and ocean services revenue in the 2023 fourth quarter was 23%, or $26 million below the 2022 fourth quarter. Non-truck transportation revenue generated in the 2023 fourth quarter was, however, consistent with the revenue these services generated in the 2023 third quarter. Total network loadings in the 2023 fourth quarter were 21% below the 2022 fourth quarter. Total load volume is somewhat influenced by customer mix. For example, Landstar provided truck capacity to other trucking companies, 3PLs and truck brokers, where volumes tend to vary more widely period-to-period with changes in the levels of freight demand.

Revenue hauled on behalf of other truck transportation companies was 15% and 19% of transportation revenue in the 2023 and 2022 fourth quarters respectively. During periods of tight truck capacity, other trucking companies, 3PLs and truck brokers reached out to Landstar to provide truck capacity more often than during times of readily available truck capacity. The freight hauled by Landstar on behalf of other truck transportation companies includes almost all of our commodity groupings. Overall, the revenue hauled on behalf of other truck transportation companies in the 2023 fourth quarter was 42% below the 2022 fourth quarter, contributing 28% of the overall $470 million decrease in quarter over prior year quarter revenue. Year end 2023 BCO truck count was approximately 13% below the 2022 year end truck count.

Physical 2023 BCO truck turnover was 41%, which is higher than the 36% turnover Landstar experience in 2019 during the most recent relatively comparable soft rate environment. We believe the increase in the turnover rate compared to the comparable 2019 period was due to the significance of the decrease in rates, the duration of the negative trend in month-to-month revenue per load and the increase cost to operate a truck today compared to pre-pandemic periods. I will now pass to Jim Todd to comment on other additional P&L metrics around the 2023 fourth quarter performance. Jim?

Jim Todd: Thanks Jim. Jim G has covered certain information on our 2023 fourth quarter, so I will cover various other fourth quarter financial information included in the press release. In the 2023 13-week fourth quarter gross profit was $124.6 million compared to gross profit of $180 million in the 2022 14-week fourth quarter. Gross profit margin was 10.3% of revenue in the 2023 fourth quarter as compared to gross profit margin of 10.7% in the corresponding period of 2022. In the 2023 fourth quarter variable contribution was $178.1 million compared to $234 million in the 2022 fourth quarter. Variable contribution margin was 14.8% of revenue in the 2023 fourth quarter compared to 14% in the same period last year. The increase in variable contribution margin compared to the 2022 fourth quarter was primarily attributable to mix as an increased percentage of revenue was generated by BCO independent contractors which typically has a higher barrier to contribution margin than revenue generated by other modes of transportation and an increased variable contribution margin on revenue generated by BCO independent contractors.

Other operating costs were $13.2 million in the 2023 fourth quarter compared to $10.3 million in 2022. This increase was primarily due to increased trailing equipment maintenance costs and decreased gains on sale of used trailing equipment. Insurance and claims costs were $27.3 million in the 2023 fourth quarter compared to $29.6 million in 2022. Total insurance and claims costs were 6% of BCO revenue in the 2023 period and 5% of BCO revenue in the 2022 period. The decrease in insurance and claims costs as compared to 2022 was primarily attributable to decrease net unfavorable development of prior year claim estimates partially offset by increased premium expense primarily for commercial auto and excess liability coverage. During the 2023 and 2022 fourth quarters, insurance and claims costs included $900,000 and $3.8 million respectively of net unfavorable adjustments to prior year claim estimates.

Selling, general and administrative costs were $52.7 million in the 2023 fourth quarter compared to $56.1 million in 2022. The decrease in selling, general and administrative costs was primarily attributable to a decreased provision for incentive and equity compensation under our variable compensation programs partially offset by increased employee benefit costs. In the 2023 fourth quarter, the provision for compensation under variable programs was $100,000 compared to $5.3 million in the 2022 fourth quarter. Depreciation and amortization was $13.7 million in the 2023 fourth quarter compared to $14.8 million in 2022. This decrease was primarily due to decreased depreciation on the company’s trailer fleet partially offset by increased depreciation on software applications resulting from continued investment in new and upgraded tools for use by agents and third-party capacity providers.

The effective income tax rate of 24.1% in the 2023 fourth quarter was 60 basis points lower than the effective income tax rate of 24.7% in the 2022 fourth quarter. As the effective income tax rate in the 2023 fourth quarter was favorably impacted by certain positive state tax developments. In addition, the effective tax rate in the 2022 fourth quarter was unfavorably impacted by the impairment and deferred tax assets related to employee equity compensation arrangements as a result of performance conditions being attained as of year end. Looking at our balance sheet, we ended the quarter with cash and short-term investments of $541 million. Cash flow from operations for 2023 was $394 million and cash capital expenditures were $26 million. Back to you, Jim.

Jim Gattoni: Thanks Jim. We entered 2023 with a challenging freight environment and very difficult year-over-year comparisons coming off of record 2022. Landstar’s revenue performance through the freight cycles that occurred over the past four years ultimately set the stage for where we are today. From the 2022 second quarter at the start of the pandemic to the record revenue Landstar achieved in the 2022 second quarter, sequential quarter-to-quarter revenue trends were above seasonal norms. That revenue upcycle lasted seven quarters. Through the 2023 fourth quarter, quarter-to-quarter revenue has now decreased below historical seasonal trends for six consecutive quarters from the record revenue set in the 2022 second quarter.

Generally in the ordinary course of our business, we experience down cycles that drive revenue from peak to trough as well as up cycles that drive revenue from trough to peak with each peak and trough being higher than the last. In the case of either down cycles or up cycles, freight cycles tend to move from peak to trough or trough to peak over six to eight quarters. These cycles are typically driven by three main factors, the level of industry demand for freight services, the level of available truck capacity, and the differential between industry-wide contract and spot pricing at any given point in time. Given we have been in a down cycle for six consecutive quarters, we expect to begin to see above normal seasonal revenue growth around mid-year 2024.

Currently we expect first quarter 2024 revenue per truckload and number of loads hauled via truck to truck in line with seasonal norms following the 2023 fourth quarter. This expectation is driven by the trends in revenue per truckload and truckload volume in the first several weeks of January and the week of the normal peak season in the 2023 fourth quarter. Given those expectations, we anticipate revenue in the 2024 first quarter to be in a range of $1.1 billion to $1.15 billion and earnings per share to be in a range of $1.25 to $1.35. This earnings estimate anticipates variable contribution margin ranging from 14.5% to 14.7%. Please note that the variable contribution margin in the first quarter is most often the highest variable contribution margin of any quarter during a given year.

This is typically attributable in large part to mix as BCO revenue which is a higher variable contribution margin in other modes often contributes a higher percentage of revenue in the first quarter. Higher variable contribution margin on third-party truck brokerage revenue in the first quarter compared to the following three quarters also may contribute this historical seasonal trend as the first quarters typically seasonally softer than the following three quarters. The expectation of a cycle upturn mid-year suggests less or could experience increasing demand or shift in mix towards truck brokerage and somewhat of a tighter truck capacity market as we move through to 2024. As such the first quarter variable contribution margin included in the first quarter guidance is not representative of what we expect for the full year.

Based on current assumptions for 2024, we expect variable contribution margin for the full year 2024 fiscal year to be below the first quarter by 50 to 100 basis points. As previously mentioned the macro freight environment softened significantly throughout 2023 as compared to the dynamic driven demand that continues to drive freight markets in the early part of fiscal year 2022. Regardless of a less robust freight environment and inflationary pressure of Landstar of labor equipment and insurance costs, the resiliency of Landstart’s variable cost business model continues to generate significant free cash flow and financial returns. Landstar’s free cash flow of $368 million in fiscal year 2023 and ended the year with a stronger balance sheet than ever before.

For 2024, has its work cut out for due to continuing soft conditions in the freight environment. Nevertheless we have been through many business cycles before and we still expect nothing less than 2024 being a terrific year by pre-pandemic standards. Before I open to questions I want to put a little more color around the first quarter guidance. We often refer to seasonal patterns as it relates to short-term trends quarter-to-quarter. And the seasonal patterns, when you look at it, the more inputs to a financial metric, the more volatile that season pattern would be. For example, when we look at truck revenue, we relate the seasonal patterns. There is only two inputs to truck revenue. Its revenue per load and it’s the number loads hauled. So it tends to in the short-term be less volatile and things like EPS.

When we look at EPS, there are more inputs for EPS, whether it’s the change in variable contribution margin from one quarter or our changes in what tend to be the most volatile numbers in our P&L below the variable contribution line which is insurance and our variable compensation programs. So, when we look at our trends and we look at the first quarter guidance and compared to the fourth quarter, we’re kind of in line with the revenue trend seasonally and again seasonally from 2015 to 2019, but off the trend somewhat when you look at EPS. And that’s generally a attributable one is we’re looking at a variable contribution margin in the first quarter that’s slightly below the fourth quarter and it’s really driven by the fact that we are looking at the BCO revenue in the first quarter to be the same as the fourth quarter where typically it’s higher in the first quarter, in the fourth quarter, and that’s due to a drop off in the fourth quarter BCO.

So we’re anticipating a slightly lower variable contribution margin in the first quarter compared to fourth quarter which is not a norm. And then you’re also dealing with some – the variable compensation programs in the first quarter along with a little bit of CEO transition cost that wasn’t necessarily in the fourth quarter. And then when I look at it, and I look at EPS falling off from the fourth quarter to the first quarter, it’s more in line with 2015, 2016, 2017, because the seasonal pattern in 2018, if you recall, it was really driven by the ELD mandate when actually the fourth quarter of 2017 compared to 2018 was abnormal, the 2018 was above expected performance. And in 2019 we just had – we’re coming off a very high set of compensation in 2018 and there was making the comp there, but 2019 comp to the fourth quarter much easier.

So that’s where we’re looking at EPS. We’re looking at about a 20% decline from the fourth quarter to the first or to the midpoint which is really more representative of what we’re anticipating and things other than the top line. And with that, I will open to questions.

Operator: Thank you very much, sir. At this time we will begin the question and answer session. [Operator Instructions]. We have questions on queue. And the first question is coming from Brian Ossenbeck of JP Morgan. Your line is now open.

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Q&A Session

Brian Ossenbeck: Hey, good morning. Thanks for taking the question. Jim, maybe you can just give us some color on the trends in BCO. You mentioned the turnover and a couple of reasons behind that and why it was up. Where you see that sort of bottoming out? Is there a risk that the longer this lasts, maybe into that eight-quarter-plus range that they just don’t seem to come back as quickly or maybe come back with a lag, really trying to understand that as it relates to just the leverage and the ability to grow in the model? That’d be helpful. Thanks.

Joe Beacom: Hey, Brian, this is Joe. I’ll answer that question. So, yes, so we’ve seen the BCO count decline at a pretty good clip. And I think, as Jim mentioned in his prepared comments, a lot of that is just the duration of the down — trending down and also the fact that your costs are up perhaps more than the rates are able to support. And that’s kind of what we’ve seen over the course for the last four quarters and it continues into the first quarter. If we go back, we’ve seen some quarters whereby it’s gone up pretty substantially as well. So, I think that the count can be reactive, but the fundamentals have to be there. If I take you back to ’17, we were up 250, up over 900 in 2018, up 750 in 2020, up 873 and 2021, so I think it speaks to the fact that BCO capacity will come back into the model, but the fundamentals have to be there.

And right now, I just don’t think the fundamentals are all that compelling. And if you look at some of the reasons for the departures, I think that helps us kind of put some color around that. The single biggest reason for departure in full year 2023 was maintenance costs, inability to make repairs. So, if your financial viability is questionable or you’re marginally profitable as a BCO and you have a significant maintenance expense, you just can’t cover it, and so you go to the sidelines. And that’s a full 20% of our terminations in 2020. So, I think that speaks to two things. One, I think the difficulty in the environment for BCOs, but also the fact that when some of those things improve, I think the model can be resilient and grow as we have in the past.

So I don’t think it’s anything that’s systemic going forward. The interest to come on and Landstar is still there. I just think it’s really a reaction to capacity leaving the market overall as it is, small carriers across the landscape are leaving the market in rapid fashion. We’re not immune to that and so that’s happening. I just think they’ll continue to look for opportunities to come back in when the freight market improves and we kind of move our way out of this freight recession.

Brian Ossenbeck: Great. Thanks for that. Maybe, Jim Gattoni, congrats on their time it best look in the next phase. Maybe you can just give us a sense of the transition costs you mentioned there. It seemed like it was an impact worth calling out in the first quarter? Thank you.

Jim Todd: Brian, its Jim Todd. So from a sequential standpoint, just related to SG&A, when you look at the reset of the variable compensation programs that Jim spoke to, coupled with the CEO transition costs, it’s about a $5.9 million sequential headwind or about 12 pennies.

Brian Ossenbeck: Okay. Thanks a lot for your time. I appreciate it.

Operator: We have the next question coming from the line of Bruce Chan of Stifel. Your line is now open.

Bruce Chan: Good morning, everyone, and thanks for the question. Jim, congrats on the retirement there. I just want to ask a question on the substitute line hall. You talked about the weak peak this year and the impact on this end market relative to some of the others. But I just wanted to get your sense of whether this is a temporary thing related to this particular down cycle or whether this might be more of a structural issue since we’ve heard of some big line hall consolidation initiatives that some of the big traditional customers during this period, so, any commentary there on the cyclicality versus structural weakness of substitute line haul?

Jim Gattoni: You know, if you were pre-pandemic, I wouldn’t call it structurally weaker. It is weaker, but not to the degree it sounds because we’re coming off a tremendous two years of substitute line hall, where those, you know, those parcel carriers really needed us to jump in. There was so much stuff coming through the network. So for us, I don’t necessarily think it’s structural. I think it’s just a downturn at peak season. And I think I would anticipate that you’re going to see a little bit of improvement going into the forward quarter next year, because it’s — I’ve been here for quite a long time. It is about the most abnormal peak season I’ve ever seen with the softness. So I don’t believe it’s structural.

Bruce Chan: Okay, great. Appreciate that. Just a quick follow-up here around your comments on unsided rates. You know, I don’t know what your sense is of what’s going on there. Is that just industrial lagging the recovery in some of the other segments of the market? And then, is there anything you’re seeing with regard to a big consolidation in the space that was recently announced?

Jim Gattoni: Look, I think its more demand than it is a consolidation or anything change in the marketplace right now. We see, you know, one of the things I talked, one of the things I talk about is the revenue per mile on the flatbed dropping as we move through the quarter. And it was just for us, it was softness in some of our customers. But I think it’s just an industry-wide thing. I think if you look at what happened in industrial production and manufacturing production in December, it was actually positive for the first time in about 12 months. And I just think that hasn’t transpired into the freight dynamic yet. We do expect that to continue to be relatively soft, at least through the first quarter. But again, it has nothing to do with competition or changes in the industry dynamic. It’s all just a little bit of softness coming through the flatbed market with 12 — you had 12 months of consecutive decreases in manufacturing.

Bruce Chan: All right. Thanks for the time.

Operator: Thank you. We will now move to the next question coming from the line of Scott Group of Wolfe Research. Your line is now open.

Scott Group: Hey, thanks. Good morning and best of luck to you, Jim. So you made a comment that you think that 2024 will be something like a really good year relative to pre-pandemic standards. When I look at the guidance for Q1, you’ve got revenue still above 2019 levels, but now the earnings below and the margins like at the lowest in like over a decade. So is Q1 a unique quarter in that the earnings and the margins are so far below? Or I just want to understand what you said on the prepared comments relative to the guidance?

Jim Todd: Yes, I think if you look at 2019 pre-inflation, you know, if we didn’t have inflation, we’d be sitting on the same margins. But especially when you look at insurance, if you remember what happened to us in insurance, we renew May 1 of every year, our basically auto trucking liability policy, which gives us the coverage on trucking accidents. If you go pre-May 1 of 2019, our premiums on that were about $8 million to cover us up to pretty significant, very, very good coverages. And as you know, the nuclear verdict has blown up that market. We are now probably above $30 million for that coverage. So you’re looking at significant inflation on the insurance line compared to pre-pandemic levels. There’s also inflationary stuff in almost every line item.