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Landstar System (NASDAQ:QLTY)

Dahlman Rose & Co Global Transportation Conference

September 06, 2012 14:10 PM ET

Executives

Henry Gerkens - President & CEO

Jim Gattoni - VP & CFO

Analysts

Justin Yagerman - Deutsche Bank

Justin Yagerman - Deutsche Bank

Good afternoon, we are going to continue along with the program here and without further ado I will turn it over to Landstar’s Chairman, President and CEO, Henry Gerkens and we also have Jim Gattoni here from Landstar, Chief Financial Officer. Thank you so much.

Henry Gerkens

Thanks Justin and good afternoon. Before we start let me make reference to our forward-looking statement disclaimer and with that those of you who have heard me speak before I always open up every Landstar presentation with our model definition because really to understand Landstar you really need to understand this model definition. I am going to spend a bulk of the time explaining the Landstar model because we operate very differently. We operate the truck loads arena, about a $255 billion marketplace, highly fragmented but the key to that model definition you see couple of key words, safety, very important for Landstar I have a few slides on safety later on but the bottom phraseology all right which network of agents, third party capacity owners and employees, very, very important to Landstar we don’t own any power equipment. We utilize third party capacity exclusively. We also utilize independent sales agents, all revenue that we have is put forth through our independent agents. Our job at Landstar is to make our business associates more successful.

So when you think about success everything we do is to try to make our agent successful and our third party capacity successful. If we can accomplish that well then Landstar is successful and obviously we have a network on employees. We are located in three different locations about 1300 employees across the United States. From a services, these are the services that we provide, 92% of our revenue is generated through truck load. We offer a variety of different services, back in 2009 we acquired two technology based companies which also allow us to play in the arena where we can also manage the freight. Our objective is really to manage the freight and move the freight. A to Z solution and what we are trying to do for customers is to go in and understand what solution best fits the customer, whether it be a technology solution or whether it be some sort of freight solution but again we have a wide array of services that we have for our customer base.

As far as the industry served we are very big in the industrial sector of the United States as you can see from this particular slide, we are 35% flatbed or on-sided probably the largest flatbed carrier in the United States. When you think of Landstar and the industrial base that we serve, statics that we follow externally that really give you a pretty good ideas for how Landstar is going to do, our industrial production figures or the ISM manufacturing index. We don’t have any customer at this point in time that’s over 5% of our revenue and we have over 25000 different build to accounts. We are very big in the secondary and tertiary markets. Our competition is primarily those localized truck load carriers, those regionalized carriers if you will. Irregular route, non-routine, we don’t do a lot of defined lane stuff, which again is very different. Let’s talk about the third party capacity network. So as I said between the broker carriers and the BCOs it's 92% of our revenue. A business capacity owner you might know him as an owner operator, we coined the phrase business capacity owner back in the 90s because we believe our guys a little bit different and if we go back through the evolution of a business capacity owner you probably started out as an employee driver being paid on a mileage based system, being told what to do, where to go.

And maybe at some point in time the company he was actually driving for financed them right into the truck he was driving. They give them an increase in the mileage rate of pay, now he is responsible for the cost of running that tractor. Well couple of things remained the same, he is forced dispatched. He is told what to do where to go, he might give him a choice of five loads but he got to take one of those five loads, he is not going to get the best.

And the other piece, in order to make more money he is got to drive more miles. As opposed to the Landstar business capacity owner it gets paid on a percentage of revenue basis. He has every available load that Landstar is putting his system at his finger tips to select from and that’s very different, the way the system works is our agent. We are going to talk about agents in a little bit puts the load in the system. It goes to two separate load boards, one external and one internal password protected only to our BCOs. All the information is going to both boards, time of pick up, destination, type of equipment et cetera except the BCO board gets the price because he is getting paid 75% of whatever that load might fall whereas the broker carrier we negotiate that rate with the broker carrier so therefore we don’t send him the price.

So in theory even though it goes the same time the BCO has the advantage. The point being from a business capacity owner, he can make more money by a smarter business man and we only want the best of the best, our guy average age is about 52 - 53 years old he has been around. He has been around, he tends to be safer and I am going to refer that safety slide later on, you will see those in the numbers. He is exclusive to Landstar because he is riding on the Landstar’s DOT authority. A broker carrier on the other hand has his DOT authority and could be a single owner operator with his own DOT authority or could be a very big company like U.S. Express.

Again that’s 92% of our revenue, generated by those we also have contracts with the railroads, air cargo carriers, ocean cargo carriers and they also get paid on a negotiated rate basis. The other item we have is warehouse capacity owners, we have a network of about 100 capacity owners across the United States. We do have on occasion customers come to us wanting warehouse space. What we do is allow then and go back out to that network is again a percentage piece that we would take but again I don’t guarantee any warehouse space, nor do we own any warehouse space. So it's just service available for customers, small, very small.

If you take a look at our capacity providers from a truck standpoint, you can see we have done a pretty good job of increasing our BCO count year-over-year, couple of years ago we saw our count going down I had gotten, we have gotten very heavily in the brokerage business back in I guess 2001, 2002 timeframe and talked a lot about brokerage but I have always said I want to grow both, but somehow that message got little bit lost and we started to see our BCO count creep down. We did a little bit of investigation, went back to basics and that has actually turned around and I will show you some of the advertising that we have utilized in order to get that count back up to where it should be but I believe that the company that can access the capacity is going to win in the long term.

So our objective is to increase capacity, because when you think about our agents. Again independent business guys what do they need to be successful, they need capacity to haul. What does capacity need? Capacity needs loading opportunities, thus we bring in more agents. So again when you think about Landstar really what we are doing is flowing information between the capacity, the agent and the traditional customer. We view all as customer, but what we have to do is create that loyalty and everything we do as I said is to try to make those two constituencies very successful. Example of some of the ads this you see at the, this is an ad and the one you are going to see next was on the second page, big ad of the trucker magazine which I am sure is something that you guys see all the time and read all the time but many event it works very well and what this ad does it goes back to basics. It emphasis percentage page, it emphasis the freedom to choose your own load, it emphasis the LCAPP program, the Landstar contractors advantage purchasing program which again is a program that we started a long time ago that allows our contractor to go in and purchase goods and services that he might need to run his business, i.e. tires, fuel, things like that.

We passed that 100% of our fuel surcharge, the business capacity owners don’t keep any for ourselves, again building up that loyalty we are on their team and we want them to be on our team. So this type I think is very successful known as speed up our recruiting process. You see that little barcode there, you scan that it goes right into our website and it's an online application which is pretty neat stuff. We recently announced that effective August 1, all new contractors all new BCOs will be required to have electronic onboard recorders in their units. Wasn’t sure what the impact was going to be. I said in my mid-quarter update call that I held last Thursday and we have seen zero impact at this point in time and our BCO count continues to increase as of that date.

This is another add, same type of add, same periodical but this is really geared towards a flatbed driver and flatbed drivers and flatbed equipment is probably the tightest than any other type of equipment out there that we are really hurt in the 2009 recession. As I said we are the largest flatbed carrier and the -- we are very big in that arena and this helps us obviously recruit more drivers but not a lot of players in that part of the industry.

If you counted all the dots here, 1200 locations, 1300 locations, these are agent locations and agent doesn’t get paid unless a load is moved remember he said he is the individual that’s putting that load in the system. Unless he gets that moved he doesn’t get paid all right. Pretty large population of agents, we are not geographically based, I can have 20 agents in Dallas, it's account based. We have field people that are employee based that manages what goes on in that territory because I don’t want one agent calling another agents customer, because an agent of record accounts as we like to call it but again so not territorial based.

What really drives Landstar is the number of $1 million, they account for approximately 90% of our revenue and I can have one agent having more than one location and you can see we had $504 million agents last year. They averaged them about 4.9 million a piece, so when you think about how much money they are making that’s Landstar revenue and if you just we are going to talk in a few slides as far as how they get paid but if you used an average of about 8% when you look at our P&L you got some pretty high priced sales people out in the field working again towards Landstar but again it's that loyalty we build out to turn over in this particular group.

I think we lost two last year, people don’t leave Landstar because the systems that we have or geared for the way they do business and as I said in order for them to be successful they need to access the capacity and we have a lot of capacity for them to source from and that’s very important.

To really understand Landstar’s P&L this was probably one of the most important slides that you will see. We defined gross profit as revenue less purchase transportation and agent’s commission because as I said before every piece of revenue has those two component parts and that yields a gross profit number. What’s really important is growing gross profit dollars, we can divide gross profit into two types of margins, fixed and variable. When the load is hold by a BCO typically he gets paid 75%, the agent gets paid 8% so Landstar’s margin on those types of loads are 17%, doesn’t matter what kind of economic environment you are in its 17% on BCO loads on average.

Brokerage, there is two types of brokerage arrangements we have, the first one I am going to talk about is one on a fixed margin and that’s where Landstar takes a percent off the top of the invoice anywhere from 8% to 12% depending on the contract with that particular agent. The purchase transportation is paid and the agent gets what’s left over. But from Landstar’s perspective that gross margin again is fixed, we know what it is. So when you think about the pieces that I have listed here of fixed gross margin in the second quarter 62% of our gross profit was on a fixed gross margin. Then you have variable which is more or less your traditional type of brokerage. The purchase transportation is paid and what’s left over and here is the difference, we split with an agent pursuant to that agent contract 50-50, 60-40 or that type of split.

So again and that’s variable and you could see here and is anything with the rail, air, ocean piece 38% in the second quarter was variable. Now you see the increase in the second quarter of ’11 to ’12 we had more loads in the system. If you have more loads in the system what’s going to happen, you got to mix change, so what you are going to see is you are going to see more loads being hold by brokerage.

Normally is what happens, because again I have got, when you go back to that chart as far as the number of capacity owners I have about 8000 compared to relationships with over 28,000 carriers logically when revenue is, we have got a loads to this system. You are going to have more brokerage and Jim will talk about that later. That really is getting to that gross profit number because once you get that gross profit number, our P&L is pretty easy to understand and really what our objective is since we don’t really any fixed assets is the leverage that grows profit number over a relatively constant SG&A number and as Jim is going to explain in the second quarter. You saw a $5 million increase in gross profit dollars, that felt right to the bottom-line and some because we had a very safe quarter.

And that’s really the key, as far as how Landstar operates and keep that in mind as Jim talks. Talked about this before as far as what Landstar really does, as far as flow information, the accurate timely flow of information is critically to a Landstar success, let’s talk a little bit about safety. These are total accidents per million miles driven, we are pretty proud of the fact that we are even driving that number down but I think probably more your main is this particular slide which talks about DOT recordable accidents and the DOT recordable accident is an accident that involves a tool way or an injury and this again is per million miles driven and you can see that when I compare our numbers, our BCO numbers to the industry we outperform the industry every single day. And we think about who we try to recruit, our BCOs off those 8000 BCOs most of them are single owner operators in other words one truck one driver, that’s their business and they tend to safer and we look very stringently on safety and that’s why our numbers are what they are and we will tell you we carry a $5 million deductible per occurrence and we are insured all the way up to $200 million.

Any quarter we could have a series of actions which are going to basically cost some volatility in those numbers. If you look at them over a continuum of time those numbers work out to be pretty straight as far as a percentage of gross profit and Jim can talk about that later but the point is we look at this every single year as far as what the actuary says we can expect that experience to be within that layer versus what we are going to be charged from premium standpoint and we would adjust that if it made sense from a financial standpoint but that’s why how we get to the $5 million deductible.

Let’s talk a little bit about the operating, this is how we set out 2012 at the beginning of the year when we did our budget process back in 2011 for preparation of 2012 and quite frankly it's been pretty much right on target throughout the year, slow economic growth. I mean it's moving north but anything that you would expect after a 2011 pretty good recovery but we just didn’t expect anything that was going to move the needle that great. Continued tight capacity market, you have seen that through the first six months I think you have started to see recently a little bit more of a balance between supply and demand and so I think you got that little bit of balance. We can talk a little bit later about really what I think is causing that really is I think the uncertainty out there as far as what else what do people want to do with the election coming up, which way I am going to go and I think people are a little bit gun shy at this point and then obviously we have got a lot of regulation in the trucking industry, a lot of regulation that we have to deal with but when you think about the model all right, Landstar provides that infrastructure to handle a lot of that regulation and compliance aspects for all of these small businesses that are associated with Landstar and that’s important.

Growth strategies, talked about existing, productive quality, agent locations. We have been pretty successful with that. If you look at our new agent growth in the first quarter I think it was $27 million of new agent growth, second quarter I think it was 21 million. Existing account penetration, we have over 25,000 different (inaudible) accounts and our objective is to continually go and into those accounts and try to get more business. The supply chain stuff I think is going, our game play is to yield more freight opportunities and we have got some success in that and then obviously the person who can access capacity and increased capacity in my opinion is going to win longer term.

And we as I said are the home of small business so I think we have a good opportunity to basically increase that capacity base but we got to keep one thing in mind, our objective at Landstar, is to make our agent successful and make our capacity successful. I don’t have any company iron, I don’t have company stores, so I don’t have any competition. The agent feels that loyalty, the capacity feels that loyalty and I think if anything that you would walk away from this meeting is to really understand that concept and that’s what makes Landstar I think better than any of the companies out there. And I am obviously prejudice, I have been here since the beginning.

Our targets we set out at the beginning of the year, I can lay that out I mean you can read that, the one thing I will point out is the third bullet there continuing to operating margin improvement couple of years ago I said I had plan to be at a 45% operating margin meaning, operating income over gross profit probably going to get there this year so just so if you are going to ask me what’s my new target, as soon as we hit that at the end of the year, I will give you that target next year. But again it's the ability for us to increase that starts with revenue and increase those gross profit dollars, leverages the SG&A and I think that’s what you will see and with that I will turn it over to Jim.

Jim Gattoni

Thanks Henry, what I will try and do here is I will just try and tie some numbers into what Henry is talking about and how basically the infrastructure is built and where the revenues are derived from but if you look at the first chart on the top left revenue, revenue grew second quarter 2012, or second quarter 2011 by 9%. As Henry said 92% of our revenues comes from Chuck Transpiration in the U.S. or across cross border Mexico. The growth of the 9% and the way we look at things it's volumes or its price and volumes as us as a load is a load of freight and price to us is revenue per load and that 9% was broken down by 8% drove in number of loads and the 1% increase in revenue per load, I said that right, number loads, revenue per load.

Moving over to gross profit, gross profit for us is revenue less what we pay the capacity, unless when we pay the agent family. If there isn’t a dollar or transportation revenue there is no cost to the capacity and there is no cost to us for the agent, so it's a 100% variable up to the gross profit line. We have to have to revenue to have those cost. You can see we grew gross profit by $5 million, 2012 second quarter over the 2011 second quarter. One thing Henry touched on was the profit margin, you can see it went from 16.5% in 2011 to 15.9% in 2012. In a typical brokerage world people will think that’s because we are getting squeezed because the trucks are charging us more and we are not able to push the pricing after to the ship to get that to keep our margins at 16.5.

But if you listened to what Henry said 62% of our business is on a fixed margin. So regardless of what’s going on in this planned demand dynamic, if the trucks are charging more we are still making our same percentages just locked in on the BCO, we are still getting 17% and on a certain part of the broker revenue we are still getting 10% or 12% right off the top. So we are little more protected from the supply and demand equation. We actually like a little tighter supply, demand equation because it drives price up and we get more dollars. We still may get 17% but it grows our dollars and grows profit so that’s really what happens.

So if you were to ask me how come 16.5 to 59 well its mix, we put more brokerage revenue over the model which has a little lower gross profit margin but it also has less infrastructure below the line.

Most often you are going to hear us talking about mix more than your pressure from the prices in between lower prices and the ship and what the carrier is going to charge us. Moving down to operating income and operating margin, we grew that $10 million in the second quarter of 2012 over the second quarter of 2011 and operating margin as Henry described in the way we looked at it, the way we manage the business truthfully is operating income or gross profit or goal at Landstar is operating income or gross profit, our goal at Landstar is to just growing gross profit and that’s been the gross profit dollars and try and get every incremental dollar of gross profit to push through that operating income and you can see in this quarter we grew gross profit $5 million and grew operating income by $10 million, so we have exceeded that because there were lower cost of insurance. We picked up about 4 million or 5 million of insurance compared to the prior year and we had some trailer gains about 1.8 million but if you pull those out you know you are pushing almost every dollar that $5 million worth of gross profit growth right down to the operating income line because the infrastructure is built.

We do not have to hit a lot of head count to keep growing this model, that’s the sales agents that’s what they do and they are paid on a variable basis, so if they don’t generate revenue they don’t get paid. As you work across the, the diluted earnings per share that grew 23% on an operating income increase of 21%.

Typically some of the highs in the industry as a non-asset based for our business model we generate high returns, return on equity, return on invested capital and return on assets, these are rolling 12 months through the second quarter 2012. We also generate a lot of free cash flow and since 1977 it's been part of the business model by stock back. If you go back to 1997 we had 102 million shares outstanding and today we have 47 million shares outstanding.

So we bought back that many shares and spent over a $1 billion doing it. The yellow line is starting of 2002 as our outstanding shares as of the end of at the beginning of 2002 which is about 63 million shares and now down to 47 million shares, over the last 10 years you can see we continue to buy the shares down.

The one anomaly here is you can see in 2005 there is no blue bar which is the free cash flow bar and in 2005 for anybody who knows this we had $275 million of (inaudible) lead service business related to the storms that hit the South-East in the third and fourth quarter of 2005. While what happened in that scenario, the government didn’t really pay us on that 275 million until 2006 so we didn’t have any free cash flow but you can see when it rolled in 2006 and 2007 free cash flow skyrocketed and we bought more shares back, it's basically the business model we buy shares back, we have been doing it since 1977. We will continue to do it opportunistically.

From a key metric standpoint we talked about 92% of our transportation it comes through truck from a load count, these are the kind of stats we watched from a volume standpoint, load count in the first quarter was about 9% over prior year and it slowed down to 8% in the second quarter and then we just updated guidance last Thursday and indicated that we are looking more to mid-single digital type volume growth for the third quarter and that was through, we have already been through eight weeks of the third quarter and only five weeks to go so we are pretty far into it.

From a revenue per load standpoint, we have known since and the last year that starting in about the second quarter we are going to have tougher revenue per load comps. We weren’t going to get the 7% and the 14% increases that we got in 2011 over 2010 it's that wasn’t sustainable unless something changed in the industry dynamics whether a lot more trucks came out or demand increased.

So we are about where we thought we would be on the revenue per load, you will see we spike up in July that’s really more of a mix. Automotive business tends to be a shorter haul and lower revenue per load and that kind of falls off a little bit in July is a switch plans out so that officially drives to light up but we are expecting a same kind of trend now coming into the rest of the years where the comp is we are running on a revenue per load, we are basically flat to prior year over the last eight weeks of the third quarter.

Justin Yagerman - Deutsche Bank

With my minute and 22 seconds, I am going to ask you about your preference for growth. Brokerage versus BCO I think the slide was interesting, where you talked about fixed margins and obviously getting fixed margins on the BCO side not all the time on the brokerage side, how do you think about that as you look to grow your business overtime.

Henry Gerkens

We are in a truck business, all right and I am really agnostic as far as if it goes on a BCO truck or a brokerage truck and the reason I say that although that margin might appear that gross margins where the mix goes down but when you think about the cost are affiliated with the BCOs, all the insurance cost is BCO related, all the other operating cost are BCO related and then we got an element on the fixed cost that deals with compliance that’s BCO related, don’t have any of those cost related to brokerage. So when you get down to the operating income line the number is pretty much equal out. So again all I want to do is satisfy the customer moving prior from point A to point B and I want to do it safely and efficiently and so I want to grow both the advantage of having BCOs. There is a lot of customers still out there that do not like brokerage loads. It allows us to do some business that otherwise we wouldn’t be able to do, so I want to grow both is really the answer.

Justin Yagerman - Deutsche Bank

Fair enough and Henry your view on where we are in the economy right now?

Henry Gerkens

Well I think I tried to allude to that I think there is a lot of uncertainty out there. I think you are going to see that right through the November election. I think once the results are in no matter who wins that election, I think some certainty has been added to the economy. People are going to then start dealing with one way or the other and I got to believe that after those are known some is going to claim that he has got a mandate and therefore we are going fix this financial cliffing and we will do something. So I think either scenario I think to me I think they will add some certainty, let me tell my political belief but that’s a fair straight answer.

Justin Yagerman - Deutsche Bank

Sounds good. With that we are out of time. Thank you so much guys.

Question-and-Answer Session

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