Good morning, and welcome to Landstar System Incorporated Third Quarter 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; Rob Brasher, Vice President and Chief Commercial Officer; Joe Beacom, Vice President and Chief Safety and Operations Officer. Now I would like to turn the call over to Mr. Jim Gattoni. Sir, you may begin..

Thank you, Yunis. Good morning, and welcome to Landstar's 2022 third quarter earnings conference call. Before we begin, let me read the following statement. The following is a safe harbor statement under the Private Securities Litigation Reform Act of 1995.

Statements made during this conference call that are not based on historical facts are forward-looking statements. During this conference call, we may make statements extend forward-looking information that relates to Landstar's business objectives, plans, strategies and expectations.

Such information by nature subject to uncertainties and risks included, but not limited to, the operational, financial and legal risks detailed in Landstar's Form 10-K for the 2021 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.

Our 2022 third quarter financial performance was the best ever third quarter financial performance in Landstar's history. Revenue was approximately 5% above the 2021 third quarter on a difficult year-over-year comparison and within the range of our third quarter guidance provided on July 30th - 20.

Earnings per diluted share was 7% above the 2021 third quarter towards the low end of our third quarter guidance. Truck revenue was 1% over the 2021 third quarter, mostly due to a 1% increase in truckload volume.

Revenue hauled via other modes of transportation increased 49% over the 2021 third quarter, mostly attributed to higher ocean and air revenue per load.

Overall truck revenue per load in the 2022 third quarter was essentially equal to truck revenue per load in the 2021 third quarter with revenue per load up 1% on truckloads hauled via unsided platform equipment, down 2% on truckloads hauled via van equipment and down 1% on truckloads hauled by other truck transportation services.

Landstar’s flat - revenue per truckload results for the 2022 third quarter versus the 2021 third quarter may seem at odds with the various industry sources that have reported significant decreases since early 2022 in year-over-year truckload spot market pricing when excluding the impact of fuel costs.

Historically, Landstar spot market pricing trends month over prior year month often are less pronounced than the industry trends during both growth and contraction cycles.

We believe that has to do with the specialized non-routine nature of much of the freight we haul, along with our drop and hook business, it tends to act somewhat more like contracted rated freight as we commit trailing capacity as part of that service. One of many metrics we follow is revenue per mile on loads hauled by BCOs.

This metric is much less influenced by changes in fuel costs as fuel surcharges billed to customers on loads hauled by BCOs are passed 100% of the BCO hauling the load and excluded from Landstar revenue.

Accordingly, given the increase in diesel fuel cost in the 2022 third quarter compared to the 2021 third quarter, I believe this metric provides a better gauge of current market conditions as compared to Landstar's overall revenue per truckload, which is influenced by many factors, including length of all delivery time, equipment requirements and fuel costs.

While we have seen revenue per mile on van equipment hauled via BCOs decreased sequentially since it peaked in February 2022, Landstar's year-over-year change in rates has not been near the magnitude reported in various industry reports.

During the 2022 third quarter, revenue per mile on van equipment hauled via BCO capacity in July was 2% over July 2021, and then August was $0.01 below August 2021. In fact, August 2022 was the first month since June 2020, where year-over-year revenue per mile on van equipment hauled by BCOs was below the corresponding month in the prior year.

In September 2022, revenue per mile on van equipment hold via BCO capacity was only 4% below September 2021. Even though on a sequential basis, revenue per mile on van equipment hauled by BCOs as of the end of the 2022 third quarter was 17% below the all-time high reach in February.

As it relates to revenue per mile on loads hauled via BCOs - hauled by BCOs via unsided equipment, this metric is somewhat influenced by the amount of heavy oversized loads hauled by BCOs as heavy oversized loads tend to have a higher revenue per mile.

Overall, revenue per mile on loads hauled by BCOs via unsided equipment in July, August and September increased approximately 9%, 6% and 2% over July, August and September 2021, respectively.

And unlike revenue per mile on van equipment, revenue per mile on unsided equipment hauled via BCOs was at a record high in the 2022 third quarter, 5% higher than the 2021 third quarter.

We attribute the strength in flatbed pricing to stable demand at an elevated level for the manufacturing sector, as that sector's recovery from the impact of COVID significantly lagged the recovery of - and expansion of consumer-based demand that took place in the van market beginning in late summer of 2020.

As to load count, total truckload volume in July was 5% over prior year July. August was approximately equal to prior year August and September '22 - 2022, was 1% below September 2021.

The deselling [ph] in growth rate in truckload volume was primarily due to slowing of the strong consumer-driven freight environment we experienced since late summer 2020. Consumer durables, building products, automotive parts, hazardous materials, machinery and metals and substitute line haul combined to represent approximately 75% of our loadings.

The rate of growth in load count for each of these industry verticals other than hazmat shipments slowed in the 2022 third quarter over the 2021 third quarter as compared to the 2022 second quarter over the 2021 second quarter.

In particular, substitute line haul volume continued its downward trend from the 2022 second quarter and decreased 27% compared to the 2021 third quarter. I attribute the decrease in substitute line haul loadings to softer consumer demand throughout the economy in general, and re-stabilization in the networks of large parcel and LTL carriers.

We continue to attract qualified agent candidates to the model. Revenue from new agents was over $38 million in the 2022 third quarter. We ended the quarter with 11,644 trucks provided by business capacity owners, 220 trucks lower than our year-end 2021 count.

The number of BCO trucks at the end of 2020 [ph] third quarter was 243 trucks below the end of the 2022 second quarter. As typical in an environment with a lower revenue per mile month-to-month, it's not unusual to experience an increase in BCO turnover.

Loads hauled via BCOs in the 2022 third quarter were approximately 5% below the 2021 third quarter on lower utilization, partly offset by slightly higher average truck count. BCO utilization defined as [ph] loads per BCO per quarter decreased 6% in the 2022 third quarter compared to the 2021 third quarter.

We ended the quarter with a record number of approved third-party carriers on our network. The number of third-party carriers hauling freight in the 2022 third quarter increased 21% over the 2021 third quarter. I'll now pass to Jim for his comments on a few specific line items within the company's third quarter financial statements..

Thanks, Jim. Jim G [ph] has covered certain information on our 2022 third quarter, so I will cover various other third quarter financial information included in the press release. In the 2022 third quarter, gross profit was $185.7 million compared to gross profit of $189.2 million in the 2021 third quarter.

Gross profit margin was 10.2% of revenue in the 2022 third quarter as compared to gross profit margin of 10.9% in the corresponding period of 2021. And the 2022 third quarter variable contribution increased 1% to $245.7 million compared to $242.3 million in the 2021 third quarter.

Variable contribution margin was 13.5% of revenue in the 2022 third quarter compared to 14% in the same period last year.

The decrease in variable contribution margin compared to the 2021 third quarter was primarily attributable to mix, as an increased percentage of revenue was generated in the 2022 period by one truck brokerage carriers, which typically has a higher rate of purchased transportation than revenue generated by BCO independent contractors and two, multi-mode capacity providers, which typically has a higher rate of purchased transportation than revenue generated by third-party truck capacity providers.

The unfavorable mix impact was partially offset by an increased variable contribution margin on revenue generated by truck brokerage carriers, as the rate paid to truck brokerage carriers in the 2022 third quarter was 224 basis points lower than the rate paid in 2021 third quarter.

Other operating costs was $13.4 million in the 2022 third quarter compared to $10.6 million in 2021.

This increase was primarily due to increased trailing equipment maintenance costs, the impact of the resumption of a large in-person event for the company's BCO independent contractors and decreased gains on disposal of operating property, partially offset by a decreased provision for contractor bad debt.

Insurance and claims costs was $31.4 million in the 2022 third quarter compared to $29.6 million in 2021. Total insurance and claims costs were 5% of BCO revenue in the 2022 period and 4.3% of BCO revenue in the 2021 period.

The increase in insurance and claims costs as compared to 2021 was primarily attributable to increased severity of current year claims during the 2022 period, as well as increased premiums for commercial auto and excess liability coverage, partially offset by decreased net unfavorable development of prior year claim estimates.

During the 2022 and 2021 third quarters, insurance and claims costs included $2.1 million and $3.5 million, respectively, of net unfavorable adjustments to prior year claim estimates. Selling, general and administrative costs were $53.5 million in the 2022 third quarter compared to $59.2 million in 2021.

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 and decreased employee benefit costs, partially offset by increased wages and increased information technology professional fees and subscription costs from continued investment in new and upgraded applications for use by agents and capacity.

In the 2022 third quarter, the provision for compensation under variable programs was $8.1 million compared to $16.6 million in the 2021 third quarter. Depreciation and amortization was $14.6 million in the 2022 third quarter compared to $12.3 million in 2021.

This increase was primarily due to increased depreciation on technology tools resulting from continued investment in new and upgraded applications for use by agency capacity with approximately $800,000 of the increase attributable to increased trailing equipment depreciation.

The effective income tax rate of 24.3% in the 2022 third quarter was essentially equal to the effective income tax rate in the 2021 third quarter.

The effective income tax rate during the 2022 period was approximately 20 basis points below the 24.5% estimated annual effective income tax rate for fiscal year 2022 due to higher than anticipated state income tax refunds and excess tax benefits realized on stock-based compensation arrangements.

Looking at our balance sheet, we ended the quarter with cash and short-term investments of $228 million. Cash flow from operations for the first 9 months of 2022 was $436 million and cash capital expenditures were $21 million.

The operating cash flow generation of $436 million during the first 9 months of fiscal year 2022 exceeds any full fiscal year operating cash flow in the company's history. Back to you, Jim..

Thanks, Jim. The 2022 fourth quarter provides for the most difficult quarter over prior year quarter revenue and earnings compressor [ph] to any quarter in 2022. As an example, fourth quarter 2021 truck revenue per load was a record quarterly truck revenue per load at the time was $390 over the 2021 first quarter.

Additionally, truck load count in the 2021 fourth quarter was an all-time lesser quarterly record of 667,000 loads.

As it relate to our 2022 fourth quarter expectations, based on the trends we have experienced in the first few weeks of fiscal October, and our anticipation of a muted holiday shipping season this quarter, I've assumed that the sequential decrease in truck revenue per load and truckload volume we have experienced thus far in October will continue throughout the rest of the 2022 fourth quarter.

On average and taking into account the extra week in the 2016 fiscal fourth quarter, truckload count was approximately equal when comparing the fourth quarter to the third quarter in the 5 years preceding the pandemic. Note also that the 2022 fourth quarter includes one more week than the 2021 fourth quarter due to the timing of fiscal year-end.

Even given the extra week in the 2022 fourth quarter, we expect the recent softening trend in truckload volume to continue and expect fourth quarter truckload volume [ph] to be below the 2021 fourth quarter in a range from 2% to 4%.

Truck revenue per load historically has been harder to predict when comparing the sequential change from the third quarter to the fourth quarter in a given year. In the 5 years preceding the pandemic, truck revenue per load on average was approximately 1% higher in the fourth quarter compared to the third quarter.

However, in 2017, truck revenue per load in the fourth quarter exceeded the third quarter by over 8%. Yet in 2018, truck revenue per load in the fourth quarter was 3% below the 2018 third quarter.

Based on recent trends, I expect truck revenue per load in 2022 fourth quarter look more like the 2018 fourth quarter, with truck revenue per load expected to be 2% to 4% below the 2022 third quarter. Given that assumption, truck revenue per load in the 2022 fourth quarter would be 5% to 7% below the 2021 fourth quarter.

Based on these expectations of truck revenue per load and the number of loads hauled via truck, I currently anticipate 2022 fourth quarter revenue to be in the range of $1.775 billion to $1.825 billion. Based on that range of revenue, assuming insurance and claim costs are approximately 4.5% of BCO revenue.

I anticipate 2022 fourth quarter diluted earnings per share to be in the range of $2.60 to $2.70. Following our typical approach of providing financial guidance and given the uncertainty of the U.S. economy, we do not expect to be providing financial guidance for periods beyond the upcoming quarter.

However, as an example of the model's resiliency if we were to experience a 20% decrease in revenue in 2023 from our 2022 full year estimate, and assuming normalized insurance, we believe Landstar would still generate an operating margin of 50% or more.

Given the scenario of a 20% decrease in revenue in 2023 from our 2020 full year estimate, we anticipate free cash flow to exceed $300 million in fiscal 2023. The domestic freight, Transportation Logistics, and new relies [ph] heavily on U.S. consumer demand and domestic manufacturing.

We'll answer our business model, however, provide strong free cash flow in almost any environment. While we continue to invest in technology, facilities and equipment that support the small and large business owners who comprise the Landstar network, we continue to return cash to shareholders.

During the 2020 third quarter, we purchased 504,000 shares of stock at a total cost of $73 million. Year-to-date, the company purchased 1.9 million shares, over 5% of the year-end 2021 outstanding share count.

Regardless to the point in the business cycle, Landstar returned a significant amount of free cash flow to shareholders via dividends and share purchases. Since 1997, when we first started our share purchase programs, Landstar has purchased approximately $2.2 billion in stock, the primary use of our excess cash flow.

And with that, Yunis, we will open to questions..

Thank you. Good morning, Jim and Jim..

Good morning..

Jim, kind of your time to shine here with the macro outlook, and I know you don't want to give any guidance towards 2023. But as you think about what you laid out for 4Q and a bridge to some of these bigger macro themes that you just can't help but getting hit over the head with every day.

What are you hearing from customers, from consumers on inventories demand? And how do you feel about, let's just say, the first half of '23 relative to the second half of '22 from a bigger picture volume perspective?.

Well, I would say that our second quarter commentary had a couple of our shippers that were more favorable to the peak season in the fourth quarter and some were more relatively going to be flat to last year. I think that – that thought process has kind of disappeared a little bit. Now everybody is flat to a soft muted peak season.

So the - since our July call, I would say things have clearly softened up compared to the anticipation of a better peak season. So I think that's turned.

Our first - and then if we talk about next year in demand there, you know, you got to look at the consumer demand side and how it really drove for us the first quarter last - this year, I'm sorry, we had a record first quarter. The comparisons are going to be extremely difficult coming into the first quarter.

We are already on a revenue per load that is you know, like where we bought [ph] 15%, 20% behind where we were in the first quarter. And typically, you see a drop off from December to January. Clearly, the demand in the first quarter is not like is in the fourth quarter, you see another 5% to 6% drop off in rates.

So I think it's going to be an extremely first - tough half next year based on - just on the comparisons and the direction of the economy.

We definitely feel that we've seen the sequential load volume trends decrease July - from July to - from June to July to August to September and anticipate kind of the peak season - kind of be stable throughout the rest of the thing, but the comp going into the first quarter and the demand scenario we're looking at is going to be very challenging first half next year..

Okay. That makes sense. And then just for a quick follow-up. I thought your commentary at the very end, 20% revenue decline would still have a 50% plus operating margin.

Can you just talk a little bit about the levers that you can pull to keep that margin pretty elevated in that type of difficult macro backdrop you just laid out?.

As our fixed costs are in a very - as a percent of our variable contribution, 50% of - pushing 50% of your variable contribution - through to operating income really shows that we don't have a lot of leverage in there. I mean there's very few fixed costs. We have maybe 1,300 employees. We've had 1,300 employees probably for 10 years now.

There's not a lot of leverage there. If the volumes - if it's a revenue per load decline, we still need all the people, right? There's - whether it's the number of trucks we have in the system on the compliance side or the number of loads passing through the system.

So there's not a leverage on - on wages and benefits because - which makes up about 70% of the SG&A. So we can tweak here and there. And if things turn down, you just don't rehire, you don't fill positions, but there's - like I've said in the past, there's not a lot of leverage. We can tweak $5 million or $10 million of the cost structure.

And the other pieces, I would guess we maybe - in a downturn next year, we could have $15 million to $20 million pickup on the variable compensation program. So you got that that we always have. But other than that, there's a lot of inflation in the system on other operating costs with labor and maintenance for our trailer repairs.

You've got elevated depreciation because we've been investing in technology over the last few years to build efficiencies with the agent network. The insurance is still so unpredictable right now, still unfavorable. I mean you've seen a couple of the other transports come out with some insurance hits that we live with that every day.

So I think, again, on the - trying to get leverage off of the fixed costs, again, it's going to be - we can tweak it a little bit, but there's not a lot to pull out other than the biggest piece is the variable compensation programs..

Okay. That makes sense. Thanks for the time Jim..

Thank you. And our next question came from the line of Bascome Majors of Susquehanna. Your line is now open..

Hey Jim, to square that last comment, can you just give us an update and apologies if we missed it.

But on the variable comp, including stock comp, where you accrued [ph] for this year? And if there's anything that has changed from the "normal year" that would make next year be maybe more of an 8 to 10?.

Hey, Bascome. Just as a follow-up, variable contribution margin, too, we should see some expansion in a downturn '23 over '22. I think in 2019, we picked up about 60 bps of variable contribution margin expansion. With respect to the compensation under variable programs, current accrual for '23 is about $31 million.

And then similar numbers as 2Q target would be approximately $20 million bear [ph] case, $8 million to $10 million..

Thank you. In the scenario you laid out where you would have a 20% revenue decline.

Would the incentive comp plan still pay out? Or could that actually go lower than the kind of 8 to 10?.

We have not set our targets for 2023 yet. I don't know if we would anticipate setting a target at a 20% decline in revenue. But we will - I'll have a better answer for you on that in January when we set our targets for 2023. There's a chance it could pay off to the $8 million, but there's also a chance it might not.

So I'll give you more update as we go through that process. We actually don't finalize our targets till January..

Thanks for the [indiscernible] And one last one for me. You talked a lot about substitute line haul, I believe it was down 35% or so in revenues. But if I look at that other truck transportation number, the volumes there are still close to 50% above the 2018 peak. So that number has still been a pretty good growth story for the year over some time.

Do you have a sense of how far some of the LTL and parcel customers are below what would have been a pre-pandemic - sorry, still above what we would have been a pre-pandemic kind of volume level? And any sense on what they're planning as we get into next year? Thank you..

It's a very good question. Look, we - our power-only pre-pandemic wasn't near the size, but it was as people start looking for just trailing capacity. That might not be - that's not just a pandemic driven demand. I think that was kind of a move in the business as people talk about the drop and hook we do.

It's almost like - it's drop and hook with someone else's trailer. After the volumes of where that was, unfortunately, I don't have that prior to 2019, we'll try and dig that up, maybe get that out. But I would say that - that I could see being a little more - that's a little bit where the substitute line haul sits.

So you're going to see that drop off a little quicker than our general business and commodities. But I apologize for not having the history back beyond last year..

Thank you..

Thank you. And our next question is from the line of Jack Atkins of Stephens. Your line is now open..

Hey, guys. Good morning. Thanks for the questions. So Jim Gattoni, let me kind of ask you about housing and sort of the impact, you think, maybe a slowdown in housing and sort of the related industries so that could have on flatbed demand, as you sort of - were unsided demand just want to think about 2023.

I mean what sort of sensitivity would you guys have to that? Or what sort of sensitivity do you think the unsided market would have to that?.

Well, I think generally, the unsided market would be negatively impacted. I mean it was - building products was a pretty strong producer for us over the last year and a half, right, as the housing market was relatively strong. So I would say that building products makes up about 8% of our revenue. Again, we're highly diversified.

So to me, it would act almost like everything else. We have consumer durables is where the appliances sit and all the other stuff that we hold.

So I would say you're going to see that decline similar you see the rest of the market decline on consumer demand, not near the substitute line haul, I mean, that was very specific to excess freight coming through the - the parcel carriers.

But we talked about applying some stuff and the stuff piling up at warehouses in June, right? And you've clearly seen a slowdown there. But overall dynamic - the economy and everything else, I think you take the building products, consumer durables. It's even affecting your machinery and metals a little bit coming across on the flatbed side.

So you think about the flatbed dynamic, general softness in any one of those categories where it's machinery or housing or stuff like that will flow into our business, even though we're not directly that tied into housing. So….

Okay….

Rough about lousy answer there, Jack. But….

No, it was a good answer, Jim. And then….

I didn't land the plane..

And then, I guess, maybe following up, when I sort of look through the different lines of business, one area that kind of surprised me to the upside was the strength and it's a smaller bucket, but the strength in air and ocean.

Can you - is that due to new agent additions that specialize there? Do you think that's just sort of lagging a slowdown that we're seeing kind of in the international markets? Any kind of commentary there? That's been a - it's been a nice tailwind for you guys over the last couple of years..

Yes, we look at it, Jack, it's mostly rate, right? I think our volumes there, I think, only look like they're about 10%. We did 11,500 loads there in ocean this year in the quarter compared to only 10,000 last year. So it's really a rate-driven. I mean, rates are still elevated to about 50% of where they were compared to last year.

And yes, the other thing is we did a few agents into the ocean, air category which drove a little bit of that volume increase, but it's mostly on the rates. As you know, at one point, I think the ocean rates were 4 or 5 times where they were a year ago, and that's pulled back a little bit, but that's what's driving it..

Okay. I'll turn it over. Thanks again for the time, guys..

Yes..

Thank you. And our next question is from the line of Todd Fowler of KeyBanc Capital Markets. Your line is now open..

Hey, great. Thanks and good morning. So Jim, I know that we've talked about this quite a bit in the past, and you had some comments about this in your prepared remarks. But I just wanted to spend a little bit more time on your commentary around how your revenue per load is trending versus some of the spot rate data that's out there.

When I look at '21, van revenue load was up 30%, and that seemed to track a little bit more in line with spot rates. And now it kind of seems like it's a little bit more correlated with contract.

And so you know, can you just spend a little bit more time, I mean, is that much more on the shift to power only and some of the mix things or you expecting that there's more that you will see van revenue per load start to decline more as you move into '23.

Just wanted to spend a little bit more time on kind of what you're seeing with that decoupling between revenue per load and spot rates? Thanks..

Like I said, a significant part of it is that when you put trailers - when you put trailers in the system and our drop and hook, that does work a little bit more. It's a little more steady, a little more stable than through spot market pricing.

They tend to not kick you out as fast if you're providing trailers and so you kind of can lock in a little longer on those rates and hold them a little more steady. But you'll get pressure there. There's no question. It just takes a little while longer.

The other thing is when you think about our BCOs, they tend to look for premium, you know, the model [ph] load, right? So they're trying to find the load that pays - pays them the most and their utilization is a little bit down because like we talked about, you saw rate slide a little bit. So they're still sitting out there.

They're not hauls many loads because they're looking for the model load. So there's a little bit of that to keep the rates up where they'll only haul - they're not going to walk away in 6 months. They're not going to drive as much if rates are down 20%, they're going to still look for the model load. So there's a whole bunch of things.

The non-routine, the flatbed like part of the - if you look at total revenue per load, combined flatbed stabilizes it because we actually have flatbed up a little bit. So that's driving the overall thing. So you're seeing a little softness in the van side, and with supporting from the flatbed side. It's just - we haven't correlated since February.

When we first started seeing freight waves and them coming out with this, we're 20% below - not us, but the spot market is 20% below last year. And to be honest with you, Todd, I just - I'm struggling with figuring out why we're so far off from where the industry is.

Now they - a lot of the stuff we read on the data is ex-fuel, and I've done some back the envelope, and even when you pull fuel out, we're like 10% behind. So not 40% or 30% that you're reading in the industry. The other thing I mentioned was I believe truck stop data is the paid to truck value, not necessarily what's billing to the shipper.

We talk about actual build to the shipper numbers as opposed to what's going on and what trucks are getting paid. And if it's a posted rate, it doesn't mean - it doesn't necessarily mean that the freight moved. And then the other piece is kind of stabilized. We don't put fuel in for the BCO. There's another stabilizing factor.

So you don't have the volatility from the fuel piece on the BCO side because the fuel surcharges are removed - I forget what the number was, but I think the BCO fuel surcharge is upwards of over $170 million or $120 million. I forget, Jim may have the number. So that's not in the numbers. So that takes a little of volatility out, too.

So we don't have the effect of fuel spikes and declines for that 40% of our revenue..

Yeah, that's helpful. And I know - I know we spoke about it. I know you've done some work on it. And so it's just helpful as we continue to try and think about the correlations and everything and what we're seeing. So I appreciate the thoughts there.

Just for a follow-up, Jim Todd, on the variable contribution margin, it's been relatively consistent for the last four quarters or so. I know that the mix is changing.

Can you maybe share with us thoughts on fourth quarter variable contribution margin? And then just if the freight market does weaken and we see some ships away from kind of the elevated brokerage loads and the ship back to the BCO, how would that trend as we move into '23? Thanks..

Yeah. Sure, Todd. I think if you look back the last 2 years, walking variable contribution margin 3Q to 4Q, we dipped about 50 to 70 bps.

We don't see that as exaggerated this year, 3Q to 4Q because if you think about the starting point, the utilization started to soften up a little bit 2Q more than we thought, we expected it to be soft in 3Q, which it was. So we've got a little bit of compression in 3Q to 4Q, but not as much as recent years.

And same with international expected to be a little bit of a smaller share in 4Q than the last couple of quarters..

And actually Jim made a comment early on about the - when things slow down, we'll get some margin expansion, which is how many bps?.

Yeah. The brokerage you guys know, the brokerage freight typically falls off faster in a downturn, right? So in a hypothetical 20% decrease, I use '19 as a guidepost. We picked up about 60 bps on VCM [ph].

Yeah. Okay, good. I did catch that. That's helpful. Thanks for the time this morning..

Yeah..

Thank you. And our next question is from the line of Scott Group of Wolfe Research. Your line is now open, Scott..

Hey, thanks. Good morning. I was wondering, is there any hurricane or FEMA benefit in the fourth quarter guide? And then Jim, as you sort of maybe contemplate potentially revenue down 20% next year.

How would you think about the mix between volume and price?.

As to the first part of the question, we do not anticipate in our guidance any hurricane, and it wasn't material in the end of the third quarter either. So there's nothing material in there that's disaster relief related.

When I think about the volatility, it's always - not always - always is such a bad word, but it's more often than not price volatility with us. Our volumes tend to not impact the model as much as the spot market pricing does.

If you look at the history, over the last 10 or 15 years, our volumes year-over-year have only dropped off 3 or 4 of those years. It's always been the volatility in price. So going into next year, I would think the same thing. I think we're going to - my - the biggest question mark is on pricing. It's the hardest part to predict.

And I would say we probably will see - we had record volumes like just crazy this year. I expect the decline in volumes next year. But I think the bigger impact is going to be on the revenue per load..

Okay. And then the BCOs count inflected lower year-over-year.

Just curious what you're seeing from - do you think that continues? And then just more bigger picture, what do you make of this AB5 thing? And how big of a risk to the model, is that if that becomes a national issue?.

Yeah, Scott, this is Joe. So yes, the BCO count, I would say we saw the peak in revenue per load in February. We saw utilization start to decline in the second and into the third quarter with that truck count decline. I think that there is a couple of pieces to that. One is the number of additions is off from where we typically see it.

And that's a - a lot of times a function of the ability or inability to get used trucks. And we're also seeing terminations up because of either the decline in price or reduced demand, but also the inability to get their trucks repaired in a timely fashion. So that's kind of factoring into BCO count.

And as some of those things normalize, I think the BCO count will kind of hit bottom and increase much like it did in 2019 where we saw kind of a similar scenario. I would expect us to see it drop a little bit further in the fourth quarter of this year and then hopefully bottom out going into next year.

And on the AB5 front, we have, as we mentioned last quarter, around 360 BCOs who were affected by 85. We been in contact with all of them or all but a few of them, and they've made their decisions as to whether to relocate from California, stay in California and not all outbound California freight or go get their own authority.

The great majority of those are going to either stay in not all California loads or have started the relocation process. So we don't see a significant impact for our ability to service California or in the BCO count going forward..

Yeah, sorry, I was talking about the Biden proposal to sort of make that more of a national issue? Maybe I asked it wrong [ph] when I said AB5..

The labor proposal?.

Correct, yes….

The same amount. Okay, yes. So on that one, Scott, so it's a little bit different or quite a bit different actually. This is as it relates to the fair labor standards, the governance of minimum wage and overtime. And right now, truck drivers are exempt from over time. So there have to be a congressional action to actually change that for truck drivers.

And unlike AB5, as you recall, there's three prongs to that and if you fail any one of the three, you're an employee driver with the DOL proposal, it's more of a holistic look at the relationship that you would have with your owner operator, and there are a number of different factors inside what they call an economic reality test.

And as we look at that current proposal, as we understand it, again, it just came out. But something we're going to watch. However, we don't really interpret that at this point is anything that we feel uncomfortable about. But again, we're going to watch it and get more detail as more details come up.

But right now, it's something that we remain comfortable with our relationship satisfying that expectation..

Very helpful. Thank you, guys..

Yeah..

Thank you. And the next question is from the line of Elliot Alper of Cowen. Your line is now open..

Great. Thank you. So you discussed the free cash flow you generated through the first 9 months of the year, I would be curious to hear any thoughts on M&A given the freight environment, that's pressuring carriers.

Are there any attractive opportunities coming across the desk within your portfolio? And kind of where do you think the best place would be for inorganic growth?.

Yeah. The model doesn't really support just wide open acquisitions because anything we look at generally conflicts with the small business owners that we support. If we were to look at buying a trucking company or even a broker here in the U.S. moving truckload freight it would compete against those agents.

So when you talk about domestic ground transportation, there aren't a lot of opportunities for us there that wouldn't create a conflict within the model. So we always lean on what is - what's out there that wouldn't really conflict with the model, and there are very few options for us.

We would continue - so our M&A, we see stuff all the time, but we don't pull triggers on it. We're not a big M&A organization. We focus on the core, support the agent, support the business capacity owners.

So we're generally - the plan - we have no long term - I mean a short-term plan to do any M&A, and I would just take our cash flow and do we do - and return it to shareholders via dividends or share buybacks. We do keep our eyes open. I don't think there's a question. I'm not going to sit there and say it's not a never thing.

It's just what's the opportunity we would have that wouldn't compete. Could it be for freight forward [ph] it could be international, it could be some kind of tech play, but nothing's popped as of yet. We're always looking, but there's nothing on the horizon for us..

Okay. Great, thanks. I guess one other one just on the visibility within the network. So peak season has come in kind of below expectations compared to a few months ago.

I guess what has changed since then, because as we move through peak season, what are the largest uncertainties that are still kind of un-visible within the rest of Q4?.

Well, with us, the volumes are pretty good. I mean, I think we - our volume estimates were pretty good. I think it's the unpredictability of the pricing and what's going to happen on the demand side.

If you - we did anticipate a little bit of slowdown in rates coming into the fourth quarter compared to the third quarter, which is pretty unusual for us to be negative. I think the most unpredictable thing is not necessarily the - the demand coming across, I think, clearly, it's going to be soft. Everybody thinks it's going to be soft.

I think what happens to pricing as we move through the quarter. We do anticipate our substitute line haul to continue to be down compared to where it was over the last year. Even Jack talked about building products and where that goes with a slowdown in housing.

Automotive is still relatively strong, which is - that's the one thing keeping the volumes up a little bit. So keep an eye on - and the other piece would be the demand from 3PLs. One of the things we're very good at is finding truck capacity and a lot of the 3PLs or the other carriers look to us when they can't find a truck in a very tight market.

And as that loosens up, we see that drop off a little faster. So that's another thing we're keeping our eye on. It dropped off those - it was 23 - that 3PL business where we haul for another carrier or another broker or a 3PL, when they're just looking for truck capacity or they use us permanently like we're part of their network.

That drops off a little quicker. It was 23% of our revenue last year, and it dropped down about 18% of our revenue now. So we're keeping an eye on that, too. As the demand coming in you know, as tender rejection rates go from 80% up to 95%, when you're accepting 95%, that business slows down a little quicker than most.

As seen in the substitute line haul line..

Okay. Thank you. Appreciate that..

Thank you. And our next question is from the line of Scott Schneeberger of Oppenheimer. Your line is now open..

Thanks very much. Good morning. And Jim Gattoni in the building products category, is that - are you predominantly residential? Or is there a large non-res component? And can you give us an idea for where that shakes out? And then I'll have a follow-up similar? Thanks..

It's a mix of both. It's not general. I mean you could be doing lumber into commercial. So it's not - and it's not - we're not doing a lot of the home stuff. We were doing shingles and stuff like that for some of the new buildings.

But I don't think we split it out between whether demand is coming in from residential or it's coming in from the commercial side. We generally may not even know what it is, right? We may be moving stuff to yards and stuff where we're not necessarily bringing to final destination..

Yeah. Understandable. And probably tricky to answer this next one, too, it's along the same mill [ph]. But just given limited visibility in the business model.

But infrastructure build, things coming up for next year, are you catching any wind just through shippers of - and not just limited to that, but maybe to plan to large energy, alternative energy, projects.

Are you catching wind of anything like that, that can be very beneficial or contributing next year? Or you just not have the visibility there?.

Well, there's nothing right now that would move the needle that we are aware of in any of the sectors where people are talking about some spike in business coming off from some of the things you mentioned. There's - not right now..

Okay. Fair enough. Last real quick one from me.

Any thoughts on investment spending as you - you kind of touched upon it earlier in the call, but thoughts about any changes of acceleration or deceleration with investment spending in the business going forward?.

Well, I think you've got the two things where we spend, right, is trailing equipment and then technology. The technology spend is probably going to be consistent year-over-year. So what's happening on that side, it's the cash spend is probably going to be about the same.

But the depreciation as we roll out these new tools, depreciation is starting to grow because you're starting to capitalize stuff that was sitting in prepaid as we launch. So you're going to see an increase in the depreciation on the technology going forward, maybe not the cash spend, but the technology.

And then as it relates to trailing equipment, still, I think the industry is struggling with keeping enough - building out enough trailers for the demand. As I said, I think, at the end of the second quarter, we're looking at - we're getting quotes on new trailers in the like $50,000 range when we were paying $35,000.

We have been unable to reach - we keep our trailers about 7 years, and we've been unable to replace them on a 7-year cycle.

And so there's - when we start replacing them, clearly, the depreciation is going to be higher, the cash spend is going to be higher because no one can predict what the trail is going to cost us as we start trying to get them back new ones back in the system next year. They're mostly replacement. We're not growing the fleet.

We're just trying to replace, but the cost of a trailer is significantly higher today than it was just a year ago. So that's really where we spend, right? The two biggest points of investment, is our trailing equipment, our technology. And the technology for us is a little more predictable to trailers.

We'll see what happens when we can get our orders in for next year and see what those trailers are going to cost..

Got it. Thanks very much..

Thank you. [Operator Instructions] Our next question is from the line of Bruce Chan of Stifel. Your line is now open..

Hey, good morning, gents. I appreciate all the color here on end market demand.

But if I look at things from a geographic standpoint, you know, wondering if there's anything to maybe call out here? Is there more maybe east to west? And do you think that's having any impact on your revenue per load?.

I don't think there's any mix issues in the revenue per load. We're pretty spread out geographically. Like we don't have any - I mean clearly, the concentrates coming out of California and Texas and Florida and all those major hubs. But I don't think there's been a shift in geographic that would drive that change in our revenue per load.

That's not moving the needle much at all..

Okay. Got it. No, that's clear. And then maybe just one quick one here on intermodal. I know it's small, but volume drop off continuing to kind of get steeper there. Is that just rail fluidity or cheaper truck spread.

Anything else happening there?.

Yeah, Bruce, this is Rob. I mean, it's a couple of different things for us. It is very small and really trust it constitutes kind of - it goes with the consumer spending, right? It's two main customers, two of our agents. One is the electronics and one is food based, and that's kind of been our decline there..

Okay.

And then has that kind of leveled off? Or do you expect that to kind of continue to sink a little further?.

I think it's leveled off for now, the electronics piece of it, the food, it kind of ebbs and flows for how we work in that market. But I don't see I don't anticipate anything different than those two accounts at present..

Okay, perfect. Appreciate the time..

Sure..

At this time, I show no further questions. I would like to turn the call back over to you, sir, for closing remarks..

Thank you. Looking forward, the current economic environment with high inflation and slowing consumer demand mix for what we anticipate will be a more challenging freight environment during the '22 fourth quarter than we experienced during the first three quarters of this year. Nevertheless, our 2022 performance thus far has been exceptional.

Going forward, we expect that even with inflation driving cost - driving higher costs tied to labor, equipment and insurance, the resiliency of Landstar's variable cost business model will continue to generate significant free cash flow and financial returns.

Thank you, and I look forward to speaking with you again on our 2022 fourth quarter and year-end conference call currently scheduled for Thursday, February 2nd. Have a good day..

Thank you for joining the conference call today. Have a good morning. Please disconnect your lines at this time..