Landstar System Inc

NASDAQ:LSTR

Earnings Call Transcript 2018-Q2

[Operator]

Good morning and welcome to Landstar System, Inc. Second Quarter 2018 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; Kevin Stout, Vice President and CFO; Pat O'Malley, Vice President and Chief Commercial and Marketing 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.

[James B. Gattoni, Landstar System, Inc.]

Thank you, Prerna. Good morning and welcome to Landstar's 2018 second quarter earnings conference call. Before we begin, let me read the following statement. The following is a Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. Statements made during this conference call that are not based on historical facts are forward-looking statements.

During this conference call, we may make statements that contain forward-looking information that relates to Landstar's business objectives, plans, strategies and expectations. Such information is, by nature, subject to uncertainties and risks, including, but not limited to the operational, financial and legal risks detailed in Landstar's Form 10-K for the 2017 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 2018 second quarter financial performance continued to build on the outstanding record results Landstar achieved in our 2018 first quarter. Second quarter revenue, gross profit, operating income and income before income taxes each set all time quarterly records, while second quarter diluted earnings per share set a second quarter record. During our first quarter earnings conference call, we provided 2018 second quarter revenue guidance to be in a range of $1.115 billion to $1.165 billion. Our revenue guidance anticipated the number of loads hauled via truck in the 2018 second quarter to exceed the 2017 second quarter in a 10% to 12% range, and revenue per load on loads hauled via truck to exceed prior year in a range of 19% to 22%.

Revenue 2018 second quarter is $1.183 billion, approximately 36% above our 2017 second quarter, and slightly above the high-end of our second quarter guidance. The number of loads hauled via truck in the 2018 second quarter increased 11% over the 2017 second quarter, while revenue per load on loads hauled via truck increased 22% over the 2017 second quarter. Our second quarter guidance called for diluted earnings per share to be in a range of $1.48 to $1.54. Actual second quarter diluted earnings per share was $1.51.

Our second quarter guidance assumed insurance and claims costs would approximate 3.5% of anticipated BCO revenue in the quarter. Insurance and claims costs were 4.1% of BCO revenue in the quarter, negatively impacting diluted earnings per share by $0.06 when comparing to our actual results to our guidance. Kevin will speak more about insurance in a minute. As it pertains to the number of loads hauled via truck, we experienced consistent growth each month of the quarter with truck loadings increasing over the prior month by 11%, 10% and 11% in April, May and June, respectively. The increase was broad based amongst many customers and industries. Demand for our truck services continues to be strong.

I expect the growth in load volumes in July and August to be similar to the growth rate experienced in the second quarter, with year-over-year comparisons becoming more difficult in September due to approximately 16,000 loads hauled by Landstar in September 2017 related to the storms that impact the Southeastern U.S. and Texas. Revenue per load on loads hauled via truck remained strong each month of the 2018 second quarter, increasing over prior year month by 21% in April and May, and 23% in June.

Seasonally, we generally experience a low single-digit increase in revenue per load on loads hauled via truck from the first quarter to the second quarter. Second quarter revenue per load on loads hauled via truck increased almost 5% from our first quarter revenue per load to a record second quarter revenue per load, a clear indication of the continuation of the tight truck market. Rates continue to be strong, and I expect that will continue throughout the remainder of the year with more difficult year-over-year comparisons beginning in September.

The number of loads hauled via rail, air and ocean carriers was 23% above the 2017 second quarter. The increase in rail, air and ocean loads was driven by a 32% increase in rail loadings and an 8% increase in air and ocean loadings.

Revenue growth in the second quarter was the result of a 37% increase in revenue from existing agents, plus $33.7 million of revenue contributed by new agents. Revenue from new agents in the 2018 second quarter was much higher than the $22.7 million in revenue from new agents in the 2017 second quarter and was the highest revenue from new agents since the 2010 second quarter. We continue to attract qualified agent candidates to the model and the agent pipeline remains full. We ended the quarter with a record 10,155 trucks provided by business capacity owners, 459 trucks above our year-end 2017 count.

During the 2018 second quarter, we recruited a slightly higher number of BCOs compared to the 2017 second quarter. However, during the 2018 second quarter, we experienced significantly fewer cancellations as compared to prior year second quarter. The net increase in the number of BCO trucks in the 2000 (sic) [2018] second quarter was our highest ever quarterly net increase. Loads hauled via BCOs increased 5% in the 2018 second quarter over the 2017 second quarter on higher truck count, partially offset by a 1% decrease in BCO truck utilization defined as loads per BCO truck per quarter.

As expected, the ELD mandate has had an insignificant impact on BCO productivity in the 2018 first half. With a record number of third-party carriers haul freight on our behalf during the 2018 second quarter; our network is strong and continues to attract qualified owner operators and other third-party truck capacity providers. Gross profit increased approximately $39 million or 29% compared to the 2017 second quarter. This represented our highest ever quarter over prior quarter increase in gross profit measured by dollar amount and by percentage growth, excluding periods that included significant disaster relief revenue.

Here's Kevin with his review of other second quarter financial information.

[L. Kevin Stout, Landstar System, Inc.]

Thanks, Jim. Jim has covered certain information on our 2018 second quarter. So I will cover various other second quarter financial information included in the press release. Gross profit, defined as revenue less the cost of purchased transportation and commissions to agents, increased 29% to $171.4 million, and represented 14.5% of revenue in the 2018 second quarter compared to $132.6 million or 15.2% of revenue in 2017. The cost of purchased transportation was 77.5% of revenue in the 2018 quarter versus 76.7% in 2017.

The increase in purchase transportation as a percent of revenue was primarily due to mix, due to an increase in the percentage of revenue contributed by truck brokerage carriers. The rate paid to truck brokerage carriers in the 2018 second quarter was 49 basis points higher than the rate paid in the 2017 second quarter. Commissions to agents was 8% of revenue in the 2018 second quarter versus 8.1% in 2017. Commissions to agents as a percentage of revenue were 9 basis points lower in the 2018 quarter as compared to 2017 due to a decreased net revenue margin, revenue less the cost of purchased transportation divided by revenue on loads hauled by truck brokerage carriers.

Other operating costs were $7.6 million in the 2018 second quarter compared to $7.5 million in 2017. This increase was primarily due to increased trailing equipment costs, partially offset by decreased contractor bad debt. Insurance and claims costs were $21.5 million in the 2018 second quarter compared to $13.9 million in 2017. Total insurance and claims costs for the 2018 quarter were 4.1% of BCO revenue compared to 3.4% in 2017. The increase in the insurance and claims as a percent of BCO revenue as compared to the 2017 period was due to $5.7 million of unfavorable development of prior year claims in 2018, mostly from four claims, three of which were settled, and increased severity of accidents in the 2018 second quarter, partly offset by the favorable effect of increased BCO revenue per load in the 2018 second quarter.

Selling, general and administrative costs were $49 million in the 2018 second quarter, compared to $40.9 million in 2017. The increase in SG&A costs was mostly attributable to an increase in the provision for bonuses under the company's incentive compensation plans, an increase in stock compensation expense and increased wages and benefits. Stock compensation expense was $4.4 million and $1.2 million in the 2018 and 2017 second quarters, respectively, mostly due to the impact of increased earnings on our variable cost equity compensation arrangements. The provision for incentive compensation was $5.4 million in the 2018 second quarter, compared to $3.9 million in the 2017 second quarter.

Quarterly SG&A expense as a percent of gross profit decreased from 30.8% in the prior year to 28.6% in 2018. Depreciation and amortization was $11 million in the 2018 second quarter compared to $10 million in 2017. This increase was primarily due to the increase in the number of company-owned trailers. Operating income was $83.4 million or 48.7% of gross profit in the 2018 quarter, versus $61 million or 46% of gross profit in 2017. The increase in operating margin was driven by increased gross profit, partially offset by increased insurance and claims costs. Operating income increased 37% year-over-year.

The effective income tax rate was 24.3% in the 2018 second quarter compared to 37.7% in 2017. The 2018 effective tax rate was favorably impacted by the Tax Cuts and Jobs Act of 2017. The effective income tax rate was also impacted in both periods by tax benefits resulting from disqualifying dispositions of the company's common stock, and by excess tax benefits related to Accounting Standards Update 2016-09. Looking at our balance sheet, we ended the quarter with cash and short-term investments of $189 million. The cash flow from operations for 2018 was $113 million and cash capital expenditures were $4 million.

During the 2018 second quarter, the company purchased approximately 986,000 shares of its common stock at an aggregate cost of approximately $104 million. There are currently 2 million shares available for purchase under the company's stock purchase programs.

Back to you, Jim.

[James B. Gattoni, Landstar System, Inc.]

Thanks, Kevin. As it relates to our 2018 third quarter expectations, I anticipate that truck capacity will continue to be tight. With few exceptions, one being 2017, third quarter revenue and gross profit historically has been fairly similar to revenue and gross profit of the second quarter. I expect that historical trend to hold true in the 2018 third quarter. Truck revenue per load in June grew at a slightly higher rate than growth in April and May, by higher growth in month over prior month revenue per load in June carried into the first few weeks of July. I expect those higher rates to continue throughout the 2018 third quarter.

However, year-over-year truck revenue per load comparisons get more difficult in September due to an unseasonal increase in revenue per load in September 2017 from August 2017. Assuming current trends continue, I expect revenue per load on loads hauled via truck to be higher than the 2017 third quarter in a range of 19% to 22%. Consistent with historical trends, I expect a number of loads hauled via truck in 2018 third quarter to be similar to the number of loads hauled via truck in the 2018 second quarter. Considering year over prior year comparison, it should be noted that the 2017 third quarter included approximately 16,000 loads hauled via truck, approximately $23 million in revenue in support of disaster relief efforts related to the storms that impact the Southeastern U.S. and Texas. We have not assumed any such services in the 2018 third quarter.

Excluding the loads hauled for disaster relief efforts from the 2017 third quarter and based on my expectation that the number of loads hauled via truck in the 2018 third quarter will be similar to the number of loads hauled in the 2018 second quarter, I expect the number of loads hauled via truck in the 2018 third quarter to be above the 2017 third quarter in the 10% to 12% range. Based on the continuation of recent revenue trends, I currently anticipate 2018 third quarter revenue to be in a range of $1.175 billion to $1.225 billion. I expect gross profit margin to be in a range of 14.4% to 14.6% in the third quarter, assuming fuel prices remain stable and truck capacity remains tight. Based on that range of revenue and gross profit margin, and assuming insurance and claim costs are approximately 3.5% of BCO revenue, I anticipate 2018 third quarter diluted earnings per share to be in a range of a $1.58 to $1.64.

Overall, I'm extremely pleased with the start to 2018. 2018 first half revenue increased approximately 35% compared to 2017 first half on a 12% increase in the number of loads hauled, and significant increase in revenue per load across all modes. 2018 second quarter diluted earnings per share was the second highest quarter diluted earnings per share in the company's history. More impressive was the fact that 2018 second quarter revenue, gross profit, operating income and pre-tax income were the highest ever achieved by Landstar in any quarter in the company's history.

In our view, the overall environment for Landstar continues to be as strong as it has been at any point over the last two decades, and we expect our results to continue on a record pace through the third quarter. We continue to focus on profitable load volume growth and increasing our available capacity to haul those loads. We also remain focused on our strategic priority to continually provide and enhance technology-based tools for the thousands of small and large business owners in our network. The first half of 2018 has witnessed many new all-time quarterly records for Landstar. We've had a remarkable start and believe 2018 is shaping up to be a truly historic year.

And with that, Preema, we will move to questions.

[Operator]

Thank you very much, sir. Our first question comes from Amit Mehrotra from Deutsche Bank. Your line is now open.

[James B. Gattoni, Landstar System, Inc.]

Good morning.

[Amit Mehrotra, Deutsche Bank Securities, Inc.]

Okay. Thank you, operator. Hi. Good morning. Thanks for taking the question. So you talked about comps obviously getting a little bit more difficult, and that obviously makes sense given just the unbelievably strong revenue growth. But more than just comps and kind of what the outlook is for the next three months, six months even, I just wanted to see if you can talk about the underlying health of the trucking market? Obviously, it's very strong, but do you think this strength can kind of be sustained for maybe 2,000 (17:24) as you move over the next 12-months, 18 months, just given what we're seeing on the truck order side, used truck pricing, driver shortages, ELDs? There is a lot of like crosscurrents in the market today, and I'd just love to get a sense of, do you think this time it's different or maybe the old kind of supply creep will ultimately spoil the market as you look out 12 months to 18 months? Just any thoughts there would be helpful, I think.

[James B. Gattoni, Landstar System, Inc.]

Well, I think, sitting here, I don't think we internally here have concerns about any supply creep, even though the truck orders have been higher than they've been in for quite a long time. I still think, like you pointed out, the driver issue – my biggest concern is the demand side. I mean, that's what we feel is kind of driving it forward. And not being an economist, it's hard to predict how far that's going to go out. But we don't see any – as of now, I mean, the capacity still remains very tight. We don't see any loosening. And again, who's ordering the trucks? Who's filling the trucks? Who's going to drive the trucks? I think that's kind of where we're focused. But historically, when you have a truck environment the way we have it today, you see the guys putting trucks into the system and then loosening up that supply. But I don't anticipate that having much of a effect over the next short term six months; 2019, hard to speak to at this point. But we see more of a – it's demand driven for us, that's what we're seeing. And there's going to be – have to have a lot of capacity come into this to disrupt this environment.

[Amit Mehrotra, Deutsche Bank Securities, Inc.]

Okay. That's helpful. And just on the demand side, you've previously characterized the strong demand environment as kind of broad based. I'd assume it's the same thing. But are there pockets of kind of strength, particularly around the Gulf related to the energy markets. I mean, anything that maybe you can kind of point to that is very specific to a certain kind of subsector of the economy.

[Patrick J. O'Malley, Landstar System, Inc.]

Amit, this is Pat. I would characterize the current environment as broad-based. And if you think about the business model with our agent group, that's very diverse, and so they bring to the table a variety of accounts. And if you look at the industry serve slide that we put out in relation to our earnings, you'll look at that and it's kind of, again it's broad-based. In fact the only category that shrunk quarter-over-quarter was the energy category, but that's largely one very sizable account within that commodity category. So it's very broad-based.

[Amit Mehrotra, Deutsche Bank Securities, Inc.]

Got it. Okay. One last one from me and then I'll just hop off. The share repurchase in the quarter was pretty, pretty staggering. I mean, it was a lot relative to what you guys have done, I guess, historically. I mean, given the fact that you guys have decided more recently in terms of favor of dividends, I'm just trying to understand the thinking around that capital allocation decision. Obviously, maybe that's bullish for your outlook for the stock price. But any thoughts there in terms of your decision of why you decided to do that as opposed to maybe a dividend.

[James B. Gattoni, Landstar System, Inc.]

No. Our philosophy hasn't changed for a long-time on being opportunistic in the marketplace. I think what you saw there was, we weren't in the market from September 2016 up and through all the way to 2017, and we saw an opportunity to get in. So we're doing, I think, I'd say that we probably did a little catch up on the pullback that we had after the first quarter, and liked the opportunity that we had at that point. Speaking to the special dividends we've done in the past, those really occurred under certain situations where we just ended up with a bunch of cash on the balance sheet at the end of the year, and didn't see an opportunity in the market.

Our stock was trading in a – compared to market multiples, we were pretty elevated during 2017. That's why we didn't buy. And we ended up with cash on the balance sheet, and we distributed the dividend as a special. Clearly, we believe in giving back to the shareholder either through buybacks or dividends or preferences buybacks. But we would do a special dividend in the event that we've got some cash on the balance sheet at the end of the year. But I would say that, speaking to the buybacks, yes, we were very heavy on the buybacks. But we're going to be opportunistic. Do I anticipate doing that again in the next two quarters? No. But I don't anticipate, I think we're going to be back to the more normal reality of our buyback if you look pre the last 18 months.

[Amit Mehrotra, Deutsche Bank Securities, Inc.]

Yeah. I mean, I'd imagine that's the case given that you'll just run out of shares at some point. All right guys. Thanks so much.

[James B. Gattoni, Landstar System, Inc.]

Yeah. No, there will be one left. I'll have it.

[Amit Mehrotra, Deutsche Bank Securities, Inc.]

Congrats on the great quarter. I appreciate your time. Thank you.

[James B. Gattoni, Landstar System, Inc.]

Yeah.

[Operator]

Thank you. Our next question comes from Jack Atkins of Stephens. Your line is now open.

[Jack Atkins, Stephens, Inc.]

Hey guys, good morning, and thank you for taking my questions. So I guess, when we kind of think about the strength in the BCO count growth, everyone's losing drivers, but you guys are gaining drivers when you look at your BCO count. Jim, I guess, as you look out at I think what's an extremely challenging driver market out there right now for some of your asset based competitors, how are you seeing the opportunity for market share gains as we head into what could really be a very tight back half of the year given your comment that demand freelancers are as strong as it has been in the last two decades? I guess, how are you thinking about the opportunity of market share gains given that your driver count is actually going up?

[Joseph J. Beacom, Landstar System, Inc.]

Jack, this is Joe. I'm trying to understand the question. You're looking to understand how we're gaining BCOs when other people can't find drivers. Is that the question?

[Jack Atkins, Stephens, Inc.]

No, I guess, I'm sorry for the longer winded, confusing, rambling question. But I guess, there's a lot of demand in the marketplace out there. Your competitors are losing drivers. Your BCO count is growing. So when I look at your load count, the potential for your load count growth over the course of the next couple of quarters, and what could be a very, very tight driver market. I guess, to me it makes me very excited about the potential growth rate for Landstar, and I'm just curious how you guys are viewing this internally.

[James B. Gattoni, Landstar System, Inc.]

Well, I think Jack, I think I kind of have a story to say. We've been built for this environment. We've always been reactive to disruptions in the marketplace. This isn't a disruption but significant demand coming in, and we can access capacity. And there's, at the rates that's getting pushed out, now capacity knows where to find quality freight, and they come to us. So it's pretty easy for us to access capacity in this environment, because they know what we're doing, and they know our systems are designed to push those loads out in the simple phone call back into between the age and the carrier and we're booking freight. We've been building this model out for 20 years, and it's built for this environment.

[Jack Atkins, Stephens, Inc.]

Yeah. That definitely makes sense. And I guess just to follow up on that, Joe when you kind of are out there doing BCO recruitment, I mean, what's driving this strong growth rate? Is it just the economics of driving for Landstar, which is so much more favorable than other owner operator models out there? Can you kind of walk us through what's yielding these great growth rates for BCO count?

[Joseph J. Beacom, Landstar System, Inc.]

Sure. I think as Jim mentioned in his prepared comments, we saw some uptick in actual in the door recruiting numbers, but we saw a really significant improvement in the number of cancellations, and I think it is largely economic. I do think we have put forth some improvements in the way that we are onboarding BCOs and carriers into network, and in some of the tools that we provide that allow them to transition into the network and become successful more quickly through the way we push loads to them that meet their criteria, that get them up and running and financially stable more quickly. I think there are some multitude of things that we're doing, but clearly the environment is probably the largest of those.

[Jack Atkins, Stephens, Inc.]

Okay. That's great. And then last question from me, Kevin, could you update us on your outlook for free cash flow this year? Has that changed? And if you could sort of give us some brackets on how you think that'll come in.

[L. Kevin Stout, Landstar System, Inc.]

No. We're still thinking, I think we threw out $200 million to $250 million annually this year. I still think that's a pretty good range.

[Jack Atkins, Stephens, Inc.]

Okay. That's great. Thanks again for the time.

[James B. Gattoni, Landstar System, Inc.]

(25:36).

[Operator]

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

[Todd C. Fowler, KeyBanc Capital Markets, Inc.]

Great. Thanks. Good morning, everyone. Jim, not to get too far ahead, but thinking through the end of the year, you've given us guidance for the third quarter, understanding that the comparisons change on a year-over-year basis. But just thinking about things sequentially, is there anything that you see right now that would kind of hold back normal seasonal patterns from the third quarter into the fourth quarter? Essentially what I'm asking is, usually you see the fourth quarter maybe a little bit stronger than the third quarter. Is there anything you're seeing in the marketplace right now that would make you kind of – or that we should consider as we think through the second half of the year?

[James B. Gattoni, Landstar System, Inc.]

No. I don't think we see anything. Actually, if the environment stays where it is, I think the capacity crunch in the fourth quarter is going to be worse than it was last year. I mean, that's what we're thinking. But we don't see any change in trends coming into the fourth quarter other than – you know Todd, it was probably about three years or four years ago when this e-commerce started really hitting us. Our third quarter and fourth quarter looked a lot similar if you go prior to probably 2014 maybe. But now with this crunch start about mid-November, the capacity demand is incredible. We don't expect that to change coming into mid-November and expect to have high demand again like we've had in the last couple of years. We don't see much changing in that trend that's been around for three years now, three years, four years.

[Todd C. Fowler, KeyBanc Capital Markets, Inc.]

And are you having those conversations at this point for people looking to secure capacity in the fourth quarter around those dynamics?

[James B. Gattoni, Landstar System, Inc.]

Absolutely, yeah. There's a lot of trailer requests coming in and just – and capacity requests to make sure that we're set for that mid-November, early-November timeframe.

[Todd C. Fowler, KeyBanc Capital Markets, Inc.]

Okay. That helps. And then, just going on a little bit further into 2019, I think that most of us think about your business as being a little bit more spot-oriented versus contract with some of your asset-based competitors. And I think that as we think through the comparisons and we think through just what should happen with spot rates going forward, can you just give us some help in thinking about your ability to grow revenues? And Jack had a good point about the BCO count, and what that should mean for share gains and volume growth, and you've been growing volumes really well. But how do you think about growing revenues if the spot market starts to decelerate or the comparisons become more difficult as you go into 2019? And then what are the variables on the cost side to help the earnings if the top-line slows down?

[James B. Gattoni, Landstar System, Inc.]

Yeah. The two components of our business is price and volumes. We don't really control spot pricing, and you know that. So our role is really to push as much volume as we can through the system, and we kind of deal with the economics around pricing. I don't want to sit here and try and predict about what's going to happen in spot pricing next year. But again, our goal is to push volumes through the system, and it's all about demand and economic environment and cyclical – and cycles. But from a cost standpoint, you can see – Kevin talked about them. The incentive compensation is elevated this year because of the great performance we're having.

And about three years or four years ago we converted our stock compensation portion of the incentives to a variable program compared to the stock options we had prior to 2012 and 2013. So that's elevated, too. So some of the cost that – some of the tailwinds you'd have on something pulling back those costs would come down from a G&A (29:00). But the infrastructure is built; we could put a lot of more revenue on top of this infrastructure. But when it pulls back, we basically need that same infrastructure to push even lower revenue dollars. So we get a lot of leverage off the growth and we pull back, there's not a lot of cost to pull out. But the biggest variables are the incentive comp and the stock comp.

[Todd C. Fowler, KeyBanc Capital Markets, Inc.]

Sure. Okay. That makes sense. But let me know when you control that spot pricing part of the equation, too.

[James B. Gattoni, Landstar System, Inc.]

We're working on that right after the call.

[Todd C. Fowler, KeyBanc Capital Markets, Inc.]

All right, guys. Thanks for the time this morning.

[Operator]

Thank you. Our next question comes from Matt Reustle of Goldman Sachs. Your line is now open.

[Matthew Reustle, Goldman Sachs & Co. LLC]

Yeah. Good morning. Thanks for taking the question. Just to follow up on the higher BCO retention rate, it sounds like you're attributing it to some of the investments that you're making. Do you think we could actually see a structurally higher BCO retention rate even if the cycle were to turn?

[Joseph J. Beacom, Landstar System, Inc.]

Well, I think, Matt – this is Joe. I think that the intent behind some of these tools is to allow our BCOs to become more productive, to make better decisions more quickly, and to improve their utilization and retention. So I think one of the tools that we more recently released allows them to really get acclimated to the system and book out loads into the future on a more automated fashion, versus doing it one-by-one, and maybe that was difficult for some guys. So I think to the extent that we can continue to develop things like that, yeah, we would like to see some long-term retention benefits from that. But we're pretty early in some of those tools, but that is clearly our intent.

[Matthew Reustle, Goldman Sachs & Co. LLC]

Okay. That makes sense. And then, just one more follow up on demand, rates have been higher for an extended period of time here. It seems like demand continues full throttle across the board. I mean, are you seeing any signs of demand destruction from these higher rates in terms of your end markets?

[Patrick J. O'Malley, Landstar System, Inc.]

This is Pat. No, we have not seen any letup in the demand because of high pricing. Certainly, our customers are working closely with our agents and our sales staff to identify opportunities to be able to rationalize their supply chains so that they could reduce their costs as much as possible. But Jim said it earlier; we don't control price in the marketplace, but we try to drive volumes. And in doing so, we collaborate with our customers on providing unique solutions to today's challenges. So I don't see any demand destruction because of price, but I do see closer collaboration between us and our customers.

[Matthew Reustle, Goldman Sachs & Co. LLC]

Great. Thank you.

[Operator]

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

[Scott H. Group, Wolfe Research LLC]

Thanks. Morning, guys.

[James B. Gattoni, Landstar System, Inc.]

Morning.

[Scott H. Group, Wolfe Research LLC]

Can you share what the net revenue margins for brokerage did in the second quarter, and what you're assuming for the third quarter?

[L. Kevin Stout, Landstar System, Inc.]

Hey Scott, this is Kevin. Year-over-year it was 49 basis points on the brokerage hire, and we're assuming something similar to that in the third quarter.

[Scott H. Group, Wolfe Research LLC]

Okay. And then, do you remember what first quarter was?

[L. Kevin Stout, Landstar System, Inc.]

Scott, that's the PT. The PT was higher by 49 basis points on the brokerage line.

[Scott H. Group, Wolfe Research LLC]

So the margins were 49 basis points lower.

[L. Kevin Stout, Landstar System, Inc.]

Yes.

[Scott H. Group, Wolfe Research LLC]

Okay. And do you remember what first quarter was?

[L. Kevin Stout, Landstar System, Inc.]

On a sequential basis or on a year-over-year basis?

[Scott H. Group, Wolfe Research LLC]

Yeah, year-over-year would be great.

[L. Kevin Stout, Landstar System, Inc.]

I have that. Hold on just one second.

[Scott H. Group, Wolfe Research LLC]

And so, maybe while you're getting that, I'll ask my other question. So just one more on the BCO count. So obviously, this moves higher and lower for you guys. It's going a lot higher right now. I don't recall you talking about it in this terms of the recruitment was similar, but the retention was a lot lower. As you look at this over time, which tends to be the more variable or volatile pieces? Is it the recruitment, or is it the retention?

[Joseph J. Beacom, Landstar System, Inc.]

Scott. This is Joe. If you look back a decade, I mean, both have been pretty variable at – just depending upon the year. I think we've over the last few years been pretty consistent in the door number, and it's been a little bit, but the retention is what's really driven some of our growth the last couple of years. But if you go back further than that, the in the door number changes sometimes as well, but clearly we're focused on – we have a certain standard for the candidate. If they meet the standard then they're coming in the door, demand drives that. So with demand comes a lot of interest and in the door numbers. And then with that we try to hold onto them with retention efforts and keeping them happy and keeping them profitable. But to answer your question, looking back, it can vary from year-to-year, and it depends a lot on the economics at the time.

[Scott H. Group, Wolfe Research LLC]

But I suppose it's normal that in the – the stronger the market the lower your turnover is.

[Joseph J. Beacom, Landstar System, Inc.]

Correct. Yes.

[Scott H. Group, Wolfe Research LLC]

Okay.

[L. Kevin Stout, Landstar System, Inc.]

Hey Scott, the PT rate for brokerage in Q1 was about 150 basis points higher than Q1 of 2017.

[Scott H. Group, Wolfe Research LLC]

Okay. So you're getting less negative. Okay. Thank you guys. I appreciate the time.

[James B. Gattoni, Landstar System, Inc.]

Yeah.

[Operator]

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

[Bascome Majors, Susquehanna Financial Group LLLP]

Good morning.

[James B. Gattoni, Landstar System, Inc.]

Good morning.

[Bascome Majors, Susquehanna Financial Group LLLP]

As we look to next year, you've talked a lot about appropriately the variable part of compensation rising pretty consistently with your results that have certainly been above just about everybody's expectations heading into the year. Can you remind us or put some numbers behind, Kevin? What do we look like on an absolute basis in either cash and or stock comp year-to-date, and kind of what pace are we accruing at? And as we think about kind of rebasing that to a more target accrual to start next year, what does that amount look like?

[L. Kevin Stout, Landstar System, Inc.]

Yeah. Bascome last year the incentive comp number was $20.5 million. We're accruing currently at something just north of that. $21 million has been the number for this year. Next year the targets get reset. So the best way to look at next year is assume our one-time pay out of $8 million annually or $2 million a quarter.

[Bascome Majors, Susquehanna Financial Group LLLP]

So that $8 million number hasn't really changed much in the last couple of years. And when you say $20.5 million, are you including stock comp and cash incentives, or is that one or the other?

[L. Kevin Stout, Landstar System, Inc.]

That's just the incentive comp.

[James B. Gattoni, Landstar System, Inc.]

Yeah, that's just cash.

[Bascome Majors, Susquehanna Financial Group LLLP]

All right. And from a stock comp perspective, is that going to be from the way you guys account for it largely stock price driven or...

[L. Kevin Stout, Landstar System, Inc.]

Well, it's based – we have, first, performance stock units. So it's dependent on how well the company performs, there's growth in EPS, so year-over-year.

[James B. Gattoni, Landstar System, Inc.]

It's actually vesting driven. It's not really price driven. The price is set the day they grant. And then if they vest is when you record the comp. So if you put it in perspective, say that Tony got a 1,000 performance units and they'd be set at the price when I got them, so it was $50. But they only vest if we hit certain performance targets, which is pretty much EPS growth. So if EPS grows 10%, I get 100 shares. That's how the variable plan works. So right now I've got some shares from last year and the year before and they're just growing faster than – due to the growth in EPS, they're accelerating the number of shares I vest. Had we not grown at all, there would be no shares vesting.

[Bascome Majors, Susquehanna Financial Group LLLP]

Understood. So that will be somewhat pro-cyclical, but not really as volatile from a P&L standpoint as the cash comp.

[James B. Gattoni, Landstar System, Inc.]

Right. Less volatile, but slightly volatile.

[Bascome Majors, Susquehanna Financial Group LLLP]

All right. Thanks for the help guys. Congratulations on the results.

[James B. Gattoni, Landstar System, Inc.]

Yeah.

[Operator]

Thank you. Our next question comes from Bruce Chan of Stifel. Your line is now open.

[Jizong Bruce Chan, Stifel, Nicolaus & Co., Inc.]

Yes. Thank you, operator and good morning, gentlemen. I want to focus in for a moment on growth from revenue from new agents. I know that number was very strong. Can you characterize what's driving those new agent wins? Is it maybe just a function of where we are in the cycle, is it agents looking for capacity in serving their clients and you're just better able to meet those needs, or is there some sort of secular shift going on in the business model, given that maybe a lot of these post deregulation small business owners are maybe getting to the point where they need some help in running the business or taking it to the next stage?

[Patrick J. O'Malley, Landstar System, Inc.]

This is Pat. I would say that all of those things are driving the new agent revenue. Certainly, the ability in the Landstar System to source capacity, whether it's the BCO side or the third-party brokerage side is a big attraction for agents. The challenges for the smaller agents, brokers, I should say, out there are pretty formidable, whether it's customers that are delaying the amount of time that they take to pay people back, whether it's some of the track and tracing and the technology that people have to have in order to be able to serve their customers.

Those are all products and services that they can find inside the Landstar business model, and they can maintain that ownership of their business. So it's all of those things. And then if you think about what we're doing with our existing agents and how we're using those tools, whether it's the pricing tools or agent analytics, to identify those opportunities within their own businesses within their own customer base and go out and capture those, I think that underlying support that they get here at Landstar is another way that we can attract not only new agents, but help grow the existing agent base and make them more productive.

[Jizong Bruce Chan, Stifel, Nicolaus & Co., Inc.]

Great. So fair to say there's a cyclical component, but a pretty strong secular component as well there.

[Patrick J. O'Malley, Landstar System, Inc.]

Yes, I would – correct.

[James B. Gattoni, Landstar System, Inc.]

And we're clearly working on new tools to attract new agents, and as Pat had mentioned, the pricing tool, we launched that last summer. We launched an agent analytics tools to help them better manage their business and see day-to-day data, where they could see where their performance is coming from a customer base, from a freight level, from an employee level. So we're really focused from a tech – when you talk about our technology projects, one of the areas we're focused on is making sure that those tools that we're providing not only help the existing agent base, but that sells well, and help recruit new agents into the system, and help them transition easily into our network.

[Jizong Bruce Chan, Stifel, Nicolaus & Co., Inc.]

Great. That's very helpful. And I guess, just a quick follow on to that, can you give us an update on your progress in rolling out the new TMS?

[James B. Gattoni, Landstar System, Inc.]

Yeah, we probably have, I want to say, right now about 100 agents are on it, and it's slow. I mean, to be honest, the nature of our industry, our business model with everything decentralized and all the agents have their own ways of doing things, it's going to be a slow rollout, but it's functioning well. The agents like it. It's just going to take us a while. This could be a two-year or three-year rollout.

[Jizong Bruce Chan, Stifel, Nicolaus & Co., Inc.]

Okay. Great. And then just one last question from me on the insurance and claim side, I know you guys are historically very focused on the safety aspect. But there have been a number of big jury verdicts coming out, and I think just generally a lot of creep in insurance costs to the industry. There's a theory out there that a lot of the new Class 8 ads are people trying to access some of the new safety tech on the trucks. Are there any levers that you guys can pull there without maybe running afoul of some of the IC classification rules?

[Joseph J. Beacom, Landstar System, Inc.]

Yeah. This is Joe. The independent contractor rules certainly are a factor in something that we deal with. And I think another thing, I think there is some benefit to some of the technology that you're seeing out there, and we have some BCOs are buying new trucks, and we're kind of keeping pace with what technology comes with those. The average age of a truck and our fleet is several years old, closer to 10 years old. So they're not really in a position to get what was typically OEM-type technology in the truck. But there is some aftermarket uses that we're seeing BCOs pursue, and we're keeping an eye on it, as I guess is the right way to say that.

[James B. Gattoni, Landstar System, Inc.]

But I would say that last, our BCOs are very safe. We have a lot of safety programs. We may not have all that technology in the trucks, but the frequency of accidents is not what's burning us. Our frequency is relatively low, and we refer to frequency as how many accidents we have per million miles, it's those one-offs where you have like a severe accident. I mean, it's more severity on our side than frequency through. We control frequency pretty well. We do a good job of – if we tend to see we're having a bunch of sideswipes, that's the message of the month and stuff like that, reminders, when we do safety meetings almost every week. It's really the individual accidents, the unpredictable one, the one that happens once every while. That's really the driver of these, what they call, nuclear verdicts, and everybody's dealing with them.

[Jizong Bruce Chan, Stifel, Nicolaus & Co., Inc.]

Great. That's very helpful. Well, thank you all.

[Operator]

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

[James B. Gattoni, Landstar System, Inc.]

Thank you Prerna. And thank you and I look forward to speaking with you again on our 2018 third quarter earnings conference call currently scheduled for October 25. Have a nice day.

[Operator]

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