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LANDSTAR SYSTEM INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with the attached interim consolidated financial statements and notes thereto, and with the Company's audited financial statements and notes thereto for the fiscal year ended December 28, 2013 and Management's Discussion and Analysis of Financial Condition and Results of Operations included in the 2013 Annual Report on Form 10-K. FORWARD-LOOKING STATEMENTS The following is a "safe harbor" statement under the Private Securities Litigation Reform Act of 1995. Statements contained in this document that are not based on historical facts are "forward-looking statements." This Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Form 10-Q contain forward-looking statements, such as statements which relate to Landstar's business objectives, plans, strategies and expectations. Terms such as "anticipates," "believes," "estimates," "intention," "expects," "plans," "predicts," "may," "should," "could," "will," the negative thereof and similar expressions are intended to identify forward-looking statements. Such statements are by nature subject to uncertainties and risks, including but not limited to: an increase in the frequency or severity of accidents or other claims; unfavorable development of existing accident claims; dependence on third party insurance companies; dependence on independent commission sales agents; dependence on third party capacity providers; decreased demand for transportation services; substantial industry competition; disruptions or failures in the Company's computer systems; dependence on key vendors; changes in fuel taxes; status of independent contractors; regulatory and legislative changes; catastrophic loss of a Company facility; intellectual property; unclaimed property; and other operational, financial or legal risks or uncertainties detailed in Landstar's Form 10-K for the 2013 fiscal year, described in Item 1A "Risk Factors", this report or in Landstar's other Securities and Exchange Commission 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 statements and the Company undertakes no obligation to publicly update or revise any forward-looking statements. Introduction Landstar System, Inc. and its subsidiary, Landstar System Holdings, Inc. (together, referred to herein as "Landstar" or the "Company"), is an asset-light provider of integrated transportation management solutions. The Company offers services to its customers across multiple transportation modes, with the ability to arrange for individual shipments of freight to enterprise-wide solutions to manage all of a customer's transportation and logistics needs. Landstar provides services principally throughout the United States and to a lesser extent in Canada, and between the United States and Canada, Mexico and other countries around the world. The Company's services emphasize safety, information coordination and customer service and are delivered through a network of independent commission sales agents and third party capacity providers linked together by a series of technological applications which are provided and coordinated by the Company. The nature of the Company's business is such that a significant portion of its operating costs varies directly with revenue. Landstar markets its integrated transportation management solutions primarily through independent commission sales agents and exclusively utilizes third party capacity providers to transport and store customers' freight. Landstar's independent commission sales agents enter into contractual arrangements with the Company and are responsible for locating freight, making that freight available to Landstar's capacity providers and coordinating the transportation of the freight with customers and capacity providers. The Company's third party capacity providers consist of independent contractors who provide truck capacity to the Company under exclusive lease arrangements (the "BCO Independent Contractors"), unrelated trucking companies who provide truck capacity to the Company under non-exclusive contractual arrangements (the "Truck Brokerage Carriers"), air cargo carriers, ocean cargo carriers, railroads and independent warehouse capacity providers. Through this network of agents and capacity providers linked together by Landstar's information technology systems, Landstar operates an integrated transportation management solutions business primarily throughout North America with revenue of $2.7 billion during the most recently completed fiscal year. The Company reports the results of two operating segments: the transportation logistics segment and the insurance segment. The transportation logistics segment provides a wide range of integrated transportation management solutions. Transportation services offered by the Company include truckload and less-than-truckload transportation, rail intermodal, air cargo, ocean cargo, expedited ground and air delivery of time-critical freight, heavy-haul/specialized, U.S.-Canada and U.S.-Mexico cross-border, project cargo and customs brokerage. Transportation management solutions offered by the Company may include integrated multi-modal solutions and warehousing. Industries serviced by the transportation logistics segment include automotive products, building products, metals, chemicals, foodstuffs, heavy machinery, retail, electronics, ammunition and explosives and military equipment. In addition, the transportation logistics segment provides transportation services to other transportation companies, including logistics and less-than-truckload service providers. Each of the independent commission sales agents has the opportunity to market all of the services provided by the transportation logistics segment. Billings for freight transportation services are typically charged to customers on a per shipment basis for the physical transportation of freight and are referred to as transportation revenue. During the twenty six weeks ended June 28, 2014, revenue hauled by BCO Independent Contractors, 16 -------------------------------------------------------------------------------- Table of Contents Truck Brokerage Carriers and railroads represented approximately 49%, 45% and 3%, respectively, of the Company's consolidated revenue. Collectively, revenue hauled by air and ocean cargo carriers represented approximately 2% of the Company's consolidated revenue in the twenty-six-week period ended June 28, 2014. The insurance segment is comprised of Signature Insurance Company, a wholly owned offshore insurance subsidiary ("Signature"), and Risk Management Claim Services, Inc. This segment provides risk and claims management services to certain of Landstar's operating subsidiaries. In addition, it reinsures certain risks of the Company's BCO Independent Contractors and provides certain property and casualty insurance directly to certain of Landstar's operating subsidiaries. Revenue at the insurance segment represents reinsurance premiums from third party insurance companies that provide insurance programs to BCO Independent Contractors where all or a portion of the risk is ultimately borne by Signature. Revenue at the insurance segment represented approximately 1% of the Company's consolidated revenue for the twenty-six-week period ended June 28, 2014. On December 28, 2013, the Company completed the sale of Landstar Supply Chain Solutions, Inc., a Delaware corporation, including its wholly owned subsidiary, Landstar Supply Chain Solutions LLC (collectively, "LSCS"), to XPO Logistics, Inc. LSCS was previously reported as a unit of the transportation logistics segment. The prior year operating results of LSCS have been reclassified in the consolidated financial statements to discontinued operations. Changes in Financial Condition and Results of Operations Management believes the Company's success principally depends on its ability to generate freight through its network of independent commission sales agents and to efficiently deliver that freight utilizing third party capacity providers. Management believes the most significant factors to the Company's success include increasing revenue, sourcing capacity and controlling costs, including insurance and claims. While customer demand, which is subject to overall economic conditions, ultimately drives increases or decreases in revenue, the Company primarily relies on its independent commission sales agents to establish customer relationships and generate revenue opportunities. Management's emphasis with respect to revenue growth is on revenue generated by independent commission sales agents who on an annual basis generate $1 million or more of Landstar revenue ("Million Dollar Agents"). Management believes future revenue growth is primarily dependent on its ability to increase both the revenue generated by Million Dollar Agents and the number of Million Dollar Agents through a combination of recruiting new agents and increasing the revenue opportunities generated by existing independent commission sales agents. During the 2013 fiscal year, 478 independent commission sales agents generated $1 million or more of Landstar revenue and thus qualified as Million Dollar Agents. During the 2013 fiscal year, the average revenue generated by a Million Dollar Agent was $5,081,000 and revenue generated by Million Dollar Agents in the aggregate represented 91% of consolidated revenue. Management monitors business activity by tracking the number of loads (volume) and revenue per load by mode of transportation. Revenue per load can be influenced by many factors other than a change in price. Those factors include the average length of haul, freight type, special handling and equipment requirements, fuel costs and delivery time requirements. For shipments involving two or more modes of transportation, revenue is generally classified by the mode of transportation having the highest cost for the load. The following table summarizes this information by mode of transportation: Twenty Six Weeks Ended Thirteen Weeks Ended June 28, June 29, June 28, June 29, 2014 2013 2014 2013 Revenue from continuing operations generated through (in thousands): BCO Independent Contractors $ 740,689 $ 645,548 $ 397,037 $ 341,499 Truck Brokerage Carriers 669,154 551,822 367,641 281,181 Rail intermodal 37,021 36,688 20,526 18,677 Ocean and air cargo carriers 36,437 45,021 19,421 23,918 Other (1) 19,339 18,191 9,818 9,115 $ 1,502,640 $ 1,297,270 $ 814,443 $ 674,390 Number of loads: BCO Independent Contractors 411,370 392,370 212,500 204,600 Truck Brokerage Carriers 357,170 331,740 191,720 167,780 Rail intermodal 14,280 14,390 7,870 7,370 Ocean and air cargo carriers 8,010 8,040 4,120 4,070 790,830 746,540 416,210 383,820 Revenue per load: BCO Independent Contractors $ 1,801 $ 1,645 $ 1,868 $ 1,669 Truck Brokerage Carriers 1,873 1,663 1,918 1,676 Rail intermodal 2,593 2,550 2,608 2,534 Ocean and air cargo carriers 4,549 5,600 4,714 5,877 (1) Includes premium revenue generated by the insurance segment and warehousing revenue generated by the transportation logistics segment. 17 -------------------------------------------------------------------------------- Table of Contents Also critical to the Company's success is its ability to secure capacity, particularly truck capacity, at rates that allow the Company to profitably transport customers' freight. The following table summarizes available truck capacity providers: June 28, 2014 June 29, 2013 BCO Independent Contractors 8,074 7,876 Truck Brokerage Carriers: Approved and active (1) 23,807 20,844 Other approved 11,743 11,228 35,550 32,072 Total available truck capacity providers 43,624 39,948 Number of trucks provided by BCO Independent Contractors 8,591 8,368 (1) Active refers to Truck Brokerage Carriers who moved at least one load in the 180 days immediately preceding the fiscal quarter end. The Company incurs costs that are directly related to the transportation of freight that include purchased transportation and commissions to agents. The Company incurs indirect costs associated with the transportation of freight that include other operating costs and insurance and claims. In addition, the Company incurs selling, general and administrative costs essential to administering its business operations. Management continually monitors all components of the costs incurred by the Company and establishes annual cost budgets which, in general, are used to benchmark costs incurred on a monthly basis. Purchased transportation represents the amount a BCO Independent Contractor or other third party capacity provider is paid to haul freight. The amount of purchased transportation paid to a BCO Independent Contractor is primarily based on a contractually agreed-upon percentage of revenue generated by the haul. Purchased transportation paid to a Truck Brokerage Carrier is based on either a negotiated rate for each load hauled or, to a lesser extent, a contractually agreed-upon fixed rate. Purchased transportation paid to railroads is based on either a negotiated rate for each load hauled or a contractually agreed-upon fixed rate. Purchased transportation paid to air cargo carriers is generally based on a negotiated rate for each load hauled and purchased transportation paid to ocean cargo carriers is generally based on contractually agreed-upon fixed rates. Purchased transportation as a percentage of revenue for truck brokerage, rail intermodal and ocean cargo services is normally higher than that of BCO Independent Contractor and air cargo services. Purchased transportation is the largest component of costs and expenses and, on a consolidated basis, increases or decreases as a percentage of consolidated revenue in proportion to changes in the percentage of consolidated revenue generated through BCO Independent Contractors and other third party capacity providers and reinsurance premiums. Purchased transportation as a percent of revenue also increases or decreases in relation to the availability of truck brokerage capacity and with changes in the price of fuel on revenue hauled by Truck Brokerage Carriers. Purchased transportation costs are recognized upon the completion of freight delivery. Commissions to agents are based on contractually agreed-upon percentages of revenue or net revenue, defined as revenue less the cost of purchased transportation, or net revenue less a contractually agreed upon percentage of revenue retained by Landstar. Commissions to agents as a percentage of consolidated revenue will vary directly with fluctuations in the percentage of consolidated revenue generated by 18-------------------------------------------------------------------------------- Table of Contents the various modes of transportation and reinsurance premiums and with changes in net revenue margin, defined as net revenue divided by revenue, on services provided by Truck Brokerage Carriers, railroads, air cargo carriers and ocean cargo carriers. Commissions to agents are recognized upon the completion of freight delivery. The Company defines gross profit as revenue less the cost of purchased transportation and commissions to agents. Gross profit divided by revenue is referred to as gross profit margin. The Company's operating margin is defined as operating income divided by gross profit. In general, gross profit margin on revenue hauled by BCO Independent Contractors represents a fixed percentage of revenue due to the nature of the contracts that pay a fixed percentage of revenue to both the BCO Independent Contractors and independent commission sales agents. For revenue hauled by Truck Brokerage Carriers, gross profit margin is either fixed or variable as a percent of revenue, depending on the contract with each individual independent commission sales agent. Under certain contracts with independent commission sales agents, the Company retains a fixed percentage of revenue and the agent retains the amount remaining less the cost of purchased transportation (the "retention contracts"). Gross profit margin on revenue hauled by railroads, air cargo carriers, ocean cargo carriers and Truck Brokerage Carriers, other than those under retention contracts, is variable in nature as the Company's contracts with independent commission sales agents provide commissions to agents at a contractually agreed upon percentage of net revenue. Approximately 58% of the Company's consolidated revenue in the twenty-six-week period ended June 28, 2014 was generated under contracts that have a fixed gross profit margin while 42% was under contracts that have a variable gross profit margin. Maintenance costs for Company-provided trailing equipment and BCO Independent Contractor recruiting costs are the largest components of other operating costs. Also included in other operating costs are the provision for uncollectible advances and other receivables due from BCO Independent Contractors and independent commission sales agents and gains/losses, if any, on sales of Company-owned trailing equipment. With respect to insurance and claims cost, potential liability associated with accidents in the trucking industry is severe and occurrences are unpredictable. For commercial trucking claims, Landstar retains liability up to $5,000,000 per occurrence. The Company also retains liability of up to $1,000,000 for each general liability claim, $250,000 for each workers' compensation claim and up to $250,000 for each cargo claim. The Company's exposure to liability associated with accidents incurred by Truck Brokerage Carriers, railroads and air and ocean cargo carriers who transport freight on behalf of the Company is reduced by various factors including the extent to which such carriers maintain their own insurance coverage. A material increase in the frequency or severity of accidents, cargo claims or workers' compensation claims or the material unfavorable development of existing claims could have a material adverse effect on Landstar's cost of insurance and claims and its results of operations. Employee compensation and benefits account for over sixty percent of the Company's selling, general and administrative costs. Depreciation and amortization primarily relate to depreciation of trailing equipment and information technology hardware and software. The following table sets forth the percentage relationship of purchased transportation and commissions to agents, both being direct costs, to revenue and indirect costs as a percentage of gross profit for the periods indicated: Twenty Six Weeks Ended Thirteen Weeks Ended June 28, June 29, June 28, June 29, 2014 2013 2014 2013 Revenue 100.0 % 100.0 % 100.0 % 100.0 % Purchased transportation 77.1 76.7 77.2 76.7 Commissions to agents 7.8 7.9 7.8 8.0 Gross profit margin 15.1 % 15.4 % 14.9 % 15.4 % Gross profit 100.0 % 100.0 % 100.0 % 100.0 % Investment income 0.3 0.4 0.3 0.4 Indirect costs and expenses: Other operating costs, net of gains on asset dispositions 5.6 4.7 5.1 4.0 Insurance and claims 11.3 11.8 11.4 11.4 Selling, general and administrative 31.9 32.0 30.2 31.4 Depreciation and amortization 5.9 6.8 5.4 6.9 Total costs and expenses 54.7 55.3 52.1 53.6 Operating margin 45.6 % 45.1 % 48.1 % 46.7 % 19 -------------------------------------------------------------------------------- Table of Contents Management believes that a discussion of indirect costs as a percentage of gross profit is useful and meaningful to potential investors for the following principal reasons: (1) disclosure of these relative measures (i.e., each indirect operating cost line item as a percentage of gross profit) allows investors to better understand the underlying trends in Landstar's results of operations; (2) due to the generally fixed nature of these indirect costs (other than insurance and claims costs), these relative measures are meaningful to investors' evaluations of the Company's management of its indirect costs attributable to operations; (3) management considers this financial information in its decision-making, such as budgeting for infrastructure, trailing equipment and selling, general and administrative costs; and (4) this information facilitates comparisons by investors of Landstar's results to the results of peer non-asset or asset-light companies in the transportation and logistics services industry who report "net revenue" in Management Discussion and Analysis, which represents revenue less the cost of purchased transportation. The difference between Landstar's use of the term "gross profit" versus its peers' use of the term "net revenue" is due to the direct cost of commissions to agents under the Landstar model, whereas peer companies generally have no commissions to agents. Also, as previously mentioned, the Company reports two operating segments: the transportation logistics segment and the insurance segment. External revenue at the insurance segment, representing reinsurance premiums, has historically been relatively consistent on a year-over-year basis at less than 2% of consolidated revenue and generally corresponds directly with the number of trucks provided by BCO Independent Contractors. The discussion of indirect cost line items in Management's Discussion and Analysis of Financial Condition and Results of Operations considers the Company's costs on a consolidated basis rather than on a segment basis. Management believes this presentation format is the most appropriate to assist users of the financial statements in understanding the Company's business for the following reasons: (1) the insurance segment has no other operating costs, (2) discussion of insurance and claims at either segment without reference to the other may create confusion amongst investors and potential investors due to intercompany arrangements and specific deductible programs that affect comparability of financial results by segment between various fiscal periods but that have no effect on the Company from a consolidated reporting perspective, (3) selling, general and administrative costs of the insurance segment comprise less than 10% of consolidated selling, general and administrative costs and have historically been relatively consistent on a year-over-year basis, and (4) the insurance segment has no depreciation and amortization. TWENTY SIX WEEKS ENDED JUNE 28, 2014 COMPARED TO TWENTY SIX WEEKS ENDED JUNE 29, 2013 Revenue for the 2014 twenty-six-week period was $1,502,640,000, an increase of $205,370,000, or 16%, compared to the 2013 twenty-six-week period. Transportation revenue increased $204,505,000, or 16%. The increase in transportation revenue was primarily attributable to approximately a 6% increase in the number of loads hauled and increased revenue per load of approximately 10%. Reinsurance premiums from third party insurance companies that provide insurance programs to BCO Independent Contractors where all or a portion of the risk of loss is ultimately borne by Signature, was $18,967,000 and $18,102,000 for the 2014 and 2013 twenty-six-week periods, respectively. Truck transportation revenue hauled by BCO Independent Contractors and Truck Brokerage Carriers (together, the "third party truck capacity providers") for the twenty-six-week period ended June 28, 2014, was $1,409,843,000, or 94% of total revenue, an increase of $212,473,000, or 18%, compared to the 2013 twenty-six-week period. The number of loads hauled by third party truck capacity providers in the 2014 twenty-six-week period increased approximately 7% compared to the 2013 twenty-six-week period, and revenue per load increased approximately 11% compared to the 2013 twenty-six-week period. The increase in the number of loads hauled via third party truck capacity providers was due to a broad-based increase in underlying demand for truck transportation services. The increase in revenue per load on loads hauled via truck was primarily attributable to increased demand and a tight truck capacity environment. Fuel surcharges on Truck Brokerage Carrier revenue identified separately in billings to customers and included as a component of Truck Brokerage Carrier revenue were $56,942,000 and $54,944,000 in the 2014 and 2013 periods, respectively. Fuel surcharges billed to customers on revenue hauled by BCO Independent Contractors are excluded from revenue. Transportation revenue hauled by rail intermodal, air cargo and ocean cargo carriers (collectively, the "multimode capacity providers") for the twenty-six-week period ended June 28, 2014, was $73,458,000, or 5% of total revenue, a decrease of $8,251,000, or 10%, 20-------------------------------------------------------------------------------- Table of Contents compared to the 2013 twenty-six-week period. The number of loads hauled by multimode capacity providers in the 2014 twenty-six-week period decreased approximately 1% compared to the 2013 twenty-six-week period and revenue per load on revenue hauled by multimode capacity providers decreased approximately 9% over the same period. The decrease in loads hauled by multimode capacity providers was primarily due to decreased rail intermodal loads due to the severe winter weather disruptions that impacted domestic rail carriers in the first half of 2014. The decrease in revenue per load on revenue hauled by multimode capacity providers was primarily due to decreased loads hauled by ocean cargo carriers, which typically have a higher revenue per load amount compared to other types of multimode shipments. Also, revenue per load on revenue hauled by multimode capacity providers is influenced by many factors, including revenue mix among the various modes of transportation used, length of haul, complexity of freight, density of freight lanes, fuel costs and availability of capacity. Purchased transportation was 77.1% and 76.7% of revenue in the 2014 and 2013 twenty-six-week periods, respectively. The increase in purchased transportation as a percentage of revenue was primarily attributable to an increased rate of purchased transportation paid to Truck Brokerage Carriers as the availability of truck capacity tightened in 2014. Commissions to agents were 7.8% and 7.9% of revenue in the 2014 and 2013 periods, respectively. The decrease in commissions to agents as a percentage of revenue was primarily attributable to a decreased net revenue margin on revenue hauled by Truck Brokerage Carriers caused by the increased rate of purchased transportation paid to Truck Brokerage Carriers. Investment income at the insurance segment was $695,000 and $745,000 in the 2014 and 2013 twenty-six-week periods, respectively. Other operating costs increased $3,444,000 in the 2014 twenty-six-week period compared to the 2013 twenty-six-week period and represented 5.6% of gross profit in the 2014 period compared to 4.7% of gross profit in the 2013 period. The increase in other operating costs compared to prior year was mostly due to lower gains on sales of trailing equipment in the 2014 period of $1,623,000 and, to a lesser extent, increased costs of various BCO programs, including recruiting and other related costs. The increase in other operating costs as a percent of gross profit was caused by the increase in other operating costs, but was somewhat reduced by the effect of increased gross profit. Insurance and claims increased $2,134,000 in the 2014 twenty-six-week period compared to the 2013 twenty-six-week period and represented 11.3% of gross profit in the 2014 period compared to 11.8% of gross profit in the 2013 period. The increase in insurance and claims compared to prior year was due to increased net unfavorable development of prior year claims in the 2014 period of $2,103,000. The decrease in insurance and claims as a percent of gross profit, however, was due to the effect of increased gross profit, which more than offset the effect of the increase in insurance and claims. Selling, general and administrative costs increased $8,375,000 in the 2014 twenty-six-week period compared to the 2013 twenty-six-week period and represented 31.9% of gross profit in the 2014 period compared to 32.0% of gross profit in the 2013 period. The increase in selling, general and administrative costs compared to prior year was due to a $6,579,000 provision for incentive compensation in the 2014 period compared to a minimal provision in the 2013 period, plus an increased provision for customer bad debt in the 2014 period. The decrease in selling, general and administrative costs as a percent of gross profit, however, was due to the effect of increased gross profit which more than offset the effect of the increase in selling, general and administrative costs. Depreciation and amortization decreased $230,000 in the 2014 twenty-six-week period compared to the 2013 twenty-six-week period and represented 5.9% of gross profit in the 2014 period compared to 6.8% of gross profit in the 2013 period. The decrease in depreciation and amortization as a percent of gross profit was primarily due to the effect of increased gross profit. Interest and debt expense in the 2014 twenty-six-week period was $25,000 lower than the 2013 twenty-six-week period. The provisions for income taxes for both the 2014 and 2013 twenty-six-week periods were based on estimated annual effective income tax rates of 38.2%, adjusted for discrete events, such as benefits resulting from disqualifying dispositions of the Company's common stock by employees who obtained the stock through exercises of incentive stock options. The effective income tax rates on income from continuing operations for the 2014 and 2013 twenty-six-week periods were each 37.7%, which was higher than the statutory federal income tax rate primarily as a result of state taxes, the meals and entertainment exclusion and non-deductible stock compensation expense. The effective income tax rates in the 2014 and 2013 twenty-six-week periods were less than 38.2% due to disqualifying dispositions of the Company's common stock by employees who obtained the stock through exercises of incentive stock options in each year. 21-------------------------------------------------------------------------------- Table of Contents Net income was $63,563,000, or $1.41 per common share ($1.40 per diluted share), in the 2014 twenty-six-week period. Income from continuing operations was $55,243,000, or $1.19 per common share ($1.19 per diluted share), in the 2013 twenty-six-week period. Net income was $57,206,000, or $1.23 per common share ($1.23 per diluted share), in the 2013 twenty-six-week period. THIRTEEN WEEKS ENDED JUNE 28, 2014 COMPARED TO THIRTEEN WEEKS ENDED JUNE 29, 2013 Revenue for the 2014 thirteen-week period was $814,443,000, an increase of $140,053,000, or 21%, compared to the 2013 thirteen-week period. Transportation revenue increased $139,492,000, or 21%. The increase in transportation revenue was primarily attributable to approximately a 9% increase in the number of loads hauled and increased revenue per load of approximately 12%. Reinsurance premiums from third party insurance companies that provide insurance programs to BCO Independent Contractors where all or a portion of the risk of loss is ultimately borne by Signature, was $9,623,000 and $9,062,000 for the 2014 and 2013 thirteen-week periods, respectively. Truck transportation revenue hauled by third party truck capacity providers for the thirteen-week period ended June 28, 2014, was $764,678,000, or 94% of total revenue, an increase of $141,998,000, or 23%, compared to the 2013 thirteen-week period. The number of loads hauled by third party truck capacity providers in the 2014 thirteen-week period increased approximately 9% compared to the 2013 thirteen-week period, and revenue per load increased approximately 14% compared to the 2013 thirteen-week period. The increase in the number of loads hauled via third party truck capacity providers was due to a broad-based increase in underlying demand for truck transportation services in the domestic marketplace and increased market share from new agents. The increase in revenue per load on loads hauled via truck was primarily attributable to increased demand and a tight truck capacity environment. Fuel surcharges on Truck Brokerage Carrier revenue identified separately in billings to customers and included as a component of Truck Brokerage Carrier revenue were $29,902,000 and $26,618,000 in the 2014 and 2013 periods, respectively. Fuel surcharges billed to customers on revenue hauled by BCO Independent Contractors are excluded from revenue. Transportation revenue hauled by multimode capacity providers for the thirteen-week period ended June 28, 2014, was $39,947,000, or 5% of total revenue, a decrease of $2,648,000, or 6%, compared to the 2013 thirteen-week period. The number of loads hauled by multimode capacity providers in the 2014 thirteen-week period increased approximately 5% compared to the 2013 thirteen-week period while revenue per load on revenue hauled by multimode capacity providers decreased approximately 11% over the same period. The increase in loads hauled by multimode capacity providers was primarily due to increased rail intermodal loads. The decrease in revenue per load on revenue hauled by multimode capacity providers was primarily due to decreased loads hauled by ocean cargo carriers, which typically have a higher revenue per load amount compared to other types of multimode shipments. Also, revenue per load on revenue hauled by multimode capacity providers is influenced by many factors, including revenue mix among the various modes of transportation used, length of haul, complexity of freight, density of freight lanes, fuel costs and availability of capacity. Purchased transportation was 77.2% and 76.7% of revenue in the 2014 and 2013 thirteen-week periods, respectively. The increase in purchased transportation as a percentage of revenue was primarily attributable to an increased rate of purchased transportation paid to Truck Brokerage Carriers as the availability of truck capacity tightened in the 2014 period and an increase in the percentage of revenue hauled by Truck Brokerage Carriers, which has a higher rate of purchased transportation. Commissions to agents were 7.8% and 8.0% of revenue in the 2014 and 2013 periods, respectively. The decrease in commissions to agents as a percentage of revenue was primarily attributable to a decreased net revenue margin on revenue hauled by Truck Brokerage Carriers caused by the increased rate of purchased transportation paid to Truck Brokerage Carriers. Investment income at the insurance segment was $332,000 and $371,000 in the 2014 and 2013 thirteen-week periods, respectively. Other operating costs increased $2,098,000 in the 2014 thirteen-week period compared to the 2013 thirteen-week period and represented 5.1% of gross profit in the 2014 period compared to 4.0% of gross profit in the 2013 period. The increase in other operating costs compared to prior year was mostly due to lower gains on sales of trailing equipment in the 2014 period of $1,040,000 and, to a lesser extent, increased trailing equipment costs and increased costs of various BCO programs. The increase in other operating costs as a percent of gross profit was caused by the increase in other operating costs, but was somewhat reduced by the effect of increased gross profit. Insurance and claims increased $2,040,000 in the 2014 thirteen-week period compared to the 2013 thirteen-week period and represented 11.4% of gross profit in both the 2014 and 2013 periods. The increase in insurance and claims compared to prior year was due to increased net unfavorable development of prior year claims in the 2014 period of $2,574,000. Selling, general and administrative costs increased $4,252,000 in the 2014 thirteen-week period compared to the 2013 thirteen-week period and represented 30.2% of gross profit in the 2014 period compared to 31.4% of gross profit in the 2013 period. The increase in 22-------------------------------------------------------------------------------- Table of Contents selling, general and administrative costs compared to prior year was due to a $4,650,000 provision for incentive compensation in the 2014 period compared to a minimal provision in the 2013 period, plus an increased provision for customer bad debt in the 2014 period. The decrease in selling, general and administrative costs as a percent of gross profit, however, was due to the effect of increased gross profit which more than offset the effect of the increase in selling, general and administrative costs. Depreciation and amortization decreased $560,000 in the 2014 thirteen-week period compared to the 2013 thirteen-week period and represented 5.4% of gross profit in the 2014 period compared to 6.9% of gross profit in the 2013 period. The decrease in depreciation and amortization as a percent of gross profit was due to the effect of increased gross profit, combined with lower trailing equipment depreciation in the 2014 period. Interest and debt expense in the 2014 thirteen-week period was $53,000 lower than the 2013 thirteen-week period. The provisions for income taxes for both the 2014 and 2013 thirteen-week periods were based on estimated annual effective income tax rates of 38.2%, adjusted for discrete events. The effective income tax rates on income from continuing operations for the 2014 and 2013 thirteen-week periods were 37.9% and 38.1%, respectively, which were higher than the statutory federal income tax rate primarily as a result of state taxes, the meals and entertainment exclusion and non-deductible stock compensation expense. The effective income tax rates in the 2014 and 2013 thirteen-week periods were less than 38.2% due to disqualifying dispositions of the Company's common stock by employees who obtained the stock through exercises of incentive stock options in each year. Net income was $35,925,000, or $0.80 per common share ($0.80 per diluted share), in the 2014 thirteen-week period. Income from continuing operations was $29,492,000, or $0.64 per common share ($0.64 per diluted share), in the 2013 thirteen-week period. Net income was $30,426,000, or $0.66 per common share ($0.66 per diluted share), in the 2013 thirteen-week period. CAPITAL RESOURCES AND LIQUIDITY Working capital and the ratio of current assets to current liabilities were $301,022,000 and 1.8 to 1, respectively, at June 28, 2014, compared with $306,808,000 and 1.8 to 1, respectively, at December 28, 2013. Landstar has historically operated with current ratios within the range of 1.5 to 1 to 2.0 to 1. Cash provided by operating activities of continuing operations was $13,600,000 in the 2014 twenty-six-week period compared with $80,136,000 in the 2013 twenty-six-week period. The decrease in cash flow provided by operating activities of continuing operations was primarily attributable to the increase in trade receivables since the beginning of the fiscal year 2014 generally driven by the significant growth in revenue in the first half of 2014. The Company declared and paid $0.12 per share, or $5,420,000, in cash dividends during the twenty-six-week period ended June 28, 2014 and, during such period, also paid $15,921,000 of dividends payable, which were declared during fiscal year 2013 and included in other current liabilities in the consolidated balance sheet at December 28, 2013. The Company did not pay cash dividends during the twenty-six-week period ended June 29, 2013. During the twenty-six-week period ended June 28, 2014, the Company purchased 939,872 shares of its common stock at a total cost of $56,393,000. As of June 28, 2014, the Company may purchase up to an additional 1,827,782 shares of its common stock under its authorized stock purchase program. Long-term debt, including current maturities, was $92,805,000 at June 28, 2014, $8,700,000 lower than at December 28, 2013. Shareholders' equity was $460,058,000, or 83% of total capitalization (defined as long-term debt including current maturities plus equity), at June 28, 2014, compared to $454,481,000, or 82% of total capitalization, at December 28, 2013. The increase in equity was primarily a result of net income, partially offset by the purchases of shares of the Company's common stock in the 2014 twenty-six-week period. On June 29, 2012, Landstar entered into a credit agreement with a syndicate of banks and JPMorgan Chase Bank, N.A., as administrative agent (the "Credit Agreement"). The Credit Agreement, which matures on June 29, 2017, provides $225,000,000 of borrowing capacity in the form of a revolving credit facility, $75,000,000 of which may be utilized in the form of letter of credit guarantees. The Credit Agreement contains a number of covenants that limit, among other things, the incurrence of additional indebtedness. The Company is required to, among other things, maintain a minimum Fixed Charge Coverage Ratio, as defined in the Credit Agreement, and maintain a Leverage Ratio, as defined in the Credit Agreement, below a specified maximum. The Credit Agreement provides for a restriction on cash dividends and other distributions to stockholders on the Company's capital stock to the extent there is a default under the Credit Agreement. In addition, the Credit Agreement under certain circumstances limits the amount of such cash dividends and other 23-------------------------------------------------------------------------------- Table of Contents distributions to stockholders to the extent that, after giving effect to any payment made to effect such cash dividend or other distribution, the Leverage Ratio would exceed 2.5 to 1 on a pro forma basis as of the end of the Company's most recently completed fiscal quarter. The Credit Agreement provides for an event of default in the event that, among other things, a person or group acquires 25% or more of the outstanding capital stock of the Company or obtains power to elect a majority of the Company's directors. None of these covenants are presently considered by management to be materially restrictive to the Company's operations, capital resources or liquidity. The Company is currently in compliance with all of the debt covenants under the Credit Agreement. At June 28, 2014, the Company had no borrowings outstanding and $33,000,000 of letters of credit outstanding under the Credit Agreement. At June 28, 2014, there was $192,000,000 available for future borrowings under the Credit Agreement. In addition, the Company has $64,432,000 in letters of credit outstanding as collateral for insurance claims that are secured by investments and cash equivalents totaling $71,233,000 at June 28, 2014. Investments, all of which are carried at fair value, include primarily investment-grade bonds and U.S. Treasury obligations having maturities of up to five years. Fair value of investments is based primarily on quoted market prices. See Notes to Consolidated Financial Statements for further discussion on measurement of fair value of investments. Historically, the Company has generated sufficient operating cash flow to meet its debt service requirements, fund continued growth, both internal and through acquisitions, complete or execute share purchases of its common stock under authorized share purchase programs, pay dividends and meet working capital needs. As an asset-light provider of integrated transportation management solutions, the Company's annual capital requirements for operating property are generally for trailing equipment and information technology hardware and software. In addition, a significant portion of the trailing equipment used by the Company is provided by third party capacity providers, thereby reducing the Company's capital requirements. During the 2014 twenty-six-week period, the Company purchased $1,354,000 of operating property and acquired $11,410,000 of trailing equipment by entering into capital leases. Landstar anticipates acquiring approximately $43,000,000 in operating property, primarily new trailing equipment to replace older trailing equipment and information technology equipment, during the remainder of fiscal year 2014 either by purchase or lease financing. Management believes that cash flow from operations combined with the Company's borrowing capacity under the Credit Agreement will be adequate to meet Landstar's debt service requirements, fund continued growth, both internal and through acquisitions, pay dividends, complete the authorized share purchase programs and meet working capital needs. LEGAL MATTERS As further described in periodic and current reports previously filed by the Company with the Securities and Exchange Commission (the "SEC"), in connection with an accident that occurred in February 2007 involving a BCO Independent Contractor leased to Landstar Ranger, Inc., on September 23, 2011, a jury sitting in a state court in Cobb County, Georgia, entered a damage award of approximately $40.2 million against Landstar Ranger, Inc., Landstar System Holdings, Inc. and Landstar System, Inc. (the "Landstar Defendants"). On May 28, 2013, the trial court entered an amended judgment that added approximately $1.0 million of pre-judgment interest, $14.0 million of attorney fees and post-judgment interest at the rate of 6.25% per annum from and after September 23, 2011 on the aggregate sum of approximately $55.2 million awarded to the plaintiffs. Such amount in the aggregate is referred to herein as the "Damage Award". Under the terms of the commercial trucking insurance program that Landstar had in place in 2007, Landstar retained liability for up to $5 million with respect to the accident giving rise to the Damage Award and had third party insurance and/or reinsurance policies in place that were expected to provide coverage for all amounts in excess of such retained liability, including all related out-of-pocket expenses, such as the costs of an appeal bond and interest. The Company recorded a $5 million charge representing its self-insured retention in respect of this accident in the consolidated financial results of the Company in the 2007 first quarter. On July 9, 2014, while an appeal of the Damage Award filed by the Landstar Defendants was pending before the Court of Appeals of the State of Georgia, the plaintiffs and the Landstar Defendants entered into an agreement in principle providing for the settlement of all claims of the plaintiffs against the Landstar Defendants for $42.0 million (the "Settlement Amount"). In connection therewith, on July 9, 2014, the plaintiffs filed a Motion to Dismiss Appeal stating that the parties have agreed to compromise and settle all claims asserted by the plaintiffs against the Landstar Defendants. Under the terms of the Company's insurance policies, the Company is the primary obligor of the amount of the Settlement Amount, and as such, the Company has reported a $40.5 million receivable from the third party insurance providers in other receivables and a corresponding liability of the same amount in insurance claims in the consolidated balance sheets at June 28, 2014. No assurances can be given regarding the impact of the Damage Award or the Settlement Amount on the premiums charged by the Company's third party insurers from time to time for commercial trucking insurance. The Company is involved in certain claims and pending litigation, including those described herein, arising from the normal conduct of business. Many of these claims are covered in whole or in part by insurance. Based on knowledge of the facts and, in certain cases, opinions of outside counsel, management believes that adequate provisions have been made for probable losses with respect to the 24 -------------------------------------------------------------------------------- Table of Contents resolution of all such claims and pending litigation and that the ultimate outcome, after provisions therefor, will not have a material adverse effect on the financial condition of the Company, but could have a material effect on the results of operations in a given quarter or year. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The allowance for doubtful accounts for both trade and other receivables represents management's estimate of the amount of outstanding receivables that will not be collected. Historically, management's estimates for uncollectible receivables have been materially correct. Although management believes the amount of the allowance for both trade and other receivables at June 28, 2014 is appropriate, a prolonged period of low or no economic growth may adversely affect the collection of these receivables. In addition, liquidity concerns and/or unanticipated bankruptcy proceedings at any of the Company's larger customers in which the Company is carrying a significant receivable could result in an increase in the provision for uncollectible receivables and have a significant impact on the Company's results of operations in a given quarter or year. However, it is not expected that an uncollectible accounts receivable resulting from an individual customer would have a significant impact on the Company's financial condition. Conversely, a more robust economic environment or the recovery of a previously provided for uncollectible receivable from an individual customer may result in the realization of some portion of the estimated uncollectible receivables. Landstar provides for the estimated costs of self-insured claims primarily on an actuarial basis. The amount recorded for the estimated liability for claims incurred is based upon the facts and circumstances known on the applicable balance sheet date. The ultimate resolution of these claims may be for an amount greater or less than the amount estimated by management. The Company continually revises its existing claim estimates as new or revised information becomes available on the status of each claim. Historically, the Company has experienced both favorable and unfavorable development of prior years' claims estimates. During the 2014 and 2013 twenty-six-week periods, insurance and claims costs included $6,747,000 and $4,644,000 of net unfavorable adjustments to prior years' claims estimates, respectively. It is reasonably likely that the ultimate outcome of settling all outstanding claims will be more or less than the estimated claims reserve at June 28, 2014. The Company utilizes certain income tax planning strategies to reduce its overall cost of income taxes. If the Company were to be subject to an audit, it is possible that certain strategies might be disallowed resulting in an increased liability for income taxes. Certain of these tax planning strategies result in a level of uncertainty as to whether the related tax positions taken by the Company would result in a recognizable benefit. The Company has provided for its estimated exposure attributable to such tax positions due to the corresponding level of uncertainty with respect to the amount of income tax benefit that may ultimately be realized. Management believes that the provision for liabilities resulting from the uncertainty in certain income tax positions is appropriate. To date, the Company has not experienced an examination by governmental revenue authorities that would lead management to believe that the Company's past provisions for exposures related to the uncertainty of such income tax positions are not appropriate. Significant variances from management's estimates for the amount of uncollectible receivables, the ultimate resolution of self-insured claims and the provision for uncertainty in income tax positions could each be expected to positively or negatively affect Landstar's earnings in a given quarter or year. However, management believes that the ultimate resolution of these items, given a range of reasonably likely outcomes, will not significantly affect the long-term financial condition of Landstar or its ability to fund its continuing operations. EFFECTS OF INFLATION Management does not believe inflation has had a material impact on the results of operations or financial condition of Landstar in the past five years. However, inflation in excess of historic trends might have an adverse effect on the Company's results of operations in the future. SEASONALITY Landstar's operations are subject to seasonal trends common to the trucking industry. Results of operations for the quarter ending in March are typically lower than for the quarters ending June, September and December. |