Landstar System Inc (LSTR) 2016 Q3 法說會逐字稿

Good afternoon, and welcome to Landstar System, Incorporated third-quarter 2016 earnings release conference call.

(Operator Instructions)

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; and Joe Beacom, Vice President and Chief Safety and Operations Officer.

Now, I would like to turn the call over to Mr. Jim Gattoni. Sir, you may begin.

Thank you, Danica. Good morning, and welcome to Landstar's 2016 third-quarter earnings conference call. This conference call will be limited to one hour. Due to a high level of participation on these calls, I am requesting that each participant have a two-question limit. Time permitting, we can circle back for additional questions.

But 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 2015 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.

Landstar continued to execute well in the 2016 third quarter considering the ongoing slow growth in the US industrial sector. Industry fundamentals during the 2016 third quarter remain similar to those experienced in the 2016 first half with truck capacity continuing to be more readily available than experienced in either of the past two years.

Keep in mind, however, that 2014 and 2015 were two of the best years of performance in Landstar's history. During 2014 and 2015, Landstar experienced significant growth on strong execution along with very favorable spot market conditions, particularly in 2014. The softer freight conditions in 2016 along with diesel fuel prices that were on average 10% lower than last year's third quarter have resulted in lower revenue per load on loads hauled via truck as compared to 2015.

Let me point out a few highlights from the quarter. Even in this comparatively soft spot market environment, Landstar increased the number of loads hauled via truck during the 2016 third quarter over the prior-year quarter when excluding loadings related to the now completed special project for an automotive customer from the 2015 flatbed load count.

We generated the second highest third-quarter gross profit in Landstar history. We ended the quarter with 9,510 trucks provided by BCOs, the highest quarter-end truck count in Landstar history.

We had a record number of truck brokerage carriers haul freight on Landstar's behalf during the 2016 third quarter as the model continues to attract quality truck capacity to the system. The 2016 third quarter had the second highest number of loads hauled via truck in any third quarter in Landstar history, behind only the 2015 third quarter which included 20,000 loads hauled via flatbed equipment related to the now completed project I previously referenced.

Landstar provided third-quarter revenue and earnings guidance on July 20. That guidance implied revenue of approximately $775 million in the 2016 third quarter and diluted earnings per share guidance of $0.79 to $0.84. Third-quarter revenue of $788 million was slightly above our revenue guidance. Diluted earnings per share of $0.86 was above the high end of our guidance.

As it pertains to year-over-year revenue trends, revenue declined 6% during the 2016 third quarter compared to the 2015 third quarter. This revenue decline was only 2% when excluding the $35 million in revenue from the automotive project from the 2015 third quarter. This decrease compares favorably with the 7% decrease in quarter-over-prior-year-quarter revenue we saw in the 2016 first quarter and the 8% decrease in the quarter-over-prior-year-quarter revenue we saw in the 2016 second quarter, excluding the revenue from the automotive project from the 2015 second quarter.

The revenue shortfalls in 2016 compared to the prior year were almost entirely due to the decreases in revenue per load across all modes. As for year-over-year revenue per load comparisons, revenue per load on loads hauled via van equipment was 5% below prior-year's third quarter, and revenue per load on loads hauled via unsided/platform equipment was 1% below prior-year's third quarter.

Truck capacity continued to be more readily available than it was in the 2015 quarter resulting lower spot market pricing. Additionally, revenue per load was negatively impacted by a lower cost per gallon of diesel which was almost 10% lower in the 2016 third quarter as compared to the 2015 third quarter.

The number of loads hauled via van equipment during the 2016 third quarter was 6% above the 2015 third quarter while unsided platform loadings deceased 14%. Excluding the loads hauled via flatbed equipment in 2015 related to the automotive project, the number of loads hauled via a flatbed increased 1% in the 2016 third quarter over the 2015 third quarter.

Overall, we have maintained stable unsided/platform volumes in a difficult flatbed environment. The number of loads hauled via Landstar-controlled trailing equipment, mostly van equipment hauled by BCOs and drop-and-hook operations, was 34% of truck loadings in the 2016 third quarter and increased 8% over the prior-year quarter.

As it pertains to sequential quarterly revenue trends, we are encouraged by improvement we saw in the quarterly revenue trends as the 2016 third quarter compared to the 2016 second quarter was slightly better than the normal seasonal pattern. In recent years, we have typically seen low-single-digit decreases in loadings in the third quarter compared to the second quarter.

This year, the number of loads hauled via truck in the 2016 third quarter was about equal to the 2016 second quarter, better than the recent historical trend. Similarly, revenue per load on loads hauled via truck increased 2% over the 2016 second quarter, slightly ahead of the typical recent years when moving from second quarter to the third quarter.

Landstar has a highly diversified customer base in a wide range of industries primarily operating in the US manufacturing sector. The Company's top 100 customers accounted for 42% of revenue in the 2016 third quarter. From an industry standpoint, revenue from the automotive sector was 33% below the 2015 third quarter, entirely due to $35 million in revenue in the 2015 third quarter driven by the project I previously referred to. Also, freight relating to the energy sector, which was approximately 4% of revenue in the 2016 third quarter, decreased over 24% compared to the 2015 third quarter.

Other sectors showing notable revenue declines during the 2016 third quarter were machinery and metals. The machinery and metals revenue decreases were mostly driven by overall market conditions and not related to any specific account as the Company's customer base in those sectors is highly diversified.

Gross profit decreased 4% compared to the 2015 third quarter on a 6% quarter-over-quarter decrease in revenue. Gross profit margin expanded 40 basis points in the 2016 third quarter compared to the 2015 third quarter. The rate of purchased transportation paid to truck brokerage carriers in the quarter was relatively equal to prior-year's third quarter yet at the lower end of the historical range.

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

Thanks, Jim. Jim has covered certain information on our 2016 third quarter, so I will cover various other financial information included in the press release.

Gross profit, defined as revenue less the cost of purchased transportation and commissions to agents, decreased 4% to $121.8 million and represented 15.5% of revenue in the 2016 third quarter compared to $126.8 million or 15.1% of revenue in 2015. The cost of purchased transportation was 76.3% of revenue in the 2016 quarter versus 76.7% in 2015. The rate paid to truck brokerage carriers in the 2016 third quarter was 8 basis points lower than the rate paid in the 2015 third quarter. The decrease in the cost of purchased transportation was mostly due to an increase in the percentage of revenue contributed by BCO independent contractors which typically have a lower rate of purchased transportation than revenue on loads hauled by truck brokerage carriers.

Commissions to agents as a percent of revenue were 4 basis points higher in the 2016 quarter as compared to 2015. Other operating costs were $7.5 million in the 2016 third quarter compared to $8.7 million in 2015. This decrease was primarily due to increased gains on the sale of used trailing equipment and decreased trailer rental costs. The Company has increased its Company-controlled trailer fleet to 11,057 trailers, a 10% increase over prior year, as the number of BCOs hauling Landstar trailing equipment has increased with the increased demand for drop-and-hook services.

Insurance and claims costs were $12.5 million in the 2016 third quarter compared to $10.5 million in 2015. Total insurance and claims costs for the 2016 quarter were 3.3% of BCO revenue compared to 2.7% in 2015. The increase in insurance and claims compared to the 2015 period was due to increased severity of commercial trucking accidents in the 2016 third quarter as compared to the 2015 third quarter, partially offset by increased net favorable development of prior-year's claims in the 2016 period.

Selling, general, and administrative costs were $34.7 million in the 2016 third quarter compared to $36.8 million in 2015. The decrease in SG&A costs was primarily attributable to reduced incentive compensation expense and a decrease in stock compensation expense partially offset by costs associated with the Company's multi-year project that we believe will increase efficiencies and improve the processing of transactions from order to delivery at both the agent's office and at Landstar.

Included in SG&A expense in the 2016 and 2015 third quarters is $2 million and $0.5 million respectively, related to the agent workflow project. SG&A expense as a percent of gross profit was 28.5% in the current year compared to 29% in 2015.

Depreciation and amortization was $9 million in the 2016 third quarter compared to $7.2 million in 2015. This increase was due to the increase in the number of Company-owned trailers.

As it relates to operating leverage, operating income was $58.5 million or 48% of gross profit in the 2016 quarter versus $64 million or 50.4% of gross profit in 2015. Operating income decreased 9% year over year.

The effective income tax rate was 36.9% in the 2016 third quarter compared to 37.8% in 2015. The effective income tax rate includes federal tax credits realized in the 2016 period and includes tax benefits resulting from the disqualifying dispositions of the Company's common stock in both periods. Assuming an effective income tax rate of 38.2%, the tax credits favorably impacted 2016 third-quarter diluted earnings per share by $0.02.

Looking at our balance sheet, we ended the quarter with cash and short-term investments of $227 million. Clash flow from operations for the 2016 year-to-date period was $171 million. Cash capital expenditures were $18 million, and the Company acquired $46 million in trailing equipment financed under capital leases. Included in the $18 million of cash CapEx is $14 million related to the ongoing project to build a new freight staging and trans-load facility in Laredo, Texas.

During the 2016 period, we purchased 773,000 shares of Landstar common stock at a total cost of $51 million, and there are currently 1 million shares available for purchase under the Company's stock purchase program. Back to you, Jim.

Thanks, Kevin. I expect capacity conditions experienced in the 2016 third quarter to continue to persist throughout the 2016 fourth quarter with the rate of purchased transportation paid to truck brokerage carriers to be similar to the 2016 third quarter. However, I expect gross profit margin to be lower than the 2016 third quarter gross profit margin as I expect a higher percentage of revenue contribution in the fourth quarter from truck broker carriers which has a higher cost of purchased transportation.

Seasonally, revenue per load on loads hauled via truck in October is typically slightly higher than September. During the first few weeks of October, revenue per load on loads hauled via truck has increased slightly from September indicating the spot market continues to hold to a more seasonal patterns. I believe we will maintain this normal seasonal pattern as we move through the remainder of the year.

Thus far, the price of fuel has been fairly stable, and truck capacity, although clearly more readily available than during 2015, seems to be holding at a consistent level. Therefore, I expect revenue per load on loads hauled via truck in the 2016 fourth quarter -- (technical difficulty).

I think we are back. I think the phone lines here at Landstar died, but we don't know what just happened there. Hopefully, everybody is back on. I will continue.

Therefore, I expect revenue per load on loads hauled via truck in the 2016 fourth quarter to be slightly lower than the 2015 fourth quarter, in the mid-single-digit percentage range. The Company's 2016 fourth quarter includes one extra week of operation. Including the impact of the extra week, I expect the number of loads hauled via truck in the 2016 fourth quarter to increase over the prior-year fourth quarter in a low-single-digit percentage range.

Based on the continuation of recent revenue trends plus the extra week, I currently anticipate 2016 fourth-quarter revenue to be in a range of $800 million to $850 million. Note that the 2015 fourth quarter included approximately $0.09 in diluted earnings per share attributable to the project for the automotive customer. Based on the range of revenue estimate and assuming insurance and claims costs are approximately 3.2% of BCO revenue, we anticipate 2016 fourth-quarter diluted earnings per share to be in a range of $0.85 to $0.90.

So far, our results have reflected a softening operating environment and low economic growth in the US economy. With that said, however, the model performed well, and we are encouraged by the improving sequential trends. We continue to add agents and capacity to the network and are well positioned for when the market improves.

With that, Danica, we can open to questions.

(Operator Instructions)

Jack Atkins of Stephens. Your line is open.

Hello, Jack.

Hello, guys. Good morning. Congrats on a great quarter.

Thanks.

I guess, Jim, just first off here on the extra week in the fourth quarter, could you walk us through the mechanics on that? Is that pulling from 1Q 2017? Obviously, that week is in a seasonally soft period of the calendar, but how should we think about what is assumed in the revenue guidance from that extra week for you guys?

It has no impact on 2017. It's really just the extension of 2016, but we see it -- it's a slow week, right. It's Christmas week. Comparable, we are saying it's $25 million plus or minus a couple million of revenue.

Okay, okay, that's helpful. Thank you for that clarification, and then from a follow up on the operating expense side. I thought you guys did a really fantastic job managing G&A expenses in the quarter. I think you were able to actually see G&A as a percentage of net revenue decline year over year despite lower net revenue in the quarter. Could you maybe talk to the actions that you guys were able to take to sort of effect that?

Well, as you know, Jack, one is our bonus program is variable. If we are not hitting our targets, there's no bonus. If you look to prior year, it's basically mostly the incentive comp coming out because we are not hitting our targets this year. If you go sequentially, if you look at second quarter to third quarter, that piece is the agent convention was held in the second quarter and there's no agent convention in the third quarter, so that's really the majority of what you're seeing on the SG&A line.

Okay, okay, great. Thanks, Jim.

Yep.

Scott Group of Wolfe Research. Your line is open.

Morning, Scott.

Hello. Thanks. Morning, guys. Just quickly on the extra week in the fourth quarter on that $25 million or so revenue, should we assume an average margin on that? Is that the best way to think of the EPS impact?

Yes, absolutely.

Okay. I wanted to ask you about the sequential pricing trend. It looks like we saw a much kind of bigger sequential uptick on flatbed than dry van, which is surprising kind of given the spot rate out there. Can you help us understand why the bigger uptick in flatbed this quarter?

Hi, Scott. This is Pat. It's really a mix and the type of freight that we're transporting. As you know, high, wide, heavy, dimensional freight carries a higher revenue per load, so it's kind of a mix of the business that we are transporting.

Is that kind of like the wind energy stuff picking back up or something like that or do you think that this mix benefit in the third quarter is sustainable?

It's -- we don't have a line of sight into that. Some of that was wind, but it was just -- I think Jim's opening remarks are worth repeating here. It was broad based across a number of industries, and so we don't see any resurrection in oil and gas. We don't see any resurrection in energy, but we I think continue to execute and I think our expertise around that platform business is what puts us in a pretty good position when it does recover.

Okay, and then just lastly, Jim. The comments in the release that I think volumes in October are better than normal. I think your comments today on the call were more normal seasonality, unless I missed that. Can you just follow up on that and to the extent that it's better than normal, kind of where you're seeing that?

What we are talking about is slight improvements to growth rates, right? We generally see the September and October say peak maybe 1% in volume growth, and we are slightly above that. It's not -- we are not by any means blowing it out of the water. It's just -- it's good to see that trend. It's a trend we had not seen. We started seeing the third quarter when the sequential trends were getting better, and the point is those sequential trends keep on going, and we are seeing a little bit better in sequential in October.

Okay, thank you, guys.

Todd Fowler of KeyBanc Capital Markets.

Great. Thanks, good morning. Nice quarter. Jim, I guess I just want to make sure I understand where you -- back to the questions about what you are seeing on the volume side. The third quarter volumes were stronger than what we were looking for and I think some of your initial commentary. So is that mostly the growth in the trailers and the drop-and-hook operations or is there something else that you are seeing specific to drive the share here in this quarter?

It's really just very broad based, Todd. It's hard to put your hands on specifically on what it is. You can see clearly our freight on our trailers has grown. We continue to see that as being favorable to us, and we keep putting more trailers in the system. And clearly, if we had more BCOs, we'd put more trailers in the system because demand there is probably more than we can handle at this point. We keep working on putting more trailers in the system, keeping up with that pace.

And plus, I think even on our side, I got to tell you that the flatbed turned out a little bit better than we thought it was going to be. I wouldn't have expected it to be positive -- slightly positive assuming we take out the automotive project. So I think on that heavy haul -- looking at the heavy haul stuff, I think we ratcheted it back to being flat to prior year. That's been dropping every quarter for the last probably 8 to 12 quarters and we saw the flatbed come back a little bit this quarter which was a nice surprise. I think you got a little bit of -- it's not like we are growing at 10% or 15% load volumes, but it's nice to see these upticks where we hadn't seen them before, especially on the heavy haul side like Pat had mentioned.

Yes, I know. I definitely agree with that. And again, I'm just trying to get a sense of kind of where you're seeing it. I know you've said it a couple of times, but it definitely seems like it's across the board and kind of maybe no one specific area that we can point to. I guess just for my follow-up, at the end of your prepared remarks, you made some comments on the gross profit trends, your expectations into the fourth quarter, and it sounds like you're expecting gross profit to come down -- the margin to come down a little bit sequentially but it sounds like most of that is mix related to more brokerage revenue in the fourth quarter. Do I understand those comments right?

Yes.

Maybe if you could just clarify that.

Absolutely. Typically, what you'll see is brokerage as a percent of revenue picks up into the fourth quarter as compared to the third quarter and brokerage has a higher PT rate and therefore -- it's a lower gross margin, I'm sorry. And therefore, it will just have an impact. It's not a -- we are not seeing any trends that the brokerage trucks are costing more or anything like that. It's really not [connected].

Okay. And it's also because the BCO is kind of dial it back a little bit towards the end of the year and that's why the brokerage piece steps up.

Slightly, but I'm not sure that's as big an impact. Yes, I mean, we do run a lot of business from about mid-November to the end of December, and a lot of that is BCO business.

Okay. Got it. Thanks for the time this morning.

Matt Brooklier of Longbow Research.

Thanks. Good morning. So just additional question on the volume side and specifically with your BCO segment, and you talked to kind of a broader based sequential pickup. Were there any big customer wins in 3Q that maybe potentially moved the needle a little bit?

Matt, this is Pat. No, there were not any major customer wins in the quarter that moved the needle. Certainly, we are out winning business, but I think it bears repeating from Jim's opening remarks. It's the model and it's the model executing. If you think about that market penetration that we have with our $1 million agents, that's 500 plus salespeople out in market that are calling on customers face to face, fundamentally different than a call center environment. I think what you are seeing is customers are more welcoming to sales calls. I think there's concerns about where does capacity line up in 2017. And so I think we have been in the right place at the right time and executing around the diversification of the model.

Okay, and then I think the IT spend this quarter was $2 million, if I heard that correctly. I guess what are your expectations for IT spend around the initiative for 4Q? And then maybe if you could talk to your expectations for next year if you continue to spend on the project, what roughly are you assuming in terms of the expense?

I was looking for my notes there. We -- yes, Q2, the spend was $2 million, and that compares to about $0.5 million last year in Q3. From a comparative stance, about $0.5 million last year, almost $2 million this year. We are going to kind of continue on this pace and maybe increase this pace through 2017. I think what we said for this year, for 2016, we expect it to be within a range of $0.5 to $0.10 impact on EPS. Year to date, I think we are at $0.7 and I expect we will probably be at that higher end, $0.10, when we get through the year. Next year, we have not finalized next year yet, but some of the preliminary numbers I'm looking at. Hopefully we are at launch and we're doing a lot of training, and stuff like that and there's some cost in there. We are looking -- we probably will be higher than that $0.10, but I don't want to commit to a number right now until we finalize what we are looking at for next year's plan.

Okay, fair enough. Thank you for the time.

Ben Hartford of Baird.

Good morning, guys. Jim, could you provide a little context to the above seasonal volumes that you're seeing here in October? You had mentioned -- it sounded like you were positively surprised about the heavy haul business stabilizing here in the third quarter. But as we look in October, how much of that is hurricane-relief activity, kind of just a normal sequential seasonal improvement, or maybe some of the stability that we are seeing in commodity and industrial end markets having a continuation of that heavy haul effect here in the fourth?

I don't believe any of it is hurricane related. The most I heard is we hauled 25 loads or something. I don't think that is going to be anything significant in the quarter. I don't think that's the sequential volume trend. I think we saw those trends -- even before the hurricane hit, we were looking at trends that looked better than the seasonal pattern from September to October.

Again, when I touch on the better seasonal pattern, it's hard to put your hands around it because it's slightly better. We are not talking about a huge breakout where things are getting better. It's just a nice sign to see because we hadn't had that for awhile. Again, it's broad based. It's hard to say where it's coming from. Again, it's good.

We saw the flatbed volumes increase over the prior year based on -- taking out those automotive loads from last year and the 6% growth in van volumes that we got through the third quarter. And that just continued through October, or at least for the first three weeks of October. It's hard to put our hands on what's driving it. I think we have a lot of demand on our drop-and-hook operations on our trailers. You can see -- (technical difficulty) third quarter. And I think we agreed it was 6% in the second quarter. So we are seeing acceleration of growth on our van equipment, so it's a combination of everything. I think there's good execution. Pat has done a good job of bringing new agents in.

I think we are over $110 million in new agent revenue for the first nine months of the year, and our target is usually $100 million and so we're beating that. I think the combination of everything that's going on, whether it's our drop-and-hook operations, a little bit better flatbed environment for us, it feels a little better. It's still flat to last year, but that's good. Then the execution on some of the new agents coming onboard.

Okay, that's great. As a follow-up, Kevin, tax rate in the fourth quarter in 2017, what are you looking at it as well on the share repurchase side? What type of run rate should we expect in the fourth quarter in 2017?

The tax rate we are modeling the 38.2%. That's our effective rate we have had over the years. As far as the share repurchases, we are going to do what we normally do. We are going to watch the share price and let history be your guide there. We modeled about 1 million shares. Year to date, we are at 773,000 I do believe, or $50 million, so I would expect something similar to that run rate. 2017 probably the same number of shares.

Okay, that's great. Thanks.

And we are probably going to budget for 1 million shares.

Okay, perfect. Thanks, Kevin.

Scott Schneeberger of Oppenheimer.

Good morning. This is Greg on for Scott. How would you characterize visibility in your industrial end markets? And has there been any change in optimism from your industrial customers in recent months?

Greg, this is Pat. No, there is not a lot of optimism in that segment of the business.

Great, thank you, guys.

Ryan Mueller of Buckingham Research.

Hello, guys. Thanks for the time.

Morning.

Morning. Can you talk about what the impact of ELDs will be on your BCOs and how many of your BCOs currently have ELDs?

Yes, Ryan, this is Joe. About 67% of our BCO fleet is ELD compliant as we speak. So we don't really anticipate much, if any, impact as we continue to roll out ELDs prior to the mandate with the BCO fleet next year.

Okay, and then as a follow-up, what's the impact on gross margin if one were to think there's potential lower BCO count or BCO revenue generation?

Well, if the number -- if the amount of revenue leans more towards brokerage because there's fewer BCOs, is that your question, Ryan?

Yes.

I think the best way, Ryan, for you to -- take a look at the last five years of the percentage of contribution from BCO and the percentage of contribution from brokerage, and you can see the trend of what happens to our gross margin there and then you could probably model it to show -- bring BCO down and you should be able to model what your gross profit is. We don't specifically get into the margins on BCO or brokerage. We kind of talk about it as a whole and we don't really discuss our margins on brokerage or BCO. I think if you take a look at the historical trends, you can make some assumptions. You can probably get pretty close to what that margin is going to do if you reduce or increase BCO as a percent of the total.

Okay. Thanks.

Jason Seidl of Cowen.

Good morning, guys. It's Matt Frankel on for Jason. First thing on the agent workflow. I just want to confirm that you guys still planning on rolling this out early next year? Is that still on schedule?

I would like to say, yes. At this point I am being told, yes. But it's slow rollout. In our business model, we are dealing with over 1,100 independent business owners being our agents. We can't just say here it is, use it. It's almost where you're rolling out -- at the very beginning, we're rolling out with very few agents and then we accelerate the growth rate. It's going to be a rollout that takes more than a year. We are thinking two years by the time -- two to three years we get every agent on it as we slowly roll it out.

Understood. Do you have your hands around the productivity increase? I know you mentioned some things down in Jacksonville, or down in Florida, rather, a few months ago when we met with you. Do you have your hands around what kind of benefits you could see more so than you did a few months ago as you get closer to the launch?

In March at our agent convention, we had an agent stand up and he described basically his business process. It is the one agent that's utilizing the system today, but he's basically using it with one customer. Where he was doing a lot of manual type interactions between his carriers and the customer, the system we put in place now is a lot of automated, a lot of EDI, a lot of electronic communications, and our goal really is to provide to make sure that the agents have tools that they can generate say let's say $2 million of revenue. At that point, they have to add an employee, and we'd like it push that to $3 million. Our goal is to build efficiencies out there and one of his comments was that before we rolled out this tool, he was probably about $1 million -- for every $1 million he had that drop in an employee, and now he looks like it's more of a $5 million per employee.

Now there's -- you got to consider his business was very manual and went very automated. We are not going to see that kind of outcome with every agent, but he's our only example. We would like to see an agent be able to do anywhere maybe $3 million of freight with a single employee. That's kind of our goal and our target, and we'll see out that rolls out as we start rolling it out to the agent base. There's more automation to it, a little bit more simplification to the process. That's what we are shooting for.

Understood, that's helpful. Thanks, Jim. The second thing is on BCOs. We've heard a lot of asset based providers talk about their desire to maintain or even shrink their fleets, their employees, or I'm sorry, their owned assets, however very happy to grow with independent contractors because of obviously the variable cost model. Does that put any more pressure on you guys? Does it make it more difficult to recruit BCOs? Has it changed at all for you guys as we've been in this soft rate market over the last year?

Matt, this is Joe. It really hasn't to date. I mean, the interest from owner/operators looking to come to Landstar is at a very high level, and we continue to again, pretty flattish, from a growth rate standpoint, but the interest is very high. We are not seeing any particular signs of increased competition that we can't meet. We think we are really the home of owner/operators, and being a completely owner/operator non-asset based fleet, I think has its advantages in many of the programs and the way we distribute freight and all those kinds of things I think went out at the end of the day against most of the asset-based models who were trying to be both.

Thanks, guys, appreciate the time.

Matt Young of Morningstar.

Good morning, guys.

Good morning.

Quick question on the gross margin again. I think you said the total gross margin percentage softened or it kind of came back a little bit because of the mix of the broker carrier business. But are you not seeing hints of softening gross margin percentage on the brokerage business alone when you consider the soft pricing in terms of the sell rates to the customers?

I think if you look quarter over quarter, we did have a slight increase in our PT rate.

The brokerage buy rate was up about 48 basis points. [Good point, Jim].

Okay, so there would be some softening on the brokerage front like we should seeing throughout the market at this point. Okay, thanks.

Yes, yes, yes.

(Operator Instructions)

Todd Fowler of KeyBanc Capital Markets.

Thanks for taking the follow-up. Jim, just on the increase in the drop-and-hook. Can you talk a little bit about the customer base that you are doing that with? And I think about your business as being a little bit more transactional versus contractual but does drop-and-hook get you more into the contract market with certain customers, or how does that change the profile of the business, if it does at all?

Todd, this is Pat. Again, the customer base that we are attracting is broad based, and if you just think about the business model and the natural diversification that the agent model kind of brings to the table, it's not surprising that it's very broad based. As it relates to contractual versus spot pricing, clearly in some of these accounts there is contracted pricing. We feel very comfortable with the pricing that we have in those situations, but in some of it, it's also spot business. So again, it's broad based. It's multiple accounts. It's many industries, and it's just a reflection of the Landstar business model.

Okay, so Pat, just because you're doing more drop-and-hook doesn't necessarily mean that you're doing more with like large national shippers at a contract rate. It's just that you're providing a different service across a very broad customer base and you have the trailer capacity to do different things at the point.

That is correct.

Okay, and then for my last follow-up, on the comments on the incentive compensation in the quarter or the impact, is that just the comparison versus the third quarter of last year you had incentive compensation or a higher amount of incentive compensation and you don't have anything this quarter or was there some sort of adjustment to incentive compensation accruals as a result of where you were trending? I wasn't sure if I followed that completely.

Hey, Todd. This is Kevin. In the third quarter, the year-over-year decrease was about $2.5 million. It should be about $1.5 million in the fourth quarter.

Got it. Okay, guys. Thanks for the follow-up.

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

Thank you, Danica. I look forward to speaking with you again on our 2016 year end earnings conference call currently scheduled for February 2, 2017. Have a nice day.

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