Landstar System - Q4 2019
January 30, 2020
Transcript
Operator (participant)
Good morning, and welcome to Landstar System, Inc.'s Year-End 2019 Earnings Release Conference Call. All lines will be in a listen-only mode until the formal question-and-answer session. TTRANSCRIPT
Jim Gattoni (CEO)
Thank you, Eunice. Good morning, and welcome to Landstar's 2019 fourth 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 2018 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. Throughout 2019, both truckload volume and revenue per load on loads hauled via truck were impacted by softening conditions in the spot market. In particular, Landstar was impacted as we moved deeper into 2019 by the slowing U.S. manufacturing sector. During the first half of 2019, I believe we were in a relatively healthy freight environment. The first half of the year was, by far, Landstar's second-best January through June performance in the company's history, second only to the first half of 2018. Throughout the second half of 2019, however, weaker economic conditions, especially in the U.S. manufacturing sector, led to seasonal softness in Landstar's truckload volumes.
This softness began mostly in September and continued through the end of the 2019 fourth quarter. While first quarter 2019 truckload volumes exceeded the 2018 first quarter by 2%, truck volumes over the next three quarters in 2019 decreased by 1%, 5%, and 7% compared to the 2018 second, third, and fourth quarters, respectively. In spite of these challenging market conditions and very difficult year-over-year comparisons due to Landstar's exceptional 2019 financial results, the Landstar variable cost business model performed relatively well in 2019. Full year 2019 revenue, gross profit, operating income, and diluted earnings per share were each the second-best financial performance in Landstar history, behind only 2018.
Also, in 2019, free cash flow was $288 million, an annual record. During 2019, Landstar purchased over $88 million of its common stock and declared dividends totaling $104 million, $79 million of which was paid in January 2020. Cash and investments grew $113 million during 2019 to over $352 million at fiscal year-end 2019. Focusing on the 2019 fourth quarter, as part of our 2019 third quarter earnings conference call, we provided revenue guidance of $970 million-$1.02 billion, or 14%-18% below the 2018 fourth quarter.
2019 fourth quarter revenue was $995 million, or 16% below the 2018 fourth quarter, at the midpoint of our previously issued revenue guidance. Our revenue guidance anticipated the number of loads hauled via truck to be below the 2018 fourth quarter in a high single-digit percentage range. The actual number of loads hauled via truck in the 2019 fourth quarter was 7% below the 2018 fourth quarter. This 7% decrease in load volume compared to the 2018 fourth quarter was due to a 9% decrease in truckloads hauled via van equipment, and a 4% decrease in truckloads hauled via unsided platform equipment, partially offset by a 3% increase in less-than-truckload volume.
From a sequential viewpoint, while historically we have experienced truckload volumes relatively flat to slightly increasing from the third quarter to the fourth quarter over the past five years, truckload volume in the 2019 fourth quarter was almost 3% below the 2019 third quarter. We believe the sequential weakness can be traced back to the weakness in the U.S. manufacturing sector during the 2019 fourth quarter. Our guidance also anticipated revenue per load to be below the 2018 fourth quarter in a high single-digit % range.
Revenue per load on loads hauled via truck in the 2019 fourth quarter was 9% below the 2018 fourth quarter, consistent with our expectations, and better than the 13% decrease when comparing the 2019 third quarter to the 2018 third quarter. On a monthly basis, revenue per load on loads hauled via truck was 8%, 10%, and 9% lower in October, November, and December of 2019 compared to each corresponding month of 2018. We also provided diluted earnings per share guidance of $1.40-$1.46, or 13%-17% below the 2018 fourth quarter.
2019 fourth quarter diluted earnings per share was $1.27, or 24% below the 2018 fourth quarter. Our diluted earnings per share guidance assumed that insurance and claim costs in the 2019 fourth quarter would approximate 3.6% of BCO revenue, based on the average of insurance and claim costs as a percent of BCO revenue over the preceding five years.... Insurance and claims cost was 5.7% of BCO revenue in the 2018 fourth quarter, well above our 3.6% assumption. Insurance and claims in the 2019 fourth quarter included $7.2 million, or $0.14 per diluted share of unfavorable development of prior year claims.
We believe Landstar is one of the safest operators in the industry, based on our low frequency of accidents. In recent periods, even though our frequency has remained relatively consistent, we've been experiencing elevated insurance and claims costs. The volatility in the cost of claims is driven by the company's high self-insured retention and the unpredictable nature of occurrences and estimating the cost of each occurrence. In recent years, the news in our industry has been filled with stories of unusually large verdicts, and the related challenges faced by motor carriers and their insurers in settling claims. The magnitude of the cost of a single accident will continue to plague not only Landstar, but the entire industry.
As of the 2021 first quarter, we've begun to use a 3-year annual average of insurance and claim costs as a % of BCO revenue, rather than a 5-year average, to estimate quarterly insurance and claim costs for purpose of our quarterly guidance. We believe a shorter look-back period is more appropriate in the current environment. As we look ahead, we believe the first quarter will be the most difficult quarter over prior year quarter comparison of fiscal year 2020. Seasonally, the 2019 first quarter was the strongest quarter of the year. The 2019 first quarter delivered record first quarter gross profit, operating income, and diluted earnings per share.
Subsequent to the 2019 first quarter, the effects of softening demand and more readily available capacity that started in late 2018 began to slow Landstar's revenue and earnings growth. In subsequent quarters, revenue, gross profit, and diluted earnings per share decreased sequentially from the second quarter to the third quarter, and again decreased in the fourth quarter of 2019. Based on recent January trends, we expect truck loadings in the 2020 first quarter to be lower than the 2019 first quarter in a mid-single digit percentage range. With respect to price, beginning in the middle of the second quarter of 2019 and continuing through December, truck revenue per load fluctuated at rates somewhat consistent with historical month-to-month patterns.
Although the current macro environment makes long-term trends somewhat unpredictable, in the near term, we expect this relatively stable pricing trend to continue through the 2020 first quarter. Accordingly, we expect revenue per load in the 2020 first quarter to be below the 2019 first quarter in a mid-single-digit percentage range. This would represent an improvement from the 7% decrease we experienced from the 2018 fourth quarter to the 2019 fourth quarter. Based on those expectations of revenue per load and number of loads hauled via truck, first quarter 2020 revenue guidance calls for $915 million-$965 million, compared to $1,033 million of revenue in the 2019 first quarter.
Our diluted earnings per share guidance calls for diluted earnings per share in a range of $1.10-$1.20, compared to $1.58 in the 2019 first quarter. The decrease in revenue and diluted earnings per share when comparing the 2019 first quarter to the 2020 first quarter guidance, is due to Landstar's record 2019 first quarter results, and the relatively soft macro environment that I expect will continue through the 2020 first quarter. From a sequential perspective, our guidance anticipates a somewhat normal seasonal decrease in revenue and gross profit moving from the 2019 fourth quarter to the 2020 first quarter. Also, keep in mind that typically, other than in 2019, the first quarter of any year is seasonally softer than any other quarter of the year.
With respect to insurance and claims, and our guidance for diluted earnings per share, in early January, a BCO was involved in a tragic accident involving a fatality. Although it is probable this accident will adversely impact the financial results of the company's 2020 first quarter, we're still in the process of investigating that accident and determining a range of ultimate costs. While our evaluation is still preliminary and our investigation continues, the company's pre-tax loss exposure at the time of this accident included our $5 million self-insured retention and up to $3.5 million relating to aggregate losses above our self-insured retention during an annual policy period. As I discussed earlier, our first quarter guidance includes an estimate of insurance and claim costs at 4% of BCO revenue, which is higher than what we have been using in our guidance over the past few years.
Please note, however, that our 2020 first quarter estimate does not include amounts specifically related to an estimate for this tragic accident, and it is highly likely that once all facts are determined, the estimated ultimate cost of this accident will reduce first quarter diluted earnings per share to amounts below the low end of our first quarter guidance. As it relates to the full year, I expect the operating environment through the first half of 2020 to continue to be challenging, with continued softness in U.S. manufacturing and readily available truck capacity. Although it is difficult to predict the economic environment in the back half of 2020, our year-over-year financial comparisons begin to ease starting with the second quarter.
Additionally, with a hardening insurance market, combined with an ongoing soft macro environment that began in late 2018, I expect capacity could tighten later in the year as trucks leave the market. Landstar remains focused on profitable load volume growth and increasing capacity to haul those loads. With our ongoing efforts to invest in and empower our network of small business owners, along with our healthy balance sheet, I believe the company's light asset, varied cost business model is performing relatively well in the current environment. Landstar continues to be confident in our positioning within the transportation and logistics marketplace. We're also well known for returning capital to our stockholders through a combination of stock buybacks and dividends. It is our intent to continue with our historic approach to buy back our stock on the open market on an opportunistic basis.
With that, I will pass it to Kevin.
Kevin Stout (CFO)
... Thanks, Jim. Jim has covered certain information on our 2019 fourth quarter, so I will cover various other fourth quarter financial information included in the press release. Gross profit, defined as revenue less the cost of purchased transportation and commissions to agents, decreased 12% to $148.7 million and represented 14.9% of revenue in the 2019 fourth quarter, compared to $168.9 million or 14.3% of revenue in 2018. The cost of purchased transportation was 76.6% of revenue in the 2019 quarter versus 77.1% in 2018. The decrease in purchased transportation as a percent of revenue was primarily due to an increase in the percentage of revenue contributed by BCO independent contractors and decreased purchased transportation rates paid to truck brokerage carriers.
The rate paid to truck brokerage carriers in the 2019 fourth quarter was 44 basis points lower than the rate paid in the 2018 fourth quarter. Commissions to agents was 8.5% of revenue in the 2019 fourth quarter versus 8.6% in 2018. The decrease in commissions to agents as a percentage of revenue as compared to 2018 was due to reduced commission incentives on BCO revenue, partially offset by increased commission rates on revenue generated by truck brokerage carriers due to an increased net revenue margin, revenue less the cost of purchased transportation divided by revenue on loads hauled by truck brokerage carriers. Other operating costs were $8.7 million in the 2019 fourth quarter, compared to $7.6 million in 2018.
This increase was primarily due to an increased provision for contractor bad debt and increased trailing equipment costs. Insurance and claims costs were $25.1 million in the 2019 fourth quarter, compared to $18 million in 2018. Total insurance and claims costs was 5.7% of BCO revenue in the 2019 period and 3.7% of BCO revenue in the 2018 period. The increase in insurance and claims as compared to 2018 was primarily due to increased unfavorable development of prior year claims. Selling, general, and administrative costs were $38.2 million in the 2019 fourth quarter, compared to $47.3 million in 2018.
The decrease in SG&A costs was mostly attributable to a decrease in the provision for bonuses under the company's incentive compensation plans and a decrease in stock compensation expense, partially offset by increased wages. Stock compensation expense and the provision for incentive compensation were both insignificant in the 2019 fourth quarter. In the 2018 fourth quarter, stock compensation expense was $5.3 million, and the provision for incentive compensation was $4.6 million. Quarterly, SG&A expense as a percent of gross profit decreased from 28% in the prior year to 25.7% in 2019. Depreciation and amortization was $11.4 million in the 2019 fourth quarter, compared to $11.1 million in 2018.
This increase was entirely due to increased depreciation on technology tools, resulting from the recent deployment of new and upgraded applications for use by agents and capacity. Operating income was $66.5 million or 44.7% of gross profit in the 2019 quarter versus $86.1 million or 51% of gross profit in 2018. Operating income decreased 23% year-over-year. The effective income tax rate was 23.8% in the 2019 fourth quarter, compared to 19.8% in 2018. The effective income tax rate was favorably impacted in both periods by resolution of certain tax items and tax benefits resulting from equity compensation arrangements. Looking at our balance sheet, we ended the quarter with cash and short-term investments of $352 million.
Cash flow from operations for 2019 was $308 million, and cash capital expenditures were $19 million. There are currently 3 million shares available for purchase under the company's stock purchase programs. Back to you, Jim.
Jim Gattoni (CEO)
Thanks, Kevin. With that, Eunice, we will open to questions.
Operator (participant)
Thank you very much, sir. At this time, we'll begin the question-and-answer session. If you would like to ask a question, please press star one on your touchtone phone. Once again, that is star one to ask a question. To cancel your request, please press star two. Our first question is from the line of Jack Atkins of Stephens. Your line is now open.
Jack Atkins (Analyst)
Morning. Thanks very much for taking my questions.
Jim Gattoni (CEO)
Sure, Jack.
Jack Atkins (Analyst)
So, Jim, if I could maybe just start with just a little bit of additional commentary on the market and what you're seeing in January. You know, could you maybe comment on how the first, call it, you know, 3, 4 weeks of the month have gone relative to, you know, expectations? And then, you know, when you kind of think about the van side of the business relative to the unsided equipment and the flatbed, are you seeing, you know, one side really performing better than the other? Just trying to get a sense if you're seeing any sort of tightening in the market. I know it's January, so it's hard to draw any conclusions, but would just be curious on any commentary there.
Jim Gattoni (CEO)
... Yeah, but, you know, if you want to talk vans and flatbeds, you know, flats are a little bit softer in January, almost every year, you know, so it's a, that's a difficult comp just for this four-week period that we're sitting in. But, you know, I think when you look at our trends in the first three to four weeks of January, what we're seeing on load volumes plus rates, we're comfortable with what we put out in our guidance. Because what we're seeing is a consistent trend with stability in our pricing, you know, where you see the pricing kind of traveling sequentially from December to January, consistent with what we've seen, in the past.
Actually, it might be a slight. I'm not—I don't want to say it's a lot better, but that trend that we forecasted for the guidance on a rate is slightly better than what you saw on the average of the last four years. And then on the volume, it's a similar situation. You know, our trend is a little bit better than what you'd see from a fourth quarter to third first quarter trend on volumes. So I think our. We believe that what we guided to is really coming off the January results, which, you know, we're seeing some stability in volume and stability in price right now. But it's a sluggish environment.
Jack Atkins (Analyst)
Sure. No, but that's encouraging that you're seeing that stability show up. So I guess kind of thinking through the bridge to the earnings guidance for a moment, you know, when I look at the revenue numbers that you provided for your guidance ranges there, relative to the earnings outlook, it certainly feels like maybe there's some additional costs that are present in the first quarter. Could you, you know, Kevin, could you maybe kind of talk about some of those different cost items? Are, you know, are you seeing some, you know, some pressure on the G&A side, you know, maybe incentive comp is coming back? Could you just kind of walk us through that for a moment?
Kevin Stout (CFO)
Sure, Jack. This is Kevin. Annually, let's just talk annually first. We do expect an increase in the SG&A line, let's say in the range of $19 million-$20 million annually. That is... I split that into two pieces, the first being incentive comp and stock comp, and that's about half of the $19 million-$20 million, okay? Everybody knows about that. The remaining $9 million-$10 million, I would say, is split also evenly between, A, wage increases and inflationary increases. That's about half of the remainder. And the rest, let's say, $4 million-$5 million increase in tech spend. So you know, if you're looking at on a quarterly basis, my SG&A, let's say, run rate $43 million-$44 million. Obviously, depreciation's up a little bit.
I think we were, like, $11.4 in Q4. Your best number there is probably $11.5 million-$12 million for the rest of 2020.
Jack Atkins (Analyst)
Okay. That's, that's great. Thank you for that. And just one quick follow-up on the, on the IT spend, the tech spend. Could you maybe just comment on sort of what sort of projects that's going towards? I mean, do you, do you feel like... It almost feels like an, an arms race on the, on the, you know, tech side within logistics. Do, do you feel like that you're investing enough to sort of keep up with what's happening, you know, on the competitive front there?
Jim Gattoni (CEO)
Absolutely. Nice question. No, if we break down what we're spending on, you know, we were, you know, up until about 5 years ago, we're sitting on an IBM iSeries from the 1980s, right? So there's a little bit of building efficiencies into the organization. When we remember about 2, or maybe 3 or 4 years ago, we announced we're going to roll out a new TMS. We're in the middle of doing that, so there's significant spending on rolling that out, from converting off our legacy systems into a more agile, flexible, better functioning, TMS. On top of that is all the pieces that face out to the customers and the shippers and the, and the carriers, where you have your apps, right? Where in the app world, where we're moving into the cloud, and all the stuff is linked into our iSeries through middleware, right?
So we got spending just to create that infrastructure, to create that plug-and-play atmosphere, the plug-and-play environment, where we, you can take any app you want and plug it into our systems and have it feed the data to any source you want. So there's some spending on there and building up that middleware so that we can create the plug-and-play atmosphere, and that is actually in place as of last year. And that gives us the capability to link in our pricing tool, which was just released over the last year and a half, our new Available Loads mobile app that's in the hands of our carriers today, and our new Maximizer. So it's across the board. But when you think of our model, it's...
We've been sharing information between agents, capacity, and customers since the inception, and we've always used the latest technology. So when you talk about what we do, we weren't that far behind the curve on a lot of what we had to do. You know, pricing was one thing. We didn't really have a good pricing tool. We have one now, so we can push pricing directly out. It's things like that. So we're more... Although technology is not cheap, so we're more tweaking all our applications and creating this environment that's more flexible and agile, where we can plug and play the best tools into our system, you know, in the future, as opposed to having to worry about a legacy iSeries.
Jack Atkins (Analyst)
Okay. That's, that's great to hear. Thanks very much for the time, guys.
Jim Gattoni (CEO)
Sure.
Operator (participant)
Thank you. The next question is from Scott Group of Wolfe Research. Your line is now open.
Scott H. Group (Analyst)
Hey, thanks. Morning, guys.
Jim Gattoni (CEO)
Morning.
Scott H. Group (Analyst)
So I understand sort of feels normal to start the year. There's this view from the TLs, the market is going to tighten, maybe in the second quarter. Do you agree with that?
Jim Gattoni (CEO)
I look at certain things, and I don't see any, as we would call, green shoots or catalysts, that it's going to jump in the second quarter. And I'll tell you why. This is probably, we're sitting in the, in the last 30 years, we're sitting in a manufacturing environment where they're shrinking manufacturing. And when you look at the three or four times it happened, it took anywhere from six to seven quarters to reverse itself. I don't know when this one started. April was negative manufacturing in the U.S., but really started consistently in July. You were negative all the way to now. So if you're counting quarters, you know, I'm somewhere, if it's six quarters, you know, we're toward the end of 2020. So that, that's one side of what I'm saying, right?
So you're looking at that, and I'm looking at what's going to happen in the manufacturing environment, because we're really impacted by U.S. manufacturing, and it's, it's been shrinking since July on a year-over-year. On the other side, you got the trucks, right? So what's going to happen with trucks? And their direction may be coming from the fact that, you know, you're going to see you had lower truck orders last year, so that, that should help reduce the number of trucks in the system. And our thing here is, you know, how is insurance going to impact the trucking industry with what's going on and, and some of these large verdicts we're dealing with?
It's not even the large verdicts, it's some of the even the smaller verdicts where you or settlements, where you look like you thought you had a fender bender, next thing you know, it cost $2 million. What's that going to do to capacity over the next 6, 12 months and renewals in the insurance, you know, in the insurance area? And then when do these small guys have to renew? Does that happen sooner than I see the economy turning? I think it does, but let's- I'm on a wait and see.
Scott H. Group (Analyst)
Okay, so you feel better about supply than demand? I get it.
Jim Gattoni (CEO)
The BCO count that was down a bunch sequentially, what are you seeing so far to start 2020? Do you-
Joe Beacom (Chief Safety and Operations Officer)
Yeah, Scott, this is Joe. What we see is that interest and demand and trucks coming in the door still remains pretty strong. But in January we were off about 20 trucks. We declined about 20, which is not unusual. Excuse me, yeah, in January. Not unusual in the first quarter. Seven of the last 10 years, we've been negative in the first quarter. I wouldn't expect that to change, but hopefully not too much more. And I just think the environment is such that, you know, we had, you know, we lost 356 trucks in 2019, and that's a pretty big number. But I think one way to look at it is we retained 70% of the adds that we created in 2017 and 2018.
We grew 1,160 trucks in 2017 and 2018, and we were able to retain 70% of them in an environment that really switched pretty quickly. I just think you have a small businesses, some that are able to adapt to change quickly, and others less so. Those that didn't adapt and couldn't hang in there are either doing something different or doing it somewhere else. But I think that comes back, but I'll dovetail what Jim said: I don't think it comes back in the first quarter or second quarter of this year. I think here, it's going to be further out than that before the supply-demand dynamic changes, and capacity begins to net grow again.
Scott H. Group (Analyst)
Okay. And then last one, so net operating margin guidance for the first quarter is in that, what, 42%-44% range. Any thoughts on how to think about the rest of the year? And, you know, if we think that revenue inflects positive in the third quarter, can you see earnings inflect positive, too? Or because of some of the cost things, do you think that the earnings inflection takes longer?
Kevin Stout (CFO)
Yeah, Scott, this is Kevin. Obviously, the first quarter is our toughest number when it comes to that margin number. Yes, what you gave is about where we're looking at. Obviously, if demand comes back in Q2, Q3, that will help that number. But again, we do have some other cost pressures out there, like I laid out on the SG&A lines, but it's all about demand and increasing the gross profit number.
Scott H. Group (Analyst)
Okay. Thank you, guys.
Operator (participant)
Thank you. The next question is from the line of Jason Seidel of Cowen and Company. Your line is now open.
Jason Seidel (Analyst)
Thank you, operator. Morning, guys. I want to drill down a little bit on your comments on expected capacity. When I look at your truck brokerage business, your approved and active guys dropped sequentially, about 4, just over 450, and I think year-over-year, you're down over 1,500. Is this the reflection of the capacity that you're seeing coming out of the marketplace? Have you heard why? Is this all higher insurance cost, and do you expect that trend to continue?
Joe Beacom (Chief Safety and Operations Officer)
Yeah, Jason, this is Joe. While you're correct, we dropped about 1,572 carriers year-over-year or through the year. I don't see that necessarily as a reduction of capacity in the marketplace. What I attribute that to largely is the fact that because of the demand environment, we're putting fewer opportunities out on public load boards, and there's fewer reasons for those carriers to remain qualified and keep their insurance up with us in order to haul freight, because there's just not as many loads being transported by a broader base of carriers. So I don't see it as necessarily an exodus yet, but I do see it as as our volume declines, then the number of carriers that are going to be there to haul our volume is going to decline.
If you look at our active count, it's really was down far less, about 1%. And so I think where we have good relationships and where we have business reliant on certain carriers, I think that's pretty much intact. I think it's the other stuff that maybe that overflow or those additional volume that we had a year ago that we don't have today, it's affecting the other carriers who maybe didn't haul much for us. There's no need for them to re-up their insurance and provide it to us and go through that exercise. I think that's kind of what, how I would interpret it at this point.
Jason Seidel (Analyst)
Okay. When I look at some of your end markets, obviously automotive was down a ton. I'm assuming that's all the GM strike. Just wanted to know sort of how that looks now, post the strike and into 1Q.
Rob Brasher (Chief Commercial Officer)
Yeah. So this is Rob, Jason. Automotive, you kind of take a look at from 2018 to 2019.
... Rates came down tremendously. The automotive manufacturers put their pricing out to bid. And quite frankly, our agents didn't chase the price. We didn't chase it downward. We focused more on freight that we could move at profitable levels, and that's kind of where we saw our automotive go. The strike did have an impact in the fourth quarter, but again, I think it was the bid and the rebid of more of the contracted rates moving through the year. And I-
Jason Seidel (Analyst)
Do you guys have any-
Rob Brasher (Chief Commercial Officer)
Go ahead.
Jason Seidel (Analyst)
Do you guys have a financial impact for that strike or no?
Rob Brasher (Chief Commercial Officer)
Only as it relates to negative revenue. We can't really quantify the direct impact of what the drop-off in revenue was related to the strike, but just dropped off.
Jason Seidel (Analyst)
Okay. No, that makes sense. I guess, lastly, looks like the industry got a stay from that California law that's out there. Any thoughts from you guys going forward about that and about that potentially catching on in other states?
Jim Gattoni (CEO)
Yeah, actually, what happened out there was a positive for us. I mean, it was kind of negative for a while, but the fact that they jumped on the federal rules to basically put an injunction in to make sure that California wasn't overruling the pre, you know, overruling what the federal rules are about interstate commerce, that was actually...
Although the legislation coming out of California was negative, the resulting decision coming out of there in January was positive for us with the injunction, and the injunction specifically on the federal side, saying, you know, "You can't put rules in place that kind of overrule what the federal says about interstate commerce." And I think that kind of makes the other states, although they may roll things out, to limit independent contractor work for various other industries within states, they really have to take a close look at the truck transportation industry and how they're going to handle that from an interstate commerce and comply with the federal regs.
Jason Seidel (Analyst)
This pretty much can provide a blanket cover, at least for now, with federal regulations.
Jim Gattoni (CEO)
Yeah.
Jason Seidel (Analyst)
It doesn't really matter that much what the other states put out.
Jim Gattoni (CEO)
Right. The other states should be watching it and make sure that, you know, that they're not going to, you know, conflict with what the federal regs are. And that's kind of... Well, we expect that California's probably going to appeal. We haven't heard anything yet, so we'll see how this plays out over the next couple of years.
Jason Seidel (Analyst)
Sounds fair. Appreciate the time as always, guys.
Operator (participant)
Thank you. The next question is from the line of Todd Fowler of KeyBanc. Your line is now open.
Todd Fowler (Analyst)
Great. Thanks. Good morning.
Jim Gattoni (CEO)
Morning.
Todd Fowler (Analyst)
Hey, Jim. So I wanted to ask on the gross profit margins in the quarter. You know, the 14.9% was up from the 14.3% in the fourth quarter of 2018. But specifically, can you talk about what you're seeing on gross margins with respect to brokerage loads? And obviously, the questions related to, you know, some of the pure transactional brokers are seeing some more pressure there. I'm curious kind of what your experience is and what you're seeing and kind of any impacts in the marketplace from a competition standpoint.
Kevin Stout (CFO)
Hey, Todd, this is Kevin. The buy rate on the brokerage, as we move throughout the year in 2019, is 177 basis points better in Q1, 168 better in Q2, 116 better in Q3, and then in Q4, it's only 44 basis points. So I don't know if I would characterize that as tightening, but we're definitely paying the broker carrier more. My best guess right now for Q1, and this, you know, it obviously depends a lot on mix and how much is BCO and how much brokerage comes back.
Todd Fowler (Analyst)
Mm-hmm.
Kevin Stout (CFO)
But, I would use 14.9%-15.2% as your gross profit margin range for Q1. Did that answer your question?
Todd Fowler (Analyst)
Yeah. And I guess, Kevin, just to follow up, I mean, so with what you're seeing just on the, on the brokerage piece, it sounds like that you're still within the range of what you've experienced historically. You're not seeing anything that's, that's unusual from, from a brokerage margin standpoint?
Kevin Stout (CFO)
No. No.
Todd Fowler (Analyst)
Okay.
Jim Gattoni (CEO)
And I think-
Kevin Stout (CFO)
Go ahead.
Jim Gattoni (CEO)
I think, Kevin, that it's true that the reason it was decelerating, that the basis point pickup in the fourth quarter is 'cause the deceleration started in the eight, it-
Kevin Stout (CFO)
That's-
Jim Gattoni (CEO)
The top got a little bit tougher, right?
Kevin Stout (CFO)
That's correct.
Jim Gattoni (CEO)
Not necessarily because it's, we're not tightening, we're just seeing a comp that got a little tougher, not a tightening in the fourth quarter.
Kevin Stout (CFO)
That is correct.
Jim Gattoni (CEO)
Yeah.
Todd Fowler (Analyst)
Okay, good. That helps. And then, you know, just on the insurance piece, you know, and I understand shifting to that three-year versus the five-year, and it looks like there's going to be some impact from that. As you think about, you know, that rolling forward into 2021 or beyond, you know, if insurance costs are going up, it feels like that's going to be, you know, an incremental cost pressure for the business. Is there anything that you can do to mitigate that cost? Is it something that, you know, you can work with either, you know, how you're approving and qualifying BCOs?
Is it something, you know, I don't know, on the rate side, but how do you think about kind of mitigating that, the incremental insurance, you know, cost that you could have, just based on the trends going forward?
Jim Gattoni (CEO)
Well, one thing that's difficult for an organization like ours when you're running independent contractors is you can't enforce certain safety rules or safety equipment that would otherwise benefit them and the organization, right? So, we rely on them to buy the safe equipment. We make sure that they get their equipment inspected. We do believe we have the best safety programs in the industry right now, and our qualification standards are really high already. So from that perspective, we believe we do everything we can right now to remain safe. And I'm not sure it's necessarily, you know, it's how do we reduce the accident or frequency of accidents, which are, like I said, already pretty low from an industry standpoint.
It's those one or two accidents that's just gonna pop on you, that you know, it's hard to determine when that's gonna happen and which truck's gonna have it. It could be a guy with 40 years experience, it could be a guy with two years experience. So trying to get our hands around how to, you know, limit the exposure to what's going on in the insurance market has, I'll admit, has been a little bit of a challenge over the last couple of years. You know, we got our eyes on it. We're trying to figure out what we can do to the equipment without, you know, stepping over the independent contractor line, and there's more to come on that.
As you know, or if you didn't know, you know, we used to be able to insure our, our losses over our $5 million self-insured, our $5-$10 million layer. That used to be a per occurrence coverage. So every time there was an accident, we were covered for everyone within the policy period. The insurance companies took that away last year, so that's why we're seeing a little bit of an uptick as it relates to cost from the $5-$10 layer. So I think that's where you're seeing some of the pressure coming from. And the industry and the, when you're turning fender benders into $1 million accidents, it's hard to figure out how that gets controlled other than by trucks are gonna shrink.
I mean, the market we're sitting in, eventually, capacity is gonna shrink, and it'll drive rates up, and maybe you get it through the revenue line.
Todd Fowler (Analyst)
Okay.
Rob Brasher (Chief Commercial Officer)
Yeah, no, Jim, all that makes sense. I mean, those are good thoughts, and I'd have to think that you guys are better positioned than most, but it does, definitely does feel like a pressure, you know, here in the, in the interim, until there's kind of a, a solution to the cost side of the problem.
Jim Gattoni (CEO)
Right.
Todd Fowler (Analyst)
Okay. Thanks for the time this morning.
Jim Gattoni (CEO)
Yep.
Operator (participant)
Thank you. We have five more questions in queue, and our next question is from the line of Bascom Majors of Susquehanna. Your line is now open.
Bascom Majors (Analyst)
Yeah, thanks for taking my questions here. You, Kevin, I don't want to beat a dead horse on the cost, but even after the pretty detailed explanation you gave, it feels like there might be, you know, some more baked into the SG&A or other operating spend for the first quarter, just based on getting to the guidance from the bottom subcomponents. Can we do this, maybe, you know, walk forward, you know, item by item, 4Q to 1Q or year-over-year? I just... I think it would be helpful to understand, you know, kind of a little more precisely how we're getting from A to B.
Kevin Stout (CFO)
Sure, sure. Let's just say at the midpoint for Q1, we'll start with gross profit. Probably, given the range, you know, $149 million-$152 million, we're looking at, and the decline in revenue, you're looking at probably $7 million-$8 million decline sequentially from Q4 to Q1. That flows down to the operating income line, because once you get underneath that, you're gonna have slightly higher other operating, let's say, to the tune of about $1 million. But you're gonna have a pickup on insurance of about $8 million. That's assuming, you know, 4% of our BCO revenue in Q4 versus the $25 million that we had, excuse me, in Q1 versus the $25 million we had in Q4.
And then SG&A, let's say an increase of $4 million-$5 million, and then depreciation, that's, you know, we're probably looking at $11.5 million-$12 million on a quarterly basis going forward. So that's gonna be a slight decline as well. So those items underneath gross profit pretty much net to each other, and then you get the gross profit flow through the decline down to operating income.
Bascom Majors (Analyst)
Yeah, thanks, thanks for all that. I really appreciate that walk through. The, you know, the one piece, just the SG&A sequential increase, you know, typically from Q4 to Q1, that's down $1-$3 million, and that $4-$5 million increase is just kind of way out of line with history, even considering that incentive comp needs to come back this year. I mean, on the tech spend, maybe if we could just focus on that piece of it, because that's, I think that's what people are trying to get their arms around. You know, the reasons, Jim, you gave for elevated tech spend weren't that different than a lot of stuff you guys have been talking about for three years now.
You know, what does the incremental 2020 step-up look like on the ground? And is that, you know, some sort of temporal project-related spend, or is that more of a structural increase? Thanks.
Jim Gattoni (CEO)
No, I think from the tech spend coming from the fourth quarter to the first quarter, I mean, the wages might be up slightly. I mean, it's not there. So it's at. It's not the tech. It's, I mean, when you're going from. If you look at here's the thing about history. In bonus years, and we have a good bonus year, we're playing catch up in SG&A because, you know, the first quarter, we're. We'd love to have your bonuses paid equally booked throughout the year, right? At the end of the first quarter, we're saying, "We're gonna have $8 million of bonuses," you put up $2 million. In the second quarter, year's looking better, we're gonna have $12 million, then you put up half.
Then by the time you get to the fourth quarter, a lot of times when we have a big bonus year, there's a lot of bonuses in that fourth quarter, and you see a more significant drop-off because of that. It's the equity program, and it's a true-up in the bonuses that happen in the fourth quarter that create that look like I went from fourth quarter of I had $48 million, and now the first quarter is only $40. That trend always seems to make sense, and a lot of it has to do with the equity comp and the incentive comp.
Bascom Majors (Analyst)
Okay, that's, that helps, that helps quite a bit.
Jim Gattoni (CEO)
Yeah, I think what I'm saying is, when you look at the historical trends, it's a little difficult due to the way the incentive comp piles up during the year, and we play catch up a lot. As the year grows, we got to keep catching up to the accrual. So you could have a pretty big number in the fourth quarter of ICP for the catch-up, and then zero in, like, some years, if we're sitting at the end of the first quarter, the year doesn't look good, it goes to zero. And that could create that huge historical spread between Q4 and Q1, where now we're not really necessarily looking at, because we didn't really have bonuses in the fourth quarter this year.
Bascom Majors (Analyst)
Okay, last one, the buyback. How are you feeling about the stock here? You know, and what's the thought after paying the special dividend as the use of capital last year?
Jim Gattoni (CEO)
... Well, I would based on what I saw in the after hours, I think people would know how we're going to react on the, on the purchases. The board, you know, I think we're prepared. The board was willing to up the available shares under the plans from I think we were sitting on 1.2 million, we now have 3 million available. I don't think our philosophy has changed, and I think this is the cycle where you might see some activity on the buybacks.
Bascom Majors (Analyst)
Thank you.
Operator (participant)
Thank you. The next question is from the line of Scott Schneeberger of Oppenheimer. Your line is now open.
Danny DeFerrari (Analyst)
Good morning, it's Danny on for Scott. Can you guys elaborate a little bit on the visibility within the consumer durables vertical, what you're seeing presently and what we could expect there going forward?
Jim Gattoni (CEO)
You know, that's very difficult because it's we, you know, we don't have any customers over 3% of our business, and consumer durables is our largest category, but the top 25 customers only makes up about 30% of that category. So drilling it down on a mid-month basis is kind of, kind of tough for us. When you, when you look at where we were in the fourth quarter on that specific commodity or, or sector, you know, it's, it's hard to draw conclusions, but if you're just looking at our charts and where the numbers fell off on consumer durables.
I believe we said that in the quarter, consumer durables was down 15%, you know, and if I pull it apart a little further, consumer durables, you know, everybody's talking about that the consumer market's a little bit stronger than the manufacturing sector, and yeah, we believe that, and we can see it in our numbers. I mean, we tie it into the manufacturing sector. But when you break down the consumer durables, being 15% down in revenue quarter-over-quarter, fourth quarter 2019 from fourth quarter 2018, the mix there was actually, we're only down 4% in volume, and most of it was rate. So it actually did a little better than the organization. So that's how we can look at it, because it is such a diversified portfolio of customers within there, and that's what we got.
And I would expect that's probably continuing into the first couple of weeks in January.
Danny DeFerrari (Analyst)
Got it. That's helpful. Thank you. Free cash flow in 2020, how do you guys think about that, please? Thank you.
Scott H. Group (Analyst)
I'll put out an early conservative estimate of, let's say, $175 million-$225 million. And obviously, once we get to Q2, I'll have a better feel for that. But, let's just pinpoint $200 million as a midpoint.
Danny DeFerrari (Analyst)
Got it. Thank you. I'll turn it over. Thanks so much.
Operator (participant)
Thank you. The next question is from the line of Stephanie Benjamin of SunTrust Robinson Humphrey. Your line is now open.
Stephanie Benjamin (Analyst)
Hi, good morning. Thank you for the question.
Jim Gattoni (CEO)
Sure.
Stephanie Benjamin (Analyst)
I was hoping you could talk a little bit about the volumes related to your drop-and-hook business, just kind of what you saw during the fourth quarter as it related to the prior year, and then how that business is really holding up to start 2020. Thanks.
Joe Beacom (Chief Safety and Operations Officer)
Yeah, Stephanie, this is Joe. We saw the drop-and-hook piece, about 34% of our business in the quarter was on company trailer. That's largely drop and hook, and that's pretty consistent with full year and pretty consistent with prior year. So what, you know, we see that continuing to be a vital part of the service offering, and BCOs are a large part of that service offering in the drop and hook. And as that count goes, so does the number of trailers that we can place at customers. And it's really, like it is in other aspects, that's kind of a demand thing.
So as demand grows, you know, clearly, if capacity grows and demand grows, we'll put more trailers into those customers and into the fleet to grow that segment. But right now we're, you know, we're kind of on a percentage of volume standpoint, it's pretty consistent in the quarter to the year and the prior year.
Stephanie Benjamin (Analyst)
Great. Thanks so much.
Operator (participant)
Thank you. The next question is from the line of Ben Hartford of Baird. Your line is now open.
Ben Hartford (Analyst)
Hey, thanks for getting me in. Kevin, maybe just a higher level perspective, you've got some expenses here, obviously from an insurance claim perspective, but also as it relates to tech. As you think about the model, and that 50% EBIT margin as a percent of net revenue that's been thrown out in the past, you did that early in 2019, and then it's moved lower. Has anything fundamentally changed to the model here with the layering of cost to prevent that? Or is this just simply a cycle and an overall net revenue issue, and as that comes back, then that kind of natural incremental margin comes back and the march to 50 and beyond should resume? Can you talk a little bit about the profile of the model in aggregate and whether that's changed here?
Kevin Stout (CFO)
Yeah, Ben, I don't see that that's changed at all. This is, from my perspective, it's all about growth and the gross profit. There aren't a lot of levers underneath gross profit that we can pull. We do have some increase in spend, but that, theoretically, that's going to drive higher gross profit, right, down the road. So no, I haven't seen. I don't see it as any change structurally, and 50%, you know, when we put that out, that was always about... We said that was net of the incremental, temporary tech spend, right? And that's the way we look at it. 50%, that's definitely where we should be, but it's all about gross profit growth.
Ben Hartford (Analyst)
And then, Jim, in the context of AB5 and, you know, understanding the injunction there helped for the time being, but we're seeing movement in New Jersey, and we'll see elsewhere whether other states go forward with it. But have you seen enough with California? I know you guys took some actions late in the year... to protect yourself against that legislation, potentially coming on board. But regardless of that preliminary injunction in California, have you seen enough to be concerned about kind of the state of how independent contractors are going to be viewed broadly over the next several years, to think about potentially changing the manner in which you guys conduct business?
Jim Gattoni (CEO)
Well, it's always a conversation, and it wasn't just AB5. I mean, if you look at our 10-K, you know, we've had that risk factor in there since we've first issued our 10-K, I think, in 1993. So there's always a mindset around here of the things we can do to stay further and further from the line, regardless whether it's the federal or the state level. So it's kind of always on the, you know, it's always on our radar to pay attention to it. And with AB5, did we sit back and look and are there ways to maybe just change this model? Not that rapidly. When they came out with that, it, you know, we didn't have enough time to come up with any ideas or plans to get out.
It was such a strict rule. It was almost impossible to get out of it. I mean, we had attorneys and everybody looking at stuff, and you had about three or four months to react to it. Our best response was to have the guys either move out of California, don't haul freight in California, or haul on their own. Yes, that is not the best answer, but we are watching what's going on in the rest of the country and are working up other ideas of, you know, how you make slight shifts to the model to avoid any of these state regulations, if possible.
Ben Hartford (Analyst)
Are you doing anything similar in New Jersey at the moment?
Jim Gattoni (CEO)
No, we are not. We are not as exposed with the number of drivers we have there as we were in California. We're kind of just sitting back and waiting to see what's going to happen in Jersey. I would think they're paying attention to the California rule, and they're going to implement it, but that prong B probably not, might not be as strong as it was out in California to allow for trucking companies to continue to operate in interstate commerce.
Ben Hartford (Analyst)
Yeah, I agree. Okay. Kevin, did you provide a CapEx number for 2020?
Kevin Stout (CFO)
That's going to be this year, our cash cap spend was about $19 million. I'm guessing $15-$20 million again this year.
Ben Hartford (Analyst)
Okay, great. Thanks for the time, guys.
Kevin Stout (CFO)
Great.
Operator (participant)
Thank you. Our final question is from the line of Barry Haimes of Sage Asset Management. Your line is now open.
Barry Haimes (Analyst)
Good morning. Thank you. Had two questions. One, back on the insurance issue for a moment, and, you know, appreciate going from five years to three-year look back, makes sense. But, is that enough? Or in other words, was the severity in 2019 per incident, let's say, a lot higher than 2017 and 2018, you know, such that the three-year look back might even still be understating? So, you know, just curious how you think about that. And then I have one other one afterwards, unrelated.
Jim Gattoni (CEO)
We look at it various different ways. We look at it the cost per truck, which is pretty, a pretty good indicator, and I would say that that 2019 was just a bad year. But I would say the conditions of the industry hasn't really changed just in that one year. I think it started earlier than that, so I think that's why the basis of the three years. And when you look at an insurance cost per average truck for the year, relatively consistent over the three-year period. You know, if you go back a little further, it's probably a little lighter on the cost per truck. So that's how we look at that. So I think the three years, that's how we came up with three. I think using anything less than three is a little bit...
We could still have a year that's, you know, 2%, I believe, you know, if we just be safe, and we don't have any of these big occurrences. But right now, it looks like the trend is more, you know, that 3.5%-4.5% range, we stick with 4.
Barry Haimes (Analyst)
Got it. Thanks. Thanks for the color on that. And then had a question related to end markets, particularly within flatbed. If you look at the fourth quarter and through January, are you seeing any changes up or down? So, you know, if you look at, you know, steel versus moving machinery versus oil patch or what have you, just curious if you're seeing any changes in the last 3 or 4 months. Thanks.
Rob Brasher (Chief Commercial Officer)
Barry, this is Rob. It's really hard to kind of predict that far out. I mean, what we do in the flatbed market, I mean, we tend to think of it as it's a little harder entry space, so we feel pretty good about our position in it. We've got great partners in wind, ag, power generation, and civil infrastructure, to name a few. We feel pretty flat coming through the first quarter, rate-wise. Not a great deal of growth, but again, it kind of depends on where we're at capacity-wise in manufacturing going forward.
Barry Haimes (Analyst)
Yeah, but my question is looking backwards, not forwards. In other words, over the last three or four months, have you seen any of those end markets, either move materially up in terms of freight volume or materially down? Just looking for the change. Thanks.
Rob Brasher (Chief Commercial Officer)
No. We've seen no big swings one way or the other, looking back.
Jim Gattoni (CEO)
January is a tough indicator because it's usually soft. January, there's always flatbed's typically soft.
Barry Haimes (Analyst)
Okay, thanks a lot. Appreciate it.
Operator (participant)
Thank you. At this point, we don't have any more questions in queue.
Jim Gattoni (CEO)
Well, thank you, Eunice, and I honestly will tell you, I can't wait to get through this first quarter. I think it'll be our most challenging quarter of the year. And thank you, and I look forward to speaking with you again on our 2021 first quarter earnings conference call, currently scheduled for April twenty-third. Have a good day.
Operator (participant)
Thank you for joining the conference call today. Have a good afternoon. Please disconnect your lines at this time.