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FEDERAL EXPRESS CORP - 10-Q - Management's Discussion and Analysis of Results of Operations and Financial Condition(Edgar Glimpses Via Acquire Media NewsEdge) GENERAL The following Management's Discussion and Analysis of Results of Operations and Financial Condition, which describes the principal factors affecting the results of operations and financial condition of Federal Express Corporation ("FedEx Express"), is abbreviated pursuant to General Instruction H(2)(a) of Form 10-Q. This discussion should be read in conjunction with the accompanying quarterly unaudited condensed consolidated financial statements and our Annual Report on Form 10-K for the year ended May 31, 2014 ("Annual Report"). Our Annual Report includes additional information about our significant accounting policies, practices and the transactions that underlie our financial results. For additional information, including a discussion of outlook, liquidity, capital resources, contractual cash obligations and critical accounting estimates, see the Quarterly Report on Form 10-Q of our parent, FedEx Corporation ("FedEx"), for the quarter ended August 31, 2014. We are the world's largest express transportation company. Our sister company FedEx Corporate Services, Inc. ("FedEx Services") provides us and our other sister companies, including FedEx Ground Package System, Inc. ("FedEx Ground"), with sales, marketing, information technology, communications and certain back-office support, as well as retail access for our customers through FedEx Office and Print Services, Inc. ("FedEx Office") and customer service, technical support and billing and collection services through FedEx TechConnect, Inc. The operating expenses line item "Intercompany charges" on the financial summary represents an allocation that primarily includes salaries and benefits, depreciation and other costs for the sales, marketing, information technology and customer service support provided to us by FedEx Services and FedEx Office's net operating costs. These costs are allocated based on metrics such as relative revenues or estimated services provided. For the international regions of FedEx Express, similar functions are performed on a regional basis by FedEx Express and reported in expense line items outside of intercompany charges. "Intercompany charges" also includes allocated charges from our parent for management fees related to services received for general corporate oversight, including executive officers and certain legal and finance functions. We believe the total amounts allocated approximate the net cost of providing these functions. FedEx allocation methodologies are refined as necessary to reflect changes in our business. The key indicators necessary to understand our operating results include: • the overall customer demand for our various services based on macro-economic factors and the global economy; • the volume of shipments transported through our network, as measured by our average daily volume and shipment weight; • the mix of services purchased by our customers; • the prices we obtain for our services, as measured by yield (revenue per package or pound); • our ability to manage our cost structure (capital expenditures and operating expenses) to match shifting volume levels; and • the timing and amount of fluctuations in fuel prices and our ability to offset these fluctuations through our fuel surcharges. The majority of our operating expenses are directly impacted by revenue and volume levels. Accordingly, we expect these operating expenses to fluctuate on a year-over-year basis consistent with the change in revenues and volumes. Therefore, the discussion of operating expense captions focuses on the key drivers and trends impacting expenses other than changes in revenues and volume. The line item "Other operating expenses" predominantly includes costs associated with outside service contracts (such as security, facility services and cargo handling), professional fees, uniforms, utilities and insurance. -15--------------------------------------------------------------------------------- Table of Contents Except as otherwise specified, references to years indicate our fiscal year ending May 31, 2015 or ended May 31 of the year referenced and comparisons are to the corresponding period of the prior year. -16--------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS FedEx Express offers a wide range of U.S. domestic and international shipping services for delivery of packages and freight including priority services, which provide time-definite delivery within one, two or three business days worldwide, and deferred or economy services, which provide time-definite delivery within five business days worldwide. The following table compares revenues, operating expenses, operating expenses as a percent of revenue, operating income and operating margin (dollars in millions) for the three-month periods ended August 31: Percent 2014 2013 Change Revenues: Package: U.S. overnight box $ 1,682 $ 1,584 6 U.S. overnight envelope 415 419 (1 ) U.S. deferred 795 729 9 Total U.S. domestic package revenue 2,892 2,732 6 International priority 1,630 1,576 3 International economy 571 532 7 Total international export package revenue 2,201 2,108 4 International domestic(1) 371 345 8 Total package revenue 5,464 5,185 5 Freight: U.S. 579 624 (7 ) International priority 395 388 2 International airfreight 46 54 (15 ) Total freight revenue 1,020 1,066 (4 ) Percent of Revenue Other 100 95 5 2014 2013 Total revenues 6,584 6,346 4 100.0 % 100.0 % Operating expenses: Salaries and employee benefits 2,401 2,360 2 36.5 37.2 Purchased transportation 457 430 6 7.0 6.8 Rentals and landing fees 419 414 1 6.4 6.5 Depreciation and amortization 371 366 1 5.6 5.8 Fuel 970 956 1 14.7 15.1 Maintenance and repairs 377 306 23 5.7 4.8 Intercompany charges 476 489 (3 ) 7.2 7.7 Other 786 795 (1 ) 11.9 12.5 Total operating expenses 6,257 6,116 2 95.0 % 96.4 % Operating income $ 327 $ 230 42 Operating margin 5.0 % 3.6 % 140 bp Other income (expense): Interest, net 3 7 NM Other, net (32 ) (21 ) NM (29 ) (14 ) NM Income before income taxes 298 216 38 Provision for income taxes 103 70 47 Net income $ 195 $ 146 34 (1) International domestic revenues represent our international intra-country express operations. -17- -------------------------------------------------------------------------------- Table of Contents The following table compares selected statistics (in thousands, except yield amounts) for the three-month periods ended August 31: Percent 2014 2013 Change Package Statistics Average daily package volume (ADV): U.S. overnight box 1,211 1,112 9 U.S. overnight envelope 527 563 (6 ) U.S. deferred 846 790 7 Total U.S. domestic ADV 2,584 2,465 5 International priority 409 406 1 International economy 170 165 3 Total international export ADV 579 571 1 International domestic(1) 816 789 3 Total ADV 3,979 3,825 4 Revenue per package (yield): U.S. overnight box $ 21.69 $ 22.27 (3 ) U.S. overnight envelope 12.32 11.61 6 U.S. deferred 14.68 14.42 2 U.S. domestic composite 17.49 17.32 1 International priority 62.19 60.65 3 International economy 52.60 50.41 4 International export composite 59.38 57.70 3 International domestic(1) 7.10 6.84 4 Composite package yield 21.46 21.18 1 Freight Statistics Average daily freight pounds: U.S. 7,318 7,423 (1 ) International priority 2,792 2,862 (2 ) International airfreight 670 850 (21 ) Total average daily freight pounds 10,780 11,135 (3 ) Revenue per pound (yield): U.S. $ 1.24 $ 1.31 (5 ) International priority 2.21 2.12 4 International airfreight 1.07 0.99 8 Composite freight yield 1.48 1.50 (1 ) (1) International domestic statistics represent our international intra-country express operations. Revenues Our revenues increased 4% in the first quarter of 2015 due to revenue growth in our U.S. and international export package business, partially offset by lower freight revenue. U.S. domestic volumes increased 5% in the first quarter of 2015 driven by both our overnight and deferred service offerings. International economy yields increased 4% in the first quarter of 2015 primarily due to higher rates, the impact of changes in service mix and higher fuel surcharges. International priority yields increased 3% in the first quarter of 2015 due to higher fuel surcharges and weight per package, while international priority volumes increased 1%. U.S. domestic package yields increased 1% primarily due to higher fuel surcharges, changes in service mix and higher rates. Freight yields decreased 1% in the first quarter of 2015 due to lower fuel surcharges and lower rates. Freight pounds decreased 3% primarily due to capacity reductions. -18--------------------------------------------------------------------------------- Table of Contents Operating Income Our operating income increased by 42% and operating margin increased by 140 basis points in the first quarter of 2015, driven by revenue growth in our U.S. and international export package business, partially offset by higher maintenance expense and lower freight revenues. In the first quarter of 2015, maintenance and repairs expense increased 23% due to the timing of aircraft engine maintenance events. Salaries and employee benefits increased 2% in the first quarter of 2015 due to additional staffing to support volume growth, partially offset by lower pension expense and the benefits from our voluntary employee severance program. Purchased transportation costs increased 6% due to higher utilization of third-party transportation providers. Fuel Fuel expense increased 1% in the first quarter of 2015 due to higher aircraft fuel prices and usage. However, fuel prices represent only one component of the two factors we consider meaningful in understanding the impact of fuel on our business. Consideration must also be given to the fuel surcharge revenue we collect. Because our fuel surcharges are indexed and intended to offset fuel price fluctuations in the pricing of our services, we believe discussion of the net impact of fuel on our results, which is a comparison of the year-over-year change in these two factors, is important to understand the impact of fuel on our business. In order to provide information about the impact of fuel surcharges on the trend in revenue and yield growth, we have included the comparative weighted-average fuel surcharge percentages in effect for the first quarter of 2015 and 2014 below. The index used to determine our fuel surcharges incorporates a timing lag of approximately six to eight weeks before they are adjusted for changes in fuel prices. For example, the fuel surcharge index in effect in June 2014 was set based on April 2014 fuel prices. In addition, our fuel surcharge index allows fuel prices to fluctuate approximately 2% before an adjustment to the fuel surcharge occurs. Because we purchase fuel on a daily basis at market prices, our operating results may be affected should the market price of fuel suddenly change by a significant amount or change by amounts that do not result in an adjustment in our fuel surcharges. Historically, our fuel surcharges have largely offset fluctuations in fuel prices over time; however the delay in the adjustments to our fuel surcharges can significantly affect our earnings either positively or negatively in the short-term. The net impact of fuel had a minimal benefit to operating income in the first quarter of 2015. This was driven by increased fuel surcharge revenue during the first quarter of 2015 versus prior year, which slightly outpaced the year-over-year increase in fuel prices during the quarter. The net impact of fuel on our operating results does not consider the effects that fuel surcharge levels may have on our business, including changes in demand and shifts in the mix of services purchased by our customers. While fluctuations in fuel surcharge percentages can be significant from period to period, fuel surcharges represent one of the many individual components of our pricing structure that impact our overall revenue and yield. Additional components include the mix of services sold, the base price and extra service charges we obtain for these services and the level of pricing discounts offered. Our fuel surcharges are indexed to the spot price for jet fuel. Using this index, the U.S. domestic and outbound fuel surcharge percentages and the international fuel surcharge percentages ranged as follows for the three-month periods ended August 31: 2014 2013 U.S. Domestic and Outbound Fuel Surcharge: Low 9.50 % 8.00 % High 9.50 9.00 Weighted-average 9.50 8.50 International Fuel Surcharges: Low 13.50 12.00 High 18.00 17.00 Weighted-average 16.26 15.36 On September 16, 2014, we announced a 4.9% average list price increase for our U.S. domestic, U.S. export and U.S. import services effective January 5, 2015. In January 2014, we implemented a 3.9% average list price increase for our U.S. domestic, U.S. export and U.S. import services. Other Income and Expense and Income Taxes Other expense increased during the first quarter of 2015 primarily due to higher management fees from FedEx. Our effective tax rate was 34.4% for the first quarter of 2015 and 32.4% for the first quarter of 2014. Our effective tax rate in the first quarter of 2014 was positively impacted by a discrete tax benefit related to the expiration of applicable statute of limitations. For 2015, we expect an effective tax rate between 34.0% and 35.0%. The actual rate, however, will depend on a number of factors, including the amount and source of operating income. We are subject to taxation in the United States and various U.S. state, local and foreign jurisdictions. Substantially all U.S. federal income tax matters through fiscal year 2011 are concluded, and we are currently under examination by the Internal Revenue Service for the 2012 and 2013 tax years. It is reasonably possible that certain income tax return proceedings will be completed during the next 12 months and could result in a change in our balance of unrecognized tax benefits. The expected impact of any changes would not be material to our consolidated financial statements. As of August 31, 2014, there were no material changes to our liabilities for unrecognized tax benefits from May 31, 2014. RECENT ACCOUNTING GUIDANCE New accounting rules and disclosure requirements can significantly impact our reported results and the comparability of our financial statements. These matters are described in our Annual Report. We believe that no other new accounting guidance was adopted or issued during the first three months of 2015 that is relevant to the readers of our financial statements. However, there are numerous new proposals under development which, if and when enacted, may have a significant impact on our financial reporting, as described in our Annual Report. -19--------------------------------------------------------------------------------- Table of Contents FORWARD-LOOKING STATEMENTS Certain statements in this report are "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to our financial condition, results of operations, cash flows, plans, objectives, future performance and business. Forward-looking statements include those preceded by, followed by or that include the words "may," "could," "would," "should," "believes," "expects," "anticipates," "plans," "estimates," "targets," "projects," "intends" or similar expressions. These forward-looking statements involve risks and uncertainties. Actual results may differ materially from those contemplated (expressed or implied) by such forward-looking statements, because of, among other things, potential risks and uncertainties, such as: • economic conditions in the global markets in which we operate; • significant changes in the volumes of shipments transported through our networks, customer demand for our various services or the prices we obtain for our services; • damage to our reputation or loss of brand equity; • disruptions to the Internet or our technology infrastructure, including those impacting our computer systems and Web site, which can adversely affect our operations and reputation among customers; • the price and availability of jet and vehicle fuel; • our ability to manage our cost structure for capital expenditures and operating expenses, and match it to shifting and future customer volume levels; • the impact of intense competition on our ability to maintain or increase our prices (including our fuel surcharges in response to fluctuating fuel price) or to maintain or grow our market share; • our ability to effectively operate, integrate, leverage and grow acquired businesses, and to continue to support the value we allocate to these acquired businesses, including their goodwill; • our ability to maintain good relationships with our employees and prevent attempts by labor organizations to organize groups of our employees, which could significantly increase our operating costs and reduce our operational flexibility; • our ability to execute on our profit improvement programs; • the impact of any international conflicts or terrorist activities on the United States and global economies in general, the transportation industry or us in particular, and what effects these events will have on our costs or the demand for our services; • any impacts on our businesses resulting from new domestic or international government laws and regulation, including regulatory actions affecting global aviation or other transportation rights, increased air cargo and other security or safety -20- -------------------------------------------------------------------------------- Table of Contents requirements, and tax, accounting, trade (such as protectionist measures enacted in response to weak economic conditions), labor (such as card-check legislation or changes to the Railway Labor Act affecting our employees), environmental (such as global climate change legislation) or postal rules; • adverse weather conditions or localized natural disasters in key geographic areas, such as earthquakes, volcanoes, and hurricanes, which can disrupt our electrical service, damage our property, disrupt our operations, increase our fuel costs and adversely affect our shipment levels; • any impact on our business from disruptions or modifications in service by the United States Postal Service ("USPS"), which is a significant customer and vendor of ours, as a consequence of the USPS's current financial difficulties or any resulting structural changes to its operations, network, service offerings or pricing; • increasing costs, the volatility of costs and funding requirements and other legal mandates for employee benefits, especially pension and healthcare benefits; • the increasing costs of compliance with federal, state and foreign governmental agency mandates (including the Foreign Corrupt Practices Act and the U.K. Bribery Act) and defending against inappropriate or unjustified enforcement or other actions by such agencies; • changes in foreign currency exchange rates, especially in the Chinese yuan, euro, Brazilian real, British pound and the Canadian dollar, which can affect our sales levels and foreign currency sales prices; • market acceptance of our new service and growth initiatives; • any liability resulting from and the costs of defending against class-action litigation, such as wage-and-hour and discrimination and retaliation claims, and any other legal or governmental proceedings; • the outcome of future negotiations to reach new collective bargaining agreements - including with the union that represents our pilots (the current pilot contract became amendable in March 2013, and the parties are currently in negotiations); • the impact of technology developments on our operations and on demand for our services, and our ability to continue to identify and eliminate unnecessary information technology redundancy and complexity throughout the organization; • governmental underinvestment in transportation infrastructure, which could increase our costs and adversely impact our service levels due to traffic congestion or sub-optimal routing of our vehicles and aircraft; • widespread outbreak of an illness or any other communicable disease, or any other public health crisis; • availability of financing on terms acceptable to FedEx and FedEx's ability to maintain its current credit ratings, especially given the capital intensity of our operations; and • other risks and uncertainties you can find in FedEx's press releases and Securities and Exchange Commission filings, including the risk factors identified under the heading "Risk Factors" in "Management's Discussion and Analysis of Results of Operations and Financial Condition" in our Annual Report, as updated by our quarterly reports on Form 10-Q. As a result of these and other factors, no assurance can be given as to our future results and achievements. Accordingly, a forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur. You should not place undue reliance on forward-looking statements, which speak only as of the date of this report. We are under no obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise. -21--------------------------------------------------------------------------------- Table of Contents |