FedEx Corporation — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and six months ended November 30, 2016, the second quarter and first half of fiscal 2017. FedEx provides express, ground and freight transportation and related services. TNT Express, acquired May 25, 2016, is included in results; its addition significantly affects year-over-year comparability. Dollar amounts are in millions unless noted.
Financial performance
| Metric | Three months 2016 | Three months 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $14,931 | $12,453 | $29,594 | $24,732 |
| Operating income | $1,167 | $1,137 | $2,431 | $2,281 |
| Operating margin | 7.8% | 9.1% | 8.2% | 9.2% |
| Net income | $700 | $691 | $1,415 | $1,383 |
| Diluted EPS | $2.59 | $2.44 | $5.24 | $4.86 |
- Revenue increased 20% in both periods, principally reflecting TNT Express, along with growth at other transportation segments. Operating income rose 3% for the quarter and 7% for the half; consolidated operating margin declined 130 and 100 basis points, respectively.
- Quarterly segment results: FedEx Express operating income $636 (up 2%); TNT Express $70, with a 3.7% margin; FedEx Ground $465 (down 12%), with a 10.5% margin; and FedEx Freight $88 (down 13%), with a 5.5% margin.
- For the first half, FedEx Express operating income was $1,260 (up 8%); TNT Express was $56, with a 1.5% margin; Ground was $1,075 (up 1%); and Freight was $223 (down 4%).
- First-half operating cash flow was $2,635, versus $2,454; capital expenditures were $2,681, versus $2,562. Cash after capital expenditures was negative $46, before other investing and financing flows. Cash and cash equivalents fell to $3,059 from $3,534 at May 31, 2016.
- At November 30, total debt was approximately $13,596, including $43 current and $13,553 long-term; long-term debt carrying value was about $13.5 billion. The debt-to-adjusted-EBITDA covenant ratio was 1.8x against a maximum of 3.5x. The $1.75 billion revolving credit facility had no commercial paper outstanding.
- Current assets were $12,052 and current liabilities $7,807. Shareholders’ investment was $14,531. First-half dividends paid were $213; share repurchases totaled $334.
Material changes and drivers
- TNT Express contributed $1,899 of second-quarter revenue and $3,703 for the half. Its operating results were included from the acquisition date; prior-year segment comparatives are not available.
- FedEx Ground revenue grew 9% for the quarter and 11% for the half on volume and yield gains, but quarterly profit and margin fell as network expansion increased rent, depreciation and staffing costs and purchased transportation rates rose.
- FedEx Freight revenue increased 3% in both periods on shipment growth, while operating income declined amid lower shipment weights, higher staffing and allocated technology costs.
- FedEx Express revenue increased 2% in both periods. Management cited yield and package-volume growth and cost-management benefits; the first-half margin improved 50 basis points to 9.4%.
- Higher interest expense reflected prior-year U.S. and European debt issuance. First-half interest expense increased $95; a $35 gain on an investment sale partly offset this increase. The first-half effective tax rate was 36.3%, versus 35.3%, with the increase partly attributable to TNT Express local-country losses for which no tax benefit was recognized.
Outlook, risks and unusual items
- Management expected fiscal 2017 earnings growth, before any pension mark-to-market benefit-plan adjustment, driven by volume and yield growth at Express and Ground and TNT Express inclusion. The outlook depends on fuel prices and global economic improvement; Ground actions to balance volume, capacity and yield were expected to moderate third-quarter volume growth.
- Management estimated approximately $250 of 2017 TNT integration and restructuring costs, with aggregate integration expense of $700–$800 over four years. Integration was expected to take four years, and management could not predict whether TNT would be GAAP-accretive in 2018. Target annual pretax synergies after integration, expected in fiscal 2020, were $750.
- Projected fiscal 2017 capital expenditures were approximately $5.6 billion. Management anticipated $2.0 billion of U.S. pension-plan contributions in 2017, including voluntary funding, and said cash, operating cash flow and available financing were adequate for expected needs.
- Reported second-quarter TNT integration and restructuring expenses were $58 ($50 after tax, or $0.18 per diluted share); first-half costs were $126 ($94 after tax, or $0.35 per diluted share). Acquisition-related intangible amortization was $10 for the quarter and $38 for the half. A newly adopted share-based-payment accounting rule benefited second-quarter net income by $21, or $0.07 per diluted share.
- FedEx Ground recorded a $204 liability, net of recognized insurance recovery, for expected losses involving independent-contractor proceedings and related matters. Several settlements remained subject to court approval; other contractor cases continued. New York cigarette-shipment litigation had a reasonably possible but unestimable loss, which management expected to be immaterial. GENCO faced California hazardous-waste proceedings; management considered an immaterial loss probable.
- Other risks include the complex TNT integration and preliminary purchase-price allocation, foreign-exchange movements, fuel-price and surcharge timing, demand and competitive pressures, pension obligations, technology disruption and litigation. The filing says the new lease standard, effective for FedEx in fiscal 2020, is expected to significantly affect the balance sheet.
- FedEx stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter. The independent accountant performed an interim review, not an audit, and reported no material modifications identified as necessary.
Most important facts for investors to verify
- Separate reported growth attributable to TNT Express from organic volume, yield and earnings trends; assess integration execution and realized synergies against the $750 annual target.
- Track Ground’s network-expansion costs and margin recovery, and Freight’s profitability and shipment-weight trends.
- Compare operating cash generation with the $5.6 billion capital-spending plan, debt service and planned pension contributions.
- Monitor TNT integration and restructuring costs, purchase-price allocation changes and resulting amortization.
- Follow court approval and final settlement amounts for contractor cases, and developments in other disclosed litigation and environmental matters.
- Assess the extent to which the $21 accounting-adoption benefit affected reported earnings and the sensitivity of results to foreign exchange, fuel and surcharge timing.