Business context and reporting period
FedEx Corporation’s Form 10-Q covers the quarter ended February 29, 2016, the third quarter of fiscal 2016, and the first nine months of fiscal 2016. Comparisons below are with the corresponding prior-year periods. FedEx operates express, ground and less-than-truckload freight transportation businesses, alongside related services. Amounts are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q3 FY2016 | Q3 FY2015 | Nine months FY2016 | Nine months FY2015 |
|---|---|---|---|---|
| Revenue | $12,654 | $11,716 | $37,386 | $35,339 |
| Operating income | $864 | $1,038 | $3,145 | $3,188 |
| Operating margin | 6.8% | 8.9% | 8.4% | 9.0% |
| Net income | $507 | $628 | $1,890 | $1,944 |
| Diluted EPS | $1.84 | $2.18 | $6.71 | $6.75 |
- Cash flow: Nine-month operating cash flow was $3,796, up from $3,473. Capital expenditures were $3,562, versus $2,969; operating cash flow less capital expenditures was negative $234. Cash and equivalents declined to $2,841 at February 29, 2016 from $3,763 at May 31, 2015.
- Debt and liquidity: Long-term debt, including current maturities, was approximately $8.5 billion, up from $7.3 billion at fiscal year-end. FedEx issued $1.25 billion of 4.75% senior notes due 2045. It had a $1.75 billion revolving facility, no commercial paper outstanding, and a 1.2-to-1 debt-to-adjusted-EBITDA ratio against a 3.5-to-1 covenant limit. Management said available cash, operating cash flow and financing sources were adequate for expected needs.
- Capital returns: FedEx repurchased 7.3 million shares during the quarter for approximately $1.0 billion and declared a quarterly dividend of $0.25 per share, up from $0.20 a year earlier.
Material changes versus the prior comparable period
- Q3 revenue rose 8%, but operating income fell 17%, net income fell 19%, diluted EPS fell 16%, and operating margin contracted 210 basis points. For the nine months, revenue rose 6%, while operating income fell 1%, net income fell 3%, and diluted EPS fell 1%.
- Revenue growth reflected Ground volume and yield gains, GENCO, and a prospective change to record FedEx SmartPost revenue gross rather than net. The SmartPost presentation change added approximately $350 million of Q3 revenue and $890 million for the nine months, with corresponding expense increases; it is not directly comparable to prior-period presentation.
- FedEx Express operating income increased 51% in Q3 and 40% year to date, with margins improving to 9.1% and 8.9%, respectively. FedEx Ground operating income was flat in Q3 and up 3% year to date; margins declined to 12.6% and 13.2%. FedEx Freight operating income fell 16% in Q3 and 17% year to date; margins declined to 3.9% and 6.3%.
- Lower fuel prices reduced fuel expense, but lower fuel surcharges reduced revenue; FedEx reported a modest net fuel benefit. The company cited higher Ground network and peak-season costs, self-insurance expense and purchased transportation rates, as well as weaker-than-anticipated Freight volume. Express results benefited from yield management and cost-improvement initiatives.
- GENCO and Bongo acquisitions were completed in 2015; GENCO is included in Ground and Bongo in Express. The pending TNT Express acquisition, valued at approximately €4.4 billion (then approximately $4.9 billion), was expected to close in the first half of calendar 2016, subject to approvals.
Outlook, risks and unusual items
- Management expected earnings growth in Q4 and fiscal 2016 before pension and postretirement benefit mark-to-market adjustments and excluding certain litigation matters. Expected drivers were Express and Ground volume growth and yield initiatives; weaker industrial production was expected to restrain revenue and weigh on Freight earnings. Outlook depended on fuel prices and moderate global economic growth and excluded impacts of the proposed TNT acquisition.
- Management forecast a fiscal 2016 effective tax rate of 35%–36% before any mark-to-market adjustment. Planned fiscal 2016 capital expenditures were approximately $4.8 billion. FedEx also expected to fund the TNT acquisition through operating cash and a further debt offering.
- Q3 included a $204 million provision for independent-contractor litigation ( $126 million after tax, or $0.46 per diluted share), and a $69 million provision for a customs-duty and processing-fee settlement ( $43 million after tax, or $0.15 per diluted share); both were net of recognized insurance recoveries. Nine-month litigation provisions were $245 million. TNT-related expenses were $25 million in Q3 and $53 million year to date.
- Legal exposures include ongoing FedEx Ground contractor-classification litigation and a DOJ criminal indictment concerning alleged online-pharmacy shipments; the company said a loss in the latter matter could be material if convicted, but it could not estimate a range. The filing also reports a $228 million settlement in a California contractor case, subject to final court approval, and other proceedings with uncertain outcomes.
- Other risks include fuel and foreign-exchange volatility, economic and shipment-demand changes, labor and benefit costs, competition, cyber disruption, and execution and regulatory risks related to TNT. Moody’s lowered FedEx’s senior unsecured rating from Baa1 to Baa2 on March 15, 2016, while maintaining a stable outlook. FedEx disclosed no material change in its previously reported risk factors.
- The new lease accounting standard, effective for FedEx fiscal 2020, is expected to significantly increase reported balance-sheet assets and liabilities; the company was evaluating its impact. The interim financial statements were reviewed by the independent auditor, not audited.
Important facts for investors to verify
- How much of reported revenue growth and Ground yield improvement reflects the SmartPost gross-presentation change and GENCO, versus underlying volume, pricing and mix.
- Whether Express and Ground operating improvements can offset Ground cost pressures and Freight weakness, and whether stated earnings-growth expectations are achieved.
- The ultimate cost, insurance recoveries and court approvals for contractor-classification cases, including settlements and remaining litigation, as well as the outcome of the DOJ matter.
- Funding and completion terms for TNT, the planned debt offering, capital spending, pension contributions and share repurchases, including the effect on leverage and liquidity.
- The impact of lower fuel surcharges, foreign-exchange movements, Moody’s downgrade and industrial-production trends on revenue, margins and financing costs.