Business context and reporting period
FedEx Corporation’s unaudited Form 10-Q covers the fiscal second quarter and six months ended November 30, 2010 (fiscal 2011), with comparisons to the prior-year periods. FedEx provides express, ground, less-than-truckload (LTL) freight, logistics, and related services. Amounts below are in millions of dollars unless noted.
Financial performance and position
| Metric | Three months ended Nov. 30, 2010 | Six months ended Nov. 30, 2010 |
|---|---|---|
| Revenue | $9,632; up 12% | $19,089; up 15% |
| Operating income | $469; down 18% | $1,097; up 24% |
| Operating margin | 4.9%, versus 6.6% | 5.7%, versus 5.3% |
| Net income | $283; down 18% | $663; up 26% |
| Diluted EPS | $0.89, versus $1.10 | $2.09, versus $1.68 |
- Cash flow: Six-month cash from operations was $2,011, compared with $1,357. Capital expenditures were $2,059, versus $1,549; investing activities used $2,052. Financing activities used $59. Cash decreased $75 to $1,877.
- Liquidity and debt: At November 30, cash was $1,877, current assets were $7,398, and current liabilities were $4,863. Current and long-term debt totaled approximately $1,918. The $1 billion revolving credit facility was fully available, with no commercial paper outstanding. The adjusted-debt-to-capital covenant ratio was 0.5 against a maximum of 0.7.
- Balance sheet: Total assets were $26,093 and stockholders’ investment was $14,561. Net property and equipment was $15,266.
- Dividends: Declared dividends were $0.12 per share for the quarter; $0.36 per share for the six months.
Material changes versus the prior comparable periods
- Revenue grew across all transportation segments on increased shipment volumes and improved yields, including strong international priority growth.
- Second-quarter earnings and margin fell despite revenue growth. The quarter included $86 of Freight/LTL combination costs and a $66 accrual for the ATA Airlines lawsuit; together, these reduced diluted EPS by $0.27 after incentive compensation effects. The prior-year quarter included a $54 self-insurance plan remeasurement benefit, worth $0.05 per diluted share after incentive compensation effects.
- Operating expenses rose with volumes and costs. In the second quarter, salaries and benefits increased 10%, purchased transportation 20%, fuel 26%, and maintenance and repairs 15%. Higher pension costs and restored employee compensation programs also weighed on earnings.
- Six-month retirement-plan costs increased to $410 from $217, reflecting a lower discount rate and partial restoration of 401(k) matching contributions. Required U.S. pension contributions were $158 in the first half; approximately $322 was expected for the remainder of fiscal 2011.
- Segment results diverged: Express operating income was $264 in the quarter, down from $345; Ground operating income was $296, up from $238; Freight recorded an operating loss of $91, versus a $12 loss. For the six months, Express and Ground income rose, while Freight’s operating loss widened to $107 from $10.
Outlook, management commentary, risks and unusual items
- Management anticipated second-half volume growth at Express and Ground and positive yield trends across transportation segments. Freight volume growth was expected to moderate as lower-yield shipments were transitioned out of the network.
- Management expected revenue growth to be partly offset by aircraft maintenance, pension, employee investment, and further Freight realignment costs. The outlook assumed global economic recovery, moderate near-term U.S. growth, and stable fuel prices. No full-year earnings or EPS guidance is stated in the supplied filing text.
- Fiscal 2011 capital expenditures were expected to be approximately $3.5 billion. FedEx cited aircraft investments, including more fuel-efficient Boeing 777 and 757 aircraft, as strategic and expected to be funded by operating cash flow.
- The Freight and National LTL businesses were scheduled to combine effective January 30, 2011. Estimated program costs were revised to $140–$170; $86 was incurred in the quarter. Management expected efficiency and cost benefits.
- FedEx announced agreements to acquire AFL/Unifreight India businesses and, on December 15, 2010, Mexico’s MultiPack. Both were expected to close in 2011, subject to customary conditions, and to be immaterial to fiscal 2011 results.
- FedEx Express pilot negotiations were ongoing after the contract became amendable October 31, 2010; financial effects could not be estimated. Proposed FAA pilot-duty and rest rules could impose material costs if adopted as drafted.
- FedEx Ground contractor-classification litigation remained a significant uncertainty. The filing says potential losses or changes to contractor status could be material, though management did not believe a material loss was probable. A December 2010 court ruling favored FedEx Ground in 19 certified cases; other claims remained pending.
- The ATA Airlines jury awarded $66 in damages; FedEx accrued the loss and was appealing. Wage-and-hour class actions remained pending; management denied liability and could not estimate a loss range, but did not consider a loss probable.
- Fuel surcharges historically offset incremental fuel costs, but adjustment lags of about six to eight weeks can affect earnings when fuel prices move sharply. Other stated risks include competition, economic conditions, employee-benefit costs, foreign exchange, labor matters, litigation, and access to financing.
- Management stated that existing cash, operating cash flow, and available financing were adequate for liquidity needs. The interim financial statements were reviewed by the independent accountant, not audited.
Most important facts for investors to verify
- Whether second-half volume and yield growth materialized, and whether higher operating costs continued to pressure margins.
- Actual remaining Freight/LTL combination charges versus the $140–$170 estimate, and whether the integration delivers anticipated efficiencies.
- Outcome and financial exposure from the ATA appeal, contractor-classification matters, pilot negotiations, wage-and-hour litigation, and proposed FAA rules.
- Execution and funding of the approximately $3.5 billion capital expenditure plan, aircraft commitments, pension contributions, and announced acquisitions.
- Fuel-price movements and surcharge timing, and whether liquidity, credit ratings, and covenant headroom remained adequate.