FedEx Corporation — Q1 FY2020 Form 10-Q
Reporting period: Three months ended August 31, 2019; balance-sheet comparisons are to May 31, 2019. Figures are in U.S. dollars; financial statement amounts are in millions unless noted. The interim statements were reviewed by the independent accountant, not audited.
Business context and results
FedEx provides express, ground and less-than-truckload transportation, along with related services. Revenue was essentially flat as growth at Ground was offset by weaker Express and Freight revenue. Management cited softening global economic conditions, trade uncertainty, a large customer loss, one fewer operating day, and a shift toward lower-yield services, including e-commerce-related deferred shipments.
Key financial metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Revenue | $17,048 | $17,052 | Flat |
| Operating income | $977 | $1,071 | Down 9% |
| Operating margin | 5.7% | 6.3% | Down 60 basis points |
| Net income | $745 | $835 | Down 11% |
| Diluted EPS | $2.84 | $3.10 | Down 8% |
| Operating cash flow | $565 | $701 | Down $136 |
| Capital expenditures | $1,418 | $1,179 | Up 20% |
Operating cash flow was below capital expenditures by $853 million, calculated from the reported figures. Cash and cash equivalents were $2,389 at quarter-end, versus $2,319 at May 31. The effective tax rate was 25.2%, compared with 24.2% a year earlier. Dividends declared were $1.30 per share, unchanged year over year.
- Segments: Express revenue was $8,945 and operating income $285, down 3% and 27%, respectively. Ground revenue was $5,179, up 8%, while operating income was $644, down 5%. Freight revenue was $1,905, down 3%, while operating income rose 10% to $194.
- Debt and liquidity: Long-term debt, including current maturities and excluding finance leases, had a carrying value of $18.6 billion. FedEx issued $2.1 billion of senior unsecured notes and used proceeds in part for $1.0 billion of U.S. pension contributions and redemption of maturing notes. It reported $3.447 billion available under its credit agreements, with no commercial paper outstanding. Debt-to-adjusted-EBITDA was 2.41x against a 3.5x covenant limit; the company reported compliance.
- Leases: Adoption of the new lease standard added $14.2 billion of operating lease liabilities and $14.1 billion of right-of-use assets at adoption. At August 31, operating lease liabilities were $14.033 billion. Management said adoption materially affected the balance sheet but had no material operating-results impact and no impact on operating cash flows.
Material changes versus prior year
- Operating income fell primarily on weaker global demand, lower-yield service mix, the large-customer loss, and added costs to expand and modernize networks. Management estimated the one-fewer-operating-day effect at approximately $100 million.
- Lower variable incentive compensation provided an approximately $300 million year-over-year benefit, partially offsetting pressure. TNT Express integration costs were $71 million, or $55 million after tax ($0.21 per diluted share), $50 million below the prior-year quarter.
- Ground volume increased 7% and yield 2%, but higher purchased-transportation costs and network-expansion costs reduced segment operating income. Freight’s higher revenue per shipment and lower third-party transportation costs supported improved operating income despite lower shipments.
- Operating cash flow declined, reflecting higher pension contributions and lower net income, partly offset by noncash credits associated with lease-standard adoption. Capital spending rose, notably for aircraft, facilities, vehicles and technology.
Outlook, risks and unusual items
- Management expected operating income to decline for the remainder of FY2020, citing lower Express revenue and higher Ground costs. It identified escalating trade tensions, tariffs, softer European markets and declining industrial production as risks to demand, particularly in Europe and Asia Pacific.
- FedEx expected approximately $280 million of TNT integration expenses in the remainder of FY2020 and approximately $1.7 billion of aggregate integration-program expenses through 2021. Management said timing and amounts could change and additional transformation costs may arise.
- FY2020 capital expenditures were expected to be approximately $5.9 billion. Management said operating cash flow should be sufficient to fund capital expenditures. It planned adjustments to Express air-network capacity, accelerated aircraft retirements and aircraft parking; these actions could increase depreciation or cause immaterial impairments.
- Other dependencies include moderate U.S. growth, expected fuel prices, no further weakening in international conditions, and no additional adverse trade-policy developments. FedEx also cited Brexit uncertainty, foreign exchange, fuel, competition, capacity, labor, pension costs and successful TNT integration as risks.
- Legal matters include FedEx Ground contractor-classification and joint-employer proceedings, for which potential loss could not be estimated in all cases; securities class actions, with loss probability and amount not yet estimable; and a California environmental matter for which an immaterial settlement was reached, subject to court approval. Chinese authorities were investigating FedEx Express package handling, and FedEx had filed suit challenging certain export-control requirements.
- FedEx expected no further U.S. pension-plan contributions for the remainder of FY2020 after contributing $1.0 billion in the quarter. Approximately $1.3 billion of cash was held in foreign jurisdictions under the company’s permanent-reinvestment strategy.
Important facts for investors to verify
- Whether Express revenue and margins stabilize as trade conditions, international demand and the large-customer loss evolve.
- Whether Ground volume and pricing can offset purchased-transportation, staffing and network-expansion costs.
- Actual operating cash flow, capital spending and debt levels against management’s FY2020 liquidity and $5.9 billion capital-expenditure outlook.
- Progress, costs and timing of TNT integration, including the expected $1.7 billion through 2021.
- Developments and potential financial exposure in contractor, securities, environmental, export-control and China-related matters.
- Effects of lease accounting on balance-sheet comparisons and the company’s leverage measures.