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FDX > SEC Filings for FDX > Form 10-Q on 16-Dec-2011All Recent SEC Filings

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Form 10-Q for FEDEX CORP


16-Dec-2011

Quarterly Report


Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition
GENERAL
The following Management's Discussion and Analysis of Results of Operations and Financial Condition ("MD&A") describes the principal factors affecting the results of operations, liquidity, capital resources, contractual cash obligations and critical accounting estimates of FedEx Corporation ("FedEx"). 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, 2011 ("Annual Report"). Our Annual Report includes additional information about our significant accounting policies, practices and the transactions that underlie our financial results, as well as a detailed discussion of the most significant risks and uncertainties associated with our financial condition and operating results.
We provide a broad portfolio of transportation, e-commerce and business services through companies competing collectively, operating independently and managed collaboratively, under the respected FedEx brand. Our primary operating companies are Federal Express Corporation ("FedEx Express"), the world's largest express transportation company; FedEx Ground Package System, Inc. ("FedEx Ground"), a leading provider of small-package ground delivery services; and FedEx Freight, Inc. ("FedEx Freight"), a leading U.S. provider of less-than-truckload ("LTL") freight services. These companies represent our major service lines and, along with FedEx Corporate Services, Inc. ("FedEx Services"), form the core of our reportable segments. Our FedEx Services segment provides sales, marketing and information technology support to our transportation segments. In addition, the FedEx Services segment provides customers with retail access to FedEx Express and FedEx Ground shipping services through FedEx Office and Print Services, Inc. ("FedEx Office") and provides customer service, technical support and billing and collection services through FedEx TechConnect, Inc. ("FedEx TechConnect"). See "Reportable Segments" for further discussion.
The key indicators necessary to understand our operating results include:
the overall customer demand for our various services;

the volumes of transportation services provided through our networks, primarily measured by our average daily volume and shipment weight;

the mix of services purchased by our customers;

the prices we obtain for our services, primarily measured by yield (revenue per package or pound or revenue per hundredweight for LTL freight shipments);

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 recover incremental fuel costs 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. Except as otherwise specified, references to years indicate our fiscal year ending May 31, 2012 or ended May 31 of the year referenced and comparisons are to the corresponding period of the prior year. References to our transportation segments include, collectively, our FedEx Express, FedEx Ground and FedEx Freight segments.

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RESULTS OF OPERATIONS
CONSOLIDATED RESULTS
The following table compares summary operating results (dollars in millions,
except per share amounts) for the periods ended November 30:

                                 Three Months Ended          Percent            Six Months Ended          Percent
                                 2011           2010         Change            2011          2010         Change
Revenues                      $    10,587      $ 9,632             10        $ 21,108      $ 19,089             11
Operating income                      780          469             66           1,517         1,097             38
Operating margin                      7.4 %        4.9 %          250 bp          7.2 %         5.7 %          150 bp
Net income                    $       497      $   283             76        $    961      $    663             45
Diluted earnings per share    $      1.57      $  0.89             76        $   3.02      $   2.09             44

The following table shows changes in revenues and operating income by reportable segment for the periods ended November 30, 2011 compared to November 30, 2010 (dollars in millions):

                                                                                           Change in                Percent change in
                                Change in                Percent change in             Operating Income              Operating Income
                                Revenues                      Revenue                       (Loss)                        (Loss)
                           Three          Six          Three             Six         Three           Six           Three           Six
                           Months       Months        Months           Months        Months         Months        Months          Months
                           Ended         Ended         Ended            Ended        Ended          Ended          Ended          Ended
FedEx Express segment     $    591      $ 1,271             10              11      $     78       $      9             30              1
FedEx Ground segment           262          579             13              14           102            222             34             38
FedEx Freight segment          104          174              9               7           131            189            144            177
FedEx Services segment          (7 )        (11 )           (2 )            (1 )           -              -              -              -
Other and eliminations           5            6             NM              NM             -              -              -              -

                          $    955      $ 2,019             10              11      $    311       $    420             66             38

Overview
Our results for the second quarter and first half of 2012 showed improvement in revenue, operating income and operating margin, led by increased yields across all our transportation segments despite continued slow economic growth. Our year-over-year comparisons for the second quarter and first half of 2012 are impacted by $152 million in charges recorded in the second quarter of 2011. These charges included $86 million in costs related to the combination of our FedEx Freight and FedEx National LTL operations and a $66 million reserve associated with an adverse jury decision in the ATA Airlines lawsuit against FedEx Express. Our FedEx Ground segment continued its strong performance with increased yields, volume and operating margin in the second quarter and first half of 2012, driven by sustained market share gains and strong demand for FedEx Home Delivery and FedEx SmartPost services. Our results for the second quarter of 2012 also benefited from a significant improvement in the performance of our FedEx Freight segment, based on higher yields and on-going improvements in efficiencies resulting from our integrated LTL network. At FedEx Express, operating income increased predominantly due to the benefit from the timing lag that exists between when fuel prices change and when indexed fuel surcharges automatically adjust. Slow global economic growth driven by constrained consumer demand resulted in package volume declines in U.S. domestic and International Priority ("IP") services during the second quarter and first half of 2012 at FedEx Express.

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The following graphs for FedEx Express, FedEx Ground and FedEx Freight show selected volume trends (in thousands) over the five most recent quarters:

[[Image Removed: (LINE GRAPH)]]

(1) Includes international domestic operations of a February 2011 business acquisition in India and a July 2011 business acquisition in Mexico.

(2) Package statistics do not include the operations of FedEx SmartPost.

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The following graphs for FedEx Express, FedEx Ground and FedEx Freight show selected yield trends over the five most recent quarters:

[[Image Removed: (LINE GRAPH)]]

(1) Package statistics do not include the operations of FedEx SmartPost.

Revenue
Revenues increased 10% during the second quarter of 2012 and 11% in the first half of 2012 due to yield increases across all of our transportation segments. At FedEx Express, U.S. domestic package yields increased 12% in both the second quarter and first half of 2012 primarily due to higher fuel surcharges and increased rate per pound, while IP package yields increased 11% in the second quarter of 2012 and 13% in the first half of 2012 led by higher fuel surcharges and increased rate per pound. At the FedEx Ground segment, revenues increased 13% for the second quarter of 2012 and 14% for the first half of 2012 due to yield and volume growth at both FedEx Ground and FedEx SmartPost. Revenues at FedEx Freight increased 9% during the second quarter of 2012 and 7% for the first half of 2012 due to higher fuel surcharges and our ongoing yield management initiatives.

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Operating Income
The following tables compare operating expenses expressed as dollar amounts (in
millions) and as a percent of revenue for the periods ended November 30:

                                         Three Months Ended          Six Months Ended
                                          2011          2010         2011         2010
     Operating expenses:
     Salaries and employee benefits    $    3,982      $ 3,779     $  7,986     $  7,582
     Purchased transportation               1,576        1,390        3,094        2,717
     Rentals and landing fees                 623          628        1,243        1,229
     Depreciation and amortization            518          502        1,027          981
     Fuel                                   1,200          938        2,444        1,825
     Maintenance and repairs                  511          473        1,062          990
     Impairment and other charges(1)            -           67            -           67
     Other                                  1,397        1,386        2,735        2,601

     Total operating expenses          $    9,807      $ 9,163     $ 19,591     $ 17,992

(1) Represents charges associated with the combination of FedEx Freight and FedEx National LTL operations, effective January 30, 2011.

                                        Percent of Revenue          Percent of Revenue
                                        Three          Three         Six            Six
                                       Months         Months       Months         Months
                                        Ended          Ended        Ended          Ended
                                        2011           2010         2011           2010
     Operating expenses:
     Salaries and employee benefits        37.6 %        39.2 %        37.8 %        39.7 %
     Purchased transportation              14.9          14.4          14.7          14.2
     Rentals and landing fees               5.9           6.5           5.9           6.4
     Depreciation and amortization          4.9           5.2           4.9           5.2
     Fuel                                  11.3           9.8          11.6           9.6
     Maintenance and repairs                4.8           4.9           5.0           5.2
     Impairment and other charges             -           0.7             -           0.4
     Other                                 13.2          14.4          12.9          13.6

     Total operating expenses              92.6          95.1          92.8          94.3


     Operating margin                       7.4 %         4.9 %         7.2 %         5.7 %

Operating income and operating margin increased for both the second quarter and first half of 2012 as a result of increased yields due to higher fuel surcharges and our other yield management programs. Our year-over-year comparisons for the second quarter and first half of 2012 are impacted by charges in the second quarter of 2011 of $86 million in costs related to the combination of our FedEx Freight and FedEx National LTL operations and a $66 million reserve associated with an adverse jury decision in the ATA Airlines lawsuit against FedEx Express. Salaries and employee benefits increased 5% in both the second quarter and the first half of 2012 due to higher incentive compensation and full 401(k) company-matching contributions effective January 1, 2011. Purchased transportation costs increased 13% in the second quarter and 14% in the first half of 2012 due to higher fuel costs and volume growth at FedEx Ground, higher utilization of third-party transportation providers in international locations primarily due to business acquisitions at FedEx Express, costs associated with the expansion of our freight forwarding business at FedEx Trade Networks and higher fuel costs and increased utilization of rail at FedEx Freight.

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The following graph for our transportation segments shows our average cost of jet and vehicle fuel per gallon for the five most recent quarters:

[[Image Removed: (LINE GRAPH)]]
Fuel expense increased 28% during the second quarter of 2012 and 34% for the first half of 2012 due to increases in the average price per gallon of fuel. Our fuel surcharges, which are more fully described in the "Quantitative and Qualitative Disclosures About Market Risk" section of this MD&A, have a timing lag and are designed to pass through the price of fuel not included in our base shipping rates to our customers. Based on a static analysis of the impact to operating income of year-over-year changes in fuel prices compared to changes in fuel surcharges, fuel surcharges more than offset incremental fuel costs for the second quarter and first half of 2012.
Our analysis considers the estimated impact of the reduction in fuel surcharges included in the base rates charged for FedEx Express and FedEx Ground services. However, this analysis does not consider the negative effects that fuel surcharge levels may have on our business, including reduced demand and shifts by our customers to lower-yielding services. While fluctuations in fuel surcharge rates 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. In order to provide information about the impact of fuel surcharges on the trend in revenue and yield growth, we have included the comparative fuel surcharge rates in effect for the second quarter and first half of 2012 and 2011 in the accompanying discussions of each of our transportation segments. Income Taxes
Our effective tax rate was 36.1% for the second quarter of 2012 and 36.0% for the first half of 2012, compared with 35.3% for the second quarter of 2011 and 36.3% for the first half of 2011. For the remainder of 2012, we expect the effective tax rate to be between 36.0% and 37.0%. The actual rate, however, will depend on a number of factors, including the amount and source of operating income.
Other than tax risks and related indemnifications recorded in connection with the business acquisition described below, there were no material changes to our liabilities for unrecognized tax benefits from May 31, 2011. We anticipate that certain income tax return proceedings, including an Internal Revenue Service audit of our 2007-2009 U.S. income tax returns, 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.

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Business Acquisition
On July 25, 2011, we completed our acquisition of Servicios Nacionales Mupa, S.A. de C.V. (MultiPack), a Mexican domestic express package delivery company, for $128 million in cash from operations. The financial results of the acquired business are included in the FedEx Express segment from the date of acquisition and were not material to our results of operations or financial condition. Substantially all of the purchase price was allocated to goodwill, which was entirely attributed to our FedEx Express reporting unit. Outlook
We anticipate revenue and earnings growth for the second half of 2012 to be driven by positive yield trends across our transportation segments due to our continued focus on improving the pricing for our services. However, demand for our services, particularly some of our premium services offerings, continues to be negatively impacted by the adverse effect of uncertain global economic conditions on our customers. These factors make it difficult to predict the level of demand for our services in the second half of 2012. While we remain committed to investing in critical long-term strategic projects focused on enhancing and broadening our service offerings to position us for stronger growth as global economic conditions improve, we will continue to adjust our networks to meet current demand levels. For additional details on key 2012 capital projects, refer to the "Liquidity Outlook" section of this MD&A. All of our businesses operate in a competitive pricing environment, exacerbated by continuing volatile fuel prices, which impact our fuel surcharge levels. Historically, our fuel surcharges have largely offset incremental fuel costs; however, volatility in fuel costs may impact earnings because adjustments to our fuel surcharges lag changes in actual fuel prices paid. Therefore, the trailing impact of adjustments to our fuel surcharges can significantly affect our earnings either positively or negatively in the short-term.
As described in Note 8 of the accompanying unaudited condensed consolidated financial statements and the "Evolution of Independent Contractor Model" section of our FedEx Ground segment MD&A, we are involved in a number of lawsuits and other proceedings that challenge the status of FedEx Ground's owner-operators as independent contractors. FedEx Ground anticipates continuing changes to its relationships with its contractors. The nature, timing and amount of any changes are dependent on the outcome of numerous future events. We cannot reasonably estimate the potential impact of any such changes or a meaningful range of potential outcomes, although they could be material. However, we do not believe that any such changes will impair our ability to operate and profitably grow our FedEx Ground business.
See "Forward-Looking Statements" for a discussion of these and other potential risks and uncertainties that could materially affect our future performance.
NEW ACCOUNTING GUIDANCE
New accounting rules and disclosure requirements can significantly impact our reported results and the comparability of our financial statements. See our Annual Report for a discussion of the impact of new accounting guidance issued but not yet effective as of May 31, 2011. We believe that no new accounting guidance was adopted or issued during the first half of 2012 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.

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REPORTABLE SEGMENTS
FedEx Express, FedEx Ground and FedEx Freight represent our major service lines
and, along with FedEx Services, form the core of our reportable segments. Our
reportable segments include the following businesses:

FedEx Express Segment         FedEx Express (express transportation)
                              FedEx Trade Networks (global trade services)
                              FedEx SupplyChain Systems (logistics services)

FedEx Ground Segment          FedEx Ground (small-package ground delivery)
                              FedEx SmartPost (small-parcel consolidator)

FedEx Freight Segment         FedEx Freight (LTL freight transportation)
                              FedEx Custom Critical (time-critical transportation)

FedEx Services Segment        FedEx Services (sales, marketing and information
                              technology functions)
                              FedEx TechConnect (customer service, technical
                              support, billings and collections)
                              FedEx Office (document and business services and
                              package acceptance)

FEDEX SERVICES SEGMENT
The FedEx Services segment operates combined sales, marketing, administrative and information technology functions in shared services operations that support our transportation businesses and allow us to obtain synergies from the combination of these functions. The FedEx Services segment includes: FedEx Services, which provides sales, marketing and information technology support to our other companies; FedEx TechConnect, which is responsible for customer service, technical support, billings and collections for U.S. customers of our major business units; and FedEx Office, which provides an array of document and business services and retail access to our customers for our package transportation businesses.
The FedEx Services segment provides direct and indirect support to our transportation businesses, and we allocate all of the net operating costs of the FedEx Services segment (including the net operating results of FedEx Office) to reflect the full cost of operating our transportation businesses in the results of those segments. Within the FedEx Services segment allocation, the net operating results of FedEx Office are allocated to FedEx Express and FedEx Ground. The allocations of net operating costs are based on metrics such as relative revenues or estimated services provided. We believe these allocations approximate the net cost of providing these functions. We review and evaluate the performance of our transportation segments based on operating income (inclusive of FedEx Services segment allocations). For the FedEx Services segment, performance is evaluated based on the impact of its total allocated net operating costs on our transportation segments.
The operating expenses line item "Intercompany charges" on the accompanying unaudited financial summaries of our transportation segments reflects the allocations from the FedEx Services segment to the respective transportation segments. The "Intercompany charges" caption also includes charges and credits for administrative services provided between operating companies and certain other costs such as corporate management fees related to services received for general corporate oversight, including executive officers and certain legal and finance functions. We believe these allocations approximate the net cost of providing these functions.
OTHER INTERSEGMENT TRANSACTIONS
Certain FedEx operating companies provide transportation and related services for other FedEx companies outside their reportable segment. Billings for such services are based on negotiated rates, which we believe approximate fair value, and are reflected as revenues of the billing segment. These rates are adjusted from time to time based on market conditions. Such intersegment revenues and expenses are eliminated in our consolidated results and are not separately identified in the following segment information because the amounts are not material.

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FEDEX EXPRESS SEGMENT
The following tables compare revenues, operating expenses, operating expenses as
a percent of revenue, operating income and operating margin (dollars in
millions) for the periods ended November 30:

                             Three Months Ended            Percent           Six Months Ended            Percent
                             2011           2010           Change           2011          2010           Change
Revenues:
Package:
U.S. overnight box        $    1,623       $ 1,489                9       $  3,263      $  2,980                9
U.S. overnight
envelope                         421           416                1            872           848                3
U.S. deferred                    731           666               10          1,462         1,327               10

Total U.S. domestic
package revenue                2,775         2,571                8          5,597         5,155                9

International priority         2,171         2,009                8          4,369         3,983               10
International domestic
(1)                              217           165               32            424           313               35

Total package revenue          5,163         4,745                9         10,390         9,451               10
Freight:
U.S.                             628           530               18          1,219         1,053               16
International priority           470           435                8            919           841                9
International
airfreight                        74            69                7            151           139                9

Total freight revenue          1,172         1,034               13          2,289         2,033               13
Other (2)                        248           213               16            496           420               18

Total revenues                 6,583         5,992               10         13,175        11,904               11
Operating expenses:
Salaries and employee
benefits                       2,377         2,253                6          4,790         4,511                6
Purchased
transportation                   448           388               15            897           757               18
Rentals and landing
fees                             421           427               (1 )          844           830                2
Depreciation and
. . .
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