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EXPD > SEC Filings for EXPD > Form 8-K on 17-Sep-2013All Recent SEC Filings

Show all filings for EXPEDITORS INTERNATIONAL OF WASHINGTON INC

Form 8-K for EXPEDITORS INTERNATIONAL OF WASHINGTON INC


17-Sep-2013

Regulation FD Disclosure


Item 7.01. Regulation FD Disclosure.
The following information is included in this document as a result of Expeditors' policy regarding public disclosure of corporate information.
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995; CERTAIN CAUTIONARY STATEMENTS Certain portions of this document, including the answers to questions 1, 2, 3, 4, 7, 8, 10, 11, 12, 13, 14, 16, 17, 18, 19, 23, 24, 26, and 27, contain forward-looking statements which are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. Actual future results and trends may differ materially from historical results or those projected in any forward-looking statements depending on a variety of factors including, but not limited to, changes in customer demand for Expeditors' services caused by a general economic slow-down, inventory build-up, decreased consumer confidence, volatility in equity markets, energy prices, political changes, changes in foreign currency rates, or the unpredictable acts of competitors. Attention should be given to other factors identified and discussed in Expeditors' annual report on Form 10-K filed on February 27, 2013. Any forward-looking statement made by Expeditors in this document is based only on information currently available to Expeditors and speaks only as of the date on which it is made. Expeditors undertakes no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.
SELECTED INQUIRIES RECEIVED THROUGH AUGUST 13, 2013
1. How should we think about EXPD's philosophy around return of capital to shareholders, inclusive of dividends but specifically as it relates to share repurchases. The company obviously generates ample free cash flow, has relatively low capital investment requirements and not much of a history for M&A. When we couple this with management's recent comments about 'signs of improvement' how should we think about the potential for more meaningful share repurchases going forward as a key use of cash flow, especially since you mention all that IPO money still sitting in the bank? The best way to understand our approach to capital allocation is to simply look at our history in combination with significant recent economic events (we aren't very good at predicting the future so we won't be guessing about what economic traps lay ahead. We will be prepared for them as best as one can expect). We understand the need and responsibility to return excess cash to shareholders….and before anyone who looks at our cash balances and categorizes us as "ratholers" of cash, they should probably first look at our record of returning cash to shareholders. During the ten year period from 2003 through 2012, we've actually returned nearly $2.1 billion of cash to our shareholders in the form of dividends and stock repurchases. And while it's true we have a lot of cash, our dividend and stock repurchase history isn't a track record of a company that disregards capital allocation considerations. The idea however that buyback or dividend policies drive stock prices up still eludes us. We are not sure that any parallel can be drawn which shows that our stock price is higher because of the nearly $2.1 billion that was returned to shareholders during the last ten years. Over the years we've had a number of discussions with investors and potential investors on the topic of dividends and share-buybacks and what we here at Expeditors think about capital allocation. These have all been interesting discussions and we're always amazed at just how passionate so many of those with whom we talk propose and defend their positions. The sum and substance of these discussions is that to us, investors seem to hold one of three positions on capital allocation:
1. Those that believe that share repurchases are the only effective thing to do with "excess cash" (or what Warren Buffett calls "unrestricted cash") and that aggressively doing so will raise the price of the stock since you are "re-slicing the pie" into larger pieces. Theoretically, the total value of the company doesn't change, but shareholders who opt not to sell, end up with a share value worth more. It's axiomatic that non-selling shareholders will have a great share percentage ownership in the company. Again, theoretically, or at least mathematically, that would result in a higher share price;

2. Those that believe that a dividend is the most effective way to return cash to shareholders. These investors believe that by increasing dividends, the stock will become more attractive and the price will go up. They also believe that by having been a loyal investor, they should be "given" their share of the earnings to re-deploy as they see fit. One argument made by pro-dividend shareholders is that "Buying back shares rewards the non-believers, i.e. those willing to sell, at the expense of the loyal shareholders, who wish to remain invested;" and

3. Those that are more concerned with the capital appreciation of their investment. They seem to want cash to be used in the most effective way. They don't seem to be "married" to either of the previous two concepts as to how any excess cash should be given back to shareholders. They just want to see the company do well and the stock value increase. These investors are most concerned with how cash deployment will drive future growth and profits, and how growth in profits will result in more valuable shares.


As a result of these discussions, we've deduced that, "What to do with excess cash lies in the eye of the beholder," to paraphrase an old saying. In many regards, from our vantage point at least, the debate over whether higher dividends or increased share buy-backs are the best vehicle to return excess cash to shareholders is as close to a corporate finance version of a Miller Lite® commercial as one can get. We think we can tell from your question which side of the Miller Lite® commercial ("Tastes Great/Less Filling") you root for.

From our experience, those in the "Tastes Great" camp prefer higher dividends and tend not to be as passionate about their positions as their "Less Filling" stock repurchase counterparts. They are however, very firm in their beliefs that regardless of what increases in dividends may do for the stock price, shareholders need to see "their" portion of earnings returned to them. To them this is not only the preferable way, but the best way to return cash to investors. They were also, collectively, not individually, much more vocal about the "Mondo One Time Dividend" last year just before the tax rate on dividends went up. Since then, they remain in the same camp, but don't seem to have as much urgency. Their arguments that we are only returning to them "their" portion of retained earnings is quite compelling. They in turn will deploy their portion of any distributed retained earnings in a way that best suits their individual risk preferences while at the same time allowing them to maintain their investment position in Expeditors. In getting their "shots" into the "Less Filling" crowd, they still argue that point noted previously in this response (i.e. that a company repurchasing shares, chooses to return capital back to those now ex-shareholders, who no longer believe in the company and who either reduced, or sold completely their investment).

Since you appear to be in the "Less Filling" share repurchase crowd, we would point out that mathematically, all things being equal in a perfect Modigliani and Miller1 "assumed" kind of world, the value of each individual shareholder who chooses not to sell their shares would be enhanced. This is because the total number of shares is reduced…i.e. cutting up the pie in fewer, larger slices. This action doesn't make the pie bigger, just the individual's portion of the pie, as there are now fewer slices dividing that pie. Hence the value of the firm would not be impacted by capital structure. That said, we are keenly aware that investors typically buy pieces of the pie, not the whole pie. The only problem with this "assumed world M&M scenario" (efficient markets, no taxes, agency or bankruptcy costs and all information is known by the investors) is that it doesn't exist. But it's a great theory for deciding how to think things might look, bearing in mind that it does create a situation where one isn't forced to confront the totality of reality despite being contained within a Nobel Laureate kind of framework.

Many years ago in this forum, we referred obliquely, as part of a very long and detailed response about another matter,2 to our high school mathematics teacher…the venerable and avuncular Mr. Beck…who taught us a lesson at the time that was most profound. Like most profound lessons, it has found numerous applications in the 40+ years since we were first exposed to it.

One day in a class on factoring equations, Mr. Beck wrote the following fraction on the board:
Mr. Beck, in one fell swoop of his chalk, "reduced" this fraction to its lowest fractional equivalent by canceling the 6's in both the numerator and the denominator in the following fashion…something we'd never seen before. We were "uber impressed"…we knew we'd just been taught something new…we really didn't understand it, but it looked cool and it appeared to us to be very unique and would have very powerful potential.

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1Franco Modigliani and Merton Miller (M&M) were two economic professors (Nobel Laureates no less… receiving the Nobel distinction in part because of their development of their theorem on capital structure and companies that are valued by the stock market). The theory that the value of a firm is based on future earnings and the riskiness of the firm's assets was first postulated by M&M in the late 1950's. According to M&M, these two factors determine value and are independent of the Company's capital structure (debt versus equity) and whether or not the earnings are paid out in the form of dividends. While much of the real world was "assumed" away in their initial theory (you had to have an efficient (random walk) kind of stock market with no taxes, agency costs, or bankruptcy costs---they were economists after all) their underlying theory has been accepted by many, maybe even by most, financial economists as an almost infallible fundamental of financial economic dogma, underpinning the theoretical arguments for firm valuations….and no, Merton Miller is not related to the Miller Lite®, Millers. We have no idea where he would come down on the "Tastes Great/Less Filing" beer debates, but it sounds like he'd be ambivalent and probably order a white wine.
2We refer you to our response to question 12 in our 8-K dated May 17, 2004.

As we sat in awe, Mr. Beck then taught the real lesson for the day when he pointed out that this was a very reliable technique that would work EVERYTIME. He continued by instructing us as to the kind of scrutiny to which the word EVERYTIME should be subjected. EVERTIME did not mean anytime you have a fraction with the same number in the numerator and the denominator…EVERYTIME meant EVERYTIME you had a fraction of:
In other words, be careful of applying techniques universally just because you've had one successful experience that upon honest self-reflection, you probably don't completely understand…even though you completely loved the outcome.

Despite the empirical studies and the anecdotal stories that are commonly shared by the various "Taste Great/Less Filing" acolytes, all which seem to invoke the universality of their respective preferences, we think that decisions about capital structure and capital allocation shouldn't be solely predicated on an expectation of what will occur with the stock price. We also think every company needs to formulate their own philosophy of how to return excess cash to shareholders in a way that optimizes corporate interests. We still believe that the best approach for Expeditors is to pursue a responsible policy that includes elements of the three things a company like ours can do with any excess cash, that being; (1) growing dividend payments; (2) regularly buying back shares, particularly when "opportunities" present themselves and (3) investing in our business…investing in our business being our first priority (which by the way, in addition to the nearly $2.1 billion returned to the shareholders from 2003 through 2012 that we mentioned previously, we also invested $663 million over the same period of time). We feel that policy ultimately brings the greatest benefit to shareholders. We have actively done all three of these for years. How best to "ratchet up" one of the three options more significantly than has been done to date to address the "problem" of having excess cash is currently a matter of debate and discussion at Expeditors at the very highest levels, including the Board of Directors.

Anything said beyond this would be making predictions, which, we would hope by now, everyone would know we don't do. We tend to follow Peter Drucker's line of thought "The best way to predict the future is to create it."

Lastly, we should clarify the comment on the IPO, since we've heard some rather strange permutations of this coming back to us. That answer was given in kind of a cavalier response to a question on what we're going to do with our cash. We made the point that capital in and of itself is not a direct driver of growth in a non-asset model. We obviously don't have the actual proceeds from the IPO in our bank. But...the IPO money provided additional working capital and got some of the pre-IPO owners off of onerous bank and customs guarantees. However, those proceeds, in and of themselves, did not drive growth.

2. Can you please provide some more detail on your monthly air freight volume trends during 2Q13 as we saw a deceleration in growth from +9% in April to +1% in June. Can you discuss some of the moving parts behind those figures - unusual shipments, different customer mix, weight impact, 2012 comps, EXPD's relative performance vs. industry trends, etc. Also can you please provide some color on how your air freight volume have trended so far in 3Q13? Do you expect your volumes will grow at a higher, lower, similar pace to the industry in 2013 (for both air and ocean)?

We're not sure what kind of "moving parts" discussion would be helpful here. We've always taken a very simple approach to how we look at our business. The numbers pretty much speak for themselves with respect to the year-over-year monthly comparisons. There was more of a percentage airfreight increase in April 2013 compared with April 2012 than in June 2013 compared with June 2012.

Interpreting what these trends mean devolves into a kind of a speculative exercise in interpolation of freight dynamics that we usually leave to others to divine for themselves. Here are the things we see:

• While the increase percentage trends looks a little odd, the actual underlying sequential monthly increases in air tonnage through the 2013 second quarter followed the monthly patterns we'd expect for a second quarter. In other words, while the monthly percentage increases suggest a year-over-year weakening trend, the monthly distribution of air tonnage throughout the three months of the 2013 second quarter followed the logical patterns we'd expect through the quarter… and the quarter appeared quite healthy to us.

• During the month of July 2013, airfreight tonnages were up approximately 10% over the amounts moved by airfreight in July 2012. There was a much smaller June-to-July drop-off in airfreight tonnage in 2013 than we experienced in 2012 (the month of June typically being the highest volume month in the quarter because of the number of corporate quarter-ends it represents).

• Year-over-year August 2013 versus August 2012 airfreight tonnage increased 1%. During the month of August


2013 airfreight tonnages were up 2% from tonnages moved in July 2013.
• High-tech remains a very big part of our July and August year-over-year increases, but retail, healthcare and oil and energy also posted good gains.

So at this stage, these things seem positive. We're keenly aware that we still have a lot of work to do.

We historically haven't commented much on "industry trends." We've actually done more of this recently because of some of the underlying changes in carrier dynamics and the high-tech markets. We've been counter to the trends so many times, that we're really more comfortable focusing on those "Expeditors trends" that we feel we can actually do something about.

3. Any commentary you can give on the competitive backdrop would be helpful. Specifically on the TransPac lane (but also generally), are you seeing increased competition from peers who've traditionally focused on other regions of the world? Are these peers pricing more aggressively in an effort to gain share on new lanes? How sustainable do you think this strategy is? How are you able to win these 'short-term market share battles without losing the long-term profitability wars'? What kind of impact has increased competition had on working capital needs? Is EXPD looking to expand its own geographic presence into new markets or markets that have been less of a focus in the past? If so, which might be they be and how are you going about doing so?

We've been asked these questions a lot lately. Tough competition is nothing new. There has always been tough competition on the Trans Pacific lanes. It is, by its nature, a very intense NVOCC market. It isn't unusual for us to deliberately "lose" business on price or onerous terms and conditions. We may opt to not service some accounts on some lanes when the pricing exercise turns into a "How Low Can You Go" Limbo routine (complete with the refrains of Chubby Checkers singing the Limbo Rock in the background). We tend to bail out on the pricing limbo exercises well before we're forced into some contorted position scraping our backsides on the ground as we attempt to shinny under a negative profitability stick. We should emphasize here that these decisions don't mean we choose to "lose" customers. We try to create relationships of trust and understanding with our customers where we can maintain engagement despite the decisions they feel they need to make in the face of our inability to perform services at rates where we don't feel we can provide the level of customer service we know they expect. We do this by being respectful of their decisions while understanding that we might not always be perceived as the customer's best choice at that time. We reinforce our commitment by being as professional as possible in how we respect our customers' supply-chain decisions when they request that we transition business to another provider. We hate it, but at the end of the day that's part of developing constructive customer relationships. Done correctly, our customers will continue to think of us when new opportunities arise.

Still, it is more usual for us to on-board new customers or increase our business with an existing customer through our active sales and customer retention efforts than it is to lose customers or business on purely pricing issues. We historically gain more share than we lose. While we are aware of competitors being more vocal about their intentions, and we'll certainly protect ourselves, offensively and defensively against vocalizations that are relayed to us, at the end of the day, certainly from a macro prospective, we really haven't noticed any difference in how we're obtaining and retaining customers beyond the normally expected trends.

This is a market where you need to be very careful not to "take" market share at rates that are unsustainable. The funny thing about focusing on one dimensional goals, like market share gains, is that you will get two dimensional results, one of which you've decided doesn't warrant any prospective consideration (i.e. market share gains without regard to sustainable profitability). Ours is a business where you need to have two dimensional success. As we've noted before, in a service business like logistics, gaining market share isn't nearly as important as gaining profitable market share. To us, this is the difference between "taking market share" and having market share "take you." We'd prefer not to be "taken." We think our shareholders would agree. Giving the shareholders' money to potential customers to induce them to move freight through our Expeditors network seems somewhat counter-productive…let alone a breach of our fiduciary responsibility and moral obligation to make money for those same shareholders.

Customers' requiring longer trade credit terms is a well-publicized trend, not just in our industry but in all industries. Some competitors seem more willing to abandon sound working capital principles than others. With interest rates low, resorting to short-term bank debt to compensate for extended payment turns might be an acceptable short-term solution, but could prove to be a problematic long-term strategy if and when interest rates rise. We've tried to create an equilibrium by managing cash inflows and outflows and minimizing cash outlays and advances.

With respect to expansion, we continue to explore opportunities in Russia and western Africa. We have a number of


places throughout the globe where we can expand our footprint by establishing satellite offices supported and linked into our full-service offices. We should emphasize here that we have no established timetable for opening offices in any of these countries. We've always said that we open new offices by "plan"…as in some markets we actively need to establish a presence to service growing customer demand. In both of these areas, we'd be offering specific services in a way we can ensure compliance with legal requirements. Both these areas would fall more into the "Plan" area. We are also keeping a close eye on a number of other markets where we sense that the right opportunity would allow us to expand. Those opportunities are either the sudden development of a critical mass of business from an existing customer or the right person who walks through the door and wants to buy into the Expeditors culture by expanding the Expeditors network in one of these markets. We know where these markets are, we know what stage of market development we've achieved in each of these locations, and we'll know when to open.

4. What operational challenges might be posed by an increasing amount of air capacity in passenger bellies vs. dedicated cargo space? How can you adjust your operations to better manage the situation? How should we think about the impact on profitability from the shift?

There are some adjustments that always need to be made as each year presents its own set of unique challenges. We've always shipped freight in passenger belly space, so it's not like we need to re-invent the wheel. We're just doing more as opposed to less of tendering cargo to be moved in passenger bellies. We need to use smaller pallets in many instances, but that is compensated by having more options and more increased capacity to pick from. For instance, the Boeing 777 has turned out to be a very good cargo plan in a passenger/ belly space combined configuration. In fact, it is in many ways superior to the esteemed 747-400 passenger/belly space's configuration. The A-380, by contrast, is not particularly well-suited to carry a lot of cargo in a 450+ passenger configuration.

Another relevant fact is that regardless of what the forwarding industry may think…or want; increasing the amount of cargo space within existing passenger flights and reducing dedicated cargo freighter capacity is the way the international air carrier industry is moving. One major US-based international air carrier discontinued and grounded their dedicated freighter fleet while expanding their emphasize on available cargo belly space on existing and expanded passenger routes. They actually moved more cargo with an extended "all belly" cargo strategy than they were moving using a mix of dedicated freighters and passenger belly space.
Whatever the perception of this shift, we've already made any necessary transitions to accommodate the carriers and our customers. We haven't seen any serious profitability impacts that are a result of using passenger versus freighter in increasing amounts relative to five years ago.

5. Customs brokerage and other services revenue increased 6% but net revenue only rose 2.1% due to a 170bp y/y contraction in the net revenue margin. Could you please explain the key factors that pinched the margin? What is the current mix in net revenues between 1) customs brokerage and 2) other?

In other words unitary costs were higher in 2013 than in 2012. Custom brokerage and import services net revenue in 2013 are más o menos 70% of the customs brokerage and other net revenue amount. This lower margin was primarily due to ourTranscon business as a result of higher costs and a decision, for market considerations, to limit how much of these increased costs we would pass through to our customers.

6. Net revenue margin (yields) expanded y/y in airfreight, while volumes decelerated through the quarter. Were yields then accelerating through the quarter due to their typical inverse relationship with volumes?

We'll start this answer by clarifying a fundamental misunderstanding that showed up in this question. Volumes did not decelerate in the second quarter. The year-over-year percentage growth in tonnage decelerated. Actual airfreight tonnage volumes accelerated throughout the quarter as one would expect. The yields declined in June relative to May, and then increased in July relative to May and June.

7. Are you seeing any noticeable changes in lane balance in the trans-Pacific (Asia to U.S. historically having ~4x the volume as U.S. to Asia) in air and/or ocean? If so, is this a net positive or negative for your business?

From a net revenue perspective, we've seen this difference shrink somewhat. That isn't always completely indicative of associated freight volumes, but can be generally relied on as a somewhat representative proxy of actual volumes. In our book, this is a positive development.


8. What was TEU growth and airfreight tonnage growth for July 2013 vs. July 2012?

Approximately 10% and 10%, respectively. We should also note here that it has been somewhat interesting to us that with some of the conjecture out there that implied that we had commented on our July volumes. This 8-K is the first time we've actually commented on what our July volumes were.

9. $4.5mm in Other income - anything significant in there besides foreign exchange gains?

Nope.

10. Historically you were comfortable with cash at about 50% of receivables. The business thrived for many years with cash at that level. Why are you running cash at 140% of receivables? Why are you not returning 100% of earning to shareholders? You could return 100% of earnings to shareholders for many years, and still fund CapEx and maintain a cash level well about 50% of receivables.

We don't ever recall making any kind of statement as to what percentage of cash as a percentage of receivables we were comfortable with.

Asking us why we are running cash at 140% of receivables is a little like asking us "Why is there air?" (apologies to Bill Cosby who once produced a record album with that title…the content of which, frankly speaking, made a lot more sense than parts of this question. Of course Bill Cosby is a comedian who gets paid to write and say things that will make people laugh). While we do have a lot of cash at the moment, hardly the worst challenge to have. As we've noted, as we're . . .

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