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EXPD > SEC Filings for EXPD > Form 10-Q on 7-Nov-2013All Recent SEC Filings

Show all filings for EXPEDITORS INTERNATIONAL OF WASHINGTON INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for EXPEDITORS INTERNATIONAL OF WASHINGTON INC


7-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995; CERTAIN CAUTIONARY STATEMENTS
Certain portions of this report on Form 10-Q including the sections entitled "Overview," "Strategy and Culture," "International Trade and Competition," "Seasonality," "Critical Accounting Estimates," "Results of Operations," "Currency and Other Risk Factors" and "Liquidity and Capital Resources" contain forward-looking statements. Words such as "expects," "goals," "plans," "believes," "estimates," "continues," "may," "will," and variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of future financial performance, our anticipated growth and trends in the Company's businesses, and other characterizations of future events or circumstances are forward-looking statements. These statements must be considered in connection with the discussion of the important factors that could cause actual results to differ materially from the forward-looking statements. Attention should be given to the factors identified and discussed in the Company's annual report on Form 10-K filed on February 27, 2013.
Overview
Expeditors International of Washington, Inc. is engaged in the business of global logistics management, including international freight forwarding and consolidation, for both air and ocean freight. The Company acts as a customs broker in all domestic offices, and in many of its international offices. The Company also provides additional services for its customers including value-added distribution, purchase order management, vendor consolidation, domestic time definite transportation services, cargo insurance and other logistics solutions. The Company does not compete for overnight courier or small parcel business. As a non-asset based carrier, the Company does not own or operate transportation assets, such as aircraft or steamships.
The Company derives its revenues from three principal sources: 1) airfreight services, 2) ocean freight and ocean services, and 3) customs brokerage and other services. These are the revenue categories presented in the financial statements.
The Company generates the major portion of its air and ocean freight revenues by purchasing transportation services on a wholesale basis from direct (asset-based) carriers and reselling those services to its customers on a retail basis. The difference between the rate billed to customers (the sell rate) and the rate paid to the carrier (the buy rate) is termed "net revenue" (a non-GAAP measure), "yield" or "margin." By consolidating shipments from multiple customers and concentrating its buying power, the Company is able to negotiate favorable buy rates from the direct carriers, while at the same time offering lower sell rates than customers would otherwise be able to negotiate themselves. The most significant drivers of changes in gross revenues and related transportation expenses are volume, sell rates and buy rates. Volume has a similar effect on the change in both gross revenues and related transportation expenses in each of our three primary sources of revenue.
In most cases the Company acts as an indirect carrier. When acting as an indirect carrier, the Company will issue a House Airway Bill (HAWB) or a House Ocean Bill of Lading (HOBL) to customers as the contract of carriage. In turn, when the freight is physically tendered to a direct carrier, the Company receives a contract of carriage known as a Master Airway Bill for airfreight shipments and a Master Ocean Bill of Lading for ocean shipments. In these transactions, the Company is the primary obligor, is obligated to compensate direct carriers for services performed regardless of whether customers accept the service, has latitude in establishing price, has discretion in selecting the direct carrier and has credit risk. Therefore, the Company is the principal in these transactions and reports revenue and the related expenses on a gross basis.
For revenues earned in other capacities, for instance, when the Company does not issue an HAWB or an HOBL or otherwise acts solely as an agent for the shipper, only the commissions and fees earned for such services are included in revenues. In these transactions, the Company is not a principal and reports only commissions and fees earned in revenue.
Customs brokerage and other services involves providing services at destination, such as helping customers clear shipments through customs by preparing and filing required documentation, calculating and providing for payment of duties and other taxes on behalf of the customers as well as arranging for any required inspections by governmental agencies, and arranging for delivery. These are complicated functions requiring technical knowledge of customs rules and regulations in the multitude of countries in which the Company has offices. The Company is managed along three geographic areas of responsibility: Americas; Asia Pacific; and Europe, Africa, Near/Middle East and Indian Subcontinent (EMAIR). Each area is divided into sub-regions which are composed of operating units with individual profit and loss responsibility. The Company's business involves shipments between operating units and typically touches more than one geographic area. The nature of the international logistics business necessitates a high degree of communication and cooperation among operating units. Because of this inter-relationship between operating units, it is very difficult to look at one geographic area and draw meaningful conclusions as to its contribution to the Company's overall success on a stand-alone basis.


The Company's operating units share revenue using the same arms-length pricing methodologies the Company uses when its offices transact business with independent agents. The Company charges its subsidiaries and affiliates for services rendered in the United States on a cost recovery basis. The Company's strategy closely links compensation with operating unit profitability. Individual success is closely linked to cooperation with other operating units within the network.
The mix of services varies by segment based primarily on the import or export orientation of local operations in each region. In accordance with the Company's revenue recognition policy (see Note 1. E. to the consolidated financial statements in the Company's annual report on Form 10-K filed on February 27, 2013), almost all freight revenues and related expenses are recorded at origin and shipment profits are split between origin and destination offices by recording a commission fee or profit share revenue at destination and a corresponding commission or profit share expense as a component of origin consolidation costs. The Asia Pacific segment is the Company's largest export oriented region and accounted for 50% of revenues and 40% of operating income for the nine months ended September 30, 2013. Asia Pacific's operating income as a percentage of revenue is lower than other segments due to the largely export nature of operations in that region.

Strategy and Culture
The Company has pursued a strategy emphasizing organic growth supplemented by certain strategic acquisitions. From the inception of the Company, management has believed that the elements required for a successful global service organization can only be assured through recruiting, training, and ultimately retaining superior personnel. The Company's greatest challenge is now and always has been perpetuating a consistent global corporate culture which demands:
Total dedication, first and foremost, to providing superior customer service;

Compliance with Company policies and government regulations;

Aggressive marketing of all of the Company's service offerings;

Ongoing development of key employees and management personnel via formal and informal means;

Creation of unlimited advancement opportunities for employees dedicated to hard work, personal growth and continuous improvement;

Individual commitment to the identification and mentoring of successors for every key position so that when inevitable change occurs, a qualified and well-trained internal candidate is ready to step forward; and

Continuous identification, design and implementation of system solutions, both technological and otherwise, to meet and exceed the needs of our customers while simultaneously delivering tools to make our employees more efficient and more effective.

The Company reinforces these values with a compensation system that rewards employees for profitably managing the things they can control. This compensation system has been in place since the Company became a publicly traded entity. There is no limit to how much a key manager can be compensated for success. The Company believes in a "real world" environment in every operating unit where individuals are not sheltered from the profit implications of their decisions. If these decisions result in operating losses, these losses must be made up from future operating profits, in the aggregate, before any cash incentive compensation can be earned. At the same time, the Company insists on continued focus on such things as accounts receivable collection, cash flow management and credit soundness in an attempt to insulate managers from the sort of catastrophic errors that might end a career.
Any failure to perpetuate this unique culture on a self-sustained basis throughout the Company provides a greater threat to the Company's continued success than any external force, which would be largely beyond our control. Consequently, management spends the majority of its time focused on creating an environment where employees can learn and develop while also improving systems and taking preventative action to reduce exposure to negative events and risks. The Company strongly believes that it is nearly impossible to predict events that, in the aggregate, could have a positive or a negative impact on future operations. As a result our focus is on building and maintaining a global corporate culture of well-trained employees and managers that are prepared to identify and react to subtle changes as they develop and thereby help the Company adapt and thrive as major trends emerge.
The Company's ability to provide services to its customers is highly dependent on good working relationships with a variety of entities including airlines, ocean steamship lines, and governmental agencies. The significance of maintaining acceptable working relationships with governmental agencies and asset-based carriers involved in global trade has gained increased importance as a result of ongoing concern over terrorism. As each carrier labors to comply with additional governmental regulations implementing security policies and procedures, inherent conflicts emerge which can and do affect global trade. A good reputation helps to develop practical working understandings that will assist in meeting security requirements while minimizing potential international trade obstacles, especially as governments promulgate new regulations and increase oversight and enforcement of new and existing laws. The Company considers its current working relationships


with these entities to be satisfactory. The airline and ocean steamship line industries have incurred significant losses in recent years and many carriers are highly leveraged with debt. This situation has required the Company to be increasingly selective in determining which carriers to utilize. Further changes in the financial stability, operating capabilities and capacity of asset-based carriers, space allotments available from carriers, governmental regulations, modernization of the regulations governing customs brokerage, and/or changes in governmental quota restrictions or trade accords could affect the Company's business in unpredictable ways.

International Trade and Competition
The Company operates in 63 countries throughout the world in the competitive global logistics industry and Company activities are tied directly to the global economy. International trade is influenced by many factors, including economic and political conditions in the United States and abroad, currency exchange rates, and laws and policies relating to tariffs, trade restrictions, foreign investments and taxation. Periodically, governments consider a variety of changes to current tariffs and trade restrictions and accords. The Company cannot predict which, if any, of these proposals may be adopted, or the effects the adoption of any such proposal will have on the Company's business. Doing business in foreign locations also subjects the Company to a variety of risks and considerations not normally encountered by domestic enterprises. In addition to being influenced by governmental policies concerning international trade, the Company's business may also be affected by political developments and changes in government personnel or policies, as well as economic turbulence, political unrest and security concerns in the nations in which it does business and the future impact that these events may have on international trade and oil prices. The global logistics services industry is intensely competitive and is expected to remain so for the foreseeable future. Consistent with continuing uncertainty in global economic conditions, concerns over volatile fuel costs, rising costs in general, political unrest and fluctuating currency exchange rates, the Company's pricing and terms continue to be pressured by customers, carriers and service providers which resulted in a compression of the Company's 2012 margins. In the quarter ended September 30, 2013, the Company's ocean freight consolidation net revenue per container decreased 16%, as compared with the third quarter of 2012, primarily related to exports out of China. The Company cannot predict what impact ongoing uncertainties in the global economy may have on its operating results, freight volumes, pricing, changes in consumer demand, carrier stability and capacity, customers' abilities to pay or on changes in competitors' behavior.

Seasonality
Historically, the Company's operating results have been subject to a seasonal trend when measured on a quarterly basis. The first quarter has traditionally been the weakest and the third and fourth quarters have traditionally been the strongest. This pattern is the result of, or is influenced by, numerous factors including weather patterns, national holidays, consumer demand, new product launches, economic conditions and a myriad of other similar and subtle forces. In addition, this historical quarterly trend has been influenced by the growth and diversification of the Company's international network and service offerings.
A significant portion of the Company's revenues are derived from customers in retail industries whose shipping patterns are tied closely to consumer demand, and from customers in industries whose shipping patterns are dependent upon just-in-time production schedules. Therefore, the timing of the Company's revenues are, to a large degree, impacted by factors out of the Company's control, such as a sudden change in consumer demand for retail goods and/or manufacturing production delays. Additionally, many customers ship a significant portion of their goods at or near the end of a quarter, and therefore, the Company may not learn of a shortfall in revenues until late in a quarter. To the extent that a shortfall in revenues or earnings was not expected by securities analysts, any such shortfall from levels predicted by securities analysts could have an immediate and adverse effect on the trading price of the Company's stock. The Company cannot accurately forecast many of these factors or estimate accurately the relative influence of any particular factor and, as a result, there can be no assurance that historical patterns, if any, will continue in future periods.

Critical Accounting Estimates
The preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States requires that the Company make estimates and judgments. The Company bases its estimates on historical experience and on assumptions that it believes are reasonable. The Company's critical accounting estimates are discussed in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of the


Company's annual report on Form 10-K for the year ended December 31, 2012, filed on February 27, 2013. There have been no material changes to the critical accounting estimates previously disclosed in that report. Results of Operations
The following table shows the calculation of consolidated net revenues (a non-GAAP measure calculated as revenues less directly related operations expenses attributable to the Company's principal services) and the Company's expenses for the three and nine-month periods ended September 30, 2013 and 2012, expressed as percentages of net revenues. Management believes that net revenues are a better measure than total revenues when analyzing and discussing management's effectiveness in managing the Company's principal services since total revenues earned by the Company as a freight consolidator includes the carriers' charges to the Company for carrying the shipment, whereas revenues earned by the Company in its other capacities include primarily the commissions and fees earned by the Company. Net revenue is one of the Company's primary operational and financial measures that demonstrates the ability of the Company to manage sell rates to customers with its ability to concentrate and leverage its purchasing power through effective consolidation of shipments from multiple customers utilizing a variety of transportation carriers and optimal routings. Using net revenue also provides a commonality for comparison among various services.
The table and the accompanying discussion and analysis should be read in conjunction with the condensed consolidated financial statements and related notes thereto which appear elsewhere in this quarterly report.

                                     Three months ended September 30,                          Nine months ended September 30,
                                      2013                         2012                       2013                        2012
                                               Percent                   Percent                     Percent                     Percent
                                               of net                    of net                      of net                      of net
                               Amount         revenues      Amount      revenues       Amount       revenues       Amount       revenues
(in thousands)
Airfreight services:
Revenues                 $    628,116                     $ 622,678                 $ 1,891,459                 $ 1,900,131
Expenses                      466,699                       471,947                   1,414,634                   1,437,301
Net revenues                  161,417             33 %      150,731         32 %        476,825         34 %        462,830         34 %
Ocean freight services
and ocean services:
Revenues                      525,193                       549,250                   1,462,679                   1,502,584
Expenses                      409,649                       432,518                   1,135,299                   1,177,919
Net revenues                  115,544             24        116,732         25          327,380         24          324,665         24
Customs brokerage and
other services:
Revenues                      381,780                       359,736                   1,091,889                   1,045,271
Expenses                      176,716                       162,061                     499,684                     467,406
Net revenues                  205,064             43        197,675         43          592,205         42          577,865         42
Total net revenues            482,025            100        465,138        100        1,396,410        100        1,365,360        100
Overhead expenses:
Salaries and related
costs                         261,613             54        252,899         54          765,599         55          748,956         55
Other                          74,099             16         67,140         15          212,401         15          213,631         16
Total overhead expenses       335,712             70        320,039         69          978,000         70          962,587         71
Operating income              146,313             30        145,099         31          418,410         30          402,773         29
Other income, net               4,179              1          3,881          1           16,348          1           14,228          1
Earnings before income
taxes                         150,492             31        148,980         32          434,758         31          417,001         30
Income tax expense             57,763             12         60,253         13          168,756         12          167,531         12
Net earnings                   92,729             19         88,727         19          266,002         19          249,470         18
Less net earnings
attributable to the
noncontrolling interest           329              -            237          -              972          -              318          -
Net earnings
attributable to
shareholders             $     92,400             19 %    $  88,490         19 %    $   265,030         19 %    $   249,152         18 %

Airfreight services:
Airfreight services revenues increased 1% for the three-month period ended September 30, 2013, as compared with the same period for 2012, due to a 3% increase in tonnage that was partially offset by the Company lowering sell rates to reflect soft market conditions primarily caused by higher available capacity relative to demand. Airfreight services expenses decreased 1% for the three-month period ended September 30, 2013, as compared with the same period for 2012, as the increase in tonnage was more than offset by improved buy rates and effective carrier utilization.
Airfreight services revenues decreased slightly and related expenses declined 2% for the nine-month period ended September 30, 2013, as compared with the same period for 2012, as a 3% increase in tonnage was offset by lower sell and buy rates for the market conditions described above.
Airfreight services net revenues increased 7% for the three-month period ended September 30, 2013, as compared with the same period for 2012. The increase in global airfreight services net revenues was primarily due to a 3% increase in airfreight tonnage and a 4% increase in net revenue per kilo. North America, Asia Pacific and Europe airfreight services net revenues increased 9%, 4% and 6%, respectively, as air export tonnage increased 3%, 1% and 5%, respectively. Airfreight services net revenues increased 3% for the nine-month period ended September 30, 2013, as compared with the same period for 2012. The increase in global airfreight services net revenues was principally due to a 3% increase in airfreight tonnage. North America, Asia Pacific and Europe airfreight services net revenues increased 2%, 4% and 2%, respectively, in the nine months ended September 30, 2013 as compared with the same periods in 2012, while airfreight export tonnage for North America, Asia Pacific and Europe increased 1%, 4% and 3%, respectively.

The global airfreight market continues to be affected by the decrease in size and weight of high technology consumer products and the timing of new product launches. Customers remain focused on improving supply-chain efficiency by utilizing deferred airfreight or ocean freight whenever possible. The Company expects these trends to continue in conjunction with carriers' efforts to manage available capacity, however, this could be affected by new product launches during periods that have historically experienced higher demands. These factors result in a higher degree of volatility in both rates and volumes. Ocean freight services and ocean services:
Ocean freight and ocean services revenues decreased 4% and 3%, respectively, for the three and nine-month periods ended September 30, 2013, as compared with the same periods for 2012, primarily driven by lower sell rates to customers, reflecting increased carrier capacity that outpaced overall market demand. Ocean freight and ocean services expenses decreased 5% and 4%, respectively, for the three and nine-month periods ended September 30, 2013, as compared with the same periods for 2012, primarily due to reduced buy rates from carriers as a result of the market conditions referenced above. The decreases in sell and buy rates were partially offset by an increase in container volumes of 9% and 3%, respectively, for the three and nine-month periods ended September 30, 2013, as compared with the same periods for 2012. Container volume is measured in terms of forty-foot container equivalent units (FEUs).
Container volumes increased 9% for the three-month period ended September 30, 2013, as compared with the same period for 2012, while ocean freight and ocean services net revenues decreased 1%, primarily resulting from pricing reductions needed to both maintain and gain market share. Ocean freight and ocean services net revenues increased 1% for the nine-month period ended September 30, 2013, as compared with the same period for 2012, primarily resulting from additional services and volumes with new and existing customers utilizing order management services. Ocean freight and ocean services net revenues are comprised of three basic services: ocean freight consolidation, direct ocean forwarding and order management. The largest component is ocean freight consolidation, which represented 44% and 46% of ocean freight net revenue for the three and nine-month periods ended September 30, 2013, respectively, and 47% for the same periods ended in 2012.
Ocean freight consolidation net revenues decreased 8% for the three-month period ended September 30, 2013, as compared with the same period in 2012, primarily due to a 16% decrease in net revenue per container, partially offset by a 9% increase in container volume. During the third quarter of 2013, ocean carriers attempted on several occasions to impose general price increases. Ultimately, these efforts were unsuccessful and market ocean rates continued to fall throughout the quarter in the face of ongoing capacity issues. In order to maintain and grow market share, the Company reacted to these market trends by temporarily absorbing carrier cost increases, when the Company anticipated such cost increases would be temporary and could not be sustained by the carriers. The Company also implemented rate reductions with its customers where needed to reflect market conditions, mostly on exports from China. Ocean freight consolidation net revenues decreased 1% for the nine-month period ended September 30, 2013, as compared with the same period in 2012, primarily due to a 5% decrease in net revenue per container, partially offset by a 3% increase in container volume.
Direct ocean freight forwarding net revenues increased 1% and remained constant, respectively, for the three and nine-month periods ended September 30, 2013, as compared with the same periods in 2012. Order management net revenues increased 9% and 6%, respectively, for the three and nine-month periods ended September 30, 2013 as compared with the same periods in 2012, mostly due to additional services and volumes with new and existing customers.
North America and Europe ocean freight and ocean services net revenues increased 3% and 1%, respectively, while Asia Pacific decreased 6% in the third quarter of 2013, as compared with the same period in 2012. North America ocean freight and ocean services net revenues increased 3%, while Europe remained flat and Asia Pacific decreased 2% in the nine-month period ended September 30, 2013, as compared with the same period in 2012. The decreases in net revenues in Asia . . .

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