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INT > SEC Filings for INT > Form 10-K on 14-Feb-2014All Recent SEC Filings

Show all filings for WORLD FUEL SERVICES CORP

Form 10-K for WORLD FUEL SERVICES CORP


14-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with "Item 6 - Selected Financial Data," and with the accompanying consolidated financial statements and related notes thereto appearing elsewhere in this 2013 10-K Report. The following discussion may contain forward-looking statements, and our actual results may differ significantly from the results suggested by these forward-looking statements. Some factors that may cause our results to differ materially from the results and events anticipated or implied by such forward-looking statements are described in "Item 1A - Risk Factors."

Overview
We are a leading global fuel logistics company, principally engaged in the marketing, sale and distribution of aviation, marine, and land fuel and related products and services on a worldwide basis. We compete by providing our customers with value-added benefits, including single-supplier convenience, competitive pricing, the availability of trade credit, price risk management, logistical support, fuel quality control and fuel procurement outsourcing. We have three reportable operating business segments: aviation, marine, and land. We primarily contract with third parties for the delivery and storage of fuel products, however, in some cases we own storage and transportation assets for strategic purposes. Additionally, we offer transaction management services which consist of card payment solutions and merchant processing services to customers in the aviation, marine and land transportation industries. In our aviation segment, we offer fuel and related products and services to major commercial airlines, second and third-tier airlines, cargo carriers, regional and low cost carriers, airports, fixed based operators, corporate fleets, fractional operators, private aircraft, military fleets and to the U.S. and foreign governments. In our marine segment, we offer fuel, lubricants and related products and services to a broad base of marine customers, including international container and tanker fleets, commercial cruise lines, yachts and time-charter operators, as well as to the U.S. and foreign governments. In our land segment, we offer fuel, lubricants and related products and services to petroleum distributors operating in the land transportation market, retail petroleum operators, and industrial, commercial and government customers and we engage in crude oil marketing activities.

In our aviation and land segments, we primarily purchase and resell fuel and other products, and we do not act as brokers. Profit from our aviation and land segments is primarily determined by the volume and the gross profit achieved on fuel resales and a percentage of card payment and processing revenue. In our marine segment, we primarily purchase and resell fuel and also act as brokers for others. Profit from our marine segment is determined primarily by the volume and gross profit achieved on fuel resales and by the volume and commission rate of the brokering business. Our profitability in our segments also depends on our operating expenses, which may be significantly affected to the extent that we are required to provide for potential bad debt.

Our revenue and cost of revenue are significantly impacted by world oil prices, as evidenced in part by our revenue and cost of revenue fluctuations in previous fiscal years, while our gross profit is not necessarily impacted by changes in world oil prices. However, significant movements in fuel prices during any given financial period can have a significant impact on our gross profit, either positively or negatively depending on the direction, volatility and timing of such price movements.


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We may experience decreases in future sales volumes and margins as a result of the ongoing deterioration in the world economy, the decline of the transportation industry, natural disasters and continued conflicts and instability in the Middle East, Asia and Latin America, as well as potential future terrorist activities and possible military retaliation. In addition, because fuel costs represent a significant part of our customers' operating expenses, volatile and/or high fuel prices can adversely affect our customers' businesses, and, consequently, the demand for our services and our results of operations. Our hedging activities may not be effective to mitigate volatile fuel prices and may expose us to counterparty risk. See "Item 1A - Risk Factors" of this 2013 10-K Report.

Reportable Segments
We have three reportable operating segments: aviation, marine and land. Corporate expenses are allocated to each segment based on usage, where possible, or on other factors according to the nature of the activity. We evaluate and manage our business segments using the performance measurement of income from operations. Financial information with respect to our business segments is provided in Note 11 to the accompanying consolidated financial statements included in this 2013 10-K Report.

Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements included elsewhere in this 2013 10-K Report, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to unbilled revenue and related costs of sales, bad debt, share-based payment awards, derivatives, goodwill and identifiable intangible assets and certain accrued liabilities. We base our estimates on historical experience and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We have identified the policies below as critical to our business operations and the understanding of our results of operations. For a detailed discussion on the application of these and other significant accounting policies, see Note 1 to the accompanying consolidated financial statements included in this 2013 10-K Report.

Revenue Recognition
Revenue from the sale of fuel is recognized when the sales price is fixed or determinable, collectability is reasonably assured and title passes to the customer, which is when the delivery of fuel is made to our customer directly from us, the supplier or a third-party subcontractor. Our fuel sales are generated as a fuel reseller as well as from on-hand inventory supply. When acting as a fuel reseller, we generally purchase fuel from the supplier, and contemporaneously resell the fuel to the customer, normally taking delivery for purchased fuel at the same place and time as the delivery is made to the customer. We record the gross sale of the fuel as we generally take inventory risk, have latitude in establishing the sales price, have discretion in the supplier selection, maintain credit risk and are the primary obligor in the sales arrangement.

Revenue from fuel-related services is recognized when services are performed, the sales price is fixed or determinable and collectability is reasonably assured. We record the sale of fuel-related services on a gross basis as we generally have latitude in establishing the sales price, have discretion in supplier selection, maintain credit risk and are the primary obligor in the sales arrangement.

Commission from fuel broker services is recognized when services are performed and collectability is reasonably assured. When acting as a fuel broker, we are paid a commission by the supplier.

Revenue from card payment and processing transactions is recognized at the time the purchase is made by the customer using the charge card. Revenue from charge card transactions is generated from processing fees.

Share-Based Payment Awards
We account for share-based payment awards on a fair value basis. Under fair value accounting, the grant-date fair value of the share-based payment award is amortized as compensation expense, on a straight-line basis, over the vesting period for both graded and cliff vesting awards. Annual compensation expense for share-based payment awards is reduced by an expected forfeiture amount on the outstanding share-based payment awards.


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The estimated fair value of stock awards, such as restricted stock and RSUs is based on the grant-date market value of our common stock, as defined in the respective plans under which the awards were granted. To determine the estimated fair value of SSAR Awards, we use the Black-Scholes option pricing model. The estimation of the fair value of SSAR Awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rates and expected dividends. The expected term of SSAR Awards represents the estimated period of time from grant until exercise or conversion and is based on vesting schedules and expected post-vesting, exercise and employment termination behavior. Expected volatility is based on the historical volatility of our common stock over the period that is equivalent to the award's expected life. Any adjustment to the historical volatility as an indicator of future volatility would be based on the impact to historical volatility of significant non-recurring events that would not be expected in the future. Risk-free interest rates are based on the U.S. Treasury yield curve at the time of grant for the period that is equivalent to the award's expected life. Dividend yields are based on the historical dividends of World Fuel over the period that is equivalent to the award's expected life, as adjusted for stock splits.

Cash flows from income tax benefits resulting from income tax deductions in excess of the compensation cost recognized for share-based payment awards (excess income tax benefits) are classified as financing cash flows. These excess income tax benefits are credited to capital in excess of par value.

Accounts Receivable and Allowance for Bad Debt Credit extension, monitoring and collection are performed for each of our business segments. Each segment has a credit committee that is responsible for approving credit limits above certain amounts, setting and maintaining credit standards, and managing the overall quality of the credit portfolio. We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer's current creditworthiness, as determined by our review of our customer's credit information. We extend credit on an unsecured basis to most of our customers. Accounts receivable are deemed past due based on contractual terms agreed to with our customers.

We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience with our customers, current market and industry conditions affecting our customers and any specific customer collection issues that we have identified. Historical payment trends may not be a useful indicator of current or future credit worthiness of our customers, particularly in these difficult economic and financial markets. Accounts receivable are reduced by an allowance for bad debt.

If credit losses exceed established allowances, our business, financial condition, results of operations and cash flows may be adversely affected. For additional information on the credit risks inherent in our business, see "Item 1A - Risk Factors" in this 2013 10-K Report.

Inventories
Inventories are valued using the average cost methodology and are stated at the lower of average cost or market. Components of inventory include fuel purchase costs, the related transportation costs and changes in the estimated fair market values for inventories included in a fair value hedge relationship.

Derivatives
We enter into financial derivative contracts in order to mitigate the risk of market price fluctuations in aviation, marine and land fuel, to offer our customers fuel pricing alternatives to meet their needs and to mitigate the risk of fluctuations in foreign currency exchange rates. We also enter into proprietary derivative transactions, primarily intended to capitalize on arbitrage opportunities related to basis or time spreads related to fuel products we sell. We have applied the normal purchase and normal sales exception ("NPNS"), as provided by accounting guidance for derivative instruments and hedging activities, to certain of our physical forward sales and purchase contracts. While these contracts are considered derivative instruments under the guidance for derivative instruments and hedging activities, they are not recorded at fair value, but rather are recorded in our consolidated financial statements when physical settlement of the contracts occurs. If it is determined that a transaction designated as NPNS no longer meets the scope of the exception, the fair value of the related contract is recorded as an asset or liability on the consolidated balance sheets and the difference between the fair value and the contract amount is immediately recognized through earnings.


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Our derivatives that are subject to the accounting guidance for derivative instruments are recognized at their estimated fair market value in accordance with the accounting guidance for fair value measurements. If the derivative does not qualify as a hedge or is not designated as a hedge, changes in the estimated fair market value of the derivative are recognized as a component of revenue, cost of revenue or other (expense) income, net (based on the underlying transaction type) in the consolidated statements of income and comprehensive income. Derivatives which qualify for hedge accounting may be designated as either a fair value or cash flow hedge. For our fair value hedges, changes in the estimated fair market value of the hedge instrument and the hedged item are recognized in the same line item as a component of either revenue or cost of revenue (based on the underlying transaction type) in the consolidated statements of income and comprehensive income. For our cash flow hedges, the effective portion of the changes in the fair market value of the hedge is recognized as a component of other comprehensive income in the shareholders' equity section of the consolidated balance sheets and subsequently reclassified into the same line item as the forecasted transaction when both are settled, while the ineffective portion of the changes in the estimated fair market value of the hedge is recognized as a component of other (expense) income, net in the consolidated statements of income and comprehensive income. Cash flows for our hedging instruments used in our hedges are classified in the same category as the cash flow from the hedged items. If for any reason hedge accounting is discontinued, then any cash flows subsequent to the date of discontinuance shall be classified in a manner consistent with the nature of the instrument.

To qualify for hedge accounting, as either a fair value or cash flow hedge, the hedging relationship between the hedging instruments and hedged items must be highly effective over an extended period of time in achieving the offset of changes in fair values or cash flows attributable to the hedged risk at the inception of the hedge. We use a regression analysis based on historical spot prices in assessing the qualification for our fair value hedges. However, our measurement of hedge ineffectiveness for our fair value inventory hedges utilizes spot prices for the hedged item (inventory) and forward or future prices for the hedge instrument. Therefore, the excluded component (forward or future prices) in assessing hedge qualification, along with ineffectiveness, is included as a component of cost of revenue in earnings. Adjustments to the carrying amounts of hedged items are discontinued in instances where the related fair value hedging instrument becomes ineffective and any previously recorded fair market value changes are not adjusted until the fuel is sold.

Goodwill and Identifiable Intangible Assets Goodwill represents the future earnings and cash flow potential of acquired businesses in excess of the fair values that are assigned to all other identifiable assets and liabilities. Goodwill arises because the purchase price paid reflects numerous factors, including the strategic fit and expected synergies these acquisitions bring to existing operations and the prevailing market value for comparable companies. Goodwill is not subject to periodic amortization; instead, it is reviewed annually at year-end (or more frequently under certain circumstances) for impairment. We assess qualitative factors to determine whether it is more likely than not that the fair value of any individual reporting unit is less than its carrying amount. In performing the qualitative assessment, we assess relevant events and circumstances that may impact the fair value of our reporting units, including the following:
(i) macroeconomic conditions, (ii) industry and market considerations,
(iii) earnings quality/sustainability, (iv) overall financial performance,
(v) events affecting a reporting unit, (vi) share price and (vii) recent fair value calculation for our reporting units, if available. After assessing the above described events and circumstances, if we determine that it is more likely than not that the fair value of a reporting unit is greater than its carrying value, then no further testing is required. Otherwise, we would perform the first step of quantitative testing for goodwill impairment.

From time to time, we may perform the first step of quantitative testing for goodwill impairment in lieu of performing a qualitative assessment. The first step of the goodwill impairment test compares the estimated fair value of a reporting unit with its carrying value. We estimate the fair value of a reporting unit using discounted cash flows and market capitalization methodologies.

In connection with our acquisitions, we record identifiable intangible assets existing at the date of the acquisitions for customer relationships, supplier and non-compete agreements, developed technology and trademark/trade name rights. Identifiable intangible assets subject to amortization are amortized over their estimated useful lives and are reviewed for impairment and appropriate remaining useful lives whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable based on market factors and operational considerations. For identifiable intangible assets not subject to amortization, we first assess qualitative factors to determine whether it is more likely than not that an asset has been impaired. After assessing qualitative factors, if we determine that it is more likely than not that the fair value of an asset is greater than its carrying value, then no further testing is required. Otherwise, we would review for impairment by comparing the fair value of the intangible asset to its carrying value.

Extinguishment of Liability
In the normal course of business, we accrue liabilities for fuel and services received for which invoices have not yet been received. These liabilities are derecognized, or extinguished, if either (i) payment is made to relieve our obligation for the liability or (ii) we are legally released from our obligation for the liability, such as when our legal obligations with respect to such liabilities lapse or otherwise no longer exist. We derecognized vendor liability accruals due to the legal release of our obligations in the amount of $8.5 million, $11.2 million and $8.3 million during 2013, 2012 and 2011, respectively, which is reflected as a reduction of cost of revenue in the accompanying consolidated statements of income and comprehensive income.


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Results of Operations
The results of operations include the results of (i) the Multi Service business (aviation, marine, and land segments) commencing on December 31, 2012, (ii) the CarterEnergy business (land segment) commencing on September 1, 2012,
(iii) Ascent (aviation segment) commencing on April 1, 2011 and (iv) NCS (aviation and land segments) commencing on March 1, 2011.

2013 compared to 2012

Revenue. Our revenue for 2013 was $41.6 billion, an increase of $2.6 billion, or 6.7%, as compared to 2012. Our revenue during these periods was attributable to the following segments (in thousands):

                           2013           2012      $ Change

Aviation segment   $ 16,087,611   $ 14,692,042   $ 1,395,569
Marine segment       14,790,342     14,750,425        39,917
Land segment         10,683,994      9,502,871     1,181,123

Total              $ 41,561,947   $ 38,945,338   $ 2,616,609

Our aviation segment revenue for 2013 was $16.1 billion, an increase of $1.4 billion, or 9.5% as compared to 2012. Of the increase in aviation segment revenue, $2.0 billion was due to increased volume attributable to new and existing customers, which was partially offset by $0.6 billion due to a decrease in the average price per gallon sold as a result of lower average jet fuel prices in 2013 as compared to 2012.

Our marine segment revenue for 2013 and 2012 was $14.8 billion. Of the increase in marine segment revenue, $0.5 billion was due to increased volume attributable to new and existing customers, which was principally offset by a decrease in the average price per metric ton sold as a result of lower average marine fuel prices in 2013 as compared to 2012.

Our land segment revenue for 2013 was $10.7 billion, an increase of $1.2 billion, or 12.4%, as compared to 2012. The increase in land segment revenue was principally due to revenue from acquired businesses.

Gross Profit. Our gross profit for 2013 was $752.8 million, an increase of $79.3 million, or 11.8%, as compared to 2012. Our gross profit during these periods was attributable to the following segments (in thousands):

                        2013        2012     $ Change

Aviation segment   $ 327,178   $ 294,601   $   32,577
Marine segment       177,052     208,028     (30,976)
Land segment         248,528     170,818       77,710

Total              $ 752,758   $ 673,447   $   79,311

Our aviation segment gross profit for 2013 was $327.2 million, an increase of $32.6 million, or 11.1%, as compared to 2012. Of the increase in aviation segment gross profit, $28.6 million was due to increased volume attributable to new and existing customers and $10.9 million was due to gross profit from acquired businesses. These increases were partially offset by $6.9 million in lower gross profit per gallon sold principally due to fluctuations in customer mix.

Our marine segment gross profit for 2013 was $177.1 million, a decrease of $31.0 million, or 14.9%, as compared to 2012. Of the decrease in marine segment gross profit, $37.6 million was due to decreased gross profit per metric ton sold principally due to limited price volatility in 2013 and fluctuations in customer mix. This decrease was partially offset by $6.6 million due to increased volume attributable to new and existing customers.

Our land segment gross profit for 2013 was $248.5 million, an increase of $77.7 million, or 45.5%, as compared to 2012. The increase in land segment gross profit was principally due to gross profit from acquired businesses.

Operating Expenses. Total operating expenses for 2013 were $488.4 million, an increase of $72.0 million, or 17.3%, as compared to 2012. The following table sets forth our expense categories (in thousands):

                                          2013        2012    $ Change

Compensation and employee benefits   $ 288,021   $ 237,362    $ 50,659
Provision for bad debt                  11,745       4,790       6,955
General and administrative             188,634     174,272      14,362

Total                                $ 488,400   $ 416,424    $ 71,976


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The $50.7 million increase in compensation and employee benefits was principally due to the inclusion of expenses from acquired businesses. The $7.0 million increase in provision for bad debt was principally due to an overall increase in the accounts receivable balance in 2013 as compared to 2012 and additional reserves for specific customers. The $14.4 million increase in general and administrative expenses was due to $26.2 million related to the inclusion of expenses from acquired businesses, which was partially offset by $11.8 million in decreased expenses due to efforts to drive greater operational efficiencies.

Income from Operations. Our income from operations for 2013 was $264.4 million, an increase of $7.3 million, or 2.9%, as compared to 2012. Income from operations during these periods was attributable to the following segments (in thousands):

                                        2013        2012     $ Change

Aviation segment                   $ 150,886   $ 128,153   $   22,733
Marine segment                        73,770     103,229     (29,459)
Land segment                          84,767      75,291        9,476

                                     309,423     306,673        2,750
Corporate overhead - unallocated      45,065      49,650      (4,585)

Total                              $ 264,358   $ 257,023   $    7,335

Our aviation segment income from operations for 2013 was $150.9 million, an increase of $22.7 million, or 17.7%, as compared to 2012. This increase resulted from $32.6 million in higher gross profit, which was partially offset by $9.9 million in increased operating expenses attributable to the inclusion of acquired businesses.

Our marine segment income from operations for 2013 was $73.8 million, a decrease of $29.5 million, or 28.5%, as compared to 2012. This decrease principally resulted from $31.0 million in lower gross profit.

Our land segment income from operations for 2013 was $84.8 million, an increase of $9.5 million, or 12.6%, as compared to 2012. This increase resulted from $77.7 million in higher gross profit, which was partially offset by increased operating expenses of $68.2 million. Of the increase in land segment operating expenses, $67.1 million was related to the inclusion of acquired businesses.

Corporate overhead costs not charged to the business segments for 2013 were $45.1 million, a decrease of $4.6 million, or 9.2%, as compared to 2012. The decrease in corporate overhead costs not charged to the business segments was attributable to decreases in general and administrative expenses, principally professional fees.

Non-Operating Expenses, net. For 2013, we had non-operating expenses, net of $17.7 million, an increase of $0.3 million, or 1.5%, as compared to 2012.

Income Taxes. For 2013, our effective income tax rate was 16.0% and our income tax provision was $39.5 million, as compared to an effective income tax rate of 16.0% and an income tax provision of $38.2 million for 2012. Although there was no net change in the overall effective income tax rate between 2013 and 2012, . . .

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