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. Answers to additional
inquiries, if any, that comply with this policy are scheduled to become
available on or about December 21, 2007.
SAFE
HARBOR FOR FORWARD-LOOKING STATEMENTS UNDER SECURITIES LITIGATION REFORM ACT OF
1995; CERTAIN CAUTIONARY STATEMENTS
Certain
portions of this document including the answers to questions 1, 2, 3, 4, 6, 7,
8, 9, 10, 12, 14, 15, 16, 17, 18, 19, 20, 21, 22, 25, 26, 27, 28, 29, 30, 31
and 32 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, or the unpredictable acts of
competitors.
SELECTED INQUIRIES RECEIVED THROUGH NOVEMBER 13,
2007
1.
The
following two questions refer to
situations where Expeditors is acting as agent for the airline (not as
consolidator) on a particular shipment:
a.
Is the commission that Expeditors
receives from the airline determined to any degree by reference to the
aggregate amount of business Expeditors does with that airline, or by any
factors not related to that particular shipment?
The
commission structure offered to forwarders acting as agents of the airlines is
a fairly standard 5% of the base airfreight rate, excluding any surcharges, and
is not usually altered for other business the agent may have with that airline.
Typically freight forwarders would rather build consolidations, where there is
a spread created by the difference between wholesale and retail rates.
b.
How does Expeditors determine
which airline to use if more than one airline is available to carry the
shipment?
Customer
service requirements, price and how those objectives relate to airline service
capabilities on specified routings, for specific shipments and on specific days
are the determinants in the decision as to which carrier is used.
2.
Does Expeditors receive any
compensation from airlines that is not tied to any particular shipment?
Were not exactly sure in what
context you are talking about compensation. We are primarily a consolidator. As
such, we paid the airlines, collectively, nearly $1.5 billion in 2006, so
receiving compensation from airlines isnt how this industry business model
works. There are, of course, volume incentive arrangements that are offered by
some airlines. As we have written before, this is a business that rewards
volume contribution and the more volume you can commit, typically the lower the
buy rates you are able to negotiate. How these lower rates are made available
from the carriers varies from carrier to carrier. Some airlines will actually
pay an incentive payment annually if predetermined
2
volume thresholds are achieved. Others
will provide a lower rate, typically over a shorter period of time (for a three
month period for example), which is taken directly off the cost of the Master
Airway Bill when the shipment is tendered to the airline at origin. In those
instances, were there to be a short-fall from the previously agreed-upon
volume, the buy rates in the ensuing months would go up to some specified level,
something which from a practical standpoint, has rarely, if ever, happened.
3.
Please help me assessing growth
rate of Expeditors for next 4 to 5 years. Please do not hide behind referring
to Madam Gildas crystal ball things or to the fact that a great man has said -
Making forecasts is dangerous, especially those about future or not to disclosing
competitive information.
As an individual investor I note
that S & Ps forecast growth rate for you is 18.3% (Start of 2007 report),
but mostly I dont believe what such agencies / analysts say. So best place
will be to ask you, the captain of this ship. To the extent of inherent risks
of forecasting and all other things considered, could you please at least give
out your own targets for growth rate of the business (earnings), say in a range
format, without having to get pinned down to an absolute number. I read your
various reports but did not find this clearly.
You seem to understand our policy
of not making predictions well enough. Having demonstrated that understanding,
were surprised you would think asking the question in this manner would in someway
incite some kind of response. Given that our previous response (which you
reference) actually mentioned, in good humor, Madame Zelda
not Gilda, youve
also demonstrated just how carefully you read (or perhaps didnt read) what we
wrote in our responses.
It has been some time since we
discussed our philosophy about not predicting growth rates or at least our
philosophy about talking about growth ratessix years really, so we guess we
cant find fault with your research efforts because you didnt go that far back
in time. Basically weve always said that we dont project or forecast growth
rates. Once a year we do a ground-up budget. If the combined budget comes in
between 15-20% above what we expect to make for the current year, we view that
as a worthy and achievable goal for the coming year. Historically, weve been
able to achieve this kind of growth so we see no reason to question the
professional expertise of our managers. It has actually been surprising in some
years just how close our combined budgets have been compared to our actual
results. Some years were right on and some years we have a variance. Usually
when we have a variance weve not met our internally budgeted expectations, but
then there is no harm in falling short of a lofty goal! As James Wang, our President-Asia and one of
our founders, is fond of saying Budget is Budget, what matters is how much
money you make. Taking James comments
one step further, projected growth rates are just that
projections and as such
you could be right and you could be wrong. Wed rather not focus on being right
or wrong on projections and turn that energy into growing our business as much
as possible without diluting the quality of our service.
4.
Understanding the importance of
Expeditors good working relationships with a variety of entities (airlines,
ocean lines, government agencies, etc.) for high service quality, would you
please discuss in more detail the risk to such relationships, which you include
in your SEC filings as
changes in space allotments available from carriers,
governmental deregulation efforts [and] modernization of regulations governing
customs brokerage
?
3
From a macro perspective,
business can be described as nothing more than the management of risk. The more
adept a business is at managing those risks, the more successful the enterprise.
As you have undoubtedly read our Securities and Exchange Commission (SEC)
filings, you should also understand, as we state therein, that the items we
list in our filings are not meant to be a comprehensive list of all possible
risks the Company could face. Those particular listed items are our attempt to
highlight those risks that management believes could have the greatest impact
on our operations should they occur. The probability that these risks might
actually occur is somewhat secondary in this consideration.
Lets look at each of these risks
and analyze why we would have included them.
Changes in space allotments
available from carriers
.
Since we are a non-asset based provider of services, being able to access space
from direct carriers who actually own assets is critical to our model. Should
carriers for some reason reduce the amount of cargo space available to
non-asset based players, that would cause a lot of turmoil in the market place.
While we dont see anything on the horizon that would indicate such a change
would take place in the long term, changes can occur in the short term. An
example of this occurred when troops were deployed to Kuwait during the pre-war
build up of troops for Gulf War I and to a lesser extent for Gulf War II.
Governmental deregulation effort
and modernization of regulations governing customs brokerage
. A significant portion of what
we do is to manage customs clearance processes for customers around the world. Should
governments reduce the complexity of, or requirements for, customs entries
before goods could be imported into, or in some instances exported from, a
country, the inability to have people pay
us to perform a non-required, or at least a much more perfunctory process,
would have an impact on our revenues. Given the current security environment
and the ongoing debate over what globalization may or may not do for individual
country economies, we would have to say that we dont see the probability of a
de-emphasis in customs brokerage requirements being an immediate concern.
5.
Also in your SEC filings, you
state that Expeditors primary competition is confined to a small number of
companies. Would you please quantify small and quantify by segment
(asset-based or non-asset-based)?
While we
cant give an exact quantification of small, we can say that on a global
basis there are probably between 15 and 20 main competitors with whom we are
actively engaged in ongoing freight wars. This group certainly includes the
most behemoth asset-based integrators, of which there are three that stand out
most visibly. There are between seven and ten large, foreign-based non-asset
based companies with whom we compete and there are other US-based non-asset
based concerns with whom we also compete.
Hopefully
that gives you some insight into the market segment we think we compete in.
6.
When our stock drops
significantly, does the company purchase shares to counter the imbalance?
4
Were not sure what the word imbalance
has to do with answering this question. In the past several years, we have been
consciously trying to buy back shares to offset the shares issued as a result
of option exercises, as they occur, by employees. Weve done this in by-and-large
a successful attempt to keep the shares outstanding relatively flat.
That having been said, from a
pricing fluctuation standpoint, there is a stock price below which we would
consider being buyers of our own stock. If you were to read our annual report,
you would note that we have an authorization from our Board of Directors to
affect a discretionary buyback of the Companys stock. We first repurchased
shares under the discretionary plan in October of 2001 after the Companys
stock price declined in the wake of the September 11
th
terrorist
attacks. At that time, we bought back 1,000,000 shares at an average price of
$45.12 (4,000,000 shares at an average price of $11.28 on a split-adjusted
basis). The price at which we would buy back stock is, of course, dependent
on circumstances at the time and it is nothing we publish, talk about or even
plan for.
7.
In response to your outstanding 2007
Second Quarter, the price of the stock increased about 20%, but recently has
taken a severe drop. Ive looked for news, and all that I see is a large group
of Form 144s and form 44s confirming that VIPs were selling large amounts of
stocks. It seemed to start with a secretary and reached out to selling trades
of more then $1,000,000. I see the trades were made from August 11 until August
22. There may be others, however, this is what I notice. I note that these
trades were after the deadline of August 8, 2007 by when e-mail questions would
be considered in managements 8-K. I dont see an 8-K. Could you send me one
please?
Why did this happen? Did the word
get out that the earning improvement could not be maintained? Was there a
selfish desire of Very Important Persons to take profit without regard of
smaller, but still important stock holders? If truly this quarter was to convey
steady growth, why did I not notice the largest number of VIPs acquiring
shares? I was impressed by your ethic
standards. I am trying to see how they were followed here. Of a lesser nature,
I note there are diluted shares and basic shares. How do they differ? Why do they have different earnings? I had
started a plan to acquire shares, but now I dont know what to do. Perhaps
other owners like my self should follow managements example and sell.
Were not sure we understand
whether you are asking a plethora of questions or making a statement. Are you
asking why the stock went up 20%; why insiders sold; the timing of when
insiders sold; why the 8-K was late; why insiders didnt acquire shares; did
insiders believe that earnings results could not be maintained; did insiders follow our ethics
standards; why did they not acquire shares; what is the difference between diluted shares and
basic shares and how do they differ and why do they have different earnings,
and last, but not least, should you sell your shares?
First, for the record, all of our
people are VERY IMPORTANT PEOPLE, as are all of our stockholders.
Before we tackle a detailed response,
let us make an observation that we think those who are obsessed with tracking
insider stock trades should consider. Over the past 10 years, weve seen a
battle waged, and won, by those who contend that stock options and stock awards
granted to employees are compensation in nature as opposed to sweat equity
investments in character. The result of that battle was the requirement to
include the fair value of stock options as a component of compensation expense
within the operating results of the company granting the options. We started
doing this in 2006. While there are some notable exceptions, such as the
founders occasionally selling shares of stock they purchased before the Company
went public, by far the majority of the share transactions by insiders
5
that you observe involve shares
that were acquired either through the exercise of a stock optionwhich in many
cases will soon be expiring and if not exercised, then lostor a purchase of
shares pursuant to the employee stock purchase plan. To digress back to the
former for a moment, the exercising of stock options often involves a
combination of both a sale and a purchase of stock. In regards to stock options
that expire, it doesnt seem fair to expect that our employees should let their
options lapse rather than exercising them. When employees receive stock
options, they have to wait five years before grants are 100% vested, so their
compensation in this area reflects a long-term commitment to the Company and
its continued success. Another reason for share transactions of employees is a
purchase of shares that took place pursuant to the employee stock purchase plan.
Even though we have to buy the shares that we acquire through the employee
stock purchase plan with after-tax money withheld from our paychecks throughout
the year, because there is a look back provision and a minimum 15% discount
off fair market value, we are required to attribute a fair value to these
options and recognize the corresponding expense over the one year term of the
annual plan
i.e. this too, at least a component, is deemed to be compensation.
Given that all these shares and
share options have been deemed to be compensation it seems somewhat at odds
with the various polemic arguments used to turn stock options from an
investment into compensation (and then press that difference into GAAP) to then
turn around and declare these stock options to have the character of an
investment when trying to read tea leaves about managements intentions. No one
seems to be interested in drawing any inferences from how insiders spend their
cash compensation, at least no one has ever asked that question of us. Given
that it is now all deemed to be compensation, if no one cares what management
does with its cash compensation, why should anyone care what management does
with the compensation that arises from stock option exercises or the sale of shares
acquired through an employee stock purchase plan?
That point having been made, here
are a few things that we think bear remembering to add some context to your
question.
a)
We have no idea why the stock
went up 20% on announcement of our earnings and why it stayed up 20% for a
whole two days following the 2nd quarter 2007 release (or why it went up 6% on
the day of our 3
rd
quarter 2007 earnings release, only to fall 12%
the next day). There were no surprises in our earnings in either case. For both
the 2
nd
and the 3
rd
quarters, we reported earnings that
were at consensus or in-line or what ever other description youd like to
apply to earnings that were reported at the markets expectation. Theoretically
at least, the stock shouldnt have moved at all upon the announcement of at
expectation earnings. However, as you probably already know, the stock market
is not linearly predictable, particularly on a day-to-day basis. There is very
little that we can do or say to explain price movements within the stock of the
kind that occurred after our 2
nd
quarter (or 3
rd
quarter)
earnings were released. To state that the price was driven down by insider
selling is perhaps overly simplistic without addressing why the price was
driven up after reporting earnings at consensus. We think it is probably more
dynamic than that. Some have suggested that the temporary spike in the stock
price in both cases might have been due to the backfilling of large short positions that were put in place
by those betting that we would come in at less than consensus. That the
stock went up immediately upon our announcement and drifted back down again to
the pre-release levels soon after reporting consensus earnings per
6
share, certainly adds some
credibility to this theory. At the end of a day, even that is only a theory and
might not be worth the HTML format its created in.
b)
Insiders are only allowed to
trade for six weeks each quarter. The reason that the trades were made after
August 8th is that insiders, according to our policies, cannot begin to trade
until the day after our earnings are released. Since our 2
nd
quarter
2007 earnings were released on the 7
th
of August before the market
opened, corporate insiders were not allowed to trade until the next day. Insiders
who traded did so within defined SEC rules and company policies. Why insiders
sold (and not all insiders sold, by the way, the vast majority did not sell) is
really something only they know. Some things, even around here in this day and
age, are personal and there is nothing more personal, to us at least, than what
people do with their compensation. One
important thing also for your consideration is that the greatest financial
asset of most of the insiders at Expeditors is both their direct holdings of
Expeditors stock and their unexercised options to purchase Expeditors stock. Approximately
80% of the personal financial assets of three of the named executive officers,
for instance, consist of Expeditors stock. Other executive officers have
significant holdings of Expeditors stock and unexercised stock options, some in
excess of 50% of their personal net worth. This goes against the often
recommended advice of not putting all your (nest) eggs in one basket.
Therefore, for Expeditors named officers, their personal assets become very
public nest eggs. Accordingly, when people do what people do with savings and
investments
they naturally are going to tap the greatest source of their
assets
Expeditors stock. As noted previously, there were also several insiders
who exercised options which were about to expire and those options were held
for a good long time. When these grants were given, they werent worth
much
even on the Black-Scholes basis
relative to todays stock price. They may
have chosen not to increase their holdings in Expeditors stock and therefore
exercised the options and sold the stock in one transaction. Even in instances
where they have chosen to increase their holdings, they may have sold nearly as
much stock as they have purchased. This is to allow the executive to pay the
taxes due on the exercise of the options, for which there is a taxable gain.
One
point to keep in mind is the
fact that the stock has split three times since 1999, which has resulted in
wealth creation for ALL shareholders.
As to your question about news
getting out that the earning improvements werent sustainable, as of August 8
th
,
there was no updated earnings information available
and when that information
was availablethat would have been for the month of Julyit showed a
year-over-year improvement indicative of strong growth. The subsequent report
of our 3
rd
quarter 2007 results should dispel any possible
conspiracy theories about corporate insiders being concerned that earnings were
unsustainable and deciding to sell stock. Insiders who have a substantial portion
of their net worth tied up in stock have an inherent interest in not doing
anything that would cause the stock price to drop. They have the greatest
amount of wealth to lose. While we agree it is desirable for insiders and
executive officers to hold significant stock in the Company, not every decision
an insider makes concerning buying or selling stock can be analyzed from the
same viewpoint as a portfolio manager. Accordingly, not all buys or sells
by insiders of Expeditors stock should be viewed as a meaningful harbinger of
good or bad things to come. Sometimes it just means that someone needed the
liquidity at that point in
7
time. To paraphrase Freuds
commentary on cigars,
sometimes an insider stock
transaction is only an insider stock transaction
.
c)
The 8-K was filed two weeks later
on the 22
nd
of August, 2007, and it can be found on our website or
on the SECs website. As to why this was late, we can only say that the filing
of 8-Ks takes a considerable amount of time on the part of management and with
the accelerated SEC filing deadlines, which compete for the same resources, and
a stubborn resolve to have management actually write the 8-Ks as opposed to
having them ghost written, we are struggling with the deadlines. That has
been a struggle for the last several years. We apologize, were trying to do a
better job, but as we said, a commitment to having management actually continue
to produce the 8-K has so far superseded any desire to publish a ghost-written
version.
If truly this quarter was to convey steady growth, why did I not
notice the largest number of VIPs acquiring shares? I was impressed by your ethic standards. I am
trying to see how they were followed here.
It isnt unethical for insiders
to exercise stock options that will expire, or sell stock that they may have
acquired, as long as they do so within the framework of securities rules and
regulations promulgated by the SEC. That is the reason that there are insider
trading rules. Your implication that anything unethical was done is, quite
frankly, offensive. The whole controversy over insider trading goes back for
decades and is, in large measure, what gave rise to the SEC in the first place
and the resulting insider trading rules, specifically. Under Rule 144 of the
SEC, executive officers are required to give public notice of intent to sell
shares at least by the close of the business day in which these shares are sold.
They are also required to file a Form 4 within 2 days after the sale. One other
thing that should be noted is that Expeditors has a very large number of
reporting officers, particularly for a company our size. We dont take
advantage of conventions to try to minimize the transparency of corporate
insider transactions. If you compare our number of reporting officers with
those of much larger concerns, youll note that we have 22. We wont name
names, but other behemoth corporations in our neck of the woods, being much
larger than ourselves, have many fewer reporting officers than we do.
Finally, in response to your
question as to why you didnt see any insiders buying shares, thankfully insiders
are not permitted to day trade their holdings up and down depending on the
anticipated short-term fortunes of the Company. In fact there are rules that
specifically address how and when they can buy and sell shares. Once youve
done one, a buy or a sell, you cant do anything different for six months from
the last transaction.
Of a lesser nature, I note there
are diluted shares and basic shares. How do they differ? Why do they have different earnings?
Interesting that you preface this
sub-question as of a lesser nature. This is a very good question for the lay
investor to understand. Basically, they do not differ. They are merely two ways
of calculating a denominator for use in two different earnings per share
calculations (net earnings divided by the particular flavor of shares
outstanding). Well explain the basic first, as it is aptly named.
8
1.
Basic shares are merely the
weighted average of shares actually issued and outstanding during the period.
If one were to look at the equity section of our balance sheet, one could note
how many shares we have outstanding as of the balance sheet date. The basic
shares outstanding is merely a weighted average calculation of how the
outstanding shares changed during the period.
2.
Diluted shares is a mathematical
convention prescribed by those who set accounting standards to take into
account the shares of stock which may not be outstanding, but could be issued and outstanding if all
stock options were exercised or any convertible
debt-to-equity
securities were converted. We dont have any debt, let alone debt that contains
a conversion feature that could require equity shares to be issued to retire
the debt. However, we do have employee stock options that have not been
exercised. In order to give some kind of effect for what the earnings per share
would be if diluted by stock option exercises, we have to go through some
mathematical gyrations that basically require us to do the following:
a.
Assume that all outstanding stock
options were exercised and outstanding as of the beginning of the accounting
period being reported upon. The kind of quirky thing is that we assume (yes
and we do remember Felixs definition of assume from that episode of The Odd
Couple) an exercise price that is the average market close price for the
entire accounting reporting period being reported upon. This increases the
shares outstanding for earnings per share calculation purposes.
b.
Having assumed that all options
are exercised at the average stock price for the accounting period in question,
we then assume that the proceeds from
this assumed exercise (including an estimate of the tax benefits received) are
used to buy back stock at the outstanding price at the beginning of the period.
This reduces the shares outstanding, but not in the same amount as were issued
by the assumed exercises. Before the advent of SFAS 123R and the whole world
of stock option expensing, we could stop here. However, since we have entered
the world of SFAS 123R, we have another gyration to go through before weve
completed calculating diluted weighted average shares.
c.
When we grant stock options, as
weve previously noted, we value those options using the Black-Scholes
valuation model. We then expense those options into our statement of earnings
over their vesting periodfive years in the case of our options. As part of the
calculation of diluted earnings per share, we are now required to assume that
the unamortized portion of this stock option expense is used as proceeds to buy
back more stock, further reducing the shares outstanding.
In the name of accounting
clarity, this is what you do to create a meaningful denominator that is
diluted for all potential stock or contingent issuance of additional shares of
stock. The resulting figure is then divided into net earnings to come up with diluted
earnings per share.
I had started a plan to acquire
shares, but now I dont know what to do. Perhaps other owners like my self
should follow managements example and sell.
9
It certainly is an individual decision
as to whether you maintain your investment in Expeditors or decide to sell. However,
after the information weve provided above, we think that the example
management sets by maintaining a substantial part of their personal financial
assets in Expeditors stock is the most effective rebuttal we could offer to
your conspiracy theories. We cant help but wonder how many owners, such as
yourself, have as high a percentage of your individual net worth invested in
one company as do most of the average corporate insiders at Expeditors? If you still remain a skeptic after this
explanation, this is certainly your prerogative and if that is the case,
perhaps it would best if you did sell. There are certainly no hard feelings on
our part.
8.
What is
your assessment of the current supply and demand environment for ocean freight
along Asia to U.S. trade lanes? How have your purchased transportation
rates/costs along these lanes changed versus a year ago?
Ocean
freight was at what we would call equilibrium plus. This time of year,
because of the holiday season, most of what is going to come in by ocean is
either on the ship or preparing to be loaded at Asian origins. So we expect to
have somewhat of a respite from peak season levels before the pre-Chinese New Year
season starts. Ocean rates are higher now than they were a year ago.
9.
Do you
believe the effective capacity at the West Coast and Asian ports has been
constrained thus far this year by congestion at those ports (origin or
destination) and/or through intermodal rail limitations?
The
larger Asian ports, generally speaking, have a greater capacity to ship than do
the West Coast ports have to receive. Infrastructure concerns related to
intermodal rail limitations have created intermittent problems. However, these
seem to be somewhat manageable.
10.
Please
provide an update on air and ocean volume growth along the U.S. to Asia, Asia
to U.S., Asia to Europe and Intra-Asia trade lanes.
Asia
outbound from major gateways, whether to the US, Europe or to other spots
within Asia, particularly from Shanghai and Hong Kong are starting to encounter
significant backlogs. US outbound to Europe, generally speaking, is
experiencing significant activity and intermittent backlogs as compared with
the prior year.
11.
Can you
please provide your monthly airfreight and ocean freight tonnage growth rates
for July, August and September?
2007 vs. 2008 Year-Over-Year Monthly Increases
|
|
Airfreight
Tonnages
|
|
Ocean Freight
TEU
|
|
July
|
|
3
|
%
|
16
|
%
|
August
|
|
16
|
%
|
13
|
%
|
September
|
|
11
|
%
|
13
|
%
|
October
|
|
17
|
%
|
12
|
%
|
12.
Based
upon trends out of the peak season, do you expect the year-over-year increase
in airfreight yields to continue into 4Q? What is your assessment of the
current airfreight capacity and how has this changed y-o-y?
10
Because
of backlogs and market conditions, we expect that there will not be an increase
in our airfreight yields continuing into the 4
th
quarter. As noted
above, the markets are much tighter out of Asia, with backlogs emerging
regularly.
13. What trends in y-o-y net revenue and
operating income growth did you see for July and August? In the past you had
provided this information.
We did this several times to mixed reviews. We will say that
the profits built progressively during the 3
rd
quarter of 2007, but
the year-over-year monthly increases were fairly consistent with the overall
quarterly increase.
14. There have been
recent public announcements by various competition authorities regarding
investigations into various airline and freight forwarders for anti-competitive
activity. Has Expeditors to date been subpoenaed either as a witness or
potential target by any of these authorities?
If certain airlines were found to have been anti-competitive in their
assessment of fuel surcharges and as a result fuel surcharge prices came down
or are forced to be calculated differently in the future, how might this impact
Expeditorss financial model going forward?
We were the recipient of a subpoena from the Department of
Justice (DOJ) on the 10
th
of October 2007. We issued a press release
that same day to inform the market of this development. We also referenced this
subpoena in our 3
rd
quarter 2007 earnings release. There isnt much
more that we can say about things at this juncture. The DOJ hasnt told us that
we are a target of this investigation.
As to your question about what would happen if surcharges
went away, given that our approach to surcharges is generally to pass the
charges along to customers to the extent we could, we cant imagine how we
would be helped or hurt by the modification in the way surcharges are
calculated, or by their total removal altogether.
15. Would you describe the seasonality in
the trans-Pacific lane as trending in line thus far with your expectations in
airfreight and ocean freight?
Things
are pretty much as we expected them to be in the ocean freight, but far busier
than we would have thought in airfreight markets.
16. Will Expeditors participation in
Lufthansa Cargos Global Partnership Programme increase the proportion of its
airfreight business done with that airline?
The fact
that we are part of the Lufthansa Cargo Global Partnership Programme should
imply (we hope) that our future co-operation with Lufthansa will be more
significant than has been our past experience
and we think our past experience
has been very, very good. We would add, however, that so much of what will
transpire in the future will be determined by Lufthansa.
Maintaining
great relationships with all our carriers is important to us. We value them. We
constantly look forward to improving our co-operation with them and were very
honored to have been considered for this Programme. We would surmise that
Lufthansa cares less about what proportion of our total freight they carry than
how much more of our freight they will carry next year than they carried this
year. Hopefully our inclusion in this Programme will be a win/win for both
Lufthansa and Expeditors. We would define a
11
win/win
as a situation where were able to increase our overall market share in
strategic lanes because of our increased support from/to Lufthansa.
17. Can you update us on your primary
airline providers used globally? Does
your Sweet 16 concept still apply?
The old
Sweet 16 has been expanded to the E-19 carriers. There are 7 Asian carriers, 5
European carriers, 4 North American carriers, 1 Middle East carrier, 1 South
Pacific carrier and 1 South American carrier.
Our
objective is to have 80% of our freight carried by these 19 airlines
and we
pretty much have been successful at doing that.
18. Please comment on the competitive
dynamics in the trans-Pacific trade lane and whether there are any signs of
greater price aggression from your competitors, in comparison to recent years,
when attempting to win new business.
Price aggression
(your term, not ours) has always been a part of this business
and nothing has
changed. This is a very competitive industry. Not only are prices getting more
aggressive, but there seems to be a greater willingness for some competitors to
take on absurd risks in the areas of potential performance penalties and
undecipherable service and liability standards. These are the most dangerous
types of price concessions, as they are costs that cannot be quantified, only
experienced when the bills show up. One needs to be very careful in discerning
the difference between taking a calculated risk and blatant gambling. Even at
the most outrageous games of chance in the green felt jungle of Las Vegas, you
can calculate, within reason, your odds of winning or losing
and, quantifiable
though they may be, the prospects of losing are so miserably high that most of
the money that goes on the table in Vegas, stays in Vegas. Even though the odds
of winning can be calculated, they are so poor, they dont qualify for calculated
risk status rather it is just called gambling. Were still looking for the definition of an
activity where the risks of losing are so high that, not only cant they be
quantified, they cant be determined until the dice stop rolling. If you have
any ideas, please let us know.
19. This question has been put a number of
times over the years, however not for some time now. It was most memorably
answered back in February 2001 when you quoted Tevye from Fiddler on the Roof.
The most recent earnings release shows cash and cash equivalents at over USD575
million. Whilst I appreciate in this time of global turmoil and private equity
leverage that cash is king, wouldnt at some point a return to share holders
via a share buy back make sense all round?
I assume the cash is invested and earns interest at or near the US cash
rate. Wouldnt these funds provide a better effective rate of return if
invested in buying back Expeditor stock?
If not now then at what point? USD800 million in cash? USD950 million?
Our hat
is off to you for having researched back to the early eons of time when we
started producing the 8-K. We would also point out that during this time weve
not sat around leaning up against a chimney on a rooftop playing our violin
with respect to stock buybacks. Since we published that response on February
16, 2001, we have bought back over $615 million dollars worth of common stock
and paid out over $175 million in dividends
that is $790 million. To be fair,
we took in approximately $231 million in proceeds from the issuance of stock
options and shares related to our stock purchase plan, but even netting this
out against the $790 million, you still come up with $559 million of net cash
paid out for stock repurchases and shareholder dividends
and we have made some
fairly substantial
12
investments
in the business during this time (i.e. about $508 million worth of property and
equipment acquisitions). We think that this is a pretty balanced approach to
handling cash generated in the business.
What we
suspect you are angling for is some kind of a one-time mondo stock buyback. While
we have done those in the past, typically the events that have given rise to
these buybacks have been external in nature rather than prompted by some
internal concern that we needed to find something to do with the cash because
our cash balances were getting too large. These one-time mondo buybacks
should not be done without some consideration of stock valuation.
While were not holding rigidly to tradition
here, we do think that doing a one-time mondo buyback should be done at a
time when it most benefits the shareholders and not merely to prove a point
because weve crossed some pre-determined threshold that kicks off a mindless
chain reaction.
20. Please provide us with your estimate
of the impact on earnings of the company of a major recession in the USA (say
negative 2%-3% real GDP growth, and lasting for 2 years). Although I appreciate
your reluctance to project exact numbers, I will greatly appreciate if you
could help us understand the way you think about this scenario in your internal
planning. What would be the impact on volumes, gross profit per ton, and expenses?
While we
appreciate your confidence in our abilities, realistically how could we be
expected to calculate this with any degree of precision? Were international logistics managers, not
economistsand thankfully, we understand the difference. We have not invested
the time and resources necessary to build a sophisticated econometric model
that would produce any kind of a projection of this nature
and even if we had,
youd then have to wonder whether or not wed done it right
we
certainly would. We dont think that making projections
about how bad things can get is the best way to manage through a recession.
To expand
that point, you dont have to go too far back in our history
back to the last
business cycle downturn actually, to find communications from our CEO
officially banning the acknowledgement or use of the R word (R meaning
recession). The focus of the communication was to put all of our employees on
notice that a recession meant a business slow down, it did not mean the end of
life as we know it. Since we focus on growing market share each year,
historically there has been no better time for us to gain market share than
during a recession. The mentality of the masses tends toward succumbing to the
temptation to wrap oneself in a blanket of excuses justifying sub-prime
performance (no pun intended). Recessions for Expeditors have always been a
time to prepare for future success
and you dont do that by giving up hard won
ground in the face of adversity. It gets accomplished by aggressively trying to
hold your position through accelerating market share gains and focusing on
opportunities that present themselves as our customers try to work through
their own issues related to cyclical downturns.
21. Many companies in the industry report
volumes in the air segment in tons and in the ocean segment in TEUs It is
difficult as an analyst to compare the cost per unit of volume (excluding
purchased freight) in each of these segments, without in some way converting
the air segment volumes to an equivalent ocean shipment volume or vice versa. From
an internal workflow and cost perspective is there a way of converting the air
segment volumes in tons to an equivalent unit of activity, say an air
container,that equates it to an
ocean TEU? I have used a
13
rule of
thumb of 5,000 lbs per air container and assumed that internal costs vary
proportionately for each one air container and one TEU. I am not sure this is
accurate. Could you please help!
This is
certainly a novel question. Youll pardon us if we dont attempt a response. This
is not a calculation we would do internally, primarily because, as for most
things we try not to do internally, we see no use for it. We are also
hard-pressed to understand how facilitating this kind of analysis will in any
way increase overall understanding of what it is that Expeditors does. Quantification
of something that has no quantitative value at all (mixing air and ocean
freight) seems like an exercise in precision self-flagellation of masochistic
proportions. Why anyone would want to inflict this kind of pain on themselves,
we cant imagine.
22. Several European forwarders provide
data on Airfreight and Ocean freight volumes. It would be useful to persons
analyzing your business to get similar information to benchmark your business
against the European peers. Would it be possible to provide that information
for 2007?
One can
publish a lot of information
and it is true that there are some forwarders who
do publish a lot of these kinds of statistics
but that doesnt mean that there
is a lot of utility in these figures. While weve all heard the saying that one
should Never confuse motion with progress, we likewise appreciate the
following anonymous quote about statistics:
Most
people use statistics the way a drunk uses a lamp post,
more
for support than enlightenment
.
24. Can you provide me with the revenue
contribution of the i) air freight ii) ocean freight and iii) customs brokerage
segments in i) China and ii) HK in 2005 and 2006 respectively? What was the
ocean (in TEU) and air freight volume (in MT) for i) HK and ii) China in 2005
and 2006?
No, but
with explanation. We actually view this information as proprietary. The
interests of the shareholders are not advanced by disclosing proprietary
numbers such as these as they can put us in positions where we can be at a
disadvantage in our negotiations with carriers and with customers. Because of
their magnitude (greater than 10%) we are required to disclose our gross and
net revenues from China (and Hong Kong-now a Special Administrative Region of
China), which we do in Footnote 9 of our most recent financial statements. We
are not required to provide this disclosure by product (which would be
disclosing yield information), and accordingly, we have not.
25. I present below the employee
productivity numbers from your filings as far back as we could find the
numbers:
We have
excluded your charts. In addition to the formatting nightmare its inclusion
creates, we have some basic problems with the numbers youve used. For
starters, you did not apply the modified retrospective method as it relates to
the inclusion in compensation expense of the amortization over the vesting
period of the fair market value of stock options granted to employees (well
address that further below). In addition you used EBITDA as a component of your
analysis. As weve noted previously, we refuse to use EBITDA in any of our
internal analyses. In fact, we think EBITDA has limited application in our business
(and probably any business). Your headcount numbers were correct, however, if that
helps you in future analysis. We think that we can answer your questions
without exhibiting the data chart (see a d below).
14
a) Are the per capita numbers for net
revenue and EBITDA significantly different in the Air or Ocean segments? If so,
why?
We would
have to do the analysis according to air and ocean to specifically answer your
questions. We havent done that and really see no reason to go through that
exercise. Not knowing what the EBITDA numbers are (per our reference above),
but drawing from our experience with operating income, we would say that ocean
freight would have a slightly higher operating profit per capita than
airfreight. Ocean freight is slightly less people intensive so one would expect
that both the net revenue and operating income per employee would be slightly
higher in ocean freight than in airfreight. Airfreight is very time intensive
because sometimes the only way to get a series of complicated steps completed
in a hurry is to have more people working on things concurrently
even with
technological support.
b) Both revenue and profit productivity
has been increasing every year (expect for a minor hiccup in 2003 for profit
productivity) for a long time, and the rate of improvement on a rolling 5 year
basis does seem to be declining. There obviously must be some theoretical limit
to how much a factor of production can produce- limited by the number of
theoretical hours they can work within the current state of telecommunication
and technological constraints. How far do you think the trend for productivity
improvement continue into the future?
We dont
understand the relevance of the comment the rate of improvement on a rolling
five year basis does seem to be declining, particularly taken in context of
the fact that our operating margin as a percentage of net revenue is among the
highest, if not the highest, at least among our public-reporting competitors. Obviously
there is a limit, but were not sure what that limit is. Weve actually been
surprised that we continue to see improvements in our operating margins over
the past several years. Were also unsure how it is that we would predict what
that limit would or could be. We try to be as efficient as we can
our employees
are directly compensated for increased productivity. We think that the best way
to maintain that productivity focus is to make sure that the relationship among
increased productivity, increased profitability and increased compensation
remains intact.
c) Why was there a 15% spike in per
employee expense in 2006?
There was
not a 15% spike in compensation per employee in 2006. In compiling your
numbers, you didnt use the modified retrospective adjusted numbers (for the
effects of SFAS 123Rexpensing of stock options) for the years 2005 and earlier.
We first implemented SFAS 123R in 2006. We published restated retrospective
numbers back to 2000 in our 2006 10-K. If you were to look at these numbers for
2006 and 2005 on a comparative basis (apples to apples), you would notice an
approximate 7.5% increase. Some of this increase is related to a declining
dollar (which makes overseas costs more expensive) between those two years and
some, most in fact, related to normal
salaries and increased bonuses in a company that pays people according to
increases in operating incomefor which there was a 38% increase in operating
profits between 2005 and 2006.
15
d) Although your average compensation
expense is $60,502 in 2006, what is the average for sales and operations
personnel? What percentage of costs are variable for sales and operations
employees?
That is like asking us how much does a hen weigh? The answer is: It depends
on whom, and on
where, among other variables. We are not nearly that granular when we review
our head count figures. Statistics and bench marks are
to quote a phrase, wonderful
slaves but horrible masters. Approximately
one-third of all compensation consists of sales commissions or bonuses based on
profitability. That figure would be a little higher with sales staff and
somewhat lower with the operations staff. Average is a very scary word here
though. Weve all heard the story about the statistician who drowned in a pond
with an average depth of 6 inches. Bonus compensation as a percentage of total
compensation, at least on the operations side, increases with time and
responsibility. Sales compensation is highly variable based on commissions
from the outset.
26. Does the company earn volume discounts
(overrides?) from carriers? Are these discounts accounted on an accrual or cash
basis? Does the discount
per TEU/k.g
increase with the total volume shipped?
In some
cases yes, in some cases no. Not all carriers are uniform in what kinds of
volume incentives they offer. Typically there are no volume discounts in ocean
freight unless it is written into the publicly-filed contracts. Volume
discounts are more such that when they exist, they exist on airfreight. These
are typically accounted for on an accrual basis once official written
notification is received from the airline indicating that our tonnages,
according to their records, have qualified for the volume discount.
27. How does the Company balance the
advantage of scale benefits that accrue from concentrating volumes with one
carrier versus the needs of the branches to maximize shorter term
profitability/client requirements?
Very
carefully. The Company needs to be particularly responsive to the needs of
individual branches in setting overall carrier strategy. If a local district manager
can consistently find better pricing in his or her particular market from a
carrier that is not among our E-19 carriers, then typically that district
managers voice needs to be heard. It is also quite common for some branches to
have very good relationships with a regional or national carrier (not one of
the E-19) that might benefit their customers on a particular lane. In these kinds
of situations, either one of the E-19 carriers comes to the table with
competitive market rates and service capabilities, or that particular business
must be tendered to a carrier who will allow us to provide the best long term
service potential to our customers at a reasonably competitive price. More
often than not, in most market places, our select airline partners (E-19) are
as competitive as any other carrier. This makes the local decision process much
easier.
28. My understanding is that Expeditors
has a very small percentage of revenues from the Oil and Gas Industry. Is that
correct, if so why? Does it see an opportunity in this area with the recent
fumble reported by Panalpina?
Relative
to other areas of concentration, Oil and Gas is a business that has
historically not been a large percentage of what weve done. It is not however,
an area with which we've no experience, having worked with a limited number of
customers over the years in certain specialized areas of
16
this
rather large and diverse market vertical. For the past several years we have
tried to focus on this business and have increased our market share and our
exposure.
As far as
opportunities in this market, we liked the market opportunities and were
actively pursing them before any competitor may have had problems. There are
plenty of other competitors out there who are pursuing this business as well,
so one competitor having some challenges doesnt necessarily translate into
instant opportunity.
29. Could you please give us some
operational metrics that will help us benchmark Expeditors versus other
forwarders? For example, in the operations areas what is the shipment/order per
employee? If shipment/order is not the right measure to compare efficiency or
the metrics are different in the air and ocean segments then what are those
metrics for Expeditors?
We dont
publish our metrics outside the Company because we consider them to be a vital
part of the knowledge management element of our business that helps
differentiate us. Its not the sole defining part of our business, but
certainly one of the elements that is critical to our ongoing efforts to
improve productivity and increase any competitive advantages we might enjoy. It
is not like were sitting on top of a recipe consisting of 11 secret herbs and
spices that we mix up and sell in a package. That having been said however, our
secret sauce comes from the unique way we do things. At Expeditors, we know we
do things differently from our competitors. Doing things differently can make a
big difference if youre doing things differently in a correct way. So far, our
productivity initiatives seem to be working and we take comfort in that. We
think it confirms that we are doing things correctly.
30. What would be the benchmark for sales
person productivity? How many operations people are required to support each
sales person in air and ocean?
One
rather cynical definition of benchmark is: A metric with little or no
relationship to reality. Reality is
the key word here. Accordingly, there is no set heuristic for how many
operations people are required to support each sales person or vice-a-versa,
depending on your perspective. While a review of our 10-Ks over the years
provides a breakout of how people are designated in different functions within
the company, the reality of the matter is that at Expeditors, everyone is in
sales, in some facet or another. All operational department managers and the
district managers are expected to be very heavily involved in sales efforts. This
includes bringing in new business with new customers as well as focusing on
retaining and hopefully expanding business with existing customers through
customer service initiatives and retention calls.
31. What percentage of activities between
the company and carriers are done electronically vs. manually? What is the
similar percentage for interactions with customers in operations?
We dont
have a quantified statistic on this. What we can say is that the entire discipline
of Electronic Data Interchange (EDI) connectivity among logistics providers,
customers and service providers is expanding as rapidly as increases in
technology allow. Our group here at corporate that is responsible for making
all these EDI connections actually work are never at any loss for something to
do. Not surprisingly, we have much more connectivity with customers than we do
with carriers
there are more customers.
As the
benefits of connectivity become more accepted, standards are starting to emerge
that over time will make this process of inter-company connectivity much more
efficient. As it stands now, there is a lot of blood, sweat, toil and tears
that goes into cranking out the
17
customized
solutions that make the connectivity possible. Weve always been willing to
take these projects on. Weve learned a lot and have increased our productivity
in the process.
32. Fuel has spiked
recently, please discuss the impact, if any, associated with the timing of fuel
surcharges on purchased transportation and your ability to pass along those
cost to your customers. How does this differ between Airfreight and Ocean?
We
attempt to push pricing increases, surcharges or other rate increases, on as a
fact of economic life. All of us who fill up our car with gasoline from time to
time are keenly aware of the rising cost of fuel. The reasons can be debated
and postulated upon
indeed entire political campaigns can be drawn around this
issue
but the reality cannot be avoided. Fuel costs are up substantially over
the last 12 months and not passing these costs on is not an option, it would be
financial suicide.
It is
generally our intention to be profit neutral when passing on these surcharges. That
is easier said than done, but we try. Let us explain. The air carriers
(airlines) do not have uniform surcharge formulas or applications. We use
different carriers from time to time to move shipments to the same place
depending on pricing and availability and customer service requirements. Accordingly,
it is not possible for us to say that we pass on the exact surcharges in a
specifically identified manner on each shipment. The dynamic nature of the
business precludes that. For example, lets assume a scenario where a shipment
moves from a point in France to New York via our Amsterdam gateway. When the
shipment is rated and the fuel surcharge affixed and an invoice is sent to the
customer in Paris, the freight is probably on a truck on its way to Amsterdam.
Once in Amsterdam, it will be consolidated with a lot of other shipments from
around Europe which are being sent to the United States through New York. The
carrier that will be chosen to carry that freight may not be determined until a
long time after the freight has left Paris, and possibly long after it arrives
in our warehouse in Amsterdam, as multiple, preset New York bound
consolidations are evaluated for that particular shipment by Expeditors
operations personnel. Since carriers have different pricing and surcharge
arrangements, the actual surcharge billed to Expeditors by the carrier for that
Amsterdam to New York consolidation cant be known when the contract of
carriage and the associated invoice is created.
Overall,
we attempt to pass on surcharges in such a way that when the shooting is done,
it leaves us at a net zero position in the aggregate with respect to these surcharges.
This means that, in the aggregate, we have never attempted to make money on
these surcharges. Were not attempting to make money on these airfreight surcharges
and in fact have been quite concerned, for obvious commercial reasons, that we
do not.
In the
case of ocean freight transactions, we receive notification from the carriers
generally 30 days in advance of their implementation. Our policy is to increase
our charges to our customers in accordance with the carrier-announced
surcharges. The mechanics of how we increase these charges on US-origin or
destination cargo, however, can differ somewhat from how we handle the rest of our
ocean freight business because of U.S. regulatory requirements.
18
33. Please provide regional headcount
figures for the September 30, 2007 compared with September 30, 2006.
|
|
30-Sep-07
|
|
30-Sep-06
|
|
Diff
|
|
% Diff
|
|
North America
|
|
4,439
|
|
4,172
|
|
267
|
|
6.4
|
%
|
Asia
|
|
3,315
|
|
3,020
|
|
295
|
|
9.8
|
%
|
Europe and Africa
|
|
1,896
|
|
1,806
|
|
90
|
|
5.0
|
%
|
Middle East
|
|
965
|
|
904
|
|
61
|
|
6.7
|
%
|
South America
|
|
604
|
|
575
|
|
29
|
|
5.0
|
%
|
Australasia
|
|
214
|
|
204
|
|
10
|
|
4.9
|
%
|
Information Systems
|
|
548
|
|
483
|
|
66
|
|
13.6
|
%
|
Corporate
|
|
171
|
|
155
|
|
16
|
|
10.2
|
%
|
|
|
12,152
|
|
11,318
|
|
833
|
|
7.4
|
%
|
19