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-look
ing statements. Words such as "will likely result", "are expected to", "will continue", "is anticipated", "estimate", "project", "plan", "believe", "probable", "reasonably possible", "may", "could", "should", "intends", "foreseeable future" 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, 2014.
Overview
Expeditors International of Washington, Inc. is a global logistics company. The Company's services include air and ocean freight consolidation and forwarding, customs brokerage, warehousing and distribution, purchase order management, vendor consolidation, 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.
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 the Company's 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 and is required 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 a HAWB or a 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 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 examine any 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, 2014
), 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
48%
of revenues and
39%
of operating income for the
three
months ended
March 31, 2014
. 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:
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Total dedication, first and foremost, to providing superior customer service;
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Compliance with Company policies and government regulations;
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Aggressive marketing of all of the Company’s service offerings;
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Ongoing development of key employees and management personnel via formal and informal means;
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Creation of unlimited advancement opportunities for employees dedicated to hard work, personal growth and continuous improvement;
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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
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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 the Company's employees more efficient and more effective.
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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, current management must make up these losses with 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 its control. 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, management's focus is on building and maintaining a global corporate culture and an environment where well-trained employees and managers 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, steamship lines, ground transportation providers and governmental agencies. The significance of maintaining acceptable working relationships with these entities has gained increased importance as a result of ongoing concern over terrorism and increased governmental regulation and oversight of international 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, and/or trade accords could adversely affect the Company’s business in unpredictable ways.
International Trade and Competition
The Company operates in 62 countries in the competitive global logistics industry and Company activities are closely tied 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 has resulted in a compression of the Company's unitary margins. We expect these competitive conditions to continue.
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 seasonal trends with the first quarter being the weakest and the third and fourth quarters being the strongest. This pattern has been the result of, or 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, product launches 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 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, 2013
, filed on February 27, 2014. There have been no material changes to the critical accounting estimates previously disclosed in that report.
Results of Operations
The following table shows the total 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-month
periods ended
March 31, 2014
and
2013
, 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 include 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 actually 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.
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Three months ended March 31,
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2014
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2013
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Amount
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Percent
of net
revenues
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Amount
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Percent
of net
revenues
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(in thousands)
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Airfreight services:
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Revenues
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$
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647,138
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$
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620,374
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Expenses
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482,882
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464,919
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Net revenues
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164,256
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35
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%
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155,455
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35
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%
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Ocean freight services and ocean services:
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Revenues
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469,224
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445,479
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Expenses
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367,375
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344,923
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Net revenues
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101,849
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22
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100,556
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22
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Customs brokerage and other services:
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Revenues
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375,283
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347,355
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Expenses
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176,802
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155,359
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Net revenues
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198,481
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43
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191,996
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43
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Total net revenues
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464,586
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100
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448,007
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100
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Overhead expenses:
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Salaries and related costs
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255,942
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55
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248,417
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55
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Other
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73,441
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16
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71,072
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16
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Total overhead expenses
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329,383
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71
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319,489
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71
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Operating income
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135,203
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29
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128,518
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29
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Other income, net
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2,416
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1
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4,774
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1
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Earnings before income taxes
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137,619
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30
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133,292
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30
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Income tax expense
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53,424
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12
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52,682
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12
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Net earnings
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84,195
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18
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80,610
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18
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Less net earnings attributable to the noncontrolling interest
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371
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—
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295
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—
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Net earnings attributable to shareholders
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$
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83,824
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18
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%
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$
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80,315
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18
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%
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Airfreight services:
Airfreight services revenues and expenses both increased 4% for the
three-month period ended
March 31, 2014
, as compared with the same period for
2013
, due to a 6% increase in tonnage that was partially offset by the Company lowering sell rates in response to competitive market conditions and negotiating lower buy rates with carriers, primarily in North America.
Airfreight services net revenues increased 6% for the three-month period ended
March 31, 2014
, as compared with the same period for
2013
. The increase in airfreight services net revenues was primarily due to a 6% increase in airfreight tonnage, slightly offset by a 1% decrease in net revenue per kilo. North America and Europe airfreight services net revenues increased 10% and 9%, respectively, as air export tonnage increased 12% and 9%, respectively. Asia Pacific net revenues and export tonnage were both comparable to the same period for
2013
.
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 buy and sell rates and volumes.
Ocean freight services and ocean services:
Ocean freight and ocean services revenues and expenses increased 5% and 6%, respectively, for the three-month period ended
March 31, 2014
, as compared with the same period for
2013
. Container volume increased 12% as the Company lowered sell rates to maintain its existing customer base and grow market share. However the Company was only partially successful in negotiating commensurately lower buy rates from carriers. Container volume is measured in terms of forty-foot container equivalent units (FEUs).
Ocean freight and ocean services net revenues increased 1% for the three-month period ended
March 31, 2014
, as compared with the same period for
2013
. 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 43% and 45% of ocean freight net revenue for the
three-month
periods ended
March 31, 2014
and
2013
, respectively.
Ocean freight consolidation net revenues decreased 4% for the three-month period ended
March 31, 2014
, as compared with the same period in
2013
, as the 12% increase in volume was more than offset by the effect of reducing sell rates, which resulted in a 14% decrease in net revenue per container, primarily in North America and Asia Pacific. Order management and direct ocean freight forwarding net revenues increased 6% and 5%, respectively, mostly due to volumes with new and existing customers.
North America ocean freight and ocean services net revenues increased 3% in the first quarter of 2014 as compared with
2013
, primarily due to increases in order management and direct ocean forwarding that were partially offset by a decline in ocean freight consolidation. Europe ocean freight and ocean services net revenues increased 4% primarily due to direct ocean forwarding. Asia Pacific decreased 2% primarily due to the Company implementing sell rate reductions to customers, which on average outpaced buy rate reductions negotiated with carriers, and was partially offset by a 15% increase in ocean freight consolidation container volumes.
Customs brokerage and other services:
Customs brokerage and other services revenues and expenses increased 8% and 14%, respectively, for the three-month period ended
March 31, 2014
, as compared with the same periods for
2013
, as a result of increased volumes from existing and new customers and higher costs associated with import and delivery services.
Customs brokerage and other services net revenues increased 3% for the
three-month
period ended
March 31, 2014
, as compared with the same period in
2013
, primarily due to higher volumes from existing and new customers in North America. The margin percentage declined primarily as a result of lower yields in domestic time-definite transportation services and import services. Customers continue to seek out customs brokers with sophisticated computerized capabilities critical to an overall logistics management program, including rapid responses to changes in the regulatory and security environment.
North America customs brokerage and other services net revenues increased 7% in the
first
quarter of
2014
, as compared with the same period in
2013
, primarily as a result of higher volumes from existing and new customers. This increase was partially offset by declines in Asia Pacific and Europe of 5% and 2%, respectively, primarily due to lower volumes and higher relative costs in these regions.
Overhead expenses:
Salaries and related costs increased 3% for the
three-month
period ended
March 31, 2014
, as compared with the same periods in
2013
, primarily as a result of a higher average number of employees, increases in base salaries and larger bonuses earned as a result of increases in operating income.
Historically, the relatively consistent relationship between salaries and net revenues is the result of a compensation philosophy that has been maintained since the inception of the Company: offer a modest base salary and the opportunity to share in a fixed and determinable percentage of the operating profit of the business unit controlled by each key employee. Using this compensation model, changes in individual incentive compensation will occur in proportion to changes in Company operating income, creating a direct alignment between corporate performance and shareholder interests. Bonuses to management for the
three-month
period ended
March 31, 2014
were up 2% as compared with the same period for
2013
, primarily as a result of a 5% increase in operating income. The Company’s management incentive compensation programs have always been incentive-based and performance driven and there is no built-in bias that favors or enriches management in a manner inconsistent with overall corporate performance. Salaries and related costs remained constant as a percentage of net revenues for the period ended
March 31, 2014
as compared with the same period for
2013
.
Because the Company’s management incentive compensation programs are also cumulative, no management bonuses can be paid unless the relevant business unit is, from inception, cumulatively profitable. Any operating losses must have been offset in their entirety by operating profits before current management is eligible for a bonus. Since the most significant portion of management compensation comes from the incentive bonus programs, the Company believes that this cumulative feature is a disincentive to excessive risk taking by its managers. Due to the nature of the Company’s services, it has a short operating cycle. The outcome of any higher risk transactions, such as overriding established credit limits, would be known in a relatively short time frame. Management believes that when the potential and certain impact on the bonus is fully considered in light of this short operating cycle, the potential for short term gains that could be generated by engaging in risky business practices is sufficiently mitigated to discourage excessive and inappropriate risk taking. Management believes that both the stability and the long term growth in revenues, net revenues and net earnings are a result of the incentives inherent in the Company’s compensation program.
Other overhead expenses increased 3% for the
three-month
period ended
March 31, 2014
, as compared with the same period in
2013
. The increase in expenses is primarily due to a $1 million increase in depreciation and amortization expenses, higher buildings and maintenance costs and increased travel-related expenses, partially offset by a $2 million reduction in bad debt expense. Other overhead expenses as a percentage of net revenues remained constant for the
three-month
period ended
March 31, 2014
, as compared with the same period in
2013
.
Income tax expense:
The Company pays income taxes in the United States and other jurisdictions. The Company’s consolidated effective income tax rate decreased to approximately
38.8%
for the
three-month
period ended
March 31, 2014
from
39.5%
for the
three-month
period ended
March 31, 2013
. The decrease in the effective tax rate is due principally to less of a negative impact in the current year period associated with the Company's stock-based compensation arrangements resulting from an increasing proportion of non-qualified stock options to total stock compensation expense when compared to the prior year periods. The tax benefit related to stock-based compensation expense is recorded for non-qualified stock options at the time the related compensation expense is recognized while the tax benefit received for disqualifying dispositions of incentive stock options and employee stock purchase plan shares cannot be anticipated and is recorded at the time of the disqualifying event.
Currency and Other Risk Factors
The nature of the Company's worldwide operations necessitates the Company dealing with a multitude of currencies other than the U.S. dollar. This results in the Company being exposed to the inherent risks of volatile international currency markets and governmental interference. Some of the countries where the Company maintains offices and/or agency relationships have strict currency control regulations which influence the Company's ability to hedge foreign currency exposure. The Company tries to compensate for these exposures by accelerating international currency settlements among its offices or agents. The Company may enter into foreign currency hedging transactions where there are regulatory or commercial limitations on the Company's ability to move money freely around the world or the short-term financial outlook in any country is such that hedging is the most time-sensitive way to mitigate short-term exchange losses. Any such hedging activity during the
three
months ended
March 31, 2014
and
2013
was insignificant. The Company had no foreign currency derivatives outstanding at
March 31, 2014
and
December 31, 2013
. Net foreign currency losses were approximately
$2 million
and
$1 million
during the
three
months ended
March 31, 2014
and
2013
, respectively.
International air and ocean freight forwarding and customs brokerage are intensively competitive and are expected to remain so for the foreseeable future. There are a large number of entities competing in the international logistics industry, many of which have significantly more resources than the Company; however, the Company’s primary competition is confined to a relatively small number of companies within this group. The industry continues to experience consolidations into larger firms striving for stronger and more complete multinational and multi-service networks. However, regional and local brokers and forwarders remain a competitive force.
The primary competitive factors in the international logistics industry continue to be price and quality of service, including reliability, responsiveness, expertise, convenience, and scope of operations. The Company emphasizes quality customer service and believes that its prices are competitive with those of others in the industry. Customers regularly solicit bids from competitors in order to improve service, pricing and contractual terms such as seeking longer payment terms, higher liability limits and performance penalties. Increased competition could result in reduced revenues, reduced margins or loss of market share, any of which would damage the Company's results of operations and financial condition.
Larger customers utilize more sophisticated and efficient procedures for the management of their logistics supply chains by embracing strategies such as just-in-time inventory management. The Company believes that this trend has resulted in customers using fewer service providers with greater technological capacity and more consistent global coverage. Accordingly, sophisticated computerized customer service capabilities and a stable worldwide network have become significant factors in attracting and retaining customers. Developing and maintaining these systems and a worldwide network has added a considerable indirect cost to the services provided to customers. Smaller and middle-tier competitors, in general, do not have the resources available to develop customized systems and a worldwide network.
Liquidity and Capital Resources
The Company’s principal source of liquidity is cash and cash equivalents, short-term investments and cash generated from operating activities. Net cash provided by operating activities for the
three
months ended
March 31, 2014
, was approximately
$174 million
as compared with
$165 million
for the same period in
2013
. The increase of
$9 million
for the
three
-month period ended
March 31, 2014
is primarily due t
o changes in working capital accounts and an increase in earnings.
At
March 31, 2014
, working capital was
$1,434 million
, including cash and cash equivalents and short-term investments of
$1,218 million
. The Company had no long-term debt at
March 31, 2014
. Management believes that the Company’s current cash position and operating cash flows will be sufficient to meet its capital and liquidity requirements for at least the next 12 months and thereafter for the foreseeable future, including meeting any contingent liabilities related to standby letters of credit and other obligations.
As a customs broker, the Company makes significant cash advances for a select group of its credit-worthy customers. These cash advances are for customer obligations such as the payment of duties and taxes to governmental authorities in various countries throughout the world. Cash advances are a “pass through” and are not recorded as a component of revenue and expense. The billings of such advances to customers are accounted for as a direct increase in accounts receivable from the customer and a corresponding increase in accounts payable to governmental customs authorities. As a result of these “pass through” billings, the conventional Days Sales Outstanding or DSO calculation does not directly measure collection efficiency. For customers that meet certain criteria, the Company has agreed to extend payment terms beyond its customary terms. Management believes that the Company has effective credit control procedures, and historically has experienced relatively insignificant collection problems.
The Company’s business is subject to seasonal fluctuations. Cash flow fluctuates as a result of this seasonality. Historically, the first quarter shows an excess of customer collections over customer billings. This results in positive cash flow. The increased activity associated with peak season (typically commencing late second or early third quarter and continuing well into the fourth quarter) causes an excess of customer billings over customer collections. This cyclical growth in customer receivables consumes available cash.
Cash used in investing activities for the
three
months ended
March 31, 2014
was
$67 million
as compared with
$10 million
for the same period in
2013
. The Company made a net investment in short-term investments of $60 million and had capital expenditures of
$9 million
for the three-month period ended
March 31, 2014
as compared with
$10 million
in capital expenditur
es for the same period in
2013
. Capital expenditures in the
three
months ended
March 31, 2014
related primarily to investments in technology, office furniture and equipment and building and leasehold improvements. The Co
mpany does have need, on occasion, to purchase buildings to house staff and to facilitate the staging of customers’ freight. Total capital expenditures in
2014
are estimated to be approximately $75 million. This includes routine capital expenditures plus additional real estate development.
Cash used in financing activities during the
three
months ended
March 31, 2014
, was
$218 million
as compared with
$13 million
for the same period in
2013
. The Company uses the proceeds from stock option exercises and available cash to repurchase the Company’s common stock on the open market to limit the growth in issued and outstanding shares. Also, during the
three
months ended
March 31, 2014
, the Company used cash to repurchase additional common stock of
5.6 million
shares to reduce the number of total outstanding shares.
The Company follows established guidelines relating to credit quality, diversification and maturities of its investments to preserve principal and maintain liquidity. The Company’s investment portfolio has not been adversely impacted by the disruption in the credit markets. However, there can be no assurance that the Company’s investment portfolio will not be adversely affected in the future.
At
March 31, 2014
, the Company was contingently liable for $78 million from standby letters of credit and guarantees. The standby letters of credit and guarantees relate primarily to obligations of the Company’s foreign subsidiaries for credit extended in the ordinary course of business by direct carriers, primarily airlines, and for duty and tax deferrals available from governmental entities responsible for customs and value-added-tax (VAT) taxation. The total underlying amounts due and payable for transportation and governmental excises are properly recorded as obligations in the books of the respective foreign subsidiaries, and there would be no need to record additional expense in the unlikely event the parent company is required to perform.
The Company's foreign subsidiaries regularly remit dividends to the U.S. parent company after evaluating their working capital requirements and needs to finance local capital expenditures. In some cases, the Company’s ability to repatriate funds from foreign operations may be subject to foreign exchange controls. At
March 31, 2014
, cash and cash equivalent balances of
$619 million
were held by the Company’s non-United States subsidiaries, of which
$53 million
was held in banks in the United States. Earnings of the Company's foreign subsidiaries are not considered to be indefinitely reinvested outside of the United States and, accordingly, a deferred tax liability has been accrued for all undistributed earnings, net of foreign related tax credits that are available to be repatriated.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risks in the ordinary course of its business. These risks are primarily related to foreign exchange risk and changes in short-term interest rates. The potential impact of the Company’s exposure to these risks is presented below:
Foreign Exchange Risk
The Company conducts business in many different countries and currencies. The Company’s business often results in billings issued in a country and currency which differs from that where the expenses related to the service are incurred. In the ordinary course of business, the Company creates numerous intercompany transactions and may have receivables, payables and currencies that are not denominated in the local functional currency. This brings foreign exchange risk to the Company’s earnings. The principal foreign exchange risks to which the Company is exposed are in Chinese Yuan, Euro, Mexican Peso and Canadian Dollar.
Foreign exchange rate sensitivity analysis can be quantified by estimating the impact on the Company’s earnings as a result of hypothetical changes in the value of the U.S. dollar, the Company’s functional currency, relative to the other currencies in which the Company transacts business. All other things being equal, an average 10% weakening of the U.S. dollar, throughout the
three
months ended
March 31, 2014
, would have had the effect of raising operating income approximately $9 million. An average 10% strengthening of the U.S. dollar, for the same period, would have the effect of reducing operating income approximately $7 million. This analysis does not take into account changes in shipping patterns based upon this hypothetical currency fluctuation. For example, a weakening in the U.S. dollar would be expected to increase exports from the United States and decrease imports into the United States over some relevant period of time, but the exact effect of this change cannot be quantified without making speculative assumptions.
The Company currently does not use derivative financial instruments to manage foreign currency risk and only enters into foreign currency hedging transactions in limited locations where regulatory or commercial limitations restrict the Company’s ability to move money freely. Any such hedging activity during the
three
months ended
March 31, 2014
and
2013
was insignificant. During the
three
months ended
March 31, 2014
and
2013
, net foreign currency losses were approximately
$2 million
and
$1 million
, respectively. The Company had no foreign currency derivatives outstanding at
March 31, 2014
and
December 31, 2013
. The Company instead follows a policy of accelerating international currency settlements to manage foreign exchange risk relative to intercompany billings. As of
March 31, 2014
, the Company had approximate
ly $54 million
of net unsettled intercompany transactions. The majority of intercompany billings are resolved within 30 days.
Interest Rate Risk
At
March 31, 2014
, the Company had cash and cash equivalents and short term investments of
$1,218 million
, of which $633 million was invested at various short-term market interest rates. The Company had no long-term debt at
March 31, 2014
. A hypothetical change in the interest rate of 10 basis points at
March 31, 2014
would not have a significant impact on the Company’s earnings.
In management’s opinion, there has been no material change in the Company’s interest rate risk exposure in the
first
quarter of
2014
.
Item 4. Controls and Procedures
Evaluation of Controls and Procedures
The Company carried out an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report at the reasonable assurance level.
Changes in Internal Controls
There were no changes in the Company’s internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
The Company's management has confidence in the Company’s internal controls and procedures. Nevertheless, the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, does not expect that the Company’s disclosure controls and procedures or the Company’s internal controls will prevent all errors or intentional fraud. An internal control system, no matter how well-conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of such internal controls are met. Further, the design of an internal control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all internal control systems, no evaluation of controls can provide absolute assurance that all the Company’s control issues and instances of fraud, if any, have been detected.
The Company is developing a new accounting system which it plans to implement on a worldwide basis over the next several years. This system is expected to improve the efficiency of certain financial and transactional processes and reporting. This transition will affect the processes that constitute the Company's internal control over financial reporting and will require testing for operating effectiveness.