EXPEDITORS INTERNATIONAL OF WASHINGTON INC. 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," "Novel Coronavirus (COVID-19)," "
Overview
We derive our revenues by entering into agreements that are generally comprised of a single performance obligation, which is that freight is shipped for and received by our customer. Each performance obligation is comprised of one or more of the Company's services. We typically satisfy our performance obligations as services are rendered over time. A typical shipment would include services rendered at origin, such as pick-up and delivery to port, freight services from origin to destination port and destination services, such as customs clearance and final delivery. Our three principal services are the revenue categories presented in our financial statements: 1) airfreight services, 2) ocean freight and ocean services, and 3) customs brokerage and other services. The most significant drivers of changes in gross revenues and related transportation expenses are volume, sell rates and buy rates. Volume has a similar effect on the change in both gross revenues and related transportation expenses in each of our three primary sources of revenue.
We generate the major portion of our air and ocean freight revenues by purchasing transportation services on a wholesale basis from direct (asset-based) carriers and then reselling those services to our customers on a retail basis. The rate billed to our customers (the sell rate) is recognized as revenues and the rate we pay to the carrier (the buy rate) is recognized in operating expenses as the directly related cost of transportation and other expenses. By consolidating shipments from multiple customers and concentrating our buying power, we are 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.
In most cases, we act as an indirect carrier. When acting as an indirect
carrier, we issue a House Airway Bill (HAWB), a House
Customs brokerage and other services involve 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 import services such as arranging for delivery. These are complicated functions requiring technical knowledge of customs rules and regulations in the multitude of countries in which we have offices. We also provide other value added services at destination, such as warehousing and distribution, time-definitive transportation services and consulting.
In these transactions, we evaluate whether it is appropriate to record the gross or net amount as revenue. Generally, revenue is recorded on a gross basis when we are primarily responsible for fulfilling the promise to provide the services, when we assume risk of loss, when we have discretion in setting the prices for the services to the customers, and we have the ability to direct the use of the services provided by the third party. When revenue is recorded on a net basis, the amounts earned are determined using a fixed fee, a per unit of activity fee or a combination thereof. For revenues earned in other capacities, for instance, when we do not issue a HAWB, a HOBL or a House Seaway Bill or otherwise act solely as an agent for the shipper, only the commissions and fees earned for such services are included in revenues. In these transactions, we are not a principal and report only commissions and fees earned in revenue.
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We manage our company along five geographic areas of responsibility:
Our operating units share revenue using the same arms-length pricing methodologies that we use when our offices transact business with independent agents. Certain costs are allocated among the segments based on the relative value of the underlying services, which can include allocation based on actual costs incurred or estimated cost plus a profit margin. Our strategy closely links compensation with operating unit profitability, which includes shared revenues and allocated costs. Therefore, individual success is closely linked to cooperation with other operating units within our network. The mix of services varies by segment based primarily on the import or export orientation of local operations in each of our regions.
Novel Coronavirus (COVID-19)
The COVID-19 pandemic has significantly affected our business operations in the first quarter of 2020, and we expect these disruptive conditions to continue through the remainder of the year. At this time, the main elements of its impact on our business are summarized below:
• Governments have designated our operations as essential business in all
regions where we operate because of our important role in supply chains
operations worldwide. As such, our districts continue to serve our
customers while operating within the regulations established in those
countries.
• We activated our business continuity plan, first regionally in China in
January 2020 , expanding to other regions worldwide in February and March
2020 . Our business continuity plan includes measures to protect and
safeguard the health of our employees and service providers, such as
sanitization of our facilities, providing protective equipment to
employees, restricting travel and requiring all employees to work remotely
if they are able to. Our plan includes measures to minimize adverse
impacts to our operations and those of our customers' businesses. We have
identified areas of the supply chain process that can be supported
remotely and through automation, and those which require physical
operations and handling. We continue to monitor the rapidly changing
situation and may take additional actions based on recommendations from
governments and local and national health authorities.
• Travel restrictions, government mandated lockdowns and additional
precautionary measures resulted in business and supply chain disruption,
and limited operations first in China , and then worldwide with a sharp
decrease in international trade. We have also seen a shift in the goods we
handle with increased shipments of medical equipment and supplies to
combat COVID-19 and technology products to support social distancing and
working remotely. In contrast, we have seen a significant decline in
shipments from our customers in retail, aerospace, automotive, oil and
energy sectors. Overall, this has negatively impacted our results of
operations in the first quarter of 2020 as our freight volumes have
decreased.
• These disruptions are threatening the financial stability of our service
providers and our ability to efficiently route customer freight. Reduced
passenger flight schedules and cancellations have significantly impacted
available belly space, limiting our ability to utilize space under our
existing capacity agreements with carriers and requiring us to buy space
in a tight airfreight market and utilize chartered planes. Ocean carriers
have continued to reduce their capacity by anchoring vessels and skipping
ports due to the decline in demand. These freight market conditions create
pricing volatility that further challenges Expeditors' ability to maintain
historical unitary profitability.
• Many of our customers are experiencing disruptions in their revenue and
cash flow, prompting these customers to attempt to renegotiate contractual
terms and increasing our accounts receivable collection risk. We have
continued to apply our established credit control procedures and
collection monitoring that have historically been effective in limiting
credit losses. These conditions could result in the loss of business and
additional bad debt allowances in the future if our customers' ability to
pay further deteriorates.
These disruptive conditions continued in
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From the inception of our 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. We believe that our greatest challenge is now and always has been perpetuating a consistent global corporate culture, which demands:
• Total dedication to providing superior customer service;
• Compliance with our policies and procedures and government regulations;
• Aggressive marketing of all of our service offerings;
• A positive, safe work environment that is inclusive and free from
discrimination and harassment;
• Ongoing development of key employees and management personnel;
• Creation of unlimited advancement opportunities for employees dedicated to
hard work, personal growth and continuous improvement;
• Individual commitment to the identification and mentoring of successors
for every key position so that when change occurs, a qualified and
well-trained internal candidate is ready to step forward; and
• Continuous identification, design and implementation of system solutions
and differentiated service offerings, both technological and otherwise, to
meet and exceed the needs of our customers while simultaneously delivering
tools to make our employees more efficient and effective.
We reinforce 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 we became a publicly traded company. There is no limit to how much a key manager can be compensated for success. We believe in a "real world" environment where the employees of our operating units are held accountable for the profit implications of their decisions. If these decisions result in operating losses, management generally must make up these losses with future operating profits, in the aggregate, before any cash incentive compensation can be earned. Executive management, in limited circumstances, makes exceptions at the branch operating unit level. At the same time, our policies, processes and relevant training focus on such things as cargo management, risk mitigation, compliance, accounts receivable collection, cash flow and credit soundness in an attempt to help managers avoid the kinds of errors that might end a career.
We believe that our unique culture is a critical component to our continued success. We strongly believe that it is nearly impossible to predict events that, individually or in the aggregate, could have a positive or a negative impact on our 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 changes as they develop and thereby help us adapt and thrive as major trends emerge.
Our business growth strategy emphasizes a focus on the right markets and, within
each market, on the right customers that lead to profitable business growth.
Our ability to provide services to customers is highly dependent on good working relationships with a variety of entities including airlines, ocean carriers, ground transportation providers and governmental agencies. The significance of maintaining acceptable working relationships with these entities has gained increased importance as a result of the effect of the COVID-19 pandemic, ongoing concern over terrorism, security, changes in 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 rapidly promulgate new regulations in reaction to the COVID-19 pandemic and increase oversight and enforcement of new and existing laws. We consider our current working relationships with these entities to be satisfactory.
Our business is also highly dependent on the financial stability and operational capabilities of the carriers we utilize. Carriers are highly leveraged with debt and incurring operating losses. As a result, carriers are facing liquidity challenges exacerbated by COVID-19 pandemic and are seeking relief under various government support programs. This environment requires that we be selective in determining which carriers to utilize. Further changes in the financial stability, operating capabilities and capacity of asset-based carriers, capacity allotments available from carriers, governmental regulations, and/or trade accords could adversely affect our business in unpredictable ways.
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International Trade and Competition
We operate in over 60 countries in the competitive global logistics industry and
our activities are closely tied to the global economy. The global economy is
experiencing a rapid slowdown as a result of the COVID-19 pandemic and related
precautionary measures including lockdown government mandates worldwide,
shutdown of manufacturing and operations for non-essential businesses and travel
restrictions. International trade is influenced by many factors, including
economic and political conditions in
The global logistics services industry is intensely competitive and is expected
to remain so for the foreseeable future. Our pricing and terms continue to be
pressured by uncertainty in global trade and economic conditions, concerns over
airfreight capacity availability, volatile airfreight pricing, disruptions in
port services, political unrest and fluctuating currency exchange rates. We
expect these operating and competitive conditions to continue. Air carriers are
experiencing significant cash flow challenges as a result of travel restrictions
resulting in cancellation of flights. Ocean carriers have incurred substantial
operating losses in recent years, and many are highly leveraged with debt. These
financial challenges have resulted in multiple carrier acquisitions and carrier
alliance formations. Additionally, carriers continue to take delivery of new and
larger ships, which may increase capacity. Carriers also face new regulatory
requirements that became effective in 2020 requiring reductions in the sulfur in
marine fuel, which are increasing their operating and capital costs. When the
market experiences seasonal peaks or any sort of disruption, the carriers often
increase their pricing suddenly. This carrier behavior creates pricing
volatility that could impact
There is uncertainty as to how new regulatory requirements and volatility in oil prices will continue to impact future buy rates. Because fuel is an integral part of carriers' costs and impacts both our buy rates and sell rates, we would expect our revenues and costs to be impacted as carriers adjust rates for the effect of changing fuel prices. To the extent that future fuel prices increase and we are unable to pass through the increases to our customers, this could adversely affect our operating income.
The global economic and trade environments remain uncertain, including the impacts of COVID-19. We cannot predict the impact of future changes in global trade on our operating results, freight volumes, pricing, changes in consumer demand, carrier stability and capacity, customers' abilities to pay or on changes in competitors' behavior. Additionally, we cannot predict the direct or indirect impact that further changes in consumer purchasing behavior, such as online shopping, could have on our business. In response to governments implementing higher tariffs on imports as well as responses to COVID-19 disruptions, some customers have begun shifting manufacturing to other countries which could negatively impact us.
Seasonality
Historically, our operating results have been subject to seasonal demand trends with the first quarter being the weakest and the third and fourth quarters being the strongest; however, there is no assurance this seasonal trend will occur in the future or to what degree it will be impacted in 2020 by COVID-19. This pattern has been the result of, or influenced by, numerous factors, including weather patterns, national holidays, consumer demand, new product launches, economic conditions, pandemics, governmental policies and inter-governmental disputes and a myriad of other similar and subtle forces. In addition, this historical quarterly trend has been influenced by the growth and diversification of our international network and service offerings.
A significant portion of our revenues is derived from customers in the retail and technology 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 our revenues are, to a large degree, impacted by factors out of our control, such as a sudden change in consumer demand for retail goods, changes in trade tariffs,
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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, we 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 or investors, any such shortfall from levels predicted by securities analysts or investors could have an immediate and adverse effect on the trading price of our stock. We cannot accurately forecast many of these factors, nor can we 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
Results of Operations
The following table shows the revenues, the directly related cost of
transportation and other expenses for our principal services and our overhead
expenses for the three months ended
The table and the accompanying discussion and analysis should be read in conjunction with the condensed consolidated financial statements and related notes thereto in this quarterly report.
Three months ended March 31,
Percentage
(in thousands) 2020 2019 change
Airfreight services:
Revenues $ 709,039 $ 714,901 (1)%
Expenses 520,169 509,210 2Ocean freight services and ocean
services: Revenues 493,427 568,641 (13) Expenses 366,483 420,331 (13) Customs brokerage and other services: Revenues 699,398 736,509 (5) Expenses 400,076 436,396 (8) Overhead expenses: Salaries and related costs 342,040 356,910 (4) Other 114,041 109,603 4 Total overhead expenses 456,081 466,513 (2) Operating income 159,055 187,601 (15) Other income, net 8,191 7,771 5 Earnings before income taxes 167,246 195,372 (14) Income tax expense 44,464 55,261 (20) Net earnings 122,782 140,111 (12)
Less net earnings attributable to
the noncontrolling interest 438 412 6
Net earnings attributable to
shareholders$ 122,344 $ 139,699 (12)% 17
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Airfreight services:
Airfreight services revenues decreased 1% during the three months ended
Airfreight services expenses increased 2% during the three months ended
As a result of travel restrictions and lower passenger demand, airlines cancelled flights reducing available belly space for cargo at a time where demand for time-sensitive delivery of essential supplies was high, resulting in imbalances between carrier capacity and demand in certain lanes. In order to accommodate the transportation of our customers' shipments we increased our use of charter flights and purchases of capacity on the spot market, which resulted in significantly higher buy and sell rates. These conditions created a high degree of volatility in volumes, buy and sell rates and are expected to continue in the second quarter of 2020 and the remainder of the year.
Ocean freight and ocean services:
Ocean freight consolidation, direct ocean forwarding and order management are
the three basic services that constitute and are collectively referred to as
ocean freight and ocean services. Ocean freight and ocean services revenues and
expenses decreased 13% for the three months ended
Ocean freight consolidation revenues and expenses decreased 20% and 19%,
respectively, for the three months ended
Direct ocean freight forwarding revenues and expenses increased 9% and 18%,
respectively, for the three months ended
Ocean carriers continue to reduce their capacity by anchoring vessels and skipping ports due to the decline in demand. We expect that pricing volatility will continue as customers solicit bids, react to governmental trade policies, adjust to the slowdown of the global economy from the COVID-19 pandemic and carriers continue to adapt to changes in capacity, market demand and merge or create alliances with other carriers. Carriers also face new regulatory requirements that became effective in 2020 to reduce the use of sulfur in marine fuel, which are increasing their operating and capital costs, which could result in higher costs for us. These conditions could result in continued lower operating income.
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Customs brokerage and other services:
Customs brokerage and other services revenues decreased 5% and expenses
decreased 8% for the three months ended
Overhead expenses:
Salaries and related costs decreased by 4% for the three months ended
Historically, the relatively consistent relationship between salaries and operating income has been the result of a compensation philosophy that has been maintained since the inception of our 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 occur in proportion to changes in our operating income, creating an alignment between branch and corporate performance and shareholder interests.
Our management compensation programs have always been incentive-based and
performance driven. Bonuses to field management for the three months ended
Because our management incentive compensation programs are also cumulative, generally no management bonuses can be paid unless the relevant business unit is, from inception, cumulatively profitable. Any operating losses must be offset in their entirety by operating profits before management is eligible for a bonus. Executive management, in limited circumstances, makes exceptions at the branch operating unit level. Since the most significant portion of management compensation comes from the incentive bonus programs, we believe that this cumulative feature is a disincentive to excessive risk taking by our managers. 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 the short operating cycle of our services, 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, operating income and net earnings are a result of the incentives inherent in our compensation programs.
Other overhead expenses increased 4% for the three months ended
Income tax expense:
Our consolidated effective income tax rate was 26.6% for the three months ended
Some elements of the recorded impacts of the 2017 Tax Act could be impacted by
further legislative action as well as additional interpretations and guidance
issued by the
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Currency and Other Risk Factors
The nature of our worldwide operations necessitates dealing with a multitude of
currencies other than the
International air and ocean freight forwarding and customs brokerage are
intensely competitive and are expected to remain so for the foreseeable future.
There are a large number of entities competing in the international logistics
industry, including new technology-based competitors entering the industry, many
of which have significantly more resources than us; however, our primary
competition is confined to a relatively small number of companies within this
group.
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. We emphasize quality customer service and believe that our 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 or unlimited liability limits and performance penalties. Increased competition and competitors' acceptance of expanded contractual terms could result in reduced revenues, reduced operating income, higher operating costs, higher claims or loss of market share, any of which would damage our 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. We believe 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
Our principal source of liquidity is cash and cash equivalents and cash
generated from operating activities. Net cash provided by operating activities
for the three months ended
As a customs broker, we make significant cash advances for a select group of our credit-worthy customers. These cash advances are for customer obligations such as the payment of duties and taxes to customs authorities in various countries throughout the world. Increases in duty rates could result in increases in the amounts we advance on behalf of our customers. 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, we have agreed to extend payment terms beyond our customary terms. Management believes that it has established effective credit control procedures, and historically has experienced relatively insignificant collection problems.
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Our business historically has been subject to seasonal fluctuations and this is expected to continue in the future. Cash flows fluctuate 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 periods of higher demand (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
Cash used in financing activities during the three months ended
We follow established guidelines relating to credit quality, diversification and maturities of our investments to preserve principal and maintain liquidity. Historically, our investment portfolio has not been adversely impacted by disruptions occurring in the credit markets. However, there can be no assurance that our investment portfolio will not be adversely affected in the future.
We cannot predict what impact growing uncertainties in the global economy, political uncertainty nor the COVID-19 pandemic may have on our operating results, freight volumes, pricing, amounts advanced on behalf of our customers, changes in consumer demand, carrier stability and capacity, customers' abilities to pay or on changes in competitors' behavior.
We maintain international unsecured bank lines of credit. At
Our foreign subsidiaries regularly remit dividends to the
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