Why did net earnings grow more slowly than operating income in 2006?

Operating income grew 38%, but net earnings grew 23% because the effective tax rate rose to 40.6% from 31.2%. The 2005 rate was lowered by a one-time $22 million IRC 965 tax benefit that did not recur in 2006, and a smaller benefit from disqualifying stock option dispositions also contributed.

Does Expeditors carry debt, and how is it funding growth?

The company had no long-term debt at December 31, 2006, and no borrowings under its $50 million U.S. credit line or its international facilities. Growth and shareholder returns were funded from operating cash flow and existing cash balances of about $512 million.

What drove the revenue and volume growth in 2006?

Airfreight net revenues rose 20% on global tonnage growth of 18%, while ocean freight net revenues increased 24% on FEU volume growth of 20%. Customs brokerage net revenues grew 20%, attributed to market share gains, service reputation, and increased demand for compliance-driven services.

What are the main risks investors should monitor?

Key risks include dependence on asset-based carriers whose pricing and capacity the company does not control, exposure to global trade disruptions and currency controls (with about $22 million of operating income sensitivity to a 10% dollar move), quarterly seasonality that can cause earnings shortfalls, and the rising cost of cargo security compliance. The filing also notes the company checked the box indicating it had not filed all required reports during the prior 12 months, which investors may want to verify.

EXPD 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 1, 2007. Cited figures are marked; the original filing is the authoritative source.

Expeditors International of Washington (EXPD), a non-asset based global logistics provider, delivered a strong 2006.

Revenues rose 19% to $4.63 billion^a, and net revenues (revenues less freight consolidation costs) grew 21% to $1.28 billion. Operating income increased 38% to $375 million, and operating margin on net revenues expanded from 26% to 29%, reflecting strong volume growth (global airfreight tonnage up 18%, ocean FEUs up 20%) and disciplined overhead control, with overhead as a percentage of net revenue falling from 74% to 71%. Net earnings rose 23% to $235 million, and diluted EPS was $1.06 (post 2-for-1 split in June 2006), up from $0.86.

The effective tax rate rose to 40.6% from 31.2%, largely because 2005 benefited from a one-time $22 million^b IRC 965 tax benefit, which compresses year-over-year earnings growth in the tax line. The balance sheet is conservative: the company had no long-term debt, $512 million of cash and short-term investments, and working capital of $633 million. Operating cash flow was $333 million, while capital expenditures roughly doubled to $141 million, including $67 million for a Miami facility and $22 million of real estate development in Seattle and Houston.

Management guided 2007 capital spending to about $106 million^c, to be funded with cash. Shareholder returns were significant: the company repurchased $176 million of stock and paid $47 million in dividends, and the dividend was raised to $0.22 per share from $0.15. Key risks in the filing include dependence on asset-based carriers (airlines and steamship lines), exposure to global trade and currency volatility, quarterly seasonality, and rising cargo security regulation.

The company also disclosed a change in stock compensation accounting under SFAS 123R with restated prior periods, and a filing-timeliness box indicating it had not filed all required reports in the preceding 12 months. Investors should weigh the strong operating momentum and cash generation against the elevated effective tax rate and the reliance on carrier relationships and macro trade conditions.

02—Key points

Key Highlights

Revenue grew 19% to $4.63 billion in 2006, while net revenues rose 21% to $1.28 billion, indicating solid growth in value-added business.
Operating income increased 38% to $375 million, and operating margin on net revenues improved to 29% from 26%, driven by volume leverage and cost containment.
Net earnings rose 23% to $235 million; diluted EPS was $1.06 (split-adjusted) versus $0.86 in 2005, but the effective tax rate increased to 40.6% from 31.2% due to the prior-year one-time tax benefit.
The company has no long-term debt and held $512 million in cash and short-term investments at year-end, with working capital of $633 million.
Operating cash flow reached $333 million, but capital expenditures nearly doubled to $141 million, and 2007 capex is guided to about $106 million.
Shareholder returns were significant: $176 million in buybacks, $47 million in dividends, and a semi-annual dividend increase to $0.11 per share ($0.22 annualized).
Risks include reliance on third-party airlines and steamship lines, currency and trade policy exposure with most revenue generated outside the U.S., and increasing government security regulation.

03—Questions

Frequently Asked Questions

Why did net earnings grow more slowly than operating income in 2006?
Operating income grew 38%, but net earnings grew 23% because the effective tax rate rose to 40.6% from 31.2%. The 2005 rate was lowered by a one-time $22 million IRC 965 tax benefit that did not recur in 2006, and a smaller benefit from disqualifying stock option dispositions also contributed.
Does Expeditors carry debt, and how is it funding growth?
The company had no long-term debt at December 31, 2006, and no borrowings under its $50 million U.S. credit line or its international facilities. Growth and shareholder returns were funded from operating cash flow and existing cash balances of about $512 million.
What drove the revenue and volume growth in 2006?
Airfreight net revenues rose 20% on global tonnage growth of 18%, while ocean freight net revenues increased 24% on FEU volume growth of 20%. Customs brokerage net revenues grew 20%, attributed to market share gains, service reputation, and increased demand for compliance-driven services.
What are the main risks investors should monitor?
Key risks include dependence on asset-based carriers whose pricing and capacity the company does not control, exposure to global trade disruptions and currency controls (with about $22 million of operating income sensitivity to a 10% dollar move), quarterly seasonality that can cause earnings shortfalls, and the rising cost of cargo security compliance. The filing also notes the company checked the box indicating it had not filed all required reports during the prior 12 months, which investors may want to verify.

04—Continue

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