Why did operating cash flow decline even though earnings grew?

Cash from operations fell to $1.87 billion from $2.23 billion mainly because FedEx made roughly $1.1 billion of discretionary contributions to its qualified U.S. pension plans in 2003 to fully fund the accumulated benefit obligation. These were not required under ERISA minimum funding rules, so the cash outflow is a one-time event for that year rather than a change in underlying operating earnings power.

Which segment is driving growth, and which is struggling?

FedEx Ground and FedEx Freight drove growth, with Ground revenue up 26% and Freight revenue up 8%. FedEx Express, the largest segment at about $16.4 billion in revenue, saw revenue rise 7% but operating income fall 3%, as U.S. domestic package volumes declined and employee benefit, maintenance and fuel costs rose. Management is targeting margin improvement at Express starting in 2005.

What are the main cost headwinds for fiscal 2004?

Management expects pension cost to rise about $115 million, driven by a lower discount rate and a reduced expected return on plan assets (cut from 10.10% to 9.10%). The voluntary early-retirement and severance programs at FedEx Express are estimated at $230-290 million pretax, with net 2004 cost of $130-160 million after savings. Fuel surcharges also lag actual fuel price changes, which could hurt operating income if prices spike suddenly.

Are there any material legal or regulatory risks disclosed?

Yes, several are disclosed. The DOT has demanded repayment of $31.6 million of airline stabilization compensation, and management says a material reduction in the $119 million recognized is reasonably possible though it expects to collect most of it. A San Diego class action over late deliveries during the 1997 UPS Teamsters strike resulted in a roughly $70 million judgment that FedEx is appealing, with no accrual recorded. The company is also litigating an IRS dispute over jet engine maintenance deductions, with about $202 million in proposed deficiencies, though tax expense impact would be limited to interest.

Is the dividend and share repurchase program a meaningful change in capital allocation?

It is a modest but notable shift. FedEx began paying dividends in 2002, and total 2003 dividends paid were $60 million, with a quarterly rate of $0.05 per share. The company bought back 3.3 million shares for $186 million at an average of $56.66, with 8.0 million shares remaining under existing authorizations. Management stresses that dividends remain subject to board approval, and capital spending is still the dominant use of cash, planned at about $1.7 billion for 2004.

FDX 10-K FY2003 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed July 17, 2003. Cited figures are marked; the original filing is the authoritative source.

FedEx's fiscal 2003 10-K (year ended May 31, 2003) shows a company whose consolidated results improved while its largest segment weakened.

Revenue rose 9% to $22.5 billion^a and operating income rose 11% to $1.47 billion, with net income up 17% to $830 million and diluted EPS of $2.74 versus $2.34. The growth was driven by FedEx Ground, where revenue grew 26% and operating margin expanded to 14.5%, plus higher international volumes at FedEx Express and higher FedEx Freight yields. FedEx Express, the largest segment, saw operating income fall 3% and its margin decline to 4.8% on sluggish U.S. domestic volumes, higher pension and healthcare costs, heavier maintenance spending, and net fuel cost pressure.

Balance sheet and cash flow picture is mixed. Operating cash flow fell to $1.87 billion^b from $2.23 billion, largely because the company made about $1.1 billion of discretionary contributions to its U.S. pension plans to fund the accumulated benefit obligation. Capital expenditures declined 6% to $1.51 billion, and the company paid its first-ever cash dividend ($0.05 per quarter) and repurchased $186 million of stock.

Long-term debt stands at roughly $1.7 billion^c, and the company held $538 million in cash at year end. Management's outlook for fiscal 2004 is cautious. Management expects a sluggish U.S. economy at least through the first quarter, with an approved early-retirement and severance program at FedEx Express expected to cost $230-290 million pretax.

Pension expense is projected to rise about $115 million^d. Investors should also note a pending dispute with the Department of Transportation over $31.6 million of airline stabilization compensation and a $70 million judgment on appeal in the 1997 Teamsters strike class action, though management views neither as likely to be material.

02—Key points

Key Highlights

Revenue grew 9% to $22.5 billion; operating income rose 11% to $1.47 billion and operating margin reached 6.5%.
Net income increased 17% to $830 million, with diluted EPS of $2.74 versus $2.34 in fiscal 2002.
FedEx Ground was the growth engine: revenue up 26% to $3.4 billion, operating margin up to 14.5%, and its home delivery service turned profitable in 2003.
FedEx Express operating income fell 3% to $786 million and margin slipped to 4.8%, reflecting weak U.S. domestic volumes, higher pension/healthcare and maintenance costs, and fuel.
Operating cash flow dropped to $1.87 billion, largely due to over $1 billion of voluntary pension contributions; capex fell 6% to $1.51 billion.
FedEx initiated its first-ever quarterly cash dividend ($0.05/share) and repurchased $186 million of common stock.
Fiscal 2004 outlook calls for pension cost up about $115 million and early-retirement charges of $230-290 million, with margin pressure at FedEx Express expected before improvement in 2005.

03—Questions

Frequently Asked Questions

Why did operating cash flow decline even though earnings grew?
Cash from operations fell to $1.87 billion from $2.23 billion mainly because FedEx made roughly $1.1 billion of discretionary contributions to its qualified U.S. pension plans in 2003 to fully fund the accumulated benefit obligation. These were not required under ERISA minimum funding rules, so the cash outflow is a one-time event for that year rather than a change in underlying operating earnings power.
Which segment is driving growth, and which is struggling?
FedEx Ground and FedEx Freight drove growth, with Ground revenue up 26% and Freight revenue up 8%. FedEx Express, the largest segment at about $16.4 billion in revenue, saw revenue rise 7% but operating income fall 3%, as U.S. domestic package volumes declined and employee benefit, maintenance and fuel costs rose. Management is targeting margin improvement at Express starting in 2005.
What are the main cost headwinds for fiscal 2004?
Management expects pension cost to rise about $115 million, driven by a lower discount rate and a reduced expected return on plan assets (cut from 10.10% to 9.10%). The voluntary early-retirement and severance programs at FedEx Express are estimated at $230-290 million pretax, with net 2004 cost of $130-160 million after savings. Fuel surcharges also lag actual fuel price changes, which could hurt operating income if prices spike suddenly.
Are there any material legal or regulatory risks disclosed?
Yes, several are disclosed. The DOT has demanded repayment of $31.6 million of airline stabilization compensation, and management says a material reduction in the $119 million recognized is reasonably possible though it expects to collect most of it. A San Diego class action over late deliveries during the 1997 UPS Teamsters strike resulted in a roughly $70 million judgment that FedEx is appealing, with no accrual recorded. The company is also litigating an IRS dispute over jet engine maintenance deductions, with about $202 million in proposed deficiencies, though tax expense impact would be limited to interest.
Is the dividend and share repurchase program a meaningful change in capital allocation?
It is a modest but notable shift. FedEx began paying dividends in 2002, and total 2003 dividends paid were $60 million, with a quarterly rate of $0.05 per share. The company bought back 3.3 million shares for $186 million at an average of $56.66, with 8.0 million shares remaining under existing authorizations. Management stresses that dividends remain subject to board approval, and capital spending is still the dominant use of cash, planned at about $1.7 billion for 2004.

04—Continue

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