FedEx sees earnings decline, due largely to TNT cyberattack

The impact of the NonPetya cyber attack and to a somewhat lesser degree that of Hurricane Harvey each had a negative impact on fiscal first quarter earnings for transportation and logistics bellwether FedEx, the company said late yesterday.

First quarter net income at $596 million was down 16% annually, with earnings per share at $2.19, which is 17.4% below last year’s $2.65 and below Wall Street estimates of $3.09. The June 27 cyberattack, which affected FedEx subsidiary TNT Express, dropped EPS by $0.79, with Hurricane Harvey accounting for $0.02 EPS. Operating income for the quarter at $1.12 billion was down 9.7%, and net margin at 7.3% was off 9.9%.

“The TNT Express cyberattack and Hurricane Harvey posted significant challenges to our operations in the first quarter,” said Fred Smith, FedEx chairman and CEO on the company’s earnings call yesterday. “I strongly believe FedEx will emerge from the cyberattack as an even stronger more resourceful company and I would like to thank the thousands of FedEx team members who work tirelessly to remediate the TNT systems problems and take care of our customers. We are confident of our prospects for long-term profitable growth. We reaffirm our commitment to improve our operating income at FedEx Express but—the segment by $1.2 billion to $1.5 billion in fiscal 2020 versus fiscal 2017.”

Individual unit quarterly performances:

FedEx Express revenue, which includes TNT Express, was flat at $8.65 billion, and operating income dropped 16.9% to $433 million. FedEx cited revenue growth from higher U.S. domestic package base rates and solid international package growth that it said was partially offset by the impact of the TNT Express cyberattack. And it said that operating income was off by an estimated $300 million, due to the cyberattack as well.

Total quarterly package revenue was up 4% at $6.633 billion, with U.S. package revenue up 3% at $3.078 billion and total international export package revenue up 4% at $2.511 billion.

Total average daily packages at 5.796 million were up 2%, with total daily U.S. domestic packages down 1% at 2.621 million and revenue per package up 2% at $17.61. Total daily international export packages at 754,000 were up 2%, with international domestic up 5% at 2.421 million.

FedEx Ground revenue headed up 8% to $4.64 billion, and operating income rose 3% to $626 million. FedEx noted that revenue rose due to average daily package volume increasing by 4%, coupled with higher commercial service base rates.

FedEx Freight, the company’s less-than-truckload segment, saw revenue head up 6% to $1.75 billion, with operating income up 30% at $133 million and a 1.9 point gain in operating margin to 10%. FedEx attributed the gains to higher base rates, increased weight per shipment, and higher fuel surcharges, with average daily LTL shipments up 1%, as the company continues to focus on revenue quality.

Addressing the TNT cyberattack on the earnings call, FedEx EVP and CFO Alan Graf said the attack resulted in a significant business interruption and financial impact. And he added that FedEx estimates the cyberattack reduced FedEx Express first quarter operating income by approximately $300 million or $0.79 per diluted share.

“Because our intra-European domestic businesses recovered more quickly, the impact from lost revenues was and continues to be more heavily weighted towards our higher-yielding international shipments, resulting in a more pronounced impact on profits.

It is taking longer to restore our international business due to the complexity of clearance systems and business processes,” he said. “We are now focused on finalizing the restoration of certain key customer specific, specialized solutions and systems in time for the peak season. While significant progress has been made on restoration of our operations and IT systems, TNT revenues, volumes and profits remained below pre-attack levels. As we look ahead to the remainder of FY18, we expect to experience ongoing but diminishing financial impacts from the cyberattack in the form of lower revenues and higher investments to further improve and strengthen our IT infrastructure.”

FedEx Executive Vice President, FedEx Information Services and CIO Rob Carter said on the call that the FedEx global IT teams have been working to rebuild the TNT technical environment to be more resilient.

“As a result, the TNT security posture is much improved,” he explained. “Leveraging every available resource, we have restored the TNT systems to a near normal state with virtually all critical systems up and available.We are now focused on the restoration of certain key customer specific solutions and systems. We expect these IT capabilities to be restored by the end of September, enabling business as usual operations with full capabilities across all customer segments. At the time of the attack, there was already work underway to replace TNT legacy systems with FedEx technology. In the wake of the attack these efforts been accelerated. We’ve hardened all of TNT servers and workstations, introduced additional network security controls, rebuilt active directory and have started enhancing the segmentation of the TNT network.”

On the economic front, Raj Subramaniam, FedEx Executive Vice President and Chief Marketing and Communications Officer, said that FedEx continues to see moderate growth in the global economy.

He observed that the FedEx calendar year 2017 U.S. forecast is mostly unchanged and reflects solid consumer spending and a rebound in industrial activity. On the international side he said recovery and capital spending is supporting higher global GDP growth and driving the best trade volume growth since 2011.

As for peak season, specifically on the pricing side, he said that FedEx is taking a “surgical” approach to how it manages peak surcharges in the form of oversized packages and pricing programs for the small number of large retail and e-tail customers that drive the surge in peak deliveries.

“FedEx will not apply holiday season surcharges except for packages that are oversized and authorized are require additional handling,” he said. The pricing programs for large customers are designed to provide incremental capacity during peak, while including some protection for FedEx if they come in below volume projections. By focusing on these two areas and applying the peak oversized package surcharge during the entire peak season, we expect to capture incremental revenue. Our approach properly aligns revenue with our incremental peak investments without burdening our millions of loyal small business customers with the holiday delivery residential surcharge. We are beginning a national marketing and sales campaign to ensure customers are aware of our peak pricing and we expect profitable volume gain and brand loyalty benefits.”

While the primary focus of the FedEx call centered in the cyberattack, on the TNT book of business, Jerry Hempstead, president of Hempstead Consulting, said that the good news is that the attack rendered many TNT systems useless and not worth salvaging and will speed up the process to migrate customers onto FedEx platforms now rather than later.

“Unsaid on the call was the damage done to customer relationships when customers were forced to scramble and convert their business to UPS or DHL because TNT systems were down,” he said. “These customers are not going to be in a hurry to now convert back to FedEx unless they are given a major financial incentive to do so. Some may never return. People are just not going to flip back because FedEx now says everything is back to ‘almost’ pre-attack levels. The ‘almost’ word was used so many times on the call it should leave one wondering what exactly that means, and it appears FedEx IT is still writing programs to get specific customers back on board with a seamless processes.

FedEx has deep pockets and will weather this but I suspect there are some in Memphis who might now regret the TNT acquisition. FedEx is going to have to put their selling shoes on for the next few quarters to bolster at least the top line.”