FedEx Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
March 21, 2024

There are 17 speakers on the call.

Operator

Good day, and welcome to the FedEx Fiscal Year 20 24 Third Quarter Earnings Call. All participants are in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Jenny Hollander, Vice President of Investor Relations. Please go ahead.

Speaker 1

Good afternoon, and welcome to FedEx Corporation's 3rd quarter earnings conference call. The 3rd quarter earnings release, Form 10 Q and stat book are on our website at investors. Fedex.com. This call and the accompanying slides are being streamed from our website, where the replay and slides will be available for about 1 year. During our Q and A session, callers will be limited to one question to allow us to accommodate all those who would like to participate.

Speaker 1

Certain statements in this conference call may be considered forward looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such forward looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those expressed or implied by such forward looking statements. For additional information on these factors, please refer to our press releases and filings with the SEC. Today's presentation also includes certain non GAAP financial measures. Please refer to the Investor Relations portion of our website at fedex.com for a reconciliation of the non GAAP financial measures discussed on this call to the most directly comparable GAAP measures.

Speaker 1

Joining us on the call today are Raj Subramaniam, President and CEO Brie Carreri, Executive Vice President and Chief Customer Officer and John Dietrich, Executive Vice President and CFO. Now I will turn the call over to Raj.

Speaker 2

Thank you, Jenny, and welcome to your first earnings call at FedEx. We are happy to have you on board leading the Investor Relations team. Before we discuss the quarter, I would like to congratulate Bob Carter on his upcoming retirement, which we announced last week. He has served as CIO for the last 24 years leading FedEx in modernizing our IT infrastructure. I'm immensely grateful to Rob for his numerous contributions in establishing FedEx as an innovative, data driven and a people focused company.

Speaker 2

We thank him for his dedication and service to FedEx over the years and wish him well in his upcoming retirement. Thank you also to the FedEx team for their exceptional work in Q3 by providing superior service for customers and delivering strong results, all while advancing our transformation initiatives. For the 3rd consecutive quarter, we delivered operating income growth and margin expansion in a declining revenue environment. This is a very positive dynamic and a unique one in our industry. It demonstrates clear progress on our transformation and ability to manage what's within our control through Drive.

Speaker 2

We're strengthening our value proposition, improving the customer experience and increasing profitability. This progress supports our long term goals for sustainable margin expansion, improvements in ROIC and value creation for our stockholders. Now turning to the details. Our transformation is driving continued improvements in adjusted operating income, margins and earnings per share. At the enterprise level, we delivered a 16% improvement in adjusted operating income and adjusted margin expansion of 90 basis points compared to the prior year even as revenue declined 2%.

Speaker 2

Adjusted operating income growth was driven by continued strength at Ground and improvement at Express. At the segment level, I'm particularly pleased with the results at Ground, where adjusted operating income increased 14% on 1% revenue growth and adjusted operating margin improved to over 11% in the quarter. This reflects continued progress controlling expenses and effective yield management including the ramping benefits from DRi. At freight, the team's continued focus on profitable growth and cost management delivered strong margins and mitigated year over year volume challenges. Service levels remain exceptionally high demonstrating our differentiated execution capabilities.

Speaker 2

We're also making progress at Express where adjusted operating income increased enabled by our ability to remove structural costs. Looking ahead, we are reaffirming the midpoint of our fiscal 2024 district EPS range while narrowing the range to $17.25 to $18.25 In fact, we now expect to deliver adjusted earnings above the midpoint of the range we shared last June despite full year revenue expectations that have deteriorated significantly over the past 9 months. This is clear evidence of our ability to execute. Turning to the Express business, it is my top priority to continue to make the changes necessary to align our air network with an evolving demand environment and unlock the full profit opportunity. While we have made progress at Express this quarter, there are several areas we're aggressively working to address in order to accelerate profit improvement.

Speaker 2

Service mix, network utilization, continued inflation and other cost headwinds. First with respect to Servicemix, we're seeing a clear international market shift towards deferred services. This is tied in part to the rapid growth of many of our e commerce customers where we are a critical enabler of global trade offering unique solutions for our customers. More on how we are addressing this mix shift shortly. 2nd, weakness in global trade continues to constrain demand in our international business, which has remained challenged for longer than expected.

Speaker 2

As such, we're continuing to proactively realign our air network to match capacity to demand. And 3rd, this quarter Express experienced over $200,000,000 of inflationary pressure on a year over year basis. We offset this with benefits from DRiV as well as responsible headcount management. The dynamics I just outlined create significant opportunities for us to improve our network utilization. Last quarter, we introduced our tricolor strategy.

Speaker 2

Ultimately, this network design will enable us to improve the efficiency and asset utilization of the entire FedEx system, Put the right product in the right network taking advantage of our continental surface networks in Europe and our market leading FedEx freight LTL network in the United States and profitably penetrate new market segments at the right cost structure including the premium airfreight market. As we move forward, we are managing the execution of Tricolor with the rigor and discipline of drive and this will be a key element to our success. Moving to another area of opportunity. In Europe, we continue to improve our service levels and focus on commercial execution. However, the B2B environment remains challenged.

Speaker 2

And in this context, we are making progress on DRiV on track to generate $600,000,000 of savings in fiscal year 2025 and seeking further profit optimization opportunities. As we have mentioned in previous calls, we are also experiencing a continued headwind for the United States Postal Service which has produced volume. Despite this volume and revenue drawdown, our service obligations to the USPS remain fixed. Express and across the business, DRiV remains a key enabler of improved profitability both in the near and the long term as we change the way we work and identify areas for structural cost reduction. In Q3, we delivered $550,000,000 of benefits from DRiV, offsetting the impact of revenue declines and cost pressures.

Speaker 2

I'm encouraged by the progress across all three categories. This includes $290,000,000 in our surface network, $110,000,000 of savings in air network and international operations and $150,000,000 of G and A. Given the progress we have made year to date, we will deliver on our goal of $1,800,000,000 in permanent cost reduction benefits from DRiV this fiscal year and are highly confident on the additional $2,200,000,000 in fiscal year 2025. The work we are doing with Drive is also helping advance planning for Network 2.0. This quarter we rolled out our new surface operations leadership structure.

Speaker 2

Under this new structure leaders and their teams will be responsible for all express and ground package operations and facilities in their respective divisions, regions and districts. This will enhance operational execution and offer greater insights into the package business overall with accountability at all levels. More broadly, we have now implemented Network 2.0 in over 50 locations with dozens more to follow in calendar 2024 all while maintaining outstanding service. And as a reminder, we will begin the rollout of Canada in April and expect to complete this transition by October of 2024. And as part of our transformation, we are on track to complete the consolidation of FedEx operating companies into one streamlined and simplified organization creating efficiencies as we build a stronger more profitable enterprise.

Speaker 2

In June 2024, FedEx Express, FedEx Ground and FedEx Services will consolidate into Federal Express Corporation. The work we're doing to create a more flexible, efficient and intelligent network is translating into direct improvements in our customer offering and profitability. When severe weather hits, it can cause a domino effect of delays and reduced service levels across our network. While we have always used data analytics to assess the effect of weather events, our new weather contingency playbook developed by our planning, engineering and data works teams enhances the process by leveraging predictive capabilities to proactively divert storm bound volumes across our networks. By combining the power of digital insights and predictive analytics with our physical network, we effectively mitigated the impact of the January winter storm that hit our Express hub in Memphis by shifting Memphis bound Express volume to ground our freight at the origin location.

Speaker 2

Despite this year's event having a longer impact to Memphis operations when compared to the weather event in February 2023, our network recovery was twice as fast. This quarter, we also announced a significant initiative FDX, a fully integrated data driven commerce platform that connects the entire customer journey from demand to returns. It will provide real time visibility to help our customers optimize and grow their business, leveraging our analytical capabilities and data from the 15,000,000 packages we deliver every day. I'm excited to have Sriram Krishnasamy serving as Chief Digital and Information Officer effective July 1. His proven track record of driving optimization and innovation for our business through data and insights combined with his deep knowledge of the network will be critical to moving FedEx forward as we become a data driven digital first company.

Speaker 2

As I look across the business and these financial results, there are clear signs of progress on our transformation. Our strategy is generating results and we are well placed to maintain our leadership position while delivering improving financial outcomes. Together, we remain focused and committed to our long term goals, supporting the creation of significant long term value for our stockholders. With that, let me turn the call over to Brie.

Speaker 3

Thank you, Raj, and good afternoon, everyone. First, I want to thank our FedEx team for strong performance during the peak season. As a result of their hard work and commitment, we once again delivered the best service offering in the industry. We continue to execute on our commercial priorities with a focus on revenue quality, while maintaining our industry leading service. As a result, we took profitable share in the quarter at market rates and we continue to retain the vast majority of the volume we gained from UPS in the second half of 2023.

Speaker 3

Our unmatched value proposition has enabled recent high value wins in the semiconductor, healthcare and aerospace industry. We will continue to execute our commercial strategy to compete and grow further in the high margin areas of the market. Looking now by geography, in the United States conditions have been weaker than we anticipated, and internationally we continue to see softness. We however remain very focused on strong commercial execution. Taking a look at 3rd quarter revenue performance by segment.

Speaker 3

At FedEx Ground, revenue was up about 1% year over year on a modest yield improvement and flat volume. Our team remains disciplined on growing with the right customers and mix while offering the best value proposition in the industry. At FedEx Freight, revenue declined 3%. While volume decreased compared to last year, the year over year decline moderated on a sequential basis. Revenue was also negatively affected by lower fuel surcharges and a decrease in weight per shipment, although the decline was partially offset by higher base yields.

Speaker 3

And at FedEx Express, revenue was down 2% year over year, driven by continued volume softness, lower fuel and demand surcharges, and a mix shift towards deferred and e commerce products. The actions Raj outlined will allow us to profitably grow this business while continuing to deliver excellent service for our customers. Turning to our monthly volume trends during the quarter. Broadly speaking, volumes are stabilizing as we lap weaker demand from a year ago. International export increased 4% in the quarter, driven by a 29% growth in international economy, which of course is a market reset we expected.

Speaker 3

Freight shipments declined, but they continued to moderate sequentially. As Raj mentioned, postal volumes were a headwind in the quarter. Our current contract with the United States Postal Service expires on September 29. We have made significant progress in negotiations for a new outstanding service we have delivered for them for more than 2 decades. A new multi year agreement would provide a more efficient network with service to fewer markets.

Speaker 3

It would allow us to better adjust our overall network to demand. We of course will let you know when we have an update. We continue to operate in a competitive but rational market environment. During the quarter, yield trends were similar to what we saw last quarter with dynamics remaining mixed across the segments. At FedEx Express, yields remained pressured due to a tapering of international export demand surcharges and an increasing mix of lower yielding e commerce and deferred products.

Speaker 3

Yield was also pressured by increased capacity in the market. At FedEx Ground, yield increased 1% driven by home delivery, partially offset by ground economy. Higher weight per package and favorable customer segment mix offset a lower fuel surcharge relative to the prior year. And at FedEx Freight, revenue per shipment was down 1%, driven by lower fuel surcharges and lower weight. In January, we rolled out a 5.9% GRI, and importantly, we've been able to capture a high percentage of that rate increase.

Speaker 3

During peak, our holiday peak residential surcharges enabled us to effectively offset higher costs, delivering $120,000,000 in profit. We are very confident we have the right strategy in place balancing both volume and yield growth. We are building our network of the future with digital and data driven solutions that simplify the customer experience and further strengthen our best in class customer offering. For example, earlier this month, we enhanced our health care offering with more powerful capabilities to prioritize critical life saving healthcare shipments above other volume within the network. Healthcare customers now have the ability to select monitoring and intervention service options.

Speaker 3

They cover categories such as temperature requirements and vaccines, and they do this at the package level. Each Express shipment now includes specific healthcare identifiers so that if we need to intervene, we are able to do it with more speed and more precision. And of course in January we announced the FDX Commerce platform. FDX connects the entire customer journey by offering end to end e commerce solutions, making it easier for companies to grow demand, increase conversion, optimize fulfillment and streamline their returns. The FDX platform will enable us to enhance our long standing relationships with merchants of all sizes to help them optimize and grow their business.

Speaker 3

We have opened a private preview for select brands and retailers and based on their feedback I am incredibly excited about the official launch later this year. In closing, I'm very proud of our entire global team and how they continue to deliver outstanding service as we navigate a very dynamic market. And with that, I'll turn it over to John to cover our financials in more detail.

Speaker 4

Thanks, Brie. Our Q3 results reflect ongoing progress on our DRiV initiatives as well as our continued focus on service and revenue quality. As a result of these efforts, we delivered operating income growth and margin expansion for the Q3 in a row despite declining revenue in a challenging market environment. Taking a closer look at our performance in the quarter on a year over year basis and at the enterprise level, adjusted operating income increased by $192,000,000 and adjusted operating margin expanded by 90 basis points. At Express, adjusted operating income increased by $134,000,000 and adjusted operating margin expanded 130 basis points.

Speaker 4

The benefits of DRiV initiatives and an additional operating date more than offset lower revenue. At Ground, the team delivered another quarter of strong results. Adjusted operating income increased by $120,000,000 and adjusted operating margin expanded by 140 basis points due to cost reductions and yield improvement. Despite slightly lower volumes and in an inflationary environment, ground cost per package was flat year over year with lower line haul expenses and improved dock productivity offsetting higher first and last mile costs. And at freight, while operating margin remained strong, operating income declined by $46,000,000 and operating margin declined by 170 basis points, driven by lower fuel surcharges, reduced weight per shipment, and lower shipments.

Speaker 4

These results also reflect the lapping of a $30,000,000 facility gain last year, partially offset by the benefit of an additional operating day during the quarter. Looking at the quarter overall, weather had an immaterial year over year effect on profitability. Before turning to the outlook, I'd like to spend a few moments updating you on our cost reduction initiatives including DRiV and more specifically G and A. As an initial matter and as part of responsible headcount management, we have reduced our workforce by nearly 22,000 over the last year and expect additional opportunities in the future as we move forward with our transformation. Within G and A, we continue to make significant changes to how we approach areas like procurement and technology so that we are a more efficient digitally led organization.

Speaker 4

In addition, global functional alignment provides savings opportunities. I'm pleased that we have achieved $350,000,000 of G and A savings year to date, including $150,000,000 in the Q3. Taking a closer look at sourcing and procurement, we've continued to evolve the sourcing and procurement function from a segregated and regional structure to a centralized global organization that will manage most third party spend across the entire enterprise. With new leaders in place, we're developing new category strategies and have already identified about 20 discrete categories that will manage centrally in cooperation with functional leaders. By implementing these new strategies at the enterprise level, we'll have tighter spend oversight, will better leverage our scale and buying power, and generate significant cost savings.

Speaker 4

Overall, I'm very pleased with our enterprise wide drive progress this quarter and we will deliver $1,800,000,000 in savings for the full fiscal year. Now turning to our fiscal year outlook and as Raj shared earlier, based on our performance year to date and our current view of the rest of the year, we are reaffirming the midpoint of our adjusted EPS range while narrowing our outlook from the prior range of $17 to $18.50 to $17.25 to $18.25 At the midpoint of the narrowed range, we continue to assume a low single digit percentage decline in revenue for the full year. As always, we'll closely monitor the global demand environment and other key factors including inventory restocking, global trade, inflation and e commerce trends, which informs our view of overall expected revenue. With regard to our Q4 expectations, as implied by our outlook range, we expect year over year profit improvement despite lapping the onset of certain structural benefits executed in last year's Q4 at Express and Ground. Looking on a sequential basis, the leap day in the 3rd quarter affects our typical seasonality.

Speaker 4

At the segment level, we're maintaining our full year expectations for a modest year over year adjusted margin contraction at Express, adjusted margin improvement at Ground, and strong but lower year over year margin at Freight. At Express, we are looking at every aspect of the business including taking a fresh look at additional opportunities to improve our European business and we're confident in our ability to unlock more value at Express and across all our businesses as we continue to seek optimization opportunities. Our bridge shows the operating profit elements embedded in our full year outlook. For illustrative purposes, we continue to use adjusted operating profit of $6,300,000,000 the equivalent to $17.75 of adjusted EPS as the midpoint of our narrowed outlook range. To walk the bridge to $6,300,000,000 of adjusted operating profit, we're now assuming that revenue net of cost increases is up $200,000,000 that we experienced $800,000,000 of international export yield pressure as peak surcharges diminish and product mix continues shifting toward deferred variable compensation increases by $300,000,000 and that these pressures are more than offset by $1,800,000,000 in structural cost savings from DRiV.

Speaker 4

At the midpoint, we would expect fiscal 2024 adjusted operating income to increase approximately 17% despite revenue declining by a low single digit percentage. As I've discussed on prior calls, we remain focused on reducing our capital intensity and continuing to provide increased stockholder returns, as well as maintaining a strong balance sheet, prudent capital allocation, and improving return on invested capital. Our capital investment priorities will be on improving efficiency, modernizing facilities and optimizing our network. Capital expenditures for the quarter were $1,400,000,000 bringing year to date CapEx to $4,000,000,000 and we now anticipate capital spend of $5,400,000,000 for the full year, which is down over $700,000,000 from last year and down $300,000,000 from our prior forecast of $5,700,000,000 We also continue to expect aircraft related CapEx to decline to approximately $1,000,000,000 in fiscal year 'twenty six. And we expect CapEx as a percentage of revenue will keep declining in the future as we reduce our facilities footprint through Network 2.0 and continue to plan for lower annual aircraft CapEx beyond fiscal year 2026.

Speaker 4

We currently have 37 jet aircraft parked, which is up from 20 last quarter and as previously communicated, we will retire 9 more MD-elevens in Q4. Consistent with our goal of increasing stockholder returns, we completed a $1,000,000,000 accelerated share repurchase transaction in the 3rd quarter, bringing our total share repurchases for the 1st 9 months of the fiscal year to $2,000,000,000 And we expect to repurchase an additional $500,000,000 of common stock in the 4th quarter, bringing total fiscal year 2024 repurchases to $2,500,000,000 while also paying our dividend in line with our previously stated capital return plan. I'm also pleased to announce that our Board of Directors has authorized a new $5,000,000,000 share repurchase program, which augments the $600,000,000 that remains available for repurchase under the $5,000,000,000 2021 authorization. This reinforces our commitment to support long term stockholder returns. Overall, I want to acknowledge and thank the entire team for their efforts in continuing to improve profitability in a challenging revenue environment.

Speaker 4

We have more work to do, but I'm encouraged by the commitment and focus I've seen from our teams to advance our transformation and provide our customers and stockholders with even greater value. With that, let's open it up for questions.

Operator

Thank you. We will now begin the question and answer session. Today's first question comes from Jordan Alliger with Goldman Sachs. Please go ahead.

Speaker 5

Yes. Hi. Thanks for the update on DRiV. If I did the math right, I think there's about $385,000,000 or so left for the final quarter of this fiscal year. Can you maybe talk to where you think this money, where the savings, which buckets are going to go to surface, air, G and A?

Speaker 5

And I'm also just sort of curious on the surface side, how much of that is actually tied to Express surface stuff? Thanks.

Speaker 4

So, thank you, Jordan for the question. It's John. And I'm not going to speak specifically to the number you raised with regard the remainder of the year on DRiV, except to say that we are committed to the $1,800,000,000 for the fiscal year. And I think it's safe to assume that's spread across all of our operating companies. And with regard to your question on surface, it's predominantly ground, but as we continue to migrate towards Network 2.0 and through our DRiV initiatives, there's a lot of complementary work that's being done together by the teams.

Speaker 4

So those savings are being realized both at Express and Ground.

Operator

The next question is from Tom Wadewitz with UBS.

Speaker 6

Yes, good afternoon. I wanted to ask you a bit about the trajectory of the margin on Express. The February quarter was quite a bit better than expected. And I'm just wondering how do we think about that as you go into fiscal 2025? I think 2 specific items you did mention, 1, the $600,000,000 improvement in Europe that I think would go to Express and just kind of visibility on that?

Speaker 6

And also how we should think about postal? Brie, you had some comments and I think that's been characterized as a $400,000,000 headwind. So is it reasonable to say that that's $400,000,000 you kind of add back to the number? So anyway, just some broader comments on Express and some of the bigger items. Thank you.

Speaker 4

Great. Thanks, Tom. It's John again. Yes, we're quite pleased with the progress we've made at Express and the margin expansion. As Raj mentioned, this is all of our primary focus to continue that expansion and we're excited about the opportunities that lie ahead for us in DRiV.

Speaker 4

With regard to Europe, that will be a key focus area of ours and we are committed to the $600,000,000 that you mentioned. And the Postal Service, certainly, as we're negotiating towards the deal, if that deal were to materialize, you would expect that it's mutually beneficial for both sides. So, we're looking forward to bringing that to closure as soon as possible. And all of that will contribute to our ability to continue to expand our margins at our largest sector at Express.

Operator

The next question is from Jonathan Chappell with Evercore. Please go ahead.

Speaker 4

Thank you. Good afternoon. Braid mentioned a competitive but rational market environment as it relates to pricing and yields. We are several quarters into the demand downturn here. And of course, there's been some competitive issues directly in your business.

Speaker 4

As you look forward, if we continue to kind of bounce along this bottom on demand internationally, but I think more specifically to the United States, does the pricing environment start to waver at all of it? Do you really need a macro tailwind before we can see maybe a stabilization or reacceleration of yield?

Speaker 3

Hi, Jonathan. Thanks for the question. I think from a competitive environment perspective, yes, it is competitive, but I don't think that's particularly different in our industry. We're very used to a competitive environment and the market does feel quite rational to me. When we look at the yield focus for the team, I'm actually pleased with the discipline of both the sales and the pricing organization.

Speaker 3

If you remove the fuel headwind across each one of our segments, Express, Ground and FedEx Freight, we have kind of low single digit yield improvement on the base. So I think the team is continuing to execute on our revenue quality strategy. And from a momentum perspective, we do have some headwinds this year that will diminish next year, especially in the international market. If you think about calendar year '23 from an air freight perspective, the overall air freight market yields decreased between 30% 40%. That is not going to repeat next year.

Speaker 3

And then of course from an international demand surcharge, it will continue to be a headwind in FY 'twenty five, but less of a headwind than this fiscal year.

Operator

The next question comes from Bhaskar Majes with Susquehanna.

Speaker 7

Thanks for taking my question. So in June, you'll complete the legal consolidation of Express Ground and Services as part of the One FedEx effort. Can you give us a look at how that will change, how you manage the business starting in July? How it will change? How you report your financials and operating stats?

Speaker 7

And can you give us some assurance that we'll get a deep history of comparable financial and operating data to help track your progress as you get further into the operational side of the integration in 2025, 'six and 'seven? Thank you.

Speaker 2

Thank you, Bascome. And let me start and then John can add on to this. First of all, we are well on track to complete our consolidation of FedEx operating companies. This has been a lot of great work has already been done and into one streamlined and simplified organization. I think 2 words kind of describe this move, one is efficiency and the other one is effectiveness.

Speaker 2

I think we are looking forward to the structure that actually moves us forward on both fronts. And I think at the end of the day, this transformation efforts will set us up to drive improved performance and profitability over the long term. I'll give it to John to talk about the rest of it. Yes.

Speaker 4

Thanks Raj. And from a reporting standpoint and we'll be providing more details regarding the new reporting structure as we go forward. But I think it's fair to say that we'll continue to break out both ground and express yield and volume by service as we currently do and frankly continue to provide sufficient data for you all to monitor the performance in those business segments.

Operator

The next question comes from David Vernon with Bernstein.

Speaker 5

Hey, good afternoon, everyone, and thanks for taking the question. So Raj, in your prepared remarks, you talked about the tricolor strategy and going after the premium airfreight market. Could you talk a little bit more about what that is? I guess I'd always been under the assumption that you guys were the premium part of the airfreight market. And how does this realignment actually open up some revenue that maybe

Speaker 8

you don't have access to today?

Speaker 2

Thank you, David. Well, I think I'm going to take a minute here to talk about Tricolor because I think it's a good opportunity. So bear with me for the time I'm going to take here. Firstly, Tricolor is a fundamental redesign of our network to improve the utilization of assets, our ROIC, profitability and our operating margin. And 1st and foremost, our overall capacity will be determined by the demand environment and tricolor will allow us to better flex our capacity to mass demand.

Speaker 2

Now within that capacity is when we'll break it into 3 networks purple, orange and white we call it and that cater to the different cohorts of traffic. The idea is to move the right product in the right network while reducing the cost to serve. The purple network will be a highly optimized and a leaner network designed to move international priority parcel volume that protects our value proposition in different geographies. Now that this network now becomes much more parcel centric, we'll have significantly better service but also density. And that density will improve the revenue per position and revenue per flight.

Speaker 2

Now turning to the orange network, that will cater to the premium freight traffic and these are FedEx planes that will operate off cycle from the purple system, which allows 2 things. Firstly, it allows us the ability once again to maximize density and asset utilization. It also decongents hubs and improves service. But most importantly, it allows a truck fly truck model that reduces the cost to serve. And in this context, you should be noted that we are fully leveraging the existing capacity in our trucking networks in the U.

Speaker 2

S. And Europe. Prior to fiscal 2024, we haven't really moved any international freight shipments in our market leading LTL network with FXF. And now it's already begun to change, but in tricolor it will take full hold here. So by doing so, we reduced the cost serve and we are able to target more of the premium airfreight segment.

Speaker 2

Now I'm going to call it a new term, think of it as the global LTL segment. That's what this is about. Now as you rightly asked, are we adding capacity to go up to low yield in traffic? The is no. We are going to gate the overall capacity by the premium demand.

Speaker 2

It should also be noted that 20% of the global airfreight shipments approximately drive about 80% of the weight, which is a primary target for freight forwarders. We're going to focus on the other 80% that will readily work with the model I described. So the white network then is primarily use of passenger belly capacity to move lower yielding e commerce and deferred traffic. So these three networks working in concert with high technological orchestration is what we call Tricolor. Let me just reinforce again that it helps the baseline productivity, it improves our existing asset utilization and makes the entire system more efficient.

Speaker 2

And we're going to manage the execution of Tricolor with the rigor of DRiV and to ensure success. So again, thanks for the question.

Operator

The next question comes from Brian Ossenbeck with JPMorgan. Please go ahead.

Speaker 9

Thanks for taking the question. Just wanted to come back and maybe better understand the moving pieces for Express during the quarter. Obviously, quite a strong result, but there's oftentimes some impact from fuel incentive compensation, I think, was a bit of a tailwind here. Has that changed a little bit as well. So maybe and then weather, that was a pretty significant surprise considering it was as difficult as you mentioned, Raj, but it seems like it really didn't affect the network.

Speaker 9

So maybe, John, if you can unpack some of the moving pieces and then Raj, if you can comment on the durability of the network if weather just isn't going to be as big of an impact going forward? Thank you.

Speaker 4

Yes. Thanks, Brian. I'll start with that last point because I think it's worth repeating on the weather piece, which ties into some of our digital strategies and our ability to adapt to allow for what was substantially poor weather here in Memphis to be rerouted in a manner that had an immaterial impact on us. So, as you'd expect, there was a lot of moving parts at Express, both positive and negative, and the levers of DRiV, the focus on flight reductions, for example, we had 5% fewer flight hours in the quarter. And there are some additional benefits that flow from that on your cost side because when you're not flying airplanes, you're able to avoid certain maintenance costs.

Speaker 4

The Air Ops team is doing an exceptional job of managing its cost for aircraft that are grounded, whether you're using what's called green time on engines that are available, limiting your inventory purchases and so forth. So it's really across the gamut where we're seeing improvement there. All in the midst of some revenue headwinds that Raj and Brie talked about. So we're going to continue to keep our head down and focused on our costs. One of the things I'd like to say, this is a journey, not a destination, and we still have a long way to go at Express, and it is our primary focus and look forward to keeping you posted on further improvements.

Speaker 2

And Brian, I don't think I have much to to what John has talked about. I think the idea that we use our latest and greatest in digital tools and the notion that we are now able to look at FedEx as overarching network and able to move things helps us. Of course, we got to see as the weather patterns, we know that it's very to predict, but I'm just pleased with the work that we did this time around and we'll continue to get better in this regard.

Operator

The next question comes from Jeff Kauffman with Vertical Research Partners.

Speaker 10

Thank you very much

Speaker 11

and thank you for the detail on DRiV. Jenny, welcome. Look forward to working with you. Real quick, the puck doesn't stay in one place. It's always moving around.

Speaker 11

And I think you're alluding to this with what you're doing with Drive and Tricolor. But I'm just kind of curious from your perspective. We announced this plan about, what, year and a half ago, back at the analyst meeting almost 2 years ago. How has the network design and some of the drive goals when you're completed with this changed since you began this process?

Speaker 2

Well, I think we introduced Tricolor in the last conference call and I think the design is just being put in place as we are speaking here. And so in terms of the DRiV commitments, we had originally talked about $4,000,000,000 by FY 2025 and less than 50% in FY 2024 where we will hit those numbers for FY 2024 and on track for FY 2025. And again, the other part of it, of course, is network to auto, which we said $2,000,000,000 by FY 2017 and that's underway. So with the focus on making sure that we have structural cost reductions, we have network redesigns with the whole FedEx portfolio in play and the idea that we are moving forward on our digital tools. All three are working.

Speaker 2

And I think we've got work to do, but it's been made some good progress. John is going to add more to

Speaker 4

what I just said. Yes. I think what I would add to that as well is to your comment about it kind of changing environment. The teams meet weekly on this and there are some programs that are delivering more than we expected and there are some programs that are delivering less than we expected, but we're always looking to fill the pipeline as well on additional opportunities. And that's an ongoing project and that speaks to DRiV being part of our culture going forward.

Speaker 4

That's not going to stop and we're going to adapt to a changing environment and I think that will help us as we move forward.

Operator

The next question comes from Ken Hoexter with Bank of America.

Speaker 5

Hey, great. Good evening. So Raj and Timah, I guess

Speaker 12

I love the results in terms of the speed here at Express, but I'm confused a bit by the messaging. Last quarter, you talked about seasonal declines at Express and what occurred from Express going down to which should be maybe near breakeven given the seasonal moves, yet it was up so significantly 130 basis points year over year. Was there a massive shift in the driver other programs or your speed of execution? Because it sounds like from what you're saying on the targets, nothing's really changed. But I'm just wondering what shifted intra quarter so much that we're now seeing this quick of an improvement?

Speaker 12

And then just I'm sorry, just a side clarification, did you say Canada was about to be rolled out? Because I thought you had already said that with Hawaii and Alaska, Canada was done. So I just maybe I want to clarify that.

Speaker 4

Thanks. So, hey, Ken, it's John. I'll start with the last one. It's about to be rolled out. It has not been completed, and Brie can talk more about that in a minute.

Speaker 4

But Q3, as I mentioned earlier, was a combination of things. We saw, while the revenue was soft, we're focused on quality revenue. The cost controls were solid and strong and there were some other levers that were alluded to earlier. As you can see, burial comp, for example, is down. So that was a contributor.

Speaker 4

But all these things taken together resulted in us and our focus on improving our results for Q3.

Speaker 3

Yes. And Ken, I'm just happy to clarify from a Network 2.0 perspective, the Canada plan has not changed. Alaska and Hawaii are done, and we are beginning the rollout of the integration in Canada that will begin this April and we will be done before peak and it's on track.

Operator

The next question comes from Brandon Oglenski with Barclays.

Speaker 13

Hi, good afternoon and thanks for taking my question. Maybe if we can follow-up there on Network 2.0. Raj, I think you mentioned you've made some management changes on both ground and express surface operations in the U. S. Can you talk maybe a little bit more about that and how that plays into long term integration?

Speaker 2

Yes. Thank you, Brandon. I think, first of all, yes, Network 2.0 is on track and we just take a step back here. You'll recall that we said we plan to deliver $2,000,000,000 in savings by the end of fiscal 20 27 and we're taking that measured and deliberate approach. And we just rolled out our new leadership structure in the United States and it's obviously a much more streamlined structure and much more effective structure and essentially with the goal of putting 1 truck and 1 neighborhood design into action.

Speaker 2

We are encouraged by the early results we're seeing in the initial ROA as well So far network 2.0 model on the whole has achieved approximately 10% reduction in P and D costs and maintained very strong service levels. As we become more tech enabled in this regard, we'll deliver even greater improvements. And as we have already talked about, we are focused on implementation of Canada before peak. And I also have to say that I'm very excited about networked auto from a service perspective because it will drive a better customer pickup experience. So we are on our way, on track and again some ways to go.

Operator

The next question is from Scott Group with Wolfe Research.

Speaker 10

Hey, thanks. Good afternoon. So John, this year is $1,800,000,000 of DRiV savings and you've talked about $900,000,000 of offset, so about $900,000,000 of actual profit. As we think about fiscal 2025, do you think the actual profit improvement should be closer to the $2,200,000,000 of drive savings? Or do you think there's another year of material offsets to that drive in fiscal 2025.

Speaker 10

And then just separately, just no one's asked about ground yet and it's by far the biggest part of the business. So if I can just ask one, the margins 12% this year, do you think there's further margin improvement to go at Gram?

Speaker 2

Thank you.

Speaker 4

Thanks, Scott. And let me start by saying on that 2.2, that's certainly our goal to have that all flow through. But we have to be realistic and understand that a lot of the pressures that we're seeing today are expected to continue for a while. And while we're going to to continue to focus on those things within our control, there are certain things outside of our control. And so our goal is to have as much pass through to

Speaker 2

the bottom line as possible and

Speaker 4

we look forward to keeping you up to speed on that including when we next talk in June. With regard to Ground, exceptional story, exceptional performance from the team. I believe those margins are sustainable and there's still a number of projects in the pipeline that allow us to continue to grow and expand that business in those margins. So again, that's going to be our focus as well.

Operator

The next question comes from Helane Becker with TD Cowen.

Speaker 14

Thanks very much operator and hi team. I have I guess, two questions. One is, as part of the whole redesign of the network and the business and collapsing everything into 1, Have you thought about shifting to a calendar year rather than staying on a May fiscal year? And my second question is maybe for Raj. A lot of investors push back to me about the business that the way you're structuring the business and I noticed the stock aftermarket was up quite a lot after the earnings release.

Speaker 14

Why do you think investors are so skeptical of your business plan and aren't willing to give you the credit that maybe you deserve for the changes you've made as speedily as you've made them?

Speaker 4

Thanks, Elaine. I'll start on the first part on the calendar year. As you'd expect with everything going on, there's legal and accounting exercises that need to take place to get us through this next period, including June 1 date of 1 FedEx. But I can share, it's certainly on my radar to migrate towards that, and we'll keep you posted on developments towards that.

Speaker 2

And Elena, as far as your second question, all I can say is that we as a team are very much convinced that we have a unique story at FedEx here. The opportunities that we have unique opportunity because of the strategies that we have deployed. We started moving early than anybody else. We are performing better than our competition both on the top and the bottom line. And we have a longer runway because of the opportunities we have identified.

Speaker 2

And so we will try to educate as many people as we possibly can on our strategy and where we are, but we're just seeing the early stages of what's possible at FedEx. Any one particular quarter sometimes kind of throw you off, but the long term strategy is sound and we all believe in it and it's going to be a good run-in the next 3, 4 years.

Operator

The next question is from Ravi Shanker with Morgan Stanley.

Speaker 5

Thanks a lot for everyone. Apologies if I missed this, but regarding the USPS contract, kind of

Speaker 2

when do you expect that

Speaker 5

to reach provision? Is that something that happens in FY 2024, 2025? And also can you share how much of the volume has come off already? And kind of how much would you dimension kind of that net with the new contract ends up being? Thank you.

Operator

Hi, Ravi. Thanks for the question. It's Brie.

Speaker 3

From a USPS contract, I really can't say more than I already said earlier. In short, we are feeling very positive about the negotiations. Both parties are working eagerly. We're at the table. I think we are days or weeks away from knowing if we will have a contract, not months.

Speaker 3

And as we have shared previously, their current contract ends on September 29. So, we will know very, very soon and I'm certainly not at liberty to talk about the details of a future contract.

Operator

The next question is from Stephanie Moore with Jefferies.

Speaker 15

Hi, good evening. Thank you for the question. I appreciate the incremental color on Network 2.0. And I was looking if you could maybe provide a little bit of color in terms of some of the investments that have to be made in order to execute on the integration, particularly as you enter or you begin the execution in a much larger market like Canada. Any color in terms of maybe lessons learned from your Alaska and Hawaii integration?

Speaker 15

And then what investments we should expect to see as you implement it in Canada? Thank you.

Speaker 4

Yes. Thanks, Stephanie. It's John. Yes, certainly there's going to be some investment required when you're consolidating facilities, particularly sort facilities. But there's also upside in that you're able to reduce your facility's footprint along the way.

Speaker 4

So that will involve certainly some planning and processes, analysis and all that, but we're excited actually about the end game here and that is our overall footprint will far the benefits of that will far exceed the investment and

Speaker 3

seen kind of the P and D benefits that we anticipated as well as we've seen the team be able to execute from a service perspective. I will say we are being very disciplined. We're being very methodical, and we are giving customers the advance notice as we go into market. That was one piece of feedback for customers. Even though we anticipate being able to deliver the same level of service, with the combined organization as we are as the individual, They do want that notification.

Speaker 3

And so we are of course are giving customers that advanced notification. And to Raja's point on the positive, I cannot under emphasize how important that single pickup is to our small customer segment. This has been the only feature gap we had to UPS in that segment and we are about to close it. So I'm pretty excited about that.

Operator

The next question is from Bruce Chan with Stifel.

Speaker 5

Hey, Raj, Brie, John and Jenny, welcome to the mix here. I don't know if you've really talked about it, but we've been hearing that you've had some pretty material service improvements, especially at Ground over the last, call it, year or so. And that's despite the cost savings push. Can you maybe talk about that a little bit? Where are the service levels today?

Speaker 5

What are the levers that you're pulling? And then what kind of opportunity do you have to drive core pricing as a result of that? Thank you.

Speaker 1

I love this

Speaker 3

question. John Smith and Scott Rae are crushing it. When we went back and looked at our Q4, the toughest quarter to deliver, I should say Q4 calendar year, the toughest quarter to deliver awesome service, Not only are we faster, I am quite confident we, on those higher standards from a delivery service perspective, we also had better reliability. How are they doing this? It's discipline.

Speaker 3

It's day in and day out execution. We look at our service metrics every single morning. We talk about net promoter score every week at our revenue management committee. And to Raj's coverage on the integrated leadership team now at the service organization, we absolutely expect to extend that across the entire network and, I just could not be more appreciative of our operators and how well they're doing.

Speaker 2

Yes, I wanted Brie to answer that question because she holds their feet to the fire every single day. So I'm glad that you heard that answer directly from Brie.

Operator

The next question is from Connor Cunningham with Melius Research.

Speaker 10

Everyone, thanks for getting me in. I was hoping you

Speaker 16

could talk about the opportunity you see just with the e commerce return business. You've obviously been a big player there, but there's been a lot of changes to the network. Is that now a larger focus? The reason why I asked, obviously, there's been a press report about you reengage on with Amazon. So just any thoughts there would be helpful.

Speaker 16

Thank you.

Speaker 3

Sure. Happy to. I think we've got the best returns portfolio in the market. When you look at our retail coverage as well as our transportation solution, it is best in class. And when we looked at our January numbers, the FedEx Ground returns portfolio did see some healthy growth.

Speaker 3

You layer that on with the new announcement of our FDX platform, we are going to be the only provider that has not only the physical capabilities, but a very comprehensive digital capability. And what do I mean by that? We are going to be able to help all retailers, brands and merchants process their returns on their websites, manage their exchanges, manage the inventory, integrate their branded tracking and communications to customers. It's a really powerful offering. As I mentioned earlier, we started to preview this with some customers.

Speaker 3

We've got some pretty big names and what we're calling our private preview and I look forward to sharing more results once we do the full launch later in the fall. As I think I'll stop there. I'm enthusiastic about this. No. I'll just say this, Mike.

Speaker 3

When you integrate

Speaker 2

with these customers, even I can program and there's a no COVID environment, I can up the returns policy. So if I can do that, anyone can do it.

Operator

The next question is from Scott Schneeberger with Oppenheimer.

Speaker 8

Thanks very much everyone. It's basically two questions. One to follow-up to Bruce's. Brie, I was hoping if you could kind of give an overview of peak season, kind of takeaways, learnings. And then I think we have 5 less calendar days for the 2024 calendar peak.

Speaker 8

So just things that you're going to learn and manage ahead of time as it's a much more condensed season. And then the second question for any of you, but just in ground cost per package, it was down 2% in the fiscal second quarter and you cited improved 1st and last mile productivity, flat here in this quarter and offset was higher first and last mile cost. Just curious if there's anything we should read into there? Thanks for taking them both.

Speaker 3

Yes. I think from a peak perspective, we're really pleased with how we're managing peak from a service, from a customer and from a profitability perspective. First and foremost, the team starts literally now for this coming peak. And what do I mean by that? We are already talking to customers about what their peak requirements are for next year.

Speaker 3

And so that John and Scott have advanced planning. And then of course, as we get closer to peak, we take the top 100 with DataWorks is also incredibly helpful so that we have real time information. We're not waiting for spreadsheets to be passed over, but we've actually got real time visibility into some of our largest customers, which has been incredibly helpful. So I don't anticipate us doing much different this year, but more of the same. And again, I also was really pleased with the peak surcharge capture.

Speaker 3

We are ensuring that the customers that really drive the investment we need in December, we're getting recouped for that cost. So we feel good.

Speaker 4

Yes. And I'll speak to the ground piece. And I think one of the drivers of the margin expansion in cost control at ground was lower line haul expense that I alluded to. And we moved a lot of high cost and ad hoc external line haul spend into our scheduled network and as a result achieved lower rates on the planned line haul purchase transportation. And this is all part of a broader optimization and ongoing optimization that's taking place in the network through DRiV and through Network 2.0.

Speaker 4

And so every aspect and even those 1st and last mile will be part of that. And we're also leveraging the capacity that we have and we do have some additional capacity in the ground network that can absorb additional volumes at no incremental cost. So that should help improve margins as well.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Raj Subramaniam for any closing remarks.

Speaker 2

Thank you, operator. In closing, we saw continued operating income growth, margin expansion despite lower revenue for the 3rd consecutive quarter. And this is clear evidence that DRiV is working. While these results are encouraging, it is our top priority to maintain momentum and continue to transform our network and the way we work. Once again, let me thank our FedEx team members for their hard work and dedication to delivering outstanding customer service.

Speaker 2

I'm really proud of the work that we have accomplished as we continue to build the world's most flexible, efficient and intelligent network. Thank you for your time and attention today.

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Earnings Conference Call
FedEx Q3 2024
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