Fedex Corp (FDX) — Q1 2017 Earnings Call Transcript

Good afternoon. Welcome to FedEx Corporation's first quarter earnings conference call. First quarter earnings release, statistical book, earnings presentation slides are on our website at fedex.com. This call is being broadcast from our website, and the replay and presentation slides will be available for about one year. Written questions are welcome via email or through the webcast console. When you send your questions, please include your full name and contact information. The email address is ir@fedex.com. Preference will be given to inquiries of a long-term strategic nature. I want to remind all listeners that FedEx Corporation desires to take advantage of the Safe Harbor Provisions of the Private Securities Litigation Reform Act. Certain statements in this conference call, such as projections regarding future performance, may be considered forward-looking statements within the meaning of the Act. Such forward-looking statements are subject to risks, uncertainties, and other factors which 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. 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. Joining us on the call today are Fred Smith, Chairman; Alan Graf, Executive Vice President and CFO; Mike Glenn, President and CEO of FedEx Services; Chris Richards, Executive Vice President, General Counsel and Secretary; Rob Carter, Executive Vice President, FedEx Information Services and CIO; David Bronczek, President and CEO of FedEx Express; Henry Maier, President and CEO of FedEx Ground; Mike Ducker, President and CEO of FedEx Freight. With that, Fred Smith will now share his views on the quarter.

Thank you, Mickey. Welcome to our discussion of results for the first quarter of fiscal 2017. Managing our operating companies as a portfolio of solutions helped FedEx achieve strong financial and operating results in the quarter, especially given the global economy's continued low growth. Mike Glenn will offer a more detailed look at economic conditions and FedEx revenue growth later in today's call. We expect FY '17 revenue and earnings to increase driven by volume growth and improved base yields at all our core transportation companies. The integration of TNT Express, which includes more than 200 countries, is proceeding smoothly and on schedule. The level of team members' engagement is outstanding and very much appreciated. More than 20 teams are working in operations, customer solutions, personnel, IT, finance, legal, security, and other areas to positively transform FedEx TNT into a seamless worldwide operation. Alan Graf will provide a more comprehensive update, including our target to exit at the end of the four-year integration process in fiscal 2020 with annual synergies of $750 million. The integration process continues. I assure you FedEx will maintain our high levels of customer service across all our operating companies with our commitment to the Purple Promise, which states simply, 'I will make every FedEx experience outstanding.' And let me thank hundreds of thousands of FedEx team members in every corner of the globe who do just that every day. Before I turn the call over to Mike, let me reiterate, we are committed to improving margins, earnings per share, cash flows, and returns. Now Mike and then Alan will provide their insights. Mike?

Thanks, Fred. I'll open with an economic update and outlook and then discuss our performance and business conditions in each segment, including revenue, volume, yield, and provide some commentary on broader industry trends and our plans for what is expected to be another record-breaking holiday shopping season. On the economic front, we see moderate growth in the global economy. Our U.S. GDP growth forecast is 1.6% for calendar '16, 20 basis points lower than our last forecast in the last quarter and 2.3% for calendar '17 led by gains in consumer spending. Our global GDP growth forecast is 2.2% for calendar '16, 10 basis points below last quarter and 2.6% for calendar '17. We expect industrial production to decline 0.7% in calendar '16, 10 basis points lower than last quarter, and increase 2.2% next year. Now I'll review revenue volume and yield trends by segment. U.S. Domestic Express package revenue grew 3% in Q1 driven by growth in both volume and yield. Excluding the impact of fuel, Domestic Express revenue grew 3.8% year-over-year. Package volume grew 1% year-over-year in the quarter driven by strong overnight volume growth. Yield per package increased 1% year over year despite lower fuel surcharges. Excluding the impact of fuel, year-over-year Express Domestic package yield grew 2.5%, primarily due to rate and discount. FedEx International Express package revenue decreased 1% year-over-year in Q1 but increased 1% if you exclude the impact of fuel. FedEx international priority volume decreased 1% while international economy volume grew 1%. International export package yield decreased 1%. If you exclude the impact of fuel, international export package yield increased 1.4%, primarily driven by the positive impact of rate and discount changes, which outweighed the negative impact of exchange rates. FedEx Ground revenue increased 12% year-over-year in Q1 and increased 12.6% if you exclude the impact of fuel. This growth was driven by higher ground volume and yield. FedEx Ground average daily volume grew 10% year-over-year in Q1 driven by robust growth in both residential and commercial segments. FedEx Ground package yield increased 2% year-over-year in Q1. If you exclude the impact of fuel, FedEx Ground yield per package increased 3% year-over-year driven by yield improvements in both Ground and SmartPost segments. FedEx Ground continues to gain revenue market share. In fact, through the end of calendar year 2015, FedEx Ground has gained revenue market share for 17 consecutive years and we are tracking to continue that trend and make it 18 years through the first half of this calendar year. FedEx Freight revenue increased 4% in Q1 and 5.4% excluding the impact of fuel. Average daily shipments increased 8% year-over-year. The continued strength in shipment volume is driven by our outstanding sales efforts with small and medium customers and reflects the speed, reliability, and choice of priority and economy service for our LTL customers. We also saw increased demand from larger customers during the quarter. Revenue per LTL shipment declined 4% in Q1 due to lower fuel surcharge revenue and lower weight per shipment. Excluding the impact of the fuel surcharge revenue, revenue per shipment was down 1.7%. I’d now like to spend a few minutes discussing industry dynamics, including pricing changes and the upcoming peak holiday season. As announced yesterday, we will be raising rates effective January 2, 2017. FedEx Express rates will increase by an average of 3.9%. Rates for FedEx Ground and FedEx Freight will increase by an average of 4.9%. We will also change the dimensional weight divisor for FedEx Express and FedEx Ground from 166 to 139. Our dimensional weight divisor for U.S. domestic and international packages will now be the same after the change is implemented. Beginning in February, we will also be updating the FedEx Express and Ground fuel surcharges weekly as we do with FedEx Freight today. There will be no changes to the fuel surcharge tables. Details of all changes to rates and surcharges are available at fedex.com/rates2017. We are deep into planning for what is expected to be another record peak holiday shipping season. The rapid growth of e-commerce has driven significant shifts in demand over the last several years. Last year, we experienced 15% growth in peak season volume and delivered more than 325 million packages. Beyond just the dramatic rise in volume, there are several other shifting industry dynamics. Holiday promotions and buying patterns have increasingly shifted, resulting in heavy demand for package delivery on Mondays during the peak. The intensity for demand on Monday has accelerated in recent years, as more and more retail locations have started serving as fulfillment centers for e-commerce orders. We expect each of the four Mondays during the upcoming peak period to be among the busiest in our company's history. We have also experienced increased demand for transportation of larger and heavier packages. As e-commerce grows, there is demand for online ordering and delivery of everything from large screen TVs to mattresses and trampolines. We've engineered our network’s sortation and delivery capacity for these larger packages, including entire temporary facilities dedicated to the sortation of oversized packages, which will be critically important this upcoming peak season. Beyond oversized packages, we will continue to make investments in technology and facilities that allow us to handle this year-round growth in demand. We've added to what is already the industry's most technologically advanced ground sortation and delivery network with additional automation in new facilities. In fact, we've added 19 automated stations in four major distribution centers for FedEx Ground since the peak season last year alone. We’ve also added more reliable and efficient aircraft to the FedEx Express fleet over the last year. And while the advanced automation provides us a competitive advantage in sortation and speed, the key to our success during the peak continues to be our people. Across the FedEx portfolio, we expect to once again add more than 50,000 seasonal positions to help the holidays arrive. Based upon growth expectations and network expansion, many of these seasonal team members will have an opportunity for full-time work at FedEx after the holidays. These investments in people, facilities, aircraft, and technology are all made to enable us to provide outstanding service even during the busiest days of the year. As a further commitment to delivering outstanding service and in recognition of Christmas falling on Sunday this year, we've adjusted some service commitments for shipments tendered in the week of Christmas. FedEx Express will be delivering on Saturday, December 24, Christmas Eve, but it is not a service day for FedEx Ground. FedEx Hold at Location is also a delivery option for customers on Christmas Eve. All service adjustments have already been communicated to customers as part of an extensive planning and collaboration effort to meet customer needs and enable outstanding service across the FedEx portfolio throughout peak. Now, I’ll turn it over to Alan Graf.

Good afternoon, everyone. Thank you for your comments, Mike. Thanks to the FedEx team for delivering strong first quarter results. For FedEx Corporation, adjusted EPS climbed 20% to $2.90 per share. Revenues increased 19% to $14.7 billion with the addition of TNT Express. Consolidated adjusted operating margin was 9.3%. We continue to increase profits while investing in the business. First quarter results improved due to higher operating income at Express, base yields improved, and expense growth was constrained at Ground where volume and yield grew. Offsetting factors include higher network expansion costs at Ground. These adjusted numbers exclude the integration and restructuring program costs as well as intangible asset amortization of TNT Express. Ground volume continued to grow. Segment operating income increased 14% and margin increased to 14.2% due to volume and yield growth and lower self-insurance costs. Headwinds included higher operational costs due to network expansion and higher purchased transportation rates. Comparisons were easier due to higher self-insurance reserves last year. We aren’t expecting that benefit to continue, and comparisons for the rest of the year are expected to be more difficult. Ground’s business continues to grow nicely driven in large part by e-commerce. We believe continued strategic investments will position Ground for long-term profitable growth by increasing capacity and efficiency to better meet the dynamic needs of our customers. Investments include continued network expansion, integration of commercial and residential networks, including SmartPost, completing the transition of our pickup and delivery service providers through a single operating model to add service capacity and operational flexibility, and incentives for our small business partners to equip their vehicles with improved safety technology. Freight’s operating income increased 2% primarily due to higher volumes and a favorable comparison as a result of a charge for a facility closure. These benefits were mostly offset by lower LTL revenue per shipment, which also drove a small decline in operating margin. Freight continues to face a difficult macro environment and is working hard to manage costs and increase yields. Express frankly knocked the ball out of the park in Q1. Adjusted operating income was up 19%, and adjusted operating margin grew 140 basis points to 9.7%. Adding to the bottom line in Express were base yield improvement, volume growth, and cost management efforts. In addition to its normal operations, Express is busy integrating TNT. As a result, integration expenses of $22 million are included in the GAAP results for the FedEx Express segment. FedEx Express continues to manage network capacity to match customer demand, reduce structural costs, modernize its air fleet, and drive continued productivity increases. Beginning this quarter, we are reporting the operating results for FedEx Express and TNT in different segments. In our 10-Q, we will provide an overview of the FedEx Express group, which is comprised of the two segments I just mentioned. The presentation of TNT in our financial statements, including purchase price allocation, is preliminary and will likely change in future periods, perhaps significantly, given the timing and complexity of the acquisition. We plan to complete our purchase price allocation no later than the fourth quarter of FY '17.

We believe the TNT acquisition, the largest acquisition in FedEx’s history, has transformed the world's transportation logistics industry, rapidly accelerating our European and global growth strategy, as one-third of total FedEx Corporation revenue now touches a country outside of the United States. We have a rich history of success in integrating businesses into FedEx, and we are doubling down our commitment to the TNT integration in terms of our people and financial resources. TNT’s 56,000 team members deliver 1 million packages daily in over 200 countries. TNT’s European road network connects more than 40 countries through 19 road hubs and over 540 depots and will substantially enhance our global footprint by leveraging TNT's lower cost road networks in Europe, the Middle East, and Asia as well. FedEx now has a strong presence in Europe, providing transportation options from express to economy parcel and freight services, helping not only our customers in Europe but also around the world shipping into Europe. We have similar and complementary corporate cultures and a common history of superior service value to customers. We had a seamless and very successful first day when we acquired TNT on May 25. Today is our 119th day of ownership of TNT. Prior to closing the transaction, we invested about a year building an integration plan, and we are well-positioned for success. Our new senior leadership team is established, and all key TNT activities and responsibilities have transitioned to the integrated FedEx senior officer teams. Hundreds of town halls have occurred across the enterprise in operations, sales, marketing, and other back-office functions. We have strong talent within the TNT legacy organization, and team members across both organizations are energized about the combination. We also have strong cultural alignment across the teams with a focus on our people, service, and profit philosophy. We expect the integration to take four years and will require significant investments in people, capital, and expense. These are network businesses and require a combination of our pickup and delivery operations at a local level for our stations and depots, our ground and air networks, and our extensive operational clearance, sales, and back-office IT systems. The IT investments that will be required are significant given the limited investment in IT at TNT over the last decade. This is also a key enabler of the integration and its benefits. We are bringing together the activities of team members across the globe. These activities and the pace are balanced against continuing to deliver world-class customer experience and a lot of returns for our shareholders.

Prior to acquisition, TNT announced its outlook strategy to double its adjusted operating income and margin percentage by 2018. That profit improvement program includes various initiatives focused on yield management, operational efficiency, and productivity as well as customer service. We are focusing on the initiatives and projects within outlook to deliver the greatest benefits balanced with our four-year integration plan. We are projecting TNT to be dilutive on a GAAP basis in FY '17 due to integration expenses, outlook restructuring expenses, and non-cash intangible asset amortization. On an as adjusted basis, excluding non-cash intangible asset amortization, integration expenses, and outlook expenses, we expect TNT to be accretive in FY '17 as the TNT outlook restructuring program has already started to lower costs. We have seen almost immediate benefits as we begin the integration. In the U.S. and Canada, we are transitioning TNT's volume formally handled by third-party carriers into the FedEx portfolio. In late September, we will begin consolidating depots and will begin transitioning customers in October. We will complete the U.S. and Canada transition by the end of fiscal year '17. In addition, we have realized procurement and sourcing benefits, transitioned four of TNT's third-party delivery partners into the FedEx direct serve operation, or moved to a single third-party provider, and will launch our initial injection of FedEx volume into five select TNT European road network lanes later in September. We’re off to a very solid start. We see the combination of these two businesses as transformative and expect significant synergies from the integration. We will drive value from four key areas: optimized pickup and delivery operations, an integrated global express network, improved efficiency of staff functions and processes, and revenue growth. We plan to optimize pickup and delivery operations by implementing new technology and processes, optimizing the locations of facilities and stations without impacting service and benefiting from the new pickup and delivery efficiencies globally where parcels will utilize a lower cost integrated pickup and delivery network to achieve greater economies of scale. We plan to form one global express network by developing integrated solutions to track en route parcels and freight and fully integrate our intercontinental airlift network. We will have one global express air network with an optimized line haul and hub strategy that will deliver the best service for our customers and significantly improve our costs.

We plan to improve the efficiency of our staff functions and processes by optimizing our systems and processes, including IT, innovating, transforming, and streamlining key support functions such as human resources, legal, security, and finance, achieving meaningful sourcing savings, lowering our effective tax rate over the long term as synergies will drive additional international profits taxed at lower rates, and greater efficiency will lead to greater cost savings. We will grow revenue with a best-in-class service portfolio with one sales team, a single online tool for customer inquiries and invoices, revenue management activities that optimize yield, improve market share, and increase profitability. As a result, customers will have access to a broader portfolio of services and will see value proposition improvements. We remain supremely confident in our initial views of the value of this acquisition and are targeting to exit the end of the four-year integration with annual synergies of $750 million. Similar to our recently completed and successful profit improvement plan at Express, we do not believe that it’s meaningful to give initial year-by-year guidance. The integration is complex, and the timing of integration and restructuring expenses beyond fiscal year '17 are not yet crystallized. How we ultimately get to our target will evolve as market conditions and other factors change. We are highly confident in our target and our goals. We currently expect the aggregate integration program expense over the four years to be in the range of $700 million to $800 million. Timing and amount of these integration-related estimates are subject to change as we implement and adjust our plans as necessary. In FY '18, TNT will be accretive including integration and restructuring costs. According to our corporate outlook, based on the moderate economic forecast that Mike discussed and the momentum we have, we project adjusted earnings to be $11.85 to $12.35 per diluted share for FY '17, excluding TNT integration, outlook restructuring costs, TNT intangible asset amortization, and year-end mark-to-market pension accounting adjustments. We are estimating combined TNT integration and outlook restructuring expenses of about $275 million and TNT related intangible asset amortization about $115 million for FY '17. We’ll expect our FY '17 integration CapEx for TNT to be about $100 million. Again, the timing and amount of these integration-related estimates are subject to change as our plans are refined. Meanwhile, Ground and Freight will continue to be focused on achieving their goals independent of the integration at Express. Our total capital expenditure forecast remains at $5.6 billion in FY '17, including TNT. We anticipate that our cash flow from operations will be sufficient to fund our increased capital expenditures in FY '17, which will include spending for network expansion at Ground to support e-commerce growth and the continued aircraft fleet modernization at Express, which continues to lower our costs. Longer term, we would target CapEx at 6% to 8% of revenues. Our balance sheet remains strong and we are well positioned to continue to increase corporate earnings, dividends, cash flows, returns, and margins. Now we look forward to answering your strategic questions and I will turn it back over to Fred. Thank you very much, Mike and Alan. I hope that gave the listeners an in-depth understanding of where we are. As you know, we are again soliciting questions over the Internet several calls ago, and we have a number of them. Quite frankly, some we’re not going to deal with because they were answered in the in-depth remarks of Mike and Alan. We’ll deal with them based on their strategic interest to the broader listeners on this call. What we’ll do is we’ll take two from the Internet and then Mickey will queue up two from the live calls. So the first question is from David Ross, Stifel. What is the benefit of having the road freight LTL/groupage business in addition to the packaged business? I presume this talks about TNT in Europe. Might it ultimately just be a small packaged network in Europe? So let me give you sort of a broad answer and then ask Mike and Dave Bronczek to jump in with any details they’d like to add. First of all, I’m not sure this is known as well as it should be that FedEx Express carries both pallets for express freight and packages. And we are the market leader in the United States with our express freight. There are three services: overnight, two-day, and then two to three days, and that is a very profitable service, and we have different pickup and delivery vehicles optimized for express freight. And obviously, we have our packaged delivery vans in the express network, mostly the sprinter-sized vans. And those two streams of traffic come together at our airport and hub locations where the pallets are sorted in one area and the packages in another, and then they’re joined together for the line haul. So TNT is very similar in Europe to the way FedEx is organized in the United States that I just mentioned. They have terminals which have pallet sortation facilities in one end and package sortation in the other. The main difference is they have had vehicles which do both pallets and larger business-to-business package deliveries. The attraction of TNT was many-fold, but I have to tell you that one of the key attractions was their unduplicated express rate network in Europe. And of course, Europe is a high density of population and their ability to move these pallets very fast throughout Western Europe was a tremendous advantage. We have a very extensive express freight capabilities in Brazil, the Middle East, Southeast Asia, and many other places around the world. So we will definitely continue in the express freight and the package business in the express segment. Now, let me hasten to add that our express freight business is very different from Mike Ducker’s FedEx Freight unit. Average weight per shipment is almost 4x. The nature of the commodities is quite different. The pricing is quite different and so forth. Similarly, Henry Maier's FedEx Ground is quite different from FedEx Express’ parcel operations. And in Europe, there is a very distinct ground parcel sector where there are a number of competitors. But TNT's aggregate pallet and package business, mainly in Europe but around the world, was a very attractive feature of that company which let us to have an interest in buying them, and we will be very much continuing to provide international priority freight and international economy freight and intra-European freight and in those other areas and regions I mentioned to you. Mike?

I’m not sure I can add to that answer.

I’m afraid to answer it any more but this is Dave Bronczek. I’d just add that Fred outlined it very well. Most of you have been to Memphis. In our Memphis hub, there's a whole freight area that you’ve seen. It’s around the world; the same Dubai, the same Hong Kong, the same Brazil, and around the world. One of the big advantages of TNT, and Fred’s right that goes unnoticed, is their ability to handle very profitable freight, and that's a part of their business that now we’re going to put into our global network of parcels and pallets, and it’s been very successful for us. It’s a nice part of the business that we added with TNT. It’s also part of what we actually viewed when we went to Australia just a month ago. Fred Smith and I went to visit our colleagues in Australia TNT and our FedEx Express folks in Australia. The combination down there could be very, very powerful for us. We’re looking at a way to make that whole marketplace much more successful, much more profitable, and it gives us an opportunity now to leverage one with the other that we didn't have in the past. So to Fred’s point, it's a great part of TNT's new business which is now part of the FedEx business.

The second question comes from Scott Schneeberger of Oppenheimer. Could you please compare and contrast major components, FedEx’s e-commerce opportunities in the U.S. and Europe now that TNT is a part of your portfolio? What are some strategic initiatives you expect to implement to capitalize on growing European e-commerce? Mike Glenn won't you take that, and then Dave can jump in.

Thanks, Fred. Well, first of all, let me say that we believe there's significant opportunity for FedEx both in the U.S. from an e-commerce market perspective as well as in Europe and around the world. Our objective is to build out a robust portfolio of services in Europe and other countries just as we have in the U.S. to include a choice for e-commerce customers in terms of getting their packages delivered in a reliable and efficient manner. That's going to be a significant focus for us as we integrate TNT and we believe the additional density within the European network that TNT will bring to FedEx will allow us to compete on a much more aggressive basis as a result.

Yes, this is Dave again. The jewel in the crown always at TNT was the very best ground road network in all of Europe. It’s great service. They have great people, a great cost structure. So with that now in our portfolio around the world, customers have always asked us for a solution for e-commerce to move across the world and mainly into Europe. Now we'll have that opportunity to do that very successfully. Thank you.

Thank you for your participation in the FedEx Corporation first quarter earnings release conference call. Feel free to call anyone on the Investor Relations team if you have any additional questions on FedEx. Thank you very much. Bye.