FedEx Corporation (NYSE:FDX) Q3 2023 Earnings Call Transcript

FedEx Corporation (NYSE:FDX) Q3 2023 Earnings Call Transcript March 16, 2023

Operator: Good afternoon, and welcome to the FedEx Corporation Third Quarter Fiscal 2023 Earnings Call. Currently all callers have being placed in a listen-only mode. And following management’s prepared remarks the call will be opened up for your questions. Please be advised that today’s call is being recorded. I will now turn the call over to Mickey Foster, Vice President of Investor Relations at FedEx. Thank you. Sir, you may begin.

Mickey Foster: Good afternoon, and welcome to FedEx Corporation’s third quarter earnings conference call. The third quarter earnings release, Form 10-Q and stat book are on our website at fedex.com. This call and the accompanying slides are being streamed from our website, where the replay and slides will be available for about one year. Joining us on the call today are members of the media. During our question-and-answer session, callers will be limited to one question in order to allow us to accommodate all those who would like to participate. 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 maybe 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. We are hosting a DRIVE Update meeting in New York City on April 5th. If you have not yet received your invitation, please call or email me or anyone on the Investor Relations team. For those who are not able to attend the meeting in person, this meeting will also be webcast.

Joining us on the call today are Raj Subramaniam, President and CEO; Mike Lenz, Executive Vice President and CFO; and Brie Carere, Executive Vice President, Chief Customer Officer. And now Raj will share his views on the quarter.

Raj Subramaniam: Good afternoon, everyone. Thanks to the hard work of the FedEx team, our third quarter earnings were ahead of our expectations in what remains the challenged demand environment. The team delivered outstanding service throughout and following peak, despite significant weather disruptions across the United States. Importantly, our third quarter results also reflect our continued progress on the fundamental transformation of FedEx as we moved with urgency to realign our cost structure. Our cost reduction actions supported margin expansion at both ground and freight, but have not yet fully offset the impact of continued pressures at Express. Results at Express came in below where they need to be and below the potential we know exists in this business.

We’re committed to addressing these cost imbalances, and we will be taking further actions in the coming months, including a more pronounced readjustment of the air network. Because of the magnitude of changes, we are planning across our air network and our continued need to maintain high service levels, there’s a lag in the timing of expense adjustments. We expect to see sequential progress in the fourth quarter. Overall, our efficiency efforts are gaining traction ahead of schedule. And I’m pleased that this translates into an improved earnings outlook for fiscal year €˜23. Now turning to slide 6 for a snapshot of the quarter. Volumes declined by a low double digit percentage across all segments partially offset by higher yields at Ground, U.S. Domestic Express and Freight.

This led to a year-over-year revenue decline. While revenue fell across all segments, the decrease was most pronounced at Express. Adjusted operating margins and EPS declined year-over-year as volume softness was partially offset by higher yields and cost reduction actions. Last quarter, we shared our expectation for continued pressures from lower volume and inflation. But what is also embedded in these results and what I’m seeing firsthand every day are tangible signs of the fundamental transformation happening at FedEx through DRIVE. We are right sizing our cost base to match today’s realities and creating a more efficient and agile network. We’re not simply taking out cost, we are simultaneously focused on running our business more efficiently, flexibly and profitably, which will create significant value for our stockholders in the years to come.

I’m particularly pleased with the progress we’re seeing in ground. The team has taken aggressive actions to address its cost structure and has effectively mitigated volume pressures. One of the key drivers at Ground was the ability to manage staffing levels and associated expenses, which resulted in reduced salaries, benefits and purchase transfers — transportation costs. Combined, these expenses were down 8% year-over-year. Despite the dynamic environment, Ground continued to deliver for its customers during peak with an average time in transit of approximately 2 days, compared to 2.35 days in fiscal year 2022. In aggregate, these initiatives led to a modest increase in cost per package of 1%, despite 11% volume declines, and total operating expenses were down $345 million year-over-year.

When combined with our continued focus on revenue quality, total operating income was up 32% year-over-year and operating margin of 9.7% that improved 240 basis points year-over-year. Freight has also illustrated disciplined commitment to profitable growth, revenue quality and managing cost of volumes. The team continues to execute cost reduction actions in this regard. Beyond day-to-day management of variable costs, the Freight team is temporarily parking and selling equipment to right size the fleet and reduce future maintenance costs. The team is also limiting hiring and furloughing employees to match staffing with volume levels. We’re taking the relevant learnings from this proven Freight model and implementing them at both Ground and Express.

Total operating expense at Freight was down 6%, supporting 270 basis points of margin expansion in the quarter. Importantly, our cost initiatives did not compromise the consistent outstanding service levels delivered by the Freight team. Turning to slide 7. We have made significant progress in taking costs out of our network with $1.2 billion in year-over-year cost savings in the third quarter. We are highly focused on taking permanent costs out of the system and remain on track to generate permanent savings of $1 billion this fiscal year relative to plan. Last month, we announced a streamlined reporting structure that will reduce the size of our officer and director team by more than 10%. We will continue to aggressively manage headcount including attrition to align our teams with the network changes underway.

By the end of this fiscal year, we expect U.S. headcount to be down roughly 25,000 year-over-year. At Express our cost base is constrained in the short-term, where Express network is vast and complex and requires time to adjust to changing demand conditions. Therefore, we’re taking additional steps to address our fixed expense structure. This quarter, we reduced flight hours by 8% and salary and benefit expenses by 4%. We also parked an additional nine aircraft, downgauged on certain routes and implemented various productivity improvements. As a result of these actions, we mitigated 45% of total revenue declines on an adjusted basis. This was significant improvement versus the first half. Within the U.S. Domestic Express, we implemented a single daily dispatch of couriers in February.

This change removes domestic pickup and delivery routes, improves hub and ramp efficiency. We expect this will achieve about $50 million in savings in Q4 and ramp up to about $300 million annual savings by fiscal 2024. We expect progress to accelerate in the fourth quarter with total flight hours expected to be down double digits and further FTE reductions by year-end. This will support mid to high single digit reductions in total expenses year-over-year at Express. We also plan to temporarily park additional aircraft in the fourth quarter. With continued cost discipline, we anticipate sequential operating margin improvement in the mid single digits for the fourth quarter. Assuming the challenging demand environment persists in Q4, we expect to be able to mitigate at least 60% of the revenue related headwinds we’re facing at Express.

This supports improved profitability in the fourth quarter compared to the third. We will build profitability from here at Express. Before we dive into the financial results in more detail, I’ll provide a quick update on DRIVE, the program to support our transformation to create a more nimble, efficient and profitable FedEx. We are on track to deliver $4 billion of permanent cost reduction by the end of fiscal 2025. I’m very pleased with the progress the team has made in identifying actions that will not only reduce costs but make our network more agile and flexible as we execute Network 2.0. One part of this effort, as shown on slide 8, is to reconfigure our air network. This requires many steps, including plans currently being developed to phase out our fleet of MD-11s.

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Our aircraft modernization program and use of 777s and 767s affords us the ability to flex our plans. And as we operate more collaboratively, we are leaning into the ground transportation more, requiring less CapEx while enabling us to reconfigure our network more quickly. This directly supports our goal for meaningful ROIC improvement in the coming years. We’re excited to share more about the strategy at our DRIVE program update on April 5th. There, we will focus on the actions we are taking to improve our performance, along with additional information to help you better model the impact on our progress. Now, let me turn it over to our Chief Customer Officer, Brie Carere, who will discuss market trends and our commercial strategy in more detail.

Brie?

Brie Carere: Thank you, Raj, and good afternoon, everyone. As expected, the operating environment in the third quarter remains challenging. The trends we saw through the first half of the year persisted, but we started to see some moderation, and importantly, our team delivered excellence for our customers. At FedEx Ground, revenue was down 2%. The volume decline was significantly offset by a double-digit percentage yield increase driven by better product mix, fuel and large package and peak surcharges. We are very pleased with the results from the implementation of our global rate increase this past January, which has maintained a very high capture rate. At FedEx Freight, revenue was down 3%. The team’s continued execution on revenue quality actions and profitable share enabled us to offset 12% volume decline throughout the quarter.

Importantly, pricing discipline across the LTL industry is strong, and we expect the market to remain rational. Revenue at FedEx Express was down 8% year-over-year, primarily due to lower volumes globally and yield softness in Asia and Europe. In Europe, we’re seeing improved operational execution with service at the best levels they have been since fiscal year €˜21. There’s more work to do but the momentum is building as our team has improved service levels while maintaining a healthy sales pipeline. Our pipeline and signed contracts are at their highest levels this fiscal year and our closes per week are at a double-digit percentage higher than they were in Q1. Additionally, having a freight and parcel bundle for our customers in Europe differentiates us from the rest of the market.

In Asia, market demand is rebalancing, resulting in lower yields and softer demand for priority services. The reopening of our international economy service this May will help stabilize our volumes out of Asia, given the market’s increased shift to deferred services. Moving now to slide 11. As expected, yield growth has been increasingly pressured across segments as year-over-year fuel surcharge comparisons normalize and customer demand shift. FedEx Express international turned negative, driven primarily by Asia, with Europe also softening. U.S. Domestic Express, Ground and Freight yield growth also decelerated. Despite market headwinds, we’re pleased with the team’s ability to manage volume, share and margin at both FedEx Ground and FedEx Freight.

Looking ahead, we remain prudent in our expectations for yield in the fourth quarter. Turning to slide 12. Service is always top of mind for us at FedEx. Our team delivered another busy peak season highlighted by FedEx Ground achieving pre-pandemic service levels. In fact, across the board, FedEx Ground delivers to more locations in one or two days than our nearest competitor’s ground service. I would also like to share progress we’re making at Express, where service levels improved significantly over fiscal €˜22 peak and are quickly approaching pre-pandemic service levels. While this is great progress, we know we have more to do, and we’re making — taking meaningful action to continuously enhance our service. For example, in Europe, with the reopening of our Duiven, Netherlands road hub this past October, we have expanded capacity, enabled a more efficient routing, and we have improved our service.

These improvements are a testament to our team’s ability to deliver outstanding service while we change our business. Coming out of peak, service improvement has translated into good momentum for our sales team. Jill and I are also very pleased with the market’s response to several new or enhanced offerings that further improve customer experience. First, the online FedEx Ship Manager has been fully modernized to make shipping more efficient, highly personal and easier to use for all of our customers. Our customers can cater the interface to the way of working they prefer and that fits their business. Customer feedback has been very positive, and we’re finding that the more customers engage with Ship Manager, the more they appreciate it. FedEx Ship Manager is the primary tool for small business customers, and we plan to migrate 98% of all parcel shippers to this new experience before next peak.

Next, we launched picture proof of delivery ahead of peak season, making us the first to market with this great capability. It has fulfilled a key customer need, driving confidence around successful package deliveries. Benefits from this launch include fewer delivery disputes and fewer customer service calls post proof of delivery. We are winning new business because of this unique feature. We have also continued to build out our dynamic pricing infrastructure with our Dataworks team. In peak, our dynamic pricing capability enabled holiday peak residential surcharges to adjust dynamically based on individual customers’ weekly peaking factor, delivering $150 million in profit. In the coming fiscal year, our predictive anomaly detection will improve revenue quality.

We have already built infrastructure that helps us identify instances when we have overbilled our customers. Now, we will use those same capabilities to better manage customer performance and contract compliance. Finally, in January, we rolled out new visibility insights in 13 countries, providing customers with a four-hour time window for their package delivery. By delivering these innovative solutions, our teams are creating great value enhancing the overall customer experience. Now, I will turn it over to Mike to discuss the financials in more detail.

Mike Lenz: Thank you, Brie. Starting with our performance in the third quarter. We delivered earnings ahead of our expectations as our team moved with urgency to align our costs with lower revenue as global volumes remain under pressure. Turning to the transportation segments. At Ground, operating income increased 32% and operating margin expanded 240 basis points to 9.7%. Margin expansion was supported by both, yield growth of 11% and cost reduction actions. These factors were partially offset by lower package volume, higher infrastructure costs related to previously committed projects and increased other operating expenses. And at Freight, the team’s focus on revenue quality and managing costs drove better profitability as operating income increased 15% and margins expanded 270 basis points.

This was driven by revenue per shipment, up 11%, as well as a gain on a facility sale and partially offset by decreased shipments. At Express, our results continue to be pressured, and our team is acutely focused on driving improved profitability. Adjusted operating income declined 81% due to 10% lower package volumes as cost reductions lagged volume declines. Volume pressures were partially offset by improved yields. Revenue per package grew 3% year-over-year, primarily driven by higher fuel surcharges and base rates, partially offset by exchange rate impacts. Yield growth decelerated and inflected negatively in international export, increasing pressure on profitability. Despite our performance in the third quarter, due to the actions we are taking in Express, we expect to see sequential operating profit and margin improvement in the fourth quarter.

To provide additional color on recent demand trends and what we are planning for in our outlook, slide 17 shows trailing monthly volume trends for our major product categories. Volume declines continued throughout the quarter. While still negative, U.S. Domestic Express, International Priority and Ground Package trends improved somewhat into February on a sequential basis. As we look to the fourth quarter, we expect volume declines to continue moderating at Express and Ground as we lap the onset of softer volumes. Yield growth will be pressured as year-over-year fuel surcharge comparisons normalize and customer demand shifts, most prominently in Asia. Moving to slide 18. Our focus on efficient and responsible capital allocation has not wavered.

We are in an era of lower capital intensity at FedEx. Last fiscal year, CapEx was 7.2% of revenue, down from our historical levels of roughly 8%. By fiscal year €˜25, our commitment is to be at 6.5% or lower. As I mentioned in December, we reduced our fiscal year €˜23 capital spend forecast to $5.9 billion, which is approximately a $900 million reduction from initial plans for the year to account for the lower demand environment. We are prudently deferring and slowing the pace of projects, improving our capacity utilization and planning for moderated aircraft fleet investment to drive ROIC improvements. In line with this approach, we expect capital spend to be roughly flat in fiscal 2024 versus fiscal 2023 and be down as a percentage of revenue.

Turning to liquidity. Our cash position remains a source of strength. We ended the quarter with $5.4 billion in cash and continue to generate solid cash flows, which supports our capital return strategy. We remain committed to rewarding our stockholders as we transform our business and execute on our long-term strategy. In fiscal year €˜23, we will return $2.7 billion to our stockholders. In summary, our capital allocation strategy reflects our commitment to reducing capital intensity and creating value for stockholders while continuing to reinvest in FedEx for today and tomorrow. Turning to slide 19. In the fourth quarter of 2023, we expect market conditions to continue to negatively impact revenue and operating profit. However, on a sequential basis, we expect FedEx’s fourth quarter results to follow our historical seasonal pattern, representing the high watermark on the year.

We will continue to execute on the previously identified cost actions and identify additional opportunities to reduce costs in order to mitigate the impact of volume declines on our operating results. As part of these reductions, we will manage capacity to lower demand levels, including further reducing flight hours at Express and reducing Sunday operations, closing certain sort operations and taking other line-haul expense actions at Ground. We are executing targeted actions to reduce shared and allocated overhead expenses, reducing vendor utilization, deferring certain technology projects and discontinuing same-day city operations at FedEx Office. In addition, we expect to achieve savings related to further headcount attrition and the elimination of certain global officer and director positions, which we announced in February.

Putting these factors together, our updated expectation for full year adjusted earnings is $14.60 to $15.20 per diluted share. And with that, let’s open it up for questions.

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Q&A Session

Operator: We’ll take our first question from Ken Hoexter of Bank of America.

Ken Hoexter: Hey. Great. Good afternoon. And great job on pulling some of the costs forward. Maybe Mike or Raj, maybe talk a little bit about that sequential improvement. You’re talking about a seasonal improvement, but I mean, you normally have that. And Mike, you mentioned you’d normally have that seasonal improvement in the fourth quarter. So, I’m trying to understand, are you muting that expectation, or are you ramping that expectation into the fourth quarter given the additional cost pull forward than what we would normally see between a fiscal third and fourth quarter? If you can kind of walk through maybe some of those detailed cost pullouts and the impact for the quarter.

Mike Lenz: Sure. Thanks, Ken. So, as Brie highlighted, for the fourth quarter, we continue to project a lower level of demand, and that just heightens the emphasis of further traction on the cost initiatives. So Express, in particular, we’ll realize greater savings from the initiatives that we’ve highlighted, and that will drive to the mid-single-digit margin projection there. At Ground, we also expect — we expect margin improvement at Ground, but not the same magnitude that we realized in the third quarter. And then, lastly, at Freight, we had an exceptional fourth quarter last year, and we’re projecting strong performance in the fourth quarter this year as well, but we’re not anticipating building upon that near term given the volume declines there. So hopefully, that puts it in context further for you there thinking ahead.

Operator: We’ll take our next question from Chris Wetherbee of Citigroup.

Chris Wetherbee: Maybe just picking back up on the Express commentary for fiscal 4Q. So, I think mid- to high single-digit year-over-year decline in total expenses for Express would probably put us kind of flattish sequentially. So, maybe you could just sort of help us a little bit with the revenue dynamic. I think, Mike, you talked about volume declines moderating as you went through the third quarter. Any thoughts on maybe how to think about the fourth quarter? I know it’s still a challenging environment, but trying to triangulate a little bit with some of the numbers you’ve given us to — on the revenue side there.

Brie Carere: Sure. Happy to help, Chris. It’s Brie. From a volume decline perspective, what we anticipate seeing in Q4 is that the decline will get less. So sequentially, the volumes will improve from Q3 to Q4. And actually, when we’re thinking about Express, we think that trend will continue into Q1 as well. That is here in the U.S., but also from an international perspective, as we talked about, we’re going to open up international economy. So, we do think that the volume decline will moderate Q4 over Q3 as well as Q1 over Q4. And again, I am talking about that decline year-over-year. I hope that helps, Chris.

Operator: Our next question is from Jack Atkins of Stephens.

Jack Atkins: So I guess, as we think about the DRIVE initiatives here, is there any way you can help us maybe frame up how much of that — of the $4 billion in savings have been implemented so far in terms of those actions. And then, I guess, as you sort of think forward, obviously, there’s a lot of uncertainty out there from a macro perspective. Are you prepared to pull more levers to be able to take costs out of the business if we start to see a further deterioration in the demand environment?