FedEx - Q1 2014

Transcript

Operator (participant)

Good day, everyone, and welcome to the FedEx Corporation first quarter fiscal year 2014 earnings conference call. As a reminder, today's call is being recorded. At this time, I'd like to turn the call over to Mr. Mickey Foster, Vice President of Investor Relations for FedEx Corporation. Please go ahead, sir.

Mickey Foster (VP of Investor Relations)

Good morning, and welcome to FedEx Corporation's first quarter earnings conference call. The first quarter earnings release in our Stat Book on our website at fedex.com. This call is being broadcast from our website, and the replay and podcast 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. If you are listening to the call through our live webcast, feel free to submit your question via email or as a message on stocktwits.com. For email, please include your full name and contact information with your question, and send it to [email protected] address. To send a question via stocktwits.com, please be sure to include $FDX in the message.

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 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. To the extent we disclose any non-GAAP financial measures on this call, please refer to the investor relations portion of our website at fedex.com for reconciliation of such measures to the most directly comparable GAAP measures. Joining us on the call today are Fred Smith, Alan Graf, Mike Glenn, Chris Richards, Rob Carter, Dave Bronczek, Henry Maier, and Bill Logue. Now our chairman, Fred Smith, will share his views on the quarter.

Frederick Smith (Chairman)

Thank you, Mickey. Good morning, everyone, and welcome to our discussion of operating and financial results for the first quarter of fiscal 2014. FedEx had a good quarter despite higher fuel costs and one fewer operating day. Growth in overall customer demand for our wide range of global transportation solutions drove improved earnings. FedEx Ground reported another outstanding quarter as average daily volume grew 11%.

FedEx Express is skillfully executing its profit improvement plans. As part of this, earlier this month, FedEx Express took delivery of its first new Boeing 767-300 freighter, which uses about 30% less fuel and offers at least a 20% operating cost over the MD-10 it replaces. We're reaffirming our forecast for full-year's earnings per share growth of 7%-13% over FY 2013's adjusted results. We believe FedEx is well positioned for continued growth and success as customers around the world realize the full value of our portfolio of solutions. Now I'll turn the call over to Mike Glenn for his views on the economy, and then to Alan Graf for details on the financial results. Mike?

Michael Glenn (EVP of Market Development and Corporate Communications)

Thank you, Fred. The FedEx economic forecast calls for continued moderate growth in the global economy. Our U.S. GDP growth forecast is 1.6% for calendar year 2013, which is down 0.4 point versus last quarter, and 2.5% for calendar 2014, which represents no change versus the last quarter. For industrial production, we expect growth of 2.4% in calendar 2013, again, down 0.4 point versus last quarter, and 3.4% in calendar 2014, which is down 0.1 point versus last quarter. It's important to note that historical data revisions account for most of the reduction in the calendar year 2013 growth rates. Policy risks remain high, but there are signs of improvement in Europe and China.

Our global GDP growth forecast is 2% for calendar 2013, down 0.3 of a point versus last quarter, and 2.9% for calendar 2014, down 0.1 of a point versus last quarter. Turning to yield per package in the Domestic Express segment, excluding the impact of fuel, year-over-year package yield increased 2.7%. The increase was primarily driven by rate and discount improvements, followed by increased weight per package and product mix. The Ground package yield increased 2.2%, excluding the impact of fuel. The year-over-year increase was driven by rate and discount improvements and increase in extra services charges and product mix.

In the International Express segment, export, excluding fuel, International Export Express package yield declined 2.1% year-over-year due to changes to rate and discount and weight. Finally, in the Freight segment or the LTL segment, excluding the impact of fuel, yield per hundredweight increased 1.1% year-over-year. The increase was primarily driven by rate and discount changes, changes in shipment class. Now I'll turn it over to Alan Graf.

Alan Graf (CFO)

Thank you, Mike, and good morning, everyone. We had a good quarter. Revenues and earnings increased, driven by the solid performances in all of our transportation segments. Operating income grew 7% year-over-year, primarily from improved profitability at Express, higher volumes and increased yields at Ground, and improved performance at Freight. Our margin improved 30 basis points versus last year to 7.2%, despite significant headwinds from the fuel surcharge timing lag, as well as one fewer operating day. Offsetting those headwinds for the quarter were benefits from lower aircraft maintenance and salaries and wages expense. For Express, quarter one operating income grew 14%, and operating margin improved 50 basis points year-over-year, despite the significant negative impact of net fuel and one fewer operating day.

The improvement was driven by stronger U.S. based business performance, lower pension expense, and the continued modernization of the company's aircraft fleet, which helped to drive maintenance costs lower. These were partially offset by higher related depreciation expense. Turning to Ground, operating income grew 5% year-over-year, despite the negative impact of fuel. Higher network expansion costs were also incurred as we continue to invest heavily in the growing Ground and SmartPost businesses at very high ROIC. The improvement in Ground was driven by higher volumes, despite one fewer operating day and higher revenue per package. Freight's operating income increased slightly, despite one fewer operating day year-over-year. Higher weight per shipment, LTL yields, and average daily LTL shipments improved income at Freight. Freight continued to optimize the line haul network by increasing the utilization of lower cost rail over the quarter, now at 17% of total line haul miles.

As for the outlook, based on the economic conditions that Mike talked about, we reaffirm our FY 2014 earnings per share growth of 7%-13% from the FY 2013 adjusted results. Our outlook depends on stable fuel prices. Fuel price volatility impacts the timing of our fuel surcharge levels in relation to fuel expense and, ultimately, demand for our services. As part of our profit improvement program, we are continuing to evaluate further cost reduction actions to continue to improve our results at Express and to ensure that we achieve our $1.6 billion profit improvement goal at Express by the end of FY 2016.

With regard to the voluntary buyout program, as of August 31st, approximately 45% of the 3,600 employees that accepted the voluntary buyout have vacated their positions. The additional 55% will depart throughout the remainder of FY 2014, with approximately 25% remaining until May 31st, 2014. Total SG&A savings from our profit improvement program is expected to be $600 million by the end, on an annual basis, by the end of FY 2016. Now we'll open up the call for questions.

Operator (participant)

Thank you. And ladies and gentlemen, if you wish to signal for a question or comment, please do so by pressing the star key followed by the digit one on your telephone keypad. If you're using a speakerphone today, please make sure your mute function is turned off to allow your signal to reach our equipment. We ask that you please limit yourself to one question to allow others the opportunity to pose their question. You may also submit your question via email at [email protected]. Once again, ladies and gentlemen, to signal for a question or comment, please press star one on your telephone keypad at this time. We'll pause for just a moment to allow everyone an opportunity to signal for questions. And we will take our first question from Justin Yagerman with Deutsche Bank.

Justin Yagerman (Managing Director and Senior Equity Research Analyst)

Hey, good morning, guys. Wanted to ask you about the capacity side in the International Express business. Obviously, margins a lot better than expected on the Express side this quarter, and, you know, I know that's due to a lot of what you've got going on on the domestic side as well. But wanted to dig in and see how the progress has been going in terms of the third-party line haul initiative and where you guys are at in terms of frequencies on export flights out of Asia.

David Bronczek (President and COO)

Thanks, Justin. This is Dave Bronczek. You're right, we adjusted for the second quarter in a row now. Last quarter in April and this quarter in July, we reduced some of our global capacity coming out of Asia, which you saw in some of our numbers in terms of fuel usage and fuel in general. That being said, our International Economy volume continues to grow at a rapid rate. It was up 15%. I think it's been in the teens now for several quarters in a row. So we're actually putting those packages and that network into the right system form now that is actually benefiting us across the world. Thank you for the question.

Operator (participant)

Thank you. Our next question comes from Dave Ross with Stifel Investments.

Bruce Chan (Analyst)

Hi. Good morning, gentlemen. It's actually Bruce Chan on for David Ross. I'm just curious on the trade network side, you know, we've heard from some of the other forwarders out there that TransPac volumes have been kind of blah, you know, with soft summer volumes and limited optimism for 2014. I'm wondering if, you know, your outlook is, you know, the same, or if you're expecting something a little bit rosier. And if rosier, is that because you're taking share, you know, whether price related or, you know, product offering related? Thank you.

David Bronczek (President and COO)

Thank you very much. This is Dave again. We're toggling our traffic back and forth between Express and FTN, so FTN is performing very well. I think the volumes are slightly higher, the yields are a little bit weaker. I think that's the case across the world, but it's performing exactly like we had planned it to. So our FTN organization is doing a terrific job, a great service, and moving the lower yielding International Economy into their network.

Operator (participant)

Thank you. Our next question comes from Ben Hartford with Baird.

Benjamin Hartford (Senior Equity Research Analyst)

Good morning. I guess if we could just tie that all together, could you give us a sense, Dave, maybe where, where you believe the network is in, in relation to needing to divert lower yielding freight off of your aircraft, into third-party capacity? Do you feel like that you've gotten out in front of this trade down phenomenon that's been discussed a lot? Do you still feel like that there's incremental progress to be made in terms of putting, the lower yielding packages onto the appropriate modes? Can you provide some perspective there?

David Bronczek (President and COO)

Yeah, it's a great question. We feel very good about where we are. We have not affected service whatsoever. We have the world-class service around the globe. We've adjusted the capacity, moving the right traffic in the right network. We have more upside opportunity to keep growing our International Economy, more financially favorably now, whereas in the past, we used to cap that traffic. So we have a great network now for International Priority, all around the world. We have more upside there. We have more upside in International Economy as well. It's been a terrific shift for us to match what's happening in the global economy.

Operator (participant)

Thank you. We'll now take our next question from Christian Wetherbee with Citi.

Christian Wetherbee (Analyst)

Good morning, this is Stephen for Chris. My question pertains to Ground margins. I was wondering if you could give us a sense of some of the individual headwinds that you faced during the quarter, the higher network expansion costs, fuel surcharge, and one less operating day, and what those effects were on margin?

Henry Maier (President and CEO of FedEx Ground)

Yeah. Hi, this is Henry Maier. Virtually, all of the year-over-year change in margin was due to fuel. As Alan pointed out, op income was impacted by fuel and one less operating day. You know, network expansion costs at this point in time are really for capacity and part of our anticipation of peak buildup.

Operator (participant)

Thank you. Our next question comes from Scott Group with Wolfe Research.

Scott Group (Managing Director and Senior Analyst)

Hey, thanks. Morning, guys. So Alan, a question for you on the SG&A. I think you mentioned you're now expecting $600 million of savings. I just want to make sure I'm understanding it right. Is that comparable with the $500 million you initially laid out at the Analyst Day over a year ago? And then can you give some color on when we should expect to see that? Just when I look at labor savings this quarter and I back out pension, you don't really see any signs of the headcount reductions. And is that a timing issue, or are there any offsets there we should think about? Thank you.

Alan Graf (CFO)

All right. All right, Scott, you had several questions in there. So let me, let me do my best. First, on the tactical one, we made acquisitions last year that are year-over-year, and so you're seeing some of that, on your last question, that's what you're seeing there. Yes, the $600 is comparable to the $500. We are actually well ahead of our cost goals that we outlined 11 months ago, and I feel very comfortable about where we are on the cost side, and we'll continue to work that hard. We have great productivity improvement programs going on in other places as well, aside from labor, notably AOD productivity, and you're seeing that in our maintenance expense at Express.

We have some additional opportunities in strategic sourcing that we're going to be tackling that I think are going to help us reach our goal. Now, having said that, to your strategic question, the world looks a lot different today than it did 11 months ago when we gave you the very specific five buckets about how we were going to improve at Express. So, after you listen to what Mike said about 2013 and 2014's economic outlook, I think that we're going to have a little bit more pressure on our base erosion at Express that we got to, as Dave talked about, match lift to load, if you will. So we're aggressively doing that.

That may mean that we may have to get to the 1.6 a little bit differently than what we described to you, and it may mean that we will be more back-end loaded towards the second half of 2015 and 2016, as we start really driving the leverage of the things that we're doing. But we're committed to the 1.6, and we'll have that by the end of FY 2016, and I feel comfortable by saying that in today's environment.

Operator (participant)

Thank you. We now take our next question from Ken Hoexter with Bank of America.

Ken Hoexter (Analyst)

Great. Good morning. Just following on the international side, I just want to understand on the trade down effect, are you taking further steps? And to Alan's point there, are you now looking at get some of those cost savings internationally? I think you talked originally maybe moving some of these cost programs into the international bucket. And have you started to look at that on the cost side?

Alan Graf (CFO)

Well, Ken, I thank you for the question because, again, I want to stress that as a strategy from FedEx Corporation, we are embracing International Economy, and we like these growth rates. We believe very strongly that we can make the shift that the customers are making while still growing the premium service of IP. It'll just be at a slower growth rate than we had anticipated 11 months ago. But the IE network is coming in place very nicely, and we're going to continue to work on that, and I feel pretty comfortable that we'll make this strategic change. I'll let Dave give you some more detail.

David Bronczek (President and COO)

Yeah, that's, that's right, Alan. You, you saw in the numbers, our, our, flight hours were down significantly, and our fuel usage was down significantly, and that's on our own backbone network. And as we expand our international, economy traffic into other networks, that's actually a very positive thing for us on both sides of the financial equation for Express. So we are embracing the economy service and those, traffic cohorts. There's a lot more upside there. We've capped it in, in the past.

Operator (participant)

Thank you. We'll take our next question from Brandon Oglenski with Barclays.

Brandon Oglenski (Analyst)

Yeah, good morning, everyone, and thanks for taking my question. I guess I want to focus for our third question here on costs. So for the first time, we actually saw Express quarterly costs, ex-fuel, come down, although slightly. Should we expect that to accelerate throughout fiscal 2014 and into 2015? And Alan, are those cost cuts just becoming a little bit more challenging to derive? Is that why you're saying it might be a little bit more back-end loaded to achieve that 75% of $1.6 billion next year?

Alan Graf (CFO)

Well, again, I'll start. Again, acquisitions that are now, you know, fully in our P&L are kind of masking what we're doing in terms of bending our costs down. And I think I also mentioned to you about, we still have over half the people that were still working here through the first quarter from our voluntary buyout program, which, a year from now, will be. They'll all have left, and we will be able to see a much bigger number from at Express directly and from the chargeback that Express gets from services. So, I think that's the macro answer to your question. Dave has a lot of specific productivity things going on. I'll turn it over to him.

David Bronczek (President and COO)

Yeah, we've hardened all of our expense programs. They're all working exactly what we would like them to work, how we'd like them to work. It's what we told you. In fact, I guess it was the question before, it's actually all around the world on our expense targets and performance there. So, you know, with the exception of acquisitions that have added a layer of expense and revenue, quite frankly, and without the impact of fuel this quarter that was significant for Express, our margins, our operating profit improving 14%, is right in line with what we've planned to achieve and are achieving.

Operator (participant)

Thank you. Our next question comes from Thomas Kim with Goldman Sachs.

Thomas Kim (Analyst)

Good morning. Thanks very much. We noticed that the cash flows continue to build up nicely, and you're now looking at about $5 billion in the quarter. Could you give us a little bit of guidance as to how we should be thinking about the capital allocation with regard to perhaps, you know, your longer-term plan for CapEx? And, you know, as we think about modeling, do we want to be thinking about modeling CapEx as some sort of ratio, as a percentage of fixed assets or revenue? And then within that component, you know, what % do you think is more for replacement as opposed to the growth side of the CapEx? Thanks very much.

Alan Graf (CFO)

Our CapEx strategy has changed over time, as we are now focused on replacement and modernization of the aircraft fleet at Express, which is driving, you're already seeing it. You notice the last two fiscal years in the fourth quarter, we've significantly reduced and we've retired a number of planes. We've shortened the depreciable lives, which, of course, is a, which is a headwind for Dave's segment. But, it's for replacement capital, which is much more efficient, and with fuel prices where they are, you know, jets at $3, it's absolutely mandatory that we continue to do that if we're going to hit our 1.6 goal. We want to put as much money as we possibly can into Ground because it's going to continue to grow. It's very high ROIC.

Ground's margins are going to stay in the 17%-19% range, and we're going to continue to take market share. As Freight, they've done a great job of continuing to tweak their operating model, a lot more on rail. We expect Freight to grow, and so we'll invest there as well. As to capital allocation, we continue to talk about that at a strategic level all the time, and we don't have anything to say about capital allocation today, and we'll keep you posted.

Operator (participant)

Thank you. We'll take our next question from Kelly Dougherty with Macquarie. Your line is now open. If the line is muted, please unmute your phone line.

Kelly Dougherty (Senior Analyst)

Can you hear me? Hello?

Operator (participant)

Yes, yes, please proceed.

Kelly Dougherty (Senior Analyst)

Oh, apologies about that. Sorry. I guess, Alan, maybe if you could give us some more color on the different buckets outside of the, the SG&A, you know, how you get to that $1.6 billion number. I know things have changed around a little bit, but if you could give us any more sense on, on what the, the size of the other buckets look like, that would be really helpful.

Alan Graf (CFO)

Well, we're only one quarter into a 12-quarter program. I was just trying to point out that we have to manage the business as well, and things change, and we're doing that. So whereas we were looking at a different revenue outlook for International Express 11 months ago, components have changed. There'll be much more IE in the future than we had anticipated, and probably less IP, although it will continue to grow. So we have to change our cost structure more than we thought. So you might see a little bit more on the cost side of the equation and a little bit less on the revenue benefit side of the equation.

David Bronczek (President and COO)

Yeah, Kelly, these are the buckets that we've gone over before, but just so you can put them down, domestic transformation or domestic cost network, if you will, international profit improvement across the world, fleet modernization, efficiency of staff functions and the process there, and of course, targeting profitable yields and revenue growth.

Operator (participant)

Thank you. We'll take our next question from Scott Schneeberger with Oppenheimer.

Scott Schneeberger (Managing Director and Senior Analyst)

Thanks. Good morning, everyone. In Ground, you've spoken about building out a capacity and spending a bit more on CapEx this year. Could you give us a progress report and update on what's going on there? You mentioned some build-out for the holidays. Also, is there any work there to strategically capitalize on e-tailer strategies, expanding the distribution networks? Thanks.

Henry Maier (President and CEO of FedEx Ground)

Well, this is Henry Maier. Okay, there were a lot of questions there, so I hope I get them all. First of all, 90% of the capital expense is to expand our capacity for growth. And the large elements of these expenditures are new hubs, building expansions and relocations, material handling, and rolling stock. So, you know, we are very disciplined, as I've said in the past here, about adding capital. We try to handle peaks and volume with operating expense instead of capital, and we generally put together a five to seven year plan based on our forecast as to how we intend to expand the network. Now, clearly, our volume is being driven by e-commerce. I think Mike has said in the past year, it's growing five to six times the rate of brick and mortar.

I would tell you that we believe that we are uniquely positioned to compete in this space. We have FedEx Home Delivery for customers that desire high touch, high value transportation services for their residential deliveries. FedEx Home Delivery offers extra services, including day definite service, appointment service, and evening delivery, in addition to signature options. And then we have FedEx SmartPost, which is uniquely positioned to offer a low cost option for customers who would like to offer free shipping to their customers, and we do this with final mile delivery by the USPS. So we think that we're uniquely positioned in the marketplace to capture our fair share of e-commerce.

Operator (participant)

Thank you. We'll take our next question from Jack, Jack Atkins, with Stephens.

Connor Hustava (Research Analyst)

Yeah. Hey, guys, this is actually Connor Hustava on for Jack today. Just had a quick question on the tech product launches that are planned here in the second half of 2013. Can you just give us some color on what you think that will do to overall industry capacity, and maybe what's baked into your guidance from a volume and rate perspective? Thanks.

Michael Glenn (EVP of Market Development and Corporate Communications)

This is Mike Glenn. Obviously, we'll see some tech launches this week. There have been changes in the way that tech products are moved into the marketplace. A lot more staging of inventory going on, on the international front, as opposed to using expedited from door to door. So we have seen some changes in that regard in terms of how product is moved to the U.S. and put into inventory. We will certainly benefit from that, with these launches. Probably a greater benefit in the domestic system, although it is a short burst. So even though it's a lot of traffic in a very short period of time, you don't see the long tail of that potentially you've seen in the past, although certainly we'll benefit from accessories and other things that come on the back end of these tech launches.

Operator (participant)

Thank you. We'll take our next question from Geoff Kaufman with Buckingham Research.

Geoff Kaufman (Analyst)

Thank you very much, and congratulations, everyone. You did take down modestly your U.S. and global forecast. I know you mentioned, Fred, that it was related to some changes in the makeups of these growth objectives. But in terms of your own outlook, you spent a little less CapEx than we were looking for. What are your thoughts on your capital budget for this year, and what is changing in your own forecast, where you're maintaining your forward guidance in the face of lower global growth?

Michael Glenn (EVP of Market Development and Corporate Communications)

Geoff, this is Mike. Let me clarify. On the calendar year 2013 economic outlook, I mentioned that it's, it's historical data revisions that are really driving the bulk of the reduction in our calendar year 2013 growth rates. Obviously, as GDP numbers are updated, which takes some time, we build that back into the historical trend, and that, that affects the forecast going forward. So really not as much material change in the fundamentals of the business, as opposed to just historical data revisions on the economic forecast, and I'll let Alan handle the second part.

Alan Graf (CFO)

Geoff, we're not changing our capital spending plans for this year. As I said, we want to continue to invest heavily in Ground, and we want to continue to do the fleet replacement at Express. As we look at 2015 and 2016, as part of the profit improvement program and other things, there may be a possibility that we will slide some of that further out, depending on how the economy goes, and we'll just have to see.

We have some flexibility to do that, but I think $4 billion is the right number for us this year. If we can sort of hold that level for a while as revenues grow, then we'll get a better CapEx to revenue ratio. I'm not making any 15 commitments yet because we're gonna just have to wait and see what the outlook looks like. But I can tell you this, the 767s, the first 25 of them, are just beautiful from a return and operating profit improvement standpoint.

Operator (participant)

Thank you. Our next question comes from William Green with Morgan Stanley.

David Campbell (Senior Research Analyst)

Hi, good morning. Mike, can you remind us on the GRI on Express, how much of the business does that cover? And also, does it include dim weight pricing changes? Because it seems like that's been quite effective.

Michael Glenn (EVP of Market Development and Corporate Communications)

Will, I'm sorry, you had trouble, we had maybe a connection issue. Could you repeat the question just a bit, maybe get a little closer to the phone?

David Campbell (Senior Research Analyst)

Sure. So, the question was on the GRI for Express. How much of the business does that cover? And does it include any changes in dim weight, because that's been pretty effective for pricing in the past?

Michael Glenn (EVP of Market Development and Corporate Communications)

Well, it's been one of our key strategies to substantially increase the amount of parcel traffic that is covered by the GRI, and we've done a terrific job over the last three to four years. That's been a key component of our revenue management program. So well over half the traffic is now impacted. We certainly have contracts that still are in place today that are locked into a GRI, and it's based upon the contract term and not the annual GRI.

But we've done our sales team and our pricing science team have done a phenomenal job of working with customers to get them on an annual rate increase. So we're very pleased with that. We did not make any changes to the dimensional weight that we put in place several years ago. That's the last time we made the change, but that clearly has benefited the company, that strategic change we made several years ago.

Operator (participant)

Thank you. Our next question comes from Allison Landry with Credit Suisse.

Allison Landry (Senior Equity Research Analyst)

Good morning. I was wondering if you could quantify what the overall fuel lag headwind was during the quarter, and if we should be expecting a similar impact in Q2. Thank you.

Alan Graf (CFO)

Well, Allison, this is Alan. While we don't give specific numbers, I can tell you it was significant. If you just think about how the fuel prices ran up towards the end of the quarter and our fuel surcharge lags by six weeks, you know, it's pretty evident that we were paying a lot higher for jet fuel and not able to pass along the surcharge. As to Q2 and the rest of the year, I wish I could tell you. I mean, it's one of the things that's a big wild card on a quarter-to-quarter basis, is what happens with particularly jet fuel prices, but also with diesel and vehicle fuel, but particularly jet fuel prices.

You know, if the global political environment calms down a little bit and the price of crude declines and jet fuel follows it, then that would be beneficial to us in the second quarter, but I can't predict it. So, we just have the six-week lag, and we just have to deal with it. Over time, it evens out, but it sure does cause volatility.

Operator (participant)

Thank you. Our next question comes from Tom Wadowitz with J.P. Morgan.

Thomas Wadewitz (Senior Analyst)

Yes, good morning. I wanted to follow up on one of the topics, Dave Bronczek, that you talked about a little bit earlier on the shift of the IE traffic and I guess, how that relates to trade down. So your, your comments were pretty optimistic that you're making good progress, and I just wanna get a sense of, is that something that's kind of early—you know, you're optimistic because you're gonna see this change, but you're early in the change in terms of shifting that traffic?

Or have you just, you know, executed this maybe quicker than we would have anticipated, and you'd say, "Hey, you know, 50% of our IE traffic is already in commercial lift, and that trade down headwind that we've been concerned about really wasn't that big of an issue in the quarter." So I guess, you know, some further perspective on the trade down and shift of IE traffic would be great. Thank you.

David Bronczek (President and COO)

Thanks, Tom. Great question. We've actually been looking at this issue, planning for it. As you know, we've talked about it for several quarters. Our team has executed this flawlessly. It's been terrific for our customers and for our network, of course. I think you're gonna see going forward that we think we have more opportunity on the International Economy side. We used to cap that International Economy traffic in our existing line haul network. And going forward, there's an opportunity to grow that and grow it successfully. So I think to answer your question, we've planned it now for several quarters. We've executed it flawlessly, and we're very excited about where we are. Mike?

Michael Glenn (EVP of Market Development and Corporate Communications)

I just would add one point. I think one of the keys to success that we've had is the terrific collaboration between our sales team and the Express operating unit in terms of getting customers into the right network. And we're early in that process, but I'm extremely happy with the results in terms of how we've been able to collaborate here to get to the right solution for our customers.

Operator (participant)

Thank you. Our next question comes from Keith Schoonmaker with Morningstar.

Keith Schoonmaker (Director of Industrials Equity Research)

Thanks. Noticed a pretty strong 16% growth in international domestic volume. Is this organic or mostly from folding in acquisitions? And I guess, related, could you comment on international regions where you've seen particular strength, please?

David Bronczek (President and COO)

Yes, good question. We, it's from both, actually, acquisitions and our, our organic European plan. The organic plan has performed, outstandingly well. I'd like to thank and congratulate our team over there. We've opened 87 stations in the last 18 months, and the service has been terrific. So that, with the, incremental acquisitions we've added, that's where you've seen the domestic international volume up 16%.

Operator (participant)

Thank you. Our next question comes from Kevin Sterling with BB&T Capital Markets.

Kevin Sterling (SVP)

Thank you. Good morning. Congratulations on the nice quarter. You talked a lot about International Economy, and, and Alan, I think you touched earlier, you said, you talked about maybe a little more base erosion in Express. So how would you characterize where we stand today with the customer trade down? Is it the same as it was a year ago? Has it accelerated? And, and maybe it sounds like you guys are embracing it more. So maybe if you could compare where we are today compared to where we were a year ago.

Michael Glenn (EVP of Market Development and Corporate Communications)

I think the bigger issue, this bigger issue, Kevin, is we're dealing with a new normal. We've seen a lot of the trade down already from customers that have, that have made the change to deferred services. I think we're now talking about more of a growth story going forward in terms of the mix of growth, growth than we are the trade down story. So this is a terrific opportunity for us, and we plan to take advantage of that opportunity, with our networks.

Alan Graf (CFO)

This is Alan. If you think about the aviation and fuel and energy intensity of an international movement, and the time differential between priority and economy, given how high fuel prices are, you can understand why customers are trading down because they get a significantly better price, and they give up a couple of days. That's much more difficult to manage in the short term than what we've been managing in the U.S. between Express, Express Deferred, and Ground, which we now have right about in the right place. As you notice, U.S. Domestic did fine in the quarter on its revenue growth.

So, I got to say, hats off to the sales and marketing team for grappling with this and handling this and how swift these changes occurred. And our pricing, I think, is right. It's just gonna take us a little bit longer than we'd hoped to get this perfectly balanced, and Dave can give you some tactical information.

David Bronczek (President and COO)

Yeah, again, Mike mentioned it before. For example, on the high tech sector, these big releases, in the past, I would have had to have added extra sections of flying. Now, we've moved it into our FTN network, and it's very consistent, it's very reliable, and we move it into our networks in the United States, in Freight and Ground. I mean, it's a perfect portfolio play for us now, and the cost and profit implications are much greater. So I think, yes, we've embraced it, and I think it's a big opportunity going forward.

Operator (participant)

Thank you. Our next question comes from David Vernon with Bernstein.

David Vernon (Senior Analyst)

Hey, just a couple follow-ups on the International Economy thing. First, Dave, did you just say that the International Economy product was coming into the Ground or Freight networks as opposed to the Express network? Just as a clarification on the last comment, I wasn't sure if I heard that correctly.

David Bronczek (President and COO)

We move the international Freight that I'm talking about coming out of Asia and around the world is just moving in a different network, in our FTN network, and we move it around the world instead of on our FedEx purple tails. When traffic gets into the United States, we look at the service requirements the customers want, and if we, if we can, we move it into Ground, we move it into Freight, we move it at Express.

David Vernon (Senior Analyst)

Thank you.

Frederick Smith (Chairman)

This is Fred, this is Fred Smith. Let me, let me try to say a couple of things here to, to clarify some of the things that we've been commenting on. In the main, Express traffic, whether it's package or light freight, is smaller and lighter than the type of traffic that's handled in the FTN network. So these big bulk shipments, coincident with product releases by the high tech folks, are very difficult to handle because they're lumpy, and they, they have expectations of, of very low yields. So that's the type of movement that Dave is talking about, FTN moving and then putting into the, to the Ground and Freight movement. The day-to-day Express movement, whether it's priority or economy, is picked up and transported by the Express unit, and it's moved in the right network.

And as Dave said, on the line haul side, depending on what the customer wants, it's toggled between Express and FTN, depending on the nature of the traffic. You certainly cannot fly and own the airplane at today's yields in the general commodity Freight network. Now, you can, you can say, "I'm making money in my underbellies," if you're a combination carrier, but at today's yields, it's almost too costly to cover the direct operating expenses, much less the capital expenses for some of these operations. So the market has changed, and as Dave and Mike have said, and I said at the last conference call, it's important that you recognize that the International Economy Express is a growth sector. Dave said it's growing 15%, so we've embraced that.

The strategy we put in place over the last year, and which our people have executed, is terrific, and it's a perfect complement to this heavier traffic that FTN carries, an awful lot of which goes on the ocean. And that is inserted into the Ground and Freight networks when they get in the United States. So I think there's a little bit of misunderstanding about the demographics of the traffic as well as the nomenclature of the traffic.

Operator (participant)

Thank you. Our next question comes from Brian Jacoby with Goldman Sachs.

Brian Jacoby (Managing Director)

Hey, thanks for taking my question. Regarding future aircraft purchases, can you maybe tell us a little bit more about where you guys stand with respect to, you know, leasing versus purchasing the aircraft? I know you said a while back, few years back, that you were probably leaning more towards putting those aircraft on balance sheet now that you guys are pretty well positioned in the investment-grade world.

This is Alan. Pretty shortly, everything is going on balance sheet, whether it's leased or not. So, that's not why we leased airplanes in the past. We're going to own airplanes going forward because we are a full effective taxpayer, and we can use those benefits. One of the reasons we accelerated our capital in the last couple of years was, in fact, to take advantage of the 100% and 50% bonus depreciation.

Michael Glenn (EVP of Market Development and Corporate Communications)

We haven't leased an airplane in years. 2000, Mickey's just informed me, so.

Operator (participant)

Thank you. Our next question comes from Jay Van Sciver with Hedgeye.

Jay Van Sciver (Managing Director)

Good morning. Thank you for taking my question. Looking at your International Express regional market position, you have a standing franchise in the Americas and Asia, but a weaker position in Europe. Does that lack of balance hurt margins, and how could you strengthen your presence in Europe?

David Bronczek (President and COO)

Yeah, the comment that I made earlier, and I think we talked about it before, our organic European expansion is adding a very nice layer of growth and cost improvement in Europe and traffic coming in from around the world into Europe. So we are working hard to be more balanced. I think that's your point, but we've seen tremendous results in our plans now. We've had it now in place for 18 months, and we plan to expand that going forward into the next fiscal year.

Alan Graf (CFO)

Just to remind you, in the last 12 months, we bought companies in Poland, France, and South Africa.

Michael Glenn (EVP of Market Development and Corporate Communications)

A couple of years ago, we made a great acquisition in the United Kingdom, and FedEx U.K. is a terrific operation now.

Operator (participant)

Thank you. Our next question comes from David Campbell with Thompson Davis & Company.

David Campbell (Senior Research Analyst)

Most of my questions have been answered, but I did just want to understand the forecasts for fiscal 2014 are partially based on so-called stable fuel prices. Does that mean stable relative to the prices in August? Stable to what?

Alan Graf (CFO)

It means that there's no volatility in them from where we are because of the lag time between the surcharge and the cost of the fuel, which I think I talked about earlier.

David Campbell (Senior Research Analyst)

Right. Okay, thank you.

Operator (participant)

Thank you. We'll take our next question from Justin Yagerman with Deutsche Bank.

Justin Yagerman (Managing Director and Senior Equity Research Analyst)

Hey, guys. I don't know if I missed it or not, but I didn't hear the change in frequencies out of Asia when I had asked that with Dave earlier. And then I wanted to ask about the GRI, following up on Will Green's question. The other thing that we didn't see this year is a change in the fuel surcharge alongside of a GRI with Express. So I was kind of curious if you guys feel like that may not be needed anymore, or if that's something that you just decided not to do this year, or if that wasn't something that you disclosed in the release.

David Bronczek (President and COO)

This is Dave Bronczek. On your first point, it was my first comments that I made. We actually adjusted our global network, coming out of Asia this quarter, similarly to what we did last quarter. So yes, you're right, we adjusted Asia down.

Michael Glenn (EVP of Market Development and Corporate Communications)

This is Mike. We began in 2005 on instituting higher base rate increases while reducing the fuel surcharge, as you noted. The strategy there was to help ensure that the fuel surcharge index was properly aligned to fuel prices, and it also gave customers more predictability because if the base rates had been adjusted to account for some of the fuel surcharge, obviously, it doesn't have the volatility that it would have if it were sitting in the fuel surcharge. We believe the index, as it sits today and has been in place since last January, is appropriate for the current environment, although obviously, we'll reevaluate that each year as part of the GRI, and we'll determine next year as to whether we need to go back to the prior practice or continue with what we did this year.

Operator (participant)

Thank you. Our next question comes from Scott Group with Wolfe Research.

Scott Group (Managing Director and Senior Analyst)

Hey, thanks for the follow-up. So wanted to ask one on Ground. Is there any way to bucket how much of the margin pressure at Ground is fuel, and how much is kind of the CapEx rollout? And as we think about that CapEx spend, is this kind of one year that sets you up with for four or five years of growth? Or are we at the point where you're going to have big CapEx increases in Ground every year for a while?

Henry Maier (President and CEO of FedEx Ground)

Scott, this is Henry Maier. As I said before, virtually all of the margin impact in the first quarter, year-over-year, is due to unfavorable fuel. Concerning CapEx, we put together five to six year forecasts on our capital needs based on our growth and where we see, we're going to be constrained in the network. I'll say again that we are very disciplined about where we add capital. We try to avoid adding capital for peaks in business as best we can. We tend to handle those with operating costs, and, I think that's probably the answer to your question.

Operator (participant)

Thank you. Our next question comes from Derek Raby with Raymond James.

Derek Raby (Analyst)

Yeah, good morning. This is Derek on for Art this morning. Thanks for taking my question. Most of my questions have been answered. Wanted to look at the Freight division, though, if I could. Maybe some commentary there on how demand trended throughout the quarter and then how it's shaping up so far in September. Thank you.

Bill Logue (President and CEO of FedEx Freight)

Okay, Derek, thank you. Appreciate the question. Again, we're pleased with our momentum as we had good balance between yield, weight per shipment, and volume. A few network adjustments during the quarter. And again, we had one less business day. So, we were pleased with our progress in the quarter. And again, the ops team is doing a really nice job on the efficiencies to balance off that one less day. But good balance overall, and our focus is on good balance yield.

Operator (participant)

Thank you. We'll take our next question from Dave Ross with Stifel Investments.

Bruce Chan (Analyst)

Hi, it's Bruce Chan again. I just wanted to switch gears a little bit to talk about SmartPost. You know, underlying postal rates there went up a little bit and, you know, foreseeably are gonna continue to do so. At what point do you guys plan on, you know, shifting some of that volume onto maybe your own fleet? Or are you gonna kind of continue to, you know, pass rates through and keep things as they are?

Henry Maier (President and CEO of FedEx Ground)

Yeah, this is Henry Maier. We have the ability through our contracts to pass through postal increases. We are always impacted, though, by the timing and customer mix in terms of how quickly we can realize that. You know, decisions to switch between networks are largely customer decisions. We don't drive that.

Bill Logue (President and CEO of FedEx Freight)

Okay. This is Bill Logue from, Freight. I've got a question here that came in on the internet from William Flynn. What are the opportunities for increasing leverage gains in Freight? It seems as if you're taking advantage of investments in equipment in the form of lower maintenance costs, but these are being offset by increased PT costs, Purchased Transportation costs. So how should we think about the dynamics in Freight, going forward? Good question. Again, we've made some, good investments in our fleets over the last three years. Purchased Transportation, is an offset. Again, PT right now is, you can see rates are up. We're moving, as we saw, moved more to the rail.

So a combination of moving to the rail, price increases in the Purchased Transportation, but again, seeing the offsetting benefit in our line haul. So again, we will keep investing in our fleet, as obviously making sure we have appropriate equipment running at good efficiencies. But again, Purchased Transportation will always be a supplement to our line haul. And again, our objective there is a combination, because rail comes in the Purchased Transportation bucket. So again, line haul is, as we all know, a key objective to improve that for the organization, and again, a great benefit for leverage going forward for our business.

Operator (participant)

Thank you. That does conclude today's question-and-answer session. Mr. Foster, at this time, I'd like to turn the conference back over to you for additional or closing remarks, sir.

Mickey Foster (VP of Investor Relations)

Thank you for your participation in FedEx Corporation's first quarter earnings release conference call. Feel free to call anyone on the investor relations team if you have additional questions about FedEx. Thanks again. Bye.

Operator (participant)

That does conclude today's conference. Ladies and gentlemen, we'd like to thank you for your participation. You may now disconnect.