FedEx Corp
NYSE:FDX
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FedEx Corp
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Good day, everyone, and welcome to the FedEx Corporation Third Quarter Fiscal Year 2018 Earnings Conference Call. Today's call is being recorded. If you have any questions for the conference call, please e-mail them to ir@fedex.com. Only questions submitted by e-mail will be discussed on the call today.
At this time, I will turn the call over to Mickey Foster, Vice President of Investor Relations for FedEx Corporation. Please go ahead.
Good afternoon. And welcome to FedEx Corporation’s third quarter earnings conference call. Third quarter earnings release, 31-page stat book and earnings presentation slides 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 1 year. Questions are welcome to our e-mail address which is ir@fedex.com. When you send your question, please include your full name and contact information. 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 mostly directly comparable GAAP measures.
Joining us on the call today are Fred Smith, Chairman; Dave Bronczek, President and Chief Operating Officer; Alan Graf, Executive VP and CFO; Mark Allen, Executive VP, General Counsel and Secretary; Rob Carter, Executive VP, FedEx Information Services and CIO; Don Colleran, Executive VP, Chief Sales Officer, FedEx Corporation; Raj Subramaniam, Executive VP, Chief Marketing and Communications Officer, FedEx Corporation; David Cunningham, President and CEO of FedEx Express; Henry Maier, President and CEO of FedEx Ground; and Mike Ducker, President and CEO of FedEx Freight.
And now, Fred Smith will share his views.
Thank you, Mickey. Welcome to our discussion of third quarter earnings first and most importantly by far we are very thankful that with no serious injuries from the package that was detonated earlier with our San Antonio, FedEx Ground Facility. FedEx has provided law enforcement extensive evidence from our advanced technology security systems, design to protect the safety of our team mates, our customers and the communities we serve. We continue to do assist authorities.
Now moving to the businesses hand and specifically turning to the earnings, execution of long-term growth strategies, customer demand for the unique value of our broad portfolio of solutions and healthy growth in the global economy are driving our performance. We expect strong operating performance in that regard during the fourth quarter in each of our transportation segments and remain confident. We will improve the operating income at the Express segment by $1.2 billion to $1.5 billion in fiscal 2020 versus fiscal 2017.
We remain committed and optimistic about growing earnings, cash flows, returns and margins. Economic growth around the world remained broadly based and we expect U.S tax reform to continue to increase economic growth and investment. FedEx is concerned about the prospect of increased protectionist tariffs as history is shown repeatedly that protectionism is counterproductive to economic growth. The better approach is to encourage open markets and free exchange of products and services and to reduce barriers to trade.
Congratulations to our team members around the world for another outstanding peak season, with record volumes and high service level. TNT integration efforts are accelerating and we are well positioned for profitable long-term growth due to investments in our network and people such as our recent commitment to $3.2 billion in wage increases, bonuses, pension funding and expanded U.S capital investment. FedEx is proud to be in the top 10 companies in Fortune magazine's world most admired lives and among its best companies to work for. We believe this reflects our team members' dedication through our purple promise, which states simply, I will make every FedEx experience outstanding.
Now let me turn the call over to my colleagues for their insight, first up Alan Graf. Alan?
Thank you, Fred. We included additional information in today's earnings release and I will provide additional detail during my discussion today about our third quarter due to unusually complex operating results and the impact of the Tax Cuts and Jobs Act or TCJA. We will also provide additional details today regarding our expected fourth quarter financial performance, given the complexities of the TCJA and third quarter results in order to help you understand the underlying performance of our businesses.
Our adjusted earnings per share for the quarter, was $3.72 up 62% from the adjusted $2.30 last year, primarily due to benefits from the TCJA. Operating income increased slightly year-over-year to 1.11 billion, with higher base rates of each of our transportation segments, increase volumes in Ground and Freight and a favorable net impact from fuel. These improved results were impacted by the timing of significantly higher variable compensation accruals which were up 140 million in third-quarter. Variable compensation increased year-over-year due to sharing some of the benefits of U.S tax reform with employees as we announced on January 26th.
Our improved outlook for FY '18 and the timing of recognizing expansion in FY '18 compared FY '17. Results were also impacted by higher peak-related costs that Express an adverse weather. Before I talk about the operating results for the segment, I’d like to mention the tax benefits in our gap results and say we’re significant this quarter we recorded benefit of 1.53 billion from the TCJA that this primarily includes a provisional benefit of 1.15 billion from the re-measurement of the Company's net U.S deferred tax liability for lower tax rate, which we have excluded from adjusted earnings.
A benefit of approximately 200 million from an incremental pension contribution made in February and deductible against the Company's prior year taxes at 35% and a benefit of approximately 170 million attributable to the phase in of the reduced tax rate applied to the Company's year-to-date earnings. Contribution to our U.S. pension plans of 1.5 billion was debt financed. Our U.S. pension plans are currently fully funded. While the funding shows up on the financial statements as a reduction in operating cash flow it provide a tremendous immediate returns in terms of tax savings as well as lower PBGC premiums versus funding the plan at a later date.
Turning to our segments and beginning with Express. Service levels of Express were excellent during peak; however, costs were impacted by lower-than-expected volumes during the first part of December and higher peak -related costs. For Express, operating income for the quarter primarily reflected by an estimated net negative impact of approximately $170 million year-over-year on the factors outlined in the release and listed on the slide.
Ground’s operating income improved 23% to 634 million due to strong revenue growth and ongoing cost management partially offset by increased purchased transportation, seasonal staffing and network expansion costs, as well as higher variable compensation accruals. Ground margins increased 110 basis points to 12.1%. During peak record volume was delivered with exceptional service around highly automated and flexible network. We believe Ground results will continue to improve.
Freights operating income increased 34% to 55 million, primarily due to higher LTL revenue per shipment, partially offset by higher variable compensation accruals. Freights continued efforts to better balance volume, pricing and capacity are paying off. We are also benefiting from an improving U.S. industrial economy.
The adjusted earnings forecast for FedEx Corporation is now $15 to $15.40 per diluted share for FY '18. We expect Q4 operating profits to be up year-over-year for the Corporation and in all of our transportation segments. Our forecast for Q4’s adjusted operating margin is 11% to 11.8%, for FedEx Corporation. As Fred mentioned, we remain committed to our target of 1.2 billion to 1.5 billion in additional operating profit for the FedEx Express segment in FY '20 versus FY '17, which includes TNT synergies, as well as base business and other operational improvements across the global FedEx Express network. This target assumes current accounting rules and tax laws.
All of our forecasts assume moderate economic growth before year end mark-to-market pension accounting adjustments, and exclude expenses related to the TNT integrations. Our FY '18 forecast also excludes the estimate of the re-measurement of the Company's net U.S. deferred tax liability and certain first quarter FedEx Trade Networks legal matters. On March 1st, we realigned our specialty logistics and e-commerce solutions in a new organizational structure under FedEx Trade Networks in the Express segment.
The realignment improves our ability to deliver the capabilities of our specialty companies to customers. This realignment will benefit Ground and Freight margins and will negatively impact Express margins starting in Q4. As we announced in January from the enactment of the TCJA, we are advancing our 2018 annual pay increases for certain U.S. hourly workers by six months to April 1st from the normal October day, which will have an impact in our year-over-year salaries and wage expenses beginning in Q4.
Our capital spending forecast for FY ’18 in now 5.8 billion down 100 million from the prior forecast due to lower projected capital spending at Ground. As we mentioned last quarter, we are optimizing CapEx to capture the benefits of 100% expensing to further grow and improve the business plans were underway to modernize our Indianapolis hub for Express, which is expected to cost 1.5 billion. We are also planning to modernize our Memphis hub for Express which is estimated to exceed $1 billion. Both of these projects will spend multiple years. These hub modernizations will bring substantial improvements and operational efficiency and reliability.
For example, the Memphis project includes construction of the large new store facility with state-of-the-art store systems, construction of the bulk truckload building and a new area to improve handling of oversized shipments that continue to increase with the growth in e-commerce. During the quarter, Express entered into an agreement with Boeing to accelerate and delivery of one 777 Freighter Aircraft to FY ’19 and through to FY ’20, we will announce our FY ’19 CapEx forecast in June.
Since our tax rates are fluctuating more than usual this year, I would like to provide some guidance for our estimated effective tax rates. All this guidance assumes no material impacts from future TCJA guidance or interpretation. Our adjusted FY effective tax rate is expected to be in the range of 20% to 21%. The lower ETR range is due to the benefits from the TCJA combined with anticipated foreign tax benefits from our international and corporate structure. This range does not includes any impact from the items excluded from our FY '18 adjusted EPS forecast.
In FY ’19, the TCJA lower corporate rate of 21% will fully phase in along with other tax cost also in acted as part of the new law, while we are still in the very complex modeling stage estimating these tax cost as we build our business plan we currently expect our FY ’19 ETR to be in the range of 25% to 26% excluding impact from MTM or mark-to-market pension accounting. The effective tax rate range for FY ’19 is expected to be higher due to tax benefits this year that will not reoccur in FY ’19. To sum it up we are expecting a great finish for the year we are meeting our profitability goals our investments are paying off and our outlook is bright.
Now, I will turn the call over to Raj to talk about the success we are having with our revenue quality initiatives. Raj?
Thanks Alan. I will open with our economic update and outlook and discuss our revenue performance and business conditions in each segment and provide some commentary on broader industry trends and enhancements to the FedEx portfolio. We continue to see broad base growth in the global economy. In the U.S., tax reform is improving investment incentives and disposable incomes by measures of consumer and business sentiment are at the highest levels in years. As a result, our 2018 U.S. GDP forecast is a half point higher than last quarter.
Internationally, trade and production growth are supporting solid momentum in the global economy. Last year's rebound in trade drove the best air cargo growth since 2010 with freight demand growing over three times faster than world GDP. Demand and outpace capacity addition for ’17 straight month.
The next few slides show details of revenue, volume and yield performance by transportation segment. It is clear our pricing strategies that allow us to grow volumes increase yields across the portfolio show continued success. For our U.S domestic Express business, both revenue and yield increased 5%. Excluding the impact of fuel yield per package increased 3% due to our continued focus on revenue quality. FedEx international export package revenue increased double-digit to 10% year-over-year in Q3, primarily due to yield increase of 9% including fuel and exchange rate impact yields increase 2%.
Ground segment revenue also saw a double digit increase at 11% in Q3 with volume and yield each up 6% as e-commerce continues to drive growth. Excluding fuel yield per package increased 5%. At FedEx Freight, LTL revenue per shipment increased 8%, mainly driven by our revenue quality efforts. Excluding fuel, LTL revenue per shipment was up 6%.
Let me now discuss some exciting new enhancements that we have the FedEx portfolio. As we announced earlier today we’re going to increase our retail network footprint through the expansion of FedEx office location inside Walmart stores. We anticipate adding 500 office locations over the next two years. The strategic initiative between FedEx office and Walmart wrinkle brand even closer to busy consumers who are looking for reliable options for packing, shipping and receiving packages.
Another new offering that is launched this month is FedEx Returns Technology. This is a solution that provides e-tailers with increased visibility, flexibility and efficiency around returns management. And for consumers, it enables simple and early credit for the returns at FedEx office locations as determined by their merchants.
FedEx experienced record breaking volumes through our global network during the peak season much of that driven by growing in e-commerce shipments at FedEx Ground. This was the first peak season that we have more than 10,000 FedEx whole locations including FedEx office and well-known retailers such as Walgreens. We are pleased with how the retail network performed and expect this extensive convenience network to be a key part of e-commerce deliveries in the future.
The approach we took on our peek pricing strategy of not applying a broad additional peak residential surcharge to all consumers or customers help us gain significant business in the small and medium customers segments. We’re proud of the strong service levels we provided to our customers during this record peak, and we are excited about the portfolio expansions that are rolling out. We will continue to innovate to provide our customers with great service and value.
Let me now turn the call over to David Bronczek for his remarks. Dave.
Thank you, Raj, and good afternoon to everyone. We are proud to report improved adjusted results at FedEx. We are especially pleased with the results of FedEx Ground where we have improved our operating margin. FedEx Ground segment achieved double-digit percent growth in revenue and operating income receiving benefits from ongoing cost management effort and improved revenue quality through a balanced approach of volume and yield growth. We are also reducing our long-term CapEx plans better match capacity expansions with pricing and volume growth. And as Alan has already talked about FedEx Ground having a great year, we expect the fourth quarter segment operating margin at Ground of 17% to 17.5%.
FedEx Express segment revenue growth of 9% was driven by our international business despite the lingering impact of the cyber attack. We continue to see a runway for opportunity in international for years to come. As Alan has said, Express had six factors that primarily affected profitability in the third quarter, but we expect the Express segment adjusted operating margin in the fourth quarter to be in the range of 9.9% to 10.4%.
The underlying fundamentals of the business remain strong with higher base rates across the board and volume growth in both international and United States. As mentioned previously, we remain committed to our target of $1.2 billion to $1.5 billion in additional operating profit for the FedEx Express segment in FY '20 versus FY '17.
I also want to provide an update on our TNT integration. As you know, this was the most significant acquisition in our company's history and dramatically improves our global capabilities and competitive posture. I'm happy to say that at TNT, we are seeing strong service levels and the integration is accelerating.
A key element of our acceleration plan was to enable the flow of packages between the legacy TNT and FedEx systems prior to full integration. This allows us to direct volumes to the highest service but the lowest-cost networks. This capability is expected to be in place by May 31st of this year. We are accelerating the migration of the FedEx clearance operations and systems as well, retiring dozens of legacy TNT applications.
Our investments in strengthening the IT environment continue on an accelerated pace. We have made significant investments to improve TNT information security posture and we’ll continue to do so. The integration of our global sales force originally expected to be complete in fiscal 2020 is now scheduled to be complete one full year early. During the third quarter, we accelerated the launch of customer migration activities in Europe and Asia by more than one full year.
Now FedEx Freight continues to show improvement in revenue and profitability. As our pricing strategies drive revenue growth while investments in the network improve safety, efficiency and lower our costs.
As I said just last quarter, we expect these improvements to continue. FedEx Freight is indeed having its best year in over a decade and we expect the Freight segment will finish the year with an 8% to 9% operating margin in the fourth quarter. Across the Corporation we're making progress or improving our margins, our cash flows, returns and earnings-per-share. We expect every segment will have year-over-year increases in operating income in the fourth quarter.
And with that, we will now turn it over for your submitted questions.
Thanks you, Dave. We have several questions on the marketing front, which I'll ask Raj to answer. One, how important our FedEx fulfillment, FedEx supply chain and other logistics offerings is long-term strategy at FedEx? How attractive are contract, logistics end markets versus traditional carrier business that's from Brandon Belinsky of Barclays. Raj?
Our strategy is to really offer value-added services to our customers as the result in more volume through all our core transportation networks, and as Alan pointed out, we have recently completed a reorganization that allows us to offer a portfolio of solutions in a more seamless manner to our customers. And I also want to point out here that this is particularly important to our profitable as small and medium customers segment as they expand their e-commerce offerings.
Our next question on marketing is from Ken Hoexter of BOA Merrill Lynch. Raj, also on postal commissions rule making hearing process and potential impact to industry rates?
Ken, FedEx is not participating in the PRC docket, but we expect to file rolling to be issued this year. However, we continue to monitor PRC regulatory developments with a review the pricing aspect of it, and we totally believe that over the cost of last mile delivery we will continue to go up in the years ahead.
From Matthew Reustle, Goldman Sachs. Can you talk about your views on the future of consumer delivery? Do you think solutions such as FedEx onsite can represent a material percentage of the market relative to residential delivery?
Matt, we don’t view onsite in terms of percentage of residential market rather we would think it is the matter of customer convenience. What we know from the e-commerce demand as you can see this increase, those increasing demand from consumers to have convenient options where they can reliably receive their packages. In this context, we are very excited about the rollout of our FedEx onsite program. As I mentioned earlier, we have more than 10,000 FedEx onsite locations in the U.S. including FedEx office and we are dramatically increased our presence with Walgreen adding more than 8,000 locations in the last year alone.
And we are very happy with the performance of this network so far. So let me add one other point. Technology solutions are also going to be critical in this regard I mean that why we are very excited about the fact that our FedEx delivery manager user base continues to grow significantly. Ultimately the combination of these things including our retail network or technology these things will result in win, win, win solutions for our shipper for our consumer and for FedEx.
And I think I’m correct, the 2,000s Rite Aid at Walgreen acquired assume as they are rebranded and putting in the Walgreen system would be 2,000 additional onsite locations. Correct?
Yes, so they will get added in the next few months here.
Let me gave Raj a breather and ask Dave Bronczek to answer a follow on question from Matthew Reustle. Where is competition most peers across your business segments today and as investments the only solution to offset this competition?
Off course, we face competition across the globe all the time throughout our whole portfolio. The pricing environment is generally rational around the world, right news. We have made significant investments in people, our technology off course facilities over many years and it's paid off by creating large highly flexible and the most automated transportation network in the industry. These long term investments have differentiated FedEx from our competition, but we also have something else to differentiate us. It's our people and it's our culture, so thanks for the question Mathew.
So, we have a question here on trade protectionism from Benjamin Hartford, which, I’m going to ask Raj to answer more fully. But I would like to do two things before I turn it over to Raj. I’m reasonably certain everybody is listening to this call, has some sort of electronic device in your hand a phone or an iPad or one sort or another. Go to your Google button. I mean, DEF meaning definition and then put in the word tariff for T-A-R-I-F-F by this table do it to. Once, you read Google dictionary there where it is, tariff, a tax or duty to be paid on a particular class or imports or exports.
So make no mistake about it. The great benefits that Alan talked about due to the tax reform bill to some degree will be offset by increased taxes due to tariffs and if we have for national defense needs bigger aluminum or specialty steel requirement, we would suggest its FedEx as those would be bought by the government same way we buy F-35 Fighters or M1A paying respectfully.
On the overall trading front, I'd like to give you a couple of numbers here that probably will surprise you. Our trade deficit in total goods and services 10 years ago was 4.9% of GDP, is now 2.9%, it's down by two percentage points of GDP for a couple major reasons. The first of which is fantastic technologies that are being employed in our oil and gas sector now, is called fracking which is reduced our dependence on imported petroleum very strategic in a law that of petroleum come from unstable and unfriendly parts of the world, owned by national oil companies of governments and aren't necessarily friendly to the West. And the second region that is gone down is that our trade surplus and services of which FedEx is a major component has gone up almost $300 billion over that 10 year period.
So as I mentioned in my opening remarks and why I brought these two facts up. The correct way to go here is to deal with China on the issues with China, but overall it’s the lower trade barriers and the lower tariffs around the world, not to engage in less trade. At any case, Benjamin wants to talk about freight protectionism and more specific detail and ask to strength in the global air freight market largely increasingly trade protectionist tone from develop markets in recent months. One, are there any immediate thoughts on the direct impact of trade from the recently announced U.S steel and aluminum tariffs? And two, have you seen the shipper behavior change in relation to supply chain design, given the risk of reduce trade openness globally? Raj
So Ben, we’ve not seen any quantifiable shipper behavior change based on the recent development in U.S trade policy. As I mentioned earlier, rebound in trade in 2017 drove the best air cargo growth since 2010. With all that being said as the Chairman just mentioned, we do continue to advocate against any move towards protectionist trade policies that could slow economic growth and undermine any -- undermine all the positive impacts from the tax reform legislation.
Okay, let’s move on to some questions about Express. What are you doing now to prepare for peak that’s different from what you've done in the past? We’ll start with Dave Bronczek and then David Cunningham will amplify.
Obviously, we’re very proud of our peak this year and we’ve been for many-many years, and I am going to make some general statements here, but I am going to have David Cunningham at Express, Henry Maier at Ground, and Mike Ducker at Freight, give a little bit more color to the answer but, generally speaking we conduct our formal reviews of our peak performance, really immediately after peak, which informs our actions for our coming years with our customers and with our employees going forward.
We are fully leveraging our big data -- we have a lot of data of course, in the artificial intelligence we have and we ensure we develop plans and optimizes our customers' volumes, our capacities and our service. In this regard a big part of our success is the strong alignment of Don Colleran that leads our great sales and solutions team with our customers. Overall, we’re very pleased with our peak performance. We’ve said it before. I’ll say it again, it’s what we are pride ourselves on is our relationship with our customers and our service.
And with that, I’m going to turn it over to David Cunningham to talk about Express.
Thanks, Dave. I want to congratulate the Express team on the best peak service ever. In this age of e-commerce, our peak continues to evolve as the customers use both Express and our great Ground company to meet shipping needs. As Dave said, we saw our customers stay in the ground system longer this year. This resulted in lower peak volumes at Express and a more concentrated surge in a few days just before Christmas. Our peak planning is already underway and we’ll take the key learnings and dial that into next year’s plans to ensure great service, but improve efficiency and productivity.
This is Henry Maier. I could not be prouder FedEx Ground teams performance this peak. Flawless execution in every aspect of the operation drove record holiday service performance. Which I might add, was greatly appreciated by shippers and holiday shoppers everywhere. In spite of record breaking volumes more than 54 million packages were delivered at least one day early. This stellar service performance was due to a number of factors. One, planning that started in January and included close coordination with customers every step of the way. Two, the network investments we've made over the last few years, resulting in the whole -- the most highly automated Ground network in North America, if not the world. Three, excellent recruiting, staffing, and employee training, leading up to the holidays. And four, the entrepreneurial real-time local decision-making with contracted service providers, which resulted in millions of outstanding customer experiences.
This is Mike Ducker. Let me just add a couple of brief comments. First of all, congratulations to the FedEx Freight team who had a tremendous peak season as well. As you know, it occurs a little bit earlier than does Ground or Express and as a result of that we were able to provide some support for our other operating companies during that critical time of the year adding to the overall performance of peak season so very pleased and again congrats to our team for the job well done.
The next question is how is recently open Shanghai hub been performing and by the way if I didn’t give credit who asked the question about peak it was David Ross of Stifel he may have said it but just today the Cunningham house that recently open Shanghai hub been performing you called out the hub as a coal change turn what trends are you seeing in the healthcare industry and the region does this limit the amount of e-commerce demand the hub can handle this is from Helene Becker of Cowen?
Well, the Shanghai hub is a fantastic modern automated facility with all of our latest technology the hubs are 134,000 square meter facility handling 66 flights like a process 36,000 packages and documents for our healthcare is an important value-added sector for FedEx and the coal chain capability of temperature control storage ranging from minus 22 to 25 degree siliceous is the key part of all of our new facilities.
Also to you Dave what cost in network efficiencies do you anticipate gaining through the completion of the modernization and expansion project at your Memphis and the Minneapolis Express hubs? That's from Jack Atkins of Stephens. And a related question from Jerome Nathan of Daiwa, where are some of the opportunities you are seeing that automated increase capacity utilization at your Express facility?
The investments in our Memphis and Indy hubs will modernize and automate these key facilities, big data and our real time ability to mind and improve efficiency and productivity of these facilities by directing packages most efficiently through the hubs. As Alan mentioned at Memphis where we'll have a new bulk truckload facility and oversize shipment handling capability plus automated sorting and secondary sorting capabilities.
At Indy, we're increasing the box stored capacity from 111,000 packages to 147,000 packages per hour. We're putting in a small package short system of a 150,000 packages per hour and we will have increase international store capacity as well. These facilities will improve the reliability of our networks lower cost improve safety for better place to work for the 1,000s of team members to work in these operations.
So Dave the last pre-submitted Express question in light of the strong demand environment in international export. Could you please update us on your progress managing capacity? Scott Schneeberger of Oppenheimer.
Commercial line haul continues to play an important role as we develop solutions to facilitate international growth ensuring we move the right traffic in the right network which enables us the growth of our priority products on the purple tail network by partnering with commercial carriers across various international gateways we are able to avoid flying empty space where we experienced in balanced trade flows such as the trans-Pacific eastbound lane. So we are experiencing constraints on some lanes we are constantly working to balance and right sizing network when compensatory revenue.
Let’s turn to Ground now the one from Benjamin Hartford of Baird. Henry, do you still view mid teens is an appropriate segment EBIT margin target? If so, what is a reasonable timeline for achieving such a level, northeaster notwithstanding, and we're in the midst of the fourth when I guess. I mean I would say about too much about the target here as we announce this. I think the rate funny a side, how much of the incremental improvement in current levels is predicated internal opportunities versus external healthy is a peer pricing growth over the macro? Henry.
Let me say I agree with Fred. Mother Nature here is not being too helpful for us in this business right now. Listen, I mean most of this is coming from the macro. Our business continues to be driven by strong volume and revenue growth, largely due to e-commerce. As I said before we believe our investments in what is today one of the most highly automated networks and North America, if not the world will continue to drive margin improvement as well as industry-leading service and our focus at this point in time is on maximizing utilization of those assets we've invested in and managing our existing capacity driving reduce CapEx.
So, we move now to Freight, Kevin Sterling of Seaport Global. Are you seeing any spillover of TL Freight into LTL given the tightness we’re seeing in the truckload market? Mike Ducker?
Kevin, thank you. First of all the LTL volumes have been very strong, including good contractual renewals, our team is handling quite well. Truckload shipments 10,000 pounds will typically account for less than 2% of our total shipments and while there's been some tonnage growth it still remain a small share of our total tonnage, and we also have an excellent transportation management team assembled to monitoring in state takes steps to manage truckload volume, if that becomes necessary.
So Mike, our rail service issues impacting your economy LTL offering? And that’s also from Kevin.
Kevin, as you well know, we have a very service sensitive product, therefore we think it's really important to negotiate contracts with good service quality, in them and we’ve done that with all of our key rail providers. Those providers are doing a great job for us as our rail on-time service levels have actually including overall, during the third quarter, and I think my partner, Henry at Ground has experienced similar strong service levels from our rail provider.
Yes, we've had great service, not seen anything.
So, this next question for Freight also. This question comes from David Vernon of Bernstein. In the past, FedEx has discussed Deming LTL Freight shipments. What is the status of those efforts? And what upside potential does the Company see on that front? Mike.
Thanks, David. We currently have about 90 dimensional standards and will soon be adding additional devices in many of Fred your service and across the network, those devices serve dual-purpose first of all they allow us to capture incremental revenue on shipments that are density based commodities. And secondarily, we capture information for costing system, so that we can more accurately develop pricing for our customers.
And finally for Freight, how much volume, can the FedEx Freight network handle without significant real estate growth? And next from David Ross of Stifel.
First of all let me give a shout out to our planning teams, who have really done an excellent job in planning capacity in our network. We continue to make investments in the facility network and plan for the future; we add capacity by strategically by market. For example, we just open two new facilities in the Chicago land market this January that added over 400 additional doors in the market, bringing total doors in the area to 1,500. So we’re also investing in technology to improve the throughput in all the facilities that will provide additional capacity as well.
Now, we had a number of pre-submitted questions, which we did not answer because they were covered in the press release itself or in the comments that were made by Alan, Raj and Dave. But we do have one technology question, which I’ll ask Rob Carter to answer before we turn to some of the questions that have come in since the call began. And that is, how well blockchain and use of cloud IT impact FedEx revenues and expenses? When will FedEx see this affect? And this is from David Campbell of Thompson Davis. Rob?
First, as a reminder, I want to point you back to last quarter’s call where we discussed points around blockchain and our charter involvement with the blockchain in transportation alliance otherwise known as BiTA, as well as the Blockchain Research Institute. You can find those discussions in a little bit more detail on fedex.com from last quarter. Of note though, Fred and I will be joining Don Tapscott at Consensus, which is the blockchain preeminent conference in New York City in May. We’ll much more -- in a much more detailed fashion discuss blockchain initiatives. And how blockchain can impact so much about our business going forward? And you may want to look at that.
With regard to cloud, our IT modernization initiatives are relentlessly focused on cloud technology. While technology offers significant advantages for business agility and cost, things like the ability to tap into elastic capacity, which allows us to provide compute capacity that grows with our peak seasons and our peak times in cloud environments, improved security, improved performance and scalability due to the modernization of these applications really horrific capabilities, and equally is important the proximity that cloud computing environments provide to our customers and our operations around the world. So the answer is, yes, we’re leaning heavily into cloud technology with all of our IT modernization initiative.
From Tom Wadewitz of UBS. Capital expenditures in FY 2019 and 2020, as there’re offsets to the additional aircraft deliveries in FY ’19 and ‘20 in terms of total CapEx budget? Or should we add these to the $5.8 billion in FY 2018 in order to estimate the ballpark CapEx spend in FY '19 and ’20? CapEx spend in Ground likely be higher or lower in FY '19 and ‘20 compared to FY ’18? Alan?
We have a varied assortment of CapEx pension tax rate and cash flow questions and I’m going to try to answer in two minutes. First of all remember that going forward we just made this huge pension contribution and as I said we’re fully funded. So I don’t believe at this point with the facts that I have today that we’re going to need to make a big pension contributions going forward not that we might elect to depending on circumstances but we don’t believe that’s going to be an issue.
Obviously with the 100% expensing continuing and with the lower rate and improved off-shore earnings, our cash tax rate is going to continue to remain low for the forcible future. And we are going to have stronger earnings to all of those supports higher cash flows. As for CapEx, it’s really too early to talk about FY ’20 although I will say we do have a few increased aircraft deliveries schedule at Express for 20, which might have Express as bumped up.
But we have projects at every single obstacle right now with great engineering and finance teams working together with the ops teams, we make our assets sweat more in the case of Express for example, we can use passenger ballets to augment our international capabilities. At Ground, we are going to see I think going forward reduce CapEx at ground as we look at a better ways to build out the network and still support the growth that we are anticipating that actually given lower cost.
Same at Freight, going forward, I don’t think we are going to be needing to add as many doors for shipment as we have done in the past because of the great engineering work that’s going on there, and lot of these we will talk about later on in the next several months as we go forward, but as I said, I would talk about FY '19 in June. I would just say this I don’t think it’s going to be much different at all than '18 is going to be. And as I said 20 might have a pick-up because of aircraft delivery. So from a cash flow standpoint, I think we are in fantastic condition.
So Tom added another question here, which I think we need to answer. Incentive compensation likely to be a significant year-over-year headwind to EPS and FY for fourth quarter FY ’18 somewhere magnitude to the headwind and in third quarter, Tom, I think that nature of the question indicates a bit of a misunderstanding about this. AICs now will be a headwind in the fourth quarter because and the weather will just stop the four quarters are gangbusters and because of all the noise that’s why, we gave you this onetime special deal of showing you what the anticipated segment margins are going to be in the fourth quarter.
So what happened here is when tax reform took place and we felt that was appropriate to do all of the things that we have described to you. What that required us to do is to pick up AIC which had been reduced because of NotPetya, and then it was put back in the third quarter for the Company as a whole and off course especially effected the FedEx Express rate. So on a go forward basis it’s baked in and the fourth quarter you can do the math with the range for the year that Alan gave you it’s going to be in the numbers and the quarter should be quite good year-over-year for all of the segments.
Again, I will give the caveat because if we are in the midst of some sort of weather system where the northeast or it's going to July, that’s a different matter, but we’re fairly confident that they will be at the end of that. Now, there is question from Jeff Kaufman of Tahoe ventures about electric vehicles for commercial trucks and the OEM following suit. What’s FedEx view on the emerging green technologies and where is the Company in terms of adoption and commitment to green technologies? Does FedEx believe these technologies are ready to meet company's needs?
First of all, I would recommend to you Jeff that you go on our website and read FedEx's social responsibility report, which shows our enormous efforts in terms of environmental efficiency in many, many different areas. And specifically to the issue of the commercial trucks, I’m going to ask Mike Ducker, if you'd just comment on that for a second.
Yes and as a matter fact, this company has long been known for its innovations. So we’re on the waiting edge of many of these technologies and we believe that the faster adoption of those will greatly improve efficiency and customer experience in the trucking industry. So were heavily invested in our safety systems and artificial intelligence with many companies that are using advanced drivers systems that include turning Telematics and many other features.
So we're working hard on the new technologies that are coming out to adopt and use the advantages that they provide for our system. Tesla as a matter of fact soon to be announced that we will be purchasing some Tesla electric vehicles in the near future. Small order, but we think they will have great benefit in our system were testing them in the near future as soon as we can get them off the line.
So here is a couple of related questions, I’m willing to pass on to Dave Bronczek and David Cunningham, I’ll give you overarching comments first, from Todd Fowler of KeyBanc. Please discuss what drove the decline in international and U.S domestic volumes within Express segment in the quarter? How important is volume growth in achieving FY 2020 profit improvement plan?
The second is from Jack Atkins of Stevens. To what degree was the June cyber attack at TNT negatively impact 3Q results? I guess it did negatively impact 3Q results at Express and would you expecting the lingering impact in the fourth quarter. Now, I think the question from Todd and Jack and I’m going to ask again Dave and David Cunningham to amplify this, reflects a bit of a misunderstanding here and that please recall that when we started this year, we told you that we were no longer going to be talking about Express and TNT.
So the numbers that are in the Express segment now are the combination of the two. So the reality is the FedEx Express volumes are growing, but the TNT volumes were adversely affected by NotPetya, and we are now going back up to two to where we would have been had this attack not happening. And let me again give enormous thanks to our sales, our customer service, and particularly our IT professionals that did the most unbelievable job of recovering from this attack which the which the U.S. government now says was a government or government sanctioned attack on the Ukraine and TNT was just a side victim of it.
So, the fourth quarter will I think began to show these in a more granular fashioned, but it’s we're not seeing a decline in Express traffic in the fourth quarter. We will have recovered most of the NotPetya volume from TNT now. Put some meat on the turkey.
Yes, this is Dave. Freights are 100% right. The reason that actually we went through all of these detail we did in the fourth quarter along with all the reasons that Alan talked about in the tax reform still is to give you an idea of where the fourth quarter is forecasted to be which is significantly different and better than the Q3 numbers. In my comments I said that they could run up to potentially 10.4% operating profit margin at Express that’s actually very strong revenue across all other Express so reasonably put in Q3 and put in the six items that effected Q3 by falling away was the variable comp and so on it was because of the reason that you just suggested that we talk about Q4 and its very strong in Q4. David?
Yes, I just had a couple of comments to look for Dave just have I think first thing you got to remember is that the effects in Q3 were mostly one-off type of effects. Q4 ends up being a seasonally strong quarter and we’ve already told you what that’s going to be. Our TNT network was fully restored and back to business as usual as of the end of 2017. The recovery of the business over the last five months has been remarkable and given the value preposition of the TNT road network our Freight volumes have been strong and we are experiencing solid growth in these products. The cyber attack continues to had a lingering effect in the third quarter and our existing customer base has not fully restored all volumes as they continue to gain confidence in our ability to provide service and recovery of our business our outstanding performance during peak is evidence of the strength of our network and our recovery and our sales teams are leveraging this in the fourth quarter and growing and winning business.
Okay, question from Ken Hoexter BOA Merrill Lynch. In this robust growth, e-commerce market, why were deferred volumes up only, only a 10th of percentage on 1% growth comp and yields negative? Raj?
Thank you, Ken. I believe you are talking about the differed in Express and really our volumes are impacted by the way we managed one large customer whose volume was at forecasted levels look at the base volume grows underlying basis especially in the small and medium customer segments we saw a very robust growth and by the way don’t forget the strong growth we saw in the ground segment which also carries e-commerce traffic.
Here is one from Scott Group, Wolfe Research. Now that Express includes GenCo and Custom Critical, do you plan to update your Express long term guidance?
Scott, we did. We told you that we intend to increase our Express earnings from FY '17 to FY ’20 by $1.2 billion to $1.5 billion. So it hopes that clarifies it.
A question from Christian Wetherbee of Citi, how much of the year-over-year ground margin expansion expected in FY 4Q as is driven by reclassification? How much of this from core improvements? Henry?
Core improvements represent about 100 basis points margin.
Here is one again about Express 3Q and 4Q. I hope I explained that six items with a big part of it was variable compensation when we decided to positive tax act, as Alan described to you, increase wages for hourly teammates and we had the benefit of the tax bill and so obviously we’re not going to penalize our participants in our AIC program, which are thousands of our frontline managers. It required a refunding if you will of the AIC in the third quarter. So the fourth quarter it's essentially normalized. Ravi Shanker what was the strategic rationale for putting FedEx office locations or FedEx Walmart locations whether strategic rationale Ravi is because they will make us more money, but the broader point you may want to serve for customer pickup and drop-off are also served as Omni-channel service points. Raj?
Ravi, I think the strategic initiative that we have with Walmart goes up on a shared goal of providing customer convenience and value. That's really makes lot of us can save time and money as Chairman talked about. As I mentioned earlier this is an opportunity to serve our consumers who want, we’re seeking secure reliable options for packing shipping and receiving packages.
So Scott Schneeberger would ask a similar issue about the financial impact of adding FedEx office 500 Walmart stores. I think that obviously as a bow wave of small proportion when you open these things. But remember we said in our press release. If you read it, we tested these at 47 locations. We have a rapid paybacks. So this is going to be inconsequential on the expense side in the near term and I think quite a important channel for us in our retail and customer convenience channel in the next several years. After the opening expenses are in essence covered, but they're not significant in the scheme of the Company the size. And we got three questions from Brian Ossenbeck, Matthew Troy and Allison Landry about DHL's launch of their new service. So I'll ask Raj and Dave if they want to comment on that and then I'll turn the floor back over to Mickey and we've exhausted all of your question? Raj?
So Brian, Matt, Ellison thank you for your question. We don't comment on specific competitive strategies, but there are multiple new test in pilots were companies are considering variations of crowd sourcing or other options for last mile delivery. As you know e-commerce increasing demand for last mile delivery but operational cost safety and brand considerations of final mile delivery that need to be factored into the ultimate potential of any new offering. Now FedEx has unique capabilities regarding, we will continue to work with retailers to provide a differentiated value preposition and ultimately as superior service to the end consumer.
Dave?
Yes, the only thing I would add because Raj is off course right I mean we focus here at FedEx on our customers and our strategic value preposition, and I would direct you to our dream video that’s out there we have it out there and so you should take a look at that. I think it’s very self explanatory. That’s how we feel about our business and everybody else’s that we can be with.
Yes, I think that’s a wonderful way to end up before I turn it back to Mickey. I'd urge all of you who've not done, the FedEx e-commerce video at fedex.com/dream it's 2.37 seconds long and it could can tell you in that 2.37 seconds, what it would take us an hour to tell you. So, thank you for your participation and Mickey close it out.
Thank you for your participation in the FedEx Corporation's third quarter earnings conference call. Feel free to call anyone on the Investor Relations team, if you have additional questions about FedEx. Thank you.
That does conclude our conference for today. Thank you for your participation.