Baird 2012 Growth Stock Conference

Benjamin Hartford
Analyst, Robert W. Baird

We'll go ahead and get started here. It's my pleasure to introduce FedEx Corporation.

FedEx has long been a leader and innovator in the integrated parcel market. And over the years, the Company has leveraged its leadership in the domestic express market and expanded its footprint, both within the domestic and international parcel market as well as more recently expanding into the heavier-weight freight and logistics arenas.

FedEx is one of the two global parcel providers with a meaningful presence in the three major geographies, North America, Asia, and Europe.  Here to talk more about FedEx's strategy today is Henry Maier, EVP of FedEx Ground.

Henry J. Maier
EVP FedEx Ground

Thanks. Thanks, everybody. It's great to be here today. It's always tough to go on after lunch. So, I'll try to be brief.

Before we get going, I'd like to remind the audience and particularly those on the Webcast that it's our desire to take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act.  Certain statements in this presentation and potentially during a Q&A period maybe forward looking within the meaning of the Act.

At FedEx Ground, we believe that we have built a better business model for the transportation of small packages over the surface. We believe we have one that combines superior service, innovation, and speed to deliver quarter-over-quarter and year-over-year growth in volume, revenue, and profitability.

One that offers three distinct services, each focused on the core market segments they serve: FedEx Ground servicing business-to-business customers, FedEx Home Delivery offering unique delivery options to higher-value, higher-weight residential customers, and FedEx SmartPost servicing really the sweet spot of e-commerce, which is low-weight, low-value residential shipments.

We believe we have one that leverages customer responsive -- the customer responsiveness, entrepreneurialism, and flexibility of small business through our independent contractor model, and finally, one that customers have rewarded us with 12 consecutive years of market share growth.

In our third fiscal quarter, we reported revenues and operating income increase from improved yields and strong demand for FedEx Home Delivery and SmartPost. Our revenues increased 14%. That's about $2.5 billion for the quarter.

And we reported that our operating margins grew to 18.8%, and operating income increased 43% to $465 million, driven by a 5% growth in volume and a 6% growth in revenue per -- I'm sorry, 8% growth in revenue per package.

We contract with approximately 9,000 small businesses, not individuals. And let me say that again. We contract with approximately 9,000 small businesses, not individuals, for the pickup, transportation, and delivery of packages throughout the US and Canada.

These businesses must be incorporated and in good standing with the state in which they operate, pay the appropriate taxes to the state, and treat their drivers as employees.

Contractor model is highly entrepreneurial, customer responsive, and flexible. And many of these small business are sizable, earning settlement in excess of $1 million a year.

From the inception of the Company, technology has been leveraged to lower cost, reduce defects, and improve customer information. We operate 33 hub facilities in the US and Canada that utilize state-of-the-art six-sided camera tunnels. We take pictures of every package, which read the address label in real time.

We utilize dynamic sorting systems that allow for the real-time routing and rerouting of packages to load doors. We utilize address cleansing and algorithms which identify potential damages on the sorter and route them to a rewrap area, where they can be remediated before further potential damage were to occur.

This investment in technology allows us to minimize our use of seasonal labor. We better balance our capacity to seasonal needs. We reduce loss and damage and provide vital package information in real time to our customers.

Now, our brand is about speed and reliability. Over the past eight years, we have accelerated 85,000 lane segments. And I should point out that that's out of a potential of about 122,500 lanes. And this -- I'm sorry, we've accelerated those lanes by at least a day or more. So, when we talk about speeding up a lane, we're speeding up. We're removing a day's transit in that lane.

And this, I should also point out, equates to tens if not hundreds of millions of zip pairs for customers who live and operate their businesses in those areas that we have accelerated the lanes.

Our speed advantage equates to customer value in the area of potential reduced inventory and better order-to-cash cycles. And I should point out that our performance over the last two years, in spite of these lane accelerations has been north of 99% on time.

The net effect of the transportation improvements is a network that delivers 82% of the volume in three days, 61% in two days or less. And about one in four packages in our network has a delivery commitment of overnight.

Now, it's important to point out that these are day-definite commitments that are not time-definite commitments. So, this in no way conflicts with our sister company FedEx Express.

We believe that we're roughly 25% faster than our largest competitor. This speed advantage is a significant differentiator in the marketplace, allowing our sales team to lead with speed in helping customers manage and make their supply chains more efficient.

We believe that we run the fastest surface transportation network in the country. And when customers need speed and economy, they absolutely, positively choose FedEx Ground.

Now, let me talk for a minute about FedEx SmartPost because I know that there's a lot of interest these days in what's going on in the e-commerce space. FedEx SmartPost provides an extremely economical service for low-weight, low-value shipments, mainly those that are purchased online.

SmartPost leverages the FedEx Ground network for pickup and line haul, utilizing a dedicated hub network of 25 facilities solely for sortation.

We deliver last mile to the postal facility -- I'm sorry, we deliver to the postal facility for last-mile delivery into the home largely through contract carriers.

Transit times average two-day -- business days. Delivery is accomplished to the home by UPS Monday through Saturday.

Shipping rates are predicated on essentially ground-based transportation rates or ground-list transportation rates and fuel to make the calculation of transportation costs extremely simple for the customer.

And I should point out there's full FedEx tracking available on fedex.com from time of shipment all the way into the home.

Now, I apologize for this after lunch, but I realize this is a busy slide. But, it occurs to me that some of you may not be aware as to how SmartPost actually works.

The operating model of SmartPost is simply to pick up from a shipper and deliver as deep into the postal network as is possible to take advantage of the maximum work-share discounts afforded by the USPS.

So, we have sophisticated technology on the SmartPost network that allows real-time determination of the best entry point to achieve with a great degree of accuracy the maximum savings on postage.

And if you'll look at this slide here -- and I realize this is busy, essentially what we do is the -- I guess the gold standard in this kind of business is to pick it up from the shipper, sort it, and deliver it to the destination delivery unit using postal lexicon or what they call a DDU because that's where the maximum work-share discounts occur.

We believe that the technology we employ at FedEx SmartPost allows us to achieve industry-leading DDU entry rates.

Now, this fact coupled with the efficiency of the Ground network and the Ground line-haul operations has resulted in double-digit growth rates at FedEx SmartPost.

Now, we believe that we are very well positioned to capitalize on industry trends. E-commerce, as I'm sure you've heard, has grown about 14% a year. FedEx Home Delivery and FedEx SmartPost are uniquely positioned to capitalize on this trend because we afford our customers a choice.

If they want economy, particularly for those customers who utilize free shipping, if they want the cheapest transportation rates possible with a little bit longer transit time, we have a network for that.

If you want the higher precision and the higher touch and the higher visibility and the feature-rich service that many customers have come to expect from FedEx, then we have FedEx Home Delivery for that.

So, we give customers a choice as to what network it goes into. And our sales people are probably the best at helping customers determine -- helping determine what the customers' needs are and making sure the package gets into the right network. And that's a very important distinction here.

We've recently introduced new offerings, such as Hold at Location, which is the option of having your residential package delivered to a retail facility, such as a FedEx Office, so that you can pick it up when it's convenient, or if you're shipping -- if you're receiving something that requires a signature, you can have it redirected to a FedEx Office, and we don't end up frustrating you with redelivery attempts or you have to be home for that.

In addition, we've recently introduced a service called Redirect to Hold, which allows customers who can see packages that they've ordered coming to them but maybe due for delivery at an inconvenient time, to be directed -- redirected to a convenient hold facility so that they can pick them up, once again, at their convenience. Both of these new services are growing at astronomical rates.

And finally, we offer multiple return options to customers so that we can effectively compete in a rapidly growing returns market.

And frankly, my opinion, for what it's worth, I think the next great frontier in e-commerce is going to be free returns. Many retailers, particularly e-commerce retailers, are realizing that returns are pretty difficult.

And all the market research that exists out there would suggest that convenient returns are probably the biggest determinant of whether or not a customer who goes to a company's website for the first time and purchases is going to repurchase.

So, in closing, we're extremely confident that FedEx Ground's best days lie ahead of us. And I'd like to thank you for your attention and the opportunity to spend this time with you today. And if there's any questions, I guess we can take them.

 

QUESTION AND ANSWER

 

Benjamin Hartford
Analyst, Robert W. Baird

Sure. Yes, we've got about 15 minutes worth of questions. I'll go ahead and get started, Henry. You had a slide on there about having improved about two thirds of the lanes in terms of transit time over the past decade.

I'm just wondering where you think the frontier is. How many more lanes can be improved from a velocity standpoint? When do you think we can get there? And then when you think beyond that, what's the next step? What's the next layer of innovation?

Henry J. Maier
EVP FedEx Ground

Well, I think, first of all, the biggest inhibitor is the laws of physics. I mean, you can only -- it takes you so much time to get between two points dependent upon the distance without breaking the law, which we won't do.

We've probably got another two, two and a half years of this left before we think we've pretty much met the law of diminishing returns. A number of the lanes that were not accelerated were not accelerated because there was nothing to accelerate. If they were already overnight when we started, well, you can't make them faster than overnight. So, obviously, those never will be.

As we replace and expand facilities, this is something that we take into account when we look at it. We always get customer and sales feedback. But, I think we've harvested I think most of the low-hanging fruit here. And most of the lanes I think that we have left, at least in terms of market potential, are probably somewhat limited.

Benjamin Hartford
Analyst, Robert W. Baird

Go ahead.

Unidentified Audience Member

(inaudible - microphone inaccessible).

Henry J. Maier
EVP FedEx Ground

Well, are you talking about the Parcel Select Market or -- ?

Unidentified Audience Member

 -- (inaudible - microphone inaccessible).

Henry J. Maier
EVP FedEx Ground

Okay. I think I understand. Year to date, SmartPost is about a $600 million company on a $6.5 billion revenue number for the larger Ground and HD. Of course, the volume is very high because the transactions rates are fairly low.

I guess I would answer your question this way. The postal service, the United States Postal Service is actually extremely efficient going from last-mile post office to a home. And the reason why they are is because they go to every address every day. So, there's a truck going to every one of those every day.

The package that we tender to the postal service for last-mile delivery is an incremental and in fact revenue opportunity for them because they're delivering to that address anyhow. So, for that reason, I think they're extremely efficient.

The other thing is the sweet spot for SmartPost is really a package that's generally of a size that can fit in a mailbox. They don't even have to get out of the truck. And this is probably a better question for the USPS. I think they have more than adequate capacity right now to take this kind of volume in their network. They're not buying bigger vehicles because of what we give them.

And they provide excellent service. I mean, I can tell you that, because of the way their network is structured and the fact that postal facilities are not designed to store anything, everything that goes out for delivery gets delivered. So, they don't bring anything back.

And our experience with them is that they've been a great partner, and their service is really excellent in this segment.

The real -- I guess the bigger -- I guess the second part of your question is the opportunity. The opportunity's really driven by how big do we think EC's going to get? We think it's going to get really big. And I think the number 14% and I think the eight-year or the 10-year number is something like $250 billion potentially. That's a pretty big market. That's a pretty big market.

And I think, as I said in the presentation, we're uniquely positioned to play in that space because we've got an answer for any customer who wants to ship a package to a home.

Unidentified Audience Member

(inaudible - microphone inaccessible).

Henry J. Maier
EVP FedEx Ground

You're asking -- are you talking about the Boeing 7 -- ?

Unidentified Audience Member

 -- Yes -- .

Henry J. Maier
EVP FedEx Ground

You're asking the wrong person.

Unidentified Audience Member

Okay.

Henry J. Maier
EVP FedEx Ground

I'm a Ground guy.

Unidentified Audience Member

Okay.

Henry J. Maier
EVP FedEx Ground

The only thing we fly is trucks.

Unidentified Audience Member

(inaudible - microphone inaccessible).

Benjamin Hartford
Analyst, Robert W. Baird

Question's about pricing trends in Ground.

Henry J. Maier
EVP FedEx Ground

Well, we have list rates, and our -- I think the list rates are fairly common across us and our largest competitors. The fuel surcharge is based on the -- I think it's the Diesel Fuel Index, which resets every eight weeks. And I'm -- I guess I'm confident that that's pretty common as well. I'm not sure I understand your question beyond that.

Unidentified Audience Member

(inaudible - microphone inaccessible).

Henry J. Maier
EVP FedEx Ground

Well, I would -- I guess I would answer the question as this. I think people pay for quality. We -- I think we provide a tremendous service product. And we obviously have to be competitive. And we have to be cognizant of our customers' cost challenges.

Our network is structured in such a way that I think we have a very good handle on our costs. We try to keep costs highly variable. We absolutely avoid adding fixed costs or fixed heads. I mean, we're very, very disciplined about that. We have I think the best CFO in the business. And if you want to add a fixed head, God love you.

So, we're very diligent and disciplined. I mean, we -- the culture of the Company is one of low cost. So, I'm pretty confident that we can compete on just about any piece of business that we want to go after.

Benjamin Hartford
Analyst, Robert W. Baird

Henry, maybe you could talk a little bit about the strategy balancing volume growth and pricing over the next three years, given -- kind of thinking about the past 10, growing annually about 6% to 8% on the Ground side, on the volume side, rate increases in the 2% to 3% type range.

What do you think is the appropriate mix over the course of the next three years, particularly given the fact that the competitive landscape has changed over the past three years?

Henry J. Maier
EVP FedEx Ground

Well, I think the -- at first, I would answer that by saying we compete in a market that's growing. I mean, the ground surface transportation market grows at something like GDP plus a percent. I think that's -- if I remember back in my marketing days, that's the number. So, you can do the math.

So, the market's expanding all the time. We are very disciplined about business we go after. We're very disciplined about how we price the business. And we're very disciplined about how we add capacity to serve that business. And I think that after 26 years now, we've got a pretty good model.

And I'm not going to speculate on what we think the growth is. Anything could happen in this economy. But, I don't see any reason to believe that the trends we've seen over the last couple years aren't going to continue, at least for us.

Unidentified Audience Member

(inaudible - microphone inaccessible).

Henry J. Maier
EVP FedEx Ground

That would be a question for the Express folks. Okay.

Benjamin Hartford
Analyst, Robert W. Baird

Maybe if we think about Domestic Express and how it interplays with Ground, can you -- and being a recipient of some of the trade-down and also managing the trade-down within Ground, can you talk about how you interact with Express and try to manage some of that quote-unquote cannibalization from Express to Ground with natural migration into lower-cost-type modes?

To what extent can you control some of that based on internal controls or pricing, etc.? Can you talk a little bit about that relationship with Express?

Henry J. Maier
EVP FedEx Ground

Well, you've got to keep in mind that there are almost no customers anymore that are just Ground-only customers. I mean, they are FedEx customers, which means that there's usually a combination of Express Domestic, Express International, Ground, both Domestic Ground, and we have an operation in Canada, so we serve a good part of North America, Freight.

Increasingly, deals are being bundled now with printing and services that are offered through FedEx Office. So, it is an entire FedEx solution when we sit down with many of our customers.

We really don't manage the trade-down. We help our customers manage that by identifying what the needs are--and our salespeople are really good at this--and making sure for the price point the customer desires, we direct that traffic into the right FedEx network to serve that business.

So, you know, I hope I'm answering your question right. But, there -- we don't spend a lot of time within the four walls of FedEx talking about moving business between networks. I mean, that is more of a market phenomenon. And our salespeople enable it.

Now, within FedEx Ground, I can talk to you a little bit about Home Delivery and SmartPost. And we've done a lot in terms of educating the sales force about what the right packages in the HD network, what the right packages in the SmartPost network to help them understand how to enable customers to make the right decisions.

Benjamin Hartford
Analyst, Robert W. Baird

Can you talk a little bit about the small businesses that you partner with the, independent contractors and managing the growth, trying to think about make -- ensuring that you have enough capacity to grow -- ?

Henry J. Maier
EVP FedEx Ground

 -- Sure -- .

Benjamin Hartford
Analyst, Robert W. Baird

 -- Among your partners, you know, any sort of perspective on that end?

Henry J. Maier
EVP FedEx Ground

Well, the vast majority of the contractors we elect to contract with now have fairly sizable businesses. So, they have a number of employees. This is sort of on the high end of the range. But, I know for a fact we have a contractor in New Jersey that puts 50 trucks on the street every day.

So, these are sizable businesses. And we have to interact with them like they're businesses. So, we share as much information as we can with them about business trends. We share with them new account starts.

We have an entire organization that exists, which is a contractor relations organization, whose sole purpose is to make sure the lines of communication are open and that we're sharing with them critical business trends and needs.

We spend a lot of time -- in fact, we spend the entire year planning for peak in terms of helping them understand where we think the business is going to come from, what we think is going to be different this year as opposed to last year or previous years so that they can make decisions and make plans in their business, like any small business person would.

They, just like any other business, have to make plans with respect to capital acquisitions. So, if they have to buy vehicles or whatever, they need a lead time to get that done. And these conversations we have with them, these meetings we have with them are intended to provide them with as much information as they need to make those decisions.

I'll say this about them. They're coin operated. So, I can't ever recall one turning any business down. So, when you bring an opportunity to them like a new account or we talked with them about a particularly good peak this year, they're onboard, and they're excited. And they want to do the right things to make sure that we deliver the best service experience to the customer.

And for that reason, I just think this -- that's one of the things that I think differentiates us. We have a great model in terms of having business partners who believe that those customers are theirs and do everything they can to make sure they're satisfied.

Unidentified Audience Member

(inaudible - microphone inaccessible).

Henry J. Maier
EVP FedEx Ground

Well, the interesting thing about the businesses is that there's a value to these businesses. And the value is really within FedEx Ground. So, if somebody is thinking, for instance, exiting the business, generally, they sell all or parts of their business to another contractor.

Now, we have a process under which that, if it's not an existing contractor who's buying that business, there's a process they go through to make sure they're properly vetted and you know, meet our requirements in order for them to be a contractor for FedEx Ground.

But, these transactions go on every single day. Most of the time, other than being notified that the sale has occurred, in which case, we ask for documentation that lets us know that the person who claims that they own the business actually does own it, etc., they go on without any involvement by us.

Benjamin Hartford
Analyst, Robert W. Baird

Any additional questions from the floor? We'll go ahead and leave it there. Please join me in thanking FedEx.

Henry J. Maier
EVP FedEx Ground

Thanks. Pleasure.