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FedEx Corporation (NYSE:FDX)

F4Q07 Earnings Call

June 20, 2007 8:30 am ET

Executives

Mickey Foster - VP of IR

Fred Smith - Chairman, President and CEO

Alan Graf - EVP and CFO

Mike Glenn - EVP of Market Development and Corporate Communications

Dave Bronczek - President and CEO of Federal Express

Dave Rebholz - President and CEO of FedEx Ground

Doug Duncan - President and CEO of FedEx Freight

Ken May - President and CEO of FedEx Kinko's

Analysts

Donald Broughton - A.G. Edwards

Ken Hoexter - Merrill Lynch

David Ross - Stifel Nicolaus

Thomas Wadewitz - JP Morgan

Edward Wolfe - Bear Stearns

William Greene - Morgan Stanley

Jon Langenfeld - Robert W. Baird

Gary Chase - Lehman Brothers

Scott Flower - Banc of America Securities

David Campbell - Thompson, Davis & Company

Jason Seidl - Credit Suisse

Edward Wolfe - Bear Stearns

John Barnes - BB&T Capital

Presentation

Operator

Good day, everyone and welcome to the FedEx Corporation's Fourth Quarter Earnings Call. Today's call is being recorded. At this time, I will turn the call over to Mickey Foster. Please go ahead.

Mickey Foster

Good morning and welcome to the FedEx Corporation fourth quarter earnings conference call. I am Mickey Foster the Vice President of Investor Relations at FedEx Corporation. The earnings release and stat book are on our website at fedex.com. This call is being broadcast from our website and the replay will be available for approximately one year.

Joining us on the call today are also members of the media. During our Q&A session, callers will be limited to one question and a follow-up so we can accommodate all those who would like to participate.

I want to remind all listeners that FedEx Corporation desires to take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act. Certain statements in this conference call may be considered forward-looking statements, such as statements relating to management's views with respect to future events and financial performance. Such forward-looking statements are subject to risks, uncertainties, and other factors, which could cause actual results to differ materially from historical experience or from future results expressed or implied by such forward-looking statements.

For additional information on these factors, please refer to FedEx Corporation and its subsidiaries' 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, Chairman, President and CEO; Alan Graf, Executive Vice President and CFO; Mike Glenn, Executive Vice President, Market Development and Corporate Communications; Chris Richards, Executive Vice President, General Counsel and Secretary; Rob Carter, Executive Vice President, FedEx Information Services and CIO; Dave Bronczek, President and CEO of FedEx Express; Dave Rebholz, President and CEO of FedEx Ground; Doug Duncan, President and CEO of FedEx Freight; and Ken May, President and CEO of FedEx Kinko's.

And now our Chairman, Fred Smith, will share his views on the quarter followed by Alan Graf. After Alan, we will have some Q&A.

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Fred Smith

Thank you, Mickey. Good morning ladies and gentlemen, we appreciate you joining our earnings conference call for the fourth quarter of fiscal year 2007 just ended. FedEx delivered solid financial results in FY '07. Our net income was more than $2 billion, largely because the payoff from our global investments helped to offset the headwind of a slowing US economy.

We remain optimistic about prospects for global economic growth and we'll continue to invest in projects critical to strong long term financial performance. The weakened US market is limiting demand for transportation services, but we expect the economy to show modest year-over-year improvement beginning in late summer or early fall.

We announced today that fiscal year '08 capital spending, the year just begun, will be about $3.5 billion, that's a 20% increase over fiscal year '07. This call in that respect is a great opportunity to remind you that at FedEx our focus is on long-term goals that will yield long-term success. Majority of this capital spending is for future growth with the biggest increases largely due to facilities and information technology needs. Alan can tell you more about that later.

We are in a leadership position today because of smart and timely investments we've made over many years in the past. These investments have cut transit times, improved and diversified services and reduced cost. We intend to stay leaders by continuing to invest in the future despite current economic conditions.

We intend to expand and strengthen the FedEx portfolio of services, giving more options to our customers and more opportunities to FedEx. In this regard, FedEx Ground is leading the competition with its money saving, high quality service and we will stay ahead of the game with investments and network improvements and service enhancements.

Since FedEx Ground was rebranded in 2000, it is more than doubled the average daily package volume, nearly tripled its annual revenue and increased profitability almost four fold.

In FedEx Freight, our acquisition of Watkins Motor Lines allows us to now offer FedEx National LTL service, a long-haul service that strengthens our regional freight offering. When bundled with FedEx Express and FedEx Ground, the entire FedEx Freight portfolio adds valuable traffic to our networks. We've also opened the FedEx Freight Canada providing intra-Canada and transporter LTL services for the first time with our own operations.

We are positioning FedEx Kinko's to become a leader in the office support market by investing in long-term profit and margin growth. We recently improved our successful Print Online digital service by collaborating with Adobe to extend its reach.

We plan to open 300 new FedEx Kinko’s centers in 2008 brining the total to more than 2,000 by the end of this fiscal year. I would note that we opened over 200 of them in the fiscal year just ended. FedEx Kinko’s will increase its revenue in FY '08. Now, this is in addition to the highly profitable $800 million a year it contributes to FedEx Express and FedEx Ground shipping revenues which appear in the Express and Ground revenue streams.

Investments abroad have positioned FedEx to take advantage of global macroeconomic trends. In the past 20 years, we've laid a strong foundation for success in Asia. We have unparalleled air and ground networks due to many years of acquisitions and internal developments.

FedEx is the leader in express transportation in China. We also lead in revenue in Hong Kong, Taiwan, Japan and Malaysia.

We launched domestic express service last month in China, the world's fastest growing economy. We'll spend a considerable amount to build our new intra-China network and add to our intercontinental network. FedEx now offers end-of-business day cut-off times with next day, early morning deliveries in 19 cities in China and that will be expanded shortly. We've created day-definite service, with 24-hour and 48-hour services to more than 90% of China's GDP. FedEx has a sizable advantage over the competition in China for several reasons.

First of all, we have been in China for more than 20 years. FedEx has 30 weekly US to China air frequencies, more frequencies than any other US cargo carrier. We believe we have a strategic advantage with plans to locate our new $150 million Asia-Pacific hub in Guangzhou, the heart of the Pearl River Delta, where more than 40% of China's exports are generated.

Now, India is another important market, and it's among the world's fastest growing economies with current and projected growth at more than 8%. Thanks to our investments in corporate development activities there, FedEx is a leader in India's express transportation market.

Europe is an extremely large parcel market and we believe there are tremendous opportunities there, and we have a wonderful franchise and a great team in Europe. We require transportation companies in the United Kingdom and Hungary during the last fiscal year.

Our acquisition in the United Kingdom means we can directly serve the entire country, with a broader portfolio of services. And we expect to see significant improvements in the overall quality of service.

I want you to know that we are also very focused on controlling costs. We've significant flexibility in terms of managing compensation because it is largely linked to FedEx's financial performance. We're reducing operating expenses through cost structure improvements, new technology and more streamlined operations. We've discussed many of these progressive innovative programs at our Investors and Lenders Meeting last March.

In summary, we believe FedEx will stay ahead of the curve. We are investing in acquisitions that give customers more choices. We are significantly enhancing our technology to provide innovative solutions. We are improving the customer experience which drives loyalty.

Our management and workforce are controlling costs and increasing efficiency throughout our operating networks. Our goal is to come out stronger and more competitive after this economic slowdown, and we are on track to succeed in those goals.

Let me conclude with a couple of remarks about our long-term financial goals, and then again the investments we are making this year. Our goals are to try and grow revenue at 10% per year, to achieve 10% plus operating margins, to increase our earnings per share 10% to 15% per year, to continue to improve cash flows and returns on invested capital.

Despite those long-term goals, it's also important as I mentioned before that we continue to invest in our networks and we are doing so in our entire core operating companies, Express, Ground, Freight and FedEx Kinko's. We think that's the smart thing to do, and now I would like to turn it over to our EVP and Chief Financial Officer, Alan Graf. Alan?

Alan Graf

Thank you Fred, good morning everyone. Our fourth quarter results were solid in a low growth economic environment, and with fuel prices rising during the quarter, which as many of you know, causes a drag on earnings due to the surcharge lags. Operating margin increased versus last year 20 basis points up to 11.1%, and our EPS grew 8%. This performance is noteworthy when considering that domestic express lines declined 1% versus last year. Fuel surcharges were lower this year but jet fuel prices were about flat year-over-year.

In the Ground segment, which continues to perform exceptionally well, we enjoyed operating income growth of 30% on the strength of an 8% line increase a 4% yield increase and improved performance at SmartPost. Freight operating income declined as regional LTL revenue was up only 1% and national LTL volumes were very soft. We also incurred reengineering costs at National to improve service and lower the cost structure.

Kinko's revenue declined slightly and margins remained low as expansion and employee development and training cost continued. For the year revenue was up 9%, EPS increased 11% and ROIC improved. So very close to our long-term objectives. I should note that on the balance sheet side we adopted SFAS 158, which resulted in $982 million charge to shareholders equity at May 31, 2007 in accumulated other comprehensive income.

Under SFAS 158 we were required to write-off our pre-paid pension asset of $1.4 billion and increase our pension and other post retirement benefit liabilities by $120 million. These adjustments net of deferred taxes of $582 million were required to recognize a liability for the un-funded projected benefit obligation in our balance sheet. These retirement plan changes announced in February 2007 were contemplated in our February 28, 2007 actuarial measurement and reduced the impact on shareholders equity of adopting SFAS 158 by $1 billion. But we are $1 billion better off than we would have been have we not modernized our plans.

Looking ahead to FY '08, we have provided earnings guidance of $7 to $7.40 per share, which assumes an improving economy beginning in late summer or early fall. Given that we expect to see continued slow economic growth this summer and fuel prices are going to remain high, our first quarter guidance is $1.45 to $1.60 a share. Express domestic volume, package volume and LTL shipments will likely continue to be restrained during Q1.

Strong Ground growth will continue. As Fred mentioned earlier we are making significant investments in our global networks in FY '08; start-up losses for China Domestic as we build and expand the network ahead of traffic, 757 start-up, the China International Hub start-up, the elimination of alternate day service at Ground and Outline areas in accelerating lines, Kinko's expansion in compensation and training programs, but a few of the programs that will have positive impact for us beyond FY '08 but will be an earnings drag during this fiscal year.

We are also investing in productivity and cost improvements, for example Express has many initiatives underway including vehicle asset strategy, airline flight optimization, efficiency improvements in aircraft fuel consumption and maintenance, and new and improved tools to better optimize pick up and delivering in long haul routings. And many of those savings are in the guidance I have given you for the year. These investments which are absolutely critical to our long-term strategy will have strong long-term positive impacts on our financial results and help us to achieve our long-term objectives.

Our track record in this regard has been pretty good, particularly in hitting our financial objectives in the last ten years, where revenues have increased to 123% and net income has increased over 300%.

We are now ready to take your questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) We will pause just a moment to assemble our roster. And we'll go first to Donald Broughton with A.G. Edwards.

Donald Broughton - A.G. Edwards

Good morning everyone. Hello.

Fred Smith

Good morning Don.

Donald Broughton - A.G. Edwards

Good. Wish you could hear me. Couple of quick questions. I was looking at the FedEx Ground numbers, 70% operating margin, you sighted the lower legal cost. Can you quantify that for us, so we can get kind of an idea what the core improvement was there?

Dave Rebholz

This is David Rebholz, if you want me to take that Alan.

Alan Graf

Go on Dave.

Dave Rebholz

The issue is that the previous quarter's legal fees included lot of discovery relative to the class actions that we explained at the last Investors' Meeting. We had the benefit this quarter of having gotten through the bulk of those expenses. That does not mean on a go forward basis we won't have a quarter or two where discovery cost pick up. But, it was substantial on a year-over-year basis and it's clearly one of the key benefits to the margin for this quarter.

Donald Broughton - A.G. Edwards

Dave, I look back and you have hit that boogie on a 17% operating margins in Ground in the fourth quarter of your fiscal '02 and '03, but you haven’t hit it since. Given you got larger scale, is it reasonable to expect that this is actually attainable number on a ongoing basis when you don't have this kind of legal fees?

Dave Rebholz

It’s more than that, quite frankly. First of all fourth quarter is one of our strongest quarters. Number two, we had some very good gains relative to, as already mentioned to the SmartPost performance by changing some of the network inputs and taking advantage of the yield that we could get with customers who further inserted into the networks, so we got a nice pick up there. Clearly, we have a nice pick up from the yield in the Ground in Home Delivery as the relationship to the rule changes with dimensional ratings. So, the combination of those give us a very strong quarter and on a year-over-year basis quarter four of last year had some very draconian cost controls in place that allowed us to show this level of performance. So, 17% would be on a higher level.

Alan Graf

Donald, this is Alan. Let me just add, of our increased CapEx in '08, 40% of that increase is going to Ground facilities and Ground IT infrastructure as we continue to accelerate lanes and grow the business and the growth is dramatic. Particularly, in this economic environment LTL's growth numbers I think it's a real tribute to the services that’s being provided and its resonating very well with our customer base.

Donald Broughton - A.G. Edwards

Yeah, no one can argue that you are not stealing shares, especially when the competitors are all showing down volume numbers in that segment. One other quick question for Doug Duncan and then I'll let someone else hit the floor. LTL showed really solid pricing gains, revenue per hundredweight up another 11% in a quarter. Prior to the Watkins acquisition, you were showing up 7.5% to say 9% revenue per hundredweight increases. How much of this 11% increase is length of haul and how much of it is absolute price increase, so basically what's price and what's the mix here, can you give us some insight to that?

Doug Duncan

Donald, the significant part of that is the additional length of haul yield that Watkins brought to the network. However, I will tell you, in the Ground segment, our yields improvements are still substantial. We are retaining the general rate increase that we took, the Freight segment, sorry. We still have very favorable contract renewals which I think is the best way to measure it, and so we are still negotiating solid increases with our contract customers as they come to. So the yield market, while we are taking a little less growth I think we've done a good job of protecting our yields in the Freight segment.

Operator

We'll go next to Ken Hoexter with Merrill Lynch.

Ken Hoexter - Merrill Lynch

Great. Good morning Fred, Alan, and team. Fred, it sounds like you were saying that despite the slowing economic and slowing use of transportation, you felt that that would be a little bit of a pick up in the summer and may be even into the second half of the year. Can you kind of extrapolate on what you are seeing that leaves you to give that positive outlook?

Fred Smith

Well, there are a couple of things here. First of all, we have a lot of confidence on our economic team, Gene Huang and his economists. And there has been a significant inventory draw down over the last several quarters. And we believe that that will begin to turn around in the late summer or the early fall.

In additional to that, we obviously have a very good view through our various networks, such as the transpacific trades, the Ground network and consumer purchases and so forth. And we base that statement on some of the trends that we are beginning to see that would support Gene's analysis. So that's why we made that statement.

Now having said, obviously the big wildcard in this whole thing is the price of fuel. You can't take hundreds of billions of dollars out of the US consumers pockets, which are then not recycled through our economy and not have an effect. And for many reasons, the price of fuel is now approaching $70 per barrel.

The congress as we speak is debating on energy bill and we are very hopeful that they will take aggressive action and not water this effort down, because this price of fuel is a major issue to the US economy. So that's a wildcard. But based on our analysis and what we are seeing in our trends, we make that statement. The inventory correction should begin to turn around a little bit late summer or in the fall.

Ken Hoexter - Merrill Lynch

That's helpful. I can give my follow-up on Alan. Can you talk about the scale of the China expenses on the roll out of the domestic network? I guess what we might see over the next four quarters that we've seen the peak in this fourth quarter should peak out in the first or second quarters? And then also can you tell us what the benefit in Express this quarter, was from the A380 sale or elimination contract.

Alan Graf

Alright. Well in China, we have very aggressive plans Ken, and we are already providing two days service to over 200 cities. We are going to be moving very quickly to add cities to our time definite next-morning service; we hope to get by the next month up to 28. Time-definite next day service to more than 50 cities, and you might guess we are picking the largest ones, and they have the most people and we are talking about significant amount of opportunity here.

So, I think that the plan that we have is about as aggressive as we can possibly do it. So, that means that we're going to continue with the sort of losses in the first couple of quarters here of '08 that we had in the fourth quarter of '07. Expect those to start narrowing in the second half and frankly don't see any reason at all why we won't have some profit in domestic China in FY '09.

Dave Bronczek

Let me add. This is Dave Bronczek. Let me just add that the business plan was outstanding. Eddy Chan and his team in China and there in Shanghai did a great job. Alan is right, its 28 cities that will be time-definite, 200 cities day-definite they called on thousands and thousands of potential new customers for this service and we are very, very excited about the upside going forward.

Operator

We will go next to David Ross with Stifel Nicolaus.

David Ross - Stifel Nicolaus

Hi, good morning gentleman. I got a question, I guess on going to back to freight Doug if you could talk a little bit about the integration costs I know that for a little bit in the quarter. And talk about I guess what they are for whether they are just for re-branding and systems, because our understanding is that the actual network build is not going to be integrated with the legacy FedEx LTL network?

Doug Duncan

David, the re-branding is obviously going on and doing very well, actually we re-brand the trailer every 42 minutes at the moment, so you should see a lot of expense there. And that expenses in there, that the network and reengineering we’ve had to move some of the hub locations for a correct position to produce the on time service, that we're going to have and this network has done a relocation of some of the drivers.

We've had to install the technology, we integrated the handheld technology in every drivers hand at FedEx National, all the hubs and the major locations they are all going to have the dock computers now to enable us to run this on-time network. So the integration of all that technology as well as positioning the drivers and the hub resources and the expansion of some of the hubs, so that we can move and process the freight every night on a very timely network to reach our 99% on-time delivery metrics is what we have been going for. And it's largely done, we still got a few more tweaks to do, but the efficiency that National, the productivities at National right now are at record levels.

They are producing service levels they have never seen before. So it's all working, we just need a little more volume into the pipeline, this company will perform exceptionally well. So if we get that up tick in the economy plus the great new value proposition we are bringing to the long-haul market, I think you'll see this company do very well.

David Ross - Stifel Nicolaus

Sounds great, I just have a follow-up maybe for Ken on Kinko's. You talked about $800 million in Express and Ground revenue coming from the Kinko's network which is great. But I guess I am wondering how fast if you want to look at the same stores sale basis maybe you are getting packages in to the store year-over-year?

Ken May

David, we don’t release package numbers but I just will let you know that we are very, very pleased with the expansion efforts our customers. We are getting a lot closer to them. We are very, very pleased, especially with Ground, the penetration in that market. Because, we know we are picking up share as we get closer to those customers. So, the expansion effort is working out very well and we're pleased with the numbers so far.

Operator

And we'll go next to Thomas Wadewitz with JP Morgan

Thomas Wadewitz - JP Morgan

Good morning. And first question is on Express margins. Alan, if you could give us a sense, couple of different pieces. What worked against you in margins in the quarter? I guess, fuel is something you mentioned, if you could give us the sense of the magnitude of that? You integrated the joint venture from China, so I think that could have caused some noise in the margins in a sense to that. And then may be just in terms of softness of the economy, if you could give us the sense of order of magnitude of those, and then how they might affect going forward?

Alan Graf

Well Tom, I mean you've hit the three right on the head. I mean, clearly when fuel prices are rising that’s very painful to Express paying jet fuel. About half of it is spot price and the surcharge has average of about six week lag. So, that was painful. From when we gave you previous guidance for the corporation to where we ended up, certainly we had lower domestic volume and little bit yield than we had anticipated back in March. That was a big impact. We knew that China start up losses what they were going to be and we would basically hit that plan straight on. So, versus previous guidance it was not a factor, but versus the previous year it was.

Looking forward to '08, again what the caveat that we keep taking about is that we get some pick up here in the fall in the economic environment. There is no question Express' operating income and margins were going to increase in '08. Dave?

Dave Bronczek

Well that's right. All three points, obviously, affected our margins. You saw that we still hit a double-digit margin in the quarter. We are on a strong path to keep increasing those operating margins. As Fred has pointed out and Alan, obviously, we are looking forward to pick up even if it’s a slight pick up in the Express segment of the business. In the fall our cost controls have been excellent. As you can see in our salaries and benefits line they were flat, their revenue is still growing at 4%. So, we are well positioned, as Alan pointed out, to increase our margins and keep marching down this path of double-digit profits.

Thomas Wadewitz - JP Morgan

Okay. And then my follow up is on the International Priority line. I think in the prior quarter you had some softness in Asia outbound. This quarter you identified Europe and Latin America. Did you see Asia bounce back, and I guess also how important is stronger IP growth in terms of what you can do on the Express margins side?

Dave Bronczek

Well, let me answer that in the middle part of your question on Asia. Yes, the answer is yes, Asia did bounce back on slightly less growth in Europe, although ahead year-over-year. In fact, all the regions around the world were positive growth on revenue year-over-year. But, you are correct that Asia did bounce back and that’s a very good sign for us, along with US outbound continuing to grow.

Operator

We will go to Edward Wolfe with Bear Stearns.

Edward Wolfe - Bear Stearns

Hey, good morning everybody.

Fred Smith

Good morning Ed.

Edward Wolfe - Bear Stearns

Hey Fred, kind of a longer-term question. As you look out on your capital spending priorities and where you want to want invest at the theaters, let's call it Europe, China, aircraft. How do you think about the priority between those three? And how long do you think we are going to be in this kind of raised CapEx period as you go out?

Fred Smith

Well, Ed you are basically talking about what goes on in the strategic management committee. We do a lot of arm wrestling in there to prioritize what we are going to do. The facts of the matter are that in all of our four operating companies, we have big opportunities. And as Alan mentioned, in the fiscal year that is upon us. One we're now in '08, the increase in CapEx is basically driven by new facilities and our key investments. It's not driven by aircraft. I think some people mistakenly thought that was the case.

Now we'll run along here in the next couple of fiscal years at CapEx levels that have been a bit higher than in the last few years. But as a percentage of revenue, we think over time that they will decline as some of these networks are built out, a good example of that, and it's a small version of it, is FedEx Kinko's. I mean we have a bow wave of expense, 200 and some odd stores last year, and 300 stores this year. The stores aren't profitable from day one. All of they are running ahead of the projections that we had.

We are putting a lot of investment in the customer experience, and in our teammates training and compensation. And then we have this fabulous product, which is one of the reasons we acquired FedEx Kinko's, our digital print online, which is where the world is going as oppose to the traditional copy service and we are investing very heavily this fiscal year in that service.

So FedEx Kinko's, as I mentioned, at the Investors and Lenders Meeting in FY '07 will rock along at break-even more or less slightly above or below the line, and then in FY '09 is at bow wave of expense from those network expansions, again to turn positive. You will start to see some real numbers drop on the bottom line. And that's even without regard to the transportation revenues that are produced is a FedEx Kinko's channel that we mentioned. So that's a small example what's going on throughout the company. And I think in FY '09 and '10 that you will see CapEx as a percentage to drift down again. It may rock along these levels as 777 coming in, I think in, is it '09 or '10, calendar '09, fiscal '10. But that's sort of what we see it.

Edward Wolfe - Bear Stearns

All right. As a follow-up, can you just talk a little bit about the Airbus benefit, what expense line that was in, and is that all in the Express in this quarter? And I am just guessing there is no more of that coming, or is there more to this settlement that we could see, as you go up?

Alan Graf

Ed, this is Alan. Thanks. Can I apologize? I skipped over that one when what you answered earlier. When we execute the settlement agreement with Airbus in March, the similar agreement provides us to receive credit memorandum with a stipulated value of a certain amount to be provided over time and utilize for future purchases of Airbus goods and services. We still remain a huge operator of Airbus equipment. So the number that we talked about and reported today, went completely to Express and went to expense reduction and it is something less than the total nominal credit memos because of the time value and because we are not certain we will be able to utilize all of them. So that's our best estimate today and we will be reevaluating that periodically as things change.

Operator

We go next to William Greene with Morgan Stanley

William Greene - Morgan Stanley

Hi, good morning. I am wondering if we can talk a little bit about despite the elevated CapEx that you have? I still have you producing a fair amount of free cash flow. Is there any appetite at all for share repurchases?

Alan Graf

As we talk from time-to-time with our board, well actually at every meeting about our financing strategy and our outlook, that's always a debate. And we think we have many opportunities to continue to invest in the business and get shareholder value that way. Having said that I am not going to sit here and rule out any potential stock buyback. But at the moment, we still have availability from our previous plan and we have not brought shares back in a long time and have no immediate plans too.

William Greene - Morgan Stanley

Okay. And then in terms of the Express business, if you look at kind of the industries that you serve, was there anyone that sort of stood out in terms of either particular strength or weakness?

Dave Bronczek

This is Dave Bronczek again. No not really it's generally what you would expect across the board in the Express segment. So nothing that stood out in a very negative way or very positive.

Fred Smith

Mike Glenn is on the line. Mike's traveling and he is on the West Coast. Do you want to amplify on that?

Mike Glenn

Yeah, the strength in the industries was largely manufacturing non-durables business and professional services and wholesale non-durables. Those were the industries that drove the greater share growth.

Operator

We go next to Jon Langenfeld with Robert W. Baird

Jon Langenfeld - Robert W. Baird

Good morning. On the international export side, looking at revenue share which are the major markets do you think you are tracking ahead and what's behind your competitors' in terms of growth?

Fred Smith

Well, I think we are doing very well in Europe we've had a very good year there. US international outbound has been exceptionally strong as well over the last several years, I think we are tracking ahead. There we are doing very well in our business model in Asia-Pacific. And so I would say we are very pleased across the board, but I think Europe and United States.

Jon Langenfeld - Robert W. Baird

Okay. And then in terms of DHL they are obviously showing some positive volume growth here in the US, are you feeling that at all yet?

Fred Smith

Answer that and then I will turn it over to Mike. My answer to that is no. Mike.

Mike Glenn

No, we are not seeing any material change in their performance relative to the FedEx performance. They tend to define volume growth in a different way than we do. They tend to group Ground Express and US export all together when they report their volume growth numbers in the US. We obviously break those out differently. So on an apples-to-apples basis we are continuing to out perform the competition.

Operator

And we will go next to Gary Chase with Lehman Brothers

Gary Chase - Lehman Brothers

Good morning guys. I just wanted to drill down a little bit on some of the segment margins, that Alan maybe Dave last quarter you noted in Express that volume in it kind of slowed a little bit quicker than you anticipated and there were things you were working on the cost side. I was just curious if you've got most of the benefit from those initiatives during this quarter or whether and you still have some adjusting to do to catch up with the decline sir?

Dave Bronczek

This is Dave, I'll start out first. We did at the end of the third quarter you are correct we saw the softening as Fred and Alan had talked about, go into the fourth quarter a little bit stronger, weaker I guess you would say. So we put a lot more discretionary freezes on things, we've done a very good job in our productivity and our FTEs in terms of managing those areas. Yes, we put a bigger emphasis on costs and in Q1 this quarter we are as well. So, that's what gives us some optimism for a strong year going out if we get that little bit of rebound in the United States economy that would be very good for us, the way we've been managing our cost down.

Gary Chase - Lehman Brothers

But, it's not sounding like it was a big drag in the quarter than you sound like you responded to it pretty well.

Alan Graf

Well, I'd say that given the fact that we had a 20 basis point improvement year-over-year and a completely different economic environment. Absolutely, our productivity and cost initiatives are working very well at Express. And the good news is, I mentioned in my monologue in beginning of the year was that there is more to come in '08. I mean we had some things that are getting ready to kick in that I think we are going to take us to some new levels in productivity in areas that I mentioned. So, that's factored into us going forward.

And we are not looking for any growth in domestic Express volume over year in fiscal '08. We just think the economy is just not going to get strong enough for that to grow and with the fuel price surcharge that we have put on, slamming a lot of Express packages to the ground network which is fine for us, as long as we manage our costs.

Dave Bronczek

The only other thing I would add to that is that's correct and we do feel very optimistic going forward. I guess the fuel issue I heard it's little bit more than we had anticipated in Q4.

Operator

And we'll go next to Scott Flower with Banc of America Securities.

Scott Flower - Banc of America Securities

Yeah, good morning to all. To pick a couple of things, I was wondering and I think you mentioned this briefly on, but I just wanted to may be get your comments or Mike Glenn's. It looks the adjusted fuel surcharge yields have been very solid domestically both in air and ground. But, I just wanted to get some sense of how you view the competitive dynamic in the yield environment. It seems as if everyone has behaved in a very disciplined and solid fashion despite some of the softening in the marketplace.

Mike Glenn

Scott this is Mike. I would say there is not been a material change in the pricing environment. Obviously, it remains competitive, especially on an account-by-account basis. But, if you look at the overarching pricing environment I would say there has not been a material change.

Scott Flower - Banc of America Securities

Okay. And then the other question is, I am just wondering on China and I think you alluded to this in the analyst meeting in Memphis. Obviously, you had different scenarios and I guess from the context of the comments you made today, as well as some of the CapEx, it sounds like you are going after this as hard as you can in terms of the ramp and to the extent that the growth there. The hockey stick or the ramp later or sooner and faster, is that a fair way of thinking about how you are approaching the China network situation?

Dave Bronczek

This is Dave Bronczek. I can say that we are going in to the China market very aggressively. We have the lot of good feedback from our customers that want this product and service offering and we are optimistic. So, yes, I would say that we are going into the market as we had planned, but it is aggressive.

Operator

And we will go to David Campbell with Thompson, Davis & Company.

David Campbell - Thompson, Davis & Company

Yes, I want to ask if the growth in domestic deferred shipments, which has not grown recently, is that any indicator of future? Is that any positive indicator of future growth in the Express business in general or the economy in general? Have you seeing that in the past with that sort leads recovery in the Express business?

Dave Bronczek

David, I will answer that first than I will kick it over to Mike Glenn. You are referring to the 2.5% growth that we had in deferred. That was very good news us in the fourth quarter and it helped us significantly. Mike you might you want to talk about the market in general?

Mike Glenn

Well, David as we have said for some time we don’t anticipate any material growth in the domestic Express sector and it has not been a growth market for some time. We look at the total parcel market. We expect it to outpace GDP roughly at 0.5 or so. So as we see strengthening in the GDP going into the fall as Fred mentioned earlier. We would love for the parcel market to obviously pick up, but we are not looking for any material growth in the domestic Express sector.

I will say that our sales team is doing a terrific job in revenue management and making sure that we have strong revenue growth despite relatively flat volumes, and typically what you do see is a bit of a pick-up in the deferred sector before you see strengthening in the overall parcel market. So first, we will look for growth primarily out of Asia and then more us leaving up to food chain and then secondarily some growth in the deferred sector. So we did view that as a good sign. But as I mentioned earlier and have been referred surely in the call, we don't look for any material growth in the domestic express sector for this fiscal year on volume basis.

David Campbell - Thompson, Davis & Company

Again my follow-up question is in Asia, the Asia export markets were a stronger in May in terms of increase than in March and April?

Mike Glenn

I would say David that the overall Q4 was a pick-up across the Q3 performance that we are very pleased with. May was a little bit stronger if I recall than March and April.

David Campbell - Thompson, Davis & Company

Thank you very much.

Operator

We'll go next to Jason Seidl with Credit Suisse.

Jason Seidl - Credit Suisse

Good morning gentlemen. Two quick questions. One, if I look at the IP volume growth here is a little bit over 2% sort of positive territory, how much of that volume growth was related to AMC?

Alan Graf

Jason, this is Alan. I would say a very little.

Jason Seidl - Credit Suisse

Very little, okay. Perfect. Follow-up question, Doug you mentioned that volumes were soft in the regional LTL market, but very soft in the national. Could you give us a little color in terms of pricing in both regional and national, please?

Doug Duncan

Jason, it's always a competitive market. We have lots of competitors and it's always very competitive. It's probably a little more competitive than it has been in the past, because I think the overall market volumes in the LTL business are down. So, everybody is competing for lesser volumes. But all-in-all, I look at their yields and the way we performed, I can't tell you things are irrational because we are still getting great contract renewals as I talked about or retaining the general rate increase.

Clearly, you've got companies moving into different sectors. You've got regional companies trying to get into the long-haul sector. You've got long-haul trying to get into the regional sectors. But I am very happy with our position. We are approaching it, so that we will give each market the absolute best service product that they demand in each of those markets. And I think over time we'll perform very well with that. But it's very competitive because the market is down, but certainly not irrational.

Jason Seidl - Credit Suisse

Alright. Thank you.

Operator

We'll go to Edward Wolfe with Bear Stearns.

Edward Wolfe - Bear Stearns

Yeah, just one clarification Alan, when you said the benefit from Airbus was in Express, what line item in expenses is it in?

Alan Graf

It’s buried in other, Ed.

Edward Wolfe - Bear Stearns

It's buried in other. If it's not in this salaries and side of things, it feels like you guys did a very good job of managing that as a percentage of revenue.

Alan Graf

That was the key. Dave was hitting earlier about what would been able to get done here in anticipation of that slow growth domestically has been really a great job by the Express Management.

Edward Wolfe - Bear Stearns

So that's something that I am guessing, you're going to keep pretty tied until you get more convention to the economy and we should expect that to keep going.

Alan Graf

That's exactly correct. We planned it that way for all of FY '08, and we started to see some of the softening as Fred pointed out in the beginning of the third quarter, right up to January and the Chinese New Year and obviously continued into the fourth quarter. And we have a lot of plans on the cost side. Yes, the salaries and benefit lines relatively looks flat is something we are managing very closely, we are very proud of that.

Edward Wolfe - Bear Stearns

And then another follow-up on the Ground yields, they look very strong up over 4%. And that seems to have accelerated. Can you talk a little bit about the Ground yield environment and what's going on there?

Dave Rebholz

Mike, do you want to talk about it?

Mike Glenn

Well again Ed, I would just say that our sales team has done a very good job from a revenue management perspective. We covered a lot of the tactics at the Investors and Lenders Meeting in terms of what we're doing to make sure that we've got very balanced performance from our volume growth and yield management perspective. I would say that our team is doing a terrific job, obviously we've got industry leading growth rates on the volume side, and we’ve got industry leading yield growth rates. So it's really a very effective job by our sales team and the team that manages our pricing environment and a revenue management committee. So we are very pleased with what's happening, we are making our ground, volume growth and yield management perspective.

Fred Smith

And I would add that last year we did not have conventional weight surcharges at Ground we do this year that had a big impact in this yield versus last year's yield.

Operator

We'll go next to John Barnes at with BB&T Capital.

John Barnes - BB&T Capital

Hey, good morning. One question on the domestic Express business, you talked about a move of some of those moves to Ground. I'm just kind of curious your thought, how much of that do you think is permanent and how much of that do you think could come back into the Express business with a little strength in the economy?

And then the second part of that is, given the sluggishness in Express and I think you've tempered your comments about the growth potential of that business longer-term and have talked a little bit more about it being a more mature market. Did that change your plans at all in terms of investment in Express and especially with regards to kind of 727 replacement program?

Dave Bronczek

I'll answer the last part of that question first. No, we're excited about the 757, that'll be very positive for our profits out going forward, as it is in the 777. In terms of the market and the shifting of the business Mike, you might want to weigh in on that.

Mike Glenn

Well, our job is to build solutions for customers, and we have introduced a tremendous amount of service enhancements in the Ground network, speeding up the network, improving the information intensity of the capability in the Ground sector. So, wherever we can meet a customers needs with Ground service capability, we'll do that. So some of it has been self induced, some of it has been due to the economy, but our job is to put solutions together that meet customers needs. We don't anticipate a lot of rebound in the Express sectors. We talked about earlier, we are planning for essentially no growth in FY '08 from a volume perspective. Having said that, we do see some opportunity to increase revenue growth in the domestic Express sector, if we do get a rebound in the economy and for example we work down the bubble in the housing market and autos began to pickup and things of that nature. We could see some modest growth in the domestic Express sector, but we don't anticipate a lot.

Fred Smith

One last point on this is that again, sometimes when you try to de-comp Express in the domestic and International, you forget that IP is growing very nicely and we have pick up, delivery, and linehaul operations throughout the US that are handling many or most of those additional packages today. So, we still will be making investments in the physical network in the US to handle our growing international business.

John Barnes - BB&T Capital

Okay. Alright. One follow-up just on the 757 and the 777. I am not saying that, the question was would you not pursue the program of replacing those aircraft. I am just curious at all, would you look at may be smaller number of planes if Express didn't show more potential. I am just kind of curious from a CapEx standpoint.

Alan Graf

I think right now we are very tight on our long range outlook with number of airplanes that we have on order and have sourced and have them on. And again, these are very high ROI capital investments versus the alternative particular with 757.

John Barnes - BB&T Capital

Okay. All right, very good. Thanks for your time guys.

Fred Smith

This is Fred Smith speaking. I have said this now for a several years and I must say it again based on the comments that just went on. I continue to be a bit disappointed that we can't get across. There is really no domestic and international express network, its one marketplace. And the people that use the Express system, for all intents and purposes look at the world as a market. So, they are moving production facilities to China and then from China to Vietnam where we have a wonderful business and a great country manager and than maybe back to Mexico and so forth. So, the focus on "domestic and international", and this is the point that Alan just made, a very, very big part of our uplift and the "domestic Express business" is simply moving intercontinental traffic into and out of the hubs.

So, there is no diminishment of the requirement for lift in the United States. It's being driven now by the prior and subsequent movement of International Priority. And that's why there is such a high ROI, as Alan mentioned on the 757. As you can replace the 727s, the 757 operates for less cost, but carries more traffic, it's much less fuel intensive, that’s also environmentally a lot better, so that's why that's a very high ROI project. It's a "domestic airplane", but it's an integral apart of our intercontinental network as the 777s are.

Okay. Thank you very much for your participation on the conference call today. Please feel free to call anyone on the Investor Relations team if you have any additional questions. Thanks again.

Operator

And that does conclude today's call. Again, thank you for your participation and have a good day.

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Source: FedEx F4Q07 (Qtr End 5/31/07) Earnings Call Transcript
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