FedEx Corporation (FDX) on Q1 2022 Results - Earnings Call Transcript

Sep. 23, 2021 6:29 AM ETFedEx Corporation (FDX)
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FedEx Corporation (NYSE:FDX) Q1 2022 Earnings Conference Call September 21, 2021 5:30 PM ET

Company Participants

Mickey Foster - VP, IR

Raj Subramaniam - President and COO

Mike Lenz - EVP and CFO

Brie Carere - EVP, Chief Marketing Officer and Communication Officer

Conference Call Participants

Scott Group - Wolfe Research

Brandon Oglenski - Barclays

Chris Wetherbee - Citi

Ravi Shanker - Morgan Stanley

Ken Hoexter - Bank of America

Tom Wadewitz - UBS

Brian Ossenbeck - JP Morgan

Jordan Alliger - Goldman Sachs

David Vernon - Bernstein

Todd Fowler - KeyBanc Capital Markets

Amit Mehrotra - Deutsche Bank

Helane Becker - Cowen

Jack Atkins - Stephens

Allison Poliniak - Wells Fargo

Bascome Majors - Susquehanna

Duane Pfennigwerth - Evercore ISI

Disclaimer*: This transcript is designed to be used alongside the freely available audio recording on this page. Timestamps within the transcript are designed to help you navigate the audio should the corresponding text be unclear. The machine-assisted output provided is partly edited and is designed as a guide.

Operator

00:03 Good day, everyone, and welcome to the FedEx Corporation First Quarter Fiscal Year Twenty Twenty Two Earnings Call. Today's call is being recorded. At this time, I would like to turn the call over to Mickey Foster, Vice President of Investor Relations for FedEx Corporation. Please go ahead.

Mickey Foster

00:22 Good afternoon, and welcome to FedEx Corporation's first quarter earnings conference call. The first quarter earnings release, Form ten Q and stat book are on our website at FedEx.com. This call is being streamed from our website where the replay will be available for about one year.

00:43 Joining us on the call today are members of the media. During our question and answer session, callers will be limited to one question in order to allow us to accommodate all those who would like to participate.

00:56 I want to remind all listeners that FedEx Corporation desires to take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act. Certain statements in this conference call such as projections regarding future performance, maybe considered forward looking statements within the meaning of the act.

01:15 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.

01:34 Please refer to the Investor Relations portion of our website at FedEx.com for a reconciliation of the non GAAP financial measures discussed on this call to the most directly comparable GAAP measures.

01:47 Joining us on the call today are Raj Subramaniam, President and COO; Mike Lenz, Executive VP and CFO; Brie Carere, Executive VP, Chief Marketing and Communications Officer. And now Raj will share his views on the quarter.

Raj Subramaniam

02:06 Thank you, Mickey, and good afternoon, everybody, and thank you for joining today's call. First and foremost, I would like to extend my sincerest thanks to our global team members who continue to deliver for our customers in an exceptionally challenging operating environment. We are extremely proud and grateful for the manner in which Team FedEx continues to move the world forward. The execution of our strategies continues to drive high demand for our differentiated services despite the disruptive impact of the pandemic to labor availability, industry capacity and global supply chains. As you look at our first quarter results, our performance was highlighted by double digit increases in yield across all our transportation businesses driven by limited capacity, high demand and our revenue management strategy. The impact of constrained labor markets remains the biggest issue facing our business as with many other companies around the world and was a key driver of our lower than expected results in the first quarter. As Mike will share in more detail momentarily, we estimate that the impact of labor shortages on our quarterly results was approximately four fifty million dollars primarily at FedEx Ground.

03:19 Labor shortages have had two distinct impacts on our business. The competition for talent, particularly for our frontline workers have driven wage rates higher and pay premiums higher.

03:32 While wage rates are higher the more significant impact is the widespread inefficiencies in our operation from constrained labor markets. To illustrate this, I'd like to share a brief example from FedEx Ground. Our Portland, Oregon hub is running with approximately sixty five percent of the staffing needed to handle its normal volume. This staffing shortage has a pronounced impact on the operations, which results in our teams diverting twenty five percent of the volume, that would normally flow to this hub because it simply cannot be processed efficiently to meet our service standards. And in this case, the volume that’s diverted must be rerouted and processed, which drives inefficiencies in our operations and in turn higher costs.

04:19 These inefficiencies included adding incremental line haul and delivery routes, meaning more miles driven and a higher use of third party transportation to enable us to bypass Portland entirely.

04:33 Now that's merely one example. Across the FedEx Ground network, there are more than six hundred thousand packages a day being rerouted. We anticipate the cost pressures from network inefficiencies such as the one I just illustrated to persist through peak as we navigate the labor market and impacts of new Covid [grades] (ph).

04:56 Overcoming these staffing and retention challenges is our utmost priority as they not only affect our cost structures and operational efficiency but also having a negative impact on service levels.

05:07 As such, we're taking bold action across the enterprise to hire and invest in our frontline team members as we prepare for the peak season ahead. These actions include targeted pay premiums, particularly for weekend shifts, increased tuition reimbursement, sponsorship of a national hiring day on September twenty third as we seek to hire ninety thousand additional positions ahead of peak; detailed volume and demand planning with customers to drive additional sorts to alleviate congestion and expanding network capacity, which I will touch on shortly.

05:46 Based on these actions, combined with our expectations for improving labor conditions we do anticipate gradual improvement in our operational efficiency as we turn into the new calendar year.

06:00 During the first quarter, the team continued to execute on our strategy even amid the challenging operating environment. As e-commerce drives higher demand, we continue to strategically invest in our network to boost daily package volume capacity, increase efficiencies and further enhance the speed and service capabilities of our networks.

06:22 Our investments continued in Q1 as FedEx Ground expanded its physical footprint with the new state of the art hub in Chino, California, which began operations in August. This fully automated hub includes large package sortation, has the capability to process up to thirty thousand packages per hour and strategically located to help address ongoing port congestion challenges. FedEx Ground also continues to see year over year improvement in last mile efficiency, driven by a two point four percent increase of packages delivered per hour compared to Q1 last year thanks to route optimization technology.

07:00 As we move into Q2, we are meticulously planning for peak season ahead including close collaboration with customers to build solutions to enable them to succeed. We expect to have substantially higher ground capacity this peak season, due to our investments in FedEx Ground’s infrastructure. This includes the addition of more than a dozen new automated facilities and several other sortation equipment expansions in addition to the Chino hub that I already mentioned.

07:29 Several key technology projects are also slated for completions this fall, including the modernization of multiple sortation, transportation management and safety systems, which will help to increase Ground’s network capacity by one hundred per thousands of ADV, as well as its flexibility and resiliency. This brings a total capacity increase of more than one million average daily volume compared to last peak.

07:56 Another significant opportunity in our growth strategy is the improvement in the profitability of our International Express operations. We reached a significant agreement with the social partners at our Liege express operations regarding the intended European Air network transformation.

08:12 This is an important milestone in the completion of the Air Network integration, which remains on track for completion in spring twenty twenty two.

08:21 That will bring the physical network integration of TNT into FedEx to a close and when combined with the benefits of our previously announced European restructuring provides significant upside in our international profitability moving forward.

08:39 In summary, we're taking bold actions in the short term to navigate through this highly uncertain environment. We remain committed to long term shareholder return and we are very confident in our strategy for the following reasons.

08:52 We have a differentiated portfolio of services to attack the fast growing e-commerce market. Our business model gives us the framework to be very successful in this regard. In fact, we are working strategically with several retailers to deliver a win-win-win solution - win for the retailer, win for end consumer and win for FedEx. For instance, we recently partnered with a large retailer to create a common data platform that drives optimization of our combined assets, and enhancement of visibility and predictability to the end customer.

09:29 Further, as a day definite residential volumes grow in our network, there's increasing opportunity to collaborate across our operating companies to improve efficiency by better utilizing our assets.

09:41 Another upside for FedEx is international hence the completion of our physical integration in Europe provides an inflection point for profitable growth. And finally, we are in the early stages of unlocking value from digital innovation. We are confident that this will play a significant part in success of FedEx for years to come as we make supply chains work smarter for everyone.

10:04 Our strategy is sound and positions us well for improved returns as we move through fiscal year twenty two and beyond. With that, let me turn it over to Brie.

Brie Carere

10:17 Thank you, Raj, and good afternoon, everyone. Our first quarter commercial results were very strong with fourteen percent revenue growth and double digit yield improvement in our Transportation segment. These results reflect the positive backdrop for growth in the parcel markets, including a very healthy pricing environment.

10:36 For fiscal year twenty two, FedEx revenue was forecasted to pass ninety billion dollars. Further, we are forecasting that the U.S. parcel market will grow to one hundred and one million packages a day by calendar year twenty twenty two, which is year over year growth of twelve percent. These market projections are slightly lower than last quarter as e-commerce percentage as a percentage of retail decline. We saw a shift to in-store shopping and buy online pickup in store and spending in services of course, increased. However, despite this moderate change in e-commerce growth, the secular trend of e-commerce growing as a percentage of retail will continue to drive healthy parcel market growth.

11:17 We are forecasting a ten percent annual growth rate of U. S. domestic market volumes through twenty twenty six.

11:25 At FedEx in the first quarter, total U.S. domestic package volumes increased year over year by one point five percent. At Express, our total U.S. domestic package volume grew seven percent year over year. Total FedEx Ground volumes were relatively flat in the quarter, however, I'm very proud as we proactively manage our capacity for higher yielding commercial and home delivery services. In fact, FedEx Ground commercial volumes grew double digits in the quarter.

11:54 In the first quarter of fiscal year twenty two, FedEx total U.S. domestic residential package volume mix was fifty seven percent versus sixty two percent a year ago.

12:05 U.S. B2B mix improved year over year in the first quarter of fiscal year twenty two as B2B volumes continue to recover with inventory replenishment and manufacturing rebounding as the economy opens. B2C mix continues to remain higher, however than pre pandemic levels.

12:22 In Q1 FedEx Freight revenue increased twenty three percent driven both by increased volume and higher revenue quality, a huge shout out to the FedEx Freight team, great job, team. FedEx Freight Direct continues to bring incredible momentum.

12:40 Turning now to our revenue quality strategy. The continued constrained capacity in both the U.S. domestic and international markets has led to a very favorable pricing environment. We are focused on protecting and growing volume in high yielding commercial segments, including commercial ground and small and medium segments. We have an incremental opportunity to improve large customer yields through contract renewals and providing large customers an ability to procure incremental capacity at current market rates.

13:10 As announced yesterday effective January third, twenty twenty two, FedEx Express, FedEx Ground and FedEx Home Delivery shipping rates will increase by an average of five point nine percent. While FedEx Freight rates will increase by an average of five point nine percent to seven point nine percent. We also announced other surcharge increases which can be found on FedEx. com.

13:33 These increases will help us continue to balance capacity with demand and mitigate the impact from the increased costs that Raj just outlined.

13:41 Turning now to International. We are forecasting the air cargo market to be more than eighty billion dollars by calendar year twenty twenty five. At FedEx, we currently have single digit market share, and as such, this remains a significant growth opportunity for us to continue to pursue. We expect air cargo capacity to remain constrained through at least the first half of calendar year twenty twenty two. A full recovery is not anticipated until twenty twenty four.

14:10 Global air cargo capacity continued to recover in July. It is still down ten percent compared to pre pandemic levels. Capacity on international lanes remains scarce, and we have seen European and APAC export demand recover to pre pandemic levels.

14:27 Globally, we continue our efforts to optimize our network and customer mix. We managed to a very high percentage of priority service on our international flights, with yield per package improvement of eleven percent for international parcel and yield per pound improvement of eighteen percent for international freight, Exports from Asia are fueled by the strong demand from B2C and B2B recovery. B2B will further benefit from a shift in demand from ocean freight to air cargo as our customers replenish stock levels in time for the peak sales season.

15:03 To provide access to reliable capacity in this constrained environment, we turn six previously ad hoc intercontinental flights into scheduled service in fiscal year quarter Q1, four trans-Pacific and two for the Asia Europe lane. We are seeing a strong recovery in Europe as well with the overall economic recovery back to pre-pandemic level.

15:27 Our inter Europe cross border B2B volumes have recovered to pre Covid levels. Our growth is further accelerated by significant B2C parcel volumes. E-commerce growth will be critical for both our Asian and European businesses. In Q1 we expanded FedEx International Connect Plus from Europe to six new global destinations, increasing coverage to eighty two percent of global GDP across a total of three hundred lanes. And on September first, we launched FICP in EMEA across eighty origin destination lanes.

16:02 For businesses looking for a cost effective solution with competitive transit FICP provides a compelling e-commerce value proposition. We continue to gain new customers through FICP and have a very robust sales pipeline.

16:16 In summary, while it continues to be a very dynamic market, we remain incredibly confident in our global growth potential and our world class commercial teams to bring in market leading yields. And with that, I'll turn it over to Mike for his remarks.

Mike Lenz

16:30 Thank you, Brie, and good afternoon, everyone. Our first quarter FY’22 adjusted earnings per share of four point three three seven dollars was negatively impacted by approximately eight hundred million dollars in year over year headwinds. And while Raj covered the operational impacts of these challenges I will detail the financial impacts for the quarter.

16:50 Of these headwinds, the [Indiscernible] year over year cost, the majority of which impacted our FedEx Ground business. As we look into the impact of labor costs on the business I want to break this impact higher wages and the impact of network inefficiencies. And we estimate that two hundred million [Indiscernible] purchased transportation rates.

17:18 This included higher wage rates and pay premiums for team members and higher rates paid for third party transportation and services.

17:27 In addition to the higher wage rates, we estimate that network inefficiencies of approximately two [Indiscernible] fifty million dollars contributed to the total impact of labor shortages on the business.

17:42 These costs include additional line haul, higher usage of third party transportation, cost of repositioned assets in the network over time and recruiting [incentives] (ph) all to address staffing shortages.

17:58 Beyond the labor impacts, our results for the first quarter also included the following headwinds. An additional one hundred and thirty five million dollars in a healthcare costs [Indiscernible] lower utilization a year ago, eighty five million dollars related to investments in the Ground network, which represents the cost of bringing online sixteen new automated facilities and expansions at a hundred facilities which are critical to improving service and adding capacity to meet growth for peak and beyond.

18:32 And at Express, an estimated sixty million dollars in incremental air network costs due to the impact of Covid restrictions on our operations, including limitations on layover, supplemental crews to ensure service continuity and immigration restrictions.

18:50 In addition, and as a reminder, our prior year results at Express included a pre-tax benefit of sixty five million dollars from a reduction in aviation excise taxes.

19:02 That said, our first quarter results did come in lower than our own expectations as difficult labor conditions persisted throughout the quarter. As a result of that variable compensation was not an expense headwind in the first quarter.

19:18 With that overview of the consolidated results let’s turn to the highlights for the segments.

19:24 At Express results declined due to the higher operating expenses from staffing challenges and Covid related air network impacts I discussed. Profitability was also impacted by fewer charter flights compared to the surge last spring during the early months of the pandemic. While we've covered the impacts to Ground results in detail, I would like to call to your attention to an enhancement in our reporting included in the release and the ten Q.

19:52 As a result of business growth and our unmatched seven day operating network at ground, we are now providing additional product level disclosures for average daily package volume.

20:03 Beginning with our first quarter, we are breaking out ADV statistics for FedEx Ground commercial, home delivery, and economy services.

20:12 Turning to Freight, we reported a record operating margin of seventeen point three percent for the quarter as our continued focus on revenue quality and profitable growth drove average daily shipments up twelve percent and revenue per shipment increased eleven percent as Brie highlighted previously.

20:29 Now let's pivot to capital spending. During the first quarter, we spent one point six billion dollars in capital as we continue to invest in our strategies for profitable growth, service excellence and modernizing our digital and IT platforms. Our capital forecast for fiscal twenty two remains at seven point two billion dollars and less than eight percent of anticipated revenue and includes following key elements: First, more than fifty percent increase in capital spending at Ground year over year for capacity expansion and new facilities to capture opportunities from growing e-commerce business.

21:08 And second, fleet modernization at Express with continued investment in seven sixty seven and seven seventy seven aircraft which not only has a high financial return, but is an important part of the strategy to reduce our carbon footprint.

21:23 In evaluating capital investments, our return on invested capital on existing capital and new projects is a critical metric to managing our business and we have a rigorous approval process in place on all new capital projects.

21:37 As we look at investments we set the internal rate of return hurdle above our weighted average cost of capital, which varies based on the nature of the project. For example, an investment in replacement capital would have a lower hurdle rate than growth capital. Capital returns has always been an important metric to managing the business both historically and in the future.

21:58 We ended our quarter with seven billion dollars in cash and are targeting over three billion dollars in adjusted free cash flow for FY’22, which puts us on pace to deliver over seven point five billion dollars in adjusted free cash flow for FY’21 and twenty two combined far exceeding our historical levels.

22:20 We continue to focus on thoughtful capital allocation and strengthening our balance sheet in fiscal twenty twenty two. During the quarter, we repurchased one point nine million shares totaling roughly five fifty million dollars and are targeting approximately one million additional shares for the balance of the year.

22:38 In addition, we plan to make a five hundred million dollars voluntary contribution to our pension plan this year. We are lowering our fiscal twenty twenty two guidance to reflect our first quarter results, which were lower than our expectations. As we look to the rest of the fiscal year, we expect certain factors to extend longer than we originally forecast in June. So, for fiscal twenty two, we are now forecasting earnings per share of eighteen point two five dollars to nineteen fifty before the mark to market retirement plan accounting adjustment and earnings per share of nineteen point seventy five to twenty one dollars before the mark to market adjustments and excluding estimated TNT integration expenses and cost associated with business realignment activities.

23:26 And our effective tax rate projection is approximately twenty four percent again prior to the mark to market retirement plan adjustments.

23:35 While our outlook reflects more uncertainty moving forward, it represents adjusted year over year EPS growth ranging from approximately nine percent to fifteen point five percent following our record fiscal twenty twenty one.

23:53 As you all know, we are navigating an inherently uncertain macro environment and managing several unknowns. The [Indiscernible] shape and timing of global economic recovery given the dynamics of the pandemic, including the spread and response to new and existing Covid variants, the uneven nature of global government restrictions, disruptions to global supply chains, and, of course, recovery and labor availability.

24:19 Our forecast assume continued growth in U.S. industrial production and global trade, a gradual improvement in labor availability, current fuel price expectations and existing tax regulations.

24:32 With respect to labor, we are assuming that the combination of these actions we are taking that Raj outlined combined with a steady increase in labor availability as we turn into calendar twenty two will allow us to add team members which will drive improvement in our efficiency, productivity and cost structure.

24:54 While we are not providing specific second quarter EPS guidance, I do want to highlight a few key assumptions within our outlook. Overall for the second quarter, we anticipate a similar level of headwinds in Q2 as we experienced in the first quarter as the challenges and impacts to our operations from the labor shortages are expected to persist in the rest of calendar twenty twenty one. Consistent with the first quarter, we also expect headwinds in Q2 to be driven by our expansion of Ground, higher healthcare expenses, COVID related air network inefficiencies at Express and the benefit in the prior year of reduced aviation excise taxes.

25:36 That said while these headwinds will persist in second quarter, we expect strong performance in the second half of fiscal twenty two.

25:43 We remain confident that our long term strategies will allow us to realize the benefits of growth investments in the future and next we'd be happy to address your questions.

Question-and-Answer Session

Operator

26:02 [Operator Instructions] And we'll go first to Scott Group from Wolfe Research. Your line is open.

Scott Group

26:24 Hey, thanks. So, guys, it strikes me that everybody in transportation right now has a lot of pricing power. And everyone's dealing with tight labor capacity and inflation, but every other transport companies reporting margin improvement and earnings growth. So, I guess my question is, why do you think you are seeing a bigger impact than anybody else in transportation and outside of just adding more capacity and spending more, what sort of meaningful significant changes do you think you need to make or are you contemplating making to start realizing more sustainable improvement in margin, earnings, returns, all that? Thank you.

Raj Subramaniam

27:14 Let me start by saying that we definitely do not see this as an us versus them situation at all. In fact, the Minneapolis Fed noted that firms in every sector reported difficulty in attracting labor and that sixty eight percent of the Fortune hundred companies - supply chain and labor disruptions over the past quarter.

27:34 So the situation is very complex, not just the availability of workers, workers impacted by safety concerns with the Covid, of course, the very really issue of childcare and our labor markets and broader economy cannot function properly and that schools and day care cannot stay open. So our approach to our teams and our people first culture combined with the flexible operating model in Ground has positioned to remain competitive in this market and we are highly confident that the actions we are taking to address the shortage as I outlined in my prepared remarks.

28:07 Let me just also add that we are very confident in our strategy. I mean where the market is growing, we have a differentiated value position, we have a network, an operating model that makes it very - that makes it good for us to succeed. And so we are confident in the long term strategy here. And as Mike said, we expect to see in the calendar year - the new calendar year the labor availability will continue to recover, Mike.

Mike Lenz

Yeah, Scott, just I would add, I think you can't just characterize all transportation companies in one singular bucket there and assume that everybody has the same considerations in terms of the nature of the business there. We've kind of explained with great specificity how this operationally impacts us and thus the financial ramifications of that. So, look, we fully recognize that the first quarter wasn't what we anticipated. We've taken a number of actions to address that. We will continue to identify further actions but I will fully say if the circumstances don't change as we identify here, we absolutely would need to revisit the pace of the plans that we have. The strategies are sound, but we would absolutely need to think about the pace of things given the environment that we're operating in. So, I think Brie highlighted the characteristics of what growth is and will continue to be in the business. So that remains the underpinning going forward.

Operator

30:02 And next we'll go to Brandon Oglenski from Barclays. Your line is open.

Brandon Oglenski

30:08 Good evening everyone and thank you for taking my question. Mike, can I just follow-up on that, I think the frustrating card from the investor perspective do you guys have definitely seen pretty substantial growth in the past decade, definitely put the capital behind that, but margins are actually lower now than they were prior peak returns have obviously come down, and we do hear lots of bold actions how to sustain forward growth. But I guess, I’m going to ask the question just the same way like what is being done in a bold way to improve returns and profitability across all these networks. And is there a way to look back and say hey we've been investing in the 777 and seven six seven for you to get Express margins [aren't showing] (ph) those traction, how do we review those prior plans to ensure that they deliver in the future? Thank you.

Mike Lenz

30:56 So, well, Brandon, let me first, you mentioned about Express investment in the aircraft there. If you rewind roughly a year and a half ago, we were in the midst of talking about parking and reducing capacity in a number of our MD11 fleet.

31:19 Obviously, the market changed radically here and there was the need for the additional capacity and the opportunity there, so we unparked those. Should things change going forward, that remains a flex lever and it absolutely is the case they're having a higher proportion of the newer more efficient aircraft with the seven sixty seven and triple seven are in the fleet will drive improved economics and margins at Express. So, again, we're ongoing looking at these different network initiatives and so that absolutely remains a long term winner in terms of the fleet renewal and we will continue with that.

32:04 What was the second part of – you started off with another aspect?

Brandon Oglenski

Well, you Mike, the frustrating thing I think for a lot of your investors is that the growth is very evident, especially in the last few years, it's just that margins have not improved. So there's always a plan to improve margins that doesn't seem to come through. So what are the bold steps that can be taken to improve those outcomes in the future?

Mike Lenz

Well, let me just step back a little bit. We had record results in twenty one and improved margins. Our guidance albeit lower than what we shared with you three months ago is if you look at the operating earnings in fact is double digit at the low end, we had some discrete tax items there. So, indeed, we are focused on driving improved margins, cash flows and returns and feel that we're projecting another record year on top of a record year. So, again, we are absolutely committed to continuing that trajectory.

Operator

33:17 And we'll go next to Chris Wetherbee from Citi. Your line is open.

Chris Wetherbee

33:22 Hey thanks for taking the question. I want to ask about costs, Mike, it’d be helpful to kind of run through a number of the items that were impacting the quarter. But if I were to sort of exclude those items and look at sort of the cost inflation on the package business, the Express and Ground package, it looks like I'm getting about nine percent cost inflation on essentially flat volume. So I was wondering maybe if you could help us understand ex some of the items that you've talked about, what's driving the cost inflation at such a high level when we're not seeing the volume growth for those individual segments. And maybe do you expect that to sort of change and do you think margins expand in both of those segments for the full year?

Mike Lenz

Well, let me let take a swing at that first. So as it relates to the cost inflation and taking that category broadly, let me just clarify what's in our outlook. The network inefficiencies inherently are contributing to that cost increase that you're talking about. We expect those to mitigate and work away. In our outlook that we're giving you here, we're not assuming any change in terms of the current labor market in terms of wage rates and that. So just to give you an illustrative example here, a year ago, our package handlers at Ground, we are paying an hourly rate that is sixteen percent more than previously, at our Express major sort locations the hourly rate is north of a twenty five percent increase. So that is the reality of the labor market right now. And so as Brie highlighted, we are taking a number of actions to recognize and address that; maybe if I help talk through as we go through the year here, I think maybe part of what you - we are also there. So again, like I said, more efficient operations as we go through the year, The pricing actions that we announced yesterday combined with our ongoing efforts, those largely will impact the second half of the year.

35:40 Raj highlighted a number of the adaptations we're making in our operating plans as well as some of the technology and other initiatives we're bringing on to execute more efficiently and then just to tie off some aspects here, we will have some tailwinds in the second half. As you may recall, we had the severe weather situation in the third quarter of last year, variable comp will be a tailwind in the second half of the year.

36:09 And then there was two other items with the frontline bonus program and then the recognition of our [yield] (ph) contribution. So trying to put all that in context for you there. Raj, anything you…

Raj Subramaniam

I just going to cap it of course by just saying that we expect in the second half that improve margins in all segments of our business.

Operator

And next we'll go to Ravi Shanker from Morgan Stanley. Your line is open.

Ravi Shanker

36:39 Thank you. I do want to follow-up on the last comment because again, some of the items that point to the second half being [Indiscernible] better than the Indiscernible]. So I'm just going to get the sense of how you have this confidence in second half being significantly better than the first half. The reason I’m asking the question is because you [Indiscernible] your full year guidance by approximately [Indiscernible] which doesn’t necessarily imply that you expect to be [Indiscernible]?.

Mike Lenz

37:25 Ravi, you broke up some there, but I there was a reference to some of these items being non-operational in the second half, I guess maybe I'd turn it around the other way and say if we were fully…

Ravi Shanker

Sorry if I can try again, if I stop [Indiscernible], I was wondering if you could get us a little bit more detail into why you think second half is going to be materially better than the first half because some of the items you quantified, the yield contribution, the variable comp etcetera, those seem kind of non-operational almost one-time [Indiscernible] nature kind of, so again, do you really feel like the top line could accelerate, the volumes are going to accelerate and the reason I’m asking this question is because you basically cut your full year guidance by approximately the magnitude of the first quarter miss, which does not seem to imply that you are expecting the labor cost [expense] (ph) to continue for the rest of the year?

Mike Lenz

Well, we're not sitting on our hands amidst the circumstances, we're taking actions to mitigate it. So, I wouldn't characterize it as just singularly looking at Q1 and changing as a result of the outcome of that. So we're aggressively managing every aspect there.

38:47 I guess, I might turn it around the other way and say, if you looked at our results in Q1 absent the labor availability challenges, it would be extraordinary and thus we realize the absolute number matters and so we're taking actions on a number of fronts that will make the second half exactly as we outlined. I'll let Brie address your volume question for later as we go through the year.

Brie Carere

39:17 Yes. I guess the only thing to add is we're still pretty bullish on the volume growth and our ability to take share both domestically and internationally. The Q1 of our fiscal year is the hardest comp year over year from a growth perspective. So for sure we had to say earlier I think there was a comment earlier about kind of flat volumes. We have to put that in perspective and we have record high volumes within the network right now as we look towards peak. We're going to see growth on what was a tremendous growth at peak last year. So, we are pretty confident in the volumes and again, to complement what Mike shared as a reminder, a lot of our increase [Indiscernible] in January, so we'll [have] (ph) it in the back half, which is obviously a big driver of back half performance and then a couple of things, John’s got some great technology that's coming into market as we head into peak and in the back half. It’s going to help us be more productive, and Karen Reddington and the Europe team has some incredible work going on as they finalize the integration of the Air Network, and we've got some other work going on there to improve European profitability. So, we are pretty confident in the back half of the year.

Operator

40:25 And next, we'll go to Ken Hoexter from Bank of America. Your line is open.

Ken Hoexter

40:30 Hi, thanks. So, Raj, I think there was a comment in the release kind of talking about some of the deceleration on some of the e-commerce with ground volumes down ten percent year over year international, domestic down thirteen percent. Is that part of what you're anticipating for labor to improve or maybe just talk about the topline where you were just mentioning still seeing strength and a good network in the peak, but yet these numbers indicate and kind of what we're hearing from the market that we're seeing some of this deceleration as you had in the print, so maybe just talk about the volume side a little more.

Raj Subramaniam

41:04 Sure. I'll start and then I'll turn it over to Brie. No, absolutely we are actually seeing very strong volume to add to what Brie just said. The only reason we are seeing a flat volume in the ground segment is because of the economy product we just broke out for you for the first time. And even from a -- the commercial volume is growing strongly and even our HD volume on a very tough year-over-year comp we’re still going on top of that, and International is growing very strong. So, over – the only place we’re not going -- restructuring our international and domestic businesses, but our IP business, our IE business, our export business is very, very strong. So no, the demand for our services continues to be very strong because of the differentiation that we are providing in the marketplace, and we continue to gain market share around the world, so Brie?

Brie Carere

41:59 Yes, I think Raj kind of outlined it pretty clearly from a volume perspective as we get beyond. I guess the one thing I should add that maybe it wasn't clear in my opening remarks is that we are constraining demand right now. As Mike and Raj talked about the labor, we are doing everything we can to strike that right balance of growth with service. And I will tell you that as we've done that, you can see where we've constrained it. It's the FedEx Economy product, it's the least profitable product, so it's the right place to constrain growth. And we have made sure that we are not constraining growth in our highest profitable segments, small and medium and at the commercial, and you saw those strong commercial numbers that I referenced earlier. So, I would say number one, we're confident in the secular growth opportunity for FedEx; two, we feel we've been gaining share, my last market share report shows that, and then we are having to constrain because of the labor issues, we are doing so in a very disciplined manner.

Operator

42:59 And next we'll go to Tom Wadewitz from UBS. Your line is open.

Tom Wadewitz

43:05 Yes, thank you. I Wanted to go back to labor. I mean, it seems like your guide really, in a pretty big way, hinges on that assumption of improving labor availability in the second half. So, I guess just two elements to that. Do you feel like you have much visibility to that improvement and what maybe have you seen that would give you confidence that that's going to happen? And then I guess a component within that if you go into peak, it would seem like if you can't [staff the swords] (ph) ahead of peak, then you have to hire, I don't know your number is fifty thousand people, seventy thousand people that could -- that problem could get worse before it gets better. So, I guess visibility on your labor and being okay during peak as well? Thank you.

Raj Subramaniam

43:57 Thank you, Tom. Yes, the number is ninety thousand, and we are well on our way here. Now, we have -- the last two weeks, we have seen pockets of opportunity and positive changes that we hadn't seen in the first quarter, so that uses a little bit of encouragement, and this is a systemic issue, and so yes, we're making some assumptions here in terms of labor availability, but if we staff up for peak, then hopefully in Q3, we will be in good shape. So, we’re making – we’re not making dramatic assumptions here in terms of Q3 and Q4, but we are assuming that Q3 is going to be better than Q2, better than Q1, and the early indication just very early indication is that that's indeed the case. So, I don't know, Mike if you want to add anything to that.

Mike Lenz

44:51 No, just to reiterate, I broke the labor impact into two pieces. The part that we're assuming that does mitigate as Raj outlined is the impact from the availability. Again, the market wage rate is what it is, and we can assume nothing different than that, and that is what is baked in to the outlook.

Operator

45:18 And next we'll go to Brian Ossenbeck from JP Morgan. Your line is open.

Brian Ossenbeck

45:24 Hi, thanks for taking the question. Just wanted to ask Brie about the trends in pricing. Obviously, we saw the GRI issue that you talked about briefly. We’ve got some new surcharges in place; fuel is going up. But I think you mentioned in your prepared remarks, there's some availability for people, the largest shippers to get capacity now at current rates. So, maybe you can just instil that -- those two factors, what do you feel about getting price in the market to capture? You are ahead on some of these costs, and then maybe if you can clarify the comments on the larger shippers and generally talk about the surges from a volume perspective? Thank you.

Brie Carere

46:07 Thanks Brian, good question. To be really clear when we're talking about incremental capacity, one of the key elements of our revenue quality strategy, which has application here in the United States as well as in our intercontinental. As we talked about it, I talked about the six new flights that we launched from an Asia outbound perspective, and that was primarily quite frankly transition from ad hoc to scheduled service to improve reliability, but that allows us to plan and predict and it also allows us to sell differently. As we sold into those flights versus previously a lot of that was kind of catch up in spot rates, we are making sure that we are bringing on customers at current rates, and we are measuring kind of those current rates. So, if a customer had “X” use of our intercontinental lift prior to the last eighteen months, we've contractual terms there. But as we increase the capacity, we give those customers that incremental business, it comes on at a higher rate.

47:05 So, we're really trying to strike the right balance with our customers, give them the predictability that they need and honour our existing contractual terms, as well as, as we expand capacity, give them availability to that capacity at an incremental current market rate, so really trying to strike that right balance. So that's what I was referring to. It's predominantly in the intercontinental side, of course it does have application from a peak perspective. As we brought on new customers this year and we look at our surging customers, they obviously -- those peak surcharges help them get the capacity they need, so they can have a successful peak. I hope that helps answer your question.

Operator

47:46 And next we'll go to Jordan Alliger from Goldman Sachs. Your line is open.

Jordan Alliger

47:51 Yeah, Hi. Just on the new ground, buckets that you’ve broken out, can you maybe talk a little bit about the three pieces and would you expect going forward roughly similar trend lines with the commercial sort of outpacing everything, but still positive on the home delivery, and as you mentioned the constraining capacity to keep limiting the last piece of the business?

Brie Carere

48:17 Great question. So, for this fiscal year, as we talked about, inventory levels are at an all-time low, and all of the economic indicators that we're tracking is saying that we're going have a very strong commercial year here in the United States as well as in Europe. And of course, that's also going to drive our intercontinental business. So, for FedEx Ground commercial, we are expecting a strong growth here from a home delivery perspective. I do think that you will see, you know we will see moderate growth for home delivery given the lapping of last year's very, very strong growth. So, I think you're going to see some good home delivery growth, and from an economy perspective this particular quarter you saw the thirty percent year-over-year decline. I do not think you will see that trend continue. John and I are working, and we've got some really great new technology coming to market, a new feature called [sort to due day] (ph), which is going to allow us to really move economy through the FedEx Ground system at a different pace and continue to lower the cost. So, I think you'll see us find a better balance of the economy to home delivery, but directionally commercial will grow the fastest followed by home delivery followed by economy as we think about this fiscal year.

Operator

49:35 And next we'll go to David Vernon from Bernstein. Your line is open.

David Vernon

49:40 Hey, good afternoon. Brie, just following up on that sort of growth outlook, you put out some numbers out there around ten percent market growth, I think in residential for the next couple years. Is your expectation that that pricing and the operation will be at a point where you can kind of participate at an above-market growth rate from – once you get past the period of volatility or do you intend to kind of grow the ground business maybe a little bit lower than the overall market as some other competitors add capacity at the lower end of the service spectrum.

Brie Carere

50:13 That's my favourite question, yes. Our intent, we have the best value proposition in the market. We have the best seven-day transit and coverage in the market. We feel really good about our value proposition. As I mentioned earlier, we are actually right now controlling demand, because we're trying to balance service in the current labor environment. So that is absolutely our intent. The market is growing. We've got a great value proposition. I can't think of a better time to lean in to growth here in the United States.

Operator

50:51 And we'll take our next question from Todd Fowler from KeyBanc Capital Markets. Your line is open.

Todd Fowler

50:57 Hi, great. Thanks, and good evening. Mike, I understand kind of the thoughts around not being too specific about quarterly guidance, but I do think from a street perspective, kind of the volatility from quarter to quarter can be an issue. So, I just want to make sure, are you seeing that in the second quarter you're expecting a similar eight hundred million dollars magnitude of year-over-year headwinds? And then secondly, when we think sequentially the second quarter, operating income is flat or down a little bit from the first quarter. Is that going to be a similar cadence this year? Are there some other things that we should think about just as we move into the second quarter from a seasonal standpoint? Thanks.

Mike Lenz

51:35 Sure, Todd. Yes, that's a fair characterization when I said the headwinds would be similar to the eight hundred million, look the pandemic and many other factors impacting our market including the supply chain disruptions, I think you have to kind of take pause in terms of assuming typical seasonality across the board. Yes, there is a degree of that that you will see, but I would say we can't just rely upon that because the dynamics are much more fluid than they were, and that’s why we're trying to outline that as best we can, but we're navigating those changes along the way, but we're very confident what we shared with you.

Operator

52:29 And next we'll go to Amit Mehrotra from Deutsche Bank. Your line is open.

Amit Mehrotra

52:35 I just wanted to follow-up on that last question. So, I just want to understand, so you’re obviously entering peak season, higher B2C mix, margin pressure, density pressure, so you typically see a pretty notable step down in ground margins fiscal 1Q to 2Q. Is that the same cadence? I mean because 1Q is obviously pretty low to begin with, just trying to get understanding of that, and just as a high level, do you think ground margins can be up year over year this year? Thanks.

Mike Lenz

53:08 So Amit, I'm just going to stick with it. We're not giving a margin forecast. What we outlined was that we expect operating profit to be up in all the transportation segments. So, I'm not going to get into giving a specific margin forecast by quarter. And again, the seasonality is we don't think it's value added to kind of get into trying to parse that at a level of precision given the dynamics of the market right now.

Operator

And next we'll go to Helane Becker from Cowen. Your line is open.

Helane Becker

53:50 Thanks very much, operator. Hi, everybody and thank you for the time. So, we've been actually doing a lot of work as you know in the China area, and you guys have about thirty thousand people employed there. I think it's getting increasingly more difficult to work there. So, can you just talk about how you're thinking longer term about being in that market versus moving more capacity offshore to places like where you have regional sorts like Japan or back to the Philippines? Thank you.

Mike Lenz

54:27 Thank you Helane for that question. We actually have twelve thousand employees in China. As you know, we have been in business in China since nineteen eighty four, and we have been serving our customers there in this extremely important market. We value our business in China, and we are committed to continuing to improve our value proposition there. Our growth in the market is very strong, and our operations in our hub in Guangzhou is just going smoothly. We also just opened up new air operations from Beijing. So, China remains a very important market for us, and we are very committed to it.

Operator

55:17 And next we'll go to Jack Atkins from Stephens. Your line is open.

Jack Atkins

55:22 Okay, great. Thank you for taking my question. I guess just to go back to the CAPEX and return discussion for all, and Mike thank you so much for the additional sort of comments around returns and free cash flow. But I guess when you think about sort of the longer-term targets for the business, you guys have always sort of talked about this double-digit consolidated operating margin. We haven't really come close to it since fiscal year sixteen.

55:49 You raised the CAPEX as a percentage of revenue targets and the proxy several weeks ago. Can you talk about why it makes sense to raise your long-term capital spending plans when the business still isn't achieving the long-term targets you've set for it from a margin perspective? Just help us square those two things. I think that's a vested issue that a lot of people are having trouble justifying.

Mike Lenz

56:19 Right. Well, Jack, First, let me just say, you brought up about ROIC, and I'll expand a little bit about on the remarks I made earlier there. We're obviously referencing to our WACC when we compare our ROIC, which we put in the seven percent to nine percent range, which I think is consistent with what we see in many of your analyses. But when it comes to the ROIC itself, there are a number of different approaches and methods that practitioners use, so this tends to be variability in the absolute as well as the comparative measurements, but that said we're revisiting the various aspects of that so that we can maybe expand the context around our discussion of the topic, but I will say regardless of how you calculate it, our ROIC does remain above our WACC.

57:12 So, since you asked about the LTI plan, look, I am not going to speak on behalf of the Board, but I will give you some context around partly about what I mentioned two, three months ago. So, again, we had record earnings in fiscal twenty one amidst the unprecedented global pandemic and delivering life-saving vaccines around the world. And we’ve talked about the radical changes in supply chains, customer expectations, and all that, so we did indeed accelerate purposefully some investment opportunities for capacity expansion and of course the replacement of the aircraft I mentioned before. So, as I did specifically say on the June call, the FY twenty two to twenty four LTI plan was eight percent to account for these opportunities, and that target is below our historical capital intensity. Fiscal twenty one was seven percent, but that was the lowest in ten years. So, again, there's absolutely a focus on returns, and I think that we will continue to address your considerations there, and I would also highlight because there was the question earlier about ground and investment there, and we're making returns there.

58:41 And we talked a lot about how we're utilizing our assets differently, more efficiently, vesting in smaller units of capacity. We got the one single hub, but there’s no other hubs on the drawing board if ground can generate a higher ROIC at different margin levels than it did probably eight, nine years ago. So, again, that absolutely factors into how we look at these things.

Operator

59:16 And next, we'll go to Allison Poliniak from Wells Fargo. Your line is open.

Allison Poliniak

Hi good evening. Brie, I think you had mentioned low-single digit share internationally, certainly unique environment, limited capacity. Can you maybe talk to how you are focused on expanding share, things you're doing there, but more importantly what are you doing to try to retain some of that share you're capturing today, you know once capacity eases at this point?

Brie Carere

Great question. So, a couple of things; number one, when we think about our international business, our largest growth opportunity is Europe. So, when we think about what are we doing to gain share, well first and foremost, we're going to complete the physical integration which is obviously critical, but when I think about Europe there's three lines of business. There's the intra- Europe. We bought TNT, and it has a very comprehensive and very unique value proposition, because it's got the parcel and the freight network intra-Europe to grow our cross-border business and we're very pleased with the momentum there. From an international perspective, late last fiscal year, we expanded our intercontinental value proposition between Europe and the United States.

60:26 We now have ninety percent of businesses in EU 17, have access with the fastest overnight services to the United States. So, we have the leading intercontinental value proposition from Europe to the US. It's a great bundle to sell B2B or commercial customers, sell the intra-Europe as well as the intercontinental. And then thirdly, when I think about Europe, we are absolutely underpenetrated in e-commerce both within Europe as well as from Europe to the United States. And we, as I talked about, have launched the FIC product, which is really a very competitive product. It's got quick transit times and it has very different features of service for last mile, so it allows us to lower our costs to serve because the features on the last mile delivery was a lot more like the ground domestic network. So that's our primary focus from a Europe perspective. I will say we are also underpenetrated between Asia and Europe, and we've got great momentum in that lane, similar metrics. We have sped up our service into Europe from Asia. In addition to that, we are launching the FICP product between those countries, obviously Asia into Europe is a very large e-commerce market. And again, we're underpenetrated there, really

pleased with the momentum of our FICP product.

61:30 So, I hope that helps clarify. I also wanted to go back. I just looked at my notes, commercial and home delivery here in the United States, as we think about the rest of the fiscal year are going to be neck and neck from a growth perspective. So, as I talked about commercial growing faster than home delivery, we are going to be pretty darn close as we look at the volume growth this year.

Operator

62:03 And next, we'll go to Bascome Majors from Susquehanna. Your line is open.

Bascome Majors

62:09 Good afternoon. When I look at the LTL freight business, it seems to be performing much better relative to at least early expectations compared to parcel. Yes, that's still a manual labor intensive business that requires a lot of drivers, line haul, freight handling, and bodies to do that. Can you characterize why you think that you haven't had these labor driven struggles in that part of your business that seem to be plaguing the parcel businesses particularly domestically, any best practices or lessons you can learn and apply elsewhere? Thank you.

Mike Lenz

62:51 Bascome, this Mike. So, I'll let Raj address more broadly, but just to clarify within that four fifty number of labor impact, there is an impact there for freight in terms of the same considerations that we talked about there. So, I don't want to have the takeaway or imply that the freight team isn't dealing with similar considerations there.

63:13 But, I'll also highlight as I mentioned to Scott early on there that different networks and different transportation businesses can have different characteristics in that. So, Raj, do you want talk about the great things at freight?

Raj Subramaniam

Well, we are extremely proud of the FedEx freight team, and they are also leading with exactly the same set of challenges, and but we have -- the team has done a fantastic job of managing through our revenue quality and operational efficiency despite these challenging circumstances, and we know it's an obviously very, very key part of our portfolio. Having said that, twenty million packages on the ground network per day or the ground US domestic parcel network is a very different – very different set of challenges than dealing with a much smaller set of shipments that go through the freight system. So, your point about sharing best practices and making sure that we do the right thing across our operating companies, that goes on every single day, and we operate collaboratively is a big mantra at FedEx now, and we are definitely doing that. So again, I'm very, very proud of what the freight team has done here.

Operator

64:30 And next we'll go to Duane Pfennigwerth from Evercore ISI. Your line is open.

Duane Pfennigwerth

64:37 Hey, thanks. So, just on the two hundred million wage pressure in the two fifty million in inefficiencies that that triggered, but just to dive a little deeper there, was this a turnover issue or an investment for growth issue? Are people leaving at a faster rate or are you struggling to staff to grow? And if it's the latter, given the environment, why grow?

Mike Lenz

So, I think if I understand the question, it is a staffing availability issue on the two fifty million piece of it. For the two hundred million, it's the rate. So, just to reiterate that, and like I said, we fully expect and are beginning to see some improvement in the availability but should not – should plan to not proceed as we fully expect. And like I said earlier, we would need to obviously reassess the pace of implementing the initiatives there, but the opportunity remains nonetheless. We just need to be mindful of the overall environment.

Raj Subramaniam

65:51 Yes, and I would just add one line to that is, if that were to happen, then there’s obviously much broader implications that’s way beyond FedEx.

Operator

66:03 And now, I'd like to turn it back to Mickey Foster for closing remarks.

Mickey Foster

66:09 Thank you for your participation in the FedEx Corporation's First Quarter Earnings Conference Call. Feel free to call anyone on the Investor Relations team if you have additional questions about FedEx. Thank you very much. Bye.

Operator

66:26 And it does conclude our call for today. Thank you for your participation. You may now disconnect.

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