聯邦快遞 (FDX) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

Welcome to the FedEx Corporation's second quarter fiscal year 2003 FedEx earnings release conference call.

At this time all participants have been placed on a listen-only mode and the floor will be open for questions and comments following the presentation.

If you would like to register your question you may do so by pressing the numbers 1 and 4 on your touch tone phone at this time.

It is now my pleasure to turn the floor over to your host, Mr. Jim Clippard.

Sir, you may begin.

Thank you, Holly and good morning, ladies and gentlemen.

Welcome to the FedEx Corporation second quarter earnings conference call.

I'm Jim Clippard, Vice President, investor relations at FedEx Corporation.

The earnings release and stat book are available on our web page at FedEx.com.

This call is being broadcast from our web site and will be available for approximately two weeks.

Joining us on the call today are members of the media.

I want to remind our listeners that FedEx Corporation desires to take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act.

Certain statements made by us during this 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, express or implied by such forward-looking statements.

Potential risks and uncertainties include, but are not limited to, any impacts on the company's business resulting from the events that occurred on September 11th, 2001, or any future acts, threats, or acts of terrorism, the timing and amount of any money that FedEx is entitled to receive under the Air Transportation Safety System Stabilization Act, the timing, speed and magnitude of any economic recovery during the remainder of the Company's 2003 fiscal year, the ability to match capacity to shifting volumes and other factors which can be found in FedEx corporation's and its subsidiaries' press releases and files with the S.E.C.

Joining us on the call today are Fred Smith, Chairman, President, and CEO;

Alan Graf, Executive Vice President, CFO;

Mike Glenn, Executive Vice President, Market Development and Corporate Communications;

Rob Carter, Executive Vice President, CIO;

Dave Bronczek, President and CEO of FedEx Express;

Dan Sullivan, President and CEO of FedEx Ground, and Doug Duncan, President and CEO of FedEx Freight.

And now our Chairman, Fred Smith, will share his views on the quarter followed by Alan Graf.

After Alan we will have time for Q&A.

Fred?

Thank you, Jim.

Good morning ladies and gentlemen.

Thank you for joining the call.

We believe FedEx continues to deliver on the strategy which we laid out for you a couple years ago and produced solid financial results.

We're executing our portfolio strategy very well in this economic environment.

Our three core operating companies saw solid revenue growth and we're particularly pleased with FedEx Ground's strong performance.

FedEx Freight also posted solid results in the volume growth trend and FedEx International Priority is particularly encouraging for our Express company.

The demand for FedEx home delivery, a part of FedEx Ground, continues to be strong, and we are enormously proud that it became profitable this quarter, well ahead of schedule.

We saw impressive growth in our ground business with an operating margin of almost 16%.

It demonstrates the improved service levels and country-wide reach of this business.

Strong growth trends in international priority service were marked particularly by strong growth of exports from Asia.

We enjoy incremental revenue from the U.S.

Postal Service transportation contract.

FedEx Freight posted very solid numbers and expanded its reach to and from Europe with a less than container load cease service.

We produced strong free cash flow, $262 million dollars, which compares to $149 million over the same six-month period last year.

We believe customers are increasingly receptive to our broad set of solutions and our industry-leading service.

We're quite proud that FedEx swept all three categories, air, ground, and international in the package delivery segment in the recent customer survey conducted by J.D.

Power and Associates.

Customer service has always been the hallmark of this company and the more than 200,000 employees, associates and contractors throughout the FedEx networks earn that recognition every day.

We're very proud of them, and I assure you that this honor will further fuel our passion to work even harder for our customers.

And we're continually looking for ways to improve how we serve our customers by operating an unparalleled global network at FedEx Express, by providing an unrivaled convenience and accessibility capability, and constantly refining our leading-edge information and technology to remain the best in the industry.

I believe our solid performance is a testament to the strong management teams throughout our company.

Our Presidents and C.E.O.s are doing a tremendous job in pursuing revenue and growth opportunities while maintaining control of discretionary and capital expenses.

Moving forward, we intend to capitalize on several growth opportunities.

We are saying, of course, strong growth [inaudible] both in ground both the business to business and business to consumer segments with our FedEx home delivery service.

We intend to continue our international expansion, especially in Asia where we were recently awarded six interim daily flight frequencies in Hong Kong, bringing our total in that market to 11.

This will allow FedEx Express to carry local traffic on key flights within the fast-growing Asia-Pacific region and it will strengthen our competitive stance and do so at minimal startup costs.

We'll continue to enjoy growth in our Freight business, and we see ongoing demand for supply chain efficiencies and fast cycle distribution methods around the world, fueling the need for FedEx services.

I want to stress that we remain very committed to continuing to improve our overall financial performance, margins, cash flow, and ROIC.

In conclusion, I think you're all aware that this is a peak week due to the holiday season.

So for all you procrastinators, I know there are a few sitting around this table, I'd like to remind you, you still have five shipping days left by FedEx Express to have those holiday gifts arrive on or before Christmas eve.

Now I turn it over to our Executive Vice President and CFO, Alan Graf.

Thank you, Fred.

Good morning, everyone.

I'd like to highlight the successes of the second quarter at FedEx Corporation.

The big take-away in my view that the FedEx strategy continues to produce solid financial results.

For the quarter we had revenue growth overall of 10%.

We saw significant operating margin improvements at Ground and Freight, and our free cash flow grew substantially on a year-over-year basis.

In terms of revenue growth, Ground was up an unbelievable 27% year over year.

Freight grew 12%.

Over all the company was up 10%, and Express international priority volume grew 13% in a less-than-robust economic environment.

The operating margin at Ground was 15.6% versus 11.8% in the previous year, an unbelievably strong performance.

Freight, the leader in terms of revenue and operating ratio, saw its operating margin improved at 10.2% from 9.8%.

Our strong cash flow generation continues.

For the six months year to date, our operating cash flows were up $262 million.

That's versus an increase of $149 million in fiscal '02's first six months and does include the $241 million pension contribution that was mentioned in our press release.

Our balance sheet continues to strengthen as a result.

We did acquire 475,000 shares this quarter on our stock repurchase plan and, of course, we continued with our dividend.

After capital expenditures, we expect fiscal '03 now to approximately $1.7 billion for the year, down nearly $200 million and for '04 our capital expenditures program will depend totally on the economic outlook that we see in the late spring of calendar '03.

You'll hear from Dan Sullivan in the Q&A period about FedEx Ground but I did want to point out that home delivery was profitable for the first time and well ahead of schedule because of the great value being added by that service.

At Express, our U.S. domestic volumes are down slightly in this quarter when normalized for the events of 9-11.

Our margins are down due to benefit increases, most notably pension and health care, which we have been discussing with you, maintenance expense and net fuel costs.

The maintenance expenses are up this quarter due to a significantly large number of wide-body engine events, and we expect maintenance in the second half will be mitigated significantly on a year-over-year basis.

In terms of fuel, the net, we expect fuel and surcharges to be in much better balance in the second half of fiscal '03 and beyond as our dynamic fuel surcharge has now been in place for a year this November, and the comparisons should be better.

And with that, operator, we are happy to begin taking the questions.

Thank you, sir.

The floor is now open for questions.

If you do have a question, please press the numbers 1 followed by 4 on your touch tone phone.

To remove yourself from the queue, please dial the pound sign.

We do ask that while you pose your question, that you please pick up the handset to provide optimum sound quality.

Once again, that is 1 followed by 4.

Our first question is coming from Donald Bralton of A.G. Edwards.

Please go ahead with your question.

Good morning, gentlemen.

Good morning, Don.

Nice quarter.

I'm most interested in the change in cash.

In addition to the positive cash flow, which is very nice to see, we saw a couple of things, a share repurchase.

Can you walk me through your decision to use cash to repurchase shares?

Sure, Don.

We have long had a philosophy that because a big part of our compensation program, our stock options, we do not want those exercises of stock options to dilute our earnings per share, so we are simply at the moment acquiring shares to offset stock option exercises.

Fair enough.

Why the decrease in CAP-X?

Well, obviously, the economy has not been as strong as we had projected when we came up with our fiscal '03 plan and we're simply managing CAP-X to meet the needs of our customers and the volumes that we have.

Still a significant investment of $1.7 billion during this year because we are planning on growing all of our businesses but just less on the margin due to the current economic environment.

All right.

Fair enough.

From interviewing drivers, even a few shippers, I got the sense that volume sequentially grew on a month-by-month basis really from July on and throughout the quarter.

Can you give me some color there on what you saw in volume trends at Ground?

Obviously, there was a phenomenal performance.

I'll let Mr. Sullivan answer that question for you, Don.

Yeah.

Good morning, Don.

We saw our volumes increase through the quarter.

After first quarter October it did slow down a little bit but we came back pretty strong in November with record volumes on a per-month basis.

So we saw good progress through the quarter.

And any color on the markets?

Obviously, you can't get this kind of gain without market share gains improvements.

Any color on where you think you're getting market share?

Well, by our analysis, we believe we are improving market share, and I think really because of our overall enhanced value proposition, certainly the strength of the brand has helped us tremendously.

We've improved our network speed and reliability of service.

We've been able to make good inroads in the overnight and small shipper segment, and of course home delivery has been a tremendous growth for our company.

Running over triple digits.

Great.

I'll let someone else have the floor.

Thank you.

Our next question is coming from John Larkin of Legg Mason.

Yes.

Hi.

Good morning, gentlemen.

I'm very interested in your FedEx Freight performance.

It looks like the revenue for 100 weight was up very strongly there, something like 8%.

I was wondering how much of that, in your opinion, was related to length of haul change and how much of that was related to mix change and/or price change.

John, this is Doug Duncan.

There were a number of factors there.

I think the first and foremost is our focus on the high service business.

You'll recall we also had a 5.9% general increase back in July.

Right.

We've had excellence contract renewals, and some of it is coming from the length of hauls because of the success of our easy flier product.

And there's about a half a point in there due to fuel surcharge differences.

So are you revealing how much of an increase you've seen in your overall length of haul?

No.

That's not a number that we make public at this point.

Okay.

And then just one other question, a broader question regarding guidance on the fiscal third quarter.

There was an indication in the press release that you're thinking that the manufacturing and industrial environment continues to be somewhat sluggish but that you would anticipate a slight tick-up in your fiscal first quarter.

Any comments on what you're seeing in what I would call the retail and consumer world here in the first month of your third quarter?

This is Mike Glenn speaking.

We've seen a little stronger performance in the retail sector here in the peak season, tends to be lead by the larger retailers.

It will be interesting to see what happens after the holiday season.

However, it's still very, very cloudy at this point although we are anticipating a slight tickup in the economy.

Just for reference point, we're kind of looking at -- for the second half of the year, somewhere in the neighborhood for the third quarter, about 2.5%, and improving a little bit to over 3% in the fourth quarter.

That's slightly below the blue chip census so we're more pessimistic on the blue chip consensus but we are anticipating some improvement.

Mike is referring to our internal GDP improvements on a quarter over quarter basis in the first and second calendar quarters of 2003.

I should add, John, that obviously, our third quarter is our seasonally low quarter, where earnings are much more sensitive to overall volumes, and then we begin to pick back up again in our fourth fiscal quarter with essentially the same fixed cost structure.

So while we've given you a range for Q3, we still think that the $2.70 cent number which we've had now for quite some time is still achievable with those modest economic improvements.

Thank you very much.

Thank you.

Our next question is coming from Scott Flower of Salomon Smith Barney.

Good morning all.

I was wondering if Dan Sullivan might give us a little sense, as we look at the home delivery product -- and obviously that's been a real success and certainly has become profitable certainly a lot sooner than you and certainly, obviously, the financial community would have expected.

Is that going to be uneven seasonally, i.e. this would be a good period in volumes, I would imagine for B2C, third calendar quarter going into fourth.

Will that ebb and flow between profitability and slight losses or stay going forward solidly in the black?

Well, Scott, I'd like to think that it's going to say solidly in the black going forward.

Certainly this is our peak season, November, and especially into December where we should perform very well, but the overall growth of home delivery has been consistently in the triple digits and we have been improving through time.

Okay.

So I think we'll -- I think we're going to keep it in the black.

So even though --you know, 'cause I was just wondering if the seasonal falloff as you go in the calendar first quarter.

Despite that we should stay break-even or better?

I believe so, yes.

And then just one other question.

And I realize the comparisons could be distorted because of last year's events.

But when I look at the product volume numbers within air express domestically, the deferred products continue to look like they are out-performing the overnight box or envelope product, and I'm just wondering, is this still a function of people in this type of economy trading down?

I wonder if Mike can lend some color on that.

Scott, I wouldn't characterize it as a function every trading down.

More importantly, I think it's an issue when you begin to see signs of economic recovery, the first things we have historically seen is a stronger growth in the deferred services prior to your overnight services coming back strong.

Having said that, as we talked about at the analysts meeting, on a customer-by-customer basis we see customers optimizing the network but that's not a major issue to us.

It's more economic driven.

And again it's not surprising to us that we would see stronger growth as we begin to see hopefully some sustained economic improvement coming first in the deferred services.

Okay.

Great.

Thank you very much.

Thank you.

Our next question is coming from Tom Albrecht of BBT.

Thank you.

Good morning.

Good morning, Tom.

A couple questions.

You commented on your international priority product growth in Asia but I'm wondering how European exports did as well as U.S. exports.

Yeah.

Hi, Tom.

This is Dave Bronczek.

Europe continues to do very well.

This is the third consecutive year of quarter-over-quarter-over-quarter of double digit growth there solidly in the middle of the double digit range of 15, 16% growth for Europe.

Asia, of course, grew at 27%, and all ups 13% so we're very, very optimistic that our international growth will continue.

Our U.S. outbound also grew this quarter.

Yeah, that's an important point.

That's the first growth in U.S. outbound in seven quarters for us, so we think we may have seen a turning point there.

Was that barely growth or was it like 6-8% or something like that on the U.S. product?

We grew at about 3.5% in the quarter.

Okay.

And then would anyone care to share exactly how profitable home delivery was?

Well, I don't think that's really important to the overall scheme of things as is the fact that it reached profitability, and by the end of this fiscal year we probably aren't even going to discuss it.

I think, the point was we made a significant investment in a new market that had startup losses.

It's driving a significant amount of volume.

Of course, the line haul networks are the same, and so the fact is it's no longer a drain on our financial performance.

In terms of the FedEx Ground profitability, where do you think the operating margins can go over the next couple of years, typically when a trucking company gets to a 15% operating margin, it's difficult to have much expansion beyond that, yet you've had a quarter, this one that was a little bit better than that.

A couple quarters ago I think it was 18%.

Can you talk about possibly the margin potential even from these great levels for FedEx Ground?

Well, we'll let Dan think about that a second.

I think the most important factor here is the continued strong growth at Ground which will drive significant cash flows.

At these levels of margins we're very happy with those and I don't think we're as concerned about expanding those margins as we are continuing the very strong growth pattern.

Dan?

Yeah.

I agree with you, Al.

And I do think, though, that we should continue to produce solid double digit margins at Ground.

As Alan mentioned before, there is sensitivity to volume as we head into the fiscal third quarter but I think we should come back strong from that.

So as long as we continue to grow, the productivity improves as it has in the past, I think we'll be in good shape.

What about growth for FedEx Ground, the next quarter or two?

I think if we go back three months ago, one of the things that people were pleasantly surprised by was your belief that you would continue to grow close to 25% here this quarter for FedEx Ground, you know, having seen the threat of a strike at a competitor go away.

Should we have this same kind of optimism, 20-plus percent growth rate for the third and fourth quarters or begin to creep back a little bit lower to maybe more of an upper teens growth rate?

Well, I'll let both Mike and Dan comment on that.

Obviously, the law of large numbers, the percentage comparisons start to begin to be much more difficult as you come around the track where you had a very strong growth in the previous year.

So I don't know that we can maintain a 25% growth rate, but on an absolute basis, I think we can continue to grow a significant amount of packages on a year over year basis and I'll let Mike and Dan comment on that.

Yeah.

Al, I agree.

Again, we grew 21% in the second half last year, so our comparables are going to be a lot tougher going forward.

I do think we're going to continue to grow.

I think hitting 25%, however, is going to be pretty tough for us.

So you know, again, I'd like to say we'll be in solid double digits for the foreseeable future.

Okay.

Thank you for your comments.

Thank you.

Our next question is coming from Richard Friery of Delphi Management.

Yeah.

The FedEx Express business, going forward, what do you think you can grow revenues, and also when might you get back to those 8% operating margins?

I'll answer the second part first.

The entire difference between last year's second quarter and this year is what Al had mentioned first.

Our maintenance expenses, primarily driven by engine events off our wide bodies, obviously, some of the additional maintenance because of the post office business that we're now handling.

Also the fuel and some pension and health care.

If you had those normalized year over year we would actually have an up quarter in operating profit.

All right.

I would say that 8% is a good target from where we are but it's certainly not our objective.

We need to drive Express's overall margins to 10 and then go from there.

The key leverage factors for us are international priority and domestic growth, in that order.

We have a very large marginal return on additional sales in the international, and we are highly focused on that.

We do expect that when the parts of the economy who are very heavy express users begin to see some relief, and they are the one that is have been hit the strongest, we will get back on that growth plane on the domestic express business as well.

One further thing.

Have you been impacted at all, have you received any benefit from the west coast dock strike?

Well, I just point out that our Asia growth rates were 27% last quarter.

They are 27% again this quarter.

Our freight pounds have gone up 10%.

We've added a few extra sections through the month, and we have added extra capacity as well.

We put a west coast around the world flight in.

So I think that we've seen some incremental freight pounds.

And there's also been some benefit at Ground and Freight also as a result of this, but that's on a static basis.

We also believe that the economic activity of the whole country was hurt somewhat by that strike, had a negative impact on us as well so dynamically, I don't think it was much of a factor in our quarter's performance.

All right.

Thank you.

Thank you.

Our next question is coming from Jim Winchester of Lazard.

Yes.

Good morning.

Good quarter.

Two questions.

First is, coming back to the question of the effect of the west coast, I wonder if you could give us the current state of Trans-Pacific Asia volume now that we're sort of getting past the typically peak season.

If you could give us some sense of how that volume growth is continuing, whether this 20 some percent which was phenomenal for the most recent quarter, what sort of range we should be looking at in the upcoming quarters as we get back to sort of the off season.

And secondly, the shape of the Trans-Pacific Asian market this year, whether you are seeing a particular change because- again - because of the impact of the west coast.

Well, I think that the 20% growth rates probably will remain for us.

The demand is increasing.

I can tell you in some of the sectors that Express services, we've actually had to look at adding more capacity, extra sections, of course, because of the west coast market but of course, China keeps growing.

We've added some new interim frequencies that Fred Smith pointed out earlier.

We have better connectivity.

The service continues to improve and then the demand keeps getting stronger.

This is Fred Smith speaking.

One of the things that I have emphasized in the last couple of analysts meetings, I want to emphasize it again today.

What's happening in the international marketplace is not totally dissimilar to what happened in the domestic marketplace 20 years ago.

What you have because of the availability of networks like we operate, that can allow shippers to ship small lots in 24-48 hours on an as-needed basis.

The traditional air freight market is in essence devolving into a smaller shipment, more just-in-time type of environment.

So you have the overall growth issues that drive volume, plus the factor that I just mentioned, and I think also, the fact that we have an unduplicated system and great information services that is go along with it, and very good people out there selling our services.

So we're very optimistic long-term that we can continue to grow at very good rates in the international business.

And as Alan mentioned, that has a very salutatory effect on FedEx Express as a result.

One final fine point on that, we grew that business 13% international priority year-over-year and we also increased yields of $1.09 per package while we were doing that.

So I think that's a testament to what Fred was just saying about the value and demand for that service.

Okay.

Great.

One quick followup relating to the Christmas season.

Given the timing this year and shortened season, I'm just wondering whether there's any relevant timing issue to recognition of revenue or the timing of when you will get the bulk of sort of the last-minute volume that typically falls into the month or month and a half prior to Christmas.

Well, this week has been our peak week.

I'll be honest.

We've been pleased with the performance overall.

It's a little bit above what we had anticipated and put out.

We were anticipating a peak day of around 6 .6 million.

We've seen a little stronger performance than that.

That could have something to do with it in terms of how the holidays have fallen but looking at it as a whole I don't think there's going to be any material change.

It's basically in line with what we had projected.

And one of our critical accounting policies, of course, is revenue recognition, and the way the dates fell this year we did have a very large in-transit adjustment at the end of November.

We book revenue based on the percentage of completion of the service.

Okay.

So that does have a little impact and that sent our second quarter results in our third quarter range.

Okay.

Would you say that that shifted revenue into November or...

Shifted revenue -- packages were picked up in November but a lot of the revenue was recognized in the month of December or will be.

Okay.

Okay.

Great.

Thanks.

Thank you.

Our next question is coming from Greg Burns of J.P. Morgan.

Hi, guys.

Obviously, very strong quarter.

Just two questions on the Express side.

I'm curious.

You guys have probably a pretty good window into what your customers' inventory levels are.

Just curious, particularly given the continued outperformance of deferred, whether you have an opinion on whether your customers' inventory levels are too high, just right, too low or whether there's a lot of potential pent up demand on the overnight side and maybe you can touch on the technology customer base.

Well, obviously, from a macro standpoint, inventory to sales ratios continue to decline.

And have been declining for a long period of time.

I think that, you know, is in part due to the fantastic services provided by companies like FedEx.

I don't think that we have a -- you know, a real strong opinion about whether or not our customers have the right amount of inventories, but they certainly don't have significant amounts of inventories.

Mike Glenn might want to add.

I would agree with the statement, certainly lower than what we have traditionally seen and we would like to think that that's going to be a good sign for us but it's very unclear at this point.

Okay.

But assuming the economy picks up, that we should, all things being equal, start to see the overnight products perhaps out-perform the deferred?

Well, I wouldn't necessarily say it will out-perform the deferred but we'll certainly expect to see strengthening in our overnight performance as the economy picks up.

Okay.

Then I guess switching to Ground, a question for Dan is just trying to drill down a little more on the home delivery going from startup losses to break-even or some modest profits there.

What exactly is it?

It's obviously a very tough business.

UPS makes less money there, a lot of people talk about the delivery cost.

Is it just pure density and pure volume or are you doing things on surcharges on profitable areas?

Can you walk us through, sort of, what the formula is to get more profits out of a low-density business?

Well, I think you hit the variables.

There's no question that it's a density game.

The more volume that we have drives our productivity but we also do a lot with technology and engineering to improve that productivity and the results there in home delivery have surpassed our expectations to this point.

We've been very pleased with what we've been able to do given the miles that we drive every day.

And certainly the residential surcharges that accrue to each of these packages is important in terms of driving yield and we have seen a modest yield increase at home delivery year over year.

And from an overall capacity standpoint, are you going to have to spend more money as - What's the relationship between capital investment and new volume growth given your current utilization?

Well, we announced in October that we were going to invest $1.8 billion here over the next six years to virtually double the capacity of our network, and that includes the expected growth at home delivery.

You have to understand that the home delivery really is a delivery-only network so the infrastructure that provides movement from pickup through up handling, line haul, et cetera through the network is really accrued by the Ground segment, and then costs allocated to home delivery.

So it's all part of that capital that we expect to spend over the next several years.

And just one final question on the potential competitive response of your competitors here.

You're obviously taking some market share.

Are you concerned or have you seen anything in the marketplace that would suggest going forward there may be more aggressive competition and make it more difficult or is it sort of business as usual out there?

Well, I think we're seeing some aggressiveness on a customer-specific basis but overall, I think as an organization we're confident in our ability to manage yields over the foreseeable future.

Great.

Thanks a lot, guys.

Thank you.

Our next question is coming from Dan Hemi of Prudential Securities.

Hi.

Good morning.

Alan, can you clarify one issue on the economic assumptions you're using and what was previously mentioned?

Are you using 2.5% and 3% sequential economic growth in your 277 estimate for '03?

Yeah.

That's approximately correct.

Okay.

Also, can you tell us more about the down road revision in CAP-X and where the 200 million coming out across the business units?

Well, it's coming from Express, and again, we have a network that doesn't need to grow at the moment on the domestic side.

It does have to grow on the international side and because the growth today is less than we thought it was last -- would be last April and May we're going to adjust accordingly, which I think shows, again, our ability to react to the conditions, manage the finances of the company and continue to provide strong returns.

And so we've done a lot of things at Express to defer, delay and cancel due to the fact that our growth rates have been so small in that business.

But you know, as I said, we get to the spring and we're doing our plans for '04, we'll take another gauge at that and see whether we need to pick back up or remain the same.

About approximately two-thirds of the capital that we're spending is for growth and usually about one-third is for replacement.

That's my analytical estimation of it.

Involving things like our new power pad that we'll be rolling out.

That's obviously a replacement in part for the current super tracker but it's also a tremendous productivity enhancement tool for our couriers which will allow them to handle more packages.

So I think it's a very good balance.

Our CAP-X has come down every year for a number of years at Express, but very difficult to say what '04 will be.

But I don't think it will be much different than '03 at this point, maybe a slight increase.

Maybe a question for Mike and a quick question.

I guess can you give us some sense as to where relative growth has been or will be in Express segment of business based on looking at the market size by customer size?

Well, a continued focus for us is in the small and mid size customer range.

However, I would say the growth overall has not changed much over the last several quarters by customer size.

We would like to obviously continue to see stronger performance out of the small and mid size customer but that will be dictated by the economy.

We've improved performance in that sector especially based upon our ability to offer a broad portfolio of services which include Express and Ground and certainly home delivery so we believe we've improved our competitive position in our value proposition there but in general, I would say growth over the last several quarters have been pretty balanced.

Okay.

Thank you very much.

Thank you.

Our next question is from Gary Yablon of CSFB.

Hi, guys.

How are you.

Hi, Gary.

Good morning.

I want to go back to something you mentioned in your formal remarks, Alan it make sure I got it straight here.

Express volume is down slightly when normalized with last year.

Are you just doing an average daily basis and adding back four days?

Is that what you're doing?

Yes.

It's an analytical exercise about where we thought we would have been last year without 9-11.

Thanks.

Staying with Express and talking about margin a little bit, can you give us a sense, second quarter last year was a little funny because of the events of 9-11 and whatnot.

When we look at the 5.6% margin for express that you reported for this quarter, how do you feel that that stacks up with where you were last year?

You could -- you almost have to kind of come up with your own number because it was such an unusual environment, unfortunately.

Could you give us a sense of how that feels year over year in firms of margin normalized?

Gary, it's very difficult.

I agree with your point very well.

I mean, last year we got government assistance for the economic environment that we were in after 9-11, and while we managed the company very hard, we did get that assistance and we believe we deserved it.

Obviously, we received it.

This year we're getting no help.

It's strictly the management of the company trying to manage through the economic environment that is out there.

While I think we've done a very good job, I think it was also a very difficult comparison because of two events that were time-related, that being significant fuel and significant maintenance charges, so if I could normalize to take those out I think we're performing actually better and that's in our numbers in the second half.

If we can achieve the $2.77, that would be a significant increase over the $2.39 we earned in the previous year for the whole year in a tough environment, and you know, I would say there aren't many companies performing at that level.

My belief is although the number looks bad, I think that what's under lying our management's performance and its cost control are very strong.

But let me make sure.

You don't want me going in and plugging in 8% margins for Express for the second half of the fiscal year.

Well, I'm not going to go there, Gary.

I've given you a $2.77 number and I think that's why they pay you the big bucks.

This is Fred Smith here.

Let me just, again, try to focus a bit more on the strategic rather than parsing quarter to quarter which is difficult at best for us.

I can't imagine how you folks do it.

The company's management is very confident that we can improve FedEx Express's margins over the long-term because we have a changing customer mix, a changing traffic mix -- by that I mean we'll get more heavier brown box shipments.

We will manage yields appropriately and we will continue to grow our international franchise which Alan mentioned has a significant incremental contribution to the bottom line of Express.

So those of you who focus on the Express side, just like we laid the thing out what we were going to do on the Ground side, I'm telling you right now we are very confident we can improve the margins in Express for the reasons I just mentioned to you.

Now that assumes that the economic assumptions that Mike read off to you a moment ago are correct, which is what we put in the press release.

Thank you.

Thank you.

Our next question is coming from James Valentine of Morgan Stanley.

Great.

Thanks.

First, great quarter, guys.

Thank you, Jim.

Especially given the conditions here.

Two questions on post office.

Assuming, if it's up 6% sequentially, then that doesn't quite jive with what the post office said they're doing in their expedited products.

Namely, their rate increase back in June or July has caused a falloff in the volumes they are reporting each period.

So I'm trying to understand what it is you guys are doing or why they are shifting more business your way.

Jim, as I've told you and I've told this group time and time and time again, we are not going to describe individual customers' volumes, profits, yields, et cetera on an individual customer basis.

The 6%'s the number that your analyst analytically arrived at.

I don't know how he did it and I can't comment on that.

I'll let Dave give you the bigger picture.

Thank you, Alan.

Jim, I just wanted to add that you probably have seen executive management from the U.S.

Post Office comment how the FedEx contract has stabilized their system.

We, of course, have the addendum going forward until May.

We're constantly in communications with them.

Their costs have come down.

Their service has gone up.

The relationship could not be better.

I can't comment on what we're talking about in terms of addendums going forward other than to tell you that the relationship is very good.

Their service is very good.

In fact, it's record service for them.

So we're very pleased with the volume and the business and of course, that's the transport piece.

The retail piece is going as well.

We now have over 9,000 drop boxes placed at the post offices as well.

So we're very pleased with that contract.

Okay.

Great.

Second question is Alan, I don't know, have you provided any guidance yet on what the potential incremental pension expense would be next year based on what you're seeing with the market right now and your return on assets?

We have a February 28th 2003 measurement date and given the very young age of our workforce, and our sensitivities to daily fluctuations in the market and discount rates, it's just simply way too early to tell.

I would say that it's more likely than not that we'll see an increase in pension expense in '04 over '03 but again, that's just based on what market conditions exist right now.

Obviously, they are significantly different today than they were September 30, so, to give you a projection, you know, for what's going to happen by February 28th is very, very difficult.

I think it is one of the issues and one of the fallacies out there with pension accounting but that's for another day and another subject.

Right.

Right.

One last question on CAP-X, you said it sounds like it might be flat, might be up a little bit next year.

I'm trying to understand aircraft as percentage of your total CAP-X and one of the things is what it would cost in terms of CAP-X to keep your fleet at the current age.

In other words, no expansion.

Is that what, 3, 4, 500 million?

I'm trying to get a ballpark figure.

In what effect is maintenance CAP-X to keep your flight the same size, same age.

Well, I haven't really examined it in that light because I don't think we need to keep the fleet at the same age at the moment.

As you know, we have a significant program going on of modifying our D.C.-10s to M.V.-10s and that will be a significant amount of the CAP-X we spend on airframes in fiscal '04.

In fact, we have what, Dave, just one or two additional airplanes.

Two additional committed for next year.

But we do have ongoing improvements from a D.C. 10 to a M.D. 10 and while it will still be the same "age" it will be significantly better in terms of it'sefficiency and operating costs.

That's good point.

I guess I just thought since you have slowed down the aircraft orders that CAP-X might start to come down next year.

Well, again, the M.D.-10s are going up from where they've been in the past to offset that, and that's one of the drivers -- one of the big drivers for '04.

But again, we have -- we think we have plenty of airframes available for even a robust economic environment in '04 at the moment.

Okay.

Great.

Thanks, guys.

Thanks, Jim.

Thank you.

Our next question is coming from Ed Wolfe of Bear Stearns.

Good morning, gentlemen.

Good morning, Ed.

Alan, was there any accrual of profit sharing for Express in this quarter?

No.

Is there any intentions to going forward?

Is that in the guidance or no?

We don't have any intention of reinstating profit sharing at this point, and that is in the guidance.

So we should assume for the rest of fiscal '03 no?

That's correct.

Okay.

Now, Ed, this is Fred Smith.

When you talk about profit sharing are you talking about all incentive compensation or are you talking about specifically the profit sharing plan?

Well, widen the discussion and let me know.

I'm not sure what I'm talking about versus where you were 18 months ago, were you paying, the way I understood it, a profit sharing in the Express business for management that was somewhere between 10 and 15% or pre-tax of Express.

That's the reason I asked the question.

The numbers that we have do have accruals for incentive compensation, and I think that the terminology has created a little bit of confusion.

Up until a couple years ago when the economy melted down, we had a very modest profit-sharing program which resulted in a small cash distribution to people in mid year.

That was not the incentive compensation that goes to the professional and management rank.

And we made a conscious decision to put more money into other programs.

For instance, we increase the rapidity with which our hourly merit employees can achieve higher compensation.

We stressed the 401K match, and we do have incentive compensation for our professional and management in the numbers that we had.

So we did not have in recent years an enormous profit-sharing plan which was a big part of the compensation.

And I think there's been some misunderstanding about that.

Well, I've forgotten the timing of it but about a year ago I think it was, you announced that you had reversed an accrual for profit sharing and not accrued for it, and that was the beginning of the downturn, maybe as far as two years ago now.

Are you saying that some of that you've made up since?

No.

What I'm saying is you're talking about apples and oranges here.

The profit-sharing plan was one thing.

The annual incentive compensation plans which all of the companies is something else, and the profit-sharing program was a relatively modest program, and we have not paid the profit sharing plan we replaced it with other compensation programs.

We do have annual incentive compensation accruals in the numbers that we've given you in the outlook that we've given you.

In any event, Ed, those are diminimus compared to the the pension and health care prices that are driving that 6% number year over year at Express.

Salaries and wages are up 4.5 so to drive

So you've already been kind of evolving the way you incentive the workforce?

Well, I'm not going to handcuff the company's management on '04 on '05.

We'll see how the economic environment is and how well the company's performance.

Okay.

Can we switch gears for a second?

The postal contracts and the additional added on volumes from last May, that contract.

Can you just take us back historically?

Has there been one add on or two add ons since the original contract was signed?

And what types of -- you know, the add-on as I understand it was to the related to priority and express but to regular mail.

Where are you in terms of, you know, historically how many add-ons were there and when did these contracts expire, these addendums expire?

Let me answer that.

We've added on one addendum and we extended that addendum.

That's probably where you're getting the two in your head.

So we had the original contract.

We had an addendum added after the 9-11 event so in October we extended that addendum to the end of this fiscal year to May 31st.

When you, extended it threw the end of the fiscal year did it increase in terms of volume or was it more of the same?

It was about the same.

Okay.

That's helpful.

Then one last question, in the guidance of 45 to 55 cents for the quarter you talked about the GDP assumptions for the next couple quarters.

Can you give guidance towards what the assumption is for some of the volumes in Ground and Express or for postal for that matter or anything else that might be different?

No.

I didn't expect as much.

Thank you guys.

Thank you.

Our next question is coming from Helein Becker of Buckingham Research.

Thanks very much, operator.

Alan, from the first to the second quarter maintenance expenses went down.

I recognized they were up year on year but sequentially they were down.

So on a go-forward basis do you think maintenance costs will continue that trend?

Well, I think on a year-over-year basis in the second half we should be relatively flat on maintenance at Express, which is the big maintenance number because we've had such a large number of engine events in this first half.

They have mitigated in the second half and that, of course, is in the guidance we've given you.

Okay.

Then the other question is, historically you've used recessions and down turns as an opportunity to pick up aircraft and other things relatively inexpensively and with so many aircraft in the desert I'm sure you're being approached on a daily basis.

Is there any desire to take a look at anything else out there to prepare for additional growth in the future?

Helene, FedEx also has aircraft in the desert so that answers in question in terms of wide bodied jet capacity.

The answer is no.

In terms of perhaps something smaller like feeders and other things that are diminimus in terms of the overall CAP-X number we're looking at that.

Okay, great.

Thanks very much for your help.

Okay.

Thank you.

Holly, this is Jim Clippard.

I think, ladies and gentlemen, we've reached the stopping point.

We've got to sign off here and have a media call.

We appreciate very much your participation.

I take it back no media call, and we appreciate your participation and look forward to next quarter.

Bye-bye.

Thank you.

This does conclude today's teleconference.

You may disconnect your lines at this time and have a great day.