FedEx (FDX) Q3 2024 Earnings Call Transcript


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FedEx (FDX 1.87%)
Q3 2024 Earnings Call
Mar 21, 2024, 5:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the FedEx fiscal year 2024 third-quarter earnings call. All participants are in listen-only mode. [Operator instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Jeni Hollander, vice president of investor relations. Please go ahead. Go ahead.

Jeni HollanderVice President, Investor Relations

Good afternoon and welcome to FedEx Corporation’s third-quarter earnings conference call. The third-quarter earnings release, Form 10-Q, and stat book are on our website at investors.fedex.com. This call and the accompanying slides are being streamed from our website where the replay and slides will be available for about one year. During our Q&A session, callers will be limited to one question to allow us to accommodate all those who would like to participate.

Certain statements in this conference call may be considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to risks, uncertainties, and other factors that 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. Today’s presentation also includes certain non-GAAP financial measures.

Please refer to the Investor Relations portion of our website at fedex.com for a reconciliation of the non-GAAP financial measures discussed on the call to the most directly comparable GAAP measures. Joining us on the call today are Raj Subramaniam, president and CEO; Brie Carere, executive vice president and chief customer officer; and John Dietrich, executive vice president and CFO. Now, I will turn the call over to Raj.

Raj SubramaniamPresident and Chief Executive Officer

Thank you, Jeni, and welcome to your first earnings call at FedEx. We are happy to have you on board leading the Investor Relations team. Before we discuss the quarter, I would like to congratulate Rob Carter on his upcoming retirement, which we announced last week. He has served as CIO for the last 24 years, leading FedEx in modernizing our IT infrastructure. I’m immensely grateful to Rob for his numerous contributions in establishing FedEx as an innovative data-driven and people-focused company.

We thank him for his dedication and service to FedEx over the years and wish him well in his upcoming retirement. Thank you also to the FedEx team for their exceptional work in Q3 by providing superior service for customers and delivering strong results, all while advancing our transformation initiatives. For the third consecutive quarter, we delivered operating income growth and margin expansion in a declining revenue environment. This is a very positive dynamic and a unique one in our industry. It demonstrates clear progress on our transformation and ability to manage what’s within our control through DRIVE.

We’re strengthening our value proposition, improving the customer experience, and increasing profitability. This progress supports our long-term goals for sustainable margin expansion, improvements in ROIC, and value creation for our stockholders. Now, turning to the details. Our transformation is driving continued improvements in adjusted operating income, margins, and earnings per share.

At the enterprise level, we delivered a 16% improvement in adjusted operating income and adjusted margin expansion of 90 basis points compared to the prior year even as revenue declined 2%. Adjusted operating income growth was driven by continued strength at Ground and improvement at Express. At the segment level, I’m particularly pleased with the results in Ground where adjusted operating income increased 14% on 1% revenue growth and adjusted operating margin improved to over 11% in the quarter. This reflects continued progress controlling expenses and effective yield management, including the ramping benefits from DRIVE. At Freight, the team’s continued focus on profitable growth and cost management delivered strong margins and mitigated year-over-year volume challenges.

Service levels remain exceptionally high, demonstrating our differentiated execution capabilities. We’re also making progress at Express where adjusted operating income increased, enabled by our ability to remove structural costs. Looking ahead, we are reaffirming the midpoint of our fiscal ’24 adjusted EPS range while narrowing the range to $17.25 to $18.25. In fact, we now expect to deliver adjusted earnings above the midpoint of the range we shared last June, despite full-year revenue expectations that have deteriorated significantly over the past nine months. This is clear evidence of our ability to execute.

Turning to the Express business. It is my top priority to continue to make the changes necessary to align our air network with an evolving demand environment and unlock the full profit opportunities. While we have made progress at Express this quarter, there are several areas we’re aggressively working to address in order to accelerate profit improvement: service mix, network utilization, continued inflation, and other cost headwinds. First, with respect to service mix, we are seeing a clearer international market shift toward deferred services.

This is tied in part to the rapid growth of many of our e-commerce customers, where we are a critical enabler of global trade, offering unique solutions for our customers. More on how we are addressing this mix shift shortly. Second, weakness in global trade continues to constrain demand in international business, which has remained challenge for longer than expected. As such, we’re continuing to proactively realign our air network to match capacity to demand. And third, this quarter, Express experienced over $200 million of inflationary pressure on a year-over-year basis. We offset this with benefits from DRIVE as well as responsible headcount management.

The dynamics I just outlined creates significant opportunities for us to improve our network utilization. Last quarter, we introduced our Tricolor strategy. Ultimately, this network design will enable us to improve the efficiency and asset utilization of the entire FedEx system, put the right product in the right network, taking advantage of our continental surface networks in Europe and our market-leading FedEx Freight LTL network in the United States, and profitably penetrate new market segments at the right cost structure including the premium air freight market. As we move forward, we are managing the execution of Tricolor with the rigor and discipline of DRIVE, and this will be a key element to our success.

Moving to another area of opportunity. In Europe, we continue to improve our service levels and focus on commercial execution. However, the B2B environment remains challenged. And in this context, we are making progress on DRIVE, on track to generate $600 million of savings in fiscal year ’25 and seeking further profit optimization opportunities. As we have mentioned in previous calls, we are also experiencing a continued headwind for the United States Postal Service, which has reduced volumes.

Despite this volume and revenue drawdown, our service obligations to the USPS remain fixed. In Express and across the business, DRIVE remains a key enabler of improved profitability, both in the near and the long term as we change the way we work and identify areas for structural cost reduction. In, Q3 we delivered $550 million of benefits from DRIVE, offsetting the impact of revenue declines and cost pressures. I’m encouraged by the progress across all three categories.

This includes $290 million in our surface network, $110 million of savings in air network and international operations, and $150 million of G&A. Given the progress we have made year to date, we will deliver on our goal of $1.8 billion in permanent cost reduction benefits from DRIVE this fiscal year and are highly confident in the additional $2.2 billion in fiscal year ’25. The work we are doing with DRIVE is also helping advance planning for Network 2.0. This quarter, we rolled out our new surface operations’ leadership structure. Under this new structure, leaders and their teams will be responsible for all Express and Ground package operations and facilities in their respective divisions, regions, and districts. This will enhance operational execution and offer greater insight into the package business overall with accountability at all levels. More broadly, we have now implemented Network 2.0 in over 50 locations with dozens more to follow in calendar 2024, all while maintaining outstanding service.

And as a reminder, we will begin the rollout of Canada in April and expect to complete this transition by October of 2024. And as part of our transformation, we are on track to complete the consolidation of FedEx operating companies into one streamlined and simplified organization, creating efficiencies as we build a stronger, more profitable enterprise. In June 2024, FedEx Express, FedEx Ground, and FedEx Services will consolidate into Federal Express Corporation. The work we are doing to create a more flexible, efficient, and intelligent network is translating into direct improvements in our customer offerings and profitability. When severe weather hits, it can cause a domino effect of delays and reduced service levels across our network. While we have always used data analytics to assess the effect of weather events, our new weather contingency playbook developed by our planning, engineering, and data works teams enhances the process by leveraging predictive capabilities to proactively divert storm-bound volumes across our networks.

By combining the power of digital insights and predictive and analytics with our physical network, we effectively mitigated the impact of the January winter storms that hit our Express hub in Memphis by shifting Memphis-bound Express volume to Ground or Freight at the origin location. Despite this year’s event having a longer impact to Memphis operations when compared to the weather event in February 2023, our network recovery was twice as fast. This quarter, we also announced a significant initiative, fdx, a fully integrated data-driven commerce platform that connects the entire customer journey from demand to returns. It will provide real-time visibility to help our customers optimize and grow their business, leveraging our analytical capabilities and data from the 15 million packages we deliver every day. I’m excited to have Sriram Krishnasamy serving as chief digital and information officer effective July the 1st. His proven track record of driving optimization and innovation for our business through data and insights, combined with his deep knowledge of the network, will be critical to moving FedEx forward as we become a data-driven digital-first company. As I look across the business and these financial results, there are clear signs of progress on our transformation.

Our strategy is generating results, and we are well placed to maintain our leadership position while delivering improving financial outcomes. Together, we remain focused and committed to our long-term goals, supporting the creation of significant long-term value for our stockholders. With that, let me turn the call over to Brie.

Brie CarereExecutive Vice President, Chief Customer Officer

Thank you, Raj, and good afternoon, everyone. First, I want to thank our FedEx team for strong performance during the peak season. As a result of their hard work and commitment, we once again delivered the best service offering in the industry. We continue to execute on our commercial priorities with a focus on revenue quality while maintaining our industry-leading service. As a result, we took profitable share in the quarter at market rates, and we continue to retain the vast majority of the volume we gained from UPS in the second half of 2023.

Our unmatched value proposition has enabled recent high-value wins in the semiconductor, healthcare, and aerospace industry. We will continue to execute our commercial strategy to compete and grow further in the high-margin areas of the market. Looking now by geography, in the United States, conditions have been weaker than we anticipated, and internationally, we continue to see softness. We, however, remain very focused on strong commercial execution. Taking a look at third-quarter revenue performance by segment.

At FedEx Ground, revenue was up about 1% year over year on a modest yield improvement and flat volumes. Our team remains disciplined on growing with the right customers and mix while offering the best value proposition in the industry. At FedEx Freight, revenue declined 3%. While volume decreased compared to last year, the year-over-year decline moderated on a sequential basis. Revenue was also negatively affected by lower fuel surcharges and a decrease in weight for shipment although the decline was partially offset by higher base yields.

And at FedEx Express, revenue was down 2% year over year driven by continued volume softness, lower fuel and demand surcharges, and a mix shift toward deferred and e-commerce products. The actions Raj outlined will allow us to profitably grow this business while continuing to deliver excellent service for our customers. Turning to our monthly volume trends during the quarter. Broadly speaking, volumes are stabilizing as we lap weaker demand from a year ago. International export increased 4% in the quarter, driven by a 29% growth in international economy, which of course is a market reset we expected.

Freight shipments declined but they continued to moderate sequentially. As Raj mentioned, postal volumes were a headwind in the quarter. Our current contract with the United States Postal Service expires on September 29th. We have made significant progress in negotiations for a new contract that aligns with our ongoing network transformation plans while providing the USPS with the operational reliability and outstanding service we have delivered for them for more than two decades. A new multiyear agreement would provide a more efficient network with service to fewer markets. It would allow us to better adjust our overall network to demand.

We, of course, will let you know when we have an update. We continue to operate in a competitive but rational market environment. During the quarter, yield trends were similar to what we saw last quarter with dynamics remaining mixed across the segments. At FedEx Express, yields remained pressured due to a tapering of international export demand surcharges and an increasing mix of lower-yielding e-commerce and deferred products.

Yield was also pressured by increased capacity in the market. A FedEx Ground, yield increased 1% driven by home delivery, partially offset by Ground economy. Higher weight per package and favorable customer segment mix offset a lower fuel surcharge relative to the prior year. And at FedEx Freight, revenue per shipment was down 1% driven by lower fuel surcharges and lower weights. In January, we rolled out a 5.9% GRI, and importantly, we’ve been able to capture a high percentage of that rate increase. During peak, our holiday peak residential surcharges enabled us to effectively offset higher costs, delivering $120 million in profit.

We are very confident we have the right strategy in place, balancing both volume and yield growth. We are building our network of the future with digital and data-driven solutions that simplify the customer experience and further strengthen our best-in-class customer offerings. For example, earlier this month, we enhanced our healthcare offering with more powerful capabilities to prioritize critical life-saving healthcare shipments above other volume within the network. Health care customers now have the ability to select monitoring and intervention service options. They cover categories such as temperature requirements and vaccines, and they do this at the package level. Each Express shipment now includes specific healthcare identifiers so that, if we need to intervene, we are able to do it with more speed and more precision. And of course, in January, we announced the fdx commerce platform.

fdx connects the entire customer journey by offering end-to-end e-commerce solutions, making it easier for companies to grow demand, increase conversion, optimize fulfillment, and streamline their returns. The fdx platform will enable us to enhance our long-standing relationship with merchants of all sizes to help them optimize and grow their business. We have opened a private preview for select brands and retailers, and based on their feedback, I am incredibly excited about the official launch later this year. In closing, I’m very proud of our entire global team and how they continue to deliver outstanding service as we navigate a very dynamic market. And with that, I’ll turn it over to John to cover our financials in more detail.

John DietrichExecutive Vice President, Chief Financial Officer

Thanks, Brie. Our third-quarter results reflect ongoing progress on our DRIVE initiatives as well as our continued focus on service and revenue quality. As a result of these efforts, we delivered operating income growth and margin expansion for the third quarter in a row despite declining revenue in a challenging market environment. Taking a closer look at our performance in the quarter on a year-over-year basis and at the enterprise level, adjusted operating income increased by $192 million, and adjusted operating margin expanded by 90 basis points. At Express, adjusted operating income increased by $134 million, and adjusted operating margin expanded 130 basis points.

The benefits of DRIVE initiatives and an additional operating day more than offset lower revenue. At Ground, the team delivered another quarter of strong results. Adjusted operating income increased by $120 million, and adjusted operating margin expanded by 140 basis points, due to cost reductions and yield improvements. Despite slightly lower volumes and an inflationary environment, Ground cost per package was flat year over year, with lower line haul expenses and improved dock productivity offsetting higher first and last-mile costs. And at Freight, while operating margin remained strong, operating income declined by $46 million and operating margin declined by 170 basis points driven by lower fuel surcharges, reduced weight per shipment, and lower shipments.

These results also reflect the lapping of a $30 million facility gain last year, partially offset by the benefit of an additional operating day during the quarter. Looking at the quarter overall, weather had an immaterial year-over-year effect on profitability. Before turning to the outlook, I’d like to spend a few moments updating you on our cost reduction initiatives including DRIVE and more specifically G&A. As an initial matter and as part of responsible headcount management, we have reduced our workforce by nearly 22,000 over the last year and expect additional opportunities in the future as we move forward with our transformation. Within G&A, we continue to make significant changes to how we approach areas like procurement and technology so that we are a more efficient digitally led organization. In addition, global functional alignment provides savings opportunities.

I’m pleased that we have achieved $350 million of G&A net savings year to date, including $150 million in the third quarter. Taking a closer look at sourcing and procurement, we’ve continued to evolve the sourcing and procurement function from a segregated and regional structure to a centralized global organization that will manage most third-party spend across the entire enterprise. With new leaders in place, we’re developing new category strategies and have already identified about 20 discrete categories that we’ll manage centrally in cooperation with functional leaders. By implementing these new strategies at the enterprise level, we’ll have tighter spend oversight, we’ll better leverage our scale and buying power, and generate significant cost savings. Overall, I’m very pleased with our enterprisewide DRIVE progress this quarter, and we will deliver $1.8 billion in savings for the full fiscal year. Now, turning to our fiscal year outlook, and as Raj shared earlier, based on our performance year to date and our current view of the rest of the year, we are reaffirming the midpoint of our adjusted EPS range while narrowing our outlook from the prior range of $17 to $18.50 to $17.25 to $18.25. At the midpoint of the narrowed range, we continue to assume a low single-digit percentage decline in revenue for the full year.

As always, we’ll closely monitor the global demand environment and other key factors including inventory restocking, global trade, inflation, and e-commerce trends, which informs our view of overall expected revenue. With regard to our fourth-quarter expectations, as implied by our outlook range, we expect year-over-year profit improvement despite lapping the onset of certain structural benefits executed in last year’s fourth quarter at Express and Ground. Looking on a sequential basis, the leap day in the third quarter affects our typical seasonality. At the segment level, we’re maintaining our full-year expectations for a modest year-over-year adjusted margin contraction at Express, adjusted margin improvement at Ground, and strong but lower year-over-year margin at Freight. At Express, we’re looking at every aspect of the business, including taking a fresh look at additional opportunities to improve our European business. And we’re confident in our ability to unlock more value at Express and across all our businesses as we continue to seek optimization opportunities. Our bridge shows the operating profit elements embedded in our full-year outlook.

For illustrative purposes, we continue to use adjusted operating profit of $6.3 billion, the equivalent to $17.75 of adjusted EPS, as the midpoint of our narrowed outlook range. To walk the bridge to $6.3 billion of adjusted operating profit, we’re now assuming that revenue, net of cost increases, is up $200 million that we experience $800 million of international export yield pressure as peak surcharges diminished and product mix continues shifting toward deferred, variable compensation increases by $300 million, and that these pressures are more than offset by $1.8 billion in structural cost savings from DRIVE. At the midpoint, we would expect fiscal 2024 adjusted operating income to increase approximately 17% despite revenue declining by a low single-digit percentage. As I’ve discussed on prior calls, we remain focused on reducing our capital intensity and continuing to provide increased stockholder returns, as well as maintaining a strong balance sheet, prudent capital allocation, and improving return on invested capital. Our capital investment priorities will be on improving efficiency, modernizing facilities, and optimizing our network. Capital expenditures for the quarter were $1.4 billion, bringing year-to-date capex to $4 billion. We now anticipate capital spend of $5.4 billion for the full year, which is down over $700 million from last year and down $300 million from our prior forecast of $5.7 billion. We also continue to expect aircraft-related capex to decline to approximately $1 billion in fiscal year ’26.

And we expect capex as a percentage of revenue will keep declining in the future as we reduce our facilities footprint through Network 2.0 and continue to plan for lower annual aircraft capex beyond fiscal year ’26. We currently have 37 jet aircraft parked, which is up from 20 last quarter. And as previously communicated, we will retire nine more MD-11 in Q4. Consistent with our goal of increasing stockholder returns. we completed a $1 billion accelerated share repurchase transaction in the third quarter, bringing our total share repurchases for the first nine months of the fiscal year to $2 billion, and we expect to repurchase an additional $500 million of common stock in the fourth quarter, bringing total fiscal year ’24 repurchases to $2.5 billion, while also paying our dividend in line with our previously stated capital return plan.

I’m also pleased to announce that our board of directors has authorized a new $5 billion share repurchase program, which augments the $600 million that remains available for repurchase under the $5 billion 2021 authorization. This reinforces our commitment to support long-term stockholder returns. Overall, I want to acknowledge and thank the entire team for their efforts in continuing to improve profitability in a challenging revenue environment. We have more work to do, but I’m encouraged by the commitment and focus I’ve seen from our teams to advance our transformation and provide our customers and stockholders with even greater value. With that, let’s open it up for questions.

Questions & Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator instructions] Today’s first question comes from Jordan Alliger with Goldman Sachs. Please go ahead.

Jordan AlligerGoldman Sachs — Analyst

Yeah, hi. Thanks for the update on DRIVE. If I did the math right, I think there’s about 385 million or so left for the final quarter of this fiscal year. So, maybe talk to where you think this money, where the savings, which buckets are going to go to, surface, air or G&A.

And I’m also just sort of curious, on the surface side, how much of that is actually tied to Express surface stuff? Thanks.

John DietrichExecutive Vice President, Chief Financial Officer

So, thank you, Jordan, for the question. It’s John, and I’m not going to speak specifically to the number you raised with regard to the remainder of the year and DRIVE except to say that we are committed to the 1.8 billion for the fiscal year. And I think it’s safe to assume that’s spread across all of our operating companies. And with regard to your question on surface, it’s predominantly Ground.

But as we continue to migrate toward Network 2.0 and through our DRIVE initiatives, there’s a lot of complementary work that’s being done together by the teams. So, those savings are being realized both at Express and Ground.

Operator

The next question is from Tom Wadewitz with UBS.

Tom WadewitzUBS — Analyst

Yeah, good afternoon. I wanted to ask you a bit about the trajectory of the margin at Express that — excuse me — the February quarter was quite a bit better than expected, and I’m just wondering how do we think about that as you go into fiscal ’25. I think two specific items you did mention: one, the 600 million improvement in Europe that I think would — would go to Express and just kind of visibility on that, and also, how we should think about postal? Brie, you had some comments, and I think that’s been characterized as a 400 million headwind. So, you know, is it reasonable to say that that’s 400 million you kind of add back to the numbers.

So, anyways, just some broader comments on Express and some of the bigger items. Thank you.

John DietrichExecutive Vice President, Chief Financial Officer

Great. Thanks, Tom. It’s John again. Yeah, we’re — we’re quite pleased with the progress we’ve made at Express in the margin expansion.

As Raj mentioned, this is all of our primary focus to continue that expansion, and we’re excited about the opportunities that lie ahead for us in DRIVE. With regard to Europe, that will be a key focus area of ours, and we are committed to the $600 million that you mentioned. In the Postal Service, certainly, as we’re negotiating toward a deal, if that deal were to materialize, you would expect that it’s mutually beneficial for both sides. So, we’re looking forward to bringing that to closure as soon as possible.

And all of that will contribute to our ability to continue to expand our margins at our largest sector at Express.

Operator

The next question is from Jonathan Chappell with Evercore. Please go ahead.

Jon ChappellEvercore ISI — Analyst

Thank you. Good afternoon. Brie, you mentioned a competitive but rational market environment as it relates to pricing and yields. We are several quarters into the demand downturn here, and of course, there’s been some competitive issues directly, you know, in your business.

As you look forward, if we continue to kind of bounce along this bottom on demand, you know, internationally, but I think more specifically to the United States, does the pricing environment start to waver at all of it? Do you really need a macro tailwind before we can see maybe a stabilization and or reacceleration of yield?

Brie CarereExecutive Vice President, Chief Customer Officer

Hi, Jonathan, thanks for the question. I think, from a competitive environment perspective, yes, it is competitive, but I don’t think that’s particularly different in our industry. We’re very used to a competitive environment, and the market does feel quite rational to me. When we look at the yield focus for the team, I’m actually pleased with the discipline of both the sales and the pricing organization.

If you remove the fuel headwind across each one of our segments, Express, Ground, and FedEx Freight, we have kind of low single-digit yield improvement on the base. So, I think the team is continuing to execute on our revenue quality strategy. And from a momentum perspective, we do have some headwinds this year that will diminish next year, especially in the international market. You know, if you think about calendar year ’23 from an air freight perspective, the overall air freight market yields decreased between 30 and 40%.

That is not going to repeat next year. And then, of course, from an international demand surcharge, it will continue to be a headwind in FY ’25 but less of a headwind than this fiscal year.

Operator

The next question comes from Bascome Majors with Susquehanna.

Bascome MajorsSusquehanna International Group — Analyst

Thanks for taking my question. So, in June, you’ll complete the legal consolidation of Express Ground and services as part of the one FedEx effort. Can you give us a look at how that will change, how you manage the business starting in July, how it will change, how you report your financials and operating stats? And can you give us some assurance that we’ll get a deep history of comparable financial and operating data to help track your progress as you get further into the operational side of the integration in 2025, ’06, and ’07? Thank you.

Raj SubramaniamPresident and Chief Executive Officer

Thank you, Bascome, and let me start, and then John can add on to this. First of all, we are well on track to complete our consolidation of FedEx operating companies. This has been a lot of great work has already been done and into one streamlined and simplified organization. I think two words can describe this move.

One is efficiency, another one is effectiveness. I think we are — we are looking forward to the structure that actually moves us forward on both fronts. And, you know, I think at the end of the day, these transformation efforts will set us up to drive improved performance and profitability over the long term. I’ll give it to John to talk about the rest of it.

John DietrichExecutive Vice President, Chief Financial Officer

Yeah, thanks, Raj. And from a reporting standpoint, and we’ll be providing more details regarding the new reporting structure as we go forward, but I think it’s fair to say that we’ll continue to break out both Ground and Express yield and volume by service as we currently do and, frankly, continue to provide sufficient data for you all to monitor the performance in those business segments.

Operator

The next question comes from David Vernon with Bernstein.

Dave VernonAllianceBernstein — Analyst

Hey, good afternoon, everyone, and thanks for taking the question. So, Raj, in your prepared remarks, you talked about the Tricolor strategy and going after the premium air freight market. Could you talk a little bit more about — about, you know, what that is? I guess I’ve always been under the assumption that you guys were the premium part of the air freight market. And how does this realignment actually open up some — some revenue that maybe you don’t have access to today?

Raj SubramaniamPresident and Chief Executive Officer

Thank you, David. Well, hey, you know, I think I’m going to take a minute here to talk about Tricolor because I think it’s a — it’s a good opportunity. So, bear with me for the time I’m going to take here. Firstly, Tricolor is a fundamental redesign of our network to improve the utilization of assets, our ROIC, profitability, and our operating margin.

And first and foremost, our overall capacity will be determined by the demand environment, and Tricolor will allow us to better flex our capacity to match demand. Now, within that capacity is when we’ll break it into three networks, purple, orange and white we call it, and that cater to the different cohorts of traffic. The idea is to move the right product in the right network while reducing the cost to serve. The purple network will be a highly optimized and a leaner network designed to move international priority parcel volume that protects our value proposition in different geographies.

Now, this network now becomes much more parcel-centric, will have significantly better service but also density. And that density will improve the revenue proposition and revenue per flight. Now, turning to the orange network, that will cater to the premium freight traffic. And these are FedEx planes that will operate off cycle from the purple system, which allows a few things.

Firstly, it allows us the ability once again to maximize density and asset utilization. It also decongest hubs and improve service, but most importantly, it allows a truck-fly truck model that reduces the cost to serve. And in this context, it should be noted that we are fully leveraging the existing capacity in our trucking networks in the US and Europe. Prior to fiscal ’24, we haven’t really moved any international freight shipments in our market-leading LTL network with FXF.

And now, it’s already begun to change. But in Tricolor, it’ll take full hold here. So, by doing so, we reduce the cost to serve and we are able to target more of the premium air freight segment. Now, I’m going to call it a new term, think of it as the “global LTL segment.” That’s what this is about.

Now, as you — as you rightly asked, if we’re already adding capacity to go after low yield and profit, the answer is no. I — we are going to gate the overall capacity by the premium demand. It should also be noted that 20% of the global air freight shipments approximately derive about 80% of the weight, which is a primary target for freight forwarders. We’re going to focus on the other 80% that will readily work with the model I described.

So, the white network then is — primarily use passenger belly capacity to move lower-yielding e-commerce and deferred traffic. So, these three networks, working in concert with high technological orchestration, is what we call Tricolor. Let me just reinforce again that it helps the baseline productivity, it improves our existing asset utilization, and makes the entire system more efficient. And we’re going to manage the execution of Tricolor with the rigor of DRIVE and to ensure success.

So, again, thanks for the question.

Operator

The next question comes from Brian Ossenbeck with J.P. Morgan. Please go ahead.

Brian OssenbeckJPMorgan Chase and Company — Analyst

Hey, thanks for taking the question. I just wanted to come back and maybe better understand the moving pieces for Express during the quarter. Obviously, quite a strong result, but there’s oftentimes some impact from fuel incentive compensation, I think was a bit of a tailwind here. Has that changed a little bit as well? So, maybe — I mean, whether, you know, that was a pretty significant surprise considering it was as — is difficult, as you mentioned, Raj, but it seems like it really didn’t affect the network.

So, maybe, John, if you can unpack some of the moving pieces. And then, Raj, if you can comment on the durability of the network, if — whether it just isn’t going to be as big of an impact going forward? Thank you.

John DietrichExecutive Vice President, Chief Financial Officer

Yeah, thanks, Brian. I’ll start with that last point because I think it’s worth repeating on the weather piece, which ties into some of our digital strategies and our ability to adapt to allow for what was substantially poor weather here in Memphis to be rerouted in a manner that had an Immaterial impact on us. So, as you’d expect, there’s — there was a lot of moving parts at Express, both positive and negative, and the levers of DRIVE, the focus on flight reductions. For example, we had 5% fewer flight hours in the quarter, and there are some additional benefits that flow from that on your cost side because when you’re not flying airplanes, you’re able to avoid certain maintenance costs.

The air ops team is doing an exceptional job of managing its cost for aircraft that are grounded, whether you’re using what’s called green time on engines that are available, limiting your inventory purchases, and so forth. So, it’s really across the gamut where we’re seeing improvement there, all in the midst of some revenue headwinds that Raj and Brie talked about. So, we’re going to continue to keep our head down and focus on our costs. One of the things I like to say, this is a journey, not a destination.

And we still have a long way to go at Express, and it is our primary focus and look forward to keeping you posted on further improvements.

Raj SubramaniamPresident and Chief Executive Officer

And, Brian, I don’t think I have much to add to what John has talked about. You know, I think the idea that we use our latest and greatest in digital tools and the notion that we are now able to look at FedEx, you know, as an overarching network and able to move things helps us. Of course, you know, we got to — we got to see is the weather patterns, you know, those are very impossible to predict. But I’m just pleased with the work that we did this time around, and we’ll continue to get better in this regard.

Operator

The next question comes from Jeff Kauffman with Vertical Research Partners.

Jeff KauffmanVertical Research Partners — Analyst

Thank you very much and thank you for the — the detail on DRIVE. Jeni, welcome. Look forward to working with you. Real quick, you know, the puck doesn’t stay in one place.

It’s always moving around, and I think you’re alluding to this with — with what you’re doing with DRIVE and Tricolor. But I’m just kind of curious from your perspective. We announced this plan about, what, a year and a half ago, back at the analyst meeting almost two years ago. How has the network design and some of the DRIVE goals when you’re completed with this changed since you began this process?

Raj SubramaniamPresident and Chief Executive Officer

Well, I think we introduced Tricolor in the last conference call, and I think this design is just being put in place as we — as we are — as we’re speaking here. And so, in terms of the DRIVE commitments, you know, we had originally talked about $4 billion by FY ’25 and, you know, less than 50% in FY ’24 where I said we will hit those numbers, right, you know, for FY ’24 and on track for FY ’25. And again, the other part of it, of course, is Network 2.0, which we said $2 billion by FY ’27, and that’s underway. So, with the — with the focus on making sure that we have structural cost reductions, we have network redesigns with the whole, you know, FedEx portfolio in play, and — and the idea that we are moving forward on our digital tools, all three are working.

And I think, you know, we’ve got work to do, but we’ve made some good progress. John’s going to add more to what I just said, yeah.

John DietrichExecutive Vice President, Chief Financial Officer

I think what I would add to that as well is, to your comment, about a kind of changing environment. The teams meet weekly on this. And there are some programs that are delivering more than we expected, and there are some programs that are delivering less than we expected, but we’re always looking to fill the pipeline as well on additional opportunities. And that’s an ongoing project and that speaks to DRIVE being part of our culture going forward.

That’s not going to stop, and we’re going to adapt to a changing environment. And I think that will help us as we move forward.

Operator

The next question comes from Ken Hoexter with Bank of America.

Ken HoexterBank of America Merrill Lynch — Analyst

Hey, great. Good evening. So, Raj — and I guess I love the results in terms of the speed here at Express, but I’m confused a bit by the messaging. Last quarter, you talked about seasonal declines at Express and what occurred from Express going down to, you know, should be maybe near breakeven given the seasonal moves, yet it was up, you know, so significantly, 130 basis points year over year.

Was there a massive shift in the DRIVE or other programs or your speed of execution? Because it sounds like from what you’re saying on the targets, nothing’s really changed. But I’m just wondering what shifted intra-quarter so — so much that we’re now seeing this quick of an improvement. And then, just — I’m sorry, just a side clarification. Did you say Canada was about to be rolled out because I thought you had already said that with Hawaii and Alaska, Canada was done.

So, I just maybe want to clarify that. Thanks.

John DietrichExecutive Vice President, Chief Financial Officer

So, hey, Ken, it’s John. I’ll start with the last one. It’s about to be rolled out. It has not been completed, and we can talk more about that in a minute.

But, you know, Q3, as I mentioned earlier, was a combination of things. We saw, while the revenue was soft, we’re focused on quality revenue. The cost controls were solid and strong, and there were some other levers that were alluded to earlier. As you can see, variable comp, for — for example, is down.

So, that was a contributor, but you know, all these things taken together resulted in us — in our focus on improving our results for Q3.

Brie CarereExecutive Vice President, Chief Customer Officer

Yep. And, Ken, I’m just happy to clarify, for the Network 2.0 perspective, the Canada plan has not changed. Alaska and Hawaii are done, and we are beginning the rollout of the integration in Canada that will begin this April. And we will be done before peak and it’s on track.

Operator

The next question comes from Brandon Oglenski with Barclays.

Brandon OglenskiBarclays — Analyst

Hi, good afternoon and thanks for taking my question. Maybe if we can follow up there. On Network 2.0, Raj, I think you mentioned you’ve made some management changes on both Ground and Express surface operations in the US. Can you talk maybe a little bit more about that and how that plays into long-term integration?

Raj SubramaniamPresident and Chief Executive Officer

Yeah. Thank you, Brandon. I think, first — first of all, Network 2.0 is on track. Let me just take a, you know, step back here.

You’ll recall that we — we said we plan to deliver 2 billion in savings by the end of fiscal ’27, and we are taking that measured and deliberate approach. And we just rolled out our new leadership structure in the — in the United States, and it’s obviously a much more streamlined structure and much more effective structure and, essentially, with the goal of putting one truck in one neighborhood design into action. We are encouraged by the early results we’re seeing in the initial rollout as well so far. Network 2.0 model on the whole has achieved approximately 10% reduction in P&D cost and maintain very strong service levels.

As we become more tech-enabled in this regard, we’ll deliver even greater improvements. And as we have already talked about, you know, we are focused on implementation of Canada before peak. And I also have to say that I’m very excited about Network 2.0 from a service perspective because it will drive a better customer pickup experience. So, you know, we’re on our way on track and, again, some ways to go.

Operator

The next question is from Scott Group with Wolfe Research.

Scott GroupWolfe Research — Analyst

Hey, thanks, afternoon. So, John, this year is a 1.8 billion of DRIVE savings and you’ve talked about 900 million of offsets, so about 900 million of actual profit. As — as we think about fiscal ’25, do you think the actual profit improvement should be closer to 2.2 billion of DRIVE savings, or do you think there’s another year of material offsets to that DRIVE in fiscal ’25? And then, just separately, just no one’s asked about Ground yet, and it’s by far the biggest part of the business. So, if I can just ask one.

The margins, you know, 12% this year, you think there’s further margin improvement to go at Ground? Thank you.

John DietrichExecutive Vice President, Chief Financial Officer

Thanks, Scott. Aand let me start by saying, on that 2.2, that’s certainly our goal to have that all flow through, but we have to be realistic and understand that a lot of the pressures that we’re seeing today are expected to continue for a while. And while we’re going to continue to focus on those things within our control, there are certain things without outside of our control. And so, our — our goal is to have as much pass-through to the bottom line as possible, and we look forward to keeping you up to speed on that including, you know, when we next talk in June.

With regard to Ground, exceptional story, exceptional performance from the team. I believe those margins are sustainable, and there’s still a number of projects in the pipeline that allow us to continue to grow and expand that business and those margins. So, again, that’s going to be our focus as well.

Operator

The next question comes from Helane Becker with TD Cowen.

Helane BeckerTD Cowen — Analyst

Oh, thanks very much, operator, and hi, team. I have, I guess, two questions. One is, as part of the whole redesign of the network and the business and collapsing everything into one, have you thought about shifting to a calendar year rather than staying on a May fiscal year? And my second question is maybe for Raj. You know, a lot of investors push back to me about the business that — you know, the way you’re structuring the business.

And I noticed the stock aftermarket was up quite a lot after, you know, the earnings release. Why do you think investors are so skeptical of your business plan and aren’t willing to give you the credit that maybe you deserve for the changes you’ve made as speedily as you’ve made them?

John DietrichExecutive Vice President, Chief Financial Officer

Thanks, Helane. I’ll start on the first part on the calendar year. You know, as you’d expect, with everything going on, there’s legal and accounting exercises that need to take place to get us through this next period including June 1 date of one Fedex. But I can share, it’s certainly on my radar to migrate toward that, and we’ll keep you posted on developments toward that.

Raj SubramaniamPresident and Chief Executive Officer

And then, as for your second question, all I can say is that we, as a team, are very much convinced that we have a unique story at FedEx here, that the opportunities that we have one — in the industry is one thing. But within the industry, we are — we have a unique opportunity because of the strategies that we have deployed. You know, we — we started moving early than anybody else. We are performing better than our competition, both on the top and the bottom line.

And we have a longer runway because of the opportunities we have identified. And so, you know, we will try to educate as many people as we possibly can on our strategy and — you know, and where we are. But we are just seeing the early stages of what’s possible at FedEx. You know, any one particular quarter sometimes kind of throw you off, but the long-term strategy is sound.

And we all believe in it, and it’s going to be a — it’s going to — it’s going to be a good — good run in the — in the next three or four years.

Operator

The next question is from Ravi Shanker with Morgan Stanley.

Ravi ShankerMorgan Stanley — Analyst

Thanks, everyone. Apologies if I missed this, but regarding the USPS contract, when do you expect that to reach fruition? Is that something that happens in ’24, ’25? And — and also, can you share how much of the volume has come off already and kind of how much would you mention kind of that — that net with the new contract ends up being? Thank you.

Brie CarereExecutive Vice President, Chief Customer Officer

Hi, Ravi, thanks for the question. It’s Brie. From a USPS contract, I really can’t say more than I already said earlier. You know, in short, we are feeling very positive about the negotiations.

Both parties are working eagerly. We’re at the table. I think we are days or weeks away from knowing if we will have a contract, not months. And as we have shared previously, their current contract ends on September 29th.

So, we will know very very soon, and you know, I’m certainly not at liberty to talk about the details of a future contract.

Operator

The next question is from Stephanie Moore with Jefferies.

Stephanie MooreJefferies — Analyst

Hi, good evening. Thank you for the question. I appreciate the incremental color on — on Network 2.0. And I was — I was hoping you could maybe provide a little bit of color in terms of some of the investments that have to be made in order to execute on the integration, particularly as you enter — or you begin the execution in a much larger market, like Canada.

Any color in terms of maybe lessons learned from your Alaska and Hawaii integration? And then, you know, what investments we should expect to see as you implement it in Canada? Thank you.

John DietrichExecutive Vice President, Chief Financial Officer

Yeah, thanks, Stephanie. It’s John. Yeah, certainly, there’s going to be some investment required when you’re consolidating facilities, particularly sort facilities, but there’s also upside in that you’re able to reduce your facilities footprint along the way. So, that will involve some — certainly some planning and processes, analysis and all that.

But we’re excited actually about the end game here and that is our overall footprint will – will — will far — the benefits of that will far exceed the — the investment and contribute to a really efficient network.

Brie CarereExecutive Vice President, Chief Customer Officer

And, honestly, from lessons learned, I think the team feels really good about their execution to date. To Raj’s point, we have seen kind of the P&D benefits that we anticipated, as well as we’ve seen the team be able to execute from a service perspective. I will say we are being very disciplined, we’re being very methodical, and we are giving customers the advance notice as we go into market. That was one piece of feedback for customers.

Even though we anticipate being able to deliver the same level of service with the combined organization as we are as an individual, they do want that notification. And so, we of course, are giving customers that advance notification. And to Raj’s point, on the positive, I cannot under-emphasize how important that single pickup is to our small customer segment. This has been the only feature gap we had to UPS in that segment, and we are about to close it.

So, I’m pretty excited about that.

Operator

The next question is from Bruce Chan with Stifel.

J. Bruce ChanStifel Financial Corp. — Analyst

Hey, Raj, Brie, John. And, Jeni, welcome to the mix here. I don’t know if you’ve really talked about it, but we’ve been hearing that you’ve had some pretty material service improvements, especially at Ground over the last, you know, call it, year or so and that’s, you know, despite the cost savings push. Can you maybe just talk about that a little bit, you know, where the service levels today, what are the levers that you’re pulling? And then, you know, what kind of opportunity do you have to DRIVE, call it, pricing as a result of that? Thank you.

Brie CarereExecutive Vice President, Chief Customer Officer

I love this question. John Smith and Scott Ray are crushing it. When we went back and looked at our Q4, the toughest quarter to — I should say Q4 calendar year, the toughest quarter to deliver awesome service, not only are we faster, I am quite confident we — on those higher standards from a delivery service perspective, we also had better reliability. How are they doing this? It’s discipline.

It’s day-in and day-out execution. We look at our service metrics every single morning. We talk about Net Promoter Score every week at our revenue management committee, into Raj’s coverage on the — the integrated leadership team, now the service organization. We absolutely expect to extend that across the entire network, and I just could not be more appreciative of our operators and how well they’re doing.

Raj SubramaniamPresident and Chief Executive Officer

Yeah, I wanted Brie to answer that question because she holds their feet to the fire every single day. So, I’m glad you heard that answered directly from Brie.

Operator

The next question is from Conor Cunningham with Melius Research.

Conor CunninghamMelius Research — Analyst

Hi, everyone. Thanks for getting me in. I was hoping you could talk about the opportunity you see just with the — the e-commerce return business. You’ve obviously been a big player there, but there’s been a lot of changes to the network.

Is that now a larger focus? The reason why I asked, obviously, there’s been a press report about you reengaging with Amazon. So, just any thoughts there would be helpful. Thank you.

Brie CarereExecutive Vice President, Chief Customer Officer

Sure, happy to. I think we’ve got the best returns portfolio in the market. When you look at our retail coverage as well as our transportation solution, it is best in class. And when we looked at our January numbers, the FedEx Ground returns portfolio did see some healthy growth.

You layer that on with the new announcement of our fdx platform, we are going to be the only provider that has not only the physical capabilities but a very comprehensive digital capability. And what do I mean by that? We are going to be able to help all retailers, brands, and merchants process their returns on their website, managers — manage their exchanges, manage the inventory, integrate their brand and tracking and communications to customers. It’s a really powerful offering. As I mentioned earlier, we’ve started to preview this with some customers.

We’ve got some pretty big names and what we’re calling our private preview, and that I look forward to sharing more results once we do the full launch later in the fall. As — I think I’ll stop there. I’m enthusiastic about this.

Raj SubramaniamPresident and Chief Executive Officer

You know, when — I’ll just say this much, when you integrate with these customers, even I can program. And in this no-code environment, I can set up the returns policy. So, if I can do that, anyone can do it.

Operator

The next question is from Scott Schneeberger with Oppenheimer.

Scott SchneebergerOppenheimer and Company — Analyst

Thanks very much, everyone. It’s — it’s basically two questions. One to follow up to Brie’s brief. Brie, I was hoping if you could kind of give an overview of peak season, kind of takeaways, learnings.

And then, I think we have five less calendar days for the 2024 calendar peak. So, just things that you’re going to learn and manage ahead of time as — as it’s a much more condensed season. And then, the second question for — for any of you, but just in — in Ground, cost per package, it was — it was down 2% in the fiscal second quarter, and you cited improved first and last mile productivity. Flat here in this quarter, and — and offset was higher first and last mile cost.

Just curious if there’s anything we should read into there. Thanks for taking both.

Brie CarereExecutive Vice President, Chief Customer Officer

Yeah, I think, from a peak perspective, you know, we’re really pleased with how we’re managing peak from a service, from a customer, and from a profitability perspective. First and foremost, the team starts, literally, now for this coming peak. And what do I mean by that? We are already talking to customers about what their peak requirements are for next year. And so, that John and Scott have advanced planning, and then, of course, as we get closer to peak, we take the top 100 customers and we are managing forecasts, on a weekly basis.

I think some of the integrated planning that we are doing with Dataworks is also incredibly helpful so that we have real-time information. We’re not waiting for spreadsheets to be passed over, but we’ve actually got real-time visibility into some of our largest customers, which has been incredibly helpful. So, I don’t anticipate us doing much different this year but more of the same. And again, I also was really pleased with the peak surcharge capture.

We are ensuring that the customers that really drive the investment we need in December, we’re getting recouped for that cost. So, we feel good.

John DietrichExecutive Vice President, Chief Financial Officer

Yeah, and I’ll speak to the Ground piece. And I think one of the drivers of the margin expansion and cost control at Ground was lower line-haul expense that I alluded to. And, you know, we moved a lot of high cost and ad hoc external line haul spend into our scheduled network and, as a result, achieved lower rates on the planned line haul purchase transportation. And this is all part of a broader optimization and ongoing optimization that’s taking place in the network through DRIVE and through Network 2.0.

And so, every aspect. And even those, you know, first and last mile will be part of that. And, you know, we’re also leveraging the capacity that we have. And we do have some additional capacity in the Ground network that can absorb additional volumes at no incremental cost.

So, that should help improve margins as well.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Raj Subramaniam for any closing remarks.

Raj SubramaniamPresident and Chief Executive Officer

Thank you, operator. In closing, we saw continued operating income growth, margin expansion despite lower revenue for the third consecutive quarter, and this is clear evidence that DRIVE is working. While these results are encouraging, it is our top priority to maintain momentum and continue to transform our network and the way we work. Once again, let me thank our FedEx team members for their hard work and dedication to delivering outstanding customer service.

I’m really proud of the work that we have accomplished as we continue to build the world’s most flexible, efficient, and intelligent network. Thank you for your time and attention today.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Jeni HollanderVice President, Investor Relations

Raj SubramaniamPresident and Chief Executive Officer

Brie CarereExecutive Vice President, Chief Customer Officer

John DietrichExecutive Vice President, Chief Financial Officer

Jordan AlligerGoldman Sachs — Analyst

Tom WadewitzUBS — Analyst

Jon ChappellEvercore ISI — Analyst

Bascome MajorsSusquehanna International Group — Analyst

Dave VernonAllianceBernstein — Analyst

Brian OssenbeckJPMorgan Chase and Company — Analyst

Jeff KauffmanVertical Research Partners — Analyst

Ken HoexterBank of America Merrill Lynch — Analyst

Brandon OglenskiBarclays — Analyst

Scott GroupWolfe Research — Analyst

Helane BeckerTD Cowen — Analyst

Ravi ShankerMorgan Stanley — Analyst

Stephanie MooreJefferies — Analyst

J. Bruce ChanStifel Financial Corp. — Analyst

Conor CunninghamMelius Research — Analyst

Scott SchneebergerOppenheimer and Company — Analyst

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