FedEx Freight Holding Company, Inc. (FDXF) Earnings Call Transcript & Summary

All right. Well, welcome, everyone. I'm Richa Harnain. I do freight transportation research here at Deutsche Bank. Welcome to our Industrials Conference. Very happy to be joined by FedEx Freight today, your first webcast as an independent company. We're honored to have you. We have Marshall Witt, who does -- who's the Chief Financial Officer at FedEx Freight, along with members of the IR team, Marianna Rose and Samantha Morris. Very pleased to have all of you here today and doing this discussion with us. So yes, maybe we can just start with a question about the state of the market. Obviously, a lot of exciting things happening under the hood at FedEx Freight as you optimize the business as a stand-alone enterprise. But you're also the largest LTL operator in North America. You see a lot. And as you assess the economic tea leaves, where do you think things stand as far as the state of the industry, opportunity for cyclical recovery after 3-plus years of a very painful recession, if you will, in freight -- in the freight market.

So Richa, thanks for having me and for the introduction. Before I start, I have to do my disclaimer on forward-looking comments. I have got couple of opening comments...

Yes, I forgot about that. Yes, you do.

I promise I'll get to the economic question. But before we start, certain statements I'll say today could be considered forward-looking statements as defined in the Private Securities Litigation Reform Act and are subject to factors that could cause actual results to differ materially from those expressed or implied. For additional information, please refer to our press release and filings with the SEC. So just a few comments before we kick it off the first question. So super excited to be here today to discuss FedEx Freight and the opportunities that lie ahead for us as a stand-alone company. As many of you know, June 1 marked an important milestone for us as we rang the opening bell on the New York Stock Exchange and began trading as an independent stand-alone company with the ticker FDXF. So we're roughly 70 days into it -- into our journey as an independent publicly traded company. And we're at where we hope to be as we're 70 days into this, both strategically, operationally and also financially. The separation has gone smoothly. As you all may know, a significant amount of investment has been underway in regards to not only FedEx Express or FedEx Corporation's investment but FedEx Freight investments, but it's going very smoothly with strong execution across the organization. Our teams do remain focused on delivering the commitments that we outlined at Investor Day and early execution reinforces our continued confidence in our ability to successfully operate as a stand-alone company. We continue to have strong confidence in the business and in our long-term opportunities. The medium-term outlook and the financial framework that we provided at Investor Day remains unchanged. Early progress continues to reinforce our conviction that we can and will achieve our stated strategies. Still, we're in early innings, if you want to call it that, in regards to our initiatives, but we're encouraged by the momentum we're seeing across our business. And we're beginning to see the strategy translate into tangible results. From a stand-alone perspective, we will continue to sharpen our strategic focus. Our ability to have a dedicated investment strategy and thesis enables us to accomplish that. The enhancement of accountability throughout the organization has been evident and seen. And so it's really neat to see that play through. The allocation of capital with a singular objective of maximizing long-term potential for FedEx Freight continues to be our North Star and better positioning from a focusing of resources and decision-making on opportunities that we believe will generate shareholder value. So while the independence is new to us, the strength of our franchise, as many of you know, is long established, starting with Viking Freight and adding to that American Freightways and then also with Watkins Motor Lines and the combination of those 3 acquisitions created a North American footprint that does allow us to be the largest LTL carrier and does put us in a position of strength really to enter the next chapter as the industry's largest LTL carrier. We operate the fastest and densest LTL network in North America by published transit standard times and it's supported by a proven operating model and a renewed focus on high-quality, efficient and profitable service. Recent quarter, which was ended May 31, delivered meaningful improvements in a number of areas, specifically safety, claims ratio and customer service. From a technology standpoint, that continues to be a key driver for future performance and future performance improvement. We continue to invest in those tools and capabilities that allow us to improve visibility, efficiency and value. We're focused on enhancing the customer experience. That is a journey that will continue on for quite some time. That allows us to continue to optimize our operational footprint. And then we want to leverage our advanced analytics, continue to expand automation and deliver digital solutions across the business. Our goal is to be a more responsive, efficient network and an easier customer experience, which we call easy-to-do-business-with attitude in regards to our customers. From a commercial perspective, we're firing on all cylinders for the first time in more than a decade. We have a dedicated LTL sales force focused exclusively on growing our business. We have an increased focus that helps deepen the existing customer relationships and expand into attractive and profitable markets. Our sales team is ramping quickly and integrating seamlessly across the organization. And already, we're seeing meaningful impact with customers and our frontline employees. One of our greatest competitive advantages is our dual service model. That's the Priority and Economy services that we offer through a single integrated network. Both operate in the same asset base, allowing us to be efficient and currently generate similar operating margins. It provides customers with the flexibility and choice while optimizing our network productivity. To us, it creates attractive returns and strengthens the customer relationships as approximately 50% of our customers use both of those services. It's a powerful differentiator that supports efficiency across our network. From a financial strength and capital allocation perspective, we're executing from a position of strength that's supported by a strong balance sheet with substantial financial flexibility. If you think about our capital allocation priorities, they remain straightforward and disciplined. We want to invest in our business. We also want to deliver and maintain a high-grade balance sheet with investment-grade rating. We want to deliver attractive shareholder returns and at the right time, evaluate selective M&A opportunities. We're focused on strengthening our competitive position while creating shareholder value. So we believe freight -- FedEx Freight and the value proposition is simple and compelling. It provides significant opportunity to unlock value that has long existed within our franchise, supported by proven leadership and a highly dedicated set of employees and leadership team, and it brings deep industry expertise, operational experience and disciplined execution. So these strengths give us the momentum and confidence in the opportunities that we see ahead of us. So why are we excited and why are we here today? First, we're the largest and densest LTL network in North America, delivering unmatched speed, reliability and scale. We have meaningful opportunities to improve efficiencies, enhance our customer experience and modernize our platform and our technologies. We have attractive end markets that are supported by a focused commercial strategy with an experienced team to deliver that and a differentiated dual-service model that combines customer flexibility with an attractive network economics and a strong financial position with a disciplined capital allocation and a relentless focus on shareholder value. Before I turn it back over to you, Richa, in closing, our strength really position us for long-term profitable growth. We expect to generate consistent free cash flow with sustainable shareholder value over time. And as an independent company, we are uniquely positioned to capitalize on future opportunities, leveraging our market-leading network, focusing on our strategy, leaning on our experienced leadership team and our strong financial foundation. So look forward to sharing more of the FedEx Freight story with you. You want me to talk about the economy?

Yes, please.

So I appreciate you allowing me to just give a little bit of preface about where we're at and where we're going. But from an economic standpoint, when we gave our guidance for the stub period, which is June 1 through December 31, 7-month period, we expect to see a slow, steady recovery in regards to average daily volume. As we were looking at quarter 3 and quarter 4, and that's a fiscal under FEC relationship, we were seeing 5-ish percent decline year-over-year in ADV. As we're coming into the June period, we expect that to slowly improve from an overall negative comparison such that when we get to that December time period, we should be at about a flat breakeven year-over-year compare. So what does that mean for calendar year 2027? We should be in a position to see for the first time, growth in our network.

Okay. And then I just -- I guess, a common theme from the other LTL providers that presented before you today was that we are seeing some cracks, I guess, in the smaller regional or privately held carriers maybe struggling to keep up with customer service expectations. Maybe their capacity is -- they don't have as much excess capacity and demand is starting to come back. Like you said, you're going to go from down 5% to sort of flat by the end of the year. So if you could talk about that, does that create share opportunities for folks like yourselves? Are you benefiting from that? Beyond kind of what the general economy is giving you?

Yes. So for us, we're more focused on what we have in terms of our strategy and what we're controlling. If you think about the segments that we're leaning into strategically, we're looking at SMB being a net new, brand-new play for us in regards to differentiation. We spoke previously and I spoke previously about that dedicated LTL sales force. Now with that SMB play, we think that, that's going to provide tremendous upside for us as we move forward. We think about the overall investment we want to have in technology and in health care and in grocery, those are the other verticals that we spoke to at Investor Day that we think have significant promise, not only in terms of revenue growth, but margin expansion as well. We've certainly spoken about our reliability and our service. We've spoken about the [freight] economy. There are some other areas that we also service, which is we have a Retail Flex, which is a residential -- excuse me, a retail tech service for those customers that have specific needs and demands. We have a direct service that enables residential deliveries to be done, which is continuing to grow and be an important part of our service offering. We have cross-border solutions and services that encompass both Mexico and Canada. So in addition to our Priority and Economy, we have other features and services that we're seeing help us gain and grow that momentum. We're less focused on what we're seeing in terms of whether it's service disruptions in with other carriers or other regional carriers and more focused on what we're doing in terms of controlling our destiny.

Heads down. Yes. And so maybe more on that specifically. You talked about your outlook June to December, the transition period. Volume is going to sort of improve throughout that period. At least the year-over-year declines get less and then we're at a steady state by the end of the year. Let's talk about margins, right? So you're at 11.8% operating margin or that's what you're expecting on like 4% to 6% growth. No margin expansion. So you have about 250 bps of pressure from variable comp TSA agreements. So on one hand, that could screen conservative given, again, no profitability improvement embedded in that guidance despite decent revenue growth, right, 4% to 6%. On the other, if I strip out that discrete headwind, you're calling for 200 bps -- 250 bps of margin expansion, and that's the way we calculate it, 60% incremental margins on 5% revenue growth. So a long-winded way, I guess, to ask, what would you say to this? And how are you framing the outlook? And maybe what is the biggest risk to the outlook? What's the biggest opportunity?

Sure. So if I think about the guide that we gave for the 7-month period, we did get that 4% to 6% growth rate. The larger element of that is the forecast we have for our fuel surcharge. If you remove that and you look at the base business, we are on track of hitting where we need to be strategically, where we are in terms of operations, where we are in terms of customer service and in our sales strategy. If you think about the TSAs, we spoke to that being a unique headwind that we expect to be about $65 million in the stub period or in the transition period. That will continue into the first half of calendar '27. So that headwind starts to decline as we get into the second half of '27. And in regards to variable comp, we had shown that in the bridge as well in the prior year of 2025, that same 7-month period, the funding rate was around 25%. And then the stub period for this year, it's expected to be at plan. So that headwind as we lap next year goes away. So if you think about the goals that we're setting out there, they are prudent. We think they're reasonably achievable. But we do think that as we get into next year, there's going to be some further investments that we have spoken to around our operational technology and our transformation investments we're going to be making there. As you may know, that's an area that we intentionally stay away from in regards to our investments pre-spin. But if you think about where our operational opportunities lie, these will be investments in P&D, dock and line haul that will create significant productivity improvements, but will serve as a cost element as we get into 2027. And I think about the biggest opportunities and threat, probably the biggest threat for us would just be the geopolitical environment, the uncertainty around what's happening on a global basis and how that could influence whether it's fuel prices and those longer-term demand impacts on our business, that's potentially one of those risks. The opportunities, I would say, it's like the collective unlock. If we continue to see an improvement in our customer experience and we continue to see a more accurate relationship with our customer in terms of invoice accuracy, the ability to improve the digital solutions and the connectivity that become more automated and seamless with our customers, combining that with the momentum that we're building in our SMB strategy with our dedicated sales teams in those verticals. If those continue to show promise, that is future and further unlock to what we have in our sector.

And in terms of risk regarding the things you can control, like talk to us about the tech journey and things like that, like do you feel okay about where you are on that path and integration of like new technology platforms or whatever? Have you done all the heavy lift and that's less of a risk for you or...

Yes. So on our technology platform, we talked about the TSAs. And just to put a little more color on what that is, those are FedEx Corporation technology platforms that they are charging us for as we begin to stand up our own technology solutions and then remove reliance on them. So that technology journey is what Mike Rodgers walked through at Investor Day, which is getting the pricing, getting the website set up, getting the simplicity around our customer hierarchy completed, putting in a new pricing platform, enabling us to have an enterprise-wide financial system in place. And then the next step for us will be to stand up the solutions around our operational technology investments. And just to give some color to us here in the room, the current operational system is probably 25 years old, very reliable, very resilient, but in need of a lot of improvement around technology innovation. There's a lot of human requirements necessary to allow that operating system to work efficiently. So we realize that as we can take what is a lot of off-the-shelf solutions today in the technology stack for operational support or solutions for LTL, we think we can quickly leverage that and that can create more opportunities for us.

Okay. Cool. So let's turn to the opportunity side of the ledger. You mentioned one of them is your dedicated sales force. Maybe you can discuss that a bit more. If the team of yours is fully ramped today, how are they incentivized? And what impact you're seeing on customer acquisition, growth, overall revenue quality as you brought these folks on?

Yes. So if I think about where the team is at today, we are, call it, fully ramped. But with that said, just like a lot of the way we've structured the support requirements for FedEx Freight, we believe it's the appropriate structure to address where we need to go as an organization. So we think about the sales team and what it was and what it is, it's important to lay that history. Pre-spin, our LTL team was part of Federal Express Corporation or FEC, and it was a sales team that collectively and was responsible for selling Express parcel and LTL. And so if you think about that focus and prioritization, there was -- majority of the investment and time and focus and incentive was on the Express and Parcel solutions. And there wasn't as much attention and focus given the LTL play in terms of leveraging the growth there. So pivoting and shifting that team out and having them dedicated to the LTL structure, we believe does a few things for us. It allows us to get properly aligned to the customer segmentation that we have, allows us to have the right focus on our regional presence in the amount of care and need that is necessary to go out and reach existing customers that use us and also to go out and reach new customers that haven't used us in a while. Again, way back 10 years ago, we had a regional sales team, and we had that relationship with the customers. And the other thing that's really important with that relationship is it's not just the salesperson doing that call by themselves, him or herself. It's in partnership with the service center. It's in partnership with the driver. The driver is an equal sales leader and part of that effective tool in terms of how we reach the customer. They see the dock, they unload and load every day. So bringing those eyes and ears and having someone like a sales rep in that same location enables them to be able to do something with that opportunity to be able to connect it back to the service center. So there's an operational alignment that didn't take place in the past that we're bringing back into the region, which is helping from a staffing standpoint. If I think about incentives, pre-spin, it was primarily focused on revenue and mostly on farming and less on the hunting side of it. In the post-spin world, we've got dedicated folks that are doing farming. We've got dedicated folks that are doing hunting. And the combination of that incentive is it's revenue and it's margin. So it's that balance to ensure we're getting profitable growth and that there's accountability to both of those, not just one or the other. Customer acquisition, we are seeing good progress on that front, specifically in the SMB space. We are seeing both existing customers and net new customers as well. So we're encouraged by the meaningful incremental volumes that we're experiencing there. In the technology space, and again, just to remind you what that is, these are the data centers that are going to grow forever, but they do have meaningful desire and need for a network like us that can take their supply chain on a North American scale and create lower-cost solutions that they prefer for us to do rather than just servicing for their own DCs. And so price isn't as important. Service matters a ton and reliability is extremely critical. So we're seeing wins in that space as well. So we expect that to continue to grow. Same with grocery and health care. On grocery, as many of you may know, we have Custom Critical, which is one of our subsidiaries that has a lot of expertise in that area. So we've got the capabilities to continue to deliver the requirements necessary to produce outcomes in that.

Okay. So it seems like already you're seeing some new customer additions, some great traction, and it was just a matter of basically turning this feature on, right, the dedicated sales force. So I guess like if we can just focus a little bit around like why it's important to have a dedicated sales force? Like before when you had a sales force that was selling Express Parcel plus LTL, you often talked about how LTL was overlooked because it's more difficult to sell. So what have you -- you made it seem very easy, Marshall, but like what really -- what's really difficult here that you sort of conquered by establishing the sales force?

Yes. For us, there is a -- there is a complexity in any sales solution. But certainly in LTL, we have our own complexities in terms of how we go to market. And so when we had slowly moved away from that SMB regional approach, we had a number of dedicated LTL sales folks that over time, we just lost. So that mind share and that understanding of the sophistication of what our customers need is also not appreciated. So it's not as if we're more complex than the other industries, but it is -- just it is a unique sell. And in many cases, there's like there's like -- there is 2 ways that customers connect. They have their own pricing platforms based on may not be antiquated pricing structures, but they're long-standing pricing structures that are commodity-based or class-based that have been established for years, maybe decades that have been deeply discounted. And so it gets it gets tricky very quickly if you don't have the right LTL salesperson to understand how to see through that. So having that skill set back in-house and strengthening them is enabling us to have a more customized discussion and solution for our customers. And then just in terms of who are these sales folks, 60% of these sales folks came over from FedEx Express Corporation. So we've got a lot of good legacy knowledge just in terms of the customers and the culture and the requirements. But we also hired a number of sales folks from outside of freight or outside of FedEx to bring that third-party expertise that have LTL experience in. So it's good to have that good balance and understanding. The other piece of that difficult to sell is also creating a more simplified structure of selling to our customers. So we know that in order to do that, our customers have to have a system to accept that. So we have to be able to sell both in a complex, kind of an older structure and a new pricing dynamic that is much more simplified. And so creating both of those needs and putting that on the shoulders of every one of our sales reps is going to be one of those critical things that enable us to win.

Okay. And you said you are fully ramped now with where you want to be, right?

Yes, I'll comment on that. For our structure and our design, we have the right sales structure in place. But like in many of our functions, just I can even use the CFO function, we have stood up a lean organization that properly supports where we need to go as an organization. But we also are going to kind of ramp and move that volume based on -- or the resources based on where the volume is going. So we feel good about the structure today. There's really no immediate need to either take it down and move it up. But I wouldn't be surprised over time if we were to see even more dedicated technical sales expertise around these sectors that we continue to focus on. So in that case, you have a generalist approach, we have an SMB, a team that covers the Chicagoland. Then you would have your experts that come in that talk about technology sales and how we focus on those data center, those hyperscalers. How we actually provide the right solution to them without requiring every SMB person to have that same skill set. So it's that localized coverage and that technical expertise. And as that blends together, we could see some movement there, but not in terms of reduction, but more in terms of a funnel.

Yes. All right. Very good. Okay. So let's talk a little bit more about your growth plan. You highlighted several industries. You reminded us of your focus on grocery, health care, data center, et cetera. Maybe talk about what makes you better positioned to go after these high-value verticals today than where you were under the FedEx Corp. umbrella. I mean the sales force is one thing, but what else?

Yes. So for us, I think let's step back and say, what is different now? Well, it's a Board that's dedicated to FedEx Freight, a leadership team that is 100% dedicated to what we're doing in terms of controlling and managing our outcomes. So that may seem simplistic, but just that 100% fit for LTL strategy does enable us to put us in a better position than what we were. So we're not necessarily saying we're the best positioned across every industry and every peer set. But where we were coming from, we've got a much more intentional focus. So that value, that visibility, that velocity, the decision speed is accelerated. Our ability to know the facts and act on those quickly is much flatter and more concise. And then the technology platforms that I spoke to earlier around enabling a much more simplified solution is something we didn't have in the past. And again, this is really more of our journey than it is compared to other peers. If you think about our journey in terms of revenue quality, our customer experience scores have been not the greatest historically. At one point in time, we were much higher in the Mastio outcomes and reports, and we've fallen from that. So we've got quite a bit of good news and goodness in front of us to improve those. And a lot of it is around that customer experience journey, simplifying that relationship with the customer, making the quality of that interaction much higher. And sometimes that translates into simple things such as having an accurate invoice and being able to do that in a repeated, in a standard way that's reliable, that provides a lot more satisfaction in that experience for our customer. So beyond just the structure itself in terms of those segments that have a meaningful impact for us going forward, there's a lot of fundamental things that we are now just doing better that enable us to achieve those results faster.