Fedex Corp (FDX) — Q2 2016 Earnings Call Transcript

Good afternoon. And welcome to FedEx Corporation's second quarter earnings conference call. The second quarter earnings release and our 26-page stat book are on our website at FedEx.com. This call is being broadcast from our website, and the replay and podcast will be available for about one year. We have moved our call to the afternoon to allow more time for us to review our results and answer your strategic questions. Written questions are welcomed via e-mail or social media. When you send your e-mail, please include your full name and contact information with your question, send it to our ir@fedex.com address. If you would like to send a question via social media go to stocktwits.com and include $FDX in your message. Preference will be given to inquiries of a long-term strategic nature. We’ll first take a couple of questions after the remarks from the conference call then we will answer questions that have been submitted via the internet. I want to remind all listeners that FedEx Corporation desires to take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act. Certain statements in this conference call may be considered forward-looking statements within the meaning of the act. Such forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. For additional information on these factors, please refer to our press releases and filings with the SEC. To the extent we disclose any non-GAAP financial measures on this call, please refer to the Investor Relations portion of our website at fedex.com for a reconciliation of such measures to the most directly comparable GAAP measures. Joining us on the call today are Fred Smith, Chairman; Alan Graf, Executive Vice President and CFO; Mike Glenn, President and CEO of FedEx Services; Chris Richards, Executive Vice President, General Counsel and Secretary; Rob Carter, Executive Vice President, FedEx Information Services and CIO; Dave Bronczek, President and CEO of FedEx Express; Henry Maier, President and CEO of FedEx Ground; and Mike Ducker, President and CEO of FedEx Freight. And now, Fred Smith, will share his views on the quarter.

Thank you, Mickey. Good afternoon. And welcome to our discussion of results for the second quarter of fiscal 2016. FedEx Corporation posted solid earnings and year-over-year EPS improvement of 19%, excluding TNT integration costs and a legal settlement charge for FedEx Ground. We continue to increase margins, earnings per share, cash flows and returns on invested capital. These basic trends should continue well into the future, barring major events or macro-economic factors. A record number of holiday shipments fueled largely by the steady rise of e-commerce are flowing through the FedEx global networks. Monday, we picked up over 26 million packages globally. We greatly appreciate the dedication of more than 340,000 FedEx team members who are delivering the holidays to our customers around the world. Express service levels in particular have been outstanding. While we have experienced extremely heavy ground volumes in the Northeast, our team members have risen to the challenge and the ground system is running as scheduled. Adherence to our people service profit philosophy and the FedEx strategy of competing collectively, operating independently and managing collaboratively are key to our success. We will exceed the profit improvement program at FedEx Express this fiscal year and the Aircraft Fleet Modernization program is paying off significantly. It's no secret that e-commerce is changing the dynamics of the transportation industry and driving remarkable growth. We have strategic plans to ensure we will continue to benefit in the years ahead from this growth. For example, we are integrating Ground and SmartPost facilities, and linehaul systems to realize incremental operating expense savings in the future. Multiyear expansion of automated FedEx Ground facilities will allow continued profitable growth and provides the most flexible and fastest ground package system possible. We are also deploying new technology that will enable us to combine FedEx Ground and FedEx SmartPost packages going to common delivery addresses, which will significantly improve efficiency, productivity and service. FedEx Freight is focused on improving margin trends in a weak industrial economy through better balance and volume and yield and higher productivity. Our recent offer to buy TNT Express assuming it's approved will quickly broaden our portfolio of solutions, particularly in Europe. Customers of both FedEx and TNT will benefit from our unmatched global network. Despite contraction of U.S. exports due to the high U.S. dollar, and low world GDP and trade growth, the overall market for international door-to-door Express continues to increase, also driven by e-commerce. A couple of developments in e-commerce are worth noting. First, oversized packages are increasing, and second, a number of e-commerce shippers continue to use extremely cubed inefficient packaging, loaded density and over-the-road ground trailers is therefore declining because of these trends. In this regard, we are extremely disappointed that Congress did not approve the use of Twin 33-foot trailers on the nation's highways versus the current 28-foot standard. 33 is already permitted in 18 states and we have safely driven them almost 1,500,000 miles in Florida alone; drivers tell us they are more stable than the 28-foot trailers, with similar handling and turning. Our industry estimates this change would, one, eliminate about 6.6 million trips annually and thereby improve safety due to fewer accidents per year, the 33’s would materially reduce congestion, and third, it would save over 200 million gallons of diesel and reduce carbon emissions by 4.4 billion pounds per year. With e-commerce exploding and U.S. automobile models driven reaching record highs this year, 33-foot trailers would be of enormous benefit to our economy and significantly improve road safety. We would like to welcome Chris Inglis to the FedEx Corporation Board of Directors. Chris retired in 2014 as the Deputy Director and Senior Civilian Leader of the National Security Agency. His Cyber Security and Information Technology expertise and significant leadership experience will be very valuable to FedEx. Regarding the vital issue of cyber security, the pending omnibus bill contains several very positive changes to the law regarding corporations and government agencies. And we sincerely hope it passes. In conclusion, let me also remind you that this is the earnings call of FedEx Corporation. We manage our portfolio of services to achieve enterprise results, which does not always translate into each segment’s individual earnings and margins. Now Mike Glenn and Alan Graf will discuss our economic outlook and further details of second quarter earnings, after which as Mickey said we’ll take your questions.

Thanks Fred. I'll open with our economic update and outlook and then I'll discuss performance and business conditions in each segment including revenue volume and yield and provide some commentary on pricing and broader industry trends that we’re experiencing. But first I’d like to take this opportunity to acknowledge our team members around the world who are delivering the holidays as we speak. As Fred noted, we've experienced record-breaking demand during this peak season largely driven by the rapid growth of e-commerce. Our busiest days during peak have exceeded our forecast and more than doubled our average daily volume and should be noted that our busiest days this year are approximately double what they were just about eight years ago. Our ability to flex our networks to meet this demand while delivering service our customers expect requires many elements. We continue to invest in new facilities, capacity expansion. We apply advanced engineering and use state-of-the-art rotation technology. We innovate the portfolio and certainly collaborate very closely with our customers. But more than anything else, our ability to meet this demand comes down to our people including our drivers, couriers, pilots, package handlers and all team members that are hard at work around the world right now to deliver the holidays. Now let me make a few economic comments. We continue to see moderate growth in the global economy. Our U.S. GDP growth forecast is 2.4% as we encounter '15 which is slightly lower than our September 2.5% growth outlook. And our forecast for calendar '16 is 2.6%, which is led by gains in consumer spending in the near-term. We expect industrial production growth to 1.5% in calendar '15, which is 40 basis points lower than our September outlook. And we have a forecast for 1.9% next year, which is consistent with our September forecast. Energy investment, strong dollar and an inventory correction are restraining growth in the sector. Our global GDP growth forecast is 2.5% for calendar '15 and 2.8% for calendar '16 which represents no change from our far outlook. Now review our revenue volume and yield trends by segment. In the Express segment, revenue decreased 6% as lower fuel surcharges and unfavorable currency exchange rates were more than offset by base yield growth. U.S. domestic package growth grew by 1%, driven by growth in overnight packages while U.S. domestic revenue per package or yield decreased 2% due to lower fuel surcharges. If you exclude the impact of fuel, year-over-year Express domestic package yields grew by 3%, primarily due to rates and discount product mix in weight per package. FedEx International economy volume grew by 3% while FedEx International Priority volume declined by 5%. International export revenue per package decreased 9% as lower fuel surcharges and unfavorable currency exchange rates more than offset higher base rates. If you’ll exclude fuel, international export express package yield decreased 3%, primarily driven by the negative impact of exchange rates which outweighed the positive impact of weight rate and discount changes. Excluding fuel and exchange rate impact, yields actually increased 1%. In the Ground segment, revenue increased 32% in the quarter due to the inclusion of GENCO results, higher ground volume and base rates and the recording of SmartPost revenues on a gross basis versus the previous net treatment. FedEx Ground average daily volume grew 9% in the quarter, primarily driven by the growth in demand for residential deliveries related to e-commerce. FedEx Ground revenue per package increased 10% due to the recording of FedEx SmartPost revenues on a gross basis and higher base rates, which include additional dimensional weight charges, partially offset by lower fuel surcharges. Excluding the impact of fuel, ground yield per package including SmartPost increased 13% year-over-year, primarily driven by changes in dimensional weight rating, extra services, and SmartPost customer mix. Normalizing for the change in treatment of SmartPost revenue on a gross basis, Ground yield excluding the impact of fuel increased 3.9%. FedEx Freight revenue declined 2% and shipments increased 1%, which is directly related to the lower levels of industrial production. We've also seen some heavier weight shipments move back to truckload as capacity has eased. LTL revenue per shipment declined 3% due to lower fuel surcharges, partially offset by higher base rates. Excluding the impact of fuel, yield per shipment increased 2% year-over-year at FedEx Freight, which was primarily driven by shipment class rate and discount. As we announced in September, we will be raising rates at FedEx Express, Ground and Freight by an average of 4.9% on January 4, 2016. In addition to the rate changes, FedEx also recently increased surcharges for unauthorized packages in the FedEx Ground network. We’ve seen significant shifts in demand across our portfolio including higher demand for residential deliveries due to e-commerce growth. We've rapidly responded to these shifts both through increased investments in capacity, expansion of our portfolio and pricing decisions across the portfolio. The rise in residential deliveries brings with it operational considerations, including the number of increased ops, higher use of fuel as a result of the increased ops and evolving package and weight dimensions. For example, packages classified as oversized account for almost 10% of ground home delivery packages during peak season. This is the primary reason why we increased the surcharge on unauthorized packages in November and will be increasing the surcharge on oversized packages in January. As we conduct our post-peak season analysis, we’ll factor all these considerations into future pricing decisions. As I mentioned earlier, we’re experiencing a record-breaking peak season with strong demand across the portfolio, especially for residential deliveries within the ground network. Strong customer collaboration is absolutely critical in preparing for peak as it enables us to anticipate surges in volume and position resources appropriately to meet the customers’ needs. We've experienced heavy demand for FedEx Ground, particularly in the Northeast as Fred noted. But our dedicated team members are working hard to deliver the holidays. Demand in our industry is rapidly evolving. And we have continued to make changes to our service portfolio and adjusted our pricing strategies to meet customer needs and generate profitable growth around the world. And now I’ll turn it over to Alan Graf.

Thank you, Mike. Good afternoon and happy holidays everyone. We had an outstanding quarter and we expect our solid earnings growth to continue in the second half of fiscal ‘16. We reaffirm our adjusted guidance for the year, $10.40 to $10.90 per share. Four highlights stand out to me. First, our adjusted EPS was up 19% for the second quarter. Second, adjusted operating margin for the quarter was 9.6%. Third, our FY16 guidance reflects nearly 20% growth at its midpoint. And fourth, cash flows from operating activities increased $300 million or 14% for the first half of FY16. I'm very proud of the entire FedEx team for its impressive efforts, which are continuing during this record peak season. Quarterly results improved largely due to higher base rates at Express and Ground, continued strong growth of e-commerce and positive impacts from the Profit Improvement Program that we announced in October of 2012 and are probably ahead of schedule at this point. These positive factors were partially offset by lower operating results at FedEx Freight, primarily due to salaries and employee benefits expense, significantly outpacing lower than anticipated volume growth and the modest negative net impact of fuel. There were two expense adjustments this quarter within eliminations, corporate and other expenses. First, expenses related to the settlement of independent contractor litigation matters of $25 million net of tax or $0.09 per diluted share. Also expenses related to our pending acquisition of TNT Express of $12 million net of tax or $0.04 per diluted share. The TNT acquisition will transform FedEx into a European offerings and accelerate global growth. We expect the acquisition will be completed in the first half of calendar 2016. Turning now to Express, another stellar quarter, operating margin grew to 9.4%, which is the best margin for Express in nearly nine years. Operating income increased 26%, despite a revenue decline of 6%. While Express fuel expense decreased 43% in the quarter due to lower fuel prices, fuel had a slight negative net impact to earnings versus last year. The negative net impact of fuel was a result of lower fuel surcharge revenue year-over-year, primarily and partially offset by lower fuel prices during the quarter. Currency fluctuations have little net impact on our P&L at Express. It can drive significant changes to revenue and expense. In addition, impacts to our P&L are more influenced by some currencies than others. Recent strength in the U.S. dollar against certain currencies has caused lower revenue expenses for FedEx Express, as well as a shift in trade patterns as U.S. imports have increased and exports have declined. A portion of our non-U.S. originating revenue, particularly from large multinational customers, is paid in U.S. dollars and therefore is not subject to currency fluctuations. This helps our international revenue and expense denominated in foreign currencies to be more balanced, causing little net impact on our P&L from currency fluctuations. That will change once we acquire TNT and we will update you on what the impact is at that point. In spite of weakening trends in global trade, Express is realizing benefits from its Profit Improvement Plan, as I mentioned before. This includes strong productivity gains, a right-sized workforce, efficient and reliable assets due to the Fleet Modernization Program and improved base yield. These structural improvements allow us to take advantage of the growing e-commerce market and to succeed under current global economic conditions. Express remains focused on ensuring the right products are in the right network and is looking for more opportunities to improve profit by using purchase transportation on a land by land basis where it meets our service level requirements and adds shareholder value. The significant network improvements we're making enable us to profitably handle growth around the globe and quickly address any imbalances due to shifts in trade patterns. Looking at Ground, FedEx Ground posted healthy results as a result of e-commerce growth, pricing actions and growth in market share. Operating income was up 13% due to higher base rates and volume. This is the financial metric that we are most focused on at Ground. As we expected, operating margin was affected by the recording of FedEx SmartPost revenues on a gross basis and the inclusion of GENCO results. Together, those items reduced the operating margin year-over-year by 2.1 percentage points for the quarter. GENCO business itself is very good. By definition, however, it will impact Ground's margins because of Ground's much higher overall margins. This is no surprise to us. The GENCO acquisition complements and differentiates the FedEx value proposition and is central to our e-commerce strategy. Opportunities from GENCO will help grow our core transportation business, especially reverse logistics and leverage existing customer relationships to open doors for both companies. Ground's long-term strategy is focused on sustainable revenue, earnings and cash flow growth. In addition to GENCO, here are five ways Ground prepares for the long game. First is automation, we’re making significant investments to add additional automated hub capacity and ensure many new stations are also fully automated, providing significant operational flexibility and capacity, particularly during sustained high-volume while keeping FedEx ahead of the competition. Second, the SmartPost integration, as one network, Ground is able to maximize the use of facilities in linehaul assets to save operating expenses and moving SmartPost packages onto a home delivery truck that is already going through a residence is significantly less costly than paying postage for the USPS to deliver the package. Over the next several years as we combine packages destined to the same delivery address, we will further increase our efficiency and profitability. Third is Monday residential service. Online shopping is a 24x7 experience, so we began a pilot test in which we make weekend pick-ups at retail locations for Monday residential deliveries in the defined area. We may consider additional markets depending on the results of the test. Fourth is technology enhancements; this is a cornerstone of how we operate inside the FedEx portfolio. We continue to identify, test, and implement new technology for our operations beyond automated sortation; scanners, package photo imaging and GPS are a few examples. And fifth is pricing. As Mike discussed, adjustments to our dimension-based and oversized pricing help offset the increase in package sizes that reduced our cube efficiency and increased our linehaul costs. The surcharges that went into effect last month apply to packages that exceed the length or weight limitations within the FedEx Ground network and are handled at our option. This proactive step helps ensure that oversized packages accepted in our network are properly priced for the space they use. We expect Ground capital expense for FY17 to remain at its FY16 level of about $1.6 billion; 90% of that will be targeted for growth, largely because of rising costs of land and equipment necessary for Ground expansion and further automation. This is a change from my Ground capital comments on the previous earnings call. At FedEx Freight, we are adjusting to challenging less-than-truckload market conditions. Manufacturing, especially in oil exploration and production, has been weakening for most of the year. The latest reading for November shows the Purchasing Managers Index, an indicator of the Economic Health for the Manufacturing Sector, down more than 15% year-over-year. Slower manufacturing and a weaker economy and mode shifts have been significant headwinds to Freight’s performance. Freight segment operating income and operating margin decreased due to salaries and employee benefits expense, significantly outpacing lower than anticipated volume growth. We are adjusting staffing levels and other items to offset the impact of the current weak industrial environment. Looking ahead, we expect our solid earnings growth to continue in the second half and it’s significant that we are reiterating our adjusted FY16 earnings guidance. This equates to an adjusted EPS growth year-over-year of 16% to 22%, despite the weaker than anticipated industrial production and global trade. Earnings growth for the second half of ‘16 will be driven by volume and base yield growth at Express and Ground, and continued benefits from our profit improvement program initiatives. Year-over-year, adjusted earnings growth is expected to be stronger in Q4 versus Q3 due to the significant net benefit from fuel in Q3 of last year and the growing benefits from our profit improvement initiatives. Remember this guidance doesn’t include any impact from TNT and mark-to-market pension adjustments. We will provide updated information at a later date. We still expect to close in the first half of calendar ‘16 and are waiting on regulatory approvals. Our tax rate is lower this quarter because we were able to resolve a state tax matter in our favor. The full year rate is expected to be about 36%, excluding any impact from TNT and mark-to-market pension adjustments. Our capital spending forecast for the fiscal year remains at $4.6 billion, primarily for fuel-efficient new aircraft and supporting e-commerce growth at Ground. We will continue to invest in our people, team members' pay increased in October, their healthcare premium held steady in calendar ’16, and our pension fund is strong with an accounting funded level of approximately 87%. On November 13th we placed our revolver and letter of credit facilities with a new five-year $1.75 billion revolving credit facility that expires in November 2020. The facility, which includes a $500 million letter of credit sub-limit and multi-currency capability, is available to finance our operations and other cash flow needs. Also during the quarter we issued $1.25 million of third-year notes at 4.75% coupon. The rating agencies affirmed our current ratings for this transaction. Interest will be $36 million for FY16 from this transaction and $60 million on an annual basis going forward. We use proceeds for some of our share repurchases, as well as other corporate purposes. Since FY14 we have returned over $7 billion to shareholders through repurchasing over 53 million shares at an average price of about $139, including over 8 million shares we have repurchased in fiscal ‘16 to-date. 4 million shares remain under our existing share repurchase authorization and we plan to repurchase all the remaining authorized shares by the end of the fiscal year. In closing, let me remind you that despite the economic headwinds, the FedEx Corporation balance sheet is strong, our cash flow is improving and we expect strong EPS growth. Thanks very much for your attention and now we will open the call up for your questions.

Hey. Great. Thanks and good afternoon. I wanted to touch, I guess, on the Express side and how it relates to the guidance. So weaker macro, maintained guidance and you’ve talked about some of the Express Profit Improvement Plan likely exceeding targets? Can you give us some context around that and sort of how you may think about the potential for fiscal ’16 and then maybe beyond?

This is Fred Smith speaking. I'll let Dave talk about it. Express' margins are going up. They are going to continue to go up, absent macroeconomic or geopolitical events. As I said in my remarks, the Fleet Modernization Program is making a huge difference; Alan said in his remarks, the productivity is going up; the system from adjustments that Dave made in his network allow us to put the right traffic in the right network and as I said, Express is in a sweet spot.

Yeah. Thanks for the question and thanks, Fred. We are in a sweet spot and if you remember our Profit Improvement Plan was driven mostly by structural costs initiatives and not as much on revenue. That being said, the revenue has been better. We've had better yield management. But again we've had a terrific performance in our fleet. The planes are flying at 99 plus reliability and the fuel saving has been great, and of course, the reliability is all around the world. That being said, of course, our productivity and we've right-sized our U.S. operations here throughout the United States. And really on a global basis, the traffic that we are moving on the international economy basis, that's growing profitable for us now, because we have it in the right network. So, yes, we are very optimistic about our profit improvement going forward. It continues to increase the profits. It doesn't stop. Of course, I saw some of the comments earlier. It just continues to keep growing and increasing. And Fred is right, I mean, we had nine-year high of our margins at Express and those will continue to grow as well with our profits.

Yes, good afternoon. Thank you for the question. I'm not sure if this is more for Alan or Dave, but regarding the Express improvement plan, I'm unclear about the specific metrics compared to when you first introduced the plan, which mentioned a target of $1.6 billion. I believe that was noted at the end of fiscal year '17, including some changes related to the pension. Could you clarify the total amount you’re considering for the plan and whether the end of fiscal year '17 is still the appropriate timing for that? I understand you will continue to make improvements over time. Thank you.

Thanks, Tom. As I think we’ve mentioned this before several times, but it’s important to mention it again. The 75% run out weight rate that we've captured, we captured at the end of last fiscal year. FY16 built on that. All five of the pillars are still the five that are producing the results. Quite frankly they're better in almost every category. You can go back and look at all the notes, so you can call IR for the five pillars. But across the board we are improving in each one of the pillars. The one that we counted on the least was the global marketplace revenue and actually we've been better on that. All that being said, that was the one that we were worried about the most. We are doing very well there, because we planned it to be less than all of our cost initiatives. So I would say going forward, obviously, you can see in the numbers, we are having a great year in ’16 and that will continue into ’17.

Good evening and thanks for taking my question. Fred you started off like talking about obviously all the changes that e-commerce has brought and how that’s allowed you to redefine your network and serve your customers? As your customer supply change evolved, how have you been able to help them and get deeper into that relationship and particularly how does GENCO help with that?

Well, I will ask Mike Glenn to comment on it after I do, but a big part of e-commerce is handling returns. So some years ago as we saw the market evolving, we decided it would be a very, very good thing for us to have a supply chain capability to offer a broader portfolio of value-added services to our e-commerce customers because this was a huge part of the marketplace. It wasn't just planning on how to get it to the end customer but how to efficiently process the returns and merchandise. So through quite frankly a serendipitous chain of events, this great company GENCO, which was coincidentally in Pittsburgh and was by far the leader in this space in our opinion became available and we did a deal with Herb Shear, a gentleman and great management team that he has assembled. And so we think there are enormous energies there. I'll ask Mike and Henry to comment on it but we just couldn't be more pleased with GENCO being part of the FedEx portfolio and think it will enhance our competitive position and problem-solving ability for our e-commerce customers.

Hi Nate. This is Mike. I think it’s important to note that our sales team has a solutions organization that works hand in glove with our large e-commerce customers to help optimize their supply chains and that includes everything from types of information management solutions to the location of distribution facilities, selection services, all designed to drive value for those companies. And sometimes those solutions are good for FedEx in the short term, sometimes they are not so good for FedEx in short-term but they're always good for us in the long-term because we’re working with customers to drive solutions that are going to benefit the relationship between FedEx and the customer over the long haul. So we're well ingrained in and embedded into our largest customers and work with them hand in glove throughout the year to prepare for peak season and operations 12 months out of the year. GENCO was a significant addition to our portfolio. We recognized we had an opportunity to enhance the portfolio. As Fred noted, they have world-class solutions in the return segment. Returns is a particularly big part of any e-commerce value proposition because they tend to be double digits whereas the traditional brick-and-mortar retailer is in the mid-to-lower digit return rate. So GENCO has been a tremendous addition to the portfolio. We’re well down the track on integration and we see a lot of benefit going forward.

I should note that GENCO does many things other than returns. And within their capabilities, they’re just outstanding in the market leader in returns. Henry, you want to add anything?

No. The only thing I would add is their product footprint on the board, logistic side as well. So customers that want, for instance, fulfillment, GENCO could do. I think it’s important for the folks on the call to understand there are a lot of transportation segments between all of these nodes on the supply chain. And this gives us an opportunity to participate in that transportation whereas before we probably didn't get a chance.

Okay. We’ve got some questions over the internet. Ken Hoexter of Bank of America Merrill Lynch. Thoughts on Amazon creating its own network. Mike Glenn, you want to comment?

Thanks, Fred. I'm not exactly sure how you're defining network, but I can say that nearly every major retailer in the U.S. has a dedicated linehaul operation for moving inventory between distribution centers and stores, and Amazon is no exception. Amazon is a significant customer of FedEx, and we collaborate closely with them to optimize delivery needs and develop new solutions for future growth. It's also important to highlight that FedEx is part of a highly integrated global transportation network. In fact, it's one of only two networks operating at a significant scale in the U.S., along with UPS and the United States Postal Service. This situation is unlikely to change anytime soon, as these networks require substantial capital and information resources. Furthermore, our network is a critical component of the e-commerce market, and our customers depend on us to support their growth. Therefore, we are quite satisfied with our current position.

Okay. There are a couple of questions here from several Internet questionnaires about the update on TNT. I think we answered that in Alan's comments. We’re hopeful we’ll close by the first half of next year. I'll ask Chris Richards to put any color on that she wants. There is another regulatory question from Helane Becker about is there a concern, the fine levied by the French will be copied by other countries and are you considering an appeal, Chris?

Thank you, Fred. I’ll start with the update on the regulatory approvals of the TNT acquisition. As we indicated in our joint press release with TNT on October 20th, we have been informed by the European Commission that no statement of objections will be issued in the review of our transaction. We are anticipating that we will receive final unconditional approval from the EU in the first two weeks of January. In addition, we have completed the process and received clearance in 10 other countries, including the U.S., Australia, Chile, Colombia, Japan, New Zealand, Russia, Taiwan, Turkey, and Ukraine. At this time, we are aggressively pursuing clearance in the remaining seven countries, Brazil, China, Argentina, Israel, Korea, Namibia, and South Africa. We are very confident that we will achieve the clearances that are necessary to close this transaction in the first half of calendar '16. Moving on to the question about the French proceeding. No, there is not any concern that the fine levied by the French will be copied by other countries because this proceeding involved TATEX, a French company that we acquired in 2012, and the events that are the subject of this proceeding occurred in 2010, long before we acquired the business. The events were limited to France, but despite that situation we are considering an appeal of this decision and will give you an update on it next quarter.

Jack Atkins of Stephens wants to know what the margin goals for the Ground segment are? He asked a couple of other questions here. But I think they were basically answered because they concern TNT and he’s interested to know Henry about the cost savings to be realized from the integration of SmartPost into the FedEx brand?

The other significant savings come from combining two delivery options. The main expense in these networks is usually stopping the truck at an address. By integrating a package from SmartPost with a FedEx home delivery package within the same network, we achieve considerable savings, as the costs are significantly lower than sending it through the U.S. Postal Service. Additionally, we can optimize the capacity between Ground and SmartPost, especially during peak volume periods. This allows us to shift some SmartPost packages into Ground hubs and process them there, rather than simply adding more staff at SmartPost to manage increased demand. We also benefit from sharing personnel, as we have streamlined our corporate structures, allowing all former SmartPost employees to be utilized in their existing roles within FedEx Ground.

Thanks. So Fred, you mentioned early in your remarks that e-commerce customers continue to use inefficient packaging. And you’re continuing to see growth in oversized packages. So given that customer behavior is not changing, how do you plan to mitigate this going forward? And do you intend to lean more enterprising?

The answer to your question is yes regarding pricing, and we've already taken steps in that direction. This is where dimensional pricing originates. We’ve noticed numerous packages that are only one or two cubic feet yet contain items like a six-ounce stuffed toy. This reflects how e-commerce operates, especially with large or even smaller fulfillment centers striving to speed up order fulfillment during peak times. Their approach to packaging often differs significantly from how manufacturers like Procter & Gamble efficiently package their products to minimize transport costs. The reason this trend continues is that e-tailers aren’t making the effort to address it because the Postal Service does not utilize dimensional pricing. I can empathize with our postal workers who manage their parcel delivery with fleets of 200,000 vehicles originally designed for mail. Watching them at work resembles a submarine maneuvering; they have to stop and rearrange packages before delivery. In my own experience, I often receive lightweight items through SmartPost or directly from e-tailers. Eventually, all markets become rational, and neither e-tailers nor transportation companies should be paying to transport empty space. I believe pricing will help address this issue. It’s unfortunate that the proposed 33-foot vehicles were not approved, which would have increased capacity by about 18% with minimal weight increase. From an environmental safety perspective, it was a straightforward improvement, and those who opposed it seemed misinformed. I hope the Department of Transportation addresses this matter promptly, as these vehicles are already in use in 18 states and offer better stability while slightly increasing the weight on twin trailers. The difference in handling the 33-foot versus 28-foot trailers at highway speeds is negligible. This presents a significant opportunity to enhance national productivity for e-commerce, lower fuel use, reduce environmental emissions, and potentially decrease the estimated 1,000 accidents annually in the Ground parcel and LTL industry. For now, we will continue to work with the 28-foot vehicles, but addressing this issue would have alleviated many of the inefficiencies we’ve discussed.

Hi. Good evening and thanks for your time. I wanted to follow-up on the Ground margin question. I’ve question I guess around the integration of SmartPost and GENCO. In the prepared remarks, you’d mentioned that operating margins had been impacted by about 1.2% or more. Is that including any one-off integration costs?

Well, this is Fred Smith speaking. Alan mentioned that of the Ground margin delta 2.1% out of I think 2.2% was having to report because of the integration of Ground and SmartPost, the revenues at the gross level versus the net level. Prior to our doing that, we simply took the net cost of the postal deliveries and excuse me, the delta between the postal delivery cost and our revenues, as a single network the accounting rules are such we had to take it on a gross basis. So there's no diminution whatsoever in earnings, cash flows, the performance of ground, it’s just an accounting situation. The second is the fact that we put GENCO into the Ground segment and Henry is in charge of this because it is so closely aligned with the Ground parcel SmartPost presence in the e-commerce market. Now again, as Henry said, GENCO does many, many other things for Express and freight and so forth. But we're very confident in our Ground margins and Henry wants to add to this and say it one more time what our goals are here.

Yeah. We strive for mid-teens margins at FedEx Ground. There is no discernible integration cost in there at all. I mean this is roughly 10 basis points frankly falls into all other. There was no single large item. You got to keep in mind with the company of this size and the fact that we recognize revenue on delivery not on pickup, having a couple thousand packages move in or out over a quarter have a huge bearing on operating profit.

Thanks very much. Good afternoon. I was curious, could you address the Transpacific and perhaps Transatlantic trade lanes? How they progressed through the quarter? What you’re seeing into the coming quarter and also with consideration for capacity? Thank you.

Yeah, this is Dave Bronczek. I think I heard your question about Transpacific and Transatlantic. It’s generally the same economic environment that Mike discussed at the beginning, which is growing, but at a more modest pace. I wouldn't say it’s growing significantly out of Asia; in fact, it seems to be growing more out of Europe due to currency exchange factors. However, we’ve balanced our network globally. In light of Mike's comments, we have taken this into account regarding package placements and network flow.

Thank you and good evening. Continuing with the topic on the Ground segment, can you explain what factors contributed to the increase in average daily package volume growth? Was a significant portion of this due to the GENCO acquisition, where we are beginning to see revenue synergies? How much did the calendar affect this, and were there any shifts related to the decline in Express' U.S. deferred volumes, which happened for the first time in several years? It would be helpful to clarify the various influences at play.

The volumes at Ground are increasing as we are gaining market share and e-commerce is expanding, particularly in the delivery of individual packages to businesses and retailers. Do you want to comment on the Express deferred, Mike?

Yeah. I wouldn't read too much into the Express deferred traffic levels on a trend basis. Again, is similar to what Henry noted, specific pricing decisions on a customer by customer basis can impact volumes in any quarter. So I wouldn't read too much into that. I mean, we are pretty pleased with where we sit from an Express volume standpoint, being up overall with the growth coming in overnight; that’s a positive thing for us.

We have some more questions about the internet. Kelly Dougherty from Macquarie asked how the unpredictability of online sales challenges affects our year-over-year planning projections. First, let me share a few thoughts and then I'll invite Mike or Alan to add their insights. As previously mentioned, we have a large sales team, which I genuinely believe is the best in the Industrial Services sector, along with an exceptional solutions group. For our loyal customers who work with us as partners, we are able to effectively anticipate their needs and supply the right equipment, including sortation equipment, at the right time. The real challenges in the e-commerce industry often come from businesses that view transportation companies merely as utilities or vendors, leading to some poor decisions. We've watched some companies make significant mistakes. However, we maintain close relationships with our good customers. Still, despite our best efforts, growth can sometimes vary based on their customers' demands. For instance, the extraordinary demand in the Northeast has been notable. FedEx Ground is quite unique in this aspect. Our hubs, which many of you may have visited, are predominantly automated. This means that if there is an overabundance of volume in our New Jersey hub, we can reroute that traffic to Hagerstown, Maryland, or Pennsylvania to sort it within a different timeframe. We're not heavily dependent on the staffing within the hub, as the only staff present are those unloading and reloading trucks. We've emphasized this aspect of automation and flexibility repeatedly, as not many fully grasp the significance of it. This provides us with a substantial competitive advantage, enabling us to manage larger challenges with more direct routing, which contributes to our 27% day-faster performance. That's our approach as we collaborate with our customers, and I must say, many of our midsize clients are clearly making strides in e-commerce, implementing very smart and creative strategies. I believe this is partly why the market is expanding as rapidly as it is. Mike, do you and Henry have anything to add?

Well, I just want to add that I think it's important to note that peak season is a very highly planned period of time. I mean we literally will start working with customers in late January, preparing for next peak season. The second point is we’re not going to over commit to traffic levels that we can't handle in our network. In other words, we understand what the capacity is on a given day and our operating companies do a tremendous job flexing up capacity. But as we've noted many times on this call, we have to cap certain customers to make sure that we’re providing the service that meets the customer expectations. In addition to that, we have a team that essentially is conducting an orchestra for about one month out of the year and they have essentially a control tower that has minute-by-minute discussions with the operating companies, which are making changes to inputs that we receive from our customers, which allow us to deploy our resources and adjust the changes in demand both up and down. So as we say in the South this is not our first rodeo and we've been doing this for awhile and I think we have a pretty good business model here and we've demonstrated that works well in terms of meeting customer expectations.

This is Henry Maier. I want to add a couple of points to this question. First, Fred mentioned the 33 fully automated hubs we have. Additionally, we currently operate 49 fully automated satellites, which gives us great flexibility in offloading volume between hubs and these satellites. They also help us divert volume from hubs and sort it directly. The main reason for our success, especially during peak times, is our FedEx team. We have an incredible group of people who I believe are the best in the world. The dedication and professionalism of our contracted service providers, along with their commitment to quality and ability to innovate on the fly, are exceptional. From my perspective, it is truly inspiring. This is the key factor that enables us to manage the unpredictability of online sales.

David Ross asked will the price of oil if it's lower for longer help or hurt Express? You know on the margin, the elasticity will certainly create more Express demand and on the margin it might be a bit more priority versus economy. But the markets for Express and increasingly the door-to-door International Express are built on customer needs and purchases. So if you need a defibrillator for an operation tomorrow at the Cleveland Hospital, you do not want that defibrillator stuck in a package being a truck with a bunch of toys and that is why our Express network is focused on these high-value added type of products and high-value added products are sold around the world in global markets. And finally, what's really exciting is increasingly they're being sold door-to-door on an e-commerce basis. One customer that has the entire wares of the world for a business or a consumer, and that is going to be a very big market and it's where the Express Intercontinental Network is focused. So on the margin, yes it will have some effect, but not as much. I think as the fact that people use Express and Global Express when they have an urgent need to move something in one to two business days door to door.

Has FedEx detail the cost-benefit opportunities and costs associated with the TNT acquisition? And does the company intend to provide guidance on these items at any point prior to their incorporation and the results what we learn as we go as we have GENCO?

I’ll respond to the first part and let Alan address the guidance issue. To answer the first question, we certainly have a comprehensive plan. We conducted a thorough strategic analysis as we do for any possible acquisition, which was examined in great detail. We have an excellent integration process led by Alan and Bob Henning on the financial side, as well as Dave Bronczek, David Cunningham, and David Banks, our President of Europe, on their end. This is a standardized approach we apply to all our acquisitions. The acquisition has been thoroughly presented to the FedEx Board of Directors. Naturally, with imperfect information and fluctuating economic conditions, details may evolve as we progress. However, we are far enough along to be optimistic about it, although we still can't delve into specifics due to lacking approvals to confirm it's going to be a great fit. We appreciate the team members there, and I believe they are excited about joining FedEx. So Alan, would you like to comment on the guidance?

We have very detailed integration planning going underway right now that I'm very excited about. First of all, they're executing on our outlook strategy. We agree with that. We've been supportive of that. And they have been successful in that regard. Secondarily the integration teams have great details to the extent we’re permitted to talk about, that is on what’s going to happen on day one, what’s going to happen on the next 100 days, in year one, two et cetera. I can tell you that the people that we’re working with are terrific. There are many, many opportunities that are equal to or greater than I thought when we built the strategic business case. Having said that, I would also tell you that the integration is going to take some time and is not easy to do. There are tax structural and accounting issues to deal with. There are IT issues, there’s rationalizing the lanes, all the things you can think of. We've got every one of those being worked on. We can't talk to their customers. They can’t talk to ours. We can talk about pricing and of course that’s where some of the big numbers are. But what I'm seeing so far is I’m very pleased with it. As I said day one, we are not going to see big synergies financially until fiscal ‘18. Fiscal ‘17 is going to be a year of getting our hands around some of these very tough issues and making sure that we don't do any harm. The business continuity is there that the customers are taking care of and that we don't miss a beat from service level. So it's not easy but I think the reward is going to be fabulous.

Let me combine two questions here into one answer because I think this is an important issue. First part of it comes from Allison Landry at Credit Suisse. Have you seen any shift changes in the marketplace with respect to UPS’ acquisition of Coyote in terms of handling the peak season? And on the same line of thinking, David Vernon, does the transition to the ISP model at Ground increase the risk of these larger contracting entities are harder to handle or deal with in essence? Well, a couple of things here. First of all, we already have a truck brokerage, and transportation management unit inside FedEx and have had for quite some time. But much more importantly, I think it's a misunderstanding of the FedEx Ground business model because the very reason we have these small businesses providing our highway and pickup and delivery capabilities is that they are very, very close to the market, very close to the customers, very close to the understanding of the roads and geographic areas that they serve. So by design, we want small business people who have those characteristics and are very, very entrepreneurial and we do not have many contract service providers that have over 7 to 10 trucks. I mean that would be a very big one. And if you start going beyond that, you lose that tactile entrepreneurial feel. And the thing I love about it and I'm most proud of the ground thing is these are entrepreneurs and they do very well if they're good business people and it's just really fun to watch them. I hated that when we bought RPS, the single route contractor, you watch these young folks and minorities and everything start off and get an area and build themselves a wonderful life. And then because of all of this litigation and the plaintiffs’ attorneys and the state tax people and all that, we've had to move to the point where you have to have a minimal level vehicles and be incorporated. To be that as it may, we still retain the best of both worlds. And in fact, it's probably much more productive based on our experience to have the somewhat larger unit. So for all intents and purposes, I will stay with this business model and that's not going to change. So we don't need the same number of purchased transportation tractors and trailers that UPS does. And so I think it was probably smart for them to get Coyote. I'm not sure that it would be smart for FedEx. And Henry wants to jump in here.

I would echo everything Fred said. It's important for everyone on the line to understand that we offer peak incentives to our PND contractors and over-the-road contractors, enabling them to bring in the necessary resources to manage our anticipated peak volumes. This approach provides us with incredible flexibility, especially during business spikes. You should view them as entrepreneurial and motivated by financial opportunities. They respond well to the chance to increase their revenue and consistently rise to the occasion each year.

So in essence, we have a huge truck brokerage capability through our highway contract service providers. They get tractors and are able to put this power on much better in the geographic area than a centralized brokerage system for us. However, again we have a wonderful truck brokerage and transportation management capability for our supply chain customers and to help with purchased transportation where we get it. Let me take one more from the Internet and then we’ll take a few from the telephone. Again, this is Allison Landry of Credit Suisse. Have you seen a contraction in domestic B2B? The answer to the question is no.

Hey. Thanks. Afternoon guys. So just wanted to follow up on the question earlier about Ground volume growth and maybe a little bit about seasonality. So nice acceleration and volume growth to 9% in the second quarter. Is this continuing in the third quarter? I’m just wondering if there's any impact of Cyber Monday which was in 2Q this year and I think in third quarter last year. So, Alan, how does that impact the seasonality of earnings? And I know you made some comments about third quarter, fourth quarter, can you just clarify what your point was there?

Well, this is Mike Glenn. And let me say, just reiterate the remarks we made earlier. I mean we’re off to a strong start in our peak season. As Fred said, we picked up over 26 million packages on Monday. We've exceeded our forecast for our peak days in the month of December and what January and February holds, we'll just have to wait and see. We don't forecast volumes for upcoming quarters. But we're very happy with where we are based on the start to peak season.

We don't forecast them for you. We forecast them internally. Henry and Alan want to weigh in on this.

Scott, this is Alan. One reason I've adjusted my guidance for you on Ground CapEx is not just due to the significant increases in land acquisitions and material handling costs related to e-commerce. It's also because Ground will keep growing. What we need to do is manage yield, which means we must either make these packages smaller or ensure we're compensated for the space they occupy. We can’t afford to have excess capacity for the rest of the year, and we won't do that. Henry is working his team tirelessly, and we’re available 24/7 throughout this peak season; our competitors aren't doing the same, and that's made a significant impact for us.

Scott, this is Henry Maier. I’ll be a little bit more to the point. I’ve been around here for a lot of peaks. This is without a doubt the busiest one I’ve ever seen. And it has been consistent every single day since 11.30 and there is no sign it’s going to let up. So that’s where we are. Our people are stepping up to the task. Our network is performing exactly the way it’s designed. If we didn’t have these automated hubs and automated satellites and the great people, I think we’d be much different shape than we are today.

Let me just state again what I said in my opening remarks here. We think we have very, very good strategic plans and an in-depth knowledge of this market better or at least as good as any entity on the planet. And we have very, very creative concepts to make our assets sweat more and be able to process more packages in all of our networks. And that's why we were so forthright in saying that we expect this to continue absent macroeconomic or geopolitical events. And let me say it again, we continue to increase margins, earnings per share, cash flows and returns on invested capital, and we are confident these basic trends should continue well into the future, barring major events or macroeconomic factors. Now having said that, I know it's very important for all you folks on the call, sometimes we are off 1% or 2% in the quarter. This is a big, big enterprise. We can pick up, transport and deliver to virtually any address in one to two business days to 90 some odd percent of the global population. That takes incredible networks. Henry Maier's network at Ground has 550 facilities. David Bronczek has 600 FedEx Express stations, which are very different in the way they're designed that just in the U.S. They're very different in the way they’re designed because they're designed to interface with airplanes, not with 28 or hopefully someday 33-foot hub. Mike Ducker’s FedEx Freight is very different and as I told you, these automated hubs that Henry is operating are some of the most incredible facilities ever put on the planet. So this is a very big complex business with an enormous amount of value add. And so we can’t get it within 1% or 2% sometimes, but directionally, we’re very confident that we will continue to achieve those things that I just said, increasing margins, earnings and cash flow and ROIC.

Good evening and thanks for taking the question. This might be best suited for Chris. Can you just provide just a little bit more color and background on the independent contractor litigation cost at Ground in the quarter, the extent to which we might see litigation expenses going forward related to any lawsuit outstanding? And maybe the overall defense ability of the independent contractor model that you employ. I realize you guys have made some changes there with respect to requesting that the contractors incorporate. But maybe we can just get a recap of the model and the litigation expenses this quarter? Thank you.

Yes. Alex, I'll try to give you some insight on this. First of all, all of the litigation involved the Ground contractor model that was being operated in the early 2000. And we have made significant changes as you know, both requiring incorporation but also requiring that every contractor treat all of their folks as employees and they provide a complete compliant program including workers compensation, unemployment compensation and all the other matters that are required by the various states to ensure that the folks are comfortable. But these are in fact, independent businesses running under their own direction and guidance. We have had some litigation that has not been as positive for us, particularly out in the Ninth Circuit. For those of you who are familiar with the Ninth Circuit, it is a very tough Circuit for business operations. They tend to be very difficult in their analysis of what constitutes an employee. And so we have had some settlements from cases where we had adverse decisions in the Ninth Circuit. That being said, we have had positive decisions in the First Circuit and in some other Circuits and we still have the bulk of the cases being held at the Seventh Circuit where we are awaiting a briefing and hearing schedule. We do opportunistically settle these lawsuits if we get in a situation where we can do that to resolve the issues and move things forward. You need to keep in mind that in most of these instances, the bulk of the people who are involved in this litigation have moved on and are not contractors anymore. So this is really in our rearview mirror and while it's my job to make sure we get through it on a satisfactory basis, we are extremely confident in our independent service provider model and are all incorporated model that we are operating today.

Yeah. Good afternoon, everyone. Thanks for taking my question and congrats on good results in a very difficult economy. So Fred or Mike, I think for an analyst, it’s been covered in for a long time. If we knew where ISM is going to be, an IP be negative, we would have thought a lot of earnings contraction here for the company because you just historically had a lot of exposure to the industrial economy. So what do you think has decoupled here that’s allowing you actually to get close to 20% growth if you hit the guidance this year? And what otherwise is a very slow growth or even contracting industrial macro backdrop?

Hey, Brandon. This is Alan. We’ve been working for a very long period of time with profit improvement program and all the things that are involved in that are preparing for the very situation that we’re in. We have significantly reduced our capacity but it's significantly more fuel and maintenance pilot efficient and more reliable and we have a network that’s running pretty tight. Having said that, we’ve got a lot of growth for IP to continue to grow and move lower yielding products off that backbone network that we flying internationally. Productivity that we’re seeing in the field with our technology and automation improvements at Express are yielding tremendous things. I mean, it's essentially we’re doing exactly what we told you we were going to do in October 2012 and we’re learning as we go. And we’ve got a lot more room to do that. I’m going to pass it over to Dave Bronczek.