Fedex Corp (FDX) — Q3 2018 Earnings Call Transcript

Good afternoon. And welcome to FedEx Corporation’s third quarter earnings conference call. Third quarter earnings release, 31-page stat book and earnings presentation slides are on our website at fedex.com. This call and the accompanying slides are being streamed from our website, where the replay and slides will be available for about 1 year. Questions are welcome to our e-mail address which is ir@fedex.com. When you send your question, please include your full name and contact information. Preference will be given to inquiries of a long-term strategic nature. I want to remind all listeners that FedEx Corporation desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act. Certain statements in this conference call, such as projections regarding future performance, 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. Please refer to the Investor Relations portion of our website at fedex.com for a reconciliation of the non-GAAP financial measures discussed on this call to the mostly directly comparable GAAP measures. Joining us on the call today are Fred Smith, Chairman; Dave Bronczek, President and Chief Operating Officer; Alan Graf, Executive VP and CFO; Mark Allen, Executive VP, General Counsel and Secretary; Rob Carter, Executive VP, FedEx Information Services and CIO; Don Colleran, Executive VP, Chief Sales Officer, FedEx Corporation; Raj Subramaniam, Executive VP, Chief Marketing and Communications Officer, FedEx Corporation; David Cunningham, 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.

Thank you, Mickey. Welcome to our discussion of third quarter earnings. First and foremost, we are very thankful that there were no serious injuries from the package that was detonated earlier at our San Antonio, FedEx Ground Facility. FedEx has provided law enforcement extensive evidence from our advanced technology security systems, designed to protect the safety of our teammates, our customers, and the communities we serve. We continue to assist authorities. Now moving to the businesses at hand and specifically turning to the earnings, execution of long-term growth strategies, customer demand for the unique value of our broad portfolio of solutions, and healthy growth in the global economy are driving our performance. We expect strong operating performance during the fourth quarter in all of our transportation segments and remain confident that we will improve the operating income in the Express segment by $1.2 billion to $1.5 billion in fiscal 2020 versus fiscal 2017. We remain committed and optimistic about growing earnings, cash flows, returns, and margins. Economic growth around the world remains broadly based and we expect U.S. tax reform to continue to increase economic growth and investment. FedEx is concerned about the prospect of increased protectionist tariffs, as history has shown repeatedly that protectionism is counterproductive to economic growth. The better approach is to encourage open markets and free exchange of products and services and to reduce barriers to trade. Congratulations to our team members around the world for another outstanding peak season, with record volumes and high service levels. TNT integration efforts are accelerating, and we are well positioned for profitable long-term growth due to investments in our network and people such as our recent commitment to $3.2 billion in wage increases, bonuses, pension funding, and expanded U.S. capital investment. FedEx is proud to be one of the top 10 companies in Fortune magazine's World Most Admired list and among its best companies to work for. We believe this reflects our team members' dedication through our purple promise, which states simply, 'I will make every FedEx experience outstanding.' Now let me turn the call over to my colleagues for their insight; first up, Alan Graf.

Thank you, Fred. We included additional information in today's earnings release, and I will provide additional detail during my discussion today about our third quarter due to unusually complex operating results and the impact of the Tax Cuts and Jobs Act or TCJA. We will also provide additional details today regarding our expected fourth quarter financial performance, given the complexities of the TCJA and third quarter results in order to help you understand the underlying performance of our businesses. Our adjusted earnings per share for the quarter were $3.72, up 62% from the adjusted $2.30 last year, primarily due to benefits from the TCJA. Operating income increased slightly year-over-year to $1.11 billion, with higher base rates in each of our transportation segments, increased volumes in Ground and Freight, and a favorable net impact from fuel. These improved results were impacted by the timing of significantly higher variable compensation accruals, which were up $140 million in the third quarter. Variable compensation increased year-over-year due to sharing some of the benefits of U.S. tax reform with employees as we announced on January 26th. Our improved outlook for FY '18 and the timing of recognizing expansion in FY '18 compared to FY '17. Results were also impacted by higher peak-related costs in Express and adverse weather. Before I talk about the operating results for the segment, I’d like to mention the tax benefits in our GAAP results and say they are significant this quarter. We recorded a benefit of $1.53 billion from the TCJA that primarily includes a provisional benefit of $1.15 billion from the re-measurement of the Company's net U.S. deferred tax liability for the lower tax rate, which we have excluded from adjusted earnings, a benefit of approximately $200 million from an incremental pension contribution made in February and deductible against the Company's prior year taxes at 35%, and a benefit of approximately $170 million attributable to the phase-in of the reduced tax rate applied to the Company's year-to-date earnings. Contributions to our U.S. pension plans of $1.5 billion were debt financed, and our U.S. pension plans are currently fully funded. While the funding shows up on the financial statements as a reduction in operating cash flow, it provides tremendous immediate returns in terms of tax savings as well as lower PBGC premiums compared to funding the plan at a later date. Turning to our segments and beginning with Express, service levels of Express were excellent during peak; however, costs were impacted by lower-than-expected volumes during the first part of December and higher peak-related costs. For Express, operating income for the quarter primarily reflected an estimated net negative impact of approximately $170 million year-over-year on the factors outlined in the release and listed on the slide. Ground’s operating income improved 23% to $634 million due to strong revenue growth and ongoing cost management, partially offset by increased purchased transportation, seasonal staffing and network expansion costs, as well as higher variable compensation accruals. Ground margins increased 110 basis points to 12.1%. During peak, record volumes were delivered with exceptional service around a highly automated and flexible network. We believe Ground results will continue to improve. Freight's operating income increased 34% to $55 million, primarily due to higher LTL revenue per shipment, partially offset by higher variable compensation accruals. Freight’s continued efforts to better balance volume, pricing, and capacity are paying off. We are also benefiting from an improving U.S. industrial economy. The adjusted earnings forecast for FedEx Corporation is now $15 to $15.40 per diluted share for FY '18. We expect Q4 operating profits to be up year-over-year for the Corporation and in all of our transportation segments. Our forecast for Q4’s adjusted operating margin is 11% to 11.8% for FedEx Corporation. As Fred mentioned, we remain committed to our target of $1.2 billion to $1.5 billion in additional operating profit for the FedEx Express segment in FY '20 versus FY '17, which includes TNT synergies as well as base business and other operational improvements across the global FedEx Express network.

Thanks, Alan. I will open with our economic update and outlook and discuss our revenue performance and business conditions in each segment and provide some commentary on broader industry trends and enhancements to the FedEx portfolio. We continue to see broad-based growth in the global economy. In the U.S., tax reform is improving investment incentives and disposable incomes, and measures of consumer and business sentiment are at the highest levels in years. As a result, our 2018 U.S. GDP forecast is a half-point higher than last quarter. Internationally, trade and production growth are supporting solid momentum in the global economy. Last year's rebound in trade drove the best air cargo growth since 2010, with freight demand growing over three times faster than world GDP. Demand has outpaced capacity addition for 17 straight months. The next few slides show details of revenue, volume and yield performance by transportation segment. It is clear our pricing strategies that allow us to grow volumes and increase yields across the portfolio show continued success. For our U.S. domestic Express business, both revenue and yield increased 5%. Excluding the impact of fuel, yield per package increased 3% due to our continued focus on revenue quality. FedEx international export package revenue increased double digits to 10% year-over-year in Q3, primarily due to a yield increase of 9%, including fuel and exchange rate impact; yields increased 2%. Ground segment revenue also saw a double-digit increase at 11% in Q3 with volume and yield each up 6% as e-commerce continues to drive growth. Excluding fuel, yield per package increased 5%. At FedEx Freight, LTL revenue per shipment increased 8%, mainly driven by our revenue quality efforts. Excluding fuel, LTL revenue per shipment was up 6%. Let me now discuss some exciting new enhancements that we have in the FedEx portfolio. As we announced earlier today, we’re going to increase our retail network footprint through the expansion of FedEx office locations inside Walmart stores. We anticipate adding 500 office locations over the next two years. The strategic initiative between FedEx office and Walmart brings our brand even closer to busy consumers who are looking for reliable options for packing, shipping and receiving packages. Another new offering that launched this month is FedEx Returns Technology. This solution provides e-tailers with increased visibility, flexibility and efficiency around returns management. For consumers, it enables simple and early credit for returns at FedEx office locations as determined by their merchants. FedEx experienced record-breaking volumes through our global network during the peak season, much of that driven by growing e-commerce shipments at FedEx Ground. This was the first peak season that we have had more than 10,000 FedEx locations, including FedEx office and well-known retailers like Walgreens. We are pleased with how the retail network performed and expect this extensive convenience network to be a key part of e-commerce deliveries in the future. The approach we took with our peak pricing strategy of not applying an additional broad peak residential surcharge to all consumers helped us gain significant business in the small and medium customer segments. We’re proud of the strong service levels we provided to our customers during this record peak, and we are excited about the portfolio expansions that are rolling out. We will continue to innovate to provide our customers with great service and value. Let me now turn the call over to David Bronczek for his remarks.

Thank you, Raj, and good afternoon to everyone. We are proud to report improved adjusted results at FedEx. We are especially pleased with the results of FedEx Ground, where we have improved our operating margin. FedEx Ground segment achieved double-digit percent growth in revenue and operating income, receiving benefits from ongoing cost management efforts and improved revenue quality through a balanced approach of volume and yield growth. We are also reducing our long-term CapEx plans to better match capacity expansions with pricing and volume growth. As Alan has already talked about, FedEx Ground is having a great year. We expect the fourth quarter segment operating margin to be around 17% to 17.5%. FedEx Express segment revenue growth of 9% was driven by our international business despite the lingering impact of the cyber attack. We continue to see a runway for opportunity in international for years to come. As Alan has said, Express has six factors that primarily affected profitability in the third quarter, but we expect the Express segment adjusted operating margin in the fourth quarter to be in the range of 9.9% to 10.4%. The underlying fundamentals of the business remain strong, with higher base rates across the board and volume growth in both international and the United States. As mentioned previously, we remain committed to our target of $1.2 billion to $1.5 billion in additional operating profit for the FedEx Express segment in FY '20 versus FY '17. I also want to provide an update on our TNT integration. As you know, this was the most significant acquisition in our company's history and dramatically improves our global capabilities and competitive posture. I'm happy to say that at TNT, we are seeing strong service levels and the integration is accelerating. A key element of our acceleration plan was to enable the flow of packages between the legacy TNT and FedEx systems prior to full integration. This allows us to direct volumes to the highest service but the lowest-cost networks. This capability is expected to be in place by May 31st of this year. We are accelerating the migration of the FedEx clearance operations and systems as well, retiring dozens of legacy TNT applications. Our investments in strengthening the IT environment continue at an accelerated pace. We have made significant investments to improve TNT's information security posture, and we will continue to do so. The integration of our global sales force, originally expected to be complete in fiscal 2020, is now scheduled to be complete one full year early. During the third quarter, we accelerated the launch of customer migration activities in Europe and Asia by more than one full year. Now, FedEx Freight continues to show improvement in revenue and profitability. As our pricing strategies drive revenue growth, investments in the network improve safety, efficiency and lower our costs. As I said just last quarter, we expect these improvements to continue. FedEx Freight is indeed having its best year in over a decade, and we expect the Freight segment will finish the year with an 8% to 9% operating margin in the fourth quarter. Across the Corporation, we're making progress in improving our margins, our cash flows, returns and earnings-per-share. We expect every segment will have year-over-year increases in operating income in the fourth quarter. And with that, we will now turn it over for your submitted questions.

Thanks you, Dave. We have several questions on the marketing front, which I'll ask Raj to answer. One, how important are FedEx fulfillment, FedEx supply chain and other logistics offerings in our long-term strategy at FedEx? How attractive are contract logistics end markets versus traditional carrier business? That's from Brandon Belinsky of Barclays. Raj?

Our strategy is to really offer value-added services to our customers, resulting in more volume through all our core transportation networks. As Alan pointed out, we have recently completed a reorganization that allows us to offer a portfolio of solutions in a more seamless manner to our customers. I also want to point out here that this is particularly important to our profitability as the small and medium customer segment expands their e-commerce offerings.

Our next question on marketing is from Ken Hoexter of BOA Merrill Lynch. Raj, also on postal commission's rule-making hearing process and potential impact on industry rates?

Ken, FedEx is not participating in the PRC docket, but we expect filings to be issued this year. However, we continue to monitor PRC regulatory developments with a review of the pricing aspect of it, and we believe that over time the cost of last mile delivery will continue to rise in the years ahead.

From Matthew Reustle, Goldman Sachs. Can you talk about your views on the future of consumer delivery? Do you think solutions such as FedEx onsite can represent a material percentage of the market relative to residential delivery?

Matt, we don’t view onsite in terms of percentage of the residential market; rather, we think it is a matter of customer convenience. What we know from the e-commerce demand, as you can see this increase, is that there is increasing demand from consumers to have convenient options where they can reliably receive their packages. In this context, we are very excited about the rollout of our FedEx onsite program. As I mentioned earlier, we have more than 10,000 FedEx onsite locations in the U.S., including FedEx office, and we are dramatically increasing our presence with Walgreen, adding more than 8,000 locations in the last year alone. We are very happy with the performance of this network so far. Let me add one other point. Technology solutions are also going to be critical in this regard, and that’s why we are very excited about the fact that our FedEx delivery manager user base continues to grow significantly. Ultimately the combination of these things, including our retail network and technology, are going to result in win-win-win solutions for our shipper, for our consumer, and for FedEx.

And I think I’m correct, the 2,000 Rite Aid locations that Walgreens acquired will be rebranded and added to the Walgreens system, right?

Yes, those will be added in the next few months.

Let me give Raj a breather and ask Dave Bronczek to answer a follow-on question from Matthew Reustle. Where is competition most fierce across your business segments today, and are investments the only solution to offset this competition?

Of course, we face competition across the globe all the time throughout our whole portfolio. The pricing environment is generally rational around the world. We have made significant investments in people, our technology, and of course facilities over many years, and it's paid off by creating a large, highly flexible, and the most automated transportation network in the industry. These long-term investments have differentiated FedEx from our competition, but we also have something else to differentiate us: it's our people and it's our culture, so thanks for the question, Matthew.

So we have a question here on trade protectionism from Benjamin Hartford. I'm going to ask Raj to answer more fully. But I would like to do two things before I turn it over to Raj. I'm reasonably certain everybody listening to this call has some sort of electronic device in their hands, a phone or an iPad or one sort or another. Go to your Google button, type 'DEF' for definition, and then put in the word 'tariff' to see its meaning. Once you read it from Google dictionary, you’ll see that a tariff is a tax or duty to be paid on a particular class of imports or exports. So make no mistake about it. The great benefits that Alan talked about due to the tax reform bill will be partially offset by increased tariffs. If we have national defense needs for larger aluminum or specialty steel requirements, we would suggest it's FedEx as those purchases would be needed by the government, similar to how we buy F-35 Fighters or M1A tanks. On the overall trading front, I'd like to give you a couple of numbers here that might surprise you. Our trade deficit in total goods and services 10 years ago was 4.9% of GDP; today, it's 2.9%. It's down by two percentage points of GDP for a couple of major reasons. The first is fantastic technologies that are employed in our oil and gas sector, now referred to as fracking, which has reduced our dependence on imported petroleum. This is particularly strategic, as a lack of petroleum imports from unstable and unfriendly parts of the world is beneficial. The second reason is that our trade surplus in services, of which FedEx is a major component, has increased by almost $300 billion over that 10-year period. As I mentioned in my opening remarks, the correct approach is to deal with issues concerning China, but overall, it’s about reducing trade barriers and tariffs globally, not lessening trade.

Ben, we’ve not seen any quantifiable changes in shipper behavior based on the recent development in U.S. trade policy. As I mentioned earlier, the rebound in trade in 2017 drove the best air cargo growth since 2010. However, we continue to advocate against any move toward protectionist trade policies that could slow economic growth and undermine all the positive impacts from the tax reform legislation.

Now let’s move on to some questions about Express. What are you doing now to prepare for peak that’s different from what you’ve done in the past? We’ll start with Dave Bronczek and then David Cunningham will amplify. Obviously, we’re very proud of our peak this year, and we’ve been so for many years. I’m going to make some general statements here, but I’m going to have David Cunningham at Express, Henry Maier at Ground, and Mike Ducker at Freight give a little bit more color to the answer. Generally speaking, we conduct our formal reviews of our peak performance immediately after peak, which informs our actions with our customers and employees going forward. We are fully leveraging big data; we have a lot of data, of course, in artificial intelligence, and we ensure we develop plans to optimize our customers' volumes, capacities, and service. In this regard, a significant part of our success is the strong alignment with Don Colleran, who leads our exceptional sales and solutions team with our customers. Overall, we’re very pleased with our peak performance. We’ve said it before, and I’ll say it again: what we pride ourselves on is our relationship with our customers and our service. I’ll now turn it over to David Cunningham to talk about Express.

Thanks, Dave. I want to congratulate the Express team on the best peak service ever. In this era of e-commerce, our peak continues to evolve as customers use both Express and our Ground company to meet shipping needs. As Dave said, we saw our customers stay in the Ground system longer this year. This resulted in lower peak volumes at Express and a more concentrated surge in a few days just before Christmas. Our peak planning is already underway, and we’ll take the key learnings and dial that into next year’s plans to ensure great service, while improving efficiency and productivity.

This is Henry Maier. I could not be prouder of the FedEx Ground team's performance this peak. Flawless execution in every aspect of the operation drove record holiday service performance, which was greatly appreciated by shippers and holiday shoppers everywhere. Despite record-breaking volumes of more than 54 million packages delivered, many were delivered at least one day early. This stellar service performance was due to a number of factors. One, planning that started in January, included close coordination with customers every step of the way. Two, the network investments we've made over the past few years have resulted in one of the most highly automated Ground networks in North America, if not the world. Three, excellent recruiting, staffing, and employee training leading up to the holidays. And four, the entrepreneurial real-time local decision-making with contracted service providers resulted in millions of outstanding customer experiences.

This is Mike Ducker. Let me just add a couple of brief comments. First of all, congratulations to the FedEx Freight team who had a tremendous peak season as well. As you know, it occurs a little bit earlier than does Ground or Express. As a result of that, we were able to provide some support for our other operating companies during that critical time of the year, adding to the overall performance of the peak season, so I’m very pleased and again, congrats to our team for a job well done.

The next question is how has the recently opened Shanghai hub been performing? By the way, if I didn’t give credit, who asked the question about peak? It was David Ross of Stifel. David Cunningham, how has the recently opened Shanghai hub been performing? You called out the hub as a game-changer. What trends are you seeing in the healthcare industry and the region? Does this limit the amount of e-commerce demand the hub can handle? This is from Helene Becker of Cowen.

The Shanghai hub is a fantastic modern automated facility with all of our latest technology. The hub spans 134,000 square meters, handling 66 flights and processing 36,000 packages and documents. Healthcare is an important value-added sector for FedEx, and the cold chain capability of temperature-controlled storage ranging from minus 22 to 25 degrees Celsius is a key part of all of our new facilities.

Also, David, what cost and network efficiencies do you anticipate gaining through the completion of the modernization and expansion projects at your Memphis and Indianapolis Express hubs? That's from Jack Atkins of Stephens. A related question from Jerome Nathan of Daiwa: where are some of the opportunities you see for automated capacity utilization at your Express facility?

The investments in our Memphis and Indianapolis hubs will modernize and automate these key facilities. The big data and our real-time ability allow us to mine and improve efficiency and productivity of these facilities by directing packages most efficiently through the hubs. As Alan mentioned, in Memphis we are constructing a new bulk truckload facility and adding capability for oversized shipments. In Indianapolis, we're increasing the box sort capacity from 111,000 packages to 147,000 packages per hour. We're putting in a small package sort system of 150,000 packages per hour and we will have increased international sort capacity as well. These facilities will improve the reliability of our networks, lower costs, and improve safety, making them better places to work for the thousands of team members employed in these operations.

So David, the last pre-submitted question on Express: in light of the strong demand environment in international exports, could you please update us on your progress managing capacity? Scott Schneeberger of Oppenheimer.

Commercial line haul continues to play an important role as we develop solutions to facilitate international growth, ensuring we move the right traffic in the right network, which enables us to grow our priority products on the purple tail network. By partnering with commercial carriers across various international gateways, we can avoid flying empty space, which we tend to experience in balanced trade flows such as the trans-Pacific eastbound lane. While we are experiencing constraints on some lanes, we are constantly working to balance and right-sizing the network with compensatory revenue.

Let’s turn to Ground now. One question comes from Benjamin Hartford of Baird. Henry, do you still view mid-teens as an appropriate segment EBIT margin target? If so, what is a reasonable timeline for achieving such a level, notwithstanding the current quarter? I guess I mean, I wouldn’t say too much about the target here as we announce this. I think the rate environment aside, how much of the incremental improvement in current levels is predicated on internal opportunities versus external market health and peer pricing growth?

Let me say I agree with Fred. The weather hasn’t been too helpful for us business-wise right now. Listen, most of this growth is coming from the macro. Our business continues to be driven by strong volume and revenue growth, largely due to e-commerce. As I said before, we believe our investments in what is today one of the most highly automated networks in North America, if not the world, will continue to drive margin improvement as well as industry-leading service. Our focus at this point in time is on maximizing utilization of those assets we've invested in and managing our existing capacity while driving reduced CapEx.

So we move now to Freight. Kevin Sterling of Seaport Global: are you seeing any spillover of TL Freight into LTL given the tightness we’re seeing in the truckload market? Mike Ducker?

Kevin, thank you. First of all, the LTL volumes have been very strong, including good contractual renewals; our team is handling that quite well. Truckload shipments, those over 10,000 pounds, will typically account for less than 2% of our total shipments, and while there's been some tonnage growth, it still remains a small share of our total volume. We also have an excellent transportation management team to monitor this and take steps to manage truckload volume if that becomes necessary.

So Mike, are rail service issues affecting your economy LTL offering? That's from Kevin.

Kevin, as you well know, we have a very service-sensitive product, so it’s really important to negotiate contracts with good service quality in them, and we’ve done that with all of our key rail providers. Those providers are doing a great job for us; our rail on-time service levels have held strong overall during the third quarter, and I think my partner Henry at Ground has experienced similar strong service levels from our rail provider.

The next question for Freight also comes from David Vernon of Bernstein. In the past, FedEx has discussed dimensioning LTL Freight shipments. What is the status of those efforts? And what upside potential does the Company see on that front? Mike?

Thanks, David. We currently have about 90 dimensional standards and will soon be adding additional devices in many of our service areas across the network. Those devices serve a dual purpose: first, they allow us to capture incremental revenue on shipments that are density-based commodities, and second, they allow us to collect data for our costing system, enabling us to develop pricing for our customers more accurately.

And finally for Freight, how much volume can the FedEx Freight network handle without significant real estate growth? That question is also from David Ross of Stifel.

First of all, let me give a shout-out to our planning teams, who have really done an excellent job in planning capacity in our network. We continue to make investments in the facility network and plan for the future; we add capacity strategically by market. For example, we just opened two new facilities in the Chicagoland market this January that added over 400 additional doors in the market, bringing the total doors in the area to 1,500. We’re also investing in technology to improve throughput in all the facilities, which will provide additional capacity as well.

We had a number of pre-submitted questions, which we did not answer because they were covered in the press release or in comments made by Alan, Raj, and Dave. But we do have one technology question, which I’ll ask Rob Carter to answer before we turn to some of the questions that have come in since the call began. That question is: how will blockchain and cloud IT impact FedEx revenues and expenses? When will FedEx see this effect? This is from David Campbell of Thompson Davis. Rob?

First, as a reminder, I want to point you back to last quarter’s call where we discussed points around blockchain and our charter involvement with the Blockchain in Transportation Alliance, otherwise known as BiTA, as well as the Blockchain Research Institute. You can find those discussions in a bit more detail on fedex.com from last quarter. Of note, Fred and I will be joining Don Tapscott at Consensus, which is the preeminent blockchain conference in New York City in May. We’ll discuss blockchain initiatives in a much more detailed fashion. With regard to cloud, our IT modernization initiatives are relentlessly focused on cloud technology. While technology offers significant advantages for business agility and cost, such as the ability to tap into elastic capacity—which allows us to provide compute capacity that grows with our peak seasons—improved security, performance, and scalability due to the modernization of these applications really enhance our capabilities. Equal to that is the proximity that cloud computing environments provide to our customers and our operations worldwide. The answer is yes; we’re leaning heavily into cloud technology with all of our IT modernization initiative.

From Tom Wadewitz of UBS: capital expenditures in FY 2019 and 2020; will there be offsets to the additional aircraft deliveries in FY ’19 and ‘20 in terms of total CapEx budget? Should we add these to the $5.8 billion in FY 2018 to estimate the ballpark CapEx spend in FY '19 and ’20? Will CapEx spend in Ground likely be higher or lower in FY '19 and ‘20 compared to FY '18? Alan?

We have a varied assortment of CapEx, pension tax rate, and cash flow questions, and I’m going to try to answer them in two minutes. First of all, remember that going forward, we just made this huge pension contribution, and as I said, we’re fully funded. So I don’t believe, at this point with the facts that I have today, that we’ll need to make big pension contributions going forward. Not that we might elect to depending on circumstances, but we don’t believe that’s going to be an issue. Obviously, with the 100% expensing continuing and the lower rate and improved offshore earnings, our cash tax rate is going to continue to remain low for the foreseeable future. We are going to have stronger earnings, which will support higher cash flows. As for CapEx, it’s really too early to talk about FY ’20, although I will say we do have a few increased aircraft deliveries scheduled at Express for 20, which might impact Express's numbers. But we have projects at every single operation right now, with great engineering and finance teams working together with the operations teams. We can make our assets sweat more: in the case of Express, for example, we can use passenger ballets to augment our international capabilities. At Ground, we are going to see reduced CapEx going forward as we look for better ways to build out the network and still support the anticipated growth. The same goes for Freight; I don’t think we are going to be needing to add as many doors for shipment as we have done in the past, thanks to the great engineering work happening there. We will talk more about this later on in the next several months. That said, I think FY '19 won't differ much from '18, and FY '20 might see a pick-up because of aircraft deliveries. So from a cash flow standpoint, I think we are in fantastic condition.

So Tom added another question here, which I think we need to answer: is incentive compensation likely to be a significant year-over-year headwind to EPS in the fourth quarter of FY ’18? To what magnitude, similar to the headwind in the third quarter? Tom, I think that nature of the question indicates a bit of a misunderstanding. AICs will be a headwind in the fourth quarter because of last quarter's performance in the third quarter, especially due to exceptional performance. This is why we provided a one-time special deal to show what the anticipated segment margins are going to be in the fourth quarter. So after the tax reforms were implemented, we felt it appropriate to do all the things that we described to you. This required us to uphold AIC, which had been reduced because of NotPetya, and that was reinstituted in the third quarter for the Company as a whole, particularly affecting the FedEx Express rate. Thus, as we move forward, it's incorporated in the numbers, and the fourth quarter should be quite good year-over-year for all segments. However, I'll add that if we find ourselves in a weather situation in the Northeast or elsewhere, that's a different story; but we are fairly confident about this quarter. Now, we have a question from Jeff Kaufman of Tahoe Ventures about electric vehicles for commercial trucks and the OEM following suit. What’s FedEx's view on the emerging green technologies, and where is the Company in terms of adoption and commitment to green technologies? Does FedEx believe these technologies are ready to meet the company's needs? First of all, I would recommend that you go on our website and read FedEx's social responsibility report, which shows our enormous efforts in terms of environmental efficiency in many different areas. Specifically, regarding commercial trucks, I’m going to ask Mike Ducker to comment on that.

Yes, absolutely. This company has long been known for its innovations. We’re on the cutting edge of many of these technologies, and we believe that faster adoption will greatly improve efficiency and customer experience in the trucking industry. So we are heavily invested in our safety systems and artificial intelligence with many companies that are using advanced driver systems that include telematics and many other features. We're working hard on the new technologies that are coming out to adopt and use the advantages those provide for our system. For example, Tesla will soon announce that we will be purchasing some Tesla electric vehicles in the near future. This is a small order, but we believe they will be greatly beneficial within our system, and we'll be testing them as soon as we can get them off the line.

Here are a couple of related questions I’m willing to pass on to Dave Bronczek and David Cunningham. I’ll give you overarching comments first: from Todd Fowler of KeyBanc. Please discuss what drove the decline in international and U.S. domestic volumes within the Express segment in the quarter. How important is volume growth in achieving the FY 2020 profit improvement plan? The second question is from Jack Atkins of Stevens: to what degree was the June cyber attack at TNT negatively impacting the 3Q results? Would you expect a lingering impact in the fourth quarter? Now, I think the questions from Todd and Jack reflect a misunderstanding here. Please recall that when we started this year, we told you we would no longer separate Express and TNT. The numbers we released for the Express segment are now a combination of the two. The reality is that FedEx Express volumes are growing; TNT volumes were adversely affected by NotPetya, and we are now scaling back up to where we would have been had this attack not occurred. I would again like to give enormous thanks to our sales, customer service, and particularly our IT professionals who did an extraordinary job of recovering from this attack, which the U.S. government has identified as a government-sanctioned cyber attack on Ukraine—TNT was simply a victim of it. The fourth quarter, I think, will begin to show these numbers in a more granular manner, but essentially, we're not seeing a decline in Express traffic in the fourth quarter; we will have recovered most of the NotPetya volume from TNT.

Yes, this is Dave. Fred is 100% right. The reason we provided all these details about the fourth quarter is to give you an idea of where it's forecasted to be, significantly different from Q3 numbers. In my comments, I noted that Express could potentially run up to a 10.4% operating profit margin. That’s actually based on strong revenue across all other Express segments, so we should put Q3 into context, particularly those six items that affected Q3, which will not affect Q4 due to variable compensation and so on. It stems from the reasons you've highlighted, hence why we are optimistic about Q4, which is looking very strong.

Yes, I just had a couple of comments to add to what Dave just said. First, remember that the effects in Q3 were mostly one-off events. Q4 typically ends up being a seasonally strong quarter, and we’ve already told you what that’s going to be. Our TNT network was fully restored and back to regular operations as of the end of 2017. The recovery of the business over the last five months has been remarkable. Given the value proposition of the TNT road network, our freight volumes have been strong, and we are experiencing solid growth in these products. The cyber attack did have a lingering effect in the third quarter, and our existing customer base has not fully restored all volumes as they continue to gain confidence in our ability to provide service and recovery from this attack. Our outstanding performance during peak is evidence of the strength of our network and recovery, and our sales teams are leveraging that in the fourth quarter to grow and win business.

Okay, question from Ken Hoexter at BOA Merrill Lynch: in this robust growth e-commerce market, why were deferred volumes up only a tenth of a percentage on 1% growth compared to last year, and why are yields negative? Raj?

Thank you, Ken. I believe you are talking about the deferred volumes in Express, and really our volumes are impacted by how we managed one large customer whose volume was at forecasted levels. Look at the base volume growth on an underlying basis; especially in the small and medium customer segments, we saw robust growth. And by the way, don’t forget the strong growth we saw in the Ground segment, which also carries e-commerce traffic.

Here is one from Scott Group at Wolfe Research: now that Express includes GenCo and Custom Critical, do you plan to update your Express long-term guidance? Scott, we did; we told you that we intend to increase our Express earnings from FY '17 to FY ’20 by $1.2 billion to $1.5 billion, so I hope that clarifies it.

How much of the year-over-year ground margin expansion expected in FY Q4 will be driven by reclassification, and how much from core improvements? Henry?

Core improvements represent about 100 basis points margin.

Here is one again about Express 3Q and 4Q: I hope I explained that a lot of the impacts were variable compensation, particularly given the positive tax act, as Alan described it to you. We had to increase wages for hourly teammates, and we had the benefit of the tax bill, and we did not want to penalize our AIC program participants, which involve thousands of our frontline managers. Thus, that triggered an increase in AIC in the third quarter. The fourth quarter should normalize, however, as we factor in all these conditions. Ravi Shanker asks what was the strategic rationale for adding FedEx office locations or FedEx Walmart locations? The strategic rationale, Ravi, is primarily derived from the financial benefits they can provide us. Additionally, the broader point is to enhance customer pickup and drop-off capabilities, which serve as omni-channel service points. Raj?

Ravi, I think the strategic initiative we have with Walmart aligns with our shared goal of providing customer convenience and value. This truly helps customers save time and money, as the Chairman mentioned earlier. Additionally, as I mentioned earlier, this is an opportunity to serve our consumers who are seeking secure, reliable options for packing, shipping, and receiving packages.

Scott Schneeberger would ask about the financial impact of adding FedEx office to 500 Walmart stores. Obviously, this will create a bow wave of small proportions when we open these locations. But remember that we said in our press release: we tested these at 47 locations; we have a rapid payback. So this channel will be inconsequential from an expense perspective near-term and will be crucial for us in the retail and customer convenience channel in the next several years. Additionally, we received three questions from Brian Ossenbeck, Matthew Troy, and Allison Landry about DHL's launch of their new service. I’ll ask Raj and Dave if they want to comment on that and then I’ll turn the floor back over to Mickey, as we’ve exhausted your questions.

So Brian, Matt, and Allison, thank you for your question. We typically don't comment on specific competitive strategies, but there are multiple new tests and pilots where companies are considering variations of crowd-sourcing or other options for last-mile delivery. As you know, the e-commerce increasing demand for last-mile delivery is combined with operational costs, safety, and brand considerations that need to be factored into the ultimate potential of any new offering. FedEx has unique capabilities regarding these matters, and we will continue to work with retailers to provide a differentiated value proposition, ultimately aiming for superior service to the end consumer.

Yes, the only thing I would add is that Raj is absolutely correct; we focus at FedEx on our customers and our strategic value proposition, and I would direct you to our Dream video that’s out there—please take a look at that. I think it is very self-explanatory. That’s how we feel about our business and how it stands relative to others.

Yes, I think that’s a wonderful way to end this. Before I turn it back over to Mickey, I urge all of you who have not done so to view the FedEx e-commerce video at fedex.com/dream. It’s a brief, 2.37-second piece that conveys what we could summarize for you in an hour. Thank you for participating, Mickey; please close it out.

Thank you for your participation in the FedEx Corporation's third quarter earnings conference call. Feel free to call anyone on the Investor Relations team if you have additional questions about FedEx. Thank you.