聯邦快遞 (FDX) 2016 Q1 法說會逐字稿

Good day, everyone.

Welcome to the FedEx Corporation first-quarter FY16 earnings conference call.

Today's call is being recorded.

At this time, I will turn the call over to Mr. Mickey Foster, Vice President of Investor Relations for the FedEx Corporation.

Please go ahead, sir.

Good morning and welcome to FedEx Corporation's first-quarter earnings conference call.

The first-quarter earnings release and our 26-page stat book are on our website at www.FedEx.com.

This call is being broadcast from our website, and the replay and podcast will be available for about one year.

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

We would like to invite questions via e-mail or as a message on www.stocktwits.com For e-mail, please indicate your full name and contact information with your question and send it to our IR@FedEx.com address.

To send a question via www.stocktwits.com, please be sure to include $FDX in the message.

Preference will be given to inquiries of a long-term strategic nature.

During our question and answer session, callers will be limited to one question in order to allow us to accommodate all those who would like to participate.

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 www.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 who's joining us via telephone today; 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 our Chairman Fred Smith will share his views on the quarter.

Good morning and welcome to our discussion of results for the first quarter of FY16.

FedEx Corporation is performing solidly given somewhat weaker than expected global economic conditions, especially in manufacturing and global trade.

Our profit improvement plan is on track and delivering impressive results.

Well done to the Express team.

FedEx Ground and FedEx Freight have several anomalies in the first quarter which will be discussed by Alan Graf and the OpCo CEOs during their presentations.

Overall FedEx service levels are excellent.

Our culture remains strong and our balance sheet is solid.

We remain confident FedEx is well positioned to deliver long-term value for customers, shareowners and team members in FY16 and beyond.

As we've said in the past and reiterate today, we're confident we can continue to increase margins, earnings per share, cash flow, and returns on invested capital in the years to come.

Now I will turn the program over to Mike Glenn that will talk about the economic outlook, and he will be followed by Alan Graf and his comments on the quarter.

Thanks, Fred.

I will open with our economic outlook and then discuss our yield in each segment along with the pricing actions that we announced yesterday.

We see moderate economic growth in the global economy.

Our US GDP forecast is 2.5% for calendar 2015 and 2.8% for calendar 2016, led by gains in consumer spending in the near term.

We expect industrial production growth of 1.6% in calendar 2015 and 2.6% next year.

Our global GDP growth forecast is 2.5% for calendar 2015 and 2.9% for calendar 2016.

The IP forecast of 1.6% of calendar 2015 is 60 basis points below our June estimate.

Weather report closures, lower oil CapEx and weak export from the strong dollar slowed production early in the year due to the strong imports we saw and inventory buildup in the first half of calendar 2015 which will be a drag on IP in the near term.

Now let me make a couple comments on the Company's yield performance in each segment.

In the domestic Express sector, excluding the impact of fuel, year-over-year yield per package grew 2.4%, primarily due to rate and discounts.

Excluding the impact of fuel and comparing the year-over-year yield on a gross basis for SmartPost, Ground yield per package including SmartPost increased 5.5%, driven primarily by changes in dimensional weight rating, extra services and SmartPost customer mix.

In the international export segment, excluding fuel, international export Express package yield decreased 1.3%, primarily driven by the negative impact of exchange rates which outweighed the positive impact of weight, rate and discount changes.

If you exclude fuel and exchange rate impact, IP base yield was up 4% and IE yield was up 4%.

In the Freight segment excluding the impact of fuel, yield per shipment increased 3.3% year over year, primarily driven by rate and discount and shipment class.

As we announced yesterday, we will be raising rates at FedEx Express, Ground and Freight by an average of 4.9% on January 4 of 2016.

In addition to the rate changes, FedEx is also increasing surcharges for unauthorized packages in the FedEx Ground network that exceed the size and weight limits as outlined in the FedEx service guide, and we're also updating certain fuel surcharge tables at FedEx Express and Ground effective November 2 of 2015.

We're also well prepared for what we expect to be another record peak holiday season, and I will note that we aren't slowing or adjusting our service commitments heading into peak.

We've been closely working with our customers all year to understand their peak shipping needs, and we stand ready to deliver.

We expect to add more than 55,000 seasonal positions throughout the network to help the holidays arrive this year.

Based upon our growth expectations and network expansion, many of these seasonal workers will have an opportunity to continue working with us after the holidays.

And now I will turn it over to Alan Graf.

Thank you, Mike and good morning, everyone.

Our first-quarter EPS was $2.42 compared to an adjusted $2.12 last year, and we achieved a 9.3% operating margin.

Our results increased due to significantly higher operating income at Express, the star of our portfolio, the benefit of one additional operating day at all of our transportation segments and the continued positive impacts from our profit improvement program.

These factors were partially offset by higher incentive compensation accruals, higher self-insurance and operating cost at Ground and lower than anticipated volumes at Freight.

The corporate net impact of fuel was also slightly negative year over year.

Looking at Express, revenues declined 4% in the first quarter due to the negative impact of lower fuel surcharges and unfavorable currency exchange rates, partially offset by US domestic base yield and volume growth and international export base yield growth.

US domestic average daily volumes increased 1% as both our deferred and overnight service offerings grew.

International priority volume declined 5% while international economy grew 4%.

Despite the lower revenues, Express operating income increased 45%, and operating margin grew 280 basis points year over year.

The increase in operating income was primarily driven by higher international export and US domestic base yield growth, the benefit from one additional operating day and lower international expenses due to currency exchange rates.

Our profit improvement initiatives for revenue quality and expense constraint are working and are on track.

Taking a quick look at TNT, the costs related to the pending acquisition of TNT Express were immaterial for the quarter.

We are making timely progress on the necessary regulatory steps required.

We have started the planning for the integration of TNT and Express after completion of the acquisition.

This planning includes addressing the issues that must be ready for day one implementation such as financial reporting, treasury, compliance and governance, as well as planning for the longer-term aspects of the integration.

Our integration plans currently assume that the acquisition will close in the first half of calendar 2016.

Turning to Ground, revenues increased 29% due to the inclusion of GENCO revenue, Ground yield and volume growth and also the recording of SmartPost revenues on a gross basis versus the previous net treatment.

Regarding the June 1 change in how we record SmartPost revenue, $240 million of the revenue increase year over year resulted from reporting SmartPost on a gross basis.

Average daily volume increased 4%, primarily due to continued growth in our home delivery service.

Ground's first-quarter operating margin was 4.4 percentage points lower, primarily due to increased self insurance reserves which was 1.7% impact, the inclusion of GENCO results which was a 1.3% impact, and the change in SmartPost revenue reporting which was a 1.1% impact.

Most of these are one-time in nature, although the inclusion of the GENCO results will remain for the next 18 to 24 months depressed due to the integration costs.

Looking at Freight, operating results declined in the first quarter as salaries and employee benefits expense outpaced lower than anticipated volume.

Salaries and employee benefits increased 10% from pay initiatives and increased staffing levels to handle higher than realized shipments.

Looking at CapEx, our spending forecast for the fiscal year remains at $4.6 billion.

Capital expenditures were higher year over year this quarter primarily due to increased spending to modernize aircraft at Express.

Aircraft and related equipment purchases included a delivery of five Boeing 767-300 freighters and one Boeing 777 freighter.

We are continuing to invest in our Ground facilities more this year than last as we expand the network, and this will be our peak year for investment at Ground for the next several years.

At Freight, we are modernizing our truck fleet, adding new vehicles with many new safety features.

Now turning to our outlook, based on the economic environment that Mike talked about, we project adjusted earnings to be $10.40 to $10.90 per diluted share for FY16 before year-end mark-to-market pension accounting adjustments, driven by continued improvement in base pricing, volume growth and benefits from our profit improvement program.

I should note although we are trimming our outlook from June slightly, we still are looking at the mid point of the range being 19% higher than what we achieved last year in terms of earnings per share.

Our new FY16 outlook is modestly lower than our initial forecast due primarily to higher than expected self-insurance reserves and operating cost of FedEx Ground and lower than planned volumes and yield at Freight.

We still expect strong earnings growth this year, and we remain focused on executing our profit improvement program, leveraging eCommerce growth and enhancing our revenue quality.

Our expectations for earnings growth in the second quarter and remainder of FY16 are dependent on key external factors including fuel prices and the pace of growth in the global economy, particularly in US industrial production as Mike discussed.

This outlook does not include any operating results nor integration planning and acquisition related expenses for TNT Express for quarters 2 through 4.

As of August 31, 2015, we have 11.1 million shares remaining for repurchase under our current authorization, and we plan to continue buying back shares.

At this point, I'm going to turn the program over to Dave Bronczek who has the first question from Art Hatfield.

Thanks, and this question is from Art Hatfield, Raymond James.

With all the discussion about perceived or real slowdown in China for some time now and recent news from the Chinese finance minister that the new normal of 7% GDP growth may last four to five years, I was hoping to get your thoughts on your trans-Pacific Express capacity going forward after last reducing flight frequency by two back in late FY13.

Thanks for the question Art.

Actually, our lanes are balanced around the world and including the Pacific.

And I think your question if you can go back and look at several quarters ago, we've actually adjusted our network two quarters ago on the Pacific, so it actually wasn't the last time we did it in 2013.

So right now we're very pleased with the how our capacity fits for the volumes and the Asia-Pacific network and around the world.

A lot of the traffic that we are handling now in FTN is also benefiting at FedEx Express and our profit improvement.

So to answer your question, we're very happy with our balanced lanes, and of course for FedEx Express, a lot of our business coming out of China are multi-national companies in the main.

At this time, we will open the floor for questions.

(Operator Instructions)

We will go first today to Allison Landry with Credit Suisse.

Good morning, thanks for taking my question.

On the LTL side, I wanted to get your initial impressions of the recent M&A activity that we've seen and whether you see further consolidation or change in industry dynamics?

Thanks, Allison.

Based on the recent activity, I would say that the market is ripe for that, but Con-way just was acquired by XPO.

We understand what it takes to integrate a rather large acquisition like that, so we have to stay focused on our strategy and execute what we're doing and that's exactly what we will do.

We will go next to Rob Salmon with Deutsche Bank.

Thanks for taking the question and congrats at the strong results over at Express.

If I could shift the discussion a little bit to Ground here, understood the impact on the self insurance reserve.

It sounded like, Alan, that was about 170 basis points.

With regard to the margins, you'd also called out in the press release some headwinds related to handling some oversized traffic in the network.

Can you give us a sense of how big a headwind that was and how quickly you expect to be able to offset the higher costs associated with that traffic either through the announcement yesterday about the increases there and perhaps an update related to any costs incurred for the integration of SmartPost into the Ground as part of the planning to potentially increase economic profit looking forward?

Rob, I will start.

This is Mike Glenn.

I will start with talking about oversize and unauthorized packaging.

The change that we announced yesterday targeted specifically unauthorized packages, and those are packages where the dimensions and/or weight exceed those as specified in the FedEx service guide.

If you were to look at one of these packages, you'd more likely to expect it to travel in an LTL network.

It is up to FedEx Ground as to whether we accept these packages, but we felt the change was needed in the price or the surcharge if we elected to do so.

The second category is oversized packages, and those are packages that have specifications that are within our current service guide features of service but happen to be longer or heavier than a typical package.

Those carry a separate surcharge.

With the dramatic shift in eCommerce where more and more eCommerce companies are electing to ship those packages through networks like ours rather than handle them in the store, we've seen an increase in those types of packages.

We're working with those individual customers that are driving that change, at least ones that are having the biggest impact, and obviously we always look at pricing opportunities to mitigate that where needed.

So overall we do an excellent job of handling those packages in our network, but it's obviously something we will continue to monitor.

Rob, this is Henry Maier.

Thanks for the question.

We announced on the last call we were merging SmartPost into the Ground.

I'd remind everybody that that's a multi-year initiative that offers a number of potential service and savings benefits.

From a service perspective, we will be able to maximize the use of both Ground and SmartPost facilities to ensure superior service year round especially during peak.

And additionally, the integrated network will enable more efficient use of our network and line haul assets throughout the year.

We also announced a change to, or the introduction of a new software program which will allow us to combine packages in the SmartPost and home delivery networks destined to the same residential address on the same day.

That makes a significant difference in our operating expense going forward because the operating expense of that incremental package is significantly less than putting it into the postal network.

So we are well down the path of implementing this, but it's going to take a couple years to integrate all of the SmartPost hubs with Ground.

We will take our next question from Chris Wetherbee with Citi.

Thanks, good morning.

Two questions I guess on the Ground side.

In terms of the self-insurance accruals, how should we think about that lasting as we move throughout the FY16?

I guess the question is when does it start to roll off and you start to see the margin performance come through underneath that?

And then just also on GENCO, trying to understand the 18 to 24 of months integration seems a bit longer than last time we talked about this.

Just want to get a rough sense will we see benefits of GENCO as we go through the peak season this year or is it something we need to wait until FY17 to see some benefit from?

Thanks.

Thanks, Chris.

First of all, on the self insurance reserve, we believe we're where we need to be right now.

You have to understand on here that one of the drivers of that is our business is growing.

We drive more miles and put more trucks on the road, and there's an accrual based on the number of miles we drive.

It's also largely a backward looking event from an accounting standpoint.

In terms of GENCO, I'd say GENCO has exceeded our expectations to date.

We are well on track to get the integration implemented as quickly as possible.

There are a number of benefits that come with the GENCO acquisition, namely the ability to sell additional value to customers.

GENCO provides us with some capabilities that customers value highly and frankly FedEx doesn't provide, so going through time, that will certainly pay dividends.

I don't -- as Alan said, we expect this to be pretty much concluded by the end of 18 months.

I don't know what more color I can give you than that.

Chris, this is Alan.

Let me add a little bit more to that.

First of all, as you well know, the GENCO business itself is very good, but it is not a high teens operating margin business.

But just by definition that's going to lower Ground segment's operating margin even after integration.

That's number one, and plus we intend to grow it.

It's performing much better than I had anticipated.

We're very proud of what's happening.

We're getting a lot of cross selling already taking over a lot of the transportation that we didn't used to have from them.

So it's very beneficial, but again, it doesn't have the same margins as the high teens that Ground has.

We will take our next question from Tom Kim with Goldman Sachs.

Great, thanks very much for your time.

I wanted to ask just a follow on with regard to that SmartPost Ground merger.

I don't recall hearing a cost number.

Will this merger actually impact cost and can you quantify that to a certain extent for us?

Yes, Tom.

The costs are going to be significantly lower.

This is why we did it.

I'm not willing to put a range around that on this call, but as you can imagine, if we combine a SmartPost package with a home delivery package on the same day and deliver them on one vehicle instead of one being delivered on an HD vehicle and the other being delivered through the postal service, there's fairly significant operating expense savings to that.

In addition, the ability to maximize the use of SmartPost assets and Ground assets particularly at peak provide us with significant opportunities to reduce our operating expense going forward.

We will take our next question from Nate Brochmann with William Blair.

Good morning and thanks for taking the question.

In regards to peak and the opportunity, you said that's shaping up well, and obviously even though the manufacturing and industrial side of the economy feels a little bit weak, the consumer side feels a little bit stronger.

Can you provide a little bit more color on -- in terms of some of your customer discussions heading into peak in terms of giving you the confidence of how that's shaping up better in terms of having another record?

Well the best indicator I can give you -- this is Mike Glenn.

The best indicator I can give you is the challenges that we have with capacity management.

We're working very closely with customers to make sure we understand their forecast where necessary.

We will have to put some caps in place as we have to do every year, and we see nothing different in that regard.

And customers are requesting more capacity, not less, so we view that as a good sign and that's why we think we're well positioned for another record peak.

We will take our next question from Helane Becker with Cowen and Company.

Thanks very much, operator.

Hi guys and thank you for the time.

To Alan, I just wanted to ask you about the pilot contract if you don't mind.

It looks like its, if ratified, a 10% increase this year and then through the years increasing so that by 2020 it's a 17% increase over 2015 rates.

So an A and a B. One, when do we hear from the pilots about whether it's ratified and two, are those cost increases included in your current guidance?

And three, does it address the Cadillac health plan costs that come into effect in 2017?

Thanks.

It's all related, Helane.

We will take it.

I will do the first part and give it over to Chris Richards for part two, and if Dave wants to add, that's fine.

We think it's a win-win contract.

It is in our outlook for not just this year but our strategic outlook that we always present to our Board in the fall where we as you know are expecting to continue to grow our earnings, our cash flows and our returns.

Nothing's changed in that regard.

Also recall that one of the key things that we're doing at Express is modernizing our fleet, and the productivity that we get from that modernization is one of the key reasons that despite a significantly different economic outlook today than when we talked about our profit improvement plan in October of 2012, you saw Express's results and an incredible increase in earnings with a decline in revenue.

That's only possible because our cost management.

And with that, let me turn it over to Chris on the specifics and then Dave.

I will go ahead and comment real quickly because Alan's right.

In our outlook going forward is the pilot contract, which we think is fair and balanced and very positive for the pilots, their families, for the Company, the shareholders.

But it's very much inclusive of our results in our profit improvement now and going forward.

And of course, the new fleet helps significantly as well.

Chris?

Hello, Helane, it's Chris Richards.

As you think about the pay increases included in the contract, you need to keep in mind that our pilots have not had a pay increase since the agreement became amendable two years ago.

So that time period is included in this overall increase as well as a six-year term of the agreement once it's ratified.

So that total number needs to be considered in the context of that time frame.

With respect to the health care benefits that are provided in the agreement, we've been very pleased that we were able to offer our pilots not only a continuation of a healthcare plan they've had in place, but two consumer-driven healthcare options which are identical to those which are provided to our other employees and have been found to be very attractive to those employees at a lower out-of-pocket rate on a monthly basis than a high care option.

So we're pleased and expect to see the pilots take advantage of those plans.

On your question with respect to Cadillac tax, the agreement does specifically provide for a process should the Cadillac tax become of impact during the term of this agreement.

It does not provide that the Company will pay some particular portion of that but has a process that will be used between the Company and the union should that come into play at the appropriate time.

Given the uncertainty in the approach on the Cadillac tax nationwide, I have to tell you I expect there to be a lot of conversations and a lot of discussion about what's actually going to happen before the tax goes into effect in 2018.

And this agreement specifically allows the flexibility for FedEx and the pilots to take advantage of whatever benefit might come from those larger national discussions.

We will go next to Scott Group with Wolfe Research.

Hi, thanks, good morning guys.

So wanted to ask another one on Ground.

I understand there's noise in the quarter, but if I take a step back, we aren't seeing the same market share growth the past couple quarters that we saw for a long time.

And now -- again I understand some one-time stuff, but the margins are not what people were hoping for.

And I want to understand if something has changed here from -- has the competitive environment changed with either UPS or the post office or the nature of the business with eCommerce?

Is that changing the margin profile of Ground, and do we need to reset expectations here?

Or maybe do you think that's not right and we should get back to margin expansion and real earnings growth at Ground next quarter or near term?

Scott, this is Mike Glenn.

I will start and turn it over to Henry.

Regarding growth, overall we're generally pleased with the growth at FedEx Ground.

It's essentially in line with our expectations.

We have seen a bit of a shift in terms of the type of growth with more growth being driven by eCommerce.

I should point out that the industrial production forecast that I noted earlier as well as the manufacturing indexes that have been published, obviously those are not great signals for the commercial side of Ground, and Ground is impacted by those numbers.

So that's a contributor, and we've also seen stronger growth coming from eCommerce.

So we have seen a bit of a mix shift, but overall growth I'd say is essentially in line with our expectations.

Scott, let me address margins, and let me also acknowledge up front that with all the moving parts at Ground over the last couple quarters, we haven't exactly made it very easy for you folks to do what you have to do.

So let me reinforce a couple things.

First of all, our business is changing rapidly.

ECommerce is clearly changing the dynamics of the industry, and it's driving incredible growth.

That's a good thing.

I think we're best positioned to benefit from an eCommerce economy.

We make decisions at this Company for the long term.

We don't make them for the week, we don't make them for the month, we don't make them for the quarter, and in some cases we don't even make them for the year.

But we look for long-term, profitable, sustainable growth.

And I believe we're focused on all the right things for today and the future.

I think some of the noise you're seeing in here is a number of one-time events, but there are also costs in here that are reflective of higher employee expenses year over year mainly driven by higher annual incentive comp accruals.

There are also higher operating expenses that are driven by the network expansion we've been going through the last couple of years, mainly in the form of higher rent and depreciation.

And in terms of that, that's a fixed cost.

Those should level out through time as these new facilities come online and we bring volume on and fill them.

I will tell you that nobody is more confident about the future of FedEx Ground than I am.

I believe that we will continue to gain market share, grow profitably and provide the fastest and most reliable service in the industry.

And our management team at Ground is committed to high teens margins.

We just have to get through some of these changes we've made, and we've made some significant ones, but I'm confident we have a plan to do that.

We will go next to Kelly Dougherty with Macquarie.

Hi, thanks for taking the question.

I think FedEx is often thought of as a global economic bell weather, but a majority of your revenue and operating income really does get generated domestically with a lot of that tied to the consumer.

So just hoping you can give us your thoughts on consumer consumption as it relates to peak and beyond and how much of the business is really consumer versus industrial dependent perhaps by segment.

And then on the international side, maybe some break down you can give us about the Asia and maybe China exposure because I think that's a lot less than some people might think.

Kelly, this is Mike Glenn.

I will start talking about the consumer impact and turn it over to Dave Bronczek to talk about China.

I would first say that while eCommerce and specifically consumer related transactions get the headlines these days, the bulk of our business is still business-to-business related on a global basis.

Residential deliveries certainly are increasing and are being driven in large part by eCommerce.

They now -- residential traffic now represents about half of the volume in the network and the US.

That's skewed a bit by SmartPost which is essentially all residential deliveries, so you have to back that out and the numbers in the Express and Ground network are somewhat lower than that.

But again, eCommerce is a growth driver, but the bulk of our business both in the US and around the world is still business-to-business, and I think that it's important to remember that.

And I will turn it over to Dave.

That's right Mike, and Kelly you're right.

It is business-to-business for us.

China is a big marketplace for us, but it's multinational companies around the world, and they're big accounts, big multinational companies.

So the impact for us is not very great, you're right.

And that's why our yields went up across-the-board and actually for all of international.

So thanks for the question Kelly.

We will take our next question from Ken Hoexter with Merrill Lynch.

Great, good morning.

Just looking at your commentary on the LTL slowdown, how much worse do you see this market?

Do you presume this is spreading to other parts of the business?

I guess I'm asking do you see this as a leading or lagging part of the economy and within your business?

And then also talk to your profit weakness at Freight if this was Company-specific or the industry.

Well this is Mike Glenn again.

I will start out talking about the LTL, and then I will let Mike Ducker have any comments he might want to add.

I think it's important to note the LTL industry is very closely tied to industrial production, so when you see a 60 basis point drop in our industrial production forecast, it's not surprising that we would see an impact on volumes and I would say not only FedEx but the industry as a whole.

I'd certainly hope we've seen the worst of that and that we're looking certainly forward at a more positive outlook.

I think we baked in what we've seen, so I think that's a positive.

I would also say in terms of it creeping into other segments of the business, it certainly had some impact on commercial Ground as I noted in response to the last question.

So those are the two areas that I think have been most impacted by the lower industrial production forecast and the manufacturing numbers that we referenced today.

We're quite confident going forward in our ability to achieve our goals at FedEx Freight.

Our sales team is working very closely with the operations folks down at the local level, and we've seen strong volume growth in FedEx Freight in key segments like small and mid sized businesses.

It's also important to note that some of the softness in the FedEx Freight segment was due to some pricing decisions that we made in head hall lanes to balance the network.

So some of this I would have to say is self-induced, and we did it for the right reasons, and some of this is obviously the IP forecast and related issues.

So again we're confident where we sit today and our ability to deliver results going forward.

Okay, we have three questions from the internet.

We will start with Henry.

This question is from Rick Patterson at Topeka Capital Markets.

How should we interpret your comment that Ground investment will peak this year and subside in the context of volumes?

Do you expect volume growth to Ground to further decelerate or stagnate going forward?

Well, my comment about peak investment or CapEx peaking this year really has nothing to do with volume.

It has everything to do with the fact that we made some decisions in the 2009 to 2010 period with respect to adding capacity in a very bad economy that put us in a position where we actually got a little bit behind on capacity with the growth in eCommerce.

We have three major hub projects that will come on line in FY16 which is driving much of the peak in CapEx.

And I'd remind everybody on the call that 100% of our hubs are highly automated, and we're moving to a net work footprint where more and more of our stations are fully automated too.

So this year, I'd call it laughingly, this is the pig in the python year in terms of these projects because it is almost unprecedented that we will bring three major hubs online in the same year.

And in addition to that, we have a pretty big project list around automated stations.

For the benefit of the folks on the call, we get some significant advantages out of automated stations.

We are able to load more points direct and bypass hubs, less handlings occur, and when less handlings occur, obviously you have lower incidents of loss and damage.

We reduce line haul expense because we're going point to point as opposed to going to a hub and rehandling and reloading those packages.

And we're going to be pretty close to 10% of the network stations being automated by the end of FY16.

So my comment about CapEx dropping 30% to 35% is more a recognition that after this year, we will be in a more normal capital expenditure pattern.

We will be ahead of the curve with respect to having network capacity to meet our planned growth, and we think going forward, we are in a pretty good place in terms of having our CapEx be a little bit more predictable.

Okay, this is Dave Bronczek.

The question came from Ben Hartford, Baird.

To what degree have you already had to take incremental cost reductions during FY16 to address the economic uncertainty in Asia in other emerging markets in recent months to insure the Express profit improvement program remains on track?

It a great question.

Our network around the world, our base powerful network we have in place is balanced around the world.

We adjusted our network several quarters ago, so right now we have a very flexible network that when the volumes go up, we can add cost.

And when the volumes go down, we take out cost, which is why we've done so well in our profit improvement program.

And a lot of the improvement has come from our international part of the business for exactly that reason.

So we're balanced.

We've made these adjustments quarters ago in anticipation of this, and so we're in good shape.

Yes, the question from Ben Hartford at Baird.

Given the softer US industrial production environment, do you think a 10% plus Freight margin is attainable on a full-year basis, and if so, what is the pathway to such a target?

Yes, Ben, we believe that a 10% Freight margin is attainable on a full-year basis.

As has been said in the press release and some comments this morning, there were several issues in the quarter.

First, we staff for a certain volume level, and those volumes were less than expected in what has typically been a pretty busy quarter, so staff size too large for volume.

We were impacted by two other areas on the volume side.

Some of the heavier shipments which migrated from truckload to LTL when capacity tightened, as a consequence of the West Coast port strike have migrated back to truckload.

There is still tight capacity in the LTL sector, and then energy, the energy sector and many of our shippers in that sector have experienced traffic declines.

We had several one-time events that affected our quarter that should not be repeated, and we see the pricing environment and the overall market environment still rational.

I don't want you to interpret that as 10% is our goal at Freight.

That is the absolute minimum bottom of the range.

We should have Freight margins in the teens.

We will take our next question from Scott Schneeberger with Oppenheimer.

Thank you and good morning.

Going back to a few questions ago, you were addressing obviously the lower economic forecast for IP domestically.

Specifically to the Ground segment, could you address how B2B trended throughout the quarter and if it in fact your tempering of the guidance range for the year can be attributed beyond the LTL to the industrial portion of commercial Ground interaction on a go-forward basis here in the year?

Thanks.

Scott, this is Mike.

As you know, we report Ground as a segment, so I'm not going to get into talking about specific growth rates in SmartPost versus home versus commercial.

But I will go back and say that industrial production and manufacturing numbers have had an impact on commercial Ground traffic.

So it's a little below where we hoped for, but overall traffic levels are fairly consistent with our expectations.

This is Fred Smith.

Let me make just one comment here.

It seems to me that people are missing about the lower guidance.

Had we not had the self-insurance reserve increase, we wouldn't have adjusted the guidance down by 2% and we would have beat the quarter.

Of course, we don't make quarterly estimates, you folks do.

So the whole thing about the quarter is one issue.

It's a self-insurance reserve.

All the rest of the stuff is just noise and various issues inside the operating Company, so it's important that you focus on that one issue.

We will go next to Tom Wadewitz with UBS.

Great.

Thank you for the question.

You've been asked a lot about the Ground margin, so -- but it seems to me like that's a pretty important topic for the call today.

I know you had the self-insurance, and Fred, you just said that's unusual, but it's the second quarter in a row of that being unusual.

And I don't, I mean I guess you're confident that it won't be a third.

What about contractor issues, maybe there is a lot of noise about contractors these days, the labor market has tightened somewhat.

So potentially maybe your contractor costs were up.

Or just -- are there other factors in the broader cost drivers for Ground that we ought to be considering here that could affect the Ground margin?

And I guess related to that, when do you think we will really see Ground operating income grow again because an uncharacteristic fashion we just haven't seen strong ground operating income growth for awhile.

This is Fred Smith speaking.

Alan answered the first part of your question and Henry answered the second part of the question, so we aren't going to go over the Ground again.

We will take our next question from Donald Broughton with Avondale Partners.

Good morning everyone.

Thanks for taking the question.

I was hoping you'd discuss the balance of volume in the IP lanes.

I know with the decline in IP, you're seeing -- I'm guessing with the decline in IP, you're seeing the balance of volume in the trans-Atlantic and trans-Pacific deteriorate.

If that's true -- or is it improving?

Given the strength of the dollar, if that's true, how much is the underlying improvement in Express margins being understated as a result?

Well, the answer to your question is the trans-Pacific lanes are balanced.

The trans-Atlantic actually we're getting a lot more traffic out of Europe because of the currency.

More than we had anticipated, and quite frankly, that's actually been positive for us.

So I think around the world, Donald, that we are in very good shape.

We have a very flexible network now.

We've moved the right traffic into the right networks, FTN's doing a great job for us as well and some of our other partners, so around the world you're probably right.

We have a lot of upside to the Express profitability in the international part of the world.

Donald, this is Alan.

As you know, our inter-continental business is by far our most profitable.

We've always had issues in Europe.

We're solving that with the TNT Express acquisition, so we're pretty pleased with where we are and where we're headed and can't wait to talk about TNT once we get it in the fold.

We will take our next question from Brandon Oglenski with Barclays.

Good morning, everyone.

Fred, I don't think that it's lost on folks here that your earnings are up 14% in this environment and you're still guiding for close to 19% growth.

So it's just about the incrementals from here.

I would just comment on that as well.

But my question is really for Chris Richards.

We've seen this MLRB ruling on the Browning-Ferris Industries come out, and apparently they are taking a more aggressive stance on joint employment.

As well as you've had a lot of disclosure around what's going on with your Kansas Ground contractor case as well which went to the Supreme Court, and I guess the 7th circuit Federal Court in the MDL has made some orders there too.

So can you talk to both, and back to the MLRBs, does it really have jurisdiction over how you can define employee/employer relationships at the State level?

Where does the federal versus State issue come into play here?

Well, I will give it a go.

The MLRB has jurisdiction over the tests that are applicable with respect to when and how employees can choose to be represented by labor unions.

And I have to say the recent actions by the MLRB are of concern and should be of concern to every business in America whether it's a large business or a small business.

The BFI decision if it stands will discourage companies from contracting with many small and minority owned businesses, and these are the businesses that are the very heart of the US economy.

Add to this the MLRB challenge to the franchise model that is used by McDonald's and any number of other companies and has been in place for decades, harms primarily the franchisees, those persons and companies that have bought businesses and are operating them as a part of their plan to achieve the American dream.

These rulings will ultimately reduce the value of those franchises.

I mean, franchising has been a successful model for many small and minority owned businesses for decades, and this action should be seen for what it is.

It's an assault on small businesses and basically on decades of valid contract law in the US.

Now that being said, the current MLRB decisions are not going to significantly have a direct impact on State law because as you know from following the issues not only with Ground but with other companies, the states individually apply their test with respect to certain statutes they have in place.

And as you note, we have been aggressively working on our defense of the contractor model at Ground.

Couple things, we are currently still engaged at the seventh circuit with the 19 remaining cases after they rendered a decision on the Kansas case.

We expect those cases to be briefed and determined individually as we go forward, so we're looking at additional time and effort there.

We also have had mixed results in some other jurisdictions of the 11th circuit, which took the appeal of the MDL decision, remanded that case for trial by jury on the classification issue.

And we expect to prove as we did in Washington State that the businesses that operate for FedEx Ground are businesses and we're pleased to have the opportunity to do that.

On the other hand we've had some recent good news in connection with a case pending in Massachusetts where the first circuit overturned another decision and found that the Federal Aviation Authorization Act preempted State regulations with respect to the situation.

And in fact, a decision that had been adverse to Ground has now been sent back for entry of an order positive to Ground.

So two things.

You should expect a continuation of our efforts as we defend the Ground operating process, and the other thing you should expect is a real increase across the board in this country on joint employment challenges.

And the ramifications of holding one business responsible for the actions or inactions of another business with which they have a contract are very broad.

And I hope that rational minds will quickly conclude that this is not a fair interpretation of the law, but I think you're going to see a lot more litigation in that area and the ramifications are way broader than FedEx.

This is Fred Smith speaking.

Let me just make one broader point here.

I think most of the people on the call know this.

All of the litigation that Christine was talking about is really in the rear view mirror.

We bought RPS years ago which was built on a very innovative model that gave people areas and as an independent contractor, you can build your business.

I met with one the other day.

I just did my heart good.

You started off with one truck and now you got 23 trucks, you've got a house and a lake house.

And we had to and relation to the litigation and the State laws which were essentially directed at contractors that were performing work for builders that have created this lawsuit cottage industry here and now of course being reflected in the Uber litigation and so fourth.

We moved years ago away from being able to give somebody that kind of an opportunity so that today we only contract with incorporated businesses, we audit them to make sure they're paying their taxes and doing all of the things.

And I think unfortunately its eliminated a great opportunity for young people to build a business.

But the litigation Chris is talking about has no relation whatsoever to the business model that FedEx Ground has today.

So it's just managing these things.

And we won this case at the MDL litigation and then it went back to California and the 9th Circuit at an adverse ruling, and we settled the case and moved on.

So it's important to recognize that litigation you were talking about, not the MLRB ruling, is essentially a model that no longer exists at Ground.

This is Mike Glenn.

I've got an e-mail question from Matt Troy from Nomura Securities International.

Given retailers' willingness to explore creative promotional activities such as the shipping promotions during the middle of the year, are you having conversations with larger retail customers about potential activities to shift or smooth demand in and around the December peak holiday season?

The answer to the question is yes.

I would say that many retailers are attempting do that.

That's why it's more difficult to actually forecast what the peak day is going to be.

It was fairly predictable in years past.

I think based upon our experience last year, it's certainly more challenging in that regard.

We're still dealing with capacity constraints in a 7 to 10 day period during peak season.

We will continue to work with retailers and E-tailers in an effort to try to shift that demand, but a lot of that's consumer driven.

And I think there's a recognition that it's going to have to occur at some point over time simply due to capacity constraints,.

But like anything in this regard, it takes longer to implement than you'd like to see.

This is Alan.

Before we sign off, I just felt compelled I want to talk about Ground for a second here.

Don't get confused between operating margin versus earnings and cash flow.

So the SmartPost change to gross revenue is simply math, and that reduces long-term margins just because of the math because we have higher revenue with the same amount of earnings.

GENCO is a great addition for us in terms of operating earnings, operating profit and cash flow generation and the high ROIC, but its business has a lower margin than the Ground business itself.

That's also math that reduces the margin, but it improves earning and cash flow.

And as Fred mentioned, the self-insurance reserves although we've had two quarters in a row, we had a pretty bad month of May.

We don't expect that to repeat.

We're improving our safety record at Ground, and so it's a one-time hit that won't be repeated.

So you can look for us to continue to improve from where we are at Ground to the rest of 2016 and beyond, but our margin position will be lower because of the SmartPost and GENCO.

Earnings and cash flows however will continue to improve as we start to reap the benefits of these CapEx investments in productivity, improvements and be able to handle, take line haul miles out and go more direct and continue to improve our technology we will be improving those.

Thank you.

Ladies and gentlemen thank you for your participation.

This does conclude today's conference.