FedEx - Q1 2015

Transcript

Operator (participant)

And welcome to the FedEx Corporation first quarter fiscal year 2015 earnings conference call. Today's call is being recorded. At this time, I'll turn the call over to Mickey Foster, Vice President of Investor Relations for FedEx Corporation. Please go ahead.

Mickey Foster (VP of Investor Relations)

Good morning, and welcome to FedEx Corporation's first quarter earnings conference call. The first quarter earnings release and our stat book are on our website at fedex.com. This call is being broadcast from our website, and the replay and podcast will be available for about one year. Joining us on the call today are members of the media. 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. If you're listening to the call through our live webcast, feel free to submit your question via email or as a message on stocktwits.com. For email, please include your full name and contact information with your question and send it to our [email protected] address. To send a question via stocktwits.com, please be sure to include $FedEx in the message.

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 may be considered forward-looking statements within the meaning of the Act. Such forward-looking statements are subject to risks, uncertainties, and other factors, which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. For additional information on these factors, please refer to our press releases and filings with the SEC. To the extent we disclose any non-GAAP financial measures on this call, please refer to the investor relations portion of our website at fedex.com for a reconciliation of such measures to the most directly comparable GAAP measures.

Joining us on the call today are Fred Smith, Chairman, Alan Graf, Executive Vice President, CFO, Mike Glenn, President and CEO of FedEx Services, Chris Richards, Executive Vice President, General Counsel, and Secretary, Rob Carter, Executive Vice President, FedEx Information Services, and CIO, Dave Bronczek, President and CEO of FedEx Express, Henry Maier, President and CEO of FedEx Ground, and Bill Logue, President and CEO of FedEx Freight. Now our chairman, Fred Smith, will share his views on the quarter.

Fred Smith (Chairman)

Thank you, Mickey. Good morning, everyone, and welcome to our discussion of results for the first quarter of fiscal 2015. As you can see in the press release, FedEx is off to a good start for the fiscal year, thanks to strong performance at Ground, solid volume and revenue increases at Freight, and volume and yield growth at Express. We expect continued revenue and earnings growth in fiscal year 2015, assuming moderate global economic growth and stable fuel prices. Clearly more customers are relying on FedEx because they appreciate the competitive advantages provided by our portfolio of solutions. FedEx Ground's performance was driven primarily by higher average daily volume as a result of increasing e-commerce. At FedEx Freight, increased revenue per shipment and strong LTL shipment growth drove operating margins higher. FedEx Express's operating income and margin improved, and we are confident we will achieve our profit improvement program goals.

Now, let me turn the call over to Mike Glenn for his thoughts on the economy, after which Alan Graf will provide more detail on the first quarter earnings. Mike?

Mike Glenn (President and CEO)

Thank you, Fred, and good morning. With private sector demand accelerating and fiscal austerity winding down, our expectation for real GDP growth is to average around 3% for the remainder of this year and next. Our U.S. GDP forecast is now 2.1% for calendar 2014 and 3.1% for calendar 2015. We have increased our expectations for industrial production growth to 4.1% this year and 3.8% in calendar 2015. The global economy has improved, although it certainly remains a multi-speed world. The U.S. is leading the way and emerging markets are picking up. We expect global growth of 2.6% in calendar 2014 and 3.1% for calendar 2015. Now, let me make a few comments regarding the company's yield performance.

Excluding the impact of fuel, year-over-year Express domestic yield increased 0.5% in the first quarter. This increase was driven by product mix and rate and discount. The Ground package yield increased 3% year-over-year in the first quarter, excluding the impact of fuel. The Ground yield has improved steadily due to rate and discount and product mix. Excluding fuel, international export Express package yield increased 1.9%, which was primarily driven by product mix. And finally, excluding the impact of fuel, yield per shipment increased 1.2% at FedEx Freight, which was driven by rate and discount and changes in weight per shipment. As noted in the press release, FedEx Express, FedEx Ground, and FedEx Freight will be increasing shipping rates an average of 4.9%, effective January 5th of 2015.

FedEx Ground will also be implementing the new Dimensional Weight policy previously announced to include packages less than three cubic feet, which will also be effective on January the 5th. Finally, just a couple of comments on peak season. We're expecting another record peak season in terms of delivery volume. Peak will once again be compressed this year, with Cyber Monday falling on December the 1st. We've been in active dialogue with our retail and e-tail customers all year to understand their peak shipping needs and plan our operations accordingly. We expect more than 50,000 seasonal positions to be added for the upcoming peak across the FedEx operating companies. This includes package handlers, helpers, drivers, and other support positions. Based upon our growth expectations and network expansion, the majority of those seasonal workers will have the opportunity to continue working for us after the holiday season.

Now let me turn it over to Alan Graf for a few comments.

Alan Graf (EVP and CFO)

Thank you, Mike, and good morning, everyone. We had an outstanding first quarter with EPS of $2.10 a share and an 8.5% operating margin. Revenue growth from increased volumes and yields drove a significant increase in earnings for each of our transportation segments. Our sales team is executing our improved revenue quality strategy at a very high level. In Q1, we repurchased 5.3 million shares of FedEx common stock and completed the share repurchase program that we announced in FY 2014. The repurchase program had a $0.15 per share year-over-year positive impact on our EPS this quarter. To improve the transparency of our results, this year, we ceased allocating the costs associated with our corporate headquarters division to our transportation segments. These costs are now included in corporate eliminations and other in our segment reporting and reconciliations.

A reserve for a legal contingency was recorded at corporate in Q1, causing an increase in these unallocated costs versus the prior year. Looking at our segments, at Express, operating income increased 35%, and operating margin increased 130 basis points. Revenue growth in our U.S. and international export package business drove higher income, partially offset by higher maintenance expense and lower freight revenues. The profit improvement programs also contributed to the improvement in operating income for Express. U.S. domestic volumes increased 5% in Q1, driven by both overnight box and deferred service offerings. International Economy volumes increased 3%. International priority volumes were up 1%. Overall, international export revenue per package increased 3%. Turning to Ground, average daily volume increased 6% during the quarter from continued growth in our home delivery service and commercial business.

SmartPost average daily volume was down 10% due to lower volume from a major customer. However, SmartPost revenue per package increased 10% from rate increases and improved customer mix, partially offset by higher postage costs. Volumes increased 8%, excluding the changes in shipping patterns from the major customer. Ground segment operating income increased 13%, and operating margin increased to 18.4% on higher revenue package and volumes. Higher network expansion costs partially offset Ground's increase in operating income as we continue to invest in the high margin, high ROIC, growing Ground businesses. At Freight, it was a great quarter, with operating margin of 10.4%, up 340 basis points from last year. Operating income and operating margin increased from higher less-than-truckload revenue per shipment, higher average daily LTL shipments, and solid cost management.

Freight saw a higher demand for both its priority and economy service offerings in the quarter, which drove an 11% increase in average daily LTL shipments. Turning to our outlook, and based on the economic outlook that Mike talked about, we reaffirm our FY 2015 earnings per share forecast of $8.50-$9 a share. Our outlook depends on key external factors, including fuel prices and the pace of improvement in the global economy. Revenue and earnings growth are expected to continue into the second quarter and the remainder of FY 2015, driven by ongoing improvements at all of our operating companies, along with continued volume and yield improvements. Profit Improvement Programs that we announced in FY 2013 will add to our FY 2015 results as we continue to execute on them.

FY 2015 will see the full benefit of the voluntary buyout program, which was completed in May. We should also see additional cost savings from sourcing and procurement. Every new 767 replacement aircraft should add about $10 million annually to profits. We have four 767s in service currently and expect to have another 12 delivered by the end of FY 2015. There are many other initiatives there that we are working on at Express. In short, we are progressing as planned with the profit improvement programs. We had an excellent quarter, and we are looking forward to a very good year. Now, we will open up the call for questions.

Operator (participant)

Thank you. If you'd like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, we do ask that you limit yourself to one question to allow others the opportunity to pose their question. You may also submit your questions via email to [email protected]. We'll go on and take our first question from Rob Salmon with Deutsche Bank.

Rob Salmon (VP and Senior Analyst)

Hey, good morning. How you, how you doing, guys?

Fred Smith (Chairman)

Good.

Rob Salmon (VP and Senior Analyst)

You know, Alan, I'll let someone else have at the guidance, given the strong results in the first quarter.

To you, Fred. I'm trying to think about the significant growth that the industry keeps talking about in terms of wide-body passenger aircraft, and how you guys think about your aircraft renewal opportunity, given the incremental capacity that's coming on in your experiences using third-party line haul to date in the international and economy package? And your thoughts in terms of where these aircraft are gonna be coming on in different lanes, if that provides you the opportunity to, you know, potentially reduce the asset intensity of the aircraft fleet over time.

Alan Graf (EVP and CFO)

Well, I think, you know, it's early, it's one quarter. Our guidance does show, 26%-33% increase in EPS, which is a little bit less than the first quarter. The second half will be a little bit tougher comparison, as we really started to hit our stride in the second half of FY 2014. So, I'm comfortable with where we are now, and we'll talk about it again in December.

Operator (participant)

Thank you. Our next question comes from Ben Hartford with Robert W. Baird.

Fred Smith (Chairman)

Let, let me

Uh

Let me go in and answer the, the question that was just answered before, just asked before, before you make the question about the fleet planning. Dave will put some color on this, but basically, our strategy is to have an unparalleled proprietary priority network, and then we do use the underbellies, as you mentioned, for our economy service. And we are very cognizant of the lift that's out there, that's planned to be out there, and it's a very sophisticated planning process that, that goes into it, that determines what sort of aircraft that we acquire.

Now, having said that, I think Alan's made this point, we're not buying any airplanes other than to modernize our fleet, and these airplanes are very profit accretive, as Alan mentioned to you, and the 777 in the international business are just unprecedented in the type of operating capabilities and competitive advantage we have. So let me turn it over to Dave to put more color on it.

Alan Graf (EVP and CFO)

Yeah, thanks, Fred, and it's a good, great question. Our 777 provide us the global powerhouse that FedEx Express is, the best in the world. We have the latest cutoff times and the earliest arrival times all over the world, coming out of Asia into the United States, into the Middle East, into Europe. The 777 are replacing the MD-11s. The MD-11s are coming back to the United States. The 767 are actually replacing, as Fred pointed out, older used airplanes, and we're getting tremendous fuel efficiency, operating efficiency, maintenance efficiency out of the 767 back here in the United States. So the combination of both of these planes into our fleet has provided us a tremendous opportunity to grow our profits and improve our service around the world.

Fred Smith (Chairman)

Now, that other question.

Operator (participant)

From Ben Hartford, again, with Robert W. Baird.

Ben Hartford (Senior Equity Research Analyst)

Hey, good morning, guys. I guess, Alan, could I get your perspective on, piggybacking on that, to the extent that, you know, CapEx is going to remain focused on fleet replacement and not growth, and you guys continue to execute on this plan within Express. Clearly, you have the cash flow capability coming. You're done with the buyback. Can you talk a little bit about how you're thinking about managing excess cash going forward between the dividend and a potential new share repurchase authorization? Thanks.

Alan Graf (EVP and CFO)

I don't have anything to say today about a new share repurchase authorization, other than the fact that we talk about this at every single board meeting, and we will continue to do that. We have stated that we want to continue to increase our dividend. We understand our dividend yield is subpar. A part of that is because of the outstanding stock performance, but we will continue to increase our dividends at some level, is our strategy and objective. And so we'll see where we get. We're very pleased with the stock buyback program that we recently executed, and we'll keep our eye on that as well, but that's a board decision.

Operator (participant)

Thank you. We'll go next to Chris Weatherby with Citi.

Chris Weatherby (Senior Research Analyst)

Great. Thanks, good morning. Wanted to touch a little bit on sort of the pricing environment when you think about turning the page into calendar 2014 with dimensional pricing coming in, and obviously, the GRIs announced last night, some of them were a bit higher than last year. LTL is a little bit faster than the annual cycle. Just wanted to get a rough sense, when you think about across the spectrum of your products and capacity being a little bit tighter, how should we be thinking about the pricing environment as it sets up for, for calendar 2015?

Mike Glenn (President and CEO)

Well, FedEx bases all pricing decisions on current market conditions, the economic environment, and things of that nature, and we feel the changes that we put in place are appropriate. They allow us to continue to invest in the value that we're providing our customers. And of course, always, our objective is to strike the right balance between yield improvement and volume growth to contribute to the bottom line, and I think we have successfully done that. So you know, that's really the backdrop on which all these pricing decisions are made, and we feel very comfortable with it, with the announcement yesterday. We think it's appropriate, given the market conditions and the economic environment. And again, I mean, our sales team is executing very crisply on the strategy to strike that right balance.

Operator (participant)

Thank you. Our next question comes from Ken Hoexter with Bank of America Merrill Lynch.

Ken Hoexter (Managing Director and Senior Equity Research Analyst)

Great, good morning. Solid start on the year here. Can you just talk about the progress of maybe some of the expense cost reductions in the profit improvement plan, in terms of the SG&A and the progress of the facility, some reallocation you had talked about or consolidations?

And then did you mention there was a one-time charge within the, within the corporate allocation? Can you, can you delve on that, too? Thanks.

Alan Graf (EVP and CFO)

Well, Ken, I'll start, and I'll turn it over to Dave. I'm very pleased with where we are on our cost reduction program. We're basically exceeding it in every category. Had we not done what we did, our costs would have been significantly higher this quarter than they were, and our earnings would have been a lot lower. I'm also proud of the fact that we've done it, and we still been able to maintain and increase our service levels and not, and not give up on that, which is a very integral part of what we, what we try to do every day. We'll continue to work hard on that. We continue to find additional opportunities, everywhere. Everyone is focused on it.

We know we have a Profit Improvement Program to hit, but also, I think we are getting to world-class in terms of cost management, in terms of our management. So I'm going to turn it over to Dave.

Dave Bronczek (President and CEO)

Thanks, Alan. Yeah, I'm extremely proud of our Express team around the world. They've executed flawlessly. As has been mentioned twice already, we're on plan, projected to be on target for the run out rate in FY 2015. We had a solid quarter, and going forward, we're expecting the same kinds of results in terms of exceeding our plan. On top of that, I wanted to say that in terms of the parts of the profit improvement plan, you mentioned the voluntary buyout, the SG&A. We're 100% in on that already, so that's already rolling into FY 2015. Our fleet modernization is rolling out as we had planned, and as Alan pointed out, probably ahead of plan in many, if not all, of these categories.

So we have our focus, and we have our eyes set on achieving those kinds of results going forward. We know what's expected, and our team is executing.

Alan Graf (EVP and CFO)

We did take a legal reserve at corporate in the first quarter, and it was for an immaterial amount.

Operator (participant)

Thank you. Our next question comes from Kelly Dougherty with Macquarie Capital.

Kelly Dougherty (Senior Analyst)

Good morning. Thanks for taking the question. I just wanted to follow up on the pricing question earlier, especially in light of what we've seen from the Post Office recently. I guess two things: How do you help us think about the magnitude of the yield impact from the price increases and the dim weight changes? And then just some thoughts on what you think about the move by the Post Office to, you know, aggressively cut price to gain share and how that, you know, plays into your market share strategy and the outlook for margins at Ground?

Mike Glenn (President and CEO)

Well, first let me say, we don't comment on specific pricing actions by our competitors. We make all of our pricing decisions independent, based upon market conditions and economic conditions, as I mentioned earlier. Having said that, we have a tremendous portfolio of services which allow us to effectively serve the e-commerce market. I think we've demonstrated the ability to develop a strategy that really targets the right kind of growth within the e-commerce segment that contributes to the bottom line and supports our yield strategy. So, we're very comfortable with our strategy there. We're very comfortable with our growth opportunities there.

Regarding the specific impact of decisions like Dimensional Weight, it would be extremely difficult to speculate on the impact of that, because we're working with customers right now to alter their packaging so that they have more efficient packaging, which is good for sustainability and certainly fits with our corporate social responsibility programs. So as those changes are made, and let me remind you, we announced that change six months early to give customers plenty of time to respond to that. And many are taking advantage of our packaging lab to redesign packaging to be more efficient, which we like. So at this stage, it would be impossible to speculate on that, but let me just say, we're very comfortable with our position going forward.

Henry Maier (President and CEO)

Hi, Kelly, this is Henry Maier. Ground margins in the first quarter were reflective of better revenue quality, cost control, and ensuring every package was in the right network. We expect to continue to deliver industry-leading margins, and as I've told you on this call before, the Ground team would not be satisfied with anything less than margins in the high teens.

Operator (participant)

Thank you. We'll take our next question from Scott Schneeberger with Oppenheimer.

Scott Schneeberger (Managing Director)

Thanks. Good morning. You know, just following up on that last point in the Ground margins, a very nice revenue growth, pretty consistent with what we were expecting, but those margins were nice. You just hit a few of the areas. I know there's some OpEx going on with network expansion. Was there any change in ebb and flow in the quarter? And how do you anticipate that going forward as an impact on margins? Thanks.

Mike Glenn (President and CEO)

Well, I don't think there was any change. I mean, we expect to spend roughly $1.2 billion in CapEx this year. 85%-90% of it is all for capacity. We are right on plan in terms of our plans to bring those new facilities on. And I think as we said in the past, we manage roughly 150 real estate projects a year, in anticipation of peak.

Operator (participant)

Thank you. Our next question comes from Bill Greene with Morgan Stanley.

Bill Greene (Managing Director)

Hi there, good morning. Mike, can I ask you about the international side? We saw the package volumes turn up a bit. In your experience, do product launches like iPhone 6 or these sorts of things have a material effect on that part of the business for FedEx? Or is it that this is just an iteration of a new product, so it wouldn't have the same kind of effect that we've seen in the past?

Mike Glenn (President and CEO)

Bill, it has some impact, but more in the area that it relates to our FedEx Trade Networks company. There's been a change in the way companies position inventory for product launches. There's much more forward deployment of that inventory, using forwarding capacity to stage product in the U.S., and then we work with companies to then deploy the product to either retail locations or individual consumers. So, you know, those product launches are now more likely to show up in the domestic businesses, and they really are surges. I mean, they're one-to-two-day surges now based upon the product launch.

Now, having said all that, there is the aftermarket effect of accessories and things of that nature, which do flow through the system, but don't have the impact of the product launch itself in terms of number of units. So you really kind of need to think, rethink the way those, or think differently about those product launches now, as much more of the product is forward deployed.

Fred Smith (Chairman)

This is Fred Smith. We've got a couple of questions over the internet. One from Art Hatfield with Raymond James, "How should we think about margin goals for Express, given the changed corporate cost allocation?" I don't think that the latter has much effect on what our goal is. Our goal is to have all three of our major transport sectors operating at double-digit margins, and we're confident that we can do so. Obviously, in this quarter, we had two out of the three, but significant progress at Express. Another question from Shelby Holliday at Bloomberg, "In addition to adding seasonal employees, what else is FedEx doing to ensure a smooth peak season in 2014?" I think if we answered that question fully, we'd spend the next two hours talking to you about it.

The peak planning begins in January, February each year after peak season. There are just scores of things that are done at each of the FedEx operating companies to accommodate a smooth peak season. Contrary to some of the popular press, we actually had an outstanding peak season last year, with the exception of a couple of weather events, and the CEOs have reported at the SMC that they're prepared for peak season this year, and hopefully, the weather will be accommodating. There's a question about the long-term strategy for handling the shift to B2C. I think Mike Glenn answered that, quite frankly. We've done a great job of understanding what parts of the B2C business make sense and that are profitable. We've got a broad portfolio of solutions.

Our customers, you know, wanna buy it and these solutions in great profusion. Then entry into emerging markets, of course, as you know, we've bought a wonderful company in Mexico. We bought a great company in Brazil. We have an outstanding operation in India. We have an excellent domestic operation in China, and recently received, after a long delay, the licenses to continue to grow that business. So we have a major focus on emerging markets as well. So we'll now take other questions from the moderator.

Operator (participant)

Thank you. Our next question comes from Allison Landry with Credit Suisse.

Allison Landry (Senior Equity Research Analyst)

Thanks. Good morning. In response to an earlier question on returns to shareholders, you know, the dividend hike and, a potential buyback, and that you, you know, are consistently talking about it at the board meetings, I was just wondering if you could remind us when the next board meeting will take place?

Fred Smith (Chairman)

Allison, our annual meeting is a week from Monday.

Allison Landry (Senior Equity Research Analyst)

Okay. Thank you.

Operator (participant)

Thank you. Our next question comes from Scott Group with Wolfe Research.

Scott Group (Managing Director and Senior Analyst)

Hey, thanks. Good morning, guys. So, Alan, one of the questions earlier about the profit improvement plan, I think you had said that you're now tracking ahead of the plan or something to that effect. And that seems to be a change from some of the commentary you were giving last year. And so I wanna understand that a little bit more in terms of what's changing to give you confidence that you're now above plan? Is it additional costs that you're finding? Is it maybe you think pricing can become a bigger part of this? Or, you know, what is really driving the confidence that you now can be better than the $1.6 billion?

Alan Graf (EVP and CFO)

Hey, Scott. Well, I think what I said was, on the cost side, we were ahead. There's still a long way to go here, and, you know, we're we just reported a, you know, a 5.4% margin. We got a long way to go to hit this profit improvement plan. So, I'm very pleased on the cost side. As I mentioned in my, in my opening remarks, I'm extremely pleased with our execution of our improved revenue quality strategy, which we've all talked about and continue to talk about on these calls and are working very hard inside the company. We need to get paid adequately for the services that we're providing. We have stabilized the Express network.

We're not expanding it, and we are continuing to work to improve the revenue quality on those international flights, which is a key part of our profit improvement program. But it's also probably one of the hardest parts of the profit improvement program, 'cause we don't see the global trade situation today as we did in October of 2012 when we announced the program. So we're doubling down on everything else, and I'm very confident on the cost side. I am confident that we are on track with the PIP, but we got seven more quarters ahead of us.

Operator (participant)

Thank you. Our next question from Thomas Kim with Goldman Sachs.

Thomas Kim (Senior Industrials Equity Research Analyst)

Thanks. Can you talk a little bit more about the state of international express markets by region? You know, we're seeing Asia seemingly rebounding nicely. Europe appears much more mixed, and some of the data actually looks like it's rolling over. And I guess, you know, if you could comment on to what extent you're seeing different commodities drive the growth, that would also be appreciated. I guess, further to one of the earlier questions, you know, to what extent, you know, is the tech launches that we're seeing driving the growth? And do you think that there's anything beyond tech that's gonna sustain the growth? And I appreciate your comment that it's.

I'm referring to comments from perhaps other companies that continuously sort of refer to the rebound, and particularly out of Asia, about tech launches driving some of the growth that some of your peers have been seeing. Thanks.

Dave Bronczek (President and CEO)

This is Dave Bronczek. I'll let Mike go back and talk about the tech launches. But in terms of our regions around the world, they've all performed very well. As you pointed out, Asia Pacific rebounded nicely. For us, Europe is performing very well. We've opened up 109 stations in the last two years, and the business is performing exactly as we had hoped it would. And I think around the world, we're very pleased with the progress we're making. I do think Alan's point is right. The global economy is still probably softer than we would like to see it, but that being said, we're performing well in it. On the international revenue side, our yields are strong, and our volume is strong, especially in our box volume.

It's also strong in our domestic business. Our box volume and overnight box is up 9%. Deferred boxes are up 7%. The overnight letters is what's down slightly. So when you look at our mix of products and our drivers of profit improvement, that's all benefiting us. I should add one other thing, one that you can see and one that you can't see, probably. In aircraft maintenance, it's a timing issue for us, and you can see that it's our number one expense, item in terms of incremental expense year-over-year. On fuel, and we talk about fuel all the time, and I know you all do, it was slightly positive, it was not material, and I think that's important to note.

Mike Glenn (President and CEO)

Let me comment again, just to make sure there's a clear understanding of my comments regarding product launches. Over the last couple of years, there has been a change in the strategy regarding product launches. This is not a FedEx strategy, let me be clear, this is a market strategy. More of these companies are electing to build time into their product launch planning, to allow them to take advantage of more traditional freight networks to forward deploy the product and move the product into the United States or other markets, and stage that inventory for the launch itself. So that is changing the mix of traffic, and this is not only affecting FedEx, it's affecting the entire transportation market in terms of how this product is forward deployed. So, I wanna make sure I'm clear about that.

Now, having said all that, once the product launch occurs, then other inventory moves through more traditional channels, and specifically accessories more, moves through more traditional channels. So the real impact of the change in product launches is a removal of, from the international perspective, of the large bubble that took place early in the product launch cycle, and that has now smoothed out quite a bit. The bubble then takes place as a result of that, for example, in the U.S., when the product starts moving through the U.S. network to achieve advance or to fulfill advance orders, either through the retail stores or direct to individuals.

So it has been a change in strategy by the companies that are launching these products, and obviously we're responding well, and we're very comfortable with our position because of the portfolio of services that we provide. Just quickly, you asked about the segments that were driving international growth. These are typically consumer-driven services, manufacturing durables, of which these high-tech products would be part of that. So those are the areas where we see a lot of growth in wholesale durables as well.

Operator (participant)

Thank you. Our next question comes from Brandon Oglenski with Barclays.

Brandon Oglenski (Director and Senior Equity Analyst)

Yes, good morning, everyone, and congratulations on the good quarter. You know, I think this question is gonna be for Fred or for Mike. You know, we talk a lot about trying to shape customer behavior, you know, with the dim weight change, trying to get smaller boxes into the system, but wouldn't one of the best levers be some form of real-time pricing, where you can really, you know, start to manage the peaks and the valleys in the network? And what's really limiting the industry from shifting to more of a real-time pricing model?

Mike Glenn (President and CEO)

Well, again, we work with our customers very specifically about the pricing that they have on a contractual basis, based upon the forecasted demand and the volume that they anticipate. That's one reason why January, excuse me, December 26th, we start focusing on the next year for peak season. So when we go into a contractual negotiation with a customer, if that customer has a peaking factor, for example, of three times three times, that would imply that they will give us about three times as much volume, for example, in the month of December, than they would the other eleven months. That information is known on the front end, and our negotiations are based upon that. So this is not a situation where we get surprised by the lumpiness, if you will, of a customer's volume.

We know that going into a negotiation. So, obviously we won't rule out other pricing tactics. We announced a change to our dim weight policy based upon the change in market conditions and the economic environment, and I'm sure there'll be future changes along those lines. But I want to be real clear, we have a great deal of understanding and data to support pricing decision and contractual negotiations based upon the forecasted volume that customers give us. A lot of our discounts are also volume-based, so if the volume goes up or down, we adjust those discounts accordingly. So there's a tremendous amount of science that goes into revenue management, and we are world-class at that. Our pricing science group is outstanding.

That's really one of the reasons why that data feeds our growth strategy, and that's one of the reasons why we've been able to sustain a balance between volume growth and yield improvements contributed to a bottom line expansion.

Operator (participant)

Thank you. Our next question comes from Jeff Kauffman with Buckingham Research.

Jeff Kauffman (Director and Senior Equity Analyst)

Thank you very much, and congratulations. Alan, I just wanted to kind of take ten steps back here. I mean, you raised your global EPS outlook. You had a very strong quarter. Fuel prices seem to be a little bit better. Costs ahead of plan, yet the guidance remains in line. Can you help me connect the dots on that?

Alan Graf (EVP and CFO)

Well, when I gave you this guidance at the end of last year, we had factored all that into the guidance. So, you know, as I said, we were very pleased with the first quarter. Second half's a little bit tougher. I have no idea about peak season weather yet, which could swing us quite a bit. So as I said, we'll have more to say about this at the end of December when we have that basically mostly behind us. And, we'll see where that is.

Operator (participant)

Thank you. Our next question comes from David Vernon with Bernstein Research.

David Vernon (Managing Director and Senior Analyst)

Hey, thanks for taking the question. Mike, a question for you on the domestic yields. David mentioned that the box volume was up 9%. That's the best quarterly figure that I can see back in my model. And I was just trying to get a sense for what the underlying rate development was and what you think is really driving that, whether it's macro, maybe, response to lower prices, any other shifts that are going in there to drive that outstanding volume growth in overnight box?

Mike Glenn (President and CEO)

Well, there are a couple issues that are in play here. One is, Express is certainly benefiting from the growth of e-commerce, which we've said previously on this call. Secondarily, as part of the profit improvement plan, Dave Bronczek and I, along with our teams, have really developed a targeted growth strategy that is targeting specific amounts of growth opportunities at targeted yields, which we feel if we're able to achieve that is gonna benefit his bottom line, and our sales team is executing that strategically- strategy perfectly. So Dave and I work very closely together. We monitor all the opportunities, all the pipelines to make sure that we're achieving our desired goals. And again, hats off to our sales team for executing that strategy.

Operator (participant)

Thank you. Our next question comes from Bruce Chan with Stifel.

Bruce Chan (Director)

Yes, thank you, gentlemen. You alluded to another compressed peak season in your prepared remarks. I'm wondering, with what's been going on over on the West Coast with the ILWU, you know, it seems that a lot of shippers have been pre-positioning inventory, and I don't just mean tech product launches here. I'd like to get your view on whether that should affect your volumes going into peak and, you know, as far as last-minute inventory supplements, whether that's been a factor in your preparations. Thank you.

Mike Glenn (President and CEO)

This is Mike again. It's certainly an issue that we're monitoring, but I would say at this stage, based upon the feedback from our customers, we don't expect that to have a material impact on our peak season at this point.

Operator (participant)

Thank you. Our next question comes from David Campbell with Thompson Davis and Company.

David Campbell (Founding Partner and SVP of Research)

Yes, thanks for taking the question. I now some of the international companies see China as more of an import freight business. Much more of an import business than an export business as it has been for the last 10 years. Do you see the same thing going on there? And of course, that import business has a lot to do with the intra-Asia growth, and I just wondered what, how you were positioning the company to participate in that growth.

Dave Bronczek (President and CEO)

Well, thanks, David. This is Dave Bronczek. As you know, we've been in China for over two decades now, and we've had three decades now. We've had growth in our international segment, and that continues to grow. The 777 continue to add more value to customers all around the world, with later cutoffs there in China, feeding the rest of the world. We have an excellent intra-Asia network off of our hub in Guangzhou, China, and then we have a domestic business in China, so we're actually playing in and succeeding in every segment of the Chinese marketplace. And thankfully, we've been in business there for a long time and have a great reputation and a great management team.

And so to your question, we're seeing international export growth, we're seeing domestic, intra-region growth and domestic China growth.

Alan Graf (EVP and CFO)

This is Alan. I have a question here from Ryan Novak, from Citadel, about the $35 million year-over-year increase in the new corporate eliminations and other line. That is largely the result of the legal reserve that we took. We are being maniacal about our corporate headquarters costs and trying to keep them down, which is why we are now reporting it separately.

so that we can show you, transparency on the progress we have there as well. Sometimes those costs tend to get lost in chargebacks, and now we're focused on it.

Operator (participant)

Thank you. Our next question comes from Kelly Dougherty with Macquarie Capital.

Kelly Dougherty (Senior Analyst)

Hi, thanks. Just wanted to get your thoughts on the pace of trade down from Priority to Economy, and how it might differ domestically versus internationally. Do you think we've hit a point where there's stabilization and maybe the delta between the two has kind of leveled out at a good level that we can assume going forward? And then how are you assuming this trend as part of the Express profit improvement plan?

Dave Bronczek (President and CEO)

Well, this is Dave Bronczek. I'll start off, and then Mike can add some color. What we feel at Express and at FedEx is the same trend and the same way of business conducted around the world as it is in the United States. People look for different means of transportation, and we have them all at FedEx in our portfolio. So we're not surprised; we're actually right in line. We've actually tweaked our model, if you will, so we can take advantage of the global economic activity in the deferred space, and that's performing well for us. In the Express overnight space, very much like the United States, we think the global marketplace is the same.

Mike Glenn (President and CEO)

Yeah, let me just say, our mission is to work with customers to deliver solutions to them, leveraging the entire bundle of services that we provide, in order to deliver the value that they need, to improve their performance. So when they win, we win. So you know, we really look for opportunities to work with customers to make their supply chains as efficient as possible. A lot of the transition has occurred. Would I say it's over? No. Customers are always looking for ways to tweak their supply chains, but clearly, we've seen, I think the economic situation starting in 2008 drove a lot of that. Obviously, as the economy improves, I think you'll probably see less focus on that and hopefully more focus on growth from our customers.

But clearly, they'll continue to look to refine their supply chains.

Fred Smith (Chairman)

Let me just add a point to this because I believe this has been an area of confusion on the part of a lot of people for a long time. What drives the selection of Express over Ground is not the fact that there's a Ground alternative and an Express alternative. It's the nature of the product being shipped and the need of the shipper that's making the transaction. So, a defibrillator going for an operation is gonna go Express. The plug-in for a charger for a new product that might be introduced by the electronics industry is almost certainly gonna go Ground.

So as the market grows, there is a percentage of the traffic by virtue of the nature of the product and the consequences of the item being delivered in a short time will pay Express rates for Express service. And, for some reason, several years ago, there was a large body of thought that, you know, everything was gonna go Ground. We tried to tell people that that wasn't the case, and I think that, that what you see in the marketplace now is a more stable picture as some of this trade down has occurred, as Mike mentioned. But there's a certain percentage of the parcel traffic and the freight traffic, whether it's international, domestic, it's gonna go Express.

We have the greatest Express company in the world, and we've mentioned over and over again, we intend to get the Express company back up to earning at the level that it should.

Operator (participant)

Thank you. Our next question comes from Keith Schoonmaker with Morningstar.

Keith Schoonmaker (Director of Industrials Equity Research)

Comments on the call sound quite positive regarding international activity, and year-over-year comps and international volume and yield are positive. You've mentioned you expect international trade to continue to grow, although you wish faster. But I've also noted that Fred speaks a fair bit on risk of heightened protectionism. And I guess, I'm wondering if you're detecting some relief, or can you give some insight into sources of expected trade despite these obstacles?

Fred Smith (Chairman)

Well, you're correct. I think we had on the investor website several speeches I gave last spring. The reality is that perhaps the most important thing that has been done since the end of World War II was American leadership to open up markets and lift literally billions of people out of poverty. I mean, it's the American consumer combined with the Chinese liberalization that has created this incredible prosperity for millions and hundreds of millions of Chinese. India began to become more market-oriented in the 1990s, Brazil did. But recently, as I point out in those speeches, there's been a real increase in the number of protectionist measures around the world and a lack of leadership on the part of the United States in moving towards more open markets.

As you know, there was just a very disappointing result in the negotiations that was, in essence, vetoed by India. And so the United States will have to resume that mantle of leadership, get trade promotion authority.

Really push these various initiatives that are underway. There are four major initiatives: treaty negotiations that the United States is involved in today. But absent that, I think you're gonna see a very difficult environment for trade around the world if these protectionist measures continue to proliferate.

Operator (participant)

Thank you. Our next question comes from Thomas Kim with Goldman Sachs.

Thomas Kim (Senior Industrials Equity Research Analyst)

Thanks for letting me ask another question. Alan, I was wondering about the dividend side. Can you help us just frame about how you're thinking about what would be deemed a sort of adequate? Are you thinking about more of a yield, or are you thinking about more of a payout ratio?

Alan Graf (EVP and CFO)

Both. I think we just need to continue to improve it until we get up into a range where people who are interested in dividends and dividend yields would be more interested in our shares than they are today. It's what Mickey's after for me about every five minutes, so we'll continue to do that. And I think every year for a many number of years now, we've increased it at our May/June board meeting, and we'll take it up again then this year.

Operator (participant)

Thank you. Our next question comes from Scott Group with Wolfe Research.

Scott Group (Managing Director and Senior Analyst)

Hey, thanks for the follow-up. So, one for Henry on the ground side. So we saw margin expansion for the first time in a bunch of quarters. Are you comfortable that we're kind of through the overhang of the capital expansion costs, and we can start seeing ground margin improvement? And do you see any impact from the outcome in California on the contractor side that could lead to more legal costs, or could lead you to change the contractor model?

Henry Maier (President and CEO)

Well, the answer to the first question is that we've probably got another year of increased capital before we're over the hump here in terms of the capacity or building out the capacity we view we need going forward in the network. Most of that expenditure is in the area of hubs and automated satellites. All of our hubs are automated.

I think the thing that's important for the folks on the call to understand is, we are expanding the footprint of our auto satellites pretty aggressively here because of the capacity it gives us, the flexibility it gives us, particularly when we see volume spike up at peak, and the ability long term of those facilities to lower our costs, both in terms of lower line haul expense and fewer handling. So I think there's one more year here, and then you'll see CapEx go back to something that we would consider to be, quote, normal, unquote. I'm gonna let Chris answer the question on California.

Chris Richards (EVP, General Counsel, and Secretary)

Hi, Scott. In light of legal and regulatory developments in several states, we've taken a number of steps in recent years to enhance the operating agreements with all the independent businesses that contract with Ground to provide transportation services. These independent businesses agree to remain incorporated and in good standing in the states in which they do business, and to treat their personnel as employees, and to comply with all applicable federal and state laws. That being said, we have announced we are transitioning to new independent service provider agreements in California, Oregon, Washington, and Nevada.

Operator (participant)

Thank you. Our next question comes from Ken Hoexter with Bank of America Merrill Lynch.

Ken Hoexter (Managing Director and Senior Equity Research Analyst)

Hey, great. Good morning. Just a follow-up on the charge that you mentioned before. Is that anything related to the California move to contractors as employees, or is that a completely separate? And being a large charge, can maybe provide some details on that?

Chris Richards (EVP, General Counsel, and Secretary)

Ken, it's Chris Richards. While we do not agree with the Ninth Circuit's decision, we have established an accrual for the estimated probable loss in these cases that was required to be recognized pursuant to applicable accounting standards.

Operator (participant)

Thank you. Our next question comes from Rob Salmon with Deutsche Bank.

Rob Salmon (VP and Senior Analyst)

Yeah, thanks for the follow-up, Henry. Just to piggyback on Scott's earlier question. With the changes that have been announced in California, should we be thinking about any sort of incremental cost to the company as you execute there? Or can this be like some of the changes in the past where we actually saw margins expand due to efficiencies that you gained?

Henry Maier (President and CEO)

Well, Rob, we've currently transitioned to 17 states. We don't expect any change here. Any additional costs we would see in terms of the transition would be immaterial. So, I guess the answer is no, I don't think you should read anything into this. In fact, if you look at the 17 states that we previously transitioned, our service actually improved. So, no.

Operator (participant)

Thank you. Seeing no further questions in queue, I'd like to turn the call back over to Mr. Mickey Foster for any additional or closing remarks.

Mickey Foster (VP of Investor Relations)

Thank you for your participation in the FedEx Corporation's first quarter earnings release conference call. Feel free to call anyone on the investor relations team if you have additional questions about FedEx. Thank you very much.

Operator (participant)

Ladies and gentlemen, thank you for your participation. This will conclude today's conference.