FedEx - Q2 2015

Transcript

Operator (participant)

Good day, and welcome to the FedEx Corporation second quarter fiscal year 2015 earnings conference call. Today's call is being recorded. At this time, I would like to turn the conference 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 second quarter earnings conference call. The earnings release and our 26-page stat book are on our website at fedex.com. This call is being broadcast from our website, and the replay and podcast will be available for about one year. Joining us on the call today are members of the media. During our Q&A session, callers will be limited to one question in order to allow us to accommodate all those who would like to participate. If you are listening to the call through our live webcast, feel free to submit your question via email or as a message on StockTwits.com. For example, please include your full name and contact information with your question and send it to [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 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, Christine 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 second quarter of fiscal 2015. FedEx posted strong results and a higher operating margin, with earnings up year-over-year 36% per share. We continued growth in volumes and base yields in our transportation segments. Results also were positively affected by the benefits from our ongoing FedEx Express Profit Improvement Program, which is on track. We expect revenue and earnings growth to continue into the third quarter and the remainder of 2015, driven by ongoing improvements in the results of our transportation segments. As we enter the final stages of this year's peak shipping season, I'd like to thank the more than 300,000 dedicated team members around the world for, again, delivering outstanding service to FedEx customers during the holidays.

We're very pleased with our plans for two transformative acquisitions announced earlier this week that will expand existing service offerings in the retail, e-commerce, and international markets. Mike Glenn will provide additional details in his remarks on these acquisitions. Before turning the call over to Mike and Alan Graf, I'd like to recognize Bill Logue, our longtime colleague and business partner, who is retiring as President and CEO of FedEx Freight on December 31st. Mike Ducker, a 40-year veteran of FedEx and currently Chief Operating Officer of FedEx Express, will succeed Bill, and he's here today as well. After 25 years of distinguished service to FedEx, Bill leaves with our gratitude, our support, our friendship, and best wishes for a long and healthy future. Mike Glenn?

Mike Glenn (President and CEO of FedEx Services)

Thank you, Fred, and good morning. First, I'd like to take this opportunity to reiterate Fred's comments and thank our team members as they work around the clock to deliver the holidays for customers worldwide. The dedication of our team members, combined with the investments that we've made in our networks, have allowed us to deliver outstanding results despite weather and all the challenges that we encounter during the holiday season. While we're still in the heart of peak season, there are several trends and developments that are affecting the season, including labor issues at the West Coast ports that have affected productivity and impacted retailers' ability to get inventory where it is needed and when it is needed. This issue has impacted our operations as we've made adjustments to capacity in key markets to support our customers facing these ongoing port slowdowns.

In some situations, the slowdowns have caused unexpected shifts in retail and e-tail customer needs in certain markets, and we've put limits on customer volumes in order to ensure we meet our service commitments. Despite these challenges and significant weather events during the peak season, both in the Northeast and on the West Coast, I'm proud to report that we've been able to maintain outstanding levels of service across our networks. We've already delivered multiple days this peak season that rank among the busiest in the history of the company, and our service levels have been terrific. I also want to briefly discuss the two acquisitions that were announced this week that are transformative in terms of the FedEx portfolio of e-commerce and supply chain solutions. GENCO is one of the largest third-party logistics providers in North America.

They have a broad range of product lifecycle and supply chain services that will significantly expand our portfolio, including market leading, a market leading position in returns, test and repair, remarketing, and product liquidation. GENCO processes more than 600 million returned items annually from many of the world's leading brands. In Bongo International, we've acquired a leader in global cross-border e-commerce technology and solutions. Bongo's technology and processes provide a comprehensive end-to-end solution that helps retailers and e-tailers grow by reaching international e-commerce consumers. Bongo is delivering cross-border enablement solutions to a base of more than 2,000 retailers to more than 200 countries worldwide. These acquisitions will transform our global portfolio through the addition of new best-in-class e-commerce and supply chain management solutions.

Moving on to our overall economic outlook, the fundamentals of the U.S. economy continue to improve, and our expectation is for real GDP growth to average around 3% for the next several quarters. Our U.S. GDP forecast is 3.1% for calendar 2015, and we expect industrial production to grow at 3.9% in calendar 2015. Global economic growth is expected to broaden, with the U.S. leading and emerging markets picking up. We expect global growth of 3% in calendar 2015. Now, let me make a couple of comments regarding the company's yield performance by segment. Excluding the impact of fuel, year-over-year Express domestic package yields declined slightly by 0.4%. While we experienced a positive impact from rate and discount, it was more than offset by a lower weight per package due to an increase in e-commerce and telecommunications traffic.

In the Ground segment, yield per package, excluding SmartPost, increased 3.3% year-over-year, excluding the fuel surcharge, driven primarily by rate and discount. For SmartPost, yield increased 7.8% year-over-year without fuel, which was driven by a change in customer mix. In the International Export segment, excluding fuel, yield per package increased 0.7%, which again, was driven by a product mix and rate and discount. And finally, excluding the impact of fuel, yield per shipment increased 2.3% at FedEx Freight. The increase was driven by rate and discount and changes in weight per shipment. And now I'll turn it over to Alan Graf.

Alan Graf (EVP and CFO)

Thank you, Mike, and good morning, everyone. We had a spectacular second quarter as our earnings per share grew 36% to $2.14. Corporate margin rose 120 basis points year-over-year to 8.5%. Revenue grew 5% to $11.9 billion from increased volumes and generally higher base yields, which drove a significant increase in earnings for each of our transportation segment, segments. At Express, Q2 operating income increased 36%, and operating margin increased 170 basis points year-over-year, driven by the revenue growth in our U.S. and international export business, cost management related to the profit improvement program and lower pension expense. U.S. domestic volumes increased 7% in Q2, driven by both overnight and deferred service offerings, and international export volumes increased 2%.

The net impact of fuel had only a slight benefit to operating income. Maintenance and repairs expense increased 16% due to the timing of aircraft maintenance events. Operating expense growth was favorably impacted by the profit improvement actions at Express. Turning to Ground, segment revenues increased 8% due to volume and yield growth at Ground and yield growth at SmartPost, partially offset by lower volumes at SmartPost. Average daily volume at Ground increased 5%, and operating income increased 6%, driven by higher revenue per package and the volume increase. Higher network expansion costs partially offset the increase in operating income as we continue to invest in the high margin, high ROIC, growing Ground businesses. Freight had another great quarter, with 35% higher operating income and operating margin up 130 basis points year-over-year.

Higher less-than-truckload revenue per shipment and higher average daily LTL shipments drove operating income and margin higher. Average LTL shipments increased 8% daily, and revenue increased 11% year-over-year. I want to speak a little bit about our fuel surcharge and our fuel surcharge tables. FedEx regularly reviews its fuel surcharge tables and will update certain tables at Express, Ground, and Freight, effective February 2, 2015. While second quarter results benefited slightly year-over-year from the net impact of fuel due to lower fuel prices this year versus last, the year-over-year reduction in fuel surcharge revenue largely offset the benefit of the lower fuel prices. Understanding the net year-over-year impact of fuel on our results involves three key considerations: timing lags and adjustments to our fuel surcharges, the structure of the fuel surcharge tables, and the manner in which we purchase fuel.

Our fuel surcharges for Express and Ground incorporate a timing lag of approximately six to eight weeks before they are adjusted for changes in fuel prices. For example, the fuel surcharge index in effect at Express in November was set based on September fuel prices. Additionally, the structure of the fuel surcharge table for Express and Ground does not adjust for direct changes in fuel price, but allows for the fuel surcharge revenue charged to our customers to remain unchanged as long as fuel prices remain within certain bands. Finally, we purchase fuel under contractual arrangements tied to various indices around the world. Approximately 75% of our jet fuel is purchased based on the index price for the preceding week, with the remainder of our purchases tied to the index for the preceding month rather than based on daily spot rates.

While a daily spot price of jet fuel declined almost 30% from the end of August to the end of November, the average monthly price we paid for jet fuel, fuel under our contractual arrangements did not change by a corresponding amount. As a result, the average price per gallon for jet fuel in Q2 only declined 8% quarter-over-quarter or 10% year-over-year. Collectively, these three considerations affect the net impact of fuel on our results in the short term. An expanded discussion of the net impact of fuel is available in our first-quarter 10-Q and will also be available in a second-quarter 10-Q when filed tomorrow. Turning now to the outlook. Based on the economic outlook that Mike outlined, we reaffirm our FY 2015 earnings per share forecast of $8.50-$9.

The outlook assumes continued moderate economic growth and a modest net benefit from fuel. We expect revenue and earnings growth to continue for the rest of the year as moderate global economic growth drives volume and yield. Our results could be constrained by the funding of incentive compensation programs. Our FY 2015 results will continue to benefit from the profit improvement programs and will also benefit from lower pension expense. In closing, I would like to thank all of our team members for their hard work and dedication during our very busy peak season. I'm very proud to be part of such an amazing team. We will open the call for questions.

Operator (participant)

Question and answer session is conducted electronically. To ask a question, please press star one on your telephone keypad. If you're using a speakerphone, please make sure that your mute function is not turned on to allow your signal to reach our equipment. Once again, that's star one if you have a question at this time. We do ask that you limit yourself to one question to allow others the opportunity to pose their question. You may also submit your question via email to [email protected]. Again, that's star one if you have a question over the phone line. We'll take our first question from Robert Salmon with Deutsche Bank.

Robert Salmon (VP and Associate Analyst)

Hey, thanks. Good morning. Alan, perhaps you could elaborate a little bit more in terms of the ground margins. What caused the contraction in the second quarter? It looks like other expense was a little bit higher than we were anticipating. I'm sure also the Cyber Week, as well as the investments played out. And then with regard to the GENCO acquisition, could you give a sense if there's any revenue synergy opportunities? It looks like they manage about $3.5 billion or got visibility into about $3.5 billion related to small package spend. And, you know, how much of that is currently being managed by, is currently running through FedEx versus other competitors?

Henry Maier (President and CEO of FedEx Ground)

Hey, Robert, this is Henry Maier. Q2 margins declined slightly due to investments in our network, many of which were in preparation for peak. The calendar this year was the same as last year. There's only one more shopping day between Black Friday and Christmas Eve. Many of these peak-related investments are driven by what customers tell us they think their volumes will be during the holiday season. So, you know, most of what you're seeing in margin decline is the result of short-term investments we make for peak. Now, let me say this, you know, once peak ends, we will shed this cost as quickly as we possibly can, and we remain committed to high teens margins in the ground segment.

Alan Graf (EVP and CFO)

As to the GENCO question, of course, there are revenue synergies. We love this acquisition for all the reasons that Mike outlined and for that fact, and we're very excited. Can't wait to get it closed and get it working for us.

Operator (participant)

Thank you. Our next question comes from Nate Brochmann with William Blair.

Nate Brochmann (Wealth Advisor and Portfolio Manager)

Good morning. Thanks for taking the question. Alan, maybe just to kind of follow up on the GENCO acquisition, and I might be a little bit misplaced on this, but I recall back in the day of you guys kind of saying that you didn't really want to get that deep into inventory, logistics management. I certainly have known the GENCO guys for a while, and I think they bring a great asset to your organization, kind of probably fill a gap. I was wondering if you could talk a little bit in terms of just strategically, where the thinking lies in terms of what GENCO brings to you, and maybe what other gaps you might look at in terms of your overall logistics framework, in terms of where the market's moving and why that's so valuable.

Fred Smith (Chairman)

This is Fred Smith speaking, and I'm gonna turn it over to Mike Glenn. In years past, we were not particularly enamored of the so-called 3PL business because it was a relatively low margin business that saw a lot of loss of contracts on the first renewal. It was more of a commodity type of business, and one of the big sales pitches of a lot of 3PLs was that they were carrier agnostic in terms of the transport system that they used. What, of course, has happened over the decades since we expressed those remarks, is the entire logistics and retailing sector has changed, particularly with the emergence of e-commerce and the empowered consignee with mobile phones and electronic devices that allow them to order and move their shipments around.

The attractive part of GENCO was that it had sailed directly with those winds into the market leadership in the reverse logistics space. And with the substantial market presence that we have, particularly with FedEx Ground and FedEx SmartPost in that sector, it was just a natural fit. So our view about that business in the main hasn't particularly changed, but the world has changed. And this was really a great fit. The culture was perfect.

The management team is terrific, very high ROIC, asset light, which complements some of our more capital-intensive businesses. And Herb Shear and his team have just done a great job of building this business over the years, and we're just very happy to get it. That's the reason that we changed our opinion about the business, and it's also why we were very, very careful in getting the right candidate that fit all those criteria that I just mentioned. Mike?

Mike Glenn (President and CEO of FedEx Services)

I'll just add a couple of comments. GENCO's expertise in infrastructure and targeted verticals, and specifically in technology, healthcare, and retail, all complement the FedEx portfolio of services, and those have been industry segments we've been interested in for a long, long time. In my opening remarks, I mentioned that GENCO processes more than 600 million returned items annually, and that's a critical decision criteria when developing relationships with our e-commerce customers. I don't have to tell this group that returns in the e-commerce segment are a more important issue than they are in the typical retail channel, represent a larger percentage of overall sales. So it's critical we have these capabilities, and as Fred mentioned, GENCO is the perfect partner.

Henry Maier (President and CEO of FedEx Ground)

This is Henry Maier. Can I just add something here at the end? GENCO is a company that we have admired for many years. Culture is, we believe, a perfect alignment with the FedEx culture. As Fred and Mike have said, they have an excellent management team. And like FedEx Ground, GENCO is proud to call Pittsburgh home, and I think this just reinforces our commitment to the region.

Operator (participant)

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

Ben Hartford (Senior Equity Research Analyst)

Hey, good morning, guys. Just looking for a little bit of perspective on the 4Q peak and how you may or may not be benefiting from some of the tightness that we're seeing in that Asia to U.S. lane. Maybe you could just walk through just that, the puts and the takes. I understand the capacity has been tight out of key gateways out of Asia, leading up to recent weeks. You talked about some of the limits on customer volumes that you had implemented, so I imagine load factors are high.

I'm curious to what extent you're able to participate in the strength in the spot market as it relates to pricing with some of the volumes against potentially having to pay more for third-party capacity into that context as well, if you could provide some perspective there. Then also maybe speak to how you see the Trans-Pacific market developing in 2015, given this volatility that we're seeing in this year's peak. Is it episodic, or is it something that can be more sustained? Thanks.

Dave Bronczek (President and CEO of FedEx Express)

Yeah. Hi, this is Dave Bronczek. First of all, we're able to participate quite a lot. You know, we have extra sections that we can fly into Asia. We've done that consistently through the month now in December. We've seen a lot of demand, quite frankly, that has come along because of what Mike pointed out on the port issue in Long Beach. So yes, we have tight capacity, but we're able to manage our capacity globally because of our extra sections that we can put in. So I would say that from a perspective from Express's point of view, we've been very, very successful in managing through this.

Mike Glenn (President and CEO of FedEx Services)

I would add just a couple of comments on peak in general. I think we've seen some shifts here that will be positives for the long haul, and that is demand is really shifting more towards the entire peak season rather than on specific days. I'm sure you've noticed that the Black Friday and Cyber Monday events have become more of week-long events to really depressurize those days a bit, and I think those are challenges that e-commerce companies and retailers are working through, but I think will be a positive impact on the peak season overall going forward.

Dave Bronczek (President and CEO of FedEx Express)

Yeah, this is Dave Bronczek. Again, just one more thing to add to what Mike said. We're seeing strong demand, obviously, through December. It's been more rational, though. It's been spread out. The volumes have been strong, but our service has been outstanding. We've had good weather to go along with it, but I just wanted to make that point as well.

Operator (participant)

Thank you. Our next question comes from Chris Wetherbee with Citi. Great, thanks. Good morning.

Chris Wetherbee (Senior Research Analyst)

I was wondering if maybe you could give a little bit more color of sort of what the benefit of the profit improvement plan was in the quarter and maybe sort of order of magnitude relative to the benefit, I think, that you said was slight from fuel within Express. And then just thinking sort of on that Express note, as you look into fiscal third quarter, Alan, would you expect sort of what we've seen with this continued step down in jet fuel prices to provide a bigger benefit to the third quarter? Or is it maybe just gonna be a little bit more in line with the type of benefit you saw in fiscal 2Q?

Dave Bronczek (President and CEO of FedEx Express)

Well, let me start off. This is Dave Bronczek again. Our profit improvement plan is working. It's on track. Our management team's successfully executing. I'm very, very proud of them. Along with the profit improvement, our service has been outstanding as well. I wanted to make that point to our management team. But from a profit improvement perspective, in Q2, fuel had a slight positive to FedEx Express. I know many of you had written that our profits for the quarter would be very high, relatively speaking, and they are.

We're up 36%, 170 basis points, but only a slight improvement in fuel that went along with that. And when you think about it, our expenses were only up 1% for the quarter, I mean, for the quarter. Our volumes were up 7% in the U.S., 2% internationally, and as Mike pointed out, our yields were all up. Our profit improvement plan is really driving most of our success.

Alan Graf (EVP and CFO)

This is Alan. I think, you know, we're continuing to do exactly what we described we were going to do. The revenue outlook at Express, particularly in the domestic business, is very good because the services are so outstanding. Our costs at Express are significantly, permanently lower than they would have been had we not done the profit improvement program, and those are gonna carry through throughout.

We haven't backfilled one person and don't intend to. So, as steady as she goes, we're exactly where we told you we would be when we had our fourth quarter earnings call for the year, and we'll just continue sailing. As far as fuel, as I said, very little improvement for the year as a result of fuel based on where our new fuel surcharge tables will be and where we think fuel will be. So, we're getting it from the old-fashioned way, which is good, solid service and unbelievable cost management.

Operator (participant)

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

Ken Hoexter (Research Analyst)

Great, good morning. Can you talk about the scale of the ground investments? Were these a surprise addition, or did you expect margins to deteriorate in your prior outlook on a year-over-year basis? And then can you delve into the incentive comp commentary and what that's expected to impact margins as we go forward?

Henry Maier (President and CEO of FedEx Ground)

Ken, this is Henry Maier. I mean, concerning the Ground margins, you know, this is, you know, there's nothing unusual here. I mean, we plan for peak every year. It's a 12-month exercise. We start working with customers in August. Based on what they tell us they're going to need in terms of capacity for the peak season, we make peak investments accordingly. The rest of this is just normal network investments for organic growth.

Alan Graf (EVP and CFO)

This is Alan. I would also say that, reference back to what Mike said, looks like peak is more spread out, than in years past. So, while we had a great November at Ground, it was a little bit lower than we had planned for, and we put in all that peak planning costs and everything, so it had a little bit of an impact. And then, as we noted, SmartPost is down year over year because of one customer. So, we're very happy with where Ground is. It's gonna continue to have a great year and, and a great next year.

Mickey Foster (VP of Investor Relations)

We have an email question coming in from William Flynn, from Potomac, and the question is: In the second quarter, freight revenues were up 11% and operating income was up 45%. How much of this excellent execution was due to yield initiatives versus market share gains? We did have an excellent quarter at FedEx Freight, and I'm particularly proud of the collaboration between our sales and marketing team and the freight operations team. We spent a lot of time working to make sure that we get the right amount of traffic in the network at the right yields. The answer to the question is, it's a combination of both. We continue to take share in the segment due to our industry-leading value proposition, and our sales team is executing crisply.

I need to mention our pricing team as well. They've done a phenomenal job working with our sales and operations team to make sure that we're getting the traffic in at the right yields that... to ensure that it drops to the bottom line. So, it's a terrific quarter for freight. We're very proud of that, and we're very proud of the collaboration we have with the freight team.

Bill Logue (President and CEO of FedEx Freight)

I'll jump in. This is Bill. And again, as Mike said, it's we are very pleased with the quarter, you know, up 35% on OI. And, you know, we've seen some great performance in the revenue quality area and commitment from all the sales team, our pricing team and partners. So, that's very encouraging going forward. And again, the ops team continues to do a great job in the frontline service to our employees, to our customers, and that's where we're seeing outstanding continued growth in our business. So, we're very pleased with the quarter.

Mickey Foster (VP of Investor Relations)

Let me correct, I read the question as submitted. It said operating income was up 45%. As Bill noted, it was actually up 35%, but I read the question as submitted.

Operator (participant)

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

Kelly Dougherty (Senior Analyst)

Hi, thanks for taking the question. After your last call, you announced plans for a buyback that seems primarily just to offset the dilution. Can you help us think about plans to return more capital to shareholders, especially as your free cash flow ramps? Or maybe now that it seems to be you're in more in an acquisitive mode, that buybacks or return of, of capital might take a back seat to that, at least for the time being?

Alan Graf (EVP and CFO)

Well, not necessarily. We're gonna, this is Alan. We're gonna continue to buy back shares. We'll probably do it at a lower pace than we did when we did the initial one. We're certainly gonna at least prevent dilution from our comp programs. We may or may not go further than that. We also review our dividend at the end of every fiscal year with our board, and, you should not, assume that the GENCO and Bongo acquisitions are in any way gonna change that, because we have plenty of cash flow to go around to solve, both of those issues.

Operator (participant)

Thank you. Our next question comes from Scott Schneeberger with Oppenheimer.

Scott Schneeberger (Managing Director)

Thanks. Good morning. Could you address, in the Freight segment, some of the puts and takes in the quarter, specifically with regard to the margin and how you see that developing over the back half of the year? Thanks.

Bill Logue (President and CEO of FedEx Freight)

Yes, Scott, it's Bill. Again, good quarter, up 35% on the operating income. And in the quarter, we took a well-deserved pay increase in October for our frontline teams. So between that and other compensations and healthcare costs, that was a pretty big headwind on our numbers, and we still came back with a 35% improvement. So, again, we're pretty excited about that. And going forward, we'll have a little bit of headwind in Q3, Q4 from the October pay increases. But again, we're still very excited where we're going here in the second half.

Operator (participant)

Next question comes from Jack Atkins with Stephens.

Jack Atkins (Research Analyst)

Great. Thanks for the time this morning, guys. I guess this question is for Fred or Dave. I'd be curious to get, you know, your thoughts on how, you know, the lower oil prices that we've seen over the past couple of couple of months will impact international air freight demand, especially if we see a period of sustained low fuel, fuel costs. Do you think that's gonna help drive increased demand for your higher yielding, you know, more time-sensitive services in the portfolio?

Dave Bronczek (President and CEO of FedEx Express)

This is Dave. Absolutely, we do believe that's correct. We've positioned our global powerful network around the world with exactly the right infrastructure. We have the triple sevens, of course, that are now flying nonstop out of Asia, Pacific, and around the world. So we think that the decrease in oil is gonna have an increase in customers' demand for our higher-yielding products.

Operator (participant)

Thank you. Our next question comes from Art Hatfield with Raymond James.

Art Hatfield (Senior Equity Analyst)

Hey, morning, everyone. Bill, hey, good luck in your retirement. Just real back to FedEx Ground margins, and Alan, I think you commented that, November, while strong, didn't live up to kind of what you thought it would. Is that a function of customers just didn't hit the level of demand they thought, or is it a timing issue where some of that actually got pushed in December?

Henry Maier (President and CEO of FedEx Ground)

Yeah, Art, it's Henry Maier. I guess I would answer that both. November volumes were softer than our expectations, but you need to know that this is not at all unusual in this new e-commerce economy. Over the last several peak seasons, we have regularly observed situations where volume hasn't always come where we expected it or come when we expected it, but one thing has been certain: it always comes.

Fred Smith (Chairman)

This is Fred Smith speaking. Let me put a little color on an issue that I think has been underreported, and I suspect you're gonna hear a lot more about in January, when the retailers start putting their results out. The slowdown in the West Coast ports has been a much bigger deal than people think, and a tremendous amount of inventory was simply not put through the ports in the timeframe that the retailers had expected. This, in turn, has led to a lot of not in stocks.

One of the things that Henry has had to deal with that's extremely important is that because these delays at the port, at the West Coast ports and the East Coast ports, because a lot of people saw this coming and diverted traffic into the East Coast ports, we received a lot of traffic on the two coasts, which normally we would have anticipated getting from distribution centers in the middle of the country. So we've had to move power where the customers needed it. But that has slowed down a lot of the retailing activity in late November and early December and led to a lot of not in stock.

I suspect that you'll see a lot of purchases of gift cards in lieu of merchandise, and in January, you'll see some of that traffic moving in the truckload sector and elsewhere into the retailing, brick-and-mortar, system. The second thing that's very different this year, and it's something that you should pay attention to, is a lot of traditional retailers have gotten very, very good at e-commerce, in terms of their marketing and their apps and their ability to sell things online.

What they haven't gotten as good at, in some cases, is processing those orders and getting them out the door. And so some of the major retailers that we deal with, particularly in Henry's organization, were telling us in November that they were seeing orders, but the orders were backlogged. We are seeing a great deal of that traffic now moving into the December time frame. But I do think you'll see when the retailers report their results, that the West Coast port issue has been a bigger deal for the peak season than most people have thought it was to date.

Operator (participant)

Thank you. Our next question comes from Donald Broughton with Avondale Partners.

Donald Broughton (Managing Director)

Yes, gentlemen, if you could, one of the big experiences between what we were looking for and what you reported was certainly in the maintenance line. You said it was timing of aircraft maintenance. Can you kind of give us a little bit more color, a little bit more understanding, so for no other reason than we can model it better in the future?

Alan Graf (EVP and CFO)

Yeah. Hey, Donald, it's Alan. Dave can add to this. It's timing has to do largely with MD-10s and to some extent, MD-11 engine maintenance. It'll probably continue in the third quarter, then it'll start to mitigate, and we should see much more normal comparisons going forward from there. It was expected. It was in our guidance. We needed to do it, particularly on the MD-10s, to keep the reliability up, and that's why we're getting 767s.

Fred Smith (Chairman)

Well, Alan said it, and I think it's in the press release. Our fourth quarter aircraft maintenance costs subside, so that's probably what you're looking for, and it's in the written report. Even with the 16% increase in aircraft maintenance expense this quarter, our all-up expense for the quarter was 1%.

Operator (participant)

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

Scott Group (Senior Analyst)

Hey, thanks. Morning, guys. I'm not sure if I missed it. Can you share with us or are you going to disclose how much you paid for GENCO and how you're going to finance it? And then just on that maintenance question from earlier, what's the total aircraft maintenance up this year in the guidance? And does it go down next year, or does it just kind of flatten out next year and not increase further?

Alan Graf (EVP and CFO)

We're not going to disclose what we paid for GENCO at this point. We will down the road. And I'll let Dave handle the maintenance thing. And, oh, by the way, Scott, I know you were disappointed in our results, but I sure I'm not.

Dave Bronczek (President and CEO of FedEx Express)

Yeah. Hi, this is Dave. Our aircraft maintenance is flat year over year, and it subsides. The costs still, of course, continue, but they continue at a lower level.

Fred Smith (Chairman)

This is Fred Smith. Let me make one other point here, which is essentially, you understand, in Dave Bronczek's results, his expenses are only up 1%, but the Express unit also had a wage increase effective on the first of October, as we did corporate-wide, and in the United States network. And so his productivity was-- is absorbing a lot of expense increase in addition to benefiting from the macro profit improvement program.

Operator (participant)

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

Allison Landry (Senior Equity Research Analyst)

Good morning. Thanks for taking my question. So you mentioned earlier that an improved consumer should help some of the premium products. So I was just wondering if that's actually dialed into your guidance.

Fred Smith (Chairman)

This is Fred Smith speaking, and I'll let Mike put some color on this. I think, as he mentioned in our macroeconomic outlook, we're looking for a 3.1%? That's correct[crosstalk] Global 3. 3.1% U.S. 2015 GDP increase and a 3% global increase. You know, I, I think that, a lot of the euphoria that people are seeing with the lower fuel prices at the pump for consumers and things of that nature, will, to some degree, be offset by the reduction in CapEx and the oil and gas exploration and production sector.

I mean, the facts of the matter are that capital expenditures are a huge driver of U.S. prosperity and income, and you see that over on the consumer side just as well as you do lower gasoline prices. So, I think it's not quite the universal good that some people think it may be. Now, having said that, consumer confidence and so forth is a very big deal in our economy, which is 70% consumption. But just be a little bit careful there about assuming that the economy is off to the races with all of the pressure that's going to be on this oil and gas sector, which has been a huge part of the increase in GDP over the last several years. Mike?

Mike Glenn (President and CEO of FedEx Services)

Yeah, let me make a comment and kind of give you an analogy. One of the strategic moves that we made in the FedEx Freight network was to adjust the network so that whether we grew in priority or economy freight, we benefited from that. And a lot of our strategy in the international line haul network and providing the flexibility in the network has been designed around that same philosophy. So, while we do expect to see some lift, those things tend not to happen as fast as you, you might think. And so the network design we have in place allows us to flex based upon demand, so we're quite comfortable with where we sit at this point.

Operator (participant)

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

William Greene (Managing Director)

Hi, good morning. Mike, I wanted to ask your thoughts on some actions the post office has been taking, so trying to compete a bit more in B2C with some price actions, but also in the holidays here, delivering seven days a week. It seems to me that you guys probably compete very vigorously every day, but competing against the government doesn't seem quite fair either. So, like, what's your view on this? Are they a meaningful competitor in that market, or is it not really something you come across?

Mike Glenn (President and CEO of FedEx Services)

Well, of course, a lot of the traffic that moves through the Postal Service actually moves on our line haul network, so we see that day in and day out, and we have a very good relationship with the Postal Service. I'm assuming you're talking about some of the pricing changes they've made to address really the low weight segment, in order to take advantage of some e-commerce capabilities. I think the thing you need to keep in mind is their network is very different than ours. They tend to operate smaller vehicles that really kind of cube out pretty quickly as opposed to the network we have in place.

The lighter weight e-commerce traffic that we target, we try to push through SmartPost, which moves actually the final mile, in most cases, through the Postal Service for final delivery. So the heavier weight traffic, which is more in tune with, our sweet spot in the home delivery network and the express network, is actually not the traffic that they've targeted with their price decreases.

There are a lot of moving parts to that question. But, again, the Postal Service plays an important role in our value proposition by providing that last mile delivery. And you are seeing more consumers and e-tailers utilize SmartPost and direct injection models through the Postal Service because it facilitates free shipping, which is a key promotional tool. So we're seeing a lot of that in the e-commerce sector, and we're benefiting from a lot of that.

Operator (participant)

Thank you. Our next question comes from Tom Wadewitz with UBS.

Tom Wadewitz (Senior Equity Research Analyst)

Yes, good morning. So, Alan, I appreciate your your thoughts on fuel and providing some further explanation. I think there was another question on it as well. But I wondered if you could give us a number of comments on how you think, you know, if we stay at substantially lower fuel prices for a period of time, for more than a quarter or two, and also looking beyond the the two-month time lag impact, is there a benefit to profitability of Express from significantly lower fuel prices, perhaps some slippage on fuel surcharge or other ways that it comes through the P&L?

Because I think there is a sense that Express is, you know, fuel intensive and fuel sensitive, or is that just the wrong way to look at it, and you don't really get a margin or, you know, an operating income benefit out a couple of quarters from, you know, fuel prices, which, you know, are pretty dramatically down? Thank you.

Alan Graf (EVP and CFO)

Tom, thanks for the question. I'll start, and then I'll let Mike add some more color. You know, everything else being equal, lower fuel prices helps the elasticity at Express by having a lower surcharge. And there is a trade-up factor, just as there's a trade-down factor when prices are extremely high. But I did qualify that by saying everything else being equal because lower oil prices seem to be roiling some of the markets at the moment, and people are still trying to figure out what it means, particularly if you're in the oil business,

And what it means for capital expenditures for the oil and exploration companies, and how that impacts the economy and everything else. So there's a big impact all around, and of course, we provide service for their machine parts and other things that they need to get on a just-in-time basis to where they need to be. So there's so many things that impact this, that it's hard to just nail that Jell-O to the wall, but maybe Mike can add to that.

Mike Glenn (President and CEO of FedEx Services)

Yeah, Tom, when you get right down to it, the fuel surcharges at all of our operating companies are, are really a pricing tool indexed to the price of fuel. And of course, we review those on a regular basis and make adjustments based upon market conditions. But if you take Express and Ground, for example, the changes that we're gonna be making to the design are largely, or at least in part, designed to reduce the volatility of the surcharges for our customers. It's also important to note that how customers view surcharges differs in the parcel segment versus the freight. In the parcel segments, customers tend to look at the fuel surcharge as part of the overall rate the customer pays.

In the freight segment, it's more put aside, and the customer is more focused on the base rate and not as much on the fuel surcharge. So, it really does differ by segment. And, of course, as I mentioned, what we try to do is to review these on an annual basis and make adjustments based upon market conditions.

Operator (participant)

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

Brandon Oglenski (Director and Senior Equity Analyst)

Well, good morning, everyone. Alan, just a quick comment. Thank you again, like Tom said, for walking through the fuel surcharge. I think a few analysts might have gotten carried away with it here, including this one. But longer term, Fred, you know, the acquisition of GENCO here, does this signal a strategic shift for the company? I mean, are you guys gonna be looking more at the non-asset part of the business here as you expand your portfolio, you know, as opposed to the acquisitions we've seen in the past at Express, more internationally focused, buying out some smaller couriers in Europe and some of the emerging markets?

Fred Smith (Chairman)

Well, you know, Alan and I both have commented on our criteria for acquisitions, and they are threefold. First, there has to be a compelling strategic rationale, and that was certainly the case in GENCO, as I mentioned a few moments ago. We've identified for several years in our Strategic Management Committee and at the board level, the gaps in our portfolio that we would like to fill either on a build or buy basis. So if an acquisition comes on the horizon, we are certainly interested in that. And I would say that clearly, we like non-asset intensive parts of our portfolio because they tend to add to our overall returns on invested capital, as well as broadening our portfolio. And, you know, we are selling a portfolio.

We've got some wonderful advertising at the moment that makes that point very clearly. So all things being equal, of course, we would rather have things that are non-asset intensive than things that are asset intensive. That's basically what most of Wall Street thinks about every day, and to some degree, too much so, in my opinion, to the detriment of job creation and increased income for our citizens.

The second criteria that we have is there a good fit in terms of the culture and the technologies? Because most acquisitions founder on one of those two bases. And then the third thing, which my partner is sitting right beside me here, feels very strongly about, is you can't overpay. I mean, why go buy something which destroys shareholder value? So that's our criteria for investment. We certainly like non-asset intensive parts of our portfolio because they're complementary, but it's basically those three criteria. Strategic fit, culture, and technology makes sense. As we said before, that's the case at GENCO in a very big way. And third, the numbers have to make sense.

Operator (participant)

Thank you. Our next question comes from David Ross with Stifel.

David Ross (Group Head and Managing Director)

Yes, good morning, everyone. Maybe a question for Bill and Mike. Now that you've moved or are moving in the new year to all, you know, dim weight or dimensional-based pricing in ground, any thoughts on shifting to dim pricing in FedEx Freight, and any barriers to that potential switch?

Bill Logue (President and CEO of FedEx Freight)

Hey, David, this is Bill. I'll jump in first. Yeah, we're rolling out right now some of the dimensional overhead machines to kind of take a good look at it. Again, we look at it in kind of three ways. One, you can capture some instantaneous revenue and get accurate dims on existing shipments, but also it's a very good tool for us to continue to improve our pricing knowledge of what's actually moving through our system. So that's kind of where we're going there. I think as far as dim technology, again, we have opportunities to currently with some customers to use some dim pricing. But again, long term, that is a key objective of ours to keep on moving both our business that way.

And again, I think as we try to become freight and FedEx becomes a significant part of our business, we want to make sure that we're also able to give customers the parcel side of the business the same type of dealings that they deal with every day on the parcel side. So we're working hard at it, and Mike's marketing team spends a lot of time kind of working this issue and leading it for us.

Mike Glenn (President and CEO of FedEx Services)

Yeah, I'll just add, the density-based pricing is something we already offer to select customers and will continue to do so. And we find it offers a more simplified alternative to the classic classification-based system, which is extremely complex and quite frankly, outdated. So, I think it would benefit the industry as a whole to move to a more simplified pricing structure and get away from the classification system, but obviously, the market will dictate that.

Operator (participant)

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

Thomas Kim (Senior Industrials Equity Research Analyst)

Good morning. Alan, can I ask you a question with regard to your FX sensitivities within Express? And then also, to what extent does lower fuel impact your purchased transport costs? Thank you.

Alan Graf (EVP and CFO)

Well, certainly, purchased transportation is a high and growing part of our cost structure, particularly around peak. So the lower fuel is, the lower those costs are, which is, you know, an indirect, not through the fuel line, but an indirect benefit to us. I think it's very, very important. What was your first question again?

Thomas Kim (Senior Industrials Equity Research Analyst)

FX sensitivities, please.

Alan Graf (EVP and CFO)

Okay. Well, remember that, you know, since we're not a big manufacturing company, we can adjust our pricing very quickly based on dramatic changes in foreign exchange. We expect the dollar to strengthen, as does everybody else. And of course, in areas where we're profitable, that'll be a very good thing for us. But it's really got a very minimal impact to our overall P&L because the way that we're able to manage the pricing side of the house, which has been very beneficial to us.

Dave Bronczek (President and CEO of FedEx Express)

Yeah, this is Dave Bronczek. I just wanted to go back and make the point again on our expenses and our costs. Our aircraft maintenance costs were actually less in Q2 than they were in Q1.

Operator (participant)

Thank you. Our next question comes from Kevin Sterling with BB&T Capital Markets.

Kevin Sterling (Managing Director and Equity Research Analyst)

Thank you, and good morning, Bill. I hope you enjoy retirement. I know, Mr. Smith, you had touched on the West Coast port congestion. Maybe I can take it a little bit, a little step further. How much of a negative impact, if it did have a negative impact, on your NVOCC business within FedEx Trade Networks and maybe some of that freight, did you see a shifting of some of that ocean freight possibly to the air side within FedEx Trade Networks? Thank you.

Fred Smith (Chairman)

Well, I think the reality is that the container lines and FedEx Trade Networks and the other NVOCCs, as you mentioned, you know, found that the die was cast by the time it became clear that the port issues were gonna be a big problem. If you followed the negotiations out there, it was really only obvious in November that the slowdown was taking place. I don't know the details of that, but certainly certain people in the shipping industry have said this work to rule activity in the ports is the cause of traffic taking a couple of weeks to get through the ports in what should have been, you know, two to four days.

So that's a very big deal in terms of the inventory decisions that were made last spring and the shipping plans that were put in place last summer. So I don't think you should think about the fact that all of a sudden this slowdown happened and everything moved by air, because what drives the movement of goods by air more than any other thing is the value per pound. And there may be some closing samples that go air express or move by air, but the vast majority of apparel is never gonna move by air simply because the price point of the goods won't justify the much higher cost of moving by air. So a lot of people get that mixed up. It's only on the margin that surface to air makes sense.

Now, longer term, as Alan said, the elasticities are very important there because markets are logical. The biggest effect, I think, as I mentioned a moment ago, on the peak season, is that there are a lot of not in stock situations among all the retailers. We have a lot of expertise and within the company and even on our board of directors in this sector, and I think you're gonna hear this from a lot of the retailers when they report their results. So I hope that clarifies some of this thing. I don't want people to go away from this and think there's a systemic shift from sea to air because of a short-term issue here. That just won't happen.

Operator (participant)

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

Jeff Kauffman (Director of Transport Logistics and Machinery)

Thank you very much, and congratulations on the quarter, Bill. Best of luck in retirement. Let me ask a kind of a broader, simpler question. Fuel is down, and I think you've said a number of times that your view is that will be good for volume on the consumer side. Your economic outlook sounds a little bolder. You've announced two pretty decent acquisitions here. Why is there no improvement in the forward outlook?

Alan Graf (EVP and CFO)

Hey, Jeff, this is Alan. Well, I think, again, there was probably a little overestimation about the benefit from fuel for us for the year.

Jeff Kauffman (Director of Transport Logistics and Machinery)

Mm-hmm.

Alan Graf (EVP and CFO)

So, we don't see that. We think it's still gonna be slight, so that's what's in the guidance. But I haven't given you FY 2016 yet, so that's coming pretty soon.

Jeff Kauffman (Director of Transport Logistics and Machinery)

Okay. And the acquisitions would take effect more in FY 2016 than in FY 2015?

Alan Graf (EVP and CFO)

Oh, for sure.

Jeff Kauffman (Director of Transport Logistics and Machinery)

Oh.

Operator (participant)

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

David Vernon (Managing Director and Senior Analyst)

Thanks for taking the question. Are you guys... With the, with the international market being a little stronger in the last few months, from the IATA data and also a little bit we're hearing sort of anecdotally on expediting, are you seeing any sign that the capacity situation in the international air freight market is getting tighter, that rates are getting a little bit better? Or are we seeing just a lot of the excess capacity that may have been put down on the ground come up, limiting any positive impact on the rate environment?

Dave Bronczek (President and CEO of FedEx Express)

Yeah, David, this is Dave Bronczek. It's, it's relatively flat still. I mean, you still have a lot of excess capacity in the underbellies of a lot of the passenger airlines and so forth. So I would say it, that right at the moment, to Fred's earlier point, because of the port issues, we've seen some increases there on rates and on freight, but generally speaking, it's flat.

Operator (participant)

Currently, I have no further questions. Thank you. I'd like to turn the conference back over to our presenters for any concluding or additional remarks.

Mickey Foster (VP of Investor Relations)

Thank you for your participation in FedEx Corporation's second 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. Happy holidays.

Operator (participant)

This does conclude today's conference. We thank you for your participation.