FedEx - Q2 2016

Transcript

Operator (participant)

Good day everyone and welcome to the FedEx Corporation second quarter fiscal year 2016 earnings conference call. Today's call is being recorded. At this time, I will 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 afternoon and welcome to FedEx Corporation's second quarter earnings conference call, the second quarter earnings release and our 2016 page statbook on our website at fedex.com. This call is being broadcast from our website and the replay and podcast will be available for about one year. We have moved our call to the afternoon to allow more time for us to review our results and answer your strategic questions. Written questions are welcome via email or social media. When you send your email, please include your full name and contact information with your question. Send it to our ir.fedex.com address. If you would like to send a question via social media, go to StockTwits.com and include $FDX in your message. Preference will be given to inquiries of a long-term strategic nature. We'll first take a couple of questions after the remarks from the conference call.

Then we'll answer questions that have been submitted via the Internet. I want to remind all listeners that FedEx Corporation desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act. Certain statements in this conference call may be considered forward-looking statements within the meaning of the Act. Such forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. For additional information on these factors, please refer to our press releases and filings with the SEC. To the extent we disclose any non-GAAP financial measures on this call, please refer to the Investor Relations portion of our website at fedex.com for a reconciliation of such measures to the most directly comparable GAAP measures.

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

Frederick Smith (Chairman)

Views on the quarter. Thank you, Mickey. Good afternoon and welcome to our discussion of results for the second quarter of fiscal 2016. FedEx Corporation posted solid earnings and a year-over-year EPS improvement of 19% excluding TNT integration costs and a legal settlement charge for FedEx Ground. We continue to increase margins, earnings per share, cash flows and returns on invested capital. These basic trends should continue well into the future, barring major events or macroeconomic factors. A record number of holiday shipments, fueled largely by the steady rise of e-commerce, are flowing through the FedEx global networks. Monday we picked up over 26 million packages globally. We greatly appreciate the dedication of more than 340,000 FedEx team members who are delivering the holidays to our customers around the world. Express service levels in particular have been outstanding.

While we have experienced extremely heavy ground volumes in the Northeast, our team members have risen to the challenge and the ground system is running as scheduled. Adherence to our people service profit philosophy and the FedEx strategy of compete collectively, operate independently and manage collaboratively are keys to our success. We will exceed the profit improvement program at FedEx Express this fiscal year and the aircraft fleet modernization program is paying off in a big way. It's no secret that e-commerce is changing the dynamics of the transportation industry and driving remarkable growth. We have strategic plans to ensure we will continue to benefit in the years ahead from this growth. For example, we're integrating ground and SmartPost facilities and line haul systems to realize incremental operating expense savings in the future.

Multiyear expansion of automated FedEx Ground facilities will allow continued profitable growth and provides the most flexible and fastest ground package system possible. We're also deploying new technology that will enable us to combine FedEx Ground and FedEx SmartPost packages going to common delivery addresses, which will significantly improve efficiency, productivity, and service. FedEx Freight is focused on improving margin trends in a weak industrial economy through better balance in volume and yield and higher productivity. Our recent offer to buy TNT Express, assuming it's approved, will quickly broaden our portfolio of solutions, particularly in Europe. Customers of both FedEx and TNT will benefit from our unmatched global network. Despite contraction of U.S. exports due to the high U.S. dollar and low world GDP and trade growth, the overall market for international door-to-door Express continues to increase, also driven by e-commerce.

A couple of developments in e-commerce are worth noting. First, oversized packages are increasing and, second, a number of e-commerce shippers continue to use extremely cube-inefficient packaging. Loaded density and over-the-road ground trailers is therefore declining because of these trends. In this regard, we are extremely disappointed that Congress did not approve the use of twin 33-foot trailers on the nation's highways versus the current 28-foot standard. 33s are already permitted in 18 states and we have safely driven them almost 1,500,000 miles in Florida alone. Drivers tell us they are more stable than the 28-foot trailers with similar handling and turning. Our industry estimates this change would one eliminate about 6.6 million trips annually and thereby improve safety due to fewer accidents per year. The 33s would materially reduce congestion.

Third, it would save over 200 million gallons of diesel and reduce carbon emissions by 4.4 billion pounds per year. With E-commerce exploding and U.S. automobile miles driven reaching a record high this year, 33-foot trailers would be of enormous benefit to our economy and significantly improve road safety. We'd like to welcome Chris Inglis to the FedEx Corporation board of directors. Chris retired in 2014 as the Deputy Director and Senior Civilian Leader of the National Security Agency. His cybersecurity and information technology expertise and significant leadership experience will be very valuable to FedEx regarding the vital issue of cybersecurity. The pending omnibus bill contains several very positive changes to the law regarding corporations and government agencies and we sincerely hope it passes. In conclusion, let me also remind you that this is the earnings call of FedEx Corporation.

We manage our portfolio of services to achieve enterprise results which does not always translate into each segment's individual earnings and margins. Now, Mike Glenn and Alan Graf will discuss our economic outlook and further details of second quarter earnings after which, as Mickey said, we'll take your questions. Mike?

Michael Glenn (President and CEO)

Thanks Fred. I'll open with our economic update and outlook and then I'll discuss performance and business conditions in each segment including revenue, volume and yield, and provide some commentary on pricing and broader industry trends that we're experiencing. But first I'd like to take this opportunity to acknowledge our team members around the world who are delivering the holidays as we speak. As Fred noted, we've experienced record-breaking demand during this peak season, largely driven by the rapid growth of e-commerce. Our busiest days during peak have exceeded our forecast and more than double our average daily volume. It should be noted that our busiest days this year are approximately double what they were just about eight years ago. Our ability to flex our networks to meet this demand and while delivering service our customers experience requires many elements.

We continue to invest in new facilities, capacity expansion. We apply advanced engineering and use state-of-the-art sortation technology. We innovate the portfolio and certainly collaborate very closely with our customers. But more than anything else, our ability to meet this demand comes down to our people, including our drivers, couriers, pilots, package handlers and all team members that are hard at work around the world right now to deliver the holidays. Now let me make a few economic comments. We continue to see moderate growth in the global economy. Our U.S. GDP growth forecast is 2.4% as we end calendar 2015, which is slightly lower than our September 2.5% growth outlook. And our forecast for calendar 2016 is 2.6%, which is led by gains in consumer spending.

In the near term, we expect industrial production growth of 1.5% in calendar 2015, which is 40 basis points lower than our September outlook. We have a forecast for 1.9% next year, which is consistent with our September forecast. Energy investment, the strong dollar and an inventory correction are restraining growth in the sector. Our global GDP growth forecast is 2.5% for calendar 2015 and 2.8% for calendar 2016, which represents no change from our prior outlook. Now I'll review our revenue volume and yield trends by segment. In the express segment, revenue decreased 6% as lower fuel surcharges and unfavorable currency exchange rates were more than offset base yield growth. U.S. domestic package growth grew by 1% driven by growth in overnight packages, while U.S. domestic revenue per package or yield decreased 2% due to lower fuel surcharges.

If you exclude the impact of fuel year-over-year, Express domestic package yields grew by 3% primarily due to rates and discount product mix and weight per package. FedEx International Economy volume grew by 3% while FedEx International Priority volume declined by 5%. International Export revenue per package decreased 9% as lower fuel surcharges and unfavorable currency exchange rates more than offset higher base rates. If you exclude fuel, International Export Express package yield decreased 3% primarily driven by the negative impact of exchange rates which outweighed the positive impact of weight, rate, and discount changes. Excluding fuel and exchange rate impact, yields actually increased 1% in the ground segment. Revenue increased 32% in the quarter due to the inclusion of GENCO results. Higher ground volume and base rates and the recording of SmartPost revenues on a gross basis versus the previous net treatment.

FedEx Ground average daily volume grew 9% in the quarter, primarily driven by the growth in demand for residential deliveries related to e-commerce. FedEx Ground revenue per package increased 10% due to the recording of FedEx SmartPost revenues on a gross basis and higher base rates which include additional dimensional weight charges partially offset by lower fuel surcharges. Excluding the impact of fuel ground yield per package including SmartPost increased 13% year-over-year, primarily driven by changes in dimensional weight rating, extra services and SmartPost customer mix normalizing for the change in treatment of SmartPost revenue on a gross basis. Ground yields excluding the impact of fuel increased 3.9%. FedEx Freight revenue declined 2% and shipments increased 1%, which is directly related to the lower levels of industrial production. We've also seen some heavier weight shipments move back to truckload as capacity has eased.

LTL revenue per shipment declined 3% due to lower fuel surcharges, partially offset by higher base rates. Excluding the impact of fuel, yield per shipment increased 2% year-over-year at FedEx Freight, which was primarily driven by shipment class, rate, and discount. As we announced in September, we will be raising rates at FedEx Express, Ground, and Freight by an average of 4.9% on January 4, 2016. In addition to the rate changes, FedEx also recently increased surcharges for unauthorized packages in the FedEx Ground network. We've seen significant shifts in demand across our portfolio, including higher demand for residential deliveries due to e-commerce growth. We've rapidly responded to these shifts, both through increased investments in capacity, expansion of our portfolio, and pricing decisions across the portfolio.

The rise in residential deliveries brings with it operational considerations including the number of increased stops, a higher use of fuel as a result of the increased stops, and evolving package and weight dimensions. For example, packages classified as oversized account for almost 10% of Ground Home Delivery packages during peak season. This is a primary reason why we increased the surcharge on unauthorized packages in November and we'll be increasing the surcharge on oversized packages in January. As we conduct our post peak season analysis, we'll factor all these considerations into future pricing decisions. As I mentioned earlier, we're experiencing a record breaking peak season with strong demand across the portfolio, especially for residential deliveries within the ground network. Strong customer collaboration is absolutely critical in preparing for peak as it enables us to anticipate surges in volume and position resources appropriately to meet the customer's needs.

We've experienced heavy demand for FedEx Ground, particularly in the Northeast, as Fred noted, but our dedicated team members are working hard to deliver the holidays. Demand in our industry is rapidly evolving and we have continued to make changes to our service portfolio and adjusted our pricing strategies to meet customer needs and generate profitable growth around the world. Now I'll turn it over to Alan Graf.

Alan B. Graf (EVP and CFO)

Thank you Mike. Good afternoon and happy holidays everyone. We had an outstanding quarter and we expect our solid earnings growth to continue in the second half of fiscal 2016. We reaffirm our adjusted guidance for the year of $10.40-$10.90 per share. Four highlights stand out to me. First, our adjusted EPS was up 19% for the second quarter. Second, adjusted operating margin for the quarter was 9.6%. Third, our FY2016 guidance reflects nearly 20% growth at its midpoint and fourth, cash flows from operating activities increased $300 million or 14% for the first half of FY2016. I'm very proud of the entire FedEx team for its impressive efforts which are continuing during this record peak season.

Quarterly results improved largely due to higher base rates at Express and Ground, continued strong growth of e-commerce and positive impacts from the Profit Improvement Program that we announced in October of 2012 and is probably ahead of schedule at this point. These positive factors were partially offset by lower operating results at FedEx Freight primarily due to salaries and employee benefits expense significantly outpacing lower than anticipated volume growth and a modest negative net impact of fuel. There were two expense adjustments this quarter within eliminations, corporate, and other expense. First, expenses related to the settlement of independent contractor litigation matters of $25 million net of tax or $0.09 per diluted share. Also, expenses related to our pending acquisition of TNT Express of $12 million net of tax or $0.04 per diluted share. TNT acquisition will transform FedEx's European offerings and accelerate global growth.

We expect the acquisition will be completed in the first half of calendar 2016. Turning now to Express, another stellar quarter. Operating margin grew to 9.4% which is the best margin for Express in nearly nine years. Operating income increased 26% despite a revenue decline of 6%, while Express fuel expense decreased 43% in the quarter due to lower fuel prices. Fuel had a slight negative net impact to earnings versus last year. The negative net impact of fuel was a result of lower fuel surcharge revenue year over year, primarily and partially offset by lower fuel prices during the quarter. Currency fluctuations have little net impact on our P&L at Express, but can drive significant changes to revenue and expense. In addition, impacts to our P and L are more influenced by some currencies than others.

Recent strength in the U.S. dollar against certain currencies has caused lower revenue expenses for FedEx Express as well as a shift in trade patterns as U.S. imports have increased and exports have declined. A portion of our non-U.S. originating revenue, particularly from large multinational customers, is paid in U.S. dollars and therefore is not subject to currency fluctuations. This helps our international revenue and expense denominated in foreign currencies to be more balanced, causing little net impact on our P&L from currency fluctuations. That will change once we acquire TNT and we will update you on what the impact is at that point. In spite of weakening trends in global trade, Express is realizing benefits from its profit improvement plan.

As I mentioned before, this includes strong productivity gains, a right-sized workforce, efficient and reliable assets due to the fleet modernization program and improved base yields. These structural improvements allow us to take advantage of the growing e-commerce market and to succeed under current global economic conditions. Express remains focused on ensuring the right products are in the right network and is looking for more opportunities to improve profit by using purchased transportation on a lane-by-lane basis where it meets our service level requirements and add shareholder value. The significant network improvements we are making enable us to profitably handle growth around the globe and quickly address any lane imbalances due to shifting trade patterns. Looking at Ground, FedEx Ground posted healthy results as a result of e-commerce growth, pricing actions and growth in market share.

Operating income was up 13% due to higher base rates and volume. This is the financial metric that we are most focused on at Ground. As we expected, operating margin was affected by the recording of FedEx SmartPost revenues on a gross basis and the inclusion of GENCO results. Together, those items reduced the operating margin year-over-year by 2.1 percentage points for the quarter. GENCO business itself is very good, point by definition. However, it will impact Ground's margins because of Ground's much higher overall margins. This is no surprise to us. The GENCO acquisition complements and differentiates the FedEx value proposition and is central to our e-commerce strategy. Opportunities from GENCO will help grow our core transportation business, especially reverse logistics and leverage existing customer relationships to open doors for both companies.

Ground's long-term strategy is focused on sustainable revenue, earnings, and cash flow growth. In addition to GENCO, here are five ways Ground prepares for the long game. First is automation. We are making significant investments to add additional automated hub capacity and ensure many new stations are also fully automated, providing significant operational flexibility and capacity particularly during sustained high volume and keeping FedEx ahead of the competition. Second is SmartPost integration as one network, Ground is able to maximize the use of facilities and linehaul assets to save operating expense and moving SmartPost packages onto a home delivery truck that is already going to a residence is significantly less costly than paying postage for the USPS to deliver the package over the next several years. As we combine packages that are destined to the same delivery address, we will further increase our efficiency and profitability.

Operator (participant)

Good day everyone and welcome to the FedEx Corporation second quarter fiscal year 2016 earnings conference call. Today's call is being recorded. At this time, I will 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 afternoon and welcome to FedEx Corporation's second quarter earnings conference call, the second quarter earnings release and our 2016 page statbook on our website at fedex.com. This call is being broadcast from our website and the replay and podcast will be available for about one year. We have moved our call to the afternoon to allow more time for us to review our results and answer your strategic questions. Written questions are welcome via email or social media. When you send your email, please include your full name and contact information with your question. Send it to our ir.fedex.com address. If you would like to send a question via social media, go to StockTwits.com and include $FDX in your message. Preference will be given to inquiries of a long-term strategic nature. We'll first take a couple of questions after the remarks from the conference call.

Then we'll answer questions that have been submitted via the Internet. I want to remind all listeners that FedEx Corporation desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act. Certain statements in this conference call may be considered forward-looking statements within the meaning of the Act. Such forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. For additional information on these factors, please refer to our press releases and filings with the SEC. To the extent we disclose any non-GAAP financial measures on this call, please refer to the Investor Relations portion of our website at fedex.com for a reconciliation of such measures to the most directly comparable GAAP measures.

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

Frederick Smith (Chairman)

Views on the quarter. Thank you, Mickey. Good afternoon and welcome to our discussion of results for the second quarter of fiscal 2016. FedEx Corporation posted solid earnings and a year-over-year EPS improvement of 19% excluding TNT integration costs and a legal settlement charge for FedEx Ground. We continue to increase margins, earnings per share, cash flows and returns on invested capital. These basic trends should continue well into the future, barring major events or macroeconomic factors. A record number of holiday shipments, fueled largely by the steady rise of e-commerce, are flowing through the FedEx global networks. Monday we picked up over 26 million packages globally. We greatly appreciate the dedication of more than 340,000 FedEx team members who are delivering the holidays to our customers around the world. Express service levels in particular have been outstanding.

While we have experienced extremely heavy ground volumes in the Northeast, our team members have risen to the challenge and the ground system is running as scheduled. Adherence to our people service profit philosophy and the FedEx strategy of compete collectively, operate independently and manage collaboratively are keys to our success. We will exceed the profit improvement program at FedEx Express this fiscal year and the aircraft fleet modernization program is paying off in a big way. It's no secret that e-commerce is changing the dynamics of the transportation industry and driving remarkable growth. We have strategic plans to ensure we will continue to benefit in the years ahead from this growth. For example, we're integrating ground and SmartPost facilities and line haul systems to realize incremental operating expense savings in the future.

Multiyear expansion of automated FedEx Ground facilities will allow continued profitable growth and provides the most flexible and fastest ground package system possible. We're also deploying new technology that will enable us to combine FedEx Ground and FedEx SmartPost packages going to common delivery addresses, which will significantly improve efficiency, productivity, and service. FedEx Freight is focused on improving margin trends in a weak industrial economy through better balance in volume and yield and higher productivity. Our recent offer to buy TNT Express, assuming it's approved, will quickly broaden our portfolio of solutions, particularly in Europe. Customers of both FedEx and TNT will benefit from our unmatched global network. Despite contraction of U.S. exports due to the high U.S. dollar and low world GDP and trade growth, the overall market for international door-to-door Express continues to increase, also driven by e-commerce.

A couple of developments in e-commerce are worth noting. First, oversized packages are increasing and, second, a number of e-commerce shippers continue to use extremely cube-inefficient packaging. Loaded density and over-the-road ground trailers is therefore declining because of these trends. In this regard, we are extremely disappointed that Congress did not approve the use of twin 33-foot trailers on the nation's highways versus the current 28-foot standard. 33s are already permitted in 18 states and we have safely driven them almost 1,500,000 miles in Florida alone. Drivers tell us they are more stable than the 28-foot trailers with similar handling and turning. Our industry estimates this change would one eliminate about 6.6 million trips annually and thereby improve safety due to fewer accidents per year. The 33s would materially reduce congestion.

Third, it would save over 200 million gallons of diesel and reduce carbon emissions by 4.4 billion pounds per year. With E-commerce exploding and U.S. automobile miles driven reaching a record high this year, 33-foot trailers would be of enormous benefit to our economy and significantly improve road safety. We'd like to welcome Chris Inglis to the FedEx Corporation board of directors. Chris retired in 2014 as the Deputy Director and Senior Civilian Leader of the National Security Agency. His cybersecurity and information technology expertise and significant leadership experience will be very valuable to FedEx regarding the vital issue of cybersecurity. The pending omnibus bill contains several very positive changes to the law regarding corporations and government agencies and we sincerely hope it passes. In conclusion, let me also remind you that this is the earnings call of FedEx Corporation.

We manage our portfolio of services to achieve enterprise results which does not always translate into each segment's individual earnings and margins. Now, Mike Glenn and Alan Graf will discuss our economic outlook and further details of second quarter earnings after which, as Mickey said, we'll take your questions. Mike?

Michael Glenn (President and CEO)

Thanks Fred. I'll open with our economic update and outlook and then I'll discuss performance and business conditions in each segment including revenue, volume and yield, and provide some commentary on pricing and broader industry trends that we're experiencing. But first I'd like to take this opportunity to acknowledge our team members around the world who are delivering the holidays as we speak. As Fred noted, we've experienced record-breaking demand during this peak season, largely driven by the rapid growth of e-commerce. Our busiest days during peak have exceeded our forecast and more than double our average daily volume. It should be noted that our busiest days this year are approximately double what they were just about eight years ago. Our ability to flex our networks to meet this demand and while delivering service our customers experience requires many elements.

We continue to invest in new facilities, capacity expansion. We apply advanced engineering and use state-of-the-art sortation technology. We innovate the portfolio and certainly collaborate very closely with our customers. But more than anything else, our ability to meet this demand comes down to our people, including our drivers, couriers, pilots, package handlers and all team members that are hard at work around the world right now to deliver the holidays. Now let me make a few economic comments. We continue to see moderate growth in the global economy. Our U.S. GDP growth forecast is 2.4% as we end calendar 2015, which is slightly lower than our September 2.5% growth outlook. And our forecast for calendar 2016 is 2.6%, which is led by gains in consumer spending.

In the near term, we expect industrial production growth of 1.5% in calendar 2015, which is 40 basis points lower than our September outlook. We have a forecast for 1.9% next year, which is consistent with our September forecast. Energy investment, the strong dollar and an inventory correction are restraining growth in the sector. Our global GDP growth forecast is 2.5% for calendar 2015 and 2.8% for calendar 2016, which represents no change from our prior outlook. Now I'll review our revenue volume and yield trends by segment. In the express segment, revenue decreased 6% as lower fuel surcharges and unfavorable currency exchange rates were more than offset base yield growth. U.S. domestic package growth grew by 1% driven by growth in overnight packages, while U.S. domestic revenue per package or yield decreased 2% due to lower fuel surcharges.

If you exclude the impact of fuel year-over-year, Express domestic package yields grew by 3% primarily due to rates and discount product mix and weight per package. FedEx International Economy volume grew by 3% while FedEx International Priority volume declined by 5%. International Export revenue per package decreased 9% as lower fuel surcharges and unfavorable currency exchange rates more than offset higher base rates. If you exclude fuel, International export Express package yield decreased 3% primarily driven by the negative impact of exchange rates which outweighed the positive impact of weight, rate, and discount changes. Excluding fuel and exchange rate impact, yields actually increased 1% in the ground segment. Revenue increased 32% in the quarter due to the inclusion of GENCO results. Higher ground volume and base rates and the recording of SmartPost revenues on a gross basis versus the previous net treatment.

FedEx Ground average daily volume grew 9% in the quarter, primarily driven by the growth in demand for residential deliveries related to e-commerce. FedEx Ground revenue per package increased 10% due to the recording of FedEx SmartPost revenues on a gross basis and higher base rates which include additional dimensional weight charges partially offset by lower fuel surcharges. Excluding the impact of fuel ground yield per package including SmartPost increased 13% year-over-year, primarily driven by changes in dimensional weight rating, extra services and SmartPost customer mix normalizing for the change in treatment of SmartPost revenue on a gross basis. Ground yields excluding the impact of fuel increased 3.9%. FedEx Freight revenue declined 2% and shipments increased 1%, which is directly related to the lower levels of industrial production. We've also seen some heavier weight shipments move back to truckload as capacity has eased.

LTL revenue per shipment declined 3% due to lower fuel surcharges, partially offset by higher base rates. Excluding the impact of fuel, yield per shipment increased 2% year-over-year at FedEx Freight, which was primarily driven by shipment class, rate, and discount. As we announced in September, we will be raising rates at FedEx Express, Ground, and Freight by an average of 4.9% on January 4, 2016. In addition to the rate changes, FedEx also recently increased surcharges for unauthorized packages in the FedEx Ground network. We've seen significant shifts in demand across our portfolio, including higher demand for residential deliveries due to e-commerce growth. We've rapidly responded to these shifts, both through increased investments in capacity, expansion of our portfolio, and pricing decisions across the portfolio.

The rise in residential deliveries brings with it operational considerations including the number of increased stops, a higher use of fuel as a result of the increased stops, and evolving package and weight dimensions. For example, packages classified as oversized account for almost 10% of ground home delivery packages during peak season. This is a primary reason why we increased the surcharge on unauthorized packages in November and we'll be increasing the surcharge on oversized packages in January. As we conduct our post peak season analysis, we'll factor all these considerations into future pricing decisions. As I mentioned earlier, we're experiencing a record breaking peak season with strong demand across the portfolio, especially for residential deliveries within the ground network. Strong customer collaboration is absolutely critical in preparing for peak as it enables us to anticipate surges in volume and position resources appropriately to meet the customer's needs.

We've experienced heavy demand for FedEx Ground, particularly in the Northeast, as Fred noted, but our dedicated team members are working hard to deliver the holidays. Demand in our industry is rapidly evolving and we have continued to make changes to our service portfolio and adjusted our pricing strategies to meet customer needs and generate profitable growth around the world. Now I'll turn it over to Alan Graf.

Alan B. Graf (EVP and CFO)

Thank you Mike. Good afternoon and happy holidays everyone. We had an outstanding quarter and we expect our solid earnings growth to continue in the second half of fiscal 2016. We reaffirm our adjusted guidance for the year of $10.40-$10.90 per share. Four highlights stand out to me. First, our adjusted EPS was up 19% for the second quarter. Second, adjusted operating margin for the quarter was 9.6%. Third, our FY2016 guidance reflects nearly 20% growth at its midpoint and fourth, cash flows from operating activities increased $300 million or 14% for the first half of FY2016. I'm very proud of the entire FedEx team for its impressive efforts which are continuing during this record peak season.

Quarterly results improved largely due to higher base rates at Express and Ground, continued strong growth of e-commerce and positive impacts from the Profit Improvement Program that we announced in October of 2012 and is probably ahead of schedule at this point. These positive factors were partially offset by lower operating results at FedEx Freight primarily due to salaries and employee benefits expense significantly outpacing lower than anticipated volume growth and a modest negative net impact of fuel. There were two expense adjustments this quarter within eliminations, corporate, and other expense. First, expenses related to the settlement of independent contractor litigation matters of $25 million net of tax or $0.09 per diluted share. Also, expenses related to our pending acquisition of TNT Express of $12 million net of tax or $0.04 per diluted share. TNT acquisition will transform FedEx's European offerings and accelerate global growth.

We expect the acquisition will be completed in the first half of calendar 2016. Turning now to Express, another stellar quarter. Operating margin grew to 9.4% which is the best margin for Express in nearly nine years. Operating income increased 26% despite a revenue decline of 6%, while Express fuel expense decreased 43% in the quarter due to lower fuel prices. Fuel had a slight negative net impact to earnings versus last year. The negative net impact of fuel was a result of lower fuel surcharge revenue year over year, primarily and partially offset by lower fuel prices during the quarter. Currency fluctuations have little net impact on our P&L at Express, but can drive significant changes to revenue and expense. In addition, impacts to our P and L are more influenced by some currencies than others.

Recent strength in the U.S. dollar against certain currencies has caused lower revenue expenses for FedEx Express as well as a shift in trade patterns as U.S. imports have increased and exports have declined. A portion of our non-U.S. originating revenue, particularly from large multinational customers, is paid in U.S. dollars and therefore is not subject to currency fluctuations. This helps our international revenue and expense denominated in foreign currencies to be more balanced, causing little net impact on our P&L from currency fluctuations. That will change once we acquire TNT and we will update you on what the impact is at that point. In spite of weakening trends in global trade, Express is realizing benefits from its profit improvement plan.

As I mentioned before, this includes strong productivity gains, a right-sized workforce, efficient and reliable assets due to the fleet modernization program and improved base yields. These structural improvements allow us to take advantage of the growing e-commerce market and to succeed under current global economic conditions. Express remains focused on ensuring the right products are in the right network and is looking for more opportunities to improve profit by using purchased transportation on a lane-by-lane basis where it meets our service level requirements and add shareholder value. The significant network improvements we are making enable us to profitably handle growth around the globe and quickly address any lane imbalances due to shifting trade patterns. Looking at Ground, FedEx Ground posted healthy results as a result of e-commerce growth, pricing actions and growth in market share.

Operating income was up 13% due to higher base rates and volume. This is the financial metric that we are most focused on at Ground. As we expected, operating margin was affected by the recording of FedEx SmartPost revenues on a gross basis and the inclusion of GENCO results. Together, those items reduced the operating margin year-over-year by 2.1 percentage points for the quarter. GENCO business itself is very good point by definition. However, it will impact Ground's margins because of Ground's much higher overall margins. This is no surprise to us. The GENCO acquisition complements and differentiates the FedEx value proposition and is central to our e-commerce strategy. Opportunities from GENCO will help grow our core transportation business, especially reverse logistics and leverage existing customer relationships to open doors for both companies.

Ground's long-term strategy is focused on sustainable revenue, earnings, and cash flow growth. In addition to GENCO, here are five ways Ground prepares for the long game. First is automation. We are making significant investments to add additional automated hub capacity and ensure many new stations are also fully automated, providing significant operational flexibility and capacity particularly during sustained high volume and keeping FedEx ahead of the competition. Second is SmartPost integration as one network, Ground is able to maximize the use of facilities and linehaul assets to save operating expense and moving SmartPost packages onto a home delivery truck that is already going to a residence is significantly less costly than paying postage for the USPS to deliver the package over the next several years. As we combine packages that are destined to the same delivery address, we will further increase our efficiency and profitability.

Third is Monday residential service. Online shopping is a 24/7 experience, so we began a pilot test in which we make weekend pickups at retail locations for Monday residential deliveries in a defined area. We may consider additional markets that, depending on the results of the test. Fourth is technology enhancements. This is a cornerstone of how we operate inside the FedEx portfolio. We continue to identify, test and implement new technology for our operations. Beyond automated sortation scanners, package photo imaging and GPS are a few examples. And fifth is pricing. As Mike discussed, adjustments to our dimension-based and oversized pricing help offset the increasing package sizes that reduce our cube efficiency and increase our line haul costs. The surcharges that went into effect last month apply to packages that exceed the length or weight limitations of the FedEx Ground network and are handled at our option.

These proactive steps help ensure that oversized packages accepted in our network are properly priced for the space they use. We expect Ground capital expense for FY17 to remain at its FY16 level of about $1.6 billion. 90% of that will be targeted for growth largely because of rising costs of land and equipment necessary for Ground expansion and further automation. This is a change from my Ground capital comments on the previous earnings call. The FedEx Freight we are adjusting to challenging less-than-truckload market conditions. Manufacturing, especially in oil exploration and production, has been weakening for most of the year. The latest reading for November showed the Purchasing Managers' Index, an indicator of the economic health of the manufacturing sector, down more than 15% year-over-year. Slower manufacturing, a weaker economy and mode shift have been significant headwinds to Freight's performance.

Freight segment operating income and operating margin decreased due to salaries and employee benefits expense significantly outpacing lower than anticipated volume growth. We are adjusting staffing levels and other items to offset the impact of the current weak industrial environment. Looking ahead, we expect our solid earnings growth to continue in the second half and it's significant that we are reiterating our adjusted FY16 earnings guidance. This equates to an adjusted EPS growth year-over-year of 16%-22% despite the weaker than anticipated industrial production and global trade. Earnings growth for 2H16 will be driven by volume and base yield growth at Express and Ground and continued benefits from our Profit Improvement Program initiatives year-over-year.

Adjusted earnings growth is expected to be stronger in Q4 versus Q3 due to the significant net benefit from fuel in Q3 of last year and the growing benefits from our profit improvement initiatives. Remember, this guidance doesn't include any impact from TNT and mark-to-market pension adjustments. We'll provide updated information at a later date. We still expect to close in the first half of calendar year 2016 and are waiting on regulatory approvals. Our tax rate is lower this quarter because we were able to resolve a state tax matter in our favor. The full year rate is expected to be about 36% excluding any impact from TNT and mark-to-market pension adjustments. Our capital spending forecast for the fiscal year remains at $4.6 billion, primarily for fuel-efficient new aircraft and support e-commerce growth.

At Ground, we will continue to invest in our people. Team members' pay increased in October, their health care premium held steady in calendar 2016 and our pension fund is strong with an accounting funded level of approximately 87%. On November 13, we replaced our revolver and letter of credit facilities with a new 5-year $1.75 billion revolving credit facility that expires in November 2020. The facility, which includes a $500 million letter of credit sublimit and multi-currency capability, is available to finance our operations and other cash flow needs. Also during the quarter we issued $1.25 million of 30-year notes at 4.75% coupon. The rating agencies affirmed our current ratings for this transaction. Interest will be $36 million for FY16 from this transaction and $60 million on an annual basis going forward.

We used the proceeds for some of our share repurchases as well as other corporate purposes. Since FY2014 we have returned over $7 billion to shareholders through repurchasing over 53 million shares at an average price of about $139, including over 8 million shares we have repurchased in fiscal 2016 to date. 4 million shares remain under our existing share repurchase authorization and we plan to repurchase all the remaining authorized shares by the end of the fiscal year. In closing, let me remind you that despite the economic headwinds, the FedEx Corporation balance sheet is strong, our cash flow is improving and we expect strong EPS growth. Thanks very much for your attention and now we'll open the call up for your questions.

Operator (participant)

Thank you. FedEx would like to invite questions via email. To email your question, please use the fedex.com email address and provide your full name and contact information. If you would like to ask a question over the phone, you may press Star one on your touchtone telephone. Please ensure your mute button is not engaged so your signal reaches our equipment. We ask that you limit yourself to one question to allow time for others to ask questions. Again, please press Star one to ask a question. We'll pause a moment to assemble our roster. We will first go to Chris Wetherbee from Citi. Great thanks and good afternoon.

Christian Wetherbee (Senior Research Analyst)

Wanted to touch, I guess, on the Express side and how it relates to the guidance. So a weaker macro, maintained guidance, and you've talked about sort of the Express profit improvement plan likely exceeding targets. Can you give us some context around that and sort of how you may think about the potential for fiscal 2016 and then maybe beyond.

Frederick Smith (Chairman)

This is Fred Smith speaking. I'll let Dave talk to it about it. Express's margins are going up. They're going to continue to go up absent macroeconomic or geopolitical events. As I said in my remarks, the fleet modernization program is making a huge difference. Alan said in his remarks the productivity because of technology is going up. The system form adjustments that Dave made in his network allow us to put the right traffic in the right network. As I said, Express is in a sweet spot.

David Bronczek (President and CEO)

Yeah, thanks for the question and thanks Fred. We are in a sweet spot and if you remember, our profit improvement plan was driven mostly by structural cost initiatives and not as much on the revenue. That being said, the revenue has been better. We've had better yield management but again we've had terrific performance in our fleet. The planes are flying at 99 plus reliability and the fuel savings has been great. And of course reliability is all around the world. That being said, of course our productivity and we've rightsized our U.S. operations here throughout the United States. And really on the global basis, the traffic that we're moving on the international economy basis that's growing is very profitable for us now because we have it in the right network. So yes, we're very optimistic about our profit improvement going forward. It continues to increase the profits.

It doesn't stop. Of course, I saw some of the comments earlier. It just continues to keep growing and increasing. And Fred's right. I mean, we hit a 9-year high of our margins at Express, and those will continue to grow as will our profits.

Operator (participant)

We'll now go to Tom Wadewitz from UBS.

Thomas Wadewitz (Senior Equity Research Analyst)

Yeah, good afternoon. Thanks for the question. If I could get, I don't know if this is more for Alan or for Dave, but on the Express improvement plan, you know, I guess it's less clear to me what the kind of metrics are versus when you originally introduced the plan. You know you talked about I think the $1.6 billion and is that and I think that was end of fiscal year 2017, but then the base changed a little bit related to the pension. Could you just run through what? The right, I think both absolute amount. You're considering to be the plan and. Is your end fiscal 2017 still the right timing on that recognizing you'll improve on an ongoing basis or you'll try to do that? Thank you.

David Bronczek (President and CEO)

Thanks, Tom. I think we've mentioned this before several times but it's important to mention again the 75% run out rate that we've captured. We captured it at the end of last fiscal year, FY16. Built on that. All five of the pillars are still the five that are producing the results. Quite frankly, they're better in almost every category. You can go back and look at all the notes or you can call IR for the five pillars. But across the board we're improving each. One of the pillars. The one that we counted on the least was the global marketplace revenue, and actually we've been better on that. All that being said, that was the one that we were worried about the most. We're doing very well there because we planned it to be less than all of our cost initiatives. So I would say going forward, obviously you can see in the numbers we're having a great year in 2016 and that will continue into 2017.

Operator (participant)

We'll now go to Nate Brochmann from William Blair.

Nate Brochmann (Wealth Advisor and Portfolio Manager)

Good evening and thanks for taking the question. Fred, you started off talking about obviously the volume that e-commerce has brought and how that's allowed you to redefine your network and serve your customers as your customer supply chains evolve. How have you been able to help them and get deeper into that relationship? And particularly how does GENCO help with that?

Frederick Smith (Chairman)

Well, I'll ask Mike Glenn to comment on it after I do. But a big part of e-commerce is handling returns. So some years ago as we saw the market evolving, we decided it would be a very, very good thing for us to have a supply chain capability to offer a broader portfolio of value added services to our e-commerce customers. Because this was a huge part of the marketplace.

It wasn't just planning on how to get it to the end customer, but how to efficiently process the returns and the merchandise. So through a quite frankly, serendipitous chain of events, this great company GENCO, which was coincidentally in Pittsburgh and was by far the leader in this space, in our opinion, became available and we did a deal with Herb Shear, a fine gentleman and a great management team that he had assembled. And so we think there are enormous synergies there. I'll ask Mike and Henry to comment on it, but we just couldn't be any more pleased with GENCO being part of the FedEx portfolio and think it will enhance our competitive position and problem solving ability for our e-commerce customers.

Michael Glenn (President and CEO)

Annette, this is Mike. You know, I think it's important to note that our sales team has a solutions organization that works hand in glove with our large e-commerce customers to help optimize their supply chains. And that includes everything from types of information management solutions to location of distribution facilities, selection of services, all designed to drive value for those companies. And sometimes those solutions are good for FedEx in the short term. Sometimes they're not so good for FedEx in the short term, but they're always good for us in the long term because we're working with customers to drive solutions that are going to benefit the relationship between FedEx and the customer over the long haul.

So we're well ingrained and embedded into our largest customers and work with them hand in glove throughout the year to prepare for peak season and operations 12 months out of the year. GENCO was a significant addition to our portfolio. We recognized we had an opportunity to enhance the product portfolio. As Fred noted, they have world-class solutions in the return segment. Returns is a particularly big part of any e-commerce value proposition because they tend to be double digits whereas a traditional brick and mortar retailer is in the mid to lower digit return rate. So GENCO has been a tremendous addition to the portfolio. We're well down the track on integration and we see a lot of benefit going forward.

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

Henry J. Maier (President and CEO)

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

Operator (participant)

I'll now turn the conference over to our speakers for any questions that may have come over the email.

Frederick Smith (Chairman)

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

Michael Glenn (President and CEO)

Yeah, thanks Fred. I'm not quite sure how you're defining network, but let me say that virtually every major retailer in the United States today has a dedicated line haul operation to move inventory between distribution centers and stores. And Amazon is certainly no different in that regard. Amazon is a very large FedEx customer and we work closely with them, as I just noted, to optimize delivery needs and of course work with them very closely to create new solutions to support their future growth. I do think it's important to point out, however, that FedEx is a highly integrated global transportation network. In fact, one of only two operating at a significant scale in the United States today and only one of three major delivery networks in the U.S., the other two being UPS and the United States Postal Service.

That's not likely to change in the foreseeable future as these networks are very capital intensive and information intensive. And I think, finally, I think it's important to note that our network is a linchpin in the e-commerce market and our customers rely on us to support their growth. So we feel quite comfortable where we're situated today.

Frederick Smith (Chairman)

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

Christine Richards (EVP, General Counsel and Secretary)

Chris, thank you, Fred. I'll start with the update on the regulatory approvals of the TNT acquisition. As we indicated in our joint press release with TNT on October 20, we have been informed by the European Commission that no statement of objections will be issued to the review of our transaction. We are anticipating that we will receive final unconditional approval from the EU in the first two weeks of January. In addition, we have completed the process and received clearance in 10 other countries, including the U.S., Australia, Chile, Colombia, Japan, New Zealand, Russia, Taiwan, Taiwan, Turkey and Ukraine. At this time, we are aggressively pursuing clearance in the remaining seven countries, Brazil, China, Argentina, Israel, Korea, Namibia and South Africa. We are very confident that we will achieve the clearances that are necessary to close this transaction in the first half of calendar 2016.

Moving on to the question about the French proceeding. No, there is not any concern that the fine levied by the French will be copied by other countries because this proceeding involved TATEX, a French company that we acquired in 2012 and the events that are the subject of this proceeding occurred in 2010 long before we acquired the business. The events were limited to France, but despite that situation, we are considering an appeal of this decision and we'll give you an update on it next quarter.

Frederick Smith (Chairman)

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

Henry J. Maier (President and CEO)

Yeah, there's significant savings when we can marry two packages together to residential delivery. Because the vast majority of the cost in any of these networks is really around stopping the truck in front of an address. So when you can pull a package out of SmartPost, for instance, marry it up in a single network with a FedEx Home Delivery package, the savings are quite a bit. Quite a bit. The costs are quite a bit less than paying the postage on that package to have the U.S. Postal Service deliver it. There are a number of other advantages as well. One is that we can maximize the capacity between ground and SmartPost from time to time and at times even geographically throughout the year we see volume spikes.

This gives us the ability to move, for instance, a SmartPost package into a Ground hub's small sort operation and process it there as opposed to essentially just bringing in more people at SmartPost to handle the added volume. There are a number of other issues just in the sense that we can share people. Now we effectively dissolved the corporate structure. So all of SmartPost's people are either being deployed in their current jobs in the former SmartPost or within FedEx Ground.

Operator (participant)

We'll now take a few questions over the phone lines. We'll go to Allison Landry from Credit Suisse.

Allison Landry (Senior Transportation Research Analyst)

Thanks.

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

Frederick Smith (Chairman)

Well, the answer to that question is yes on the pricing. And of course we've already done some of that and we've announced more. That's really where dimensional pricing came from. I mean, we were getting lots of packages that were 1 or 2 cubic feet and inside was a 6-ounce stuffed toy. And that comes from the way e-commerce is processed. These large fulfillment centers, or perhaps not so large, but they're using a lot of effort, particularly during the holidays, to speed up order fulfillment. And they put things in boxes and it's quite different than say Procter & Gamble packaging toothpaste in the most efficient and most dense way to minimize transportation costs. So the reason this continues, quite frankly with more effort not put into it on the part of the e-tailers is the postal service doesn't have dimensional pricing.

And I have to tell you, I feel for a lot of our postal folks out there. They operate their parcel delivery system with 200,000 jeeps which were basically designed for mail delivery and watching them, it looks like a submarine. You know these people are, they got all these packages on the left-hand side of the truck, they have to stop, they have to pull them out, resequence them for delivery. And at my house I can promise you we're getting a lot of very lightweight cube items coming from retailers through SmartPost or directly from an e-tailer. So over time all markets are rational and it does not make a lot of sense for the e-tailer or the transportation company or the delivery company and in the case of the postal service to pay money to deliver air. So I think pricing will rationalize it.

As I said in my remarks, it's just a terrible shame that the 33-footers were not approved. That gives about 18% more cube, very little increase in weight. As I mentioned from an environmental and safety standpoint it was just a complete layup. The forces that opposed it quite frankly were not well informed on the issue. Hopefully the Department of Transportation will move smartly to correct this because as I said, these are already used in 18 states and they're more stable because they put slightly more weight on the axle of the twin trailers. Passing a 33-foot set of doubles versus 28-foot doubles at 60 miles an hour is basically inconsequential. It's about a tenth of a second difference.

So it was a great opportunity to have a win, win, win solution in terms of national productivity for e-commerce, reduction in fuel and environmental emissions, and then would reduce over, I think it was 1,000 accidents estimated with the ground parcel and LTL industry per year. But it is what it is, and obviously we have to operate the 28-footers, but that would have mitigated a lot of these inefficient cube developments we've been talking about.

Operator (participant)

Our next question comes from Tom Kim from Goldman Sachs.

Thomas Kim (Analyst)

Hi, good evening and thanks for your time.

I wanted to follow up on the ground margin question. I have a question, I guess around.

The integration of SmartPost and GENCO in the prepared remarks you mentioned that operating.

Margins had been impacted by about 1.2% or more.

Is that including any one-off integration costs?

Frederick Smith (Chairman)

Well, this is Fred Smith speaking. Alan mentioned that of the ground margin delta, 2.1% out of, I think 2.2 was having to report because of the integration of ground and SmartPost the revenues at the gross level versus the net level. Prior to our doing that we simply took the net cost of the postal deliveries and excuse me, the delta between the postal delivery cost and our revenues as a single network. The accounting rules are such we had to take it on a gross basis. So there's no diminution whatsoever in earnings, cash flows, the performance of ground. It's just an accounting situation.

The second is the fact that we put GENCO into the Ground segment and Henry is in charge of this because it is so closely aligned with the ground parcel SmartPost presence in the e-commerce market. Now again, as Henry said, GENCO does many, many other things for Express and Freight and so forth, but we're very confident in our Ground margins. And Henry, won't you add to this and say it one more time what our goals are here?

Henry J. Maier (President and CEO)

We strive for mid-teens margins at FedEx Ground. There's no discernible integration costs in there at all. I mean this was roughly 10 basis points, frankly, falls into all other. There was no single large item. You got to keep in mind with a company of this size and the fact that we recognize revenue on delivery, not on pickup, you know, having 2,000 packages move in or out of a quarter, you know, can have a huge bearing on operating profit.

Operator (participant)

Our next question comes from Scott Schneeberger from Oppenheimer.

Scott Schneeberger (Analyst)

Thanks very much.

Michael Glenn (President and CEO)

Good afternoon.

Scott Schneeberger (Analyst)

I was curious, could you address please the trans-Pacific and perhaps transatlantic trade lanes, how they progress through the quarter, what you're seeing into the coming quarter, and also with consideration for capacity? Thank you.

David Bronczek (President and CEO)

Yeah, this is Dave Bronczek. I think I heard your question. Trans Pacific, Transatlantic. It's generally the same economic environment that Mike talked about at the beginning. Around the world it's growing, but it's more modest. So I wouldn't say, I think it is actually growing more out of Europe because of the currency exchange, a little bit less out of Asia. But around the world we've balanced our network. So for us, in Mike's comments, we took that into consideration as to where we put our packages and how we flow our network.

Operator (participant)

Our next question comes from Rob Salmon from Deutsche Bank.

Robert Salmon (Analyst)

Hey, thanks and good evening. I guess continuing on the ground line of questions, can you give us a sense of what drove the acceleration in the average daily package volume growth? Was this a lot of this as a result of the GENCO acquisition? We're starting to see some of those revenue synergies showing up. How much of an impact was the calendar? And if there were any shifts coming out of Express's U.S. deferred volumes, which declined for the first time in a few years, it would be helpful to kind of understand the different puts and takes there. The volumes at ground are growing because we're taking market share and because e-commerce, the delivery of individual packages to businesses and retail is growing. And on the what was the express deferred? You want to comment on that?

Alan B. Graf (EVP and CFO)

Mike?

Michael Glenn (President and CEO)

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

Operator (participant)

I'll now turn the conference over to our speakers for more email questions.

Frederick Smith (Chairman)

Okay, we have some other Internet questions here. Kelly Dougherty, Macquarie, how does the greater unpredictability of online sales challenge impact your year-out-year planning projections? Well, let me make a couple of comments here and then, and then ask Mike to jump in or Alan. As we mentioned earlier, we have this enormous sales group which I unabashedly think is the best in the industrial services sector. And as an integral part of that, we have this wonderful solutions group. So our good customers that work with us in a partnership basis, we can do an excellent job of anticipating what their needs are and provide the equipment in the right place and the sortation equipment.

The people that have the real problem in the e-commerce business by and large are those that view the transportation equipment companies as some sort of utility or a vendor and they make some really, really bad decisions. I mean we've just watched in amazement, several of them just really dig themselves into a hole. But our good customers, we work very closely with them now, despite all of the best efforts, despite that sometimes they grow faster and sometimes they grow in different places because of their customers. I mentioned in the Northeast the demand was just extraordinary. However, FedEx Ground is very unique in this regard. Our hubs and those of you who have been in them, you'll know this, they're essentially completely automated.

So what that means is that if we're over volume in our New Jersey hub, we can divert that traffic to Hagerstown, Maryland or into Pennsylvania and sort it in a different time frame. But we're not reliant on the manning inside the hub because really the only labor that's at the location are the people that offload the trucks and the.

People that reload the trucks.

And we've been talking about this over and over over the years and I don't think that a lot of people understand the profundity of that automation and that flexibility we have. It's a big competitive advantage. It allows us to use bigger hubs with more direct routings, which is a big part of our 27% day faster situation. So that's how we do it, is we try to work with our customers. And I have to tell you, there are a lot of our mid-sized customers that it is very clear that they are figuring out this e-commerce world. They are doing some very, very smart things and creative things. And I think in part that's why the market is growing as much as it is. Mike, you and Henry want to amplify that?

Michael Glenn (President and CEO)

Well, I just want to add that I think it's important to note that peak season is a very highly planned, planned period of time. I mean, we literally will start working with customers in late January preparing for next peak season. The second point is we're not going to over commit to traffic levels that we can't handle in our network. In other words, we understand what the capacity is on a given day and our operating companies do a tremendous job flexing up capacity. But as we've noted many times on this call, we have to cap certain customers to make sure that we're providing the service that meets the customer expectations. In addition to that, we have a team that essentially is conducting an orchestra for about one month out of the year.

They have essentially a control tower that has minute-by-minute discussions with the operating companies which are making changes to inputs that we receive from our customers which allow us to deploy our resources and adjust to changes in demand both up and down. You know, as we say in the South, this is not our first rodeo and we've been doing this for a while and I think we've got a pretty good business model here and we've demonstrated that it works well in terms of meeting customer expectations.

Henry J. Maier (President and CEO)

Yeah, this is Henry Maier. I'd just like to add to this question a couple things. First of all, Fred mentioned the 33 fully automated hubs we have. The second thing I would add is that we currently operate 49 fully automated satellites as well, which give us enormous flexibility in being able to offload volume from hubs to these automated satellites and vice versa. They also provide a bit of a relief valve, if you will, for diverting volume away from hubs and being able to sort it and move it direct. The biggest reason why we are as successful as we are at peak and when we see these surges in volume is simply FedEx People. We have the greatest group of people of any company I believe in the world.

You add in the yeoman effort of our contracted service providers and the dedication and professionalism, the commitment to quality and just plain innovation to be able to adapt on the fly. I can tell you for somebody who sits in my chair, it's nothing short of inspirational. I think that's the secret sauce here which allows us to be able to handle the unpredictability of online sales.

Frederick Smith (Chairman)

David Ross asks, will the price of oil, if it's lower for longer, help or hurt Express? You know, on the margin the elasticity will certainly create more express demand. On the margin it might be a bit more priority versus economy. But the markets for Express and increasingly the door-to-door International Express are built on customer needs and purchases. So if you need a defibrillator for an operation tomorrow at a Cleveland hospital, you do not want that defibrillator stuck in a package, a truck with a bunch of toys. That is why our Express Network is focused on these high-value-added type of products. High-value-added products are sold around the world in global markets. Finally what's really exciting is increasingly they're being sold door-to-door on an e-commerce basis.

One customer that has the entire wares of the world for a business or a consumer and you know that is going to be a very big market and it's where the Express Intercontinental Network is focused. So on the margin, yes, it'll have some effect, but not as much I think as the fact that people use Express and Global Express when they have an urgent need to move something in one to two business days door to door. David Vernon of Bernstein asks, has FedEx detailed the cost benefit opportunities and costs associated with the TNT acquisition and does the company intend to provide guidance on these items at any point prior to their incorporation into results or will we learn as we go as we have with Genco? I'll answer the first and ask Alan to comment on the guidance issue.

The answer to the first part of the question is of course we have a detailed plan. We did an in-depth strategic business case as we do for any particular potential acquisition which was studied in great detail. We have a very, very good integration process that's run through a formal process headed up by Alan and Bob Henning on the financial side and Dave Bronczek and David Cunningham and David Binks, our President of Europe on their side. This is a process, a template that we use on all our acquisitions. The acquisition of course was presented to the FedEx board of directors, and it is in great detail now, obviously based on imperfect knowledge and changing economic circumstances. As you get in deeper and you understand things, things will change.

But we're already far enough into it, although we're still not able to completely get into the details because we don't have approvals to know that this is going to be just a terrific fit. And we love the team members over there and, you know, I think they love being part of FedEx prospectively. So, Alan, on the guidance you want to comment.

Alan B. Graf (EVP and CFO)

We have a very detailed integration planning going under way right now that I'm very excited about. First of all, they're executing on their Outlook strategy. We agree with that. We've been supportive of that, and they are being successful in that regard. Secondarily, the integration teams have great details, to the extent we're permitted to talk about areas on what's going to happen on day one, what's going to happen in the next 100 days in year 1, 2, et cetera. I can tell you that the people that we're working with are terrific, that there are many, many opportunities that are equal to or greater than I thought when we built the strategic business case. Having said that, I will also tell you that the integration is going to take some time and is not easy to do. There are tax, structural and accounting issues to deal with.

There are IT issues. There's rationalizing the lanes, all the things you can think of, and we've got every one of those being worked on. We can't talk to their customers; they can't talk to ours. We can't talk about pricing. And of course, that's where some of the big numbers are. But what I'm seeing so far is I'm very pleased with it. As I said, day one, we're not going to see big synergies financially until fiscal 2018. Fiscal 2017 is going to be a year of getting our hands around some of these very tough issues and making sure that we don't do any harm, that business continuity is there, that the customers are taken care of, and that we don't miss a beat from service level. So it's not easy, but I think the reward is going to be fabulous.

So let me combine two questions here into one answer, because I think this is an important issue. The first part of it comes from Allison Landry of Credit Suisse. Have you seen any shift changes in the marketplace with respect to UPS's acquisition of Coyote in terms of handling the peak season? And on the same line of thinking, David Vernon asked does the transition to the ISP model at Ground increase the risk that these larger contracting entities are harder to handle or deal with? In essence, a couple of things here. First of all, we already have a truck brokerage and transportation management unit inside FedEx and have had for quite some time. But much more importantly, I think it's a misunderstanding of the FedEx Ground business.

David Bronczek (President and CEO)

Model.

Because the very reason we have these small businesses providing our highway and pickup and delivery capabilities is that they are very, very close to the market, very close to the customers, very close to the understanding of the roads and the geographic areas that they serve. So by design, we want small business people who have those characteristics and are very, very entrepreneurial. And we do not have many contract service providers that have over 7-10 trucks. I mean, that would be a very big one. And if you start going beyond that, you lose that tactile entrepreneurial feel. And the thing I love about it, and I'm most proud about in the ground thing is these are entrepreneurs and they do very well if they're good business people. And it's just really fun to watch them.

I hate it that when we bought RPS that the single route contractor, you watch these young folks and minorities and everything start off and get an area and build themselves a wonderful life. And then because of all of this litigation and the plaintiffs attorneys and the state tax people and all they, we've had to move to the point where you have to have a minimum level of vehicles and be incorporated. But be that as it may, we still retain the best of both worlds. And in fact, it's probably much more productive, based on our experience, to have the somewhat larger unit. So for all intents and purposes, we'll stay with this business model and that's not going to change. So we don't need the same number of purchased transportation tractors and trailers that UPS does.

And so I think it was probably smart for them to get Coyote. I'm not sure that it would be smart for FedEx, and Henry, why don't you jump in here?

Henry J. Maier (President and CEO)

Well, I would echo everything Fred said. I think it's important for the folks on the phone to understand that we provide some peak incentives so that both our P and D contractors and over the road contractors bring on the necessary resources within their business to handle our projected peak volumes. That just gives us unbelievable flexibility, particularly when business spikes, et cetera. I would add that the way you need to think about them is they're coin operated, they are entrepreneurs, they respond very well to the opportunity to earn more revenue for their businesses and they step up every single year.

Frederick Smith (Chairman)

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

Operator (participant)

Thank you for those email questions. We'll now take a few questions over the phone line and we will go to Scott Group from Wolfe Research.

Scott Group (Analyst)

Hey, thanks.

Afternoon guys.

So I just want to follow up on the question earlier about ground volume growth and maybe a little bit about seasonality. So nice acceleration in volume growth to.

David Bronczek (President and CEO)

9% in the second quarter.

Alan B. Graf (EVP and CFO)

Is this continuing in the third quarter?

David Bronczek (President and CEO)

I'm just wondering if there's any impact.

Alan B. Graf (EVP and CFO)

Of Cyber Monday, which was in 2Q.

David Bronczek (President and CEO)

This year and I think in third quarter last year.

Alan B. Graf (EVP and CFO)

Alan, how does that impact the seasonality of earnings?

Frederick Smith (Chairman)

I know you made some comments.

Alan B. Graf (EVP and CFO)

About third quarter, fourth quarter.

Michael Glenn (President and CEO)

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

Frederick Smith (Chairman)

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

Alan B. Graf (EVP and CFO)

Scott, this is Alan. You know, one of the reasons that I've taken up my guidance for you on ground CapEx is not just the, by the way, fairly stellar increases in land acquisitions and material handling costs. And that's all got to do with e-commerce. It's also because ground's going to continue to grow. What we can't do, and I'm a good Missouri Lutheran, so I can say this, we can't build the church for Easter. So part of what we're doing about yield management and everything else is we've got to get these packages a little bit smaller or we've got to get paid for the space they're using. But we can't have a lot of excess capacity laying around the other 11 months of the year. And we're not going to do that. Henry's working his people every day of the week.

We're open 24/7 for this entire peak season. Competition is not doing that and it's made a big difference for us.

Henry J. Maier (President and CEO)

Scott, this is Henry Maier. I'll be a little bit more to the point. I've been around here for a lot of peaks. This is without a doubt the busiest one I've ever seen. It has been consistent every single day since 11/30. There's no sign it's going to let up. That's where we are. Our people are stepping up to the task. Our network is performing exactly the way it's designed. If we didn't have these automated hubs and automated satellites and the great people, I think we'd be much different shape than we are today.

Frederick Smith (Chairman)

You know, let me just state again what I said in my opening remarks here. We think we have very, very good strategic plans and an in-depth knowledge of this market better or at least as good as any entity on the planet. And we have very, very creative concepts to make our assets sweat more and be able to process more packages in all of our networks. And that's why we were so forthright in saying that we expect this to continue absent macroeconomic or geopolitical events. And let me say it again. You know, we continue to increase margins, Earnings Per Share, cash flows and Return on Invested Capital. And we are confident these basic trends should continue well into the future, barring major events or macroeconomic factors. Having said that, I know it's very important for all of you folks on the call.

Sometimes we're off 1% or 2% in a quarter. This is a big, big enterprise. We can pick up, transport and deliver to virtually any address in one to two business days to 90-some-odd% of the global population. That takes incredible networks. Henry Maier's network at Ground has 550 facilities. David Bronczek has 600 FedEx Express stations which are very different in the way they're designed. That's just in the U.S. they're very different in the way they're designed because they're designed to interface with airplanes, not with 28- or hopefully someday 33-foot trucks. Mike Ducker's FedEx Freight is very different. And as I told you, these automated hubs that Henry is operating are some of the most incredible facilities ever put on the planet. So this is a very big, complex business with an enormous amount of value add.

And so we can't get it within 1% or 2% sometimes, but directionally we're very confident that we will continue to achieve those things that I just said, increasing margins, earnings and cash flow and ROIC.

Operator (participant)

Thank you. We'll now go to Alex Vecchio from Morgan Stanley.

Alexander Vecchio (Analyst)

Good evening.

Thanks for taking the question. This might.

Be best suited for.

Chris, can you just provide just a little bit more color and background on the independent contractor litigation cost at Ground?

In the quarter, the extent to which we might see litigation expenses going forward related to any lawsuits outstanding, and maybe the overall defensibility of the independent contractor model that you employ.

I realize you guys have made some.

Changes there with respect to requesting that.

The contractors incorporate, but maybe we can.

Just get a recap of the model.

And the litigation expenses this quarter? Thank you.

Christine Richards (EVP, General Counsel and Secretary)

Yes, Alex, I'll try to give you some insight on this. First of all, all of the litigation involves the ground contractor model that was being operated in the early 2000s. We have made significant changes, as you note, both requiring incorporation, but also requiring that every contractor treat all of their folks as employees and they provide a complete compliant program, including workers compensation, unemployment compensation, and all the other matters that are required by the various states to ensure that folks are comfortable that these are in fact, independent businesses running under their own direction and guidance. We have had some litigation that has not been as positive for us, particularly out in the 9th Circuit. For those of you who are familiar with the Ninth Circuit, it is a very tough circuit for business operation.

They tend to be very difficult in their analysis of what constitutes. So we have had some settlements from cases where we had adverse decisions in the Ninth Circuit. That being said, we have had positive decisions in the First Circuit and in some other circuits, and we still have the bulk of the cases being held at the Seventh Circuit, where we are awaiting a briefing and hearing schedule. We do opportunistically settle these lawsuits if we get in a situation where we can do that. To resolve the issues and move things forward, you need to keep in mind that in most of these instances, the bulk of the people who are involved in this litigation have moved on and are not contractors anymore. This is really in our rear view mirror.

While it's my job to make sure we get through it on a satisfactory basis, we are extremely confident in our independent service provider model and our fully incorporated model that we are operating today.

Operator (participant)

Thank you. Our next question will come from Brandon Oglenski from Barclays.

Brandon Oglenski (Analyst)

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

Alan B. Graf (EVP and CFO)

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

I'm going to pass it over to Dave.

David Bronczek (President and CEO)

Yeah, this is Dave. Alan's right. I mean, if you remember what I said at the beginning, we structured our network to flex up and to flex down and we would win on either side of that equation. Quite frankly, we're not flexing down much anymore because the economy is pretty robust for us. International economy is growing and IP is still 72% or more of my all up revenue for international. So it's significant, it's high yields. So when we actually can flex up or down when we win, we're in a really good spot. So that's the international network. Couple that with the U.S. network and the Asia to the U.S. and U.S. back. That's why you're seeing such high margins in profits from Express.

Frederick Smith (Chairman)

Bear in mind also we have a huge outbound market share in Express from the United States. So the dollar exchange ratio means that our outbound is affected much more than our inbound and I think Dave mentioned earlier, our European to the U.S. traffic is substantially up and our Asia to the U.S. traffic is, you know, it's sort of flattish, but it's not declining. And the real pony in here again is e-commerce. And you're starting to see these patterns where people are shipping individual items door-to-door because they can now with the software that we're putting out there and others, they can see what the landed cost is and what the duties and taxes are. So it's a sea change.

The same thing that's driving e-commerce in the United States, but it's more industrial because there are business products in the main and to some degree individual consumer B2C as well. There's an international question about FedEx Trade Networks. It's an integral part of the Express segment. The request is to comment on them, on the forwarding industry. I don't think it's appropriate for us to do that. But it's an integral part of the value proposition that Dave offers. The Express system is essentially focused on door-to-door express. There's some freight that moves through that network. We're capable of flying extra sections if customers need it, particularly at peak. And then FTN handles the cargo, the freight and the heavy consolidation. So our FTN network, which we built from scratch, is a perfect complement for our customers to our Express network.

Operator (participant)

We'll now go to Kevin Sterling from BB&T Capital Markets.

Kevin Sterling (Analyst)

Thank you.

Good evening, Alan.

In your prepared remarks, you briefly mentioned a Monday residential trial run you're trying in certain cities. Could you expand on that a little bit? What exactly you guys are doing there?

Kind of some of the successes you're having.

I'd imagine it's trying to increase.

Stop density, if you will.

So maybe you could expand on that.

Trial run a little bit with Monday residential deliveries.

Frederick Smith (Chairman)

Yeah, let me. This is Smith here. Let me turn it over to Henry because he can give you some detail. And Alan wanted Henry to answer this, but our home delivery network was set up to deliver Tuesday through Saturday. And remember our remarks a few minutes ago about we have lots of concepts based on the growth of e-commerce, how to make our assets sweat more, how to move more traffic, deliver more traffic with the same assets. So Henry has begun to deliver six days a week, not just the five days a week. Now B2B has always been different than the B2C, so why don't you give some color around that, Henry?

Henry J. Maier (President and CEO)

Yeah, since its inception, FedEx Home Delivery deliveries deliver Tuesday through Saturday, which means we essentially deliver Monday's volume the previous Saturday. You know, with the advent of e-commerce, I mean, it's a 24 market. You can buy things online from your phone any time of the day or night. The way we are able to flex up our capacity at peak every year is we essentially operate a Monday through Saturday network and we run hubs on Sunday so that we can advance weekend pickup volume into the network so that we can smooth, you know, the huge peaks and valleys during peak throughout the six days of the week. It occurred to us some number of years ago that why don't we just operate that way year-round, you know, with e-commerce? You know, Mondays tend to be fairly heavy pickup days anyhow.

You know, why not begin working that volume on the weekend rather than on Monday? Deliver the volume on Monday and then operate the network six days a week, year round? You know, the benefits of that are obvious. The first is that on the residential service side, we essentially advance, you know, roughly 20% of the volume in the network by a whole day. So the customer gets it a day sooner than they would have been. The other thing is it gives us the ability to smooth the volume, which means that we can operate, you know, our fixed network more efficiently throughout the week. And by smoothing the capacity, we frankly don't need as much of it as we had in years past. And we've tried, as Fred or Alan mentioned here, we've had a pilot running since roughly May of this year.

I would say it's a success. We're currently studying where we roll it out next.

Operator (participant)

Our next question comes from Ken Hoexter from Merrill Lynch.

Kenneth Hoexter (Analyst)

Just quickly on the other operating loss, it increased to $112 million. Can you kind of delve into what scaled that up?

Alan B. Graf (EVP and CFO)

Prior year had the pension credit in it from Mark-to-Market accounting, really arcane. If you want a lot more detail, we'll be happy to take that offline.

Mickey Foster (VP of Investor Relations)

Okay, that's the end of the call. Thank you for participating in FedEx Corporation second quarter earnings release conference call.

Frederick Smith (Chairman)

Feel free to call anyone on the.

Mickey Foster (VP of Investor Relations)

Investor Relations team, if you have any additional questions about FedEx.

Frederick Smith (Chairman)

Thank you very much.

Operator (participant)

This concludes today's presentation. Thank you for your participation.