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Edited Transcript of FDX earnings conference call or presentation 17-Sep-19 9:30pm GMT

Q1 2020 FedEx Corp Earnings Call

Memphis Sep 20, 2019 (Thomson StreetEvents) -- Edited Transcript of FedEx Corp earnings conference call or presentation Tuesday, September 17, 2019 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alan B. Graf

FedEx Corporation - Executive VP & CFO

* Brie A. Carere

FedEx Corporation - Executive VP and Chief Marketing & Communications Officer

* Frederick W. Smith

FedEx Corporation - Founder, Executive Chairman & CEO

* Henry J. Maier

FedEx Corporation - President & CEO of Fedex Ground

* Mickey Foster

FedEx Corporation - Staff VP of IR

* Rajesh Subramaniam

FedEx Corporation - President & COO

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Conference Call Participants

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* Allison M. Landry

Crédit Suisse AG, Research Division - Director

* Amit Singh Mehrotra

Deutsche Bank AG, Research Division - Director and Senior Research Analyst

* Brandon Robert Oglenski

Barclays Bank PLC, Research Division - VP & Senior Equity Analyst

* Christian F. Wetherbee

Citigroup Inc, Research Division - VP

* David Griffith Ross

Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Global Transportation and Logistics

* Helane R. Becker

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Jack Lawrence Atkins

Stephens Inc., Research Division - MD & Analyst

* Jordan Robert Alliger

Goldman Sachs Group Inc., Research Division - Research Analyst

* Scott Andrew Schneeberger

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Scott H. Group

Wolfe Research, LLC - MD & Senior Transportation Analyst

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Presentation

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Operator [1]

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Good day, everyone, and welcome to the FedEx Corporation First Quarter Fiscal Year 2020 Earnings Conference. Today's call is being recorded.

At this time, I would like to turn the conference over to Mickey Foster, Vice President of Investor Relations for FedEx Corporation. Please go ahead.

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Mickey Foster, FedEx Corporation - Staff VP of IR [2]

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Good afternoon, and welcome to FedEx Corporation's first quarter earnings conference call. The first quarter earnings release and stat book are on our website at fedex.com. In addition, certain speakers may refer to charts we posted on the website this afternoon. This call is being streamed from our website where the replay will be available for about 1 year.

Joining us on the call today are members of the media. During our Q&A session, callers will be limited to one question in order to allow us to accommodate all those who would like to participate.

I want to remind all listeners that FedEx Corporation desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act. Certain statements in this conference call, such as projections regarding future performance, may be considered forward-looking statements within the meaning of the act. Such forward-looking statements are subject to risks, uncertainties and other factors, which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. For additional information on these factors, please refer to our press releases and filings with the SEC. Please refer to the Investor Relations portion of our website at fedex.com for a reconciliation of the non-GAAP financial measures discussed on this call to the most directly comparable GAAP measures.

Joining us on the call today are: Fred Smith, Chairman; Raj Subramaniam, President and COO; Alan Graf, Executive Vice President and CFO; Mark Allen, Executive VP, General Counsel and Secretary; Brie Carere, Executive VP, Chief Marketing Communications Officer; and Rob Carter, Executive Vice President, FedEx Information Services and CIO, who is calling in remotely.

And now Fred Smith will share his views on the quarter.

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Frederick W. Smith, FedEx Corporation - Founder, Executive Chairman & CEO [3]

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Thank you, Mickey. Good afternoon. Thanks, everyone, for participating in our first quarter FY '20 analyst call. Let me also thank the hundreds of thousands of FedEx teammates around the world who work every day to keep our Purple Promise. I will make every FedEx experience outstanding.

When our Strategic Management Committee presented the FY '20 business plan to our Board of Directors last spring, we identified 3 significant challenges to increasing earnings this fiscal year consistent with our stated long-term goals. One, beginning in the fall of 2018, it had become clear that global trade disputes were adversely affecting manufacturing in Europe and Asia, thereby slowing international shipping demand. Two, our TNT integration was facing its most important phase leading to the integration of European Ground operations by the end of FY '20. And three, we plan to add capabilities to enhance our services for the rapidly growing e-commerce market, which we expect to grow in the United States from 50 million to 100 million packages per day by 2026. These shipments will be destined increasingly to residences, and 1 in 4 packages will be short distance deliveries. While the backbone of FedEx is the B2B business, our unmatched Ground and Express line all and short networks carried both B2B and B2C commerce with great efficiency.

The lead in e-commerce, we have launched or announced FedEx Extra Hours and Express service, which provides nightly pickup with the delivery the next business day. In sourcing, FedEx SmartPost packages for FedEx Ground delivery by peak 2020. FedEx Ground 6- and 7-day delivery, expanding the FedEx Ground oversized package network to approximately 100 facilities by peak 2020. New return services and thousands of additional pickup and shipping points, including $8,000 general on-site locations in less dense areas. And finally, FedEx Freight Direct for heavy and hard-to-handle items requiring delivery over the threshold, the so-called H3D market. FedEx can handle millions of additional shipments generated by these new offerings without adding significant additional sortation capacity. It should be noted a large amount of Ground growth will be short-haul zone 1 that will be lower yield, but with improved margin due to increasing density and minimal line haul cost. There is a new video on our website that goes into detail about our broad portfolio, and I hope you will watch it.

Our services and capabilities and costs will be industry-leading in the short-haul zone 1 sector. The FedEx Board of Directors endorsed making these moves as FY '19 came to a close, understanding the short-term cost as we believe by the end of this fiscal year, FY '20, we will have significantly repositioned FedEx for strong future earnings.

The market is changing as volumes are moving out of the USPS and we are insourcing more. We have a chart on the IR website that shows these trends.

Over the summer, these challenges increased somewhat due to the decision to not renew our largest Amazon contracts and deepening trade disputes. While the Amazon contracts represented only a small proportion of our revenues, the nature of our businesses is such that near-term profits will be adversely affected since the last bit of volume has significant flow-through to the bottom line. However, we have closed additional business to replace this traffic, which is being onboarded, and we are taking out significant costs, which were unique to Amazon's requirements.

Also, the global macro economy continues to soften, and we are taking steps to reduce capacity. Specifically, we will retire 20 MD-10-10 aircraft over the current and next fiscal year, which will eliminate that fleet type from our air operations. We are highly likely to also retire the remaining 10 A310 aircraft this year, which will also lead to the elimination of that fleet type.

In addition, we are parking the equivalent capacity of 7 MD-11 aircraft this fiscal year. Accordingly, assuming no recession, we will continue the initiatives announced in May and June with confident optimism about FedEx' long-term future competitive position and industry leadership.

We posted a chart on our website that shows the significant customer correlation among our 3 core opcos. Our ability to bundle Express, Ground and Freight services is essential to success in our competitive ecosphere. FedEx Office and FedEx Logistics also provide important value-added services to our portfolio against the major competitors we face every day.

Let me now ask Brie to amplify our views on the marketplace and the economy, then Raj to discuss current operations, including our plans for peak season, and Alan will give you more details on our financials. Then we will take your questions. Brie?

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Brie A. Carere, FedEx Corporation - Executive VP and Chief Marketing & Communications Officer [4]

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Thank you, Fred. Good afternoon, everyone. I'll open with our economic outlook, then dive directly into how we're tackling market opportunities and delivering solutions for our customers at FedEx.

Comparing to where we were in June, our overall outlook for U.S. economic growth is down 20 basis points, currently at 2.3% for real GDP. Our outlook has changed despite consumer-driven growth of 2% in the U.S. in Q2 of CY '19. This change is because the industrial sector remains sluggish due to an inventory buildup and increased geopolitical trade tensions.

As you can see on Chart #3 on the IR site, U.S. manufacturing PMI has been very weak this year. Given that, our industrial production outlook is down 70 basis points from June, currently at 0.9%.

From a global perspective, economic growth has decreased as the developed world outside of the U.S. sees weaker growth and both domestic and external factors weigh on emerging markets.

In Europe, ongoing decline in Germany's industrial sector is a drag on growth, while uncertainty over Brexit is impacting not just the U.K. where no sector has been immune to the negative impact that is major trading partners as well. Growth in Italy remains weak, with Q2 CY '19 data showing no gain in real GDP.

In reference to Chart 4 in the presentation, you can see eurozone manufacturing PMI has been signaling contraction for most of the year. In Asia, Chinese industrial production growth had a 10-year low in July, and exports remained weak. Chinese exports in the U.S. have declined every month in 2019. More broadly, all manufacturer -- sorry, excuse me -- all major exporting economies have been impacted by the slowdown in trade, especially Asian economies with high exposure to China.

I want to highlight that Q2 CY '19 global trade volumes declined year-over-year, which is the first decline since 2009. This decline, coupled with JPMorgan's global PMI manufacturing export orders index falling from 47.5 in August, from 49 in May, leads us to expect global trade volumes will contract this year on an annual basis for the first time since 2009.

As we have stressed before, a 0 tariff, 0 subsidy global trade environment is the most powerful economic growth engine there is, we will continue to push for policies that stimulate rather than depress global trade.

Now turning our focus to what we can control. We remain laser-focused on executing strategies across 3 key areas: international, e-commerce and small business. Right now, our sights are set on an addressable transportation market totaling $550 billion worldwide. The majority of this opportunity lies outside of the United States where FedEx shares have significant opportunity for growth. International is a clear opportunity for us with tremendous runway ahead.

As we integrate TNT and lower our cost of serving Europe, we will be ideally positioned to gain share from the competition. The European team is gaining traction in accelerating the acquisition of parcel customers. Unfortunately, this momentum has been offset by reduction in industry airfreight volumes between Europe and the United States.

In Europe, we are simplifying our pricing structures and are opening the valve for e-commerce for the first time ever to further stimulate growth. It is important to note that our European competitors have a larger e-commerce volume base, which insulates them from economic headwinds impacting commercial business. We are very excited about the e-commerce potential for our European business.

We are also creating new pricing and improving our value proposition between Asia and Europe. This is the largest trade lane in the world. Prior to the TNT acquisition, we did not have the European buyer base to pull this volume from Asia as European payers make the majority of buying decisions in this lane.

Now shifting my focus to e-commerce. In reference to Chart 5 on the IR site, in the U.S., more than 90% of incremental domestic parcel volume from 2018 to 2026 is expected to come from e-commerce period. This is why we are busy building a world-class portfolio of solutions to best serve thousands of retailers in this space. We are very proud of the rapid of innovation we have brought e-commerce in the last 3 years, and you can certainly expect more innovation in the months ahead.

On the same chart, you'll see that more than 50% of the U.S. domestic e-commerce market is our addressable growth market with a CAGR of 12%. As e-commerce market grows, so does the market for returns, up 35% since 2015. Packages dropped off at our retail locations result in a higher pickup density and drive greater operational efficiency, making FedEx even more competitive in the returns market. We are very excited about our network expansion with Dollar General. We will have 1,800 incremental locations open by peak. We also expect our walk-in volume to reach a record high this holiday season.

Innovation and customer value are driving every decision we make when it comes to e-commerce. We are very excited about making every day a delivery day with the launch of our 7-day service at FedEx Ground. We are already faster than the competition by at least 1 day and 26% of the lanes. This move will further speed up our network and allow us to continue to gain market share.

We are also building powerful relationships with many retailers and leveraging solutions like FedEx Extra Hours and FedEx Ground zone 1, which is our local portfolio. Our local portfolio enables retailers to leverage local inventory in stores in DCs, take orders later in the day and still deliver them the next day.

We just forged a new strategic delivery partnership with Dick's Sporting Goods. The majority of their spend with us is on their e-commerce business. By leveraging our portfolio of Ground commercial, Home Delivery and Express services, they are getting the product to their customers faster, which, of course, is paramount to them and to their business growth.

Another retailer we work closely with is Chewy. Chewy was one of the first home delivery customers that benefited from our 6-day expansion. Due to their 1- to 2-day shipping commitment and 24-by-7 operations, they are ready to take full advantage of our new 7-day service.

Retailers and brands, large and small, have recognized our commercial teams for their partnership and for our ability to help them grow their business and successfully compete in the market.

Also, e-commerce will continue to create great opportunities for our LTL business. Our new FedEx Freight Direct service moves large bulky items into consumers homes and into businesses. Backed by the power of the FedEx brand and the speed and reliability of our nationwide priority network, we are able to reach over 80% of the U.S. population, and we have a unique ability to service a large part of this $10 billion market.

And of course, we can't forget about Roxo, the FedEx same-day bot, who has recently been in 3 test markets: Memphis, Tennessee; Plano, Texas; and Manchester, New Hampshire. Roxo is preparing to change the way on-demand e-commerce shipments make it to customers doorsteps.

While these e-commerce investments benefit the broader market, I am particularly excited about how the strategy will support small and medium businesses who remain our most profitable customers. In FY '19, our small and medium businesses grew more than 8%, and there is still a lot of room to grow as there are more than 32 million small businesses in the U.S.

Speaking of being there for small and medium businesses, we will not apply a residential peak surcharge this holiday season, a decision that has received outstanding feedback from countless small and medium-sized customers. It's a great way to help make our customers the hero, and e-commerce continues to grow and become a major part of their business.

Now let me turn the call over to Raj for his remarks.

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Rajesh Subramaniam, FedEx Corporation - President & COO [5]

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Thank you, Brie, and good afternoon, everyone.

As you all are aware, the global economic and trade environment remains very uncertain. Despite this uncertainty, FedEx remains committed to delivering long-term profitable growth. We are taking decisive actions to address the 3 topics that Fred covered in his opening.

Number one, reducing capacity, especially in our intercontinental network and overall directional costs in our Express business; number two, completing TNT integration; and number three, leveraging our infrastructure at FedEx Ground and making targeted investments that allow us to successfully go all-in on e-commerce.

Let me talk about each of these in turn. First, capacity cuts and overall cost reduction at FedEx Express. We expect the current softness in air cargo demand to continue into calendar year 2020. As such, we will take actions to reduce our intercontinental flights after our peak season to better match supply to demand. We are already decreased U.S. domestic flight hours, and we'll be aggressively looking for additional opportunities. The Express team is intensely focused on overall cost reduction. This includes different noncritical hiring, limiting discretionary spending and implementing structural cost initiatives such as the United States voluntary buyout program. In addition, we're looking at every opportunity to reduce capital spending. Benefits from all these changes will be realized in the coming quarters.

Secondly, let me update you on changing integration. Overall, I'm pleased to report that we have picked up the pace of integration and are continuing to improve our value proposition for our customers. Cross utilization of combined FedEx Express and TNT networks, which we shared on previous call, was a major step to our full integration of the operations. In June, these capabilities expanded across Europe. The transit times for FedEx intra-Europe and economy partner shipments improved at least 1 business day on approximately 40% of the European lanes across the 28 countries in Europe. We are well on our way to achieving full ground interoperability in our pickup and delivery networks in Europe by the end of May 2020.

Going into continental packages into the combined European Ground network allows us to improve service while simultaneously reducing our cost to serve. This will help us accelerate growth into Europe from all around the world. Asia-Europe lane, which remains the largest intercontinental trade lane, is particularly important in this regard. Given our strong presence in APAC and significantly enhanced presence in Europe, we expect to gain share in this lane in the months and years to come.

Additionally in Q1, we integrated customs clearance and brokerage services in Europe to provide a more seamless experience for our customers. This milestone ensures well prepared for Brexit no matter the outcome.

Clearance integration is also very important for us to enable cross utilization of TNT road network for intercontinental shipments. And as mentioned on the previous call, sales integration is practically complete. And now we are presenting a single face to our customers nearly everywhere around the world.

And thirdly, e-commerce. Fred and Brie have discussed our robust portfolio. Let me now address the enhancements specifically underway within FedEx Ground, which is the backbone of our e-commerce strategy. FedEx Ground continues to transform the package delivery business in response to a growing market demand. Network investments, including 7-day residential delivery, large package capabilities and SmartPost integration position us for future growth. Leveraging the most automated network in the industry, we once again offer 7-day residential service to our customers throughout the peak season. After peak, the 7-day residential delivery will become a permanent piece of our service offering. This will speed up our lanes throughout the week and further extend our competitive advantage in some cases by 2 days.

We're also well underway in building our Ground's largest package handling capabilities to accommodate items like TVs, tires and furniture. This includes dedicated large package facilities, plus new handling equipment in more than 30 of our existing stations prior to peak.

In terms of SmartPost, the integration of that volume into our network directly addresses one of the biggest challenges in the industry, density. From a cost perspective, moving these packages to the same service providers already delivering Ground commercial and residential packages goes a long way in driving density up and driving the cost per delivery down. Integrating this volume provide significant growth opportunities for thousands of entrepreneurs who run pickup and delivery businesses with FedEx Ground.

We're already started transitioning SmartPost volume. Majority of which will move during next calendar year. This should be complete before peak season in 2020. Investments FedEx Ground has made and will continue to make in technology aim to optimize operations, reduce costs and enable real-time decision making based on applied data analytics. We're offering our service providers new technology tools so they can make decisions about how best to run their businesses each day in terms of staffing needs, vehicular plans and optimized routes. Arming our employees and service providers with these state-of-the-art tools expected to drive efficiency in FedEx Ground operations as well as the operations of service providers, all while strengthening the reliability of FedEx Ground service.

Several of these tools have started to be implemented in select markets prior to peak. Immediate benefits will begin to be realized in fiscal year '20, with increased benefit in the years to come. These investments will allow us to provide the speed and reliability our customers value while offering market-competitive prices as the low-cost last-mile provider. This means we are facing near-term headwinds, including additional costs related to our service expansions and SmartPost volume integration, but these investments are necessary and will pay off in coming years.

And speaking of last mile, we're strategically working with a number of retailers to leverage their physical infrastructure with our transportation and logistic infrastructure to provide market-leading value proposition for the end consumer. Interest from retailers remain very high in this regard.

In closing, as we approach another busy peak shipping season, we are well prepared to once again deliver exceptional service to our customers. We expect record-breaking volumes in multiple Mondays during the peak season. E-commerce growth continues, which in turn drive strong demand for residential delivery. Peak season is 4 days shorter this year, and operational intensity remains the same.

We have been preparing in close collaboration with our customers all year. The FedEx team of more than 450,000 outstanding team members is the best in the business and is ready to deliver the holidays once again for our customers around the world.

In summary, the power of our network, coupled with the hard work and dedication of our global team, sets us on a path of long-term profitable growth.

Now I will turn it over to Alan Graf to provide details on our financials. Alan?

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Alan B. Graf, FedEx Corporation - Executive VP & CFO [6]

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Thank you, Raj, and good afternoon, everyone.

First quarter operating results were impacted by several factors, weakening global trade and industrial production have resulted in less-than-expected demand for our most profitable Express package and freight services. Express yields have also been negatively impacted due to the result in mix shift, lower weight per package and customer trade down to slower, lower priced services. These conditions are especially challenging in Europe where capacity and network reductions are limited due to the current stage of integration as we are operating duplicate road and air networks.

FedEx Ground operating costs were higher due primarily to our expansion of operations to 6 days per week, higher purchased transportation costs attributable to volume growth and expansion to 6-day operations and higher self-insurance expenses. Each transportation segment had 1 fewer operating day in the first quarter versus the prior year, which is estimated to have lowered earnings by approximately $100 million. The loss of volume from Amazon had a negative impact to the quarter. Operating costs, including depreciation, also increased with strategic investment programs, including the modernization of FedEx Express aircraft and hubs and investment in technology across the enterprise that will further optimize our networks as well as enhance safety and capabilities.

The modernization of our aircraft fleet lowers costs through enhanced reliability, reduced maintenance costs and improve fuel efficiency. Partially offsetting these negative factors were the benefits from an approximate $300 million decrease in variable incentive compensation, FedEx Ground volume growth of 7%, increased revenue per shipment at FedEx Freight and FedEx Ground, and cost reductions from business realignment activities, including the U.S. voluntary employee buyout initiated last year.

Looking ahead through the rest of fiscal 2020, we are now forecasting adjusted earnings per share of $11 to $13 per share. The new forecast reflects our lower revenue outlook driven by increasing trade tensions and the corresponding weakening in global economic conditions, especially industrial production that has occurred since our June earnings release. With the increasing uncertainty of trade negotiations and government policies, forecasting customer demand and our corresponding earnings is exceedingly difficult. Our forecasts assume moderate U.S. economic growth, current fuel price expectations and no further weakening in international economic conditions. A further ramping in any trade measures and/or adverse changes in international trade policies and relations would likely drive additional weakness in our business.

While our current expectation is to earn slightly above the midpoint of our $11 to $13 range, we believe the range is appropriate given the current macro and business conditions we are experiencing.

In addition to the impact of macro uncertainty, FedEx Ground operating expenses are expected to be higher than our previous forecast due to volume mix, lower-than-planned delivery density, higher wage rates and ongoing investments to enhance our e-commerce capabilities, including our expansion of 7-day operations. The new forecast also reflects the loss of FedEx Ground business from Amazon that began in August.

Our FY '20 effective tax rate prior to the year-end mark-to-market retirement plan accounting adjustment is now expected to increase 24% to 26% due to lower-than-expected earnings in certain non-U. S. jurisdictions.

In response to these issues, we are taking additional actions on a number of fronts to better align our costs, including post peak reductions to the global FedEx Express air network. We continue to expect to incur $350 million of TNT integration expenses in FY '20 and $1.7 billion in total through FY '21. We also continue to expect FY '20 capital spending to be approximately $5.9 billion. While it's early in the process, we anticipate FY '21 capital spending will be similar to FY '20.

During the first quarter, we issued $2.1 billion of debt. We used the proceeds to redeem debt maturing in this fiscal year as well as to contribute $1 billion to our pension plans. We do not expect to make additional contributions to our U.S. pension plans this fiscal year. We also have no material debt maturities prior to fiscal 2022.

In conclusion, we are taking actions to mitigate the effects of macroeconomic uncertainty. However, we are continuing to make strategic investments to improve our capabilities and efficiency, which we expect will drive long-term growth of earnings, margins, cash flow and returns.

Now the operator can begin the question-and-answer session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll hear first from Chris Wetherbee from Citi.

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Christian F. Wetherbee, Citigroup Inc, Research Division - VP [2]

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I guess I wanted to just talk about the reduction in guidance and get a little bit specific if we could. If you think about the difference of where you were 3 months ago versus where you are today, it kind of equates to almost the $900 million write-down in the operating profit of the business this fiscal year. So if you could give us a little bit more specific sort of bucket breakdown, what may be the lower revenue based on macro and then what may be caused by higher costs associated with certain restructuring in the network to adapt to e-commerce, that would be very helpful.

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Frederick W. Smith, FedEx Corporation - Founder, Executive Chairman & CEO [3]

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Chris, I would say that the vast majority of this $900 million is the reduction of our revenue forecast associated with the macroeconomic conditions that we did not expect. Some of the cost increases that you are seeing, that have some impact, but the main reason was the macro. The biggest impact, of course, was that Express and that was in international with a large degree of that in Europe.

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Operator [4]

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We'll hear next from Scott Group with Wolfe Research.

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Scott H. Group, Wolfe Research, LLC - MD & Senior Transportation Analyst [5]

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So this is, I think, the fifth straight quarter of either missing or cutting missing numbers or cutting guidance. Are you approaching guidance any differently, meaning taking a more conservative approach here? Anything that you think that gives you some confidence or have some confidence that this is the final cut? And then separately, just want to understand, Raj, you said we're doing everything we can to reduce capital spending and, yet CapEx is staying unchanged and now flat next year as well. So can you help us understand that? I know that's 2 questions, but we need some handle in here, I think.

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Alan B. Graf, FedEx Corporation - Executive VP & CFO [6]

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Scott, I'll take them both. The lack of being able to hit our forecast is just the difficulty associated with forecasting in this environment. I don't think we've been too aggressive based on what we knew at the time. You've noticed that we widened the range this year. And I did mention that our current point estimate is higher than the midpoint of that range, so we're giving ourselves a little bit more downside. I also said that we don't -- we're not expecting any additional weaknesses in the international macro environment from where we are today, which is a wild card. So I just want to point those things out to you.

As far as CapEx, trust me, FY '21 would be a lot higher than $5.9 billion had we not started cutting already. I think there are 2 things that are really important to understand. And number one is we have to continue to modernize the fleet. The profound impact of the lower costs and high reliability of the new twins is just remarkable. And we're going to continue to do that. We're going to maybe stretch that out a bit, but not much because the faster we can get those in there, the faster we can enjoy those benefits. Fred mentioned a number of aircraft that we're going to take out of service, either fully retiring or parking. So we're not adding capacity in our international network. And in fact, we're reducing that, and we're reducing our domestic flight hours. But we need to modernize and fleet. It's very important.

Secondarily on the hubs at Express, where they're underway, we have a lot of things that are committed. But the improved automation and processing capabilities of those 2 hubs when we finish are also profound in terms of the productivity and amount of throughput we can handle, and we anticipate that we're going to need that. If we get further deterioration in the macro environment or we see something in the U.S. that looks like a recession, we'll definitely cut further. But those are our plans at the moment.

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Operator [7]

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We'll hear next from Jack Atkins with Stephens.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [8]

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Can you quantify the P&L benefits from the capacity cost actions you announced this afternoon? And I guess from a bigger picture perspective, why are these capacity adjustments only being made now when it feels like we've been facing more challenging trade and industrial production trends since last December? What's prevented you from taking these actions before today?

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Frederick W. Smith, FedEx Corporation - Founder, Executive Chairman & CEO [9]

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Let me take a shot at that. This is Fred Smith speaking. First of all, I think it's important to look at the things that we've said over the last few earnings call in the context of about what's going on globally. I mean I watch the business press every day, and I have to tell you I think there is a lot of whistling past the graveyard about the U.S. consumer and the United States economy versus what's going on globally. So the serious trade disputes began in the spring of 2018, and they escalated throughout the summer of 2018. And most people don't think about the fact that when China slows down because of U.S. tariffs or uncertainty or for whatever reason, as big a victim if you want to call it that of the China slowdown is Europe because Germany's contraction is because of they're not selling as much to China, which is a huge customer of Europe.

So remember last spring, there was a tremendous amount of euphoria when we were going to get a deal -- China trade deal. And then at the last minute, it broke up. And then over the period of the summer, there have been escalating tariffs on both sides and increasingly lowered industrial production. And that's why we put those charts up on the IR website. So we're reacting inside of FedEx to these same things. So as we went into the fiscal year, we were hopeful of a trade deal and some sort of restoration of normalcy, that has not taken place.

And the U.S. consumer, which is a remarkable driver of growth and employment and all the things that are spoken about every day, sort of masked the fact that the goods-producing sector, which we're in the midst off, is much more global in nature than the U.S. consumer, which is largely services and certain consumption. So that's the reason that we began the year the way we began it. And should we have moved faster or known faster or what have you. I mean all I can do is report the numbers as we see them.

And I would point out to you that last fall, we were the first people that call this out, and I remember very vividly. I mean we are the leading prognosticator of this. We have 15 million votes every day in our system. And I remember when we made this call on CNBC, they took our heads off that we were "blaming" someone. We're just reporting what's going on and reacting to these macroeconomic things. And as Alan said, that's why it makes it so hard to forecast. We think we've taken appropriate steps. We'll do more if we have to, but I can't get any better answer than what I just did.

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Operator [10]

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And from Barclays, we'll move on to Brandon Oglenski.

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Brandon Robert Oglenski, Barclays Bank PLC, Research Division - VP & Senior Equity Analyst [11]

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So Fred, I guess, coming off of that, I mean, clearly, you guys have a culture of forward innovation and growth at FedEx. But I guess on the flip side, is there any like real ingrained process of the company that says, "Hey, we need to challenge every day what isn't working?" Because maybe even outside this cyclical pressures, I mean, if you look at your LTL business, we can benchmark to other carriers that do better. Obviously, Express margins are quite at a low point right now. And you look at logistics or like FedEx Office, which we don't think have contributed a lot in the past. So I guess what can you tell investors is the process for looking at things that maybe didn't pan out quite as well as you thought?

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Frederick W. Smith, FedEx Corporation - Founder, Executive Chairman & CEO [12]

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Well, I think you are a great person to ask that, Brandon, because your so-called deep dives. So let's talk about LTL. I don't think we have John Smith here today. First of all, there are other carriers that do better than FedEx with the exclusion of perhaps a little small carriers, one store I'm not familiar with. I believe the better way to put that is there is 1 LTL carrier that does better than we do. And that's Old Dominion, and we're great admirers of Old Dominion. But Old Dominion operates a network that has, I believe, somewhere in the 200 and some odd stations versus our 360 that don't deliver every day to every part of the United States. And they've been very brilliant in finding a niche that's, for lack of a better term, near TL. It's in that zone between LTL and TL, and their average weight per shipment in a much more dense network is about 350, 400 pounds higher. So their margins are outstanding, and they are terrific. And obviously, we benchmark them carefully as our other competitors, which gets to your point, do we ever think about doing things differently. And the answer to that question is we think about doing things differently constantly.

Secondly, in the Express business, there is a belief, including you, Brandon, that somehow, our Express operation in the United States is not profitable. Our Express operation in the United States is very profitable. And we have some of the best industrial engineers and operating -- operations research people in the country. So there has been this constant mantra for 10 years that, oh, we ought to put Express and Ground together. Well, my goodness. We've gained market share in Ground for 19 out of 20 years. And Brie and Raj just told you, we think it's going to continue, and our competitive advantage is going to improve. So we're very convinced that the way that we are operating is the preferred way. And yes, we look at it every day.

The third thing, I guess, people fired up and, I guess, what Scott Group just mentioned is about CapEx is we're profligate in terms of CapEx. The reality is about $0.60 out of every $1 we're spending on CapEx are to modernize the Express hubs, to put in this new technology. We can't get people in Indianapolis and Memphis to work. They're not out there, plus it improves the productivity, so the failure to do it would be very dire. And as Alan has said and we've said over and over again, every time we bring on a 767 and to a much lesser degree, the 777 because we're not buying many of them. It's accretive to earnings. The reliability goes up. So could we stop buying 767s and 777s? Yes. But why don't we stop buying them? Because we put a chart on the earnings -- the IR website today that showed the synergy between the 3 major opcos. So 80% of our customers buy all 3 of the services.

So if you took FedEx and tried to subject it, let's say, to -- I think, it was BCG that came up to that diagram. We have -- and cash flows in one thing or another, if you did not improve the Express company unless your costs get out of control, you couldn't win in the Ground sector and vice versa. So we are very convinced, and we put up a chart that specifically addressed your comments about this. FedEx will unquestionably be the low-cost producer in the domestic Express business because of the fleet modernization. And that includes any new entrants into the business. Yes, we have far -- higher pilot cost and AMT cost perhaps than the third-party providers. We think that's a good thing, but our total productivity and cost per ton-mile are down 2% over the past 10 years in this year's dollars. I'm not talking about inflated dollars. I'm talking about 2019 dollars are 2% less than 2009 dollars.

So the fleet modernization, yes, we could stop it, and yes, we could stop that CapEx, but the competitive positioning against our major competitors. And the last thing I'm going to say is we basically compete in an ecosphere that's got 5 entities in it. There's UPS. There's DHL. There's the U.S. Postal Service. And now increasingly, there's Amazon. That's who we wake up every day trying to think about how we compete against and give the best services to our sales force. So it reminds me of the days in the service where you run all these fake maneuvers one thing or another. It's a lot different when you've got competition on the other side. So we try to beat these folks, the UPS, and in particular has a very strong retail presence, and both UPS and DHL have significant forwarding presences. So we decided that we would basically cover those portfolio gaps with more focused capabilities. And that's why we operate differently. We carry retail freight on our Purple tails and interline it, we don't have a huge forwarding operation. And we have a retail network that is smaller than UPS store or franchise network, but utilizes partners, as Brie talk to you about Walgreens and, more recently, Dollar General and some others. So the reason I'm going on about this, I'm not quite sure about how those mantra got started that we're hardheaded or we're not willing to look. We'll look at anything. But what we can't do is to change the reality of the math. We can't make the competition go away. I wish they would. Just leave the field. They're very good operators. And the third thing that we have to deal with is the macroeconomic environment. And by the way, there is no company and no person that has been more vocal in our opposition to the trade policies that we are pursuing. Now to be fair, I think it's not just the U.S. I think China is also pursuing bad trade policy. So you're taking a system. Over the last 7 years has drawn more people out of poverty than in the entire previous history of the world and essentially putting in all at risk. So these numbers on these macroeconomic production indicators, we didn't make those up. That's what's going on. So I apologize for the length of the response, but it's to this continuing drumbeat that somehow we're not willing to look at something and you take selective things like your LTL operation isn't as good as "all the others." It's not as good as one, and it's not as good as the other ones in terms of margins for the reasons that I gave you. So it's important to look at this thing with those context in mind. Next question.

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Operator [13]

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We'll hear now from Allison Landry with Crédit Suisse.

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Allison M. Landry, Crédit Suisse AG, Research Division - Director [14]

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So you talked a lot about the short-term cost inflation at Ground and driving down the cost of delivery longer term. I think you've done a pretty good job of explaining that to the market, but it sounds like you're also seeing some unexpected costs for higher wage rates, lower delivery density and so forth. So I guess could you help us understand some kind of time line for when we should expect to see some of the operating leverage and inflection in margins at the Ground segment? Is fiscal '21 the right way to think about it? Or do we need to look further out than that?

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Alan B. Graf, FedEx Corporation - Executive VP & CFO [15]

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I like our Ground margins. I think they're fine. And I think we told you early on in the intro, Allison, that there's at least it goes to zone 1, where we think we're growing to grow really rapidly. We're talking about lower yields and higher margins. So I think Ground is performing admirably. The issue at Ground is there's just not the commercial traffic we plan to have, which has significantly higher density than Home Delivery does. Home Delivery is growing like crazy, and the commercial business is not because of industrial production and all the other things we said. So that's a fairly simple explanation. We're adjusting the model accordingly to do that. I think Ground is in great shape. I think it's doing fantastic, and I don't see anybody making better margins than us.

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Frederick W. Smith, FedEx Corporation - Founder, Executive Chairman & CEO [16]

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Let me make one comment here, and then Raj and/or Henry Maier, the CEO of FedEx Ground, is sitting here, so he can speak to this, too, Allison. First thing that people need to understand, the things we announced this spring and this summer, we didn't dream them up in the last few months. We've been working on these for almost 4 years. And during that period of time, we have invested an enormous amount of money in IT, which has been dragged through the P&L to make sure that I can make a statement, and let me make it again because I think it may have gone over some people's heads. We will in the short zone market, the zone 1 market, the shift from store or ship from local DC, FedEx will be the low-cost, high-service producer. You can put the traffic in very, very late at night or in the morning and at lower cost than anybody, and I mean anybody. All of the 5 competitors that I mentioned a moment ago. So all of these moves that we announced were triggered by a series of developments, and the strategy has been in production for a long time. So we're very confident about where this market is going that Brie described to you, and we're very confident in Ground's position. But as Alan just mentioned, the B2B Ground business is being adversely affected for the same reason that the international PMI is going down. The trade effects in the goods production side of the house is much greater than it is in the services business, and that's being reflected across all our businesses, Freight, Ground commercial, and particularly, international. Henry? Raj?

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Rajesh Subramaniam, FedEx Corporation - President & COO [17]

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Well, let me just add onto that by just saying that there's a strong divergence between the strong consumer sector and the weak factory sector around the world, and U.S. has been no exception. The industrial production in the U.S. is expected to be flat to negative in the second half of CY '19. That's the issue. And once we get the commercial traffic. That's the issue. Ground is doing very, very well. And we are definitely investing for the future, and we are going to have the market-leading value proposition best servers at low cost. Let me turn it over to Henry for his comments.

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Henry J. Maier, FedEx Corporation - President & CEO of Fedex Ground [18]

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Allison, let me just add cost headwinds at Ground are largely 6- and 7-day because there's a minimum number of people, and just to staff a building in order to operate it prior to the volume and revenue coming on. The way trade issue is a number of things. First is year-over-year driver rates, which are reflective of the intense competition for truck drivers in certain geographic markets both in P&D and line haul. However, what we see going forward as we transition out of the current model into the independent service provider model, which will be completely stood up on October 12 is annual, if not multiyear negotiations with those businesses about their settlement rates.

Finally, we've talked about the robust labor environment out there. There are geographic markets where it's highly competitive to get package handlers into the building. And while our automated network benefits us greatly in that regard or employees where we're competing for the same unskilled labor in the market, we have to be cost competitive. And that's just a function of strength of the economy and the markets we operate in.

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Operator [19]

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From Goldman Sachs, we'll move to Jordan Alliger.

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Jordan Robert Alliger, Goldman Sachs Group Inc., Research Division - Research Analyst [20]

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Just sort of from big picture standpoint, can you remind a little bit what your long-term earnings or profit growth targets would be sort of once we get past this noise? And perhaps assess the ability of things to bounce back, assuming the economy is okay and assuming you implement the cost initiatives and the capacity initiatives that you do, do you anticipate as we look into fiscal '21 and '22 that sort of growth can exceed sort of that long-term EPS growth target?

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Alan B. Graf, FedEx Corporation - Executive VP & CFO [21]

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It depends on your outlook for the economy for sure. I mean we said we're going to be really well positioned by the end of '21. Yes, we were late and over budget on the TNT integration, but we're there. We will be there. And I don't know what the economic environment in Europe will be at that point, but we will be able to significantly reduce our costs and improve our service for all the reasons we've told you about. That's one. Two, there's some of the things that we talked about at Ground like the loss of Amazon, getting ready for 6- and 7-day, a lot of that stuff will be behind us, and we'll be ready to move forward.

So given a decent economic environment, we ought to be able to easily hit our 10% to 15% earnings EPS growth going forward. But I can't tell you that, that's going to be the case because I can't tell you what exactly the comment is going to look like right now. So if I'm a little gun shy, yes, probably, yes.

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Operator [22]

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Moving on to David Ross with Stifel.

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David Griffith Ross, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Global Transportation and Logistics [23]

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Maybe a question for Mark. With Assembly Bill 5 out in California, I know that since the [stratification] has been refining the independent contractor model and now we're moving toward an all-ISP model. Is there anything in that proposed bill that could challenge the current ISP model? Or how are you guys viewing that right now?

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Henry J. Maier, FedEx Corporation - President & CEO of Fedex Ground [24]

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David, it's Henry Maier. I've been designated the company paralegal for this call. Let me give the people listening in a little bit of background on Assembly Bill 5. Back on April 30 of 2018, the California Supreme Court issued a ruling in the Dynamex case, which held that an ABC test should be used to determine whether workers, an employee or an independent contractor. Assembly Bill 5 is just an attempt by the legislature to codify the dynamics decision of the Supreme Court. For those who weren't aware, there are a number of states that have ABC test. The A prong, an individual must be free of control and direction. The B prong is service has to be performed outside the usual course of business of the employer. And the C prong is the individual is customarily engaged in an independently established trade occupation profession or business. This is intended to address individuals who are classified as independent contractors. We believe it's largely directed at the ride-sharing and food delivery business in California. And because FedEx Ground only contracts with businesses that are incorporated and in good standing in the states in which would they operate, we, therefore, have no individuals who are classified as independent contractors. All service provider or employees under contract to FedEx Ground are subject to tax withholdings and are eligible for workers' comp, unemployment insurance and overtime. And all of our service providers are contractually obligated to treat their workers as employees are registered, as I said, in good standing with the states and agreed to compliance audits by the company. So therefore, we think that any risk that would accrue to FedEx Ground would be minimal to nonexistent, the way the bill is currently structured.

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Operator [25]

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Helane Becker with Cowen and Company has our next question.

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Helane R. Becker, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [26]

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Brie, I think you talked about demand from China being down between 10 in the U.S. and 10 in Europe. But did you speak at all to goods going from China to third countries? And then how those volumes are doing? For example, China to Vietnam and then Vietnam to the U.S. or Thailand or places elsewhere in Asia. So maybe you could talk about trends you're seeing in goods moving that way, if at all.

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Brie A. Carere, FedEx Corporation - Executive VP and Chief Marketing & Communications Officer [27]

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Sure. Great question. Obviously, right now, from an outlook perspective, we are seeing pressure and all intercontinental and even within Asia. All of intra-Asia really is connected from a supply chain perspective. So even if it isn't direct to China, we are seeing a lot of pressure intra-Asia. What I think is most important to note as we both Raj and I mentioned is we are underpenetrated from a market share perspective between Asia and Europe and Europe to Asia. We now unleashed an incredible buyer base in Europe, which we never had access to before. We have traditionally been very underpenetrated in this lane. And Joe and I are locked arm and arm to grow share despite the macroeconomic headwind. So I think that's really what's most important. That's what's newsworthy for us as we think about growth moving forward.

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Operator [28]

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And from Oppenheimer, we'll move to Scott Schneeberger.

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Scott Andrew Schneeberger, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [29]

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(technical difficulty)

in International priority and international economy and the environment. And perhaps provide a perspective on the influence of fuel prices and the trade down dynamic if and how that may factor into this updated guidance.

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Alan B. Graf, FedEx Corporation - Executive VP & CFO [30]

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Scott, fuel prices have very little to do with us at this point. And I think it's just a macroeconomic environment and primarily the industrial sector of the global economy that's driving that change.

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Operator [31]

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We'll move next to Bernstein Research's David Vernon.

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Unidentified Analyst, [32]

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Asking on behalf of David Vernon. How should we think about the greater than 20% increase in corporate center loss? And is there any outlook there?

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Alan B. Graf, FedEx Corporation - Executive VP & CFO [33]

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Well, we have moved FedEx Office out to its own now. As you noticed, and while FedEx Office itself, for reporting purposes, reports a loss, you can view that as a channel cost, if you like. It's vital channel. And we've talked about this over and over and over again. Our most profitable packages come through FedEx Office. FedEx office has got many places where you can pick up, drop off, great relationship going with in-store at Walmart. So I wouldn't be too concerned about that. We have work to do on our logistics side of the house. We are working very hard on that. And I expect those will improve over time. But really, at the end of the day, again, the real issue -- I want to make sure I get this clear to everybody, all things we talked about are issues international at Express.

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Operator [34]

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And from Deutsche Bank, we'll move to Amit Mehrotra.

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Amit Singh Mehrotra, Deutsche Bank AG, Research Division - Director and Senior Research Analyst [35]

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Just wanted to ask if you think 2020 will represent a trough in Ground margins that you can build on in 2021 given the, I guess, the SmartPost integration? And then can you just update us on the integration of TNT businesses in the U.K., France and Germany? Where are those countries given their size? And when do you expect the integration to be complete for those regions?

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Alan B. Graf, FedEx Corporation - Executive VP & CFO [36]

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I think that was 2. I think we've answered them both, but I'll try to stab at this again. We will be complete with those countries at the end of May 2020. Again, as you well pointed out in your note, we were a little bit late, a little bit over budget on that. Thank you for that. And as far as FedEx Ground margins, again, we will have a lot of these things behind us. It will depend on our mix and the economic environment about how fast we can move margins up, but we do expect our zone 1 traffic to grow rapidly. And although at lower yield, it will be at higher margins.

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Operator [37]

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And with that at this time, I'd like to turn things back to you all for any additional or closing remarks.

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Mickey Foster, FedEx Corporation - Staff VP of IR [38]

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Thank you for your participation in the FedEx Corporation First Quarter Earnings Conference Call. Feel free to call anyone on the Investor Relations team if you have additional questions about FedEx. Thank you very much. Bye.

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Operator [39]

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Again, that will conclude today's conference. Thank you all for joining us.