UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 2004,
	OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO __________

 

Commission File Number:  1-7806

 

FEDERAL EXPRESS CORPORATION

(Exact name of registrant as specified in its charter)

 

 

(901) 369-3600

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨   No ý

 

The number of shares of common stock outstanding as of December 10, 2004 was 1,000.  The Registrant is a wholly owned subsidiary of FedEx Corporation, and there is no market for the Registrant’s common stock.

 

The Registrant meets the conditions set forth in General Instructions H(1)(a) and (b) of Form 10-Q and is filing this form with the reduced disclosure format permitted by General Instruction H(2).

 

 

FEDERAL EXPRESS CORPORATION

 

INDEX

 

PART I.  FINANCIAL INFORMATION

 

		PAGE
ITEM 1.  Financial Statements
	Condensed Consolidated Balance Sheets November 30, 2004 and May 31, 2004	3-4
	Condensed Consolidated Statements of Operations Three and Six Months Ended November 30, 2004 and 2003	5
	Condensed Consolidated Statements of Cash Flows Six Months Ended November 30, 2004 and 2003	6
	Notes to Condensed Consolidated Financial Statements	7-12
	Report of Independent Registered Public Accounting Firm	13
ITEM 2.  Management’s Discussion and Analysis of Results of Operations and Financial Condition		14-19
ITEM 3.  Quantitative and Qualitative Disclosures About Market Risk		20
ITEM 4.  Controls and Procedures		20
PART II.  OTHER INFORMATION
ITEM 6.  Exhibits		21
Signature		22
Exhibit Index		E-1

 

2

 

FEDERAL EXPRESS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN MILLIONS)

 

ASSETS

 

		November 30, 2004			May 31, 2004
		(Unaudited)
CURRENT ASSETS
Cash and cash equivalents		$	240		$	274
Receivables, less allowances of $114 and $119		2,643			2,475
Spare parts, supplies and fuel, less allowances of $134 and $124		206			205
Deferred income taxes		394			393
Prepaid expenses and other		55			71
Total current assets		3,538			3,418
PROPERTY AND EQUIPMENT, AT COST		14,147			13,849
Less accumulated depreciation and amortization		8,080			7,782
Net property and equipment		6,067			6,067
OTHER LONG-TERM ASSETS
Due from parent company		1,999			1,961
Goodwill		341			340
Other assets		687			419
Total other long-term assets		3,027			2,720
		$	12,632		$	12,205

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3

 

FEDERAL EXPRESS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN MILLIONS, EXCEPT SHARE DATA)

 

LIABILITIES AND OWNER’S EQUITY

 

		November 30, 2004			May 31, 2004
		(Unaudited)
CURRENT LIABILITIES
Current portion of long-term debt		$	161		$	133
Accrued salaries and employee benefits		694			687
Accounts payable		1,216			1,131
Accrued expenses		877			851
Due to parent company and other FedEx subsidiaries		217			247
Total current liabilities		3,165			3,049
LONG-TERM DEBT, LESS CURRENT PORTION		1,031			1,123
OTHER LONG-TERM LIABILITIES
Deferred income taxes		497			528
Pension, postretirement healthcare and other benefit obligations		621			589
Self-insurance accruals		508			486
Deferred lease obligations		491			494
Deferred gains, principally related to aircraft transactions		407			422
Other liabilities		39			36
Total other long-term liabilities		2,563			2,555
COMMITMENTS AND CONTINGENCIES
OWNER’S EQUITY
Common stock, $0.10 par value; 1,000 shares authorized, issued and outstanding		—			—
Additional paid-in capital		298			298
Retained earnings		5,570			5,213
Accumulated other comprehensive income (loss)		5			(33		)
Total owner’s equity		5,873			5,478
		$	12,632		$	12,205

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4

 

FEDERAL EXPRESS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(IN MILLIONS)

 

		Three Months Ended November 30,						Six Months Ended November 30,
		2004			2003			2004			2003
REVENUES		$	4,803		$	4,250		$	9,388		$	8,359
OPERATING EXPENSES:
Salaries and employee benefits		1,833			1,768			3,682			3,562
Purchased transportation		211			172			407			332
Rentals and landing fees		397			381			777			749
Depreciation and amortization		196			200			392			399
Fuel		513			310			935			603
Maintenance and repairs		321			292			645			576
Business realignment costs		—			276			—			408
Airline Stabilization Act charge		48			—			48			—
Intercompany charges, net		373			350			734			697
Other		584			520			1,138			1,030
		4,476			4,269			8,758			8,356
OPERATING INCOME (LOSS)		327			(19		)	630			3
OTHER INCOME (EXPENSE):
Interest, net		(11		)	(16		)	(24		)	(3		)
Other, net		(16		)	(13		)	(33		)	(23		)
		(27		)	(29		)	(57		)	(26		)
INCOME (LOSS) BEFORE INCOME TAXES		300			(48		)	573			(23		)
PROVISION (BENEFIT) FOR INCOME TAXES		111			(18		)	215			(16		)
NET INCOME (LOSS)		$	189		$	(30	)	$	358		$	(7	)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5

 

FEDERAL EXPRESS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(IN MILLIONS)

 

		Six Months Ended November 30,
		2004			2003
OPERATING ACTIVITIES
Net income (loss)		$	358		$	(7	)
Noncash charges (credits):
Depreciation and amortization		392			399
Other, net		(30		)	28
Changes in operating assets and liabilities, net		(12		)	434
Cash provided by operating activities		708			854
INVESTING ACTIVITIES
Capital expenditures		(641		)	(261		)
Proceeds from asset dispositions		1			2
Cash used in investing activities		(640		)	(259		)
FINANCING ACTIVITIES
Principal payments on debt		(64		)	(43		)
Net payments to parent company		(38		)	(400		)
Cash used in financing activities		(102		)	(443		)
CASH AND CASH EQUIVALENTS
Net (decrease) increase in cash and cash equivalents		(34		)	152
Cash and cash equivalents at beginning of period		274			137
Cash and cash equivalents at end of period		$	240		$	289

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6

 

FEDERAL EXPRESS CORPORATION (FEDEX EXPRESS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

(1) General

 

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.  This Quarterly Report on Form 10-Q reflects the operations of Federal Express Corporation (“FedEx Express”) and our subsidiaries.  These interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information, the instructions to Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X and should be read in conjunction with our Annual Report on Form 10-K for the year ended May 31, 2004.  Accordingly, significant accounting policies and other disclosures normally provided have been omitted since such items are disclosed therein.

 

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (including normal recurring adjustments) necessary to present fairly our financial position as of November 30, 2004, the results of our operations for the three- and six-month periods ended November 30, 2004 and 2003 and our cash flows for the six-month periods ended November 30, 2004 and 2003.  Operating results for the three- and six-month periods ended November 30, 2004 are not necessarily indicative of the results that may be expected for the year ending May 31, 2005.

 

We are a wholly owned subsidiary of FedEx Corporation (“FedEx”) engaged in a single line of business and operate in one business segment – the worldwide express transportation and distribution of goods and documents.

 

Except as otherwise specified, references to years indicate our fiscal year ending May 31, 2005 or ended May 31 of the year referenced and comparisons are to the corresponding period of the prior year.

 

BUSINESS REALIGNMENT COSTS.  During 2004, we incurred $422 million of business realignment costs related to voluntary early retirement and severance programs ($276 million in the second quarter and $408 million in the first half of the year).  At May 31, 2004, we had remaining business realignment related accruals of $23 million.  At November 30, 2004, these accruals had decreased to $11 million due predominantly to cash payments made in the first half of 2005. The remaining accruals relate to management severance agreements, which are payable over future periods.

 

GUARANTEES.   We provide guarantees on FedEx debt instruments jointly and severally with other affiliated companies in the FedEx consolidated group.  In addition, we guarantee, jointly and severally with other affiliated companies in the FedEx consolidated group, FedEx’s $1 billion revolving credit agreements, which back its commercial paper program.

 

EMPLOYEES UNDER COLLECTIVE BARGAINING ARRANGEMENTS.  Our pilots, who represent a small number of our total employees, are employed under a collective bargaining agreement that became amendable on May 31, 2004.  Negotiations with the pilots’ union began in March 2004.  In accordance with applicable labor law, we will continue to operate under our current agreement while we negotiate with our pilots.  We cannot estimate the financial impact, if any, the results of these negotiations may have on our future results of operations.

 

AIRLINE STABILIZATION ACT CHARGE. During the second quarter of 2005, the United States Department of Transportation (“DOT”) issued a final order in its administrative review of our claim for compensation under the Air Transportation Safety and System Stabilization Act (“Act”).  Under their

 

7

 

interpretation of the Act, the DOT determined that we are entitled to $72 million of compensation, an increase of $3 million from its initial determination.  Because we had previously received $101 million under the Act, the DOT has demanded repayment of $29 million.  While we will vigorously contest this determination judicially and will continue to aggressively pursue our compensation claim, we can no longer conclude that collection of the entire $119 million recorded in fiscal 2002 is probable.  Accordingly, we recorded a charge of $48 million in the second quarter of 2005, representing the DOT’s repayment demand of $29 million and the write-off of a $19 million receivable.  Should any additional amounts ultimately be recovered by us on this matter, they will be recognized in the period that they are realized.

 

(2) Comprehensive Income (Loss)

 

The following table provides a reconciliation of net income (loss) reported in our financial statements to comprehensive income (in millions):

 

		Three Months Ended November 30,
		2004			2003
Net income (loss)		$	189		$	(30	)
Other comprehensive income:
Foreign currency translation adjustments, net of deferred taxes of $6 and $4		31			20
Comprehensive income (loss)		$	220		$	(10	)
		Six Months Ended November 30,
		2004			2003
Net income (loss)		$	358		$	(7	)
Other comprehensive income:
Foreign currency translation adjustments, net of deferred taxes of $6 in 2004		38			10
Comprehensive income		$	396		$	3

 

8

 

(3) Employee Benefit Plans

 

A majority of our employees are covered by the FedEx Corporation Employees’ Pension Plan, a defined benefit pension plan sponsored by our parent, FedEx.  The plan covers certain U.S. employees age 21 and over, with at least one year of service.  For more information about this plan refer to the financial statements of FedEx included in its Form 10-Q for the quarter ended November 30, 2004.  We incurred a net periodic benefit cost of $62 million and $128 million for the second quarter and six months ended November 30, 2004, respectively, for our participation in the FedEx Corporation Employees’ Pension Plan.  We incurred a net periodic benefit cost of $62 million and $124 million for the second quarter and six months ended November 30, 2003, respectively, for our participation in the FedEx Corporation Employees’ Pension Plan.  These amounts were paid to our parent, FedEx.  We also sponsor or participate in nonqualified benefit plans covering certain of our U.S. employee groups and other pension plans covering certain of our international employees.  For the plans currently sponsored by us, the following table summarizes the net periodic benefit cost of the pension and postretirement healthcare plans for the three- and six-month periods ended November 30 (in millions):

 

		Three Months Ended November 30,						Six Months Ended November 30,
Pension Plans		2004			2003			2004			2003
Service cost		$	4		$	3		$	8		$	7
Interest cost		3			3			6			5
Expected return on plan assets		(2		)	(2		)	(4		)	(3		)
Net amortization and deferral		1			1			2			1
		$	6		$	5		$	12		$	10
		Three Months Ended November 30,						Six Months Ended November 30,
Postretirement Healthcare Plans		2004			2003			2004			2003
Service cost		$	8		$	7		$	16		$	15
Interest cost		7			8			14			13
Expected return on plan assets		—			—			—			—
Net amortization and deferral		—			—			—			—
		$	15		$	15		$	30		$	28

 

No material contributions were made during the second quarter and first half of 2005 to pension plans sponsored by us and none are expected to be required in 2005.

 

9

 

(4) Commitments

 

As of November 30, 2004, our purchase commitments for the remainder of 2005 and annually thereafter under various contracts were as follows (in millions):

 

 

		Aircraft			Aircraft- Related (1)			Other (2)			Total
2005 (remainder)		$	111		$	88		$	8		$	207
2006		48			201			10			259
2007		116			98			9			223
2008		131			53			8			192
2009		567			55			8			630
Thereafter		1,142			94			129			1,365

 

⁽¹⁾ Primarily aircraft modifications.

⁽²⁾ Primarily advertising and promotions contracts.

 

The amounts reflected in the table above for purchase commitments represent noncancelable agreements to purchase goods or services.  Commitments to purchase aircraft in passenger configuration do not include the attendant costs to modify these aircraft for cargo transport.  Open purchase orders that are cancelable are not considered unconditional purchase obligations for financial reporting purposes.

 

We are committed to purchase three MD11s, five Airbus A300s, nine Airbus A310s and one ATR (all in passenger configuration) and ten Airbus A380s (a new high-capacity, long-range aircraft).  The three MD11s, one A300, seven A310s and the ATR are expected to be delivered in 2005.  We expect to take delivery of four A300s and one A310 in 2006, one A310 in 2007 and three of the ten A380s in each of 2009, 2010 and 2011 and the remaining one in 2012.  Deposits and progress payments of $33 million have been made toward these purchases and other planned aircraft-related transactions.  In addition, we have committed to modify our DC10 aircraft for passenger-to-freighter and two-man cockpit configurations.  Payments related to all of these activities are included in the table above.  Aircraft and aircraft-related contracts are subject to price escalations.

 

A summary of future minimum lease payments under capital leases and noncancelable operating leases (principally aircraft and facilities) with an initial or remaining term in excess of one year at November 30, 2004 is as follows (in millions):

 

		Capital Leases			Operating Leases
2005 (remainder)		$	67		$	654
2006		111			1,168
2007		19			1,123
2008		98			1,058
2009		10			948
Thereafter		224			7,355
		529			$	12,306
Less amount representing interest		88
Present value of future minimum lease payments		$	441

 

10

 

While certain of our lease agreements contain covenants governing the use of the leased assets or requiring us to maintain certain levels of insurance, our lease agreements include no material financial covenants or limitations.

 

(5) Contingencies

 

Wage and Hour.  We are a defendant in several lawsuits filed in California state courts containing various class-action allegations under California’s wage-and-hour laws.  The plaintiffs in these lawsuits are our employees who allege, among other things, that they were forced to work “off the clock” and were not provided work breaks or other benefits.  The plaintiffs generally seek unspecified monetary damages, injunctive relief or both.

 

To date, one of these wage-and-hour cases, Foster et al. v. FedEx, has been certified as a class action.  In this matter, which is pending in California state court, the plaintiffs purport to represent a class of all hourly employees in California from October 15, 1998 to present.  The plaintiffs allege that hourly employees are routinely required to work “off the clock” and are not paid for this additional work.  The court issued a ruling on December 13, 2004 granting class certification on all issues.  The ruling, however, does not address whether we will ultimately be held liable.

 

We have denied any liability with respect to these claims and intend to vigorously defend ourselves in these cases.  Given the nature and status of these wage-and-hour claims, we are currently evaluating, but cannot yet determine the amount of potential loss in these matters; however, it is reasonably possible that such amounts could be material.

 

Jet Engine Maintenance.  During the first quarter of 2004, we received a favorable ruling from the U.S. District Court in Memphis over the tax treatment of jet engine maintenance costs.  The Court held that these costs were ordinary and necessary business expenses and properly deductible.  As a result of this decision, we recognized a one-time benefit of $26 million, net of tax, in the first quarter of 2004, primarily related to the reduction of accruals related to this matter and the recognition of interest earned on amounts previously paid to the IRS.  These adjustments affected both net interest expense ($30 million pre-tax) and income tax expense ($7 million).  Future periods are not expected to be materially affected by the resolution of this matter.  Although the IRS has appealed this ruling, we believe the District Court’s ruling will be upheld on appeal.  Oral arguments were conducted before the Sixth Circuit Court of Appeals in December 2004.

 

Other.  We are subject to other legal proceedings that arise in the ordinary course of their business.  In the opinion of management, the aggregate liability, if any, with respect to these other actions will not materially adversely affect our financial position, results of operations or cash flows.

 

 (6) Parent/Affiliate Transactions

 

Affiliate company balances that are currently receivable or payable relate to charges for services provided by or to other FedEx affiliates and are settled on a monthly basis.  The noncurrent intercompany balance amounts at November 30, 2004 and May 31, 2004 primarily represent the net activity from participation in FedEx’s consolidated cash management program.  These net amounts are reflected as financing activities on the statements of cash flows.  In addition, we are allocated interest income on these amounts at market rates.

 

We also receive allocated charges from FedEx Corporate Services, Inc. (“FedEx Services”), a wholly owned subsidiary of FedEx, for sales, marketing and information technology functions and from our parent for management fees related to services received for general corporate oversight, including executive officers and certain administrative functions.  We believe the total amounts allocated reasonably reflect the cost of providing such services.

 

11

 

Customers doing business with both us and FedEx Ground Package System, Inc. (“FedEx Ground”), a wholly owned subsidiary of FedEx, are provided the ability to receive a single invoice for their shipping charges.  Revenue is recognized by the operating company performing the transportation services and the corresponding total receivable is recorded and collected by us.  The net customer balances for transportation services performed by FedEx Ground are reflected in trade receivables on our balance sheet and totaled $398 million at November 30, 2004 and $347 million at May 31, 2004.

 

(7) Supplemental Cash Flow Information

 

		Six Months Ended November 30,
		2004			2003
		(In millions)
Cash payments for:
Interest (net of capitalized interest)		$	41		$	46
Income taxes primarily paid to (received from) parent		296			(24		)

 

We amended two leases for MD11 aircraft during the first quarter of 2004, which required us to record $110 million in both fixed assets and long-term liabilities.

 

12

 

REPORT OF INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Stockholder

Federal Express Corporation

 

We have reviewed the condensed consolidated balance sheet of Federal Express Corporation as of November 30, 2004, and the related condensed consolidated statements of operations for the three-month and six-month periods ended November 30, 2004 and 2003 and the condensed consolidated statements of cash flows for the six-month periods ended November 30, 2004 and 2003. These financial statements are the responsibility of the Company’s management.

 

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Federal Express Corporation as of May 31, 2004, and the related consolidated statements of income, changes in owner’s equity and comprehensive income, and cash flows for the year then ended not presented herein, and in our report dated June 22, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of May 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

 

	/s/ Ernst & Young LLP
Memphis, Tennessee
December 15, 2004

 

13

 

Item 2.  Management’s Discussion and Analysis of Results of Operations and Financial Condition

 

GENERAL

 

The following management’s discussion and analysis, which describes the principal factors affecting the results of operations of FedEx Express, is abbreviated pursuant to General Instruction H(2)(a) of Form 10-Q.  This discussion should be read in conjunction with the accompanying unaudited financial statements and our Annual Report on Form 10-K for the year ended May 31, 2004 (“Annual Report”), which include additional information about our significant accounting policies, practices and the transactions that underlie our financial results.  For additional information, including a discussion of outlook, liquidity and capital resources, see the Quarterly Report on Form 10-Q of our parent, FedEx, for the quarter ended November 30, 2004.  Also, for information regarding our critical accounting policies, see FedEx’s Annual Report on Form 10-K, as amended, for the year ended May 31, 2004.

 

FedEx Services, a wholly owned subsidiary of FedEx, provides the customer-facing sales, marketing and information technology functions of FedEx Express and our sister company FedEx Ground.  The costs for these activities are allocated based on metrics such as relative revenues and estimated services provided.  These allocations materially approximate the cost of providing these functions.  The line item “Intercompany charges” on the financial summary below represents an allocation primarily of salaries and benefits, depreciation and other costs for the sales, marketing and information technology functions provided to us by FedEx Services.  In addition, “Intercompany charges” also includes allocated charges from our parent for management fees related to services received for general corporate oversight, executive officers and certain administrative functions.  We believe the total amounts allocated reasonably reflect the cost of providing such services.

 

The key factors that affect our operating results are as follows:

•                  the overall customer demand for our various services;

•                  the volume of shipments transported through our network, as measured by our average daily volume and shipment weight;

•                  the mix of services purchased by our customers;

•                  the prices we obtain for our services, as measured by average revenue per package and pound (yield);

•                  our ability to manage our cost structure for capital expenditures and operating expenses such as salaries and benefits, fuel and maintenance; and

•                  our ability to match operating costs to shifting volume levels.

 

Except as otherwise specified, references to years indicate our fiscal year ending May 31, 2005 or ended May 31 of the year referenced and comparisons are to the corresponding period of the prior year.

 

14

 

RESULTS OF OPERATIONS

 

The following table compares revenues, operating expenses and operating income (loss) (dollars in millions) and selected statistics (in thousands, except yield amounts) for the three- and six-month periods ended November 30:

 

		Three Months Ended						Percent		Six Months Ended						Percent
		2004			2003			Change		2004			2003			Change
Revenues:
Package:
U.S. overnight box		$	1,471		$	1,347		9		$	2,920		$	2,695		8
U.S. overnight envelope		432			408			6		871			840			4
U.S. deferred		682			626			9		1,330			1,232			8
Total U.S. domestic package revenue		2,585			2,381			9		5,121			4,767			7
International Priority (IP)		1,537			1,258			22		2,977			2,413			23
Total package revenue		4,122			3,639			13		8,098			7,180			13
Freight:
U.S.		470			401			17		892			766			16
International		91			98			(7)		181			203			(11)
Total freight revenue		561			499			12		1,073			969			11
Other		120			112			7		217			210			3
Total revenues		4,803			4,250			13		9,388			8,359			12
Operating expenses:
Salaries and employee benefits		1,833			1,768			4		3,682			3,562			3
Purchased transportation		211			172			23		407			332			23
Rentals and landing fees		397			381			4		777			749			4
Depreciation and amortization		196			200			(2)		392			399			(2)
Fuel		513			310			65		935			603			55
Maintenance and repairs		321			292			10		645			576			12
Business realignment costs		—			276			NM		—			408			NM
Airline Stabilization Act charge		48			—			NM		48			—			NM
Intercompany charges		373			350			7		734			697			5
Other		584			520			12		1,138			1,030			10
Total operating expenses		4,476			4,269			5		8,758			8,356			5
Operating income (loss)		$	327		$	(19	)(1)	NM		$	630		$	3	(2)	NM
Operating margin		6.8		%	(0.4		)%(1)			6.7		%	0.0		%(2)
Package Statistics
Average daily package volume (ADV):
U.S. overnight box		1,179			1,169			1		1,164			1,169			—
U.S. overnight envelope		663			655			1		663			668			(1)
U.S. deferred		941			924			2		901			898			—
Total U.S. domestic ADV		2,783			2,748			1		2,728			2,735			—
IP		443			397			12		430			383			12
Total ADV		3,226			3,145			3		3,158			3,118			1
Revenue per package (yield):
U.S. overnight box		$	19.81		$	18.29		8		$	19.59		$	18.15		8
U.S. overnight envelope		10.33			9.90			4		10.27			9.90			4
U.S. deferred		11.51			10.74			7		11.54			10.81			7
U.S. domestic composite		14.74			13.75			7		14.67			13.72			7
IP		55.13			50.30			10		54.04			49.57			9
Composite package yield		20.28			18.37			10		20.03			18.13			10
Freight Statistics
Average daily freight pounds:
U.S.		9,008			8,649			4		8,605			8,270			4
International		1,874			2,092			(10)		1,867			2,185			(15)
Total average daily freight pounds		10,882			10,741			1		10,472			10,455			—
Revenue per pound (yield):
U.S.		$	0.83		$	0.74		12		$	0.81		$	0.73		11
International		0.77			0.74			4		0.76			0.73			4
Composite freight yield		0.82			0.74			11		0.80			0.73			10

 

⁽¹⁾  Includes $276 million of business realignment costs, described herein, which reduced operating margin by 615 basis points.

⁽²⁾  Includes $408 million of business realignment costs, described herein, which reduced operating margin by 435 basis points.

 

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Revenues

 

Total revenues increased in the second quarter and first half of 2005, principally due to higher IP revenues (particularly in Asia, U.S. outbound and Europe) and higher U.S. domestic yields.  During the second quarter, IP revenues experienced strong growth of 22% on a 10% increase in yield and volume growth of 12%.  During the first half, IP revenues experienced strong growth of 23% on a 9% increase in yield and volume growth of 12%.  Asia experienced strong average daily volume growth during both the second quarter and first half of 2005.  Outbound shipments from the United States, Europe and Latin America also continued to improve.  IP yield increased across all regions during the second quarter and first half of 2005 due to higher fuel surcharge revenue, increases in international average weight per package and favorable exchange rate differences, partially offset by a decline in international average rate per pound.

 

U.S. domestic composite yield increased 7% in both the second quarter and first half of 2005 due to higher fuel surcharge revenue and increases in average weight per package and average rate per pound.  An average list price increase of 2.5%, along with certain surcharge increases, became effective in January 2004 for U.S. domestic shipments and U.S. outbound international shipments.  U.S. domestic volumes increased 1% during the second quarter, but were slightly down for the first half of 2005.  The domestic volume decrease for the first half reflects the transition of a major domestic shipper’s volume to FedEx Ground in the first quarter of 2005.  Freight revenue increased during the first half due to higher yields and domestic volumes, which more than offset the effect of lower international volumes.  We expect continuing decreases in international freight volumes as we prioritize sales efforts to fill space on international flights with higher yielding IP shipments.  In November 2004, we announced a 4.6% average list price increase effective January 3, 2005 on our  U.S. domestic shipments and U.S. outbound international shipments while lowering our fuel surcharge index by 2%.

 

Fuel surcharge revenue was higher in the second quarter and first half of 2005 due to higher jet fuel prices.  Our fuel surcharge is indexed to the spot price for jet fuel.  Using this index, the U.S. domestic fuel surcharge ranged between 6.0% and 11.0% during the first half of 2005 and between 3.0% and 4.5% during the prior year period.  International fuel surcharges ranged between 3.0% and 11.0% during the first half of 2005 and between 2.0% and 4.5% during the prior year period.

 

During the second quarter of 2005, we entered into a fifth addendum to the transportation agreement with the U.S. Postal Service, allowing us to continue carrying incremental pounds of mail through May 31, 2006 at higher committed volumes than under the original agreement.  Revenues under this agreement are included in U.S. freight revenue.

 

Operating Income

 

Operating income increased during the second quarter and first half of 2005.  The second quarter and first half of 2004 included $276 million and $408 million, respectively, of costs related to our business realignment programs.  The savings from these programs were reflected in lower growth of salaries and employee benefits costs in the second quarter and first half of 2005.  Increases in revenues, savings from our business realignment programs and ongoing cost control efforts more than offset salary increases, higher incentive compensation, an Airline Stabilization Act charge (see details below) higher purchased transportation and higher maintenance costs.  In addition, we benefited from one additional operating day in the first half of 2005.

 

During the second quarter and first half of 2005, fuel costs were higher due to an increase in the average price per gallon of aircraft fuel, while gallons consumed increased slightly.  However, fuel surcharge revenue offset higher jet fuel prices.  The second quarter of 2005 included an Airline Stabilization Act charge of $48 million (see details below) representing the United States Department of Transportation’s repayment demand of $29 million and the write-off of a $19 million receivable.  Purchased transportation costs increased in the first half of 2005 as IP volume growth led to an increase in contract pick-up and delivery services.  Depreciation and amortization expense decreased, reflecting lower capital spending over the past several years.  Higher maintenance costs during the first half of 2005 were driven by a higher utilization of aircraft and a higher average age of certain types of our aircraft.

 

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Airline Stabilization Charge

 

During the second quarter of 2005 the United States Department of Transportation (“DOT”) issued a final order in its administrative review of our claim for compensation under the Air Transportation Safety and System Stabilization Act (“Act”). Under its interpretation of the Act, the DOT determined that we are entitled to $72 million of compensation, an increase of $3 million from its initial determination. Because we had previously received $101 million under the Act, the DOT has demanded repayment of $29 million. While we will vigorously contest this determination judicially and will continue to aggressively pursue our compensation claim, we can no longer conclude that collection of the entire $119 million recorded in fiscal 2002 is probable. Accordingly, we recorded a charge of $48 million in the second quarter of 2005 ($30 million net of tax), representing the DOT’s repayment demand of $29 million and the write-off of a $19 million receivable. Should any additional amounts ultimately be recovered by us on this matter, they will be recognized in the period that they are realized.

 

Business Realignment Costs

 

During 2004, voluntary early retirement incentives with enhanced pension and postretirement healthcare benefits were offered to certain groups of employees at FedEx Express who were age 50 or older.  Voluntary cash severance incentives were also offered to eligible employees at FedEx Express.  These programs, which commenced August 1, 2003 and expired during the second quarter of 2004, were limited to eligible U.S. salaried staff employees and managers and approximately 3,600 employees accepted offers under these programs.  Costs were also incurred for the elimination of certain management positions based on the staff reductions from the voluntary programs and other cost reduction initiatives.  Costs for the benefits provided under the voluntary programs were recognized in the period that eligible employees accepted the offer.  Other costs associated with business realignment activities were recognized in the period incurred.

 

During 2004, we incurred $422 million of business realignment costs related to these programs ($276 million in the second quarter and $408 million in the first half of the year).  At May 31, 2004, we had remaining business realignment related accruals of $23 million.  At November 30, 2004, these accruals had decreased to $11 million due predominantly to cash payments made in the first half of 2005.  The remaining accruals relate to management severance agreements, which are payable over future periods.

 

Interest and Income Taxes

 

Net interest expense increased $21 million during the first half of 2005, as the favorable resolution of the tax case described below lowered net interest expense in the first half of 2004.

 

Our effective tax rate was 37% for the second quarter of 2005 and 37.5% for the first half of 2005.  For 2005, we expect the effective tax rate to approximate 38%; however, the actual rate will depend on a number of factors, including the amount and source of operating income and the timing and nature of discrete income tax events.  Our effective tax rates for the second quarter and first half of 2004 were 37.5% and 68.3%, respectively.  The effective tax rate for the first half of 2004 is higher than the statutory rate primarily due to the one-time tax benefit of $7 million described below.

 

During the first quarter of 2004, we received a favorable ruling from the U.S. District Court in Memphis over the tax treatment of jet engine maintenance costs.  The Court held that these costs were ordinary and necessary business expenses and properly deductible.  As a result of this decision, we recognized a one-time benefit of $26 million, net of tax, in the first quarter of 2004, primarily related to the reduction of accruals related to this matter and the recognition of interest earned on amounts previously paid to the IRS.  These adjustments affected both net interest expense ($30 million pre-tax) and income tax expense ($7 million).  Future periods are not expected to be materially affected by the resolution of this matter.  Although the IRS has appealed this ruling, we believe the District Court’s ruling will be upheld on appeal. Oral arguments were conducted before the Sixth Circuit Court of Appeals in December 2004.

 

Net Income

 

Net income increased substantially during the second quarter and first half of 2005, primarily due to revenue growth and improved margins.  Also, we benefited from the realization of savings from our 2004 business realignment programs.  Second quarter 2004 results included business realignment costs of $276 million ($171 million, net of tax).  For the first half of 2004, these costs were $408 million ($253 million, net of tax).

 

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FORWARD-LOOKING STATEMENTS

 

Certain statements in this report are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to the financial condition, results of operations, cash flows, plans, objectives, future performance and business of FedEx Express.  Forward-looking statements include those preceded by, followed by or that include the words “may,” “could,” “would,” “should,” “believes,” “expects,” “anticipates,” “plans,” “estimates,” “targets,” “projects,” “intends” or similar expressions.  These forward-looking statements involve risks and uncertainties.  Actual results may differ materially from those contemplated (expressed or implied) by such forward-looking statements, because of, among other things, potential risks and uncertainties, such as:

 

•                              economic conditions in the domestic and international markets in which we operate;

•                              any impacts on our business resulting from new domestic or international government regulation, including regulatory actions affecting aviation rights and labor rules;

•                              the impact of any international conflicts or terrorist activities or related security measures on the United States and global economies in general, or the transportation industry in particular, and what effects these events will have on our costs or the demand for our services;

•                              our ability to manage our cost structure for capital expenditures and operating expenses and match them, especially those relating to aircraft, vehicle and sort capacity, to shifting customer volume levels;

•                              the ability of FedEx to effectively operate, integrate and leverage the FedEx Kinko’s business;

•                              sudden changes in fuel prices or currency exchange rates;

•                              our ability to maintain or increase our fuel surcharges in response to rising fuel prices due to competitive pressures;

•                              significant changes in the volumes of shipments transported through our network, customer demand for our various services or the prices we obtain for our services;

•                              the outcome of negotiations to reach a new collective bargaining agreement with the union that represents our pilots;

•                              market acceptance of our new service and growth initiatives;

•                              competition from other providers of transportation services, including our ability to compete with new or improved services offered by our competitors;

•                              the impact of technology developments on our operations and on demand for our services;

 

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