TMCnet News

FEDEX CORP - 10-Q - Management's Discussion and Analysis of Results of Operations and Financial Condition
[September 18, 2014]

FEDEX CORP - 10-Q - Management's Discussion and Analysis of Results of Operations and Financial Condition


(Edgar Glimpses Via Acquire Media NewsEdge) GENERAL The following Management's Discussion and Analysis of Results of Operations and Financial Condition ("MD&A") describes the principal factors affecting the results of operations, liquidity, capital resources, contractual cash obligations and critical accounting estimates of FedEx Corporation ("FedEx").



This discussion should be read in conjunction with the accompanying quarterly unaudited condensed consolidated financial statements and our Annual Report on Form 10-K for the year ended May 31, 2014 ("Annual Report"). Our Annual Report includes additional information about our significant accounting policies, practices and the transactions that underlie our financial results, as well as a detailed discussion of the most significant risks and uncertainties associated with our financial condition and operating results.

We provide a broad portfolio of transportation, e-commerce and business services through companies competing collectively, operating independently and managed collaboratively, under the respected FedEx brand. Our primary operating companies are Federal Express Corporation ("FedEx Express"), the world's largest express transportation company; FedEx Ground Package System, Inc. ("FedEx Ground"), a leading North American provider of small-package ground delivery services; and FedEx Freight, Inc. ("FedEx Freight"), a leading U.S. provider of less-than-truckload ("LTL") freight services. These companies represent our major service lines and, along with FedEx Corporate Services, Inc. ("FedEx Services"), form the core of our reportable segments.


Our FedEx Services segment provides sales, marketing, information technology, communications and certain back-office support to our transportation segments.

In addition, the FedEx Services segment provides customers with retail access to FedEx Express and FedEx Ground shipping services through FedEx Office and Print Services, Inc. ("FedEx Office") and provides customer service, technical support and billing and collection services through FedEx TechConnect, Inc. ("FedEx TechConnect"). See "Reportable Segments" for further discussion. Additional information on our businesses can also be found in our Annual Report.

The key indicators necessary to understand our operating results include: • the overall customer demand for our various services based on macro-economic factors and the global economy; • the volumes of transportation services provided through our networks, primarily measured by our average daily volume and shipment weight; • the mix of services purchased by our customers; • the prices we obtain for our services, primarily measured by yield (revenue per package or pound or revenue per hundredweight and shipment for LTL freight shipments); • our ability to manage our cost structure (capital expenditures and operating expenses) to match shifting volume levels; and • the timing and amount of fluctuations in fuel prices and our ability to offset these fluctuations through our fuel surcharges.

The majority of our operating expenses are directly impacted by revenue and volume levels. Accordingly, we expect these operating expenses to fluctuate on a year-over-year basis consistent with the change in revenues and volumes.

Therefore, the discussion of operating expense captions focuses on the key drivers and trends impacting expenses other than changes in revenues and volume.

The line item "Other operating expenses" predominantly includes costs associated with outside service contracts (such as security, facility services and cargo handling), professional fees, insurance, uniforms and advertising.

- 24 --------------------------------------------------------------------------------- Table of Contents Except as otherwise specified, references to years indicate our fiscal year ending May 31, 2015 or ended May 31 of the year referenced and comparisons are to the corresponding period of the prior year. References to our transportation segments include, collectively, our FedEx Express, FedEx Ground and FedEx Freight segments.

RESULTS OF OPERATIONS CONSOLIDATED RESULTS The following table compares summary operating results (dollars in millions, except per share amounts) for the three-month periods ended August 31: Percent 2014 2013 Change Revenues $ 11,684 $ 11,024 6 Operating income 987 795 24 Operating margin 8.5 % 7.2 % 130 bp Net income $ 606 $ 489 24 Diluted earnings per share $ 2.10 $ 1.53 37 The following table shows changes in revenues and operating income by reportable segment for the three-month periods ended August 31, 2014 compared to August 31, 2013 (dollars in millions): Revenues Operating Income Dollar Percent Dollar Percent Change Change Change Change FedEx Express segment $ 257 4 $ 96 35 FedEx Ground segment 230 8 62 13 FedEx Freight segment 185 13 69 70 FedEx Services segment (1 ) - - - Corporate, eliminations and other (11 ) 10 (35 ) 58 $ 660 6 $ 192 24 Overview Our results for the first quarter of 2015 were strong as revenue growth in each of our transportation segments from increased volumes and yields drove a significant increase in earnings. Our results for the quarter were positively impacted by lower pension expense and the impact of the benefits from the profit improvement programs commenced in 2013. These factors were partially offset by higher aircraft maintenance expense due to the timing of aircraft engine maintenance events.

In the first quarter of 2015, we repurchased an aggregate of $791 million of our common stock through open market purchases as part of the share repurchase program announced in 2014. The existing share repurchase program was completed in the first quarter of 2015 and had a $0.15 year-over-year positive impact on the first quarter earnings per diluted share. See additional information on the share repurchase program in Note 1 of the accompanying unaudited condensed consolidated financial statements.

- 25 --------------------------------------------------------------------------------- Table of Contents The following graphs for FedEx Express, FedEx Ground and FedEx Freight show selected volume trends (in thousands) over the five most recent quarters: [[Image Removed: LOGO]] (1) International domestic average daily package volume represents our international intra-country express operations.

- 26 - -------------------------------------------------------------------------------- Table of Contents The following graphs for FedEx Express, FedEx Ground and FedEx Freight show selected yield trends over the five most recent quarters: [[Image Removed: LOGO]] Revenue Revenues increased 6% during the first quarter of 2015 due to improved performance at all our transportation segments. At FedEx Express, revenues increased 4% in the first quarter of 2015 due to volume and yield growth in our U.S. and international export package business partially offset by lower freight revenue. At FedEx Ground, revenues increased 8% in the first quarter of 2015 due to higher volume from continued growth in both our FedEx Home Delivery service and commercial business, as well as increased yields primarily resulting from rate increases. Revenues at FedEx Freight increased 13% during the first quarter of 2015 primarily due to higher average daily LTL shipments and revenue per LTL shipment.

- 27 - -------------------------------------------------------------------------------- Table of Contents Operating Income The following table compares operating expenses expressed as dollar amounts (in millions) and as a percent of revenue for the three-month periods ended August 31: Percent of Revenue 2014 2013 2014 2013 Operating expenses: Salaries and employee benefits $ 4,189 $ 4,077 35.8 % 37.0 % Purchased transportation 2,054 1,879 17.6 17.0 Rentals and landing fees 660 640 5.6 5.8 Depreciation and amortization 651 639 5.6 5.8 Fuel 1,120 1,104 9.6 10.1 Maintenance and repairs 556 480 4.8 4.3 Other 1,467 1,410 12.5 12.8 Total operating expenses $ 10,697 $ 10,229 91.5 92.8 Operating margin 8.5 % 7.2 % Operating income increased in the first quarter of 2015 primarily as a result of higher volumes and increased yields at FedEx Express, improved revenue per shipment and volumes at FedEx Freight, and increased yields and higher volumes at FedEx Ground. Results in the first quarter include benefits from lower pension expense and our profit improvement programs, which we commenced in 2013.

These benefits were partially offset by higher aircraft maintenance expense due to the timing of engine maintenance events at FedEx Express.

Operating expenses in the first quarter of 2015 included an increase of 9% in purchased transportation costs due to volume growth and higher rates at FedEx Ground, higher utilization of third-party transportation providers and higher rates at FedEx Freight, higher utilization of third-party transportation providers at FedEx Express and the expansion of our freight-forwarding business at FedEx Trade Networks. Salaries and employee benefits expense increased 3% due to additional staffing to support volume growth, partially offset by lower pension expense and the positive impact of our voluntary buyout program.

Maintenance and repairs expense increased 16% in the first quarter of 2015 due to the timing of aircraft engine maintenance events at FedEx Express. Other operating expenses increased 4% in the first quarter of 2015 primarily due to a legal reserve recorded in connection with the multi-district litigation matter described in Note 8. This amount was recorded in the results of our corporate headquarters division and was not allocated to our transportation segments.

- 28 --------------------------------------------------------------------------------- Table of Contents Fuel The following graph for our transportation segments shows our average cost of jet and vehicle fuel per gallon for the five most recent quarters: [[Image Removed: LOGO]] Fuel expense increased 1% in the first quarter of 2015 due to higher aircraft fuel prices and usage. However, fuel prices represent only one component of the two factors we consider meaningful in understanding the impact of fuel on our business. Consideration must also be given to the fuel surcharge revenue we collect. Because our fuel surcharges are indexed and intended to offset fuel price fluctuations in the pricing of our services, we believe discussion of the net impact of fuel on our results, which is a comparison of the year-over-year change in these two factors, is important to understand the impact of fuel on our business. In order to provide information about the impact of fuel surcharges on the trend in revenue and yield growth, we have included the comparative weighted-average fuel surcharge percentages in effect for the first quarter of 2015 and 2014 in the accompanying discussions of each of our transportation segments.

The index used to determine the fuel surcharge percentage for our FedEx Freight business adjusts weekly, while our fuel surcharges for FedEx Express and FedEx Ground businesses incorporate a timing lag of approximately six to eight weeks before they are adjusted for changes in fuel prices. For example, the fuel surcharge index in effect at FedEx Express in June 2014 was set based on April 2014 fuel prices. In addition, our fuel surcharge index allows fuel prices to fluctuate approximately 2% for FedEx Express and approximately 4% for FedEx Ground before an adjustment to the fuel surcharge occurs. Because we purchase fuel on a daily basis at market prices, our operating results may be affected should the market price of fuel suddenly change by a significant amount or change by amounts that do not result in an adjustment in our fuel surcharges.

Historically, our fuel surcharges have largely offset fluctuations in fuel prices over time; however the delay in the adjustments to our fuel surcharges can significantly affect our earnings either positively or negatively in the short-term.

The net impact of fuel had a modest benefit to operating income in the first quarter of 2015. This was driven by increased fuel surcharge revenue during the first quarter of 2015 versus prior year, which slightly outpaced the year-over-year increase in fuel prices during the quarter.

The net impact of fuel on our operating results does not consider the effects that fuel surcharge levels may have on our business, including changes in demand and shifts in the mix of services purchased by our customers. While fluctuations in fuel surcharge percentages can be significant from period to period, fuel surcharges represent one of the many individual components of our pricing structure that impact our overall revenue and yield. Additional components include the mix of services sold, the base price and extra service charges we obtain for these services and the level of pricing discounts offered.

Income Taxes Our effective tax rate was 35.3% for the first quarter of 2015 and 36.2% for the first quarter of 2014. The tax rate in the first quarter of 2015 decreased primarily due to discrete tax benefits related to changes in valuation allowances required in certain entities and jurisdictions. For 2015, we expect an effective tax rate between 36.0% and 37.0%. The actual rate, however, will depend on a number of factors, including the amount and source of operating income.

We are subject to taxation in the United States and various U.S. state, local and foreign jurisdictions. Substantially all U.S. federal income tax matters through fiscal year 2011 are concluded, and we are currently under examination by the Internal Revenue Service for the 2012 and 2013 tax years. It is reasonably possible that certain income tax return proceedings will be completed during the next 12 months and could result in a change in our balance of unrecognized tax benefits. The expected impact of any changes would not be material to our consolidated financial statements. As of August 31, 2014, there were no material changes to our liabilities for unrecognized tax benefits from May 31, 2014.

- 29 - -------------------------------------------------------------------------------- Table of Contents Outlook We expect revenue and earnings growth to continue into the second quarter and the remainder of 2015, driven by ongoing improvements in the results of all of our transportation segments as our expectations for continued moderate global economic growth drive volume and yield improvements. Our results in 2015 will continue to benefit from execution of the profit improvement programs announced in 2013 and which are further described in our Annual Report. Our results for the second quarter and the remainder of 2015 will also benefit from lower pension expense due to strong asset returns in 2014. Our expectations for earnings growth in the second quarter and the remainder of 2015 are dependent on key external factors including fuel prices and the pace of improvement in the global economy.

Other Outlook Matters. For details on key 2015 capital projects, refer to the "Liquidity Outlook" section of this MD&A.

As described in Note 8 of the accompanying unaudited condensed consolidated financial statements and the "Independent Contractor Model" section of our FedEx Ground segment MD&A, we are involved in a number of lawsuits and other proceedings that challenge the status of FedEx Ground's owner-operators as independent contractors. FedEx Ground anticipates continuing changes to its relationships with its owner-operators. The nature, timing and amount of any changes are dependent on the outcome of numerous future events. We cannot reasonably estimate the potential impact of any such changes or a meaningful range of potential outcomes, although they could be material. However, we do not believe that any such changes will impair our ability to operate and profitably grow our FedEx Ground business.

See "Forward-Looking Statements" for a discussion of these and other potential risks and uncertainties that could materially affect our future performance.

RECENT ACCOUNTING GUIDANCE New accounting rules and disclosure requirements can significantly impact our reported results and the comparability of our financial statements. These matters are described in our Annual Report.

We believe that no other new accounting guidance was adopted or issued during the first three months of 2015 that is relevant to the readers of our financial statements. However, there are numerous new proposals under development which, if and when enacted, may have a significant impact on our financial reporting, as described in our Annual Report.

- 30 --------------------------------------------------------------------------------- Table of Contents REPORTABLE SEGMENTS FedEx Express, FedEx Ground and FedEx Freight represent our major service lines and, along with FedEx Services, form the core of our reportable segments. Our reportable segments include the following businesses: FedEx Express Segment FedEx Express (express transportation) FedEx Trade Networks (air and ocean freight forwarding and customs brokerage) FedEx SupplyChain Systems (logistics services) FedEx Ground Segment FedEx Ground (small-package ground delivery) FedEx SmartPost (small-parcel consolidator) FedEx Freight Segment FedEx Freight (LTL freight transportation) FedEx Custom Critical (time-critical transportation) FedEx Services Segment FedEx Services (sales, marketing, information technology, communications and back-office functions) FedEx TechConnect (customer service, technical support, billings and collections) FedEx Office (document and business services and package acceptance) FEDEX SERVICES SEGMENT The FedEx Services segment operates combined sales, marketing, administrative and information technology functions in shared services operations that support our transportation businesses and allow us to obtain synergies from the combination of these functions. For the international regions of FedEx Express, some of these functions are performed on a regional basis by FedEx Express and reported in the FedEx Express segment in their natural expense line items.

The FedEx Services segment provides direct and indirect support to our transportation businesses, and we allocate all of the net operating costs of the FedEx Services segment (including the net operating results of FedEx Office) to reflect the full cost of operating our transportation businesses in the results of those segments. Within the FedEx Services segment allocation, the net operating results of FedEx Office, which are an immaterial component of our allocations, are allocated to FedEx Express and FedEx Ground. We review and evaluate the performance of our transportation segments based on operating income (inclusive of FedEx Services segment allocations). For the FedEx Services segment, performance is evaluated based on the impact of its total allocated net operating costs on our transportation segments.

The operating expenses line item "Intercompany charges" on the accompanying unaudited financial summaries of our transportation segments reflects the allocations from the FedEx Services segment to the respective transportation segments. The "Intercompany charges" caption also includes charges and credits for administrative services provided between operating companies. The allocations of net operating costs are based on metrics such as relative revenues or estimated services provided. We believe these allocations approximate the net cost of providing these functions and our allocation methodologies are refined as necessary to reflect changes in our businesses.

During the first quarter of 2015, we ceased allocating to our transportation segments the costs associated with our corporate headquarters division. These costs included services related to general oversight functions, including executive officers and certain legal and finance functions. This change allows for additional transparency and improved management of our corporate oversight costs. These costs were previously included in the operating expenses line item "Intercompany charges" on the accompanying unaudited financial summaries of our transportation segments. Beginning in 2015, these costs are included in "Corporate, - 31 - -------------------------------------------------------------------------------- Table of Contents eliminations and other" in our segment reporting and reconciliations. Prior year amounts have been revised to conform to the current year segment presentation.

The increase in these unallocated costs from the prior year was driven by a legal contingency reserve recorded in the first quarter of 2015 associated with the multi-district litigation matter described in Note 8.

OTHER INTERSEGMENT TRANSACTIONS Certain FedEx operating companies provide transportation and related services for other FedEx companies outside their reportable segment. Billings for such services are based on negotiated rates, which we believe approximate fair value, and are reflected as revenues of the billing segment. These rates are adjusted from time to time based on market conditions. Such intersegment revenues and expenses are eliminated in our consolidated results and are not separately identified in the following segment information, because the amounts are not material.

- 32 - -------------------------------------------------------------------------------- Table of Contents FEDEX EXPRESS SEGMENT FedEx Express offers a wide range of U.S. domestic and international shipping services for delivery of packages and freight including priority services, which provide time-definite delivery within one, two or three business days worldwide, and deferred or economy services, which provide time-definite delivery within five business days worldwide. The following table compares revenues, operating expenses, operating expenses as a percent of revenue, operating income and operating margin (dollars in millions) for the three-month periods ended August 31: Percent 2014 2013 Change Revenues: Package: U.S. overnight box $ 1,682 $ 1,584 6 U.S. overnight envelope 415 419 (1 ) U.S. deferred 795 729 9 Total U.S. domestic package revenue 2,892 2,732 6 International priority 1,630 1,576 3 International economy 571 532 7 Total international export package revenue 2,201 2,108 4 International domestic(1) 371 345 8 Total package revenue 5,464 5,185 5 Freight: U.S. 579 624 (7 ) International priority 395 388 2 International airfreight 46 54 (15 ) Total freight revenue 1,020 1,066 (4 ) Percent of Revenue Other(2) 378 354 7 2014 2013 Total revenues 6,862 6,605 4 100.0 % 100.0 % Operating expenses: Salaries and employee benefits 2,485 2,440 2 36.2 36.9 Purchased transportation 647 608 6 9.4 9.2 Rentals and landing fees 426 421 1 6.2 6.4 Depreciation and amortization 374 369 1 5.5 5.6 Fuel 970 956 1 14.1 14.5 Maintenance and repairs 379 307 23 5.5 4.6 Intercompany charges(3) 449 458 (2 ) 6.6 7.0 Other 763 773 (1 ) 11.1 11.7 Total operating expenses(3) 6,493 6,332 3 94.6 % 95.9 % Operating income(3) $ 369 $ 273 35 Operating margin(3) 5.4 % 4.1 % 130 bp (1) International domestic revenues represent our international intra-country express operations.

(2) Includes FedEx Trade Networks and FedEx SupplyChain Systems.

(3) Prior year amounts have been revised to conform to the current year segment presentation regarding the allocation of corporate headquarters costs.

- 33 - -------------------------------------------------------------------------------- Table of Contents The following table compares selected statistics (in thousands, except yield amounts) for the three-month periods ended August 31: Percent 2014 2013 Change Package Statistics(1) Average daily package volume (ADV): U.S. overnight box 1,211 1,112 9 U.S. overnight envelope 527 563 (6 ) U.S. deferred 846 790 7 Total U.S. domestic ADV 2,584 2,465 5 International priority 409 406 1 International economy 170 165 3 Total international export ADV 579 571 1 International domestic(2) 816 789 3 Total ADV 3,979 3,825 4 Revenue per package (yield): U.S. overnight box $ 21.69 $ 22.27 (3 ) U.S. overnight envelope 12.32 11.61 6 U.S. deferred 14.68 14.42 2 U.S. domestic composite 17.49 17.32 1 International priority 62.19 60.65 3 International economy 52.60 50.41 4 International export composite 59.38 57.70 3 International domestic(2) 7.10 6.84 4 Composite package yield 21.46 21.18 1 Freight Statistics(1) Average daily freight pounds: U.S. 7,318 7,423 (1 ) International priority 2,792 2,862 (2 ) International airfreight 670 850 (21 ) Total average daily freight pounds 10,780 11,135 (3 ) Revenue per pound (yield): U.S. $ 1.24 $ 1.31 (5 ) International priority 2.21 2.12 4 International airfreight 1.07 0.99 8 Composite freight yield 1.48 1.50 (1 ) (1) Package and freight statistics include only the operations of FedEx Express.

(2) International domestic statistics represent our international intra-country express operations.

FedEx Express Segment Revenues FedEx Express segment revenues increased 4% in the first quarter of 2015 due to revenue growth in our U.S. and international export package business, partially offset by lower freight revenue. U.S. domestic volumes increased 5% in the first quarter of 2015 driven by both our overnight and deferred service offerings.

International economy yields increased 4% in the first quarter of 2015 primarily due to higher rates, the impact of changes in service mix and higher fuel surcharges. International priority yields increased 3% in the first quarter of 2015 due to higher fuel surcharges and weight per package, while international priority volumes increased 1%. U.S. domestic package yields increased 1% primarily due to higher fuel surcharges, changes in service mix and higher rates. Freight yields decreased 1% in the first quarter of 2015 due to lower fuel surcharges and lower rates. Freight pounds decreased 3% primarily due to capacity reductions.

- 34 - -------------------------------------------------------------------------------- Table of Contents Our fuel surcharges are indexed to the spot price for jet fuel. Using this index, the U.S. domestic and outbound fuel surcharge percentages and the international fuel surcharge percentages ranged as follows for the three-month periods ended August 31: 2014 2013 U.S. Domestic and Outbound Fuel Surcharge: Low 9.50 % 8.00 % High 9.50 9.00 Weighted-average 9.50 8.50 International Fuel Surcharges: Low 13.50 12.00 High 18.00 17.00 Weighted-average 16.26 15.36 On September 16, 2014, FedEx Express announced a 4.9% average list price increase for FedEx Express U.S. domestic, U.S. export and U.S. import services effective January 5, 2015. In January 2014, we implemented a 3.9% average list price increase for FedEx Express U.S. domestic, U.S. export and U.S. import services.

FedEx Express Segment Operating Income FedEx Express operating income increased by 35% and operating margin increased by 130 basis points in the first quarter of 2015, driven by revenue growth in our U.S. and international export package business, partially offset by higher maintenance expense and lower freight revenues.

In the first quarter of 2015, maintenance and repairs expense increased 23% due to the timing of aircraft engine maintenance events. Salaries and employee benefits increased 2% in the first quarter of 2015 due to additional staffing to support volume growth, partially offset by lower pension expense and the benefits from our voluntary employee severance program. Purchased transportation costs increased 6% due to higher utilization of third-party transportation providers and costs associated with the expansion of our freight-forwarding business at FedEx Trade Networks.

Fuel expense increased 1% during the first quarter of 2015 due to higher aircraft fuel prices and usage. The net impact of fuel had a minimal benefit to operating income in the first quarter of 2015. See the "Fuel" section of this MD&A for a description and additional discussion of the net impact of fuel on our operating results.

- 35 - -------------------------------------------------------------------------------- Table of Contents FEDEX GROUND SEGMENT FedEx Ground service offerings include day-certain service delivery to businesses in the U.S. and Canada and to nearly 100% of U.S. residences. FedEx SmartPost consolidates high-volume, low-weight, less time-sensitive business-to-consumer packages and utilizes the United States Postal Service ("USPS") for final delivery. The following tables compare revenues, operating expenses, operating expenses as a percent of revenue, operating income and operating margin (dollars in millions) and selected package statistics (in thousands, except yield amounts) for the three-month periods ended August 31: Percent 2014 2013 Change Revenues: FedEx Ground $ 2,739 $ 2,506 9 Percent of Revenue FedEx SmartPost 221 224 (1 ) 2014 2013 Total revenues 2,960 2,730 8 100.0 % 100.0 % Operating expenses: Salaries and employee benefits 448 414 8 15.1 15.2 Purchased transportation 1,154 1,064 8 39.0 39.0 Rentals 108 92 17 3.7 3.4 Depreciation and amortization 119 111 7 4.0 4.1 Fuel 3 3 - 0.1 0.1 Maintenance and repairs 56 53 6 1.9 1.9 Intercompany charges(1) 275 270 2 9.3 9.8 Other 252 240 5 8.5 8.8 Total operating expenses(1) 2,415 2,247 7 81.6 % 82.3 % Operating income(1) $ 545 $ 483 13 Operating margin(1) 18.4 % 17.7 % 70 bp Average daily package volume FedEx Ground 4,576 4,313 6 FedEx SmartPost 1,880 2,092 (10 ) Revenue per package (yield) FedEx Ground $ 9.33 $ 9.05 3 FedEx SmartPost $ 1.84 $ 1.67 10 (1) Prior year amounts have been revised to conform to the current year segment presentation regarding the allocation of corporate headquarters costs.

FedEx Ground Segment Revenues FedEx Ground segment revenues increased 8% during the first quarter of 2015 due to volume and yield growth at FedEx Ground and yield growth at FedEx SmartPost, partially offset by lower volumes at FedEx SmartPost.

Average daily volume at FedEx Ground increased 6% during the first quarter of 2015 due to continued growth in our FedEx Home Delivery service and commercial business. FedEx Ground yield increased 3% during the first quarter of 2015 primarily due to rate increases and higher residential and fuel surcharges.

FedEx SmartPost average daily volume decreased 10% due to the reduction in volume from a major customer, while FedEx SmartPost yield increased 10% due to rate increases and improved customer mix, partially offset by higher postage costs. FedEx SmartPost yield represents the amount charged to customers net of postage paid to the USPS.

- 36 - -------------------------------------------------------------------------------- Table of Contents The FedEx Ground fuel surcharge is based on a rounded average of the national U.S. on-highway average price for a gallon of diesel fuel, as published by the Department of Energy. Our fuel surcharge percentages ranged as follows for the three-month periods ended August 31: 2014 2013 Low 6.50 % 6.50 % High 7.00 7.00 Weighted-average 6.83 6.66 On September 16, 2014, FedEx Ground and FedEx Home Delivery announced a 4.9% increase in average list price effective January 5, 2015. In addition, as announced in May 2014, FedEx Ground will apply dimensional weight pricing to all shipments effective January 5, 2015. In January 2014, FedEx Ground and FedEx Home Delivery implemented a 4.9% increase in average list price. FedEx SmartPost rates also increased.

FedEx Ground Segment Operating Income FedEx Ground segment operating income increased 13% and operating margin increased by 70 basis points to 18.4% during the first quarter of 2015 driven by higher revenue per package and volumes. The increase to operating income was partially offset by higher network expansion costs, as we continue to invest heavily in the growing FedEx Ground and FedEx SmartPost businesses.

Purchased transportation expense increased 8% in the first quarter of 2015 due to volume growth and higher rates. Salaries and employee benefits expense increased 8% during the first quarter of 2015 due to additional staffing to support volume growth. Rentals expense increased 17% in the first quarter of 2015 due to network expansion. Depreciation and amortization expense increased 7% in the first quarter of 2015 due to network expansion and trailer purchases.

Independent Contractor Model FedEx Ground is involved in numerous lawsuits and other proceedings (such as state tax or other administrative challenges) where the classification of its independent contractors is at issue. We are vigorously defending ourselves in all of these proceedings and continue to believe that FedEx Ground's owner-operators are properly classified as independent contractors and not employees of FedEx Ground. For a description of these proceedings, see Note 8 of the accompanying unaudited condensed consolidated financial statements.

For additional information on the FedEx Ground Independent Service Provider model, see Part 1, Item 1 of our Annual Report under the caption "Independent Contractor Model." - 37 - -------------------------------------------------------------------------------- Table of Contents FEDEX FREIGHT SEGMENT FedEx Freight service offerings include priority services when speed is critical and economy services when time can be traded for savings. The following table compares revenues, operating expenses, operating expenses as a percent of revenue, operating income (dollars in millions), operating margin and selected statistics for the three-month periods ended August 31: Percent Percent of Revenue 2014 2013 Change 2014 2013 Revenues $ 1,609 $ 1,424 13 100.0 % 100.0 % Operating expenses: Salaries and employee benefits 656 598 10 40.8 42.0 Purchased transportation 284 234 21 17.7 16.4 Rentals 32 32 - 2.0 2.3 Depreciation and amortization 58 57 2 3.6 4.0 Fuel 147 145 1 9.1 10.2 Maintenance and repairs 46 46 - 2.9 3.2 Intercompany charges(1) 110 113 (3 ) 6.8 7.9 Other 108 100 8 6.7 7.0 Total operating expenses(1) 1,441 1,325 9 89.6 % 93.0 % Operating income(1) $ 168 $ 99 70 Operating margin(1) 10.4 % 7.0 % 340 bp Average daily LTL shipments (in thousands) Priority 69.0 61.1 13 Economy 29.1 27.6 5 Total average daily LTL shipments 98.1 88.7 11 Weight per LTL shipment (lbs) Priority 1,258 1,244 1 Economy 1,013 993 2 Composite weight per LTL shipment 1,185 1,166 2 LTL revenue per shipment Priority $ 228.07 $ 222.45 3 Economy 265.42 256.47 3 Composite LTL revenue per shipment $ 239.16 $ 233.05 3 LTL revenue per hundredweight Priority $ 18.14 $ 17.88 1 Economy 26.19 25.84 1Composite LTL revenue per hundredweight $ 20.18 $ 19.99 1 (1) Prior year amounts have been revised to conform to the current year segment presentation regarding the allocation of corporate headquarters costs.

FedEx Freight Segment Revenues FedEx Freight segment revenues increased 13% during the first quarter of 2015 due to higher average daily LTL shipments and revenue per LTL shipment. Average daily LTL shipments increased 11% in the first quarter of 2015 due to higher demand for our FedEx Freight Priority and FedEx Freight Economy service offerings. LTL revenue per shipment increased 3% in the first quarter of 2015 due to higher weight per LTL shipment, higher fuel surcharges and higher rates.

- 38 - -------------------------------------------------------------------------------- Table of Contents The indexed LTL fuel surcharge is based on the average of the national U.S.

on-highway average price for a gallon of diesel fuel, as published by the Department of Energy. The indexed LTL fuel surcharge percentages ranged as follows for the three-month periods ended August 31: 2014 2013 Low 25.70 % 22.70 % High 26.20 23.20 Weighted-average 26.00 23.00 On September 16, 2014, FedEx Freight announced a 4.9% average increase in certain U.S. and other shipping rates effective January 5, 2015. In June 2014, FedEx Freight increased its published fuel surcharge indices by three percentage points. In March 2014, FedEx Freight increased certain U.S. and other shipping rates by an average of 3.9%. In July 2013, FedEx Freight increased certain U.S.

and other shipping rates by an average of 4.5%.

FedEx Freight Segment Operating Income FedEx Freight segment operating income and operating margin increased in the first quarter of 2015 due to the positive impacts of higher LTL revenue per shipment, higher average daily LTL shipments and solid cost management.

In the first quarter of 2015, salaries and employee benefits increased 10% primarily due to a volume-related increase in labor hours. Purchased transportation expense increased 21% due to the increased utilization of third-party transportation providers and higher rates.

- 39 --------------------------------------------------------------------------------- Table of Contents FINANCIAL CONDITION LIQUIDITY Cash and cash equivalents totaled $2.4 billion at August 31, 2014, compared to $2.9 billion at May 31, 2014. The following table provides a summary of our cash flows for the three-month periods ended August 31 (in millions): 2014 2013 Operating activities: Net income $ 606 $ 489 Noncash charges and credits 759 810 Changes in assets and liabilities (383 ) (370 ) Cash provided by operating activities 982 929 Investing activities: Capital expenditures (720 ) (572 ) Proceeds from asset dispositions and other 4 10 Cash used in investing activities (716 ) (562 ) Financing activities: Proceeds from stock issuances 97 131 Excess tax benefit on the exercise of stock options 10 14 Dividends paid (57 ) (48 ) Purchase of treasury stock (791 ) (278 ) Cash used in financing activities (741 ) (181 ) Effect of exchange rate changes on cash (17 ) (7 ) Net (decrease) increase in cash and cash equivalents $ (492 ) $ 179 Cash flows from operating activities increased $53 million in the first quarter of 2015 predominately due to higher net income. Capital expenditures during the first three months of 2015 were higher than capital expenditures in the first three months of 2014, primarily due to increased spending for aircraft at FedEx Express. See "Capital Resources" for a discussion of capital expenditures during 2015 and 2014.

In 2014, our Board of Directors authorized a new share repurchase program of up to 32 million shares of common stock. Repurchases were made at the company's discretion, based on ongoing assessments of the capital needs of the business, the market price of its common stock and general market conditions. During the first quarter of 2015, we repurchased 5.3 million shares of FedEx common stock at an average price of $148 per share for a total of $791 million. As of August 31, 2014, no shares remained under the existing share repurchase authorizations.

CAPITAL RESOURCES Our operations are capital intensive, characterized by significant investments in aircraft, vehicles, technology, facilities, and package-handling and sort equipment. The amount and timing of capital additions depend on various factors, including pre-existing contractual commitments, anticipated volume growth, domestic and international economic conditions, new or enhanced services, geographical expansion of services, availability of satisfactory financing and actions of regulatory authorities.

- 40 --------------------------------------------------------------------------------- Table of Contents The following table compares capital expenditures by asset category and reportable segment for the three-month periods ended August 31 (in millions): Dollar Percent 2014 2013 Change Change Aircraft and related equipment $ 299 $ 197 $ 102 52 Facilities and sort equipment 147 125 22 18 Vehicles 129 149 (20 ) (13 ) Information and technology investments 74 71 3 4 Other equipment 71 30 41 137 Total capital expenditures $ 720 $ 572 $ 148 26 FedEx Express segment 467 305 162 53 FedEx Ground segment 140 161 (21 ) (13 ) FedEx Freight segment 36 40 (4 ) (10 ) FedEx Services segment 77 66 11 17 Total capital expenditures $ 720 $ 572 $ 148 26 Capital expenditures during the first quarter of 2015 were higher than the prior-year period primarily due to increased spending for aircraft at FedEx Express. Aircraft and related equipment purchases at FedEx Express during the first quarter of 2015 included the delivery of six Boeing 757 ("B757") aircraft, as well as the modification of certain aircraft before being placed into service.

LIQUIDITY OUTLOOK We believe that our cash and cash equivalents, cash flow from operations and available financing sources are adequate to meet our liquidity needs, including working capital, capital expenditure requirements and debt payment obligations.

Our cash and cash equivalents balance at August 31, 2014 includes $459 million of cash in offshore jurisdictions associated with our permanent reinvestment strategy. We do not believe that the indefinite reinvestment of these funds offshore impairs our ability to meet our domestic debt or working capital obligations. Although we expect higher capital expenditures in 2015, we anticipate that our cash flow from operations will be sufficient to fund these expenditures. Historically, we have been successful in obtaining unsecured financing, from both domestic and international sources, although the marketplace for such investment capital can become restricted depending on a variety of economic factors.

Our capital expenditures are expected to be approximately $4.2 billion in 2015 and include spending for aircraft and aircraft-related equipment at FedEx Express, sort facility expansion, primarily at FedEx Ground, and vehicle replacement at all our transportation segments. We invested $299 million in aircraft and aircraft-related equipment in the first quarter of 2015 and expect to invest an additional $1.4 billion for aircraft and aircraft-related equipment during the remainder of 2015.

We have a shelf registration statement filed with the Securities and Exchange Commission ("SEC") that allows us to sell, in one or more future offerings, any combination of our unsecured debt securities and common stock.

A $1 billion revolving credit facility is available to finance our operations and other cash flow needs and to provide support for the issuance of commercial paper. We are in compliance with all the covenants of our revolving credit agreement and do not expect the covenants to affect our operations, including our liquidity or expected funding needs. As of August 31, 2014, no commercial paper was outstanding and the entire $1 billion under the revolving credit facility was available for future borrowings. See Note 3 and our Annual Report for a description of the term and significant covenants of our revolving credit facility.

In September 2014, we made $165 million in required contributions to our U.S.

Pension Plans. Our U.S. Pension Plans have ample funds to meet expected benefit payments. For the remainder of 2015, we have $330 million in required contributions to our U.S. Pension Plans.

- 41 --------------------------------------------------------------------------------- Table of Contents Standard & Poor's has assigned us a senior unsecured debt credit rating of BBB and commercial paper rating of A-2 and a ratings outlook of "stable." Moody's Investors Service has assigned us a senior unsecured debt credit rating of Baa1 and commercial paper rating of P-2 and a ratings outlook of "stable." If our credit ratings drop, our interest expense may increase. If our commercial paper ratings drop below current levels, we may have difficulty utilizing the commercial paper market. If our senior unsecured debt credit ratings drop below investment grade, our access to financing may become limited.

CONTRACTUAL CASH OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS The following table sets forth a summary of our contractual cash obligations as of August 31, 2014. Certain of these contractual obligations are reflected in our balance sheet, while others are disclosed as future obligations under accounting principles generally accepted in the United States. Except for the current portion of interest on long-term debt, this table does not include amounts already recorded in our balance sheet as current liabilities at August 31, 2014. We have certain contingent liabilities that are not accrued in our balance sheet in accordance with accounting principles generally accepted in the United States. These contingent liabilities are not included in the table below. We have other long-term liabilities reflected in our balance sheet, including deferred income taxes, qualified and nonqualified pension and postretirement healthcare plan liabilities and other self-insurance accruals.

The payment obligations associated with these liabilities are not reflected in the table below due to the absence of scheduled maturities. Accordingly, this table is not meant to represent a forecast of our total cash expenditures for any of the periods presented.

Payments Due by Fiscal Year (Undiscounted) (in millions) 2015 (1) 2016 2017 2018 2019 Thereafter Total Operating activities: Operating leases $ 1,615 $ 1,989 $ 2,017 $ 1,529 $ 1,301 $ 7,092 $ 15,543 Non-capital purchase obligations and other 360 319 171 94 55 102 1,101 Interest on long-term debt 129 231 231 231 231 3,925 4,978 Quarterly contributions to our U.S.

Pension Plans 495 - - - - - 495 Investing activities: Aircraft and aircraft-related capital commitments 995 1,244 959 1,341 860 4,461 9,860 Other capital purchase obligations 152 - - - - - 152 Financing activities: Debt - - - - 750 3,990 4,740 Total $ 3,746 $ 3,783 $ 3,378 $ 3,195 $ 3,197 $ 19,570 $ 36,869 (1) Cash obligations for the remainder of 2015.

Open purchase orders that are cancelable are not considered unconditional purchase obligations for financial reporting purposes and are not included in the table above. Such purchase orders often represent authorizations to purchase rather than binding agreements. See Note 7 of the accompanying unaudited condensed consolidated financial statements for more information.

Operating Activities The amounts reflected in the table above for operating leases represent future minimum lease payments under noncancelable operating leases (principally aircraft and facilities) with an initial or remaining term in excess of one year at August 31, 2014.

Included in the table above within the caption entitled "Non-capital purchase obligations and other" is our estimate of the current portion of the liability ($1 million) for uncertain tax positions and amounts for purchase obligations that represent noncancelable - 42 - -------------------------------------------------------------------------------- Table of Contents agreements to purchase goods or services that are not capital related. Such contracts include those for printing and advertising and promotions contracts.

We cannot reasonably estimate the timing of the long-term payments or the amount by which the liability for uncertain tax positions will increase or decrease over time; therefore, the long-term portion of the liability for uncertain tax positions ($36 million) is excluded from the table.

The amounts reflected in the table above for interest on long-term debt represent future interest payments due on our long-term debt, all of which are fixed rate.

We had $519 million in deposits and progress payments as of August 31, 2014 on aircraft purchases and other planned aircraft-related transactions.

Investing Activities The amounts reflected in the table above for capital purchase obligations represent noncancelable agreements to purchase capital-related equipment. Such contracts include those for certain purchases of aircraft, aircraft modifications, vehicles, facilities, computers and other equipment.

Financing Activities The amounts reflected in the table above for long-term debt represent future scheduled payments on our long-term debt. For the remainder of 2015, we have no scheduled principal debt payments.

Additional information on amounts included within the operating, investing and financing activities captions in the table above can be found in our Annual Report.

CRITICAL ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make significant judgments and estimates to develop amounts reflected and disclosed in the financial statements. In many cases, there are alternative policies or estimation techniques that could be used. We maintain a thorough process to review the application of our accounting policies and to evaluate the appropriateness of the many estimates that are required to prepare the financial statements of a complex, global corporation. However, even under optimal circumstances, estimates routinely require adjustment based on changing circumstances and new or better information.

GOODWILL. Goodwill is tested for impairment between annual tests whenever events or circumstances make it more likely than not that the fair value of a reporting unit has fallen below its carrying value. We do not believe there has been any change of events or circumstances that would indicate that a reevaluation of the goodwill of our reporting units is required as of August 31, 2014, nor do we believe the goodwill of our reporting units is at risk of failing impairment testing. For additional details on goodwill impairment testing, refer to Note 1 of our Annual Report.

Information regarding our critical accounting estimates can be found in our Annual Report, including Note 1 to the financial statements therein. Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors and with our independent registered public accounting firm.

- 43 --------------------------------------------------------------------------------- Table of Contents FORWARD-LOOKING STATEMENTS Certain statements in this report, including (but not limited to) those contained in "Outlook," "Liquidity," "Capital Resources," "Liquidity Outlook," "Contractual Cash Obligations" and "Critical Accounting Estimates," and the "General," "Retirement Plans," and "Contingencies" notes to the consolidated financial statements, are "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to our financial condition, results of operations, cash flows, plans, objectives, future performance and business. 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 global markets in which we operate; • significant changes in the volumes of shipments transported through our networks, customer demand for our various services or the prices we obtain for our services; • damage to our reputation or loss of brand equity; • disruptions to the Internet or our technology infrastructure, including those impacting our computer systems and Web site, which can adversely affect our operations and reputation among customers; • the price and availability of jet and vehicle fuel; • our ability to manage our cost structure for capital expenditures and operating expenses, and match it to shifting and future customer volume levels; • the impact of intense competition on our ability to maintain or increase our prices (including our fuel surcharges in response to fluctuating fuel price) or to maintain or grow our market share; • our ability to effectively operate, integrate, leverage and grow acquired businesses, and to continue to support the value we allocate to these acquired businesses, including their goodwill; • our ability to maintain good relationships with our employees and prevent attempts by labor organizations to organize groups of our employees, which could significantly increase our operating costs and reduce our operational flexibility; • the impact of costs related to (i) challenges to the status of FedEx Ground's owner-operators as independent contractors, rather than employees, and (ii) any related changes to our relationship with these owner-operators; • our ability to execute on our profit improvement programs; • the impact of any international conflicts on the United States and global economies in general, the transportation industry or us in particular, and what effects these events will have on our costs or the demand for our services; • any impacts on our businesses resulting from new domestic or international government laws and regulation, including regulatory actions affecting global aviation or other transportation rights, increased air cargo and other security or safety requirements, and tax, accounting, trade (such as protectionist measures enacted in response to weak economic conditions), labor (such as card-check legislation or changes to the Railway Labor Act affecting FedEx Express employees), environmental (such as global climate change legislation) or postal rules; - 44 - -------------------------------------------------------------------------------- Table of Contents • adverse weather conditions or localized natural disasters in key geographic areas, such as earthquakes, volcanoes, and hurricanes, which can disrupt our electrical service, damage our property, disrupt our operations, increase our fuel costs and adversely affect our shipment levels; • any impact on our business from disruptions or modifications in service by the USPS, which is a significant customer and vendor of FedEx, as a consequence of the USPS's current financial difficulties or any resulting structural changes to its operations, network, service offerings or pricing; • increasing costs, the volatility of costs and funding requirements and other legal mandates for employee benefits, especially pension and healthcare benefits; • the increasing costs of compliance with federal, state and foreign governmental agency mandates (including the Foreign Corrupt Practices Act and the U.K. Bribery Act) and defending against inappropriate or unjustified enforcement or other actions by such agencies; • changes in foreign currency exchange rates, especially in the Chinese yuan, euro, Brazilian real, British pound and the Canadian dollar, which can affect our sales levels and foreign currency sales prices; • market acceptance of our new service and growth initiatives; • any liability resulting from and the costs of defending against class-action litigation, such as wage-and-hour and discrimination and retaliation claims, and any other legal or governmental proceedings; • the outcome of future negotiations to reach new collective bargaining agreements - including with the union that represents the pilots of FedEx Express (the current pilot contract became amendable in March 2013, and the parties are currently in negotiations); • the impact of technology developments on our operations and on demand for our services, and our ability to continue to identify and eliminate unnecessary information technology redundancy and complexity throughout the organization; • governmental underinvestment in transportation infrastructure, which could increase our costs and adversely impact our service levels due to traffic congestion or sub-optimal routing of our vehicles and aircraft; • widespread outbreak of an illness or any other communicable disease, or any other public health crisis; • availability of financing on terms acceptable to us and our ability to maintain our current credit ratings, especially given the capital intensity of our operations; and • other risks and uncertainties you can find in our press releases and SEC filings, including the risk factors identified under the heading "Risk Factors" in "Management's Discussion and Analysis of Results of Operations and Financial Condition" in our Annual Report, as updated by our quarterly reports on Form 10-Q.

As a result of these and other factors, no assurance can be given as to our future results and achievements. Accordingly, a forward-looking statement is neither a prediction nor a guarantee of future events or circumstances and those future events or circumstances may not occur. You should not place undue reliance on the forward-looking statements, which speak only as of the date of this report. We are under no obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise.

- 45 --------------------------------------------------------------------------------- Table of Contents

[ Back To TMCnet.com's Homepage ]