10-Q 1 a2106040z10-q.htm 10-Q
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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 FEBRUARY 28, 2003, 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)

Delaware
(State of incorporation)
  71-0427007
(I.R.S. Employer
Identification No.)

3610 Hacks Cross Road
Memphis, Tennessee
(Address of principal
executive offices)

 

38125
(Zip Code)

(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  o    No  ý

        The number of shares of common stock outstanding as of March 14, 2003 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 (FEDEX EXPRESS)

INDEX

 
  Page
PART I. FINANCIAL INFORMATION    

ITEM 1: Financial Statements

 

 
 
Condensed Consolidated Balance Sheets
    February 28, 2003 and May 31, 2002

 

3-4
 
Condensed Consolidated Statements of Income
    Three and Nine Months Ended February 28, 2003 and 2002

 

5
 
Condensed Consolidated Statements of Cash Flows
    Nine Months Ended February 28, 2003 and 2002

 

6
 
Notes to Condensed Consolidated Financial Statements

 

7-12
 
Independent Accountants' Review Report

 

13

ITEM 2: Management's Discussion and Analysis of Results of Operations and Financial Condition

 

14-18

ITEM 3: Quantitative and Qualitative Disclosures About Market Risk

 

19

ITEM 4: Controls and Procedures

 

19

PART II. OTHER INFORMATION

 

 

ITEM 6: Exhibits and Reports on Form 8-K

 

20

Signature

 

21

Certifications

 

22-23

Exhibit Index

 

E-1

2



PART I. FINANCIAL INFORMATION

Item 1. Financial Statements


FEDERAL EXPRESS CORPORATION (FEDEX EXPRESS)
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)

ASSETS

 
  February 28,
2003

  May 31,
2002

 
  (Unaudited)

   
Current Assets:            
  Cash and cash equivalents   $ 124   $ 118
  Receivables, less allowances of $116 and $107     2,141     1,978
  Spare parts, supplies and fuel, less allowances of $101 and $91     221     226
  Deferred income taxes     347     384
  Prepaid expenses and other     46     54
  Due from parent company and other FedEx subsidiaries     153     5
   
 
    Total current assets     3,032     2,765

Property and Equipment, at Cost

 

 

13,141

 

 

12,574
  Less accumulated depreciation and amortization     7,179     6,790
   
 
    Net property and equipment     5,962     5,784

Other Assets:

 

 

 

 

 

 
  Goodwill     340     340
  Due from parent company     840     769
  Other     249     291
   
 
    Total other assets     1,429     1,400
   
 
    $ 10,423   $ 9,949
   
 

See accompanying Notes to Condensed Consolidated Financial Statements.

3


FEDERAL EXPRESS CORPORATION (FEDEX EXPRESS)
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE DATA)

LIABILITIES AND OWNER'S EQUITY

 
  February 28,
2003

  May 31,
2002

 
 
  (Unaudited)

   
 
Current Liabilities:              
  Current portion of long-term debt   $ 31   $ 6  
  Accrued salaries and employee benefits     489     537  
  Accounts payable     909     904  
  Accrued expenses     838     807  
  Due to parent company and other FedEx subsidiaries     100     97  
   
 
 
    Total current liabilities     2,367     2,351  

Long-Term Debt, Less Current Portion

 

 

826

 

 

851

 

Deferred Income Taxes

 

 

430

 

 

284

 

Other Liabilities:

 

 

 

 

 

 

 
  Pension, retiree medical and other benefits     550     515  
  Deferred lease obligations     428     409  
  Deferred gains, principally related to aircraft transactions     457     482  
  Self-insurance accruals     353     330  
  Other     62     54  
   
 
 
    Total other liabilities     1,850     1,790  

Commitments and Contingencies

 

 

 

 

 

 

 

Owner's Equity:

 

 

 

 

 

 

 
  Common stock, $.10 par value; 1,000 shares authorized, issued and outstanding          
  Additional paid-in capital     298     298  
  Retained earnings     4,684     4,422  
  Accumulated other comprehensive income     (32 )   (47 )
   
 
 
    Total owner's equity     4,950     4,673  
   
 
 
    $ 10,423   $ 9,949  
   
 
 

See accompanying Notes to Condensed Consolidated Financial Statements.

4



FEDERAL EXPRESS CORPORATION (FEDEX EXPRESS)
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN MILLIONS)

 
  Three Months Ended
February 28,

  Nine Months Ended
February 28,

 
 
  2003
  2002
  2003
  2002
 
Revenues   $ 4,064   $ 3,776   $ 12,096   $ 11,328  

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 
  Salaries and employee benefits     1,743     1,611     5,108     4,787  
  Purchased transportation     151     136     445     422  
  Rentals and landing fees     388     382     1,166     1,151  
  Depreciation and amortization     199     204     600     602  
  Fuel     320     226     898     748  
  Maintenance and repairs     268     242     837     718  
  Airline stabilization compensation         (3 )       (119 )
  Intercompany charges     333     333     1,001     990  
  Other     529     500     1,552     1,454  
   
 
 
 
 
      3,931     3,631     11,607     10,753  
   
 
 
 
 
Operating income     133     145     489     575  

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 
  Interest, net     (12 )   (17 )   (33 )   (42 )
  Other, net     (12 )   (18 )   (36 )   (36 )
   
 
 
 
 
      (24 )   (35 )   (69 )   (78 )
   
 
 
 
 
Income before income taxes     109     110     420     497  

Provision for income taxes

 

 

40

 

 

41

 

 

157

 

 

186

 
   
 
 
 
 
Net income   $ 69   $ 69   $ 263   $ 311  
   
 
 
 
 

        See accompanying Notes to Condensed Consolidated Financial Statements.

5



FEDERAL EXPRESS CORPORATION (FEDEX EXPRESS)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)

 
  Nine Months Ended
February 28,

 
 
  2003
  2002
 
Operating Activities:              
 
Net income

 

$

263

 

$

311

 
  Noncash charges (credits):              
    Depreciation and amortization     600     602  
    Other, net     137     35  
  Changes in operating assets and liabilities, net     (201 )   (43 )
   
 
 
Net cash provided by operating activities     799     905  

Investing Activities:

 

 

 

 

 

 

 
  Capital expenditures     (724 )   (883 )
  Proceeds from dispositions     3     8  
  Other, net         (7 )
   
 
 
Net cash used in investing activities     (721 )   (882 )

Financing Activities:

 

 

 

 

 

 

 
  Principal payments on debt         (21 )
  Net (payments to) receipts from parent company     (71 )   22  
  Other, net     (1 )   8  
   
 
 
Net cash (used in) provided by financing activities     (72 )   9  
   
 
 
Net increase in cash and cash equivalents     6     32  
Cash and cash equivalents at beginning of period     118     99  
   
 
 
Cash and cash equivalents at end of period   $ 124   $ 131  
   
 
 

        See accompanying Notes to Condensed Consolidated Financial Statements.

6



FEDERAL EXPRESS CORPORATION (FEDEX EXPRESS)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(1)
Summary of Significant Accounting Policies

        These interim financial statements of Federal Express Corporation ("FedEx Express") 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, 2002. 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 consolidated financial position as of February 28, 2003, the consolidated results of our operations for the three- and nine-month periods ended February 28, 2003 and 2002, and our consolidated cash flows for the nine-month periods ended February 28, 2003 and 2002. Operating results for the three-and nine-month periods ended February 28, 2003 are not necessarily indicative of the results that may be expected for the year ending May 31, 2003.

        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 indicated, references to years mean our fiscal year ending May 31, 2003 or ended May 31 of the year referenced and comparisons are to the corresponding period of the prior year.

        The Emerging Issues Task Force ("EITF") issued EITF 01-10, "Accounting for the Impact of the Terrorist Attacks of September 11, 2001" in September 2001 to establish accounting for the impact of the terrorist attacks of September 11, 2001. Under EITF 01-10, federal assistance provided to air carriers in the form of direct compensation from the U.S. government under the Air Transportation Safety and System Stabilization Act (the "Act") should be recognized when the related losses are incurred and compensation under the Act is probable. During the second and third quarters of 2002, we recognized $119 million ($3 million in the third quarter) of compensation under the Act. To date $101 million of this compensation has been received. On March 19, 2003, we learned that the Department of Transportation is now asserting an overpayment in the amount of $31.6 million and has demanded repayment. While we believe we have complied with all aspects of the Act and that it is probable we will ultimately receive the remaining $18 million, the $119 million of compensation previously recognized is subject to audit and interpretation by the Department of Transportation. We cannot be assured of the ultimate outcome and it is reasonably possible that a material reduction to the amount of compensation recognized by us under the Act could occur.

        In 2003, we adopted Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations;" No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets;" and No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The adoption of these statements did not have any effect on our financial position or results of operations.

        Effective January 1, 2003, we adopted Financial Accounting Standards Board ("FASB") Interpretation No. ("FIN") 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 elaborates on the disclosures that must be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The adoption of this interpretation did not

7


have a material effect on our financial position or results of operations. Disclosure of our guarantees and indemnifications is included in Note 4.

        In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." FIN 46 requires a variable interest entity ("VIE") to be consolidated by the primary beneficiary of the entity under certain circumstances. FIN 46 is effective for all new VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. We do not expect adoption of this interpretation will have a material impact on our financial position or results of operations. Our VIE disclosure is included in Note 5.

        Certain prior period amounts have been reclassified to conform to the current period's presentation.

(2)
Intangible Assets

        The components of our amortizing intangible assets follow (in millions):

 
  February 28, 2003
  May 31, 2002
 
 
  Gross Carrying
Amount

  Accumulated
Amortization

  Gross Carrying
Amount

  Accumulated
Amortization

 
Contract based   $ 73   $ (36 ) $ 73   $ (32 )

        Amortization expense for intangible assets during the third quarter of 2003 was $1 million ($4 million year-to-date). Estimated amortization expense is $1 million for the remainder of 2003 and $5 million for each of the five succeeding fiscal years.

(3)
Comprehensive Income

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

 
  Three Months
Ended February 28,

 
 
  2003
  2002
 
Net income   $ 69   $ 69  
Other comprehensive income:              
  Foreign currency translation adjustments, net of deferred taxes of $2 and deferred tax benefit of $1     12     (4 )
   
 
 
    Comprehensive income   $ 81   $ 65  
   
 
 
 
  Nine Months
Ended February 28,

 
 
  2003
  2002
 
Net income   $ 263   $ 311  
Other comprehensive income:              
  Foreign currency translation adjustments, net of deferred taxes of $4 and deferred tax benefit of $1     15     (6 )
   
 
 
    Comprehensive income   $ 278   $ 305  
   
 
 

8


(4)
Guarantees and Indemnifications

        We adopted FIN 45 effective January 1, 2003. The initial recognition and measurement provisions of FIN 45 apply on a prospective basis to certain guarantees and indemnifications issued or modified after December 31, 2002. Accordingly, any contractual guarantees or indemnifications we issue or modify subsequent to December 31, 2002 will be evaluated and, if required, a liability for the fair value of the obligation undertaken will be recognized. Our adoption of FIN 45 did not have a material effect on our financial position or results of operations during the third quarter.

        Substantially all of our guarantees and indemnifications were entered into prior to December 31, 2002 and have not been modified since then. Therefore, no amounts have been recognized in our financial statements for the underlying fair value of these agreements. With the exception of residual value guarantees in certain operating leases, a maximum obligation is generally not specified in our guarantees and indemnifications. As a result, the overall maximum potential amount of the obligation under such guarantees and indemnifications cannot be reasonably estimated. Historically, we have not been required to make significant payments under our guarantee or indemnification obligations.

        Operating Leases.    We have guarantees under certain operating leases, amounting to $104 million as of February 28, 2003, for the residual values of aircraft and vehicles at the end of the respective operating lease periods. Under these leases, if the fair market value of the leased asset at the end of the lease term is less than an agreed-upon value as set forth in the related operating lease agreement, we will be responsible to the lessor for the amount of such deficiency. Based upon our expectation that none of these leased assets will have a residual value at the end of the lease term that is less than the value specified in the related operating lease agreement, we do not believe it is probable that we will be required to fund any amounts under the terms of these guarantee arrangements. Accordingly, no accruals have been recognized for these guarantees.

        Certain of our operating leases contain other indemnification obligations to the lessor, which are considered ordinary and customary (e.g., use and environmental indemnifications), the terms of which range in duration and often are not limited. Such indemnification obligations continue until and, in many cases, after expiration of the respective lease.

        Other Contracts.    In conjunction with certain transactions, primarily sales or purchases of operating assets or services in the ordinary course of business, we sometimes provide routine indemnifications (e.g., environmental, tax and employee liabilities), the terms of which range in duration and often are not limited.

        Intra-Company Guarantees.    We provide guarantees on FedEx debt instruments aggregating approximately $1 billion at February 28, 2003, 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. At February 28, 2003, $200 million of commercial paper was outstanding and $800 million under the revolving credit agreements was available for future borrowings. The guarantees are full and unconditional and are required by the lenders since FedEx has no independent assets or operations.

(5)
Variable Interest Entities

        We entered into a lease in July 2001 for two MD-11 aircraft. These assets are held by a separate entity, which was established and is owned by independent third parties who provide financing through debt and equity participation. This lease is accounted for as an operating lease. Under current accounting principles generally accepted in the United States, the assets and the related

9


obligations are excluded from the consolidated balance sheet, and the entity is not consolidated. The original cost of the assets under the lease was approximately $150 million.

        This lease contains residual value guarantees that obligate us, not the third party owners, to absorb the majority of the losses, if any, of the entity. The lease also provides us with the right to receive any residual returns of the entity if they occur. At February 28, 2003, the residual value guarantee associated with this lease, which represents the maximum exposure to loss, was $89 million (included in the $104 million operating lease residual value guarantees disclosed in Note 4). Under FIN 46, we will be required to consolidate the separate entity that owns the two MD-11 aircraft beginning September 1, 2003. Since the entity was created before February 1, 2003, we will initially measure the assets and liabilities at their carrying amounts, which is the amounts at which they would have been recorded in the consolidated financial statements if FIN 46 had been effective at the inception of the lease. Accordingly, our long-term assets and long-term liabilities will increase by approximately $140 million at September 1, 2003. The consolidation of this VIE will not have a material effect on our results of operations.

(6)
Commitments and Contingencies

        As of February 28, 2003, our purchase commitments for the remainder of 2003 and annually thereafter for each of the next five years under various contracts were as follows (in millions):

 
  Aircraft
  Aircraft-
Related(1)

  Other(2)
  Total
2003 (remainder)   $ 27   $ 156   $ 36   $ 219
2004     20     293     12     325
2005         287     8     295
2006     19     251     8     278
2007     102     175     8     285
2008     104     77     8     189
(1)
Primarily aircraft modifications, rotables, spare parts and spare engines.
(2)
Primarily vehicles, facilities, advertising and promotions contracts and other equipment.

        We are committed to purchase four DC10s, two A300s, two A310s and ten A380s to be delivered through 2012. Deposits and progress payments of $36 million have been made toward these purchases and other planned aircraft-related transactions.

        A class action lawsuit is pending in Federal District Court in San Diego, California against us generally alleging that customers who had late deliveries during the 1997 Teamsters strike at United Parcel Service were entitled to a full refund of shipping charges pursuant to our money-back guarantee, regardless of whether they gave timely notice of their claim. At the hearing on the plaintiffs' motion for summary judgment, the court ruled against us. The judgment totaled approximately $68 million, including interest and fees for the plaintiffs' attorney. We have denied any liability with respect to this claim and intend to vigorously defend ourselves in this case. We have appealed the judgment to the U.S. Court of Appeals for the 9th Circuit and expect a ruling in the next 12 to 18 months. No accrual has been recorded as we believe the case is without merit and it is probable we will prevail upon appeal.

        The Illinois state court has approved a settlement of the Illinois fuel surcharge class action matter. Class members objecting to the settlement have appealed. The lawsuit alleges that we imposed a fuel surcharge in a manner that is not consistent with the terms and conditions of our contracts with customers. Under the terms of the settlement, we will issue coupons to qualifying class

10


members toward the purchase of future shipping services with us. The coupons will be subject to certain terms and conditions and will be redeemable for a period of one year from issuance. No coupons will be issued, however, pending resolution of the appeals. The ultimate cost to us under the settlement agreement will not be material.

        In connection with an Internal Revenue Service ("IRS") audit for the tax years 1993 and 1994, the IRS proposed adjustments characterizing routine jet engine maintenance costs as capital expenditures that must be recovered over seven years, rather than as expenses that are deducted immediately, as has been our practice. We filed an administrative protest of these adjustments and engaged in discussions with the Appeals office of the IRS. After these discussions failed to result in a settlement, in 2001 we paid $70 million in tax and interest and filed suit in Federal District Court for a complete refund of the amounts paid, plus interest. The trial in the U.S. District Court in Memphis has been set for April 2003. Pre-trial settlement discussions have not resulted in a settlement. No further pre-trial settlement discussions are scheduled.

        The IRS has continued to assert its position in audits for the years 1995 through 1998 with respect to maintenance costs for jet engines and rotable aircraft parts. Based on these audits, the total proposed deficiency for the 1995-1998 period, including tax and interest through February 28, 2003, was approximately $198 million (representing $107 million of tax and $91 million of interest). In addition, we have continued to expense these types of maintenance costs subsequent to 1998. Previously, the IRS made similar attempts to require capitalization of airframe maintenance costs. In December 2000, the IRS issued a revenue ruling, which permitted current deductions for routine airframe maintenance costs. As a result, the IRS conceded 100% of the airframe issue for 1993-1994 and we anticipate a similar result for all future years.

        We believe that our practice of expensing these types of maintenance costs is correct and consistent with industry practice and certain IRS rulings. We intend to vigorously contest the adjustments and do not believe it is probable that we will be required to pay $198 million to the IRS. Additionally, we expect to fully recover the amounts previously paid in litigation. Because the amounts in question relate solely to the timing of the income tax deduction for the above expenditures for federal income tax purposes, any adverse determination in this matter would not have an impact on our total income tax expense. Accordingly, we have not recognized any provision for the tax portion of the proposed deficiency. The income statement consequences if we do not prevail in the litigation on this matter would be for interest on the income taxes that would be payable upon assessment. The IRS has not assessed penalties on this matter. We do not expect any amounts that may ultimately be payable on this matter to be material to our financial position, results of operations or cash flows.

        We are subject to other legal proceedings that arise in the ordinary course of 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.

(7)
Related Party Transactions

        Affiliate company balances that are currently receivable or payable relate to charges for services provided by or to other affiliates of our parent company, FedEx. The noncurrent intercompany balance amounts at February 28, 2003 and May 31, 2002 primarily represent the net activity from participation in FedEx's consolidated cash management program.

        Certain customers doing business with both us and FedEx Ground Package System, Inc. ("FedEx Ground") 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

11


receivables on our balance sheet and totaled $244 million at February 28, 2003 and $140 million at May 31, 2002.

        In addition, we also receive allocated charges from FedEx Corporate Services, Inc. for sales, marketing and information technology functions and from our parent for management fees related to services received for general corporate oversight, executive officers and certain legal and finance functions. We are also allocated net interest from participation in FedEx's consolidated cash management program. We believe the total amounts allocated reasonably reflect the cost of providing such services.

(8)
Supplemental Cash Flow Information

 
  Nine Months Ended
February 28,

 
  2003
  2002
 
  (In millions)

Cash payments for:            
  Interest (net of capitalized interest)   $ 50   $ 60
  Income taxes (principally paid to parent)     54     145
Noncash investing and financing activities:            
  Fair value of assets acquired under exchange agreements     1     3

        Noncash investing activities reflect the contractual acquisition of aircraft, spare parts and other equipment in exchange for engine noise reduction kits.

12



INDEPENDENT ACCOUNTANTS' REVIEW REPORT



The Board of Directors and Stockholder
Federal Express Corporation

We have reviewed the accompanying condensed consolidated balance sheet of Federal Express Corporation as of February 28, 2003, and the related condensed consolidated statements of income for the three-month and nine-month periods ended February 28, 2003 and 2002, and the condensed consolidated statements of cash flows for the nine-month periods ended February 28, 2003 and 2002. These financial statements are the responsibility of the Company's management.

We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States.

We have previously audited, in accordance with auditing standards generally accepted in the United States, the consolidated balance sheet of Federal Express Corporation as of May 31, 2002, 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 24, 2002, 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, 2002, 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
March 19, 2003

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 Federal Express Corporation ("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 financial statements and our Annual Report on Form 10-K for the year ended May 31, 2002, 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 Corporation ("FedEx"), for the quarter ended February 28, 2003. Also, for information regarding our critical accounting policies, see FedEx's Annual Report on Form 10-K for the year ended May 31, 2002.

        The key factors that affect our operating results include the volumes of shipments transported through our network, as measured by our average daily volume; the mix of services purchased by our customers; the prices we obtain for our services, as measured by average price per shipment (yield); our ability to manage our cost structure for capital expenditures and operating expenses such as salaries, wages and benefits, fuel and maintenance; and our ability to match operating costs to shifting volume levels.

        Except as otherwise indicated, references to years mean our fiscal year ending May 31, 2003 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 (dollars in millions) and selected statistics (in thousands, except yield amounts) for the three- and nine-month periods ended February 28:

 
  Three Months Ended
   
  Nine Months Ended
   
 
  Percent
Change

  Percent
Change

 
  2003
  2002
  2003
  2002
Revenues:                                
  Package:                                
    U.S. overnight box(1)   $ 1,355   $ 1,299   + 4   $ 4,041   $ 3,970   + 2
    U.S. overnight envelope(2)     418     424   - 1     1,267     1,309   - 3
    U.S. deferred     666     618   + 8     1,881     1,775   + 6
   
 
     
 
   
      Total U.S. domestic package revenue     2,439     2,341   + 4     7,189     7,054   + 2
    International Priority (IP)     1,051     899   +17     3,181     2,807   +13
   
 
     
 
   
        Total package revenue     3,490     3,240   + 8     10,370     9,861   + 5
  Freight:                                
    U.S.     394     357   +10     1,175     892   +32
    International     100     90   +11     294     286   + 3
   
 
     
 
   
        Total freight revenue     494     447   +11     1,469     1,178   +25
  Other     80     89   -10     257     289   -11
   
 
     
 
   
        Total revenues     4,064     3,776   + 8     12,096     11,328   + 7
Operating expenses:                                
  Salaries and employee benefits     1,743     1,611   + 8     5,108     4,787   + 7
  Purchased transportation     151     136   +11     445     422   + 5
  Rentals and landing fees     388     382   + 2     1,166     1,151   + 1
  Depreciation and amortization     199     204   - 2     600     602  
  Fuel     320     226   +42     898     748   +20
  Maintenance and repairs     268     242   +11     837     718   +17
  Airline stabilization compensation         (3 ) n/a         (119 ) n/a
  Intercompany charges, net     333     333       1,001     990   + 1
  Other     529     500   + 6     1,552     1,454   + 7
   
 
     
 
   
        Total operating expenses     3,931     3,631   + 8     11,607     10,753   + 8
   
 
     
 
   
Operating income   $ 133   $ 145   - 8   $ 489   $ 575   - 15
   
 
     
 
   
Operating margin     3.3 %   3.8 %       4.0 %   5.1 %  

Package Statistics:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Average daily packages:                                
    U.S. overnight box(1)     1,189     1,193       1,175     1,167   + 1
    U.S. overnight envelope(2)     662     698   - 5     676     698   - 3
    U.S. deferred     977     958   + 2     908     871   + 4
   
 
     
 
   
      Total U.S. domestic packages     2,828     2,849   - 1     2,759     2,736   + 1
    IP     358     332   + 8     366     335   + 9
   
 
     
 
   
        Total packages     3,186     3,181       3,125     3,071   + 2
   
 
     
 
   
  Revenue per package (yield):                                
    U.S. overnight box   $ 18.09   $ 17.56   + 3   $ 18.10   $ 17.91   + 1
    U.S. overnight envelope     10.03     9.78   + 3     9.87     9.86  
    U.S. deferred     10.82     10.41   + 4     10.90     10.72   + 2
      U.S. domestic composite     13.69     13.25   + 3     13.71     13.57   + 1
    IP     46.67     43.75   + 7     45.83     44.14   + 4
        Composite     17.39     16.43   + 6     17.47     16.90   + 3
Freight Statistics:                                
  Average daily pounds:                                
    U.S.     9,131     8,985   + 2     9,187     7,254   +27
    International     2,183     1,989   +10     2,157     2,063   + 5
   
 
     
 
   
        Total freight     11,314     10,974   + 3     11,344     9,317   +22
   
 
     
 
   
  Revenue per pound (yield):                                
    U.S.   $ 0.69   $ 0.64   + 8   $ 0.67   $ 0.65   + 3
    International     0.73     0.73       0.72     0.73   - 1
        Composite     0.69     0.66   + 5     0.68     0.67   + 1
(1)
The U.S. overnight box category includes packages exceeding 8 ounces in weight.
(2)
The U.S. overnight envelope category includes envelopes weighing 8 ounces or less.

15


Revenues

        Total revenues increased in both the third quarter and nine months of 2003, largely due to increased IP revenues, particularly in Asia and Europe. During the third quarter, IP revenues grew on 8% volume growth and 7% higher yield, and during the nine months IP revenues grew on 9% volume growth and 4% higher yield. Asia experienced double-digit volume growth during both the third quarter and nine months.

        Both U.S. outbound international shipments and U.S. domestic shipments were affected in 2002 by the loss of revenue during the temporary grounding of our aircraft and by the resulting economic decline after the terrorist attacks of September 11, 2001. Year-to-date revenue comparisons were also impacted by higher U.S. freight revenues in 2003, on 27% higher average daily pounds, as we benefited from a full nine months of operations under our transportation contract with the U.S. Postal Service ("USPS"). Our agreement with the USPS commenced in late August 2001.

        Yield for U.S. domestic packages increased in the third quarter and nine months, due to higher fuel surcharge revenue and list price increases during the quarter. For U.S. domestic shipments and U.S. outbound IP shipments, an average list price increase of 3.5% became effective January 6, 2003. IP yield improvements were primarily due to exchange rate differences, increased fuel surcharges and growth in higher-yielding lanes.

        We recently entered into the third addendum to the transportation agreement with the USPS, allowing us to continue carrying incremental pounds of mail through May 29, 2004 at higher committed volumes than required under the original agreement.

Operating Income

        Operating income decreased during the third quarter and nine months of 2003, despite one additional operating day in the third quarter. The decrease is attributable to higher salary and employee benefit and purchased transportation costs, higher maintenance expenses and the net impact of higher fuel costs. Higher pension and medical costs contributed to increased benefits during the third quarter and nine months. Maintenance expenses are higher primarily due to the timing of scheduled maintenance events and increased aircraft utilization, although the increases in these expenses have abated since the first half of 2003. The growth in salary and employee benefits is expected to slow in the fourth quarter due to reduced wage increases and improved productivity, while maintenance expenses are expected to be similar to last year's levels.

        Higher net fuel costs negatively affected operating income by $15 million during the third quarter and $70 million in the nine months, as fuel surcharge revenue increases were not sufficient to fully offset higher fuel prices. Third quarter operating results were also impacted by severe winter weather, which decreased business shipping and increased certain operating costs, such as for snow removal and de-icing. Depreciation and amortization expense declined for the third quarter and nine months reflecting a trend of decreasing levels of capital spending.

        Other operating expenses also increased in the third quarter and nine months of 2003. In the prior year, reimbursements from the USPS for network expansion costs were reflected as credits to other operating expenses. These reimbursements, however, had no effect on operating income, as they represented the recovery of incremental costs incurred. Last year's results also included $17 million of income from the favorable resolution of a state sales tax matter, recognized during the second quarter of 2002. Partially offsetting higher operating costs during the nine months of 2003 was a gain from the insurance settlement on an aircraft destroyed in an accident in July 2002 that resulted in a net $8 million favorable impact on operating income.

16


Income Taxes

        Our effective tax rate for the third quarter and nine months of both 2003 and 2002 was 37.5%, compared to 37.0% for all of 2002.

Airline Stabilization Compensation

        Prior year operations were significantly affected by the terrorist attacks on September 11, 2001. During 2002, we recognized a total of $119 million of compensation under the Air Transportation Safety and System Stabilization Act (the "Act"), of which $101 million has been received as of February 28, 2003. The amounts recognized were for our estimate of losses we incurred as a result of the mandatory grounding of our aircraft and for incremental losses incurred through December 31, 2001. All amounts recognized are reflected as reduction of operating expense under the caption "Airline stabilization compensation."

        On March 19, 2003, we learned that the Department of Transportation is now asserting an overpayment in the amount of $31.6 million and has demanded repayment. While we believe that we have complied with all aspects of the Act, and that it is probable we will ultimately collect the remaining $18 million receivable, the $119 million of compensation previously recognized is subject to audit and interpretation by the Department of Transportation. We cannot be assured of the ultimate outcome and it is reasonably possible that a material reduction to the amount of compensation recognized by us under the Act could occur.

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, 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 markets in which we operate, including the timing, speed and magnitude of the economy's recovery from the downturn that began in calendar 2001 in the sectors that drive demand for our services;

    any impacts on our business resulting from new domestic or international government regulation;

    the impact of any terrorist activities or international conflicts, including military action in Iraq, 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;

    sudden changes in fuel prices;

    our ability to increase our fuel surcharge in response to rising fuel prices due to competitive pressures;

    significant changes in the volumes of shipments transported, the mix of services purchased by our customers or the prices we obtain for our services;

    the timing and amount of any money we are entitled to receive under the Air Transportation Safety and System Stabilization Act;

    market acceptance of our new service and growth initiatives;

    competition from other providers of transportation and logistics services,

17


      including our ability to compete with new or improved services offered by our competitors;

    changes in customer demand patterns;

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

    our ability to obtain and maintain aviation rights in important international markets;

    adverse weather conditions;

    availability of financing on terms acceptable to us; and

    other risks and uncertainties you can find in the press releases and SEC filings of FedEx and FedEx Express.

        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.

18



Item 3.    Quantitative and Qualitative Disclosures About Market Risk

        Omitted under the reduced disclosure format permitted by General Instruction H(2)(c) of Form 10-Q.


Item 4.    Controls and Procedures

        We maintain a rigorous set of disclosure controls and procedures and internal controls designed to ensure that our assets are adequately safeguarded and the information required to be disclosed in our filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. We perform a quarterly assessment of these procedures and controls requiring certification by all principal executive and financial management.

        We maintain appropriate policies, procedures and systems to support the timely and accurate reporting of our financial results. Our corporate forecasting and accounting close reporting processes form the foundation to ensure that all relevant information about our financial results is available to management. In addition, FedEx maintains a thorough quarterly and annual public financial reporting process that ensures all key members of management have direct and meaningful input into our financial disclosures.

        FedEx has controls that include the presence of an extensive internal audit function staffed by professional auditors that review the operational and financial effectiveness of our internal control systems on a global basis. In addition, our control environment is evaluated on an ongoing basis by our financial management and annually by our external auditors in connection with their audit of our financial statements.

        While we believe our disclosure controls and procedures and our internal controls are adequate, no system of controls can prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable assurance that the objectives of the control system are met. Additionally, controls can be circumvented by the individual acts of some persons or by collusion of two or more people.

        Our principal executive and financial officers have evaluated our disclosure controls and procedures within 90 days prior to the filing of this Quarterly Report on Form 10-Q and have determined that such disclosure controls and procedures are effective.

        Subsequent to their evaluation, there were no significant changes in internal controls or other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

19



PART II.    OTHER INFORMATION

Item 6.    Exhibits and Reports on Form 8-K

(a)
Exhibits.

Exhibit
Number

  Description of Exhibit

10.1   Amendment dated June 12, 2002, Investigative and Security Procedures Addendum dated January 9, 2003 and Third Addendum dated January 30, 2003, each amending the Transportation Agreement dated January 10, 2001 between The United States Postal Service and FedEx Express. Confidential treatment has been requested for confidential commercial and financial information, pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended. (Filed as Exhibit 10.1 to FedEx's 2003 Third Quarter Report on Form 10-Q, and incorporated herein by reference.)

12.1

 

Computation of Ratio of Earnings to Fixed Charges.

15.1

 

Letter re: Unaudited Interim Financial Statements.

99.1

 

Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

99.2

 

Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b)
Reports on Form 8-K.

    No reports on Form 8-K were filed during the quarter ended February 28, 2003.

20



SIGNATURE

        Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

    FEDERAL EXPRESS CORPORATION

 

 

 

Date: March 21, 2003

 

/s/  
TRACY G. SCHMIDT      
Tracy G. Schmidt
Senior Vice President and
Chief Financial Officer

21



CERTIFICATION

I, David J. Bronczek, President and Chief Executive Officer of Federal Express Corporation ("registrant"), certify that:

1.   I have reviewed this quarterly report on Form 10-Q of the registrant;

2.

 

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.

 

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.

 

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

 

a)

 

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

 

b)

 

evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and

 

 

c)

 

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

 

The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

 

 

a)

 

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

 

 

b)

 

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.

 

The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 21, 2003

 

 

/s/  
DAVID J. BRONCZEK      
David J. Bronczek
President and Chief Executive Officer

 

 

22


CERTIFICATION

I, Tracy G. Schmidt, Senior Vice President and Chief Financial Officer of Federal Express Corporation ("registrant"), certify that:

1.   I have reviewed this quarterly report on Form 10-Q of the registrant;

2.

 

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.

 

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.

 

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

 

a)

 

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

 

b)

 

evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and

 

 

c)

 

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

 

The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

 

 

a)

 

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

 

 

b)

 

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.

 

The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 21, 2003

 

 

/s/  
TRACY G. SCHMIDT      
Tracy G. Schmidt
Senior Vice President and Chief Financial Officer

 

 

23



EXHIBIT INDEX

Exhibit
Number

  Description of Exhibit

10.1   Amendment dated June 12, 2002, Investigative and Security Procedures Addendum dated January 9, 2003 and Third Addendum dated January 30, 2003, each amending the Transportation Agreement dated January 10, 2001 between The United States Postal Service and FedEx Express. Confidential treatment has been requested for confidential commercial and financial information, pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended. (Filed as Exhibit 10.1 to FedEx's 2003 Third Quarter Report on Form 10-Q, and incorporated herein by reference.)

12.1

 

Computation of Ratio of Earnings to Fixed Charges.

15.1

 

Letter re: Unaudited Interim Financial Statements.

99.1

 

Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

99.2

 

Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

E-1




QuickLinks

PART I. FINANCIAL INFORMATION
FEDERAL EXPRESS CORPORATION (FEDEX EXPRESS) CONDENSED CONSOLIDATED BALANCE SHEETS (IN MILLIONS)
FEDERAL EXPRESS CORPORATION (FEDEX EXPRESS) CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (IN MILLIONS)
FEDERAL EXPRESS CORPORATION (FEDEX EXPRESS) CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN MILLIONS)
FEDERAL EXPRESS CORPORATION (FEDEX EXPRESS) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
PART II. OTHER INFORMATION
SIGNATURE
CERTIFICATION
EXHIBIT INDEX