-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Wdpo9EJuBKVGVL+6uotTVksZhQjvwIx1gE/4V4syYRBRBBbpemh6OsWmqeU7qyJf CwIYyjbR2JVdUSnYzNNrOw== 0001047469-98-037115.txt : 19981014 0001047469-98-037115.hdr.sgml : 19981014 ACCESSION NUMBER: 0001047469-98-037115 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980831 FILED AS OF DATE: 19981013 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FEDERAL EXPRESS CORP CENTRAL INDEX KEY: 0000230211 STANDARD INDUSTRIAL CLASSIFICATION: AIR COURIER SERVICES [4513] IRS NUMBER: 710427007 STATE OF INCORPORATION: DE FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-07806 FILM NUMBER: 98724747 BUSINESS ADDRESS: STREET 1: 2005 CORPORATE AVE CITY: MEMPHIS STATE: TN ZIP: 38132 BUSINESS PHONE: 9013693600 MAIL ADDRESS: STREET 1: 2005 CORPORATE AVE CITY: MEMPHIS STATE: TN ZIP: 38132 10-Q 1 FORM 10-Q - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED AUGUST 31, 1998, OR / / 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 71-0427007 (State of incorporation) (I.R.S. Employer Identification No.) 2005 Corporate Avenue 38132 Memphis, Tennessee (Zip Code) (Address of principal executive offices) (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 /X/ No / / The number of shares of common stock outstanding as of September 30, 1998 was 1,000. The Registrant is a wholly-owned subsidiary of FDX 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 AND SUBSIDIARIES INDEX PART I. FINANCIAL INFORMATION
PAGE Condensed Consolidated Balance Sheets August 31, 1998 and May 31, 1998.......................... 3-4 Condensed Consolidated Statements of Income Three Months Ended August 31, 1998 and 1997............... 5 Condensed Consolidated Statements of Cash Flows Three Months Ended August 31, 1998 and 1997............... 6 Notes to Condensed Consolidated Financial Statements........... 7-9 Review of Condensed Consolidated Financial Statements by Independent Public Accountants......................... 10 Report of Independent Public Accountants....................... 11 Management's Discussion and Analysis of Results of Operations and Financial Condition................................... 12-18 PART II. OTHER INFORMATION Legal Proceedings.............................................. 19 Exhibits and Reports on Form 8-K............................... 19 EXHIBIT INDEX.................................................. E-1
- 2 - FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS ASSETS
August 31, 1998 May 31, (Unaudited) 1998 -------------- ------------- (In thousands) Current Assets: Cash and cash equivalents................................................ $ 114,288 $ 104,606 Receivables, less allowances of $44,372,000 and $43,245,000........................................................ 1,694,866 1,669,568 Spare parts, supplies and fuel........................................... 324,379 338,745 Deferred income taxes.................................................... 192,097 183,063 Prepaid expenses and other............................................... 59,086 80,696 ----------- ----------- Total current assets................................................. 2,384,716 2,376,678 ----------- ----------- Property and Equipment, at Cost............................................... 11,453,917 11,063,893 Less accumulated depreciation and amortization........................... 6,059,081 5,863,325 ----------- ----------- Net property and equipment........................................... 5,394,836 5,200,568 ----------- ----------- Other Assets: Goodwill................................................................. 348,361 351,507 Equipment deposits and other assets...................................... 425,055 504,353 ----------- ----------- Total other assets................................................... 773,416 855,860 ----------- ----------- $ 8,552,968 $ 8,433,106 ----------- ----------- ----------- -----------
See accompanying Notes to Condensed Consolidated Financial Statements. - 3 - FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS LIABILITIES AND OWNER'S EQUITY
August 31, 1998 May 31, (Unaudited) 1998 -------------- ------------- (In thousands) Current Liabilities: Current portion of long-term debt........................................ $ 265,481 $ 257,529 Accounts payable......................................................... 841,052 965,167 Salaries, wages and benefits............................................. 510,382 547,805 Accrued expenses ........................................................ 723,606 630,798 ---------- ---------- Total current liabilities............................................ 2,340,521 2,401,299 ---------- ---------- Long-Term Debt, Less Current Portion ......................................... 1,171,302 1,185,180 Deferred Income Taxes......................................................... 215,755 218,328 Other Liabilities............................................................. 1,324,387 1,226,570 Commitments and Contingencies (Notes 3 and 4) Owner's Equity: Common Stock, $.10 par value; 1,000 shares authorized, issued and outstanding........................ - - Additional paid-in capital............................................... 893,469 893,469 Retained earnings........................................................ 2,648,256 2,535,537 Cumulative foreign currency translation adjustments................................................ (40,722) (27,277) ---------- ---------- Total owner's equity................................................. 3,501,003 3,401,729 ---------- ---------- $8,552,968 $8,433,106 ---------- ---------- ---------- ----------
See accompanying Notes to Condensed Consolidated Financial Statements. - 4 - FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended August 31, ----------------------------- 1998 1997 ------------- ------------ (In thousands) Revenues ................................................................. $3,417,183 $3,297,218 Operating Expenses: Salaries and employee benefits....................................... 1,540,761 1,450,487 Rentals and landing fees............................................. 313,470 274,468 Maintenance and repairs.............................................. 229,639 198,337 Depreciation and amortization........................................ 220,200 202,421 Fuel................................................................. 146,578 173,780 Other................................................................ 747,463 733,520 ---------- ---------- 3,198,111 3,033,013 ---------- ---------- Operating Income.......................................................... 219,072 264,205 Other Income (Expense): Interest, net........................................................ (21,952) (25,828) Other, net........................................................... (4,438) 8,618 ---------- ---------- (26,390) (17,210) ---------- ---------- Income Before Income Taxes................................................ 192,682 246,995 Provision for Income Taxes................................................ 79,963 103,738 ---------- ---------- Net Income................................................................ $ 112,719 $ 143,257 ---------- ---------- ---------- ----------
See accompanying Notes to Condensed Consolidated Financial Statements. - 5 - FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended August 31, ----------------------------- 1998 1997 ------------- ------------ (In thousands) Net Cash Provided by Operating Activities................................. $ 322,119 $ 206,782 Investing Activities: Purchases of property and equipment, including deposits on aircraft............................................... (452,541) (365,957) Proceeds from disposition of property and equipment: Sale-leaseback transactions...................................... - 81,500 Reimbursements of A300 deposits.................................. 23,630 85,169 Other dispositions............................................... 1,551 8,046 Proceeds from sale of A300 purchase rights and other, net..................................................... 42,745 14,513 --------- --------- Net cash used in investing activities..................................... (384,615) (176,729) --------- --------- Financing Activities: Proceeds from debt issuances......................................... - 267,105 Principal payments on debt........................................... (6,000) (209,446) Borrowings from parent company....................................... 78,178 - Other, net........................................................... - 47 --------- --------- Net cash provided by financing activities................................. 72,178 57,706 --------- --------- Net increase in cash and cash equivalents................................. 9,682 87,759 Cash and cash equivalents at beginning of period.......................... 104,606 122,023 --------- --------- Cash and cash equivalents at end of period................................ $ 114,288 $ 209,782 --------- --------- --------- --------- Cash payments for: Interest (net of capitalized interest)............................... $ 13,727 $ 8,631 --------- --------- --------- --------- Income taxes......................................................... $ 18,653 $ 24,817 --------- --------- --------- --------- Non-cash investing and financing activities: Fair value of assets surrendered under exchange agreements (with two airlines)............................ $ 10,446 $ 25,741 Fair value of assets acquired under exchange agreements................................................ 6,690 31,413 --------- --------- Fair value of assets receivable (liabilities incurred) under exchange agreements................................ $ 3,756 $ (5,672) --------- --------- --------- ---------
See accompanying Notes to Condensed Consolidated Financial Statements. - 6 - FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES On January 27, 1998, Federal Express Corporation ("the Company") became a wholly-owned subsidiary of FDX Corporation ("FDX"). These interim financial statements of the Company have been prepared in accordance with generally accepted accounting principles 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 the Company's Annual Report on Form 10-K for the year ended May 31, 1998. 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 necessary to present fairly the consolidated financial position of the Company as of August 31, 1998 and the consolidated results of its operations and its consolidated cash flows for the three-month periods ended August 31, 1998 and 1997. Operating results for the three-month period ended August 31, 1998 are not necessarily indicative of the results that may be expected for the year ending May 31, 1999. Effective June 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." The Statement requires the Company to include within its financial statements information on comprehensive income, which is defined as all activity impacting equity from non-owner sources. For the Company, comprehensive income includes net income and foreign currency translation adjustments. Total comprehensive income, net of taxes, for the three months ended August 31, 1998 and 1997 was $99,274,000 and $139,355,000, respectively. Also effective June 1, 1998, the Company adopted Statement of Position ("SOP") 98-1, "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use." SOP 98-1 provides guidance on accounting for these costs, requiring certain of them to be capitalized. For the three months ended August 31, 1998, incremental costs of $6,400,000 were capitalized. Certain prior period amounts have been reclassified to conform to the current presentation. - 7 - (2) LONG-TERM DEBT
August 31, 1998 May 31, (Unaudited) 1998 -------------- ------------- (In thousands) Unsecured notes payable, interest rates of 7.60% to 10.57%, due through 2098................................... $1,047,872 $1,053,770 Unsecured sinking fund debentures, interest rate of 9.63%, due through 2020..................................... 98,546 98,529 Capital lease obligations and tax exempt bonds, interest rates of 5.35% to 7.88%, due through 2017.................................................... 253,425 253,425 Less bond reserves.................................................. 9,024 9,024 ---------- ---------- 244,401 244,401 Other debt, interest rates of 9.68% to 9.98%.......................... 45,964 46,009 ---------- ---------- 1,436,783 1,442,709 Less current portion................................................ 265,481 257,529 ---------- ---------- $1,171,302 $1,185,180 ---------- ---------- ---------- ----------
(3) COMMITMENTS As of August 31, 1998, the Company's purchase commitments for the remainder of 1999 and annually thereafter under various contracts are as follows (in thousands):
Aircraft- Aircraft Related(1) Other(2) Total -------- ---------- -------- ---------- 1999 (remainder) $244,600 $413,400 $415,600 $1,073,600 2000 639,400 578,800 211,400 1,429,600 2001 269,800 509,000 59,600 838,400 2002 240,600 156,200 18,100 414,900 2003 457,400 156,600 - 614,000
(1) Primarily aircraft modifications, rotables and spare parts and engines. (2) Vehicles, facilities, computers and other equipment. The Company is committed to purchase nine Airbus A300s, 33 MD11s and 50 Ayres ALM 200s to be delivered through 2007. Deposits and progress payments of $70,094,000 have been made toward these purchases. The Company has entered into agreements with two airlines to acquire 53 DC10 aircraft, spare parts, aircraft engines and other equipment, and maintenance services in exchange for a combination of aircraft engine noise reduction kits and cash. Delivery of these aircraft began in 1997 and will continue through 2001. Additionally, these airlines may exercise put options through December 31, 2003, requiring the Company to purchase up to 29 additional DC10s along with additional aircraft engines and equipment. During the three-month period ended August 31, 1998, the Company acquired three Airbus A300s under operating leases. These aircraft were included as purchase commitments as of May 31, 1998. At the time of delivery, the Company sold its rights to purchase these aircraft to third parties who reimbursed the Company for its deposits on the aircraft and paid additional consideration. The Company then entered into operating leases with each of the third parties who purchased the aircraft from the manufacturer. - 8 - Lease commitments added since May 31, 1998 for the three Airbus A300s are as follows (in thousands): 1999 $ 12,900 2000 15,500 2001 15,800 2002 15,900 2003 17,700 Thereafter 336,200
(4) LEGAL PROCEEDINGS Customers of the Company have filed four separate class-action lawsuits against the Company generally alleging that the Company has breached its contract with the plaintiffs in transporting packages shipped by them. These lawsuits allege that the Company continued to collect a 6.25% federal excise tax on the transportation of property shipped by air after the tax expired on December 31, 1995, until it was reinstated in August 1996. The plaintiffs seek certification as a class action, damages, an injunction to enjoin the Company from continuing to collect the excise tax referred to above, and an award of attorneys' fees and costs. Three of those cases were consolidated in Minnesota Federal District Court. That court stayed the consolidated cases in favor of a case filed in Circuit Court of Greene County, Alabama. The stay was lifted in July 1998. The complaint in the Alabama case also alleges that the Company continued to collect the excise tax on the transportation of property shipped by air after the tax expired again on December 31, 1996. A fifth case, filed in the Supreme Court of New York, New York County, containing allegations and requests for relief substantially similar to the other four cases was dismissed with prejudice on the Company's motion on October 7, 1997. The Court found that there was no breach of contract and that the other causes of action were preempted by federal law. The plaintiffs have appealed. This case originally alleged that the Company continued to collect the excise tax on the transportation of property shipped by air after the tax expired on December 31, 1996. The New York complaint was later amended to cover the first expiration period of the tax (December 31, 1995 through August 27, 1996) covered in the original Alabama complaint. The air transportation excise tax expired on December 31, 1995, was reenacted by Congress effective August 27, 1996, and expired again on December 31, 1996. The excise tax was then reenacted by Congress effective March 7, 1997. The expiration of the tax relieved the Company of its obligation to pay the tax during the periods of expiration. The Taxpayer Relief Act of 1997, signed by President Clinton in August 1997, extended the tax for 10 years through September 30, 2007. The Company intends to vigorously defend itself in these cases. No amount has been reserved for these contingencies. The Company is subject to other legal proceedings and claims which arise in the ordinary course of its business. In the opinion of management, the aggregate liability, if any, with respect to these other actions will not materially adversely affect the financial position or results of operations of the Company. (5) RELATED PARTY TRANSACTIONS As of August 31, 1998, the Company had a payable balance due to its parent, FDX Corporation, of $36,800,000, which is included in Other liabilities. Included in the payable amount is an intercompany operating payable of $8,500,000; the remaining balance of $28,300,000 represents the net activity from funds transferred between FDX and the Company for working capital purposes. - 9 - REVIEW OF CONDENSED CONSOLIDATED FINANCIAL STATEMENTS BY INDEPENDENT PUBLIC ACCOUNTANTS Arthur Andersen LLP, independent public accountants, has performed a review of the condensed consolidated balance sheet of the Company as of August 31, 1998, and the related condensed consolidated statements of income for the three-month periods ended August 31, 1998 and 1997 and the condensed consolidated statements of cash flows for the three-month periods ended August 31, 1998 and 1997, included herein, as indicated in their report thereon included on page 11. - 10 - REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholder of Federal Express Corporation: We have reviewed the accompanying condensed consolidated balance sheet of Federal Express Corporation and subsidiaries as of August 31, 1998 and the related condensed consolidated statements of income for the three-month periods ended August 31, 1998 and 1997 and the condensed consolidated statements of cash flows for the three-month periods ended August 31, 1998 and 1997. These financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical review 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 generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of Federal Express Corporation and subsidiaries as of May 31, 1998 and the related consolidated statements of income, changes in owner's equity and cash flows for the year then ended. In our report dated July 8, 1998, we expressed an unqualified opinion on those financial statements, which are not presented herein. In our opinion, the accompanying condensed consolidated balance sheet as of May 31, 1998 is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived. Arthur Andersen LLP Memphis, Tennessee September 23, 1998 - 11 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS For the three months ended August 31, 1998, the Company recorded net income of $113 million on revenues of $3.4 billion compared with net income of $143 million on revenues of $3.3 billion for the same period in the prior year. The prior year's results included the impact of the Teamsters strike against United Parcel Service ("UPS") in August 1997. During the 12 operating days of the strike, the Company delivered approximately 800,000 additional U.S. domestic express packages per day. Although it is difficult to estimate with precision the impact of this additional volume, the Company has retained a portion of this volume. The Company analytically calculated that the volume not retained at the end of the first quarter of 1998 contributed approximately $150 million and $50 million in U.S. domestic revenues and operating income, respectively, in that quarter. Excluding the strike-related impact, current quarter earnings reflect improved domestic results, partially offset by continued weak international conditions. Revenues The following table shows a comparison of revenues (in millions):
Three Months Ended August 31, ----------------------- Percent 1998 1997 Change -------- -------- --------- U.S. domestic express............................................... $2,423 $2,335 + 4 International Priority (IP)......................................... 725 655 +11 International Express Freight (IXF) and Airport-to-Airport (ATA).................................... 134 151 -11 Charter, Logistics services and other....................................................... 135 156 -13 ------ ------ $3,417 $3,297 + 4 ------ ------ ------ ------
- 12 - The following table shows a comparison of selected operating statistics (packages and pounds in thousands):
Three Months Ended August 31, ----------------------- Percent 1998 1997 Change -------- -------- --------- U.S. domestic express: Average daily packages.............................................. 2,725 2,692 + 1 Revenue per package................................................. $13.47 $13.55 - 1 IP: Average daily packages.............................................. 265 246 + 8 Revenue per package................................................. $41.45 $41.56 - IXF/ATA: Average daily pounds................................................ 2,621 2,652 - 1 Revenue per pound................................................... $ .77 $ .89 -13 Operating weekdays..................................................... 66 64
The Company's U.S. domestic package volume growth was relatively flat primarily due to the impact of the additional volume during the UPS strike in the prior year. The majority of the strike-related volume was in the deferred service category, generally at list price and above average weight per package. Excluding the revenue and volume associated with the strike and the proceeds from a temporary fuel surcharge in the prior year, U.S. domestic average daily package volume and revenue per package (yield) increased 6% and 2% year over year in the current quarter. Management expects total U.S. domestic package volume in 1999 to grow at a lower rate than that experienced in the past two fiscal years. Management believes that U.S. domestic yield should remain stable or increase slightly year over year during the remainder of 1999 due to continued effects of yield-management actions, including a 3% to 4% rate increase in February 1998. Actual results may vary depending on the impact of domestic economic conditions, competitive pricing changes, customer responses to yield-management initiatives and changing customer demand patterns. The Company's IP revenue and volume year-over-year growth rates slowed to 11% and 8% for the quarter, respectively. In the current quarter, which contained two additional operating days, IP revenue rose 7% on a daily basis. Slower growth in the current quarter was primarily due to weakness in Asian markets and was especially evident in U.S. outbound shipments to that region. Total IP yield remained stable during the quarter compared to the same period of the prior year. Management expects continued pressure on IP volume and yield for the remainder of 1999. Actual IP results will depend on international economic conditions, actions by the Company's competitors and regulatory conditions for international aviation rights. -13- The Company's airfreight (IXF/ATA) volume, revenue and yield declined year over year for the quarter. IXF volume (a space-confirmed, time-definite service) increased 3% for the quarter, but yield declined 12% for the same period. ATA volume (a lower-priced, space-available service) decreased 9% for the quarter, with yield lower by 17% for the same period. Management expects airfreight volume and yield to continue to decline, year over year, through the balance of 1999. Due to the impact of difficult international economic conditions on IP and airfreight traffic, management has adjusted the Company's expansion and aircraft deployment plans accordingly. Actual airfreight results will, however, depend on international economic conditions, actions by the Company's competitors, including capacity fluctuations, and regulatory conditions for international aviation rights. Operating Expenses Salaries and employee benefits rose 6% for the quarter, primarily due to higher employment levels associated with volume growth. After adjusting for prior year items, primarily the additional revenue and salaries and employee benefits expense associated with the UPS strike and the proceeds from a temporary fuel surcharge, the increase is consistent with the rate of revenue growth. Included in the prior year's expense was a $25 million special appreciation bonus for U.S. operations employees for their extra efforts during the UPS strike and increased provisions under the Company's performance-based incentive compensation plans. An increase in rentals and landing fees of 14% for the quarter was primarily due to additional facilities and aircraft leased by the Company. The current year's expense includes additional building leases at the Indianapolis and Alliance-Fort Worth hubs. As of August 31, 1998, the Company had 89 wide-bodied aircraft under operating lease compared with 82 as of August 31, 1997. The prior year's expense was favorably impacted by approximately $9 million of a $17 million net gain resulting from the destruction of a leased MD11 aircraft in an accident in July 1997 (described below in Other Income and Expense and Income Taxes). Management expects year-over-year increases in lease expense to continue as the Company enters into additional aircraft rental agreements during 1999 and thereafter. The Company expects to be able to convert its A300 purchase commitments into direct operating leases. (See Note 3 of Notes to Condensed Consolidated Financial Statements.) Maintenance and repairs expense increased 16% for the quarter primarily due to higher year-over-year engine and airframe maintenance on MD11 and B727 aircraft. In the first quarter of 1998, an operating reserve for the disposition of leased B747 was increased $9 million, with the majority of this increase recorded as maintenance and repairs expense. Management believes that maintenance and repairs expense will continue a long-term trend of year-over-year increases for the foreseeable future due to the increasing size and age of the Company's fleet and the variety of aircraft types. Fuel expense fell 16% for the quarter due to a 24% decline in average jet fuel price per gallon, partially offset by a 10% increase in jet fuel gallons consumed. The prior year's first quarter fuel expense included payments made by the Company under contracts that were designed to limit the Company's exposure to fluctuations in jet fuel prices. Effective August 1, 1997, the Company lifted its temporary 2% fuel surcharge that had been in place on certain U.S. domestic and U.S. export shipments. This surcharge was implemented on February 3, 1997 to mitigate the impact of rising jet fuel prices. Other operating expenses increased at a lower rate than revenue because the prior year included incremental expenses associated with the additional volume during the UPS strike, including transportation of packages by third parties, temporary manpower and uniforms and supplies. These expenses and the cost of sales of engine noise reduction kits are the largest items included in other operating expense. - 14 - Operating Income Including the impact of the UPS strike on prior year results, the Company's consolidated operating income decreased 17% for the quarter from the prior year. Excluding the impact of the UPS strike, operating income increased 2% due to improved results in the Company's U.S. domestic operations, largely offset by declining results in international operations. U.S. domestic operating income was $205 million and $241 million for the quarters ending August 31, 1998 and 1997, respectively. The prior year's operating income included approximately $50 million related to the UPS strike as well as proceeds from a 2% temporary fuel surcharge through August 1, 1997. Excluding these prior year factors, operating income increased 23%, cost per package rose 0.9%, yields increased 2% and package volume grew 6%. Sales of engine noise reduction kits contributed $29 million and $36 million to U.S. domestic operating income in the first quarter of 1999 and 1998, respectively. U.S. domestic margin for the quarter was 8.2%, compared with 9.9% (7.4%, excluding the aforementioned prior year items) for the same period in the prior year. The Company's international operating income was $14 million for the quarter, compared with $23 million for the prior year. International operating results declined as a result of slower IP volume growth and declining airfreight volumes at a time of year-over-year capacity increases. Fixed costs associated with the increased capacity, including salaries and employee benefits and aircraft lease expense, also negatively impacted international results. In addition, the net effect of foreign currency fluctuations contributed to the decline in the Company's international operating income. International operating margin was 1.5% for the quarter compared with 2.7% for the same period in the prior year. Other Income and Expense and Income Taxes Net interest expense declined 15% for the quarter due to lower debt levels and a slightly higher amount of capitalized interest. Other, net for the prior year's first quarter included a gain from an insurance settlement for an MD11 aircraft destroyed in an accident in July 1997. At that time, FedEx realized a net gain of $17 million from the insurance settlement and the release from certain related liabilities on the leased aircraft. Approximately $8 million of this gain was recorded in non-operating income. FINANCIAL CONDITION Liquidity Cash and cash equivalents totaled $114 million at August 31, 1998, an increase of $10 million since May 31, 1998. Cash provided from operations was $322 million for the current quarter compared with $207 million for the same period in the prior year. Management believes that cash flow from operations and the parent company's (FDX Corporation) commercial paper program and bank revolving credit facility will adequately meet the Company's working capital needs for the foreseeable future. - 15 - Capital Resources The Company's operations are capital intensive, characterized by significant investments in aircraft, vehicles, computer and telecommunication equipment, package handling facilities and sort equipment. The amount and timing of capital additions depend on various factors including global economic conditions, volume growth, new or enhanced services, geographical expansion of services, competition, availability of satisfactory financing and actions of regulatory authorities. Capital expenditures for the first three months of 1998 totaled $453 million and included one MD11, aircraft modifications, customer automation and computer equipment and vehicles and ground support equipment. In comparison, prior year expenditures totaled $366 million and included one MD11, aircraft modifications, vehicles and ground support equipment and customer automation and computer equipment. In June 1997, an MD11 purchased in February 1997 was sold and leased back. For information on the Company's purchase commitments, see Note 3 of Notes to Condensed Consolidated Financial Statements. Management believes that the capital resources available to the Company provide flexibility to access the most efficient markets for financing its capital acquisitions, including aircraft, and are adequate for the Company's future capital needs. Market Risk Sensitive Instruments and Positions There have been no material changes in the Company's market risk sensitive instruments and positions since its disclosure in its Annual Report on Form 10-K for the year ended May 31, 1998. YEAR 2000 COMPLIANCE Introduction The Company relies heavily on sophisticated information technology ("IT") for its business operations. For example, the Company maintains electronic connections with more than a million customers via its proprietary products and technologies. The Company's Year 2000 ("Y2K") computer compliance issues are, therefore, broad and complex. The Y2K Project Office, which was established in 1996, coordinates and supports the Company's Y2K compliance effort. The Company has engaged a major international consulting firm to assist it in its Y2K program management. The Company's Y2K compliance efforts are focused on business-critical items. Hardware, software, systems, technologies and applications are considered "business-critical" if a failure would either have a material adverse impact on the Company's business, financial condition or results of operations or involve a safety risk to employees or customers. Generally, the Company believes that its Y2K compliance effort is on schedule. State of Readiness The Company has inventoried all business-critical infrastructure and applications software (collectively, "IT Systems"). Assessment/Design (researching the compliance status and determining the impact of, and renovation requirements for, the Company's IT Systems) and renovation (making the Company's IT Systems compliant) are approximately 85% and 75% complete, respectively. Testing, which involves validating compliance, is approximately 65% complete. Certification, which involves the Company's independent, internal review to verify that the appropriate testing process has occurred, is approximately 40% complete. The Company's IT Systems compliance effort is targeted to be 95% complete by December 31, 1998 and 100% complete by September 1, 1999. The inventory and assessment phases of the Company's Y2K program relating to business-critical purchased hardware and software, customized software applications, facilities/equipment and other embedded chip systems (collectively, "Non-IT Systems") are 100% complete. The remaining phases relating to Non-IT Systems are targeted for completion by May 31, 1999. Y2K Interfaces with Material Third Parties The Company is making concerted efforts to understand the Y2K status of third parties (including, among others, domestic and international government - 16 - agencies, customs bureaus, U.S. and international airports and air traffic control systems, vendors and suppliers) whose Y2K non-compliance could either have a material adverse effect on the Company's business, financial condition or results of operations or involve a safety risk to employees or customers. The Company is actively encouraging Y2K compliance on the part of third parties and is developing contingency plans in the event of their Y2K non-compliance. In conjunction with the International Air Transport Association (IATA) and the Air Transport Association of America (ATA), the Company is involved in a global and industry-wide effort to understand the Y2K compliance status of airports, air traffic systems, customs clearance and other U.S. and international government agencies, and common vendors and suppliers. The Company's vendor and product compliance program includes the following tasks: assessing vendor compliance status; product testing; tracking vendor compliance progress; developing contingency plans, including identifying alternate suppliers, as needed; addressing contract language; replacing, renovating or upgrading parts; requesting presentations from vendors or making on-site assessments, as required; and sending questionnaires. Failure to respond to these questionnaires results in further mail or phone correspondence, contingency plan development or vendor/product replacement. Testing The Company's Y2K testing effort includes functional testing of remedial measures and regression testing to validate that changes have not altered existing functionality. The Company's test plans include sections which define the scope of the testing effort, roles and responsibilities of test participants, the test approach planned, software, hardware and data requirements, and test environments/techniques to be used, as well as other sections defining the test effort. System functionality is being verified and documented for future dates. A separate Y2K mainframe environment has been created to test all operating system software and program product software. This Y2K environment is designed to accomplish future date "end to end" testing of the larger applications and to validate interface communications between applications. The Company uses an independent, internal review to verify that the appropriate testing process has occurred. Costs to Address Y2K Compliance Since 1996, the Company has spent approximately $57 million on Y2K compliance. The Company expects that its Y2K compliance efforts will require additional expenditures of approximately $85 million through 2000. The Company's Y2K compliance effort is being funded entirely by internal cash flows. For the fiscal - 17 - year ending May 31, 1999, Y2K expenditures should represent less than 10% of the Company's total IT expense budget. Although there are opportunity costs to the Company's Y2K compliance efforts, management believes that no significant information technology projects have been deferred due to this work. Contingency Planning and Risks The Company has begun developing contingency plans for Y2K non-compliance. These plans will include identifying alternate suppliers, vendors, procedures and operational sites, generating supply/equipment lists, conducting staff training and developing communication plans. A Company-wide contingency planning task force has been formed to ensure appropriate coverage and coordination of these plans and to integrate these with the Company's existing contingency plans. The Company's goal for completion of key Y2K contingency plans is January 31, 1999, with all other Y2K contingency plans targeted for completion by September 30, 1999. The Company plans to establish a contingency command and control center by April 30, 1999 to address any issues caused by Y2K non-compliance, with personnel on call beginning in November 1999. Due to the general uncertainty inherent in the Company's Y2K compliance, mainly resulting from the Company's dependence upon the Y2K compliance of the government agencies, third-party suppliers, vendors and customers with whom the Company deals, the Company is unable to determine at this time its most reasonably likely worst case scenario. While costs related to the lack of Y2K compliance by third parties, business interruptions, litigation and other liabilities related to Y2K issues could materially and adversely affect the Company's business, results of operations and financial condition, the Company expects its Y2K compliance efforts to reduce significantly the Company's level of uncertainty about the impact of Y2K issues affecting both its IT Systems and Non-IT Systems. Statements in this "Management's Discussion and Analysis of Results of Operations and Financial Condition" or made by management of the Company which contain more than historical information may be considered forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) which are subject to risks and uncertainties. Actual results may differ materially from those expressed in the forward-looking statements because of important factors identified in this section. -18- PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Note 4 Legal Proceedings in Part I is hereby incorporated by reference. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits.
Exhibit Number Description of Exhibit -------- ---------------------- 12.1 Computation of Ratio of Earnings to Fixed Charges. 15.1 Letter re Unaudited Interim Financial Statements. 27.1 Financial Data Schedule.
(b) Reports on Form 8-K. During the quarter ended August 31, 1998, the Registrant filed four Current Reports on Form 8-K. The first report was dated July 8, 1998 and filed under Item 5, Other Events, and Item 7, Financial Statements and Exhibits. The report related to and contained a portion of Appendix A to the Preliminary Official Statement prepared with respect to the Indianapolis Airport Authority Special Facility Refunding Revenue Bonds, Series 1998 (Federal Express Corporation Project). The second report was dated June 30, 1998 and filed under Item 7, Financial Statements and Exhibits. The report contained documents related to 1998-1 Pass Through Certificates. The third report was dated July 15, 1998 and filed under Item 7, Financial Statements and Exhibits. The report contained documents related to 1998-1 Pass Through Certificates. The fourth report was dated August 27, 1998 and filed under Item 7, Financial Statements and Exhibits. The report contained documents related to 1998-1 Pass Through Certificates. - 19- 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 (Registrant) Date: October 13, 1998 /s/ MICHAEL W. HILLARD --------------------------- MICHAEL W. HILLARD VICE PRESIDENT & CONTROLLER (PRINCIPAL ACCOUNTING OFFICER) -20- EXHIBIT INDEX
Exhibit Number Description of Exhibit - ------- ---------------------- 12.1 Computation of Ratio of Earnings to Fixed Charges. 15.1 Letter re Unaudited Interim Financial Statements. 27.1 Financial Data Schedule.
E-1 EX-12.1 2 EXHIBIT 12-1 EXHIBIT 12.1 FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (Unaudited)
Three Months Ended Year Ended May 31, August 31, ------------------------------------------------------- -------------------- 1994 1995 1996 1997 1998 1997 1998 --------- -------- ---------- --------- ---------- --------- --------- (In thousands, except ratios) Earnings: Income before income taxes.......................... $378,462 $522,084 $ 539,959 $ 628,221 $ 735,213 $246,995 $192,682 Add back: Interest expense, net of capitalized interest............................ 152,170 130,923 105,449 95,689 117,726 27,364 23,181 Amortization of debt issuance costs.................................. 2,860 2,493 1,628 1,328 1,339 337 206 Portion of rent expense representative of interest factor................................. 285,261 329,370 386,254 434,846 499,823 111,883 128,743 -------- -------- ---------- ---------- ---------- -------- -------- Earnings as adjusted................................ $818,753 $984,870 $1,033,290 $1,160,084 $1,354,101 $386,579 $344,812 -------- -------- ---------- ---------- ---------- -------- -------- -------- -------- ---------- ---------- ---------- -------- -------- Fixed Charges: Interest expense, net of capitalized interest.............................. $152,170 $130,923 $ 105,449 $ 95,689 $ 117,726 $ 27,364 $ 23,181 Capitalized interest................................ 29,738 27,381 39,254 39,449 31,443 9,987 10,958 Amortization of debt issuance costs.................................... 2,860 2,493 1,628 1,328 1,339 337 206 Portion of rent expense representative of interest factor................................... 285,261 329,370 386,254 434,846 499,823 111,883 128,743 -------- -------- ---------- ---------- ---------- -------- -------- $470,029 $490,167 $ 532,585 $ 571,312 $ 650,331 $149,571 $163,088 -------- -------- ---------- ---------- ---------- -------- -------- -------- -------- ---------- ---------- ---------- -------- -------- Ratio of Earnings to Fixed Charges.................. 1.7 2.0 1.9 2.0 2.1 2.6 2.1 -------- -------- ---------- ---------- ---------- -------- -------- -------- -------- ---------- ---------- ---------- -------- --------
EX-15.1 3 EXHIBIT 15-1 EXHIBIT 15.1 September 23, 1998 Federal Express Corporation 2005 Corporate Avenue Memphis, Tennessee 38132 We are aware that Federal Express Corporation will be incorporating by reference in its previously filed Registration Statements No. 2-74000, 2-95720, 33-20138, 33-38041, 33-55055, 333-03443, and 333-49411 its Report on Form 10-Q for the quarter ended August 31, 1998, which includes our report dated September 23, 1998 covering the unaudited interim financial information contained therein. Pursuant to Regulation C of the Securities Act of 1933, that report is not considered part of these registration statements prepared or certified by our firm or a report prepared or certified by our firm within the meaning of Sections 7 and 11 of the Act. Very truly yours, Arthur Andersen LLP EX-27 4 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONDENSED CONSOLIDATED BALANCE SHEETS AND CONDENSED CONSOLIDATED STATEMENTS OF INCOME ON PAGES 3-5 OF THE COMPANY'S FORM 10-Q FOR THE QUARTERLY PERIOD ENDING AUGUST 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS MAY-31-1999 JUN-01-1998 AUG-31-1998 114,288 0 1,739,238 44,372 324,379 2,384,716 11,453,917 6,059,081 8,552,968 2,340,521 1,171,302 0 0 0 3,501,003 8,552,968 0 3,417,183 0 3,198,111 0 0 21,952 192,682 79,963 0 0 0 0 112,719 0 0
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