FedEx 10-K 2006
Documents found in this filing:
Washington, D.C. 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended May 31, 2006.
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 1-15829
(Exact Name of Registrant as Specified in its Charter)
Registrants telephone number, including area code: (901) 818-7500
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the Registrant is not required to file reports pursuant to Rule 13 or Section 15(d) of the Exchange Act. Yes o No x
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 o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The aggregate market value of the common stock held by non-affiliates of the Registrant, computed by reference to the closing price as of the last business day of the Registrants most recently completed second fiscal quarter, November 30, 2005, was approximately $27.6 billion. The Registrant has no non-voting stock.
As of July 10, 2006, 306,410,446 shares of the Registrants common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrants definitive proxy statement to be delivered to stockholders in connection with the 2006 annual meeting of stockholders to be held on September 25, 2006 are incorporated by reference in response to Part III of this Report.
FedEx Corporation (FedEx) provides a broad portfolio of transportation, e-commerce and business services through companies operating independently, competing collectively and managed collaboratively, under the respected FedEx brand. These companies are included in four reportable business segments:
· FedEx Express: Federal Express Corporation (FedEx Express) is the worlds largest express transportation company, offering time-certain delivery within one to three business days and serving markets that comprise more than 90% of the worlds gross domestic product. The FedEx Express segment also includes FedEx Trade Networks, Inc., which provides international trade services, specializing in customs brokerage and global cargo distribution.
· FedEx Ground: FedEx Ground Package System, Inc. (FedEx Ground) is a leading provider of small-package ground delivery service. FedEx Ground provides low-cost residential delivery to nearly 100% of U.S. residences through FedEx Home Delivery. The FedEx Ground segment also includes FedEx SmartPost, Inc., which specializes in the consolidation and delivery of high volumes of low-weight, less time-sensitive business-to-consumer packages using the U.S. Postal Service for final delivery to residences.
· FedEx Freight: FedEx Freight Corporation (FedEx Freight) is a leading U.S. provider of regional next-day and second-day and interregional less-than-truckload (LTL) freight services. The FedEx Freight segment also includes FedEx Custom Critical, Inc., North Americas largest time-specific, critical shipment carrier, and Caribbean Transportation Services, Inc., the leading provider of airfreight forwarding services between the United States and Puerto Rico.
· FedEx Kinkos: FedEx Kinkos Office and Print Services, Inc. (FedEx Kinkos) is a leading provider of document solutions and business services. FedExs Kinkos global network of digitally-connected locations offers access to technology for black & white and color copying/printing, finishing and presentation services, signs and graphics, Internet access, videoconferencing, outsourcing, managed services, Web-based printing, document management solutions, the full range of FedEx day-definite ground shipping and time-definite global express shipping services, and a variety of other retail services and products, including office supplies.
For financial information concerning our reportable business segments, refer to the accompanying financial section, which includes managements discussion and analysis of results of operations and financial condition and our consolidated financial statements.
Our Web site is located at fedex.com. Detailed information about our services and our e-commerce tools and solutions can be found on our Web site. In addition, we make our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to such reports available, free of charge, through our Web site, as soon as reasonably practicable after they are filed with or furnished to the SEC. These and other SEC filings are available through the Investor Relations page of our Web site, the address of which is http://www.fedex.com/us/investorrelations. The information on our Web site, however, is not incorporated by reference in, and does not form part of, this Annual Report on Form 10-K.
Except as otherwise specified, any reference to a year indicates our fiscal year ended May 31 of the year referenced.
FedEx was incorporated in Delaware on October 2, 1997 to serve as the parent holding company of FedEx Express and each of our other operating companies. Through our holding company and FedEx Corporate Services, Inc. (FedEx Services), we provide strategic direction to, and coordination of, the FedEx portfolio of companies. We intend to continue to leverage and extend the FedEx brand and to provide our customers with convenient, seamless access to our entire portfolio of integrated business solutions.
We are pursuing a number of initiatives to continue to enhance the FedEx customer experience. For instance, in May 2006, we launched FedEx Expedited Freight Services, a new, one-call solution that enables customers to quickly and easily evaluate surface and air freight shipping options available from FedEx Express, FedEx Freight and FedEx Custom Critical in order to select the best service meeting their needs. Through one point of contact, customers can select from a broad range of freight services, based on their pickup and delivery requirements, time sensitivity and the characteristics of the products being shipped. This new freight shipping solution further demonstrates our commitment to enhancing the customer experience through state-of-the-art technology.
We believe that sales and marketing activities, as well as the information systems that support the extensive automation of our package delivery services, are functions that are best coordinated across operating companies. Through the use of advanced information systems that connect the FedEx companies, we make it convenient for customers to use the full range of FedEx services. We believe that seamless information integration is critical to obtain business synergies from multiple operating units. For example, our Web site, fedex.com, provides a single point of contact for our customers to access FedEx Express, FedEx Ground and FedEx Freight shipment tracking, customer service and invoicing information and FedEx Kinkos office and print services.
We manage our business as a portfolioin the best interest of FedEx as a whole, not a particular operating company. As a result, we base decisions on capital investment, expansion of delivery, information technology and retail networks, and service additions or enhancements on achieving the highest overall long-term return on capital for our business as a whole. For each FedEx company, we focus on making appropriate investments in the technology and assets necessary to optimize our earnings performance and cash flow. As an example of our commitment to managing collaboratively, certain of our management incentive compensation programs are tied in part to the performance of FedEx as a whole.
While we have increased our emphasis on competing collectively and managing collaboratively, we continue to believe that operating independent networks, each focused on its own respective markets, results in optimal service quality, reliability and profitability from each business unit. Each FedEx company focuses exclusively on the market sectors in which it has the most expertise. Each companys operations, cost structure, policies and culture are designed to serve the unique customer needs of a particular market segment.
Our operate independently, compete collectively, manage collaboratively strategy also provides flexibility in sizing our various operating companies to align with varying macro-economic conditions and customer demand for the market segments in which they operate. For example:
· To accommodate international growth at FedEx Express, we have added flights, purchased aircraft, increased capacity and improved services to and from Europe and Asia based on the growth prospects of these regions.
· We are expanding network capacity at our growing FedEx Ground and FedEx Freight companies. For instance, we expect to increase FedEx Grounds daily package pick-up capacity to approximately five million by 2011.
· We are expanding the FedEx Kinkos retail network, which will further increase customer access to FedEx shipping services and offer growth opportunities in commercial document solutions and other business services.
We believe the following four trends continue to drive world commerce and shape the global marketplace:
· Globalization: As the worlds economy becomes more fully integrated, and as barriers and borders to trade continue to decrease, companies are sourcing and selling globally. The increase in global sourcing and selling has led companies to streamline their supply chains and open new markets. With customers in more than 220 countries and territories, we facilitate this supply chain through our global reach, delivery services and information capabilities.
· Supply Chain Acceleration: As the economy has become increasingly global, it has also become more fast-paced. Businesses cannot wait weeks to source components and finished goods from around the world, especially in high-tech industries with high obsolescence rates. As a result, companies of all sizes depend on the delivery of just-in-time inventory to help them compete faster and more efficiently. We have taken advantage of the move toward faster, more efficient supply chains by helping customers substitute near real-time information to manage inventory in motion, thereby reducing overhead and obsolescence and speeding time-to-market.
· Increase in High-Tech and High-Value-Added Businesses: High-tech and high-value-added goods continue to increase as a percentage of total economic output. These goods can be roughly defined as any product with a relatively high value-to-weight ratio or a high value-added contentfor example, computers, pharmaceuticals, automotive goods, electronics, high-fashion goods and aviation products. Our various operating companies offer a unique menu of services to fit virtually all shipping needs of high-tech and high-value-added industries.
· Growth of the Internet and E-Commerce: E-commerce acts as a catalyst for the other three trends and is a vital growth engine for businesses today. It makes low-cost information available to anyone with Internet access, regardless of time or space. It enables small and mid-sized companies to source and sell globally, just like large corporations. Through our global transportation and technology networks, we contribute to and benefit from the growth of the Internet and e-commerce.
These trends have produced an unprecedented expansion of customer accessto goods, services and information. We continue to position our companies to facilitate and capitalize on this access and move toward even stronger long-term growth, productivity and profitability by:
· Optimizing and expanding our worldwide FedEx Express network, particularly in key markets such as China and India.
· Increasing the capacity, speed and reliability of our FedEx Ground and FedEx Freight networks and expanding the FedEx Kinkos retail network.
· Emphasizing the compete collectively part of our core strategy through service improvements and focusing our employees and contractors on delivering the best customer experience in the industry, resulting in better alignment across the entire FedEx network.
In 2006, we also agreed to make two strategic acquisitions, each of which is expected to provide important contributions to our long-term growth, productivity and profitability.
· On January 24, 2006, FedEx Express signed an agreement with Tianjin Datian W. Group Co., Ltd. (DTW Group) to acquire DTW Groups fifty percent share of the FedEx-DTW International Priority express joint venture and DTW Groups domestic express network in China for approximately $400 million in cash. The acquisition will convert our joint venture with DTW Group, formed in 1999, into a wholly owned subsidiary and increase our presence in China in the international and domestic express
businesses. The acquisition is expected to close in the first half of 2007 and is subject to customary conditions, including government approvals and licensing.
· On May 26, 2006, FedEx signed an agreement to acquire the U.S. and Canadian LTL freight operations of Watkins Motor Lines and certain affiliates for approximately $780 million in cash. Watkins Motor Lines, a privately held company headquartered in Lakeland, Florida, is a leading provider of long-haul LTL freight services. Watkins U.S. long-haul LTL freight business will be rebranded FedEx National LTL and will operate as a separate network within the FedEx Freight segment. Watkins Canadian business, known as Watkins Canada Express, will be rebranded FedEx Freight Canada and will extend FedEx Freights reach and create opportunities for growth in the Canadian market. The addition of Watkins three-day or more long-haul service to FedEx Freights industry-leading next-day and second-day regional LTL freight service will extend our leadership position in the heavyweight freight market. The acquisition is expected to close in the first half of 2007 and is subject to customary conditions.
By competing collectively under the FedEx brand, our operating companies benefit from one of the worlds most recognized brands. FedEx is one of the most trusted and respected brands in the world, and the FedEx brand name is a powerful sales and marketing tool. Among the many reputation awards we received during 2006:
· FedEx ranked second in FORTUNE magazines Americas Most Admired Companies list and fourth in its Worlds Most Admired Companies listthe fifth consecutive year we have been ranked in the top ten on both lists.
· For the third consecutive year, FedEx ranked in the top ten in corporate reputation in The Wall Street Journals Harris Interactive/Reputation Institute RQ Survey.
· FedEx continued to rank highest in customer satisfaction in the University of Michigan Business School National Quality Research Centers American Customer Satisfaction Index in the express delivery category.
· FedEx ranked in the top 100 of InformationWeek magazines InformationWeek 500 list of the most innovative users of information technology, and FedEx Chief Information Officer Rob Carter was named IT Chief of the Year by the same magazine.
FedEx is well recognized as a leader, not only in the transportation industry and technological innovation, but also in social and environmental responsibility and corporate governance. Along with a strong reputation among customers and the general public, FedEx is widely acknowledged as a great place to work. In 2006, we were listed among FORTUNEs 100 Best Companies to Work for in America, a list that we have made every year it has been published, and we have the largest employee base on that list. In June 2006, we were listed among Computerworld magazines 100 Best Places to Work in IT. It is our peopleour greatest assetthat give us our strong reputation. In addition to superior physical and information networks, FedEx has an exemplary human network, with more than 260,000 employees and contractors who are absolutely, positively focused on safety, the highest ethical and professional standards, and the needs of their customers and communities. Through our internal Purple Promise and Humanitarian Award programs, we recognize and reward employees who enhance customer service and promote human welfare.
We are committed to causes that help improve the communities where we live and work, all around the world. As an example, we routinely donate our transportation equipment and services to deliver aid to disaster sites and to support charitable causes. For example, following Hurricanes Katrina and Rita last
year, we worked directly with several relief organizations to facilitate the distribution of needed supplies. We donated transportation for more than 1,000 tons of relief supplies to the Gulf Coast region. We also provided IT and logistics support to emergency management personnel across the region.
In addition to corporate philanthropy and employee volunteerism, we develop strategic relationships with charitable organizations that share our values, including:
· United Way of America: We believe the United Way is one of the most effective and efficient ways of meeting community needs. FedEx supports a yearly fundraising campaign company-wide, and FedEx employee volunteers donate thousands of hours each year to support United Way community efforts.
· American Red Cross: FedEx works with the Red Cross to provide a quick response to disasters around the world. FedEx uses its logistics and transportation expertise to provide complimentary shipping of emergency supplies and assists with financial support.
· National SAFE KIDS Campaign: Reflecting the fact that safety is one of our top priorities, FedEx is the sole corporate sponsor of SAFE KIDS Walk This Way, a global program that advocates child pedestrian safety and teaches children, parents and communities how to prevent pedestrian accidents.
· ORBIS International: FedEx helps ORBIS International provide eye care and treatment to people in developing countries. FedEx provides free aircraft maintenance and our pilots volunteer their time for ORBISs Flying Eye Hospitala converted DC-10 aircraft equipped with surgical and training facilities.
· National Civil Rights Museum: FedEx serves as a major corporate sponsor of the National Civil Rights Museum, which educates the public on the lessons of the civil rights movement in the United States and its impact and influence on the human rights movement worldwide.
· March of Dimes: FedEx is a national sponsor of March of Dimes WalkAmerica, and thousands of FedEx employees participate in it and other events that raise funds to help improve the health of babies by preventing birth defects and infant mortality.
· Heart to Heart International: FedEx helps Heart to Heart International deliver food, medicine and emergency supplies to areas in need throughout the world.
We are committed to protecting the environment. FedEx evaluates the environmental impacts of FedEx packaging products and minimizes waste generation through efforts that include recycling and pollution prevention. FedEx Kinkos history also includes a longstanding dedication to protecting the environment, such as through the use of copy paper with a high recycled content, and its global commitment sets standards for incorporating sustainable business practices that generate economic, social and environmental value today and for future generations.
FedEx is actively involved in efforts to promote cleaner air by reducing emissions through efficient route planning and the use of clean, alternative and renewable energy sources. For example, the FedEx Express OptiFleet E700 hybrid electric vehicle decreases particulate emissions by over 90 percent and greenhouse gas emissions by over 25 percent and increases fuel economy by over 40 percent. In August 2005, FedEx Express opened Californias then largest corporate solar electric system atop its regional hub in Oakland. To date, this solar electric system has provided over 900,000 kilowatt hours of renewable energy generated by sunlight. FedEx Express is also modernizing its aircraft fleet, retiring and replacing its older Boeing 727s with more fuel-efficient and quieter aircraft, which will have the effect of reducing greenhouse gas emissions and airport noise.
FedEx has an independent Board of Directors committed to the highest quality corporate governance. Reflecting this commitment, we have embraced the spirit of corporate governance reform rather than merely meeting the minimum compliance standards set forth in the Sarbanes-Oxley Act of 2002 and the New York Stock Exchanges corporate governance listing standards. We have implemented many governance enhancements that go well beyond those legal requirements. For example, in April 2006, our Board of Directors announced its decision to submit to stockholders a proposal to amend FedExs certificate of incorporation and bylaws to eliminate all supermajority voting requirements. FedEx stockholders will vote on the Boards simple majority vote proposal at the September 25, 2006 annual meeting.
In addition, we have made compliance with the reporting requirements of Section 404 of the Sarbanes-Oxley Act of 2002 one of our highest priorities, and we have leveraged this expensive and time-consuming effort to further improve our already rigorous disclosure controls and procedures and effective internal control over financial reporting. Our goal has been not only to comply with the law, but also to build upon a process that will further enhance a strong controls mindset across FedEx today and in the future.
We have a Code of Business Conduct & Ethics, which applies to all of our directors, officers and employees, including our principal executive officer and senior financial officers. Our Code of Business Conduct & Ethics is available in the corporate governance section of the Investor Relations page of our Web site at http://www.fedex.com/us/investorrelations. We intend to post in the corporate governance section of the Investor Relations page of our Web site information regarding any amendment to, or waiver from, the provisions of our Code of Business Conduct & Ethics to the extent such disclosure is required. The information on our Web site, however, does not form part of this Report.
The following describes in more detail the operations of each of our business segments, as well as FedEx Services:
FedEx Express invented express distribution in 1973 and remains the industry leader, providing rapid, reliable, time-definite delivery of packages and freight to more than 220 countries and territories. FedEx Express offers time-certain delivery within one to three business days, serving markets that generate more than 90% of the worlds gross domestic product through door-to-door, customs-cleared service, with a money-back guarantee. FedEx Expresss unmatched air route authorities and extensive transportation infrastructure, combined with its leading-edge information technologies, make it the worlds largest express transportation company. FedEx Express employs more than 138,000 employees and operates approximately 53,500 drop-off locations, 671 aircraft and 41,000 vehicles and trailers in its integrated global network.
FedEx Express offers a wide range of shipping services for delivery of packages and freight. Overnight package services are backed by money-back guarantees and extend to virtually the entire United States population. FedEx Express offers three U.S. overnight delivery services: FedEx First Overnight, FedEx Priority Overnight and FedEx Standard Overnight. FedEx SameDay service is available for urgent
shipments up to 70 pounds to virtually any U.S. destination. FedEx Express also offers express freight services to handle the needs of the time-definite global freight market.
International express delivery with a money-back guarantee is available to more than 220 countries and territories, with a variety of time-definite services to meet distinct customer needs. FedEx Express also offers a comprehensive international freight service, backed by a money-back guarantee, real-time tracking and advanced customs clearance.
For information regarding FedEx Express e-shipping tools and solutions, see FedEx Services Technology.
FedEx Express is focused on further expanding its international presence, especially in key markets such as China and India. China and India are the two fastest growing major economies in the world, consistently recording gross domestic product growth rates of over 7% a year. China is already the third largest trading country in the world, behind the United States and Germany, with total foreign trade exceeding $1.4 trillion in calendar 2005.
We began serving China in 1984 and, since that time, have expanded our service to cover more than 200 cities across the country with plans to add 100 additional cities over the next few years. We have recently taken several important actions that increase our presence in China and India and bolster our leadership in the global, air cargo industry:
· In March 2005, we launched the express air cargo industrys first direct flight from mainland China to Europe (a daily direct flight from Shanghai to Frankfurt, Germany) as part of a new westbound around-the-world route that originates and terminates in Memphis and provides connections via the FedEx AsiaOne network to and from more than 130 cities in northern and eastern China. Additionally, the flight links key manufacturing regions in Germany into the FedEx network, while other parts of Europe connect with the FedEx EuroOne network via our Paris hub.
· In September 2005, we launched the first overnight express link between India and China as part of our new eastbound around-the-world route, which connects Europe, India, China and Japan with the FedEx Express U.S. hub in Memphis.
· In November 2005, we expanded our service in India. We increased our flight frequencies in and out of India and improved connectivity between key export centers and regional hubs, resulting in improved service, especially for customers in Delhi and north India.
· In January 2006, we broke ground on a new Asia-Pacific hub at the Guangzhou Baiyun International Airport in Southern China, which is expected to employ approximately 1,200 workers. The new Asia-Pacific hub is expected to assume and expand the current activities of our existing hub in Subic Bay, Philippines, beginning in 2009. We believe the new hub will better serve our global customers doing business in and with the fast-growing China and Asia-Pacific markets.
· In January 2006, we signed an agreement to acquire DTW Groups fifty percent share of the FedEx-DTW International Priority express joint venture and DTW Groups domestic express network in China. See Strategy.
· In March 2006, we began using three new flight frequencies into China. We now have a total of 26 weekly flights to China, the most of any U.S.-based cargo carrier.
In support of our international expansion, we have agreed to purchase ten Airbus A380 aircraft, with deliveries beginning in 2009. FedEx Express also holds options for ten additional A380 aircraft. FedEx Express is scheduled to be the first company to take delivery of the Airbus A380 freighter and the first to deploy the plane into service. The immense capacity, extensive range and excellent efficiency of this aircraft make it ideally suited for the anticipated needs of the FedEx Express global network later this decade. To facilitate the use of our growing international network, we offer strong international trade consulting services and a variety of online tools that enable customers to more easily determine and comply with international shipping requirements.
U.S. Postal Service Agreements
Under two agreements with the U.S. Postal Service that run through August 2008, FedEx Express provides air capacity for transportation of Priority, Express and First-Class Mail and has approximately 5,000 drop boxes at U.S. Post Offices in approximately 340 metropolitan areas. FedEx Express also provides transportation and delivery for the U.S. Postal Services international delivery service called Global Express Guaranteed (GXG).
FedEx Express periodically publishes list prices in its Service Guides for the majority of its services. In general, during 2006, U.S. shipping rates were based on the service selected, destination zone, weight, size, any ancillary service charge and whether the shipment was picked up by a FedEx Express courier or dropped off by the customer at a FedEx Express, FedEx Kinkos or FedEx Authorized ShipCenter location. International rates are based on the type of service provided and vary with size, weight and destination. FedEx Express offers its customers discounts generally based on actual or potential average daily revenue produced.
FedEx Express has an indexed fuel surcharge for all U.S. domestic and U.S. outbound shipments and for shipments originating internationally, where legally and contractually possible. The surcharge percentage is subject to monthly adjustment based on the spot price for jet fuel. For example, the fuel surcharge for June 2006 was based on the spot price for jet fuel published for April 2006. Changes to the FedEx Express fuel surcharge, when calculated according to the spot price for jet fuel and FedEx Express trigger points, are applied effective from the first Monday of the month. These trigger points may change from time to time, but information on the fuel surcharge for each month is available at fedex.com approximately two weeks before the surcharge is applicable.
FedEx Expresss primary sorting facility, located in Memphis, serves as the center of the companys multiple hub-and-spoke system. A second national hub is located in Indianapolis. In May 2006, we extended the term of our lease at the Indianapolis International Airport by twelve years and announced plans to significantly expand the Indianapolis hub facility. In addition to these national hubs, FedEx Express operates regional hubs in Newark, Oakland and Fort Worth and major metropolitan sorting facilities in Los Angeles and Chicago. FedEx Express is building a new regional hub in Greensboro, North Carolina, which is scheduled to begin operations in 2009.
Facilities in Anchorage, Paris and Subic Bay, Philippines, serve as sorting facilities for express package and freight traffic moving to and from Asia, Europe and North America. Additional major sorting and freight handling facilities are located at Narita Airport in Tokyo, Stansted Airport outside London and Pearson Airport in Toronto. The facilities in Subic Bay and Paris are also designed to serve as regional hubs for their respective market areas. A new facility in Miami the Miami Gateway Hub serves our South Florida, Latin American and Caribbean markets. In January 2006, we broke ground on a new Asia-
Pacific hub at the Guangzhou Baiyun International Airport in Southern China. The new Asia-Pacific hub is expected to assume and expand the current activities of our existing hub in Subic Bay, Philippines, beginning in 2009.
Throughout its worldwide network, FedEx Express operates city stations and employs a staff of customer service agents, cargo handlers and couriers who pick up and deliver shipments in the stations service area. For more information about our sorting and handling facilities, see Part I, Item 2 of this Annual Report on Form 10-K under the caption FedEx Express Segment. In some international areas, independent agents (Global Service Participants) have been selected to complete deliveries and to pick up packages.
FedEx Kinkos offers retail access to FedEx Express shipping services at all of its U.S. locations and is adding FedEx Express shipping services at its international locations. FedEx Express also has alliances with certain other retailers to provide in-store drop-off sites. Our unmanned FedEx Drop Boxes provide customers the opportunity to drop off packages in office buildings, shopping centers, corporate or industrial parks and outside U.S. Post Offices.
Fuel Supplies and Costs
During 2006, FedEx Express purchased jet fuel from various suppliers under contracts that vary in length and which provide for specific amounts of fuel to be delivered. The fuel represented by these contracts is purchased at market prices that may fluctuate daily. Because of our indexed fuel surcharge, we do not have any jet fuel hedging contracts. See FedEx Express Pricing.
The following table sets forth FedEx Expresss costs for jet fuel and its percentage of total revenues for the last five fiscal years:
Approximately 9% of FedEx Expresss requirement for vehicle fuel is purchased in bulk. The remainder of FedEx Expresss requirement is satisfied by retail purchases with various discounts.
We believe that, barring a substantial disruption in supplies, our fuel purchase contracts will ensure the availability of an adequate supply of fuel for FedEx Expresss needs for the immediate future. A substantial reduction of crude oil supplies or refining capacity, or other events causing a substantial reduction in the supply of jet or vehicle fuel, however, could have a significant adverse effect on FedEx Express.
The express package and freight markets are both highly competitive and sensitive to price and service. The ability to compete effectively depends upon price, frequency and capacity of scheduled service, ability to track packages, extent of geographic coverage, reliability and innovative service offerings. Competitors in these markets include other package delivery concerns, principally United Parcel Service, Inc. (UPS), DHL, passenger airlines offering express package services, regional express delivery concerns, airfreight forwarders and the U.S. Postal Service.
FedEx Expresss principal competitors in the international market are DHL, UPS, foreign postal authorities such as Deutsche Post and TNT N.V., freight forwarders, passenger airlines and all-cargo airlines. Many of FedEx Expresss competitors in the international market are government-owned,
-controlled or -subsidized carriers, which may have greater resources, lower costs, less profit sensitivity and more favorable operating conditions than FedEx Express.
David J. Bronczek is the President and Chief Executive Officer of FedEx Express, which is headquartered in Memphis, Tennessee. As of May 31, 2006, FedEx Express employed approximately 87,400 permanent full-time and 51,000 permanent part-time employees, of which approximately 18% are employed in the Memphis area. FedEx Expresss international employees in the aggregate represent approximately 18% of all employees. FedEx Express believes its relationship with its employees is excellent.
The pilots of FedEx Express are represented by the Air Line Pilots Association, International (ALPA), and are employed under a collective bargaining agreement that became amendable on May 31, 2004. In accordance with applicable labor law, we will continue to operate under our current agreement while we negotiate with our pilots. Contract negotiations with ALPA began in March 2004. These negotiations are ongoing and are being mediated through the National Mediation Board.
Attempts by other labor organizations to organize certain other groups of employees occur from time to time. Although these organizing attempts have not resulted in any certification of a U.S. domestic collective bargaining representative (other than ALPA), we cannot predict the outcome of these labor activities or their effect, if any, on FedEx Express or its employees.
FedEx Trade Networks
FedEx Trade Networks is a leading provider of international trade services, specializing in customs brokerage and global cargo distribution. Its value-added products and services include Global Trade Data, an information tool that allows customers to track and manage imports. FedEx Trade Networks provides international trade advisory services, including assistance with the Customs-Trade Partnership Against Terrorism (C-TPAT) program, and through its WorldTariff subsidiary, FedEx Trade Networks publishes customs duty and tax information for over 100 customs areas worldwide. FedEx Trade Networks has approximately 3,500 employees and over 100 offices in approximately 80 locations throughout North America. Offices are also maintained in major Asian and European markets through dedicated agents.
By leveraging the FedEx brand, maintaining a low cost structure and efficiently using information technology and advanced automation systems, FedEx Ground continues to enhance its competitive position as a leading provider of business and residential money-back-guaranteed ground package delivery services. FedEx Ground serves customers in the North American small-package market, focusing primarily on business and residential delivery of packages weighing up to 150 pounds. Ground service is provided to 100% of the United States population and overnight service up to 400 miles to nearly 100% of the United States population. Through a subsidiary, service is also provided to nearly 100% of the Canadian population. In addition, FedEx Ground offers service to Puerto Rico, Alaska and Hawaii through a ground and air network operation coordinated with other transportation providers.
FedEx Ground continues to improve the speed, reach and service capabilities of its network, by reducing transit time for many of its lanes and introducing or expanding overnight ground service in many metropolitan areas. In addition, to meet growing customer demand for its services, FedEx Ground is in the midst of a major network capacity expansion program, which is expected to increase its daily package pick-up capacity to approximately five million by 2011. The multi-phase plan includes the addition of nine new
hubs, the expansion of existing hubs and the expansion or relocation of other existing facilities. Each of the new hubs will feature the latest automated sorting technology. Three of the nine new hubs already have been opened in the metro areas of Dallas, Cincinnati and Hagerstown, Maryland, and two others are under construction in the metro areas of Memphis and Atlanta.
In addition to the continuing success of FedEx Grounds business-to-business service, the increasing popularity of FedEx Home Delivery, which reaches nearly 100% of U.S. residences, has driven growth in the companys package volumes and financial results. FedEx Home Delivery is dedicated exclusively to meeting the delivery needs of residential customers and provides routine Saturday and evening delivery and premium options such as day-specific, appointment and signature delivery. FedEx Home Delivery brings unmatched services to residential shippers and their customers and also offers a money-back guarantee.
In 2005, FedEx acquired FedEx SmartPost, a leading national small-parcel consolidator. FedEx SmartPost specializes in the consolidation and delivery of high volumes of low-weight, less time-sensitive business-to-consumer packages, using the U.S. Postal Service for final delivery to residences. FedEx SmartPosts customers include e-tailers and catalog companies. Through its network of 16 distribution hubs and approximately 1,160 employees, FedEx SmartPost provides delivery Monday through Saturday to all residential addresses in the U.S., including P.O. Boxes and military destinations.
FedEx Ground periodically publishes list prices for the majority of its services in its Service Guide. In general, during 2006, U.S. shipping rates were based on the service selected, destination zone, weight, size, any ancillary service charge and whether the shipment was picked up by a FedEx Ground contractor or dropped off by the customer at a FedEx Kinkos or FedEx Authorized ShipCenter.
FedEx Ground has an indexed fuel surcharge, which applies to all shipments. The surcharge percentage is subject to monthly adjustment based on a rounded average of the national U.S. on-highway average price for a gallon of diesel fuel as published monthly by the U.S. Department of Energy. For example, the fuel surcharge for June 2006 was based on the average diesel fuel price published for April 2006. Changes to the FedEx Ground fuel surcharge, when calculated according to the rounded index average and FedEx Ground trigger points, are applied effective from the first Monday of the month. These trigger points may change from time to time, but information on the fuel surcharge for each month is available at fedex.com approximately two weeks before the surcharge is applicable.
FedEx Ground operates a multiple hub-and-spoke sorting and distribution system consisting of approximately 500 facilities, including 29 hubs (as of May 31, 2006), in the U.S. and Canada. FedEx Ground conducts its operations primarily with approximately 19,300 owner-operated vehicles and 21,300 company-owned trailers. To provide FedEx Home Delivery service, FedEx Ground leverages its existing pickup operation and hub and linehaul network. FedEx Home Deliverys operations are often co-located with existing FedEx Ground facilities to achieve further cost efficiencies.
Advanced automated sorting technology is used to streamline the handling of approximately 2.9 million daily packages, with each hub processing an average of 18,300 packages per hour. Using overhead laser and six-sided charge-coupled device (CCD) scan technologies, hub conveyors electronically guide packages to their appropriate destination chute, where they are loaded for transport to their respective destination terminals for local delivery. Software systems and Internet-based applications are also deployed to offer customers new ways to connect internal package data with external delivery information. FedEx Ground provides shipment tracing and proof-of-delivery signature functionality through the FedEx Web site,
fedex.com. For additional information regarding FedEx Ground e-shipping tools and solutions, see FedEx Services Technology.
FedEx Kinkos offers retail access to FedEx Ground shipping services at all its U.S. locations. FedEx Ground is also available as a service option at many FedEx Authorized ShipCenters in the U.S.
As of May 31, 2006, FedEx Ground had approximately 41,100 employees and 13,500 independent contractors. Although FedEx Ground believes its relationship with its employees and independent contractors is excellent, the company is involved in numerous purported class-action lawsuits and other proceedings that claim that the companys owner-operators should be treated as employees, rather than independent contractors. For a description of these proceedings, see Item 1A of this Annual Report on Form 10-K (Risk Factors) and Note 19 of the accompanying consolidated financial statements.
Daniel J. Sullivan is the President and Chief Executive Officer of FedEx Ground. Mr. Sullivan will retire effective January 5, 2007, and will be succeeded by David F. Rebholz, who currently is FedEx Expresss Executive Vice President, Operations & Systems Support. FedEx Ground is headquartered in Pittsburgh, Pennsylvania, and its primary competitors are UPS, DHL and the U.S. Postal Service.
FedEx Freight provides regional next-day and second-day and interregional LTL freight services and is known for its exceptional service, reliability and on-time performance. Through a comprehensive network of service centers and advanced information systems, FedEx Freight provides regional LTL freight service to virtually all U.S. ZIP Codes, including Alaska and Hawaii. FedEx Freight also offers a premium service between all regions in the U.S., providing seamless coverage and industry-leading transit times. FedEx Freights regional and interregional LTL freight service is supported by a no-fee money-back guarantee on eligible shipments. Internationally, FedEx Freight serves Canada, Mexico, Puerto Rico, Central and South America, the Caribbean, Europe and Asia via alliances and purchased transportation. FedEx Freight has an indexed fuel surcharge that applies to the majority of its revenue. The indexed surcharge percentage is subject to weekly adjustment based on a rounded average of the national U.S. on-highway average price for a gallon of diesel fuel.
We are focused on expanding the FedEx Freight regional LTL freight network opening new service centers and increasing capacity at a number of key locations to better meet customer demand. For example, in 2006, FedEx Freight opened four new service centers and expanded 12 others. In 2007, FedEx Freight expects to add a long-haul LTL freight network and Canadian operations by completing our pending acquisition of the U.S. and Canadian LTL freight operations of Watkins Motor Lines and certain affiliates. See Strategy.
FedEx Freight provides tailored shipping solutions to help shippers meet tight deadlines. Through its many service offerings, FedEx Freight can match customers time-critical needs with reduced transit times, after-hours pickup or delivery, or same-day delivery. FedEx Freight specializes in fast-cycle distribution. Currently, more than 85% of FedEx Freight shipments are delivered next- or second-business-day. FedEx Freights fully integrated Web site and other e-tools, including a bill of lading generator and e-mail delivery notification, make freight shipping easier and bring customers closer to their own account information. During 2006, FedEx Freight launched FedEx Freight Advance Notice, a free service feature that provides customers with greater visibility and control of their LTL freight shipments. This new feature uses the companys innovative technology systems to proactively notify FedEx Freight customers via the Internet or fax when a shipment may be delayed beyond its estimated delivery date.
FedEx Freight has leveraged its relationships with other FedEx operating companies to meet the increasingly global needs of customers. For example, the FedEx Freight sales force sells FedEx Express
freight services, and FedEx Services sales representatives share LTL leads with their counterparts at FedEx Freight. The sales effort is one phase of a broad initiative aimed at leveraging FedExs competitive advantage in U.S. domestic freight services.
FedEx Freight subsidiary Caribbean Transportation Services, Inc. (CTS) is the leading provider of airfreight forwarding services between the United States and Puerto Rico, specializing in arranging the shipment of heavyweight and oversized cargo. CTS, which also offers service to the Dominican Republic and Costa Rica, provides several delivery options for door-to-door or airport-to-airport airfreight forwarder services, principally to the medical, pharmaceutical and technology sectors.
As of May 31, 2006, FedEx Freight had approximately 28,500 employees operating approximately 42,500 vehicles and trailers from a network of approximately 325 service centers. Douglas G. Duncan is the President and Chief Executive Officer of FedEx Freight, which is based in Memphis, Tennessee. FedEx Freights primary multiregional LTL freight competitors are Con-Way Freight, a subsidiary of Con-way Inc. (formerly CNF Inc.), YRC Regional Transportation (which comprises the USF regional companies), a division of YRC Worldwide Inc. (formerly Yellow Roadway Corporation), and UPS Freight (formerly Overnite Corporation).
FedEx Custom Critical
FedEx Custom Critical provides a range of expedited, time-specific freight-shipping services throughout the United States, Canada and Mexico. Among its divisions are Surface Expedite, for exclusive-use and network-based transport of critical shipments; White Glove Services, for shipments that require special care-in-handling, such as temperature-sensitive materials; and Air Expedite, which offers an array of air solutions to meet customers critical delivery times. Service is available 24 hours a day, 365 days a year, including weekends and holidays at no extra cost. FedEx Custom Critical continuously monitors shipments through an integrated proprietary shipment-control system, including two-way satellite communications on exclusive-use shipments. Through the Shipping Toolkit, located at customcritical.fedex.com, customers can quote, ship, track and map shipments; view and print out copies of a shipments bill of lading, proof of delivery and invoice; and manage their online accounts. FedEx Custom Critical utilizes approximately 1,400 trucks, operated by owner-operators and their drivers, which are dispatched out of approximately 150 geographically-based staging areas. FedEx Custom Critical also provides door-to-door vehicle transport through its Passport Auto Transport and AutoTrans subsidiaries.
FedEx Kinkos Segment
FedEx Kinkos is a global leader in the document services market, offering a wide array of innovative business solutions, including retail access to the full range of FedEx day-definite ground shipping and time-definite global express shipping services. We acquired FedEx Kinkos in February 2004. We have rebranded Kinkos locations as FedEx Kinkos Office and Print Centers, converted FedEx World Service Centers into full-service FedEx Kinkos Ship Centers, and expanded FedEx Kinkos service offerings.
We are focused on expanding the FedEx Kinkos retail network, which will substantially increase customer access to FedEx Express and FedEx Ground services and provide growth opportunities in commercial document solutions and other business services. During 2006, FedEx Kinkos opened 36 new locations, including eight internationally. In 2007, FedEx Kinkos plans to open approximately 200 new locations.
As of May 31, 2006, FedEx Kinkos operations included approximately 1,300 FedEx Kinkos Office & Print Centers and Ship Centers in the United States and approximately 150 additional locations in ten other countries, as well as 40 commercial production centers. These locations create an unmatched global network of state-of-the-art printing and copying technology, which FedEx Kinkos leverages to provide highly differentiated, innovative solutions to its customers. In January 2006, FedEx Kinkos opened its new World Production Center, a 28,500 square foot facility featuring state-of-the-art, commercial-grade
printing equipment. The World Production Center, which is located near the FedEx Express hub in Memphis, allows FedEx Kinkos to easily handle complex, large-scale orders from commercial customers and quickly distribute the resulting documents anywhere in the world.
FedEx Kinkos specifically focuses on key customer segments that are important to the other FedEx companies. To small- and medium-sized business customers, FedEx Kinkos provides complete document management and meets basic office needs. To large corporate customers, FedEx Kinkos provides facilities management and outsourcing of copying, printing and document management services. To the rapidly growing mobile professional market segment, which includes business travelers and mobile salespeople, FedEx Kinkos provides a comprehensive office on the road, including Internet access, videoconferencing and presentation support.
FedEx Kinkos offers a full range of black-and-white, color and custom printing, copying and binding services and an increasingly broad array of other business services, including, among others, facilities management and outsourcing, high-speed Internet access and computer rental, Wi-Fi (wireless fidelity) services, videoconferencing, and signs and graphics production services. FedEx Kinkos has capitalized on the trend toward e-business, offering many Web-based services, including File, Print FedEx Kinkos, a free software tool that works over the Web to connect Microsoft Windows desktop users to copying and printing services at FedEx Kinkos Office and Print Centers; and DocStore, an online ordering solution for digital print-on-demand. FedEx Kinkos also offers retail products, such as specialty papers, greeting cards, printer cartridges, stationery and office supplies.
FedEx Kinkos offers the full range of FedEx Express and FedEx Ground services at virtually all U.S. locations and is adding FedEx shipping services at its international locations. In addition, FedEx Kinkos offers packing services at virtually all U.S. Office and Print Centers, and packing supplies and boxes are included in FedEx Kinkos retail product assortment. By allowing customers to have unpackaged items professionally packed by specially trained FedEx Kinkos team members and then shipped using any of the full range of FedEx day-definite ground shipping and time-definite global express shipping services, FedEx Kinkos provides a complete pack-and-ship solution.
FedEx Kinkos is headquartered in Dallas, Texas. Kenneth A. May is the President and Chief Executive Officer of FedEx Kinkos, which has approximately 22,000 employees. FedEx Kinkos competitors on the retail side of its business include locally owned or franchised quick printers, office-supply superstores, such as Staples, Inc., OfficeMax Incorporated and Office Depot, Inc., pack and ship chains, such as The UPS Store, and small local and regional copy and pack and ship shops. FedEx Kinkos competitors on the facilities management and corporate outsourcing side of its business include Xerox Global Services, IKON Office Solutions, Inc. and Pitney Bowes Inc.
FedEx Services provides a convenient single point of access for many customer support functions, enabling us to more effectively sell the entire portfolio of express and ground services. FedEx Services provides much of the sales, marketing, information technology and customer service support for FedEx Express and FedEx Ground. Effective June 1, 2006, we moved several additional groups that are responsible for FedEx Express and FedEx Ground customer information (credit, collections and customer service) into a newly formed subsidiary of FedEx Services named FedEx Customer Information Services, Inc. Bringing these groups under a common management structure will help to ensure a consistent and outstanding experience for our customers.
Through FedEx Services, we provide our customers with a high level of service quality, as evidenced by our ISO 9001 certification for our global express and ground operations. ISO 9001 registration is required by thousands of customers around the world. FedExs global certification, encompassing the processes of FedEx Express, FedEx Ground and FedEx Services, enhances our single-point-of-access strategy and solidifies our reputation as the quality leader in the transportation industry. ISO 9001 is currently the most rigorous international standard for Quality Management and Assurance. ISO standards were developed by the International Organization for Standardization in Geneva, Switzerland to promote and facilitate international trade. More than 150 countries, including European Union members, the United States and Japan, recognize ISO standards.
T. Michael Glenn is the President and Chief Executive Officer of FedEx Services, which is based in Memphis, Tennessee. As of May 31, 2006, FedEx Services had approximately 10,150 employees.
In 1979, FedEx founder Frederick W. Smith said, The information about a package is as important as the delivery of the package itself. Mr. Smiths vision for FedEx technology in 1979 was a radical idea. Yet, todays FedEx is a world leader in technology, and his vision remains at the core of our comprehensive technology strategy.
Our technology strategy is driven by our desire for customer satisfaction. We strive to build technology solutions that will solve our customers business problems with simplicity, convenience, speed and reliability. The focal point of our strategy is our award-winning Web site, together with our integration solutions.
The fedex.com Web site was launched over ten years ago, and during that time, customers have used the Web site to track the status of over a billion packages online. The fedex.com Web site is widely recognized for its speed, ease of use and customer-focused features. At fedex.com, our customers ship packages, determine international documentation requirements, track package status, pay invoices and access FedEx Kinkos office and printing services. Our FedEx Insight application provides customers with visibility and package status of their inbound and outbound FedEx Express, FedEx Ground and FedEx Freight shipments. Our FedEx Global Trade Manager online resource enables customers to more easily navigate the complexities of international commerce by helping them identify the documents they need to ship to and from specific countries. FedEx Global Trade Manager also offers a currency converter, profiles of regulatory information by country, a customs regulation guide and, through its Estimate Duties and Taxes features, customers can estimate applicable governmental charges, duties and fees. FedEx Billing Online provides customers real-time access to their accounts, invoices and paid shipment details.
We have extended the reach of the fedex.com Web site to be accessible from most wireless devices, making it faster and easier for U.S. and Canadian customers to access real-time package status tracking information, rates and drop-off location data for FedEx Express and FedEx Ground shipments. Our wireless service is available through Web-enabled devices, such as mobile telephones, personal digital assistants and Research In Motion (RIM) devices (such as the BlackBerry). FedEx also uses wireless data collection devices to scan bar codes on shipments. Our data collection device, the FedEx PowerPad, uses Bluetooth wireless technology to give our couriers wireless access to the FedEx network, thereby enhancing and accelerating the package information available to our customers.
We design our e-commerce tools and solutions to be easily integrated into our customers applications, as well as into third-party software being developed by leading e-procurement, systems integration and enterprise resource planning companies. Our FedEx Ship Manager suite of solutions offers a wide range of options to help our customers manage their shipping and associated processes.
The FedEx brand name is a symbol for high-quality service, reliability and speed. FedEx is one of the most widely recognized brands in the world. Special emphasis is placed on promoting and protecting the FedEx brand, one of our most important assets. In addition to traditional print and broadcast advertising, we promote the FedEx brand through corporate sponsorships and special events. For example, FedEx sponsors:
· The National Football League, as its Official Delivery Service Sponsor
· The PGA TOUR and the Champions Tour golf organizations, as their Official Shipping Company
· A Joe Gibbs Racing car in the NASCAR NEXTEL Cup Series
· FedExField, home of the NFLs Washington Redskins
· The FedEx Orange Bowl, host of one of college footballs Bowl Championship Series games
· FedExForum, the home of the NBAs Memphis Grizzlies
· The FedEx Kinkos Classic, a PGA Champions Tour event
· The BMW WilliamsF1 Formula One racing team
· The French Open tennis tournament
In 2006, FedEx and the PGA TOUR announced the establishment of the FedEx Cup, a new season-long points bonus program for players and the centerpiece to the entire PGA TOUR season. The inaugural FedEx Cup program will begin in January 2007.
FedEx Global Supply Chain Services
FedEx Services offers a range of supply chain solutions, including transportation management, fulfillment and fleet services, through its FedEx Global Supply Chain Services subsidiary. FedEx Global Supply Chain Services focuses on information technology-sensitive business to meet the needs of its customers and to drive transportation business to other FedEx operating companies. FedEx Global Supply Chain Services service offerings use advanced electronic data interchanges to speed communications between customers and their suppliers, resulting in more cost-effective solutions and enhanced levels of customer service. The operations of FedEx Global Supply Chain Services were included in the FedEx Ground segment through 2006.
In June 2006, FedEx Global Supply Chain Services introduced FedEx Critical Inventory Logistics, a new supply chain service that will enable customers to more efficiently manage high-value and time-critical inventory. FedEx Critical Inventory Logistics will focus on customers in telecommunication, semiconductor, biomedical and other high-technology industries. The new service will use the varied transportation networks of FedEx Express, FedEx Ground, FedEx Freight and FedEx Custom Critical and will allow customers to deploy replacement parts and devices at FedEx Kinkos locations throughout the United States.
The FedEx trademark, service mark and trade name is essential to our worldwide business. FedEx, FedEx Express, FedEx Ground, FedEx Freight, FedEx Kinkos, FedEx Services, FedEx Global Supply Chain Services, FedEx Customer Information Services, FedEx Trade Networks, FedEx SmartPost and FedEx Custom Critical, among others, are trademarks, service marks and trade names of Federal Express Corporation for which registrations, or applications for registration, are on file. We have authorized,
through licensing arrangements, the use of certain of our trademarks, service marks and trade names by our contractors and Global Service Participants to support our business. In addition, we license the use of certain of our trademarks, service marks and trade names on promotional items for the primary purpose of enhancing brand awareness.
Air. Under the Federal Aviation Act of 1958, as amended, both the U.S. Department of Transportation (DOT) and the Federal Aviation Administration (FAA) exercise regulatory authority over FedEx Express.
The FAAs regulatory authority relates primarily to operational aspects of air transportation, including aircraft standards, maintenance and corrosion control, as well as personnel and ground facilities, which may from time to time affect the ability of FedEx Express to operate its aircraft in the most efficient manner. FedEx Express holds an air carrier certificate granted by the FAA pursuant to Part 119 of the federal aviation regulations. This certificate is of unlimited duration and remains in effect so long as FedEx Express maintains its standards of safety and meets the operational requirements of the regulations.
The DOTs authority relates primarily to economic and security aspects of air transportation. The DOTs jurisdiction extends to aviation route authority and to other regulatory matters, including the transfer of route authority between carriers. FedEx Express holds various certificates issued by the DOT, authorizing FedEx Express to engage in U.S. and international air transportation of property and mail on a worldwide basis. FedEx Expresss international authority permits it to carry cargo and mail from several points in its U.S. route system to numerous points throughout the world. The DOT regulates international routes and practices and is authorized to investigate and take action against discriminatory treatment of United States air carriers abroad. The right of a United States carrier to serve foreign points is subject to the DOTs approval and generally requires a bilateral agreement between the United States and the foreign government. The carrier must then be granted the permission of such foreign government to provide specific flights and services. The regulatory environment for global aviation rights may from time to time impair the ability of FedEx Express to operate its air network in the most efficient manner.
In 2001, the Aviation and Transportation Security Act transferred responsibility for aviation security from the FAA to the Transportation Security Administration (TSA) within the DOT, and ultimately, the Department of Homeland Security. In May 2006, the TSA adopted new rules enhancing many of the security requirements for air cargo on both passenger and all-cargo aircraft. The TSA is currently seeking comments on a draft version of a new all-cargo aircraft security program, which would implement the new rules. Until the required security program is finalized, we cannot determine the effect that these new rules will have on our cost structure or our operating results. It is reasonably possible, however, that these rules or other future security requirements for air cargo carriers could impose material costs on us.
FedEx Express participates in the Civil Reserve Air Fleet (CRAF) program. Under this program, the U.S. Department of Defense may requisition for military use certain of FedEx Expresss wide-bodied aircraft in the event of a declared need, including a national emergency. FedEx Express is compensated for the operation of any aircraft requisitioned under the CRAF program at standard contract rates established each year in the normal course of awarding contracts. Through its participation in the CRAF program, FedEx Express is entitled to bid on peacetime military cargo charter business. FedEx Express, together with a consortium of other carriers, currently contracts with the U.S. Government for charter flights.
Ground. The ground transportation performed by FedEx Express is integral to its air transportation services. The enactment of the Federal Aviation Administration Authorization Act of 1994 abrogated the authority of states to regulate the rates, routes or services of intermodal all-cargo air carriers and most
motor carriers. States may now only exercise jurisdiction over safety and insurance. FedEx Express is registered in those states that require registration.
The operations of FedEx Ground, FedEx Freight and FedEx Custom Critical in interstate commerce are currently regulated by the DOT and the Federal Motor Carrier Safety Administration, which retain limited oversight authority over motor carriers. Federal legislation preempts regulation by the states of rates and service in intrastate freight transportation.
Like other interstate motor carriers, our operations are subject to certain DOT safety requirements governing interstate operations. In addition, vehicle weight and dimensions remain subject to both federal and state regulations.
Communication. Because of the extensive use of radio and other communication facilities in its aircraft and ground transportation operations, FedEx Express is subject to the Federal Communications Commission Act of 1934, as amended. Additionally, the Federal Communications Commission regulates and licenses FedEx Expresss activities pertaining to satellite communications.
Environmental. Pursuant to the Federal Aviation Act, the FAA, with the assistance of the U.S. Environmental Protection Agency, is authorized to establish standards governing aircraft noise. FedEx Expresss aircraft fleet is in compliance with current noise standards of the federal aviation regulations. FedEx Expresss aircraft are also subject to, and are in compliance with, the regulations governing engine emissions. In addition to federal regulation of aircraft noise, certain airport operators have local noise regulations, which limit aircraft operations by type of aircraft and time of day. These regulations have had a restrictive effect on FedEx Expresss aircraft operations in some of the localities where they apply but do not have a material effect on any of FedEx Expresss significant markets. Congresss passage of the Airport Noise and Capacity Act of 1990 established a National Noise Policy, which enabled FedEx Express to plan for noise reduction and better respond to local noise constraints. FedEx Expresss international operations are also subject to noise regulations in certain of the countries in which it operates.
We are subject to federal, state and local environmental laws and regulations relating to, among other things, contingency planning for spills of petroleum products, the disposal of waste oil and the disposal of toners and other products used in FedEx Kinkos copy machines and photo film developing operations. Additionally, we are subject to numerous regulations dealing with underground fuel storage tanks, hazardous waste handling, vehicle and equipment emissions and the discharge of effluents from our properties and equipment. We have environmental management programs to ensure compliance with these regulations.
Customs. Our activities, including customs brokerage and freight forwarding, are subject to regulation by the Bureau of Customs and Border Protection and the TSA within the Department of Homeland Security (customs brokerage and security issues), the U.S. Federal Maritime Commission (ocean freight forwarding) and the DOT (airfreight forwarding). Our offshore operations are subject to similar regulation by the regulatory authorities of foreign jurisdictions.
We present information about our risk factors on pages 65 through 68 of this Annual Report on Form 10-K.
FedEx Expresss principal owned and leased properties include its aircraft, vehicles, national, regional and metropolitan sorting facilities, administration buildings, FedEx Drop Boxes and data processing and telecommunications equipment.
Aircraft and Vehicles
As of May 31, 2006, FedEx Expresss operating aircraft fleet consisted of the following:
(1) Maximum operational revenue payload is the lesser of the net volume-limited payload and the net maximum structural payload.
(2) The MD10-30s and MD10-10s are DC10-30s and DC10-10s, respectively, that have been converted to an MD10 configuration.
(3) Includes 9 aircraft not currently in operation and awaiting completion of passenger-to-freighter modification.
(4) Includes 8 aircraft not currently in operation and awaiting completion of passenger-to-freighter modification.
(5) Includes 4 aircraft not currently in operation and awaiting completion of passenger-to-freighter modification.
(6) Includes 6 aircraft not currently in operation and awaiting completion of passenger-to-freighter modification.
(7) Includes 5 aircraft not currently in operation and awaiting completion of passenger-to-freighter modification.
· The MD11s are three-engine, wide-bodied aircraft that have a longer range and larger capacity than DC10s.
· The DC10s are three-engine, wide-bodied aircraft that have been specially modified to meet FedEx Expresss cargo requirements. The DC10s come in two versions, the DC10-10 and the DC10-30. The DC10-30 has a longer range and higher weight capacity than the DC10-10.
· The MD10s are three-engine, wide-bodied DC10 aircraft that have received an Advanced Common Flightdeck (ACF) modification, which includes a conversion to a two-pilot cockpit, as well as upgrades of electrical and other systems.
· The A300s and A310s are two-engine, wide-bodied aircraft that have a longer range and more capacity than B727s.
· The B727s are three-engine aircraft configured for cargo service.
· The Fokker F27, Cessna 208 and ATR turbo-prop aircraft are leased to independent operators to support FedEx Express operations in areas where demand does not justify use of a larger aircraft.
An inventory of spare engines and parts is maintained for each aircraft type.
In addition, FedEx Express wet leases approximately 45 smaller piston-engine and turbo-prop aircraft which feed packages to and from airports served by FedEx Expresss larger jet aircraft. The wet lease agreements call for the owner-lessor to provide flight crews, insurance and maintenance, as well as fuel and other supplies required to operate the aircraft. FedEx Expresss wet lease agreements are for terms not exceeding one year and are generally cancelable upon 30 days notice.
At May 31, 2006, FedEx Express operated approximately 41,000 ground transport vehicles, including pickup and delivery vans, larger trucks called container transport vehicles and over-the-road tractors and trailers.
Aircraft Purchase Commitments
The following table is a summary of our aircraft purchase commitments as of May 31, 2006 with the year of expected delivery by type:
Deposits and progress payments of $64 million have been made toward these purchases and other planned aircraft-related transactions. Also see Note 18 of the accompanying consolidated financial statements for more information about our purchase commitments.
Sorting and Handling Facilities
At May 31, 2006, FedEx Express operated the following sorting and handling facilities:
(1) Documents and packages.
(2) Handles international express package and freight shipments to and from Asia, Europe and North America.
(3) Handles intra-Europe express package and freight shipments, as well as international express package and freight shipments to and from Europe.
(4) Handles intra-Asia express package and freight shipments, as well as international express package and freight shipments to and from Asia.
FedEx Expresss facilities at the Memphis International Airport also include aircraft maintenance hangars, flight training and fuel facilities, administrative offices and warehouse space. FedEx Express leases these facilities from the Memphis-Shelby County Airport Authority (the Authority) under several leases. The leases cover land, administrative and sorting buildings, other facilities, ramps and certain related equipment. FedEx Express has the option to purchase certain equipment (but not buildings or improvements to real estate) leased under such leases at the end of the lease term for a nominal sum. The
leases obligate FedEx Express to maintain and insure the leased property and to pay all related taxes, assessments and other charges. The leases are subordinate to, and FedEx Expresss rights thereunder could be affected by, any future lease or agreement between the Authority and the U.S. Government.
FedEx Express has major international sorting and freight handling facilities located at Narita Airport in Tokyo, Japan, Stansted Airport outside London, England and Pearson Airport in Toronto, Canada. FedEx Express also has a substantial presence at airports in Hong Kong; Taiwan; Dubai, United Arab Emirates; Frankfurt, Germany; and Miami.
Administrative and Other Properties and Facilities
The World Headquarters of FedEx Express is located in southeastern Shelby County, Tennessee. The headquarters campus, which comprises eight separate buildings with more than 1.1 million square feet of space, houses approximately 1,900 employees. FedEx Express also has facilities housing administrative and technical operations on approximately 200 acres adjacent to the Memphis International Airport. Of the eight buildings located on this site, four are subject to long-term leases and the other four are owned by FedEx Express. FedEx Express also leases approximately 25 facilities in the Memphis area for administrative offices and warehouses. FedEx Express leases state-of-the-art technology centers in Collierville, Tennessee, Irving, Texas, Colorado Springs, Colorado, and Orlando, Florida. These facilities house FedEx Express personnel and FedEx Services personnel responsible for strategic software development and other functions that support FedExs technology and e-commerce solutions.
FedEx Express owns or leases approximately 665 facilities for city station operations in the United States. In addition, approximately 225 city stations are owned or leased throughout FedEx Expresss international network. The majority of these leases are for terms of five to ten years. City stations serve as the sorting and distribution center for a particular city or region. We believe that suitable alternative facilities are available in each locale on satisfactory terms, if necessary.
As of May 31, 2006, FedEx Express had approximately 42,500 Drop Boxes, including 5,000 Drop Boxes outside U.S. Post Offices. As of May 31, 2006, FedEx Express also had approximately 11,000 FedEx Authorized ShipCenters and FedEx ShipSites, which are drop-off locations situated within certain retailers, such as FedEx Kinkos, OfficeMax and Staples. Internationally, FedEx Express has over 2,000 drop-off locations.
FedEx Grounds corporate offices and information and data centers are located in the Pittsburgh, Pennsylvania, area in an approximately 500,000 square-foot building owned by FedEx Ground. As of May 31, 2006, FedEx Ground had approximately 21,300 company-owned trailers and owned or leased approximately 500 facilities, including 29 hubs. In addition, approximately 19,300 owner-operated vehicles support FedEx Grounds business. Of the approximately 300 facilities that support FedEx Home Delivery, more than 185 are co-located with existing FedEx Ground facilities. Leased facilities generally have terms of five years or less. The 29 hub facilities are strategically located to cover the geographic area served by FedEx Ground. The hub facilities average 245,000 square feet and range in size from 31,000 to 488,000 square feet.
FedEx Freights corporate headquarters are located in Memphis, Tennessee. FedEx Freight also has administrative offices located in Harrison, Arkansas and San Jose, California. As of May 31, 2006, FedEx Freight operated approximately 42,500 vehicles and trailers and 325 service centers, which are strategically located to provide service to virtually all U.S. ZIP Codes. These facilities range in size from 950 to 220,400 square feet of office and dock space. FedEx Custom Criticals headquarters are located in Green, Ohio.
FedEx Kinkos corporate headquarters are located in Dallas, Texas in leased facilities. As of May 31, 2006, FedEx Kinkos operated approximately 1,500 locations, including approximately 150 locations in ten foreign countries and 40 commercial production centers. Substantially all FedEx Kinkos Office and Print Centers and Ship Centers are leased, generally for terms of five to ten years with varying renewal options. FedEx Kinkos Office and Print Centers and Ship Centers are generally located in strip malls, office buildings or stand-alone structures and average approximately 5,200 square feet in size.
FedEx and its subsidiaries are subject to legal proceedings and claims that arise in the ordinary course of their business. For a description of material pending legal proceedings, see Note 19 of the accompanying consolidated financial statements.
On June 23, 2006, FedEx and its subsidiaries received a grand jury subpoena for the production of documents in connection with an ongoing investigation by the Antitrust Division of the U.S. Department of Justice (DOJ) into possible violations of federal criminal antitrust laws in the air cargo transportation industry. We have no reason to believe that we are a target of the investigation, and we are cooperating with the DOJ.
There were no matters submitted to a vote of security holders during the fourth quarter of 2006.
Information regarding executive officers of FedEx is as follows (included herein pursuant to Instruction 3 to Item 401(b) of Regulation S-K and General Instruction G(3) of Form 10-K):
Executive officers are elected by, and serve at the discretion of, the Board of Directors. There is no arrangement or understanding between any executive officer and any person, other than a director or executive officer of FedEx or of any of its subsidiaries acting in his or her official capacity, pursuant to which any executive officer was selected. There are no family relationships between any executive officer and any other executive officer or director of FedEx or of any of its subsidiaries.
FedExs common stock is listed on the New York Stock Exchange under the symbol FDX. As of July 10, 2006, there were 20,152 holders of record of our common stock. The following table sets forth, for the periods indicated, the high and low sale prices, as reported on the NYSE, and the cash dividends paid per share of common stock.
FedEx also paid a cash dividend on July 1, 2006 ($0.09 per share). We expect to continue to pay regular quarterly cash dividends, though each subsequent quarterly dividend is subject to review and approval by our Board of Directors. We intend to evaluate the dividend payment amount on an annual basis at the end of each fiscal year.
There are no material restrictions on our ability to declare dividends, nor are there any material restrictions on the ability of our subsidiaries to transfer funds to us in the form of cash dividends, loans or advances.
FedEx did not repurchase any of its common stock during the fourth quarter of 2006.
Selected financial data as of and for the five years ended May 31, 2006 is presented on pages 108 through 109 of this Annual Report on Form 10-K.
Managements discussion and analysis of results of operations and financial condition is presented on pages 35 through 68 of this Annual Report on Form 10-K.
Quantitative and qualitative information about market risk is presented on page 107 of this Annual Report on Form 10-K.
FedExs consolidated financial statements, together with the notes thereto and the report of Ernst & Young LLP dated July 11, 2006 thereon, are presented on pages 71 through 106 of this Annual Report on Form 10-K.
The management of FedEx, with the participation of our principal executive and financial officers, has evaluated the effectiveness of our disclosure controls and procedures in ensuring that 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 Commissions rules and forms, including ensuring that such information is accumulated and communicated to FedEx management as appropriate to allow timely decisions regarding required disclosure. Based on such evaluation, our principal executive and financial officers have concluded that such disclosure controls and procedures were effective as of May 31, 2006 (the end of the period covered by this Annual Report on Form 10-K).
Managements report on our internal control over financial reporting is presented on page 69 of this Annual Report on Form 10-K. The report of Ernst & Young LLP with respect to managements assessment of internal control over financial reporting is presented on page 70 of this Annual Report on Form 10-K.
During our fiscal quarter ended May 31, 2006, no change occurred in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Information regarding members of the Board of Directors and FedExs Code of Business Conduct & Ethics will be presented in FedExs definitive proxy statement for its 2006 annual meeting of stockholders, which will be held on September 25, 2006, and is incorporated herein by reference. Information regarding executive officers of FedEx is included above in Part I of this Annual Report on Form 10-K under the caption Executive Officers of the Registrant pursuant to Instruction 3 to Item 401(b) of Regulation S-K and General Instruction G(3) of Form 10-K. Information regarding FedExs Code of Business Conduct & Ethics is included above in Part I, Item 1 of this Annual Report on Form 10-K under the caption Reputation and Responsibility Governance.
Information regarding executive compensation will be presented in FedExs definitive proxy statement for its 2006 annual meeting of stockholders, which will be held on September 25, 2006, and is incorporated herein by reference.
Information regarding security ownership of certain beneficial owners and management and related stockholder matters will be presented in FedExs definitive proxy statement for its 2006 annual meeting of stockholders, which will be held on September 25, 2006, and is incorporated herein by reference.
Information regarding certain relationships and related party transactions will be presented in FedExs definitive proxy statement for its 2006 annual meeting of stockholders, which will be held on September 25, 2006, and is incorporated herein by reference.
Information regarding principal accountant fees and services will be presented in FedExs definitive proxy statement for its 2006 annual meeting of stockholders, which will be held on September 25, 2006, and is incorporated herein by reference.
FedExs consolidated financial statements, together with the notes thereto and the report of Ernst & Young LLP dated July 11, 2006 thereon, are listed on page 34 and presented on pages 71 through 106 of this Annual Report on Form 10-K. FedExs Schedule II Valuation and Qualifying Accounts, together with the report of Ernst & Young LLP dated July 11, 2006 thereon, is presented on pages 111 through 112 of this Annual Report on Form 10-K. All other financial statement schedules have been omitted because they are not applicable or the required information is included in FedExs consolidated financial statements or the notes thereto.
See the Exhibit Index on pages E-1 through E-9 for a list of the exhibits being filed or furnished with or incorporated by reference into this Annual Report on Form 10-K.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
The financial section of the FedEx Corporation (also referred to as FedEx) Annual Report on Form 10-K (Annual Report) consists of the following Managements Discussion and Analysis of Results of Operations and Financial Condition (MD&A), the Consolidated Financial Statements and the notes to the Consolidated Financial Statements, and Other Financial Information, all of which include information about our significant accounting policies, practices and the transactions that underlie our financial results. The following MD&A describes the principal factors affecting the results of operations, liquidity, capital resources, contractual cash obligations and the critical accounting estimates of FedEx. The discussion in the financial section should be read in conjunction with the other sections of this Annual Report, particularly Item 1: Business and our detailed discussion of risk factors included in this MD&A.
ORGANIZATION OF INFORMATION
Our MD&A is comprised of three major sections: Results of Operations, Financial Condition and Critical Accounting Estimates. These sections include the following information:
· Results of Operations includes an overview of our consolidated 2006 results compared to 2005, and 2005 results compared to 2004. This section also includes a discussion of key actions and events that impacted our results, as well as a discussion of our outlook for 2007.
· The overview is followed by a financial summary and analysis (including a discussion of both historical operating results and our outlook for 2007) for each of our four reportable business segments.
· Our financial condition is reviewed through an analysis of key elements of our liquidity, capital resources and contractual cash obligations, including a discussion of our cash flows statements and our financial commitments.
· We conclude with a discussion of the critical accounting estimates that we believe are important to understanding certain of the material judgments and assumptions incorporated in our reported financial results.
DESCRIPTION OF BUSINESS
FedEx provides a broad portfolio of transportation, e-commerce and business services through companies operating independently, competing collectively and managed collaboratively, under the respected FedEx brand. These operating companies are primarily represented by FedEx Express, the worlds largest express transportation company; FedEx Ground, a leading provider of small-package ground delivery services; FedEx Freight, a leading U.S. provider of regional less than truckload (LTL) freight services; and FedEx Kinkos, a leading provider of document solutions and business services. These companies form the core of our reportable segments. See Reportable Segments for further discussion and refer to Item 1: Business for a more detailed description of each of our operating companies.
The key indicators necessary to understand our operating results include:
· the overall customer demand for our various services;
· the volumes of transportation and business services provided through our networks, primarily measured by our average daily volume and shipment weight;
· the mix of services purchased by our customers;
· the prices we obtain for our services, primarily measured by average price per shipment (yield);
· our ability to manage our cost structure for capital expenditures and operating expenses and to match our cost structure to shifting volume levels; and
· the timing and amount of fluctuations in fuel prices and our ability to recover incremental fuel costs through our supplemental fuel surcharges.
Except as otherwise specified, references to years indicate our fiscal year ended May 31, 2006 or ended May 31 of the year referenced and comparisons are to the prior year. References to our transportation segments mean, collectively, our FedEx Express, FedEx Ground and FedEx Freight segments.
The following table compares revenues, operating income, operating margin, net income and diluted earnings per share (dollars in millions, except per share amounts) for the years ended May 31:
(1) Operating expenses include a $79 million ($49 million, net of tax, or $0.16 per diluted share) charge to adjust the accounting for certain facility leases, predominantly at FedEx Express.
(2) Results include $48 million ($31 million, net of tax, or $0.10 per diluted share) related to the Airline Stabilization Act charge and a $12 million or $0.04 per diluted share benefit from an income tax adjustment described below.
(3) Results include $435 million ($270 million, net of tax, or $0.89 per diluted share) of business realignment costs and a $37 million or $0.12 per diluted share benefit related to a favorable ruling on a tax case and the reduction of our effective tax rate described below. Also see Note 12 to the accompanying consolidated financial statements.
The following table shows changes in revenues and operating income by reportable segment for 2006 compared to 2005, and 2005 compared to 2004 (in millions):
(1) FedEx Express 2006 operating expenses include a $75 million charge to adjust the accounting for certain facility leases, as described below.
(2) FedEx Express 2005 operating expenses include a $48 million charge related to the Airline Stabilization Act, as described below.
(3) FedEx Express 2004 operating expenses include $428 million of business realignment costs, as described below.
(4) The FedEx Kinkos segment was formed in the fourth quarter of 2004.
The following table shows selected operating statistics (in thousands, except yield amounts) for the years ended May 31:
During 2006, revenue growth was primarily attributable to yield improvement across our transportation segments, package volume growth in our International Priority (IP) services at FedEx Express and volume growth at FedEx Ground and FedEx Freight. Yields improved principally due to incremental fuel surcharges and base rate increases. Volumes benefited from IP package volume growth of 8% at FedEx Express and volume growth of 8% at FedEx Ground. Package volume growth at FedEx Ground accelerated in the second half of 2006. Revenues at FedEx Kinkos grew slightly, as a more competitive environment for copies slowed growth in 2006.
Operating income increased during 2006 primarily due to revenue growth and improved margins across all our transportation segments. Yield and cost management activities, combined with productivity gains across all transportation segments, contributed to our margin growth. Operating income improvement was partially offset by higher costs at FedEx Express to support international volume growth, expansion costs at FedEx Ground and reduced operating profit at FedEx Kinkos.
While fuel costs increased substantially in 2006, fuel surcharges more than offset the effect of higher fuel costs on our operating results based on a static analysis of the year-over-year changes in fuel prices compared to changes in fuel surcharges. However, as indicated below, there are other implications that the overall high level of fuel prices have to our businesses. For example, in response to the significant fluctuations in jet and diesel fuel prices during the second and third quarters of 2006, we temporarily capped certain of our fuel surcharges to ensure our services remain competitively priced in the marketplace. While fluctuations in fuel surcharge rates can be significant from period to period, fuel surcharges represent one of the many individual components of our pricing structure that impact our overall revenue and yield. Additional components include the mix of services purchased, the base prices and other extra service charges we obtain for these services and the level of pricing discounts offered. In order to provide information about the impact of fuel surcharges on the trend in revenue and yield growth, we have included the comparative fuel surcharge rates in effect during the past three years in the following discussions of each of our transportation segments.
Salaries and employee benefits increased 5% in 2006 due largely to increases in wage rates, pension and medical expenses. Pension expense increased $64 million in 2006 due primarily to a reduction in the discount rate. Purchased transportation increased 11% in 2006 due primarily to the continued increase in the use of contract carriers to support increasing volumes at FedEx Ground, increased IP volumes at
FedEx Express and higher fuel surcharges from third-party transportation providers, including our independent contractors.
Revenue growth during 2005 was attributable to volume and yield improvements across all transportation segments and the inclusion of FedEx Kinkos for the full year. Combined volume growth in our package businesses increased 8%. Yields improved during 2005 primarily due to incremental fuel surcharges and base rate increases.
During 2005, operating income increased primarily due to revenue growth in all transportation segments and improved margins at FedEx Express and FedEx Freight. FedEx Express benefited from the realization of a full year of savings from our 2004 business realignment programs (versus a half year in 2004), which reduced the growth in salaries, wages and benefits.
Although our fuel costs increased significantly during 2005, higher revenues from our jet and diesel fuel surcharges at FedEx Express and FedEx Freight more than offset these higher fuel costs. Salaries and employee benefits expense increased 12% during 2005 primarily due to higher incentive compensation, a full year of costs associated with FedEx Kinkos and increased medical costs. In 2005, purchased transportation increased at a faster rate than revenue, reflecting higher fuel surcharges from third-party transportation providers and increased use of contract carriers to support international express and domestic LTL volumes.
Other Income and Expense
Net interest expense decreased $35 million during 2006 due primarily to the reduction in the level of outstanding debt and capital leases as a result of scheduled payments, increased interest income due to higher cash balances and interest rates, and higher capitalized interest related to modification of certain aircraft at FedEx Express. Net interest expense increased $23 million during 2005 mainly due to the full year effect of borrowings related to the FedEx Kinkos acquisition and the impact on comparisons of the interest on a prior year favorable tax adjustment resulting from the positive resolution of the tax case described below. In 2005, other expense increased $14 million, primarily due to the write down of certain individually immaterial investments and foreign exchange transaction losses.
Our effective tax rate was 37.7% in 2006, 37.4% in 2005, and 36.5% in 2004. The 37.4% effective tax rate in 2005 was favorably impacted by the reduction of a valuation allowance on foreign tax credits arising from certain of our international operations as a result of the passage of the American Jobs Creation Act of 2004 ($12 million tax benefit or $0.04 per diluted share) and by a lower effective state tax rate. The 36.5% effective tax rate in 2004 was favorably impacted by a reduction of accruals relating to the tax treatment of jet engine maintenance costs, stronger than anticipated international results and the results of tax audits during 2004. In 2004, we received a favorable ruling regarding the tax treatment of jet engine maintenance costs. The decision was affirmed by the appellate court in February 2005, and became final in May 2005, when the period for appeal lapsed. As a result, we recognized a one-time benefit of $26 million, net of tax, or $0.08 per diluted share in 2004. These adjustments affected both net interest expense ($30 million pretax) and income tax expense ($7 million). For 2007, we expect our effective tax rate to be 38.0% to 38.5%. The actual rate, however, will depend on a number of factors, including the amount and source of operating income.
Lease Accounting Charge
Our results for 2006 included a one-time, noncash charge of $79 million ($49 million after tax or $0.16 per diluted share), which represented the impact on prior years to adjust the accounting for certain facility leases, predominately at FedEx Express. The charge related primarily to rent escalations in on-airport
facility leases. The applicable accounting literature provides that rent expense under operating leases with rent escalation clauses should be recognized evenly, on a straight-line basis over the lease term. During the first quarter of 2006, we determined that a portion of our facility leases had rent escalation clauses that were not being recognized appropriately. Because the amounts involved were not material to our financial statements in any individual prior period and the cumulative amount was not material to 2006 results, we recorded the cumulative adjustment, which increased operating expenses by $79 million, in the first quarter of 2006.
Airline Stabilization Act Charge
During the second quarter of 2005, the United States Department of Transportation (DOT) issued a final order in its administrative review of the FedEx Express claim for compensation under the Air Transportation Safety and System Stabilization Act. As a result, we recorded a charge of $48 million in the second quarter of 2005 ($31 million net of tax, or $0.10 per diluted share), representing the DOTs repayment demand of $29 million and the write-off of a $19 million receivable.
Business Realignment Costs
During the first half of 2004, voluntary early retirement incentives with enhanced pension and postretirement healthcare benefits were offered to certain groups of employees at FedEx Express who were age 50 or older. Voluntary cash severance incentives were also offered to eligible employees at FedEx Express. Approximately 3,600 employees accepted offers under these programs. We recognized $435 million of business realignment costs during 2004 ($428 million at the FedEx Express segment) as a result of these programs. No material costs for these programs were incurred in 2006 or 2005.
Over the past few years, we have taken many steps to bring our expense growth in line with revenue growth, particularly at FedEx Express, while maintaining our industry-leading service levels. The business realignment programs were another step in this ongoing process of managing our cost structure to increase our competitiveness, meet the future needs of our employees and provide the expected financial returns for our shareholders.
On May 26, 2006, we announced an agreement to acquire the LTL operations of Watkins Motor Lines (Watkins), a privately held company, and certain affiliates for approximately $780 million in cash. Watkins is a leading provider of long-haul LTL services. Watkins will be rebranded as FedEx National LTL and will be included in the FedEx Freight segment from the date of acquisition, which is expected to occur during the first half of 2007, subject to customary closing conditions.
On January 24, 2006, FedEx Express entered into an agreement with Tianjin Datian W. Group Co., Ltd. (DTW Group) to acquire DTW Groups 50% share of the FedEx-DTW International Priority express joint venture (FedEx-DTW) and DTW Groups domestic express network in China for approximately $400 million in cash. This acquisition will convert our joint venture with DTW Group, formed in 1999 and currently accounted for under the equity method, into a wholly-owned subsidiary and increase our presence in China in the international and domestic express businesses. The acquisition is expected to be completed in the first half of 2007, subject to customary closing conditions. The financial results of this transaction will be included in the FedEx Express segment from the date of acquisition.
On September 12, 2004, we acquired the assets and assumed certain liabilities of FedEx SmartPost (formerly known as Parcel Direct), a division of a privately held company, for $122 million in cash. FedEx SmartPost is a leading small-parcel consolidator and broadens our portfolio of services by allowing us to offer a cost-effective option for delivering low-weight, less time-sensitive packages to U.S. residences
through the U.S. Postal Service. The financial results of FedEx SmartPost are included in the FedEx Ground segment from the date of acquisition.
On February 12, 2004, we acquired FedEx Kinkos for approximately $2.4 billion in cash. FedEx Kinkos is a leading provider of document solutions and business services. Its network of worldwide locations offers access to color printing, finishing and presentation services, Internet access, videoconferencing, outsourcing, managed services, Web-based printing and document management solutions. The results of FedEx Kinkos are included in our consolidated financial statements from the date of acquisition.
Our outlook for 2007 is based on an expectation of global economic growth of 3%, which is slower than prior years and a return to historical levels. Strong international growth is expected to help offset moderating growth in the U.S. We believe oil prices will continue to remain high and volatile based on world events. While our growth is expected to moderate in comparison to our strong results in 2006 and 2005, we expect revenue and earnings growth across all transportation segments in 2007, driven by revenue growth in high-margin services, productivity improvements and continued focus on yield management.
At FedEx Express we anticipate strong growth in IP package volumes and yields, driven by Asia, and a slight improvement in U.S. domestic volumes and yields. We also anticipate year-over-year increases in volumes and yields at FedEx Ground and FedEx Freight, as FedEx Ground continues its multi-year capacity expansion plan and FedEx Freight continues to grow its regional and interregional services. FedEx Kinkos will focus on key strategies related to adding new locations, improving customer service and increasing investments in employee development and training, which we expect to result in decreased profitability in the short term.
We expect to continue to make investments to expand our networks and broaden our service offerings, in part through the integration and expansion of the businesses we agreed to acquire in 2006.
All of our transportation businesses operate in a competitive pricing environment, exacerbated by continuing high fuel prices. While our fuel surcharges have been sufficient to offset increased fuel prices, we cannot predict the impact on the overall economy if fuel costs significantly fluctuate from current levels. Volatility in fuel costs may also impact quarterly earnings because adjustments to our fuel surcharges lag changes in actual fuel prices paid. Therefore, the trailing impact of adjustments to FedEx Express and FedEx Ground fuel surcharges can significantly affect earnings in the short term.
Our management teams continue to examine additional cost reductions and operational productivity opportunities as we focus on optimizing our networks, improving our service offerings, enhancing the customer experience and rewarding our employees and contractors through effective compensation and incentive programs.
In 2007, we will adopt Statement of Financial Accounting Standards (SFAS) 123R, Share-Based Payment. The new standard will require FedEx to record compensation expense for stock-based awards beginning in 2007, which is expected to negatively impact our results by approximately $0.15 per diluted share. See our additional discussion of the adoption of SFAS 123R under New Accounting Pronouncements.
The pilots of FedEx Express, which represent a small number of FedEx Express total employees, are employed under a collective bargaining agreement that became amendable on May 31, 2004. In accordance with applicable labor law, we will continue to operate under our current agreement while we negotiate with our pilots. Contract negotiations with the pilots union began in March 2004. These negotiations are ongoing and are being mediated through the National Mediation Board. We cannot estimate the financial impact, if any, the results of these negotiations may have on our future results of operations.
In May 2006, the U.S. Transportation Security Administration (TSA) adopted new rules enhancing many of the security requirements for air cargo on both passenger and all-cargo aircraft. The TSA is currently seeking comments on a draft version of a new all-cargo aircraft security program, which would implement the new rules. Until the required security program is finalized, we cannot determine the effect that these new rules will have, if any, on our cost structure or our operating results. It is reasonably possible, however, that these rules or future security requirements for air cargo carriers could impose material costs on us.
Also, see Risk Factors for a discussion of these and other potential risks and uncertainties that could materially affect our future performance.
Seasonality of Business
Our businesses are seasonal in nature. Seasonal fluctuations affect volumes, revenues and earnings. Historically, the U.S. express package business experiences an increase in volumes in late November and December. International business, particularly in the Asia-to-U.S. market, peaks in October and November due to U.S. holiday sales. Our first and third fiscal quarters, because they are summer vacation and post winter-holiday seasons, have historically experienced lower volumes relative to other periods. Normally, the fall is the busiest shipping period for FedEx Ground, while late December, June and July are the slowest periods. For FedEx Freight, the spring and fall are the busiest periods and the latter part of December, January and February are the slowest periods. For FedEx Kinkos, the summer months are normally the slowest periods. Shipment levels, operating costs and earnings for each of our companies can also be adversely affected by inclement weather, particularly in our third fiscal quarter. In addition, the transportation and business services industries are directly affected by the state of the overall global economy.
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123R, Share-Based Payment. SFAS 123R is a revision of SFAS 123 and supersedes Accounting Principles Board Opinion No. (APB) 25. The new standard requires companies to record compensation expense for stock-based awards using a fair value method. Compensation expense will be recorded over the requisite service period, which is typically the vesting period of the award.
We will adopt this standard using the modified prospective method as of June 1, 2006. We believe that the adoption of this standard will result in a reduction of diluted earnings per share of approximately $0.15 in 2007. This estimate is impacted by the levels of share-based payments granted in the future, assumptions used in our fair value model and the market price of our common stock, so the actual effect per diluted share could differ from this estimate.
The FASB issued FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes, on July 13, 2006. The new rules will most likely be effective for FedEx in 2008. At this time, we have not completed our review and assessment of the impact of adoption of FIN 48.
FedEx Express, FedEx Ground, FedEx Freight and FedEx Kinkos form the core of our reportable segments. (For further discussion of our operating companies, refer to Item 1: Business.) As of May 31, 2006, our reportable segments included the following businesses:
FedEx Services provides customer-facing sales, marketing and information technology support, primarily for FedEx Express and FedEx Ground. The costs for these activities are allocated based on metrics such as relative revenues or estimated services provided. We believe these allocations approximate the cost of providing these functions.
The operating expenses line item Intercompany charges on the accompanying unaudited financial summaries of our reportable segments includes the allocations from FedEx Services to the respective segments. The Intercompany charges caption also includes allocations for administrative services provided between operating companies and certain other costs such as corporate management fees related to services received for general corporate oversight, including executive officers and certain legal and finance functions. Management evaluates segment financial performance based on operating income.
In addition, certain FedEx operating companies provide transportation and related services for other FedEx companies outside their reportable segment. Billings for such services are based on negotiated rates, which we believe approximate fair value, and are reflected as revenues of the billing segment. FedEx Kinkos segment revenues include package acceptance revenue, which represents the fee received by FedEx Kinkos from FedEx Express and FedEx Ground for accepting and handling packages at FedEx Kinkos locations on behalf of these operating companies. Package acceptance revenue does not include the external revenue associated with the actual shipments. All shipment revenues are reflected in the segment performing the transportation services. Such intersegment revenues and expenses are eliminated in the consolidated results but are not separately identified in the following segment information, as the amounts are not material.
FEDEX EXPRESS SEGMENT
The following table compares revenues, operating expenses, operating income and operating margin (dollars in millions) for the years ended May 31:
(1) Other revenues includes FedEx Trade Networks.
(2) Includes a $75 million one-time, noncash charge to adjust the accounting for certain facility leases.
(3) The $428 million of business realignment costs, described herein, reduced operating margin by 244 basis points.
The following table compares selected statistics (in thousands, except yield amounts) for the years ended May 31: