FedEx 10-K 2007
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number 1-15829
Registrants telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ 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 þ
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 þ 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. þ
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):
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Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
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, 2006, was approximately $33.1 billion. The Registrant has no non-voting stock.
As of July 9, 2007, 308,769,004 shares of the Registrants common stock were outstanding.
Portions of the Registrants definitive proxy statement to be delivered to stockholders in connection with the 2007 annual meeting of stockholders to be held on September 24, 2007 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 that compete collectively, operate independently and manage collaboratively, under the respected FedEx brand. These companies are included in four reportable business segments:
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 leveraging and extending the FedEx brand and providing 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, we are expanding our transportation and retail networks (as described below) to accommodate future volume growth and increase customer convenience. In addition, we are broadening and more effectively bundling our portfolio of services in response to the needs and desires of our customers, such as through our recent acquisitions in the long-haul LTL freight and international domestic express transportation markets (as described below) and our new and improved service offerings for example, FedEx Kinkos Print Online (see FedEx Kinkos Segment below).
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. Similarly, by making one call to the new FedEx Expedited Freight Services, our customers can 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 this 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.
We manage our business as a portfolio in the long-term 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, most of our management incentive compensation programs are tied 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 and culture are designed to serve the unique customer needs of a particular market segment.
Our compete collectively, operate independently, 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:
We believe the following four trends continue to drive world commerce and shape the global marketplace:
These trends have produced an unprecedented expansion of customer access to goods, services and information. This access is fueling a remarkable transformation of the worlds economy, helping businesses and nations flourish, and empowering individuals with greater choices and opportunities. Through our global transportation, information technology and retail networks, we help to make this access possible. 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:
During 2007, we made several strategic acquisitions, each of which is expected to provide important contributions to our long-term growth, productivity and profitability.
In sum, our overall long-term goal is to continue to:
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 2007:
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. It is our people our greatest asset that give us our strong reputation. In addition to superior physical and information networks, FedEx has an exemplary human network, with more than 280,000 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 capabilities and services to deliver aid to disaster sites and to support charitable causes. We support and promote diversity and ethnic outreach by, among other things, making contributions to various non-profit organizations that serve the African-American and Hispanic communities, such as the Hispanic Scholarship Fund, the National Council of La Raza, the National Association for the Advancement of Colored People (NAACP), INROADS, the Trumpet Awards and the Little Rock Nine Foundation. In addition to corporate philanthropy and employee volunteerism, we develop strategic relationships with certain charitable organizations that share our values, including:
We are committed to protecting the environment. FedEx evaluates the environmental impacts of FedEx packaging 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.
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. FedEx Express operates 93 hybrid vehicles in North America, with more than 1 million miles in revenue service. In August 2005, we opened Californias then largest corporate solar electric rooftop system atop the FedEx Express regional hub in Oakland. To date, this solar electric system has provided approximately 2 billion watt hours of renewable energy generated by sunlight. We are also modernizing our aircraft fleet. For example, we are retiring and replacing older Boeing 727s with more fuel-efficient and quieter Boeing 757s. The use of newer and more fuel efficient aircraft will have the effect of reducing greenhouse gas emissions and airport noise and increasing our jet fuel efficiency.
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 March 2007, our Board of Directors adopted a majority-voting standard in uncontested director elections and a resignation requirement for directors who fail to receive the required majority vote. The Board is prohibited from changing back to a plurality-voting standard without the approval of our stockholders.
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.
Our Board of Directors reviews all aspects of our governance policies and practices, including our Corporate Governance Guidelines and our Code of Business Conduct & Ethics, at least annually in light of best practices and makes whatever changes are necessary to further our longstanding commitment to the highest standards of corporate governance. The Guidelines and the Code, which applies to all of our directors, officers and employees, including our principal executive officer and senior financial officers, are available in the corporate governance section of the Investor Relations page of our Web site at http://www.fedex.com/us/investorrelations. We will 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 the Code 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 leading-edge information technologies, make it the worlds largest express transportation company. FedEx Express employs more than 143,000 employees and has approximately 53,500 drop-off locations (including at FedEx Kinkos centers), 669 aircraft and 53,000 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 backed by money-back guarantees 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. During 2007, FedEx Express significantly increased the reach of its FedEx International Priority Freight service to cover more than 130 countries.
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 $1.7 trillion in calendar 2006.
We began serving China in 1984, and since that time, we have expanded our service to cover more than 200 cities and counties across the country with plans to add 100 additional cities and counties over the next few years. We now employ approximately 6,000 workers in China. 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. For example, during 2007, we completed the DTW Group and PAFEX acquisitions (see Strategy) and initiated a next-business-day, time-definite domestic express delivery service in China, which is available to more than 30 cities and counties throughout the country. The new China domestic express service is supported by a money-back guarantee and real-time package status tracking. Our China domestic express network relies on a hub-and-spoke system centered at the Hangzhou Xiaoshan International Airport, located in East Chinas Zhejiang Province. Other recent actions in China and India include:
In support of our international expansion, we have agreed to purchase 15 Boeing 777 Freighter (B777F) aircraft, a new high-capacity, long-range airplane, with deliveries beginning in calendar 2009. We also hold an option to purchase an additional 15 B777F aircraft. 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.
Under a July 2006 agreement with the U.S. Postal Service that runs through September 2013, FedEx Express provides domestic air transportation services to the U.S. Postal Service, including for its First-Class, Priority and Express Mail. FedEx Express also has approximately 5,000 drop boxes at U.S. Post Offices in approximately 340 metropolitan areas and 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 2007, 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, destination and,
whenever applicable, 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. FedEx Express offers its customers discounts generally based on actual or potential average daily revenue produced.
FedEx Express has an indexed fuel surcharge for 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 2007 was based on the spot price for jet fuel published for April 2007. 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 facility, which we are significantly expanding, is located in Indianapolis. 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 calendar 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 facility in Miami the Miami Gateway Hub serves our South Florida, Latin American and Caribbean markets. In 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.
During 2007, 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 10% 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.
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, 2007, FedEx Express employed approximately 93,000 permanent full-time and 50,000 permanent part-time employees, of which approximately 16% are employed in the Memphis area. FedEx Expresss international employees in the aggregate represent approximately 25% 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 four-year collective bargaining agreement that took effect on October 30, 2006. 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 is a leading provider of international trade services, specializing in customs brokerage and global cargo distribution. Its value-added 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 100 offices in 70 service 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. 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 pick-up capacity to approximately five million packages by 2012. 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.
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.
FedEx SmartPost (a subsidiary of FedEx Ground) is a leading national small-parcel consolidator, 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. The company picks up shipments from customers (including e-tailers and catalog companies), provides sorting and linehaul services and then delivers the packages to a U.S. Postal Service facility for final delivery by a postal carrier. Through its network of 20 distribution hubs and approximately 1,680 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 2007, 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 2007 was based on the average diesel fuel price published for April 2007. 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, in the U.S. and Canada. FedEx Ground conducts its operations primarily with approximately 20,600 owner-operated vehicles and 25,800 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 over 3.1 million packages daily. 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 of 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, 2007, FedEx Ground had approximately 44,000 employees and 13,800 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 17 of the accompanying consolidated financial statements.
David F. Rebholz is the President and Chief Executive Officer of FedEx Ground. FedEx Ground is headquartered in Pittsburgh, Pennsylvania, and its primary competitors are UPS, DHL and the U.S. Postal Service.
FedEx Freight Corporation provides a full range of LTL freight services through its FedEx Freight business (regional next-day and second-day and interregional LTL freight services), its FedEx National LTL business (long-haul LTL freight services) and its FedEx Freight Canada business, 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 service to virtually all U.S. ZIP Codes (including Alaska and Hawaii) with industry-leading transit times. FedEx Freights regional and interregional LTL freight services are supported by a no-fee money-back guarantee on eligible shipments. Internationally, FedEx Freight serves Mexico, Puerto Rico, Central and South America, the Caribbean, Europe and Asia via alliances and purchased transportation. FedEx Freight and FedEx National LTL have an indexed fuel surcharge, which 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 network opening new service centers and increasing capacity at a number of key locations to better meet customer demand. For example, in 2007, FedEx Freight opened seven new service centers and expanded eight others. In 2007, FedEx Freight Corporation also added a long-haul LTL freight business and Canadian operations by acquiring the U.S. and Canadian LTL freight operations of Watkins Motor Lines and certain affiliates, now known as FedEx National LTL and FedEx Freight Canada. See Strategy.
FedEx Freight specializes in fast-cycle distribution and 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 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. The FedEx Freight Advance Notice service 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, providing customers with greater visibility and control of their LTL freight shipments.
FedEx Freight Corporation has leveraged its relationships with other FedEx operating companies to meet the increasingly global needs of customers. For example, the FedEx Freight Corporation sales force sells FedEx Express freight services, and FedEx Services sales representatives share LTL leads with their counterparts at FedEx Freight Corporation. The sales effort is one phase of a broad initiative aimed at leveraging FedExs competitive advantage in U.S. domestic freight services.
FedEx Freight Corporation 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 serves the Dominican Republic, Costa Rica and the Caribbean Islands, 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, 2007, FedEx Freight Corporation had approximately 37,000 employees operating approximately 59,000 vehicles and trailers from a network of approximately 470 service centers. Douglas G. Duncan is the President and Chief Executive Officer of FedEx Freight Corporation, which is based in Memphis, Tennessee. FedEx Freights primary multiregional LTL freight competitors are Con-Way Freight, a subsidiary of Con-way Inc., YRC Regional Transportation (which comprises the USF regional companies), a division of YRC Worldwide Inc., and UPS Freight. FedEx National LTLs primary long-haul LTL freight competitors are YRC National Transportation (which comprises Yellow Transportation and Roadway), a division of YRC Worldwide Inc., and ABF Freight System, Inc.
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 FedEx Freight network-based transport of critical shipments and expedited LTL shipments; Air Expedite, which offers an array of air solutions to meet customers critical delivery times; and White Glove Services, for shipments that require extra care in handling, temperature control or specialized security. 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 vehicles, 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 subsidiary.
FedEx Kinkos is a leader in the document and business services market, offering a wide array of innovative solutions, including retail access to the full range of FedEx day-definite ground shipping and time-definite global express shipping services. 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 e-commerce and other business services. FedEx Kinkos opened 226 new centers in 2007 and plans to open approximately 300 new centers in 2008. The new lower-cost centers, which are approximately one-third the size of a traditional center, are based on a new format designed to enhance customer service and convenience. As an example, the new centers include enhanced pack-and-ship stations and offer twice as many office products as traditional centers.
As of May 31, 2007, FedEx Kinkos operations included approximately 1,500 FedEx Kinkos Office & Print Centers and Ship Centers in the United States and approximately 160 additional locations in 10 other countries, as well as 35 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. FedEx Kinkos World Production Center, which is located near the FedEx Express hub in Memphis, is a 28,500 square foot facility featuring state-of-the-art, commercial-grade printing equipment. The World Production Center 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 services and meets basic office needs. 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.
During 2007, we launched FedEx Kinkos Direct Mail Services, a new offering designed to help small- and medium-sized businesses easily communicate to target audiences, and FedEx Kinkos Print Online, a new Web-based, print-on-demand application. Services available through FedEx Kinkos Direct Mail Services include design, production, professional finishing, address cleansing and verification and mail processing. Print Online enables customers to digitally send documents to FedEx Kinkos Office and Print Centers for printing. With the new Print Online application, customers may select from extensive printing and finishing options, track order status, reuse saved print jobs and review order history. In June 2007, we extended the application to users of the popular Adobe Reader and Adobe Acrobat software applications, both of which will now feature a FedEx Kinkos Print Online connection for sending documents directly to a FedEx Kinkos Office and Print Center for printing.
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, high-speed Internet access and computer rental, videoconferencing, signs and graphics production services and direct mail services. FedEx Kinkos has capitalized on the trend toward e-business, offering many Web-based services, including Print Online (described above); 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 22,600 employees. FedEx Kinkos competitors 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 Services provides sales, marketing, information technology and customer service support for FedEx Express, FedEx Ground and FedEx Kinkos. Through FedEx Services and its subsidiary FedEx Customer Information Services, Inc., we provide 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 and to help ensure a consistent and outstanding experience for our customers.
FedEx Services provides 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, 2007, FedEx Services had approximately 15,000 employees.
FedEx is a world leader in technology, and FedEx founder Frederick W. Smiths vision that the information about a package is as important as the delivery of the package itself 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 customer integrated solutions.
The fedex.com Web site was launched over ten years ago, and during that time, customers have shipped and tracked billions of packages at fedex.com. 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 express, ground and freight shipments. Our FedEx Global Trade Manager resource enables customers to more easily navigate the complexities of international commerce by helping them identify the documents they need in order 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:
FedEx Services offers a range of supply chain solutions, including critical inventory logistics, 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 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 National LTL, 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 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 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.
Under the Aviation and Transportation Security Act of 2001, as amended, the Transportation Security Administration (TSA), an agency within the Department of Homeland Security, has responsibility for aviation 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, and in May 2007, the TSA issued a revised model all-cargo aircraft security program for implementing the new rules. Together with other all-cargo aircraft operators, we have filed comments with the TSA requesting clarification regarding several provisions in the revised model program. Until the requirements for our security program under the new rules are 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, FedEx National LTL 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 62 through 65 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, 2007, FedEx Expresss aircraft fleet consisted of the following:
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 the aircraft, 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, 2007, FedEx Express operated approximately 53,000 ground transport vehicles, including pickup and delivery vans, larger trucks called container transport vehicles and over-the-road tractors and trailers.
The following table is a summary of the number and type of aircraft we were committed to purchase as of May 31, 2007, with the year of expected delivery:
Deposits and progress payments of $109 million have been made toward aircraft purchases, options to purchase additional aircraft and other planned aircraft-related transactions. Also see Note 16 of the accompanying consolidated financial statements for more information about our purchase commitments.
Sorting and Handling Facilities
At May 31, 2007, FedEx Express operated the following sorting and handling facilities:
FedEx Expresss primary sorting facility, which serves as the center of its multiple hub-and-spoke system, is located at the Memphis International Airport. FedEx Expresss facilities at the Memphis International Airport also include aircraft hangars, aircraft ramp areas, vehicle parking areas, flight training and fuel facilities, administrative offices and warehouse space. FedEx Express leases these facilities from the Memphis-Shelby County Airport Authority (the Authority). The lease obligates FedEx Express to maintain and insure the leased property and to pay all related taxes, assessments and other charges. The lease is 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 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.
The World Headquarters of FedEx Express is located in southeastern Shelby County, Tennessee. The headquarters campus, which comprises eight separate buildings with approximately 1.1 million square feet of
space, houses approximately 1,800 employees. FedEx Express also leases approximately 30 facilities in the Memphis area for administrative offices and warehouses. FedEx Express and FedEx Services lease state-of-the-art technology centers in Collierville, Tennessee, Irving, Texas, Colorado Springs, Colorado, and Orlando, Florida. These facilities house 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 740 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 a 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, 2007, FedEx Express had approximately 42,500 Drop Boxes, including 5,000 Drop Boxes outside U.S. Post Offices. As of May 31, 2007, FedEx Express also had approximately 10,500 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 approximately 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, 2007, FedEx Ground had approximately 25,800 company-owned trailers and owned or leased approximately 500 facilities, including 29 hubs. In addition, approximately 20,600 owner-operated vehicles support FedEx Grounds business. Of the approximately 300 facilities that support FedEx Home Delivery, more than 200 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 252,000 square feet and range in size from 31,000 to 488,000 square feet.
FedEx Freight Corporations corporate headquarters are located in Memphis, Tennessee. FedEx Freight Corporation also has administrative offices located in Harrison, Arkansas, San Jose, California and Lakeland, Florida. As of May 31, 2007, FedEx Freight Corporation operated approximately 59,000 vehicles and trailers and 470 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. CTSs headquarters are located in Greensboro, North Carolina, and 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, 2007, FedEx Kinkos operated approximately 1,700 locations, including approximately 160 locations in ten foreign countries and 35 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 5,500 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 17 of the accompanying consolidated financial statements.
In June 2006, we received a grand jury subpoena for the production of documents in connection with an ongoing criminal investigation by the Antitrust Division of the U.S. Department of Justice (DOJ) into
possible anti-competitive behavior in the air freight transportation industry. In December 2006, we received a formal request for certain information and documents in connection with an ongoing civil investigation by the Directorate General for Competition of the European Commission (EC) into possible anti-competitive behavior relating to air freight transportation services in Europe. In July 2007, we received a notice from the Australian Competition and Consumer Commission (ACCC) requiring us to provide certain information and documents in connection with the ACCCs investigation into possible anti-competitive behavior relating to air cargo transportation services in Australia. We do not believe that we have engaged in any anti-competitive activities, and we are cooperating with these investigations.
There were no matters submitted to a vote of security holders during the fourth quarter of 2007.
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 9, 2007, there were 20,165 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 2, 2007 ($0.10 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 2007.
Selected financial data as of and for the five years ended May 31, 2007 is presented on page 113 of this Annual Report on Form 10-K.
Managements discussion and analysis of results of operations and financial condition is presented on pages 33 through 65 of this Annual Report on Form 10-K.
Quantitative and qualitative information about market risk is presented on page 112 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 9, 2007 thereon, are presented on pages 68 through 111 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, as amended, 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, 2007 (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 66 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 67 of this Annual Report on Form 10-K.
During our fiscal quarter ended May 31, 2007, 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, compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, FedExs Code of Business Conduct & Ethics and certain other aspects of FedExs corporate governance (such as the procedures by which FedExs stockholders may recommend nominees to the Board of Directors and information about the Audit Committee, including its members and our audit committee financial expert) will be presented in FedExs definitive proxy statement for its 2007 annual meeting of stockholders, which will be held on September 24, 2007, 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 director and executive compensation will be presented in FedExs definitive proxy statement for its 2007 annual meeting of stockholders, which will be held on September 24, 2007, and is incorporated herein by reference.
Information regarding security ownership of certain beneficial owners and management and related stockholder matters, as well as equity compensation plan information, will be presented in FedExs definitive proxy statement for its 2007 annual meeting of stockholders, which will be held on September 24, 2007, and is incorporated herein by reference.
Information regarding certain relationships and transactions with related persons (including FedExs policies and procedures for the review and preapproval of related person transactions) and director independence will be presented in FedExs definitive proxy statement for its 2007 annual meeting of stockholders, which will be held on September 24, 2007, and is incorporated herein by reference.
Information regarding the fees for services provided by Ernst & Young LLP during 2007 and 2006 and the Audit Committees administration of the engagement of Ernst & Young LLP, including the Committees preapproval policies and procedures (such as FedExs Policy on Engagement of Independent Auditor), will be presented in FedExs definitive proxy statement for its 2007 annual meeting of stockholders, which will be held on September 24, 2007, and is incorporated herein by reference.
FedExs consolidated financial statements, together with the notes thereto and the report of Ernst & Young LLP dated July 9, 2007 thereon, are listed on page 32 and presented on pages 68 through 111 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 9, 2007 thereon, is presented on pages 114 through 115 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-4 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.
Dated: July 12, 2007
Frederick W. Smith
Chairman, President and
Chief Executive Officer
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.
FINANCIAL SECTION TABLE OF CONTENTS
MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The financial section of the FedEx Corporation (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.
Our MD&A is comprised of three major sections: Results of Operations, Financial Condition and Critical Accounting Estimates. These sections include the following information:
FedEx provides a broad portfolio of transportation, e-commerce and business services through companies competing collectively, operating independently 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 Corporation, a leading U.S. provider of less-than-truckload (LTL) freight services; and FedEx Kinkos, a leading provider of document solutions and business services. These companies represent our major service lines and 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:
Except as otherwise specified, references to years indicate our fiscal year ended May 31, 2007 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.
RESULTS OF OPERATIONS
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:
The following table shows changes in revenues and operating income by reportable segment for 2007 compared to 2006, and 2006 compared to 2005 (in millions):
The following graphs for FedEx Express, FedEx Ground and the FedEx Freight LTL Group show selected operating statistics (in thousands, except yield amounts) for the years ended May 31:
Overall results for 2007 were solid in spite of several challenges, as we continued to execute our business strategy during a time of slower economic growth and expanded our service offerings through key acquisitions. Operating results moderated during 2007, reflecting the impact of weaker volumes in the second half of our fiscal year in our FedEx Express and FedEx Freight segments due to the slowing economic environment. The year-over-year negative impact from the timing lag in our fuel surcharges and a $143 million charge associated with upfront compensation and benefits under the new contract with our pilots also negatively impacted 2007 operating results.
Revenue growth in 2007 was due to strong FedEx Ground package volume growth and continued growth in FedEx Express International Priority (IP) services, as we continued to focus on expanding these service offerings. Our 2007 revenues also reflected the acquisition of FedEx National LTL (formerly known as Watkins Motor Lines), which added approximately $760 million to 2007 revenue. Revenue growth in 2007 was slightly offset by declines in copy product revenues at FedEx Kinkos.
Operating income increased in 2007, as revenue growth at FedEx Express and FedEx Ground more than offset reduced profitability at the FedEx Freight segment and FedEx Kinkos. Operating margin was flat in 2007 due to slower economic growth, the negative impact of higher salaries and benefits primarily as a result of the new labor contract with our pilots and the timing of adjustments to our fuel surcharges at FedEx Express (described below), as well as operating losses at FedEx National LTL. Softening volumes in the LTL sector and ongoing expenses to integrate the FedEx National LTL network negatively impacted the performance of the FedEx Freight segment in 2007.
Salaries and employee benefits increased in 2007 as a result of the new labor contract for the pilots of FedEx Express and the FedEx National LTL acquisition. The impacts of expensing stock options commencing in 2007 and higher retirement plan costs were largely offset by lower incentive compensation accruals. Purchased transportation costs increased in 2007 due to FedEx Ground volume growth, the FedEx National LTL acquisition and IP package volume growth.
The pilots of FedEx Express, who represent a small number of our total employees, are employed under a collective bargaining agreement. In October 2006, the pilots ratified a new four-year labor contract that included signing bonuses and other upfront compensation of approximately $143 million, as well as pay increases and other benefit enhancements. These costs were partially mitigated by reductions in variable incentive compensation. The effect of this new agreement on second quarter 2007 net income was approximately $78 million net of tax, or $0.25 per diluted share.
The timing and amount of fluctuations in fuel prices and our ability to recover incremental fuel costs through our various fuel surcharges continue to impact our results. Fuel costs increased during 2007 due to an increase in the average price per gallon of fuel and an increase in gallons consumed. Because of the timing lag that exists between when we purchase fuel and when our fuel surcharges are automatically adjusted at FedEx Express, fuel surcharges were not sufficient to offset the effect of changes in fuel costs on our operating results for 2007. Though 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 price and other extra service fees 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 for 2007, 2006 and 2005 in the accompanying discussions of each of our transportation segments.
Our 2006 results benefited from strong growth in the global economy. During 2006, revenue growth was primarily attributable to yield improvement across our transportation segments, package volume growth in our 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.
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 these higher fuel costs. Salaries and employee benefits increased 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 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.
Net interest expense decreased $51 million during 2007 primarily due to increased interest income earned on higher cash balances. 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.
Our effective tax rate was 37.3% in 2007, 37.7% in 2006 and 37.4% in 2005. Our 2007 tax rate was favorably impacted by the conclusion of various state and federal tax audits and appeals. This favorable impact was
partially offset by tax charges incurred as a result of a reorganization in Asia associated with our acquisition in China (described below). 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 and by a lower effective state tax rate. For 2008, we expect our effective tax rate to be between 37.5% and 38%. The actual rate, however, will depend on a number of factors, including the amount and source of operating income.
On September 3, 2006, we acquired the assets and assumed certain obligations of the LTL operations of Watkins Motor Lines, a privately held company, and certain affiliates for $787 million in cash. Watkins, a leading provider of long-haul LTL services, was renamed FedEx National LTL and meaningfully extends our leadership position in the heavyweight LTL freight sector. The financial results of FedEx National LTL are included in the FedEx Freight segment from the date of acquisition.
On December 16, 2006, we acquired all of the outstanding capital stock of ANC Holdings Ltd. (ANC), a United Kingdom domestic express transportation company, for $241 million, predominantly in cash. This acquisition allows FedEx Express to better serve the United Kingdom domestic market, which we previously served primarily through independent agents.
On March 1, 2007, FedEx Express acquired Tianjin Datian W. Group Co., Ltd.s (DTW Group) 50% share of the FedEx-DTW International Priority express joint venture and assets relating to DTW Groups domestic express network in China for $427 million in cash. This acquisition converts our joint venture with DTW Group into a wholly owned subsidiary and increases our presence in China in the international and domestic express businesses. Prior to the fourth quarter of 2007, we accounted for our investment in the joint venture under the equity method.
The financial results of the ANC and DTW Group acquisitions, as well as other immaterial business acquisitions during 2007, are included in the FedEx Express segment from the date of acquisition. These acquisitions were not material to our results of operations or financial condition.
We paid the purchase price for these acquisitions from available cash balances, which included the net proceeds from our $1 billion senior unsecured debt offering completed during 2007. See Note 6 of the accompanying consolidated financial statements for further discussion of this debt offering.
See Note 3 of the accompanying consolidated financial statements for further information about these acquisitions.
Our results for 2006 included a noncash charge of $79 million ($49 million net of tax, or $0.16 per diluted share) to adjust the accounting for certain facility leases, predominantly at FedEx Express. The charge, which included the impact on prior years, related primarily to rent escalations in on-airport facility leases that were not being recognized appropriately.
In 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 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.
Our outlook for 2008 reflects continued investment in several major, long-term initiatives in a soft but stable U.S. economy. Outside the United States, economic activity is expected to continue to expand, but at a more
moderate pace than in 2007. As a result, we expect our revenue trends to moderate in 2008, with growth driven by increased shipments at FedEx Ground, the full-year benefit of the FedEx National LTL business and expansion of international business at FedEx Express (both IP and international domestic services).
We expect our earnings in 2008 to be below our long-term goal of 10% to 15% annual earnings growth due to the softening U.S. economy and planned investments in our businesses, which are critical to our long-term strategy. We remain optimistic about the long-term prospects for all of our business segments.
We expect to make significant investments to expand our global networks, in part through the continued integration and expansion of the businesses we acquired in 2007. Our planned investments for 2008 are focused on the following three key opportunities:
FedEx Kinkos will continue to focus on key strategies related to adding new locations, improving customer service and increasing investments in employee development and training. We expect these strategies to continue to adversely affect profitability in 2008. FedEx Kinkos plans to open approximately 300 new centers in the coming year, which will bring the total number of centers to approximately 2,000 by the end of 2008.
All of our transportation businesses operate in a competitive pricing environment, exacerbated by continuing volatile fuel prices. Historically, our fuel surcharges have generally been sufficient to offset incremental fuel costs; however, volatility in fuel costs may impact earnings because adjustments to our fuel surcharges lag changes in actual fuel prices paid. Therefore, the trailing impact of adjustments to our fuel surcharges can affect our earnings.
See Risk Factors for a discussion of these and other potential risks and uncertainties that could materially affect our future performance.
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 in advance of the U.S. holiday sales season. 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 the FedEx Freight LTL Group, 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.
New accounting rules and disclosure requirements can significantly impact the comparability of our financial statements. We believe the following new accounting pronouncements, which were issued or became effective for us during 2007, are relevant to the readers of our financial statements.
On June 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards (SFAS) 123R, Share-Based Payment, which requires recognition of compensation expense for stock-based awards using a fair value method. The adoption of SFAS 123R reduced earnings for 2007 by $0.17 per diluted share. For
additional information on the impact of the adoption of SFAS 123R, refer to Note 1 to the accompanying consolidated financial statements.
On May 31, 2007, we adopted SFAS 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, which requires recognition in the balance sheet of the funded status of defined benefit pension and other postretirement benefit plans, and the recognition in accumulated other comprehensive income of unrecognized gains or losses, prior service costs or credits and transition assets or obligations existing at the time of adoption. Additionally, SFAS 158 requires the measurement date for plan assets and liabilities to coincide with the sponsors year-end. We currently use a February 28 measurement date for our plans; therefore, this standard will require us to change our measurement date to May 31 (beginning in 2009).
The funded status recognition and disclosure provisions of SFAS 158 were effective for FedEx as of May 31, 2007. The requirement to measure plan assets and benefit obligations as of our fiscal year-end is effective for FedEx no later than 2009.
The adoption of SFAS 158 resulted in a $982 million charge to shareholders equity at May 31, 2007 through accumulated other comprehensive income. Under SFAS 158, we were required to write off our prepaid pension asset of $1.4 billion and increase our pension and other postretirement benefit liabilities by $120 million. These adjustments, net of deferred taxes of $582 million, were required to recognize the unfunded projected benefit obligation in our balance sheet. SFAS 158 has no impact on the determination of expense for our pension or other postretirement benefit plans.
In February 2007, we announced changes to modernize certain of our retirement programs over the next two fiscal years. Effective January 1, 2008, we will increase the annual company matching contribution under the largest of our 401(k) plans covering most employees from $500 to a maximum of 3.5% of eligible compensation. Effective May 31, 2008, benefits previously accrued under our primary pension plans using a traditional pension benefit formula will be capped for most employees, and those benefits will be payable beginning at retirement. Beginning June 1, 2008, future pension benefits for most employees will be accrued under a cash balance formula we call the Portable Pension Account. These changes will not affect the benefits of current retirees. For additional information on the adoption of SFAS 158 and these changes, see Note 12 to the accompanying audited financial statements and the Critical Accounting Estimates section of this MD&A.
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes. This interpretation establishes new standards for the financial statement recognition, measurement and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. The new rules will be effective for FedEx in the first quarter of 2008. The adoption of this interpretation will not have a material effect on our financial statements.
In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, which eliminates the diversity in practice surrounding the quantification and evaluation of financial statement errors. The guidance outlined in SAB 108 was effective for FedEx in the fourth quarter of 2007 and is consistent with our historical practices for assessing such matters when circumstances have required such an evaluation.
FedEx Express, FedEx Ground, FedEx Freight and FedEx Kinkos represent our major service lines and form the core of our reportable segments. (For further discussion of our operating companies, refer to Item 1: Business.) As of May 31, 2007, our reportable segments included the following businesses:
FedEx Express (express transportation)
FedEx Trade Networks (global trade services)
FedEx Ground (small-package ground delivery)
FedEx SmartPost (small-parcel consolidator)
FedEx Freight LTL Group:
FedEx Freight (regional LTL freight transportation)
FedEx National LTL (long-haul LTL freight transportation)
FedEx Custom Critical (time-critical transportation)
Caribbean Transportation Services (airfreight forwarding)
FedEx Kinkos (document solutions and business services)
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.
Effective June 1, 2006, we moved the credit, collections and customer service functions with responsibility for FedEx Express U.S. and FedEx Ground customer information from FedEx Express into a new subsidiary of FedEx Services named FedEx Customer Information Services, Inc. (FCIS). Also, effective June 1, 2006, we moved FedEx Supply Chain Services, Inc., the results of which were previously reported in the FedEx Ground segment, into a new subsidiary of FedEx Services named FedEx Global Supply Chain Services, Inc. The costs of providing these customer service functions and the net operating costs of FedEx Global Supply Chain Services are allocated back to the FedEx Express and FedEx Ground segments. Prior year amounts have not been reclassified to conform to the current year segment presentation, as the financial results are materially comparable.
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 that we believe approximate fair value and are reflected as revenues of the billing segment. These rates are adjusted from time to time based on market conditions. 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. Such intersegment revenues and expenses are eliminated in the consolidated results and are not separately identified in the following segment information, as the amounts are not material.
The following table compares revenues, operating expenses, operating income and operating margin (dollars in millions) for the years ended May 31:
The following table compares selected statistics (in thousands, except yield amounts) for the years ended May 31:
Solid yield growth primarily due to pricing discipline contributed to revenue growth in 2007, despite flat package volume growth. Package revenue growth in 2007 was driven by IP revenues, which grew 9% on yield growth of 5% as a result of yield improvements across all regions and a 5% increase in volumes due to IP volume growth in U.S. outbound, Asia and Europe, as we continued to focus on expanding this service. Also contributing to revenue growth in 2007 were increases in other revenues primarily due to our acquisition of ANC and increases in freight revenues due to higher U.S. and international priority freight volumes. U.S. domestic package revenues increased 1% as a result of yield improvements, partially offset by a decrease in volumes.
IP yield increased during 2007 as a result of favorable exchange rates, higher package weights and an increase in the average rate per pound. U.S. domestic composite yield increases in 2007 were due to an increase in the
average rate per pound, partially offset by changes in product mix and lower package weights. U.S. freight yield increased in 2007 due to an increase in the average rate per pound and higher fuel surcharges.
IP volume growth in 2007 was primarily due to increased demand in the U.S. outbound, Asia and Europe markets. U.S. domestic package volumes decreased during 2007 primarily due to the moderating growth rate of the U.S. economy.
FedEx Express segment revenues increased in 2006 due to yield improvements and volume growth in IP services (particularly in Asia, U.S. outbound and Europe). U.S. domestic package and U.S. freight revenue growth also contributed to the revenue increase for 2006. U.S. volumes were flat compared to the prior year, as growth in our U.S. domestic overnight services was offset by declines in deferred volumes that resulted from yield management actions.
IP yield increased during 2006 due to higher fuel surcharges and increases in international average weight per package and average rate per pound. U.S. domestic composite yield increases were due to higher fuel surcharges and improved yields on U.S. domestic deferred packages. Improvements in U.S. domestic deferred yield resulted from our continued efforts to improve the profitability of this service. U.S. freight yield increases were due to an increase in average rate per pound and higher fuel surcharges.
Our fuel surcharges are indexed to the spot price for jet fuel. Using this index, the U.S. domestic and outbound fuel surcharge and the international fuel surcharges ranged as follows for the years ended May 31:
Despite slower overall revenue growth, operating income and operating margin increased in 2007. Increases in operating income and margin in 2007 resulted from growth in IP services and were partially offset by costs associated with the ratification of a new labor contract with our pilots in October 2006. These costs included signing bonuses and other upfront compensation of $143 million, as well as pay increases and other benefit enhancements, which were mitigated by reductions in variable incentive compensation. Year-over-year results in 2007 were positively affected by a $75 million charge in 2006 to adjust the accounting for certain facility leases.
Fuel costs increased during 2007 due to an increase in the average price per gallon of fuel. Fuel surcharges did not offset the effect of higher fuel costs on our year-over-year operating results for 2007, due to the timing lag that exists between when we purchase fuel and when our fuel surcharges are adjusted, based on a static analysis of the year-over-year changes in fuel prices compared to changes in fuel surcharges.
Salaries and employee benefits increased in 2007 primarily as a result of the new labor contract with our pilots. Purchased transportation costs increased 13% in 2007 due to IP volume growth, which required a higher utilization of contract pickup and delivery services and an increase in the cost of purchased transportation. We use purchased transportation in markets where we do not have a direct presence or to meet short-term capacity needs. Maintenance and repairs increased 7% in 2007 primarily due to higher aircraft maintenance expenses for various airframes and Airbus A300 engines. The 5% decrease in rentals and landing fees in 2007 was attributable to the one-time adjustment for leases in 2006 described above. Intercompany charges increased 35% in 2007 due to allocations as a result of moving the FCIS organization from FedEx
Express to FedEx Services in 2007. The costs associated with the FCIS organization in 2006 were of a comparable amount but were reported in individual operating expense captions.
During 2007, we terminated our agreement with Airbus for the purchase of A380 aircraft and in March 2007 entered into a separate settlement agreement with Airbus that, among other things, provides us with credit memoranda applicable to the purchase of goods and services in the future. The net impact of this settlement was immaterial to our 2007 results and was recorded as an operating gain during the fourth quarter of 2007.
Operating income grew significantly in 2006 as a result of strong revenue growth and improved operating margin. Volume growth in higher margin U.S. domestic overnight and IP services contributed to yield improvements. Improved yields, combined with productivity gains and cost containment, allowed FedEx Express to improve operating margin in 2006. Revenue and margin growth for 2006 more than offset the one-time adjustment for leases and costs associated with two new around-the-world flights.
In 2006, salaries and benefits increased primarily due to higher pension costs and wage rates. Fuel costs were higher in 2006 primarily due to an increase in the average price per gallon of jet fuel, while gallons consumed increased slightly, primarily related to the two new around-the-world flights. However, our fuel surcharges substantially mitigated the impact of higher jet fuel prices. Purchased transportation costs increased in 2006, though at a slower rate than in 2005, driven by IP volume growth, which required a higher utilization of contract pickup and delivery services. Rentals and landing fees increased in 2006, primarily due to the one-time adjustment for leases of $75 million.
We expect moderate revenue growth at FedEx Express in 2008, as growth in both IP and domestic package services will continue to slow as a result of the softening U.S. economy and declining growth outside the U.S. The majority of the revenue increase in 2008 will be provided by IP services, as we continue to focus on growing our service offerings in international markets, particularly China and Europe. Our international domestic revenue is projected to increase in 2008 due to the full-year benefit of 2007 acquisitions such as ANC and DTW Group and the expansion of our China domestic service.
Operating income and operating margin are expected to improve in 2008 despite the soft U.S. economy due to continued cost containment and productivity improvements. Capital expenditures at FedEx Express are expected to be higher in 2008 due to investments in equipment and facilities necessary to support projected long-term volume growth, as well as continued investments in China. In March 2006, we broke ground on a new $150 million Asia-Pacific hub in the southern China city of Guangzhou. This hub is planned to be operational in 2009. Aircraft-related capital and expense outlays, including support of our Boeing 757 program and the new Boeing 777 Freighter fleet, are expected to approximate 2007 spending levels. We will continue to make strategic investments despite short-term economic softness.
The following table compares revenues, operating expenses, operating income and operating margin (dollars in millions) and selected package statistics (in thousands, except yield amounts) for the years ended May 31:
Strong volume growth fueled a 14% increase in revenue during 2007. Average daily volumes at FedEx Ground rose 11% because of increased commercial business and the continued growth of our FedEx Home Delivery service. Yield improvement during 2007 was primarily due to the impact of general rate increases and higher extra service revenues, primarily on our residential services. This yield increase was partially offset by higher customer discounts and a lower average weight and zone per package. Additionally, revenue at FedEx SmartPost increased significantly in 2007 due to increased market share, as a major competitor exited this market in 2006, enabling significant growth in the customer base and related volumes.
Revenues increased during 2006 due to volume increases and yield improvement. Average daily volumes increased across all of our services, led by the continued growth of our FedEx Home Delivery service. Yield improvement during 2006 was primarily due to increased fuel surcharges, higher extra service revenue and the impact of general rate increases. These increases were partially offset by higher customer discounts and a lower average weight per package.
The FedEx Ground fuel surcharge is based on a rounded average of the national U.S. on-highway average prices for a gallon of diesel fuel, as published by the Department of Energy. Our fuel surcharge ranged as follows for the years ended May 31:
No fuel surcharge was in effect from January 2004 to January 2005.
FedEx Ground segment operating income increased 15% during 2007 principally due to revenue growth and improved results at FedEx SmartPost. Operating margin increased only slightly in 2007, as revenue growth was partially offset by increased purchased transportation costs, increased legal costs and higher depreciation and rent expense associated with network expansion.
Purchased transportation increased 15% in 2007 primarily due to volume growth and higher rates paid to our independent contractors, including fuel supplements. Our fuel surcharge was sufficient to 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 the fuel surcharge. Other operating expenses increased 14% in 2007 primarily due to increased legal costs. Depreciation expense increased 20% and rent expense increased 25% principally due to higher spending on material handling and scanning equipment and facilities associated with our multi-year network expansion.
Effective June 1, 2006, we moved FedEx Supply Chain Services, Inc., the results of which were previously reported in the FedEx Ground segment, into a new subsidiary of FedEx Services named FedEx Global Supply Chain Services, Inc. The net operating costs of this entity are allocated to FedEx Express and FedEx Ground. Prior year amounts have not been reclassified to conform to the current year segment presentation, as financial results are materially comparable.
FedEx Ground segment operating income increased in 2006, resulting principally from revenue growth and yield improvement. Operating margin for the segment improved in 2006 due to fuel surcharges, general rate increases, improved productivity and the inclusion in 2005 of a $10 million charge at FedEx Supply Chain Services related to the termination of a vendor agreement. A portion of the operating margin improvement was offset by higher year-over-year expenses related to investments in new technology and the opening of additional FedEx Ground facilities.
Salaries and employee benefits increased in 2006 principally due to wage rate increases and increases in staffing and facilities to support volume growth. Depreciation expense in 2006 increased at a higher rate than revenue due to increased spending associated with material handling and scanning equipment. In 2006, purchased transportation increased due to increased volumes and an increase in the cost of purchased transportation due to higher fuel surcharges from third-party transportation providers, including our independent contractors.
We expect the FedEx Ground segment to have revenue growth in 2008 consistent with 2007, led by continued strong volume growth at FedEx Ground and FedEx SmartPost. FedEx Grounds average daily volume is expected to increase in 2008 due to increased base business and FedEx Home Delivery volumes. FedEx SmartPost volumes are also expected to grow, because of increased market share and improved service levels. Yields for all services at FedEx Ground are expected to increase in 2008 from increases in list prices and residential and commercial delivery area surcharges.
FedEx Grounds operating margin in 2008 is expected to improve from continued cost controls, productivity gains and yield improvements, partially offset by the impact of our network expansion and increased purchased transportation costs. Capital spending is expected to grow, as we continue with comprehensive network expansion and productivity-enhancing technologies within the FedEx Ground segment. During 2008, the multi-phase expansion plan includes one new hub, 14 expanded hubs and two relocated facilities. We are committed to investing in the FedEx Ground network because of the long-term benefits we will experience from these investments.
The following table shows revenues, operating expenses, operating income and operating margin (dollars in millions) and selected statistics for the years ended May 31:
The results of operations of FedEx National LTL are included in FedEx Freight segment results from the date of acquisition on September 3, 2006.
FedEx Freight segment revenues increased 26% in 2007 primarily as a result of the acquisition of FedEx National LTL, which contributed significantly to an increase in average daily LTL shipments of 16% and LTL yield of 11%. Average daily LTL shipments excluding FedEx National LTL grew slightly in 2007 due to increased demand for our regional and interregional services. This growth rate moderated throughout the year, however, with year-over-year declines in the second half of 2007. LTL yield growth was due to higher yields from longer-haul FedEx National LTL shipments, higher rates and favorable contract renewals.
FedEx Freight segment revenues increased 13% in 2006 due to growth in LTL yield and average daily LTL shipments. LTL yield grew during 2006, reflecting incremental fuel surcharges resulting from higher fuel prices and higher rates. Average daily LTL shipment growth in 2006 was driven in part by features such as our no-fee money-back guarantee and our Advance Notice service, which continue to differentiate us in the LTL market.
The indexed LTL fuel surcharge is based on the average of the national U.S. on-highway average prices for a gallon of diesel fuel, as published by the Department of Energy. The indexed LTL fuel surcharge ranged as follows for the years ended May 31:
FedEx Freight segment operating income decreased 5% during 2007 due to operating losses at FedEx National LTL, which resulted from softening volumes and ongoing expenses to integrate its network. The inclusion of FedEx National LTL in our results has impacted the year-over-year comparability of all of our operating expenses. Along with incremental costs from FedEx National LTL (including amortization of acquired intangible assets), depreciation expense increased due to prior-year purchases of vehicles and other operating equipment to support volume growth. Purchased transportation increased due to higher rates paid to our third-party transportation providers and the utilization of third-party providers at FedEx National LTL. While fuel costs increased in 2007, our fuel surcharge was more than sufficient to offset the effect of higher fuel costs, based on a static analysis of the year-over-year changes in fuel prices compared to changes in the fuel surcharge.
FedEx Freight segment operating income increased in 2006 primarily due to LTL revenue growth, as well as our ability to control costs in line with volume growth. Increased staffing to support volume growth and higher incentive compensation expense increased salaries and employee benefits in 2006. While fuel costs increased substantially in 2006, fuel surcharges more than offset the effect of higher fuel costs. Depreciation costs increased in 2006 primarily due to investments in operating equipment, which in some cases replaced leased equipment. Maintenance and repairs decreased in 2006 due to the presence of rebranding costs in 2005, as well as an increase in the purchase of new fleet vehicles. Purchased transportation costs decreased, due to increased utilization of company equipment in our interregional freight services.
We expect FedEx Freight segment revenue to increase in 2008 due to continued growth in our LTL business and the inclusion of FedEx National LTL for the full year. LTL yield is expected to increase due to our continued focus on pricing discipline, as well as the impact of higher yields on longer-haul FedEx National LTL shipments. Ongoing costs to integrate information technology systems and to increase sales resources to support long-term growth opportunities, as well as incremental costs associated with facility expansions, are expected to restrain operating income and operating margin growth in 2008. Continued investments in facilities and equipment to support revenue growth and in technology to improve productivity and to meet our customers needs account for the majority of the total incremental capital spending anticipated for 2008. We expect our rebranding efforts at FedEx National LTL to continue in 2008.
The following table shows revenues, operating expenses, operating income and operating margin (dollars in millions) for the years ended May 31:
Revenues decreased slightly during 2007 due to decreased demand for copy products and the discontinuation of unprofitable service offerings, which more than offset higher package acceptance fees from FedEx Express and FedEx Ground. During 2007, FedEx Kinkos announced a multi-year network expansion plan, including the model for new centers, which will be approximately one-third the size of a traditional center and will include enhanced pack-and-ship stations and a doubling of the number of retail office products offered. While revenues from new centers were not significant in 2007, this multi-year expansion of the FedEx Kinkos network is a key strategy relating to FedEx Kinkos future revenue growth. In addition, this expansion will provide FedEx Express and FedEx Ground customers with more retail access points. FedEx Kinkos opened 226 new centers during 2007.
In 2006, a year-over-year increase in package acceptance revenue led to modest revenue growth. Package acceptance revenue benefited year over year from the April 2005 conversion of FedEx World Service Centers to FedEx Kinkos Ship Centers. FedEx Kinkos experienced declines in copy product line revenues in 2006 due to decreased demand for these services and a competitive pricing environment.
Operating income decreased $12 million during 2007 primarily due to the decrease in copy product revenues, as well as the impact of increased salaries and employee benefit costs incurred in connection with expansion activities and significant investments in employee training and development programs. Rentals decreased during 2007 due to declines in copier rental expenses, which are variable based on usage. The increase in intercompany charges was primarily due to increased allocations of sales and marketing and IT support functions in 2007.
Operating income decreased in 2006, as the increase in package acceptance revenues was more than offset by a decline in copy product line revenues. In 2006, salaries and employee benefits increased due to the addition of FedEx Kinkos Ship Centers, higher group health insurance costs and increased costs associated with employee training and development programs. Increased depreciation in 2006 was driven by center rebranding and investments in new technology to replace legacy systems. The increase for 2006 in other operating expenses was primarily due to increased costs related to technology, strategic and product offering initiatives.
We expect increased revenue at FedEx Kinkos in 2008 primarily due to the new store openings associated with the multi-year network expansion, together with a sales force realignment and marketing and service initiatives. The network expansion program, combined with employee training and retention programs, is expected to negatively impact operating income and operating margin in 2008. These investments, however, are focused on long-term profit and margin growth. Initiatives in e-commerce technology such as Print Online and new service offerings, including our direct mail service, are expected to support additional growth opportunities for 2008 and beyond. Capital spending is expected to increase at FedEx Kinkos in 2008 primarily due to the multi-year network expansion and technology investments. FedEx Kinkos plans to open approximately 300 new centers in 2008, which will bring the total number of centers to approximately 2,000 by the end of the year.
Cash and cash equivalents totaled $1.569 billion at May 31, 2007, compared to $1.937 billion at May 31, 2006 and $1.039 billion at May 31, 2005. The following table provides a summary of our cash flows for the years ended May 31 (in millions):
We believe that our existing cash and cash equivalents, cash flow from operations, our commercial paper program, revolving bank credit facility and shelf registration statement with the SEC are adequate to meet our current and foreseeable future working capital and capital expenditure needs. In addition, other forms of secured financing may be used to obtain capital assets if we determine that they best suit our needs for the foreseeable future. We have been successful in obtaining investment capital, both domestic and international, although the marketplace for such capital can become restricted depending on a variety of economic factors. We believe the capital resources available to us provide flexibility to access the most efficient markets for financing capital acquisitions, including aircraft, and are adequate for our future capital needs.
Cash Provided by Operating Activities. Cash flows from operating activities decreased $113 million in 2007 primarily due to an increase in income tax payments of $184 million, partially offset by increased earnings. The $559 million increase in cash flows from operating activities in 2006 was principally due to increased earnings. During 2007, we made tax-deductible voluntary contributions to our principal U.S. domestic pension plans of $482 million, compared to $456 million during 2006 and $460 million during 2005.
Cash Used in Investing Activities. During 2007, $1.3 billion of cash was used for the FedEx National LTL, ANC, DTW Group and other immaterial acquisitions. See Note 3 of the accompanying audited financial statements for further discussion of these acquisitions. See Capital Resources for a discussion of capital expenditures during 2007 and 2006.
Financing Activities. On August 2, 2006, we filed an updated shelf registration statement with the SEC. The new registration statement does not limit the amount of any future offering. By using this shelf registration statement, we may sell, in one or more future offerings, any combination of our unsecured debt securities and common stock.
On August 8, 2006, under the new shelf registration statement, we issued $1 billion of senior unsecured debt, comprised of floating-rate notes totaling $500 million due in August 2007 and fixed-rate notes totaling $500 million due in August 2009. The floating-rate notes bear interest at the three-month London Interbank Offered Rate (LIBOR) plus 0.08%, reset on a quarterly basis. As of May 31, 2007, the floating interest rate was 5.44%. The fixed-rate notes bear interest at an annual rate of 5.5%, payable semi-annually. The net proceeds were used for working capital and general corporate purposes, including the funding of the acquisitions referenced above.
During 2007, $700 million of senior unsecured notes and $18 million of medium-term notes matured and were repaid. During 2006, $250 million of senior unsecured notes matured and were repaid. In addition, other debt was reduced by $118 million as a result of the purchase by FedEx Express of two MD11 aircraft in March 2007. In 2001, FedEx Express entered into a lease for the two MD11 aircraft from a separate entity, which we were required to consolidate under FIN 46. The purchase of these aircraft extinguished this liability.
A $1.0 billion revolving credit facility is available to finance our operations and other cash flow needs and to provide support for the issuance of commercial paper. Our revolving credit agreement contains a financial covenant, which requires us to maintain a leverage ratio of adjusted debt (long-term debt, including the current portion of such debt, plus six times rentals and landing fees) to capital (adjusted debt plus total common stockholders investment) that does not exceed 0.7. Our leverage ratio of adjusted debt to capital was 0.6 at May 31, 2007. We are in compliance with this and all other restrictive covenants of our revolving credit agreement and do not expect the covenants to affect our operations. As of May 31, 2007, no commercial paper was outstanding and the entire $1.0 billion under the revolving credit facility was available for future borrowings.
The $500 million of floating rate notes issued in 2007 will become due in August 2007. The timing of cash requirements in the first half of 2008 may dictate that we refinance a portion of this debt through our commercial paper program. As discussed in Note 1 of the accompanying consolidated financial statements, we adopted SFAS 158 on May 31, 2007. Our adoption of this standard did not impact our compliance with any current loan covenants or affect our debt ratings, pension funding requirements or our overall liquidity.
Dividends. Dividends paid were $110 million in 2007, $97 million in 2006 and $84 million in 2005. On May 25, 2007, our Board of Directors declared a dividend of $0.10 per share of common stock, an increase of $0.01 per share. The dividend was paid on July 2, 2007 to stockholders of record as of the close of business on June 11, 2007. Each quarterly dividend payment is subject to review and approval by our Board of Directors, and we intend to evaluate our dividend payment amount on an annual basis at the end of each fiscal year.
Other Liquidity Information. We have a senior unsecured debt credit rating from Standard & Poors of BBB and a commercial paper rating of A-2. Moodys Investors Service has assigned us a senior unsecured debt credit rating of Baa2 and a commercial paper rating of P-2. Moodys characterizes our ratings outlook as stable, while Standard & Poors characterizes our ratings outlook as positive. If our credit ratings drop, our interest expense may increase. If our commercial paper ratings drop below current levels, we may have difficulty utilizing the commercial paper market. If our senior unsecured debt ratings drop below investment grade, our access to financing may become more limited.
Our operations are capital intensive, characterized by significant investments in aircraft, vehicles, technology, package handling facilities and sort equipment. The amount and timing of capital additions depend on various factors, including pre-existing contractual commitments, anticipated volume growth, domestic and international economic conditions, new or enhanced services, geographical expansion of services, availability of satisfactory financing and actions of regulatory authorities.
The following table compares capital expenditures by asset category and reportable segment for the years ended May 31 (in millions):
Capital expenditures increased during 2007 primarily due to increased spending at FedEx Express for facility expansion and aircraft and related equipment and expenditures at FedEx Kinkos associated with its multi-year expansion program. Capital expenditures during 2006 were higher than the prior year primarily due to the purchase of vehicles at FedEx Express and FedEx Freight and information technology investments at FedEx Services. In addition, investments were made in the FedEx Ground and FedEx Freight networks in 2006 to support growth in customer demand.
While we pursue market opportunities to purchase aircraft when they become available, we must make commitments regarding our airlift requirements years before aircraft are actually needed because of substantial lead times associated with the manufacture and modification of aircraft. We are closely managing our capital spending based on current and anticipated volume levels and will defer or limit capital additions where economically feasible, while continuing to invest strategically in growing service lines.
During 2007, FedEx Express announced two aircraft acquisition programs designed to meet future capacity needs. The first is a $2.6 billion multi-year program to acquire and modify approximately 90 Boeing 757-200 aircraft to replace our narrowbody fleet of Boeing 727-200 aircraft. The second is an agreement to acquire 15 new Boeing 777F (B777F) aircraft and an option to purchase an additional 15 B777F aircraft. The B777F aircraft will provide us with non-stop, point-to-point transoceanic routes with shorter flight times. See Note 16 of the accompanying consolidated financial statements for further discussion of our aircraft purchase commitments.
Our capital expenditures are expected to be approximately $3.5 billion in 2008, with much of the year-over-year increase due to spending for facilities and sort equipment at FedEx Express and FedEx Ground and network expansion at FedEx Kinkos. We also continue to invest in productivity-enhancing technologies. Aircraft-related capital and expense outlays, including support of the narrowbody aircraft replacement program and the B777F fleet, are expected to approximate 2007 aircraft spending levels. We currently expect to fund our 2008 capital requirements with cash from operations.
CONTRACTUAL CASH OBLIGATIONS
The following table sets forth a summary of our contractual cash obligations as of May 31, 2007. Certain of these contractual obligations are reflected in our balance sheet, while others are disclosed as future obligations under accounting principles generally accepted in the United States. Except for the current portion of long-term debt and capital lease obligations, this table does not include amounts already recorded in our balance
sheet as current liabilities at May 31, 2007. Accordingly, this table is not meant to represent a forecast of our total cash expenditures for any of the periods presented.
We have certain contingent liabilities that are not accrued in our balance sheets in accordance with accounting principles generally accepted in the United States. These contingent liabilities are not included in the table above.
We have certain financial instruments representing potential commitments, not reflected in the table above, that were incurred in the normal course of business to support our operations, including surety bonds and standby letters of credit. These instruments are generally required under certain U.S. self-insurance programs and are also used in the normal course of international operations. The underlying liabilities insured by these instruments are reflected in our balance sheets, where applicable. Therefore, no additional liability is reflected for the surety bonds and letters of credit themselves.
We have other long-term liabilities reflected in our balance sheet, including deferred income taxes, qualified and non-qualified pension and postretirement healthcare liabilities and other self-insurance accruals. The payment obligations associated with these liabilities are not reflected in the table above due to the absence of scheduled maturities. Therefore, the timing of these payments cannot be determined, except for amounts estimated to be payable within twelve months that are included in current liabilities.
The amounts reflected in the table above for purchase commitments represent non-cancelable agreements to purchase goods or services. Such contracts include those for certain purchases of aircraft, aircraft modifications, vehicles, facilities, computers, printing and other equipment and advertising and promotions contracts. In addition, we have committed to modify our DC10 aircraft for two-man cockpit configurations, which is reflected in the table above. Commitments to purchase aircraft in passenger configuration do not include the attendant costs to modify these aircraft for cargo transport unless we have entered into a non-cancelable commitment. Open purchase orders that are cancelable are not considered unconditional purchase obligations for financial reporting purposes and are not included in the table above. Such purchase orders often represent authorizations to purchase rather than binding agreements.
The amounts reflected in the table above for interest on long-term debt represent future interest payments due on our long-term debt, which are primarily fixed rate.
The amounts reflected in the table above for operating leases represent future minimum lease payments under non-cancelable operating leases (principally aircraft and facilities) with an initial or remaining term in excess of one year at May 31, 2007. In the past, we financed a significant portion of our aircraft needs (and certain other equipment needs) using operating leases (a type of off-balance sheet financing). At the time that the decision to lease was made, we determined that these operating leases would provide economic benefits favorable to ownership with respect to market values, liquidity or after-tax cash flows.
In accordance with accounting principles generally accepted in the United States, our operating leases are not recorded in our balance sheet. Credit rating agencies routinely use information concerning minimum lease payments required for our operating leases to calculate our debt capacity. In addition, we have guarantees under certain operating leases, amounting to $17 million as of May 31, 2007, for the residual values of vehicles and facilities at the end of the respective operating lease periods. Although some of these leased assets may have a residual value at the end of the lease term that is less than the value specified in the related operating lease agreement, we do not believe it is probable that we will be required to fund material amounts under the terms of these guarantee arrangements. Accordingly, no material accruals have been recognized for these guarantees.
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make significant judgments and estimates to develop amounts reflected and disclosed in the financial statements. In many cases, there are alternative policies or estimation techniques that could be used. We maintain a thorough process to review the application of our accounting policies and to evaluate the appropriateness of the many estimates that are required to prepare the financial statements of a complex, global corporation. However, even under optimal circumstances, estimates routinely require adjustment based on changing circumstances and new or better information.
The estimates discussed below include the financial statement elements that are either the most judgmental or involve the selection or application of alternative accounting policies and are material to our financial statements. Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors and with our independent registered public accounting firm.
As discussed in the notes to our financial statements and previously in this MD&A, we are required to adopt new accounting rules for income taxes under FIN 48, commencing in 2008. While the adoption of FIN 48 will not have a material effect on our financial statements, its application substantially increases the sensitivities of the estimation process used in the accounting and reporting for tax contingencies. Therefore, we will add a Contingencies, including Income Taxes category to our critical accounting estimates in the first quarter of 2008.
Over the past several years, we have substantially improved and automated the rating and billing processes for our package businesses. As a result, our experience with invoice corrections and bad debts has improved markedly, as has the accuracy of our revenue estimates for shipments not yet billed at period end. Therefore, substantially less judgment is required in the reporting of revenue and we have concluded that revenue recognition will no longer be considered a critical accounting estimate commencing in 2008.
Overview. We sponsor programs that provide retirement benefits to most of our employees. These programs include defined benefit pension plans, defined contribution plans and retiree healthcare plans. The accounting for pension and healthcare plans includes numerous assumptions, such as: discount rates; expected long-term investment returns on plan assets; future salary increases; employee turnover; mortality; and retirement ages. These assumptions most significantly impact our U.S. domestic pension plan.
A summary of our retirement plans costs over the past three years is as follows (in millions):
The determination of our annual retirement plans cost is highly sensitive to changes in the assumptions discussed above because we have a large active workforce, a significant amount of assets in the pension plans, and the payout of benefits will occur over an extended period in the future. Total retirement plans cost increased approximately $33 million in 2007, $83 million in 2006 and $37 million in 2005, primarily due to changes to these assumptions.
In February 2007, we announced changes to modernize certain of our retirement programs over the next two fiscal years. Effective January 1, 2008, we will increase the annual company matching contribution under the largest of our 401(k) plans covering most employees from $500 to a maximum of 3.5% of eligible compensation. Employees not participating in the 401(k) plan as of January 1, 2008 will be automatically enrolled at 3% of eligible pay with a company match of 2% of eligible pay. Effective May 31, 2008, benefits previously accrued under our primary pension plans using a traditional pension benefit formula will be capped for most employees, and those benefits will be payable beginning at retirement. Beginning June 1, 2008, future pension benefits for most employees will be accrued under a cash balance formula we call the Portable Pension Account. These changes will not affect the benefits of current retirees.
Under the Portable Pension Account, the retirement benefit is expressed as a dollar amount in a notional account that grows with annual credits based on pay, age and years of credited service and interest on the notional account balance. An employees pay credits are determined each year under a graded formula that combines age with years of service for points. The plan interest credit rate will vary from year to year based on the selected U.S. Treasury index, with a minimum rate of 4% or the one-year Treasury Constant Maturities rate and a maximum rate based on the average 30-year Treasury rate.
Under the new programs, we expect the long-term costs and funding for our retirement plans will approximate those under the current design. However, we expect that the costs of our retirement plans will become more predictable, as we reduce highly volatile pension costs in favor of more predictable 401(k) costs associated with our matching contributions. These retirement plan changes were contemplated in our February 28, 2007 actuarial measurement and reduced the impact on shareholders equity of adopting SFAS 158 by $1 billion. Because it will take several years to fully implement the increases to our 401(k) plan contributions, we will realize a net retirement plans cost reduction in the near term from these changes.
Retirement plans cost in 2008 is expected to be approximately $615 million, a decrease of $83 million from 2007. This expected decrease in cost is due to the retirement plan design changes described above, which will be partially offset by changes in assumptions related to plan asset rate of return, mortality, benefit age for deferred vested participants and pilot-specific benefit formula and salary increases. Retirement plans cost is included in the Salaries and Employee Benefits caption in our consolidated income statements.
As part of our strategy to manage future pension costs and net funded status volatility, we are also in the process of re-evaluating our pension investment strategy. We have decided to move certain equity investments out of actively managed funds and into index funds. Also, we are currently evaluating the mix of investments between equities and fixed income securities, whose cash flows will more closely align with the cash flows of our pension obligations. Based on these considerations, we have reduced our estimated long-term rate of return on plan assets from 9.1% to 8.5% for 2008.
Pension Cost. Of all of our retirement plans, our largest qualified U.S. domestic pension plan is the most significant and subjective. The components of pension cost for all pension plans recognized in our income statements are as follows (in millions):
Following is a discussion of the key estimates we consider in determining our pension costs:
Discount Rate. This is the interest rate used to discount the estimated future benefit payments that have been accrued to date (the projected benefit obligation, or PBO) to their net present value. The discount rate is determined each year at the plan measurement date (February 28) and affects the succeeding years pension cost. A decrease in the discount rate increases pension expense.
This assumption is highly sensitive, as the following table illustrates:
We determine the discount rate (which is required to be the rate at which the projected benefit obligation could be effectively settled as of the measurement date) with the assistance of actuaries, who calculate the yield on a theoretical portfolio of high-grade corporate bonds (rated Aa or better) with cash flows that generally match our expected benefit payments in future years. This bond modeling technique allows for the use of non-callable and make-whole bonds that meet certain screening criteria to ensure that the selected bonds with a call feature have a low probability of being called. To the extent scheduled bond proceeds exceed the estimated benefit payments in a given period, the yield calculation assumes those excess proceeds are reinvested at the one-year forward rates implied by the Citigroup Pension Discount Curve. The trend of declines in the discount rate negatively affected our primary domestic pension plan expense by $89 million in 2007, $101 million in 2006 and $32 million in 2005. Pension costs will be favorably affected in 2008 by approximately $27 million due to the slight increase in the discount rate.
Plan Assets. Pension plan assets are invested primarily in listed securities. Our pension plans hold only a minimal investment in FedEx common stock that is entirely at the discretion of third-party pension fund investment managers. The estimated average rate of return on plan assets is a long-term, forward-looking assumption that also materially affects our pension cost. It is required to be the expected future long-term rate of earnings on plan assets. At February 28, 2007, with approximately $11.3 billion of plan assets, a one-basis-point change in this assumption for our domestic pension plans affects pension cost by approximately $1.1 million. We have assumed an 8.5% compound geometric long-term rate of return on our principal U.S. domestic pension plan assets for 2008, down from 9.1% in 2007, as discussed above.
Establishing the expected future rate of investment return on our pension assets is a judgmental matter. Management considers the following factors in determining this assumption:
As noted above, we have refined our investment strategy and lowered the long-term rate of return for 2008. To support our conclusions, we periodically commission asset/liability studies performed by third-party professional investment advisors and actuaries to assist us in our reviews. These studies project our estimated future pension payments and evaluate the efficiency of the allocation of our pension plan assets into various investment categories. These studies also generate probability-adjusted expected future returns on those assets. The following table summarizes our current asset allocation strategy:
The actual historical return on our U.S. pension plan assets, calculated on a compound geometric basis, was 9.8%, net of investment manager fees, for the 15-year period ended February 28, 2007. In addition, our actual return on plan assets exceeded the estimated return in each of the past four fiscal years.
Pension expense is also affected by the accounting policy used to determine the value of plan assets at the measurement date. We use a calculated-value method to determine the value of plan assets, which helps mitigate short-term volatility in market performance (both increases and decreases). Another method used in practice applies the market value of plan assets at the measurement date. The application of the calculated-value method equaled the result from applying the market-value method for 2005 through 2007.
Salary Increases. The assumed future increase in salaries and wages is also a key estimate in determining pension cost. Generally, we correlate changes in estimated future salary increases to changes in the discount rate (since that is an indicator of general inflation and cost of living adjustments) and general estimated levels of profitability (since most incentive compensation is a component of pensionable wages). Our average future salary increases based on age and years of service were 3.46% for 2007 and 3.15% for 2006 and 2005. Future salary increases are estimated to be 4.47% for our 2008 pension costs, reflecting the impact of the modernization of our retirement plans (discussed above). In the future, a one-basis-point across-the-board change in the rate of estimated future salary increases will have an immaterial impact on our pension costs.
Following is information concerning the funded status of our pension plans as of May 31 (in millions):
The funded status of the plans reflects a snapshot of the state of our long-term pension liabilities at the plan measurement date. Our plans remain adequately funded to provide benefits to our employees as they come due and current benefit payments are nominal compared to our total plan assets (benefit payments for 2007 were approximately 2% of plan assets). As described previously in this MD&A, the adoption of SFAS 158 resulted in a $982 million charge to shareholders equity in accumulated other comprehensive income from the elimination of our prepaid pension asset of $1.4 billion and an increase in other postretirement benefit liabilities of $120 million, net of tax. Under SFAS 158 we are required to recognize the funded status of the PBO and cannot defer actuarial gains and losses even though such items continue to be deferred for the determination of pension expense.
We made tax-deductible voluntary contributions of $482 million in 2007 and $456 million in 2006 to our qualified U.S. domestic pension plans. We expect approximately $10 million of contributions to such plans to be legally required in 2008, and we currently expect to make tax-deductible voluntary contributions to our qualified plans in 2008 at levels approximating those in 2007.
Cumulative unrecognized actuarial losses for pension plans expense determination were approximately $3.3 billion through February 28, 2007, compared to $3.0 billion at February 28, 2006. These unrecognized losses primarily reflect the declining discount rate from 2002 through 2006 and other changes in assumptions. A portion is also attributable to the differences between expected and actual asset returns, which are being
amortized over future periods. These unrecognized losses may be recovered in future periods through actuarial gains. However, unless they are below a corridor amount, these unrecognized actuarial losses are required to be amortized and recognized in future periods. For example, projected U.S. domestic plan pension expense for 2008 includes $162 million of amortization of these actuarial losses versus $136 million in 2007, $107 million in 2006 and $60 million in 2005.
We are self-insured up to certain limits for costs associated with workers compensation claims, vehicle accidents and general business liabilities, and benefits paid under employee healthcare and long-term disability programs. At May 31, 2007 there were approximately $1.3 billion of self-insurance accruals reflected in our balance sheet ($1.2 billion at May 31, 2006). In 2007 approximately 41% of these accruals were classified as current liabilities and in 2006 approximately 43% of self-insurance accruals were classified as current liabilities.
The measurement of these costs requires the consideration of historical cost experience, judgments about the present and expected levels of cost per claim and retention levels. We account for these costs primarily through actuarial methods, which develop estimates of the undiscounted liability for claims incurred, including those claims incurred but not reported, on a quarterly basis for material accruals. These methods provide estimates of future ultimate claim costs based on claims incurred as of the balance sheet date. We self-insure up to certain limits that vary by operating company and type of risk. Periodically, we evaluate the level of insurance coverage and adjust insurance levels based on risk tolerance and premium expense. Historically, it has been infrequent that incurred claims exceeded our self-insured limits. Other acceptable methods of accounting for these accruals include measurement of claims outstanding and projected payments based on historical development factors.
We believe the use of actuarial methods to account for these liabilities provides a consistent and effective way to measure these highly judgmental accruals. However, the use of any estimation technique in this area is inherently sensitive given the magnitude of claims involved and the length of time until the ultimate cost is known. We believe our recorded obligations for these expenses are consistently measured on a conservative basis. Nevertheless, changes in healthcare costs, accident frequency and severity, insurance retention levels and other factors can materially affect the estimates for these liabilities.
Property and Equipment. Our key businesses are capital intensive, with more than 53% of our total assets invested in our transportation and information systems infrastructures. We capitalize only those costs that meet the definition of capital assets under accounting standards. Accordingly, repair and maintenance costs that do not extend the useful life of an asset or are not part of the cost of acquiring the asset are expensed as incurred. However, consistent with industry practice, we capitalize certain aircraft-related major maintenance costs on one of our aircraft fleet types and amortize these costs over their estimated service lives.
The depreciation or amortization of our capital assets over their estimated useful lives, and the determination of any salvage values, requires management to make judgments about future events. Because we utilize many of our capital assets over relatively long periods (the majority of aircraft costs are depreciated over 15 to 18 years), we periodically evaluate whether adjustments to our estimated service lives or salvage values are necessary to ensure these estimates properly match the economic use of the asset. This evaluation may result in changes in the estimated lives and residual values used to depreciate our aircraft and other equipment. These estimates affect the amount of depreciation expense recognized in a period and, ultimately, the gain or loss on the disposal of the asset. Historically, gains and losses on operating equipment have not been material (typically less than $15 million annually). However, such amounts may differ materially in the future due to technological obsolescence, accident frequency, regulatory changes and other factors beyond our control.
Because of the lengthy lead times for aircraft manufacture and modifications, we must anticipate volume levels and plan our fleet requirements years in advance, and make commitments for aircraft based on those projections. These activities create risks that asset capacity may exceed demand and that an impairment of our
assets may occur. In addition, aircraft purchases (primarily aircraft in passenger configuration) that have not been placed in service totaled $71 million at May 31, 2007 and $208 million at May 31, 2006. We plan to modify these assets in the future to place them into operation.
The accounting test for whether an asset held for use is impaired involves first comparing the carrying value of the asset with its estimated future undiscounted cash flows. If the cash flows do not exceed the carrying value, the asset must be adjusted to its current fair value. Because the cash flows of our transportation networks cannot be identified to individual assets, and based on the ongoing profitability of our operations, we have not experienced any significant impairment of assets to be held and used. However, from time to time we make decisions to remove certain long-lived assets from service based on projections of reduced capacity needs and those decisions may result in an impairment charge. Assets held for disposal must be adjusted to their estimated fair values when the decision is made to dispose of the asset and certain other criteria are met. There were no material asset impairment charges recognized in 2007, 2006 or 2005.
Leases. We utilize operating leases to finance certain of our aircraft, facilities and equipment. Such arrangements typically shift the risk of loss on the residual value of the assets at the end of the lease period to the lessor. As disclosed in Contractual Cash Obligations and Note 7 to the accompanying consolidated financial statements, at May 31, 2007 we had approximately $13 billion (on an undiscounted basis) of future commitments for payments under operating leases. The weighted-average remaining lease term of all operating leases outstanding at May 31, 2007 was approximately seven years.
The future commitments for operating leases are not reflected as a liability in our balance sheet because these leases do not meet the accounting definition of capital leases. The determination of whether a lease is accounted for as a capital lease or an operating lease requires management to make estimates primarily about the fair value of the asset and its estimated economic useful life. We believe we have well-defined and controlled processes for making this evaluation, including obtaining third-party appraisals for material transactions to assist us in making these evaluations.
Goodwill. We have approximately $3.5 billion of goodwill in our balance sheet resulting from business acquisitions. Our business acquisitions in 2007 contributed approximately $670 million in goodwill, as follows:
The annual evaluation of goodwill impairment requires the use of estimates and assumptions to determine the fair value of our reporting units using a discounted cash flow methodology, such as: revenue growth rates; operating margins; discount rates and expected capital expenditures. Estimates used by management can significantly affect the outcome of the impairment test. Each year, independent of our goodwill impairment test, we update our weighted-average cost of capital calculation and perform a long-range planning analysis to project expected results of operations. Using this data, we complete a separate fair-value analysis for each of our reporting units. Changes in forecasted operations and other assumptions could materially affect these estimates. We compare the fair value of our reporting units to the carrying value, including goodwill, of each of those units. We performed our annual impairment tests in the fourth quarter of 2007. Because the fair value of each of our reporting units exceeded its carrying value, including goodwill, no additional testing or impairment charge was necessary.
Intangible Asset with an Indefinite Life. We have an intangible asset of $567 million associated with the Kinkos trade name. This intangible asset is not amortized because it has an indefinite remaining useful life. We must review this asset for impairment on at least an annual basis. This annual evaluation requires the use of estimates about the future cash flows attributable to the Kinkos trade name to determine the estimated fair
value of the trade name. Changes in forecasted operations and changes in discount rates can materially affect this estimate. However, once an impairment of this intangible asset has been recorded, it cannot be reversed. We performed our annual impairment test in the fourth quarter of 2007. Because the fair value of the trade name exceeded its carrying value, no impairment charge was necessary.
While FedEx Kinkos experienced a slight revenue decline in 2007 and decreased profitability in 2007 and 2006, we believe that our long-term growth and expansion strategies support our fair value conclusions. For both goodwill and recorded intangible assets at FedEx Kinkos, the recoverability of these amounts is dependent on execution of key initiatives related to revenue growth, location expansion and improved profitability.
Historically, the policies adopted to recognize revenue have been deemed critical because an understanding of the accounting applied in this area is fundamental to assessing our overall financial performance and because revenue and revenue growth are key measures of financial performance in the marketplace. Revenue recognition will no longer be considered a critical accounting estimate category for 2008 due to the improvements we have made in our rating and billing processes, which have significantly reduced the level of management judgment applied in these areas.
Our businesses are primarily involved in the direct pickup and delivery of commercial package and freight shipments, as well as providing document solutions and business services. Our employees, independent contractors and agents are involved throughout the process and our operational, billing and accounting systems directly capture and control all relevant information necessary to record revenue, bill customers and collect amounts due to us. Certain of our transportation services are provided through independent contractors. FedEx is the principal to the transaction in most instances and in these cases revenue from these transactions is recognized on a gross basis. Costs associated with independent contractor settlements are recognized as incurred and included in the purchased transportation caption in the accompanying income statements.
We recognize revenue upon delivery of shipments for our transportation businesses and upon completion of services for our business services, logistics and trade services businesses. Transportation industry practice includes four acceptable methods for revenue recognition for shipments in process at the end of an accounting period, two of which are predominant: (1) recognize all revenue and the related delivery costs when shipments are delivered or (2) recognize a portion of the revenue earned for shipments that have been picked up but not yet delivered at period end and accrue delivery costs as incurred. We use the second method and recognize the portion of revenue earned at the balance sheet date for shipments in transit and accrue all delivery costs as incurred. We believe this accounting policy effectively and consistently matches revenue with expenses and recognizes liabilities as incurred.
Our contract logistics, global trade services and certain transportation businesses engage in some transactions wherein they act as agents. Revenue from these transactions is recorded on a net basis. Net revenue includes billings to customers less third-party charges, including transportation or handling costs, fees, commissions, taxes and duties. These amounts are not material.
There are three key estimates that are included in the recognition and measurement of our revenue and related accounts receivable under the policies described above: (1) estimates for unbilled revenue on shipments that have been delivered; (2) estimates for revenue associated with shipments in transit; and (3) estimates for future adjustments to revenue or accounts receivable for billing adjustments and bad debts.
Unbilled Revenue. There is a time lag between the completion of a shipment and the generation of an invoice that varies by customer and operating company. Accordingly, unbilled revenue is recognized through estimates using actual shipment volumes and historical trends of shipment size and length of haul. These estimates are adjusted in subsequent months to the actual amounts invoiced. Due to strong system controls and shipment visibility, there is a low level of subjectivity inherent in these accrual processes and the estimates have historically not varied significantly from actual amounts subsequently invoiced.
Shipments in Process. Because the majority of our shipments have short cycle times, less than 5% of a total months revenue is typically in transit at the end of a period. We periodically perform studies to measure the percentage of completion for shipments in process. At month end, we estimate the amount of revenue earned on shipments in process based on actual shipments picked up, the scheduled day of delivery, the day of the week on which the month ends (which affects the percentage of completion) and current trends in our average price for the respective services. We believe these estimates provide a reasonable approximation of the actual revenue earned at the end of a period.
Future Adjustments to Revenue and Accounts Receivable. In the transportation industry, pricing that is put in place may be subsequently adjusted due to continued negotiation of contract terms, earned discounts triggered by certain shipment volume thresholds, and/or no-fee money-back guarantee refunds caused by on-time service failures. We account for estimated future revenue adjustments through a reserve against accounts receivable that takes into consideration historical experience and current trends. For 2007, 2006 and 2005, revenue adjustments as a percentage of total revenue averaged approximately 1%. Due to our reliable on-time service, close communication with customers, strong revenue systems and minimal volume discounts in place, we have maintained a consistently low revenue adjustment percentage. A one-basis-point change in the revenue adjustment percentage would increase or decrease revenue adjustments by approximately $2 million. While write-offs related to bad debts do occur from time to time, they are small compared to our total revenue and accounts receivable balances due to the small value of individual shipping transactions spread over a large customer base, our short credit terms and our strong credit and collection practices. Bad debt expense associated with credit losses has averaged approximately 0.3% in 2007, 0.4% in 2006 and 0.3% in 2005 of total revenue and reflects our strong credit management processes.
Our financial and operating results are subject to many risks and uncertainties, as described below.
Our businesses depend on our strong reputation and the value of the FedEx brand. The FedEx brand name symbolizes high-quality service, reliability and speed. FedEx is one of the most widely recognized, trusted and respected brands in the world, and the FedEx brand is one of our most important and valuable assets. In addition, we have a strong reputation among customers and the general public for high standards of social and environmental responsibility and corporate governance and ethics. The FedEx brand name and our corporate reputation are powerful sales and marketing tools, and we devote significant resources to promoting and protecting them. Adverse publicity (whether or not justified) relating to activities by our employees, contractors or agents could tarnish our reputation and reduce the value of our brand. Damage to our reputation and loss of brand equity could reduce demand for our services and thus have an adverse effect on our financial condition, liquidity and results of operations, as well as require additional resources to rebuild our reputation and restore the value of our brand.
We rely heavily on technology to operate our transportation and business networks, and any disruption to our technology infrastructure or the Internet could harm our operations and our reputation among customers. Our ability to attract and retain customers and to compete effectively depends in part upon the sophistication and reliability of our technology network, including our ability to provide features of service that are important to our customers. Any disruption to the Internet or our technology infrastructure, including those impacting our computer systems and Web site, could adversely impact our customer service and our volumes and revenues and result in increased costs. While we have invested and continue to invest in technology security initiatives and disaster recovery plans, these measures cannot fully insulate us from technology disruptions and the resulting adverse effect on our operations and financial results.
Our businesses are capital intensive, and we must make capital expenditures based upon projected volume levels. We make significant investments in aircraft, vehicles, technology, package handling facilities, sort equipment, copy equipment and other capital to support our transportation and business networks. We also make significant investments to rebrand, integrate and grow the companies that we acquire. The amount and timing of capital investments depend on various factors, including our anticipated volume growth. For example, we must make commitments to purchase or modify aircraft years before the aircraft are actually
needed. We must predict volume levels and fleet requirements and make commitments for aircraft based on those projections. If we miss our projections, we could end up with too much or too little capacity relative to our shipping volumes.
We face intense competition. The transportation and business services markets are both highly competitive and sensitive to price and service. Some of our competitors have more financial resources than we do, or they are controlled or subsidized by foreign governments, which enables them to raise capital more easily. We believe we compete effectively with these companies for example, by providing more reliable service at compensatory prices. However, our competitors determine the charges for their services. If the pricing environment becomes irrational, it could limit our ability to maintain or increase our prices (including our fuel surcharges in response to rising fuel costs) or to maintain or grow our market share. In addition, maintaining a broad portfolio of services is important to keeping and attracting customers. While we believe we compete effectively through our current service offerings, if our competitors offer a broader range of services or more effectively bundle their services, it could impede our ability to maintain or grow our market share.
If we do not effectively operate, integrate, leverage and grow acquired businesses, our financial results and reputation may suffer. Our strategy for long-term growth, productivity and profitability depends in part on our ability to make prudent strategic acquisitions and to realize the benefits we expect when we make those acquisitions. In furtherance of this strategy, during 2007 we acquired the LTL freight operations of Watkins Motor Lines (renamed FedEx National LTL) and made strategic acquisitions in China, the United Kingdom and India. While we expect these acquisitions to enhance our value proposition to customers and improve our long-term profitability, there can be no assurance that we will realize our expectations within the time frame we have established, if at all. We acquired FedEx Kinkos in February 2004 to expand our portfolio of business services and enhance our ability to provide package-shipping services to small- and medium-sized business customers through its network of retail locations. However, FedEx Kinkos financial performance has not yet met our expectations. Accordingly, we have undertaken key initiatives at FedEx Kinkos relating to revenue growth, network expansion and improved profitability. There can be no assurance that our acquisitions will be successful or that we can continue to support the value we allocate to these acquired businesses, including their goodwill or other intangible assets.
Our transportation businesses may be impacted by the price and availability of fuel. We must purchase large quantities of fuel to operate our aircraft and vehicles, and the price and availability of fuel can be unpredictable and beyond our control. To date, we have been successful in mitigating the impact of higher fuel costs through our indexed fuel surcharges, as the amount of the surcharges is closely linked to the market prices for fuel. If we are unable to maintain or increase our fuel surcharges because of competitive pricing pressures or some other reason, fuel costs could adversely impact our operating results. In addition, disruptions in the supply of fuel could have a negative impact on our ability to operate our transportation networks.
FedEx Ground relies on owner-operators to conduct its operations, and the status of these owner-operators as independent contractors, rather than employees, is being challenged. FedEx Grounds use of independent contractors is well suited to the needs of the ground delivery business and its customers. We are involved in numerous purported class-action lawsuits and other proceedings, however, that claim that these owner-operators should be treated as employees and not independent contractors. We expect to incur certain costs, including legal fees, in defending the status of FedEx Grounds owner-operators as independent contractors. We strongly believe that the owner-operators are properly classified as independent contractors and that we will prevail in our defense. However, adverse determinations in these matters could, among other things, entitle some of our contractors to the reimbursement of certain expenses and to the benefit of wage-and-hour laws and result in employment and withholding tax liability for FedEx Ground. Moreover, if FedEx Ground is compelled to convert its independent contractors to employees, our operating costs could increase and we could incur significant capital outlays.
Increased security requirements could impose substantial costs on us, especially at FedEx Express. As a result of concerns about global terrorism and homeland security, governments around the world are adopting or are considering adopting stricter security requirements that will increase operating costs for businesses, including those in the transportation industry. For example, 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, and in May 2007, the TSA issued a revised model all-cargo aircraft security program for implementing the new rules. Together with other all-cargo aircraft operators, we have filed comments with the TSA requesting clarification regarding several provisions in the revised model program. Until the requirements for our security program under the new rules are 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.
The regulatory environment for global aviation rights may impact our air operations. Our extensive air network is critical to our success. Our right to serve foreign points is subject to the approval of the Department of Transportation and generally requires a bilateral agreement between the United States and foreign governments. In addition, we must obtain the permission of foreign governments to provide specific flights and services. Regulatory actions affecting global aviation rights or a failure to obtain or maintain aviation rights in important international markets could impair our ability to operate our air network.
We are also subject to risks and uncertainties that affect many other businesses, including:
We are directly affected by the state of the economy. While the global, or macro-economic, risks listed above apply to most companies, we are particularly vulnerable. The transportation industry is highly cyclical and especially susceptible to trends in economic activity. Our primary business is to transport goods, so our
business levels are directly tied to the purchase and production of goods key macro-economic measurements. When individuals and companies purchase and produce fewer goods, we transport fewer goods. In addition, we have a relatively high fixed-cost structure, which is difficult to adjust to match shifting volume levels. Moreover, as we grow our international business, we are increasingly affected by the health of the global economy.
Certain statements in this report, including (but not limited to) those contained in Outlook (including segment outlooks), Liquidity, Capital Resources, Contractual Cash Obligations and Critical Accounting Estimates, and the Retirement Plans note to the consolidated financial statements, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to our financial condition, results of operations, cash flows, plans, objectives, future performance and business. Forward-looking statements include those preceded by, followed by or that include the words may, could, would, should, believes, expects, anticipates, plans, estimates, targets, projects, intends or similar expressions. These forward-looking statements involve risks and uncertainties. Actual results may differ materially from those contemplated (expressed or implied) by such forward-looking statements, because of, among other things, the risk factors identified above and the other risks and uncertainties you can find in our press releases and other SEC filings.
As a result of these and other factors, no assurance can be given as to our future results and achievements. Accordingly, a forward-looking statement is neither a prediction nor a guarantee of future events or circumstances and those future events or circumstances may not occur. You should not place undue reliance on the forward-looking statements, which speak only as of the date of this report. We are under no obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended). Our internal control over financial reporting includes, among other things, defined policies and procedures for conducting and governing our business, sophisticated information systems for processing transactions and a properly staffed, professional internal audit department. Mechanisms are in place to monitor the effectiveness of our internal control over financial reporting and actions are taken to correct deficiencies identified. Our procedures for financial reporting include the active involvement of senior management, our Audit Committee and our staff of highly qualified financial and legal professionals.
Management, with the participation of our principal executive and financial officers, assessed our internal control over financial reporting as of May 31, 2007, the end of our fiscal year. Management based its assessment on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria).
Based on this assessment, management has concluded that our internal control over financial reporting was effective as of May 31, 2007.
Our independent registered public accounting firm, Ernst & Young LLP, audited managements assessment and the effectiveness of our internal control over financial reporting. Ernst & Young LLP has issued their report concurring with managements assessment, which is included in this Annual Report on Form 10-K.
The Board of Directors and Stockholders
We have audited managements assessment, included in the accompanying Managements Report on Internal Control over Financial Reporting, that FedEx Corporation maintained effective internal control over financial reporting as of May 31, 2007, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). FedEx Corporations management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, managements assessment that FedEx Corporation maintained effective internal control over financial reporting as of May 31, 2007, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, FedEx Corporation maintained, in all material respects, effective internal control over financial reporting as of May 31, 2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of FedEx Corporation as of May 31, 2007 and 2006, and related consolidated statements of income, changes in stockholders investment and comprehensive income, and cash flows for each of the three years in the period ended May 31, 2007 of FedEx Corporation and our report dated July 9, 2007 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
July 9, 2007
The Board of Directors and Stockholders
We have audited the accompanying consolidated balance sheets of FedEx Corporation as of May 31, 2007 and 2006, and the related consolidated statements of income, changes in stockholders investment and comprehensive income, and cash flows for each of the three years in the period ended May 31, 2007. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of FedEx Corporation at May 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended May 31, 2007, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, effective June 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment, and effective May 31, 2007 the Company adopted SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Benefit Plans An Amendment of FASB Statements No. 87, 88, 106 and 132(R).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of FedEx Corporations internal control over financial reporting as of May 31, 2007, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 9, 2007 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
July 9, 2007