<PAGE>
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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTER ENDED AUGUST 31, 1998, OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________TO________.
COMMISSION FILE NUMBER: 1-7806
FEDERAL EXPRESS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 71-0427007
(State of incorporation) (I.R.S. Employer
Identification No.)
2005 Corporate Avenue 38132
Memphis, Tennessee (Zip Code)
(Address of principal
executive offices)
(901) 369-3600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
The number of shares of common stock outstanding as of September 30, 1998 was
1,000. The Registrant is a wholly-owned subsidiary of FDX Corporation, and there
is no market for the Registrant's common stock.
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H(1)(a)
AND (b) OF FORM 10-Q AND IS FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT
PERMITTED BY GENERAL INSTRUCTION H(2).
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<PAGE>
FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
<S> <C>
Condensed Consolidated Balance Sheets
August 31, 1998 and May 31, 1998.......................... 3-4
Condensed Consolidated Statements of Income
Three Months Ended August 31, 1998 and 1997............... 5
Condensed Consolidated Statements of Cash Flows
Three Months Ended August 31, 1998 and 1997............... 6
Notes to Condensed Consolidated Financial Statements........... 7-9
Review of Condensed Consolidated Financial Statements
by Independent Public Accountants......................... 10
Report of Independent Public Accountants....................... 11
Management's Discussion and Analysis of Results of Operations
and Financial Condition................................... 12-18
PART II. OTHER INFORMATION
Legal Proceedings.............................................. 19
Exhibits and Reports on Form 8-K............................... 19
EXHIBIT INDEX.................................................. E-1
</TABLE>
- 2 -
<PAGE>
FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
August 31,
1998 May 31,
(Unaudited) 1998
-------------- -------------
(In thousands)
<S> <C> <C>
Current Assets:
Cash and cash equivalents................................................ $ 114,288 $ 104,606
Receivables, less allowances of $44,372,000
and $43,245,000........................................................ 1,694,866 1,669,568
Spare parts, supplies and fuel........................................... 324,379 338,745
Deferred income taxes.................................................... 192,097 183,063
Prepaid expenses and other............................................... 59,086 80,696
----------- -----------
Total current assets................................................. 2,384,716 2,376,678
----------- -----------
Property and Equipment, at Cost............................................... 11,453,917 11,063,893
Less accumulated depreciation and amortization........................... 6,059,081 5,863,325
----------- -----------
Net property and equipment........................................... 5,394,836 5,200,568
----------- -----------
Other Assets:
Goodwill................................................................. 348,361 351,507
Equipment deposits and other assets...................................... 425,055 504,353
----------- -----------
Total other assets................................................... 773,416 855,860
----------- -----------
$ 8,552,968 $ 8,433,106
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
- 3 -
<PAGE>
FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
LIABILITIES AND OWNER'S EQUITY
<TABLE>
<CAPTION>
August 31,
1998 May 31,
(Unaudited) 1998
-------------- -------------
(In thousands)
<S> <C> <C>
Current Liabilities:
Current portion of long-term debt........................................ $ 265,481 $ 257,529
Accounts payable......................................................... 841,052 965,167
Salaries, wages and benefits............................................. 510,382 547,805
Accrued expenses ........................................................ 723,606 630,798
---------- ----------
Total current liabilities............................................ 2,340,521 2,401,299
---------- ----------
Long-Term Debt, Less Current Portion ......................................... 1,171,302 1,185,180
Deferred Income Taxes......................................................... 215,755 218,328
Other Liabilities............................................................. 1,324,387 1,226,570
Commitments and Contingencies (Notes 3 and 4)
Owner's Equity:
Common Stock, $.10 par value;
1,000 shares authorized, issued and outstanding........................ - -
Additional paid-in capital............................................... 893,469 893,469
Retained earnings........................................................ 2,648,256 2,535,537
Cumulative foreign currency
translation adjustments................................................ (40,722) (27,277)
---------- ----------
Total owner's equity................................................. 3,501,003 3,401,729
---------- ----------
$8,552,968 $8,433,106
---------- ----------
---------- ----------
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
- 4 -
<PAGE>
FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
August 31,
-----------------------------
1998 1997
------------- ------------
(In thousands)
<S> <C> <C>
Revenues ................................................................. $3,417,183 $3,297,218
Operating Expenses:
Salaries and employee benefits....................................... 1,540,761 1,450,487
Rentals and landing fees............................................. 313,470 274,468
Maintenance and repairs.............................................. 229,639 198,337
Depreciation and amortization........................................ 220,200 202,421
Fuel................................................................. 146,578 173,780
Other................................................................ 747,463 733,520
---------- ----------
3,198,111 3,033,013
---------- ----------
Operating Income.......................................................... 219,072 264,205
Other Income (Expense):
Interest, net........................................................ (21,952) (25,828)
Other, net........................................................... (4,438) 8,618
---------- ----------
(26,390) (17,210)
---------- ----------
Income Before Income Taxes................................................ 192,682 246,995
Provision for Income Taxes................................................ 79,963 103,738
---------- ----------
Net Income................................................................ $ 112,719 $ 143,257
---------- ----------
---------- ----------
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
- 5 -
<PAGE>
FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
August 31,
-----------------------------
1998 1997
------------- ------------
(In thousands)
<S> <C> <C>
Net Cash Provided by Operating Activities................................. $ 322,119 $ 206,782
Investing Activities:
Purchases of property and equipment, including
deposits on aircraft............................................... (452,541) (365,957)
Proceeds from disposition of property
and equipment:
Sale-leaseback transactions...................................... - 81,500
Reimbursements of A300 deposits.................................. 23,630 85,169
Other dispositions............................................... 1,551 8,046
Proceeds from sale of A300 purchase rights
and other, net..................................................... 42,745 14,513
--------- ---------
Net cash used in investing activities..................................... (384,615) (176,729)
--------- ---------
Financing Activities:
Proceeds from debt issuances......................................... - 267,105
Principal payments on debt........................................... (6,000) (209,446)
Borrowings from parent company....................................... 78,178 -
Other, net........................................................... - 47
--------- ---------
Net cash provided by financing activities................................. 72,178 57,706
--------- ---------
Net increase in cash and cash equivalents................................. 9,682 87,759
Cash and cash equivalents at beginning of period.......................... 104,606 122,023
--------- ---------
Cash and cash equivalents at end of period................................ $ 114,288 $ 209,782
--------- ---------
--------- ---------
Cash payments for:
Interest (net of capitalized interest)............................... $ 13,727 $ 8,631
--------- ---------
--------- ---------
Income taxes......................................................... $ 18,653 $ 24,817
--------- ---------
--------- ---------
Non-cash investing and financing activities:
Fair value of assets surrendered under
exchange agreements (with two airlines)............................ $ 10,446 $ 25,741
Fair value of assets acquired under
exchange agreements................................................ 6,690 31,413
--------- ---------
Fair value of assets receivable (liabilities
incurred) under exchange agreements................................ $ 3,756 $ (5,672)
--------- ---------
--------- ---------
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
- 6 -
<PAGE>
FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
On January 27, 1998, Federal Express Corporation ("the Company") became a
wholly-owned subsidiary of FDX Corporation ("FDX").
These interim financial statements of the Company have been prepared in
accordance with generally accepted accounting principles for interim financial
information, the instructions to Quarterly Report on Form 10-Q and Rule 10-01 of
Regulation S-X, and should be read in conjunction with the Company's Annual
Report on Form 10-K for the year ended May 31, 1998. Accordingly, significant
accounting policies and other disclosures normally provided have been omitted
since such items are disclosed therein.
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments necessary to
present fairly the consolidated financial position of the Company as of
August 31, 1998 and the consolidated results of its operations and its
consolidated cash flows for the three-month periods ended August 31, 1998 and
1997. Operating results for the three-month period ended August 31, 1998 are
not necessarily indicative of the results that may be expected for the year
ending May 31, 1999.
Effective June 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." The Statement
requires the Company to include within its financial statements information on
comprehensive income, which is defined as all activity impacting equity from
non-owner sources. For the Company, comprehensive income includes net income and
foreign currency translation adjustments. Total comprehensive income, net of
taxes, for the three months ended August 31, 1998 and 1997 was $99,274,000 and
$139,355,000, respectively.
Also effective June 1, 1998, the Company adopted Statement of Position
("SOP") 98-1, "Accounting for the Cost of Computer Software Developed or
Obtained for Internal Use." SOP 98-1 provides guidance on accounting for these
costs, requiring certain of them to be capitalized. For the three months ended
August 31, 1998, incremental costs of $6,400,000 were capitalized.
Certain prior period amounts have been reclassified to conform to the
current presentation.
- 7 -
<PAGE>
(2) LONG-TERM DEBT
<TABLE>
<CAPTION>
August 31,
1998 May 31,
(Unaudited) 1998
-------------- -------------
(In thousands)
<S> <C> <C>
Unsecured notes payable, interest rates of
7.60% to 10.57%, due through 2098................................... $1,047,872 $1,053,770
Unsecured sinking fund debentures, interest
rate of 9.63%, due through 2020..................................... 98,546 98,529
Capital lease obligations and tax exempt bonds,
interest rates of 5.35% to 7.88%,
due through 2017.................................................... 253,425 253,425
Less bond reserves.................................................. 9,024 9,024
---------- ----------
244,401 244,401
Other debt, interest rates of 9.68% to 9.98%.......................... 45,964 46,009
---------- ----------
1,436,783 1,442,709
Less current portion................................................ 265,481 257,529
---------- ----------
$1,171,302 $1,185,180
---------- ----------
---------- ----------
</TABLE>
(3) COMMITMENTS
As of August 31, 1998, the Company's purchase commitments for the
remainder of 1999 and annually thereafter under various contracts are as follows
(in thousands):
<TABLE>
<CAPTION>
Aircraft-
Aircraft Related(1) Other(2) Total
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
1999 (remainder) $244,600 $413,400 $415,600 $1,073,600
2000 639,400 578,800 211,400 1,429,600
2001 269,800 509,000 59,600 838,400
2002 240,600 156,200 18,100 414,900
2003 457,400 156,600 - 614,000
</TABLE>
(1) Primarily aircraft modifications, rotables and spare parts and
engines.
(2) Vehicles, facilities, computers and other equipment.
The Company is committed to purchase nine Airbus A300s, 33 MD11s and 50
Ayres ALM 200s to be delivered through 2007. Deposits and progress payments of
$70,094,000 have been made toward these purchases.
The Company has entered into agreements with two airlines to acquire 53
DC10 aircraft, spare parts, aircraft engines and other equipment, and
maintenance services in exchange for a combination of aircraft engine noise
reduction kits and cash. Delivery of these aircraft began in 1997 and will
continue through 2001. Additionally, these airlines may exercise put options
through December 31, 2003, requiring the Company to purchase up to 29 additional
DC10s along with additional aircraft engines and equipment.
During the three-month period ended August 31, 1998, the Company acquired
three Airbus A300s under operating leases. These aircraft were included as
purchase commitments as of May 31, 1998. At the time of delivery, the Company
sold its rights to purchase these aircraft to third parties who reimbursed the
Company for its deposits on the aircraft and paid additional consideration. The
Company then entered into operating leases with each of the third parties who
purchased the aircraft from the manufacturer.
- 8 -
<PAGE>
Lease commitments added since May 31, 1998 for the three Airbus A300s are
as follows (in thousands):
<TABLE>
<S> <C>
1999 $ 12,900
2000 15,500
2001 15,800
2002 15,900
2003 17,700
Thereafter 336,200
</TABLE>
(4) LEGAL PROCEEDINGS
Customers of the Company have filed four separate class-action lawsuits
against the Company generally alleging that the Company has breached its
contract with the plaintiffs in transporting packages shipped by them. These
lawsuits allege that the Company continued to collect a 6.25% federal excise tax
on the transportation of property shipped by air after the tax expired on
December 31, 1995, until it was reinstated in August 1996. The plaintiffs seek
certification as a class action, damages, an injunction to enjoin the Company
from continuing to collect the excise tax referred to above, and an award of
attorneys' fees and costs. Three of those cases were consolidated in Minnesota
Federal District Court. That court stayed the consolidated cases in favor of a
case filed in Circuit Court of Greene County, Alabama. The stay was lifted in
July 1998. The complaint in the Alabama case also alleges that the Company
continued to collect the excise tax on the transportation of property shipped by
air after the tax expired again on December 31, 1996.
A fifth case, filed in the Supreme Court of New York, New York County,
containing allegations and requests for relief substantially similar to the
other four cases was dismissed with prejudice on the Company's motion on October
7, 1997. The Court found that there was no breach of contract and that the other
causes of action were preempted by federal law. The plaintiffs have appealed.
This case originally alleged that the Company continued to collect the excise
tax on the transportation of property shipped by air after the tax expired on
December 31, 1996. The New York complaint was later amended to cover the first
expiration period of the tax (December 31, 1995 through August 27, 1996) covered
in the original Alabama complaint.
The air transportation excise tax expired on December 31, 1995, was
reenacted by Congress effective August 27, 1996, and expired again on December
31, 1996. The excise tax was then reenacted by Congress effective March 7, 1997.
The expiration of the tax relieved the Company of its obligation to pay the tax
during the periods of expiration. The Taxpayer Relief Act of 1997, signed by
President Clinton in August 1997, extended the tax for 10 years through
September 30, 2007.
The Company intends to vigorously defend itself in these cases. No amount
has been reserved for these contingencies.
The Company is subject to other legal proceedings and claims which arise
in the ordinary course of its business. In the opinion of management, the
aggregate liability, if any, with respect to these other actions will not
materially adversely affect the financial position or results of operations of
the Company.
(5) RELATED PARTY TRANSACTIONS
As of August 31, 1998, the Company had a payable balance due to its
parent, FDX Corporation, of $36,800,000, which is included in Other
liabilities. Included in the payable amount is an intercompany operating
payable of $8,500,000; the remaining balance of $28,300,000 represents the
net activity from funds transferred between FDX and the Company for working
capital purposes.
- 9 -
<PAGE>
REVIEW OF CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
BY INDEPENDENT PUBLIC ACCOUNTANTS
Arthur Andersen LLP, independent public accountants, has performed a
review of the condensed consolidated balance sheet of the Company as of August
31, 1998, and the related condensed consolidated statements of income for the
three-month periods ended August 31, 1998 and 1997 and the condensed
consolidated statements of cash flows for the three-month periods ended August
31, 1998 and 1997, included herein, as indicated in their report thereon
included on page 11.
- 10 -
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholder of Federal Express Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of
Federal Express Corporation and subsidiaries as of August 31, 1998 and the
related condensed consolidated statements of income for the three-month periods
ended August 31, 1998 and 1997 and the condensed consolidated statements of cash
flows for the three-month periods ended August 31, 1998 and 1997. These
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical review
procedures to financial data and making inquiries of persons responsible for
financial and accounting matters. It is substantially less in scope than an
audit conducted in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted
auditing standards, the consolidated balance sheet of Federal Express
Corporation and subsidiaries as of May 31, 1998 and the related consolidated
statements of income, changes in owner's equity and cash flows for the year then
ended. In our report dated July 8, 1998, we expressed an unqualified opinion on
those financial statements, which are not presented herein. In our opinion, the
accompanying condensed consolidated balance sheet as of May 31, 1998 is fairly
stated in all material respects in relation to the consolidated balance sheet
from which it has been derived.
Arthur Andersen LLP
Memphis, Tennessee
September 23, 1998
- 11 -
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
For the three months ended August 31, 1998, the Company recorded net
income of $113 million on revenues of $3.4 billion compared with net income of
$143 million on revenues of $3.3 billion for the same period in the prior year.
The prior year's results included the impact of the Teamsters strike
against United Parcel Service ("UPS") in August 1997. During the 12 operating
days of the strike, the Company delivered approximately 800,000 additional
U.S. domestic express packages per day. Although it is difficult to estimate
with precision the impact of this additional volume, the Company has retained
a portion of this volume. The Company analytically calculated that the volume
not retained at the end of the first quarter of 1998 contributed
approximately $150 million and $50 million in U.S. domestic revenues and
operating income, respectively, in that quarter.
Excluding the strike-related impact, current quarter earnings reflect
improved domestic results, partially offset by continued weak international
conditions.
Revenues
The following table shows a comparison of revenues (in millions):
<TABLE>
<CAPTION>
Three Months
Ended
August 31,
----------------------- Percent
1998 1997 Change
-------- -------- ---------
<S> <C> <C> <C>
U.S. domestic express............................................... $2,423 $2,335 + 4
International Priority (IP)......................................... 725 655 +11
International Express Freight (IXF)
and Airport-to-Airport (ATA).................................... 134 151 -11
Charter, Logistics services
and other....................................................... 135 156 -13
------ ------
$3,417 $3,297 + 4
------ ------
------ ------
</TABLE>
- 12 -
<PAGE>
The following table shows a comparison of selected operating statistics
(packages and pounds in thousands):
<TABLE>
<CAPTION>
Three Months
Ended
August 31,
----------------------- Percent
1998 1997 Change
-------- -------- ---------
<S> <C> <C> <C>
U.S. domestic express:
Average daily packages.............................................. 2,725 2,692 + 1
Revenue per package................................................. $13.47 $13.55 - 1
IP:
Average daily packages.............................................. 265 246 + 8
Revenue per package................................................. $41.45 $41.56 -
IXF/ATA:
Average daily pounds................................................ 2,621 2,652 - 1
Revenue per pound................................................... $ .77 $ .89 -13
Operating weekdays..................................................... 66 64
</TABLE>
The Company's U.S. domestic package volume growth was relatively flat
primarily due to the impact of the additional volume during the UPS strike in
the prior year. The majority of the strike-related volume was in the deferred
service category, generally at list price and above average weight per package.
Excluding the revenue and volume associated with the strike and the proceeds
from a temporary fuel surcharge in the prior year, U.S. domestic average daily
package volume and revenue per package (yield) increased 6% and 2% year over
year in the current quarter. Management expects total U.S. domestic package
volume in 1999 to grow at a lower rate than that experienced in the past two
fiscal years. Management believes that U.S. domestic yield should remain stable
or increase slightly year over year during the remainder of 1999 due to
continued effects of yield-management actions, including a 3% to 4% rate
increase in February 1998. Actual results may vary depending on the impact of
domestic economic conditions, competitive pricing changes, customer responses to
yield-management initiatives and changing customer demand patterns.
The Company's IP revenue and volume year-over-year growth rates slowed
to 11% and 8% for the quarter, respectively. In the current quarter, which
contained two additional operating days, IP revenue rose 7% on a daily basis.
Slower growth in the current quarter was primarily due to weakness in Asian
markets and was especially evident in U.S. outbound shipments to that region.
Total IP yield remained stable during the quarter compared to the same period
of the prior year. Management expects continued pressure on IP volume and
yield for the remainder of 1999. Actual IP results will depend on
international economic conditions, actions by the Company's competitors and
regulatory conditions for international aviation rights.
-13-
<PAGE>
The Company's airfreight (IXF/ATA) volume, revenue and yield declined
year over year for the quarter. IXF volume (a space-confirmed, time-definite
service) increased 3% for the quarter, but yield declined 12% for the same
period. ATA volume (a lower-priced, space-available service) decreased 9% for
the quarter, with yield lower by 17% for the same period. Management expects
airfreight volume and yield to continue to decline, year over year, through
the balance of 1999. Due to the impact of difficult international economic
conditions on IP and airfreight traffic, management has adjusted the
Company's expansion and aircraft deployment plans accordingly. Actual
airfreight results will, however, depend on international economic
conditions, actions by the Company's competitors, including capacity
fluctuations, and regulatory conditions for international aviation rights.
Operating Expenses
Salaries and employee benefits rose 6% for the quarter, primarily due
to higher employment levels associated with volume growth. After adjusting
for prior year items, primarily the additional revenue and salaries and
employee benefits expense associated with the UPS strike and the proceeds
from a temporary fuel surcharge, the increase is consistent with the rate of
revenue growth. Included in the prior year's expense was a $25 million
special appreciation bonus for U.S. operations employees for their extra
efforts during the UPS strike and increased provisions under the Company's
performance-based incentive compensation plans.
An increase in rentals and landing fees of 14% for the quarter was
primarily due to additional facilities and aircraft leased by the Company. The
current year's expense includes additional building leases at the Indianapolis
and Alliance-Fort Worth hubs. As of August 31, 1998, the Company had 89
wide-bodied aircraft under operating lease compared with 82 as of August 31,
1997. The prior year's expense was favorably impacted by approximately $9
million of a $17 million net gain resulting from the destruction of a leased
MD11 aircraft in an accident in July 1997 (described below in Other Income and
Expense and Income Taxes). Management expects year-over-year increases in lease
expense to continue as the Company enters into additional aircraft rental
agreements during 1999 and thereafter. The Company expects to be able to convert
its A300 purchase commitments into direct operating leases. (See Note 3 of Notes
to Condensed Consolidated Financial Statements.)
Maintenance and repairs expense increased 16% for the quarter primarily
due to higher year-over-year engine and airframe maintenance on MD11 and B727
aircraft. In the first quarter of 1998, an operating reserve for the disposition
of leased B747 was increased $9 million, with the majority of this increase
recorded as maintenance and repairs expense. Management believes that
maintenance and repairs expense will continue a long-term trend of
year-over-year increases for the foreseeable future due to the increasing size
and age of the Company's fleet and the variety of aircraft types.
Fuel expense fell 16% for the quarter due to a 24% decline in average jet
fuel price per gallon, partially offset by a 10% increase in jet fuel gallons
consumed. The prior year's first quarter fuel expense included payments made by
the Company under contracts that were designed to limit the Company's exposure
to fluctuations in jet fuel prices. Effective August 1, 1997, the Company lifted
its temporary 2% fuel surcharge that had been in place on certain U.S. domestic
and U.S. export shipments. This surcharge was implemented on February 3, 1997 to
mitigate the impact of rising jet fuel prices.
Other operating expenses increased at a lower rate than revenue
because the prior year included incremental expenses associated with the
additional volume during the UPS strike, including transportation of packages
by third parties, temporary manpower and uniforms and supplies. These
expenses and the cost of sales of engine noise reduction kits are the largest
items included in other operating expense.
- 14 -
<PAGE>
Operating Income
Including the impact of the UPS strike on prior year results, the
Company's consolidated operating income decreased 17% for the quarter from the
prior year. Excluding the impact of the UPS strike, operating income increased
2% due to improved results in the Company's U.S. domestic operations, largely
offset by declining results in international operations.
U.S. domestic operating income was $205 million and $241 million for the
quarters ending August 31, 1998 and 1997, respectively. The prior year's
operating income included approximately $50 million related to the UPS strike as
well as proceeds from a 2% temporary fuel surcharge through August 1, 1997.
Excluding these prior year factors, operating income increased 23%, cost per
package rose 0.9%, yields increased 2% and package volume grew 6%. Sales of
engine noise reduction kits contributed $29 million and $36 million to U.S.
domestic operating income in the first quarter of 1999 and 1998, respectively.
U.S. domestic margin for the quarter was 8.2%, compared with 9.9% (7.4%,
excluding the aforementioned prior year items) for the same period in the prior
year.
The Company's international operating income was $14 million for the
quarter, compared with $23 million for the prior year. International operating
results declined as a result of slower IP volume growth and declining airfreight
volumes at a time of year-over-year capacity increases. Fixed costs associated
with the increased capacity, including salaries and employee benefits and
aircraft lease expense, also negatively impacted international results. In
addition, the net effect of foreign currency fluctuations contributed to the
decline in the Company's international operating income. International operating
margin was 1.5% for the quarter compared with 2.7% for the same period in the
prior year.
Other Income and Expense and Income Taxes
Net interest expense declined 15% for the quarter due to lower debt
levels and a slightly higher amount of capitalized interest.
Other, net for the prior year's first quarter included a gain from an
insurance settlement for an MD11 aircraft destroyed in an accident in July 1997.
At that time, FedEx realized a net gain of $17 million from the insurance
settlement and the release from certain related liabilities on the leased
aircraft. Approximately $8 million of this gain was recorded in non-operating
income.
FINANCIAL CONDITION
Liquidity
Cash and cash equivalents totaled $114 million at August 31, 1998, an
increase of $10 million since May 31, 1998. Cash provided from operations was
$322 million for the current quarter compared with $207 million for the same
period in the prior year. Management believes that cash flow from operations and
the parent company's (FDX Corporation) commercial paper program and bank
revolving credit facility will adequately meet the Company's working capital
needs for the foreseeable future.
- 15 -
<PAGE>
Capital Resources
The Company's operations are capital intensive, characterized by
significant investments in aircraft, vehicles, computer and telecommunication
equipment, package handling facilities and sort equipment. The amount and timing
of capital additions depend on various factors including global economic
conditions, volume growth, new or enhanced services, geographical expansion of
services, competition, availability of satisfactory financing and actions of
regulatory authorities.
Capital expenditures for the first three months of 1998 totaled $453
million and included one MD11, aircraft modifications, customer automation and
computer equipment and vehicles and ground support equipment. In comparison,
prior year expenditures totaled $366 million and included one MD11, aircraft
modifications, vehicles and ground support equipment and customer automation and
computer equipment. In June 1997, an MD11 purchased in February 1997 was sold
and leased back. For information on the Company's purchase commitments, see Note
3 of Notes to Condensed Consolidated Financial Statements.
Management believes that the capital resources available to the Company
provide flexibility to access the most efficient markets for financing its
capital acquisitions, including aircraft, and are adequate for the Company's
future capital needs.
Market Risk Sensitive Instruments and Positions
There have been no material changes in the Company's market risk
sensitive instruments and positions since its disclosure in its Annual Report
on Form 10-K for the year ended May 31, 1998.
YEAR 2000 COMPLIANCE
Introduction
The Company relies heavily on sophisticated information technology
("IT") for its business operations. For example, the Company maintains
electronic connections with more than a million customers via its proprietary
products and technologies. The Company's Year 2000 ("Y2K") computer
compliance issues are, therefore, broad and complex. The Y2K Project Office,
which was established in 1996, coordinates and supports the Company's Y2K
compliance effort. The Company has engaged a major international consulting
firm to assist it in its Y2K program management.
The Company's Y2K compliance efforts are focused on business-critical
items. Hardware, software, systems, technologies and applications are
considered "business-critical" if a failure would either have a material
adverse impact on the Company's business, financial condition or results of
operations or involve a safety risk to employees or customers. Generally, the
Company believes that its Y2K compliance effort is on schedule.
State of Readiness
The Company has inventoried all business-critical infrastructure and
applications software (collectively, "IT Systems"). Assessment/Design
(researching the compliance status and determining the impact of, and
renovation requirements for, the Company's IT Systems) and renovation (making
the Company's IT Systems compliant) are approximately 85% and 75% complete,
respectively. Testing, which involves validating compliance, is approximately
65% complete. Certification, which involves the Company's independent,
internal review to verify that the appropriate testing process has occurred,
is approximately 40% complete. The Company's IT Systems compliance effort is
targeted to be 95% complete by December 31, 1998 and 100% complete by
September 1, 1999.
The inventory and assessment phases of the Company's Y2K program
relating to business-critical purchased hardware and software, customized
software applications, facilities/equipment and other embedded chip systems
(collectively, "Non-IT Systems") are 100% complete. The remaining phases
relating to Non-IT Systems are targeted for completion by May 31, 1999.
Y2K Interfaces with Material Third Parties
The Company is making concerted efforts to understand the Y2K status of
third parties (including, among others, domestic and international government
- 16 -
<PAGE>
agencies, customs bureaus, U.S. and international airports and air traffic
control systems, vendors and suppliers) whose Y2K non-compliance could either
have a material adverse effect on the Company's business, financial condition
or results of operations or involve a safety risk to employees or customers.
The Company is actively encouraging Y2K compliance on the part of third
parties and is developing contingency plans in the event of their Y2K
non-compliance.
In conjunction with the International Air Transport Association (IATA)
and the Air Transport Association of America (ATA), the Company is involved
in a global and industry-wide effort to understand the Y2K compliance status
of airports, air traffic systems, customs clearance and other U.S. and
international government agencies, and common vendors and suppliers.
The Company's vendor and product compliance program includes the
following tasks: assessing vendor compliance status; product testing;
tracking vendor compliance progress; developing contingency plans, including
identifying alternate suppliers, as needed; addressing contract language;
replacing, renovating or upgrading parts; requesting presentations from
vendors or making on-site assessments, as required; and sending
questionnaires. Failure to respond to these questionnaires results in further
mail or phone correspondence, contingency plan development or vendor/product
replacement.
Testing
The Company's Y2K testing effort includes functional testing of remedial
measures and regression testing to validate that changes have not altered
existing functionality. The Company's test plans include sections which
define the scope of the testing effort, roles and responsibilities of test
participants, the test approach planned, software, hardware and data
requirements, and test environments/techniques to be used, as well as other
sections defining the test effort. System functionality is being verified and
documented for future dates.
A separate Y2K mainframe environment has been created to test all
operating system software and program product software. This Y2K environment
is designed to accomplish future date "end to end" testing of the larger
applications and to validate interface communications between applications.
The Company uses an independent, internal review to verify that the
appropriate testing process has occurred.
Costs to Address Y2K Compliance
Since 1996, the Company has spent approximately $57 million on Y2K
compliance. The Company expects that its Y2K compliance efforts will require
additional expenditures of approximately $85 million through 2000. The
Company's Y2K compliance effort is being funded entirely by internal cash
flows. For the fiscal
- 17 -
<PAGE>
year ending May 31, 1999, Y2K expenditures should represent less than 10% of
the Company's total IT expense budget. Although there are opportunity costs
to the Company's Y2K compliance efforts, management believes that no
significant information technology projects have been deferred due to this
work.
Contingency Planning and Risks
The Company has begun developing contingency plans for Y2K
non-compliance. These plans will include identifying alternate suppliers,
vendors, procedures and operational sites, generating supply/equipment lists,
conducting staff training and developing communication plans. A Company-wide
contingency planning task force has been formed to ensure appropriate
coverage and coordination of these plans and to integrate these with the
Company's existing contingency plans. The Company's goal for completion of
key Y2K contingency plans is January 31, 1999, with all other Y2K contingency
plans targeted for completion by September 30, 1999. The Company plans to
establish a contingency command and control center by April 30, 1999 to
address any issues caused by Y2K non-compliance, with personnel on call
beginning in November 1999.
Due to the general uncertainty inherent in the Company's Y2K compliance,
mainly resulting from the Company's dependence upon the Y2K compliance of the
government agencies, third-party suppliers, vendors and customers with whom
the Company deals, the Company is unable to determine at this time its most
reasonably likely worst case scenario. While costs related to the lack of Y2K
compliance by third parties, business interruptions, litigation and other
liabilities related to Y2K issues could materially and adversely affect the
Company's business, results of operations and financial condition, the
Company expects its Y2K compliance efforts to reduce significantly the
Company's level of uncertainty about the impact of Y2K issues affecting both
its IT Systems and Non-IT Systems.
Statements in this "Management's Discussion and Analysis of Results of
Operations and Financial Condition" or made by management of the Company which
contain more than historical information may be considered forward-looking
statements (as such term is defined in the Private Securities Litigation Reform
Act of 1995) which are subject to risks and uncertainties. Actual results may
differ materially from those expressed in the forward-looking statements because
of important factors identified in this section.
-18-
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Note 4 Legal Proceedings in Part I is hereby incorporated by reference.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
-------- ----------------------
<S> <C>
12.1 Computation of Ratio of Earnings to Fixed Charges.
15.1 Letter re Unaudited Interim Financial Statements.
27.1 Financial Data Schedule.
</TABLE>
(b) Reports on Form 8-K.
During the quarter ended August 31, 1998, the Registrant filed four
Current Reports on Form 8-K. The first report was dated July 8, 1998 and filed
under Item 5, Other Events, and Item 7, Financial Statements and Exhibits. The
report related to and contained a portion of Appendix A to the Preliminary
Official Statement prepared with respect to the Indianapolis Airport Authority
Special Facility Refunding Revenue Bonds, Series 1998 (Federal Express
Corporation Project).
The second report was dated June 30, 1998 and filed under Item 7,
Financial Statements and Exhibits. The report contained documents related to
1998-1 Pass Through Certificates.
The third report was dated July 15, 1998 and filed under Item 7,
Financial Statements and Exhibits. The report contained documents related to
1998-1 Pass Through Certificates.
The fourth report was dated August 27, 1998 and filed under Item 7,
Financial Statements and Exhibits. The report contained documents related to
1998-1 Pass Through Certificates.
- 19-
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FEDERAL EXPRESS CORPORATION
(Registrant)
Date: October 13, 1998 /s/ MICHAEL W. HILLARD
---------------------------
MICHAEL W. HILLARD
VICE PRESIDENT & CONTROLLER
(PRINCIPAL ACCOUNTING OFFICER)
-20-
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
- ------- ----------------------
<S> <C>
12.1 Computation of Ratio of Earnings to Fixed Charges.
15.1 Letter re Unaudited Interim Financial Statements.
27.1 Financial Data Schedule.
</TABLE>
E-1
<PAGE>
EXHIBIT 12.1
FEDERAL EXPRESS CORPORATION AND SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
Year Ended May 31, August 31,
------------------------------------------------------- --------------------
1994 1995 1996 1997 1998 1997 1998
--------- -------- ---------- --------- ---------- --------- ---------
(In thousands, except ratios)
<S> <C> <C> <C> <C> <C> <C> <C>
Earnings:
Income before income taxes.......................... $378,462 $522,084 $ 539,959 $ 628,221 $ 735,213 $246,995 $192,682
Add back:
Interest expense, net of
capitalized interest............................ 152,170 130,923 105,449 95,689 117,726 27,364 23,181
Amortization of debt
issuance costs.................................. 2,860 2,493 1,628 1,328 1,339 337 206
Portion of rent expense
representative of
interest factor................................. 285,261 329,370 386,254 434,846 499,823 111,883 128,743
-------- -------- ---------- ---------- ---------- -------- --------
Earnings as adjusted................................ $818,753 $984,870 $1,033,290 $1,160,084 $1,354,101 $386,579 $344,812
-------- -------- ---------- ---------- ---------- -------- --------
-------- -------- ---------- ---------- ---------- -------- --------
Fixed Charges:
Interest expense, net of
capitalized interest.............................. $152,170 $130,923 $ 105,449 $ 95,689 $ 117,726 $ 27,364 $ 23,181
Capitalized interest................................ 29,738 27,381 39,254 39,449 31,443 9,987 10,958
Amortization of debt
issuance costs.................................... 2,860 2,493 1,628 1,328 1,339 337 206
Portion of rent expense
representative of
interest factor................................... 285,261 329,370 386,254 434,846 499,823 111,883 128,743
-------- -------- ---------- ---------- ---------- -------- --------
$470,029 $490,167 $ 532,585 $ 571,312 $ 650,331 $149,571 $163,088
-------- -------- ---------- ---------- ---------- -------- --------
-------- -------- ---------- ---------- ---------- -------- --------
Ratio of Earnings to Fixed Charges.................. 1.7 2.0 1.9 2.0 2.1 2.6 2.1
-------- -------- ---------- ---------- ---------- -------- --------
-------- -------- ---------- ---------- ---------- -------- --------
</TABLE>
<PAGE>
EXHIBIT 15.1
September 23, 1998
Federal Express Corporation
2005 Corporate Avenue
Memphis, Tennessee 38132
We are aware that Federal Express Corporation will be incorporating by
reference in its previously filed Registration Statements No. 2-74000,
2-95720, 33-20138, 33-38041, 33-55055, 333-03443, and 333-49411 its Report on
Form 10-Q for the quarter ended August 31, 1998, which includes our report
dated September 23, 1998 covering the unaudited interim financial information
contained therein. Pursuant to Regulation C of the Securities Act of 1933,
that report is not considered part of these registration statements prepared
or certified by our firm or a report prepared or certified by our firm within
the meaning of Sections 7 and 11 of the Act.
Very truly yours,
Arthur Andersen LLP
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEETS AND CONDENSED CONSOLIDATED STATEMENTS OF
INCOME ON PAGES 3-5 OF THE COMPANY'S FORM 10-Q FOR THE QUARTERLY PERIOD ENDING
AUGUST 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAY-31-1999
<PERIOD-START> JUN-01-1998
<PERIOD-END> AUG-31-1998
<CASH> 114,288
<SECURITIES> 0
<RECEIVABLES> 1,739,238
<ALLOWANCES> 44,372
<INVENTORY> 324,379
<CURRENT-ASSETS> 2,384,716
<PP&E> 11,453,917
<DEPRECIATION> 6,059,081
<TOTAL-ASSETS> 8,552,968
<CURRENT-LIABILITIES> 2,340,521
<BONDS> 1,171,302
0
0
<COMMON> 0
<OTHER-SE> 3,501,003
<TOTAL-LIABILITY-AND-EQUITY> 8,552,968
<SALES> 0
<TOTAL-REVENUES> 3,417,183
<CGS> 0
<TOTAL-COSTS> 3,198,111
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 21,952
<INCOME-PRETAX> 192,682
<INCOME-TAX> 79,963
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 112,719
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
