avatar Fedex Corporation Transportation, Communications, Electric, Gas, And Sanitary Services
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    FINANCIAL HIGHLIGHTS Percent (in millions, except earnings per share) 2013(1) 2012(2) Change Revenue (in billions) 2009 $35.5 Operating Results 2010 $34.7 Revenues $ 44,287 $ 42,680 4 2011 $39.3 2012 $42.7 Operating income 2,551 3,186 (20) 2013 $44.3 Operating margin 5.8% 7.5% (170)bp Net income 1,561 2,032 (23) Operating Margin Diluted earnings per common share 4.91 6.41 (23) 2009(4) 2.1% Average common and common 2010 5.8% equivalent shares 317 317 – 2011(3) 6.1% Capital expenditures 3,375 4,007 (16) 2012(2) 7.5% 2013(1) 5.8% Financial Position Cash and cash equivalents $ 4,917 $ 2,843 73 Diluted Earnings Per Share Total assets 33,567 29,903 12 2009(4) $0.31 Long-term debt, including 2010 $3.76 current portion 2,990 1,667 79 2011(3) $4.57 2012(2) $6.41 Common stockholders’ investment 17,398 14,727 18 2013(1) $4.91 Return on Average Equity 2009(4) 0.7% Comparison of Five-Year Cumulative Total Return* 2010 8.6% 2011(3) 10.0% $140 2012(2) 13.6% $120 2013(1) 9.7% $100 Debt to Total Capitalization $80 2009 15.9% 2010 12.3% $60 2011 10.0% $40 2012 10.2% 2013 14.7% 5/08 5/09 5/10 5/11 5/12 5/13 FedEx Corporation S&P 500 Dow Jones Transportation Average Stock Price (May 31 close) 2009 $55.43 *$100 invested on 5/31/08 in stock or index, including reinvestment of dividends. Fiscal year 2010 $83.49 ending May 31. 2011 $93.64 2012 $89.14 (1) Results for 2013 include $560 million ($353 million, net of tax or $1.11 per diluted share) of 2013 $96.34 business realignment costs and a $100 million ($63 million, net of tax, or $0.20 per diluted share) impairment charge resulting from the decision to retire 10 aircraft and related engines at FedEx Express. (2) Results for 2012 include a $134 million ($84 million, net of tax or $0.26 per diluted share) impairment charge resulting from the decision to retire 24 aircraft and related engines at FedEx Express and the reversal of a $66 million legal reserve initially recorded in 2011. (3) Results for 2011 include charges of approximately $199 million ($104 million, net of tax and applicable variable incentive compensation impacts, or $0.33 per diluted share) for the combination of our FedEx Freight and FedEx National LTL operations and a $66 million reserve associated with a legal matter at FedEx Express. (4) Results for 2009 include a charge of $1.2 billion ($1.1 billion, net of tax, or $3.45 per diluted share) primarily for impairment charges associated with goodwill and aircraft. 8


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    MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION OVERVIEW OF FINANCIAL SECTION transportation company; FedEx Ground Package System, Inc. (“FedEx Ground”), a leading North American provider of small-package ground The financial section of the FedEx Corporation (“FedEx”) Annual delivery services; and FedEx Freight, Inc. (“FedEx Freight”), a leading Report (“Annual Report”) consists of the following Management’s North American provider of less-than-truckload (“LTL”) freight Discussion and Analysis of Results of Operations and Financial services. These companies represent our major service lines and, Condition (“MD&A”), the Consolidated Financial Statements and the along with FedEx Corporate Services, Inc. (“FedEx Services”), form the notes to the Consolidated Financial Statements, and Other Financial core of our reportable segments. Our FedEx Services segment provides Information, all of which include information about our significant sales, marketing, information technology, communications and accounting policies, practices and the transactions that underlie our back-office support to our transportation segments. In addition, the financial results. The following MD&A describes the principal factors FedEx Services segment provides customers with retail access to affecting the results of operations, liquidity, capital resources, FedEx Express and FedEx Ground shipping services through FedEx contractual cash obligations and the critical accounting estimates Office and Print Services, Inc. (“FedEx Office”) and provides customer of FedEx. The discussion in the financial section should be read in service, technical support and billing and collection services through conjunction with the other sections of this Annual Report and our FedEx TechConnect, Inc. (“FedEx TechConnect”). See “Reportable detailed discussion of risk factors included in this MD&A. Segments” for further discussion. The key indicators necessary to understand our operating results Organization of Information include: Our MD&A is composed of three major sections: Results of > the overall customer demand for our various services based on Operations, Financial Condition and Critical Accounting Estimates. macro-economic factors and the global economy; These sections include the following information: > the volumes of transportation services provided through our > Results of operations includes an overview of our consolidated 2013 networks, primarily measured by our average daily volume and results compared to 2012, and 2012 results compared to 2011. This shipment weight; section also includes a discussion of key actions and events that impacted our results, as well as our outlook for 2014. > the mix of services purchased by our customers; > The overview is followed by a financial summary and analysis > the prices we obtain for our services, primarily measured by yield (including a discussion of both historical operating results and our (revenue per package or pound or revenue per hundredweight for outlook for 2014) for each of our reportable transportation segments. LTL freight shipments); > Our financial condition is reviewed through an analysis of key > our ability to manage our cost structure (capital expenditures and elements of our liquidity, capital resources and contractual cash operating expenses) to match shifting volume levels; and obligations, including a discussion of our cash flows and our finan- > the timing and amount of fluctuations in fuel prices and our ability cial commitments. to recover incremental fuel costs through our fuel surcharges. > Critical accounting estimates discusses those financial statement The majority of our operating expenses are directly impacted by elements that we believe are important to understanding certain revenue and volume levels. Accordingly, we expect these operating of the material judgments and assumptions incorporated in our expenses to fluctuate on a year-over-year basis consistent with the financial results. change in revenues and volumes. Therefore, the discussion of > We conclude with a discussion of risks and uncertainties that may operating expense captions focuses on the key drivers and trends impact our financial and operating results. impacting expenses other than changes in revenues and volume. Except as otherwise specified, references to years indicate our fiscal Description of Business year ended May 31, 2013 or ended May 31 of the year referenced and We provide a broad portfolio of transportation, e-commerce and comparisons are to the prior year. References to our transportation business services through companies competing collectively, segments include, collectively, our FedEx Express, FedEx Ground and operating independently and managed collaboratively, under the FedEx Freight segments. respected FedEx brand. Our primary operating companies are Federal Express Corporation (“FedEx Express”), the world’s largest express 9


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    MANAGEMENT’S DISCUSSION AND ANALYSIS RESULTS OF OPERATIONS Consolidated Results The following table compares summary operating results (dollars in millions, except per share amounts) for the years ended May 31: Percent Change (1) (2) (3) 2013 2012 2011 2013/2012 2012/2011 Revenues $ 44,287 $ 42,680 $ 39,304 4 9 Operating income 2,551 3,186 2,378 (20) 34 Operating margin 5.8% 7.5% 6.1% (170)bp 140bp Net income $ 1,561 $ 2,032 $ 1,452 (23) 40 Diluted earnings per share $ 4.91 $ 6.41 $ 4.57 (23) 40 (1) Operating expenses include $560 million for business realignment costs and a $100 million impairment charge resulting from the decision to retire 10 aircraft and related engines at FedEx Express. (2) Operating expenses include an impairment charge of $134 million resulting from the decision to retire 24 aircraft and related engines at FedEx Express and the reversal of a $66 million legal reserve which was initially recorded in 2011 at FedEx Express. (3) Operating expenses include $133 million in costs associated with the combination of our FedEx Freight and FedEx National LTL operations, effective January 30, 2011, and a $66 million legal reserve at FedEx Express. The following table shows changes in revenues and operating income by reportable segment for 2013 compared to 2012, and 2012 compared to 2011 (dollars in millions): Revenues Operating Income Dollar Change Percent Change Dollar Change Percent Change 2013/2012 2012/2011 2013/2012 2012/2011 2013/2012 2012/2011 2013/2012 2012/2011 FedEx Express segment(1) $ 656 $ 1,934 2 8 $ (705) $ 32 (56) 3 FedEx Ground segment(2) 1,005 1,088 10 13 24 439 1 33 FedEx Freight segment(3) 119 371 2 8 46 337 28 193 FedEx Services segment (91) (13) (5) (1) – – – – Other and eliminations (82) (4) NM NM – – – – $ 1,607 $ 3,376 4 9 $ (635) $ 808 (20) 34 (1) FedEx Express segment 2013 operating expenses include $405 million of direct and allocated business realignment costs and an impairment charge of $100 million resulting from the decision to retire 10 aircraft and related engines. Additionally, FedEx Express segment 2012 operating expenses include an impairment charge of $134 million resulting from the decision to retire 24 aircraft and related engines and the reversal of a $66 million legal reserve that was initially recorded in 2011. (2) FedEx Ground segment 2013 operating expenses include $105 million of allocated business realignment costs. (3) FedEx Freight segment 2013 operating expenses include $50 million of direct and allocated business realignment costs. Additionally, FedEx Freight segment 2011 operating expenses include $133 million in costs associated with the combination of our FedEx Freight and FedEx National LTL operations, effective January 30, 2011. 10


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    MANAGEMENT’S DISCUSSION AND ANALYSIS Overview retire from service 10 aircraft and related engines, which resulted in a Our results for 2013 reflect a significant impact of certain charges noncash asset impairment charge of $100 million. (described below), which negatively impacted our earnings by $1.31 In addition, actions in 2012 at FedEx Express related to fleet modern- per diluted share. Beyond these factors, our results for 2013 benefited ization resulted in the accelerated retirement of certain aircraft which from the strong performance of FedEx Ground, which continued to negatively impacted our 2013 results by $69 million due to additional grow market share, and ongoing profit improvement at FedEx Freight. depreciation recorded for the shortened lives of the aircraft. However, a decline in profitability was experienced at our FedEx Express segment resulting from ongoing shifts in demand from our Our 2012 revenues, operating income and operating margins reflected priority international services to economy international services the exceptional performance of our FedEx Ground segment, improved which could not be fully offset by network cost and capacity profitability at FedEx Freight and increased yields across all our reductions in 2013. operating segments. Our results significantly benefited in 2012 from the timing lag that exists between when fuel prices change and Our 2013 results include business realignment costs of $560 million, when indexed fuel surcharges automatically adjust. Our 2012 primarily related to our voluntary cash buyout program (see “Business results included the reversal of a $66 million legal reserve initially Realignment, Impairment and Other Charges” for additional recorded in 2011 and an aircraft impairment charge of $134 million information). Furthermore, in May 2013, we made the decision to at FedEx Express. The following graphs for FedEx Express, FedEx Ground and FedEx Freight show selected volume trends (in thousands) for the years ended May 31: FedEx Express U.S. Domestic FedEx Express International(1) Average Daily Package Volume Average Daily Package Volume 2,800 1,200 1,000 2,700 2,684 800 785 2,638 2,600 600 523 575 559 2,577 348 576 2,543 400 318 495 2,500 200 2,400 0 2010 2011 2012 2013 2010 2011 2012 2013 International export International domestic FedEx Ground FedEx Freight Average Daily Package Volume Average Daily LTL Shipments 4,500 4,222 90.0 3,907 4,000 3,746 3,523 86.0 3,500 84.9 85.7 85.0 3,000 82.3 2,500 2,058 80.0 2,000 1,692 1,432 1,500 1,222 1,000 75.0 2010 2011 2012 2013 2010 2011 2012 2013 FedEx Ground SmartPost FedEx Express and FedEx Ground (1) International domestic average daily package volume includes our international Total Average Daily Package Volume intra-country express operations, including acquisitions in India (February 2011), Mexico (July 2011), Poland (June 2012), France (July 2012) and Brazil (July 2012). 10,500 10,184 10,000 9,500 9,230 9,000 8,785 8,500 8,224 8,000 2010 2011 2012 2013 11


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    MANAGEMENT’S DISCUSSION AND ANALYSIS The following graphs for FedEx Express, FedEx Ground and FedEx Freight show selected yield trends for the years ended May 31: FedEx Express U.S. Domestic FedEx Express International Revenue per Package – Yield Revenue per Package – Yield $19.00 $70.00 $60.83 $58.72 $18.00 $60.00 $56.08 $17.33 $53.10 $17.12 $50.00 $17.00 $40.00 $16.00 $15.59 $30.00 $15.00 $14.61 $20.00 $14.00 $10.00 $7.14 $7.38 $6.74 $6.99 $13.00 $0 2010 2011 2012 2013 2010 2011 2012 2013 International export composite International domestic FedEx Ground FedEx Freight Revenue per Package – Yield LTL Revenue per Hundredweight – Yield $10.00 $22.00 $8.94 $8.17 $8.77 $8.00 $7.73 $19.94 $20.00 $6.00 $19.57 $4.00 $18.24 $18.00 $1.72 $1.81 $1.77 $17.07 $2.00 $1.56 $0 $16.00 2010 2011 2012 2013 2010 2011 2012 2013 FedEx Ground SmartPost Revenue During 2012, revenues increased 9% due to yield growth across all Revenues increased 4% in 2013 primarily driven by increases in our transportation segments. At FedEx Express, revenues increased international domestic revenue at FedEx Express and volume growth 8% in 2012 led by higher U.S. domestic and international export at FedEx Ground. At FedEx Ground, revenues increased 10% in 2013 package yields. However, U.S. domestic package and international primarily due to volume growth from market share gains. At FedEx export package volumes declined due to weakening global economic Express, revenues increased 2% due to increases in international conditions. Revenues increased 13% during 2012 at our FedEx Ground domestic revenues from recent acquisitions and growth in our segment due to higher yields and strong demand for all our major freight-forwarding business at FedEx Trade Networks. Base revenue services. At FedEx Freight, revenues increased 8% during 2012 due growth at FedEx Express in 2013 was constrained by global economic to higher LTL yield as a result of higher fuel surcharges and yield conditions as shifts in demand from our priority international services management programs, despite a decrease in volume. to our economy international services and lower rates resulted in declines in international export package yields. At FedEx Freight, revenues increased 2% as a result of higher yield and average daily LTL shipments. 12


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    MANAGEMENT’S DISCUSSION AND ANALYSIS Operating Income increases in pension and group health insurance costs, partially offset The following tables compare operating expenses expressed as dollar by lower incentive compensation accruals. Other expenses increased amounts (in millions) and as a percent of revenue for the years ended 5% in 2013 primarily due to the impact of business acquisitions and May 31: the reversal in 2012 of a legal reserve. The following graph for our transportation segments shows our 2013 2012 2011 average cost of jet and vehicle fuel per gallon for the years ended Operating expenses: May 31: Salaries and employee benefits $ 16,570 $ 16,099 $ 15,276 Average Fuel Cost per Gallon Purchased transportation 7,272 6,335 5,674 $5.00 Rentals and landing fees 2,521 2,487 2,462 Depreciation and amortization 2,386 2,113 1,973 $4.00 $3.80 $3.81 Fuel 4,746 4,956 4,151 $3.25 $3.31 Maintenance and repairs 1,909 1,980 1,979 $3.00 $2.69 $3.22 Business realignment, impairment $2.66 $2.00 and other charges 660(1) 134(2) 89(3) $2.15 Other (4) 5,672 5,390 5,322 $1.00 Total operating expenses $ 41,736 $ 39,494 $ 36,926 2010 2011 2012 2013 Vehicle Jet Percent of Revenue 2013 2012 2011 Fuel expense decreased 4% during 2013 primarily due to lower jet fuel prices and lower aircraft fuel usage. Our fuel surcharges, Operating expenses: which are more fully described in the “Quantitative and Qualitative Salaries and employee benefits 37.4% 37.7% 38.9% Disclosures About Market Risk” section of this MD&A, have a timing Purchased transportation 16.4 14.9 14.4 lag and are designed to pass through the price of fuel not included in Rentals and landing fees 5.7 5.8 6.3 our base shipping rates to our customers. Based on a static analysis Depreciation and amortization 5.4 5.0 5.0 of the impact to operating income of year-over-year changes in fuel prices compared to year-over-year changes in fuel surcharges, fuel Fuel 10.7 11.6 10.6 had a negative impact on operating income in 2013. Maintenance and repairs 4.3 4.6 5.0 Our analysis considers the estimated impact of the reduction in fuel Business realignment, impairment and other charges 1.5(1) 0.3(2) 0.2(3) surcharges included in the base rates charged for FedEx Express and FedEx Ground services. However, this analysis does not consider the Other (4) 12.8 12.6 13.5 negative effects that fuel surcharge levels may have on our business, Total operating expenses 94.2 92.5 93.9 including reduced demand and shifts by our customers to lower- Operating margin 5.8% 7.5% 6.1% yielding services. While fluctuations in fuel surcharge rates can be (1) Includes predominantly severance costs associated with our voluntary buyout program significant from period to period, fuel surcharges represent one of the and charges resulting from the decision to retire 10 aircraft and related engines at FedEx Express. many individual components of our pricing structure that impact our (2) Represents charges resulting from the decision to retire 24 aircraft and related engines overall revenue and yield. Additional components include the mix of at FedEx Express. services sold, the base price and extra service charges we obtain for (3) Represents charges associated with the combination of our FedEx Freight and FedEx National LTL operations effective January 30, 2011. these services and the level of pricing discounts offered. In order to (4) Includes the 2012 reversal of a $66 million legal reserve at FedEx Express that was provide information about the impact of fuel surcharges on the trend initially recorded in 2011. in revenue and yield growth, we have included the comparative fuel Our 2013 operating income and operating margin decreased primarily surcharge rates in effect for 2013, 2012 and 2011 in the accompanying due to the impact of business realignment costs, aircraft impairment discussions of each of our transportation segments. charges and accelerated aircraft depreciation (see “Overview” section In 2012, operating income increased 34% and operating margin above). Beyond these factors, operating income was positively impacted increased 140 basis points driven by higher yields across all our in 2013 by higher volumes and increased yields at our FedEx Ground transportation segments due to higher fuel surcharges and our yield segment and by increased yields and higher volumes at our FedEx management programs. Our results also significantly benefited in Freight segment. However, the ongoing shifts in demand from priority 2012 from the timing lag that exists between when fuel prices change international services to economy international services and lower rates and when indexed fuel surcharges automatically adjust. FedEx Ground resulted in a substantial decline in profitability at FedEx Express. segment operating income increased $439 million in 2012 driven by Purchased transportation increased 15% in 2013 due to volume higher yields and strong demand for all our major services. At our growth at FedEx Ground, recent international business acquisitions FedEx Freight segment, operating income increased $337 million due and the expansion of our freight forwarding business at FedEx Trade to higher LTL yield and efficiencies gained from the combination of our Networks. Salaries and benefits increased 3% in 2013 primarily due to LTL operations in 2011. 13


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    MANAGEMENT’S DISCUSSION AND ANALYSIS Salaries and benefits increased 5% in 2012 primarily due to higher For 2014, we expect our effective tax rate to be between 36.5% and incentive compensation costs and the full reinstatement of 401(k) 37.0%. The actual rate, however, will depend on a number of factors, company-matching contributions effective January 1, 2011. Purchased including the amount and source of operating income. We also expect transportation costs increased 12% in 2012 due to volume growth our current federal income tax expense will increase in 2014 due to and higher fuel surcharges at FedEx Ground, costs associated with lower accelerated depreciation benefits than in prior years. the expansion of our freight forwarding business at FedEx Trade Additional information on income taxes, including our effective tax Networks and higher utilization of third-party transportation providers rate reconciliation, liabilities for uncertain tax positions and our global in international locations primarily due to business acquisitions at tax profile can be found in Note 12 of the accompanying consolidated FedEx Express. financial statements. Fuel expense increased 19% during 2012 primarily due to price increases. Based on a static analysis of the impact to operating Business Acquisitions income of year-over-year changes in fuel prices compared to year- During 2013, we expanded the international service offerings of FedEx over-year changes in fuel surcharges, fuel surcharges significantly Express by completing the following business acquisitions: exceeded incremental fuel costs in 2012. > Rapidão Cometa Logística e Transporte S.A., a Brazilian transporta- Other Income and Expense tion and logistics company, for $398 million in cash from operations on July 4, 2012 Interest expense increased $30 million in 2013 primarily due to a reduction in capitalized interest and increased interest expense from > TATEX, a French express transportation company, for $55 million in 2013 debt issuances. Other expense increased in 2013 driven by cash from operations on July 3, 2012 foreign currency translation due to global currency volatility. Interest > Opek Sp. z o.o., a Polish domestic express package delivery com- expense decreased $34 million in 2012 due to debt maturities, an pany, for $54 million in cash from operations on June 13, 2012 increase in capitalized interest related to the timing of progress pay- ments on aircraft purchases and lower financing fees. These acquisitions give us more robust transportation networks within these countries and added capabilities in these important interna- Income Taxes tional markets. See Note 3 of the accompanying consolidated financial Our effective tax rate was 36.4% in 2013, 35.3% in 2012 and 35.9% statements for further discussion of these acquisitions. in 2011. Our 2012 rate was favorably impacted by the conclusion of In 2012, we completed our acquisition of Servicios Nacionales Mupa, the Internal Revenue Service (“IRS”) audit of our 2007-2009 consoli- S.A. de C.V. (MultiPack), a Mexican domestic express package delivery dated income tax returns. Our permanent reinvestment strategy with company, for $128 million in cash from operations on July 25, 2011. In respect to unremitted earnings of our foreign subsidiaries provided 2011, we completed the acquisition of the Indian logistics, distribution a 1.2% benefit to our 2013 effective tax rate. Our total permanently and express businesses of AFL Pvt. Ltd. and its affiliate Unifreight India reinvested foreign earnings were $1.3 billion at the end of 2013 and Pvt. Ltd. for $96 million in cash from operations on February 22, 2011. $1.0 billion at the end of 2012. The financial results of these acquired businesses are included in the Our current federal income tax expenses in 2013, 2012 and 2011 FedEx Express segment from the date of acquisition and were not were significantly reduced by accelerated depreciation deductions we material, individually or in the aggregate, to our results of operations claimed under provisions of the American Taxpayer Relief Act of 2013 and therefore, pro forma financial information has not been presented. and the Tax Relief and the Small Business Jobs Acts of 2010. Those Substantially all of the purchase price in each of these acquisitions Acts, designed to stimulate new business investment in the U.S., was allocated to goodwill, which was entirely attributed to our FedEx accelerated our depreciation deductions for qualifying investments, Express reporting unit. such as our Boeing 777 Freighter (“B777F”) aircraft. These were timing benefits only, in that depreciation accelerated into an earlier year is On June 20, 2013, we signed agreements to acquire the businesses foregone in later years. Our 2013 current provision for federal income operated by our current service provider Supaswift (Pty) Ltd. in five taxes was, therefore, higher than in 2012 and 2011. countries in Southern Africa. The acquisition will be funded with cash from operations and is expected to be completed in the second half The components of the provision for federal income taxes for the of 2014, subject to customary closing conditions. The financial results years ended May 31 were as follows (in millions): of the acquired businesses will be included in the FedEx Express segment from the date of acquisition and will be immaterial to our 2013 2012 2011 2014 results. Current $ 512 $ (120) $ 79 Deferred 175 947 485 Total Federal Provision $ 687 $ 827 $ 564 14


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    MANAGEMENT’S DISCUSSION AND ANALYSIS Business Realignment, Impairment and per diluted share) was recorded in the fourth quarter. The decision to Other Charges retire these aircraft, which were temporarily idled and not in revenue During 2013, we announced profit improvement programs primarily service, aligns with the plans of FedEx Express to modernize its through initiatives at FedEx Express and FedEx Services that include aircraft fleet and improve its global network. the following: In May 2012, we retired from service 24 aircraft and related engines, > Cost reductions in selling, general and administrative functions the majority of which were temporarily idled and not in revenue ser- through headcount reductions, streamlining of processes and elimi- vice. As a consequence of this decision, a noncash impairment charge nation of less essential work, as well as deriving greater value from of $134 million ($84 million, net of tax, or $0.26 per diluted share) was strategic sourcing recorded in the fourth quarter of 2012. > Modernization of our aircraft fleet, transformation of the U.S. domestic See the “Long-lived Assets” section of our “Critical Accounting operations and international profit improvements at FedEx Express Estimates” for a discussion of our accounting for aircraft retirement decisions. > Improved efficiencies and lower costs of information technology at FedEx Services Outlook During 2013, we conducted a program to offer voluntary cash buyouts We anticipate revenue and earnings growth in 2014 driven by the to eligible U.S.-based employees in certain staff functions. The continued strong performance of our FedEx Ground and FedEx Freight voluntary buyout program includes voluntary severance payments and businesses and improving performance at FedEx Express. Our funding to healthcare reimbursement accounts, with the voluntary expected results for 2014 will be constrained by moderate growth in severance calculated based on four weeks of gross base salary the global economy and continued challenges from the demand shift for every year of FedEx service up to a maximum payment of two trend from our priority international services to our economy interna- years of pay. This program was completed in the fourth quarter and tional services. In response to these trends, we will be evaluating approximately 3,600 employees have left or will be voluntarily leaving additional capacity reductions and other actions in 2014. During 2014 the company by the end of 2014. Eligible employees are scheduled we will incur incremental costs to transform our information technol- to vacate positions in phases to ensure a smooth transition in the ogy operations at FedEx Services in connection with our profit impacted functions so that we maintain service levels to our custom- improvement programs, which will increase the costs allocated to our ers. Of the total population leaving the company, approximately 40% transportation segments. In May 2013, in conjunction with the of the employees vacated positions on May 31, 2013. An additional retirement of aircraft, FedEx Express shortened the depreciable lives 35% will depart throughout 2014 and approximately 25% of this popu- of 76 aircraft and related engines. As a result of this decision and the lation will remain until May 31, 2014. Costs of the benefits provided 2012 decision to shorten the depreciable lives of 54 aircraft, we under the voluntary program were recognized as special termination expect to incur additional year-over-year accelerated depreciation benefits in the period that eligible employees accepted their offers. expense of $74 million in 2014. However, lower pension expense in 2014 will positively impact our operating results. We incurred costs of $560 million ($353 million, net of tax, or $1.11 per diluted share) during 2013 associated with our business realign- In addition to continued profit improvements in the base businesses ment activities. These costs related primarily to severance for at FedEx Ground and FedEx Freight, our profit improvement programs employees who accepted voluntary buyouts in the third and fourth announced in 2013 are targeting annual profitability improvement of quarters of 2013. Payments will be made at the time of departure. $1.6 billion at FedEx Express by the end of 2016 (from the full year Approximately $180 million was paid under this program during 2013. 2013 base business). Collectively, these initiatives are expected to The cost of the buyout program is included in the caption “Business increase margins, improve cash flows and increase our competitive- realignment, impairment and other charges” in our consolidated ness. However, the amount of benefit ultimately realized will vary statements of income. Also included in that caption are other external depending upon future customer demand, particularly for priority costs directly attributable to our business realignment activities, such international services. We expect to begin realizing a portion of the as professional fees. benefits of these programs in 2014; however, the majority of the benefits, including those from our voluntary severance program, will In addition, actions in 2012 at FedEx Express related to fleet modern- not occur until 2015 and 2016. ization resulted in accelerated depreciation of $69 million in 2013 included in the caption “Depreciation and amortization” in our Our capital expenditures for 2014 are expected to increase to approxi- consolidated statements of income as we shortened the lives of mately $4.0 billion for additional aircraft deliveries in 2014 to support certain aircraft. our fleet modernization program and continued expansion of the FedEx Ground network. We will continue to evaluate our investments in In May 2013, we made the decision to retire from service two Airbus critical long-term strategic projects to ensure our capital expenditures A310-200 aircraft and four related engines, three Airbus A310-300 generate high returns on investments and are balanced with our aircraft and two related engines, and five Boeing MD10-10 aircraft outlook for global economic conditions. For additional details on key and 15 related engines. As a consequence of this decision, a noncash 2014 capital projects, refer to the “Capital Resources” and “Liquidity impairment charge of $100 million ($63 million, net of tax, or $0.20 Outlook” sections of this MD&A. 15


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    MANAGEMENT’S DISCUSSION AND ANALYSIS Our outlook is dependent upon a stable pricing environment for fuel, Recent Accounting Guidance as volatility in fuel prices impacts our fuel surcharge levels, fuel New accounting rules and disclosure requirements can significantly expense and demand for our services. Historically, our fuel surcharges impact our reported results and the comparability of our financial have largely offset incremental fuel costs; however, volatility in statements. fuel costs may impact earnings because adjustments to our fuel surcharges lag changes in actual fuel prices paid. Therefore, the On June 1, 2012, we adopted the authoritative guidance issued by the trailing impact of adjustments to our fuel surcharges can significantly Financial Accounting Standards Board (“FASB”) on the presentation affect our earnings either positively or negatively in the short-term. of comprehensive income. The new guidance requires companies to report components of comprehensive income by including compre- As described in Note 18 of the accompanying consolidated financial hensive income on the face of the income statement or in a separate statements and the “Independent Contractor Model” section of our statement of comprehensive income. We have adopted this guidance FedEx Ground segment MD&A, we are involved in a number of lawsuits by including a separate statement of comprehensive income (loss) and other proceedings that challenge the status of FedEx Ground’s for the three years ending May 31, 2013 and by including expanded owner-operators as independent contractors. FedEx Ground anticipates accumulated other comprehensive income disclosure requirements continuing changes to its relationships with its owner-operators. The in the notes to our consolidated financial statements. In addition, on nature, timing and amount of any changes are dependent on the June 1, 2012, we adopted the FASB’s amendments to the fair value outcome of numerous future events. We cannot reasonably estimate measurements and disclosure requirements, which expanded existing the potential impact of any such changes or a meaningful range of disclosure requirements regarding the fair value of our long-term debt. potential outcomes, although they could be material. However, we do not believe that any such changes will impair our ability to operate In February 2013, the FASB issued new guidance requiring additional and profitably grow our FedEx Ground business. information about reclassification adjustments out of comprehensive income, including changes in comprehensive income balances by See “Risk Factors” for a discussion of these and other potential risks component and significant items reclassified out of comprehensive and uncertainties that could materially affect our future performance. income. This new standard is effective for our fiscal year ending May 31, 2014 and will have no impact on our financial condition or Seasonality of Business results of operations. Our businesses are cyclical in nature, as seasonal fluctuations affect volumes, revenues and earnings. Historically, the U.S. express pack- In May 2013, the FASB issued a revised exposure draft outlining age business experiences an increase in volumes in late November proposed changes to the accounting for leases. Under the revised and December. International business, particularly in the Asia-to-U.S. exposure draft, the recognition, measurement and presentation of market, peaks in October and November in advance of the U.S. holi- expenses and cash flows arising from a lease would depend primarily day sales season. Our first and third fiscal quarters, because they are on whether the lessee is expected to consume more than an insig- summer vacation and post winter-holiday seasons, have historically nificant portion of the economic benefits embedded in the underlying experienced lower volumes relative to other periods. Normally, the fall asset. A right-of-use asset and a liability to make lease payments will is the busiest shipping period for FedEx Ground, while late December, be recognized on the balance sheet for all leases (except short-term June and July are the slowest periods. For FedEx Freight, the spring leases). The enactment of this proposal will have a significant impact and fall are the busiest periods and the latter part of December on our accounting and financial reporting. The FASB has not yet through February is the slowest period. For FedEx Office, the summer proposed an effective date of this proposal. months are normally the slowest periods. Shipment levels, operating We believe that no other new accounting guidance was adopted or costs and earnings for each of our companies can also be adversely issued during 2013 that is relevant to the readers of our financial affected by inclement weather, particularly the impact of severe statements. However, there are numerous new proposals under devel- winter weather in our third fiscal quarter. opment which, if and when enacted, may have a significant impact on our financial reporting. 16


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    MANAGEMENT’S DISCUSSION AND ANALYSIS Reportable Segments The FedEx Services segment provides direct and indirect support to FedEx Express, FedEx Ground and FedEx Freight represent our major our transportation businesses, and we allocate all of the net operat- service lines and, along with FedEx Services, form the core of our ing costs of the FedEx Services segment (including the net operating reportable segments. Our reportable segments include the following results of FedEx Office) to reflect the full cost of operating our businesses: transportation businesses in the results of those segments. Within the FedEx Services segment allocation, the net operating results of FedEx Express Segment > FedEx Express FedEx Office, which are an immaterial component of our allocations, (express transportation) are allocated to FedEx Express and FedEx Ground. The allocations > FedEx Trade Networks of net operating costs are based on metrics such as relative rev- (air and ocean freight forwarding enues or estimated services provided. We believe these allocations and customs brokerage) approximate the net cost of providing these functions. We review and > FedEx SupplyChain Systems evaluate the performance of our transportation segments based on (logistics services) operating income (inclusive of FedEx Services segment allocations). FedEx Ground Segment > FedEx Ground For the FedEx Services segment, performance is evaluated based on the impact of its total allocated net operating costs on our transporta- (small-package ground delivery) > FedEx SmartPost tion segments. (small-parcel consolidator) The operating expenses line item “Intercompany charges” on the FedEx Freight Segment > FedEx Freight accompanying unaudited financial summaries of our transportation (LTL freight transportation) segments reflects the allocations from the FedEx Services segment to > FedEx Custom Critical the respective transportation segments. The “Intercompany charges” (time-critical transportation) caption also includes charges and credits for administrative services provided between operating companies and certain other costs such FedEx Services Segment > FedEx Services as corporate management fees related to services received for gen- (sales, marketing, information eral corporate oversight, including executive officers and certain legal technology, communications and and finance functions. We believe these allocations approximate the back-office functions) net cost of providing these functions. > FedEx TechConnect (customer service, technical support, Other Intersegment Transactions billings and collections) Certain FedEx operating companies provide transportation and related > FedEx Office services for other FedEx companies outside their reportable segment. (document and business services Billings for such services are based on negotiated rates, which we and package acceptance) 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. Such intersegment revenues and expenses are FedEx Services Segment eliminated in our consolidated results and are not separately identi- The FedEx Services segment operates combined sales, marketing, fied in the following segment information, because the amounts are administrative and information technology functions in shared ser- not material. vices operations that support our transportation businesses and allow us to obtain synergies from the combination of these functions. For FedEx Express Segment the international regions of FedEx Express, some of these functions FedEx Express offers a wide range of U.S. domestic and international are performed on a regional basis by FedEx Express and reported in shipping services for delivery of packages and freight including priority the FedEx Express segment in their natural expense line items. The services, which provide time-definite delivery within one, two, or three FedEx Services segment includes: FedEx Services, which provides business days worldwide, and deferred or economy services, which sales, marketing, information technology, communications and back- provide time-definite delivery within five business days worldwide. office support to our other companies; FedEx TechConnect, which is responsible for customer service, technical support, billings and collections for U.S. customers of our major business units; and FedEx Office, which provides an array of document and business services and retail access to our customers for our package transportation businesses. 17


  • Page 11

    MANAGEMENT’S DISCUSSION AND ANALYSIS The following tables compare revenues, operating expenses, operating Percent of Revenue expenses as a percent of revenue, operating income and operating 2013 2012 2011 margin (dollars in millions) for the years ended May 31: Operating expenses: Percent Salaries and employee benefits 37.0% 36.4% 37.4% Change Purchased transportation 8.6 6.9 6.4 2013/ 2012/ 2013 2012 2011 2012 2011 Rentals and landing fees 6.2 6.3 6.8 Revenues: Depreciation and amortization 5.0 4.4 4.3 Package: Fuel 15.2 16.2 14.4 U.S. overnight box $ 6,513 $ 6,546 $ 6,128 (1) 7 Maintenance and repairs 4.6 5.0 5.5 U.S. overnight envelope 1,705 1,747 1,736 (2) 1 Business realignment, impairment and other charges(3) 0.9 0.5 – U.S. deferred 3,020 3,001 2,805 1 7 Intercompany charges(4) 8.7 8.3 8.3 Total U.S. domestic package revenue 11,238 11,294 10,669 – 6 Other(5) 11.8 11.2 11.9 International priority 6,586 6,849 6,760 (4) 1 Total operating expenses 98.0 95.2 95.0 International economy 2,046 1,859 1,468 10 27 Operating margin(6) 2.0% 4.8% 5.0% Total international (1) International domestic revenues include our international intra-country express operations including acquisitions in India (February 2011), Mexico (July 2011), Poland (June 2012), export package France (July 2012) and Brazil (July 2012). revenue 8,632 8,708 8,228 (1) 6 (2) Includes FedEx Trade Networks and FedEx SupplyChain Systems. (3) 2013 includes $143 million of predominantly severance costs associated with our voluntary International domestic(1) 1,398 853 653 64 31 buyout program and a $100 million impairment charge resulting from the decision to retire Total package revenue 21,268 20,855 19,550 2 7 10 aircraft and related engines. 2012 represents impairment charges resulting from the decision to retire 24 aircraft and related engines. Freight: (4) Includes allocations of $262 million in 2013 for business realignment costs. (5) Includes the 2012 reversal of a $66 million legal reserve that was initially recorded in 2011. U.S. 2,562 2,498 2,188 3 14 (6) The direct and indirect charges described in notes (3) and (4) above reduced 2013 operating International priority 1,678 1,827 1,722 (8) 6 margin by 190 basis points. The charges and credit described in notes (3) and (5) above reduced 2012 operating margin by 20 basis points. International airfreight 276 307 283 (10) 8 Total freight revenue 4,516 4,632 4,193 (3) 10 Other(2) 1,387 1,028 838 35 23 Total revenues 27,171 26,515 24,581 2 8 Operating expenses: Salaries and employee benefits 10,045 9,657 9,183 4 5 Purchased transportation 2,331 1,828 1,573 28 16 Rentals and landing fees 1,684 1,680 1,672 – – Depreciation and amortization 1,350 1,169 1,059 15 10 Fuel 4,130 4,304 3,553 (4) 21 Maintenance and repairs 1,244 1,332 1,353 (7) (2) Business realignment, impairment and other charges(3) 243 134 – NM NM (4) Intercompany charges 2,379 2,193 2,043 8 7 Other(5) 3,210 2,958 2,917 9 1 Total operating expenses 26,616 25,255 23,353 5 8 Operating income $ 555 $ 1,260 $ 1,228 (56) 3 Operating margin(6) 2.0% 4.8% 5.0% (280)bp (20)bp 18


  • Page 12

    MANAGEMENT’S DISCUSSION AND ANALYSIS The following table compares selected statistics (in thousands, except FedEx Express Segment Revenues yield amounts) for the years ended May 31: FedEx Express segment revenues increased 2% in 2013 primarily due to the impact of new business acquisitions and growth in our freight- Percent forwarding business at FedEx Trade Networks. Core revenue growth Change was constrained by global economic conditions as revenue growth 2013/ 2012/ from higher international export volume was offset by decreased yields 2013 2012 2011 2012 2011 due to shifts in demand from our priority international services to (1) Package Statistics our economy international services, as well as lower rates. In 2013, Average daily package international domestic revenues increased 64% due to recent acquisi- volume (ADV): tions in Brazil, France and Poland. International export revenues were U.S. overnight box 1,134 1,146 1,184 (1) (3) down in 2013 as revenue per package decreased 3% due to the demand U.S. overnight envelope 574 586 627 (2) (7) shift to our lower-yielding economy services and lower rates, while U.S. deferred 835 845 873 (1) (3) volume increased 3% driven by our economy services. A decrease in U.S. domestic package volumes more than offset an increase in Total U.S. domestic ADV 2,543 2,577 2,684 (1) (4) U.S. domestic package yield, resulting in slightly lower U.S. domestic International priority 421 421 459 – (8) package revenues in 2013. Total average daily freight pounds decreased International economy 155 138 116 12 19 2% in 2013 due to weakness in economic global conditions. Total international export FedEx Express segment revenues increased 8% in 2012 primarily ADV 576 559 575 3 (3) due to an increase in U.S. domestic and international export package International domestic(2) 785 495 348 59 42 yields, partially offset by decreases in U.S. domestic and interna- Total ADV 3,904 3,631 3,607 8 1 tional export package volumes. In 2012, U.S. domestic package yields Revenue per package (yield): increased 10% due to higher fuel surcharges and increased rate per U.S. overnight box $ 22.52 $ 22.31 $ 20.29 1 10 pound. International export package yields increased 8% in 2012 due to higher fuel surcharges, increased package weights and increased U.S. overnight envelope 11.66 11.65 10.86 – 7 rate per pound. Continued softness in the global economy resulted U.S. deferred 14.18 13.87 12.60 2 10 in decreased demand for our U.S. domestic and international export U.S. domestic composite 17.33 17.12 15.59 1 10 package services in 2012. International export revenue growth was International priority 61.28 63.47 57.68 (3) 10 negatively impacted by a lower-yielding mix of services, consisting of growth in deferred services and declines in premium services. International economy 51.77 52.77 49.76 (2) 6 International export Our fuel surcharges are indexed to the spot price for jet fuel. Using composite 58.72 60.83 56.08 (3) 8 this index, the U.S. domestic and outbound fuel surcharge and the International domestic(2) 6.99 6.74 7.38 4 (9) international fuel surcharges ranged as follows for the years ended Composite package yield 21.36 22.44 21.25 (5) 6 May 31: Freight Statistics(1) 2013 2012 2011 Average daily freight pounds: U.S. Domestic and Outbound Fuel Surcharge: U.S. 7,612 7,487 7,340 2 2 Low 10.00% 11.50% 7.00% International priority 3,048 3,303 3,184 (8) 4 High 14.50 16.50 15.50 International airfreight 1,066 1,171 1,235 (9) (5) Weighted-average 11.84 14.23 9.77 Total average daily International Fuel Surcharges: freight pounds 11,726 11,961 11,759 (2) 2 Low 12.00 13.50 7.00 Revenue per pound (yield): High 20.50 23.00 21.00 U.S. $ 1.32 $ 1.30 $ 1.17 2 11 Weighted-average 17.02 17.45 12.36 International priority 2.16 2.16 2.12 – 2 International airfreight 1.01 1.02 0.90 (1) 13 In both January 2013 and 2012, we implemented a 5.9% average list Composite freight yield 1.51 1.51 1.40 – 8 price increase for FedEx Express U.S. domestic, U.S. export and U.S. (1) Package and freight statistics include only the operations of FedEx Express. import services, while we lowered our fuel surcharge index by two (2) International domestic statistics include our international intra-country express operations, percentage points. including acquisitions in India (February 2011), Mexico (July 2011), Poland (June 2012), France (July 2012) and Brazil (July 2012). 19


  • Page 13

    MANAGEMENT’S DISCUSSION AND ANALYSIS FedEx Express Segment Operating Income Salaries and employee benefits increased 5% in 2012 due to higher FedEx Express segment operating results were negatively impacted incentive compensation accruals and the full reinstatement of 401(k) by $405 million of costs associated with our business realignment company-matching contributions effective January 1, 2011. Purchased program, both directly and through intercompany allocations. transportation costs increased 16% in 2012 due to costs associated Additionally, results for 2013 were negatively impacted by a with the expansion of our freight forwarding business at FedEx Trade $100 million impairment charge as a result of the decision to retire Networks, business acquisitions in India and Mexico and higher 10 aircraft and related engines from service. FedEx Express incurred utilization of third-party transportation providers, primarily in Europe. $69 million in year-over-year incremental depreciation costs in 2013 due Intercompany charges increased 7% in 2012 due to higher allocated to the decision in 2012 to accelerate the retirement of certain aircraft. variable incentive compensation expenses. Operating income and operating margin also decreased in 2013 due Fuel costs increased 21% in 2012 due to increases in the average to the demand shift toward lower-yielding international services. price per gallon of fuel. Fuel usage in 2012 was down slightly. Operating comparisons were also impacted by an aircraft impairment charge in 2012 and a legal reserve accrual reversal as discussed below. FedEx Express Segment Outlook Purchased transportation costs increased 28% in 2013 due to recent We expect revenues and earnings to increase at FedEx Express during business acquisitions and costs associated with the expansion of 2014 due to slight growth in our international package and interna- our freight forwarding business at FedEx Trade Networks. Salaries tional domestic services. In addition, we expect operating income and benefits increased 4% in 2013 due to recent acquisitions and to improve through ongoing execution of our profit improvement higher pension costs, partially offset by lower incentive compensation programs including improving yields, adjusting network capacity and accruals. Other operating expenses increased 9% due to the impact reducing structural costs. However, the demand shift from our priority of recent business acquisitions and the negative year-over-year com- international services to our economy international services will parison of the legal reserve accrual reversal in 2012. Depreciation and continue to constrain earnings growth in 2014. Base yields on priority amortization expense increased 15% in 2013 as a result of aircraft international services at FedEx Express continue to weaken based on recently placed into service and accelerated depreciation due to the our customers’ accelerating preference for our lower-yielding services. shortened life of certain aircraft. Given the persistence of this trend, we will continue evaluating further actions to adjust our FedEx Express network capacity and shift FedEx Express aircraft maintenance and repairs costs are largely lower yielding services into lower cost delivery networks. driven by aircraft utilization and required periodic maintenance events. When newer aircraft are introduced into our operating fleet, less Capital expenditures at FedEx Express are expected to increase in maintenance costs are incurred. As a part of our fleet modernization 2014 driven by an increase in aircraft investment. We will continue to program, FedEx Express has retired older, less efficient aircraft prior modernize our aircraft fleet at FedEx Express during 2014 by adding to required periodic maintenance events and has introduced newly newer aircraft that are more reliable, fuel-efficient and technologi- manufactured aircraft into the fleet. As a result, a decrease in cally advanced, and retiring older, less-efficient aircraft. Due to the maintenance and repairs costs was experienced in 2013 and 2012. accelerated retirement of certain aircraft and related engines to aid in modernizing our fleet and improving our global network, we expect an Fuel costs decreased 4% in 2013 due to lower jet fuel prices and lower additional $74 million in year-over-year depreciation expense in 2014. aircraft fuel usage. Based on a static analysis of the net impact of year- over-year changes in fuel prices compared to year-over-year changes in In April 2013, FedEx Express was selected as the sole awardee of the fuel surcharges, fuel had a slightly positive impact in 2013. This analysis recent U.S. Postal Service air cargo solicitation, representing the considers the estimated impact of the reduction in fuel surcharges majority of the United States Postal Service’s (“USPS”) air linehaul included in the base rates charged for FedEx Express services. traffic. This new seven year agreement begins on October 1, 2013. The agreement provides reduced rates for the USPS versus the prior FedEx FedEx Express segment operating income increased 3% in 2012 Express agreement and offers the opportunity for incremental revenue. primarily due to the benefit from the timing lag that exists between when fuel prices change and when indexed fuel surcharges automati- FedEx Ground Segment cally adjust and U.S. domestic and international export package yield FedEx Ground service offerings include day-certain service delivery improvements. Results of the FedEx Express segment reflect the to businesses in the U.S. and Canada and to nearly 100% of U.S. impact of two one-time items in 2012. FedEx Express segment results residences. FedEx SmartPost consolidates high-volume, low-weight, for 2012 were negatively impacted by $134 million as a result of the less time-sensitive business-to-consumer packages and utilizes the decision to retire from service 18 Airbus A310-200 aircraft and USPS for final delivery. 26 related engines as well as six Boeing MD10-10 aircraft and 17 related engines to better align the U.S. domestic air network capacity of FedEx Express to match current and anticipated shipment volumes. The 2012 operating results at the FedEx Express segment were favorably impacted by the reversal of a legal reserve of $66 million that was initially recorded in 2011. FedEx Express segment results also benefited from a milder winter compared to the negative impact of unusually severe winter weather in 2011. 20


  • Page 14

    MANAGEMENT’S DISCUSSION AND ANALYSIS The following tables compare revenues, operating expenses, operating FedEx Ground Segment Revenues expenses as a percent of revenue, operating income and operating FedEx Ground segment revenues increased 10% during 2013 due to margin (dollars in millions) and selected package statistics (in thousands, volume increases at both FedEx Ground and FedEx SmartPost, as well except yield amounts) for the years ended May 31: as yield growth at FedEx Ground. Percent FedEx Ground average daily package volume increased 8% during 2013 Change due to market share gains from continued growth in our FedEx Home 2013/ 2012/ 2013 2012 2011 2012 2011 Delivery service and increases in our commercial business. FedEx Ground yield increased 2% in 2013 primarily due to increased rates Revenues: and higher residential surcharge revenue, partially offset by lower fuel FedEx Ground $ 9,652 $ 8,791 $ 7,855 10 12 surcharges and package weights. FedEx SmartPost 926 782 630 18 24 FedEx SmartPost average daily volume grew 22% during 2013 primar- Total revenues 10,578 9,573 8,485 10 13 ily as a result of growth in e-commerce. Yields at FedEx SmartPost Operating expenses: decreased 2% during 2013 primarily due to higher postage costs, Salaries and employee partially offset by increased rates. FedEx SmartPost yield represents benefits 1,586 1,451 1,282 9 13 the amount charged to customers net of postage paid to the USPS. Purchased transportation 4,191 3,762 3,431 11 10 During 2012, FedEx Ground segment revenues increased 13% due to Rentals 331 284 263 17 8 yield and volume growth at both FedEx Ground and FedEx SmartPost. Depreciation and amortization 434 389 337 12 15 FedEx Ground yields increased 7% during 2012 primarily due to rate increases, higher fuel surcharges and higher extra service revenue. Fuel 17 14 12 21 17 Average daily package volume increased 4% at FedEx Ground in 2012 Maintenance and repairs 190 176 169 8 4 due to market share gains from continued growth in our FedEx Home Intercompany charges(1) 1,148 978 897 17 9 Delivery service and an increase in our commercial business. Other 893 755 769 18 (2) At FedEx SmartPost, yields increased 5% in 2012 primarily due to higher Total operating expenses 8,790 7,809 7,160 13 9 fuel surcharges and increased rates, partially offset by an unfavorable Operating income $ 1,788 $ 1,764 $ 1,325 1 33 service mix. Average daily volume increased 18% at FedEx SmartPost (1) in 2012 as a result of growth in e-commerce. Operating margin 16.9% 18.4% 15.6% (150)bp 280bp Average daily package The FedEx Ground fuel surcharge is based on a rounded average of the volume: national U.S. on-highway average price for a gallon of diesel fuel, as FedEx Ground 4,222 3,907 3,746 8 4 published by the Department of Energy. Our fuel surcharge ranged as follows for the years ended May 31: FedEx SmartPost 2,058 1,692 1,432 22 18 Revenue per package (yield): 2013 2012 2011 FedEx Ground $ 8.94 $ 8.77 $ 8.17 2 7 Low 6.50% 7.50% 5.50% FedEx SmartPost $ 1.77 $ 1.81 $ 1.72 (2) 5 High 8.50 9.50 8.50 Weighted-average 7.60 8.46 6.20 Percent of Revenue 2013 2012 2011 In January 2013 and 2012, FedEx Ground and FedEx Home Delivery Operating expenses: implemented a 4.9% average list price increase. The full average Salaries and employee benefits 15.0% 15.2% 15.1% rate increase of 5.9% was partially offset by adjusting the fuel Purchased transportation 39.6 39.3 40.4 price threshold at which the fuel surcharge begins, reducing the fuel surcharge by one percentage point. FedEx SmartPost rates also increased. Rentals 3.1 3.0 3.1 Depreciation and amortization 4.1 4.1 4.0 FedEx Ground Segment Operating Income Fuel 0.2 0.1 0.1 FedEx Ground segment operating income increased 1% during 2013 Maintenance and repairs 1.8 1.8 2.0 primarily due to volume growth and higher yields. However, operat- Intercompany charges(1) 10.9 10.2 10.6 ing margin decreased as the benefit of higher volume and revenue per package was more than offset by intercompany charges of $105 million Other 8.4 7.9 9.1 associated with the business realignment program and a favorable Total operating expenses 83.1 81.6 84.4 self-insurance true-up in the prior year. Purchased transportation costs Operating margin(1) 16.9% 18.4% 15.6% (1) Includes allocations of $105 million in 2013 for business realignment costs which reduced operating margin by 100 basis points. 21


  • Page 15

    MANAGEMENT’S DISCUSSION AND ANALYSIS increased 11% in 2013 primarily as a result of volume growth and FedEx Freight Segment higher rates paid to our independent contractors. Other operating FedEx Freight service offerings include priority services when speed expenses increased 18% primarily due to a favorable self-insurance is critical and economy services when time can be traded for savings. true-up in the prior year and higher legal expenses in the current The following tables compare revenues, operating expenses, operat- year. Salaries and employee benefits expense increased 9% in 2013 ing expenses as a percent of revenue, operating income (loss) and primarily due to increased staffing to support volume growth. operating margin (dollars in millions) and selected statistics for the FedEx Ground segment operating income increased 33% and operating years ended May 31: margin increased 280 basis points during 2012 primarily due to higher Percent yields and volume growth. FedEx Ground has continued to shorten Change transit times throughout 2012 by accelerating various lanes through- 2013/ 2012/ out the U.S. and Canada, while maintaining consistently high on-time 2013 2012 2011 2012 2011 service. Purchased transportation costs increased 10% in 2012 primarily Revenues $ 5,401 $ 5,282 $ 4,911 2 8 as a result of volume growth and higher fuel surcharges. Salaries and Operating expenses: employee benefits increased 13% primarily due to increased staffing to support volume growth and higher incentive compensation accruals. Salaries and employee benefits 2,342 2,316 2,303 1 1 Intercompany charges increased 9% in 2012 primarily due to higher allocated information technology costs. Depreciation expense increased Purchased transportation 865 851 779 2 9 15% in 2012 due to higher capital spending across the network, Rentals 118 114 122 4 (7) including technology and transportation equipment upgrades and an Depreciation and initiative to replace lighting fixtures throughout the network in order amortization 217 185 205 17 (10) to reduce energy costs. Fuel 598 636 585 (6) 9 Maintenance and repairs 191 192 182 (1) 5 Independent Contractor Model Business realignment, Although FedEx Ground is involved in numerous lawsuits and other impairment and other proceedings (such as state tax or other administrative challenges) charges(1) 3 – 89 NM NM where the classification of its independent contractors is at issue, a Intercompany charges (2) 484 433 427 12 1 number of recent judicial decisions support our classification, and we Other 375 393 394 (5) – believe our relationship with the contractors is generally excellent. For a description of these proceedings, see “Risk Factors” and Note 18 of Total operating expenses 5,193 5,120 5,086 1 1 the accompanying consolidated financial statements. Operating income (loss) $ 208 $ 162 $ (175) 28 193 Operating margin(3) 3.9% 3.1% (3.6)% 80bp 670bp FedEx Ground Segment Outlook Average daily LTL shipments FedEx Ground segment revenues and operating income are expected (in thousands)(4) to continue to grow in 2014, led by volume growth across all our Priority 59.3 60.4 (2) major services due to market share gains. We also anticipate yield Economy 26.4 24.5 8 growth in 2014 through yield management programs. We will continue to make investments to grow our highly profitable FedEx Total average daily LTL shipments 85.7 84.9 86.0 1 (1) Ground network through hub expansion and vehicle and equipment (4) purchases. Earnings growth may be dampened slightly during periods Weight per LTL shipment (lbs) of increased network expansion. Priority 1,237 1,202 3 We will continue to vigorously defend various attacks against our Economy 990 1,045 (5) independent contractor model and incur ongoing legal costs as a part of Composite weight per this process. While we believe that FedEx Ground’s owner-operators are LTL shipment 1,161 1,156 1,144 – 1 properly classified as independent contractors, it is reasonably possible LTL yield (revenue per that we could incur a material loss in connection with one or more of hundredweight)(4) these matters or be required to make material changes to our contractor Priority $ 17.80 $ 18.02 (1) model. However, we do not believe that any such changes will impair Economy 25.90 23.96 8 our ability to operate and profitably grow our FedEx Ground business. Composite LTL yield $ 19.94 $ 19.57 $ 18.24 2 7 22


  • Page 16

    MANAGEMENT’S DISCUSSION AND ANALYSIS Percent of Revenue The indexed LTL fuel surcharge is based on the average of the national U.S. on-highway average price for a gallon of diesel fuel, as published 2013 2012 2011 by the Department of Energy. The indexed LTL fuel surcharge ranged as Operating expenses: follows for the years ended May 31: Salaries and employee benefits 43.4% 43.9% 46.9% 2013 2012 2011 Purchased transportation 16.0 16.1 15.9 Low 21.80% 19.80% 15.10% Rentals 2.2 2.2 2.5 High 24.40 24.30 20.70 Depreciation and amortization 4.0 3.5 4.2 Fuel 11.1 12.0 11.9 Weighted-average 23.38 22.90 17.00 Maintenance and repairs 3.5 3.6 3.7 On June 10, 2013, FedEx Freight announced it will increase U.S. Business realignment, impairment and certain other shipping rates by an average of 4.5% effective on and other charges(1) – – 1.8 July 1, 2013. In July 2012, FedEx Freight implemented a rate increase Intercompany charges(2) 9.0 8.2 8.7 of 6.9% for LTL shipments. In June 2011, FedEx Freight increased the Other 6.9 7.4 fuel surcharge rate to a maximum of 3.6 percentage points above 8.0 previous levels. Total operating expenses 96.1 96.9 103.6 Operating margin(3) 3.9% 3.1% (3.6)% FedEx Freight Segment Operating Income (1) 2013 includes severance costs associated with our voluntary buyout program. 2011 includes severance, impairment and other charges associated with the combination of The FedEx Freight segment operating results for 2013 improved as a our FedEx Freight and FedEx National LTL operations, effective January 30, 2011. result of LTL yield growth and increased average daily LTL shipments, (2) Includes allocations of $47 million in 2013 for business realignment costs. along with ongoing improvement in operational efficiencies in our inte- (3) The direct and indirect charges disclosed in notes (1) and (2) above reduced 2013 operating margin by 90 basis points. grated network. However, operating results for 2013 were negatively (4) FedEx Freight introduced Priority and Economy services during the fourth quarter of 2011; impacted by $50 million of costs associated with our business realign- therefore, full-year detail has not been presented for 2011. ment program both directly and through intercompany allocations. FedEx Freight Segment Revenues Depreciation and amortization expense increased 17% due to FedEx Freight segment revenues increased 2% in 2013 due to higher continued investment in replacement transportation equipment. LTL yield and average daily LTL shipments. LTL yield increased 2% Salaries and employee benefits increased 1% in 2013 primarily due in 2013 due to improvements in FedEx Freight Economy yield result- to increases in volume and higher healthcare, workers’ compensation ing from higher rates and lower weight per LTL shipment. Average and pension costs, partially offset by operational efficiencies and daily LTL shipments increased 1% in 2013 driven by our FedEx Freight lower incentive compensation. Purchased transportation costs Economy services offering, partially offset by transitional challenges increased 2% in 2013 due to increased utilization of rail and higher encountered by some customers in the second half of 2013 while rates, partially offset by a lower cost per mile due to our ability to migrating FedEx Freight functionality to the FedEx enterprise auto- optimize mode of transportation. mated platform. Fuel costs decreased 6% in 2013 due to increased utilization of rail Revenue per hundredweight is a commonly-used indicator of pricing and fuel efficiency improvements. Based on a static analysis of the trends, but this metric can be influenced by many other factors, such net impact of year-over-year changes in fuel prices compared to year- as changes in fuel surcharges, weight per shipment, length of haul and over-year changes in fuel surcharges, fuel had a minimal impact on the mix of freight. Generally, LTL freight is rated using a standard class operating income in 2013. system for the LTL industry and classes are assigned based on trans- In 2012, the FedEx Freight segment operating income increased signifi- portation characteristics including density, risk and handling. Under cantly as a result of higher fuel surcharges, yield growth and ongoing the class system, low-value freight that is easy to handle, unlikely to improvements in operational efficiencies due to the combination of our damage and dense will receive lower class ratings (and lower yields) FedEx Freight and FedEx National LTL operations in 2011. Additionally, than expensive, light, bulky freight which is highly susceptible to dam- the FedEx Freight segment’s 2012 results benefited from milder winter age (and produces higher yields). As a result, changes in revenue per weather, while our 2011 results were negatively impacted by unusu- hundredweight do not necessarily indicate actual changes in underly- ally severe winter weather. ing base rates. Purchased transportation costs increased 9% in 2012 due to higher During 2012, FedEx Freight revenues increased 8% due to increased rates and the increased utilization of rail, partially offset by a lower LTL yield and weight per LTL shipment, partially offset by lower aver- cost per mile due to our ability to optimize mode of transportation age daily LTL shipments. LTL yield increased 7% during 2012 due to while meeting service standards. Fuel costs increased 9% in 2012 higher fuel surcharges and base yield improvement. Average daily LTL due to a higher average price per gallon of diesel fuel, partially offset shipments decreased 1% in 2012; however, during the second half of by the increased utilization of rail. Based on a static analysis of the 2012, LTL shipment year-over-year comparisons improved sequentially net impact of year-over-year changes in fuel prices compared to (2% in the third quarter and 4% in the fourth quarter) due to enhanced year-over-year changes in fuel surcharges, fuel had a positive impact service levels, strong customer satisfaction from our service offerings to operating income in 2012. Depreciation and amortization expense and the impact of severe weather in the prior year. 23


  • Page 17

    MANAGEMENT’S DISCUSSION AND ANALYSIS decreased 10% in 2012 primarily due to accelerated depreciation CASH PROVIDED BY OPERATING ACTIVITIES. Cash flows from in 2011 associated with the combination of our LTL operations. operating activities decreased $147 million in 2013 primarily due to decreased earnings and higher tax, variable compensation and FedEx Freight Segment Outlook voluntary buyout payments, partially offset by a decrease in pension We expect modest revenue growth at the FedEx Freight segment in contributions. Cash flows from operating activities increased 2014 driven by yield and volume initiatives from our differentiated $794 million in 2012 primarily due to increased earnings, partially LTL services. offset by higher pension contributions. We made contributions of $560 million to our tax-qualified U.S. domestic pension plans (“U.S. FedEx Freight operating income and operating margin are expected to Pension Plans”) during 2013 and contributions of $722 million to increase in 2014 driven by improvements in yields and volume, as well our U.S. Pension Plans during 2012. We made contributions of as continued improvement in productivity and efficiency across our $480 million to our U.S. Pension Plans during 2011. integrated network. We will continue to use investments in technology, focused on network and equipment planning and customer automation, CASH USED IN INVESTING ACTIVITIES. Capital expenditures were to further enhance customer service levels throughout 2014. 16% lower in 2013 largely due to decreased spending at FedEx Express and 17% higher in 2012 primarily due to increased spending Capital expenditures in 2014 are expected to be comparable to 2013, at FedEx Express and FedEx Freight. See “Capital Resources” for a with the majority of our spending for replacement of vehicles and discussion of capital expenditures during 2013 and 2012. freight handling equipment. FINANCING ACTIVITIES. In April 2013, we issued $750 million of senior unsecured debt under our current shelf registration statement, FINANCIAL CONDITION comprised of $250 million of 2.70% fixed-rate notes due in April 2023 and $500 million of 4.10% fixed-rate notes due in April 2043. Interest on these notes is payable semi-annually. We utilized the net proceeds Liquidity for working capital and general corporate purposes. In July 2012, we Cash and cash equivalents totaled $4.9 billion at May 31, 2013, com- issued $1 billion of senior unsecured debt under a then current shelf pared to $2.8 billion at May 31, 2012. The following table provides a registration statement, comprised of $500 million of 2.625% summary of our cash flows for the periods ended May 31 (in millions): fixed-rate notes due in August 2022 and $500 million of 3.875% fixed-rate notes due in August 2042. Interest on these notes is 2013 2012 2011 payable semi-annually. We utilized the net proceeds for working Operating activities: capital and general corporate purposes. Net income $ 1,561 $ 2,032 $ 1,452 During 2013, we made principal payments of $116 million related to Business realignment, impairment capital lease obligations and repaid our $300 million 9.65% unsecured and other charges 479 134 29 notes that matured in June 2012 using cash from operations. Other noncash charges and credits 3,183 3,504 2,892 Changes in assets and liabilities (535) (835) (332) During 2013, we repurchased 2.7 million shares of FedEx common Cash provided by operating activities 4,688 4,835 4,041 stock at an average price of $91 per share for a total of $246 million. In March 2013, our Board of Directors authorized the repurchase of up Investing activities: to 10 million shares of common stock. It is expected that the additional Capital expenditures (3,375) (4,007) (3,434) share authorization will primarily be utilized to offset the effects of Business acquisitions, net of equity compensation dilution over the next several years. As of cash acquired (483) (116) (96) May 31, 2013, 10,188,000 shares remained under existing share Proceeds from asset dispositions repurchase authorizations. During 2012, we repurchased 2.8 million and other 55 74 111 FedEx common shares at an average price of $70 per share for a total Cash used in investing activities (3,803) (4,049) (3,419) of $197 million. Financing activities: Purchase of treasury stock (246) (197) – Capital Resources Principal payments on debt (417) (29) (262) Our operations are capital intensive, characterized by significant Proceeds from debt issuance 1,739 – – investments in aircraft, vehicles, technology, facilities, and package- Dividends paid (177) (164) (151) handling and sort equipment. The amount and timing of capital additions depend on various factors, including pre-existing contractual Other 285 146 126 commitments, anticipated volume growth, domestic and international Cash provided by (used in) financing activities 1,184 (244) (287) economic conditions, new or enhanced services, geographical expansion of services and actions of regulatory authorities. Effect of exchange rate changes on cash 5 (27) 41 Net increase in cash and cash equivalents $ 2,074 $ 515 $ 376 24


  • Page 18

    MANAGEMENT’S DISCUSSION AND ANALYSIS The following table compares capital expenditures by asset category and landing fees) to capital (adjusted debt plus total common stock- and reportable segment for the years ended May 31 (in millions): holders’ investment) that does not exceed 70%. Our leverage ratio of adjusted debt to capital was 51% at May 31, 2013. We believe the Percent Change leverage ratio covenant is our only significant restrictive covenant 2013/ 2012/ in our revolving credit agreement. Our revolving credit agreement 2013 2012 2011 2012 2011 contains other customary covenants that do not, individually or in the aggregate, materially restrict the conduct of our business. We are in Aircraft and related equipment $ 1,190 $ 1,875 $ 1,988 (37) (6) compliance with the leverage ratio covenant and all other covenants Facilities and sort equipment 727 638 555 14 15 of our revolving credit agreement and do not expect the covenants Vehicles 734 723 282 2 156 to affect our operations, including our liquidity or expected funding Information and technology needs. As of May 31, 2013, no commercial paper was outstanding, investments 452 541 455 (16) 19 and the entire $1 billion under the revolving credit facility was Other equipment 272 230 154 18 49 available for future borrowings. Total capital expenditures $ 3,375 $ 4,007 $ 3,434 (16) 17 Standard & Poor’s has assigned us a senior unsecured debt credit rat- FedEx Express segment $ 2,067 $ 2,689 $ 2,467 (23) 9 ing of BBB and a commercial paper rating of A-2 and a ratings outlook FedEx Ground segment 555 536 426 4 26 of “stable.” Moody’s Investors Service has assigned us a senior unsecured debt credit rating of Baa1 and a commercial paper rating FedEx Freight segment 326 340 153 (4) 122 of P-2 and a ratings outlook of “stable.” If our credit ratings drop, our FedEx Services segment 424 437 387 (3) 13 interest expense may increase. If our commercial paper ratings drop Other 3 5 1 NM NM below current levels, we may have difficulty utilizing the commercial Total capital expenditures $ 3,375 $ 4,007 $ 3,434 (16) 17 paper market. If our senior unsecured debt credit ratings drop below investment grade, our access to financing may become limited. Capital expenditures during 2013 were lower than the prior year Our capital expenditures are expected to be $4.0 billion in 2014. We primarily due to decreased spending for aircraft and related equip- anticipate that our cash flow from operations will be sufficient to fund ment at FedEx Express. Aircraft and aircraft-related equipment our increased capital expenditures in 2014, which will include spend- purchases at FedEx Express during 2013 included the delivery of ing for aircraft and aircraft-related equipment at FedEx Express, sort 16 Boeing 757s (“B757”) to be modified for cargo transport and four facility expansion, primarily at FedEx Ground, and vehicle replacement B777Fs. Capital expenditures during 2012 were higher than the prior at all our transportation segments. We expect approximately 50% of year primarily due to increased spending for vehicles at FedEx capital expenditures in 2014 will be designated for growth initiatives, Express, FedEx Freight and FedEx Ground, although spending for predominantly at FedEx Ground and 50% dedicated to maintaining aircraft and related equipment at FedEx Express decreased. Aircraft our existing operations. Our expected capital expenditures for 2014 and aircraft-related equipment purchases at FedEx Express during include $1.4 billion in investments for delivery of aircraft, as well as 2012 included delivery of seven B777Fs and 15 B757s. progress payments toward future aircraft deliveries at FedEx Express. Liquidity Outlook For 2014, we anticipate making required contributions totaling approx- imately $650 million to our U.S. Pension Plans. Our U.S. Pension Plans We believe that our cash and cash equivalents, which totaled have ample funds to meet expected benefit payments. $4.9 billion in 2013, cash flow from operations and available financ- ing sources will be adequate to meet our liquidity needs, including We have several aircraft modernization programs underway which working capital, capital expenditure requirements and debt payment are supported by the purchase of B777F, Boeing 767-300 Freighter obligations. Our cash and cash equivalents balance at May 31, 2013 (“B767F”) and B757 aircraft. These aircraft are significantly more includes $420 million of cash in offshore jurisdictions associated fuel-efficient per unit than the aircraft types previously utilized, and with our permanent reinvestment strategy. We do not believe that these expenditures are necessary to achieve significant long-term the indefinite reinvestment of these funds offshore impairs our ability operating savings and to replace older aircraft. Our ability to delay to meet our domestic debt or working capital obligations. the timing of these aircraft-related expenditures is limited without incurring significant costs to modify existing purchase agreements. We have a shelf registration statement filed with the Securities and During 2013, FedEx Express entered into an agreement to purchase Exchange Commission (“SEC”) that allows us to sell, in one or more 14 additional B757 aircraft, the delivery of which began in 2013 and future offerings, any combination of our unsecured debt securities will continue through 2014. The agreement provides the option to pur- and common stock. chase up to 16 additional B757 aircraft, subject to the satisfaction of A $1 billion revolving credit facility is available to finance our certain conditions. In addition, FedEx Express entered into agreements operations and other cash flow needs and to provide support for the to purchase an additional 23 B767F aircraft, the delivery of which will issuance of commercial paper. In March 2013, we entered into an occur between 2014 and 2019. The delivery of two firm B777F amendment to our credit agreement to, among other things, extend aircraft orders were also deferred from 2015 to 2016. its maturity date from April 26, 2016 to March 1, 2018. The agree- Effective as of June 14, 2013, FedEx Express entered into a supple- ment contains a financial covenant, which requires us to maintain a mental agreement to purchase 13 of the 16 B757 option aircraft noted leverage ratio of adjusted debt (long-term debt, including the current above. Delivery of the aircraft will occur during 2014 and 2015. portion of such debt, plus six times our last four fiscal quarters’ rentals 25


  • Page 19

    MANAGEMENT’S DISCUSSION AND ANALYSIS Contractual Cash Obligations and Off-Balance Sheet Arrangements The following table sets forth a summary of our contractual cash obligations as of May 31, 2013. 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, this table does not include amounts already recorded in our balance sheet as current liabilities at May 31, 2013. We have certain contingent liabilities that are not accrued in our balance sheet in accordance with accounting principles generally accepted in the United States. These contingent liabilities are not included in the table below. We have other long-term liabilities reflected in our balance sheet, including deferred income taxes, qualified and nonqualified pension and postretirement healthcare plan liabilities and other self-insurance accruals. The payment obligations associated with these liabilities are not reflected in the table below due to the absence of scheduled maturities. Accordingly, this table is not meant to represent a forecast of our total cash expenditures for any of the periods presented. Payments Due by Fiscal Year (Undiscounted) (in millions) 2014 2015 2016 2017 2018 Thereafter Total Operating activities: Operating leases $ 1,936 $ 1,834 $ 1,636 $ 1,689 $ 1,230 $ 6,650 $ 14,975 Non-capital purchase obligations and other 285 183 123 101 44 109 845 Interest on long-term debt 157 138 138 138 138 2,582 3,291 Contributions to our U.S. Pension Plans 650 – – – – – 650 Investing activities: Aircraft and aircraft-related capital commitments 968 1,054 1,140 959 1,382 4,492 9,995 Other capital purchase obligations 249 1 – – – – 250 Financing activities: Debt 250 – – – – 2,740 2,990 Total $ 4,495 $ 3,210 $ 3,037 $ 2,887 $ 2,794 $ 16,573 $ 32,996 Open purchase orders that are cancelable are not considered uncon- The amounts reflected for purchase obligations represent noncan- ditional purchase obligations for financial reporting purposes and are celable agreements to purchase goods or services that are not not included in the table above. Such purchase orders often represent capital-related. Such contracts include those for printing and advertis- authorizations to purchase rather than binding agreements. See ing and promotions contracts. Note 17 of the accompanying consolidated financial statements for Included in the table above within the caption entitled “Non-capital more information. purchase obligations and other” is our estimate of the current portion of the liability ($1 million) for uncertain tax positions. We cannot rea- Operating Activities sonably estimate the timing of the long-term payments or the amount In accordance with accounting principles generally accepted in the by which the liability will increase or decrease over time; therefore, United States, future contractual payments under our operating leases the long-term portion of the liability ($46 million) is excluded from the (totaling $15 billion on an undiscounted basis) are not recorded in our table. See Note 12 of the accompanying consolidated financial state- balance sheet. Credit rating agencies routinely use information con- ments for further information. cerning minimum lease payments required for our operating leases to calculate our debt capacity. The amounts reflected in the table above The amounts reflected in the table above for interest on long-term for operating leases represent future minimum lease payments under debt represent future interest payments due on our long-term debt, noncancelable operating leases (principally aircraft and facilities) with all of which are fixed rate. an initial or remaining term in excess of one year at May 31, 2013. Under the proposed new lease accounting rules, the majority of these Investing Activities leases will be required to be recognized on the balance sheet as a The amounts reflected in the table above for capital purchase obliga- liability with an offsetting right-to-use asset. In the past, we financed tions represent noncancelable agreements to purchase capital-related a significant portion of our aircraft needs (and certain other equipment equipment. Such contracts include those for certain purchases of needs) using operating leases (a type of “off-balance sheet financ- aircraft, aircraft modifications, vehicles, facilities, computers and ing”). At the time that the decision to lease was made, we determined other equipment. Commitments to purchase aircraft in passenger that these operating leases would provide economic benefits favor- configuration do not include the attendant costs to modify these able to ownership with respect to market values, liquidity or after-tax aircraft for cargo transport unless we have entered into noncancelable cash flows. commitments to modify such aircraft. 26


  • Page 20

    MANAGEMENT’S DISCUSSION AND ANALYSIS Financing Activities The current rules for pension accounting are complex and can produce We have certain financial instruments representing potential com- tremendous volatility in our results, financial condition and liquidity. mitments, not reflected in the table above, that were incurred in Our pension expense is primarily a function of the value of our plan the normal course of business to support our operations, including assets and the discount rate used to measure our pension liabilities at standby letters of credit and surety bonds. These instruments are a single point in time at the end of our fiscal year (the measurement required under certain U.S. self-insurance programs and are also used date). Both of these factors are significantly influenced by the stock in the normal course of international operations. The underlying liabili- and bond markets, which in recent years have experienced substantial ties insured by these instruments are reflected in our balance sheets, volatility. where applicable. Therefore, no additional liability is reflected for the In addition to expense volatility, we are required to record year-end letters of credit and surety bonds themselves. adjustments to our balance sheet on an annual basis for the net The amounts reflected in the table above for long-term debt represent funded status of our pension and postretirement healthcare plans. future scheduled payments on our long-term debt. In 2014, we have These adjustments have fluctuated significantly over the past several scheduled debt payments of $250 million. years and like our pension expense, are a result of the discount rate and value of our plan assets at the measurement date. The funded status of our plans also impacts our liquidity, as current funding laws CRITICAL ACCOUNTING ESTIMATES require increasingly aggressive funding levels for our pension plans. However, the cash funding rules operate under a completely differ- The preparation of financial statements in accordance with account- ent set of assumptions and standards than those used for financial ing principles generally accepted in the United States requires reporting purposes, so our actual cash funding requirements can differ management to make significant judgments and estimates to develop materially from our reported funded status. Temporary funding relief amounts reflected and disclosed in the financial statements. In was passed in July 2012 that will improve our funded status for those many cases, there are alternative policies or estimation techniques purposes over the next several years. that could be used. We maintain a thorough process to review the Our retirement plans cost is included in the “Salaries and Employee application of our accounting policies and to evaluate the appropriate- Benefits” caption in our consolidated income statements. A summary ness of the many estimates that are required to prepare the financial of our retirement plans costs over the past three years is as follows statements of a complex, global corporation. However, even under (in millions): optimal circumstances, estimates routinely require adjustment based on changing circumstances and new or better information. 2013 2012 2011 The estimates discussed below include the financial statement ele- U.S. domestic and international pension plans $ 679 $ 524 $ 543 ments that are either the most judgmental or involve the selection or application of alternative accounting policies and are material to U.S. domestic and international defined contribution plans 354 338 257 our financial statements. Management has discussed the develop- U.S. domestic and international ment and selection of these critical accounting estimates with the postretirement healthcare plans 78 70 60 Audit Committee of our Board of Directors and with our independent registered public accounting firm. $ 1,111 $ 932 $ 860 Retirement Plans Total retirement plans cost increased $179 million in 2013 driven OVERVIEW. We sponsor programs that provide retirement benefits to by lower discount rates used to measure our benefit obligations at most of our employees. These programs include defined benefit pension our May 31, 2012 measurement date. Total retirement plans cost plans, defined contribution plans and postretirement healthcare plans. increased $72 million in 2012 primarily due to higher expenses for our 401(k) plans due to the full restoration of company matching Pension benefits for most employees are accrued under a cash contributions on January 1, 2011. balance formula we call the Portable Pension Account. Under the Portable Pension Account, the retirement benefit is expressed as a Amounts recognized in our balance sheet reflect a snapshot of the dollar amount in a notional account that grows with annual credits state of our long-term pension liabilities at the plan measurement based on pay, age and years of credited service, and interest on the date and the effect of year-end accounting on plan assets. Cumulative notional account balance. The Portable Pension Account benefit is unrecognized actuarial losses were $7.0 billion through May 31, 2013, payable as a lump sum or an annuity at retirement at the election of compared to $8.9 billion through May 31, 2012. These unrecognized the employee. The plan interest credit rate varies from year to year losses reflect changes in the discount rates and differences between based on a U.S. Treasury index and corporate bond rates. Prior to expected and actual asset returns, which are being amortized over 2009, certain employees earned benefits using a traditional pension future periods. These unrecognized losses may be recovered in future formula (based on average earnings and years of service). Benefits periods through actuarial gains. However, unless they are below a under this formula were capped on May 31, 2008 for most employees. corridor amount, these unrecognized actuarial losses are required to be amortized and recognized in future periods. Our pension expense includes amortization of these actuarial losses of $506 million in 2013, $302 million in 2012 and $276 million in 2011. 27


  • Page 21

    MANAGEMENT’S DISCUSSION AND ANALYSIS PENSION COST. The accounting for pension and postretirement part of our strategy to manage pension costs and funded status vola- healthcare plans includes numerous assumptions, including the dis- tility, we have transitioned to a liability-driven investment strategy to count rate and expected long-term investment returns on plan assets. better align plan assets with liabilities. These assumptions most significantly impact our U.S. Pension Plans. Establishing the expected future rate of investment return on our Following is a discussion of the key estimates we consider in deter- pension assets is a judgmental matter, which we review on an annual mining our pension cost: basis and revise as appropriate. Management considers the following factors in determining this assumption: DISCOUNT RATE. This is the interest rate used to discount the esti- mated future benefit payments that have been accrued to date (the > the duration of our pension plan liabilities, which drives the invest- projected benefit obligation, or “PBO”) to their net present value and ment strategy we can employ with our pension plan assets; to determine the succeeding year’s pension expense. The discount > the types of investment classes in which we invest our pension plan rate is determined each year at the plan measurement date. A assets and the expected compound geometric return we can reason- decrease in the discount rate increases pension expense. The discount ably expect those investment classes to earn over time; and rate affects the PBO and pension expense based on the measurement dates, as described below. > the investment returns we can reasonably expect our investment management program to achieve in excess of the returns we could Amounts Determined by Measurement Discount Measurement Date and expect if investments were made strictly in indexed funds. Date Rate Discount Rate We have assumed an 8.0% expected long-term rate of return on our 5/31/2013 4.79% 2013 PBO and 2014 expense U.S. Pension Plan assets for 2013, 2012 and 2011. The actual returns 5/31/2012 4.44 2012 PBO and 2013 expense during each of the last three fiscal years have exceeded that long-term assumption. The actual historical return on our U.S. Pension 5/31/2011 5.76 2011 PBO and 2012 expense Plan assets, calculated on a compound geometric basis, was 5/31/2010 6.37 2010 PBO and 2011 expense 6.9%, net of investment manager fees, for the 15-year period ended May 31, 2013 and 7.4%, net of investment manager fees, for the We determine the discount rate with the assistance of actuaries, who 15-year period ended May 31, 2012. For 2014, we plan to lower our calculate the yield on a theoretical portfolio of high-grade corporate expected return on plan assets assumption for long-term returns on bonds (rated Aa or better). In developing this theoretical portfolio, plan assets to 7.75% as we continue to refine our asset and liability we select bonds that match cash flows to benefit payments, limit management strategy. In lowering this assumption we considered our concentration by industry and issuer, and apply screening criteria our historical returns, our investment strategy for our plan assets, to ensure bonds with a call feature have a low probability of being including the impacts of the long duration of our plan liability and the called. To the extent scheduled bond proceeds exceed the estimated relatively low annual draw on plan assets on that investment strategy. benefit payments in a given period, the calculation assumes those A one-basis-point change in our expected return on plan assets excess proceeds are reinvested at one-year forward rates. impacts our pension expense by $1.9 million. The discount rate assumption is highly sensitive, as the following Pension expense is also affected by the accounting policy used to table illustrates for our largest pension plan: determine the value of plan assets at the measurement date. We use a calculated-value method to determine the value of plan assets, Sensitivity (in millions) which helps mitigate short-term volatility in market performance (both Effect on 2014 Effect on 2013 increases and decreases) by amortizing certain actuarial gains or Pension Expense Pension Expense losses over a period no longer than four years. Another method used One-basis-point change in practice applies the market value of plan assets at the measure- in discount rate $ 2.1 $ 2.3 ment date. For purposes of valuing plan assets for determining 2014 At our May 31, 2013 measurement date, a 50-basis-point increase pension expense, the calculated value method resulted in the same in the discount rate would have decreased our 2013 PBO by approxi- value as the market value. mately $1.4 billion and a 50-basis-point decrease in the discount rate FUNDED STATUS. Following is information concerning the funded would have increased our 2013 PBO by approximately $1.5 billion. status of our pension plans as of May 31 (in millions): From 2010 to 2013, the discount rate used to value our liabilities has declined by over 150 basis points, which increased the valuation of 2013 2012 our liabilities by over $3.8 billion. Funded Status of Plans: PLAN ASSETS. The estimated average rate of return on plan assets is Projected benefit obligation (PBO) $ 22,600 $ 22,187 a long-term, forward-looking assumption that also materially affects Fair value of plan assets 19,433 17,334 our pension cost. It is required to be the expected future long-term Funded status of the plans $ (3,167) $ (4,853) rate of earnings on plan assets. Our pension plan assets are invested primarily in publicly tradeable securities, and our pension plans hold Cash Amounts: only a minimal investment in FedEx common stock that is entirely at Cash contributions during the year $ 615 $ 780 the discretion of third-party pension fund investment managers. As Benefit payments during the year $ 589 $ 502 28


  • Page 22

    MANAGEMENT’S DISCUSSION AND ANALYSIS Our retirement plans costs are expected to decrease approximately Long-Lived Assets $190 million in 2014 due to significant increases in the value of our PROPERTY AND EQUIPMENT. Our key businesses are capital plan assets in 2013 and an increase in our discount rates at our intensive, with approximately 55% of our total assets invested in our May 31, 2013 measurement date. transportation and information systems infrastructures. We capital- FUNDING. The funding requirements for our U.S. Pension Plans are ize only those costs that meet the definition of capital assets under governed by the Pension Protection Act of 2006, which has aggressive accounting standards. Accordingly, repair and maintenance costs that funding requirements in order to avoid benefit payment restrictions do not extend the useful life of an asset or are not part of the cost of that become effective if the funded status determined under IRS rules acquiring the asset are expensed as incurred. falls below 80% at the beginning of a plan year. All of our U.S. Pension The depreciation or amortization of our capital assets over their Plans have funded status levels in excess of 80% and our plans remain estimated useful lives, and the determination of any salvage values, adequately funded to provide benefits to our employees as they come requires management to make judgments about future events. due. Additionally, current benefit payments are nominal compared to our Because we utilize many of our capital assets over relatively long total plan assets (benefit payments for our U.S. Pension Plans for 2013 periods (the majority of aircraft costs are depreciated over 15 to 30 were approximately $572 million or 3% of plan assets). years), we periodically evaluate whether adjustments to our estimated During 2013, we made $560 million in required contributions to our service lives or salvage values are necessary to ensure these esti- U.S. Pension Plans. Over the past several years, we have made volun- mates properly match the economic use of the asset. This evaluation tary contributions to our U.S. Pension Plans in excess of the minimum may result in changes in the estimated lives and residual values used required contributions. Amounts contributed in excess of the minimum to depreciate our aircraft and other equipment. For our aircraft, we required can result in a credit balance for funding purposes that can typically assign no residual value due to the utilization of these assets be used to reduce minimum contribution requirements in future years. in cargo configuration, which results in little to no value at the end of Our current credit balance exceeds $2 billion at May 31, 2013. For their useful life. These estimates affect the amount of depreciation 2014, we anticipate making required contributions to our U.S. Pension expense recognized in a period and, ultimately, the gain or loss on Plans totaling approximately $650 million. the disposal of the asset. Changes in the estimated lives of assets will result in an increase or decrease in the amount of depreciation See Note 13 of the accompanying consolidated financial statements recognized in future periods and could have a material impact on our for further information about our retirement plans. results of operations. Historically, gains and losses on disposals of operating equipment have not been material. However, such amounts Self-Insurance Accruals may differ materially in the future due to changes in business levels, We are self-insured up to certain limits for costs associated with technological obsolescence, accident frequency, regulatory changes workers’ compensation claims, vehicle accidents and general business and other factors beyond our control. liabilities, and benefits paid under employee healthcare and long-term disability programs. Our reserves are established for estimates of loss In May 2013, FedEx Express made the decision to accelerate the on reported claims, including incurred-but-not-reported claims. Self- retirement of 76 aircraft and related engines to aid in our fleet insurance accruals reflected in our balance sheet were $1.7 billion at modernization and improve our global network. In May 2012, we May 31, 2013, and $1.6 billion at May 31, 2012. Approximately 41% shortened the depreciable lives for 54 aircraft and related engines of these accruals were classified as current liabilities. to accelerate the retirement of these aircraft, resulting in a deprecia- tion expense increase of $69 million in 2013. As a result of these Our self-insurance accruals are primarily based on the actuarially accelerated retirements, we expect an additional $74 million in estimated, undiscounted cost of claims incurred as of the balance year-over-year accelerated depreciation expense in 2014. sheet date. These estimates include consideration of factors such as severity of claims, frequency of claims and future healthcare costs. Because of the lengthy lead times for aircraft manufacture and Cost trends on material accruals are updated each quarter. We self- modifications, we must anticipate volume levels and plan our fleet insure up to certain limits that vary by operating company and type requirements years in advance, and make commitments for aircraft of risk. Periodically, we evaluate the level of insurance coverage and based on those projections. Furthermore, the timing and availability adjust insurance levels based on risk tolerance and premium expense. of certain used aircraft types (particularly those with better fuel Historically, it has been infrequent that incurred claims exceeded our efficiency) may create limited opportunities to acquire these aircraft self-insured limits. at favorable prices in advance of our capacity needs. These activities create risks that asset capacity may exceed demand and that We believe the use of actuarial methods to account for these liabili- an impairment of our assets may occur. Aircraft purchases (primar- ties provides a consistent and effective way to measure these highly ily aircraft in passenger configuration) that have not been placed in judgmental accruals. However, the use of any estimation technique in service totaled $129 million at May 31, 2013 and $127 million at this area is inherently sensitive given the magnitude of claims involved May 31, 2012. We plan to modify these assets in the future and and the length of time until the ultimate cost is known. We believe our place them into operations. recorded obligations for these expenses are consistently measured on a conservative basis. Nevertheless, changes in healthcare costs, accident The accounting test for whether an asset held for use is impaired frequency and severity, insurance retention levels and other factors can involves first comparing the carrying value of the asset with its esti- materially affect the estimates for these liabilities. mated future undiscounted cash flows. If the cash flows do not exceed 29


  • Page 23

    MANAGEMENT’S DISCUSSION AND ANALYSIS the carrying value, the asset must be adjusted to its current fair value. The weighted-average remaining lease term of all operating leases We operate integrated transportation networks and, accordingly, cash outstanding at May 31, 2013 was approximately six years. The future flows for most of our operating assets are assessed at a network level, commitments for operating leases are not reflected as a liability in our not at an individual asset level for our analysis of impairment. Further, balance sheet under current U.S. accounting rules. decisions about capital investments are evaluated based on the impact The determination of whether a lease is accounted for as a capital to the overall network rather than the return on an individual asset. We lease or an operating lease requires management to make estimates make decisions to remove certain long-lived assets from service based primarily about the fair value of the asset and its estimated economic on projections of reduced capacity needs or lower operating costs of useful life. In addition, our evaluation includes ensuring we properly newer aircraft types, and those decisions may result in an impairment account for build-to-suit lease arrangements and making judgments charge. Assets held for disposal must be adjusted to their estimated fair about whether various forms of lessee involvement during the values less costs to sell when the decision is made to dispose of the construction period make the lessee an agent for the owner-lessor or, asset and certain other criteria are met. The fair value determinations in substance, the owner of the asset during the construction period. for such aircraft may require management estimates, as there may not We believe we have well-defined and controlled processes for making be active markets for some of these aircraft. Such estimates are subject these evaluations, including obtaining third-party appraisals for to revision from period to period. material transactions to assist us in making these evaluations. In the normal management of our aircraft fleet, we routinely idle Under a proposed revision to the accounting standards for leases, we aircraft and engines temporarily due to maintenance cycles and would be required to record an asset and a liability for our outstanding adjustments of our network capacity to match seasonality and overall operating leases similar to the current accounting for capital leases. customer demand levels. Temporarily idled assets are classified as Notably, the amount we record in the future would be the net present available-for-use, and we continue to record depreciation expense value of our future lease commitments at the date of adoption. This associated with these assets. These temporarily idled assets are proposed guidance has not been issued and has been subjected to assessed for impairment on a quarterly basis. Factors which could numerous revisions since the proposal was issued, most recently in cause impairment include, but are not limited to, adverse changes May 2013. While we are not required to quantify the effects of the in our global economic outlook and the impact of our outlook on our proposed rule changes until these rules are finalized, we believe that current and projected volume levels, including lower capacity needs a majority of the operating lease obligations reflected in the contractual during our peak shipping seasons; the introduction of new fleet types cash obligations table would be required to be reflected in our balance or decisions to permanently retire an aircraft fleet from operations; sheet were the proposed rules to be adopted. Furthermore, our existing or changes to planned service expansion activities. We currently financing agreements and the rating agencies that evaluate our have one aircraft temporarily idled. This aircraft has been idled for creditworthiness already take our operating leases into account. 15 months and is expected to return to revenue service. GOODWILL. As of May 31, 2013, we had $2.8 billion of recorded good- In May 2013, we made the decision to retire from service two Airbus will from our acquisitions, representing the excess of the purchase A310-200 aircraft and four related engines, three Airbus A310-300 price over the fair value of the net assets we have acquired. Several aircraft and two related engines and five Boeing MD10-10 aircraft factors give rise to goodwill in our acquisitions, such as the expected and 15 related engines, to align with the plans of FedEx Express benefit from synergies of the combination and the existing workforce to modernize its aircraft fleet and improve its global network. As of the acquired entity. a consequence of this decision, a noncash impairment charge of $100 million ($63 million, net of tax, or $0.20 per diluted share) was In our evaluation of goodwill impairment, we perform a qualitative recorded in the fourth quarter. All of these aircraft were temporarily assessment which requires management judgment and the use of idled and not in revenue service. estimates to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the qualitative In 2012, we incurred a noncash impairment charge of $134 million assessment is not conclusive, we proceed to a two-step process to test ($84 million, net of tax, or $0.26 per diluted share). This charge related goodwill for impairment, including comparing the fair value of each to our May 2012 decision to permanently retire 24 aircraft and reporting unit with its carrying value (including attributable goodwill). 43 related engines to better align the U.S. domestic air network Fair value is estimated using standard valuation methodologies capacity of FedEx Express to match current and anticipated shipment (principally the income or market approach) incorporating market volumes. The majority of these aircraft were temporarily idled and participant considerations and management’s assumptions on revenue not in revenue service. growth rates, operating margins, discount rates and expected capital LEASES. We utilize operating leases to finance certain of our aircraft, expenditures. Estimates used by management can significantly affect facilities and equipment. Such arrangements typically shift the risk the outcome of the impairment test. Changes in forecasted operating of loss on the residual value of the assets at the end of the lease results and other assumptions could materially affect these estimates. period to the lessor. As disclosed in “Contractual Cash Obligations” We perform our annual impairment tests in the fourth quarter unless and Note 7 of the accompanying consolidated financial statements, at circumstances indicate the need to accelerate the timing of the tests. May 31, 2013 we had approximately $15 billion (on an undiscounted basis) of future commitments for payments under operating leases. 30


  • Page 24

    MANAGEMENT’S DISCUSSION AND ANALYSIS Our reporting units with significant recorded goodwill include our We recognize liabilities for uncertain income tax positions based on a FedEx Express, FedEx Freight and FedEx Office (reported in the FedEx two-step process. The first step is to evaluate the tax position for rec- Services segment) reporting units. We evaluated these reporting units ognition by determining if the weight of available evidence indicates during the fourth quarters of 2013 and 2012. The estimated fair value that it is more likely than not that the position will be sustained on of each of these reporting units exceeded their carrying values in 2013 audit, including resolution of related appeals or litigation processes, and 2012, and we do not believe that any of these reporting units if any. The second step requires us to estimate and measure the tax were at risk as of May 31, 2013. benefit as the largest amount that is more than 50% likely to be real- ized upon ultimate settlement. It is inherently difficult and subjective Contingencies to estimate such amounts, as we must determine the probability of We are subject to various loss contingencies, including tax proceed- various possible outcomes. We reevaluate these uncertain tax posi- ings and litigation, in connection with our operations. Contingent tions on a quarterly basis or when new information becomes available liabilities are difficult to measure, as their measurement is subject to management. These reevaluations are based on factors including, to multiple factors that are not easily predicted or projected. Further, but not limited to, changes in facts or circumstances, changes in tax additional complexity in measuring these liabilities arises due to the law, successfully settled issues under audit and new audit activity. various jurisdictions in which these matters occur, which makes our Such a change in recognition or measurement could result in the ability to predict their outcome highly uncertain. Moreover, different recognition of a tax benefit or an increase to the related provision. accounting rules must be employed to account for these items based We classify interest related to income tax liabilities as interest on the nature of the contingency. Accordingly, significant management expense, and if applicable, penalties are recognized as a component judgment is required to assess these matters and to make determina- of income tax expense. The income tax liabilities and accrued interest tions about the measurement of a liability, if any. Our material pending and penalties that are due within one year of the balance sheet date loss contingencies are described in Note 18 of the accompanying are presented as current liabilities. The remaining portion of our consolidated financial statements. In the opinion of management, the income tax liabilities and accrued interest and penalties are presented aggregate liability, if any, of individual matters or groups of matters as noncurrent liabilities because payment of cash is not anticipated not specifically described in Note 18 is not expected to be material to within one year of the balance sheet date. These noncurrent income our financial position, results of operations or cash flows. The follow- tax liabilities are recorded in the caption “Other liabilities” in the ing describes our methods and associated processes for evaluating accompanying consolidated balance sheets. these matters. We account for operating taxes based on multi-state, local and TAX CONTINGENCIES. We are subject to income and operating tax foreign taxing jurisdiction rules in those areas in which we operate. rules of the U.S., its states and municipalities, and of the foreign Provisions for operating taxes are estimated based upon these rules, jurisdictions in which we operate. Significant judgment is required in asset acquisitions and disposals, historical spend and other variables. determining income tax provisions, as well as deferred tax asset and These provisions are consistently evaluated for reasonableness liability balances and related deferred tax valuation allowances, if against compliance and risk factors. necessary, due to the complexity of these rules and their interaction with one another. We account for income taxes by recording both We measure and record operating tax contingency accruals in current taxes payable and deferred tax assets and liabilities. Our accordance with accounting guidance for contingencies. As discussed provision for income taxes is based on domestic and international below, this guidance requires an accrual of estimated loss from a statutory income tax rates in the jurisdictions in which we operate, contingency, such as a tax or other legal proceeding or claim, when it applied to taxable income, reduced by applicable tax credits. is probable that a loss will be incurred and the amount of the loss can be reasonably estimated. Tax contingencies arise from uncertainty in the application of tax rules throughout the many jurisdictions in which we operate and are OTHER CONTINGENCIES. Because of the complex environment in impacted by several factors, including tax audits, appeals, litigation, which we operate, we are subject to other legal proceedings and changes in tax laws and other rules and their interpretations, and claims, including those relating to general commercial matters, changes in our business. We regularly assess the potential impact employment-related claims and FedEx Ground’s owner-operators. of these factors for the current and prior years to determine the Accounting guidance for contingencies requires an accrual of esti- adequacy of our tax provisions. We continually evaluate the likelihood mated loss from a contingency, such as a tax or other legal proceeding and amount of potential adjustments and adjust our tax positions, or claim, when it is probable (i.e., the future event or events are likely including the current and deferred tax liabilities, in the period in which to occur) that a loss has been incurred and the amount of the loss can the facts that give rise to a revision become known. In addition, man- be reasonably estimated. This guidance also requires disclosure of a agement considers the advice of third parties in making conclusions loss contingency matter when, in management’s judgment, a material regarding tax consequences. loss is reasonably possible or probable. 31


  • Page 25

    MANAGEMENT’S DISCUSSION AND ANALYSIS During the preparation of our financial statements, we evaluate our QUANTITATIVE AND QUALITATIVE contingencies to determine whether it is probable, reasonably pos- sible or remote that a liability has been incurred. A loss is recognized DISCLOSURES ABOUT MARKET RISK for all contingencies deemed probable and estimable, regardless of amount. For unresolved contingencies with potentially material INTEREST RATES. While we currently have market risk sensitive exposure that are deemed reasonably possible, we evaluate whether instruments related to interest rates, we have no significant exposure a potential loss or range of loss can be reasonably estimated. to changing interest rates on our long-term debt because the interest rates are fixed on all of our long-term debt. As disclosed in Note 6 Our evaluation of these matters is the result of a comprehensive to the accompanying consolidated financial statements, we had process designed to ensure that accounting recognition of a loss or outstanding fixed-rate, long-term debt (exclusive of capital leases) disclosure of these contingencies is made in a timely manner and with estimated fair values of $3.2 billion at May 31, 2013 and involves our legal and accounting personnel, as well as external $2.0 billion at May 31, 2012. Market risk for fixed-rate, long-term counsel where applicable. The process includes regular communica- debt is estimated as the potential decrease in fair value resulting tions during each quarter and scheduled meetings shortly before the from a hypothetical 10% increase in interest rates and amounts to completion of our financial statements to evaluate any new legal $77 million as of May 31, 2013 and $30 million as of May 31, 2012. proceedings and the status of any existing matters. The underlying fair values of our long-term debt were estimated based In determining whether a loss should be accrued or a loss contingency on quoted market prices or on the current rates offered for debt with disclosed, we evaluate, among other factors: similar terms and maturities. > the current status of each matter within the scope and context of the We have interest rate risk with respect to our pension and postre- entire lawsuit (i.e., the lengthy and complex nature of class-action tirement benefit obligations. Changes in interest rates impact our matters); liabilities associated with these benefit plans as well as the amount of pension and postretirement benefit expense recognized. Declines > the procedural status of each lawsuit; in the value of plan assets could diminish the funded status of our > any opportunities to dispose of the lawsuit on its merits before trial pension plans and potentially increase our requirement to make con- (i.e., motion to dismiss or for summary judgment); tributions to the plans. Substantial investment losses on plan assets will also increase pension and postretirement benefit expense in the > the amount of time remaining before the trial date; years following the losses. > the status of discovery; FOREIGN CURRENCY. While we are a global provider of transporta- > the status of settlement, arbitration or mediation proceedings, and; tion, e-commerce and business services, the substantial majority of our transactions are denominated in U.S. dollars. The principal > our judgment regarding the likelihood of success prior to or at trial. foreign currency exchange rate risks to which we are exposed are in In reaching our conclusions with respect to accrual of a loss or loss the Chinese yuan, euro, Brazilian real, Canadian dollar and the British contingency disclosure, we take a holistic view of each matter based pound. Historically, our exposure to foreign currency fluctuations is on these factors and the information available prior to the issuance more significant with respect to our revenues than our expenses, as of our financial statements. Uncertainty with respect to an individual a significant portion of our expenses are denominated in U.S. dollars, factor or combination of these factors may impact our decisions such as aircraft and fuel expenses. During 2013 and 2012, foreign cur- related to accrual or disclosure of a loss contingency, including a rency fluctuations had a slightly positive impact on operating income. conclusion that we are unable to establish an estimate of possible However, favorable foreign currency fluctuations also may have had loss or a meaningful range of possible loss. We update our disclo- an offsetting impact on the price we obtained or the demand for our sures to reflect our most current understanding of the contingencies services, which is not quantifiable. At May 31, 2013, the result of a at the time we issue our financial statements. However, events may uniform 10% strengthening in the value of the dollar relative to the arise that were not anticipated and the outcome of a contingency currencies in which our transactions are denominated would result in may result in a loss to us that differs materially from our previously a decrease in operating income of $132 million for 2014. This theoreti- estimated liability or range of possible loss. cal calculation required under SEC guidelines assumes that each exchange rate would change in the same direction relative to the U.S. Despite the inherent complexity in the accounting and disclosure of dollar, which is not consistent with our actual experience in foreign contingencies, we believe that our processes are robust and thorough currency transactions. In addition to the direct effects of changes in and provide a consistent framework for management in evaluating the exchange rates, fluctuations in exchange rates also affect the volume potential outcome of contingencies for proper accounting recognition of sales or the foreign currency sales price as competitors’ services and disclosure. become more or less attractive. The sensitivity analysis of the effects of changes in foreign currency exchange rates does not factor in a potential change in sales levels or local currency prices. 32


  • Page 26

    MANAGEMENT’S DISCUSSION AND ANALYSIS COMMODITY. While we have market risk for changes in the price (whether or not justified) relating to activities by our employees, of jet and vehicle fuel, this risk is largely mitigated by our fuel contractors or agents, such as customer service mishaps or noncom- surcharges because our fuel surcharges are closely linked to market pliance with anti-corruption laws, could tarnish our reputation and prices for fuel. Therefore, a hypothetical 10% change in the price of reduce the value of our brand. With the increase in the use of social fuel would not be expected to materially affect our earnings over the media outlets such as YouTube and Twitter, adverse publicity can be long term. disseminated quickly and broadly, making it increasingly difficult for us to defend against. Damage to our reputation and loss of brand However, our fuel surcharges have a timing lag (approximately six equity could reduce demand for our services and thus have an adverse to eight weeks for FedEx Express and FedEx Ground) before they are effect on our financial condition, liquidity and results of operations, adjusted for changes in fuel prices. Our fuel surcharge index also as well as require additional resources to rebuild our reputation and allows fuel prices to fluctuate approximately 2% for FedEx Express restore the value of our brand. and approximately 4% for FedEx Ground before an adjustment to the fuel surcharge occurs. Accordingly, our operating income in a specific We rely heavily on information and technology to operate our period may be significantly affected should the spot price of fuel sud- transportation and business networks, and any disruption to our denly change by a substantial amount or change by amounts that do technology infrastructure or the Internet could harm our opera- not result in an adjustment in our fuel surcharges. tions and our reputation among customers. Our ability to attract and retain customers and to compete effectively depends in part upon OTHER. We do not purchase or hold any derivative financial instru- the sophistication and reliability of our technology network, includ- ments for trading purposes. ing our ability to provide features of service that are important to our customers. External and internal risks, such as malware, code anoma- lies, “Acts of God,” attempts to penetrate our networks, transitional RISK FACTORS challenges in migrating operating company functionality to our FedEx enterprise automation platform, data leakage and human error, pose a Our financial and operating results are subject to many risks and direct threat to our products, services and data. Any disruption to the uncertainties, as described below. Internet or our complex, global technology infrastructure, including We are directly affected by the state of the economy. While those impacting our computer systems and customer websites, could macro-economic risks apply to most companies, we are particularly adversely impact our customer service, volumes, and revenues and vulnerable. The transportation industry is highly cyclical and espe- result in increased costs. These types of adverse impacts could also cially susceptible to trends in economic activity. Our primary business occur in the event the confidentiality, integrity, or availability of com- is to transport goods, so our business levels are directly tied to the pany and customer information was compromised due to a data loss purchase and production of goods — key macro-economic measure- by FedEx or a trusted third party. While we have invested and continue ments. When individuals and companies purchase and produce fewer to invest in technology security initiatives, information technology risk goods, we transport fewer goods, and as companies expand the management and disaster recovery plans, these measures cannot fully number of distribution centers and move manufacturing closer to con- insulate us from technology disruptions or data loss and the resulting sumer markets, we transport goods shorter distances. In addition, we adverse effect on our operations and financial results. have a relatively high fixed-cost structure, which is difficult to quickly Our transportation businesses are impacted by the price and adjust to match shifting volume levels. Moreover, as we continue to availability of fuel. We must purchase large quantities of fuel to grow our international business, we are increasingly affected by the operate our aircraft and vehicles, and the price and availability of health of the global economy and the typically more volatile econo- fuel can be unpredictable and beyond our control. To date, we have mies of emerging markets. In 2013, slower than expected economic been mostly successful in mitigating over time the expense impact of growth resulted in a continued customer preference for slower, higher fuel costs through our indexed fuel surcharges, as the amount less costly shipping services, which had a negative impact on our of the surcharges is closely linked to the market prices for fuel. If we profitability. are unable to maintain or increase our fuel surcharges because of Our businesses depend on our strong reputation and the value competitive pricing pressures or some other reason, fuel costs could of the FedEx brand. The FedEx brand name symbolizes high-quality adversely impact our operating results. Even if we are able to offset service, reliability and speed. FedEx is one of the most widely recog- the cost of fuel with our surcharges, high fuel surcharges could move nized, trusted and respected brands in the world, and the FedEx brand our customers away from our higher-yielding express services to our is one of our most important and valuable assets. In addition, we have lower-yielding deferred or ground services or even reduce customer a strong reputation among customers and the general public for high demand for our services altogether. In addition, disruptions in the sup- standards of social and environmental responsibility and corporate ply of fuel could have a negative impact on our ability to operate our governance and ethics. The FedEx brand name and our corporate transportation networks. reputation are powerful sales and marketing tools, and we devote sig- nificant resources to promoting and protecting them. Adverse publicity 33


  • Page 27

    MANAGEMENT’S DISCUSSION AND ANALYSIS Our businesses are capital intensive, and we must make capital Labor organizations attempt to organize groups of our employ- decisions based upon projected volume levels. We make signifi- ees from time to time, and potential changes in labor laws could cant investments in aircraft, vehicles, technology, package handling make it easier for them to do so. If we are unable to continue to facilities, sort equipment, copy equipment and other assets to support maintain good relationships with our employees and prevent labor our transportation and business networks. We also make significant organizations from organizing groups of our employees, our operating investments to rebrand, integrate and grow the companies that we costs could significantly increase and our operational flexibility could acquire. The amount and timing of capital investments depend on be significantly reduced. Despite continual organizing attempts by various factors, including our anticipated volume growth. We must labor unions, other than the pilots of FedEx Express, all of our U.S. make commitments to purchase or modify aircraft years before the employees have thus far chosen not to unionize. The U.S. Congress aircraft are actually needed. We must predict volume levels and fleet has, in the past, considered adopting changes in labor laws, how- requirements and make commitments for aircraft based on those pro- ever, that would make it easier for unions to organize units of our jections. Missing our projections could result in too much or too little employees. For example, there is always a possibility that Congress capacity relative to our shipping volumes. Overcapacity could lead to could remove most FedEx Express employees from the purview of the asset dispositions or write-downs and undercapacity could negatively Railway Labor Act of 1926, as amended (the “RLA”). Such legislation impact service levels. For example, in the fourth quarter of 2013, we could expose our customers to the type of service disruptions that the made a decision to retire from service certain aircraft and excess RLA was designed to prevent — local work stoppages in key areas aircraft engines and thus recorded a noncash impairment charge of that interrupt the timely flow of shipments of time-sensitive, high- $100 million. value goods throughout our global network. Such disruptions could threaten our ability to provide competitively priced shipping options We face intense competition. The transportation and business ser- and ready access to global markets. There is also the possibility that vices markets are both highly competitive and sensitive to price and Congress could pass other labor legislation that could adversely affect service, especially in periods of little or no macro-economic growth. our companies, such as FedEx Ground and FedEx Freight, whose Some of our competitors have more financial resources than we do, employees are governed by the National Labor Relations Act of 1935, or they are controlled or subsidized by foreign governments, which as amended (the “NLRA”). In addition, federal and state governmental enables them to raise capital more easily. We believe we compete agencies, such as the National Labor Relations Board, have and may effectively with these companies — for example, by providing more continue to take actions that could make it easier for our employees reliable service at compensatory prices. However, an irrational pricing to organize under the RLA or NLRA. Finally, changes to federal or state environment can limit our ability not only to maintain or increase laws governing employee classification could impact the status of our prices (including our fuel surcharges in response to rising fuel FedEx Ground’s owner-operators as independent contractors. costs), but also to maintain or grow our market share. In addition, high volume package shippers could develop in-house ground delivery FedEx Ground relies on owner-operators to conduct its linehaul capabilities, which would in turn reduce our revenues and market and pickup-and-delivery operations, and the status of these share. While we believe we compete effectively through our current owner-operators as independent contractors, rather than service offerings, if our current competitors or potential future com- employees, is being challenged. FedEx Ground’s use of independent petitors offer a broader range of services or more effectively bundle contractors is well suited to the needs of the ground delivery business their services or our current customers become competitors, it could and its customers, as evidenced by the strong growth of this business impede our ability to maintain or grow our market share. segment. We are involved in numerous lawsuits and state tax and other administrative proceedings that claim that the company’s If we do not effectively operate, integrate, leverage and grow owner-operators or their drivers should be treated as our employees, acquired businesses, our financial results and reputation may rather than independent contractors. We incur certain costs, including suffer. Our strategy for long-term growth, productivity and profitability legal fees, in defending the status of FedEx Ground’s owner-operators depends in part on our ability to make prudent strategic acquisitions as independent contractors. We believe that FedEx Ground’s owner- and to realize the benefits we expect when we make those acquisi- operators are properly classified as independent contractors and that tions. In furtherance of this strategy, in 2013, we made strategic FedEx Ground is not an employer of the drivers of the company’s acquisitions in Poland, France and Brazil. While we expect our past independent contractors. However, adverse determinations in these and future acquisitions to enhance our value proposition to customers matters could, among other things, entitle certain of our owner- and improve our long-term profitability, there can be no assurance operators and their drivers to the reimbursement of certain expenses that we will realize our expectations within the time frame we have and to the benefit of wage-and-hour laws and result in employment established, if at all, or that we can continue to support the value and withholding tax and benefit liability for FedEx Ground, and could we allocate to these acquired businesses, including their goodwill or result in changes to the independent contractor status of FedEx other intangible assets. Ground’s owner-operators. Changes to state laws governing the definition of independent contractors could impact the status of FedEx Ground’s owner-operators. If FedEx Ground is compelled to convert its independent contractors to employees, labor organizations could more easily organize these individuals, our operating costs could increase materially and we could incur significant capital outlays. 34


  • Page 28

    MANAGEMENT’S DISCUSSION AND ANALYSIS Failure to execute on our business realignment program will We may be affected by global climate change or by legal, cause our future financial results to suffer. In 2013, we announced regulatory or market responses to such change. Concern over profit improvement programs primarily through initiatives at FedEx climate change, including the impact of global warming, has led to Express and FedEx Services that include cost reductions, modern- significant U.S. and international legislative and regulatory efforts to ization of our aircraft fleet, transformation of the U.S. domestic limit greenhouse gas (“GHG”) emissions, including our aircraft and operations and international profit improvements at FedEx Express, diesel engine emissions. For example, during 2009, the European and improved efficiencies and lower costs of information technology Commission approved the extension of the European Union Emissions at FedEx Services. To this end, during 2013, we conducted a program Trading Scheme (“ETS”) for GHG emissions, to the airline industry. to offer voluntary cash buyouts to eligible U.S.-based employees in Under this decision, all FedEx Express flights to and from any airport certain staff functions. Additionally, we announced in May 2013 our in any member state of the European Union are now covered by the decision to retire from service 10 aircraft and related engines, as ETS requirements, and each year we are required to submit emission well as to shorten the depreciable lives of an additional 76 aircraft allowances in an amount equal to the carbon dioxide emissions from and related engines, in an effort to modernize our aircraft fleet and such flights. Because the European Union ETS is being contested by improve our global network. We will continue to work towards the many countries on a number of fronts, and the effective date for parts plan of annual profitability improvement of $1.6 billion by the end of of the ETS has been delayed until next year, the future impact on us 2016, but if we are not able to reach this goal in the face of challeng- is unclear. In addition, the U.S. Congress has, in the past, considered ing economic conditions, our future financial results may suffer. bills that would regulate GHG emissions, and some form of federal climate change legislation is possible in the future. Increased regula- The transportation infrastructure continues to be a target of tion regarding GHG emissions, especially aircraft or diesel engine terrorist activities. Because transportation assets continue to be emissions, could impose substantial costs on us, especially at FedEx a target of terrorist activities, governments around the world are Express. These costs include an increase in the cost of the fuel and adopting or are considering adopting stricter security requirements other energy we purchase and capital costs associated with updat- that will increase operating costs and potentially slow service ing or replacing our aircraft or vehicles prematurely. Until the timing, for businesses, including those in the transportation industry. For scope and extent of such regulation becomes known, we cannot example, the U.S. Transportation Security Administration continues predict its effect on our cost structure or our operating results. It is to require FedEx Express to comply with a Full All-Cargo Aircraft reasonably possible, however, that it could impose material costs on Operator Standard Security Plan, which contains evolving and strict us. Moreover, even without such regulation, increased awareness and security requirements. These requirements are not static, but change any adverse publicity in the global marketplace about the GHGs emit- periodically as the result of regulatory and legislative requirements, ted by companies in the airline and transportation industries could imposing additional security costs and creating a level of uncertainty harm our reputation and reduce customer demand for our services, for our operations. Thus, it is reasonably possible that these rules or especially our air express services. Finally, given the broad and global other future security requirements could impose material costs on scope of our operations and our susceptibility to global macro- us. Moreover, a terrorist attack directed at FedEx or other aspects economic trends, we are particularly vulnerable to the physical risks of the transportation infrastructure could disrupt our operations and of climate change that could affect all of humankind, such as shifts adversely impact demand for our services. in weather patterns and world ecosystems. The regulatory environment for global aviation or other transpor- A localized disaster in a key geography could adversely impact tation rights may impact our operations. Our extensive air network our business. While we operate several integrated networks with is critical to our success. Our right to serve foreign points is subject assets distributed throughout the world, there are concentrations to the approval of the Department of Transportation and generally of key assets within our networks that are exposed to localized requires a bilateral agreement between the United States and foreign risks from natural or manmade disasters such as tornados, floods, governments. In addition, we must obtain the permission of foreign earthquakes or terrorist attacks. The loss of a key location such as governments to provide specific flights and services. Our opera- our Memphis super hub or one of our information technology centers tions outside of the United States, such as FedEx Express’s growing could cause a significant disruption to our operations and cause us international domestic operations, are also subject to current and to incur significant costs to reestablish or relocate these functions. potential regulations, including certain postal regulations and licens- Moreover, resulting economic dislocations, including supply chain and ing requirements, that restrict, make difficult and sometimes prohibit, fuel disruptions, could adversely impact demand for our services. the ability of foreign-owned companies such as FedEx Express to compete effectively in parts of the international domestic transporta- tion and logistics market. Regulatory actions affecting global aviation or transportation rights or a failure to obtain or maintain aviation or other transportation rights in important international markets could impair our ability to operate our networks. 35


  • Page 29

    MANAGEMENT’S DISCUSSION AND ANALYSIS Our business may be adversely impacted by disruptions or modi- FORWARD-LOOKING STATEMENTS fications in service by the USPS. The USPS is a significant customer and vendor of FedEx, and thus, disruptions or modifications in services Certain statements in this report, including (but not limited to) those by the USPS as a consequence of the USPS’s current financial difficul- contained in “Outlook” (including segment outlooks), “Liquidity,” ties or any resulting structural changes to its operations, network, “Capital Resources,” “Liquidity Outlook,” “Contractual Cash service offerings or pricing could have an adverse effect on our opera- Obligations” and “Critical Accounting Estimates,” and the “Retirement tions and financial results. Plans” and “Contingencies” notes to the consolidated financial state- We are also subject to other risks and uncertainties that affect ments, are “forward-looking” statements within the meaning of the many other businesses, including: Private Securities Litigation Reform Act of 1995 with respect to our financial condition, results of operations, cash flows, plans, objec- > increasing costs, the volatility of costs and funding requirements and tives, future performance and business. Forward-looking statements other legal mandates for employee benefits, especially pension and include those preceded by, followed by or that include the words healthcare benefits; “may,” “could,” “would,” “should,” “believes,” “expects,” “antici- > the increasing costs of compliance with federal and state govern- pates,” “plans,” “estimates,” “targets,” “projects,” “intends” or mental agency mandates and defending against inappropriate or similar expressions. These forward-looking statements involve risks unjustified enforcement or other actions by such agencies; and uncertainties. Actual results may differ materially from those con- templated (expressed or implied) by such forward-looking statements, > the impact of any international conflicts on the United States and because of, among other things, the risk factors identified above and global economies in general, the transportation industry or us in the other risks and uncertainties you can find in our press releases and particular, and what effects these events will have on our costs or other SEC filings. the demand for our services; As a result of these and other factors, no assurance can be given as > any impacts on our businesses resulting from new domestic or inter- to our future results and achievements. Accordingly, a forward-looking national government laws and regulation; statement is neither a prediction nor a guarantee of future events > changes in foreign currency exchange rates, especially in the Chinese or circumstances and those future events or circumstances may not yuan, euro, Brazilian real, Canadian dollar and the British pound, which occur. You should not place undue reliance on the forward-looking can affect our sales levels and foreign currency sales prices; statements, which speak only as of the date of this report. We are under no obligation, and we expressly disclaim any obligation, to > market acceptance of our new service and growth initiatives; update or alter any forward-looking statements, whether as a result of > any liability resulting from and the costs of defending against class- new information, future events or otherwise. action litigation, such as wage-and-hour and discrimination and retaliation claims, and any other legal or governmental proceedings; > the outcome of future negotiations to reach new collective bargain- ing agreements — including with the union that represents the pilots of FedEx Express (the current pilot contract became amendable in March 2013, and the parties are currently in negotiations); > the impact of technology developments on our operations and on demand for our services, and our ability to continue to identify and eliminate unnecessary information technology redundancy and complexity throughout the organization; > widespread outbreak of an illness or any other communicable dis- ease, or any other public health crisis; and > availability of financing on terms acceptable to us and our ability to maintain our current credit ratings, especially given the capital intensity of our operations. 36


  • Page 30

    FEDEX CORPORATION MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING 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 transac- tions 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 all identified deficiencies. 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, 2013, 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, 2013. The effectiveness of our internal control over financial reporting as of May 31, 2013, has been audited by Ernst & Young LLP, the independent registered public accounting firm who also audited the Company’s consolidated financial statements included in this Annual Report. Ernst & Young LLP’s report on the Company’s internal control over financial reporting is included in this Annual Report. 37


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    REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders FedEx Corporation We have audited FedEx Corporation’s internal control over financial reporting as of May 31, 2013, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). FedEx Corporation’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s 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, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, 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 company’s 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 company’s 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 company’s 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, FedEx Corporation maintained, in all material respects, effective internal control over financial reporting as of May 31, 2013, 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, 2013 and 2012, and the related consolidated statements of income, comprehensive income (loss), changes in stockholders’ investment, and cash flows for each of the three years in the period ended May 31, 2013 of FedEx Corporation and our report dated July 15, 2013 expressed an unqualified opinion thereon. Memphis, Tennessee July 15, 2013 38


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    FEDEX CORPORATION CONSOLIDATED STATEMENTS OF INCOME Years ended May 31, (in millions, except per share amounts) 2013 2012 2011 Revenues $ 44,287 $ 42,680 $ 39,304 Operating Expenses: Salaries and employee benefits 16,570 16,099 15,276 Purchased transportation 7,272 6,335 5,674 Rentals and landing fees 2,521 2,487 2,462 Depreciation and amortization 2,386 2,113 1,973 Fuel 4,746 4,956 4,151 Maintenance and repairs 1,909 1,980 1,979 Business realignment, impairment and other charges 660 134 89 Other 5,672 5,390 5,322 41,736 39,494 36,926 Operating Income 2,551 3,186 2,378 Other Income (Expense): Interest expense (82) (52) (86) Interest income 21 13 9 Other, net (35) (6) (36) (96) (45) (113) Income Before Income Taxes 2,455 3,141 2,265 Provision For Income Taxes 894 1,109 813 Net Income $ 1,561 $ 2,032 $ 1,452 Basic Earnings Per Common Share $ 4.95 $ 6.44 $ 4.61 Diluted Earnings Per Common Share $ 4.91 $ 6.41 $ 4.57 The accompanying notes are an integral part of these consolidated financial statements. 39


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    FEDEX CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) Years ended May 31, (in millions) 2013 2012 2011 Net Income $ 1,561 $ 2,032 $ 1,452 Other Comprehensive Income (Loss): Foreign currency translation adjustments, net of tax benefit of $12 and $26 in 2013 and 2012 and tax expense of $27 in 2011 41 (95) 125 Amortization of unrealized pension actuarial gains/losses and other, net of tax expense of $677 in 2013 and tax benefit of $1,369 and $141 in 2012 and 2011 1,092 (2,308) (235) 1,133 (2,403) (110) Comprehensive Income (Loss) $ 2,694 $ (371) $ 1,342 The accompanying notes are an integral part of these consolidated financial statements. 40


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    FEDEX CORPORATION CONSOLIDATED BALANCE SHEETS May 31, (in millions, except share data) 2013 2012 Assets Current Assets Cash and cash equivalents $ 4,917 $ 2,843 Receivables, less allowances of $176 and $178 5,044 4,704 Spare parts, supplies and fuel, less allowances of $205 and $184 457 440 Deferred income taxes 533 533 Prepaid expenses and other 323 536 Total current assets 11,274 9,056 Property and Equipment, at Cost Aircraft and related equipment 14,716 14,360 Package handling and ground support equipment 6,452 5,912 Computer and electronic equipment 4,958 4,646 Vehicles 4,080 3,654 Facilities and other 7,903 7,592 38,109 36,164 Less accumulated depreciation and amortization 19,625 18,916 Net property and equipment 18,484 17,248 Other Long-Term Assets Goodwill 2,755 2,387 Other assets 1,054 1,212 Total other long-term assets 3,809 3,599 $ 33,567 $ 29,903 Liabilities and Stockholders’ Investment Current Liabilities Current portion of long-term debt $ 251 $ 417 Accrued salaries and employee benefits 1,688 1,635 Accounts payable 1,879 1,613 Accrued expenses 1,932 1,709 Total current liabilities 5,750 5,374 Long-Term Debt, Less Current Portion 2,739 1,250 Other Long-Term Liabilities Deferred income taxes 1,652 836 Pension, postretirement healthcare and other benefit obligations 3,916 5,582 Self-insurance accruals 987 963 Deferred lease obligations 778 784 Deferred gains, principally related to aircraft transactions 227 251 Other liabilities 120 136 Total other long-term liabilities 7,680 8,552 Commitments and Contingencies Common Stockholders’ Investment Common stock, $0.10 par value; 800 million shares authorized; 318 million shares issued as of May 31, 2013 and 317 million shares issued as of May 31, 2012 32 32 Additional paid-in capital 2,668 2,595 Retained earnings 18,519 17,134 Accumulated other comprehensive loss (3,820) (4,953) Treasury stock, at cost (1) (81) Total common stockholders’ investment 17,398 14,727 $ 33,567 $ 29,903 The accompanying notes are an integral part of these consolidated financial statements. 41


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    FEDEX CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended May 31, (in millions) 2013 2012 2011 Operating Activities Net Income $ 1,561 $ 2,032 $ 1,452 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization 2,386 2,113 1,973 Provision for uncollectible accounts 167 160 152 Deferred income taxes and other noncash items 521 1,126 669 Business realignment, impairment and other charges 479 134 29 Stock-based compensation 109 105 98 Changes in assets and liabilities: Receivables (451) (254) (400) Other current assets 257 (231) (114) Pension assets and liabilities, net (335) (453) (169) Accounts payable and other liabilities 10 144 370 Other, net (16) (41) (19) Cash provided by operating activities 4,688 4,835 4,041 Investing Activities Capital expenditures (3,375) (4,007) (3,434) Business acquisitions, net of cash acquired (483) (116) (96) Proceeds from asset dispositions and other 55 74 111 Cash used in investing activities (3,803) (4,049) (3,419) Financing Activities Principal payments on debt (417) (29) (262) Proceeds from debt issuances 1,739 – – Proceeds from stock issuances 280 128 108 Excess tax benefit on the exercise of stock options 23 18 23 Dividends paid (177) (164) (151) Purchase of treasury stock (246) (197) – Other, net (18) – (5) Cash provided by (used in) financing activities 1,184 (244) (287) Effect of exchange rate changes on cash 5 (27) 41 Net increase in cash and cash equivalents 2,074 515 376 Cash and cash equivalents at beginning of period 2,843 2,328 1,952 Cash and cash equivalents at end of period $ 4,917 $ 2,843 $ 2,328 The accompanying notes are an integral part of these consolidated financial statements. 42


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    FEDEX CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ INVESTMENT Accumulated Additional Other Common Paid-in Retained Comprehensive Treasury (in millions, except share data) Stock Capital Earnings Income (Loss) Stock Total Balance at May 31, 2010 $ 31 $ 2,261 $ 13,966 $ (2,440) $ (7) $ 13,811 Net income – – 1,452 – – 1,452 Other comprehensive loss, net of tax of $114 – – – (110) – (110) Purchase of treasury stock – – – – (5) (5) Cash dividends declared ($0.48 per share) – – (152) – – (152) Employee incentive plans and other (2,229,051 shares issued) 1 223 – – – 224 Balance at May 31, 2011 32 2,484 15,266 (2,550) (12) 15,220 Net income – – 2,032 – – 2,032 Other comprehensive loss, net of tax of $1,395 – – – (2,403) – (2,403) Purchase of treasury stock – – – – (197) (197) Cash dividends declared ($0.52 per share) – – (164) – – (164) Employee incentive plans and other (2,359,659 shares issued) – 111 – – 128 239 Balance at May 31, 2012 32 2,595 17,134 (4,953) (81) 14,727 Net income – – 1,561 – – 1,561 Other comprehensive gain, net of tax of $665 – – – 1,133 – 1,133 Purchase of treasury stock – – – – (246) (246) Cash dividends declared ($0.56 per share) – – (176) – – (176) Employee incentive plans and other (4,172,976 shares issued) – 73 – – 326 399 Balance at May 31, 2013 $ 32 $ 2,668 $ 18,519 $ (3,820) $ (1) $ 17,398 The accompanying notes are an integral part of these consolidated financial statements. 43


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    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: DESCRIPTION OF BUSINESS Our contract logistics, global trade services and certain transportation businesses, such as FedEx SmartPost, engage in some transactions AND SUMMARY OF SIGNIFICANT wherein they act as agents. Revenue from these transactions is ACCOUNTING POLICIES recorded on a net basis. Net revenue includes billings to customers less third-party charges, including transportation or handling costs, DESCRIPTION OF BUSINESS. FedEx Corporation (“FedEx”) provides a fees, commissions, and taxes and duties. broad portfolio of transportation, e-commerce and business services Certain of our revenue-producing transactions are subject to taxes, through companies competing collectively, operating independently such as sales tax, assessed by governmental authorities. We present and managed collaboratively, under the respected FedEx brand. Our these revenues net of tax. primary operating companies are Federal Express Corporation (“FedEx Express”), the world’s largest express transportation company; FedEx CREDIT RISK. We routinely grant credit to many of our customers Ground Package System, Inc. (“FedEx Ground”), a leading North for transportation and business services without collateral. The risk American provider of small-package ground delivery services; and of credit loss in our trade receivables is substantially mitigated by FedEx Freight, Inc. (“FedEx Freight”), a leading North American pro- our credit evaluation process, short collection terms and sales to a vider of less-than-truckload (“LTL”) freight services. These companies large number of customers, as well as the low revenue per transac- represent our major service lines and, along with FedEx Corporate tion for most of our services. Allowances for potential credit losses Services, Inc. (“FedEx Services”), form the core of our reportable are determined based on historical experience and the impact of segments. Our FedEx Services segment provides sales, marketing, current economic factors on the composition of accounts receiv- information technology, communications and back-office support to able. Historically, credit losses have been within management’s our transportation segments. In addition, the FedEx Services segment expectations. provides customers with retail access to FedEx Express and FedEx ADVERTISING. Advertising and promotion costs are expensed as Ground shipping services through FedEx Office and Print Services, Inc. incurred and are classified in other operating expenses. Advertising (“FedEx Office”) and provides customer service, technical support and and promotion expenses were $424 million in 2013, $421 million in billing and collection services through FedEx TechConnect, Inc. (“FedEx 2012 and $375 million in 2011. TechConnect”). CASH EQUIVALENTS. Cash in excess of current operating require- FISCAL YEARS. Except as otherwise specified, references to years ments is invested in short-term, interest-bearing instruments with indicate our fiscal year ended May 31, 2013 or ended May 31 of the maturities of three months or less at the date of purchase and is year referenced. stated at cost, which approximates market value. PRINCIPLES OF CONSOLIDATION. The consolidated financial state- SPARE PARTS, SUPPLIES AND FUEL. Spare parts (principally aircraft- ments include the accounts of FedEx and its subsidiaries, substantially related) are reported at weighted-average cost. Allowances for all of which are wholly owned. All significant intercompany accounts obsolescence are provided for spare parts expected to be on hand and transactions have been eliminated in consolidation. We are not at the date the aircraft are retired from service. These allowances the primary beneficiary of, nor do we have a controlling financial are provided over the estimated useful life of the related aircraft and interest in, any variable interest entity. Accordingly, we have not engines. Additionally, allowances for obsolescence are provided for consolidated any variable interest entity. spare parts currently identified as excess or obsolete. These allow- REVENUE RECOGNITION. We recognize revenue upon delivery of ances are based on management estimates, which are subject to shipments for our transportation businesses and upon completion change. The majority of our supplies and our fuel are reported at of services for our business services, logistics and trade services weighted average cost. businesses. Transportation services are provided with the use of PROPERTY AND EQUIPMENT. Expenditures for major additions, employees and independent contractors. FedEx is the principal to improvements and flight equipment modifications are capitalized the transaction for most of these services and revenue from these when such costs are determined to extend the useful life of the asset transactions is recognized on a gross basis. Costs associated with or are part of the cost of acquiring the asset. Expenditures for equip- independent contractor settlements are recognized as incurred and ment overhaul costs of engines or airframes prior to their operational included in the caption “Purchased transportation” in the accompa- use are capitalized as part of the cost of such assets as they are nying consolidated statements of income. For shipments in transit, costs required to ready the asset for its intended use. Maintenance revenue is recorded based on the percentage of service completed and repairs are charged to expense as incurred. We capitalize certain at the balance sheet date. Estimates for future billing adjustments direct internal and external costs associated with the development of to revenue and accounts receivable are recognized at the time of internal-use software. Gains and losses on sales of property used in shipment for money-back service guarantees and billing corrections. operations are classified within operating expenses. Delivery costs are accrued as incurred. 44


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    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For financial reporting purposes, we record depreciation and amor- flows or internal and external appraisals, as applicable. Assets to be tization of property and equipment on a straight-line basis over the disposed of are carried at the lower of carrying value or estimated net asset’s service life or related lease term, if shorter. For income tax realizable value. purposes, depreciation is computed using accelerated methods when We operate integrated transportation networks, and accordingly, cash applicable. The depreciable lives and net book value of our property flows for most of our operating assets are assessed at a network and equipment are as follows (dollars in millions): level, not at an individual asset level, for our analysis of impairment. Net Book Value at In the normal management of our aircraft fleet, we routinely idle May 31, aircraft and engines temporarily due to maintenance cycles and Range 2013 2012 adjustments of our network capacity to match seasonality and overall Wide-body aircraft and customer demand levels. Temporarily idled assets are classified as related equipment 15 to 30 years $ 7,191 $ 7,161 available-for-use, and we continue to record depreciation expense Narrow-body and feeder associated with these assets. These temporarily idled assets are aircraft and related equipment 5 to 18 years 2,284 1,881 assessed for impairment on a quarterly basis. Factors which could Package handling and ground cause impairment include, but are not limited to, adverse changes support equipment 3 to 30 years 2,311 2,101 in our global economic outlook and the impact of our outlook on our Vehicles 3 to 15 years 1,748 1,411 current and projected volume levels, including lower capacity needs Computer and electronic during our peak shipping seasons; the introduction of new fleet types equipment 2 to 10 years 993 930 or decisions to permanently retire an aircraft fleet from operations; Facilities and other 2 to 40 years 3,957 3,764 or changes to planned service expansion activities. We currently have one aircraft temporarily idled. This aircraft has been idled for 15 months and is expected to return to revenue service. Substantially all property and equipment have no material residual values. The majority of aircraft costs are depreciated on a straight-line In May 2013, we made the decision to retire from service two Airbus basis over 15 to 30 years. We periodically evaluate the estimated A310-200 aircraft and four related engines, three Airbus A310-300 service lives and residual values used to depreciate our property and aircraft and two related engines and five Boeing MD10-10 aircraft equipment. This evaluation may result in changes in the estimated and 15 related engines to align with the plans of FedEx Express to lives and residual values as it did in 2013 and 2012 with certain modernize its aircraft fleet and improve its global network. As a aircraft. In May 2013, FedEx Express made the decision to accelerate consequence of this decision, a noncash impairment charge of the retirement of 76 aircraft and related engines to aid in our fleet $100 million ($63 million, net of tax, or $0.20 per diluted share) was modernization and improve our global network. In May 2012, we recorded in the FedEx Express segment in the fourth quarter. All of shortened the depreciable lives for 54 aircraft and related engines to these aircraft were temporarily idled and not in revenue service. accelerate the retirement of these aircraft, resulting in a deprecia- In May 2012, we made the decision to retire from service 18 Airbus tion expense increase of $69 million in 2013. As a result of these A310-200 aircraft and 26 related engines, as well as six Boeing accelerated retirements, we expect an additional $74 million in year- MD10-10 aircraft and 17 related engines. As a consequence of this over-year depreciation expense in 2014. decision, a noncash impairment charge of $134 million ($84 million, Depreciation expense, excluding gains and losses on sales of property net of tax, or $0.26 per diluted share) was recorded in the FedEx and equipment used in operations, was $2.3 billion in 2013, $2.1 billion Express segment in the fourth quarter. The decision to retire these air- in 2012 and $1.9 billion in 2011. Depreciation and amortization expense craft, the majority of which were temporarily idled and not in revenue includes amortization of assets under capital lease. service, better aligns the U.S. domestic air network capacity of FedEx Express to match current and anticipated shipment volumes. CAPITALIZED INTEREST. Interest on funds used to finance the acquisition and modification of aircraft, including purchase deposits, The combination of our FedEx Freight and FedEx National LTL opera- construction of certain facilities, and development of certain software tions was completed on January 30, 2011. These actions resulted up to the date the asset is ready for its intended use is capitalized and in total program costs of $133 million recorded during 2011, which included in the cost of the asset if the asset is actively under construc- includes $89 million of impairment and other charges (recorded in the tion. Capitalized interest was $45 million in 2013, $85 million in 2012 “Business realignment, impairment and other charges” caption on the and $71 million in 2011. consolidated income statements), and $44 million of other program costs (primarily recorded in the “Depreciation and amortization” IMPAIRMENT OF LONG-LIVED ASSETS. Long-lived assets are caption on the consolidated income statements). reviewed for impairment when circumstances indicate the carry- ing value of an asset may not be recoverable. For assets that are to GOODWILL. Goodwill is recognized for the excess of the purchase be held and used, an impairment is recognized when the estimated price over the fair value of tangible and identifiable intangible net undiscounted cash flows associated with the asset or group of assets assets of businesses acquired. Several factors give rise to goodwill is less than their carrying value. If impairment exists, an adjustment is in our acquisitions, such as the expected benefit from synergies of made to write the asset down to its fair value, and a loss is recorded the combination and the existing workforce of the acquired entity. as the difference between the carrying value and fair value. Fair val- Goodwill is reviewed at least annually for impairment. In our evalua- ues are determined based on quoted market values, discounted cash tion of goodwill impairment, we perform a qualitative assessment to 45


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    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS determine if it is more likely than not that the fair value of a reporting if any. The second step requires us to estimate and measure the tax unit is less than its carrying amount. If the qualitative assessment benefit as the largest amount that is more than 50% likely to be real- is not conclusive, we would proceed to a two-step process to test ized upon ultimate settlement. It is inherently difficult and subjective goodwill for impairment including comparing the fair value of each to estimate such amounts, as we must determine the probability of reporting unit with its carrying value (including attributable goodwill). various possible outcomes. We reevaluate these uncertain tax posi- Fair value for our reporting units is determined using an income or tions on a quarterly basis or when new information becomes available market approach incorporating market participant considerations to management. These reevaluations are based on factors including, and management’s assumptions on revenue growth rates, operating but not limited to, changes in facts or circumstances, changes in tax margins, discount rates and expected capital expenditures. Fair value law, successfully settled issues under audit and new audit activity. determinations may include both internal and third-party valuations. Such a change in recognition or measurement could result in the Unless circumstances otherwise dictate, we perform our annual recognition of a tax benefit or an increase to the related provision. impairment testing in the fourth quarter. We classify interest related to income tax liabilities as interest PENSION AND POSTRETIREMENT HEALTHCARE PLANS. Our defined expense, and if applicable, penalties are recognized as a component benefit plans are measured using actuarial techniques that reflect of income tax expense. The income tax liabilities and accrued interest management’s assumptions for discount rate, expected long-term and penalties that are due within one year of the balance sheet date investment returns on plan assets, salary increases, expected retire- are presented as current liabilities. The remaining portion of our ment, mortality, employee turnover and future increases in healthcare income tax liabilities and accrued interest and penalties are presented costs. We determine the discount rate (which is required to be the as noncurrent liabilities because payment of cash is not anticipated rate at which the projected benefit obligation could be effectively within one year of the balance sheet date. These noncurrent income settled as of the measurement date) with the assistance of actuar- tax liabilities are recorded in the caption “Other liabilities” in the ies, who calculate the yield on a theoretical portfolio of high-grade accompanying consolidated balance sheets. corporate bonds (rated Aa or better) with cash flows that are designed SELF-INSURANCE ACCRUALS. We are self-insured for costs associ- to match our expected benefit payments in future years. A calculated- ated with workers’ compensation claims, vehicle accidents and general value method is employed for purposes of determining the asset business liabilities, and benefits paid under employee healthcare and values for our tax-qualified U.S. domestic pension plans (“U.S. Pension long-term disability programs. Accruals are primarily based on the Plans”). Our expected rate of return is a judgmental matter which is actuarially estimated, undiscounted cost of claims, which includes reviewed on an annual basis and revised as appropriate. incurred-but-not-reported claims. Current workers’ compensation The accounting guidance related to employers’ accounting for defined claims, vehicle and general liability, employee healthcare claims and benefit pension and other postretirement plans requires recognition long-term disability are included in accrued expenses. We self-insure in the balance sheet of the funded status of defined benefit pension up to certain limits that vary by operating company and type of risk. and other postretirement benefit plans, and the recognition in other Periodically, we evaluate the level of insurance coverage and adjust comprehensive income (“OCI”) of unrecognized gains or losses and insurance levels based on risk tolerance and premium expense. prior service costs or credits. Additionally, the guidance requires the LEASES. We lease certain aircraft, facilities, equipment and vehicles measurement date for plan assets and liabilities to coincide with the under capital and operating leases. The commencement date of all plan sponsor’s year end. leases is the earlier of the date we become legally obligated to make At May 31, 2013, we recorded an increase to equity through OCI of rent payments or the date we may exercise control over the use of $861 million (net of tax) based primarily on year-end adjustments the property. In addition to minimum rental payments, certain leases related to an increase in the value of our plan assets and an increase provide for contingent rentals based on equipment usage principally in the discount rate used to measure the liabilities at May 31, 2013. related to aircraft leases at FedEx Express and copier usage at FedEx At May 31, 2012, we recorded a decrease to equity through OCI of Office. Rent expense associated with contingent rentals is recorded as $2.4 billion (net of tax) based primarily on year-end adjustments incurred. Certain of our leases contain fluctuating or escalating pay- related to increases in our projected benefit obligation due to a ments and rent holiday periods. The related rent expense is recorded decrease in the discount rate used to measure the liabilities at on a straight-line basis over the lease term. The cumulative excess May 31, 2012. of rent payments over rent expense is accounted for as a deferred lease asset and recorded in “Other assets” in the accompanying INCOME TAXES. Deferred income taxes are provided for the tax consolidated balance sheets. The cumulative excess of rent expense effect of temporary differences between the tax basis of assets and over rent payments is accounted for as a deferred lease obligation. liabilities and their reported amounts in the financial statements. The Leasehold improvements associated with assets utilized under capital liability method is used to account for income taxes, which requires or operating leases are amortized over the shorter of the asset’s use- deferred taxes to be recorded at the statutory rate expected to be in ful life or the lease term. effect when the taxes are paid. DEFERRED GAINS. Gains on the sale and leaseback of aircraft and We recognize liabilities for uncertain income tax positions based on a other property and equipment are deferred and amortized ratably over two-step process. The first step is to evaluate the tax position for rec- the life of the lease as a reduction of rent expense. Substantially all of ognition by determining if the weight of available evidence indicates these deferred gains are related to aircraft transactions. that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, 46


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    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOREIGN CURRENCY TRANSLATION. Translation gains and losses impacted functions so that we maintain service levels to our custom- of foreign operations that use local currencies as the functional ers. Of the total population leaving the company, approximately 40% currency are accumulated and reported, net of applicable deferred of the employees vacated positions on May 31, 2013. An additional income taxes, as a component of accumulated other comprehensive 35% will depart throughout 2014 and approximately 25% of this income within common stockholders’ investment. Transaction gains population will remain until May 31, 2014. Costs of the benefits and losses that arise from exchange rate fluctuations on transactions provided under the voluntary program were recognized as special denominated in a currency other than the local currency are included termination benefits in the period that eligible employees accepted in the caption “Other, net” in the accompanying consolidated state- their offers. ments of income and were immaterial for each period presented. We incurred costs of $560 million ($353 million, net of tax, or $1.11 EMPLOYEES UNDER COLLECTIVE BARGAINING ARRANGEMENTS. per diluted share) during 2013 associated with our business realign- The pilots of FedEx Express, which represent a small number of FedEx ment activities. These costs related primarily to severance for Express’s total employees, are employed under a collective bargaining employees who accepted voluntary buyouts in the third and fourth agreement. The contract became amendable in March 2013, and the quarters of 2013. Payments will be made at the time of departure. parties are currently in negotiations. In addition to our pilots at FedEx Approximately $180 million was paid under this program during 2013. Express, certain FedEx non-U.S. employees are unionized. The cost of the buyout program is included in the caption “Business realignment, impairment and other charges” in our consolidated STOCK-BASED COMPENSATION. We recognize compensation expense statements of income. Also included in that caption are other external for stock-based awards under the provisions of the accounting guidance costs directly attributable to our business realignment activities, such related to share-based payments. This guidance requires recognition as professional fees. of compensation expense for stock-based awards using a fair value method. We issue new shares or repurchase shares on the open market USE OF ESTIMATES. The preparation of our consolidated financial to cover employee share option exercises and restricted stock grants. statements requires the use of estimates and assumptions that affect Accordingly, we plan to repurchase approximately 3.7 million shares the reported amounts of assets and liabilities, the reported amounts in 2014. of revenues and expenses and the disclosure of contingent liabilities. Management makes its best estimate of the ultimate outcome for TREASURY SHARES. During 2013, we repurchased 2.7 million shares these items based on historical trends and other information available of FedEx common stock at an average price of $91 per share for a total when the financial statements are prepared. Changes in estimates are of $246 million. In March 2013, our Board of Directors authorized the recognized in accordance with the accounting rules for the estimate, repurchase of up to 10 million shares of common stock. It is expected which is typically in the period when new information becomes avail- that the additional share authorization will primarily be utilized to off- able to management. Areas where the nature of the estimate makes set the effects of equity compensation dilution over the next several it reasonably possible that actual results could materially differ from years. As of May 31, 2013, 10,188,000 shares remained under existing amounts estimated include: self-insurance accruals; retirement plan share repurchase authorizations. obligations; long-term incentive accruals; tax liabilities; accounts DIVIDENDS DECLARED PER COMMON SHARE. On June 3, 2013, our receivable allowances; obsolescence of spare parts; contingent Board of Directors declared a quarterly dividend of $0.15 per share of liabilities; loss contingencies, such as litigation and other claims; and common stock. The dividend was paid on July 1, 2013 to stockholders impairment assessments on long-lived assets (including goodwill). of record as of the close of business on June 17, 2013. Each quarterly dividend payment is subject to review and approval by our Board of Directors, and we evaluate our dividend payment amount on an NOTE 2: RECENT ACCOUNTING annual basis at the end of each fiscal year. GUIDANCE BUSINESS REALIGNMENT COSTS. During 2013, we announced New accounting rules and disclosure requirements can significantly profit improvement programs including reducing our selling, general impact our reported results and the comparability of our financial and administrative cost functions through a voluntary employee statements. separation program. On June 1, 2012, we adopted the authoritative guidance issued by the During 2013, we conducted a program to offer voluntary cash buyouts Financial Accounting Standards Board (“FASB”) on the presentation to eligible U.S.-based employees in certain staff functions. The of comprehensive income. The new guidance requires companies to voluntary buyout program includes voluntary severance payments report components of comprehensive income by including compre- and funding to healthcare reimbursement accounts, with the voluntary hensive income on the face of the income statement or in a separate severance calculated based on four weeks of gross base salary for statement of comprehensive income. We have adopted this guidance every year of FedEx service up to a maximum payment of two years of by including a separate statement of comprehensive income (loss) pay. This program was completed in the fourth quarter and approxi- for the three years ending May 31, 2013 and by including expanded mately 3,600 employees have left or will be voluntarily leaving the accumulated other comprehensive income disclosure requirements company by the end of 2014. Eligible employees are scheduled to in the notes to our consolidated financial statements. In addition on vacate positions in phases to ensure a smooth transition in the June 1, 2012, we adopted the FASB’s amendments to the fair value 47


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    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS measurements and disclosure requirements, which expanded existing The estimated fair values of the assets and liabilities related to these disclosure requirements regarding the fair value of our long-term debt. acquisitions have been recorded in the FedEx Express segment and are included in the accompanying consolidated balance sheet based In February 2013, the FASB issued new guidance requiring additional on an allocation of the purchase prices (summarized in the table information about reclassification adjustments out of comprehensive below in millions). income, including changes in comprehensive income balances by component and significant items reclassified out of comprehensive Current assets $ 145 income. This new standard is effective for our fiscal year ending Property and equipment 91 May 31, 2014 and will have no impact on our financial condition or Goodwill 351 results of operations. Intangible assets 60 In May 2013, the FASB issued a revised exposure draft outlining Other non-current assets 70 proposed changes to the accounting for leases. Under the revised Current liabilities (174) exposure draft, the recognition, measurement and presentation of Long-term liabilities (36) expenses and cash flows arising from a lease would depend primarily on whether the lessee is expected to consume more than an insig- Total purchase price $ 507 nificant portion of the economic benefits embedded in the underlying asset. A right-of-use asset and a liability to make lease payments will The goodwill of $351 million is primarily attributable to expected be recognized on the balance sheet for all leases (except short-term benefits from synergies of the combinations with the existing FedEx leases). The enactment of this proposal will have a significant impact Express business and other acquired entities. The portion of the on our accounting and financial reporting. The FASB has not yet purchase price allocated to goodwill is not deductible for U.S. income proposed an effective date of this proposal. tax purposes. The intangible assets acquired consist primarily of customer-related intangible assets, which will be amortized on an We believe that no other new accounting guidance was adopted or accelerated basis over their average estimated useful lives of nine issued during 2013 that is relevant to the readers of our financial years, with the majority of the amortization recognized during the first statements. However, there are numerous new proposals under devel- five years. opment which, if and when enacted, may have a significant impact on our financial reporting. On June 20, 2013, we signed agreements to acquire the businesses operated by our current service provider Supaswift (Pty) Ltd. in five coun- tries in Southern Africa. The acquisition will be funded with cash from NOTE 3: BUSINESS COMBINATIONS operations and is expected to be completed in the second half of 2014, subject to customary closing conditions. The financial results of the During 2013, we expanded the international service offerings of FedEx acquired businesses will be included in the FedEx Express segment from Express by completing the following business acquisitions: the date of acquisition and will be immaterial to our 2014 results. > Rapidão Cometa Logística e Transporte S.A., a Brazilian transporta- In 2012, we completed our acquisition of Servicios Nacionales Mupa, tion and logistics company, for $398 million in cash from operations S.A. de C.V. (MultiPack), a Mexican domestic express package delivery on July 4, 2012 company, for $128 million in cash from operations on July 25, 2011. In 2011, FedEx Express completed the acquisition of the Indian logistics, > TATEX, a French express transportation company, for $55 million in distribution and express businesses of AFL Pvt. Ltd. and its affiliate cash from operations on July 3, 2012 Unifreight India Pvt. Ltd. for $96 million in cash from operations on > Opek Sp. z o.o., a Polish domestic express package delivery com- February 22, 2011. The financial results of these acquired businesses pany, for $54 million in cash from operations on June 13, 2012 are included in the FedEx Express segment from the date of acquisition and were not material, individually or in the aggregate, to our results These acquisitions give us more robust transportation networks within of operations or financial condition and therefore, pro forma financial these countries and added capabilities in these important interna- information has not been presented. Substantially all of the purchase tional markets. price was allocated to goodwill, which was entirely attributed to our The financial results of these acquired businesses are included in the FedEx Express reporting unit. FedEx Express segment from the date of acquisition and were not material, individually or in the aggregate, to our results of operations and therefore, pro forma financial information has not been presented. 48


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    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4: GOODWILL AND OTHER INTANGIBLE ASSETS GOODWILL. The carrying amount of goodwill attributable to each reportable operating segment and changes therein are as follows (in millions): FedEx Express FedEx Ground FedEx Freight FedEx Services Segment Segment Segment Segment Total Goodwill at May 31, 2011 $ 1,272 $ 90 $ 735 $ 1,539 $ 3,636 Accumulated impairment charges – – (133) (1,177) (1,310) Balance as of May 31, 2011 1,272 90 602 362 2,326 Goodwill acquired(1) 104 – – – 104 Purchase adjustments and other(2) (32) – – (11) (43) Balance as of May 31, 2012 1,344 90 602 351 2,387 Goodwill acquired(3) 351 – – – 351 Purchase adjustments and other(2) 20 – – (3) 17 Balance as of May 31, 2013 $ 1,715 $ 90 $ 602 $ 348 $ 2,755 Accumulated goodwill impairment charges as of May 31, 2013 $ – $ – $ (133) $ (1,177) $ (1,310) (1) Goodwill acquired in 2012 relates to the acquisition of the Mexican domestic express package delivery company, MultiPack. See Note 3 for related disclosures. (2) Primarily currency translation adjustments. (3) Goodwill acquired in 2013 relates to the acquisitions of transportation companies in Poland, France and Brazil. See Note 3 for related disclosures. Our reporting units with significant recorded goodwill include our NOTE 6: LONG-TERM DEBT FedEx Express, FedEx Freight and FedEx Office (reported in the FedEx Services segment) reporting units. We evaluated these reporting units AND OTHER FINANCING during the fourth quarter of 2013. The estimated fair value of each of ARRANGEMENTS these reporting units exceeded their carrying values in 2013 and 2012, and we do not believe that any of these reporting units were at risk as The components of long-term debt (net of discounts), along with of May 31, 2013. maturity dates for the years subsequent to May 31, 2013, are as follows (in millions): OTHER INTANGIBLE ASSETS. The net book value of our other intangible assets was $72 million at May 31, 2013 and $34 million May 31, at May 31, 2012. Amortization expense for intangible assets was 2013 2012 $27 million in 2013, $18 million in 2012 and $32 million in 2011. Senior unsecured debt: Estimated amortization expense is expected to be immaterial in Interest Rate % Maturity 2014 and beyond. 9.65 2013 $ – $ 300 7.38 2014 250 250 NOTE 5: SELECTED CURRENT 8.00 2019 750 750 2.625 2023 499 – LIABILITIES 2.70 2023 249 – The components of selected current liability captions were as follows 3.875 2043 493 – (in millions): 4.10 2043 499 – May 31, 7.60 2098 239 239 2013 2012 Total senior unsecured debt 2,979 1,539 Accrued Salaries and Employee Benefits Capital lease obligations 11 128 Salaries $ 489 $ 280 2,990 1,667 Employee benefits, including variable compensation 615 803 Less current portion 251 417 Compensated absences 584 552 $ 2,739 $ 1,250 $ 1,688 $ 1,635 Accrued Expenses Interest on our fixed-rate notes is paid semi-annually. Long-term debt, Self-insurance accruals $ 796 $ 678 exclusive of capital leases, had estimated fair values of $3.2 billion at May 31, 2013 and $2.0 billion at May 31, 2012. The estimated Taxes other than income taxes 368 386 fair values were determined based on quoted market prices and the Other 768 645 current rates offered for debt with similar terms and maturities. The $ 1,932 $ 1,709 fair value of our long-term debt is classified as Level 2 within the fair 49


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    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS value hierarchy. This classification is defined as a fair value deter- NOTE 7: LEASES mined using market-based inputs other than quoted prices that are observable for the liability, either directly or indirectly. We utilize certain aircraft, land, facilities, retail locations and equip- We have a shelf registration statement filed with the Securities and ment under capital and operating leases that expire at various dates Exchange Commission that allows us to sell, in one or more future through 2046. We leased 10% of our total aircraft fleet under operat- offerings, any combination of our unsecured debt securities and ing leases as of May 31, 2013 and 10% of our total aircraft fleet under common stock. capital and operating leases as of May 31, 2012. A portion of our supplemental aircraft are leased by us under agreements that provide In April 2013, we issued $750 million of senior unsecured debt under for cancellation upon 30 days’ notice. Our leased facilities include our current shelf registration statement, comprised of $250 million of national, regional and metropolitan sorting facilities, retail facilities 2.70% fixed-rate notes due in April 2023 and $500 million of 4.10% and administrative buildings. fixed-rate notes due in April 2043. We utilized the net proceeds for working capital and general corporate purposes. In July 2012, we Rent expense under operating leases for the years ended May 31 was issued $1 billion of senior unsecured debt under a then current shelf as follows (in millions): registration statement, comprised of $500 million of 2.625% fixed-rate 2013 2012 2011 notes due in August 2022 and $500 million of 3.875% fixed-rate notes due in August 2042. We utilized the net proceeds for working capital Minimum rentals $ 2,061 $ 2,018 $ 2,025 and general corporate purposes. Contingent rentals(1) 192 210 193 During 2013, we made principal payments of $116 million related to $ 2,253 $ 2,228 $ 2,218 (1) Contingent rentals are based on equipment usage. capital lease obligations and repaid our $300 million 9.65% unsecured notes that matured in June 2012 using cash from operations. A summary of future minimum lease payments under noncancelable A $1 billion revolving credit facility is available to finance our operating leases with an initial or remaining term in excess of one operations and other cash flow needs and to provide support for the year at May 31, 2013 is as follows (in millions): issuance of commercial paper. On March 1, 2013, we entered into an amendment to our credit agreement to, among other things, extend Operating Leases its maturity date from April 26, 2016 to March 1, 2018. The agree- Aircraft and ment contains a financial covenant, which requires us to maintain a Related Facilities and Total Operating leverage ratio of adjusted debt (long-term debt, including the current Equipment Other Leases portion of such debt, plus six times our last four fiscal quarters’ rentals 2014 $ 462 $ 1,474 $ 1,936 and landing fees) to capital (adjusted debt plus total common stock- 2015 448 1,386 1,834 holders’ investment) that does not exceed 70%. Our leverage ratio of adjusted debt to capital was 51% at May 31, 2013. We believe the 2016 453 1,183 1,636 leverage ratio covenant is our only significant restrictive covenant 2017 391 1,298 1,689 in our revolving credit agreement. Our revolving credit agreement 2018 326 904 1,230 contains other customary covenants that do not, individually or in the Thereafter 824 5,826 6,650 aggregate, materially restrict the conduct of our business. We are in compliance with the leverage ratio covenant and all other covenants Total $ 2,904 $ 12,071 $ 14,975 of our revolving credit agreement and do not expect the covenants Property and equipment recorded under capital leases and future to affect our operations, including our liquidity or expected funding needs. As of May 31, 2013, no commercial paper was outstanding, minimum lease payments under capital leases were immaterial at and the entire $1 billion under the revolving credit facility was avail- May 31, 2013. The weighted-average remaining lease term of all able for future borrowings. operating leases outstanding at May 31, 2013 was approximately six years. While certain of our lease agreements contain covenants We issue other financial instruments in the normal course of business governing the use of the leased assets or require us to maintain to support our operations, including standby letters of credit and certain levels of insurance, none of our lease agreements include surety bonds. We had a total of $538 million in letters of credit out- material financial covenants or limitations. standing at May 31, 2013, with $128 million unused under our primary $500 million letter of credit facility, and $539 million in outstanding FedEx Express makes payments under certain leveraged operating surety bonds placed by third-party insurance providers. These instru- leases that are sufficient to pay principal and interest on certain ments are required under certain U.S. self-insurance programs and pass-through certificates. The pass-through certificates are not direct are also used in the normal course of international operations. The obligations of, or guaranteed by, FedEx or FedEx Express. underlying liabilities insured by these instruments are reflected in our We are the lessee in a series of operating leases covering a portion balance sheets, where applicable. Therefore, no additional liability is reflected for the letters of credit and surety bonds themselves. of our leased aircraft. The lessors are trusts established specifically to purchase, finance and lease aircraft to us. These leasing entities meet the criteria for variable interest entities. We are not the primary beneficiary of the leasing entities, as the lease terms are consistent with market terms at the inception of the lease and do not include 50


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    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS a residual value guarantee, fixed-price purchase option or similar NOTE 8: PREFERRED STOCK feature that obligates us to absorb decreases in value or entitles us to participate in increases in the value of the aircraft. As such, we are Our Certificate of Incorporation authorizes the Board of Directors, at not required to consolidate the entity as the primary beneficiary. Our its discretion, to issue up to 4,000,000 shares of preferred stock. The maximum exposure under these leases is included in the summary of stock is issuable in series, which may vary as to certain rights and future minimum lease payments shown above. preferences, and has no par value. As of May 31, 2013, none of these shares had been issued. NOTE 9: ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The following table provides changes in accumulated other comprehensive income (loss), net of tax, reported in our financial statements (in millions): Foreign currency Retirement plans Accumulated other translation adjustment adjustments comprehensive income (loss) Balance at May 31, 2010 $ 31 $ (2,471) $ (2,440) Other comprehensive gain (loss) 125 (235) (110) Balance at May 31, 2011 156 (2,706) (2,550) Other comprehensive gain (loss) (95) (2,308) (2,403) Balance at May 31, 2012 61 (5,014) (4,953) Other comprehensive gain (loss) 41 1,092 1,133 Balance at May 31, 2013 $ 102 $ (3,922) $ (3,820) NOTE 10: STOCK-BASED VALUATION AND ASSUMPTIONS. We use the Black-Scholes option pricing model to calculate the fair value of stock options. The value COMPENSATION of restricted stock awards is based on the stock price of the award on the grant date. We record stock-based compensation expense in Our total stock-based compensation expense for the years ended the “Salaries and employee benefits” caption in the accompanying May 31 was as follows (in millions): consolidated statements of income. 2013 2012 2011 The key assumptions for the Black-Scholes valuation method include the Stock-based compensation expense $ 109 $ 105 $ 98 expected life of the option, stock price volatility, a risk-free interest rate, and dividend yield. Following is a table of the weighted-average Black- We have two types of equity-based compensation: stock options and Scholes value of our stock option grants, the intrinsic value of options restricted stock. exercised (in millions), and the key weighted-average assumptions used STOCK OPTIONS. Under the provisions of our incentive stock plans, in the valuation calculations for the options granted during the years key employees and non-employee directors may be granted options to ended May 31, and then a discussion of our methodology for developing purchase shares of our common stock at a price not less than its fair each of the assumptions used in the valuation model: market value on the date of grant. Vesting requirements are deter- mined at the discretion of the Compensation Committee of our Board 2013 2012 2011 of Directors. Option-vesting periods range from one to four years, with Weighted-average 83% of our options vesting ratably over four years. Compensation Black-Scholes value $ 29.20 $ 29.92 $ 28.12 expense associated with these awards is recognized on a straight-line Intrinsic value of options exercised $ 107 $ 67 $ 80 basis over the requisite service period of the award. Black-Scholes Assumptions: RESTRICTED STOCK. Under the terms of our incentive stock plans, Expected lives 6.1 years 6.0 years 5.9 years restricted shares of our common stock are awarded to key employees. Expected volatility 35% 34% 34% All restrictions on the shares expire ratably over a four-year period. Risk-free interest rate 0.94% 1.79% 2.36% Shares are valued at the market price on the date of award. The terms Dividend yield 0.609% 0.563% 0.558% of our restricted stock provide for continued vesting subsequent to the employee’s retirement. Compensation expense associated with these awards is recognized on a straight-line basis over the shorter of the remaining service or vesting period. 51


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    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The expected life represents an estimate of the period of time options grant over a past period equal to the expected life of the options. The are expected to remain outstanding, and we examine actual stock risk-free interest rate is the U.S. Treasury Strip rate posted at the date option exercises to determine the expected life of the options. Options of grant having a term equal to the expected life of the option. The granted have a maximum term of 10 years. Expected volatilities are expected dividend yield is the annual rate of dividends per share over based on the actual changes in the market value of our stock and the exercise price of the option. are calculated using daily market value changes from the date of The following table summarizes information about stock option activity for the year ended May 31, 2013: Stock Options Weighted-Average Aggregate Weighted-Average Remaining Intrinsic Value Shares Exercise Price Contractual Term (in millions)(1) Outstanding at June 1, 2012 21,031,538 $ 84.39 Granted 2,547,290 88.08 Exercised (3,979,359) 70.41 Forfeited (464,035) 91.44 Outstanding at May 31, 2013 19,135,434 $ 87.62 5.5 years $ 229 Exercisable 12,447,517 $ 90.23 4.2 years $ 137 Expected to vest 6,288,642 $ 82.77 8.1 years $ 87 Available for future grants 6,482,410 (1) Only presented for options with market value at May 31, 2013 in excess of the exercise price of the option. The options granted during the year ended May 31, 2013 are primarily The following table summarizes information about stock option related to our principal annual stock option grant in June 2012. vesting during the years ended May 31: The following table summarizes information about vested and Stock Options unvested restricted stock for the year ended May 31, 2013: Vested during Fair value the year (in millions) Restricted Stock Weighted-Average 2013 2,824,757 $ 81 Shares Grant Date Fair Value 2012 2,807,809 70 Unvested at June 1, 2012 589,872 $ 76.79 2011 2,721,602 67 Granted 220,391 85.45 As of May 31, 2013, there was $133 million of total unrecognized Vested (253,423) 75.46 compensation cost, net of estimated forfeitures, related to unvested Forfeited (27,506) 80.13 share-based compensation arrangements. This compensation expense Unvested at May 31, 2013 529,334 $ 80.86 is expected to be recognized on a straight-line basis over the remaining weighted-average vesting period of approximately two years. During the year ended May 31, 2012, there were 214,435 shares Total shares outstanding or available for grant related to equity of restricted stock granted with a weighted-average fair value of compensation at May 31, 2013 represented 8% of the total $88.95. During the year ended May 31, 2011, there were 235,998 outstanding common and equity compensation shares and equity shares of restricted stock granted with a weighted-average fair compensation shares available for grant. value of $78.74. 52


  • Page 46

    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 11: COMPUTATION OF were timing benefits only, in that depreciation accelerated into an earlier year is foregone in later years. Our 2013 current provision for EARNINGS PER SHARE federal income taxes was, therefore, higher than in 2012 and 2011. The calculation of basic and diluted earnings per common share for Pre-tax (loss) earnings of foreign operations for 2013, 2012 and 2011 the years ended May 31 was as follows (in millions, except per share were $(55) million, $358 million and $472 million, respectively. These amounts): amounts represent only a portion of total results associated with international shipments and accordingly, do not represent our interna- 2013 2012 2011 tional or domestic results of operations. Basic earnings per common share: A reconciliation of the statutory federal income tax rate to the Net earnings allocable to common shares(1) $ 1,558 $ 2,029 $ 1,449 effective income tax rate for the years ended May 31 was as follows: Weighted-average common shares 315 315 315 Basic earnings per common share $ 4.95 $ 6.44 $ 4.61 2013 2012 2011 Statutory U.S. income tax rate 35.0% 35.0% 35.0% Diluted earnings per common share: Increase (decrease) resulting from: Net earnings allocable to common shares(1) $ 1,558 $ 2,029 $ 1,449 State and local income taxes, Weighted-average common shares 315 315 315 net of federal benefit 2.1 2.1 1.7 Dilutive effect of share-based awards 2 2 2 Other, net (0.7) (1.8) (0.8) Weighted-average diluted shares 317 317 317 Effective tax rate 36.4% 35.3% 35.9% Diluted earnings per common share $ 4.91 $ 6.41 $ 4.57 Anti-dilutive options excluded from Our 2012 rate was favorably impacted by the conclusion of the IRS diluted earnings per common share 11.1 12.6 9.3 audit of our 2007-2009 consolidated income tax returns. (1) Net earnings available to participating securities were immaterial in all periods presented. The significant components of deferred tax assets and liabilities as of May 31 were as follows (in millions): NOTE 12: INCOME TAXES 2013 2012 Deferred Deferred Deferred Deferred The components of the provision for income taxes for the years ended Tax Tax Tax Tax May 31 were as follows (in millions): Assets Liabilities Assets Liabilities Property, equipment, 2013 2012 2011 leases and intangibles $ 157 $ 3,676 $ 248 $ 3,436 Current provision (benefit) Employee benefits 1,771 11 2,300 11 Domestic: Self-insurance accruals 533 – 495 – Federal $ 512 $ (120) $ 79 Other 251 238 338 271 State and local 86 80 48 Net operating loss/credit Foreign 170 181 198 carryforwards 298 – 179 – 768 141 325 Valuation allowances (204) – (145) – Deferred provision (benefit) $ 2,806 $ 3,925 $ 3,415 $ 3,718 Domestic: The net deferred tax liabilities as of May 31 have been classified in Federal 175 947 485 the balance sheets as follows (in millions): State and local (7) 21 12 2013 2012 Foreign (42) – (9) Current deferred tax asset $ 533 $ 533 126 968 488 Noncurrent deferred tax liability (1,652) (836) $ 894 $ 1,109 $ 813 $ (1,119) $ (303) Our current federal income tax expenses in 2013, 2012 and 2011 We have $940 million of net operating loss carryovers in various were significantly reduced by accelerated depreciation deductions we foreign jurisdictions and $500 million of state operating loss carry- claimed under provisions of the American Taxpayer Relief Act of 2013 overs. The valuation allowances primarily represent amounts reserved and the Tax Relief and the Small Business Jobs Acts of 2010. Those for operating loss and tax credit carryforwards, which expire over Acts, designed to stimulate new business investment in the U.S., varying periods starting in 2014. As a result of this and other factors, accelerated our depreciation deductions for new qualifying invest- we believe that a substantial portion of these deferred tax assets ments, such as our Boeing 777 Freighter (“B777F”) aircraft. These may not be realized. 53


  • Page 47

    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Permanently reinvested earnings of our foreign subsidiaries amounted Our liabilities recorded for uncertain tax positions include $42 million to $1.3 billion at the end of 2013 and $1 billion at the end of 2012. We at May 31, 2013 and $47 million at May 31, 2012 associated with have not recognized deferred taxes for U.S. federal income tax purposes positions that if favorably resolved would provide a benefit to our on those earnings. In 2013, our permanent reinvestment strategy with effective tax rate. We classify interest related to income tax liabilities respect to unremitted earnings of our foreign subsidiaries provided as interest expense, and if applicable, penalties are recognized as a 1.2% benefit to our effective tax rate. Were the earnings to be a component of income tax expense. The balance of accrued interest distributed, in the form of dividends or otherwise, these earnings could and penalties was $29 million on both May 31, 2013 and May 31, be subject to U.S. federal income tax and non-U.S. withholding taxes. 2012. Total interest and penalties included in our consolidated state- Unrecognized foreign tax credits potentially could be available to reduce ments of income are immaterial. a portion of any U.S. tax liability. Determination of the amount of It is difficult to predict the ultimate outcome or the timing of resolution unrecognized deferred U.S. income tax liability is not practicable due for tax positions. Changes may result from the conclusion of ongoing to uncertainties related to the timing and source of any potential audits, appeals or litigation in state, local, federal and foreign tax distribution of such funds, along with other important factors such as jurisdictions, or from the resolution of various proceedings between the amount of associated foreign tax credits. Cash in offshore jurisdic- the U.S. and foreign tax authorities. Our liability for uncertain tax tions associated with our permanent reinvestment strategy totaled positions includes no matters that are individually or collectively $420 million at the end of 2013 and $410 million at the end of 2012. material to us. It is reasonably possible that the amount of the benefit In 2013, more than 85% of our total enterprise-wide income was with respect to certain of our unrecognized tax positions will increase earned in U.S. companies of FedEx that are taxable in the United or decrease within the next 12 months, but an estimate of the range States. As a U.S. airline, our FedEx Express unit is required by Federal of the reasonably possible changes cannot be made. However, we Aviation Administration and other rules to conduct its air operations, do not expect that the resolution of any of our uncertain tax positions domestic and international, through a U.S. company. However, we will be material. serve more than 220 countries and territories around the world, and are required to establish legal entities in many of them. Most of our entities in those countries are operating entities, engaged in picking NOTE 13: RETIREMENT PLANS up and delivering packages and performing other transportation services. In the meantime, we are continually expanding our global We sponsor programs that provide retirement benefits to most of our network to meet our customers’ needs, which requires increasing employees. These programs include defined benefit pension plans, investment outside the U.S. We typically use cash generated overseas defined contribution plans and postretirement healthcare plans. The to fund these investments and have a foreign holding company which accounting for pension and postretirement healthcare plans includes manages our investments in several foreign operating companies, numerous assumptions, such as: discount rates; expected long-term including new acquisitions made in 2013 in Poland, France and Brazil. investment returns on plan assets; future salary increases; employee turnover; mortality; and retirement ages. These assumptions most We are subject to taxation in the U.S. and various U.S. state, local significantly impact our U.S. Pension Plans. and foreign jurisdictions. We are currently under examination by the IRS for the 2010 and 2011 tax years. It is reasonably possible that The accounting guidance related to postretirement benefits requires certain income tax return proceedings will be completed during the recognition in the balance sheet of the funded status of defined bene- next 12 months and could result in a change in our balance of unrec- fit pension and other postretirement benefit plans, and the recognition ognized tax benefits. The expected impact of any changes would not in accumulated other comprehensive income (“AOCI”) of unrecognized be material to our consolidated financial statements. gains or losses and prior service costs or credits. The funded status is measured as the difference between the fair value of the plan’s assets A reconciliation of the beginning and ending amount of unrecognized and the projected benefit obligation (“PBO”) of the plan. We recorded tax benefits is as follows (in millions): an increase to equity of $861 million (net of tax) at May 31, 2013, 2013 2012 2011 and a decrease to equity of $2.4 billion (net of tax) at May 31, 2012, Balance at beginning of year $ 51 $ 69 $ 82 attributable to our plans. Increases for tax positions taken in A summary of our retirement plans costs over the past three years is the current year 1 2 2 as follows (in millions): Increases for tax positions taken in prior years 3 4 6 2013 2012 2011 Decreases for tax positions taken in U.S. domestic and international prior years (3) (35) (10) pension plans $ 679 $ 524 $ 543 Settlements (9) (3) (11) U.S. domestic and international defined contribution plans 354 338 257 Increases due to acquisitions 4 15 – U.S. domestic and international Decrease from lapse of statute postretirement healthcare plans 78 70 60 of limitations (2) – – $ 1,111 $ 932 $ 860 Changes due to currency translation 2 (1) – Balance at end of year $ 47 $ 51 $ 69 54


  • Page 48

    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Total retirement plans costs in 2013 were higher than 2012 due to the their eligible dependents. U.S. employees covered by the principal negative impact of a significantly lower discount rate at our May 31, plan become eligible for these benefits at age 55 and older, if they 2012 measurement date. Total retirement plans cost increased in 2012 have permanent, continuous service of at least 10 years after primarily due to higher expenses for our 401(k) plans due to the full attainment of age 45 if hired prior to January 1, 1988, or at least restoration of company matching contributions on January 1, 2011. 20 years after attainment of age 35 if hired on or after January 1, 1988. Postretirement healthcare benefits are capped at 150% of the PENSION PLANS. Our largest pension plan covers certain U.S. 1993 per capita projected employer cost, which has been reached and, employees age 21 and over, with at least one year of service. Pension therefore, these benefits are not subject to additional future inflation. benefits for most employees are accrued under a cash balance formula we call the Portable Pension Account. Under the Portable PENSION PLAN ASSUMPTIONS. Our pension cost is materially Pension Account, the retirement benefit is expressed as a dollar affected by the discount rate used to measure pension obligations, amount in a notional account that grows with annual credits based the level of plan assets available to fund those obligations and the on pay, age and years of credited service, and interest on the notional expected long-term rate of return on plan assets. account balance. The Portable Pension Account benefit is payable as a We use a measurement date of May 31 for our pension and postre- lump sum or an annuity at retirement at the election of the employee. tirement healthcare plans. Management reviews the assumptions The plan interest credit rate varies from year to year based on a used to measure pension costs on an annual basis. Economic and U.S. Treasury index and corporate bond rates. Prior to 2009, certain market conditions at the measurement date impact these assumptions employees earned benefits using a traditional pension formula (based from year to year. Actuarial gains or losses are generated for changes on average earnings and years of service). Benefits under this formula in assumptions and to the extent that actual results differ from those were capped on May 31, 2008 for most employees. We also sponsor assumed. These actuarial gains and losses are amortized over the or participate in nonqualified benefit plans covering certain of our remaining average service lives of our active employees if they exceed U.S. employee groups and other pension plans covering certain of our a corridor amount in the aggregate. Additional information about international employees. The international defined benefit pension our pension plans can be found in the Critical Accounting Estimates plans provide benefits primarily based on final earnings and years of section of Management’s Discussion and Analysis of Results of service and are funded in compliance with local laws and practices. Operations and Financial Condition (“MD&A”) in this Annual Report. POSTRETIREMENT HEALTHCARE PLANS. Certain of our subsidiaries offer medical, dental and vision coverage to eligible U.S. retirees and Weighted-average actuarial assumptions for our primary U.S. retirement plans, which represent substantially all of our PBO and accumulated postretirement benefit obligation (“APBO”), are as follows: Pension Plans Postretirement Healthcare Plans 2013 2012 2011 2013 2012 2011 Discount rate used to determine benefit obligation 4.79% 4.44% 5.76% 4.91% 4.55% 5.67% Discount rate used to determine net periodic benefit cost 4.44 5.76 6.37 4.55 5.67 6.11 Rate of increase in future compensation levels used to determine benefit obligation 4.54 4.62 4.58 – – – Rate of increase in future compensation levels used to determine net periodic benefit cost 4.62 4.58 4.63 – – – Expected long-term rate of return on assets 8.00 8.00 8.00 – – – 55


  • Page 49

    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The estimated average rate of return on plan assets is the expected The investment strategy for pension plan assets is to utilize a diversi- future long-term rate of earnings on plan assets and is a forward- fied mix of global public and private equity portfolios, together with looking assumption that materially affects our pension cost. fixed-income portfolios, to earn a long-term investment return that Establishing the expected future rate of investment return on our meets our pension plan obligations. Our pension plan assets are pension assets is a judgmental matter. We review the expected invested primarily in publicly tradeable securities, and our pension long-term rate of return on an annual basis and revise it as appropri- plans hold only a minimal investment in FedEx common stock that is ate. Management considers the following factors in determining this entirely at the discretion of third-party pension fund investment man- assumption: agers. Our largest holding classes are U.S. Large Cap Equities, which > the duration of our pension plan liabilities, which drives the invest- is indexed to the S&P 500 Index, Corporate Fixed Income Securities and Government Fixed Income Securities. Accordingly, we do not have ment strategy we can employ with our pension plan assets; any significant concentrations of risk. Active management strategies > the types of investment classes in which we invest our pension plan are utilized within the plan in an effort to realize investment returns in assets and the expected compound geometric return we can reason- excess of market indices. As part of our strategy to manage pension ably expect those investment classes to earn over time; and costs and funded status volatility, we have transitioned to a liability- > the investment returns we can reasonably expect our investment driven investment strategy to better align plan assets with liabilities. management program to achieve in excess of the returns we could Our investment strategy also includes the limited use of derivative expect if investments were made strictly in indexed funds. financial instruments on a discretionary basis to improve investment returns and manage exposure to market risk. In all cases, our invest- Our expected long-term rate of return on plan assets was 8% for ment managers are prohibited from using derivatives for speculative 2013, 2012 and 2011. Our actual return in each of the past three purposes and are not permitted to use derivatives to leverage a years exceeded that amount for our principal U.S. domestic pension portfolio. plan. For the 15-year period ended May 31, 2013, our actual returns were 6.9%. For 2014, we plan to lower our expected return on plan Following is a description of the valuation methodologies used for assets assumption for long-term returns on plan assets to 7.75% as investments measured at fair value: we continue to refine our asset and liability management strategy. > Cash and cash equivalents. These Level 1 investments include In lowering this assumption we considered our historical returns, our cash, cash equivalents and foreign currency valued using exchange investment strategy for our plan assets, including the impacts of the rates. The Level 2 investments include commingled funds valued long duration of our plan liability and the relatively low annual draw using the net asset value. on plan assets on that investment strategy. > Domestic and international equities. These Level 1 investments Pension expense is also affected by the accounting policy used to are valued at the closing price or last trade reported on the major determine the value of plan assets at the measurement date. We market on which the individual securities are traded. The Level 2 use a calculated-value method to determine the value of plan assets, investments are commingled funds valued using the net asset value. which helps mitigate short-term volatility in market performance (both > Private equity. The valuation of these Level 3 investments requires increases and decreases) by amortizing certain actuarial gains or significant judgment due to the absence of quoted market prices, losses over a period no longer than four years. Another method used the inherent lack of liquidity and the long-term nature of such in practice applies the market value of plan assets at the measure- assets. Investments are valued based upon recommendations of our ment date. For purposes of valuing plan assets for determining 2014 investment managers incorporating factors such as contributions pension expense, the calculated value method resulted in the same and distributions, market transactions, market comparables and value as the market value, as it did in 2013. For determining 2012 pen- performance multiples. sion expense, we used the calculated value method which resulted in a portion of the asset gain in 2011 being deferred to future years > Fixed income. We determine the fair value of these Level 2 corpo- because our actual returns on plan assets significantly exceeded our rate bonds, U.S. and non-U.S. government securities and other fixed assumptions. income securities by using bid evaluation pricing models or quoted prices of securities with similar characteristics. 56


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    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The fair values of investments by level and asset category and the weighted-average asset allocations for our domestic pension plans at the measurement date are presented in the following table (in millions): Plan Assets at Measurement Date 2013 Quoted Prices in Other Observable Unobservable Target Active Markets Inputs Inputs Asset Class Fair Value Actual% Range% Level 1 Level 2 Level 3 Cash and cash equivalents $ 456 2% 0-5% $ 15 $ 441 Equities 35-55 U.S. large cap equity 5,264 28 37 5,227 U.S. SMID cap equity 1,741 9 1,741 International equities 2,271 12 1,904 367 Private equities 332 2 $ 332 Fixed income securities 45-65 Corporate 4,972 26 4,972 Government 3,888 20 3,888 Mortgage backed and other 200 1 200 Other (77) – (83) 6 $ 19,047 100% $ 3,614 $ 15,101 $ 332 2012 Quoted Prices in Other Observable Unobservable Target Active Markets Inputs Inputs Asset Class Fair Value Actual% Range% Level 1 Level 2 Level 3 Cash and cash equivalents $ 618 4% 0-3% $ 8 $ 610 Equities 45-55 U.S. large cap equity 4,248 25 9 4,239 U.S. SMID cap equity 1,368 8 1,368 International equities 1,657 10 1,395 262 Private equities 402 2 $ 402 Fixed income securities 45-55 Corporate 4,565 27 4,565 Government 4,175 24 4,175 Mortgage backed and other 59 – 59 Other (79) – (85) 6 $ 17,013 100% $ 2,695 $ 13,916 $ 402 The change in fair value of Level 3 assets that use significant unobservable inputs is shown in the table below (in millions): 2013 2012 Balance at beginning of year $ 402 $ 403 Actual return on plan assets: Assets held during current year (29) 3 Assets sold during the year 55 38 Purchases, sales and settlements (96) (42) Balance at end of year $ 332 $ 402 57

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