UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
   
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED AUGUST 31,NOVEMBER 30, 2006 OR
   
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM           TO           
Commission File Number: 1-15829
FEDEX CORPORATION
(Exact name of registrant as specified in its charter)
   
Delaware
(State or other jurisdiction of incorporation or organization)		 62-1721435
(I.R.S. Employer Identification No.)
   
942 South Shady Grove Road
Memphis, Tennessee
(Address of principal executive offices)		 
38120
(ZIP Code)
(901) 818-7500
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesþ No¨o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filerþ   Accelerated filer¨o   Non-accelerated filer¨o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes¨o Noþ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
   
Common Stock
Common Stock, par value $0.10 per share		 Outstanding Shares at SeptemberDecember 18, 2006
306,633,491307,117,815
 
 

 

 

 

FEDEX CORPORATION
INDEX
PART I.   FINANCIAL INFORMATION
       
    PAGE
PART I. FINANCIAL INFORMATION
 
ITEM 1.   Financial Statements    
       
  
Condensed Consolidated Balance Sheets August 31,
November 30, 2006 and May 31, 2006
  3-4 
       
  
Condensed Consolidated Statements of Income
Three and Six Months Ended August 31,November 30, 2006 and 2005
  5 
       
  
Condensed Consolidated Statements of Cash Flows Three
Six Months Ended August 31,November 30, 2006 and 2005
  6 
       
  Notes to Condensed Consolidated Financial Statements  7-227-23 
       
  Report of Independent Registered Public Accounting Firm  2324 
       
ITEM 2.   Management’s Discussion and Analysis of Results of Operations and Financial Condition  24-4225-45 
       
ITEM 3.   Quantitative and Qualitative Disclosures About Market Risk  4346 
       
ITEM 4.   Controls and Procedures  4346 
       
PART II.   OTHER INFORMATION
       
ITEM 1.   Legal Proceedings  4447 
       
ITEM 1A.   Risk Factors  4447 
       
ITEM 4.   Submission of Matters to a Vote of Security Holders  4447 
       
ITEM 6.   Exhibits  4547 
       
Signature  4648 
       
Exhibit Index  E-1 
Exhibit 3.1
Exhibit 3.2
 Exhibit 10.1
 Exhibit 10.2
 Exhibit 12.1
 Exhibit 15.1
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 

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FEDEX CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
ASSETS
                
 August 31,    November 30,   
 2006 May 31,  2006 May 31, 
 (Unaudited) 2006  (Unaudited) 2006 
ASSETS 
CURRENT ASSETS  
Cash and cash equivalents $2,690 $1,937  $1,855 $1,937 
Receivables, less allowances of $138 and $144 3,624 3,516 
Spare parts, supplies and fuel, less allowances of $152 and $150 320 308 
Receivables, less allowances of $147 and $144 3,956 3,516 
Spare parts, supplies and fuel, less allowances of $153 and $150 325 308 
Deferred income taxes 536 539  515 539 
Prepaid expenses and other 172 164  192 164 
          
Total current assets 7,342 6,464  6,843 6,464 
PROPERTY AND EQUIPMENT, AT COST 24,724 24,074  25,904 24,074 
Less accumulated depreciation and amortization 13,609 13,304  13,916 13,304 
          
Net property and equipment 11,115 10,770  11,988 10,770 
OTHER LONG-TERM ASSETS  
Goodwill 2,825 2,825  2,941 2,825 
Prepaid pension cost 1,351 1,349  1,636 1,349 
Intangible and other assets 1,245 1,282  1,305 1,282 
          
Total other long-term assets 5,421 5,456  5,882 5,456 
          
 $23,878 $22,690  $24,713 $22,690 
          
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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FEDEX CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE DATA)
LIABILITIES AND STOCKHOLDERS’ INVESTMENT
                
 August 31,    November 30,   
 2006 May 31,  2006 May 31, 
 (Unaudited) 2006  (Unaudited) 2006 
LIABILITIES AND STOCKHOLDERS’ INVESTMENT 
CURRENT LIABILITIES  
Current portion of long-term debt $1,130 $850  $1,168 $850 
Accrued salaries and employee benefits 1,025 1,325  1,269 1,325 
Accounts payable 1,875 1,908  2,060 1,908 
Accrued expenses 1,593 1,390  1,477 1,390 
          
Total current liabilities 5,623 5,473  5,974 5,473 
LONG-TERM DEBT, LESS CURRENT PORTION 2,090 1,592  2,047 1,592 
OTHER LONG-TERM LIABILITIES  
Deferred income taxes 1,369 1,367  1,352 1,367 
Pension, postretirement healthcare and other benefit obligations 953 944  952 944 
Self-insurance accruals 715 692  745 692 
Deferred lease obligations 660 658  635 658 
Deferred gains, principally related to aircraft transactions 365 373  357 373 
Other liabilities 82 80  93 80 
          
Total other long-term liabilities 4,144 4,114  4,134 4,114 
COMMITMENTS AND CONTINGENCIES  
COMMON STOCKHOLDERS’ INVESTMENT  
Common stock, $0.10 par value; 800 million shares authorized; 307 million shares issued as of August 31, 2006 and 306 million shares issued as of May 31, 2006 31 31 
Common stock, $0.10 par value; 800 million shares authorized, 307 million shares issued as of November 30, 2006 and 306 million shares issued as of May 31, 2006 31 31 
Additional paid-in capital 1,500 1,438  1,554 1,438 
Retained earnings 10,516 10,068  10,999 10,068 
Accumulated other comprehensive loss  (24)  (24)  (22)  (24)
Treasury stock, at cost  (2)  (2)  (4)  (2)
          
Total common stockholders’ investment 12,021 11,511  12,558 11,511 
          
 $23,878 $22,690  $24,713 $22,690 
          
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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FEDEX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
                        
 Three Months Ended  Three Months Ended Six Months Ended 
 August 31,  November 30, November 30, 
 2006 2005  2006 2005 2006 2005 
REVENUES $8,545 $7,707  $8,926 $8,090 $17,471 $15,797 
OPERATING EXPENSES:  
Salaries and employee benefits 3,285 3,062  3,526 3,081 6,811 6,143 
Purchased transportation 896 771  996 812 1,892 1,583 
Rentals and landing fees 570 665  584 584 1,154 1,249 
Depreciation and amortization 399 370  430 386 829 756 
Fuel 941 728  860 891 1,801 1,619 
Maintenance and repairs 515 468  492 445 1,007 913 
Other 1,155 1,059  1,199 1,101 2,354 2,160 
              
 7,761 7,123  8,087 7,300 15,848 14,423 
              
OPERATING INCOME 784 584  839 790 1,623 1,374 
OTHER INCOME (EXPENSE):  
Interest, net  (9)  (24)  (17)  (30)  (26)  (54)
Other, net  (5)  (11) 1 —  (4)  (11)
              
  (14)  (35)  (16)  (30)  (30)  (65)
              
INCOME BEFORE INCOME TAXES 770 549  823 760 1,593 1,309 
PROVISION FOR INCOME TAXES 295 210  312 289 607 499 
              
NET INCOME $475 $339  $511 $471 $986 $810 
              
EARNINGS PER COMMON SHARE:  
Basic $1.55 $1.12  $1.67 $1.55 $3.22 $2.67 
              
Diluted $1.53 $1.10  $1.64 $1.53 $3.17 $2.63 
              
DIVIDENDS DECLARED PER COMMON SHARE $0.09 $0.08  $0.09 $0.08 $0.18 $0.16 
              
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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FEDEX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
                
 Three Months Ended  Six Months Ended 
 August 31,  November 30, 
 2006 2005  2006 2005 
Operating Activities:  
Net income $475 $339  $986 $810 
Adjustments to reconcile net income to cash provided by operating activities:  
Depreciation and amortization 399 368  829 754 
Provision for uncollectible accounts 29 29  61 57 
Lease accounting charge — 79  — 79 
Deferred income taxes and other noncash items 13  (31) 4 64 
Changes in operating assets and liabilities: 
Changes in operating assets and liabilities, net of the effect of acquired business: 
Receivables  (138)  (3)  (352)  (314)
Other current assets  (13) 7   (38)  (15)
Accounts payable and other operating liabilities  (85)  (82) 167  (9)
Other, net  (15) 77   (309)  (291)
          
Net cash provided by operating activities 665 783  1,348 1,135 
Investing Activities:  
Capital expenditures  (699)  (671)  (1,459)  (1,326)
Business acquisition  (784) — 
Proceeds from asset dispositions 5 1  22 37 
Other, net 10 — 
          
Net cash used in investing activities  (694)  (670)  (2,211)  (1,289)
Financing Activities:  
Proceeds from debt issuance 999 —  999 — 
Principal payments on debt  (221)  (95)  (226)  (102)
Proceeds from stock issuances 30 18  55 53 
Excess tax benefit on the exercise of stock options 6 — 
Dividends paid  (28)  (24)  (55)  (48)
Other, net  (4) —  8  (2)
          
Net cash provided by (used in) financing activities 782  (101) 781  (99)
          
Net increase in cash and cash equivalents 753 12 
Net decrease in cash and cash equivalents  (82)  (253)
Cash and cash equivalents at beginning of period 1,937 1,039  1,937 1,039 
          
Cash and cash equivalents at end of period $2,690 $1,051  $1,855 $786 
          
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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FEDEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1)General
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.These interim financial statements of FedEx Corporation (“FedEx”) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information, the instructions to Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X, and should be read in conjunction with our Annual Report on Form 10-K, as amended, for the year ended May 31, 2006 (“Annual Report”). Accordingly, significant accounting policies and other disclosures normally provided have been omitted, sinceas such items are disclosed therein.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (including normal recurring adjustments) necessary to present fairly our financial position as of August 31,November 30, 2006 and the results of our operations for the three- and six-month periods ended November 30, 2006 and 2005 and our cash flows for the three-monthsix-month periods ended August 31,November 30, 2006 and 2005. Operating results for the three-month periodthree- and six-month periods ended August 31,November 30, 2006 are not necessarily indicative of the results that may be expected for the year ending May 31, 2007.
Except as otherwise specified, references to years indicate our fiscal year ending May 31, 2007 or ended May 31 of the year referenced and comparisons are to the corresponding period of the prior year.
Certain prior period amounts have been reclassified to conform to the current period’s presentation.
EMPLOYEES UNDER COLLECTIVE BARGAINING ARRANGEMENTS.The pilots of FedEx Express, whichwho represent a small number of FedEx Expressour total employees, are employed under a collective bargaining agreement that became amendableagreement. Our net income for the second quarter and first six months of 2007 includes the impact of a new four-year labor contract ratified by the pilots on May 31, 2004. In August 2006, FedEx Express and the pilots’ union reached a tentativeOctober 17, 2006. The effect of this new agreement on anet income for the second quarter of 2007 was approximately $78 million after tax, or $0.25 per diluted share. The new labor contract. The proposed new contractagreement includes signing bonuses and other upfront compensation that would result in a charge in the period of ratification of approximately $145 million. Contract ratification is expected during the second quarter of 2007 but cannot be assured. If ratified, the new four-year contract will become amendable$143 million, as well as pay increases and other benefit enhancements. These costs were partially mitigated by reductions in 2010.variable incentive compensation.
DIVIDENDS DECLARED PER COMMON SHARE.On August 18,November 17, 2006, our Board of Directors declared a dividend of $0.09 per share of common stock. The dividend will be paid on OctoberJanuary 2, 20062007 to stockholders of record as of the close of business on September 11,December 12, 2006. Each quarterly dividend payment is subject to review and approval by our Board of Directors, and we evaluate our dividend payment amount on an annual basis at the end of each fiscal year.
BUSINESS ACQUISITIONS.On September 3, 2006, we acquired the assets and assumed certain obligations of the less-than-truckload (“LTL”) operations of Watkins Motor Lines (“Watkins”), a privately held company, and certain affiliates for approximately $780$784 million in cash. Watkins, is a leading provider of long-haul LTL services. Watkinsservices, is being rebranded as FedEx National LTL and will beis expected to extend our leadership position in the heavyweight freight sector. The financial results of FedEx National LTL are included in the FedEx Freight segment commencingfrom the date of acquisition. Pro forma results of this acquisition would not differ materially from reported results in any of the periods presented.

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The assets and liabilities related to FedEx National LTL have been included in the secondaccompanying unaudited balance sheet based on a preliminary allocation of the purchase price. The purchase price allocation is expected to be complete by the end of 2007.
The accompanying unaudited balance sheet reflects the following preliminary allocation of the purchase price (in millions):
     
Current assets, primarily accounts receivable $121 
Property and equipment  528 
Customer-related intangible assets  77 
Goodwill  114 
Other assets  4 
Current liabilities  (60)
    
Total purchase price $784 
    
Customer-related intangible assets will be amortized on an accelerated basis over a weighted-average estimated useful life of approximately seven years. The portion of the purchase price allocated to goodwill and other identified intangible assets will be deductible for tax purposes over 15 years.
We paid the purchase price from available cash balances, which included the proceeds from our $1 billion senior unsecured debt offering completed during the first quarter of 2007. See Note 4 for further discussion of this debt offering.
On January 24, 2006, FedEx Express entered into an agreement with Tianjin Datian W. Group Co., Ltd. (“DTW Group”) to acquire DTW Group’s 50% share of the FedEx-DTW International Priority express joint venture (“FedEx-DTW”) and DTW Group’s domestic express network in China for approximately $400 million in cash. This acquisition will convert our joint venture with DTW Group, formed in 1999 and currently accounted for under the equity method, into a wholly-ownedwholly owned subsidiary and increase our presence in China in the international and domestic express businesses. The acquisition is expected to be completed

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during 2007, subject to customary closing conditions. The financial results of this transaction will be included in the FedEx Express segment from the date of acquisition.
On November 2, 2006, FedEx Express entered into an agreement to acquire Prakash Air Freight Pvt. Ltd., its primary service provider in India, for approximately $30 million in cash. This acquisition will extend our operations in the global express industry with a wholly owned company in one of the world’s fastest growing markets. The acquisition is expected to be completed during 2007, subject to customary closing conditions. The financial results of the acquired company will be included in the FedEx Express segment from the date of acquisition.
On December 16, 2006, FedEx Express acquired all of the outstanding capital stock of ANC Holdings Ltd., a United Kingdom domestic express transportation company, for approximately $235 million. This acquisition will allow FedEx Express to better serve the United Kingdom domestic market, which was previously served in part through independent agents. The financial results of the acquired company will be included in the FedEx Express segment from the date of acquisition.
LEASE ADJUSTMENT.Our results for the first quarter of 2006six months ended November 30, 2005 included a noncash charge of $79 million ($49 million after tax or $0.16 per diluted share), which represented the impact on prior years to adjust the accounting for certain facility leases, predominantly at FedEx Express. The charge related primarily to rent escalations in on-airport facility leases that were not being recognized appropriately.

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NEW ACCOUNTING PRONOUNCEMENTSPRONOUNCEMENTS.. TheIn September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. (“SFAS”) 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” which amended several other FASB Statements. SFAS 158 requires recognition in the balance sheet of the funded status of defined benefit pension and other postretirement benefit plans, and the recognition in other comprehensive income of unrecognized gains or losses and prior service costs or credits arising during the period. Additionally, SFAS No. 158 requires the measurement date for plan assets and liabilities to coincide with the sponsor’s year-end. We currently use a February 28 measurement date for our plans, so this standard will require us to change our measurement date to May 31.
The funded status recognition and disclosure provisions of SFAS 158 are effective for FedEx as of May 31, 2007. The requirement to measure plan assets and benefit obligations as of our fiscal year-end is effective for FedEx in 2009.
The impact of this standard on our balance sheet will depend on the funded status of our plans based on our February 28, 2007 measurement date. However, if the provisions of SFAS 158 were effective as of May 31, 2006, we estimate that the incremental after-tax impact of adopting SFAS 158 would have been a decrease in assets of approximately $1.4 billion, an increase in liabilities of approximately $400 million, and a decrease in total shareholders’ equity of approximately $1.8 billion. The actual amount of these adjustments at May 31, 2007 could differ materially from the amounts above. However, any adjustments resulting from the adoption of these new rules are not expected to impact our compliance with any current loan covenants or affect our debt ratings, pension funding requirements or our overall liquidity.
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which eliminates the diversity in practice surrounding the quantification and evaluation of financial statement errors. The guidance outlined in SAB 108 is effective for FedEx in 2008 and is consistent with our historical practices for assessing such matters when circumstances have required such an evaluation. Accordingly, we do not believe that adoption of SAB 108 will have any impact on us.
The FASB issued FASB Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes,” in July 2006. This interpretation establishes new standards for the financial statement recognition, measurement and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. The new rules will be effective for FedEx in 2008. We are evaluatingcontinue to evaluate this interpretation, but do not presently anticipate its adoption will have a material impact on our financial statements.
(2)Stock Compensation
On June 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”)SFAS 123R, “Share-Based Payment,” which requires recognition of compensation expense for stock-based awards using a fair value method. SFAS 123R is a revision of SFAS 123, “Accounting for Stock-Based Compensation”Compensation,” and supersedes Accounting Principles Board Opinion No. (“APB”) 25, “Accounting for Stock Issued to Employees.” Prior to the adoption of SFAS 123R, we applied APB 25 and its related interpretations to measure compensation expense for stock-based compensation plans. As a result, no compensation expense was recorded for stock options, as the exercise price was equal to the market price of our common stock at the date of grant.
We adopted SFAS 123R using the modified prospective method, which resulted in prospective recognition of compensation expense for all outstanding unvested share-based payments to employees based on the fair value on the original grant date. Under this method of adoption, our financial statement amounts for the prior period presented have not been restated.

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Our total share-based compensation expense was $31$25 million for the three months ended August 31,November 30, 2006, and $56 million for the six months ended November 30, 2006. The impact of adopting SFAS 123R to the second quarter of 2007 was approximately $22$17 million ($1612 million, net of tax), or $0.05$0.04 per basic and diluted share, which isand $39 million ($28 million, net of tax), or $0.09 per basic and diluted share, for the first six months of 2007. These amounts are not material to earnings or cash flows for the quarter. A comparable amount would have been recognized in thesecond quarter or first quartersix months of 2006 had these accounting rules been applied.2007.

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For the three months ended August 31, 2005, stockStock option compensation expense, pro forma net income and basic and diluted earnings per common share, if determined under SFAS 123 at fair value using the Black-Scholes method, would have been as follows (in millions, except for per share amounts): for the three- and six-month periods ended November 30, 2005:
        
 Three Months Six Months 
     Ended Ended 
Net income, as reported $339  $471 $810 
Add: Stock compensation included in reported net income, net of tax  (1) 3 2 
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax benefit 11  13 23 
        
Pro forma net income $327  $461 $789 
        
Earnings per common share:  
Basic — as reported $1.12  $1.55 $2.67 
        
Basic — pro forma $1.08  $1.52 $2.60 
        
Diluted — as reported $1.10  $1.53 $2.63 
        
Diluted — pro forma $1.06  $1.50 $2.56 
        
The key terms of the stock options and restricted stock granted under our incentive stock plans are set forth in our Annual Report. At November 30, 2006, there were 7,255,899 shares available for future grants under these plans.
We use the Black-Scholes option pricing model to calculate the fair value of stock options. We recognize stock-based compensation expense on a straight-line basis over the requisite service period of the award in the “Salaries and employee benefits” caption of our income statement. The intrinsic value of options exercised during the first quarter of 2007six-month period ended November 30, 2006 was $33$61 million.
For unvested stock options and restricted stock awards granted prior to June 1, 2006, the terms of these awards 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. This provision was removed from all stock option awards granted subsequent to May 31, 2006.
As of August 31,November 30, 2006, there was $192$169 million of total unrecognized compensation cost, net of estimated forfeitures, related to unvested share-based compensation arrangements. This compensation expense is expected to be recognized on a straight-line basis over the remaining weighted-average vesting period of approximately four years.
The key terms of the stock options and restricted stock granted under our incentive stock plans are set forth in our Annual Report. At August 31, 2006, there were 6,408,749 shares available for future grants under these plans.

 

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Following is a table of the key weighted-average assumptions used in the valuation calculations under both SFAS 123R and SFAS 123 for the options granted during the six-month periods presented. See our Annual Report for a discussion of our methodology for developing each of the assumptions used in the valuation model:model.
        
 Three Months Ended         
 August 31,  November 30, 
 2006 2005  2006 2005 
Expected lives 5 years 5 years 5 years 5 years
Expected volatility  22%  25%  22%  25%
Risk-free interest rate  4.99%  3.68%  4.95%  3.70%
Dividend yield  0.299%  0.323%  0.300%  0.325%
Forfeiture rate  8%  8%
The following table summarizes information about stock option and restricted stock activity for the three monthssix-month period ended August 31,November 30, 2006:
                            
                     Stock Options Restricted Stock 
 Stock Options Outstanding Restricted Stock  Weighted- Weighted-     
 Weighted-      Average Average     
 average      Exercise Remaining Aggregate     
 Shares exercise price Fair Value Shares Fair Value  Shares Price Fair Value Life Intrinsic Value Shares Fair Value 
Outstanding at June 1, 2006 17,099,526 $60.82 $307,436,781 583,106 $44,941,947  17,099,526 $60.82 $307,436,781 583,106 $44,941,947 
Granted 1,644,965 110.33 52,775,290 161,857 17,843,307  1,801,146 109.88 57,291,006 170,456 18,734,924 
Exercised  (565,074) 53.57  (9,174,511)  (241,266)  (16,631,329)  (1,041,653) 53.19  (16,905,962)  (247,597)  (17,125,777)
Forfeited  (57,080) 76.97  (1,242,232)  (1,099)  (95,294)  (144,709) 87.17  (3,484,175)  (10,791)  (981,289)
                  
Outstanding at August 31, 2006 18,122,337 65.53 $349,795,328 502,598 $46,058,631 
Outstanding at November 30, 2006 17,714,310 $66.10 $344,337,650 6.1 years $870,709,639 495,174 $45,569,805 
                      
Options Exercisable 11,427,422 $52.94 4.9 years $712,089,373 
       
The options granted induring the three monthssix-month period ended August 31,November 30, 2006 are primarily related to our principal annual stock option grant in June 2006. The weighted-average Black-Scholes value of theseour stock option grants underusing the assumptions indicated above was $32.08$31.81 per option.
The following table summarizes information about vested and nonvested stock options as of November 30, 2006 and June 1, 2006 and August 31, 2006:
                                
 June 1, 2006 August 31, 2006  November 30, 2006 June 1, 2006 
 Shares Fair Value Shares Fair Value  Shares Fair Value Shares Fair Value 
Vested  9,665,894 $144,823,786  11,778,653 $189,087,443  11,427,422 $184,337,742 9,665,894 $144,823,786 
Nonvested 7,433,632 162,612,995 6,343,684 160,707,885  6,286,888 159,999,908 7,433,632 162,612,995 
                  
Total 17,099,526 $307,436,781 18,122,337 $349,795,328  17,714,310 $344,337,650 17,099,526 $307,436,781 
                  
During the threesix months ended August 31,November 30, 2006, 2,677,8332,778,196 stock options vested with a fair value of $53$56 million.
Total equity compensation shares outstanding or available for grant at August 31,November 30, 2006 represented 7.8%7.7% of the total outstanding common and equity compensation shares and equity compensation shares available for grant.

 

-10--11-

The following table summarizes information regarding stock options outstanding as of August 31, 2006:
                             
  Options Outstanding  Options Exercisable 
      Weighted-  Weighted-          Weighted-    
      Average  Average  Aggregate      Average  Aggregate 
Range of Number  Remaining  Exercise  Intrinsic  Number  Exercise  Intrinsic 
Exercise Prices Outstanding  Contractual Life  Price  Value  Exercisable  Price  Value 
$15.34  -   22.16  62,874  1.7 years $16.85       62,874  $16.85     
23.81  - -   35.69  1,632,761  1.5 years  30.17       1,632,761   30.17     
35.89  - -   53.77  5,181,650  4.9 years  44.69       5,172,150   44.68     
55.94  - -   83.73  6,212,200  6.6 years  66.68       4,123,294   64.80     
84.57  - - 117.59  5,032,852  9.1 years  97.62       787,674   90.07     
                           
$15.34  - 117.59  18,122,337  6.3 years $65.53  $636,184,069   11,778,753  $52.60  $565,755,727 
                           
(3)Comprehensive Income
The following table providestables provide a reconciliation of net income reported in our financial statements to comprehensive income (in millions):
        
         Three Months Ended 
 Three Months Ended August 31,  November 30, 
 2006 2005  2006 2005 
Net income $475 $339  $511 $471 
Other comprehensive income:  
Foreign currency translation adjustments, net of deferred taxes of $1 in 2005 — 5 
Foreign currency translation adjustments, net of deferred taxes of $2 in 2006 and deferred tax benefit of $3 in 2005 2  (4)
          
Comprehensive income $475 $344  $513 $467 
          
         
  Six Months Ended 
  November 30, 
  2006  2005 
Net income $986  $810 
Other comprehensive income:        
Foreign currency translation adjustments, net of deferred taxes of $2 in 2006 and deferred tax benefit of $4 in 2005  2   1 
       
Comprehensive income $988  $811 
       
(4)Financing Arrangements
From time to time, we finance certain operating and investing activities, including acquisitions, through borrowings under our $1.0 billion revolving credit facility or the issuance of commercial paper. The revolving credit agreement contains certain covenants and restrictions, none of which are expected to significantly affect our operations or ability to pay dividends. Our commercial paper program is backed by unused commitments under the revolving credit facility and borrowings under the program reduce the amount available under the credit facility. At August 31,November 30, 2006, no commercial paper borrowings were outstanding and the entire amount under the credit facility was available.
On August 2, 2006, we filed an updated shelf registration statement with the SEC. The new registration statement does not limit the amount of any future offering. By using this shelf registration statement, we may sell, in one or more future offerings, any combination of our unsecured debt securities and common stock.
On August 8, 2006, under the new shelf registration statement, we issued $1 billion of senior unsecured debt, comprised of floating rate notes totaling $500 million due in August 2007 and fixed rate notes totaling $500 million due in August 2009. The floating rate notes bear interest at the three-month London Interbank Offered Rate (“LIBOR”) plus 0.08%, reset on a quarterly basis. At August 31,November 30, 2006, the floating interest rate was 5.58%5.45%. The fixed rate notes bear interest at an annual rate of 5.5%, payable semi-annually. WeThe net proceeds are using the net proceedsbeing used for working capital and general corporate purposes, including the funding of acquisitions.acquisitions (such as the FedEx National LTL and ANC acquisitions).

 

-11--12-

(5)Computation of Earnings Per Share
The calculation of basic and diluted earnings per common share for the three-monththree- and six-month periods ended August 31November 30 was as follows (in millions, except per share amounts):
                
         Three Months Ended Six Months Ended 
 2006 2005  2006 2005 2006 2005 
Net income $475 $339  $511 $471 $986 $810 
              
Weighted-average shares of common stock outstanding 306 303  307 303 306 303 
Common equivalent shares:  
Assumed exercise of outstanding dilutive options 17 17  18 16 18 17 
Less shares repurchased from proceeds of assumed exercise of options  (13)  (12)  (14)  (11)  (13)  (12)
              
Weighted-average common and common equivalent shares outstanding 310 308  311 308 311 308 
              
Basic earnings per common share $1.55 $1.12 
Basic earnings per share $1.67 $1.55 $3.22 $2.67 
              
Diluted earnings per common share $1.53 $1.10 
Diluted earnings per share $1.64 $1.53 $3.17 $2.63 
              
We have excluded from the calculation of diluted earnings per share approximately 1.70.1 million antidilutive options for the three monthsthree- and six-month periods ended August 31,November 30, 2006, and approximately 3.23.1 million antidilutive options for the three monthsthree- and six-month periods ended August 31,November 30, 2005, as the exercise price of these options was greater than the average market price of common stock for the period.
(6)Employee Benefit Plans
We sponsor defined benefit pension plans covering a majority of our employees. The largest plan covers certain U.S. employees age 21 and over with at least one year of service. Certain of our subsidiaries also offer medical, dental and vision coverage to eligible U.S. retirees and their eligible dependents. Net periodic benefit cost of the pension and postretirement healthcare plans for the three-month periods ended August 31 wasNovember 30 were as follows (in millions):
                                
 Postretirement  Three Months Ended Six Months Ended 
 Pension Plans Healthcare Plans 
 2006 2005 2006 2005 
Pension Plans 2006 2005 2006 2005 
Service cost $132 $119 $8 $10  $133 $118 $265 $237 
Interest cost 177 161 7 8  177 161 354 322 
Expected return on plan assets  (232)  (203) — —   (233)  (203)  (465)  (406)
Recognized actuarial losses/(gains) 34 26  (1) — 
Recognized actuarial losses 35 29 69 55 
Amortization of transition obligation  (1)  (1)  (1)  (1)
Amortization of prior service cost 3 3 — —  3 3 6 6 
                  
 $114 $106 $14 $18  $114 $107 $228 $213 
                  
Postretirement Healthcare Plans 
Service cost $8 $11 $16 $21 
Interest cost 7 8 14 16 
Recognized actuarial gain  (1) —  (2) — 
         
 $14 $19 $28 $37 
         

-13-

We made tax-deductible voluntary contributions to our qualified U.S. domestic pension plans of $100$482 million during the first quartersix months of 2007, and made no contributions during$456 million in the first quartersix months of 2006. On September 1, 2006,Although additional contributions are not required, we made additional tax-deductiblemay elect to make further voluntary contributions to our qualified U.S. domestic pension plans of $382 million. On September 1, 2005, we made tax-deductible voluntary contributions totaling $456 million to our qualified U.S. domestic pension plans.in 2007.

-12-

(7)Business Segment Information
We provide a broad portfolio of transportation, e-commerce and business services through companies operating independently, competing collectively and managed collaboratively under the respected FedEx brand. Our operations are primarily represented by Federal Express Corporation (“FedEx Express”), the world’s largest express transportation company; FedEx Ground Package System, Inc. (“FedEx Ground”), a leading provider of small-package ground delivery services; FedEx Freight Corporation, (“FedEx Freight”), a leading U.S. provider of LTL freight services; and FedEx Kinko’s Office and Print Services, Inc. (“FedEx Kinko’s”), a leading provider of document solutions and business services. These businesses form the core of our reportable segments. Management evaluates segment financial performance based on operating income.
FedEx Corporate Services, Inc. (“FedEx Services”) provides customer-facing sales, marketing and information technology support, primarily for FedEx Express and FedEx Ground. The costs for these functions are allocated based on metrics such as relative revenues or estimated services provided. We also allocate costs for administrative functions provided between operating companies and certain other costs such as costs associated with services received for general corporate oversight, including executive officers and certain legal and finance functions. We believe these allocations approximate the cost of providing these functions.
Effective June 1, 2006, we moved the credit, collections and customer service functions with responsibility for FedEx Express and FedEx Ground customer information from FedEx Express into a newly formed subsidiary of FedEx Services named FedEx Customer Information Services, Inc. (“FCIS”). Also, effective June 1, 2006, we moved FedEx Supply Chain Services, Inc., the results of which were previously reported in the FedEx Ground segment, into a new subsidiary of FedEx Services named FedEx Global Supply Chain Services, Inc. The costs of providing these customer service functions and the net operating costs of FedEx Global Supply Chain Services are allocated back to the FedEx Express and FedEx Ground segments. Prior year amounts have not been reclassified to conform to the current year segment presentation as the financial results of all segments are materially comparable.
In addition, certain FedEx operating companies provide transportation and related services for other FedEx companies outside their reportable segment. Billings for such services are based on negotiated rates, which we believe approximate fair value, and are reflected as revenues of the billing segment. FedEx Kinko’s segment revenues include package acceptance revenue, which represents the fee received by FedEx Kinko’s from FedEx Express and FedEx Ground for accepting and handling packages at FedEx Kinko’s locations on behalf of these operating companies. Package acceptance revenue does not include the external revenue associated with the actual shipments. All shipment revenues are reflected in the segment performing the transportation services. Intersegment revenues and expenses are eliminated in the consolidated results but are not separately identified in the following segment information as the amounts are not material.

 

-13--14-

As of August 31,November 30, 2006, our reportable segments included the following businesses:
   
FedEx Express Segment
 FedEx Express (express transportation)
FedEx Trade Networks (global trade services)
FedEx Ground Segment
 FedEx Ground (small-package ground delivery)
FedEx SmartPost (small-parcel consolidator)
FedEx Freight Segment
 FedEx Freight LTL Group:
     FedEx Freight (regional LTL freight transportation)
     FedEx National LTL (long-haul LTL freight transportation)
FedEx Custom Critical (time-critical transportation)
Caribbean Transportation Services (airfreight forwarding)
FedEx Kinko’s Segment
 FedEx Kinko’s (document solutions and business services)
The following table provides a reconciliation of reportable segment revenues and operating income to our consolidated financial statement totals (in millions):
                        
 Three Months Ended  Three Months Ended Six Months Ended 
 August 31,  November 30, November 30, 
 2006 2005  2006 2005 2006 2005 
Revenue  
FedEx Express segment $5,640 $5,122  $5,693 $5,370 $11,333 $10,492 
FedEx Ground segment 1,417 1,219  1,520 1,307 2,937 2,526 
FedEx Freight segment 1,013 892 
FedEx Freight segment(3)
 1,225 932 2,238 1,824 
FedEx Kinko’s segment 504 517  519 528 1,023 1,045 
Other and eliminations  (29)  (43)  (31)  (47)  (60)  (90)
              
 $8,545 $7,707  $8,926 $8,090 $17,471 $15,797 
              
Operating Income  
FedEx Express segment(1)(2)
 $467 $285  $502 $476 $969 $761 
FedEx Ground segment 157 148  191 163 348 311 
FedEx Freight segment 150 135 
FedEx Freight segment(3)
 138 135 288 270 
FedEx Kinko’s segment 10 16  8 16 18 32 
Other and eliminations — —  — — — — 
              
 $784 $584  $839 $790 $1,623 $1,374 
              
(1) FedEx Express segment results for the threesecond quarter and first six months of 2007 include a $143 million charge for signing bonuses and other upfront compensation associated with the new labor contract with our pilots, which was ratified in October 2006.
(2)FedEx Express segment results for the six months ended August 31,November 30, 2005 include a $75 million noncash charge to adjust the accounting for certain facility leases.
(3)FedEx Freight segment results for the second quarter and first six months include the results of FedEx National LTL from the date of its acquisition on September 3, 2006.

 

-14--15-

(8)Commitments
As of August 31,November 30, 2006, our purchase commitments for the remainder of 2007 and annually thereafter under various contracts were as follows (in millions):
                                
 Aircraft-      Aircraft-     
 Aircraft Related(1) Other(2) Total  Aircraft Related(1) Other(2) Total 
2007 (remainder) $149 $101 $753 $1,003  $225 $79 $369 $673 
2008 431 113 217 761  407 129 167 703 
2009 480 61 159 700  678 61 111 850 
2010 659 67 104 830  922 68 71 1,061 
2011 460 66 70 596  613 54 59 726 
Thereafter 157 8 218 383  — 8 218 226 
(1) Primarily aircraft modifications.
 
(2) Primarily vehicles, facilities, computers, printing and other equipment and advertising and promotions contracts.
The amounts reflected in the table above for purchase commitments represent non-cancelable agreements to purchase goods or services. Commitments to purchase aircraft in passenger configuration do not include the attendant costs to modify these aircraft for cargo transport unless we have entered into non-cancelable commitments to modify such aircraft. Open purchase orders that are cancelable are not considered unconditional purchase obligations for financial reporting purposes and are not included in the table above.
FedEx Express is committedOn September 25, 2006, we announced a $2.6 billion multi-year program to acquire and modify approximately 90 Boeing 757-200 aircraft to replace our narrow body fleet of Boeing 727-200 aircraft. We expect to bring the new aircraft into service during the eight-year period between calendar years 2008 and 2016 contingent upon identification and purchase of suitable 757-200 aircraft. As of November 30, 2006, we had entered into agreements to purchase certain15 757-200 aircraft under this program.
On November 7, 2006, we entered into an agreement to acquire 15 new Boeing 777 Freighter (“777F”) aircraft and an option to purchase an additional 15 Boeing 777F aircraft. In connection with the decision to purchase these aircraft, we cancelled our order of ten Airbus A380-800F aircraft. We do not expect the cancellation of this contract to have any material negative impact to us.
Deposits and progress payments of $63$126 million have been made toward theseaircraft purchases, options to purchase additional aircraft and other planned aircraft-related transactions. In addition, we have committed to modify our DC10 aircraft for passenger-to-freighter and two-man cockpit configurations. Future payments related to these activities are included in the table above. Aircraft and aircraft-related contracts are subject to price escalations. The following table is a summary of ourthe number and type of aircraft we are committed to purchase commitments as of August 31,November 30, 2006, with the year of expected delivery by type:delivery:
                            
 A300 A380 Total  A300 B757 777F Total 
2007 (remainder) 4 — 4  4 4 — 8 
2008 9 — 9  9 2 — 11 
2009 4 2 6  4 3 — 7 
2010 — 4 4  — 5 6 11 
2011 — 3 3  — 1 9 10 
Thereafter — 1 1  — — — — 
                
Total 17 10 27  17 15 15 47 
                

 

-15--16-

A summary of future minimum lease payments under capital leases at August 31,November 30, 2006 is as follows (in millions):
        
2007 (remainder) $17  $11 
2008 100  100 
2009 12  12 
2010 97  97 
2011 8  8 
Thereafter 144  144 
      
 378  372 
Less amount representing interest 70  66 
      
Present value of net minimum lease payments $308  $306 
      
A summary of future minimum lease payments under non-cancelable operating leases with an initial or remaining term in excess of one year at August 31,November 30, 2006 is as follows (in millions):
                        
 Aircraft and Related Facilities and    Aircraft and
Related		 Facilities and   
 Equipment Other Total  Equipment Other Total 
2007 (remainder) $495 $802 $1,297  $410 $539 $949 
2008 586 935 1,521  587 990 1,577 
2009 555 775 1,330  555 831 1,386 
2010 544 606 1,150  544 672 1,216 
2011 526 486 1,012  526 552 1,078 
Thereafter 3,934 2,962 6,896  3,934 3,326 7,260 
              
 $6,640 $6,566 $13,206  $6,556 $6,910 $13,466 
              
While certain of our lease agreements contain covenants governing the use of the leased assets or require us to maintain certain levels of insurance, none of our lease agreements include material financial covenants or limitations.
FedEx Express makes payments under certain leveraged operating leases that are sufficient to pay principal and interest on certain pass-through certificates. TheThese pass-through certificates are not direct obligations of, or guaranteed by, FedEx or FedEx Express.
(9)Contingencies
Wage-and-Hour.We are a defendant in a number of lawsuits filed in federal or California state courts containing various class-action allegations under federal or California wage-and-hour laws. The plaintiffs in these lawsuits are employees of FedEx operating companies who allege, among other things, that they were forced to work “off the clock” and were not provided work breaks or other benefits. The plaintiffs generally seek unspecified monetary damages, injunctive relief, or both.
To date, one of these wage-and-hour cases,Foster v. FedEx Express, has been certified as a class action. The plaintiffs inFosterrepresent a class of hourly FedEx Express employees in California from October 14, 1998 to present. The plaintiffs allege that hourly employees are routinely required to work “off the clock” and are not paid for this additional work. The court issued a ruling in December 2004 granting class certification on all issues. In February 2006, the parties reached a settlement that received final approval from the court on September 18, 2006. FedEx Express denies liability in this matter, but entered into the settlement to avoid the cost and uncertainty of further litigation. The amount of the settlement was fully accrued at the end of the third quarter of 2006 and is not material to FedEx.

-16-

With respect to the other wage-and-hour cases, we We have denied any liability and intend to vigorously defend ourselves. Given the nature and preliminary status of these other wage-and-hour claims, we cannot yet determine the amount or a reasonable range of potential loss in these other matters, if any.
Race Discrimination.On September 28, 2005, a California federal district court granted class certification inSatchell v. FedEx Express, a lawsuit alleging discrimination by FedEx Express in the Western region of the United States against certain current and former minority employees in pay and promotion. The district court’s ruling on class certification is not a decision on the merits of the plaintiffs’ claim and does not address whether we will be held liable. Trial is currently scheduled for February 2007. We have denied any liability and intend to vigorously defend ourselves in this case. Given the nature and preliminary status of the claim, we cannot yet determine the amount or a reasonable range of potential loss in this matter, if any. It is reasonably possible, however, that we could incur a material loss as this case develops.

-17-

On May 24, 2006, a jury ruled against FedEx Ground inIssa & Rizkallah v. FedEx Ground, a California state court lawsuit brought in July 2001 by two independent contractors who allege, among other things, that a FedEx Ground manager harassed and discriminated against them based upon their national origin. The jury awarded the two plaintiffs a total of $60 million (which includes $50 million of punitive damages), plus attorney’s fees and other litigation expenses. On September 5, 2006, the trial court reduced the total damage award to approximately $12 million (which includes over $10 million of punitive damages), plus attorney’s fees and other litigation expenses in an amount to be determined later. If the plaintiffs do not consent to the reduction of damages by October 5, 2006, FedEx Ground will be entitled to a new trial on the issue of damages. Based on the court’s ruling, we no longer believe that it is reasonably possible we could incur a material loss on this matter.
Independent Contractor.FedEx Ground is involved in numerous purported class-action lawsuits and other proceedings that claim that the company’s owner-operators should be treated as employees, rather than independent contractors. These matters includeEstrada v. FedEx Ground, a class action involving single work area contractors that was filed in California state court. Although the trial court has granted some of the plaintiffs’ claims for relief in Estrada ($18 million, inclusive of attorney’s fees, plus equitable relief), wethe appellate court has reversed the trial court’s issuance of equitable relief. We expect to prevail on appeal.the rest of the pending appeal as well. Adverse determinations in these matters could, among other things, entitle certain of our contractors to the reimbursement of certain expenses and to the benefit of wage-and-hour laws and result in employment and withholding tax liability for FedEx Ground. On August 10, 2005, the Judicial Panel on Multi-District Litigation granted our motion to transfer and consolidate the majority of the class-action lawsuits for administration of the pre-trial proceedings by a single federal court — the U.S. District Court for the Northern District of Indiana. We strongly believe that FedEx Ground’s owner-operators are properly classified as independent contractors and that we will prevail in these proceedings. Given the nature and preliminary status of these claims, we cannot yet determine the amount or a reasonable range of potential loss in these matters, if any.
FedEx Ground is also involved in several lawsuits, including twoone purported class actions,action, that claim that the drivers of the company’s independent contractors were jointly employed by the contractor and FedEx Ground. We strongly believe that FedEx Ground is not an employer of these drivers and that we will prevail in these proceedings. Given the nature and preliminary status of these claims, we cannot yet determine the amount or a reasonable range of potential loss in these matters, if any.
Other.FedEx and its subsidiaries are subject to other legal proceedings that arise in the ordinary course of their business. In the opinion of management, the aggregate liability, if any, with respect to these other actions will not materially adversely affect our financial position, results of operations or cash flows.

-17-

(10)Supplemental Cash Flow Information
                
 Three Months Ended  Six Months Ended 
 August 31,  November 30, 
 2006 2005  2006 2005 
 (In millions)  (In millions) 
Cash payments for:  
Interest (net of capitalized interest) $37 $44  $64 $64 
Income taxes 125 27  642 475 
(11)Condensed Consolidating Financial Statements
On August 2, 2006, we released certain subsidiary guarantors from their respective guarantees of our public debt. As a result, weWe are required to present condensed consolidating financial information in order for the subsidiary guarantors (other than FedEx Express) to continueof our public debt to be exempt from reporting under the Securities Exchange Act of 1934.

-18-

The guarantor subsidiaries, which are wholly-owned by FedEx, guarantee approximately $2.2 billion of our debt. The guarantees are full and unconditional and joint and several. Our guarantor subsidiaries were not determined using geographic, service line or other similar criteria, and as a result, the “Guarantor” and “Non-Guarantor”“Non-guarantor” columns each include portions of our domestic and international operations. Accordingly, this basis of presentation is not intended to present our financial condition, results of operations or cash flows for any purpose other than to comply with the specific requirements for subsidiary guarantor reporting.

-18-

Condensed consolidating financial statements for our guarantor subsidiaries and non-guarantor subsidiaries are presented in the following tables (in millions):
CONDENSED CONSOLIDATING BALANCE SHEETS
August 31,(UNAUDITED)
November 30, 2006
                                        
 Guarantor Non-guarantor      Guarantor Non-guarantor     
 Parent Subsidiaries Subsidiaries Eliminations Consolidated  Parent Subsidiaries Subsidiaries Eliminations Consolidated 
ASSETS  
CURRENT ASSETS  
Cash and cash equivalents $2,360 $150 $180 $— $2,690  $1,563 $143 $149 $— $1,855 
Receivables, less allowances — 2,945 700  (21) 3,624  3 3,114 875  (36) 3,956 
Spare parts, fuel, supplies, prepaid expenses and other, less allowances 6 436 50 — 492  4 447 66 — 517 
Deferred income taxes — 519 17 — 536  — 488 27 — 515 
                      
Total current assets 2,366 4,050 947  (21) 7,342  1,570 4,192 1,117  (36) 6,843 
PROPERTY AND EQUIPMENT, AT COST 22 23,047 1,655 — 24,724  22 23,650 2,232 — 25,904 
Less accumulated depreciation and amortization 12 12,689 908 — 13,609  13 12,955 948 — 13,916 
                      
Net property and equipment 10 10,358 747 — 11,115  9 10,695 1,284 — 11,988 
INTERCOMPANY RECEIVABLE — 454 1,497  (1,951) —  — 569 881  (1,450) — 
GOODWILL — 2,675 150 — 2,825  — 2,675 266 — 2,941 
PREPAID PENSION COST 1,313 19 19 — 1,351  1,591 21 24 — 1,636 
INVESTMENT IN SUBSIDIARIES 12,775 2,148 —  (14,923) —  13,348 2,292 —  (15,640) — 
OTHER ASSETS 78 516 684  (33) 1,245  74 489 775  (33) 1,305 
                      
 $16,542 $20,220 $4,044 $(16,928) $23,878  $16,592 $20,933 $4,347 $(17,159) $24,713 
                      
LIABILITIES AND STOCKHOLDERS’ INVESTMENT  
CURRENT LIABILITIES  
Current portion of long-term debt $1,000 $130 $— $— $1,130  $1,000 $168 $— $— $1,168 
Accrued salaries and employee benefits 26 872 127 — 1,025  33 1,065 171 — 1,269 
Accounts payable 35 1,564 297  (21) 1,875  33 1,703 360  (36) 2,060 
Accrued expenses 40 1,424 129 — 1,593  43 1,264 170 — 1,477 
                      
Total current liabilities 1,101 3,990 553  (21) 5,623  1,109 4,200 701  (36) 5,974 
LONG-TERM DEBT, LESS CURRENT PORTION 1,248 842 — — 2,090  1,248 799 — — 2,047 
INTERCOMPANY PAYABLE 1,951 — —  (1,951) —  1,450 — —  (1,450) — 
OTHER LIABILITIES  
Deferred income taxes — 1,144 258  (33) 1,369  — 1,107 278  (33) 1,352 
Other liabilities 228 2,471 76 — 2,775  233 2,460 89 — 2,782 
                      
Total other long-term liabilities 228 3,615 334  (33) 4,144  233 3,567 367  (33) 4,134 
STOCKHOLDERS’ INVESTMENT 12,014 11,773 3,157  (14,923) 12,021  12,552 12,367 3,279  (15,640) 12,558 
                      
 $16,542 $20,220 $4,044 $(16,928) $23,878  $16,592 $20,933 $4,347 $(17,159) $24,713 
                      

 

-19-

CONDENSED CONSOLIDATING BALANCE SHEETS
May 31, 2006
                                        
 Guarantor Non-guarantor      Guarantor Non-guarantor     
 Parent Subsidiaries Subsidiaries Eliminations Consolidated  Parent Subsidiaries Subsidiaries Eliminations Consolidated 
ASSETS  
CURRENT ASSETS  
Cash and cash equivalents $1,679 $114 $144 $— $1,937  $1,679 $114 $144 $— $1,937 
Receivables, less allowances — 2,864 681  (29) 3,516  — 2,864 681  (29) 3,516 
Spare parts, fuel, supplies, prepaid expenses and other, less allowances 7 423 42 — 472  7 423 42 — 472 
Deferred income taxes — 522 17 — 539  — 522 17 — 539 
                      
Total current assets 1,686 3,923 884  (29) 6,464  1,686 3,923 884  (29) 6,464 
PROPERTY AND EQUIPMENT, AT COST 22 22,430 1,622 — 24,074  22 22,430 1,622 — 24,074 
Less accumulated depreciation and amortization 12 12,410 882 — 13,304  12 12,410 882 — 13,304 
                      
Net property and equipment 10 10,020 740 — 10,770  10 10,020 740 — 10,770 
INTERCOMPANY RECEIVABLE — 680 1,399  (2,079) —  — 680 1,399  (2,079) — 
GOODWILL — 2,675 150 — 2,825  — 2,675 150 — 2,825 
PREPAID PENSION COST 1,310 18 21 — 1,349  1,310 18 21 — 1,349 
INVESTMENT IN SUBSIDIARIES 12,301 2,093 —  (14,394) —  12,301 2,070 —  (14,371) — 
OTHER ASSETS 69 571 675  (33) 1,282  69 571 675  (33) 1,282 
                      
 $15,376 $19,980 $3,869 $(16,535) $22,690  $15,376 $19,957 $3,869 $(16,512) $22,690 
                      
LIABILITIES AND STOCKHOLDERS’ INVESTMENT  
CURRENT LIABILITIES  
Current portion of long-term debt $700 $150 $— $— $850  $700 $150 $— $— $850 
Accrued salaries and employee benefits 50 1,107 168 — 1,325  50 1,107 168 — 1,325 
Accounts payable 33 1,594 310  (29) 1,908  33 1,594 310  (29) 1,908 
Accrued expenses 37 1,221 132 — 1,390  37 1,221 132 — 1,390 
                      
Total current liabilities 820 4,072 610  (29) 5,473  820 4,072 610  (29) 5,473 
LONG-TERM DEBT, LESS CURRENT PORTION 749 843 — — 1,592  749 843 — — 1,592 
INTERCOMPANY PAYABLE 2,079 — —  (2,079) —  2,079 — —  (2,079) — 
OTHER LIABILITIES              
Deferred income taxes — 1,143 257  (33) 1,367  — 1,143 257  (33) 1,367 
Other liabilities 226 2,447 74 — 2,747  226 2,447 74 — 2,747 
                      
Total other long-term liabilities 226 3,590 331  (33) 4,114  226 3,590 331  (33) 4,114 
STOCKHOLDERS’ INVESTMENT 11,502 11,475 2,928  (14,394) 11,511  11,502 11,452 2,928  (14,371) 11,511 
                      
 $15,376 $19,980 $3,869 $(16,535) $22,690  $15,376 $19,957 $3,869 $(16,512) $22,690 
                      

 

-20-

CONDENSED CONSOLIDATING STATEMENTS OF INCOME
(UNAUDITED)
Three Months Ended August 31,November 30, 2006
                                        
 Guarantor Non-guarantor      Guarantor Non-guarantor     
 Parent Subsidiaries Subsidiaries Eliminations Consolidated  Parent Subsidiaries Subsidiaries Eliminations Consolidated 
REVENUES $— $7,468 $1,162 $(85) $8,545  $— $7,541 $1,479 $(94) $8,926 
OPERATING EXPENSES:  
Salaries and employee benefits 27 2,870 388 — 3,285  25 2,987 514 — 3,526 
Purchased transportation — 729 174  (7) 896  — 762 241  (7) 996 
Rentals and landing fees — 514 56 — 570  2 519 64  (1) 584 
Depreciation and amortization — 362 37 — 399  1 373 56 — 430 
Fuel — 904 37 — 941  — 807 53 — 860 
Maintenance and repairs — 497 18 — 515  — 460 32 — 492 
Intercompany charges, net  (50)  (31) 81 — —   (49)  (63) 112 — — 
Other 23 1,037 173  (78) 1,155  21 1,055 209  (86) 1,199 
                      
 — 6,882 964  (85) 7,761  — 6,900 1,281  (94) 8,087 
                      
OPERATING INCOME — 586 198 — 784  — 641 198 — 839 
OTHER INCOME (EXPENSE):  
Equity in earnings of subsidiaries 475 125 —  (600) —  511 123 —  (634) — 
Interest, net 1  (10) — —  (9)  (7)  (11) 1 —  (17)
Intercompany charges, net 1  (9) 8 — —  8  (6)  (2) — — 
Other, net  (2)  (1)  (2) —  (5)  (1) 1 1 — 1 
                      
INCOME BEFORE INCOME TAXES 475 691 204  (600) 770  511 748 198  (634) 823 
Provision for income taxes — 237 58 — 295  — 261 51 — 312 
                      
NET INCOME $475 $454 $146 $(600) $475  $511 $487 $147 $(634) $511 
                      
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
(UNAUDITED)
Three Months Ended August 31,November 30, 2005
                                        
 Guarantor Non-guarantor      Guarantor Non-guarantor     
 Parent Subsidiaries Subsidiaries Eliminations Consolidated  Parent Subsidiaries Subsidiaries Eliminations Consolidated 
REVENUES $— $6,773 $1,014 $(80) $7,707  $— $7,057 $1,131 $(98) $8,090 
OPERATING EXPENSES:  
Salaries and employee benefits 17 2,701 344 — 3,062  20 2,707 354 — 3,081 
Purchased transportation — 625 150  (4) 771  — 653 163  (4) 812 
Rentals and landing fees 1 610 54 — 665  1 524 59 — 584 
Depreciation and amortization 1 333 36 — 370  — 349 37 — 386 
Fuel — 700 28 — 728  — 855 36 — 891 
Maintenance and repairs — 452 16 — 468  — 428 17 — 445 
Intercompany charges, net  (36)  (32) 68 — —   (41)  (79) 120 — — 
Other 17 953 165  (76) 1,059  20 991 184  (94) 1,101 
                      
 — 6,342 861  (80) 7,123  — 6,428 970  (98) 7,300 
                      
OPERATING INCOME — 431 153 — 584  — 629 161 — 790 
OTHER INCOME (EXPENSE):  
Equity in earnings of subsidiaries 339 80 —  (419) —  471 102 —  (573) — 
Interest, net  (16)  (8) — —  (24)  (17)  (13) — —  (30)
Intercompany charges, net 20  (23) 3 — —  19  (22) 3 — — 
Other, net  (4)  (3)  (4) —  (11)  (2)  (1) 3 — — 
                      
INCOME BEFORE INCOME TAXES 339 477 152  (419) 549  471 695 167  (573) 760 
Provision for income taxes — 168 42 — 210  — 231 58 — 289 
                      
NET INCOME $339 $309 $110 $(419) $339  $471 $464 $109 $(573) $471 
                      

 

-21-

CONDENSED CONSOLIDATING STATEMENTS OF INCOME
(UNAUDITED)
Six Months Ended November 30, 2006
                     
      Guarantor  Non-guarantor       
  Parent  Subsidiaries  Subsidiaries  Eliminations  Consolidated 
REVENUES $—  $15,009  $2,641  $(179) $17,471 
OPERATING EXPENSES:                    
Salaries and employee benefits  52   5,857   902   —   6,811 
Purchased transportation  —   1,491   415   (14)  1,892 
Rentals and landing fees  2   1,033   120   (1)  1,154 
Depreciation and amortization  1   735   93   —   829 
Fuel  —   1,711   90   —   1,801 
Maintenance and repairs  —   957   50   —   1,007 
Intercompany charges, net  (99)  (94)  193   —   — 
Other  44   2,092   382   (164)  2,354 
                
   —   13,782   2,245   (179)  15,848 
                
OPERATING INCOME  —   1,227   396   —   1,623 
OTHER INCOME (EXPENSE):                    
Equity in earnings of subsidiaries  986   237   —   (1,223)  — 
Interest, net  (6)  (21)  1   —   (26)
Intercompany charges, net  9   (15)  6   —   — 
Other, net  (3)  —   (1)  —   (4)
                
INCOME BEFORE INCOME TAXES  986   1,428   402   (1,223)  1,593 
Provision for income taxes  —   498   109   —   607 
                
NET INCOME $986  $930  $293  $(1,223) $986 
                
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
(UNAUDITED)
Six Months Ended November 30, 2005
                     
      Guarantor  Non-guarantor       
  Parent  Subsidiaries  Subsidiaries  Eliminations  Consolidated 
REVENUES $—  $13,830  $2,145  $(178) $15,797 
OPERATING EXPENSES:                    
Salaries and employee benefits  37   5,408   698   —   6,143 
Purchased transportation  —   1,278   313   (8)  1,583 
Rentals and landing fees  2   1,134   113   —   1,249 
Depreciation and amortization  1   682   73   —   756 
Fuel  —   1,555   64   —   1,619 
Maintenance and repairs  —   880   33   —   913 
Intercompany charges, net  (77)  (111)  188   —   — 
Other  37   1,944   349   (170)  2,160 
                
   —   12,770   1,831   (178)  14,423 
                
OPERATING INCOME  —   1,060   314   —   1,374 
OTHER INCOME (EXPENSE):                    
Equity in earnings of subsidiaries  810   179   —   (989)  — 
Interest, net  (33)  (21)  —   —   (54)
Intercompany charges, net  39   (45)  6   —   — 
Other, net  (6)  (4)  (1)  —   (11)
                
INCOME BEFORE INCOME TAXES  810   1,169   319   (989)  1,309 
Provision for income taxes  —   399   100   —   499 
                
NET INCOME $810  $770  $219  $(989) $810 
                

-22-

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
Three(UNAUDITED)
Six Months Ended August 31,November 30, 2006
                                        
 Guarantor Non-guarantor    �� Guarantor Non-guarantor     
 Parent Subsidiaries Subsidiaries Eliminations Consolidated  Parent Subsidiaries Subsidiaries Eliminations Consolidated 
CASH PROVIDED BY OPERATING ACTIVITIES $123 $474 $68 $— $665 
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES $(290) $1,439 $199 $— $1,348 
INVESTING ACTIVITIES  
Capital expenditures —  (655)  (44) —  (699) —  (1,355)  (104) —  (1,459)
Business acquisition — —  (784) —  (784)
Proceeds from asset dispositions — 1 4 — 5  — 5 17 — 22 
Other, net — 10 — — 10 
                      
CASH USED IN INVESTING ACTIVITIES —  (654)  (40) —  (694) —  (1,340)  (871) —  (2,211)
FINANCING ACTIVITIES  
Net transfers (to) from Parent  (245) 237 8 — —   (633)  (44) 677 — — 
Proceeds from debt issuance 999 — — — 999  999 — — — 999 
Principal payments on debt  (200)  (21) — —  (221)  (200)  (26) — —  (226)
Proceeds from stock issuances 30 — — — 30  55 — — — 55 
Excess tax benefit on the exercise of stock options 6 — — — 6 
Dividends paid  (28) — — —  (28)  (55) — — —  (55)
Other, net  (4) — — —  (4) 8 — — — 8 
                      
CASH PROVIDED BY FINANCING ACTIVITIES 558 216 8 — 782 
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 174  (70) 677 — 781 
                      
CASH AND CASH EQUIVALENTS  
Net increase in cash and cash equivalents 681 36 36 — 753 
Net (decrease) increase in cash and cash equivalents  (116) 29 5 —  (82)
Cash and cash equivalents at beginning of period 1,679 114 144 — 1,937  1,679 114 144 — 1,937 
                      
Cash and cash equivalents at end of period $2,360 $150 $180 $— $2,690  $1,563 $143 $149 $— $1,855 
                      
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
Three(UNAUDITED)
Six Months Ended August 31,November 30, 2005
                                        
 Guarantor Non-guarantor      Guarantor Non-guarantor     
 Parent Subsidiaries Subsidiaries Eliminations Consolidated  Parent Subsidiaries Subsidiaries Eliminations Consolidated 
CASH PROVIDED BY OPERATING ACTIVITIES $241 $493 $49 $— $783 
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES $(304) $1,300 $139 $— $1,135 
INVESTING ACTIVITIES  
Capital expenditures  (2)  (619)  (50) —  (671)  (3)  (1,221)  (102) —  (1,326)
Proceeds from asset dispositions — 1 — — 1  — 35 2 — 37 
                      
CASH USED IN INVESTING ACTIVITIES  (2)  (618)  (50) —  (670)  (3)  (1,186)  (100) —  (1,289)
FINANCING ACTIVITIES  
Net transfers (to) from Parent  (183) 201  (18) — —  97  (46)  (51) — — 
Principal payments on debt —  (95) — —  (95) —  (102) — —  (102)
Proceeds from stock issuances 18 — — — 18  53 — — — 53 
Dividends paid  (24) — — —  (24)  (48) — — —  (48)
Other, net  (2) — — —  (2)
                      
CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES  (189) 106  (18) —  (101) 100  (148)  (51) —  (99)
                      
CASH AND CASH EQUIVALENTS  
Net (decrease) increase in cash and cash equivalents 50  (19)  (19) — 12   (207)  (34)  (12) —  (253)
Cash and cash equivalents at beginning of period 742 151 146 — 1,039  742 151 146 — 1,039 
                      
Cash and cash equivalents at end of period $792 $132 $127 $— $1,051  $535 $117 $134 $— $786 
                      

 

-22--23-

REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
FedEx Corporation
We have reviewed the condensed consolidated balance sheet of FedEx Corporation as of August 31,November 30, 2006, and the related condensed consolidated statements of income for the three-month and six-month periods ended November 30, 2006 and 2005 and the condensed consolidated statements of cash flows for the three-monthsix-month periods ended August 31,November 30, 2006 and 2005. These financial statements are the responsibility of the Company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of FedEx Corporation as of May 31, 2006, and the related consolidated statements of income, changes in stockholders’ investment and comprehensive income, and cash flows for the year then ended not presented herein, and in our report dated July 11, 2006 (except Note 22, as to which the date is August 2, 2006), we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of May 31, 2006, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
Memphis, Tennessee
September 20,December 19, 2006

 

-23--24-

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition
GENERAL
The following Management’s Discussion and Analysis of Results of Operations and Financial Condition describes the principal factors affecting the results of operations, liquidity, capital resources, contractual cash obligations and critical accounting estimates of FedEx. This discussion should be read in conjunction with the accompanying quarterly unaudited condensed consolidated financial statements and our Annual Report on Form 10-K, as amended, for the year ended May 31, 2006.2006 (“Annual Report”). Our Annual Report includes additional information about our significant accounting policies, practices and the transactions that underlie our financial results, as well as our detailed discussion of the most significant risks and uncertainties to whichassociated with our financial and operating results are subject.
results.
FedEx provides a broad portfolio of transportation, e-commerce and business services through companies operating independently, competing collectively and managed collaboratively under the respected FedEx brand. These operating companiesoperations are primarily represented by FedEx Express, the world’s largest express transportation company; FedEx Ground, a leading provider of small-package ground delivery services; FedEx Freight Corporation, a leading U.S. provider of less than truckload (“LTL”) freight services; and FedEx Kinko’s, a leading provider of document solutions and business services. These companies form the core of our reportable segments. See “Reportable Segments” for further discussion.
The key indicators necessary to understand our operating results include:
the overall customer demand for our various services;
the volumes of transportation and business services provided through our networks, primarily measured by our average daily volume and shipment weight;
the mix of services purchased by our customers;
the prices we obtain for our services, primarily measured by average price per shipment (yield);
our ability to manage our cost structure for capital expenditures and operating expenses and to match our cost structure to shifting volume levels; and
the timing and amount of fluctuations in fuel prices and our ability to recover incremental fuel costs through our fuel surcharges.
•the overall customer demand for our various services;
•the volumes of transportation and business services provided through our networks, primarily measured by our average daily volume and shipment weight;
•the mix of services purchased by our customers;
•the prices we obtain for our services, primarily measured by average price per shipment (yield);
•our ability to manage our cost structure for capital expenditures and operating expenses and to match our cost structure to shifting volume levels; and
•the timing and amount of fluctuations in fuel prices and our ability to recover incremental fuel costs through our fuel surcharges.
Except as otherwise specified, references to years indicate our fiscal year ending May 31, 2007 or ended May 31 of the year referenced and comparisons are to the corresponding period of the prior year. References to our transportation segments mean, collectively, our FedEx Express, FedEx Ground and FedEx Freight segments.

 

-24--25-

RESULTS OF OPERATIONS
CONSOLIDATED RESULTS
The following table compares revenues, operating income, operating margin, net income and diluted earnings per share (dollars in millions, except per share amounts) for the three monthsthree- and six-month periods ended August 31:November 30:
                                    
 Percent  Three Months Ended Percent Six Months Ended Percent 
 2006 2005(1) Change  2006(1) 2005 Change 2006(1) 2005(2) Change 
Revenues $8,545 $7,707 11  $8,926 $8,090 10 $17,471 $15,797 11 
Operating income 784 584 34  839 790 6 1,623 1,374 18 
Operating margin  9.2%  7.6% 160bp  9.4%  9.8% (40)bp  9.3%  8.7% 60bp
Net income $475 $339 40  $511 $471 8 $986 $810 22 
                    
Diluted earnings per share $1.53 $1.10 39  $1.64 $1.53 7 $3.17 $2.63 21 
                    
(1) Operating expenses for the threesecond quarter and first six months ended August 31, 2005of 2007 include a $143 million charge associated with upfront compensation and benefits under the new labor contract with our pilots, which was ratified in October 2006. The impact of this new contract on net income was approximately $78 million after tax, or $0.25 per diluted share.
(2)Operating expenses for the first six months of 2006 include a $79 million ($49 million, net of tax, or $0.16 per diluted share) charge to adjust the accounting for certain facility leases, predominantly at FedEx Express, which reduced operating margin by 103 basis points.Express.
The following table shows changes in revenues and operating income by reportable segment for the three monthsthree- and six-month periods ended August 31,November 30, 2006 compared to 2005 (in millions):
                                                
 Revenues Operating Income  Change in Percent Change in Change in Percent Change in 
 Dollar Percent Dollar Percent  Revenues Revenue Operating Income Operating Income 
 Change Change Change Change  Three Six Three Six Three Six Three Six 
FedEx Express segment(1)
 $518 10 $182 64 
 Months Months Months Months Months Months Months Months 
 Ended Ended Ended Ended Ended Ended Ended Ended 
FedEx Express segment $323 $841 6 8 $26(1) $208(1)(2) 5 27 
FedEx Ground segment 198 16 9 6  213 411 16 16 28 37 17 12 
FedEx Freight segment 121 14 15 11 
FedEx Freight segment(3)
 293 414 31 23 3 18 2 7 
FedEx Kinko’s segment  (13)  (3)  (6)  (38)  (9)  (22)  (2)  (2)  (8)  (14)  (50)  (44)
Other and Eliminations 14 NM — NM  16 30 NM NM — — NM NM 
              
 $838 11 $200 34  $836 $1,674 10 11 $49 $249 6 18 
              
(1) FedEx Express operating expenses for the three and six months ended August 31,November 30, 2006 include a $143 million charge associated with upfront compensation and benefits under the new labor contract with our pilots, which was ratified in October 2006.
(2)FedEx Express operating expenses for the six months ended November 30, 2005 include a $75 million charge to adjust the accounting for certain facility leases.
(3)FedEx Freight segment results include the results of FedEx National LTL from the date of its acquisition on September 3, 2006.

 

-25--26-

The following table shows selected operating statistics (in thousands, except yield amounts) for the three monthsthree- and six-month periods ended August 31:November 30:
                                    
 Percent  Three Months Ended Percent Six Months Ended Percent 
 2006 2005 Change  2006 2005 Change 2006 2005 Change 
Average daily package volume (ADV):  
FedEx Express 3,194 3,233  (1) 3,285 3,279 — 3,239 3,255 — 
FedEx Ground 2,926 2,586 13  3,242 2,843 14 3,082 2,712 14 
              
Total ADV 6,120 5,819 5  6,527 6,122 7 6,321 5,967 6 
              
Average daily LTL shipments:  
FedEx Freight 70 65 8 
FedEx Freight LTL Group 87 68 28 78 67 16 
Revenue per package (yield):  
FedEx Express $23.04 $20.80 11  $23.22 $21.99 6 $23.13 $21.39 8 
FedEx Ground 7.13 6.92 3  7.04 6.90 2 7.08 6.91 2 
LTL yield (revenue per hundredweight):  
FedEx Freight $17.90 $16.55 8 
FedEx Freight LTL Group $18.73 $16.80 11 $18.35 $16.68 10 
Revenue growth for the second quarter and first quarterhalf of 2007 was primarily attributable to yield improvement across all of our transportation segments, volume growth at FedEx Ground and FedEx Freight and package volume growth in our International Priority (“IP”) services at FedEx Express. IP volume increases in the first half of 2007 offset the impact of a 2% decline in U.S. domestic volume at FedEx Express. Revenue growth during the second quarter and first half of 2007 also benefited from our acquisition of Watkins Motor Lines (“Watkins”), which is being rebranded as FedEx National LTL, as described below. Yield improvements were principally due to higher fuel surcharges and rate increases.favorable exchange rates at FedEx Express and the acquisition of FedEx National LTL at FedEx Freight. Volume increases at FedEx Ground resulted from increases in both commercial business and FedEx Home Delivery service, which helped mitigate the impact of domestic volume declines at FedEx Express. Shipment volumes grew 8% atservice. FedEx Freight LTL Group volumes increased in the second quarter and first half of 2007 primarily due to the acquisition of FedEx National LTL. Average daily LTL shipments, excluding FedEx National LTL, grew for the second quarter, although the growth rate moderated each month during the second quarter of 2007, while IP package volumes at FedEx Express grew 6% for the quarter.2007. Revenues at FedEx Kinko’s decreased slightly during the first quarterhalf of 2007 primarily due to a continued competitive environment fordeclines in copy services.product revenues.
Operating income increased in the second quarter and first quarterhalf of 2007 primarily due to revenue growth in our transportation segments and improveddeclining fuel prices during the second quarter. Operating margins atdeclined slightly in the second quarter of 2007 due to higher salaries and employee benefits. Salaries and employee benefits increased in the second quarter and first half of 2007 as a result of the new labor contract for the pilots of FedEx Express (described below) and was slightly offset by reduced operating income atthe FedEx Kinko’s. Effective cost controls and revenue management actions contributed toNational LTL acquisition. Purchased transportation costs increased operating margin at FedEx Express in the second quarter and first quarterhalf of 2007. FedEx Express operating2007 due to IP and ground package volume growth, which required a higher utilization of contract pickup and delivery services, and higher fuel surcharges from third-party transportation providers, including fuel supplement payments to our independent contractors. Operating income in the first quarter of 2006six months ended November 30, 2005 included a $75$79 million charge to adjust the accounting for certain facility leases described below.
While fuel costs increased approximately 30% duringThe pilots of FedEx Express, who represent a small number of our total employees, are employed under a collective bargaining agreement. Our net income for the firstsecond quarter and six months of 2007 includes the impact of a new four-year labor contract ratified by the pilots on October 17, 2006. The effect of this new agreement on net income for the second quarter of 2007 was approximately $78 million after tax, or $0.25 per diluted share. The new agreement includes signing bonuses and other upfront compensation of approximately $143 million, as well as pay increases and other benefit enhancements. These costs were partially mitigated by reductions in variable incentive compensation.

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Fuel costs decreased in the second quarter of 2007 due to a decrease in the average price per gallon of fuel. Fuel costs increased for the six-month period ended November 30, 2006 due to an increase in the average price per gallon of fuel. However, fuel surcharges were sufficient to mitigatemore than offset the effect of higher fuel costs on our operating results in both the second quarter and first half of 2007, based on a static analysis of the year-over-year changes in fuel prices compared to changes in fuel surcharges. Though fluctuations in fuel surcharge rates can be significant from period to period, fuel surcharges represent one of the many individual components of our pricing structure that impact our overall revenue and yield. Additional components include the mix of services purchased, the base price and other extra service charges we obtain for these services and the level of pricing discounts offered. In order to provide information about the impact of fuel surcharges on the trend in revenue and yield growth, we have included the comparative fuel surcharge rates in effect for the second quarter and first quarterhalf of 2007 and 2006 in the followingaccompanying discussions of each of our transportation segments.
Our results for the first quartersix months of 2006 included a noncash charge of $79 million ($49 million after tax or $0.16 per diluted share), which represented the impact on prior years to adjust the accounting for certain facility leases, predominantly at FedEx Express. The charge related primarily to rent escalations in on-airport facility leases that were not being recognized appropriately.
Net interest expense decreased during the second quarter and first quarterhalf of 2007 primarily due to scheduled debt payments and increased interest income from higher cash balances and an increase in interest rates.

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Our effective tax rate was 38.3%37.9% for both the firstsecond quarter of 2007 and 2006.38.1% for the first half of 2007. We expect the effective tax rate to be approximately 38.0% to 38.5% for the remainder of 2007. The actual rate will depend on a number of factors, including the amount and source of operating income. Our effective tax rate for both the second quarter and first half of 2006 was 38.0%.
Business Acquisitions
On September 3, 2006, we acquired the assets and assumed certain obligations of the LTL operations of Watkins, Motor Lines (“Watkins”), a privately held company, and certain affiliates for approximately $780$784 million in cash. Watkins, is a leading provider of long-haul LTL services. Watkinsservices, is being rebranded as FedEx National LTL and will beis expected to extend our leadership position in the heavyweight freight sector. The financial results of FedEx National LTL are included in the FedEx Freight segment commencingfrom the date of acquisition.
The assets and liabilities related to FedEx National LTL have been included in the secondaccompanying unaudited balance sheet based on a preliminary allocation of the purchase price derived primarily from management’s estimates of cash flows. The purchase price allocation is expected to be complete by the end of 2007. See Note 1 of the accompanying unaudited financial statements for further discussion of this acquisition.
We paid the purchase price from available cash balances, which included the proceeds from our $1 billion senior unsecured debt offering completed during the first quarter of 2007. See Note 4 of the accompanying unaudited financial statements for further discussion of this debt offering.
InOn January 24, 2006, FedEx Express entered into an agreement with Tianjin Datian W. Group Co., Ltd. (“DTW Group”) to acquire DTW Group’s 50% share of the FedEx-DTW International Priority express joint venture (“FedEx-DTW”) and DTW Group’s domestic express network in China for approximately $400 million in cash. This acquisition will convert our joint venture with DTW Group, formed in 1999 and currently accounted for under the equity method, into a wholly-owned subsidiary and increase our presence in China in the international and domestic express businesses. The acquisition is expected to be completed during 2007, subject to customary closing conditions. The financial results of this transactionthe acquired company will be included in the FedEx Express segment from the date of acquisition.

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On November 2, 2006, FedEx Express entered into an agreement to acquire Prakash Air Freight Pvt. Ltd., its primary service provider in India, for approximately $30 million in cash. This acquisition will extend our operations in the global express industry with a wholly owned company in one of the world’s fastest growing markets. The acquisition is expected to be completed during 2007, subject to customary closing conditions. The financial results of the acquired company will be included in the FedEx Express segment from the date of acquisition.
On December 16, 2006, FedEx Express acquired all of the outstanding capital stock of ANC Holdings Ltd., a United Kingdom domestic express transportation company, for approximately $235 million. This acquisition will allow FedEx Express to better serve the United Kingdom market, which was previously served in part through independent agents. The financial results of the acquired company will be included in the FedEx Express segment from the date of acquisition.
Outlook
WhileWe expect revenue and earnings improvement across all transportation segments for the second half of 2007, but our growth rate is expected to moderate in comparison to our strong growth in 2006,2006. Our results for the third quarter will be subject to a difficult year-over-year comparison, as last year’s third quarter benefited from the timing lag between when we expect revenuepurchase fuel and earnings improvement across all transportation segments in 2007.when our indexed fuel surcharges automatically adjust. Our outlook is based on solidcontinued global economic growth, with the U.S. economy growing at a moderate sustainable rate. We anticipate revenue growth in our high-margin services, productivity improvements and continued focus on yield management.
We anticipate growth in total U.S. domestic package volumes and yields, as well as continued growth in FedEx Express IP shipments and yields. We also anticipate year-over-year increasesthat our new FedEx National LTL business will extend our leadership position in volumesthe heavyweight freight sector and yields at FedEx Freight as that segment continuesprovide new growth opportunities for our LTL operations in 2007 and beyond. We expect to continue to make investments to expand itsour networks and broaden our service offerings, in part through the integration and expansion of FedEx National LTL network and service offerings.our investments overseas.
FedEx Kinko’s will continue to focus on key strategies related to adding new locations, improving customer service and increasing investments in employee development and training, which we expect to continue to result in decreased profitability in the short-term. In the first quarter of 2007, FedEx Kinko’s announced the model for new centers, which will be approximately one-third the size of a traditional center and will include enhanced pack-and-ship stations and a doubling of the number of office products offered. Through the second quarter of 2007, FedEx Kinko’s plans to openhad opened 86 of the approximately 200 new centers across the United States duringplanned to be opened in 2007, which will bring the total number of domestic centers to over 1,500.
We expect to continue to make investments to expand our networks and broaden our service offerings, in part through1,500 by the integration and expansionend of FedEx National LTL and our investments overseas. We anticipate that our new FedEx National LTL business will extend our leadership position in the heavy freight sector and provide new growth opportunities for our LTL operations in 2007 and beyond.
On September 25, 2006, we announced a $2.6 billion multi-year program to acquire and modify approximately 90 Boeing 757-200 aircraft to replace our narrow body fleet of Boeing 727-200 aircraft. We expect to bring the new aircraft into service during the eight-year period between calendar years 2008 and 2016 contingent upon identification and purchase of suitable 757 aircraft. The impact to 2007 of this program has been reflected in our expected 2007 capital expenditures of approximately $3 billion.2007.
All of our transportation businesses operate in a competitive pricing environment, exacerbated by continuing highvolatile fuel prices. While our fuel surcharges have been sufficient to offset increased fuel prices, we cannot predict the impact on the overall economy if fuel costs significantly fluctuate from current levels. Volatility in fuel costs may also impact quarterly earnings because adjustments to our fuel

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surcharges lag changes in actual fuel prices paid. Therefore, the trailing impact of adjustments to FedEx Express and FedEx Ground fuel surcharges can significantly affect earnings in the short-term.
The pilots of FedEx Express, which represent a small number of FedEx Express total employees, are employed under a collective bargaining agreement that became amendable on May 31, 2004. In August 2006, FedEx Express and the pilots’ union reached a tentative agreement on a new labor contract. The proposed new contract includes signing bonuses and other compensation that would result in a charge in the period of ratification of approximately $145 million. Contract ratification is expected during the second quarter of 2007 but cannot be assured. If ratified, the new four-year contract will become amendable in 2010.
In July 2006, FedEx Express entered into a new seven-year transportation agreement with the United States Postal Service (“USPS”) under which FedEx Express will continue to provide domestic air transportation services to the USPS, including for its First Class, Priority and Express Mail. The agreement is expected to generate more than $8 billion in revenue for FedEx Express over its term, which begins on September 25, 2006, and ends on September 30, 2013. The agreement will replace the existing seven-year transportation agreement between FedEx Express and the USPS.
See “Forward-Looking Statements” for a discussion of potential risks and uncertainties that could materially affect our future performance.

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NEW ACCOUNTING PRONOUNCEMENTS
On June 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) 123R, “Share-Based Payment,” which requires recognition of compensation expense for stock-based awards using a fair value method. We adopted SFAS 123R using the modified prospective method, which resulted in prospective recognition of compensation expense for all outstanding unvested share-based payments to employees based on the fair value on the original grant date. Under this method of adoption, our financial statement amounts for the prior period presented have not been restated. The adoption of SFAS 123R reduced earnings for the second quarter and first quarterhalf of 2007 by $0.05$0.04 and $0.09 per diluted share.share, respectively. For additional information on the impact of the adoption of SFAS 123R, refer to Note 2 in the accompanying unaudited condensed consolidated financial statements.
In September 2006, the FASB issued SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” which amended several other FASB Statements. SFAS 158 requires recognition in the balance sheet of the funded status of defined benefit pension and other postretirement benefit plans, and the recognition in other comprehensive income of unrecognized gains or losses and prior service costs or credits arising during the period. Additionally, SFAS 158 requires the measurement date for plan assets and liabilities to coincide with the sponsor’s year end. We currently use a February 28 measurement date for our plans, so this standard will require us to change our measurement date to May 31.
The FASBfunded status recognition and disclosure provisions of SFAS 158 are effective for FedEx as of May 31, 2007. The requirement to measure plan assets and benefit obligations as of our fiscal year-end is effective for FedEx in 2009.
The impact of this standard on our balance sheet will depend on the funded status of our plans based on our February 28, 2007 measurement date. However, if the provisions of SFAS 158 were effective as of May 31, 2006, we estimate that the incremental after-tax impact of adopting SFAS 158 would have been a decrease in assets of approximately $1.4 billion, an increase in liabilities of approximately $400 million, and a decrease in total shareholders’ equity of approximately $1.8 billion. The actual amount of these adjustments at May 31, 2007 could differ materially from the amounts above. However, any adjustments resulting from the adoption of these new rules are not expected to impact our compliance with any current loan covenants or affect our debt ratings, pension funding requirements or our overall liquidity.
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which eliminates the diversity in practice surrounding the quantification and evaluation of financial statement errors. The guidance outlined in SAB 108 is effective for FedEx in 2008 and is consistent with our historical practices for assessing such matters when circumstances have required such an evaluation. Accordingly, we do not believe that adoption of SAB 108 will have any impact on us.
The Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes,” in July 2006. This Interpretation establishes new standards for the financial statement recognition, measurement and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. The new rules will be effective for FedEx in 2008. We are evaluatingcontinue to evaluate this interpretation, but do not presently anticipate its adoption will have a material impact on our financial statements.

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REPORTABLE SEGMENTS
FedEx Express, FedEx Ground, FedEx Freight and FedEx Kinko’s form the core of our reportable segments. As of August 31,November 30, 2006, our reportable segments included the following businesses:
   
FedEx Express Segment
 FedEx Express (express transportation)
FedEx Trade Networks (global trade services)
FedEx Ground Segment
 FedEx Ground (small-package ground delivery)
FedEx SmartPost (small-parcel consolidator)
FedEx Freight Segment
 FedEx Freight LTL Group:
     FedEx Freight (regional LTL freight transportation)
     FedEx National LTL (long-haul LTL freight transportation)
FedEx Custom Critical (time-critical transportation)
Caribbean Transportation Services (airfreight forwarding)
FedEx Kinko’s Segment
 FedEx Kinko’s (document solutions and business services)

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FedEx Services provides customer-facing sales, marketing and information technology support, primarily for FedEx Express and FedEx Ground. The costs for these activities are allocated based on metrics such as relative revenues or estimated services provided. We believe these allocations approximate the cost of providing these functions.
The operating expenses line item “Intercompany charges” on the accompanying unaudited financial summaries of our reportable segments includes the allocations from FedEx Services to the respective segments. The “Intercompany charges” caption also includes allocations for administrative services provided between operating companies and certain other costs such as corporate management fees related to services received for general corporate oversight, including executive officers and certain legal and finance functions. Management evaluates segment financial performance based on operating income.
Effective June 1, 2006, we moved the credit, collections and customer service functions with responsibility for FedEx Express and FedEx Ground customer information from FedEx Express into a new subsidiary of FedEx Services named FedEx Customer Information Services, Inc. (“FCIS”). Also, effective June 1, 2006, we moved FedEx Supply Chain Services, Inc., the results of which were previously reported in the FedEx Ground segment, into a new subsidiary of FedEx Services named FedEx Global Supply Chain Services, Inc. The costs of providing these customer service functions and the net operating costs of FedEx Global Supply Chain Services are allocated back to the FedEx Express and FedEx Ground segments. Prior year amounts have not been reclassified to conform to the current year segment presentation as the financial results are materially comparable.
In addition, certain FedEx operating companies provide transportation and related services for other FedEx companies outside their reportable segment. Billings for such services are based on negotiated rates, which we believe approximate fair value, and are reflected as revenues of the billing segment. FedEx Kinko’s segment revenues include package acceptance revenue, which represents the fee received by FedEx Kinko’s from FedEx Express and FedEx Ground for accepting and handling packages at FedEx Kinko’s locations on behalf of these operating companies. Package acceptance revenue does not include the external revenue associated with the actual shipments. All shipment revenues are reflected in the segment performing the transportation services. Such intersegment revenues and expenses are eliminated in the consolidated results but are not separately identified in the following segment information, as the amounts are not material.

 

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FEDEX EXPRESS SEGMENT
The following table compares revenues, operating expenses, operating income and operating margin (dollars in millions) for the three-monththree- and six-month periods ended August 31:November 30:
                                    
 Percent  Three Months Ended Percent Six Months Ended Percent 
 2006 2005 Change  2006 2005 Change 2006 2005 Change 
Revenues:  
Package:  
U.S. overnight box $1,654 $1,560 6  $1,634 $1,604 2 $3,288 $3,165 4 
U.S. overnight envelope 511 489 4  488 480 2 1,000 969 3 
U.S. deferred 705 687 3  716 702 2 1,421 1,388 2 
              
Total U.S. domestic package revenue 2,870 2,736 5  2,838 2,786 2 5,709 5,522 3 
International Priority (IP) 1,914 1,634 17  1,969 1,757 12 3,882 3,391 14 
              
Total package revenue 4,784 4,370 9  4,807 4,543 6 9,591 8,913 8 
Freight:  
U.S. 607 505 20  624 564 11 1,231 1,070 15 
International 104 105  (1) 106 117  (9) 209 222  (6)
              
Total freight revenue 711 610 17  730 681 7 1,440 1,292 11 
Other(1)
 145 142 2  156 146 7 302 287 5 
              
Total revenues 5,640 5,122 10  5,693 5,370 6 11,333 10,492 8 
Operating expenses:  
Salaries and employee benefits 2,002 1,971 2  2,116�� 1,959 8 4,118 3,930 5 
Purchased transportation 263 241 9  269 236 14 532 477 12 
Rentals and landing fees 398 483  (18) 392 409  (4) 790 892  (11)
Depreciation and amortization 205 193 6  208 203 2 413 396 4 
Fuel 798 628 27  716 760  (6) 1,514 1,388 9 
Maintenance and repairs 398 361 10  365 339 8 763 700 9 
Intercompany charges 510 358 42  526 383 37 1,036 741 40 
Other 599 602 —  599 605  (1) 1,198 1,207  (1)
              
Total operating expenses(2)
 5,173 4,837 7 
Total operating expenses(2) (3)
 5,191 4,894 6 10,364 9,731 7 
              
Operating income $467 $285 64  $502 $476 5 $969 $761 27 
              
Operating margin  8.3%  5.6% 270bp  8.8%  8.9% (10)bp  8.6%  7.3% 130bp
(1) Other revenues includes FedEx Trade Networks.
 
(2) Operating expenses for the threesecond quarter and first half of 2007 included a $143 million charge associated with upfront compensation and benefits under the new labor contract with our pilots, which was ratified in October 2006.
(3)Operating expenses for the first six months ended August 31, 2005of 2006 include a $75 million charge, primarily recorded in rentals and landing fees, to adjust the accounting for certain facility leases, which reduced operating margin by 146 basis points.leases.

 

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The following table compares selected statistics (in thousands, except yield amounts) for the three-monththree- and six-month periods ended August 31:November 30:
                                    
 Percent  Three Months Ended Percent Six Months Ended Percent 
 2006 2005 Change  2006 2005 Change 2006 2005 Change 
Package Statistics(1)
  
Average daily package volume (ADV):  
U.S. overnight box 1,166 1,180  (1) 1,183 1,211  (2) 1,174 1,195  (2)
U.S. overnight envelope 703 711  (1) 700 702 — 702 707  (1)
U.S. deferred 855 897  (5) 895 886 1 875 891  (2)
              
Total U.S. domestic ADV 2,724 2,788  (2) 2,778 2,799  (1) 2,751 2,793  (2)
IP 470 445 6  507 480 6 488 462 6 
              
Total ADV 3,194 3,233  (1) 3,285 3,279 — 3,239 3,255 — 
              
Revenue per package (yield):  
U.S. overnight box $21.83 $20.34 7  $21.92 $21.03 4 $21.87 $20.69 6 
U.S. overnight envelope 11.19 10.57 6  11.06 10.86 2 11.13 10.71 4 
U.S. deferred 12.69 11.78 8  12.70 12.56 1 12.69 12.16 4 
U.S. domestic composite 16.21 15.10 7  16.21 15.80 3 16.21 15.44 5 
IP 62.58 56.54 11  61.68 58.14 6 62.12 57.36 8 
Composite package yield 23.04 20.80 11  23.22 21.99 6 23.13 21.39 8 
Freight Statistics(1)
  
Average daily freight pounds:  
U.S. 9,374 8,885 6  9,917 9,544 4 9,642 9,209 5 
International 1,899 2,039  (7) 1,946 2,283  (15) 1,922 2,159  (11)
              
Total average daily freight pounds 11,273 10,924 3  11,863 11,827 — 11,564 11,368 2 
              
Revenue per pound (yield):  
U.S. $1.00 $0.88 14  $1.00 $0.94 6 $1.00 $0.91 10 
International 0.84 0.79 6  0.86 0.81 6 0.85 0.80 6 
Composite freight yield 0.97 0.86 13  0.98 0.91 8 0.97 0.89 9 
(1) Package and freight statistics include only the operations of FedEx Express.
FedEx Express Segment Revenues
FedEx Express segment revenues increased in the second quarter and first quarterhalf of 2007, principally due to highervolume and yield improvements in IP revenuesservices (particularly in U.S. outbound, AsiaEurope and Europe) and higherAsia). U.S. domestic package and U.S. freight revenues.revenue growth also contributed to the revenue increase for the second quarter and first half of 2007. During the firstsecond quarter of 2007, IP revenues grew 17%12% on yield growth of 11%6% and a 6% increase in volume. During the first six months of 2007, IP revenues grew 14% on yield growth of 8% and a 6% increase in volume. U.S. domestic package revenues grew 5% in2% during the second quarter of 2007 and increased 3% for the first quarterhalf of 2007 due to a yield increaseincreases of 7%, partially offset by a 2% decrease in volume. Freight revenues grew in3% during the second quarter and 5% for the first quarter based principally on strongerhalf of 2007. U.S. domestic yield and volumes.package volumes decreased during the first half of 2007 primarily due to revenue management actions that began last year.
IP yield increased during the second quarter of 2007 primarily due to favorable exchange rates, a higher rate per pound and an increase in the average weight per package. IP yield increased in the first quarterhalf of 2007, primarily due to higher fuel surcharges, increases in international average weight per package,favorable exchange rates, a higher rate per pound and favorable exchange rate impacts. U.S. domestic composite yield increases were due to higher fuel surcharges and an increase in the average weight per package. U.S. domestic composite yield increases in the second quarter and the first half of 2007 were due to increases in the average rate per pound. We continue to manage our U.S. domestic revenue to improve the profitability of these services.pound, partially offset by changes in product mix. U.S. freight yield increased due to higher fuel surcharges and an increase in the average rate per pound.
Asia experienced solidIn November 2006, we announced a 5.5% average daily volume growth during the first quarterlist price increase effective January 1, 2007 on FedEx Express U.S. domestic shipments and U.S. outbound international shipments and made various changes to other surcharges, while we lowered our fuel surcharge index by 2%. In January 2006, we implemented an average list price increase of 2007,5.5% on FedEx Express U.S. domestic shipments and U.S. outbound international shipments and made various changes to certain surcharges, while outbound shipments from the United States and Europe also increased. IP and international freight capacity has increased significantly as a result ofwe lowered our two around-the-world flights which we added in late 2005 and early 2006. This additional capacity resulted in higher IP volume. U.S. volumes decreased primarily due to revenue management actions that began last year.fuel surcharge index by 2%.

 

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Fuel surcharges increased in the second quarter and first quarterhalf of 2007 due to higher jet fuel prices. Our fuel surcharge is indexed to the spot price for jet fuel. Using this index, the U.S. domestic and outbound fuel surcharge and the international fuel surcharges ranged as follows for the three monththree- and six-month periods ended August 31:November 30:
                
         Three Months Ended Six Months Ended 
 2006 2005  2006 2005 2006 2005 
U.S. Domestic and Outbound Fuel Surcharge:  
Low  16.00%  10.50%  12.50%  13.00%  12.50%  10.50%
High 16.00 12.50  17.00 20.00 17.00 20.00 
Weighted-average 16.00 11.48  15.35 16.14 15.67 13.82 
International Fuel Surcharges:  
Low 12.50 10.00  12.00 11.00 12.00 10.00 
High 16.00 12.50  17.00 20.00 17.00 20.00 
Weighted-average 14.63 10.93  14.33 14.09 14.55 12.62 
FedEx Express Segment Operating Income
During the second quarter and first quarterhalf of 2007, our operating income grew as a result of IP revenue growth and improveddeclining fuel prices during the second quarter of 2007. Operating income and operating margin. Continued volume growthmargin for the second quarter of 2007 were negatively impacted by costs associated with the ratification of a new labor contract with our pilots on October 17, 2006. These costs included signing bonuses and other upfront compensation of $143 million, as well as pay increases and other benefit enhancements, which were partially mitigated by reductions in IP services contributed to solid yield improvements.variable incentive compensation. Operating margin improvement during the first quarterhalf of 2007 was primarily due to higher yields, combined with cost containment and the inclusion in the first quarterhalf of 2006 of a $75 million charge to adjust the accounting for certain facility leases.
Fuel costs were higher duringSalaries and employee benefits increased in the second quarter and first quarterhalf of 2007 due toprimarily as a result of the new labor contract with our pilots, as described above. Increased purchased transportation costs in the second quarter and first half of 2007 were driven by IP volume growth, which required a higher utilization of contract pickup and delivery services and an increase in the average price per galloncost of jet fuel, while gallons consumed increased slightly. However, fuel surcharges substantially mitigated the impact of higher jet fuel prices.purchased transportation. The decrease in rentals and landing fees in the first half of 2007 is primarily attributable to the one-time adjustment for leases in 2006 described above. Fuel costs decreased in the second quarter of 2007, due to a decrease in the average price per gallon of fuel. Fuel costs increased for the first half of 2007, due to an increase in gallons consumed and an increase in the average price per gallon of fuel. However, our fuel surcharges more than offset the effect of fuel prices in both the second quarter and first half of 2007, based on a static analysis of the year-over-year changes in fuel prices compared to changes in fuel surcharges. Intercompany charges increased in the second quarter and first half of 2007, primarily due to allocations as a result of moving the FCIS organization from FedEx Express to FedEx Services in 2007. The costs associated with the FCIS organization in 2006 were of a comparable amount but were reported in individual operating expense captions. Prior year amounts have not been reclassified to conform to the current year presentation as financial results are materially comparable.

 

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FEDEX GROUND SEGMENT
The following table compares revenues, operating expenses, operating income and operating margin (dollars in millions) and selected package statistics (in thousands, except yield amounts) for the three monththree- and six-month periods ended August 31:November 30:
                                    
 Percent  Three Months Ended Percent Six Months Ended Percent 
 2006 2005 Change  2006 2005 Change 2006 2005 Change 
Revenues $1,417 $1,219 16  $1,520 $1,307 16 $2,937 $2,526 16 
Operating expenses:  
Salaries and employee benefits 241 221 9  256 230 11 497 451 10 
Purchased transportation 553 466 19  592 506 17 1,145 972 18 
Rentals 36 31 16  44 36 22 80 67 19 
Depreciation and amortization 61 50 22  65 53 23 126 103 22 
Fuel 31 18 72  28 27 4 59 45 31 
Maintenance and repairs 31 29 7  32 28 14 63 57 11 
Intercompany charges 136 120 13  147 129 14 283 249 14 
Other 171 136 26  165 135 22 336 271 24 
              
Total operating expenses 1,260 1,071 18  1,329 1,144 16 2,589 2,215 17 
              
Operating income $157 $148 6  $191 $163 17 $348 $311 12 
              
Operating margin  11.1%  12.1% (100)bp  12.6%  12.5% 10bp  11.8%  12.3% (50)bp
Average daily package volume(1)
 2,926 2,586 13  3,242 2,843 14 3,082 2,712 14 
Revenue per package (yield)(1)
 $7.13 $6.92 3  $7.04 $6.90 2 $7.08 $6.91 2 
(1) Package statistics include only the operations of FedEx Ground.
FedEx Ground Segment Revenues
Revenues increased during the second quarter and first quarterhalf of 2007 principally due to volume and yield growth. Average daily volumes at FedEx Ground rose 13%,14% in both the second quarter and six months of 2007 due to increased commercial business and the continued growth of our FedEx Home Delivery service. Yield improvement during the second quarter and first quarterhalf of 2007 was primarily due to the impact of the January 2006 general rate increase, increased fuel surcharges and higher extra service revenue (primarily on our residential and signature services). This yield increase was partially offset by higher customer discounts and a lower average weight and zone per package.
On December 4, 2006, we announced standard list rate increases averaging 4.9% for our ground and home delivery services and changes to various surcharges. The new rates and surcharge changes will be effective January 1, 2007. In January 2006, we implemented standard list rate increases averaging 3.9% and changes to various surcharges.
The FedEx Ground fuel surcharge is based on a rounded average of the national U.S. on-highway average prices for a gallon of diesel fuel, as published by the Department of Energy. Our fuel surcharge ranged as follows for the three monththree- and six-month periods ended August 31:November 30:
                
         Three Months Ended Six Months Ended 
 2006 2005  2006 2005 2006 2005 
Low  4.25%  2.50%  4.50%  3.00%  4.25%  2.50%
High 4.75 2.75  5.25 4.50 5.25 4.50 
Weighted-average 4.58 2.67  4.84 3.68 4.71 3.19 

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FedEx Ground Segment Operating Income
FedEx Ground segment operating income increased 6%17% during the second quarter of 2007 and 12% during the first quarterhalf of 2007, resulting principally from revenue growth and yield improvement.improvement, as well as improved results at FedEx SmartPost. Second quarter results also benefited from declining fuel prices during the quarter.
Purchased transportation increased 17% in the second quarter of 2007 primarily due to higher package volume and an increase in the rates paid to our independent contractors. Purchased transportation increased 18% in the first half of 2007 principally due to volume growth and an increase in the rates paid to our independent contractors, including fuel supplements. Salaries and employee benefits, as well as other operating costs, increased in the second quarter and first quarterhalf of 2007 largely due to increases in staffing and facilities to support volume growth. Depreciation expense in the first quarter of 2007 increased due to higher spending on material handling and scanning equipment and facilities associated with our multi-year capacity expansion. In the first quarter of 2007, purchased transportation increased 19% due to higher

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fuel surcharges from third-party transportation providers, including our independent contractors. Increased fuel costs in the first quarter of 2007 were mostly offset by fuel surcharges. Other operating expenses increased 26%22% in the second quarter of 2007 and 24% in the first half of 2007 due primarily due to increased legal costs, including settlements and reserves, which also negatively impacted operating margin.costs.
Effective June 1, 2006, we moved FedEx Supply Chain Services, Inc., the results of which were previously reported in the FedEx Ground segment, into a new subsidiary of FedEx Services named FedEx Global Supply Chain Services, Inc. The net operating costs of this entity are allocated to FedEx Express and FedEx Ground. Prior year amounts have not been reclassified to conform to the current year segment presentation, as financial results are materially comparable.
FEDEX FREIGHT SEGMENT
The following table shows revenues, operating expenses, operating income and operating margin (dollars in millions) and selected statistics for the three monththree- and six-month periods ended August 31:November 30:
                                    
 Percent  Three Months Ended Percent Six Months Ended Percent 
 2006 2005 Change  2006 2005 Change 2006 2005 Change 
Revenues $1,013 $892 14  $1,225 $932 31 $2,238 $1,824 23 
Operating expenses:  
Salaries and employee benefits 484 439 10  592 442 34 1,076 881 22 
Purchased transportation 83 72 15  140 81 73 223 153 46 
Rentals and landing fees 23 24  (4) 30 25 20 53 49 8 
Depreciation and amortization 31 30 3  52 29 79 83 59 41 
Fuel 112 82 37  116 104 12 228 186 23 
Maintenance and repairs 32 28 14  45 30 50 77 58 33 
Intercompany charges 14 9 56  16 9 78 30 18 67 
Other 84 73 15  96 77 25 180 150 20 
              
Total operating expenses 863 757 14  1,087 797 36 1,950 1,554 25 
              
Operating income $150 $135 11  $138 $135 2 $288 $270 7 
              
Operating margin  14.8%  15.1% (30)bp  11.3%  14.5% (320)bp  12.9%  14.8% (190)bp
Average daily LTL shipments (in thousands) 70 65 8  87 68 28 78 67 16 
Weight per LTL shipment (lbs) 1,130 1,132 —  1,127 1,161  (3) 1,128 1,147  (2)
LTL yield (revenue per hundredweight) $17.90 $16.55 8  $18.73 $16.80 11 $18.35 $16.68 10 
The results of operations of FedEx National LTL are included in FedEx Freight segment results from the date of its acquisition on September 3, 2006.

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FedEx Freight Segment Revenues
FedEx Freight segment revenues increased 14% during31% for the second quarter and 23% for the first quarter due to growth inhalf of 2007 primarily as a result of the impact of the acquisition of FedEx National LTL. Average daily LTL yield and average daily shipments. LTL yieldshipments grew during the second quarter and first quarterhalf of 2007 reflecting incremental fuel surcharges resulting from higher fuel pricesdue to the inclusion of FedEx National LTL and higher rates. Increased customer demand for our regional and interregional LTL services contributed to the increase in averageservices. Average daily LTL shipments.shipments, excluding FedEx National LTL, grew for the second quarter, although the growth rate moderated each month during the second quarter of 2007. LTL yield grew during the second quarter and first half of 2007, reflecting higher yields from longer-haul FedEx National LTL shipments and higher rates.
The indexed LTL fuel surcharge is based on the average of the national U.S. on-highway average prices for a gallon of diesel fuel, as published by the Department of Energy. The indexed LTL fuel surcharge ranged as follows for the three-monththree- and six-month periods ended August 31:November 30:
                        
 2006 2005  Three Months Ended Six Months Ended 
 2006 2005 2006 2005 
FedEx Freight Fuel Surcharge: 
Low  19.5%  12.5%  15.9%  15.6%  15.9%  12.5%
High 21.2 16.8  20.5 19.6 21.2 19.6 
Weighted-average 20.4 14.5  17.0 17.0 18.7 15.7 
FedEx National LTL Fuel Surcharge: 
Low 15.0 
High 19.5 
Weighted-average 16.0 

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FedEx Freight Segment Operating Income
FedEx Freight segment operating income increased 11%2% during the second quarter and 7% during the first half of 2007. The results of FedEx National LTL, along with moderating demand for LTL services, contributed to reduced operating margin in both the second quarter and first half of 2007. Our reduced margin in the second quarter and first half of 2007 primarily due to LTL revenue growth. Operating margin declined slightly inwas partially offset by a gain recorded on the first quartersale of 2007 due to the impact of higher purchased transportation and otheran operating costs.facility. Salaries and employee benefits increased in the second quarter and first quarterhalf of 2007, from increased staffingprimarily due to support volume growth. Purchased transportationthe FedEx National LTL acquisition. Fuel costs increased indue to the inclusion of the results of FedEx National LTL and due to higher fuel prices during the first quarter of 2007, primarily as a result of volume growth, as well as an increaseoffset partially by declining fuel prices in the cost of purchased transportation. Fuel costs increased in the firstsecond quarter of 2007 due to higher fuel prices; however, our2007. Our fuel surcharges more than offset the effect of these higher costs.fuel costs for both the second quarter and first half of 2007. Purchased transportation costs increased in the second quarter and first half of 2007 as a result of the FedEx National LTL acquisition, volume growth and an increase in the cost of purchased transportation.

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FEDEX KINKO’S SEGMENT
The following table shows revenues, operating expenses, operating income and operating margin (dollars in millions) for the three-monththree- and six-month periods ended August 31:November 30:
                                    
 Percent  Three Months Ended Percent Six Months Ended Percent 
 2006 2005 Change  2006 2005 Change 2006 2005 Change 
Revenues $504 $517  (3) $519 $528  (2) $1,023 $1,045  (2)
Operating expenses:  
Salaries and employee benefits 191 186 3  198 190 4 389 376 3 
Rentals 94 102  (8) 96 99  (3) 190 201  (5)
Depreciation and amortization 34 36  (6) 35 37  (5) 69 73  (5)
Maintenance and repairs 15 18  (17) 17 19  (11) 32 37  (14)
Intercompany charges 11 4 NM  16 6 NM 27 10 NM 
Other operating expenses:  
Supplies, including paper and toner 65 67  (3) 67 70  (4) 133 137  (3)
Other 84 88  (5) 82 91  (10) 165 179  (8)
              
Total operating expenses 494 501  (1) 511 512 — 1,005 1,013  (1)
              
Operating income $10 $16  (38) $8 $16  (50) $18 $32  (44)
              
Operating margin  2.0%  3.1% (110)bp  1.5%  3.0% (150)bp  1.8%  3.1% (130)bp
FedEx Kinko’s Segment Revenues
Revenues decreased duringslightly for the second quarter and first quartersix months of 2007 due to declines in base copy product revenues. These declines were due to decreased demand and more than offset the growth in package acceptance and retail office product revenues. The declines in copy product revenues are due to decreased demand and a continued competitive pricing environment. In the first quarter of 2007, FedEx Kinko’s announced the details of a multi-year network expansion plan, including the model for new centers, which will be approximately one-third the size of a traditional center and will include enhanced pack-and-ship stations and a doubling of the number of retail office products offered. This multi-year expansion of the FedEx Kinko’s network is a key strategy relating to FedEx Kinko’s future revenue growth. FedEx Kinko’s added 86 centers to its global network during the first half of 2007.
FedEx Kinko’s Segment Operating Income
Operating income decreased $6$8 million in the second quarter of 2007 and $14 million in the first quarterhalf of 2007 primarily due mainly to the decrease in base copy product revenues. Operating income was also negatively impacted by higher health insurancerevenues, as well as the impact of increased salaries and employee benefit costs incurred in connection with a reorganization of the FedEx Kinko’s sales force, expansion activities and increased costs associated with employee training and development programs, as well as other administrativeprograms. In addition, expenses associated with enhancing service, adding 31 newthe addition of 55 centers during the second quarter and 86 in the first half of 2007, along with expansion planning activities to add a total of approximately 200 new centers during 2007.2007, negatively impacted operating income. Rentals decreased due to reduced equipment rentals as a result of lower copy volumes and favorable lease renegotiations.

 

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FINANCIAL CONDITION
LIQUIDITY
Cash and cash equivalents totaled $2.690$1.855 billion at August 31,November 30, 2006, compared to $1.937 billion at May 31, 2006. The following table provides a summary of our cash flows for the three monthsix-month periods ended August 31November 30 (in millions):
                
 2006 2005  2006 2005 
Operating activities:  
Net income $475 $339  $986 $810 
Noncash charges and credits 441 445  894 954 
Changes in operating assets and liabilities  (251)  (1)  (532)  (629)
          
Net cash provided by operating activities 665 783  1,348 1,135 
          
Investing activities:  
Business acquisition  (784) — 
Capital expenditures and other investing activities  (694)  (670)  (1,427)  (1,289)
          
Net cash used in investing activities  (694)  (670)  (2,211)  (1,289)
          
Financing activities:  
Proceeds from debt issuances 999 —  999 — 
Principal payments on debt  (221)  (95)  (226)  (102)
Dividends paid  (28)  (24)  (55)  (48)
Proceeds from stock issuances 30 18  55 53 
Other 2 —  8  (2)
          
Net cash provided by (used in) financing activities 782  (101) 781  (99)
          
Net increase in cash and cash equivalents $753 $12 
Net decrease in cash and cash equivalents $(82) $(253)
          
Cash Provided by Operating Activities.Cash flows from operating activities decreasedincreased by $118$213 million in the first quarterhalf of 2007 as increased earnings were more than offset by an increase in receivablesprimarily due to revenue growth and contributions to our principal U.S. domestic pension plans. Weincreased earnings. During the first half of 2007, we made tax-deductible voluntary contributions to our principal U.S. domestic pension plans of $100$482 million in($456 million during the first quarterhalf of 2007. On September 1, 2006, we made additional tax-deductible voluntary contributions to our qualified U.S. domestic pension plans of $382 million. On September 1, 2005, we made tax-deductible voluntary contributions totaling $456 million to our qualified U.S. domestic pension plans.2006).
Cash Used for Investing Activities. On September 3, 2006, we acquired FedEx National LTL for $784 million in cash. Capital expenditures during the first quarterhalf of 2007 were 4%10% higher than the prior year period largely due to planned expenditures for FedEx Ground’s comprehensive network expansion.expansion and increased spending at FedEx Express for facility expansion and aircraft and related equipment. See “Capital Resources” below for further discussion.
Debt Financing Activities. On August 2, 2006, we filed an updated shelf registration statement with the SEC. The new registration statement does not limit the amount of any future offering. By using this shelf registration statement, we may sell, in one or more future offerings, any combination of our unsecured debt securities and common stock.
On August 8, 2006, under the new shelf registration statement, we issued $1 billion of senior unsecured debt, comprised of floating rate notes totaling $500 million due in August 2007, and fixed rate notes totaling $500 million due in August 2009. The floating rate notes bear interest at the three-month London Interbank Offered Rate (“LIBOR”) plus 0.08%, reset on a quarterly basis. As of August 31, 2006,November 30, the floating interest rate was 5.58%5.45%. The fixed rate notes bear interest at an annual rate of 5.5%, payable semi-annually. WeThe net proceeds are using the net proceedsbeing used for working capital and general corporate purposes, including the funding of acquisitions.acquisitions (such as the FedEx National LTL and ANC acquisitions).

 

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During the first quartersix months of 2007, $200 million of senior unsecured debt and $18 million of medium term notes matured and were repaid.
A $1.0 billion revolving credit agreement is available to finance our operations and other cash flow needs and to provide support for the issuance of commercial paper. Our revolving credit agreement contains a financial covenant, which requires us to maintain a leverage ratio of adjusted debt (long-term debt, including the current portion of such debt, plus six times rentals and landing fees) to capital (adjusted debt plus total common stockholders’ investment) that does not exceed 0.7 to 1.0. Our leverage ratio of adjusted debt to capital was 0.6 at August 31,November 30, 2006. We are in compliance with this and all other restrictive covenants of our revolving credit agreement and do not expect the covenants to affect our operations. As of August 31,November 30, 2006, no commercial paper was outstanding and the entire $1.0 billion under the revolving credit facility was available for future borrowings.
Dividends.WeDividends paid $28 million of dividends in the first quarterhalf of 2007 and $242006 were $55 million in the first quarter of 2006.and $48 million, respectively. On August 18,November 17, 2006, our Board of Directors declared a dividend of $0.09 per share of common stock. The dividend is payable on OctoberJanuary 2, 2006,2007, to stockholders of record as of the close of business on September 11,December 12, 2006.
Other Liquidity Information. We believe that our existing cash and cash equivalents, cash flow from operations, our commercial paper program, revolving bank credit facility and shelf registration statement will adequately meet our working capital and investing activities needs for the foreseeable future and finance our pending acquisitions. In the future, other forms of secured financing may be used to obtain capital assets if we determine that they best suit our needs. We have been successful in obtaining investment capital, both domestic and international, although the marketplace for such capital can become restricted depending on a variety of economic factors. We believe the capital resources available to us provide flexibility to access the most efficient markets for financing capital acquisitions, including aircraft, and are adequate for our future capital needs.
We have a senior unsecured debt credit rating from Standard & Poor’s of BBB and a commercial paper rating of A-2. Moody’s Investors Service has assigned us a senior unsecured debt credit rating of Baa2 and a commercial paper rating of P-2. Moody’s characterizes our ratings outlook as “stable,” while Standard & Poor’s characterizes our ratings outlook as “positive.” If our credit ratings drop, our interest expense may increase. If our commercial paper ratings drop below current levels, we may have difficulty utilizing the commercial paper market. If our senior unsecured debt ratings drop below investment grade, our access to financing may become more limited.
CAPITAL RESOURCES
Our operations are capital intensive, characterized by significant investments in aircraft, vehicles, technology, package handling facilities and sort equipment. The amount and timing of capital additions depend on various factors, including pre-existing contractual commitments, anticipated volume growth, domestic and international economic conditions, new or enhanced services, geographical expansion of services, competition, availability of satisfactory financing and actions of regulatory authorities.

 

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The following table compares capital expenditures by asset category and reportable segment for the three-monththree- and six-month periods ended August 31November 30 (in millions):
                        
 Percent Change 
                 2006/2005 
 Dollar Percent  Three Months Ended Six Months Ended Three Months Six Months 
 2006 2005 Change Change  2006 2005 2006 2005 Ended Ended 
Aircraft and related equipment $302 $276 $26 9  $215 $208 $517 $484 3 7 
Facilities and sort equipment 101 92 9 10  189 137 290 229 38 27 
Information and technology investments 86 91  (5)  (5) 96 94 182 185 2  (2)
Vehicles 163 176  (13)  (7) 184 166 347 342 11 1 
Other equipment 47 36 11 31  76 50 123 86 52 43 
                
Total capital expenditures $699 $671 $28 4  $760 $655 $1,459 $1,326 16 10 
                
FedEx Express segment $394 $388 $6 2  $376 $336 $770 $724 12 6 
FedEx Ground segment 134 116 18 16  183 138 317 254 33 25 
FedEx Freight segment 86 82 4 5  83 94 168 176  (12)  (5)
FedEx Kinko’s segment 24 14 10 71  42 32 66 47 31 40 
Other, principally FedEx Services 61 71  (10)  (14) 76 55 138 125 38 10 
                
Total capital expenditures $699 $671 $28 4  $760 $655 $1,459 $1,326 16 10 
                
Capital expenditures during the first quarterhalf of 2007 were higher than the prior year period primarily due to investments in the FedEx Ground network to support volume growth.growth and increased spending at FedEx Express for facility expansion and aircraft and related equipment. We expect capital expenditures of approximately $3.0$3.1 billion for 2007, compared to $2.5 billion in 2006. Much of the anticipated increase in 2007 is due to facility expansions at FedEx Express, vehicle expenditures at FedEx Ground to support network expansions and replacement needs and the addition of new locations at FedEx Kinko’s, based on theirits new center model. We also plan to continue investing in productivity-enhancing technologies and the multi-year capacity expansion of the FedEx Ground network.
Because of substantial lead times associated with the manufacture or modification of aircraft, we must generally plan our aircraft orders or modifications three to eight years in advance. While we also pursue market opportunities to purchase aircraft when they become available, we must make commitments regarding our airlift requirements years before aircraft are actually needed.
On September 25, 2006, we announced a $2.6 billion multi-year program to acquire and modify approximately 90 Boeing 757-200 aircraft to replace our narrow body fleet of Boeing 727-200 aircraft. We are closely managingexpect to bring the new aircraft into service during the eight-year period between calendar years 2008 and 2016 contingent upon identification and purchase of suitable 757-200 aircraft. As of November 30, 2006, we had entered into agreements to purchase 15 757-200 aircraft under this program. The impact to 2007 of this program has been reflected in our expected 2007 capital spending based on currentexpenditures of approximately $3.1 billion.
On November 7, 2006, we entered into an agreement to acquire 15 new Boeing 777 Freighter (“777F”) aircraft and anticipated volume levels.an option to purchase an additional 15 Boeing 777F aircraft. The 777F is the world’s largest twin-engine cargo aircraft and will provide us with non-stop, point-to-point transoceanic routes with shorter flight times. We expect to take delivery of six of the 777F aircraft in 2010 and the remaining nine in 2011. In connection with the decision to purchase these aircraft, we cancelled our order for ten Airbus A380-800F aircraft. We do not expect the cancellation of this contract to have any material negative impact to us.

 

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CONTRACTUAL CASH OBLIGATIONS
The following table sets forth a summary of our contractual cash obligations as of August 31,November 30, 2006. Certain of these contractual obligations are reflected in our balance sheet, while others are disclosed as future obligations under accounting principles generally accepted in the United States. Except for the current portion of long-term debt and capital lease obligations, this table does not include amounts already recorded on our balance sheet as current liabilities at August 31,November 30, 2006. 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  Payments Due by Fiscal Year 
 (in millions)  (in millions) 
 There-    There-   
 2007(1) 2008 2009 2010 2011 after Total  2007(1) 2008 2009 2010 2011 after Total 
Amounts reflected in Balance Sheet:
  
Long-term debt $625 $500 $500 $499 $249 $539 $2,912  $622 $500 $500 $499 $249 $539 $2,909 
Capital lease obligations(2)(3)
 17 100 12 97 8 144 378 
Capital lease obligations(2) (3)
 11 100 12 97 8 144 372 
Other cash obligations not reflected in Balance Sheet:
  
Unconditional purchase obligations (3)
 1,003 761 700 830 596 383 4,273  673 703 850 1,061 726 226 4,239 
Interest on long-term debt 125 118 110 79 65 1,599 2,096  80 117 110 79 65 1,599 2,050 
Operating leases(3)
 1,297 1,521 1,330 1,150 1,012 6,896 13,206  949 1,577 1,386 1,216 1,078 7,260 13,466 
                              
Total $3,067 $3,000 $2,652 $2,655 $1,930 $9,561 $22,865  $2,335 $2,997 $2,858 $2,952 $2,126 $9,768 $23,036 
                              
(1) Cash obligations for the remainder of 2007.
 
(2) Capital lease obligations represent principal and interest payments.
 
(3) See Note 8 to the accompanying unaudited consolidated financial statements.
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 above.
Amounts Reflected in Balance Sheet
We have certain financial instruments representing potential commitments, not reflected in the table above, that were incurred in the normal course of business to support our operations, including surety bonds and standby letters of credit. These instruments are generally required under certain U.S. self-insurance programs and are also used in the normal course of international operations. While the notional amounts of these instruments are material, there are no additional contingent liabilities associated with them because the underlying liabilities are already reflected in our balance sheet.
We have other long-term liabilities reflected in our balance sheet, including deferred income taxes, non-qualified pension and postretirement healthcare liabilities and other self-insurance accruals. The payment obligations associated with these liabilities are not reflected in the table above due to the absence of scheduled maturities. Therefore, the timing of these payments cannot be determined, except for amounts estimated to be payable within twelve months that are included in current liabilities.
Other Cash Obligations Not Reflected in Balance Sheet
The amounts reflected in the table above for purchase commitments represent non-cancelable agreements to purchase goods or services. Such contracts include those for certain purchases of aircraft, aircraft modifications, vehicles, facilities, computers, printing and other equipment and advertising and promotions contracts. In addition, we have committed to modify our DC10 aircraft for passenger-to-freighter and two-man cockpit configurations, which is reflected in the table above. Commitments to purchase aircraft in passenger

 

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purchase aircraft in passenger configuration do not include the attendant costs to modify these aircraft for cargo transport unless we have entered into a non-cancelable commitment to modify such aircraft. Open purchase orders that are cancelable are not considered unconditional purchase obligations for financial reporting purposes and are not included in the table above. Such purchase orders often represent authorizations to purchase rather than binding agreements.
The amounts reflected in the table above for interest on long-term debt represent future interest payments due on our long-term debt, which are primarily fixed rate.
The amounts reflected in the table above for operating leases represent future minimum lease payments under non-cancelable operating leases (principally aircraft and facilities) with an initial or remaining term in excess of one year at August 31,November 30, 2006. In the past, we financed a significant portion of our aircraft needs (and certain other equipment needs) using operating leases (a type of “off-balance sheet financing”). At the time that the decision to lease was made, we determined that these operating leases would provide economic benefits favorable to ownership with respect to market values, liquidity or after-tax cash flows.
In accordance with accounting principles generally accepted in the United States, our operating leases are not recorded in our balance sheet. Credit rating agencies routinely use information concerning minimum lease payments required for our operating leases to calculate our debt capacity.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make significant judgments and estimates to develop amounts reflected and disclosed in the financial statements. In many cases, there are alternative policies or estimation techniques that could be used. We maintain a thorough process to review the application of our accounting policies and to evaluate the appropriateness of the many estimates that are required to prepare the financial statements of a large, global corporation. However, even under optimal circumstances, estimates routinely require adjustment based on changing circumstances and new or better information.
Information regarding our “Critical Accounting Estimates” can be found in our Annual Report. The four critical accounting policies that we believe are either the most judgmental, or involve the selection or application of alternative accounting policies, and are material to our financial statements are those relating to pension cost, self-insurance accruals, long-lived assets and revenue recognition. Management has discussed the development and selection of these critical accounting policies and estimates with the Audit Committee of our Board of Directors and with our independent registered public accounting firm. In addition, Note 1 to the financial statements in our Annual Report contains a summary of our significant accounting policies.
FORWARD-LOOKING STATEMENTS
Certain statements in this report, including (but not limited to) those contained in “Outlook,” “Liquidity,” “Capital Resources” andResources,” “Contractual Cash Obligations,” and in Footnote 1, “General,” are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to our financial condition, results of operations, cash flows, plans, objectives, future performance and business. Forward-looking statements include those preceded by, followed by or that include the words “may,” “could,” “would,” “should,” “believes,” “expects,” “anticipates,” “plans,” “estimates,” “targets,” “projects,” “intends” or similar expressions. These forward-looking statements involve risks and uncertainties. Actual results may differ materially from those contemplated (expressed or implied) by such forward-looking statements, because of, among other things, potential risks and uncertainties, such as:
economic conditions in the global markets in which we operate;

 

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the impact of any international conflicts or terrorist activities on the United States and global economies in general, the transportation industry or us in particular, and what effects these events will have on our costs or the demand for our services;
damage to our reputation or loss of brand equity;
disruptions to the Internet or our technology infrastructure, including those impacting our computer systems and Web site;
the price and availability of jet and diesel fuel;
the impact of intense competition on our ability to maintain or increase our prices (including our fuel surcharge in response to rising fuel costs) or to maintain or grow our market share;
our ability to manage our cost structure for capital expenditures and operating expenses, and match it to shifting and future customer volume levels;
our ability to effectively operate, integrate, leverage and grow acquired businesses, including FedEx Kinko’s, and to continue to support the value we allocate to these acquired businesses, including their goodwill;
any impacts on our businesses resulting from new domestic or international government regulation, including regulatory actions affecting global aviation rights, increased air cargo and other security requirements, and tax, accounting, labor or environmental rules;
changes in foreign currency exchange rates, especially in the Japanese yen, Taiwan dollar, Canadian dollar and euro, which can affect our sales levels and foreign currency sales prices;
our ability to defend against challenges to the status of FedEx Ground’s owner-operators as independent contractors, rather than employees;
any liability resulting from and the costs of defending against class-action litigation, such as wage-and-hour and race discrimination claims, and any other legal proceedings;
the outcome of voting by the pilots of FedEx Express to ratify the tentative four-year collective bargaining agreement reached in August 2006;
our ability to maintain good relationships with our employees and prevent attempts by labor organizations to organize groups of our employees, which could significantly increase our operating costs;
a shortage of qualified labor and our ability to mitigate this shortage through recruiting and retention efforts and productivity gains;
increasing costs and the volatility of costs for employee benefits, especially pension and healthcare benefits;
significant changes in the volumes of shipments transported through our networks, customer demand for our various services or the prices we obtain for our services;
market acceptance of our new service and growth initiatives;

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•economic conditions in the global markets in which we operate;
•the impact of any international conflicts or terrorist activities on the United States and global economies in general, the transportation industry or us in particular, and what effects these events will have on our costs or the demand for our services;
•damage to our reputation or loss of brand equity;
•disruptions to the Internet or our technology infrastructure, including those impacting our computer systems and Web site;
•the price and availability of jet and diesel fuel;
•the impact of intense competition on our ability to maintain or increase our prices (including our fuel surcharge in response to rising fuel costs) or to maintain or grow our market share;
•our ability to manage our cost structure for capital expenditures and operating expenses, and match it to shifting and future customer volume levels;
•our ability to effectively operate, integrate, leverage and grow acquired businesses, including FedEx Kinko’s and FedEx National LTL, and to continue to support the value we allocate to these acquired businesses, including their goodwill;
•any impacts on our businesses resulting from new domestic or international government regulation, including regulatory actions affecting global aviation rights, increased air cargo and other security requirements, and tax, accounting, labor or environmental rules;
•changes in foreign currency exchange rates, especially in the Japanese yen, Taiwan dollar, Canadian dollar and euro, which can affect our sales levels and foreign currency sales prices;
•our ability to defend against challenges to the status of FedEx Ground’s owner-operators as independent contractors, rather than employees;
•any liability resulting from and the costs of defending against class-action litigation, such as wage-and-hour and race discrimination claims, and any other legal proceedings;
•our ability to maintain good relationships with our employees and prevent attempts by labor organizations to organize groups of our employees, which could significantly increase our operating costs;
•a shortage of qualified labor and our ability to mitigate this shortage through recruiting and retention efforts and productivity gains;
•increasing costs and the volatility of costs for employee benefits, especially pension and healthcare benefits;
•significant changes in the volumes of shipments transported through our networks, customer demand for our various services or the prices we obtain for our services;
•market acceptance of our new service and growth initiatives;

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the impact of technology developments on our operations and on demand for our services (for example, the impact that low-cost home copiers and printers are having on demand for FedEx Kinko’s copy services);
adverse weather conditions or natural disasters, such as earthquakes and hurricanes, which can damage our property, disrupt our operations, increase fuel costs and adversely affect shipment levels;
widespread outbreak of an illness, such as avian influenza (bird flu), severe acute respiratory syndrome (SARS) or any other communicable disease, or any other public health crisis;
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; and
other risks and uncertainties you can find in our press releases and SEC filings, including the risk factors identified under the heading “Risk Factors” in “Management’s Discussion and Analysis of Results of Operations and Financial Condition” in our Annual Report, as updated by our quarterly reports on Form 10-Q.
•the impact of technology developments on our operations and on demand for our services (for example, the impact that low-cost home copiers and printers are having on demand for FedEx Kinko’s copy services);
•adverse weather conditions or natural disasters, such as earthquakes and hurricanes, which can damage our property, disrupt our operations, increase fuel costs and adversely affect shipment levels;
•widespread outbreak of an illness, such as avian influenza (bird flu), severe acute respiratory syndrome (SARS) or any other communicable disease, or any other public health crisis;
•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; and
•other risks and uncertainties you can find in our press releases and SEC filings, including the risk factors identified under the heading “Risk Factors” in “Management’s Discussion and Analysis of Results of Operations and Financial Condition” in our Annual Report, as updated by our quarterly reports on Form 10-Q.
As a result of these and other factors, no assurance can be given as to our future results and achievements. Accordingly, a forward-looking statement is neither a prediction nor a guarantee of future events or circumstances and those future events or circumstances may not occur. You should not place undue reliance on forward-looking statements, which speak only as of the date on which they are made. We undertake no obligation to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk
At August 31,November 30, 2006, we had approximately $500 million of outstanding floating-rate senior unsecured debt issued in August 2006 for working capital and general corporate purposes, including the funding of acquisitions. We have not employed interest rate hedging to mitigate the risks with respect to these borrowings. A hypothetical 10% increase in the interest rate on our outstanding floating-rate borrowings would not have a material effect on our results of operations. As of August 31,November 30, 2006, there had been no other material changes in our market risk sensitive instruments and positions since the disclosure in our Annual Report. While we are a global provider of transportation, e-commerce and business services, the substantial majority of our transactions are denominated in U.S. dollars. The distribution of our foreign currency denominated transactions is such that foreign currency declines in some areas of the world are often offset by foreign currency gains in other areas of the world. The principal foreign currency exchange rate risks to which we are exposed are in the Japanese yen, Taiwan dollar, Canadian dollar and euro. Foreign currency fluctuations during the three-month periodthree- and six-month periods ended August 31,November 30, 2006 did not have a material effect on our results of operations.
We have market risk for changes in the price of jet and diesel fuel; however, thisfuel. This risk is largely mitigated by our fuel surcharges. However, our fuel surcharges have a lag that exists before they are adjusted for changes in fuel prices and fuel prices can fluctuate within certain ranges before resulting in a change into our fuel surcharges. Therefore, our operating income may be significantly affected in the short term should the spot price of fuel suddenly change by a significant amount or change by amounts that do not result in a change in our fuel surcharges.
Item 4. Controls and Procedures
The management of FedEx, with the participation of our principal executive and financial officers, has evaluated the effectiveness of our disclosure controls and procedures in ensuring that the information required to be disclosed in our filings under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, including ensuring that such information is accumulated and communicated to FedEx management as appropriate to allow timely decisions regarding required disclosure. Based on such evaluation, our principal executive and financial officers have concluded that such disclosure controls and procedures were effective as of August 31,November 30, 2006 (the end of the period covered by this Quarterly Report on Form 10-Q).
During our fiscal quarter ended August 31,November 30, 2006, no change occurred in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
For a description of all material pending legal proceedings, see Note 9 of the accompanying unaudited condensed consolidated financial statements.
On December 19, 2006, FedEx Express received a formal request for certain information in connection with an ongoing investigation by the Directorate General for Competition of the European Commission (“EC”) into possible anti-competitive behavior relating to air freight transport services in the European Union/European Economic Area. This investigation is in addition to the ongoing investigation by the Antitrust Division of the U.S. Department of Justice (“DOJ”) that was disclosed in our Annual Report. We do not believe that we have engaged in any anti-competitive activities, and we are cooperating with both the EC and the DOJ.
Item 1A. Risk Factors
On August 26, 2006, FedEx Express and the union that represents the pilots of FedEx Express reached a tentative agreement on a new four-year collective bargaining agreement. The new agreement is subject to ratification by the pilots. Otherwise, thereThere have been no material changes from the risk factors disclosed in our Annual Report (under the heading “Risk Factors” in “Management’s Discussion and Analysis of Results of Operations and Financial Condition”) in response to Part I, Item 1A of Form 10-K.10-K, as updated by our quarterly report on Form 10-Q for the quarter ended August 31, 2006.
Item 4. Submission of Matters to a Vote of Security Holders
AtFor the FedEx Corporation annual meeting of stockholders heldinformation called for by this item, see our quarterly report on September 25, 2006, FedEx’s stockholders took the following actions:
The stockholders elected fourteen directors, each for a one-year term. The tabulation of votes with respect to each nominee for director was as follows:
         
Nominee For  Withheld 
Frederick W. Smith  277,393,999   5,857,411 
James L. Barksdale  254,669,693   28,581,717 
August A. Busch IV  279,289,785   3,961,625 
John A. Edwardson  279,306,801   3,944,609 
Judith L. Estrin  276,072,238   7,179,172 
J. Kenneth Glass  278,063,467   5,187,943 
Philip Greer  277,321,385   5,930,025 
J.R. Hyde, III  276,490,900  ��6,760,510 
Shirley A. Jackson  277,804,310   5,447,100 
Steven R. Loranger  280,134,422   3,116,988 
Charles T. Manatt  280,079,815   3,171,595 
Joshua I. Smith  277,439,719   5,811,691 
Paul S. Walsh  278,810,864   4,440,546 
Peter S. Willmott  250,759,295   32,492,115 
The stockholders approved the adoption of amendments to FedEx’s Amended and Restated Certificate of Incorporation, as amended, and Restated Bylaws to eliminate all supermajority voting requirements by a vote of 275,652,470 for and 1,689,235 against. There were 5,909,705 abstentions. The Board of Directors has restated FedEx’s Amended and Restated Certificate of Incorporation, as amended, and Restated Bylaws to reflect the simple majority vote amendments. The resulting Second Amended and Restated Certificate of Incorporation has been executed, acknowledged, filed and recorded in accordance with the Delaware General Corporation Law and is attached to this Report as Exhibit 3.1. The resulting Amended and Restated Bylaws are attached to this Report as Exhibit 3.2.
The Audit Committee’s designation of Ernst & Young LLP as FedEx’s independent registered public accounting firmForm 10-Q for the fiscal year ending Mayquarter ended August 31, 2007 was ratified by the stockholders. The tabulation of votes on this matter was as follows:2006.
•279,620,062 votes for
•1,791,986 votes against
•1,839,362 abstentions
•There were no broker non-votes for this item.
A stockholder proposal requesting that the Board of Directors report on the scientific and economic analyses relevant to FedEx’s environmental policy concerning greenhouse gases was not approved by stockholders. The tabulation of votes on this matter was as follows:
•11,866,241 votes for
•201,298,753 votes against
•36,949,949 abstentions
•33,136,467 broker non-votes
A stockholder proposal requesting that the Board of Directors take the necessary steps to amend FedEx’s governance documents to provide that each director nominee be elected by the affirmative vote of a majority of votes cast at an annual meeting of stockholders was not approved by stockholders. The tabulation of votes on this matter was as follows:
•111,420,718 votes for
•132,447,517 votes against
•6,246,708 abstentions
•33,136,467 broker non-votes

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Item 6. Exhibits
   
Exhibit  
Number Description of Exhibit
3.1Second Amended and Restated Certificate of Incorporation of FedEx Corporation.
3.2Amended and Restated Bylaws of FedEx Corporation.
10.1 Seventh Addendum dated July 31, 2006 to the TransportationBoeing 777 Freighter Purchase Agreement dated January 10, 2001, as amended,of November 7, 2006 between the United States Postal ServiceThe Boeing Company and Federal Express Corporation. Confidential treatment has been requested for confidential commercial and financial information, pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.
   
10.2 Amendment dated November 30, 2006 to the Transportation Agreement dated July 31, 2006 between the United States Postal Service and Federal Express Corporation. Confidential treatment has been requested for confidential commercial and financial information, pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.
   
12.1 Computation of Ratio of Earnings to Fixed Charges.
   
15.1 Letter re: Unaudited Interim Financial Statements.
   
31.1 Certification of Principal Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
31.2 Certification of Principal Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
32.1 Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
32.2 Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
     
 FEDEX CORPORATION
 		 
Date: September 25,December 22, 2006 /s/ JOHN L. MERINO   
 JOHN L. MERINO  
 CORPORATE VICE PRESIDENT
PRINCIPAL ACCOUNTING OFFICER 		 
 

 

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EXHIBIT INDEX
   
Exhibit  
Number Description of Exhibit
3.1Second Amended and Restated Certificate of Incorporation of FedEx Corporation.
3.2Amended and Restated Bylaws of FedEx Corporation.
10.1 Seventh Addendum dated July 31, 2006 to the TransportationBoeing 777 Freighter Purchase Agreement dated January 10, 2001, as amended,of November 7, 2006 between the United States Postal ServiceThe Boeing Company and Federal Express Corporation. Confidential treatment has been requested for confidential commercial and financial information, pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.
   
10.2 Amendment dated November 30, 2006 to the Transportation Agreement dated July 31, 2006 between the United States Postal Service and Federal Express Corporation. Confidential treatment has been requested for confidential commercial and financial information, pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.
   
12.1 Computation of Ratio of Earnings to Fixed Charges.
   
15.1 Letter re: Unaudited Interim Financial Statements.
   
31.1 Certification of Principal Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
31.2 Certification of Principal Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
32.1 Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
32.2 Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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