Financial Results 33 Management’s Discussion and Analysis 53 Consolidated Financial Statements 57 Notes to Consolidated Financial Statements 76 Report of Independent Registered Public Accounting Firm 77 Selected Financial Data 78 Board of Directors 79 Executive Officers and Senior Management 80 Corporate Information MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION GENERAL These companies form the core of our reportable segments. In 2004, we changed the reporting and responsibility relationships The following Management’s Discussion and Analysis of Results of our smaller business units so that they now report directly to a of Operations and Financial Condition (“MD&A”) describes the core segment. See Reportable Segments for further discussion. principal factors affecting the results of operations, liquidity, cap- ital resources and contractual cash obligations, as well as the The key factors that affect our operating results are as follows: critical accounting policies and estimates, of FedEx Corporation • the overall customer demand for our various services; (also referred to as “FedEx”). This discussion should be read in conjunction with the accompanying audited financial statements, • the volumes of transportation and business services provided which include additional information about our significant account- through our networks, primarily measured by our average daily ing policies, practices and the transactions that underlie our volume and shipment weight; financial results. • the mix of services purchased by our customers; Our MD&A is comprised of three major sections: Results of • the prices we obtain for our services, primarily measured by Operations, Financial Condition and Critical Accounting Policies average price per shipment (yield); and Estimates. Results of Operations begins with an overview of consolidated 2004 results compared to 2003, and of 2003 results • our ability to manage our cost structure for capital expenditures compared to 2002. This section includes a discussion of key and operating expenses such as salaries and benefits, fuel and actions, such as our business realignment initiatives and the maintenance; and acquisition of FedEx Kinko’s, as well as a discussion of our out- • our ability to match operating costs to shifting volume levels. look for 2005. The overview is followed by a financial summary and narrative (including a discussion of both historical operating Except as otherwise specified, references to years indicate our results and our outlook for 2005) for each of our four reportable fiscal year ended May 31, 2004 or ended May 31 of the year operating segments. We then provide an analysis of changes in referenced and comparisons are to the prior year. our balance sheet and cash flows and discuss our financial com- mitments in the Financial Condition section. We conclude with a discussion of the critical accounting policies and estimates that we believe are important to understanding the judgments and assumptions incorporated in our reported financial results. FedEx provides a broad portfolio of transportation, e-commerce and business services with companies that operate indepen- dently and compete collectively under the respected FedEx brand. These operating companies are primarily represented by FedEx Express, the world’s largest express transportation company; FedEx Ground, North America’s second largest provider of small- package ground delivery service; FedEx Freight, a leading U.S. provider of regional LTL freight services; and FedEx Kinko’s, a leading provider of document solutions and business services. 33 FEDEX CORPORATION RESULTS OF OPERATIONS CONSOLIDATED RESULTS The following table compares revenues, operating income, operating margin, net income and diluted earnings per share (dollars in mil- lions, except per share amounts) for the years ended May 31: $ Change Percent Change 2004 2003 2002 2004/2003 2003/2002 2004/2003 2003/2002 Revenues $24,710 $22,487 $20,607 2,223 1,880 10 9 Operating income 1,440 (1) 1,471 1,321 (31) 150 (2) 11 Operating margin 5.8% 6.5% 6.4% n/a n/a (70) bp 10 bp Net income $838(1)(2) $ 830 $ 710 (3) 8 120 1 17 Diluted earnings per share $ 2.76 (1)(2) $ 2.74 $ 2.34(3) 0.02 0.40 1 17 (1) Includes $435 million ($270 million, net of tax, or $0.89 per diluted share) of business realignment costs described below. See Note 4 to the accompanying audited financial statements. (2) Includes a $37 million, net of tax, or $0.12 per diluted share benefit related to a favorable ruling on a tax case and the reduction of our effective tax rate described below. See Note 11 to the accompanying audited financial statements. (3) Results for 2002 reflect our adoption of SFAS 142, “Goodwill and Other Intangible Assets.” We recognized an adjustment of $25 million ($15 million, net of tax, or $0.05 per diluted share) to reduce the carrying value of certain goodwill to its implied fair value. See Note 3 to the accompanying audited financial statements. The following table shows changes in revenues and operating income by reportable segment for 2004 compared to 2003, and 2003 compared to 2002 (in millions): $ Change Percent Change $ Change Percent Change Revenues Revenues Operating Income Operating Income 2004/2003 2003/2002 2004/2003 2003/2002 2004/2003 2003/2002 2004/2003 2003/2002 FedEx Express segment 1,030 1,029 6 7 (154) (1) (18) (20) (2) FedEx Ground segment 329 663 9 23 28 157 6 47 FedEx Freight segment 246 190 10 8 51 8 26 4 FedEx Kinko’s segment 521 n/a n/a n/a 39 n/a n/a n/a Other and Eliminations (2) 97 (2) n/a n/a 5 3 n/a n/a 2,223 1,880 10 9 (31) 150 (2) 11 (1) Includes $428 million of business realignment costs described below. (2) Includes the results of operations of FedEx Kinko’s from February 12, 2004 (date of acquisition) through February 29, 2004 (approximately $100 million of revenue and $6 million of operating income). Revenue growth during 2004 was attributable to increased vol- increased 11% as FedEx Ground significantly improved its oper- umes of FedEx Express International Priority (IP), FedEx Ground ating margin, which more than offset a decline in the operating and FedEx Freight shipments, as well as strong growth of IP margin at FedEx Express. The sluggish economy, combined with yields at FedEx Express. Yield improvements at FedEx Ground and significant increases in pension and healthcare costs and higher FedEx Freight also contributed to revenue growth. In addition, maintenance expenses, reduced profitability at FedEx Express in FedEx Kinko’s (acquired on February 12, 2004) added $621 million 2003 despite continued cost control efforts. of revenue during 2004. During 2003, revenue growth was due to Salaries and benefits expense increased 10% during 2004 due to the substantial growth of our FedEx Ground business, increased higher incentive compensation and pension costs, wage rate international volumes at FedEx Express and higher revenues at increases and the acquisition of FedEx Kinko’s. Incentive com- FedEx Freight. Increased U.S. freight volumes at FedEx Express pensation increased approximately $240 million during 2004 due also contributed to consolidated revenue growth in 2003, as we to above-plan operating income, primarily at FedEx Express and benefited from a full twelve months of revenue under the trans- FedEx Freight. Incentive compensation declined in 2003 based on portation agreement with the U.S. Postal Service (“USPS”), which below-plan performance at FedEx Express. Pension costs were commenced in late August 2001. approximately $115 million higher in 2004 (on top of an $80 million Operating income decreased 2% in 2004 as costs related to our increase in 2003), due principally to lower discount rates and business realignment initiatives totaled $435 million (partially off- decreased returns on pension plan assets. Although not legally set by approximately $150 million of savings). See “Business required, we made $320 million in contributions to our qualified Realignment Costs” for a discussion of these costs and related U.S. pension plans in 2004 compared to total contributions savings. In total, operating expenses, other than business realign- exceeding $1 billion in 2003. Our 2003 contributions were made to ment costs, increased less than the increase in revenue during ensure our qualified U.S. pension plan assets exceeded the related 2004, despite significant increases in incentive compensation, accumulated benefit obligations at our February 28, 2003 plan pension and maintenance costs. During 2003, operating income measurement date. 34 MANAGEMENT’S DISCUSSION AND ANALYSIS Other Income and Expense and Income Taxes Costs were also incurred in 2004 for the elimination of certain Net interest expense decreased slightly in 2004 as the effects of management positions at FedEx Express and other business the tax case described below offset increases to interest units based on the staff reductions from the voluntary programs expense. These increases were due to the amendment of aircraft and other cost reduction initiatives. Costs for the benefits pro- operating leases and the adoption of Financial Accounting vided under the voluntary programs were recognized in the Standards Board Interpretation No. (“FIN”) 46, “Consolidation of period that eligible employees accepted the offer. Other costs Variable Interest Entities, an Interpretation of ARB No. 51,” which associated with business realignment activities were recognized together resulted in eight MD11 aircraft being recorded as fixed in the period incurred. assets and the related obligations being recorded as long-term We recognized $435 million of business realignment costs during debt. Interest expense also increased due to additional borrow- 2004. Savings of approximately $150 million were realized, reflected ings related to the FedEx Kinko’s acquisition. Net interest expense primarily in lower salaries and benefits costs. The components of was 15% lower in 2003 due to reduced borrowings. our business realignment costs and changes in the related accru- In August 2003, we received a favorable ruling from the U.S.