Federal Express 2006 Annual Report Download - page 59

MANAGEM ENT’S DISCUSSION AND ANALYSIS
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mated fair values when the decision is made to dispose of the
asset and certain other criteria are met. There were no material
asset impairment charges recognized in 2006, 2005 or 2004.
Leases. We utilize operating leases to finance certain of our air-
craft and facilities. Such arrangements typically shift the risk of
loss on the residual value of the assets at the end of the lease
period to the lessor. As disclosed in “Contractual Cash Obligations”
and Note 8 to the accompanying consolidated financial state-
ments, at May 31, 2006 we had approximately $13 billion (on an
undiscounted basis) of future commitments for payments under
operating leases. The weighted-average remaining lease term
of all operating leases outstanding at May 31, 2006 was approx-
imately six years.
The future commitments for operating leases are not reflected as
a liability in our balance sheet because these leases do not meet
the accounting definition of capital leases. The determination of
whether a lease is accounted for as a capital lease or an operat-
ing lease requires management to make estimates primarily about
the fair value of the asset and its estimated economic useful life.
We believe we have well-defined and controlled processes for
making this evaluation, including obtaining third-party appraisals
for material transactions to assist us in making these evaluations.
Our results for 2006 included a one-time, 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, predominately at FedEx Express. The
charge related primarily to rent escalations in on-airport facility
leases. The applicable accounting literature provides that rent
expense under operating leases with rent escalation clauses
should be recognized evenly, on a straight-line basis over the
lease term. During the first quarter of 2006, we determined that a
portion of our facility leases had rent escalation clauses that
were not being recognized appropriately. Because the amounts
involved were not material to our financial statements in any
individual prior period and the cumulative amount was not mate-
rial to 2006 results, we recorded the cumulative adjustment,
which increased operating expenses by $79 million, in the first
quarter of 2006.
Goodwill. We have approximately $2.8 billion of goodwill in our
balance sheet resulting from the acquisition of businesses, which
includes approximately $1.8 billion from our acquisition of FedEx
Kinko’s in 2004. Accounting standards require that we do not
amortize goodwill but review it for impairment on at least an
annual basis.
The annual evaluation of goodwill impairment requires the use of
estimates and assumptions to determine the fair value of our
reporting units using a discounted cash flow methodology. In
particular, the following estimates used by management can sig-
nificantly affect the outcome of the impairment test: revenue
growth rates; operating margins; discount rates and expected
capital expenditures. Each year, independent of our goodwill
impairment test, we update our weighted-average cost of capital
calculation and perform a long-range planning analysis to pro-
ject expected results of operations. Using this data, we complete
a separate fair-value analysis for each of our reporting units.
Changes in forecasted operations and other assumptions could
materially affect these estimates. We compare the fair value of
our reporting units to the carrying value, including goodwill, of
each of those units. We performed our annual impairment tests in
the fourth quarter of 2006. Because the fair value of each of our
reporting units exceeded its carrying value, including goodwill,
no impairment charge was necessary.
Intangible Asset with an Indefinite Life. We have an intangible
asset of $567 million associated with the Kinko’s trade name. This
intangible asset is not amortized because it has an indefinite
remaining useful life. We must review this asset for impairment
on at least an annual basis. This annual evaluation requires the use
of estimates about the future cash flows attributable to the Kinko’s
trade name to determine the estimated fair value of the trade
name. Changes in forecasted operations and changes in discount
rates can materially affect this estimate. However, once an
impairment of this intangible asset has been recorded, it cannot be
reversed. We performed our annual impairment test in the fourth
quarter of 2006. Because the fair value of the trade name exceeded
its carrying value, no impairment charge was necessary.
While FedEx Kinko’s experienced slight revenue growth with
decreased profitability in 2006, we believe that our long-term
growth and expansion strategies support our fair value conclu-
sions. For both goodwill and recorded intangible assets at FedEx
Kinko’s, the recoverability of these amounts is dependent on exe-
cution of key initiatives related to revenue growth, location
expansion and improved profitability.