Federal Express 2009 Annual Report Download - page 35

MANAGEMENT’S DISCUSSION AND ANALYSIS
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assumptions related to these charges is included in Note 4 to our
consolidated fi nancial statements.
During 2009, the U.S. recession had a signifi cant negative impact
on demand for FedEx Offi ce services, resulting in lower revenues
and continued operating losses at this reporting unit. In response
to these conditions, FedEx Offi ce initiated an internal reorganiza-
tion designed to improve revenue-generating capabilities and
reduce costs. Several actions were taken during 2009 to reduce
FedEx Offi ce’s cost structure and position it for long-term growth
under better economic conditions. These actions included head-
count reductions, domestic store closures and the termination of
operations in some international locations. In addition, we sub-
stantially curtailed future network expansion in light of current
economic conditions.
The valuation methodology to estimate the fair value of the
FedEx Offi ce reporting unit was based primarily on an income
approach. We believe use of the income approach is an appro-
priate methodology for the FedEx Offi ce reporting unit because it
is the most direct method of measuring enterprise value for this
reporting unit. Because of the nature of the service offerings at
FedEx Offi ce, it exhibits characteristics of a retailer, a business
services provider and a printing provider. Accordingly, it is dif-
fi cult to fi nd directly comparable companies for use under the
market approach. However, market approach information was
incorporated into our test to ensure the reasonableness of our
conclusions on estimated value under the income approach. Key
assumptions considered were the revenue, operating income
and capital expenditure forecasts, the assessed growth rate
in the periods beyond the detailed forecast period, and the
discount rate.
For 2009, we used a discount rate of 12.0%, versus a discount
rate of 12.5% in 2008. Our discount rate of 12.0% for 2009 rep-
resents our WACC of the FedEx Offi ce reporting unit adjusted
for company-specifi c risk premium to account for the estimated
uncertainty associated with our future cash fl ows. The develop-
ment of the WACC used in our estimate of fair value considered
the following key factors:
• current market conditions for the equity-risk premium and risk-
free interest rate;
• benchmark capital structures for guideline companies with
characteristics similar to the FedEx Offi ce reporting unit;
• the size and industry of the FedEx Offi ce reporting unit; and
• risks related to the forecast of future revenues and profi tability
of the FedEx Offi ce reporting unit.
The discount rate incorporates current market participant con-
siderations, as indicated above, and decreased year over year,
as increases in the WACC (due to general economic conditions)
were offset by reductions in the company-specifi c risk premium.
The company-specifi c risk premium was reduced primarily due to
lower long-term growth and profi tability assumptions associated
with the 2009 forecast. The WACC used in the estimate of fair
value in future periods may be impacted by changes in market
conditions (including those of market participants), as well as the
specifi c future performance of the FedEx Offi ce reporting unit
and are subject to change, based on changes in specifi c facts
and circumstances.
The key drivers of enterprise value for FedEx Offi ce in 2008 were
signifi cant improvements in long-term revenue and profi tabil-
ity growth, as well as continued network expansion activities.
Despite the benefi ts of the internal reorganization described
above, the current and projected impact of the recession and
the elimination of future network expansion signifi cantly reduced
the value of the FedEx Offi ce reporting unit for 2009. The valua-
tion of the FedEx Offi ce reporting unit was sensitive to both the
underlying forecast assumptions and the discount rate assump-
tions. For example, a 50-basis-point increase or decrease in the
discount rate impacted the estimate of fair value by $40 million.
Further, a 100-basis-point improvement or deterioration in the
operating margin in each year of the forecast period impacted
the fair value by $220 million.
Upon completion of the impairment test, we concluded that the
recorded goodwill was impaired and recorded an impairment
charge of $810 million during the fourth quarter of 2009. The
remaining goodwill attributable to the FedEx Offi ce reporting
unit is $362 million as of May 31, 2009. The goodwill impairment
charge is included in operating expenses in the accompanying
consolidated statements of income. This charge is included in the
results of the FedEx Services segment and was not allocated to
our transportation segments, as the charge was unrelated to the
core performance of those businesses.
FedEx National LTL Goodwill. During 2009, the U.S. recession
had a signifi cant negative impact on the LTL industry, resulting
in steep volume declines, intense yield pressure and the exit of
numerous small to medium competitors from the market. The out-
look for the LTL market is uncertain due to the recession and the
negative impact of aggressive pricing resulting from continued
excess capacity in the market. The results for the FedEx National
LTL reporting unit in 2009 refl ect the impact of the recession, with
reduced revenues and increased operating losses.
The valuation methodology to estimate the fair value of the
FedEx National LTL reporting unit was based primarily on a mar-
ket approach (revenue multiples and/or earnings multiples) that
considered market participant assumptions. We believe use of
the market approach for FedEx National LTL is appropriate due to
the forecast risk associated with the projections used under the
income approach, particularly in the outer years of the forecast
period (as described below). Further, there are directly com-
parable companies to the FedEx National LTL reporting unit for
consideration under the market approach. The income approach
also was incorporated into the impairment test to ensure the rea-
sonableness of our conclusions under the market approach. Key
assumptions considered were the revenue, operating income and
capital expenditure forecasts and market participant assump-
tions on multiples related to revenue and earnings forecasts.
The forecast used in the valuation assumes operating losses will
continue in the near-term due to the current economic condi-
tions and excess capacity in the industry. However, the long-term
outlook assumes that this excess capacity exits the market. This
assumption drives signifi cant volume and yield improvement
into the FedEx National LTL reporting unit in future periods. The
decision to include an assumption related to the elimination of
excess capacity from the market and the associated cash fl ows
is signifi cant to the valuation and refl ects management’s outlook
on the industry for future periods as of the valuation date.