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 for the year ended May 31, 2008 ("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 a detailed discussion of the most significant risks and uncertainties associated with our financial and operating results.
We provide a broad portfolio of transportation, e-commerce and business services through companies competing collectively, operating independently and managed collaboratively under the respected FedEx brand. Our primary operating companies include 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; and FedEx Freight Corporation, a leading U.S. provider of less-than-truckload ("LTL") freight services. Our FedEx Services segment provides customer-facing sales, marketing, information technology and customer service support, as well as retail access for customers through FedEx Office and Print Services, Inc. ("FedEx Office"), primarily for the benefit of FedEx Express and FedEx Ground. These companies represent our major service lines and 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 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 yield (average price per shipment or pound or average price per hundredweight for FedEx Freight LTL Group shipments);

• our ability to manage our cost structure (capital expenditures and operating expenses) to match 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 majority of our operating expenses are directly impacted by revenue and volume levels. Accordingly, we expect these operating expenses to fluctuate on a year-over-year basis consistent with the change in revenues and volume. The following discussion of operating expenses describes the key drivers impacting expense trends beyond changes in revenues and volume.
Except as otherwise specified, references to years indicate our fiscal year ending May 31, 2009 or ended May 31 of the year referenced and comparisons are to the corresponding period of the prior year. References to our transportation segments include, collectively, our FedEx Express, FedEx Ground and FedEx Freight segments.

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- and six-month periods ended November 30:

                                 Three Months Ended          Percent              Six Months Ended          Percent
                                 2008           2007          Change             2008          2007         Change
Revenues                      $    9,538       $ 9,451               1         $ 19,508      $ 18,650              5

Operating income                     784           783               -            1,414         1,597            (11 )

Operating margin                     8.2 %         8.3 %           (10 ) bp         7.2 %         8.6 %         (140 ) bp

Net income                    $      493       $   479               3         $    877      $    973            (10 )


Diluted earnings per share    $     1.58       $  1.54               3         $   2.81      $   3.12            (10 )

The following table shows changes in revenues and operating income by reportable segment for the three- and six-month periods ended November 30, 2008 compared to November 30, 2007 (dollars in millions):

                                Change in                 Percent Change in                Change in                Percent Change in
                                 Revenue                       Revenue                  Operating Income             Operating Income
                           Three          Six           Three             Six         Three           Six          Three           Six
                           Months        Months        Months           Months        Months        Months        Months          Months
                           Ended         Ended          Ended            Ended        Ended          Ended         Ended          Ended

FedEx Express segment     $     61      $    591              1               5      $      9       $  (165 )            2            (16 )
FedEx Ground segment            91           234              5               7            39            45             23             12
FedEx Freight segment          (36 )          84             (3 )             3           (47 )         (63 )          (59 )          (34 )
FedEx Services segment         (22 )         (34 )           (4 )            (3 )           -             -              -              -
Other and eliminations          (7 )         (17 )           NM              NM             -             -              -              -


                          $     87      $    858              1               5      $      1       $  (183 )            -            (11 )

The following graphs for FedEx Express, FedEx Ground and the FedEx Freight LTL Group show selected volume statistics (in thousands) for the five most recent quarters:

(1) Package statistics do not include the operations of FedEx SmartPost.

The following graph shows our average cost of jet and vehicle fuel per gallon for our transportation segments for the five most recent quarters:

Revenue
Revenue growth for the second quarter and first half of 2009 was attributable to yield increases in FedEx Express U.S. domestic package, IP and freight services. These yield increases were driven by higher fuel surcharges, partially offset by the competitive pricing environment. Revenue growth during the second quarter and first half of 2009 was partially offset by reduced U.S. domestic express package, IP and freight volumes as a result of the ongoing weak U.S. economy and higher fuel surcharges, which drove U.S. domestic express shipping volumes to pre-1998 levels and led some customers to shift to lower-yielding services. Operating Income
The following table compares operating expenses and operating income as a percent of revenue for the three- and six-month periods ended November 30:

                                        Percent of Revenue          Percent of Revenue
                                        Three          Three         Six            Six
                                       Months         Months       Months         Months
                                        Ended          Ended        Ended          Ended
                                        2008           2007         2008           2007
     Operating expenses:
     Salaries and employee benefits        36.8 %        37.1 %        36.4 %        37.5 %
     Purchased transportation              12.4          12.4          12.6          12.0
     Rentals and landing fees               6.4           6.5           6.3           6.4
     Depreciation and amortization          5.1           5.1           5.0           5.1
     Fuel                                  11.6          10.8          13.5          10.5
     Maintenance and repairs                5.5           5.5           5.4           5.7
     Other                                 14.0          14.3          13.6          14.2

     Total operating expenses              91.8          91.7          92.8          91.4


     Operating income (margin)              8.2 %         8.3 %         7.2 %         8.6 %

Operating income was essentially flat in the second quarter of 2009, as the benefit provided from the timing lag between changes in fuel prices and adjustments to our fuel surcharges offset the negative impact of significantly lower shipping volumes during the second quarter due to the weak global economy. Volumes declined year-over-year in the second quarter at all transportation segments. Operating margins continued to be negatively impacted by the deteriorating economic environment, which has contributed to a more competitive pricing environment and pressured base yields.
Operating income and operating margin decreased in the first half of 2009, as weak economic conditions drove decreases in volumes at FedEx Express and restrained volume growth at FedEx Ground and FedEx Freight. Our results were also negatively impacted by the overall effects of significantly higher fuel costs on demand for our services and increased purchased transportation costs. Fuel expenses increased 35% during the first half of 2009, primarily due to an increase in the average price per gallon of fuel. However, jet fuel usage decreased 7% from last year's second quarter, as we reduced flight hours in light of lower business levels.

During the second quarter and first half of 2009, fuel prices significantly decreased, while changes in fuel surcharges for FedEx Express and FedEx Ground lagged these decreases by approximately six to eight weeks. We experienced the opposite effect during the second quarter and first half of 2008, as fuel prices significantly increased throughout those periods. As a result, fuel surcharges significantly exceeded incremental fuel costs for both the second quarter and first half of 2009, based on a static analysis of the impact to operating income of year-over-year changes in fuel prices compared to changes in fuel surcharges. This analysis considers the estimated benefits of the reduction in fuel surcharges included in the base rates charged for FedEx Express services. However, this analysis does not consider the negative effects that the significantly higher fuel surcharge levels have on our business, including reduced demand and shifts by our customers to lower-yielding services. While 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 half of 2009 and 2008 in the accompanying discussions of each of our transportation segments. Purchased transportation costs increased during the second quarter and first half of 2009, primarily due to higher rates paid to FedEx Ground's contractors and our other third-party transportation providers. The impact of higher fuel costs also contributed to the increase in purchased transportation costs for the first half of 2009. Reduced copy revenues and incremental operating expenses at FedEx Office related to new locations opened in 2008 and 2009 also had a negative impact on our results for the second quarter and first half of 2009. Cost containment activities (described above) and lower variable incentive compensation partially mitigated the negative impact of these factors. Income Taxes
Our effective tax rate was 36.3% for the second quarter of 2009 and 37.0% for the first half of 2009, compared with 37.6% for the second quarter of 2008 and 37.4% for the first half of 2008. The lower rate in 2009 was primarily due to the resolution of an immaterial state income tax matter during the second quarter of 2009. We expect the effective tax rate to be between 37.0% and 38.0% for 2009. The actual rate will depend on a number of factors, including the amount and source of operating income.
Our liabilities recorded under Financial Accounting Standards Board ("FASB") Interpretation No. ("FIN") 48, "Accounting for Uncertainty in Income Taxes," totaled $88 million at May 31, 2008 and $71 million at November 30, 2008, including $68 million at May 31, 2008 and $56 million at November 30, 2008 associated with positions that if favorably resolved would provide a benefit to our effective tax rate. The changes relate primarily to the resolution of an immaterial state income tax matter during the second quarter of 2009. The U.S. Internal Revenue Service ("IRS") and certain state tax authorities are currently examining our returns for various years through 2007. It is reasonably possible that the 2004-2006 IRS audit, along with certain state income tax return audits, will be completed during the next 12 months and could result in a change in our balance of unrecognized tax benefits. The expected net impact of any changes would not be material to our consolidated financial statements. Outlook
We expect that the difficult global economic environment that we experienced in the first half of 2009 will worsen in the second half of 2009, and we have significantly reduced our earnings forecast for 2009. Weak economic conditions in the U.S. have spread to Europe and Asia, and ongoing weak global economic factors are expected to further reduce demand for all of our transportation services in the second half of 2009. With the exception of FedEx SmartPost, shipping volumes in our third quarter, which includes our historical peak shipping season for our package businesses, are expected to be particularly weak and well below prior-year levels. While we expect to benefit in the long term from the exit of one of our principal competitors (DHL) from the U.S. domestic market, we cannot predict the extent of the benefit under present economic conditions.

In December 2008, we announced several additional cost reduction initiatives in response to continued deterioration in economic conditions. These include base salary reductions for U.S. salaried personnel effective January 1, 2009, elimination of calendar 2009 merit-based pay increases for U.S. salaried personnel and a minimum one-year suspension of 401(k) company matching contributions (effective February 1, 2009). The reductions in base pay include a 20% reduction for our Chairman of the Board, President and Chief Executive Officer, 7.5%-10% reductions for our other senior officers and a 5% reduction for remaining U.S. salaried personnel. If economic conditions deteriorate further, additional actions will be taken to control costs. However, we will not compromise our outstanding service levels or take actions that negatively impact the customer experience in exchange for short-term cost reductions. For the remainder of 2009, we will continue to balance the need to control spending with the opportunity to make investments with high returns, such as in substantially more fuel-efficient Boeing 757 ("B757") and Boeing 777 Freighter ("B777F") aircraft. Moreover, we will continue to invest in critical long-term strategic projects focused on expanding our global networks and broadening our service offerings to position us for stronger growth under improved economic conditions. For additional details on key 2009 capital projects, refer to the Liquidity Outlook section of this MD&A.
All of our businesses operate in a competitive pricing environment, exacerbated by continuing volatile fuel prices. Historically, our fuel surcharges have largely been sufficient to offset incremental fuel costs; however, volatility in fuel costs may impact earnings because adjustments to our fuel surcharges lag changes in actual fuel prices paid. Therefore, the trailing impact of adjustments to our fuel surcharges can significantly affect our earnings either positively or negatively in the short-term.
As described in Note 9 of the accompanying unaudited condensed consolidated financial statements and the "Independent Contractor Matters" section of our FedEx Ground segment MD&A, we are involved in a number of litigation matters and other proceedings that challenge the status of FedEx Ground's owner-operators as independent contractors. FedEx Ground anticipates continuing changes to its relationships with its contractors. The nature, timing and amount of any changes are dependent on the outcome of numerous future events. We cannot reasonably estimate the potential impact of any such changes or a meaningful range of potential outcomes, although they could be material. However, we do not believe that any such changes will impair our ability to operate and profitably grow our FedEx Ground business.
See "Forward-Looking Statements" for a discussion of these and other potential risks and uncertainties that could materially affect our future performance.
NEW ACCOUNTING PRONOUNCEMENTS
New accounting rules and disclosure requirements can significantly impact our reported results and the comparability of our financial statements. We believe the following new accounting pronouncements are relevant to the readers of our financial statements.
On May 31, 2007, we adopted Statement of Financial Accounting Standards ("SFAS") 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans." 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 accumulated other comprehensive income ("AOCI") of unrecognized gains or losses and prior service costs or credits. Additionally, SFAS 158 requires the measurement date for plan assets and liabilities to coincide with the plan sponsor's year end. On June 1, 2008, we made our transition election for the measurement date provision of SFAS 158 using the two-measurement approach. Under this approach, we completed two actuarial measurements, one at February 29, 2008 and the other at June 1, 2008. This approach required us to record the net periodic benefit cost for the transition period from March 1, 2008 through May 31, 2008 as an adjustment to beginning retained earnings ($44 million, net of tax) and actuarial gains and losses for the period (a gain of $372 million, net of tax) as an adjustment to the opening balance of AOCI. These adjustments increased the amount recorded for our pension assets by $528 million. Our actuarial gains resulted primarily from a 19 basis point increase in the discount rate for our primary pension plan and an increase in plan assets at June 1, 2008.

On June 1, 2008, we adopted SFAS 157, "Fair Value Measurements," which provides a common definition of fair value, establishes a uniform framework for measuring fair value and requires expanded disclosures about fair value measurements. There is a one-year deferral of the adoption of the standard as it relates to non-financial assets and liabilities. The adoption of SFAS 157 had no impact on our financial statements at June 1, 2008.
In December 2007, the FASB issued SFAS 141R, "Business Combinations," and SFAS 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51." These new standards significantly change the accounting for and reporting of business combination transactions, including noncontrolling interests (previously referred to as minority interests). For example, these standards require the acquiring entity to recognize the full fair value of assets acquired and liabilities assumed in the transaction and require the expensing of most transaction and restructuring costs. Both standards are effective for us beginning June 1, 2009 (fiscal 2010) and are applicable only to transactions occurring after the effective date.

REPORTABLE SEGMENTS
FedEx Express, FedEx Ground and FedEx Freight represent our major service lines
and, along with FedEx Services, form the core of our reportable segments. Our
reportable segments include 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 Services Segment      FedEx Services (sales, marketing and information technology
                            functions)
                            FedEx Office (document and business services and package
                            acceptance)
                            FedEx Customer Information Services ("FCIS") (customer
                            service, billings and collections)
                            FedEx Global Supply Chain Services (logistics services)

FEDEX SERVICES SEGMENT
The FedEx Services segment includes: FedEx Services, which provides sales, marketing and information technology support; FCIS, which is responsible for customer service, billings and collections for FedEx Express and FedEx Ground U.S. customers; FedEx Global Supply Chain Services, which provides a range of logistics services to our customers; and FedEx Office, which provides retail access to our customers for our package transportation businesses and an array of document and business services.

The costs of the sales, marketing and information technology support provided by FedEx Services and the customer service functions of FCIS, together with the normal, ongoing net operating costs of FedEx Global Supply Chain Services and FedEx Office, are allocated primarily to the FedEx Express and FedEx Ground segments based on metrics such as relative revenues or estimated services provided. We believe these allocations approximate the net cost of providing these functions.
FedEx Services segment revenues, which reflect the operations of FedEx Office and FedEx Global Supply Chain Services, decreased during the second quarter and first half of 2009. Revenue generated from new FedEx Office locations added in 2008 and the first half of 2009 did not offset declines in copy revenues, incremental operating costs associated with the new locations and expenses associated with organizational changes. Therefore, the allocated net operating costs of FedEx Office increased during the first half of 2009 despite ongoing cost management efforts. In September 2008, FedEx Office began implementation of organizational changes intended to improve profitability and enhance the customer experience. . . .