聯邦快遞 (FDX) 2003 Q3 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the FedEx Corporation third quarter earnings release fiscal year '03 conference call.

At this time all participants have been placed in a listen-only mode and the floor will be opened for questions and comments following today's presentation.

It is now my pleasure to introduce today's host Mr. Jim Clippard.

Sir, you may begin.

Thank you very much.

Good morning, and welcome to the FedEx Corporation third-quarter earnings conference call.

I'm Jim Clippard, Vice President of Investor Relations of FedEx Corporation.

The earnings release and staff work are on our web page at FedEx.com.

This call is being broadcast from our website and a replay will be available for approximately a year from this date.

Joining on the call today are members of the media.

I want to remind all listeners that FedEx Corporation desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act.

Certain statements in this press release may be considered forward-looking statements such as statements relating to management's views with respect to future events and financial performance.

Such forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from historical experience or from future results expressed or implied by such forward-looking statements.

Potential risks and uncertainties include, but are not limited to, any impacts on the company's business resulting from the timing, speed, and magnitude of the U.S. domestic economic recovery, new U.S. domestic or international government regulations, the impact from any terrorist activities or international conflicts, including military action in Iraq, the impact of rising fuel prices, our ability to match capacity to shifting volume levels, the timing and amount of any money that FedEx is entitled to receive under the Air Transportation Safety and System Stabilization Act, and other factors which can be found in FedEx Corporation's and its subsidiaries press releases and filings with the SEC.

Joining us on the call today are Fred Smith, Chairman, President and Chief Executive Officer, Alan Graf, Executive Vice President and CFO, Mike Glenn, Executive Vice President, Market Development and Corporate Communications, Dave Bronczek, President and CEO of FedEx Express, Dan Sullivan President and CEO of FedEx Ground and Doug Duncan President and CEO of FedEx Freight.

And now our chairman Fred Smith will share his views on the quarter followed by Alan Graf.

Good morning, ladies and gentlemen, thank you for participating in this call.

We believe that our company has again posted solid financial results with a 23% net income increase over the previous year, and doing so against a backdrop of significant challenges.

The economy, war concerns, and some of the worst weather that we have ever operated in during the winter season.

Our earnings growth this quarter is led by international priority growth at FedEx Express, strong revenue and volume growth at FedEx Ground, and solid revenue growth at FedEx Freight.

FedEx Ground's home delivery unit volumes continue to grow with a number of customers now using the service double the level of a year ago.

Our overall FedEx international service volume grew at 8% led by Asia with an 18% year-over-year volume growth.

Traffic from China is up 35% where we have a significant competitive advantage given the number of frequencies per week that we operate versus our competitors.

For four straight quarters ground growth rates have been above 20%.

FedEx home delivery became profitable in the second quarter of this fiscal year, significantly ahead of schedule.

We've entered into the third addendum to the transportation agreement with the U.S.

Postal Service that extends through the next fiscal year, and that alliance continues to go extremely well for both parties.

FedEx trade is now the clear leader in the regional less-than-truckload market and we've expanded our reach at FedEx Freight across the Atlantic by now offering a LCL service to and from Europe with our FedEx Trade Networks unit and our alliance partner in Europe, [INAUDIBLE] .

You may be interested to know also that FedEx Trade Networks is now the largest customs broker in North America.

We believe customers are increasingly receptive to our broad set of transportation solutions and industry-leading service.

We're continually looking for ways to get closer to our customers and improve how we're serving them across all customer touch points and do increasingly become a company that's easy to do business with.

Our employees and associates and contractors passionate commitment to these service levels is recognized and valued by our customers we believe.

Fortune Magazine for the second straight year ranked us eighth in the America's most admired company's list and one of the top 10 world's most admired companies.

FedEx also ranked highest in the recent JD Power Transportation customer satisfaction study in all categories of air, ground and international delivery services.

These rankings are important because they validate that our most important stake holders are employees, contractors, customers, share owners and the public, place trust in FedEx and the services we provide.

Our management teams throughout our companies do an excellent job despite the weak economy, rising fuel prices, war concerns and very strong winter storms during the quarter, all of our business units have managed their operations very well.

We continue to resize our express network in line with current volume levels and overall FedEx is more flexible and agile today with the ability to put the right resources against the right business opportunities, expanding or contracting each business unit as IT's's market segment dictates.

I'm proud of our sales team as it continues to improve its cross selling ability for a variety of FedEx services and they're clearly hitting their stride.

Moving forward, we intend to capitalize on a number of growth opportunities.

Obviously, the continued double-digit momentum both in the business-to-business and business-to-consumer segments of FedEx ground and FedEx home delivery unit are something that we will exploit.

We will continue to place significant emphasis on international expansion.

As I mentioned, a moment ago the rapidly-growing China market validates, I believe, our early investment there and we think we will continue to see that strategic decision paying off for us in the years ahead.

FedEx Freight as key part of our business portfolio as it differentiates us from the competition and with FedEx Freight's recent expansion into Europe it increases the supply chain capabilities we can provide our customers.

In closing I would like to reemphasize our strong commitment to improving our financial performance, increasing margins, cash flow and returns on invested capital.

And with that I'll turn it over to your CFO Alan Graf.

Thank you very much, Fred.

Good morning, everyone.

We had very good quarter in Q3 with earnings of 49 cents per share which is up 26 cents from the previous year and right in line with our previous guidance of 45 to 55 cents a share.

In fact, we are we were on track for even better improvement until the severe winter storms reduced our earnings for 4 cents a share, let me describe that for you.

We lost approximately $20 million of revenue that we were not able to recover mostly at express.

And while we had also had some additionally higher expenses those were offset by reduction to our bonus accruals, so a net impact for the quarter was approximately 4 cents.

Ground again delay is operating income grew 58% on a 24% volume increase.

And while Express did did have a small decline in its operating margin, there were several impacts that we do not believe will continue into the fourth quarter.

Weather, as I mentioned, previously, negative fuel impact year-over-year, as fuel prices rose quicker than surcharge, salaries and benefits which were up 8%, maintenance which was up 11% due to some MD costs that were certainly higher than we anticipated on our last call.

In the fourth quarter expressed salaries and benefits growth should slow as we have reduced wage increases and expect improved productivity and maintenance should be about flat in the fourth quarter with the previous year.

Increasing Express operating margins is obviously the key to our financial goals.

And as Fred mentioned, we will continue to grow international priority.

We expect to increase package weights and yields, by bundling with ground and freight in the U.S., and we will continue to resize the Express network in line with expected business levels.

A tremendous amount of cost reduction work is ongoing at Express.

And we expect that to continue and to prove fruitful for us in Q4 and beyond.

IT yields were up smartly in the quarter versus last year due to exchange rates, fuel surcharge and a favorable region mix.

I should note that our international expenses also rose as a result of exchange rates because we are fairly well balanced on a global basis.

We also had a very good quarter at freight as well, with operating income up 30%.

Even though volume was flat in a very tough environment, yields of freight were up nearly 10%.

We did make substantial additional contributions to United States pension funds to fully fund their accumulated benefit obligations during the quarter with a February 28th measurement date for FedEx Corporation.

Even with that, cash provided by operating activities will exceed cash used and investing activities as we continue to manage Cap Ex lower.

In fact, capital expenditures have decreased from 15% of revenues in FY '98, to 8% in FY '02 and less than that in FY '03.

Earnings-per-share for Q4 are projected to be in the 85, 88 to 95 cents range. 88 to 95 cent range.

Although few political situation could have a significant impact on our results.

Depending on a possible craft call-ups, spiking fuel costs terrorism acts and any general economic impact.

We have reduced our GDP forecast to 1.6% for the first quarter of calendar '03, and 1.9% for the second calendar quarter of 2003.

Those are the financial highlights as I see them.

With that Elsa would be more than happy to take questions.

Thank you.

The floor's now open for questions, if you have a question you may press the No. 1 followed by 4 on your telephone keypad at this time.

If at any point your question has been answered you may remove yourself from the cue by pressing the pound key.

Our first question is coming from Jon Laggenfeld of Robert W. Baird.

Please go ahead with your question.

Good morning.

Couple questions, first on the fuel surcharge side.

Obviously did a good job offsetting the rising cost there but at some points are you capped in terms of how high you think you can raise that fuel surcharge?

And have you noticed any competitive disadvantage there given on the express side your fuel surcharge relative to UPS?

We have not had any -- this is Mike Glenn.

We have not had any pressure to date that has been noticeable and of course, we'll continue to manage that closely and make decisions literally reviewing that on a weekly basis, but so far we have not had any significant push back and have been able to manage that whatever has been.

Should remind you, John, we have a lag from when we measure our actual cost through the U.S.

Gulf Coast index to when we pass that along so, February fuel prices that were exceptionally high throughout the whole month will be reflected in our April surcharge.

So there's still some room to move that up without the pushback?

Yes, we think so.

Okay.

And then secondly, just in terms of prices you had a couple months now with your new prices.

Are there any trends relative to past years in terms of the acceptance of those price increases?

And has there been any differences across the line of businesses?

Well, this is Mike Glenn again, we've seen more aggressive pricing from our competitors in the past month especially for accounts with significant ground opportunities.

Having said that, customers continue to respond very favorably to the FedEx value proposition, and our broad portfolio of services and we are therefore confident that we'll be able to continue to strike the proper balance between yield management and volume growth.

So far you're happy with how you've progressed?

We're pleased with our ability to manage and strike that proper balance between yield management and volume growth.

Thanks a lot.

Our next question is coming from John Larkin of Legg Mason.

Please go ahead with your question.

Yes, good morning, gentlemen.

Just to follow up here on the FedEx Ground scenario.

It looks like your market share is getting up to the mid- to upper teens, and looks like you're continuing to gain share at a pretty rapid rate there.

At what point do you think that the pricing competition will intensify from your major competitor as you gain market share?

Well, as I just stated we have seen more aggressive pricing from our competitors in the last several months.

Having said that, customers continue to respond extremely favorably to the FedEx value proposition and I think have noticed the significant service enhancements that we've made particularly in FedEx Ground.

Clearly we've expanded home delivery to where we now have complete coverage of the United States.

We've significantly improved our overnight coverage and information capabilities and customers have taken note of that.

And I think that's fueling our growth along with our strategy to bring this service to our small and mid-size customers.

So we're comfortable that we've got the correct value proposition and I said, striking the right balance between yield management and volume growth going forward.

Then just one question on your use of the word "resizing the domestic express network."

Certainly levels of traffic there have been somewhat flat to depressed over the last couple of years.

And I'm wondering if you're beginning to believe that that's more of a permanent reduction related to a shifting of manufacturing capacity, particularly over the Pacific rim and whether there's going to be less of a rebound than perhaps you might have originally thought in the overnight service product levels.

Yeah, this is Dave Bronczek, I'll answer the first part of that question.

On the express century kind of businesses that we're in, the GDP is tracking right along with where our volume growths have been and that's historically been the case and has been for many, many years.

That being said, we're very aggressive in going after cost -- structural cost issues, we've been doing that for several quarters now, we'll continue to do that in terms of right sizing the capacity into the network and so forth.

As Alan mentioned before, I started talking about our cost structures on the pay and benefit side, we're realigning our pay and benefits more in line with our expected revenue growth and going forward we're feeling confident about that.

In terms of volume across the Pacific as Fred mentioned at the beginning, it's continuing to be very strong.

It has been for many, many quarters.

And we're projecting that to be the case going forward.

Thank you very much.

This is Fred Smith speaking.

Let me reiterate something I said and Dave Bronczek has said on several occasions.

We are committed to and quite confident that we will get our express margins to double digits in a reasonable period of time.

We've got a lot of initiatives underway, and we're particularly enthused about our position in the international marketplace as the numbers indicate here.

Those shipments are very, very profitable for us, and we continue to exploit that position and to some degree the market will catch up with our Express size and in the cost initiatives that Dave has mentioned there will pay off for us as well.

Our next question is coming from Ken Hoexter of Merrill Lynch.

Please go ahead with your question.

Great, thank you.

Good morning.

Just wanted to ask a follow-up on the pension.

You had noted that you had made a large payment for the third quarter and I wanted to ask about the charge you were taking in the fourth quarter, or the payment you plan on making in 2004.

Have you changed assumptions at all or is this just another voluntary payment that you plan on making for the plan?

And then secondly on the ground business, the run rate for the margins, I understand that they were -- I guess we had a strong 17% last year's fourth fiscal quarter.

Were there any one timers that made that particularly strong or could we see a rebound as the weather gets nicer here in the fourth quarter.

Thanks.

This is Alan, I'll take the first one and I'll have Dan take the second one.

You're absolutely right about the strong fourth quarter ground last year.

It was spectacular.

As to the pension, we made the contributions to fully fund the accumulated benefit obligation and avoid the minimum liability charge that you see so many companies take through comprehensive income to balance sheet equity.

We thought it was the appropriate thing to do.

We can't afford to do it, we're cash flow positive, we expect the markets to recover and we expect to earn a decent return on those assets going forward.

We'll be lowering our assumptions for market return on assets, as well as, the discount rate and those are embedded in our forecast of increasing pension cost for '04 of 120 to $150 million.

We, frankly, hope that's a temporary one year event that's been driven by of course, the declining market and very low, extremely low, record low discount rates for liabilities, and for a company like FedEx Corporation which has an average work force age of 40, the liability tale for us is very long and the lower discount rate severely impacts our liabilities as measured by accumulated benefit obligation or projected benefit obligation.

I should point out, we have $5.8 billion in our pension fund.

We only pay out $8.5 million a month as we have 20 active employees for every one retiree.

Very few other companies are in that situation, so while it's an accounting issue it's not one I worry about from a cash flow situation.

So with that, let me turn it over to Dan to talk about his fourth quarter bit.

Sure, thanks, Alan.

You are right, last year we had a tremendous fourth quarter partly, and I think we talked about this on the call last year because of some fairly extensive accrual reversals in Q4 that we don't expect this year.

However, our projections are for a very solid fourth quarter with excellent margins.

So is that 15 to 16% normalized, is that a good run rate?

That's, you're in the ball park there, yeah.

Alan, just a follow-up on that, can you tell us what you've lowered your assumptions to on the returns?

I'm sorry, could you repeat the question?

You said you had made a change to the 10.1% projected return on planned assets.

Can you tell us what you have's change it had to?

We haven't finalized that yet but we will be bringing it down considerably.

Great.

Thank you.

Our next question is coming from Dan Hemme of Prudential Securities.

Please go ahead with your question.

Thanks.

Two questions.

First postal related, in the press release it mentioned in the call, you had said that the postal contract had been renewed at higher committed volumes.

Can you provide a little bit more detail on the addendum contract and then my second question is related to the reduction in Cap Ex and where will that be coming out of?

Dave do you want to take it?

I'll be glad to take the first part of that.

On the postal addendum that we extended for another year for us starting in May to the following May, it's roughly the same weights and volumes that we've been running for them for the last, actually two quarters.

The service has been excellent.

The relationship is as good as the service.

And we're very pleased with the new contract extension of the addendum.

Okay.

Under the capital plans analysis, we work under the old adage here that, what interests my boss fascinates me, and we are extremely into ROIC improvements around here and one of the direct ways to do that is to get better returns on your assets.

Higher returns on your capital investments.

And we have significantly reduced Cap Ex particularly at express as its domestic growth has been flat for the last couple of years.

However, we will increase our investments where we have very high returns and that's particularly notable at ground.

Or where we have a substantial increase in capital investments this year versus the previous year and at freight it as well, which has earned a very nice return on its invested capital.

The corporation as a whole I should tell you is in the positive in terms of ROIC versus our weighted average cost to capital for fiscal '03 and the way we view it, and we intend it to keep it that way.

Maybe just to follow.

What is your calculated weighted customer capital?

Today we're in the approximately the 7 1/2% range given our balance sheet structure.

Okay.

Thank you very much.

Our next question is coming from Richard [Fryree] of Delphi Management.

Please go ahead with your question.

Good morning.

Can you tell me what kind of an impact the West Coast dock strike is having on you right now, if any?

Not much.

All right.

And also back when the technology part of the economy was doing a lot better, seems to me you were doing a lot of business shipping technology components.

I'm wondering if you can tell me how much that's declined and what part of your business that was in its hay day?

Well, this is Fred Smith here.

Let me make a brief comment and then ask Mike or Dave Bronczek to amplify on it.

The customer base that primarily ships express or the express centric group of customers is heavily weighted toward the technology sector and the dot.com and telcom meltdown obviously was the primary driving force behind the flattening of the express volume growth.

As those industries pick up, Express will benefit from that, but I would also point out was mentioned earlier, there's a substantial part of the tech manufacturing base that's now located offshore, and we're getting a lot of benefit in that regard because of our international system.

As you saw in these significant growth rates, 18% out of Asia, but Europe's very strong too.

So, Mike, Dave, do you want to amplify on that.

I was going to say the exact same thing.

A lot of our growth out of Asia is exactly from those sectors of the technology sector that we used to get more traffic in the United States that's transferred over to parts of China and Southeast Asia and that continues to be very strong for us there.

Yeah, but you listen to some of these technology companies report and Intel is kind of soft, applied materials just announced huge layoffs.

Maybe you are not shipping for them specifically, but they are good bellwether for the whole industry and I'm kind wondering what you've lost since the peak and obviously you've made some in Asia, but can you quantify that in any way.

You can quantify it on the basis of the growth rates.

I mean the growth rates are as we've reported them and tech is a substantial part of that.

You saw domestic growth rates in the express business flatten and tech's a big part of that.

I don't know how to quantify it any more.

The numbers are what the numbers are.

All right.

Thank you very much.

Our next question is coming from Gary Yablon of First Boston.

Please being with your question.

First question, Fred, if I can come to you and get back to your comment about express margins getting to be double digits in a reasonable period of time.

Could you give us a range of reasonable period of time, and your comment about, "Size of our business will catch up with the express size."

Does that mean domestically or internationally.

My understanding was domestically we were seeing a more permanent slowing of that growth and the cost structure needed to be ratcheted down a bit.

Could you help us out with that.

First of all, we have ratcheted down the cost structure at Express and will continue to do so.

We've changed the rate of increase of our pay systems.

We've changed the structure of our pension program for new employees going forward on the first of June.

As Alan and Dave both mentioned we have substantially reduced our Cap Ex that we have put into the Express business and there will be other measures which we will be taking and, of course, we will announce those in the months and quarters ahead.

The second point, as to the right sizing, I mentioned on a couple of occasions and I know Dave has too, we were in the midst of several programs in Express which were underway during the more boom period for the Express centric sectors of the economy, particularly the MD 10 program, rather than cancelling it outright, we scaled it back.

We have some major sort center development projects that were underway.

We felt that it would cost us more to cancel those or take some one-time charges, and so what will happen over the next couple of years is even though domestic growth rates are roughly in line with GDP which is what I think we have said, we anticipate for domestic express growth rates, the traffic levels will sort of catch up with the infrastructure that we felt was important to keep in place.

The growth story in Express will be in the international sectors as the numbers indicate, 18% growth out of Asia, 8% overall, 35% out of China, strong growth out of Europe and don't forget that our domestic infrastructure also provides the feed for our international system.

So that's what I mean about it sort of catching up, and with the cost-reduction efforts that Dave has accomplished, many of which you'll start to see the payoff for here shortly, and the sort of cap on some of these programs that were underway prior to the dotcom meltdown and the outstanding sales capabilities we have now to bundle both Express and Ground, that's what leads us to believe that we can achieve double-digit margins in the Express business in a reasonable period of time.

Could I try and corner you, Fred, for a period of years, some kind of a bracket, a range for what reasonable period of time means?

We have those internally, but I'm not sure that we want to announce those publicly because there are a couple of programs that Dave has that we haven't approved at the strategic management committee level, and I will say this much to you.

We will try to get that information out in the next quarter or so so it's transparent to you.

Gary.

We can't do it without a better world economy.

Yeah, and what I was trying to get at Alan, how much is the world needing to cooperate with you and how much can you push it on your own?

Back to the tech question.

We believe and all our tech customers also believe there's a huge pent-up demand where there's IT investment just waiting to happen everywhere with productivity improvement capabilities are there and ripe for the picking with high returns for many, many companies.

In fact, we haven't curtailed our IT spending much at all because we get so much great productivity improvements out of it we're continuing to invest in programs like power pad for our couriers and so on.

So when that comes back it's going to be a thrilling ride and dependent on express networks on a global basis to be able to meet those demands and you're going to see a thrilling upswing.

That will be part of it, and that will happen.

I don't know if it will be this year or next year, but we're fairly confident it will happen.

Our pension cost will get back more in line after 2004, particularly with our portable pension accounts that we're putting in for new employees and the choice we're giving the currents employees.

We've done system form changes, facilities optimization, we've got center led sourcing talking to thousands of vendors right now about reviewing specs and costs and amounts and prices and all of these are going to yield positive impact so it's a combination of a lot of things that we all believe will work but it'll be led by growth and international growth in particular.

Let me add one final piece to this Gary.

Along with our industry-leading service which is obviously the number one priority for us to take care of our customers, we have laser like focus on our cost structure.

And you can rest assured that that is the top priority behind customer satisfaction that we are working on Express.

Okay.

Thank you.

Thank you.

Our next question is coming from Greg Burns with J. P. Morgan.

Please go ahead with your question.

Thanks, Hi, guys.

Alan, just curious on the IT product, it sounds like just from what you are regions were doing that North America was down, perhaps down big.

What was that percentage decline and what do you think drove it?

Actually North America was about flat in the third quarter which we saw was a pretty good sign actually.

Okay.

And shifting to Dan on the pricing to grounds getting more aggressive on some accounts, I'm curious whether that was a bundled pricing attack so people are subsequently getting more aggressive on a total bid or whether they're going just aggressively after ground, in other words, is that pricing comment that Dan alluded to going to filter into the air or do you think that's just a ground issue?

Do you want me to answer that, Al?

Sure.

I think that many of the pricing deals that we're seeing from the competitors impact both express and ground when we're trying to bundle with specific customers but I think on balance as Mike has said a couple of times, that the target seems to be in our segment and we have seen much more aggressive price thing last quarter.

And Dan, just following up.

When you look at your checklist of capabilities, you've obviously built out a lot of lanes and filled a lot.

Is there any capability you feel you don't have or aren't strong enough or do you feel now it's just a matter of marketing that you have everything that you need to have?

No, I feel very comfortable the way we've built out the network the fact that we now have full coverage for home delivery.

We feel we're totally competitive in our overnight lanes and that's really helped our growth obviously in both of those segments.

So I feel real good about that.

We want to continue to build density in the home delivery market.

That's critical for us to improve our productivity and lower unit cost, but we're making good progress getting that done.

So I think the evolution of the business at this point is right on, ahead of plan and I'm very pleased with the performance of our people and the results that we're producing.

And one follow-up question.

Alan, on the fuel surcharge and your surcharge versus others, I guess it's not clear to me how your customers would shop the surcharge since my understanding is a lot of your customers are under contract.

Am I missing something?

I mean can your customers that are under contract simply penalty free switch volume to someone with a lower surcharge?

That's a two-part question.

Let me answer the first part and let Mike answer the second part.

Remember that a fuel surcharge is one piece of a overall pricing program and and also remember that we were very clear with our customers back about 16, 17 months ago when we developed a fuel surcharge index.

Customers understand that fuel prices are at record highs in February, and, you know, are willing to pay a surcharge, hopefully in the belief like we all have that these spikes are temporary.

And so, therefore, we haven't had much of a pushback.

But it's not just a surcharge.

It's the entire package that's being offered and Mike can expand on that.

Just to answer the question directly about contract customers.

It depends upon how the contract is written and much of our business as you know is not under contract with our small and mid-size customer base.

A lot of our business is under contract.

It depends upon the specific customer and contract that is written for that account.

I also want to correct what I said about North America IP.

Let me go back and say United States outbound international priority actually grew .9 percent in the third quarter this year versus last year, so we did have a growth rate.

That's our second consecutive quarter of having actual growth rates outbound U.S. and IP.

Great.

Thanks a lot.

Our next question is coming from Jeff Kaufman of Fulcrum Global Partners.

Please go ahead with your question.

Thank you, good morning.

My name is Salvatore [Vaitalah].

I have a question for Jeff Kaufman from Fulcrum.

The question I have is regarding the potential cargo security rules.

There has been speculation recently that the 24-hour shipment manifest rules requiring shippers to transmit critical cargo done on international shipments may soon also apply to domestic shipments.

Can you just give some clarification as to what your understanding of this development is and how do you foresee it affecting your operations.

This is Fred Smith speaking.

We do not anticipate that that will be the case in domestic shipping.

Or, for that matter, for international air shipping.

That's been applied to C-container shipping.

That's quite a different situation because historically the information surrounding C-containers has been very rudimentary in most cases.

Whereas in our industry it's very quick and very full already, and secondarily and probably the most important, the shipments for all intents and purposes are all visible in our industry.

I mean if customs and the Transportation Security Administration wants to see an individual shipment they can see it.

Or look at the information.

Whereas in containers you have these very large devices, 20, 30, 40,000 pounds with cargo entombed in them at the shipping dock, so there really isn't such justification or rational for the same type of requirement in our primary sector of the industry.

Our FedEx Trade Networks unit is involved in sea transportation and obviously we're complying with those rules.

But we don't think that will be the case in the air or express or less in truckload business.

Thank you.

Our next question is coming from Jordan Aliger of Goldman Sachs.

Please go with your question.

Yeah, Hi.

Good morning.

Just a couple questions.

One, any thoughts at some point of making the U.S.

P. S. contract more of a permanent rather than sort of this addendum type of strategy I guess that's in place right now?

Well, there is a seven year contract for the vast majority of the arrangement between U.S.

P. S. and FedEx.

It's only the additional traffic which is a relatively small percentage of it, that is renewed from time to time.

The former basically covers express and priority mail, and the latter or the addendum is really supplemental transportation with the postal service for other products that they may need to move.

Having said that, it works spectacularly well for them.

It takes a lot of cost out of their system and they are very pleased with it.

So during --

Jordan, this is Alan, implicitly we intend to make it permanent by giving them unbelievable service at a great price that they can't duplicate anywhere else and that is the case today.

Yeah.

Just a second question.

On the LPL business, I think you mentioned in the release with yields up 10%, there was a few factors driving that.

Any sense for the breakout between in terms of the up 10% coming from price versus the fuel surcharge?

Jordan, this is Doug Duncan.

There's three components to that yield increase.

By far the biggest is our ability to hold on to the general rate increase and the contractual renewals because of our focus on the next and second day market and customers executing fast cycle logistics.

But clearly, there is a piece in that which is the fuel surcharge and then there is another piece as well for the expedited inner regional service that we are offering and is growing at pretty spectacular rates.

Okay.

Thank you.

Our next question is coming from James Valentine of Morgan Stanley.

Please go with your question.

Great, thanks.

Guys, good job on the ground.

Those numbers are very impressive and also signing with the Post Office again.

I had two questions here.

First, in terms of pricing, we've also been seeing this discounting of the large accounts, not necessarily by you but by one of your competitors in the last few months.

Some of these large shippers are telling us they're seeing one of your competitors come out with 5% to 10% discounts year-over-year.

And I guess first I was wondering, is this being driven meaning more competitive marketplace on the ground, is this being driven by anything you are doing in terms of changing your competitive strategy or is it the same thing you've been doing for years with trying to penetrate more of the ground market.

And second, what's the possibility that this eventually bleeds into the lower tiers namely; it's not going to be just the large accounts that we're hearing from?

Jim, I think the nature of the issue really resides in the value proposition that we're able to bring to the marketplace and this goes back to the strategy that we put in place three years ago where we made the decision to rebrand RPS to FedEx Ground and we made the decision to get into the home delivery business.

We've improved service levels consistently, improved the information and clearly we've improved our overnight coverage and we've improved availabilities.

As you know, traditionally the former RPS service was predominantly sold to large customers, now it's available to anyone.

You can go on fedex.com today and ship a ground package just as easy as you can express package, so I think customers are responding to that, and that's driving our growth rates.

And then clearly, when you are in a situation where you are taking shares, sometimes that yields a competitive response and we've seen more aggressive pricing from the competition as you note in the last several months.

However, as I've said, we're confident that we can strike that proper balance because of the way we're growing our ground business that we'll be able to manage yields going forward and I think quite candidly this thing will sort itself out in the future.

So in other words, when I take down, I've taken down the competitor's numbers for this and I haven't yours yet because the thought that you would manage for growth as opposed to watch margin tier rate, we saw that margins actually improved here for your ground in the quarter, so there's no reason to think that trend of either stable or even improving margins for ground should change?

I didn't say that we were managing for growth.

I want to be clear about that.

We're managing and we're meeting customer demand for our services and customers are responding very well to the enhancements that we've made in our service.

And as I've said before we're confident that we're going to be able to strike the proper balance between yield management and volume growth and our hope is that we'll compete on service as we've traditionally done.

We haven't changed our strategy in terms of pricing at all, this is Dan.

But we are defending our customer base no doubt about that.

And that's the feedback I'm getting from shippers.

The second question is maybe for Fred or Alan, there's been some chatter in the marketplace about who could be possibly up for sale or acquisitions going on in the industry and especially in Europe and I guess I'm just wondering, obviously not what your plans are near term, but maybe just your appetite for acquisitions over the years, FedEx has maybe, two, three years attempted to add something on a complimentary service or expand into a new region.

I'm trying to understand if you had to choose between getting into freight forwarding, getting into other theaters of the globe in terms of domestic parcel shipments or anything else that I'm missing, where is that appetite or is there just not an appetite given the fact that you're pulling back Cap Ex and trying to generate more cash?

Obviously we don't comment on corporate development activities as a matter of policies but if you've got any ideas let us know, we'll take a look at them.

Just all kidding aside, we're in the fortunate position I think at the moment that we don't have to do anything.

We basically have a very strong portfolio of services which we think we can grow and meet our earnings targets conservatively and as we've said that, said over and over again, our long-term goals are to deliver EPS growth of 10 to 15% per year with improving margins and returns and positive cash flows.

So one of the things that would guide us in any corporate development activities that we would undertake would be that it was consistent with those goals.

We're not going to go out and do something foolish because we don't have to, but having said that, there are several things I can think of that if the right opportunities came along we would take a look at it.

Unlike a lot of companies I think our corporate development strategy and success has been phenomenal.

They absolutely have, absolutely.

I didn't it mean imply they hadn't been.

Think about Flying Tiger, Caliber and American Freightways, they all exceeded expectations in the financial returns that we laid out.

It's a very good thing we did them because we have this diversified portfolio that's helped us to improve our cash flows while Express hasn't grown.

Five years ago you never would have believed that could have been possible.

So we're always on the lookout.

And I think that's what Fred was alluding to there.

Yeah, but I want to reiterate, I think that the three acquisitions that Alan just mentioned are different from our current situation.

When we acquired Tigers we were very convinced that world wide express opportunities was where we needed to take FedEx express towards, and we had to get the route authorities and the facilities and the landing slots and so forth and that continues to this date to give us an enormous competitive advantage.

In the case of Caliber, it was clear to us that we had to have both a grounds and express offering and we were fortunate enough to be able to hook up with Dan and that's worked very well, and then third, we had a very good western regional LTL carrier and we needed to compliment that to sort of complete our portfolio.

So those were acquisitions that we felt strongly that we needed to do.

As I mentioned, a moment ago we're in the fortunate position now that there's nothing that we feel that we have to do although there are some opportunities out there that could arise that could be opportunistic, so I think that is quite different than where we were before and will be quite disciplined in doing it.

Great.

Thanks so much, guys.

Our next question is coming from Scott Flower from Salomon Smith Barney.

Please go ahead with your question.

Yeah, good morning, gentleman.

A lot of questions have been answered.

I just had some quick follow-ups.

One of those was related to Cap Ex, and it may be too cloudy to really know, Alan, but back in September you gave us some sense that, at that juncture, I know it was preliminary and not locked in stone that Cap Ex in fiscal '04 would likely be up slightly versus fiscal '03.

Do you have any sense of what the direction of Cap Ex will be toward next year.

Obviously you do have a number of investments in the ground and I'm trying to get a sense of direction, not precision at this point?

Well I would say I had more confidence back then that the economy would be well on its way to a very solid recovery by now and as just told you what our corporate GDP forecast is for the first half of calendar '03, it's not as robust as we had hoped so Cap Ex is going to be driven by Grounds continued growth and I'm pretty confident in those plans.

And Freight's continued growth and I'm confident there and Express is going to be dependent on the U.S. and world economic recovery so that's the timing of Cap Ex.

We'll be below $1.6 billion this year, which will be yet another year of lower Cap Ex and next year will probably be somewhere around 1.7 or 1.8.

We're in the business planning process right at the moment and trying to finalize that but we are continuing to make important IT investments because we get very good returns that are very quick.

As I said, Ground has a very high return on invested capital and we don't want to rip the wings off off it but as we have announced in our $1.8 billion expansion campaign, we're going to get it pretty big pretty quick.

Right.

All of those will be contributing factors.

And then I guess, two questions for Dave Bronczek.

Could you give us a flavor of just how Europe did on the quarter.

I know you talked about robust growth but is that teens?

And then the other quick follow-up was, I know you talked about the addendum being more of less comparable weights and volumes.

I take it pricing has not changed.

Europe has been spectacular performance for us for three consecutive years now they've had double-digit growth rates and I think they were just slightly off 10% once again in the third quarter.

They continue to perform exceptionally well.

On the Post Office contract, what was your question again.

Pricing I take it did not change in the rollover of the addendum.

No, it did not change.

And then just the last question, which is a broader one is understanding that you're intensely focusing on cost and looking at all aspects of Express particularly as the U.S. hasn't rebounded in some of the industries that would typically use Express have not been as robust, how do you try to strike the balance and you may have been doing that over the last couple of years and it just hasn't happened, make sure that you don't cut back or be too aggressive on some of your investments just as perhaps this slow period ends.

I'm wondering how do you balance trying to get cost out but within a network business not going too far that just as things come back that you were too good with the knife too quickly just as things come back as we look toward '04 or '05?

Of course, that's what the board of directors hires us to do in representing the shareholders is to strike that very balance.

And I think we've done an excellent job.

I'm very proud of our cash flows, I keep talking about them.

They would have been really spectacular this year but for the perfect storm in the pension area which we don't expect to continue, but you're exactly right.

We haven't had a reduction in force or layoffs or those things.

We managed this very carefully with that in mind.

We do believe there's going to be an upturn that is going to be thrilling.

We just can't pinpoint when and we need to be ready and we can't compromise service.

Dave?

I'd say the exact same thing.

The first and foremost consideration that we always have, Scott, in our business is taking care of our customer and providing the industry-leading service and we continue to do that.

That being said, along with the economic rebounds that Alan's referring to, we have cost initiative activities that we are very confident that we can undertake in, reduce and still provide world class service, and we're going hard after those, Scott.

Can you give me a flavor of what those are conceptually if not specific.

I'm not trying to get into those programs that Fred said you are working on that you haven't announced, but just conceptually give me flavor of one or two areas?

Sure.

We've already mentioned one of them.

Salaries and wages in pulling back to more comparable merit increases that go along with our revenue forecast.

Also on the line haul in the consolidation of our fleet there and taking advantage of our great network to be more efficient and more productive.

Our field operations people led by Dave Rebholz and Ken May are working exceptionally hard on their productivity.

We're also working with ground and freight to leverage both of our operating companies together.

There's a lot of opportunities in our vendor and supplier area that Alan mentioned before.

There's a myriad of opportunities that we have that we're going after and taking advantage of.

Great, thank you very much, all.

When Dave was talking about working with freight and ground specifically, we've taken some facilities that were surplused to Express and they've worked well for ground or freight and we've taken some Express facilities and reduced the connectivity that those facilities have to other parts of the network.

For instance, some of the flights that we had through Fort Worth were redirected back through the Memphis hub because we had excess capability.

Those are the types of things that are going on quarter after quarter.

And while we're very confident that we'll be able to move Express towards a double-digit margin.

One other thing, Scott, over the last two years through attrition primarily our head count in the United States has gone down by more than 7%.

You look at the FTEs and you'll see that they're basically flat year-over-year but remember we are billing a significant amount of capability for the United States postal service that would have been inquired us to increase significantly.

We've added a number of pilots.

We have a lot more ground handling at the hub during the day and those kind of things so they've been shifted into higher return, better margin, better cash flow businesses and that's in line with what I told you fascinates me.

Great.

Thank you.

Our next question is coming from Donald Broughton of A.G. Edwards.

Please go ahead with your question.

Good morning, gentlemen.

Morning.

Morning.

Looking at ground numbers, we are seeing growth eclipsing, to see 33% growth on 24, 25% growth we saw in the first fiscal quarters of this year for you was impressive, but you were close eight and 10% growth rate in previous years, now we're seeing 24% growth on top of a 20% growth quarter.

Should we be modeling for another 20% growth volume quarter in the fourth quarter this year?

Donald, this is Dan, I'll tell you our fourth quarter comparables are obviously very difficult.

We had again a great fourth quarter last year with well over 20% growth.

So we're moving toward that number but I think it'll be close but I think as Fred said in his opening comments we've had four straight quarters now at better than 20% growth.

So definitely north of 15 I'm hearing you saying, but even you would be surprised to see another 20% growth quarter?

I got to give you, -- I'm not going to give you the exact number but probably a little north of 15.

Hey, Don, this is Alan, would you come to Memphis and help me with Dan's plan for next year?

I'm on the next flight out.

I guess I should have said yes.

Well, again great job on the ground and good luck, gentlemen.

Our next question is coming from Edward Wolfe of Bear Stearns, please go ahead with your question.

Good morning.

It's Peter [Neswold] for Ed Wolfe.

Two questions, first on the May addendum you talked about that being renewed with higher committed volumes.

It would seem like that puts upward pressure on maintenance cost but on the other hand, you talk about maintenance being flattish in fiscal fourth quarter.

Second question, I guess a follow-up to the last question.

Sustainability of ground volume growth.

In the past you've talked about building out your ground capacity at about 10% per year at the end of the decade and currently you're tracking at double that.

Do you have to add more capacity, does it seem like volume growth slows down two years out, can you talk about that a little bit?

Dave will answer the first question and Dan can answer the second.

Peter, on the Post Office issue that you're referring to on the maintenance, that's, of course, some of the reasons over the last nine months over the last thee quarters we've had a bit higher maintenance and as Alan pointed out, we have that factored into our flat, relatively flat fourth quarter for maintenance.

Dan.

Okay.

Yeah.

As we've said before, we expect over the long-range outlook that we should sustain solid double-digit growth and with that in mind, we've announced $1.8 billion expansion that virtually will double our capacity over the next six years.

So that should get you pretty much into the range.

But if you sort of just take it compound annual growth rate from that you back into it comes out to 10%.

Am I splitting hairs or do you need to add more capacity in order to sustain double-digit volume growth?

Well, 10% on a basis might be a little light, but, again, the plan that we've announced is what we expect to put in place and we expect to grow our business each year accordingly to fill up that capacity.

I mean, that's the art of the business really.

Okay.

Thanks for the time.

Uh-huh.

Operator, --

Yes, sir.

This is Jim Clippard.

I think we've reached that point where it's time draw it to a close.

I want to express my appreciation to all of my colleagues for being with us and all of you ladies and gentlemen on the line out there and the questions that we received.

Appreciate it very much.

And we'll see you next quarter.

Bye-bye.

Thank you, this does conclude today's teleconference, you may disconnect your lines at this time and have a wonderful day.