聯邦快遞 (FDX) 2006 Q3 法說會逐字稿

Good day, everyone, and welcome to the FedEx Corporation's third-quarter earnings conference call.

Today's call is being recorded.

At this time I would like to turn the call over to Vice President of Investor Relations, Mr. Jim Clippard, for opening remarks and introductions.

Please go ahead, sir.

Good morning, ladies and gentlemen, and welcome to the FedEx Corp. third-quarter earnings conference call.

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

The earnings release and stat book on our website at FedEx.com.

This call is being broadcast from our website and the replay will be available for approximately one year.

Joining us on the call today are members of the media.

During our Q&A session callers will be limited to one question and a follow-up so we can accommodate all those who would like to participate.

I want to remind all listeners that FedEx Corp. desires to take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act.

Certain statements in this conference call 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.

For additional information on these factors, please refer to FedEx Corporation's and its subsidiaries press releases and filings with the SEC including, but not limited to, its reports on forms 10-K and 10-Q.

Please note that we will implement the new accounting rules for expensing stock options in our next fiscal year which begins in June 2006.

We anticipate that the impact of the adoption of these new rules will approximate the pro forma results presented in our SEC filings.

For further information, please refer to the footnotes to our financial statement in our 10-Q.

In our earnings release we provide an estimate of our full-year diluted earnings per share excluding a onetime non-cash lease accounting charge recorded in the first quarter.

This is a non-GAAP financial measure.

We may discuss this non-GAAP financial measure and the excluded charge on this call.

Please refer to our earnings release available on our website for a further discussion of this measure and a reconciliation of it to our GAAP earnings per share estimate.

To the extent we disclose any other non-GAAP financial measures on this call, please refer to the Investor Relations portion of our website at FedEx.com for a reconciliation of such measures to the most directly comparable GAAP measures.

Joining us on the call today are Fred Smith, Chairman, President and CEO;

Alan Graf, Executive Vice President and CFO;

Mike Glenn, Executive Vice President, Market Development and Corporate Communications;

Chris Richards, Executive Vice President, General Counsel and Secretary;

Rob Carter, Executive Vice President and CIO;

Dave Bronczek, President and CEO of FedEx Express;

Dan Sullivan, President and CEO of FedEx Ground;

Doug Duncan, President and CEO of FedEx Freight; and Ken May, President and CEO of FedEx Kinko's.

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

After Alan we will have time for Q&A.

Fred?

Thank you very much, Jim.

Good morning and thanks to everyone for joining our earnings conference call.

In our third fiscal quarter FedEx continued to deliver strong results due to the following factors.

One, I think we have remained firmly focused on delivering on our purple promise -- to make every customer experience outstanding.

Second, we've crisply executed our business strategy to balance volume and revenue growth with excellent cost controls to improve margins.

Third, we've steadily and profitably grown our international priority and ground shipments.

We've also increased yields and continue to improve productivity.

Now a solid global economy and a very strong peak shipping season also contributed to our strong financial performance in this quarter.

The third fiscal quarter was quite significant for our Company in other ways.

One, in January FedEx strengthened its industry-leading position in China.

We announced our intention to acquire DTW Group's 50% share of the FedEx DTW International Priority Express joint venture and DTW Group's domestic express network in China.

We believe this strategic investment in the long-term growth of China will broaden and deepen our relationship with the Chinese by improving access to important markets and fueling economic developments for years to come.

In fact, I just came back from China over the weekend and reviewed all of these plans during that visit.

Later this month, also in regard to China, we expect to receive approval from the U.S. government for three additional frequencies to serve China which will bring our total of flights to 26; more all-cargo flights to and from China than any other U.S. all-cargo air carrier.

Also in January FedEx was ranked among the 100 best companies to work for in the United States for the ninth consecutive year by Fortune magazine and the Great Place to Work Institute.

I'd also like to note that FedEx is known as a great place to work in many countries around the world.

In 2005 alone FedEx Express was named among the best places to work in Europe, India, Latin America as well as in China, Malaysia and Singapore.

In February FedEx was ranked number two among America's most admired companies and number four among the world's most admired companies as reported by Fortune magazine.

Also in this fiscal quarter Ken May, one of our veteran FedEx executives, was promoted to become Chief Executive Officer of FedEx Kinko's office and print services and Brian Phillips, Vice President of FedEx Marketing, became the Chief Operating Officer of FedEx Kinko's.

I can tell you I have the utmost confidence that Ken and Brian will strengthen FedEx Kinko's by building on the outstanding record of innovation and service to our customers that they've demonstrated over many years of service at FedEx.

As we look ahead we believe that the U.S. economy will continue to expand at a pace of 3.2% in FY '07 which begins on the 1st of June and that global GDP growth will remain stable with sources of growth broadening.

The United States and China continue to lead the developed and emerging markets respectively.

Improvement in Japan where we also have a substantial business also seems to be taking hold.

These trends should result in a global growth pattern similar to what we have seen in the last 12 months.

Before I turn it over to Alan I'd like to remind you once again of our resolute commitment to continue increasing our earnings per share by growing our revenues, holding costs to a minimum, maintaining our information technology leadership, continuing to exploit our unmatched international global network and by offering a broad portfolio of services.

We are, in short, continuing to focus on improving shareowner value, return on invested capital, improved cash flows and margins.

Now with that I'd like to turn it over to Alan Graf, our Chief Financial Officer.

Alan?

Thank you, Fred, and good morning, everyone.

I would like to highlight some key results from this outstanding quarter before we open the phones for questions.

At FedEx Corp. operating margin rose 140 basis points to 8.9% on a revenue increase of 9%.

EPS increased 34% to $1.38 per share.

So you can see from these numbers that we are leveraging our networks with solid yield management and strong productivity.

We did exceed the range that we had provided you for the third quarter as we had stronger than expected peak, tremendous productivity, lower-than-expected fuel costs and a lower tax rate.

In addition, during the third quarter we deferred some advertising and promotion costs to our fourth quarter.

In the express segment revenue increased 9% while operating income jumped 31% and operating margin improved 150 basis points to 8.4%.

International priority volume growth, domestic yield management and increased productivity all contributed to the improved performance.

International priority volume growth was strong again at 10% led by Asia-Pacific's 22% growth rate.

Let me just say right now that this is a tribute to the great service levels and terrific performance from our international sales and marketing team.

Domestic package yield improved by $1.18 per package or 8%.

Of note is that less than half of this improvement was a result of higher fuel surcharge.

Rate per pound mix and weight provided the rest of the increase.

Express U.S. freight yields were also up significantly, increasing to $0.96 per pound, up 17%.

Nearly all of this increase was the result of better base rates.

Turning to the ground segment, revenues grew 14% on strong ground package growth of 11%.

And yields were up $0.31 per package.

Of that $0.31 per package, slightly over half is attributable to fuel surcharge and the rest is raising base rates.

Increased base rates and growing volume at 11% is again a tribute to the tremendous service levels, speed and reliability provided by the ground network as well as, again, our outstanding sales and marketing teams.

Ground also had strong productivity and recorded an operating income increase of 26% and an operating margin of 13.7%, up 130 basis points from last year.

Freight also delivered a great quarter with revenue up 14%, operating income up 35%, and operating margin up 140 basis points to 8.6%.

LTL shipments increased 7% and yields were up 7% as well.

Obviously the transportation businesses performed extremely well during the quarter and we have a lot of momentum going into Q4 and FY '07.

Taking a look at Kinko's, you will note that revenue was essentially flat year-over-year and operating income declined slightly.

You should know that we are investing heavily in enhanced service levels, technology, new products and expansion which continue to depress operating margin and will for the rest of the fiscal year.

And keep in mind that Kinko's is providing significant value to the express and ground networks through our retail package acceptance capabilities.

As to financial strength, so far this fiscal year for the Corporation, cash provided by operating activities has exceeded cash used in investing activities by over $400 million.

I would now like to open the phones for questions.

(OPERATOR INSTRUCTIONS).

Ken Hoexter, Merrill Lynch.

Good morning; nice job on the quarter in the rebounding margins.

But just on the express side a little bit, can you talk about what's going on within the box performance?

It looked like we saw a little bit of a drop-off compared to the trends.

Are you stills seeing some of the overflow from DHL?

And then the recent bankruptcy of a small forwarder; is there any kind of flow on volumes that could aid the forwarding quarter just because it looked like fourth-quarter targets were a little bit conservative as well?

Thanks a lot.

Ken, this is Dave Bronczek and Mike might want to comment on this further.

We had focused very heavily on our overnight box and our IP volume box traffic.

That grew 3.5% for the quarter.

Our deferred traffic declined by 11%, but our yields actually improved by 11% on purpose.

It was our design plan to improve our yields and increase our profit margins and flow some of that deferred traffic to our sister company at ground and some to freight.

So by design, as we did in the last quarter, we've moved some of our traffic in the deferred box network out of express into our sister company.

By the way, I should add that the 3.5% growth in overnight box and IP volume was right along with the fact that we actually decreased our FTEs increasing our productivity significantly.

Mike?

I think Dave has covered the key issues; it's all part of a revenue management strategy to deliver the results we were looking for.

I just want to clarify then, Dave.

So year saying that the revenue strategy is also blending into the box side, not just what you're talking about on the deferred as you started a couple quarters ago?

Yes, that's absolutely right, Ken.

Okay.

And just last question is just anything on the pricing environment?

You commented before it was competitive.

Are you still seeing anything increasing in that environment?

I would characterize the pricing environment as competitive but stable.

Our primary focus is to continue to work our revenue management strategy to ensure that we have a proper balance between volume growth and yield management to deliver our financial goals and I think we've been delivering the results there.

Great, thanks for your time.

Jon Langenfeld, Robert W. Baird.

Just going down the path of that deferred freight and deemphasizing that.

How far into the strategy are you and is this something that we should expect to carry out over the next couple quarters or the next couple years?

Well, we had several larger opportunities which we took advantage of in the prior quarters.

I think you'll continue to see us execute the revenue management strategy, although it will be on a more selective basis.

So the larger volume impact has occurred.

Again, our primary focus is to balance volume growth and yield management to ensure increasing margins and hit our financial goals and we'll continue to execute that strategy.

But I think the biggest impact on volume has been seen.

Okay, good.

And then just more generally from each of the freight segments, can you just generally comment on how freight trends have progressed on a year-over-year basis into March relative to what you were seeing in January and February?

This is Doug Duncan, Jon.

At the LTL company, the freight network, we've had a strong quarter all the way through.

February was not a weak quarter, it was actually a very good quarter.

And the comment that Fred made about the strength of the economy is certainly something we continue to see and I think our value proposition is still allowing us to take market share as well.

And on the ground and express?

This is Dave Bronzcek again.

On the express side obviously you saw that our revenues grew 19.9% and our freight is growing from our U.S. domestic express freight and international combined.

So combined we're up almost 20% and continuing to grow there.

Jon, this is Dan Sullivan.

We had an excellent peak season, as Fred pointed out.

However, we have experienced solid growth in January and February and that continues into March, so we expect, again, a solid fourth quarter.

Great, thank you for the comments.

James Valentine, Morgan Stanley.

Dan, I was wondering if you could maybe give us a little more color here on two areas.

First, the impact from a fairly large consolidator that I believe went bankrupt here in the last week or two and if you're seeing any volume impact in the margins, and I'm thinking specifically with SmartPost?

And the second is I'm just wondering for this third quarter now that's behind us, where did you take share?

Was most of it from the express side, just simply downshifting a customer?

Or do you think it took some meaningful volume away from some of the bigger competitors out there given the fact that you grew at multiples of GDP?

The second part first.

I think we had some modest movement of volume from express to ground has already been discussed, but most of our growth did come from the marketplace from competition.

So although we haven't done our share analysis yet at this point, I expect that we'd continue to grow share based on these results and the 11% growth.

As far as SmartPost is concerned, we've been very busy in the last four days, we expect to significantly improve our volume in that segment and at better yields.

The consolidator segment pricing has been very difficult over the last six months to a year, so hopefully we'll be able to improve that.

We have capacity in place now to increase our business substantially, but we'll have to bring on some capacity, some facilities to process peak volumes when we get to that point.

We're also seeing some modest spillover of volume into the home delivery and ground networks as well.

I'd expect that we'll evaluate that and migrate as much of that business as we can back to SmartPost if successful to the customers once we have rates and contracts in place.

So we have a pretty well thought out coordinated plan between operations, sales, marketing and legal in place and we're taking advantage of this opportunity.

And I think we'll provide high service levels to our existing as well as new customers that we're bringing onboard.

That's great; a good problem to have.

Yes, it is.

Can I just ask one other question, one of Dave?

Dave, I was wondering if you might be able to quantify the impact of the Resi Release Program now that you've had a full quarter behind you in terms of whether it's headcount or dollars of savings, and the run rate or some kind of feel for us to help quantify the cost of the around the world flights where we're at on those as a drag.

Let me start off with the Resi Release Program.

First of all, let me just say that it's actually done three great things for our Company.

It's improved our overall service performance, it's increased our customer satisfaction, we monitor that all the time.

And obviously it's eliminated tens of thousands of stops that were reaccounts and obviously were in some cases causing some customer concern, even though they may not have been home.

So on the dollar figure, it's well in excess of tens of millions of thousands of dollars a quarter for us.

But again, it's a combination of the three factors, not just financial performance, but actually improving service and increasing customer satisfaction.

But I've got to tell you that the program has been very well received by the customers.

The employees of course are very happy that they can actually move into areas that can provide better service to customers, so the program is working exceptionally well.

On the eastbound and westbound around the world's, we're actually right on our targets and our plans.

They're performing exactly as we would hope they would have.

We've added the capacity of course, primarily for Asia-Pacific, but I have opened up U.S. to Europe and Europe back to Asia.

And so we're very pleased with the revenue and the financial performance.

Jim, it Alan.

They certainly have continued to drag our performance, but obviously the performance is outstanding which is why we made the investment at the time we did.

Fuel prices have continued to hurt them a bit more than we had targeted, but the trendline is very good and they'll have substantial improvement in '07 versus '06.

Jim, if I could clarify one thing about our revenue management strategy relative to the express volumes, specifically in the deferred sector.

Going into this activity we anticipated and had hoped to retain about a third of the volume that moved out of the networks in another FedEx network.

And we accomplished that goal plus or minus a point or two, so that will give you some magnitude.

We anticipated about two-thirds of the volume would move out of our FedEx networks and that was consistent with our thinking going into it.

So we were happy with the result.

Donald Broughton, A.G. Edwards.

Good morning, gentlemen.

Congratulations on a great quarter.

We're hearing anecdotal and direct reports of the belly space of planes coming east across these Pacific being not only full but backlogged.

I'm assuming that some of that (technical difficulty) is having a positive effect on demand on your volumes.

Can you put some, as they like to say, color and can you just (multiple speakers)?

This is Alan.

I'll led Dave talk about that in a little bit more detail, Donald, but that service doesn't even remotely compare to what we offer.

So we're providing very high levels of service with complete information, constant tracking, 48 hours almost anywhere around the world which they're not getting in the bellies of passenger planes.

The only thing I would add to that, Donald, is that our eastbound round the world flight that, of course, comes out of China has been very successful with very high load factors coming into the United States and we put it on just in time I believe for the capacity.

So you're seeing levels of demand that are similar?

That's where I'm going.

Well, we actually had backed up capacity and we needed to put that flight on anyway, but the flight is very successful for us and the flight is pretty full already.

Fantastic.

Thanks, gentlemen.

Adam Hylan, HSBC.

Good morning, everybody.

IP volume was up 10% but revenue per package up only 2%.

Could you quantify or give us some color on the impact of currency exchange rates on that revenue per package growth and whether that will reverse in the next quarter?

I don't know if I heard you correctly.

Our volumes were up 10%, our revenue was up 12%.

So we actually had a 2% increase in yield on top of the 10% on volume.

Do you want to talk about that, Alan?

Yes.

Exchange rate actually worked against us in the quarter on our IP yields.

They reduced the yields and that probably will continue in the fourth quarter.

And on the pilot negotiations, can you give us an update on where those are and if there's any sort of time frame for a resolution?

Well, I can say that the negotiations are proceeding well.

We're very pleased with the talks right now and we're hoping to get to a resolution in the very near future.

Thanks very much.

Ed Wolfe, Bear Stearns.

Good morning, gentlemen.

Can you give a little bit of flavor on the direction for some of the volume and yield trends in your earnings guidance for fiscal fourth quarter?

Should we see ground continue at double-digit for instance?

Should we see more of the double-digit declines in deferred [air]?

Can you just give a little bit more meat on the bones of what's in your guidance?

Ed, this is Mike.

We expect a strong fourth quarter in terms of ground, although it will be difficult to hit the levels that we achieved in the third quarter primarily because we had a very strong peak season which was a key contributor to that.

But certainly, as Dan mentioned earlier, we're quite satisfied with the trends early on in the fourth quarter.

Express, we do anticipate some continued drag in the quarter as a result of our revenue management activities, but we'll be working our way out of that, again, with a focus on revenue management as opposed to volume growth in and of itself, but we do expect to see some firmness there going forward as we work our way out of this deferred issue.

Ed, if you take a look at the range that I've given you, which is I think pretty strong on a year-over-year basis, I think we've got a lot of momentum across all the operating companies and I think we're going to continue to invest heavily in Kinko's to get it to the levels that we think we need it for it to get to the performance level that it can achieve and that it will achieve.

But the closest thing you're ever going to get out of me on an opco basis is I want you to follow very carefully the express operating margin in Q4.

Okay, I will focus on that.

Kinko's -- in your notes you talked about Kinko's, more of the same through this fiscal year.

Is the implication that in fiscal '07 we'll start to see some real margin improvement in Kinko's?

Is that the expectation?

Ed, this is Ken May.

As Alan said earlier, we're in a period of an investment.

We're working very hard in the short-term to improve our service levels and the quality of our customer service.

We're doing a significant amount of training right now -- retraining all of our team members, trying to improve that customer experience.

That being said, we're also going to be opening more stores over the next year which are going to provide some drag.

So I don't think you're going to see significant margin improvement in Kinko's over the foreseeable future.

As we open up those new stores it will take a while before they mature.

And we've also -- from a sales and marketing standpoint we've recently hired one of FedEx's best marketeers to come down to be our Chief Operating Officer.

So we feel like we can do a better job on the sales and marketing front and we'll be focusing on that as well.

Okay.

And then one last question for Fred.

Just strategically, as you look at what's in the arsenal and you go forward, which areas are ripe for acquisition for FedEx as you look out in the world?

Which geographies and which types of products, even more importantly, as you look out might be something that FedEx would add over time?

Well, Alan has got me in a headlock, so I can't talk very much about this.

Obviously, Ed, we have been successful in making strategic acquisitions.

We look at them all the time, a lot of different things that would complement our portfolio, deepen our services or broaden our capabilities into various adjacencies.

And as you know, I can't comment on anything that has any specificity to it, but what I have said on many occasions and would reiterate today -- the three things that guide us in corporate development activities are, one, having good financial discipline and due diligence in whatever we might look at.

We're simply not going to be foolish in terms of overpaying for something because it destroys shareowner value.

The second thing is we're going to be very, very clear in our mind that there's a good strategic fit and there are synergies with what we're already doing.

And the third thing is we need to be sure that we can manage the cultural issues because achieving that purple promise is a very big thing for this Company.

I mean, it is a huge part of the franchise.

I think what you should pick up on Ken May's comments were how hard we're working on getting our FedEx Kinko's network up to the same type of customer experience levels that FedEx is known for.

So we definitely continue to look for corporate development opportunities, but those three fundamental criteria I mentioned right there are the ones that will guide us if we do anything.

(OPERATOR INSTRUCTIONS).

Tom Wadewitz, JPMorgan.

Good morning.

Strong performance on the cost side in express and I wanted to drill down into that a little bit further.

Can you give us a sense of if this margin performance could perhaps accelerate?

Alan, you made a comment on fourth quarter, pay attention to the margin.

Could we see that margin improvement actually accelerate and the headcount and that actually -- the performance on headcount actually get better as we go out the next couple quarters?

This is Dave Bronczek.

Let me start off by -- let me just say that -- go back into our numbers again.

I started off by pointing it out at the beginning.

The revenue and yield management that we've undertaken has been very, very effective for us because it's done a number of things.

Obviously it's giving us higher yields, better profits.

It's let us hold or actually decrease our FTEs at express while we're going the right traffic in our network, the overnight box and the IP volumes.

If you go back and look, our total sales -- our total salaries and benefits only grew 3% and yet our overall revenue grew 8.6%.

On the productivity side our FTEs declined and our volume in overnight box and IP increased by 3.5%.

That's very significant productivity and we can continue to do that.

Alan?

Tom, this is Alan.

I would just say that we are in the middle of our fiscal '07 planning process as well as finalizing our long-range outlook.

And the great thing about being a FedEx Corp. is we have so many opportunities that we're really debating on which ones are the ones we want to be most aggressive with and invest in.

So I'm very happy with the express margin trends and I think we'll just stay on that line.

Certainly we could accelerate it if we wanted to, but we also need to continue to think about the long-term and our international opportunity as well.

So with the acquisition of our -- as Fred mentioned, of our joint venture partner in China, we're going to be investing significantly there in '07 and '08.

So we're going to stay on the trendline that we've been on, but again, keep an eye on the fourth quarter here.

Okay, great.

And then my second question -- or follow-up for Dan.

On the ground side you commented a little bit about mix of growth I was wondering if you could give us a little further insight in terms of roughly how much would have been a strong market and a strong peak season versus what you're doing with some new customer wins and a bit stronger performance versus your competitor?

Is it 50-50, is it a lot more the customer wins, or any color you can provide on that?

Well, I think during peak and really during the whole third quarter we did see a strengthening with our existing customers, but at the same time we did bring on a good bit of business.

We saw increases in the residential side of our business with both our brick and mortar retailers as well as our online customers.

We saw an increase in multi weight which pleased me during this quarter and our overnight business was also strong.

So it was pretty consistent across each of the major segments of our business and I think a good mix of better business with existing customers and, of course, we're always bringing on new business at a fairly rapid clip.

So pretty well-balanced.

John Barnes, BB&T Capital Markets.

Good morning.

Two things real quick.

Number one, could you give us an update on where you stand with some of the legal decisions on your contract employees on the ground side?

Good morning, this is Chris Richards.

We are appealing the decision that was reached in state court in California in the Estrada case.

This was a decision that impacted the status of our independent contractors.

It is a decision that is limited solely to single rail contractors.

The court concluded that both our multi-route and our incorporated contractors model is absolutely correct and they are appropriately classified.

We are very confident in our likelihood of success on appeal; expect the first phase of that appeal to take place this summer and go forward from there.

On the multidistrict litigation, as you know, a number of class actions have been consolidated in the Northern District of Indiana.

The discovery phase of those cases is being initiated.

We expect that to run into the summer with the current schedule that we have.

Class certification issues will be taken up in the fall, and we expect decisions in that area before the end of the calendar year.

Okay, very good.

Lastly, Alan, in the press release you noted that third-quarter margin benefited from a deferral of some promotion and advertising costs in the fourth quarter, yet your fourth-quarter guidance is kind of off the charts.

Can you quantify for us what those costs are that are being deferred?

I'm trying to get a real read on if I were to strip those out or kind of spread them out over the normal course of a year, is your fourth quarter even better?

Is it materially better if you exclude those costs?

No, John, it is just a number of small things that happened to occur in the third quarter, and I wanted to make sure everybody understood that when I gave you guidance for the fourth quarter that that is pretty strong guidance for the fourth quarter, even though the last couple of quarters we have exceeded what we have given you.

All of those items in total helped to succeed the range, but none of them individually and frankly in total are material.

But this is our first year of really expensing our advertising and promotion as we go, as opposed to accruing it evenly through the year.

As you move things from one weekend through the next, they cross over quarter lines, and it did have some impact on exceeding the range, but certainly not material.

Jordan Alliger, Deutsche Bank.

A question for you.

You have shown -- continue to show good year-over-year improvement on the FedEx Express margin.

Just wondering, are you able to sort of get a sense from your internal accounting how much of that is mix related with the growth in the presumably higher margin IT business versus some of the things you're doing domestically from a productivity standpoint, cost standpoint, etc.?

Well, Jordan, I can tell you that we look at express altogether collectively.

It's a combination of our international revenue, our international growth in a profitable way.

It is our cost initiatives across the world, not just in the U.S. but also offshore.

It is our revenue yield management.

It is our relationships with the USPS.

It is a combination of about five things that we focus on every day at Express that in its entirety drive our margins at Express.

It is not one thing or another.

It is the global view of Express across all of our divisions.

Okay, thank you.

Jason Seidl, Credit Suisse.

Good morning, gentlemen.

You mentioned there was a planned movement of product out of your U.S. deferred box into some of the other areas and specifically on the freight side.

Doug, did that negatively impact the yield a little bit, because I notice on a sequential basis yields dropped moderately from Q2 to Q3?

This is Mike Glenn.

Let me clarify that issue, that freight actually saw very little impact from that effort.

The primary benefactors in the movement of deferred traffic out of Express went into ground and to SmartPost, and again that was about a third of the traffic that moved.

I'll turn it over to Doug.

The decline of the growth rate of the yield from the second quarter to the third quarter was all fuel surcharge related.

The base rates were actually up slightly.

Okay, the base rates were up.

Could you give us a percentage of that?

We don't break those out because it is really all combined the way the customer looks at it, and that is the way we manage it.

I guess I will follow up since I've got you here.

Doug, you had previously mentioned before that you would like to build out a little bit in Canada, and you were considering acquisitions.

Is that still the plan going forward?

Well, as Fred mentioned, we can't comment on it with any specificity, but I think our long-term desire is to be a North American carrier for LTL and services.

David Ross, Stifel Nicolaus.

Good morning.

Ground volume and freight volumes were both good, up 11% and 7%.

Could you break out the volume trends, how much of that was in December and then how much year-over-year growth was seen in January and February?

Was that for freight?

I couldn't hear it.

For ground and freight.

As Dan mentioned, the volume growth that we saw in ground in the third quarter was certainly aided by a strong peak season.

Having said that, we had specific sales and marketing initiatives in place for some period of time, which our team has executed with great precision which has improved the trends coming out of the first and second quarter and are continuing into the fourth quarter.

So certainly there was some impact in the quarter as a result of a strong peak season, but we're quite happy with the trends going into the fourth quarter.

At freight our quarter was pretty consistent and February was a strong month, not a weak month at all.

Okay.

And then one follow-up question on SmartPost.

You had trouble getting it profitable previously.

I was just wondering if it's profitable yet and if this new volume that's coming on is going to make it even more profitable or go from unprofitable to profitable?

SmartPost was slightly unprofitable in the quarter; however, we have been experiencing good growth.

We're not going to be specific on those volumes.

We're still expanding the network, improving service levels, doing everything that we need to do to be the premier provider in that space.

Obviously with increased volume as we build critical mass there and, as I said before, hopefully at slightly better yields I have every confidence that we should bring it to profitability in a steady-state.

So stay tuned for that.

This is Alan.

Also remember that the SmartPost offering is important to us because if we didn't have it there were other customers we would not have that are giving us ground and express packages.

So a static cost accounting analysis that Dan was talking about is really not how we're managing that.

We are managing it on a portfolio basis and it's important for us to have that service capability.

Kevin Fogarty, DuPont Capital.

I was just wondering if you could clarify your ground volume, what do you think the volume growth was ex the movement from deferred.

And I know you had mentioned it's preliminary, but I guess how much do you think you're gaining share?

We're not in a position to comment on a share analysis primarily because we haven't been in a position to do a deep dive on that.

And certainly we're not motivated by share gains, we're motivated by financial returns to the business.

So we're doing a good job of managing the ground growth.

Our sales and marketing team are doing a great job.

We're quite happy with the growth rates, as I mentioned. going forward.

And while we did see a great peak season, even if we had not seen the peak season that we did, we would have been quite pleased with the growth rates in the quarter.

And really, this diversion from express to ground at 3 million packages a day is really a modest contribution.

Okay.

But if I assume -- you're reporting 11% growth.

If we take out a third of your decline in deferred is that the right way to look at it, getting kind of apples-to-apples closer to a 9?

You really can't do it that way because some of the volume went into SmartPost, some of the volume when into ground and home.

And obviously the third quarter, because it does peak, you had a little bit greater impact of that than you would see on a basis going forward.

So it's a little bit difficult to do that math.

Art Hatfield, Morgan Keegan.

Good morning, gentlemen.

Just, Alan, for years you guys have had a stated goal of getting express margins to 10%.

It looks like that's becoming reality.

And I hate to ask this question, but where do you go from here?

Are margins in the teens a possibility and if so do you think that's something that we can see in the next few years?

Art, I'm glad you asked that question because since we're in the middle of the '07 planning process that's exactly what I've told Dave is that we're not stopping at 10, so quit thinking that way.

Thanks, Art.

But seriously, with the opportunities in front of us and with the international growth that we know that we're going to have and the capabilities that we have there, yes, we're going to get to 10 and say, okay, we told you we were going to do it and we've done it, but we're thinking well past that, particularly in our long range outlook.

Thank you.

Just as a follow-up, and this may be more directed to Dave.

You talked about productivity improvements at express; now that you're there do you feel comfortable that you have enough flexibility in your cost structure to stay there if and when things slow down in the economy?

Yes, we have enough flexibility.

We manage our business on a day to day basis.

I know a lot of you know this, we've talked to you about it in the past -- don't forget the power that comes out of express, that international business that's both here in the United States export and around the world and we have the A-380s on in the future and the power that that produces in terms of revenue and profits and we have a lot of opportunities to flex up and to flex down.

Thank you.

Scott Flower, International Priority Research.

A couple of questions.

I wander -- for Mike Glenn.

I know you talked about the overall yield environment and obviously I know you can't do this but it's the data we've got.

It looks as if the trends in ground might be toward a little less robustness and a little bit of greater firming in the express segment.

Are you seeing any differentiation in the yield trends between your different products at your different units?

I would say there's no material difference, Scott.

Again, what we're focused on is the bottom-line performance.

And so it won't be uncommon for us to tweak yields a bit in one quarter versus the next in one segment of our business due balance out the volume and revenue and yield growth.

So I wouldn't read too much into that.

Okay.

And then the other question I had -- I know that this will get closed I guess in fiscal '07, but tell me if it's possible to think about what is the closure of the purchase of the JV and DTW do to your performance or impact on the operating income/international priority volumes when we look toward '07?

Does it have some meaningful impact when we think about growth rates or impact operating income by buying out that joint venture?

This is Alan, Scott, and I'll let Dave go into it.

One of the things that we're debating right now is that in our plan is when exactly we're going to actually be able to take charge of those operations.

Today we have a joint venture of which we only get 50% of the profitability of a very profitable joint venture and the revenues are -- there's a revenue sharing opportunity for us in.

Some of the revenues are hitting the top line but certainly not all of them.

So we'll see an increase in revenue and operating income when we complete that acquisition offset by how rapidly we expand ourselves into the domestic China market.

And those plans are still being developed.

But in general I would say you can expect some accretion from the acquisition in '07, but it's certainly not going to be material in '07, but beyond that I expect it will be.

And this is Dave.

Just to add to that, beyond the financials obviously the global connectivity of China, not only in the international front but the domestic front, is so significant for us as that part of the world keeps producing double-digit growth rates, in our volume of course very strong GDP.

So obviously Alan is correct, it will be at some point in FY '07 that we get the other half of that join venture revenue.

But more importantly, it's the connectivity of both domestic China and international China to the rest of our global network.

It's really going to be powerful.

Helane Becker, Benchmark.

Just two questions.

First, Alan, I think you made a comment about the tax rate in the third quarter being lower and I was wondering if you could just comment on what the outlook is going forward and if that's a new level we should be thinking about?

And two, the U.S.

Postal Service contract has been one that you've had for several years.

And my understanding was they were very happy with your service.

But I've seen reports out there that other players are considering bidding on some of that and I'm just kind of wondering if there's any chance that any of that business would go elsewhere or if you would encourage it to go elsewhere?

Thank you, that's all.

Helane, on the tax rate, I think you need to think about in the range of 38 to 38.5% going forward.

This particular adjustment was a result of -- we file our fiscal year tax returns in February of the following calendar year.

So generally we have a true up of tax rate in our third quarter as a result of that.

Additionally, we had numerous small items from settlements and reserve adjustments and things that all occurred during this third quarter to lower from 38.1 to 37.85.

But going forward in '07 for your planning purposes, back to the 38 to 38.5 is the right number.

And I'll let Dave answer the second question.

Yes, Helane, on the relationship with the USPS, the relationship remains excellent.

We're a little bit more than halfway through the original seven year deal.

Of course, we're in our fifth addendum and obviously we're carrying more traffic in the addendum than the original base contract.

So we're working with the post office right now and we have a great relationship and we'll keep you posted.

And no one can do what we do.

David Campbell, Thompson Davis & Co.

Thanks very much.

Jim Clippard, you mentioned stock options at the beginning and I couldn't hear it totally.

Did you say this June -- this fiscal quarter of June '06 you're going to start expensing it or are you talking about '07?

We're talking about fiscal '07, David.

Our fiscal '07 first quarter starts the 1st of June, as you know.

So beginning with the first quarter of '07 and continuing we'll be expensing stock options.

And you can all take a look at last quarter's 10-Q, as well as the one that we'll file on Friday, to get some insight into what you can expect to see in '07.

Thanks.

Most of my questions have been asked, but I just have one other and that is the international package growth.

Was that international growth imports into U.S. and exports both and how would you describe the growth rates of those areas?

David, it's all the international volumes combined produce that 10% volume.

Obviously it's 12% on the revenue.

All the regions of the world actually had year-over-year better performance on revenue and we were very pleased with that.

Thank you.

That concludes the question-and-answer session.

I'd like to turn the conference back over to you for any additional or closing remarks.

We don't have any closing remarks.

Thank you very much.

Ladies and gentlemen, thank you for being a part of the call.

I'd like to thank all of my colleagues for being on the call and their help and wish you all the best for the rest of the week.

Talk to you later.

Bye.

Thanks, everyone.

That does conclude today's conference.

You may now disconnect.