聯合包裹運送服務公司 (UPS) 2002 Q3 法說會逐字稿

Welcome to the United Parcel Services third quarter earnings conference call.

Today's call is being recorded.

At the conclusion of the prepared remarks we will have a question-and-answer session.

To ask a question, please press one, four on your touch-tone keypad.

Now we'll turn the call over to Vice President of Investor Relations, Mr. Kurt Kuhen.

Please go ahead sir.

Kurt Kuhen, Vice President of Investor Relations, United Parcel Service: Thank you.

And good morning, everyone.

It's a pleasure to be here with you today to provide insight on our third quarter results.

With me this morning is Scott Davis our CFO who will review the quarter, cover our continued international momentum, discuss recent volume trends, the impact of the west coast disruption and provide guidance on our view of the fourth quarter and 2003.

While the last few quarters have certainly been challenging for UPS, we're very excited about the prospects for improvement that we see going forward.

We've had to climb a steep hill this year, and feel that we're now picking up steam.

Of course, we do have work to do, but all of our businesses are gaining in momentum and we should see those accelerate through the next several quarters.

Before I turn the program over to Scott, I need a few moments to review the Safe Harbor language.

Some of the information you'll hear today may be considered forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.

Such statements are subject to risks and uncertainties that could cause our actual results to differ materially from our statements today.

These include, but are not limited to, our competitive environment, economic and other conditions in the markets in which we operate.

Strikes, work stoppages and slow downs or customer behavior in anticipation of such events; governmental regulation, increases in aviation and motor fuel prices; cyclical and season fluctuations in our operating results; and other factors identified in the company's Form 10-K and other documents we've filed with the Securities and Exchange Commission all of which are available through the SEC.

Well, having made it through my verbal agility test for the morning, we can move on from here.

As a reminder, our third quarter earnings release and accompanying summary information including a schedule on our pension plan status are available on UPS's Investor Relations Web site.

In addition, this conference call is being Webcast and will remain accessible on the Web for a couple of weeks.

At this point, I'll turn the mike over to Scott.

Scott Davis, Chief Financial Officer: Thank you, Kurt, and good morning to everyone.

Three months ago, we indicated earnings would be between 50 and 55 cents per share, depending how quickly diverted volume returns and on the condition of the economy.

At 51 cents per share, we delivered the low end of that range.

Volume is returning and I'll talk about that in a moment.

But we certainly saw now boost from the economy.

Our domestic operations had a tough quarter as we worked hard to win back the diverted volume caused by the labor negotiations completed in mid July.

In contrast, we again achieved very strong results in our international business with both Europe and Asia continuing their growth trends.

Let's first look at the domestic package operation.

Volume declines for July reached five percent due primarily to diversion.

August saw modest recovery with volume up 3.5 percent and September was slightly positive although helped by an easy comparison with last September.

For the quarter, domestic volumes declined 2.1 percent in total with ground volume declining 2.4 and deferred down 2.6 percent.

Our next-day air product posted a two percent gain in average daily.

Without the impact of last September, however, next day volume would have declined slightly.

Profitability in this segment was down almost 10 percent.

Margin in the domestic business contracted by 170 basis points as a result of the volume declines and cost increases.

These increases are notable in the benefits area particularly healthcare, where we're facing the impacts that other businesses are facing.

Also included in the quarter is a one-time increase in payroll due to initial increases in our contracts.

This is typical of new contracts and will decline over the next few quarters.

Going forward, like all companies, we face continuing challenges in health care and pension costs.

But unlike a lot of companies, UPS is fortunate their pension funding levels is not a problem for us.

For many years, a strong cash flow has enabled us to fund our pension plans at the maximum level allowed by the IRS.

We measure our plans as of September 30, admittedly tough time for the market.

Even so, our pension plans are a very health 97 percent funded for next year.

If we include the recent market recovery in our calculations, we would be over 100 percent funded.

We are, however, facing some increased expenses.

In making our calculations for next year, we plan to use the discount rate of 6.75 percent and plan to reduce our expected return on plan assets to 9.2 percent.

Overall, we expect UPS pension plan expense for next year to increase $135 million.

A continuing bright spot for us is our exceptionally strong balance sheet and cash flow.

Free cash flow for the first nine months of the year totaled $2.6 billion.

Our actual cash balance increased by 1.1 billion.

In addition, we paid $400 million in debt, 600 million in dividends and 500 million in stock repurchases.

Our total cap ex this year will come in below $1.9 billion which will likely be less than six percent of revenue.

Typically our cap ex spend is between six and eight percent of revenue.

Next year, we anticipate cap ex will be about $2 billion which should be about six percent of revenue.

While we may be experiencing a little pressure on our margins, we're certainly demonstrating the underlying financial strength of the business.

Before I move on to other segments, I know the topic of diverted volume is high on your list of questions, so I'll provide an update.

A bit of a historic perspective may be helpful here.

Five years ago, the work stoppage was a major issue to overcome, and we experienced three or four quarters of tough comparisons as we worked to regain lost volume.

After that, we came back very strong.

This time, we're confident the impact will not be so severe since we successfully completed our contract two weeks early.

Certainly, there has been market share disruption and volume shifts to our competitors as our customers took precautionary measures against the lingering concerns of 1997.

But so far, we've recovered just over 50 percent of the volume.

It was diverted because of labor uncertainty and we expect that number to increase.

We're finding that small mid size customers who have shorter term contracts with alternate shippers are quicker to return than our large national customers.

In addition, for several quarters prior to settlement of the labor contract, it has become increasing difficult to sell new business against the head wind of uncertainty.

Now with that concern eliminated, our pipeline of bid activity is filling quickly.

Therefore, we're optimistic that we'll increase momentum substantially in the quarters to come.

Our focus is on growing the business and not just on recovering lost volume.

In doing this, however, we're being disciplined in approach to pricing.

We do not intend to sacrifice yields to significantly accelerate the process.

At UPS we try to be patient and take a long view in our business and we think it's prudent for investors to also.

We're committed to a philosophy of controlled profitable growth.

We're finding that one of the primary reasons many of our customers offer for return use of UPS is reliability.

They tell us that our competition has difficulty matching our service levels.

In addition, providing multiple service options from a single source makes UPS an easy shipper to work with.

As we characterize it in some of our ads, we provide the power of one, a benefit the customers appreciate.

Now for the international segment which continues to perform exceptionally well and outpace market growth.

Revenue is up 17 percent with average deal in the export volume increasing 10 percent.

And average revenue per piece for export products up 6.3 percent or 1.1 percent when restated for currency impact.

We're experiencing successful growth in export products while we keep airline expenses in line.

In essence we're leveraging the capacity that we've added to our network over the last couple of years.

Our international domestic operations showed solid results.

Despite a modest volume decline, revenue increased 12 percent.

And even after adjusting for a strong euro, we showed over a four percent increase in yield a clear sign that our yield management efforts and a firm pricing environment are bearing fruit.

The strong volume gains experienced in the second quarter in Asia and Europe continued in the third quarter.

Export volume from each of these regions increased 15 percent.

In addition, we're seeing some strengthening in the rest of the world.

We continue to be bullish on growth prospects in Europe.

After all, our compound annual export volume growth in Europe over the last six years has been 22 percent, despite the slowing economic environment over the last year-and-a-half.

To ensure our ability to handle increased volumes there, we've begun an expansion to our primary European hub in Colon.

This effort will almost double the volume the facility can handle from 60,000 packages per hour to 110,000.

Investment in this expansion in this expansion is estimated at $135 million and construction should be completed in several years.

This is our biggest facility investment in Europe.

It will be our largest facility outside the U.S.

It will have the same benefits for UPS as does our Louisville expansion, increased productivity due to automation.

And the ability to handle larger aircraft, enabling us to optimize our network for more efficient use of our planes.

On the other side of the world, our inter Asia hub continues to play a significant role in improving our volume there.

In the quarter, our inter Asia volume increased 17 percent.

And volume out of China was up 41 percent.

A question I know you'll ask, what effect do we expect the west coast Long Shoreman's labor disruption to have on our business?

At this point, we're not sure of the overall impact.

It will likely be a modest drag of the freight services group and a benefit to our international air network.

Let me tell you a bit about what we're doing.

Our UPS rate services group currently charters three MD-11s (ph) per week from Hong Kong to Chicago and New York, two of which are in operation to handle traditional peak shipping needs.

These charters will continue to operate indefinitely subject to customer demand.

UPS Airlines had been operating 35 cargo flights per week between Asia and the U.S.

We've added six additional flight rotations.

These will operate as long as volume demand warrants.

All flights are full carrying mostly general cargoes, such as apparel, retail items and high tech electronics.

We've also seen an increase in small package volume, directly attributable to the port situation.

The air freight industry can carry only a small portion of the goods that typically travel by ship.

Significant to us also was the service we can provide and quickly get in the goods sitting at the ports to their destinations.

UPS has a large flexible network in place that's helping to move goods rapidly.

In addition, we're one of the largest users of the rail transportation and we have our own dedicated rail space.

We're working around the clock with their customers to expeditiously move goods out of the ports using these capabilities.

Turning now to the non package segment of our operations.

Our logistics group achieved a 41 percent increase in revenues.

Significantly, 20 percent of that growth was organic.

Our service parts logistics unit led the growth as it continues to sign up after sales business support for existing high test customers.

The freight services unit posted a record net revenue for air service in the quarter.

But ocean service declined slightly year-over-year.

The business would have shown a solid mid single digit revenue gain, but the comparison was hindered by the exclusion of a FedEx brokerage business following the sale of that business earlier this year.

As is the case across the industry, costs for transportation were up in the quarter, which resulted in some margin contraction, although the business remained solidly profitable.

We continued to see emerging cross selling opportunities in the freight services unit with several long-term freight customers expanding their user of our supply chain services and converting their small package volume to the UPS network.

Most noteworthy about this segment is the progress we're making on our integration efforts.

We told you earlier this year, that we had formed the supply chain solutions group to bring together the sales and marketing efforts of our business units that address different pieces of the supply chain.

We're carrying that integration further by melding all of the logistics and freight service capabilities and operating the resulting business along geographic lines.

Beginning in 2003, we'll function on a geographic rather than on a product basis with Americas as one region and Europe/Asia as another.

Each will be responsible for all logistics and freight services, sales and execution within its area.

Our shares services approach to human resources, finance and accounting, and most importantly information technology will support the entire supply chain organization.

Over the last three years, we've made 16 acquisitions in logistics, forwarding and brokerage.

Having a common platform of putting (ph) IT systems to support these entities makes for a much more cohesive and efficient operation.

In addition by combining these operations, we will consolidate facilities which there are now over 840 worldwide and reduce space requirements by over one million square feet.

We'll update you on the overall impact as work progresses.

As we look at to 2003, we believe this entity will be a much more powerful player in the supply chain arena.

Turning now to share repurchases.

In the third quarter, UPS was less active in the market.

Our inclusion in the S&P 500 index covered (ph) a very significant demand for shares by index funds and other investors who use that index for their investment decisions.

Now that their index related purchasing as subsided UPS is again an optimistic buyer with about $700 million of authorized funds available.

At the end of the quarter, there were 655 million A shares and 461 million B shares out standing.

Now I'll take up my murky crystal ball and provide what insights I can into our expectations for the quarter and for 2003.

For this quarter, we expect earnings to be within the range of 55 to 60 cents per share compared with 57 cents last year.

The strength of this holiday season will obviously dictate the strength of our quarter, and frankly, that's a question mark now.

The economic conditions and our success in drawing the business will also influence performance.

Diverted volume will continue to return.

Domestic volume will likely be one percent below last year's fourth quarter level.

Timing also plays a bigger role this year.

Thanksgiving falls as late as it possibly can in November this year.

This means there will be one less week between that day and Christmas than there was last year.

Therefore, peak will be more concentrated and probably fall later in the month.

In addition, the backlog of inventory caused by the Long Shoreman's disruption may also push demand a bit later into the quarter.

I share these observations to explain that there probably won't be a lot of visibility in to how the quarter shapes up until close to its end.

For 2003, with a reasonably firming economy we expect to generate profit improvements at our above our historical average of 13 percent.

These improvements will be more substantial in the second half than in the first half for a couple of reasons.

We're assuming a gradual economic recovery with more strength later in the year.

And volume momentum should increase as the year unfolds and we cycle through the impact from our labor negotiations.

In conclusion, I want to leave you with a few key thoughts.

One, UPS has successfully weathered a tough storm this year with a double whammy of a weak economy and a labor induced diversion.

Yet, we have strong momentum in all of our businesses going forward.

Two, we remain financially ver sound.

And three, our focus on solving customer problems from straight forward package transportation to the most complex supply chain is a solid foundation on which to grow the business.

We're convinced that this is a great industry with an exciting future.

Our strong position, sound strategies and ability to execute will reap benefits for years to come.

Thanks for your attention.

Now, Kurt and I will be happy to answer your questions.

Today's question-and-answer session will be conducted electronically.

If you would like to ask a question, please press one four on your touch-tone keypad.

We'll take as many questions as time permits.

And we'll take them in the order that you signal us.

We'll pause for just a moment.

Thank you.

Our first question is coming from Scott Flower of Salomon Smith Barney.

Please go ahead with your question.

Scott Flower, Salomon Smith Barney: Good morning, Scott and Kurt.

Good morning, Scott.

Good morning, Scott.

Yes, just a couple of quick questions.

I was wondering, obviously you talked about where you are now relative to diverted volumes.

And that you're going to incrementally recapture a further amount.

Can you give us any sense of what you think may locked up in long-term contracts that just won't transparently come back any time soon?

Well, Scott, first of all, we are generating a lot of momentum right now.

I think we've come back from down about five percent, you know, at the peak in July in to about two percent today.

So good progress to date, we'll expect for the quarter to end up down about one percent.

So we're bringing an awful lot of it back.

I think there's a minor portion of the packages locked up in long-term contracts.

As to how many packages we recover second quarter, third quarter next year that's still a question market.

But we're very optimistic.

Our bid activity is picking up.

We're winning a lot of good bids lately.

So we're anxious and excited about the future.

Hey, Scott, if I could just add one point of color though, at some point our focus shifts away from winning back to just winning in general and that's where the elimination of the head winds of the labor uncertainty are starting to show some impact.

That would be my follow up, is how much of what, if you look at the fourth quarter being down one percent it's just actually perhaps other business be it from the postal services with their big price increases and the elimination of the uncertainty in just new business.

Not all of obviously the improvement in your declines is going to come from recapture.

Oh, absolutely.

I think the volume that we do win in the fourth quarter is a combination of the two.

Certainly, a lot of what we gained back from the last couple of months has been volume we lost in June and July.

But we are awaiting new business not just from the Post Office but from other competitors.

And then our value equation is unbeatable out there.

I think the service reliability is showing.

OK.

And then, one thing you mentioned the rate of decline had slowed through the quarter, but obviously September was an unusual comp last year.

Do you have anyway of looking at that sequentially or seasonally to give us a better sense of what is the trend really doing?

Because obviously September was a very unusual comparison.

Well it's difficult, as you said, with September.

But I think that, I guess the picture we're painting as we were down five percent at the peak in July, down about three-and-a-half percent in August.

And I would guess probably around two percent maybe two-and-a-half percent in September would have been the numbers.

We have won back a little more and earned - and gained some more volume in October.

So I would say in the vicinity of two to two-and-a-half percent down in September.

And then just one last question, and I'll let somebody else have at it.

You obviously are building a lot of cash in your balance sheet.

And given where the multiple of your stock is you do need to be opportunistic relative to I guess repurchases, I know historically, you all have not been big fans of dividend increases.

But I'm just wondering with, you know, triple A credit, stock at a high multiple what are you thoughts relative to looking at a dividend increase at some point?

Well we evaluate, you know, dividends every quarter, but once a year in February we take a look at - an in depth look at dividend policy.

Dividend policy for us is a facts and circumstances basis.

So we would look at where we are and determine what the dividend level should be.

Clearly the investment mentality has changed an awful lot in the last 12 to 18 months.

You know, a year ago - two years ago, I'd be out talking to investors and dividends were a sign of weakness.

Obviously today there's much more interest in dividends in the investment community.

So that'll factor into our discussions also.

All right.

Great.

Thank you.

Thank you.

Our next question is coming from Helane Becker of Buckingham Research.

Please go ahead with your question.

Helane Becker, Buckingham Research: Thanks very much, operator.

Two questions for you, Scott.

First, thank you for the pension information.

Is the increase expense included in the go forward guidance then?

Yes, Helen, and good morning.

It is included in the guidance for 2003.

OK.

Again (ph), the ...

And then the other question is, I know there were some issues earlier this year with respect to China and their post office, and small packages, and so on, and I know that we've been going back and forth, you know, between them and us.

Could you maybe bring us up to date on what the status of all that is now and where we stand?

Well, it's still not totally resolved.

There certainly has been some progress along those fronts.

There's - China's folks is still - or wants all their competitors to sign the - have an agreement signed by China Post - agreed to by China Post, and we think that's inappropriate.

But as far as the restriction on packages, I think it's primarily geared to communist party traffic and personal letters, is what those restrictions are at this point in time.

It should not have a major impact on our business going forward.

It's just the idea of having , as a competitor, that China first (ph) approve the licenses does not make sense to us.

OK.

Well, thanks for your help there.

Thank you.

Our next question is coming from John Barnes Deutsche Bank.

Please go ahead with your question.

John Barnes, Deutsche Bank: Hey, to follow up on the earlier question on usage of your cash, can you give us an idea, are you in the process now of trying to harvest, you know, the - you know, harvest from the investment you've already made in Asia in the logistics area?

Or, are you still open to further acquisitions in logistics and further investment in whether it be Europe, or Asia, or elsewhere?

Yes, John.

We're certainly always looking for opportunities to expand our capabilities.

And the likely areas for us would be in the logistics arena, where we still have some geographical and vertical needs that we can go after.

In this environment, there may be some good opportunities and certainly we are in a good cash position to do it.

We're always looking for the right place to invest our money to increase returns to shareholders.

OK, is there anything - I mean, or - I - there's been a lot of consolidation already.

I know there's still a lot to go in a variety of areas in transportation.

Do you still feel that there are a significant number of opportunities in the logistics space?

And I guess what I'm getting at is, are the opportunities large enough to have a meaningful impact on a company the size of UPS?

Well, again our philosophy is not necessarily going out and buy big companies.

We have a tremendous customer base, so what we're looking for is the ability to buy capabilities that will help us serve that customer base.

And there's plenty of that - plenty of those opportunities out there still.

OK.

All right, that'll do it.

Thanks so much, guys.

Thank you.

Our next question is coming from Joe Morano (ph) of T. Rowe Price.

Please go ahead with your question.

Edward Wolfe, Bear Stearns: Hey, Scott.

It's actually Ed Wolfe.

How are you?

In Wolfe's (ph) clothing, huh?

Good morning, Ed.

Thinking left, going right.

A couple of different things.

First of all, what's the assumption you're using on the pension for wage increases going forward, and has that changed?

It has not changed.

Four percent is the assumption that we've built into our pension assumptions.

That's the only one that didn't change.

Obviously, we've brought down the discount rate and changed the rate of return expectations.

OK.

You've talked about that you've thought about 50 percent plus of the freight has come back that was diverted.

What's the absolute volume number that you're looking at that you thought was diverted?

Well, we think that probably the 3,500,000 (ph) packages in July roughly.

I think we said we were down five percent and roughly four percent of that we attributed to diversion.

OK.

And when you look at the domestic margin, that flipped quite a bit in the quarter.

How quickly can that come back?

How much of that is because there was really a lot of uncertainty around the contract when it was going to get signed and what was going to be diverted?

How much of that comes back quickly, how much of that really needs the economy to get back to where it was say in '99 or '00?

Well, certainly, the margins got squeezed domestically in the third quarter, primarily because of the five percent volume decrease in the July.

That's put a lot of pressure on our overall margins.

Going forward, surely a stronger economy, and volume, and growth will help us.

But we anticipate improving domestic margins going forward.

And the big - one of the drags (ph) obviously going forward, is to help current cost and pension costs.

We've talked about it'll be a hurdle for us to overcome but we would anticipate improving margins going forward.

Kurt Kuhen (?): Ed, maybe just to add a little color, I guess.

One issue with the pension plan, is we revalued and recollaborated our plan as of September 30.

And frankly, you couldn't pick a worse time to do that given the conditions of the market, but that's the historical time we do that and we've stuck with that.

So that does - that did cause us then to create a fairly large charge for next year.

Certainly, if the market stays firm and continues to recover, then that's a non-cash event that, you know, that hopefully will correct itself in two or three years.

Do you think, given this - you know, let's assume we have a steady - say (ph) gradual but not a homerun improvement in the economy over time, can you get the domestic A/R back to '83, '84 range without that kind of an economy (ph) or do you need it to get back there?

Kurt Kuhen (?): I think we need a solid economy.

I think GDP growth of three to four percent, we can get our margins back to those levels that we saw in the year 2000, the 17 percent margins.

On the pricing side of things, do you feel any pressure at this point that makes that more difficult or easier than you would've thought at this point?

Scott Davis (?): No.

I think there's been a lot of - a lot of rumors out there in pricing.

I think the yields, as you see, held strong in the third quarter.

I think you saw very little change in the third quarter from earlier in the year.

Ground yield (ph) is up two percent, self strengthen (ph) is the deferred (ph) yield.

So I don't see anything really that's changed out there dramatically in the pricing environment.

We're confident that it's going to be a rational market.

OK.

Thanks a lot guys for your time.

Thank you.

Our next question is coming from Daniel McKinley of McDonald Investments.

Please go ahead with your question.

Daniel McKinley, McDonald Investments: Good morning.

I was wondering if you could give us some guidance.

You talked about the fiscal '03 operating margins improving greater than the historical 13 percent.

Can you talk a little bit more about the top line by sector?

Scott Davis (?): We're really not at the point, Dan, to having all the specifics on that.

We certainly expect the, you know, the logistics supply chain group to show the highest growth.

International, especially with a little bit of the tailwind on the currency, is showing some great results.

And we feel good about that too (ph) on the (ph) momentum.

And then the domestic would be most dependent upon the economic recovery.

So we don't have specifics yet, but we'll share more as we get a little closer.

OK.

Do you see improvement in each of the operating segments in terms of operating margins?

You talked about now being in line with the 13 percent growth, but there's a big difference between the six percent (inaudible) you're putting up this year and 13.

Scott Davis (?): Yes.

No.

We see - we see all three segments showing good improvement next year.

I think you're seeing that already this year in the non-package international, but we're showing good improvement.

Domestically, obviously is the area we've got to get turning around and showing better improvement.

But still most competitors would love to see a 13, 14 percent margin.

We're unhappy with that.

We will see some improvements in 2003.

Gotcha.

Can you tell me on the pension side you said that the pricing was done on September 30.

And I believe you said in your comments it put you (ph) 53 (ph) percent below 100 percent funding.

At today's prices you would be at 100 percent funding.

At today's prices, would the guidance you gave on the pension cost increase still hold?

Scott Davis (?): No.

It would probably come down some.

You know, the dramatic change in the funding of the PBO (ph) was due to the discount rate change.

The actual discount rate change went from seven-and-a-half to six-and-three-quarters.

The draw (ph) of PBO (ph) increase was almost $1.3 billion from last year.

So clearly, a discount rate has a big impact on not just only the funding levels but expenses going forward.

Gotcha.

When you talked about Asia and Europe being on trend from prior quarter growth rates, you talked about both being in the 15 percent range, isn't that a slight decrease in the overall growth in Asia?

I thought it was up, you know, closer to 20 percent?

Scott Davis (?): It is.

We've been doing extremely well in Asia since the latter part of last year where we started good growth.

We're up 15 percent - we're up 15 percent - we're up 17 percent in the second quarter, 15 percent in the third quarter.

We actually had gross about 20 percent in July and August.

We fell off some in September due primarily to a slowing of the semiconductor shipments.

But we've seen a bounce back in October where growth is back on a very fast track in the fourth quarter.

Fast track back in line with the July and August?

Scott Davis (?): Correct.

Great.

Thank you.

No more further...

Thank you.

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

Please go ahead with your question.

Ken Hoexter, MERRILL LYNCH: Good morning, Scot and Kurt.

Kurt Kuhen (?): Good morning.

A couple of questions.

First, just the strength in the air - next day air market was a lot stronger on the volume side than I guess we were expecting.

Is there any trends that you're seeing there or is that strictly related to the more kind of port avoidance?

Secondly, on the domestic side, actually on the margin side, we've been talking I guess (inaudible) benefits expenses seem to be relatively in line with where they were last year at about 58.2 percent of revenues.

Is there some other non-employee expense that kind of hurts the margins overall?

Kurt Kuhen (?): Well, first on next day air, clearly the growth in the quarter was driven an awful lot by comparisons with September 11 a year ago.

Yes, we think domestic air, the next day air business is doing pretty well, but it still wouldn't not have been positive for the quarter without the comparisons against last year.

Going forward, we still think that express next day air will grow at or above the ground rates in the future.

Clearly, what will drive that is the economy coming back and manufacturing and wholesale coming back.

As far as the margins and the question there, there really is nothing dramatic, I think, in the cost for the quarter other than the health care, which is up more than it has been - more than we expected it to be.

Scott Davis (?): And I guess one other thing, Ken, and we mentioned it briefly on the call, is that when as sign a new contract, there is some front loading of wages.

With a - with a new six-year contract, all seniority employees did receive an increase on the date of the contract.

During a normal year, those increases happen on the employee's anniversary dates.

So there is some front loading in these - in - when you get a new contract.

Over the next couple of quarters as we cycle over when those employees would normally get their increases, that we'll mitigate and will recover some of that.

Plus the other significant issue is that there's our part-time workforce, which is more fluid of college students turns over, we bring those new part-timers in at the starting rate that will remain unchanged for the next six years.

So there are some moving parts in the way that the, you know, the labor contract works that does add a little more cost into the first quarter or two.

OK.

Any update on the OPL (ph) settlement?

I know you guys announced it in the last queue that it was all settled.

Have you - are you prepared to make any further statements on that?

Kurt Kuhen (?): Well, it's not, Ken, all settled at this point in time.

We had a handshake at the end of the agreement with the IRS.

Unfortunately, there's a process you got to go through.

We're trying to get the final definitive agreement down.

And part of getting the final at the end of the agreement, is you need a joint congressional approval when you - when you have refunds.

So that likely will not get done, our best guess would be late second quarter, third quarter next year.

And we'll - as far as recognizing anything, our financial statements will not do that until we have a definitive agreement.

We're very optimistic we'll get it done.

We hope we'll get it done next year.

Sounds great.

Thank you.

Thank you.

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

Please go ahead with your question.

James Valentine, Morgan Stanley: Great.

Thanks.

You know, I'm just thought maybe you would explain a little bit more on the whole pricing issue.

And I'm glad you dispelled these, I guess, unfounded rumors that there's price discounting going on because we're not seeing it from shippers and even UPS - FedEx has said they have no intention of discounting relative to you on the ground.

And given the fact that your healthcare costs are going up, you get this new labor contract, we're hearing from shippers that they're saying that they're hearing from their UPS salespeople to expect annual - the annual price increase to be announced later this year to be at the higher end of the historical range.

Last year it was three-and-a-half percent.

That is the higher end.

We're wondering, you know, if you can get some feel for in terms of modeling for next year's earnings, if we're looking at three-and-a-half, maybe even as high as a four percent increase in ground rates?

Scott Davis (?): Well, Jim, we're certainly currently reviewing our options for 2003 rate increases.

You know, actually the cost in this contract is comparable to what we signed in previous years.

So the labor contract is not going to have a big major impact in our cost.

You know, I think - I think some of the - as a follow on to us getting the contract ratification, you know our competitors have been out to scare our customers with the big rate increase forthcoming.

I guess it's part of their tactics.

We have a history of a pretty stable rate increases over the last over many years.

So we see no reason to change that in the future.

OK.

So likely it's somewhere in the historical range, the kind of two-and-a-half to three-and-a-half percent?

Scott Davis (?): It'll be in the historical range, yes.

OK - great.

The other question, I had has to do with purchase transportation.

It was running at five - over five percent of revenue in the quarter, ran as low as 4.4 percent of revenue in the second quarter, and we were really impressed with that.

And in fact, I think it came up during the conference call that you guys said you weren't flying as many third party charters, and just running that part of the business better and tighter.

I know some of this has to do with logistics follow through, but trying to understand, you know, I guess for most companies, it wouldn't be a big deal.

But given the size of your company to see if, you know, 70 basis point increase in a line item as a percentage of revenue is meaningful.

Trying to get some understanding at how sustainable this is or will it go back down to that second quarter run rate?

Scott Davis (?): I think the third quarter was a little higher than what you'd expect going forward on purchase transportation.

So I think you'll see, you know, at least that level of transportation being somewhat flat in the future and not up.

But over the third quarter, it was really - some of the growth (ph) in the international business we did have additional charters and common carriage related some of the Asia cargo growth that we saw.

And if you remember, cargo revenue grew 17 percent in the third quarter.

So there was some more additional purchase transportation involved there.

We also saw a very slight increase in (inaudible) rates in the quarter.

I think going forward, we're (inaudible) the purchase transportation will remain under control.

Kurt Kuhen (?): Hey, Jim, just to add a couple more things, the - you know, the flip side of the stronger euro currency also that has boosted the revenues is also to increase some of our incurred expense in Europe.

So there was a - there's a diverse effect there that those European denominated charges for agents and common carriage gets converted to dollars that shows an increase.

What kind of common carriage would you have in Europe and Asia?

Kurt Kuhen (?): The smaller countries, you know, where our brown tails don't fly directly, then we would make some use in the - you know, certainly the third world and some of the most remote countries.

Oh - OK.

Great.

Thanks.

Thank you.

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

Please go ahead with your question.

John Larkin, Legg Mason: Yes.

Good morning, gentlemen.

A question on the guidance for next year - the 13 percent growth assumption for net income, which I guess, has been your historical average.

Can you give us a little more college on the underlying economic assumptions that are attached to that guidance?

Are you assuming a normal economy for the entire year?

Or are you assuming that every economy returns to normalcy in the second half of the year?

What exactly are the assumptions?

Scott Davis (?): Well, John, I think we're seeing an economy that is improving in 2003, although not at a real fast pace.

We actually start off our forecast showing GDP growing in the first quarter just a little over two percent.

As the year goes on, we see by the end of the year, from Q4 growing nearly four percent.

So we'd say a good gradual recovery, but back end loaded in economy.

OK.

Another question regarding the U.S. domestic package business, I think there's a perception out there that there's really only one other major competitor and they're gaining some share.

Are you seeing any other share losses to what I would call smaller regional type players, or zone skippers, or the USPS?

Scott Davis (?): No.

I think overall, I guess if you look at the ground market in general, you know we think that the ground market has over 20 million packages a day generally.

We probably have slightly less than half of that overall market today.

Slightly less than 50 percent.

You know, the largest competitor out there is the post office with probably four to five million priority mails and packages and about a million parcel post.

We think probably a quarter of the LTL (ph) shipments can be small packaged compatible and be part of the ground market.

As I said, there are many regionals and small local package carriers that compete with us.

But an overall market, we think we're doing fine.

We're holding our own.

You know, Federal's (ph) had some good gains over the last couple of years.

A lot of that came selling against our contract negotiations.

Now beyond that, although, I think we've actually held our own and gained some market share against the other competitors.

OK.

And then one last question on the UPS freight services gross revenue line, which was up a very strong 40 percent.

It appears that the UPS freight services net revenue line was almost flat.

Could you give us some color on what was going on there?

Scott Davis (?): Well, that is primarily related to - and I referred to it earlier, is - it was the that margin squeezed somewhat the cost, the transportation increased during the quarter So that obviously squeezed the margins, which is really the net revenue you see out of - out of the freight services group.

That was true across all modes, I presume?

Kurt Kuhen (?): Yes, it really was.

It was both - I mean, the ocean and air both were up fairly...

Scott Davis (?): Yes.

There was 25 to 30 percent contraction in the margins.

All right.

Thank you very much.

Scott Davis (?): Yes.

Thank you.

Our next question is coming from Steve Jacobs of US Bancorp.

Please go ahead with your question.

Stephen Jacob, US Bancorp: Good morning, Scott, Kurt.

Good morning.

Good morning.

You have a nice increase operating profit wise and non-package year over year.

Could you give a little detail, in terms of the pieces, with regard to the operating profit for the fixed rate (ph) services and other.

Scott Davis (?): Well, I think we're - you know, we've shown good stability in freight services.

We've actually - this is our fourth quarter in a row that we've shown profits in freight services, so I think the first quarter after the acquisition of Fritz (ph) we didn't make money.

Since then we have generated profits.

So good progress there.

On the logistics side, we're still showing improvement each quarter.

Service, parts and logistics which referred to, which showed 25 percent organic growth in the quarter, has gotten better every quarter for the last seven or eight, so great progress there.

We also had some nice wins in Europe and Asia on the supply chain side of the logistics group.

So we're seeing good steady progress across all fronts.

Is the logistics still operating at a loss though?

Kurt Kuhen (?): It is just slightly at an operating loss on its own, in the third quarter.

We anticipate it will be profitable in the fourth quarter.

OK.

And then on the other side, your comments with regard to your supply chain wins, will that resulted in profitable - at the operating level, with regard to the other ...

Kurt Kuhen (?): Absolutely.

I mean I think we're signing good contracts, the more (inaudible) that get in the books I think the more profits will improve, going forward.

However, we're very optimistic on the trends in this business going up in the next several years.

And our objective is to get to a 10 percent margin four or five years out in this business and that - there's nothing there that says that we won't achieve that.

Scott Davis (?): I guess, Steve, just add a little more color, you know we do have a lot of work we're doing in that segment.

The integration work is very intense right now and so it's still a work in progress but, you know, we're doing a lot of things, reorganizing and streamlining the business, so we think both of the - at the revenue side and the cost side, we'll see some improvements.

That was my follow-up question.

I would assume, then, that your comment with regard to accelerated integration, will also have some operating income leverage - operating expense leverage.

Scott Davis (?): Well, we certainly expect that.

I mean we think that we can pull as much as - from the operating expense, as we can pull cost down, with facility consolidation, we also see significant improvements in the SG&A.

We think we can pull our SG&A expenses down by 20 percent.

That would probably equate to three or four margin points and that business.

OK.

And then the other question, what's the current surcharge, placed on your index, for fuel?

Scott Davis (?): Well, I think in November it goes to 1 1/4 percent.

It's maybe the highest we spend this year and we're certainly well below the competition in surcharge.

OK, great.

Thanks a lot.

Thank you.

Our next question is coming from Jim Winchester of Lazard.

Please go ahead with your question.

James Winchester, Lazard: Yes.

OK.

You've opened - I guess answered most of the questions but I have one or two more line item issues.

One is, could you give a little bit more color on the sequential change both in investment income, interest expense.

Investment income is up 10 million quarter to quarter and interest income is down about 15 million.

And, also, on the DNA (ph), if you wouldn't mind commenting.

That moved up a bit in the quarter, what the run rate should look like.

Scott Davis (?): Yes.

The - you know, the investment income is still significantly below last year and that's primarily because the rates are about half of what they were a year ago.

Our balances are up slightly versus the previous quarter, although not dramatically.

And on the interest expense, we're significantly below last year.

Clearly, the rate drop there has helped also.

Our effective interest rates are down from around a percent or so.

And, Jim (ph), I missed the second half of your question.

Just a question on the DNA (ph), which jumped up a little bit in the quarter, and also on the investment income interest expense.

I guess my - one of the questions I would like you to answer is whether there were any items in there that caused a difference from the previous quarter?

Or if this is just, basically, being driven by cash balances and interest rates.

Scott Davis (?): There's occasionally some capitalized interest that can jump around as we finish major projects.

That's probably the only real volatility outside the interest rate issues.

As we wrapped up the Hub 2K (ph), sometimes those numbers can move a little bit.

So do you - would that also reflect, basically, the transition in the DNA line?

You're saying that maybe some of the capitalized interest that you were reflecting in prior quarters came out and, therefore, now we're starting to see - we're seeing the DNA reflecting that capital?

Scott Davis (?): Yes.

That would be a little better.

But in general, depreciation and amortization was actually not up as much as it was the previous couple of quarters, so we're only up three percent and part of that was for overlapping some acquisitions last year that had additional depreciation and amortization.

OK.

Kurt Kuhen (?): Yes, the - you know it, this is really the last quarter that we're overlapping any acquisitions, so the last several quarters we've seen some significant shifts in some of those cost lines because of the significant number of new expenses brought in.

OK, do you actually break up capitalized interest in your quarterly report?

Kurt Kuhen (?): I don't think we do.

No.

Can you give us some sense of what that was this quarter and the previous quarter?

Scott Davis (?): Typically, it's not very material.

I don't have any of that information available right now.

OK.

OK.

Great.

Thanks.

Thank you, our next question is coming from Gary Yablon of Credit Suisse First Boston.

Please go ahead with your question.

Gary Yablon, Credit Suisse First Boston: Hi guys.

How are you?

Good, Gary.

Good, Gary.

I just want to get back at - you've talked a little bit about the market in the three different spots.

Can we talk specifically, when you look at the ground market business, in which you complete with Federal Express, can you help us out with the degree to which postal and LPO business should be part of that denominated.?

Scott Davis (?): Well, again, I missed a little bit of that earlier, Gary, I think that - you know, I guess people define that differently, but in our mind, we include parity mail and parcel post in our definition of the ground market.

Even if you - and that's about you know four to five million parity packages a day and about a million parcel post.

Even if you excluded parity mail packages weigh less than a pound, post offices still have over 4 million packages a day, so it would be probably the No. 2 player in the market.

Again, LTL (ph), you know we would say we get about 25 percent of the LTL (ph) passages or business would be small package compatible.

In general, we would characterize the ground market as over 200 million packages a day, which we've had just slightly less than half.

OK.

That's all I have.

Thank you.

Thanks.

Thank you, our next question is coming from Greg Burns of J.P. Morgan.

Please go ahead with your question.

Greg Burns, JP Morgan: Hi, Scott, Kurt.

Hi, Greg.

Hi, Greg.

Most of my question has been answered.

I just want to revisit the ground and maybe the pricing outlook there, and I guess, Scott, you know, FedEx Ground is out there with a sort of target of volume growth about 11 1/2 percent compound annual growth rate, which is obviously in excess of the market growth and probably about 100 basis points a share, if you believe they achieve that.

My question is, is that type of growth, by that organization, tolerable, which obviously implies some share gains or, if it's not, how are you going to react?

I mean I guess the question is will that put pressure or will you feel the need to respond in some way on price or do you really not care if they achieve their growth targets?

Scott Davis (?): Well, first of all, Greg, the ground market is a big marketplace, as I mentioned.

It's over 20 million packages a day.

And we think that we're in a position to - you know, with a single network, an integrated network, to really compete against anybody.

We're going to let our service and our reliability do the talking for us.

We think that through this year and the diversion we saw, our customers are coming back and saying they appreciate the reliability and service of UPS more than ever before.

Now, you know, any survey that I've ever seen shows that nobody compares with the service levels that UPS are offering these days.

And I think that's what's going to drive the business - to keep our business.

So, in general, we think that it's a big marketplace and we'll have plenty of opportunities to win business, Federal (ph) will have opportunities to win some business but we can - we'll do find in there with our pricing.

So, if I hear you, it's common to some price and no change to the sort of 3.1 percent average increase we've seen in ground.

Scott Davis (?): Well, I'm saying that, you know, we'll do (inaudible) competition with service.

Pricing, going forward, I think will be similar to what we've seen in the past.

OK.

And then just a follow-up.

You talked about an outlook on the U.S. economy was backend loaded in the second half.

What's your outlook on both Europe and international?

What are your guys saying there?

Obviously, there's been very strong growth out there and, you know, the U.S. still seems to be a lot weaker than those regions.

What are you guys thinking about, you know, the international economic backdrop?

Scott Davis (?): Well, we're certainly extremely bullish on both Europe and Asia.

I mean Asia is going to show strong growth for many years to come and not only you know, the China flights will have grown at big rate, you know, the new freedom rights of Hong Kong - U.S. negotiated, I think, 56 additional cargo - weekly cargo flights.

We hope to get some of those rights in the future.

We're excited about that.

We'll have to really improve our service between Hong Kong and Europe and between Hong Kong and our inter-Asia hub in Manila.

So we're excited about that.

Europe, the economy has been not doing well in Europe over the last 18 months.

Our business, you know, with the service offerings we have there, it's performing extremely well.

So I think that you're going to see - in Europe, you're going to still see small package growing as a percentage of GDP over there.

You know, we anticipate our growth continuing.

And just a final question in Europe.

Is there anything more that you want to do on a regulatory front?

You've obviously gotten some favorable action against competitor Deutsche Post, are you are happy with the regulatory system there now or do think there's more opportunity from your standpoint?

Scott Davis (?): Well, Greg, we just want a level playing field over there and as long as they play the game fairy, we're happy.

As long as the regulators keep an eye on what's going on, we're happy.

Kurt Kuhen (?): Yes.

I think, Greg, the issue is that, you know, they'd have to be monitored to make sure that the, you know, the danger of cross subsidization really is protected against.

So we've had some favorable rulings, but certainly the implementation and execution all those rulings will be important.

Great, thanks a lot.

Yes.

Thank you.

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

Please go ahead with your question?

Jordan Alliger, Goldman Sachs: Yes, hi.

Just a couple of quick follow-ups.

First, can you touch on international package profitability.

I would imagine, generally, sequentially, given the volumes that have been coming in, we should continue to see some improvement there.

And then, secondarily, can you just quickly describe, you know, what is doing well internationally and contrast that to the domestic markets, which continue to be soft?

Scott Davis (?): Well, Jordan, international profitability is something that you know we've talked about before.

We're excited about the prospects there, we think that over the next several years, over the next decade, that the margins there should get to the domestic levels, so we anticipate improving margins every year going forward in the international arena.

We're obviously getting back on track in 2002 with improving margins, and we certainly expect 2003 to improve on those margins.

As far as what's doing well internationally, clearly the, I think that the change you see, you really see it in Europe, as you're seeing small package become a bigger piece of the economy over there, the service operating to where we provide there, or to help drive that.

Also, I don't know if you've read recently, but that the European Union is looking at adding ten more countries as early as 2003, 2004.

That's just going to increase the transporter business that's doing so well for UPS in Europe.

So we're very excited about the possibilities over there.

Thank you.

Thank you.

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

Please go ahead with your question.

Dan Hemme, Prudential Securities: Hi, thanks.

I'd like to take you back to the issue of the port closures to the west coast and the related impacts.

What are your expectations I guess really in the fourth quarter for the type of recovery that you're expecting, and is there, is there any downside risk to your estimates really if there's a second closure at the end of the lockout?

Kurt Kuhen (?): No, I think the port closures, as I mentioned earlier, probably is kind of a mixed bag.

It has some negative impact I think on the freight services business.

It has a positive impact on our air cargo business.

I think we've seen in October clearly an improvement in not just freight, but also worldwide express products internationally as people shift some promotion to air.

Yes, you're not going to see a dramatic shift promotion to air, but you'll see some of that, and that'll help us on the air cargo side.

As I said, it's kind of a mixed bag for us we think in the fourth quarter.

OK.

That's it.

Thanks very much.

Thank you.

Our next question is coming from Donald Broughton of AG Edwards.

Please go ahead with your question.

Donald Broughton, AG Edwards: Good morning, Scott.

Good morning, Kurt.

Scott Davis (?): Good morning Don.

I'm looking at purchase transportation, let's just revisit that line, I know Jim already asked a question but the way it was reported last year in the third quarter, it was 464 million, as restated it's 381 million.

That's $83 million delta.

That's all as a result of the sale of the logistics unit to FedEx?

Scott Davis (?): No, no.

That was when we restated net and gross, Don, to get consistent in our treatment of purchase transportation.

OK.

Scott Davis (?): So we restated all the numbers back to the beginning of this year.

Right.

OK.

Scott Davis (?): So the FedEx - the FedEx was pure brokerage, there was no purchase trans in that.

All right.

Is there anything in your contract with the teamsters that limits the amount of purchase transportation you can use that wouldn't cause us to make this, look for this line to continue to be lower?

Kurt Kuhen (?): No, that's one of the things about our relationship with the Teamsters, you know, we pay our people the best in the business, that we have operating flexibilities in our contract, and that's the way we've negotiated with the Teamsters for many years.

All right.

In this quarter you guys had an easier comp on volume definitely generated by the events of September last year, then at least partially disguises the volume losses.

When I compare this quarter's volume versus two years ago, I see a pattern in which next day air is down 3.2 percent, deferred is down 6.7 percent, ground is down 5.9 percent, overall domestic volume's down 5.7 percent from a volume perspective versus third quarter two years ago.

I hear you expressing confidence in regaining volumes to pre-contract negotiation levels.

What's it going to take to get volumes back to the levels you saw in third quarter of 2000?

Scott Davis (?): Well that's - you know, Don the, certainly the last couple quarters we've had some market deterioration with the labor, so to try to extract long-term trends out of the quarter that had our peak diversion distorts things a bit.

So we're hanging in there from a market perspective, if you, if you take out the last quarter or two and other than that certainly, you know, this has been a brutal economy for business to business transactions, and that is about 80 percent of our business.

So clearly an increase in business investment and a, and a more broad scaled firming of the level of economic activity would be a big boost.

But, you know, we still feel that this is a great industry.

Clearly it's moderately impacted, and our earnings volatility, even around those kind of declines has been very low, and we've held in there pretty well we think.

All right.

Thanks, I'll let someone ask - else ask a question.

Kurt Kuhen (?): OK.

We've got time for just one more question, operator.

Thank you sir.

Our final question is coming from Davis Parr (ph) of Seneca Capital.

Please go ahead with your question.

Davis Parr (ph), Seneca Capital: I actually didn't queue.

Kurt Kuhen (?): Great.

Well that made it easy.

Other than that we'd like to thank you all.

This was a long call, but there's a lot of moving parts.

Clearly this is a, you know, a busy quarter for us, you know, most of you as investors have never tracked us through labor negotiations, and that's taken some learning.

But we've been through a number of them, and even though clearly there was some traction in the quarter, I think we feel pretty good going forward, and we'll continue to execute along the lines that we have for many years with a patient strategy of expanding our competitive advantage.

So look forward to talking to you all in the quarter.

Thank you.

This does conclude today's teleconference.

You may disconnect your lines at this time, and have a great day.

END 18