聯合包裹運送服務公司 (UPS) 2002 Q4 法說會逐字稿

Welcome to 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 1, followed by 4 on your touchtone phone keypad.

Now we'll turn the call over to Vice President of Investor Relations, Mr. Kurt Kuehn, please go ahead, sir.

Good morning, and thank you for joining us.

As you know, 2002 was quite a year for UPS.

We're pleased that despite the headwinds of labor negotiation and the pervasive economic weakness, the company's performance was actually better than in the prior year.

Our revenue was up 3% and both operating profits and earnings per share were up 1% over the prior year.

Overall, we held our own pretty well in 2002, given the many challenges we faced.

Our CFO Scott Davis is with me today to provide color on the results we announced earlier today and some insight into our expectations for the future.

Several events complicate the results for the fourth quarter and we'll do our best to make them understandable.

We don't want to make model building too easy for all of you.

These events include the booking of a settlement to our dispute with the IRS, a write-down in our supply chain business, a reduction in the tax rate for the quarter and the year and a change in our vacation policy.

Scott will explain some of these, especially where they related more substantially to the results, and I'll shed light on the others in a moment.

Before I do that, however, I'd like to review the safe harbor language so please bear with me.

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 slowdowns, governmental regulations, increases in aviation and motor fuel prices, cyclical and seasonal fluctuations in our operating results and other factors identified in our 10-K and other documents we filed with the Securities and Exchange Commission, all of which are available from the SEC.

Well, that said, we can get on

with our regularly scheduled program.

We showed an adjustment this period to our tax rate that lowers our taxes for the quarter and the year.

Our income taxes were reduced by $26 million, due to favorable resolution of several tax matters unrelated to the big excess value insurance case.

A similar adjustment occurred in the year 2001, making comparisons to the previous fourth quarter quite appropriate.

As a consequence, our tax rate in the fourth quarter was 36% and for the year over all, it was 37.8%.

The good news is that this benefit will extend into 2003, lowering our estimated tax rate down to 37.5% for 2003.

Now, a few words about the changes we've implemented in our vacation policy.

In the past, UPS employees were eligible for their full annual vacation after working just one day of the year.

So basically, we started off each year with a $200 million accrual for vacation pay that was worked off gradually during the course of the year.

Beginning this year, employees now earn vacation during the course of the year, so that we no longer start the year with that accrual.

This doesn't actually change the amount of vacation for which employees are eligible, but the company will realize a savings if an employee leaves during the course of the year.

All of this said, I'll now turn the program over to Scott to review the issues of a very busy quarter.

Scott?

Thank you and good morning.

As Kurt mentioned, the fourth quarter is a little complicated because of a number of one-time events, but bottom line, the domestic business showed some strengthening.

International business results were outstanding and the non packaged segment is encouraging.

As a consequence, without these one-time items we achieved earnings per share of 59 cents.

At the higher end of the range we gave you as our expectations for the quarter.

I'd like to start with the review of the domestic package business.

Volume trends for the quarter were down about 1%, which is what we had told you we thought would happen.

Deferred volumes declined about 1.5% due to the weak economy, but this was partially offset by continuing positive results in our overnight air business.

Adjusted domestic operating profit was down 9% as a result of volume declines.

By the end of the quarter, we had regained approximately two-thirds of the volume that had been diverted as a result of our labor negotiations.

While additional volume should return over the next couple of quarters, our primary focus now is on growing the business with new volume.

In doing this, we're committed to a philosophy of controlled profitable growth.

You probably notice that domestic package yield showed a lower increase than in previous quarters.

That's a result of a new methodology we adopted in the quarter to determine deferred revenue, which is revenue due for packages picked up but not yet delivered by year end.

We hone this process every few years.

The increased amount of electronic data we now have on each package enable us to adjust this figure more precisely than was possible in the past.

This had the effect of negatively impacting revenue per piece.

Without this change in methodology, revenue per piece would have been .7% higher or up 2% for quarter.

Consistent with the third quarter increase.

Now, a few comments about our peak shipping period in December.

We've noticed a trend in the last few years.

Peak shipping volume days are getting closer to Christmas, most likely because shippers are increasingly comfortable with the reliability of our service offerings.

The holiday season started slowly but picked up throughout December culminating in our peak day of over 19 million packages above our expectations and above the prior year's peak day.

Holiday shipping was impacted by increased reliance on electronic commerce.

Most surveys show electronic commerce increased substantially in 2002 with UPS being the carrier of choice for on-line shippers.

Our top 10 customers with substantial internet shipping posted a 15% increase in December sales, compared with a year ago.

The UPS Web site received over 9 million tracking requests on December 23rd, our busiest tracking day.

A discussion of peak performance wouldn't be complete without some mention of our new world port facility in Louisville.

Much like a new car, this is our chance to take it for a test drive at high speed.

And we're pleased to say it handled well and performed beyond our expectations.

Overall, productivity increased over 40%.

We operated this facility with significantly fewer people than we needed to handle 2001's peak period.

International customs offices are very enthusiastic about world port where our target search capability lets them pinpoint which package they want to inspect and electronically delivers those packages to them.

It enables customs officers to inspect more packages and it speeds up the process for inspective and un-inspective pieces.

In addition, international packages can enter the system anywhere in the building without special handling.

While efficiency inside the facility is important, world port has a huge impact on the efficiency of the network as a whole.

With increased capacity at world port, we can handle larger planes carrying more volume and reduce sorting at regional hubs. [inaudible] central hub enables us to gradually upsize our aircraft lead adding larger and more efficient MD-11s and A 300s while continuing to phase out the older, smaller 727s.

We're very pleased with world port's roll in servicing the surge of inbound international volume from Asia in the fourth quarter.

A nice segue to my remarks on international business.

UPS's international operation were outstanding in the fourth quarter, significantly above expectations for revenue and profits.

Adjusted operating profit was up over 130% to $154 million, making this the best quarterly performance ever for this segment.

Even eliminating the $35 million boost to profitability from the Longshoreman's lockout, profit still would be up 80% over last year's results Our international operations achieved an unprecedented 12% operating margin for the quarter or 9.5% without the benefit from the lockout, particularly heartening is the fact that this record quarter follows the best third quarter we've ever had for international business.

All of this was achieved in an environment of continued weak U.S. exports.

Export volume increased in all regions of the world.

Volume from Asia was up 24% and Europe posted a 13% gain.

In the quarter export volume out of China was up over 60%.

Other regions were up modestly, including the US where volume has strengthened for the second consecutive quarter.

The decline in non U.S. domestic volume is due to weakness in the European economy and our increased focus on revenue management.

We showed solid gains in revenue per piece even after currency adjustments.

Revenue per piece for all international products was up 11%, adjusted for the impact of currency.

This was helped in part by rapid growth in higher yielding Asian export products but there was real yield improvement in all areas of the world.

Asia was extremely busy in the quarter.

The Longshoremen's labor problems had a substantial impact on the quarter's results.

To help our customers cope with this disruption, UPS pulled out all of the stops.

We operated over 100 more flight segments this year versus last year and many people worked around the clock.

As a result, we moved an unprecedented amount of freight and packages on time.

The combination of our small packages and forwarding capability proved to be a great combination which we believed helped strengthen customer relationships.

Going forward, we're looking for great things from this business.

Turning now to the non package segment where our supply chain solutions group, comprised of logistics and freight services, is the largest piece.

Revenue per logistics was up 27%.

All of which was organic growth.

We're pleased to share with you that the logistics operation obtained profitability in the quarter reflecting a combination of solid growth and cost reduction.

We achieved good international growth as we execute more global solutions for U.S. clients.

In fact, slightly over half of the supply chain solutions group revenue in the quarter was generated outside of the U.S.

Freight services posted flat revenues just as in preceding quarters and will likely continue this way until we overlap the loss of the FedEx brokerage business in March of this year.

Revenue would have been up about 4% without the loss of this business.

Freight services experienced a significant increase in air forwarding with west coast disruption but this was partially offset by a drop in ocean business.

The lack luster U.S. economy is a major drag on this business.

Within the supply chain solutions group a major effort is underway to educate and train our local salespeople about the full range of service offerings.

We're training our freight forwarding sales people how to sell service part logistic services, and vice versa.

Our sales pipeline is beginning to show increases in both new leads and contracts in active negotiations.

Once our entire sales force is trained, we should see the pipeline continue to expand.

The integrated enterprise portfolio we offer is fueling growth by expanding the SCS footprint among key accounts.

In other words, we're growing by providing more services to current clients.

As you know, we spent the last year in an intense three-phase integration effort to align the business rationally and improve efficiency and effectiveness.

With 26 acquisitions in the Non packaged segment of the last four years, there are substantial synergies but also some overlap, including excess space, excess personnel and too many IT systems.

Through integration will significantly reduce cost in infrastructure without any loss of capability.

We intend to reduce our total SCS space by 2 million square feet going from about 860 facilities to 750 by the end of 2003.

To do this, we're merging brokerage, logistics, freight services and warehousing into a common organizational structure.

We're also reducing our work force by nearly 800 people across all geographies and all levels within the organization.

Lastly, we're consolidating IT support.

We spent a year in exhaustive evaluation to select those systems most extendible to meet our needs.

For example, we've gone from 9 to 3 warehouse management systems and from 42 to 8 web sites to support customer interface.

As a result, we'll take $127 million write down this segment of our business. $106 million in the fourth quarter.

The rest will be recorded primarily in the results for the first half of this year.

The write down is divided equally between reductions in staffing, IT systems and facilities.

We expect to realize $ $75 million in annual savings once this process is complete in mid-'03.

With a portion of those savings realized in this year and the full benefit next year.

This integration will make us a financially stronger organization and better able to add more value with less cost.

There are two other topics I want to mention before I get into comments for our Lookout outlook in the first quarter of 2003 and beyond.

This is our successful settlement of the IRS case in an impairment charge for an acquisition we made in 2001.

We're very pleased to report that our dispute with the IRS over the excess value insurance tax issue has been resolved.

UPS is booking a pretax credit for over $1 billion to reflect the reduced tax and interest liability, compared to what we previously recorded.

The settlement centers on an agreed transfer price and adjustment between UPS and the offshore company that had been providing excess value insurance to our customers.

The exact timing of the cash flows to the company is not certain and will depend on the resolution of various other tax issues in the tax filings for the years 1985 through 1999.

Since we have settled all issues related to the 1984 tax year, it's likely we'll receive approximately $140 million later this year.

We have booked the refund as a credit to other income in the fourth quarter.

The end return portion will continue to earn interest until the years are closed and cash will be refunded to us or applied to liabilities for other tax issues as our remaining tax years close.

The other topic I want to mention briefly is an impairment charge.

Over the last four years, UPS made 26 acquisitions at a total cost of about $1.5 billion.

Throughout 2002 we Performed vigorous testing to these evaluations and the value of goodwill associated with those acquisitions.

Mail technologies is a software system that integrate print production and mail processing through the use of proprietary technology platforms is the only one that's not retained the evaluation that it commanded in the hay day of technology acquisitions.

Therefore we're taking a $72 million impairment charge as a reduction of goodwill which equates to just 5% of our total acquisition investment in the last four years.

This charge affected first quarter of 2002 results as required by the FAS 142 accounting rule and is a non cash event.

Speaking of cash, let me talk a bit about our cash flow, which continues to be a Hallmark of the company.

We controlled cap ex well and came in below $1.8 billion.

Pre cash flow was $3.4 billion of which we used $700 million to pay down debt.

In addition, we spent $500 million to repurchase shares and paid $800 million in dividends.

With the pace of acquisitions moderating and capital corporate requirements stabilized, we generated significant cash, ending the year with $1.4 billion more in cash and investments than we had a year earlier.

As a consequence, we finished 2002 with a long-term debt to equity ratio of 28% and a long term debt to total capital ratio of 22%, not bad, given the tough challenges we faced in 2002.

We expect cash to continue to be strong going forward.

The domestic operation is a strong generator of cash flow.

International is a great growth engine, but capital requirements moderating since the network is about built out.

In the supply chain operation has established its global presence requiring only modest reinvestment in the business going forward.

In addition, we have over a billion dollars coming back to us over time from a pretty reliable credit, the U.S. treasury.

Now, let me turn to our outlook for the first quarter in 2003 as a whole.

We remain cautious in the short-term.

At this point we don't see any catalyst in the economy that would spark a quick recovery.

We expect domestic volume to be about equal to last year for the first quarter.

We look to gain momentum as the year unfolds and we overlap weak quarters resulting from last year's labor negotiations.

We believe first quarter earnings, which were 50 cents per share last year will be in the range of 48 to 53 cents per share.

Earnings will be impacted by increases in Pensions, healthcare and worker's compensation cost.

We're more bullish on the rest of the year.

If The economy strengthens Gradually as forecasters predict, we should see a 10% to 15% increase in earnings per share for the year.

Current trends should continue in our international operations.

We expect to see strong export volume growth in a 20% or more increase in profitability for the year, even overlapping the exceptional fourth quarter we just experienced.

We also expect continued improvement in the non packaged segment, which should post $100 million improvement in profitability.

As restructuring takes hold, the supply chains solutions group should generate revenue growth in the low teens, depending on economic improvement.

In our capital expenditures for this year should come in around $2 billion.

To summarize, looking back over the 2002 year, I'm very proud of this organization.

We maintained our earnings on a par with a prior year, even with the challenges of contract negotiations and an under underperforming economy.

It was tough.

UPS is pulling together and made it happen.

Looking forward, the company is strong and moving ahead rapidly to expand its competitive position in our industry.

Thanks much for your attention and we'll 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 the 1, followed by 4 on your touchtone phone keypad.

We'll take as many questions as time permits.

I'll take them in the order in which you signal us.

We'll pause for just a moment.

Thank you.

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

Good morning, Scott and Kurt.

Good morning, Scott.

A couple of quick ones, and not trying to get you to forecast what's going on in Washington, because nobody quite knows what comes out, but one of your historical views of buyback versus dividend has been that the taxing efficiency of dividends has been such that you preferred to look at stock buy buyback as a way to repatriate cash to shareholders.

How has your views changed depending on tax policy shifts in Washington because obviously, as you mentioned, you're building quite a bit of cash relative to needs for the business either, at least in your terms, strategically or for ongoing cap ex.

That's a good question.

Our dividend policy, which we review initially in the year in February board meeting and evaluate it ever quarterly board meeting after that, but we look at facts and circumstances.

What really drives it for us, our first choice obviously with excess cash and capital is to reinvest it in the company.

So if we have acquisitions or cap ex requirements that meet our [inaudible] rates, that where it goes first.

Beyond that, you have a good question.

In the past, clearly stock repurchase was a more efficient way for us to put cash back out to the share owners.

If this tax law does change, that changes it.

In other words the dividends may become more efficient or as efficient as stock repurchases.

That would impact stock buyback versus the dividend policy going forward.

We'll see what comes out of Washington, though.

And one other question.

You had mentioned the strong peak relative to last year.

How much of what strengthening you may have seen do you believe may have been a result of sheer gain that you are taking from the postal service with priority mail being a less attractive value proposition for a lot of these shippers relative to yourself or other small package delivery entities?

Scott, probably some of the growth may have come from that.

I think in general, though, the UPS has been the shipper of choice for holiday shopping.

I think we saw good gains in E-tailing, I think it was up 15%.

Clearly we've been the dominant choice in that market.

I'd say a bit from the post office, but in general, I think it's comparable to prior years.

It's most notable in some of the lighter wait sales, clearly the area we have seen a little bit of that.

It's not a huge impact at this point.

All right.

Great.

Thanks very much.

Certainly.

Thank you.

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

Good morning.

How are you?

Scott, can you talk a little bit more on the international front in regards to margin, even taking out what you talked about relative to the ILWU?

You had a very strong improvement there.

What kind of things are going on company specific going forward, how comfortable do you feel about the pace of improvement as it relates to that margin?

Gary I've talked an awful lot about long term that we see international as obviously a very strong segment where we'll continue to have good growth on the top line, and we expected margins over the next 10 years to get close to the domestic margins.

Fourth quarter obviously, we got there quicker than we thought.

I wouldn't anticipate that we will see that type of margin improvement going forward.

We'll have steady margin improvement.

I've always said that I would like to see us improve those margins by 1 to 200 basis points per year for many years to come.

That's the way we're going.

I think our network is getting pretty well complete.

We're seeing great growth in Asia.

Europe, we've had 5 years of an annual [inaudible] of over 20% of revenue growth.

We’re optimistic we'll see that going forward.

China, 60% growth this year, good profitable growth out of china.

Okay.

And if I could just follow up and ask a question.

With the supply chain side of the house coming together for you, some of the restructuring moves you're making, pushing that along faster, could you talk a little bit about how that might better cross sell with the core business?

Well, I think we've really made an effort over the last couple of years of putting together the sales forces where the core sales force joint sell with the SCS people.

We really -- the SCS sales force consolidation-integration started almost a year ago.

So I think we're farther along that way than we are on the operational side at this point in time.

We're seeing an awful lot of opportunities.

I think you saw it during the west coast work stoppage where joint teams went out in between the package business and the freight services business we were able to solve customers problems.

Good progress in that area.

All right, thank you.

Thank you.

Our next question is coming from Edward Wolfe of Bear Stearns.

Hey, Scott, hey Kurt.

If you had to say what felt weaker than the rest of the operations in the quarter, it would be the domestic margin and domestic operations.

Backing out some of the things that you said, if you assume $35 million of the profit in international was related to the west coast ports, you still have an operating ratio of 90.8, which is substantially higher going forward than what we have in our model for international, and when you look at the non package guidance you gave of $100 million in operating income improvement year over year, that's higher than we have in our model as well.

I'm guessing based on your guidance, we're too optimistic on the domestic side.

I wanted to get a sense from you on the cost side domestically how much of the worse year over year OR we've seen since around the strike issues is related to the new contract and how do you leverage that over time and what other issues are involved there?

Well, certainly the -- in the fourth quarter, the volume still -- still being down 1.3% had an impact and squeezed the margins.

Beyond that, the -- I think the contract wage increase, we talked about it and it is front-end loaded.

You have more pressure in the first few quarters of a new sign contract.

That'll ease as we get later into the year.

You will not see as much in the way of comp and benefit increases going forward.

Another thing that hurt us in the fourth quarter, Ed, was the fuel prices.

We had roughly a $28 million increase in fuel costs for the quarter.

And actually had no benefit in surcharge revenue.

Last year, if you recall, we had a 6 surcharge and converted in the fourth quarter to the index fuel surcharge.

If you look at actual surcharge revenue between the two quarters, they were flat.

That's something that you saw in the fourth quarter.

You won't see that going forward.

Where is the surcharge now as we go forward?

1.25% and March it goes to 1.5%.

We have been below the rest of the industry in fuel surcharges.

Can you talk a little bit about china.

You alluded to the growth there.

There have been some recent new regulatory issues in china where they are allowing U.S. express carriers to own up to 75% of partnerships up from 50.

Does that change the view of how you are participating in china and what your expectations are going forward and what are some of the longer term goals there?

Clearly we've been very happy with our relationship with Sinotrans, our joint venture partner in China.

We've seen at this point in time no reason to change that relationship and no reason to change the ownership percentages.

It's worked well.

We've been profitable out of china.

Growth has been excellent.

In 2005 I think is when WTO actually opens it up for outside ownership up to 100%.

It will be evaluated down the road.

Right now we're pleased with the Sinotrans relationship.

And one last question as a follow-up to the dividend question.

I've gotten a sense from you guys that you've been looking at increasing the payout on dividend before the Bush proposal.

Is that something that is a fair comment regardless of whether that goes through it's an issue that you are looking at, increasing the dividend payout?

The board will sit down and evaluate that and they do it every board meeting.

In February, we try to determine an annual policy.

It's facts and circumstances.

It depends on what else we can do with our cash.

Again, if we reinvest our cash in the business, that's where it'll go first.

We’ve always been a strong dividend payer.

We tend to be going forward.

But that's up to the board, we'll do that in February.

Okay, thanks, Scott.

Thank you, our next question is coming from Dan Hemme of Prudential Securities.

Good morning, Scott, Kurt.

Can you talk about what your expectations are in the forward year regarding the domestic competitive environment for parcel traffic?

What are you using?

What do you see from a pricing standpoint?

Well, domestically we're optimistic.

We think that from a pricing standpoint, you know, we think the pricing is rational.

We think the rate increases were strong this year for our sales center and our competitors.

We don't see any weakness in the pricing going forward.

Competitively, I think that likely if we get any help from the economy, we should be able to grow our business, you know, at GDP or slightly above GDP going forward.

Our own assumptions on GDP are reasonably conservative.

We're looking from really the first three quarters to be in the mid-2s and maybe the fourth quarter up to the mid-3s.

So, again, that's the assumption we're basing the forecast on.

Pretty consistent with consensus out there.

That's a quarter -- a year over year GDP number.

Not quarterly.

We're seeing steady progress in winning back some of the volume, we did mention that we've gotten over two-thirds of that back.

Some of that will cycle through.

We're back out certainly selling the overall UPS portfolio.

We feel good about the competitiveness.

And one other quick question.

Have you had any changes in your long-term growth expectation for the non package business?

You in the past talked about a five-year view.

No, I think it's pretty much the same.

We're looking at next year to be in the low teens, revenue growth.

Certainly a little help in the economy will boost that up.

It is slower coming back than it expected given the growth rates a year ago, still, we had good growth in '02 and we've project projected growth in '03.

A economy boost would help it.

Our next question is coming from John Barnes of Deutsche Banc.

Good morning guys.

Good morning, John.

Could you on your cap ex guidance, could you give us a breakdown a little bit by category between revenue, equipment and the like?

Pretty consistent with what we have done in the past.

We expect roughly 40% of next year's $2 billion to be in the airplane area, 30% in building facilities, say 20% in IT and the balance in vehicles.

Okay.

During the fourth quarter, it looks like you took on much fewer -- many fewer part-time employees than historically, with the peak shipping season shrinking down to fewer days around the Christmas holiday.

Do you expect that ongoing that you could see less and less part-time employees in the system.

That's not necessarily a trend.

Clearly volume was down a bit, so we had a need for less peak hiring than we normally would.

The world port with its increased efficiency has moderated the needs locally but that is not a dramatic impact.

It's really driven by growth.

As the economy picks up and we gain momentum, we'll be looking for lots of good college students to help staff our hubs and sort packages.

There is no real structuring change going forward.

Okay.

And then in the fourth quarter, you obviously saw the benefits from the west coast port.

It looks like you've got two other issues floating around in terms of ocean activity, one potential strikes at the European ports.

I think a couple have occurred.

You have the implementation of the 24-hour advance manifest filing in some of the Asian countries are not yet prepared for that for February 1st.

Are your customers beginning to call and say, you know, we need air freight capacity starting on February 1st or are there some of those fears running around?

We haven't heard too much.

Europe is still pretty spotty.

We're working hard to get our systems in place to facilitate full compliance with this 24-hour advance notice.

Certainly being, you know, very tech capable, we think we'll be at an advantage in helping customers work through some of these new restrictions, but so far we don't see this as being a major dislocation either way.

John, we are more concerned about some of the other straw man proposals that came out of the custom department regarding 8-hour electronic manifest for air and advance on rail.

Those have been rescinded, and pulled back.

I think customs is going to spend time talking to companies and understanding what the impact would be.

We likely won't see regulations on that until October.

Okay.

And I guess, the new -- the lot has taken over for Hutchison on the Sinad aviation committee.

Hutchison was big on cargo security.

That was a big push for her.

Do you feel like some of that is off the table with Lott taking over?

I don't think it's off the table.

We're very interested in cargo security ourselves.

I think we've got some systems set up that are -- that make us feel pretty good about security.

I don't think that'll change it dramatically.

Okay.

Thanks, guys.

Thank you.

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

Can you hear me?

Yes.

First, the impact from the change in revenue recognition at the package division.

Does that have a corresponding cost associated with it or should we look at that as having impacted the profitability for the quarter?

It was really a combination, but you know, basically there are more packages in the network and we do exclude the costs spent on those packages.

There was a slight impact on profit, but not a significant reduction.

It did impact revenue per piece in the domestic for the ground by about .7 of a percent.

That's a one-time adjustment.

As we said, we expect to be back on a more normal trend after that.

Jim, we used to use an average revenue per piece on the deferred packages.

With the electronic data we have now, we know which packages were not delivered.

The packages not delivered are longer zone, higher revenue per piece.

That's why it distorted the fourth quarter revenue per piece.

That'll not happen in the future future.

Good.

I had a few market share issue questions.

We look at deferred packages down about 2%.

And the post office has shown their numbers down about 10% and FedEx for a comparable were up 7%.

I'm trying to understand as a follow-up to Scott's question earlier, except I'm coming from a different angle, to me it looks like you are not keeping up with that market share, but maybe I'm missing something out in the market place.

It depends how you define the deferred market.

If you are talking priority mail, we bunch that in with our ground product.

Volume we see shifting from priority mail most times will end up going into ground products, not our premium two-day air product.

So that sector is a little noisy, Jim, depending on which way you slice it.

But the deferred air product is the most volatile in general.

It has the most trade up and trade down.

There certainly has been a big shift with priority mail declining, we see that as a ground market issue.

Okay.

And then in terms of domestic next-day air and your deferred volumes, if you add them up, you were flat.

Whereas you had been gaining what appeared to be some pretty good market share against FedEx, but given adjusting for 9/11, their comparable period you are only down 1% for those two and you were flat.

Is it fair to say that some of your market sharing rose by having a bundled product, where as FedEx has one, maybe some of the momentum is slowing?

I don't think you can make that conclusion on one quarter.

I think the trends we have seen are pretty strong.

We feel good about that market going forward.

Clearly the overnight we feel good about continued momentum.

I'm not clear on some of the deferred issues with the FedEx guys.

Those numbers are different than any other trends we've seen, but the overnight, we're continuing to gain share.

Thanks so much guys.

Thank you.

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

Just a couple of quick questions.

Scott, I'm curious what the customer base by category looks like, whether you've seen any changes particularly in the industrial side which I think you had indicated had been weak and the financial side which had been strong and is there any change or any changes you move into the first quarter in some of those large categories?

Well, certainly in the fourth quarter, if you look at the segments, once again, I hate to report that manufacturing and wholesale were still weak.

It's been that way for a long time and we're all looking for those industries to recover.

I would say services probably weakened a little bit in the fourth quarter, maybe a little less with the refinancing going on than we saw previously.

The one area that improved was retail for us.

You know, the late peak season we saw a pretty good strength in retail.

What does that mean going into ' '03?

It's hard to say.

There is a lot of room for improvement in manufacture and wholesale.

And another question on the cargo business, obviously is a small part of your international, but profitable in the fourth quarter.

Is it fair to assume that as that sort of panic air cargo demand subsides, not only will you see lower prices but also it'll be less attractive relative to your growing package volume?

Is that business essentially going to get crowded out as sort of the 15% to 20% growth rate will go back to 5% or 6%?

Could we see those growth rates go negative?

Obviously it would please me to see them go negative, that means we will have more express packages on the airplanes and we'll make more money.

I don't think it will move that dramatically, certainly the rates did firm an awful lot in the west coast work stoppage.

You won't see those rates going forward.

We still think it's a pretty good market, particularly coming out of Asia.

Our objective is to use cargo as a filler and fill the plane with express packages.

Scott, did the pricing on cargo in the fourth quarter enable cargo to reach a cross-over point where it's actually closed the profitability gap?

Or is it still even with the unusual rates still just much less profitable than your package business?

It closed the gap and didn't get to the package profitability.

Great.

Thanks a lot.

Certainly.

Thank you.

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

Hi, gentlemen.

Just a couple of questions.

One, what will principal payments be this year?

Principal payments on debt?

Yeah, sorry.

I think virtually nil.

We have maybe a few notes, programs that are -- that have maturities in 90 to 180 days that come due, but very little.

Okay.

And then the other question is with respect to pension, you said that I think healthcare and pension costs would be up this year.

Did you quantify that number?

Or can you?

I did.

I think in the last call I mentioned -- it's $135 million increase in pension expense for '03 versus '02 driven by the discount rate change we did in September.

Right, okay, good.

I notice that DHL is buying into Sinotrans.

They announced last night or this morning that they were going to invest around $60 or $65 million U.S. dollars.

I know that you have an express agreement with Sinotrans.

Will their ownership of this in any way affect your relationship?

No, Helane, but we've also announced that we will be an investor also.

We're investing $35 million or approximately 3% of the offering.

Okay.

So their investment in no way changes your thought process?

It does not.

And then my last question is with respect to the fuel surcharge, you said it would go up to around 1.5% in March.

I know you're one of the lowest fuel surcharges.

Do you think you would consider, given where oil is, changing the formula?

I think right now, we obviously are pleased to have the lowest fuel surcharge in the industry.

A lot of that is because we manage our fuel quite well.

We also have hedging programs in place where we have pretty much all of our consumption hedged in '03.

So we're really protected above $30 a barrel.

It gives us an advantage in working with customers that we can keep the low fuel surcharge.

And my last question is with regard to military call-up and the percent of people in your work force, would you stand to lose a lot of pilots?

We've had quite a few pilots obviously serving over the last couple of years.

It did have an impact, but I don't think it will be a major impact in operation.

We've looked.

We're pretty sure we can continue operations without disruption under most scenarios.

Right, okay, good.

Thank you for your help then.

Certainly.

Thank you.

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

I want to talk about the rate increases that you announced at the beginning of the year.

Any kind of flow-through you can give us on how those are being taken by customers?

And secondly, just the business with Asia since the resolution of the strike.

Can you talk about how volumes have gone through the beginning of this year, if we're still seeing strong growth numbers or if they've full pulled back tremendously?

First, on the rate increases, I think it's like any other year.

Rate increases have held like they have any other year.

We're pleased we're not seeing any more pushback than we would normally see.

We're confident that yields will improve in '03.

As far as Asia, no, I think the growth obviously spiked some with the west coast work stoppage.

China we've normally been running 35% to 40% volume growth.

We ran 60% in that time frame.

I think throughout '02, we showed good growth in mid-teens out of Asia.

We expect to do that going forward.

Fourth quarter was a spike.

You don't always do 24% out of Asia, but we expect strong growth going forward.

One follow up on the tax rate, you mentioned at the beginning of the call we were going to see about a 37.5% tax rate.

Is that for 2003 or is that a complete change in ongoing taxes.

We see that as an ongoing rate for the foreseeable future, so I would say beyond '03.

Thank you.

Thank you.

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

A real quick question here.

With the teamsters in negotiations with the nationwide network LTL carriers currently, do you see any pick-up in what you refer to as lesson pallet load freight.

Is that a significant portion of your ground business and are you seeing strength there?

Yeah, John, we do continue to focus on less than pallet load or LPL as we call it as a good alternative for mid-sized shipments, maybe up to 500 pounds or so.

At this point I can't really characterize that we've seen any direct impact as a result of possible diversion, but you know know, clearly we do have that capability if that becomes a need in the market.

One following question related to the J.D.

Power survey that came out a couple of months ago, which one of your competitors has been touting indicating that there is a perception out there.

Does this UPS have a view on that

survey in terms of how it was conducted, et cetera?

Well, frankly, we were perplexed by it.

There has been an awful lot of surveys including some of you on the call today who have done your own freight surveys.

Every other survey we've seen had UPS clearly superior in value, equation, reliability and service on the ground.

A lot you are showing the same thing on the air surveys.

We looked at the details, we were surprised by the conclusions that they came up with.

It's a one-op survey and the only one we've seen to come up with those results.

Thank you very much.

Thank you, or next question is coming from Donald Broughton of A.G. Edwards.

Good morning.

Certainly you are to be complimented for the cash producing and strength of the international and non package, but let's face it, greater than three-quarters of your operating profit comes out of the domestic and the line's share of that is domestic ground, so help me here.

I'm looking at the volume trends over the last 8 quarters, down 1.3%, down 3.2%, down .7%, down 1.6%., down 2.5%, down 2.4%, down 1.5%.

How do I model anything other than flat to slightly down?

What is going to change this trend.

If I go back and look at domestic volume, Don, certainly we went through a recession in '01, and anybody with an established base would see the same thing, the GP goes down.

In '02, we had the contract negotiations which had a big impact.

But a look at overall volume in '02 the first quarter was down 1.5%.

Quarter 2 and 3 we were down 2.6% and 2.1%, heavy diversion in the contract negotiations in the second two quarters.

Came back to down 1.3% in the fourth quarter and projecting flat in the first quarter.

When you get into Q2 and Q3 of ‘03, the comps will get much easier and we would expect to show positive growth and any help out of the economy would add to that.

In the same time frame we're seeing significant rises.

I understand that there are far smaller bases but we're seeing 20% and even 30% gains out of FedEx ground and nice gains out of even Airborne's ground.

Is there a point on which you decide to compete on price?

What else is out there.

They are growing and you're not.

It's a big market and again, if you look at the whole market, the ground market we've got probably is a little bit under half of the market.

The post office is clearly the number 2 player.

They are losing market share.

There are other players that you can compete with.

Like you saw in '02, a lot of that was driven by the contract.

As you look into '03, I think the numbers will come closer.

Very good.

Good luck, gentlemen.

Thank you.

The next question comes from Larry Robbins of Glen View.

Mr. Robins, your line is live at this time.

I guess we'll talk to Larry later.

We'll move on to David Campbell of Thompson.

Good morning, everybody.

I just wanted to ask you about the international gains you mentioned, $35 million benefit from the dock strike.

That was a profit and revenue benefit or just a revenue?

That was a profit benefit, David.

And the revenue would have been above that number.

Uh-huh.

And how is that calculated?

Just our best guess of the variation from what the trends were and the specific increase in cargo.

We worked pretty hard to calculate it and we're pretty confident with that number.

Uh-huh.

And on the ground operations, I've heard what you said about the competitive situation, the contract dispute, so forth.

But priority mail has been losing business and you've been gaining a lot of that, I imagine.

Is that not correct?

Well certainly that's a portion of it.

And you need to include that priority mail into the total market share to get a view of what's going on.

So that is -- we think that's a better view to look at the entire market, including those packages.

I'm just curious, what happens if priority mail stops losing business?

We will just go on -- do you think it's going to go on losing business forever?

I can't speak for that.

Clearly in a weak economy, everybody struggles a bit.

We feel real good about our competitiveness with both priority mail and the other carriers, and you know, with a little bit of perk up in business to business investment which is one of the real catalysts we're looking for, we think the ground product and the other ones can show upward momentum.

My last question is, on U.S. exports, you mentioned still weak and gave know indication that you thought it would improve.

I'm beginning to see some companies talk about better U.S. exports and just wondering why we haven't seen it it.

It's better than it was a year ago.

We did see growth in third quarter and we grew 2% in fourth quarter.

As opposed to the negative numbers, I think the market we’re seeing in total throughout a lot of '01 and '02, you are seeing some strength.

Obviously, if the dollar continues to weaken, that would help exports and help U.S. origin business.

And that export business, you are including package and cargo business?

It's primarily package business.

We're talking about 2% growth.

Thank you very much.

Sure.

The next question comes from --

We can't hear you.

The next question is coming from Jennifer Ritter of Lehman Brothers.

Good morning.

Good morning.

Hi.

Just wanted to get more color on the port stoppage and the traffic you got from that.

Did you get any of those customers to sign long-term contracts or was most of it just one-time in nature?

Well, I think a lot of the customers were regular customers that just maybe moved some shipments from ocean to air.

I think they were not new customers.

They were regular customers.

We didn't sign new long-term contracts for that.

Yeah, we do feel, though, Jennifer, clearly it was a great opportunity to strengthen relationships and, you know, our ability to scramble and move a tremendous amount of freight for customers to help them get their by peak.

It has put us in a good position to continue to gain share.

Just a housekeeping question on the restructuring charge.

Was all of that cash?

No.

I mean, as far as the SCS restructuring?

Uh-huh.

No, part of it -- well, part of it will have an impact on cash going forward when you actually terminate the leases, it's not a cash charge yet.

Okay.

Great.

It sounds like the IT write down will be a reduction of some of the asset of the books, too.

A mixture of cash and non cash.

[inaudible] severance pay for employees, which will be cash and then the lease terminations.

Okay.

That's helpful, thanks.

The next question comes from Eric Woodworth of DSM.

My questions have been answered, thank you.

Maybe just one more question then.

Our next question comes from Edward Wolfe of Bear, Stearns.

Yeah, hey, Scott, just a follow-up.

Throughout the quarter, could you give us a little bit of direction taking the seasonality out year over year of the trends both domestically and internationally and how does it feel so far in January.

Domestically, October was the weakest month of the quarter.

We were down about 2%.

We ended up the quarter down 1.3%.

So a lot of that strength came in December.

It's hard to judge November because Thanksgiving came so late.

That distorted November where it fell this year.

So clearly we saw more strength in December, which raised the overall quarter.

Internationally in the fourth quarter, it was pretty steady.

We had good strength right through December.

Probably a little more in November, but still had good strength in December internationally.

Clearly the west coast issue was pretty much over by the first week of December, as far as we could is tell.

So most of that $35 million impact was in November?

It would have been November.

October/November.

Going forward, we're down slightly, you know, in the first quarter, in January so far.

That's down slightly is volume, domestic?

What are you talking about

Down slightly on domestic volume, about 1%.

And you expect the rest of the quarter to be up slightly so that you'll break even kind of?

Right.

Thank you, that's helpful.

Great.

Well, thanks.

We will -- we'll wrap it up at this point and thank you all for your patience and endurance in helping us walk through a pretty complicated quarter.

There are a lot of one-time events, but we think the core results are still pretty solid.

We're continuing to regain momentum in the domestic and look forward to improving results there over time.

The velocity in international certainly was incredible in the fourth quarter.

Some of that was one-time, but there is still a very strong trend in that business, and we remain excited, and as we get more and more traction in this realignment in the SCS group.

It will benefit itself and grow the other two segments.

Stay tuned for further actions.

We look forward to talking to you in the future.

Thank you, that does conclude today's teleconference.

You may disconnect your lines at this time.

Have a wonderful day.