聯合包裹運送服務公司 (UPS) 2003 Q1 法說會逐字稿

Welcome to the United Parcel Service first quarter earnings conference call.

Today's call is being recorded.

At the conclusion of the prepared remarks, we will open for question-and-answer session, to ask a question please press numbers 1, then 4 on your touch-tone keypad.

Now we'll turn the call over to VPof IR, Mr. Kurt Kuehn.

Sir, go ahead.

Good morning, everyone, an thank you for joining us today.

As usual, Scott Davis, our CFO, is with me to provide insight into the results we announced earlier this morning and on our expectations going forward.

This conference call is being webcast and will be available on our IR website.

Now, if you'll indulge me, I'll start off by reviewing 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 slowdowns, governmental regulations, increases in aviation and motor fuel prices, cyclical and seasonal fluctuations in our operating results, and other factors identified in our 10K and other documents we filed with the Securities & Exchange Commission, all of which are available from the SEC.

Having said that, before I turn the program over to Scott, I want to quickly review two one-time events that affected our results for the quarter.

These include the resolution of a number of open tax issues and an investment impairment charge.

Since we've settled our differences with the IRS on the excess value insurance case that was in litigation for a number of years, we have now been able to address and resolve other open tax issues for the years since 1984.

As a result during the quarter, UPS realized a $55 million tax benefit, or 5 cents a share from resolution with the IRS of several issues regarding capitalization, credits, and other expense items for certain years.

In addition to the one-time benefit I just described, we're also forecasting that our overall tax rate for 2003 should be reduced from 37.5 to 37%.

To the second topic, the investment impairment charge.

The FASB's emerging issues task force has issued proposed guidance that would refine the definition of a so-called other than temporary decline in the value of an investment.

This would require recognition of an impairment charge in the income statement as opposed to a direct charge to share owners equity.

Essentially, if an investment has been below cost for a year, there is a strong presumption that that impairment is other than temporary and that it is unlikely that the presumption could be overcome by other factors.

For UPS, this recent guidance has caused us to reevaluate what "other than temporary" means with respect to our investments and in some S&P 500 portfolios which are included in our marketable securities.

As a result, we recognize that pretax $58 million impairment charge to investment income during the quarter which was primarily related to these S&P 500 index portfolios.

The EITF has yet to finalize this issue but it represents the best published guidance currently available and we felt that it was prudent to take this guidance into consideration at this time.

The impact of this action was to lower earnings per share for the quarter by 3 cents.

Well, enough of the boring details.

Let's move on to the big picture and I'll now turn the program over to Scott Davis.

Thank you, Kurt, and good morning, everyone.

I'm pleased to join you once again to discuss results of our most recent quarter.

Two of our business segments, international and nonpackage, performed exceptionally well.

The third segment, U.S. domestic package, did not meet our expectations, partly the result of weather.

However, in March we saw positive volume growth in this business and expect volume growth in the second quarter will continue to improve.

Total revenue was up almost 6%, although severe weather in the U.S. in February impacted profits.

Net income increased substantially with earnings per share at 54 cents, above the range we had anticipated.

These earnings include the 5 cent tax benefit partially offset by the 3 cent impairment charge Kurt just described.

Excluding these one-time items, earnings were 52 cents, still at the high end of our expectations for the quarter.

In the domestic package segment, total volume declined 1.2%, approximately half of this decline is attributable to weather problems.

Ground volume was up 1 1/2% but showed steady improvement other than for the impact of the February storms.

Next-day air volume was up 4% as we continue to gain share in this market with increases in both letter and package volume.

Deferred volume showed a 4% decline, affecting the loss of several large customers due to last year's labor issues as well as some trade down in service.

Overall, we saw gradual strengthening during the quarter with March volume comparing positively with last year.

The development has continued so far in April.

We're confident that this trend will accelerate as we recapture lost business and win new accounts.

We know the market has been concerned about pricing.

As you see it from our results for the quarter, revenue per piece in the domestic business was excellent, up 3.3%, with ground particularly impressive at 3.7%.

The strength reflects the impact of the rate increase that went into effect in January a7/10% benefit from the fuel surcharge and what continues to be a rational pricing environment in the market.

The negative in this segment was costs which were up over 5%.

A number of factors contributed.

Inclement weather increased costs and reduced operating profit by over $30m.

Fuel was up over $60 million, accounting for over 1% of the cost increase of which approximately $20 million was not covered by our fuel surcharge.

Pension expense was up $35 million, adding 1/2% to costs.

Healthcare showed a double-digit increase and compensation and benefit obligations, some of which are front-end loaded in our labor contract, added substantially to our expense for the quarter.

Wage expense for the quarter was higher than expected because the usual turnover for more senior employees to entry level employees was slowed by the difficult economy and tight job market.

We expect this trend to moderate over the next few quarters due to the projected improvement in volume growth, as well as increased part-time job turnover stemming from college graduations.

Together, these cost increases resulted in 290 basis point decline in our operating margin compared with last year.

The first quarter was a tough environment for us domestically and our results in this part of the business were disappointing.

We are confident, however, that the combination of increasing volume momentum we're seeing and the moderation of these expense items will enable us to show significant improvements in earnings over the next few quarters.

We continue to expand and grow our domestic franchise.

Just after the quarter ended, we began rebranding our Mail Boxes, Etc. stores.

Over 3,000 of the MBEs in the U.S. elected to change to this format.

This change will be complete by September.

The convergence is based on extensivetesting on a number of branded concepts in the franchise network.

The overwhelming new acceptance of this format by the franchisees will bring convenience and lower prices to the retail market, primarily home office and frequent shippers who tend the use the U.S.

Postal Service.

Besides elevating our retail presence, it will also afford UPS a vehicle for servicing large customers that have a mobile employee base such as electronic repair technicians who have product drop-off and pickup needs.

We're very excited about this development in our retail strategy which happens to be the largest since rebranding in franchise history and about the potential for new services and new revenue streams it will provide.

The new UPS store locations will be among the first and most visible places consumers will begin to see the new UPS lo go that was unveiled during the quarter.

The corporate rebranding reflects a significant broadening of capabilities that occurred in recent years as UPS expanded across the globe and introduced a portfolio of new supply chain services.

While package delivery is and it will remain the foundation of our business, UPS is dramatically expanding its scope of services at synchronized commerce.

Our new logo better represents what UPS is today and will be in the future.

Turning now to the international segment which continues to produce outstanding results.

Volume was up 10% exceeding market growth.

In fact, we saw double-digit volume growth in all areas of the world outside the U.S. with Asia up 16%, Europe up 11%, and both Canada and Latin America up mid teens.

Even in the U.S., export volume growth was positive and stronger than in the fourth quarter of '02.

In fact, the first quarter saw the best overall international volume growth in two years.

Revenue in this segment increased 24%, or 13% without the positive currency effect.

Revenue repeats was up 9 1/2% after adjusting for currency due to product mix and excellent revenue management.

Best of all, it's the strong improvement in profitability, $134 million compared with $30 million a year ago, this translates into an operating margin of over 10%.

It continues the very strong trends we experienced in the second half of 2002.

A combination of factors are at work here.

Excellent yield management, favorable currency translation that boosted earnings by $27 million, and a balanced performance out of almost all areas of the world.

Additionally we're harvesting the benefits of our expanded network, achieving improved operating efficiencies throughout the organization and finding that customers increasingly value our solutions-oriented approach.

Technology, too, is having an impact.

Customers continue to integrate our technology tools into their business processes to achieve greater efficiency and improved service.

Our international products and services such as World Ease, exchange collect and trade direct cross border make it easier and faster for customers to meet their international shipping needs.

By integrating these products with other UPS capabilities, we can develop comprehensive solutions that address each customer's problems.

Now for the nonpackage segment.

I'm very pleased to report that the first quarter of 2003 was the best quarter ever for this segment.

Revenue was up 11% and profitability increased to $107 million from $55 million a year ago.

The largest piece of the segment is the UPS Supply Chain Solutions business unit.

Here revenue increased $8.7% to $500 million, without the FedEx business in 2002's first quarter, revenue was up 10.8%.

Profitability in this unit was up significantly, a clear indication that the improvements anticipated with the integration and restructuring efforts are very improved.

Integration of what were separate logistics and trade services groups has blurred the distinction between those operations as we offer more integrated customer solutions.

Therefore we have combined the revenue lines for those two units in our financial statements into an overall supply chains solutions line.

Generally speaking what comprised our former logistics business showed a revenue increase in the low teens.

Freight services posted a mid single digit revenue growth, excluding the act of the brokerage business last year.

Including that business will result in a 1-2% revenue increase.

Freight forwarding net air revenue was up 20% and net ocean revenue was flat due primarily to margin squeeze.

The rest of the non package segment, which includes Mail Boxes, Etc., Capital Corporation and our mail consulting services posted a 19% increase in revenue.

Clearly all parts of this segment demonstrated increased velocity in the quarter.

Now some comments on cash flow and share repurchase.

Once again we experienced an excellent quarter for cash flow.

During the period we generated $1.5 billion in cash from operations, paid down $500 million in short-term debt, repurchased over 2 1/2 million shares, increased our dividend 11% and still ended the quarter with a $3 billon cash balance.

At the end of the quarter we had about $560 million of authorized funds remaining for share repurchase.

Currently, about 45% of UPS shares were held by the public as Class B shares with remainder of Class A shares being held by UPS employees, retirees and families of the company's founders.

As we look to the current quarter, we're optimistic.

We anticipate that earnings will be in the range of 58-62 cents per share, up solidly from the 54 cents last year.

We expect domestic package volume to continue the momentum begun in March and April and post between a 1-2% increase over last year's results.

All three domestic product lines should show positive growth rates.

Next-day air should continue as industry-leading momentum due to new customer wins and the over lap in weakening conditions last year.

In addition, yields in our ground business should remain firm, aided by a bit of an increase in our fuel surcharge.

We expect current international trends to continue with solid results in all regions of the world, export growth should be strong and yields firm.

Therefore we also anticipate substantial improvements in profitability.

Our streamlined Supply Chain Solutions unit is on track.

While we have more work to do there, progress so far has been great, we anticipate solid growth and improving margins from this business.

Based on first quarter results and our expectations for the second quarter, we believe we are well on our way to achieving the 10-15% increase in profits we had targeted in 2003.

Two segments, international and nonpackage, are executing very well, and we're confident that the domestic package segment will demonstrate increasing momentum as the rest of the year unfolds.

Going forward we will continue to execute our strategy, maintain the disciplined approach to our domestic business while growing that very successful franchise.

We're reaping the benefits of years of investment in the international arena and we're excited about the potential this business has for years to come.

Finally, as we better align the supply chain unit, we see great potential for developing integrated solutions that help synchronize commerce.

This concludes my prepared remarks.

Now Kurt and I would be happy to answer your questions.

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

If you would like to ask a question, please press the numbers 1, then 4 on your touchtone keypad.

We'll take as many questions as time permits and we'll take them in order in the way you signal us.

We'll pause for just a moment.

Thank you.

Our first question is coming from Jordan Alinger of Al Lessard.

Hi.

A question for you.

The international trends on profitability, even if you take out the FX, continue to be pretty strong.

Do you have some sense given sort of the volumes outlook which I guess continues to look pretty good as to the sustainability or maybe reaching that 10% margin target quicker than originally anticipated?

Good morning, Jordan.

Yeah, we're very proud of the results of international.

We've seen some great trends, started typically the last half of last year and carrying forward into the first quarter.

We see that these trends should carry forward, we expect double-digit volume growth in the quarters ahead.

We have no reason not to believe that Europe will continue its growth.

Asia still looks very strong.

Clearly there's a risk out there in Asia with SARS, over the long term nobody knows what's going to develop there, at this point it's had no impact.

It's been neutral to us as far as results.

As far as the operating profit, yeah, we're pleased with results.

There is no reason not to think we'll continue those results going forward.

So we're optimistic.

Thank you.

Thank you.

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

Good morning, Scott and Kurt.

Morning, Scott.

Yeah, a couple of questions.

Obviously international will probably be a focus of some of those.

What's going on with export pricing?

Because even looking at the tables you provide, taking out currency effect, the last few quarters, export pricing has been up 5.8 and 5.6% which is dramatically better than what you saw in the first three quarters of last year.

In fourth quarter I thought there might be some effect from the west coast port stoppage but obviously that's carried on to 1Q.

Has something changed with respect to export pricing?

Is that a mix effect?

What's going on with international export pricing?

Well, Scott, I think it's a combination.

I think, one, when Asia grows at that rapid pace, those are higher revenue per piece packages.

That will certainly help.

That's the mix part of the answer.

The other part of the answer I think is just excellent revenue management by our managers.

I think customers are valuing the service and are willing to pay for the service.

They have done a super job, particularly in Europe on revenue management.

Has the pricing environment in general, though, gotten just better in addition to your revenue management, or is it just that you are managing better with what the market's giving you and that the market environment hasn't gotten better?

I think we're managing better.

I think there's been some firming in prices in Europe.

We've seen that over the last couple of years with the privatization of the government postal services, so a combination of the two.

Okay.

And then one other question.

You mentioned in your up-front remarks about some recapturing of business.

Have some customers found their way back to you?

I guess I was presuming that some of that had sort of finalized its way in terms of what business you were going to recapture versus just growing the business.

I think it's a combination.

We're still winning back some of the business that we lost during the contract negotiations last year.

So, we're still seeing some of that win back.

We're also winning some new business.

Okay.

A combination of the two.

Clearly, --

Scott, this is Kurt.

The focus is just growing going forward, not looking backwards over what may have happened in the past.

So, clearly our focus is just on, you know, moving forward and growing wherever we can.

Got it.

Great.

Thank you.

Certainly.

Thank you.

Our next question is coming from John Lengenfeld of Ralph W. Baird.

Kurt, Scott, good morning.

Good morning.

You made reference in your press release in terms of your initiatives of what you put in place.

I was wondering if you could specifically talk about how a couple of those initiatives have really powered the growth on the next-day air side.

A combination of things we've been doing.

Clearly, the UPS Store is one good initiative that shows we've been addressing I think in the field and not standing still and giving market share to anybody.

I think the store is showing the test that it has increased volume up to 70% in the test stores that we have run, we expect the same type of results as we launch these 3,000 UPS stores in the market.

So, the technology operating we've done, the campus ship, a variety of technology operatives have really enhanced our service offerings.

I think the other things you are seeing is a fuel surcharge, there is a big gap between UPS and the competition in the fuel surcharge which is probably driving some customers to UPS.

Great, great.

And then when you look at it from the pricing perspective, obviously as you mentioned you had some nice yield increases on the deferred and ground on the pricing strength but when you look at the next-day side, when should we expect to see some positive comparisons there and how is the yield management thought process progressing on that side of the business?

Well, first of all, I think that, you know, we didn't raise our next-day air rates as much as ground back in January.

So, that's one of the reasons I think ground outperformed air but the big issue there is still the mix.

The letters are growing faster than the packages really for the last 12 months.

I think when you'll see that change is when the economy does start picking up and you'll see more manufacturing, more wholesale, heavier packages.

So the first quarter, you know, the mix hurt us with the letters growing at a faster pace, although packages did grow, actually packages did grow, but the average weight was down about 2%.

So, I think the biggest key is growth in the economy.

Okay.

John, one other factor.

The thing that's really driving that letter Rothe is the incredibly low interest rates and clearly those came back down in the quarter and that creates a flurry of refinancing activities that drives a lot of letters through the network.

Good.

Okay.

Thanks a lot.

Thank you.

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

Yes.

Good morning, gentlemen.

Just a quick question on your guidance for the second quarter and for the entirety of the year.

I think you said that profits are expected to be up 10-15%, I presume you are talking about EPS, number one.

Correct.

And number two, in the past, I think you've given us sort of a economic backdrop against which we should think of these guidance numbers, would you want to share your view of the economy here going forward?

John, first of all, I guess in the second quarter our guidance, I would presume the economy is going to stay somewhat similar to what we saw in the first quarter.

So, our second quarter guidance is not based on a stronger economy.

When you get to the second half of the year, our own plans call for the economy to grow probably in the low 3's.

Now, I think that the impact of the economy will impact where we fall in that range.

You know, we think we can still hit that range at today's economy growing at the level we see in the first quarter, but where we fall in that range I think will depend on how strong the economy is in the second half of the year.

If we get growth, we expect it to be higher in that range.

Okay.

Another question on the fuel front.

With your fuel surcharge having increased as fuel prices have been declining here, and I know you do have some fuel hedges in place, is it possible that fuel could actually end up being a slight positive in the second quarter?

That's a good observation, fuel will help us in the second quarter.

You know, in the first quarter, you know, actual prices were up nearly $90 million and we offset that by about $25 million in hedging gains, but we were still -- a surcharge was about $20 million short of covering the net fuel price increase.

In the second quarter, what happens there is when fuel prices rise at a rapid rate, you know, you won't get the benefit.

When they turn around and drop at a rapid rate, you'll get a benefit, so what we'll see is the other side of that in the second quarter, we'll benefit in the second quarter.

And then lastly, you may or may not want to comment on this.

With respect to the pending merger of DHL and Airborne, what is UPS's current view on that and what do you think the impact on your operations would be if that merger were allowed to go ahead?

Well, first of all, you know, we've had a concern, we had a long-standing concern over the fact that we think Deutsche Post really controls DHL Airways.

So, really for about two years we've asked the DOT to have a public hearing with an administrative law judge.

So first of all, we're quite pleased that that has happened and there will be a public hearing and I think the administrative law judge is due a recommendation by, like, September 2nd, so we're pleased with that.

As far as the impact on the competition, you know, we're not afraid of competition, we just want to make sure they play on a level playing field.

We still have Airbornes out there today competing with us, DHL was going to be competing with us, instead of two, we'll have one competitor but, you know, we're willing to take them on.

That's very helpful.

Thank you very much.

Thank you.

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

A couple of things.

First, could you talk, Scott, a little bit about the Asian marketplace?

We're seeing a lot of growth in that trade lane in all kinds of places, where it's no one planes, on ocean vessels and what not.

Is anything that you see changing in the way that marketplace is evolving because the growth is really explosive?

I don't think so, Gary.

I think it clearly appears that there is more and more manufacturing that's continued to move to Asia and particularly to China.

So I think, you know, we expect to see that kind of growth for many years to come.

I don't see anything that's going to change those trends other than something out of the ordinary like the SARS virus which could disrupt things and it's unknown yet what the impact would be.

I guess, Gary, just to add a little color, clearly China continues to be very strong for us.

It was up over 40% again in the quarter, and also, both Hong Kong and Philippines continue to be very strong, you know, to some extent due to the increased network capabilities we've gotten.

The Hong Kong and beyond rights, Gary, we think will be very beneficial when we get those and they should be awarded in the summer, this summer.

We have interim rights right now for six flights between Hong Kong and the Philippines, but that will also boost growth in the future.

Vis-a-vis the SARS issue, passenger carriers taking belly space out, are you asked to run a bunch more charters like you had when the ILW lockout occurred?

I think, Gary, it's pretty minor impact at this point in time.

There may be some additional cargo and freight but I don't think there's been a dramatic -- we haven't seen a dramatic impact at this point in time.

And one other question I had, on the labor front you mentioned earlier in the call the issue of the older workforce not rolling into the younger as fast as you would have thought.

I wasn't clear as to what you were thinking about and what adjustments you made going forward as we think about your labor costs going forward.

Could you help me out with that?

Well, I guess the general statement there is that we think that the rates, the average rates will come down as we add volume.

So we project through the next few quarters that there will be more turnover and that our average rate will come down some.

Some of that is just natural with turnover with college graduations with part-time students.

But it's really added volume that will help in the wage rate column.

Was that the principle cost area that impacted the domestic business from as you see it?

I would say that, but clearly benefits are a big issue.

We talked about that the last couple of quarters, that the pension expense, the healthcare costs being up double digits, workers' comp being up tied to healthcare and in addition we had the weather and the fuel costs in the first quarter.

So a variety of things that hit us in the first quarter.

All right.

Thanks a lot.

Thank you.

Thank you.

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

Hey, Scott, hey, Kurt.

Hey, Ed.

You know, I think you said it well.

Two of the three legs are cranking here but the core domestic business isn't operating so well and when you talk about some of the costs that are impacting you, pension, healthcare, wages, what's the visibility to when you start to see improvement on these things, and can you get back to where you were in '00 in terms of margin domestically and in your opinion when can you get there?

Well, I think that the, first of all, some of the things that will go away will go away in the second quarter and that's the weather impact we saw in the first quarter.

The fuel impact's going to flip and we'll actually have a benefit in the second quarter and I think, as I mentioned earlier on Gary's question, the wage rates I think will start benefiting us in the second quarter with the improved volume.

The real key to us to get back to the 2000 operating margins domestically is volume, we need that growth, I think, going forward.

We're going to show good margin expansion the second half of this year and I think compared favorably versus last year and we're going to show in the second quarter certainly good comparisons versus the first quarter of this year, but to really get back to the 17% margins we saw in 2000, we need some good volume growth.

And just to clarify, the margin expansion in the second half is in the domestic business you are talking about?

In the domestic business, yes.

Okay.

You gave some comments before on the volume side that March domestic volumes were positive, but were ground volumes domestically positive in March?

They were basically flat but the ground volumes drive the domestic volume.

So, they are a good indicator of the overall volume.

And in April, are ground volumes basically flat to positive?

They are flat to positive, correct.

Okay.

And then you mentioned a couple of times the rebranding effort with the UPS Store.

Are there some costs that were in this quarter related to that and are there some that you expect going forward?

There were, they weren't significant.

They were probably about a penny a share of cost in the rebranding and advertising in conjunction with those stores.

They are probably a little less this quarter than we'll see going forward.

And then finally on the logistics side in terms of profitability, was logistics profitable in the first quarter?

I know you were profitable in the fourth quarter.

Yeah, absolutely it was profitable and in fact, almost all of the improvement we see in nonpackage came from the Supply Chain Solutions group so that the improvement was really the combination of the logistics and freight services which we look at as one at this point in time.

Strong profits and good trends there going forward to the second quarter.

Thanks, as always, for the time.

Thank you.

Thank you.

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

Morning, gentlemen.

Morning, Don.

Three trends here continue to worry me, the first two I think I understand what's going on, the ground volume's been down for eight quarters, express yield's been down for 11 quarters in a row now, but the third trend is what I want your help on.

You've had the deployment of some cutting-edge technology to improve your productivity, yet comp and benefits cost per package delivered is growing at greater than 6%.

Should I be modeling for that to continue and if not, why?

Well, we've talked about it in the last couple of questions frankly, Don.

A big piece of this is that the lack of volume clearly has impacted, you know, the wage rates.

I think the wage rates are a little higher and as we add volume, that clearly is going to help the comp and benefit line.

One area that won't be helped, near term probably, is the benefits side.

You know, I think all of the U.S. industry is suffering from high, you know, workers comp, healthcare, and pension expense right now.

So that will be an issue with us at least through the end of this year, I think, but the key to us is the increased volume to bring down those costs.

So as you spin on technology, what kind of productivity is being disguised here, what kind of productivity improvements?

We are showing some productivity improvements, a lot of the big productivity improvements we've talked about are really in the future.

You know, the dispatch tools and the preload tools we've talked about which will give us significant savings, you know, are being more of beta tested, are out in various centers right now but we'll really see the benefit there in probably beginning next year and the year after.

So that's not so much in '03 event on our financial statements but we'll see that benefit beginning in '04 and.

So put another way, until we see a pickup in volume, we're going to continue to see cost pressure on this line?

Yeah, although, Don, this is Kurt, I would say certainly, the first quarter was a tough one.

You know, we both had a bunch of headwinds and some unusual expenses we talked about.

So I don't think we would see it extrapolate in the first quarter.

Yeah, but the benefits delivered per package were up, 6.1, 6.3, 6.9, 4.9 in the fourth quarter and then 6.7 in this quarter.

So we're not talking about a new trend.

Right.

The other factor, though, as we did mention is there was some front-loaded increases in the labor contract in August as we cycle through three, four quarters of that, some of those increases moderate partially with turnover, partially with growth and partially just with cycling through the fact that we gave all the employees a increase at the time of the signing of the contract.

So that tends to front-load some of the expenses.

All right.

Good luck, gentlemen.

We feel pretty good and that's embedded in our guidance, Don, and clearly a firmer economy will certainly help us, but we feel pretty good even without that.

All right.

Well, good luck, gentlemen.

Thank you.

Thank you.

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

Good morning, Scott, Kurt.

Morning, Dan.

Hey, I want to assess, kind of take you back to your comments on the sustainability of yield.

I think you are predicting that it will hold firm and specifically I guess maybe as it relates to the pricing environment.

Can you tell me, I guess, really what you see domestically from the competitive pricing environment?

Well, I think, you know, we've held pretty steady, that we think it's a rational market.

We think that our rate increases we came out with in January were consistent with prior years.

The competitors raised their rates consistent with prior years.

We said back in January we expected the yield to be strong in the first quarter and through this year it has been.

Everybody else seems to be making something out of it, but the facts are yield is strong.

The yield will be strong again in the second quarter.

And quickly on the nonpackage side, supply chain logistics, it looks like you are on track with your integration and really two questions.

Where are you in the process of integration?

Is it the seventh inning, the ninth inning and then what does the pipeline look like and how should we think about the business developing really from current levels and beyond?

We're making very good progress, Dan, on that.

As far as where we actually are on the integration, we're about 80% of the way through the personnel side of turning the people out.

We're about halfway through on the lease, on the facility side cutting back the space.

So we're making good progress.

We're actually ahead of schedule I think where we thought we would be at this point in time, we've obviously seen some great results.

I think the progress just didn't start in the first quarter.

We've seen progress over the last several quarters, some of that got lost in the restructuring charge in the fourth quarter but we've seen some good trends.

We clearly are the top line is helping us and we're growing the revenue at a good pace and that's to better utilize the infrastructure, I think.

So we're adding revenue with less incremental cost and it's helping the margins.

We are very confident that we'll see, you know, mid digit margins by the end of the year.

Dan, one comment on the pipeline.

We did see a little bit of a challenge in March from the sales guys.

It sounds like a lot of customers just put their plans into neutral, so we didn't close a lot of deals in March and I think people were preoccupied with the war but they seem pretty optimistic that, you know, we've got plenty of opportunities going forward.

Great.

Thanks very much.

Thank you.

Our next question is coming from Jeff Kaufmann of Fulcrum.

Thank you very much.

Hi, Scott.

Hi, Kurt.

Hi, Jeff.

A lot of good questions have been asked already.

So let me go off in a different direction.

Just like you, Jeff. [ LAUGHTER ]

You mentioned that you were outgrowing the domestic market and you expected to continue to do so.

First question on the domestic market SEC second question on Europe.

Can you talk about magnitude-wise how much business you are expecting to get back that you had lost a year ago and then, you know, we're hearing rumors about various customers.

I know you don't want to name them but I'll throw it out, Williams and Sonoma possibly has crossed a barrier.

Can you talk about what's going on on the pricing side, on the customer side in terms of some of the wins and why you believe you'll be growing faster than the market in the next few quarters?

Well, I mean, first of all I think that, you know, we don't talk about specific customers.

Right.

At all in that situation.

So, you know, I think we're winning the customers based on, you know, the portfolio of the customers at this point in time.

So, I think there is no reason to believe that's not going to continue.

Okay.

Well, could you identify -- I mean, when you are talking about the growth rate look thing into 2Q and 3Q, how much of that growth is business that was a temporary displacement versus say core growth and new business?

Well, I think it's a combination.

We said last quarter we won back about two thirds of the volume we lost during the contract negotiations, and we've added to that number.

We haven't quantified the number and we'll continue to win back some of that volume I think as we wrap a year of the contract negotiation talks.

This combination, we're certainly winning new business on top of that and again I think the combination of the service operatives between Supply Chain Solutions and the package business is proving the value that the customers want to see.

So it's a mix of the two, Jeff.

Okay.

Thank you.

Final question.

You've given us some very good flavor on Asia.

Can you talk a little bit about Europe?

Because we're seeing some news in France and Germany that you might be getting a bit of a slowdown domestically here but your numbers certainly don't seem to be showing that.

Well we, since 1997, have shown double-digit export growth, volume growth in Europe and that hasn't slowed down at all.

I think we're feeling a little bit of that pressure domestically in some of the countries where maybe the economys are suffering and maybe impacting the growth.

We're more flat on the domestic side.

It does not seem to be impacting the export in the express volume and, again, I think the network we've set up over there has really benefited us.

I think you are still seeing that shift from the LTL truckload to small package growing a little faster in Europe than it is in the U.S.

Okay.

Solid quarter.

Thank you.

Thank you.

Thank you.

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

Thank you.

Great job, guys, on international and nonpackage.

I was wondering on international if you could give me some more clarification because I think back in January, Scott, I believe you may have said that you expect about 20% increase in international profitability for the year, and given the great first quarter you had, that pretty much means you could have a very weak rest of the year and still hit that bogey and I guess I'm wondering, well, first if I got that number right and second, if that is right, does that mean you are taking up your expectations here for international for the rest of the year?

That's a good observation, Jim.

I figured somebody would ask that.

But the answer is certainly we had a great first quarter, and we will do better in the rest of the year.

We'll still compare favorably to the rest of the year.

So, our expectations are growing, I haven't quantified them but they are built into our guidance and we'll do better internationally.

Great.

The next question is the long-term strategy for domestic growth.

I think you have this goal here for the second quarter.

I'm talking about domestic package growth, to be up 1-2% but, you know, keeping in mind that you started feeling the impact of the strike last year in June and your volumes in the second quarter of last year were down about 2 1/2%.

It would seem as though you have fairly easy comparisons and I guess I am trying to understand in looking at the marketplace where two of your competitors are growing their ground business where the post offices are not, I guess I'm trying to understand how do we get back to growing at, you know, 1 1/2 times GDP as we had seen throughout the 1990's.

Well, I think clearly that we're, you know, we're making progress and we've really made progress from the third quarter on last year, getting better, you know, each quarter on the volume.

The first quarter got hurt obviously the weather, or you would have shown, you know, the same improvement we saw fourth quarter over third last year and the second quarter will be the same type of comparison.

You know, we probably had a net of about 1% volume diversion last year in the second quarter.

So, we're going to get that back and then we'll get a little more.

I think it's going to be gradual improvement.

I would anticipate probably growing around GDP as opposed to well over GDP for the near term.

But we think the momentum we've built here will carry through the rest of this year and we'll see those numbers grow.

Okay.

And my last question is, trying to understand international profitability once again real good numbers and clearly there's some leverage on the having this wide international network of planes, and in the past I know you've talked about that's the best place for you to spend your incremental dollar of capital because of the type of returns you get on that business.

What I'm trying to understand is, you know, are these planes running at, you know, 80, 90% of utilization so that, you know, the incremental profits here, the margins may not be as strong going forward in terms of on the incremental business or do you still have a lot of excess capacity in the international fleet so we can see this going on for many, many quarters?

Well, we certainly think we have potential to grow well into the future.

Certainly the answer to that question varies by lanes, some are at capacity, some aren't.

Now you are putting cargo out and putting high-yield express packages in, so, that really helps the overall operating margins internationally and that will continue for the foreseeable future.

Do you feel a -- do you have a kind of feel for that mix?

Is it 70/30, 50/50 and where it's going in the next two to three years?

It's really not a number, Jim.

It varies so much.

This is upside.

Jim, this is Kurt.

Let me add one other point.

For us this whole international network is not just about aircraft, though.

Aircraft is not the majority of expense in this network, it's pickup and delivery, it's technology, it's integrated solutions.

So the management of the, you know, the revenue on the aircraft is a big piece but the, you know, the real leverage even beyond that comes from growing a network that's in place and that can handle incremental volume.

Right.

I guess what I'm looking at is if your planes are starting to hit 80-90% utilization, that tells us that all the things you are doing on the ground internationally are being fully utilized because presumably if there is additional business there, you are going put more planes in the air.

There's ample of where we could get a lot of incremental profit is if U.S. export picks up because obviously the planes flying U.S. to Asia, U.S. to Europe are not nearly as full as the planes coming back.

So, we have a lot of potential in those areas, in those lanes.

Okay.

Great.

Thanks so much, guys.

Thank you.

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

Good morning, Scott, Kurt.

Hi, Greg.

You had a very strong quarter.

I just wanted to drill down on a couple of items.

On the ground yields which were quite strong, particularly for a pricing war, are you seeing any mixed shift?

I know you've got the 100 weight program.

I know LTL price has been very strong.

I'm just curious, you know, if you chip away some of the mix items what you think pricing is doing on a pure parcel basis or is that too significant to matter?

I don't think that's significant.

I think the mix shift in our ground product would not be a big factor there.

Rates are fairly flat.

There's not been any major shift.

Okay, and then I guess the, on the cost side, Scott, I'm just curious on the healthcare cost, the double-digit.

I guess the way I had always thought about it was you sort of locked in your healthcare costs with the union and sort of the union took the medical inflation risk.

Is this medical inflation in nonunion employees, or is it part of your contract, can you just help me understand what's driving that increase?

Yeah, it's a combination.

Clearly it's the nonunion plans and certain of the union plans are actually UPS-sponsored plans, too, so it's a combination of the two.

It does not involve the contribution that we make to the union people.

So when you refer to double-digit healthcare increases, then that's -- that must mean that's the nonunion piece, right?

That's fair.

Okay, and that's going to continue through this year?

That's your outlook?

I don't see anything that's going to change in 2003.

Okay.

That also impacts things like workers' comp because the medical increases drive the additional workers' comp costs.

So, we need to get the medical inflation under control, the country does.

Okay, and then just on your volume guidance for the second quarter, sounds like you finished the quarter, you know, relatively stronger on a volume perspective.

But, you know, when you look at the comparisons domestically, the second quarter looks like your easiest comparison.

I'm curious, is it your view that your domestic product lines, given the economy being flat, will continue to accelerate so even as you face what looks like somewhat tougher comps in the second half, do you think that your volume growth domestically based on the economy being flat will sort of continue to get better as you pick up more momentum?

I think that's a fair assessment.

I think that the comps are still pretty easy in the third quarter, maybe a little bit more difficult in the fourth quarter, but with the momentum and the wins we've got, I think we expect to see that continue to grow throughout the year.

Great, and then just finally on the economy, any mix, any different activity among -- you know, you've talked about your financial customers versus your retail customers, any change in how some of the industries that you deal with are behaving?

Yeah, it sounds like a broken record, but manufacturing and wholesale are still, you know, down, not getting any worse, not getting by better to speak of.

The trends we saw in the first quarter, I think retail slept some in the first quarter and a lot of that was the weather and, you know, the President's Day weekend got washed out with the storms in the northeast.

The financial services area, as Kurt referred to earlier, is still very strong with low interest rates.

So, some of the same but the only real note-worthy change was the weakness in retail we saw in the first quarter.

Great.

Thanks a lot.

Thank you.

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

Good morning.

I was hoping you could comment on your nonpackage margins which were really strong this quarter, and I know part of that is from the restructuring that you did, but should we think about those margins as sustainable for the next few quarters and years, or is it -- was there some sort of blip this quarter that made it higher than usual?

No, Jennifer, there were no blips, and the margins are at the levels we expected in the first quarter and we anticipate we should be able to do better on those margins as we go forward.

So, you know, right now sorting by the end of the year we would expect to be mid single digits on the non-SCS and we expect those margins to expand in the years to come.

Mid single digits on, what was that, Kurt?

The mid single digits on the Supply Chain Solutions piece this year and then expanding those margins going into '04 and '05.

Okay.

Great.

Thanks.

Thank you.

Thank you.

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

Hey, guys.

Hi, John.

Can you, in just a little bit more color on Jim's question earlier, with you getting close, anywhere near network, and I'm talking domestically or internationally, are you getting anywhere close to reaching a capacity level that would require you to go in and make wholesale changes to your investment strategy at this point, whether it's aircraft, technology?

Is there anything out there that you can --

No, our cap ex, you know, is built on the volume forecasts that we are incurring right now and expect to see in the next several quarters.

So I mean, we did things last year like the intra-Asia hub was something we needed last year.

Over the next few years were expanding our Cologne hub in Europe which is, you know, not significant dollars but that's built into our capex forecast and as you've seen, you know, with the slow growth over the last couple of years, you know, our cap ex has hung in the lower end of our normal range in the 5-6% of revenue.

I don't see that changing certainly in '03 and nothing dramatic in '04.

Okay.

Can you give us an idea the status of the furloughs of the pilots and the status of your contract negotiations between the company and the pilots union, are you still on plan to maybe achieve getting something ratified by the end of the year?

Yeah, we're making good progress, John, working through interest-faith bargaining and certainly there will be some issues but so far everything's going well.

Yeah, with the military call-up, our need to furlough the pilots was mitigated, and we did have a number of pilots that took voluntary early retirement and so, at this point we're in pretty good shape but clearly, as we bring in new, more efficient aircraft, it does -- that have three per cockpit -- two per cockpit rather than three, it does create less need and we'll face that issue going forward.

All right.

As some of the military call-up begins to roll over and you get some of these guys back in the system, I mean, does that -- where do you stand on that, then you have to go back in and identify somebody else in the system, a lower seniority and to stick with the same furlough or attrition that you want?

Yeah, that will take some time.

It's not that everybody will come back quickly.

So at this point, you know, we don't think there will be anything imminent but it will be a big change and we'll see where things happen.

Scott again, you know, phenomenal cash flow generation by this company.

Can you elaborate at all on the status on the tax refund from the government, where do you stand in terms of getting some of that back?

John, the $140 million in 1984 which we referred to in the past is due anytime, we have not received that cash yet but it is due.

We have -- getting the big excess value litigation out of the way has allowed us to get with the IRS and start resolving a lot of the smaller outstanding issues from the 1985 through 1990 years, so we're very hopeful to get all those resolved in the near term and that will free up a bunch more of the refund but it's hard to actually pinpoint the date at this point in time.

The $140 million should be back any day and hopefully we'll get some of these other issues resolved soon.

Okay.

In the meantime we do earn interest from the IRS on this.

Great.

Thanks, John.

Thank you.

We know we've got to field some more questions in the queue.

We're going to take one more call this morning and I apologize to those of you that are left waiting in the queue.

One more call, please.

Thank you.

Our final question will be coming from Ken Hoexter with Merrill Lynch.

Good morning, Scott and Kurt.

Thanks for making me the last one.

I just want to go back to touch on the economic signals.

Obviously we're getting conflicting estimates here, but you said you were seeing continued weakness in the manufacturing and wholesale still down and financial is strong, retail kind of flattish.

Where are we seeing going forward, I guess to catch up to those growth estimates?

Where are you seeing that strength to get to that 1-2% growth?

We're not presuming much of a change from what we saw in the first quarter to get to the 1-2% growth.

We're basically giving that guidance based on the economy that's similar to what we saw in the first quarter.

And then, Kurt, you mentioned briefly before the tax rate's going to go down to 37%.

That just rolling forward the impact of the first quarter, or does the rest of the year actually come down a bit?

No, that's really, in light of some of these issues we've resolved, there is a lower burden going forward on that.

So that's an ongoing, going forward benefit.

Okay.

And, Scott, can you just on the domestic side, you talked about pension costs also.

Can you talk about what it was for the quarter and for the year?

Well, we had said earlier that we expected the additional pension costs to be about $135 million to $140 million for 2003.

It came in about $35 million during the first quarter.

So it's right on target.

Again that was driven by the lower discount rates an rate of turn estimates.

Certainly our plan remains very well funded, though, but with the changing assumptions last year this is a noncash expense that we had to increase.

Okay, then one final one, if I may, and I was pleasantly surprised by the strength in the average revenue per package growth in the quarter of that 3.6%, obviously about 3% without fuel.

I just want to get your concept, I know that you've harped on this a little bit before earlier on the call but is that sustainable, that kind of rate going forward based on your increased rates that you just imposed in January, should we see that temper a bit, what are your kind of feel going forward on that number because it was so strong?

Well, I would say that, again, I go back to the fact we did the rate increase in January, normal rate increase.

It seems to have stuck, similar to what has done in the prior years, I would say certainly going into the second quarter we would expect to see strong yield increases.

You know, one area that may not be quite as robust is the deferred air as we lapse some contracts we lost a year ago, but I would say ground is going to be strong.

Next-day, the key to getting next-day up is the mix.

Again, we need the heavier packages and more packages versus letters to get that going.

Okay.

Great.

Thank you.

Thanks a lot.

Thanks, everybody, for hanging in.

In summary, we're encouraged by where the business is heading.

Domestic is gaining momentum, international is very strong, and clearly the nonpackage is making good progress, and all of this in the face of less than stellar economic conditions.

For those of you that are interested in learning more about the international business, because you can see there's clearly a lot of momentum there, we will be conducting our first ever investor meeting in Europe on June 2nd and 3rd.

This meeting will include tours of a couple of our facilities and also some overviews and presentations by some of the key international personnel.

So, if you are interested in a trip over there in June, give us a holler and we'll be glad to host you.

Other than that, thanks for listening to us today and we'll look forward to seeing you in the future.

Thank you.

This does conclude today's teleconference.

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