聯合包裹運送服務公司 (UPS) 2003 Q2 法說會逐字稿

Welcome to the UPS second quarter earnings conference call.

Today's call is being recorded.

At the conclusion of the prepared remarks there will be a question-and-answer session.

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

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

Please go ahead, sir.

Good morning, ladies and gentlemen, and thank you for joining us today for an update and review of our second quarter results.

As usual, Scott Davis, our CFO, is with me to offer insights into the quarter and give our outlook going forward.

After that we'll both take questions.

This conference call is being webcast and will be available on our Investor Relations website for a couple of weeks.

Now, please bear with me as I review the save 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 regulation, increases in aviation and motor fuel prices, cyclical and seasonal fluctuation in our operating reports and other factors identified in our 10-K and other documents we've filed with the Securities & Exchange Commission, all of which are available from the SEC.

Having gotten that out of the way and before turning the program over to Scott, I would like to note that we will be conducting an investor conference this coming October 30th.

The conference will be held in Manhattan near to many of you, and will include Mike Eskew, our CEO and a number of other executives.

During the day we'll give detailed updates on the status of our business segments and also bring you up to speed on the outlook for things to come.

Look forward to seeing you there.

At this point, without further ado, I'll turn the program over to Scott.

Thank you, Kurt and good morning ladies and gentlemen.

We're pleased with UPS' second quarter performance.

A 13% increase in earnings and a 7% revenue gain, driven by all parts of the business is heartening, especially since there was no noticeable sign of an improving economy.

I'd like to start with a review of the international segment.

Once again, the segment turned in excellent results.

Revenue was up 20% and profitability up over 150%.

This performance resulted in an operating margin of 11 1/2%, making this the third consecutive quarter of double-digit margins.

This exceptional performance resulted from the combination of continued growth, firm yield management and excellent cost control, all supported by highly-integrated technology.

International volume growth slowed a bit from the pace we experienced in the prior quarter, reflecting primarily the weak European economy.

Export volume increased 6.2% due to solid growth across all regions.

After 25 quarters of double-digit growth in Europe, export volume increased 5% in the second quarter.

Several factors caused growth to slow.

Among them were unusual calendar impacts from holidays in Europe, the struggling economy and the strength in the euro, which makes European exports less attractive to the U.S. and Asia.

Export volume from Asia increased 15%.

Shipments out of Asia were strong to the U.S. and Europe, but interAsia volume was weak.

Likely due to the impact of SARS.

China also continued to exhibit excellent results with export volume up 47% for the quarter.

Both Latin America and Canada realized double-digit export volume gains.

Part of the result of our new Trade Direction cross border service.

Export volume from the U.S. was also in the mid-single digit range, continuing a steady improvement over the last three quarters.

Export revenue apiece improved 16% or 5% restated for currency.

Besides the currency impact, improvements in product mix and continued focus on yield management contributed to the revenue gain.

We were pleased to learn last week that UPS had been awarded tentatively 12 frequencies to fly beyond Hong Kong.

We currently use six of these to connect Hong Kong with the Asian hub in the Philippines and we use the other six to connect Hong Kong with our European hub in Cologne.

The Cologne route is particularly important to serve the fast-growing Asia Europe trade link.

We plan to be operating in these routes in late October.

Now I'll turn to the domestic segment.

This business achieved volume growth across all product lines and came in within the 1% to 2% growth range we projected, even without help from the economy.

Most notable was the 9% improvement in our overnight air product.

This volume gain was driven by the more than 20 percent increase in overnight letters, reflecting the continued strength in the mortgage re-financing sector.

Revenue per piece declined for the product due to the substantial increase in letter volume versus packages and a 5% reduction in average weight per package.

Growth in ground volume turned positive in the quarter.

Ground growth has improved steadily over the last several quarters as we've won new volume and regained volume lost over labor negotiations last year.

Revenue for piece for ground packages remained firm, increasing 3 1/2%.

Of note is the success of the newly-launched UPS stores, which have been well-received by both franchises and their customers.

These stores now offer over 3,000 very visible points of contact for accessing UPS shipping services.

Domestic profits were down 7 1/2% for the quarter, resulting in a domestic operating margin of 13.6%, better than in the first quarter of this year, but 160 basis points below a year ago.

While we're slowly making progress, we still have work to do.

We continue to feel the effects of rising healthcare and pension costs.

In this quarter alone pension and healthcare costs increased more than $100 million.

While we expect these costs will remain challenging, the increases should slow over the next several quarters.

Regarding wages, as we continue to grow volume and cycle through the labor contract increases in the third quarter, wage increases should moderate.

Fuel costs were up moderately and the surcharge more than offsetting the increase.

In this quarter we experienced the opposite situation from the first quarter.

Our field surcharge caught up with costs, whereas in the first quarter the surcharge lagged price increases.

All in all, the continued progress on the cost side and growth in the business, we expect domestic profits to show year-over-year increases beginning in the third quarter.

Now, some comments about our non-package segment.

This segment posted strong revenue gains of 16%.

Most of which was generated by our Supply Chain Solutions business unit.

Revenue in this business unit accounted for $530 million of the $731 million total for non-packaged.

Growth in this business was driven by excellent results in Europe and Asia.

Air freight services increased 17% and ocean services improved 7% in the quarter with most of the increases coming out of Asia.

The pipeline of new supply chain business opportunities continues to be strong, positively impacted by the UPS Brand launch in March.

Under the new brand, joint sales initiatives with other parts of the company have been well received by customers and prospects.

This has resulted in more opportunities to develop integrated sales solutions that pull together capabilities and service offerings across the company.

SCS profitability also improved substantially.

Cost control as well as benefits from the re-organization contributed to profit gains.

As of the end of the quarter, 90% of the head count reduction and over half of the facility rationalization had been completed.

The remaining parts of our non-package segment also performed well in the quarter.

Revenue from these combined energies was up over 16% and profitability also improved.

Nonpackage results for the quarter were impacted by the sale of the company's Mail Technologies unit.

This transaction reduced the segment's operating income by $24 million, although this was offset by a $38 million tax benefit, leading to a net $14 million gain.

Before I address our outlook going forward, I want to update you on our cash flow.

UPS continues to generate significant free cash flow.

Year-to-date, free cash flow before dividends and share re-purchase came in at $1.6 billion.

Since the beginning of the year we have paid down $600 million in debt, purchased $200 million in stock, increased the dividend 11% and still increased cash by over $350 million, leaving a cash balance of $3.4 billion.

Turning now to the future -- UPS' third quarter historically is not as strong as the second.

However, this year we believe improving trends will off-set some of the normal summer weakness.

We expect to see a 2% to 3% volume gain in our U.S. domestic business with improving trends in ground and differed products and continued strong results in next-day air, although this will somewhat depend on refinancing activities.

Typically the international segment slows in the third quarter because much of Europe goes on vacation for the month of August.

Nevertheless, we expect to achieve growth in this segment at about the same rate as in the second quarter.

The international operating margins will improve over last year, but will likely be in the upper single digit range due to the seasonal slowdown.

In the nonpackage business we anticipate low double-digit revenue growth with healthy gains in profitability.

With this in mind we expect earnings to be between 58 to 62 cents per share, compared with 51 cents last year.

This equates to a 14% to 22% increase.

Over a midley-weak third quarter last year.

As we've said in the past, we have no strong conviction on the direction of the economy.

Our sense is that it hasn't really strengthened, but it hasn't worsened either.

Consequently, we've moved our expectations for recovery back a bit from what we expected at the beginning of the year and are now looking to see some pickup later this year with GDP up 3% or so on a year-over-year base yas by the fourth quarter.

Nonetheless, we remain confident that UPS will achieve its targeted earnings improvement for the year, in the 10% to 15% range as we've said all along.

In summary: We continue to execute our strategy.

Much of our improved performance centers around our ability to present customers with broad solutions.

By integrating technology, financial and supply chain services and our package expertise, we're creating business solutions that uniquely address our customers' strategic needs.

We believe that this positions UPS well for the future.

Thanks for your attention.

Now Kurt and I will be happy to take your questions.

Our first question comes from John Barnes of Deutsche bank.

Hey, guys, good morning.

Good morning, John.

First of all, can you comment a little bit on the new fifth freedom rights you were granted in the last couple weeks?

John, it's something that certainly we've worked on for a long time to procure those rights and we're very excited about the tentative granting of those rights.

We think it's going to -- particularly the Hong Kong, the Cologne will improve our service tremendously, allowing for later pickup times in mainland China.

And in a market that's already growing 47% last quarter, I think that's gonna give us potential greater growth in the future.

Okay.

Any need for -- any need for an expansion of the infrastructure to support the new rights?

No, I think the infrastructure is there.

No expansion is planned.

Okay.

On the bonus depreciation that's gone into affect, has that made any changes to your Cap Ex plan?

It really hasn't had an impact on it right now.

You know, we're gonna spend according to our needs, as we always have.

We'll look at that.

We've got I think through 2004 to take advantage of that.

But it won't change our near-term plans.

Okay, and the big question with you guys is always what to do with the cash.

Have you given any further you know, thought into dividend share re-purchase?

What's key on your list right now in terms of uses of the cash?

John, I sound like a broken record on this one always, but you know, the first thing for us is always we're looking to reinvest in the business.

Reinvestment must meet our hurl rates going forward.

Paying down debt again, some of that, but it's not a big issue for us as a AAA.

What's really changed with the tax reform act obviously is a split dividend policy on par with share repurchases.

We have not had a board meeting since the tax law has changed, and as always at a board meeting we'll discuss dividend policy going forward.

Okay, thanks for your time, guys.

Thanks.

Thank you.

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

Hi Scott, hi Kurt.

Good morning, ed.

Can we talk a little bit about next-day air?

Volumes were tremendous, up 9%, but when you look at the yield, down 4.8%, it feels like maybe UPS is making a little bit of a market share grab in the next-day air business.

Can you talk a little bit about how much of that was pricing?

Are there other mix issues?

And you know, am I reading this correct?

I think it's primarily mixed.

I think we've had some tremendous gains in the next-day air market over the last ten years.

We've been gaining market share.

I think what you saw in the second quarter was clearly a strong growth in the letter market.

And we've several customers with large campaigns out there in the re-financing market, which helped boost that growth.

But what really drove the yield again, was the 20%-plus growth in letters.

Packages were up, but certainly low single digits.

Weight of the packages also dropped 5%.

Which had a big impact on it.

So I think it's not so much aggressive pricing as it is the mix issue.

Yeah, this is Kurt.

I mean, we've been a little surprised at the velocity of the re-financing activity also, because it's unprecedented.

We've been talking about this for a couple of quarters, but it really seemed to take off in the second quarter with just an increase in the amount of activity.

Okay, so if I'm summarizing you right, it's mix and prices positive or pricing is negative, but not as negative as it might appear?

It's not nearly as negative as it might appear.

Pricing is neutral in the market, weight is a big issue, 5% drop in weight.

Even some of our packaged growth came from the re-financing business.

We have letter packs, which would bring down the overall weight per shipment, so that did drive the yield.

Okay.

Flipping over to the ground side -- 0.3% off of an easy comp, couldn't have been -- the original guidance was a little more than that.

What do you expect going forward in the ground going forward in third quarter and how much of what we're not seeing is related to the economy?

Well, you know our guidance really came -- was 1% to 2% on domestic volume and we're not far from where we thought we'd be on ground.

In fact we operated in the second quarter pretty much in line with what we expected.

As we move into the third quarter we do expect to see more gains than ground.

I think -- we went from a minus 1.2% overall domestic volume in the first quarter, plus 1.2% in the second quarter.

Now we're saying 2% to 3% volume in the third quarter.

Third quarter you'll see bigger improvements in ground and deferred air and probably still staying strong on next-day air if the refinancing stays there, but we'll see improvement in ground and deferred in the third quarter.

So it's a good, steady improvement, I think.

And if we look at margins, I'm guessing what you need is ground volume to really see the domestic margins improve?

Is that a fair comment?

Without a doubt.

As you head into the third quarter we expect domestic profits in the third quarter to exceed last year's.

We haven't seen that in a while.

Volume will certainly help us in the area, overlapping the contract at August first of last year will help us to get back to the 2000 levels we need help on benefit expenses.

And what kind of volumes do you think you need to see to get there and over how many periods of quarters?

I mean, is 2%, 3% volume enough?

And if so, over how many quarters before you can start to get the 00-kind of margin levels?

I think the key to get to the 00-margin levels will be some leveling in benefit expenses.

And things like interest rates will have an impact on that, looking at the pension expense for 2004.

Also, as you look longer-term, we've got a lot of technology being employed in the operations, which will help us down the road in '04 and '05 pull some of the comps out of it.

You are going to see trending -- improving trends of domestic operating profit, even at levels of 2% to 3% volume growth.

Thank you.

As a reminder, ladies and gentlemen, please limit yourself to one question to allow for the maximum number of callers to ask their question.

Our next question comes from Charles Lipinsky of Forrestman.

My question was answered, thank you.

Thank you.

Our next question will be coming from Scott Flower of Smith Barney.

Yeah, good morning all.

Hi, Scott.

Yeah, just a couple quick ones.

How much -- you've talked in the past about on the labor cost side, part of this was that everyone got an increase in the beginning of the contract and that because the economy's been a little bit mixed.

Some of the traditional turnover that you've seen or expected in your part-time reports hadn't been there.

I'm just wondering, is that at all still the case?

Is the turnover turning back to more traditional levels?

Help me understand that facet on the cost expense side.

There's some turnover, Scott, not the turnover levels we've seen in the past.

And I think you know, the growth in the economy and jobs will certainly help that situation as we go forward.

We will still get some comp benefits due to the turnover we've had, but probably not at historical levels.

Okay, and two other quick ones.

One -- and maybe it's de minimis because it just happened.

Obviously you've owned (inaudible) for a while, but was there anything effect from a volume perspective in Q2 or is that that because you've owned it you've already seen that, therefore it wasn't important or B, that because of the cutover to the UPS Store format was just that recent ago that you didn't see much benefit?

I think you're actually seeing good benefit.

The actual results of the UPS Store in the second quarter are exceeding what we saw in the beta tests that we had done last year, so we're seeing very good growth there.

Actually, it's driving a lot of the air growth we talked about, some of the next-day air business.

We're also seeing a fair amount of international business coming out of the UPS stores.

So it's making a difference.

As I said at the last call, the retail market's a 2 1/2 million piece a day market in the U.S. it's a big market, where the post office has some 75 percent of it.

So we have a lot of upside in the market.

Last quick question, just curious, you mentioned that you got the positive on the fuel surcharge versus fuel cost.

Can you give us any sense of what that positive spread was?

We did.

As we said last quarter, you know, last quarter -- in the first quarter if you ignore the hedging benefit, you know, the drag and surcharge, the lagging effect I said, costs us about $45 million.

In the second quarter we said that would turn around.

It did, we benefited about $52 million the second quarter from the surcharge.

So it's a long term -- it's a zero-sum gain as our surcharge just covers our cost.

Will that be more toward normal in Q3?

I think it would be more towards normal.

A higher surcharge, but the costs are higher too.

Got it.

Thanks.

Thank you Our next question is coming from John Legenfeld of Robert W. Baird.

Good morning.

Good morning, John.

Nice quarter.

Question on the non-packaged side.

Can you characterize a bit the type of work, the type of new engagements that you're coming across?

Are they across all types -- contract, logistics, forwarding -- are are there specific areas where you're seeing more activity?

We're seeing good growth in the logistics and freight forwarding side.

A little more growth in the logistics side, but we're actually growing in the upper teens level.

You're seeing some of the big North American customers, for example in the supply chain arena, expand geographically for us, having our service parts logistics service performed in Asia and south America.

So you're seeing a lot of the bigger customers -- if you really broaden out geographically with our services.

Okay, great, thanks for the color.

Thank you.

Our next question comes from Jordan Alger of Lazard.

Question, I'm not sure, did you guys quantify the profit impact of foreign currency on the quarter?

I'm not sure that we did.

The actual impact in the second quarter was about $32 million, Jordan.

Even without the $32 million benefit international profits would have doubled.

So very strong quarter, even without the currency benefit.

I think the first quarter was about $27 million.

And we would expect in Q3 and Q4 still to have a positive currency.

Not to the level we saw in the second quarter, but still positive going forward.

Jordan, I guess the one downside of that is that we did see, as we'd said, a slowing in exports coming out of the European theater.

That currency has some drag, so there is some give and take around that too.

Great, thanks very much.

Thank you.

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

Hi, guys.

Hi.

Scott, go back to margin in the domestic operations.

You talked about what it takes to get back to 2000 levels.

I guess that was about a 15% margin, maybe a touch better than that --

17%.

Excuse me, 17%.

I just want to make sure I understand.

How much of that do you think is economy?

How much of that is the benefits expenses that you mentioned now a couple of times?

Or should we just think about you know, that's not something we're gonna see again for whatever the reasons might be?

I think we can get there, it's not gonna happen overnight.

I think that clearly the economy will help a bunch.

I mean, volume -- the volume projections we gave here for the third quarter are based on the economy being somewhat where it is in the second quarter.

If the economy improves, it would help us move in that direction, but I think it's difficult in this environment with the healthcare costs up in the mid-teens, with pension expenses up so high, you know, and the impact on pension expense for next year really we don't determine until September 30th when we do -- take our new actuarial assumptions.

So the actual impact of interest rates, which are kinda' out of our control, will certainly impact that cost going forward.

It's a combination of both.

Okay.

But if we go out a couple three years, forgetting the next quarter or two, you don't see something structural as regards to your recent labor agreement that should get in the way of that?

I think we can get ourselves back to those margins.

But again, it's gonna have to be -- we need to grow the volume and we need to have reasonable benefits expense increases.

Certainly Gary as we mentioned early, there's a lot of R&D and development on stream lining and operating our informational processes and we'll be talking more about that at the investor conference at the end of October, give you more visibility where that's heading.

Okay, thank you.

Thank you.

Our next question is coming from Helene Becker of Benchmark Company.

Thank you, operator.

Hi, everybody.

I just had a couple balance sheet questions, Scott.

I thought you said that you paid down debt in the quarter when talking about the cash flow.

Did you just say that or did you say something else about that?

We did pay down the debt.

Well, you're probably look at -- most of it was in the current portion, our liability.

So we did pay down the first half of the year about $600 million in debt, but it shows up in current liabilities.

That's what the reduction is.

Okay, so the 23% increase in working capital is on the increase in cash offset by the pay-down in the debt, right?

That's pretty much answers it.

Okay, and the other question I had was with respect to the pension, and you may have answered this when you answered Gary.

I noticed that your pension costs were down in the past six months.

Can you just -- did you talk about that and I missed it?

No, no, pension expenses are definitely up.

And the balance sheet you're saying, that's just amortizing the expense off of the asset account.

That's to reduce the asset.

That's what I thought you said, that pension expense was up.

So now did you answer this already, what's your pension expense for the rest of this year and what was it in the second quarter?

Well, I think we said that we expected pension expense for the year to be up about $135 to $140 million.

So that's pretty much divided over the four quarters.

Okay.

And the real question is the impact, what it's gonna be in 2004 and that will depend on actuarial assumptions for next year, although we had good asset growth in the second quarter in our plans.

Okay, thanks for your help there.

Thank you.

Thank you.

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

Just wanted to follow up on the international questions.

You talked about seeing continued weakness or strength I guess in the euro, which was slowing the international volumes.

And domestic international seemed to slow significantly.

Is that a trend that we should see continue as the economy overseas, if I understood you right, you said was continuing to get weaker?

No, I think that a big piece of our european domestic volume is Germany, and Germany is probably the weakest of the countries economically over there right now.

We wouldn't expect much decrease over where we are at this time and hopefully as the economy firms do a little better.

As I think you know, that whole -- domestic product line is not a high growth priority for us.

It's really there to offer a broad level of service to customers.

Our real focus is on growing the export.

So we've had kind of a managed growth strategy around the domestics for a number of years.

So it's really not off the normal trend, although it did soften a bit from Q1 to Q2.

Just a quick follow-up on the ground, a small part of the ground.

The 100 weight.

Is there any benefit from the yellow roadway merger that you're seeing?

We're certainly a large player in the LTL market.

It's really I think too early to tell if customers are going to do shopping based on this merger.

A lot of opinions out there.

Okay, great, thanks.

Thank you.

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

Thank you.

Everybody's focusing on the business fundamentals.

Let me focus on the some of the below the line issues.

No real talk about the $38 million tax benefit that was about 3 1/2 cents a share to the quarter.

Is that a one-time item?

What was causing it?

Will we be looking at a 34% tax rate going forward?

No, Jeff.

The net impact of that was we sold off a technology business and we took a $24 million loss in the non-package area.

And then we had a $38 million gain -- benefit -- in taxes.

The reason the benefit is so high is we had impaired some goodwill on that property last year.

So we had prepared over $70 million last year to goodwill.

So you take the $70 million plus the $24 million loss and you get the benefit.

So net impact to financial statements was a positive $14 million or about a penny.

Fair enough.

And that's 37% rate going forward?

37% rate going forward, correct.

Okay, great, thanks.

Sure.

Thank you.

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

Great, thanks.

Scott, Kurt, good NDA numbers.

I think I accounted for one of those envelopes this quarter.

Good!

due to refinancing. --

Hopefully it came UPS, Jim.

It absolutely was, both ways!

In terms of your margins, domestically.

If we go through and adjust for the pension healthcare inflation it looks like margins would have been about flat, maybe just slightly down by our estimate.

And you had 3.7% topline growth.

I guess I'm trying to understand, given you had such strength in next-day air, which presumably is a very high incremental margin business, and with the benefit of hub 2000, which I thought kicked in fully last year in the third quarter.

I guess I would have thought that you could have had better operating leverage once again, taking out pension healthcare costs.

I would have thought you would have had some level of margin improvement and we didn't see that.

I'm trying to figure out, is that just too high expectations or in terms of incremental margin expectations?

Are there are possibly other -- costs in there or maybe a change of business that's not allowing the operating leverage to show through?

Yeah, you know, we did say that healthcare and pensions were up over $100 million.

So clearly without that increase we would have shown expanding margins.

And you know, we only showed a 1% volume growth, so we're starting to cook up a little bit.

There are some other head winds, the economy's still weak, but you know, our guidance clearly looks for domestic margins to improve as we wrap some of the upfront stuff for the first year of the contract.

That will moderate.

So no, we feel pretty good about being able to get this domestic engine cooking and we think we've demonstrated steady progress anyway, Jim.

Okay, and then on the teamster wage increase, I believe, I thought there might have been a component of it tied to inflation, given we have a fairly weak inflation in our environment, that be good, but I thought there was also a fixed component over the life of the contract in terms of annual wage inflation.

Can you just bring u us up to speed on the two components to the extent there are two?

Well, the inflation component -- there is an inflation component, there's one component we're talking about.

That is, we're a long ways away from that kicking in.

I can't recall the exact percentage, but we're a long ways from that being an issue at this point in time.

I don't see the next couple years being an issue at all.

So it was more protection for employees on the high end as opposed to potential benefit for the company to the extent we had a low inflation in our environment?

That's correct.

Jim, let me just to recap because we have a lot of questions around this.

We have three or four key factors we think will contribute to domestic margins over the next several quarters.

Clearly as volume growth continues to pick up that does give us scale economy, certainly Worldport has low incremental costs, as well as a lot of our network.

So you're correct on that side.

It also allows us to bring in new employees at lower starting rates, so that has a benefit on the wage side.

Our part-time work force as we said, has been a little stickier.

Normally more of the college students go onto full-time positions with the company or elsewhere.

As we continue to grow we'll make more opportunities and as the economy picks up they'll move onto other locations.

Once again, which has a benefit on the wage side.

We do wrap over the contract.

It did have up-front issues.

There were some one-time issues that we'll cycle through, starting in the third quarter.

And then also on the benefits side, we've seen significant increases in healthcare and other things that many companies are facing.

Frankly, last year -- and in some of the current quarters we're catching up a little bit.

And we think those increases will moderate, although clearly healthcare remains a challenge.

And then with the interest rates firming somewhat, that may help to moderate some of the pension increases.

So, as you put together all these pieces of the puzzle, not counting major structural issues, we're working on, we feel pretty good about the outlook for domestic margins.

Interest rates impact more than just pensions.

They even impact your retiring healthcare, which also uses the interest rate of the expense.

So as the rates go up, some of the healthcare costs will come down also.

Great, thanks, appreciate your response.

Thank you.

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

Good morning, gentlemen.

Hi, Don.

I'm a little confused on the math on the currency benefit.

When I take last year's yield for total international and subtract this year's yield year-over-year basis I get a $2.88 differential between per-package rev.

No, on the revenue side certainly the numbers are different.

That was the P&L impact, Don.

I'm looking at per-package.

And looking at your breakout which you shared with us which I really appreciate, it looks like if you adjusted for currency the difference was only $1.22 per package.

Okay.

Which is still excellent.

Right.

So if I take the $2.88 and sub extract the $1.22 the difference is the benefit, correct?

You're looking at the P&L impact.

Let's start with the difference between the $2.88 and $1.22 is the currency.

Right.

So if I take the currency per package and I multiply it by the total packages per day and the total days in the quarter, I get to $127.8 million.

$126 million is the revenue impact.

You're right on.

Okay.

That's 7 cents, not -- or 127, not $52 million.

Where's the disconnect here?

You have another -- you have expenses on the other side of the equation and expenses go up with currency also, so you have to figure that out.

Expenses were up almost $100 million due to currency.

That clearly shows up both in the wage and benefits and in the other expense.

So that was the offset.

Of course.

We're trying to be as transparent as possible on this, Don.

I appreciate that, I just saw the differential between the 52 and what is obviously $127 million.

Yeah, give me a call afterward and we can dig some more, but the bottom line is the P&L benefit was about $32 million and revenue benefit was $126 million due to currency.

So we got $52 million on currency, $32 million on fuel, $38 million in tax, that's 7 cents a share as a flat quarter earnings-wise without the benefits.

You have $24 million on loss on a sale of operation also.

Okay.

Comp and benefit per average daily package continues to go up 6%.

That's been the rate -- steady.

You're saying you have pension costs, but before the pension cost that was the rate.

Should I be modeling for that to start to come down in later '03 and '04 or is that a steady state expectation?

No, that number has been moderating a bit quarter over quarter.

Certainly a chunk of that is currency also.

Over 100 basis points.

So that increase is pure currency with salaries from over the U.S. coming in.

But no, we certainly are expecting to see improved unit cost results in the domestic.

We don't break those lines out for a domestic versus international, but we are showing improvement trends --

But are running up 6%.

Should I model it now to be up 4 percent on an on-going basis per package?

We don't have specific guidance on that.

We're given the general margin guidance and it will certainly depend also on volume growth.

We have 2 1/2% higher growth this quarter than we did the previous quarter too, which certainly drives a little cost.

Fair enough!

Thanks.

Good luck, gentlemen.

Thank you.

Your next question is coming from Greg Burns of JP Morgan.

Hi, guys.

Just a quick question on the grounds side.

Scott, did you guys see a -- I assume you saw a month-over-month volume pickup, and I'm curious.

There was commentary in the market that the retail side of the ground market was a little weak.

I'm curious whether you saw weakness in the retail segment on your ground and just sort of what you're seeing there?

We saw pretty steady improvement through the second quarter.

So each month got a little better.

The trend has really carried on into July.

Frankly, we didn't see much weakness in retail.

Retail actually strengthened some from what we saw in the first quarter.

The first quarter obviously was impacted by weather.

But looking at the economic sector, I would say we saw little improvement in retail.

We also saw some stabilizing in technology and telecom, which we hadn't seen in the past.

Services were very strong, financial services, as we saw from next-day letters, and wholesale and manufacturing pretty much stayed flat.

They didn't show improvements.

Greg, one thing.

We don't think that's necessarily economy, though.

Don't interpret Scott's remarks to feel we saw it strengthen in economy over the quarter.

The way I'm interpreting it is that you're gaining share, at least you gained share, your share momentum picked up throughout the quarter.

Is that accurate?

I think that's fair.

We certainly lost some share on the ground in 2002 with contract negotiations.

We think we've stopped that erosion.

I'd say so.

And just one quick question on the international margins.

You're coming up to the seasonally weak third quarter.

I know you've diversified a little bit away from Europe, but do you think you can hold double digits in the seasonally weak third quarter?

Do you think you're back in single digits.

I actually think, Greg, that will be a stretch to get double digits in the third quarter.

Europe is still about half of our revenue internationally, and I think that will have an impact.

I think it will still have very strong comparisons versus last year, but it will more likely be upper single digits on the margins for the third quarter, and hopefully double after that.

Great, thanks, guys.

Thank you.

Your next question is coming from Dan Hemme of Prudential Equity.

Good morning Scott, Kurt.

Good morning.

I think maybe following up on the yield and pricing question, or discussion, can you share your perspective or thoughts on the domestic pricing policies as you see them now for both the air and ground and what your expectations are?

That's certainly been a question everybody's been looking at and written a lot about it in the last six months, and I think again the ground yields for both ourselves and competitors have stayed strong.

Again, 3 1/2% in the second quarter.

We would expect good, strong yields in the third quarter going forward.

So I don't think things have changed dramatically there.

Again, I think the air yields -- again, it's you know, there's always competition out there, but I think this is primarily a mixed issue, the letter growth.

I don't see any major changes in the pricing policy, domestically.

Thanks very much.

Thank you.

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

Yes, good morning, gentlemen.

Just to bore a little bit more into the compensation and benefits line item, which I think was up 7.4% year-over-year.

I realize pension costs were up and healthcare costs were up.

Are there any specific programs that you can share with us that you're embarking upon to try and carve that back some, perhaps higher co-pays on your healthcare program, perhaps some sort of an employee buy-out program such as the one that fed ex is implementing?

Any thoughts along those lines?

No, we're obviously always looking at our costs to find out how we can reduce costs.

We don't have any major program.

We think the people would have on the -- we have on the payroll we need on the payroll.

But I think Kurt's talked an awful lot about the lack of turnover, not enough turnover has really impacted the overall comp and benefit increase and that's gonna change.

It's gonna change going forward.

So we'll see some moderation in those costs.

I guess another item we didn't talk about much on the wage and benefits, but probably 1% of that 7% increase was currency alone.

We pay a lot of international employees and you translate that, it's a currency of that too.

So, this will moderate.

Thank you very much.

Thank you.

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

Good morning.

I was hoping you could give us your thoughts on the DHL Airborne merger, what's happened lately and what you foresee happening in the next few months.

You know, Jennifer, the big issue that obviously we've challenged is UPS believes the German post office controls DHL Airways and we've asked for a public hearing and gotten one.

The administrative law judge is having a public hearing at this point in time.

You know, we're pleased to see that.

We think it's going to be an open process and we expect you know, hopefully a good decision to come out of that.

As far as a timing of this thing, the decision is supposed to be made by October 31st, although the administrative law judge has asked for a 3-month delay to get more information, and we certainly support that if he needs that time to make an informed decision.

What impact that's gonna have on the ABX transaction remains to be seen.

We're not sure what that impact will be.

But what we're looking for is a fair hearing to find out who actually controls DHL Airways and we're getting that.

Great.

Just a quick housekeeping.

You mentioned domestic revenue growth rate and I missed it.

Can you give guidance?

It was just under --

For Q3.

Well, for Q3 the volume's gonna grow at 2% to 3%.

At least the -- it yields to be comparable.

Great, thanks.

Thank you.

Your next question is coming from David Campbell of Thompson Davis.

Yes, hi, good morning.

Thank you very much.

The Hong Kong air rights, will that require more aircraft than you have on order?

And increasing capital spending?

No, it will not increase capital spending.

We'll just shift some airplanes to fit those routes.

Shift them internationally or from domestic markets?

Yeah, it's really, it will be a re-routing of existing aircraft that will take advantage of being able to do the beyond Hong Kong.

So it's a re-routing of the Asia flights that exist today.

Okay thanks.

And second and last question is ground business was down from the first quarter.

Is that normal?

Because you mentioned you thought ground was where you thought it would be for the second quarter.

Is that a normal situation where it's less than the first quarter on a daily basis?

I mean, I think there's some seasonality.

Easter falls can have an impact on volume.

So, the second quarter came in pretty much where we thought it would, but a lot -- there is some seasonality.

If Easter I think was in March rather than April, it impacts it year-over-year.

If it had been earlier it would have been more adverse, right?

Well, it can shift absolute volume from March to April or April to March, depending where it falls.

So no, we clearly felt that our results were stronger in the second quarter for ground than the first, even though the absolute average daily numbers show a slight decline, but adjusting out the seasonal stuff, we thought there was a strengthening and clearly the year to year comps reflect that.

Okay, thank you.

Thank you.

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

Yeah, I just had a follow-up and I don't know whether I can get some color on this.

Obviously next-day air was strong and you mentioned that --but I had two questions related to that.

You talked obviously about domestic refinancing.

I'm not trying to get you to forecast the fixed income markets, but, obviously, rates are starting to back up and I guess I had several quick questions related to the next-day air and the refinancing (inaudible).

One would be, are you seeing, and maybe it's took quick, any kind of impact in July on some of the back up in rates or is that too quick?

Might you just have a flurry of refinancings, you know, people trying to catch the refinancing opportunity before it backs away from them?

And, two, is how much of the growth in next-day air really was refinancings or financial services when you look at your growth in second quarter?

Well, refinancing, it is too quick.

We're still seeing the same trends in July that we saw in the second quarter.

And frankly, Scott.

If rates go up that probably means the economy's getting better and we'll like that because we'll get more heavy packages, next-day air packages, which will have even more profit.

So if that goes away, it's probably a good thing for us.

Can you give me any sense -- I mean, was 20% of your growth in the next-day air category refinancing-type product or I mean just broadly, even just a range of how much of the growth was due to re-FI?

It certainly accounted for the majority of that next-day air, over 20% letter growth and more than half of the 9% increase.

Got it, thank you.

Thank you.

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

Yeah, just a couple follow-ups.

Kurt, you said in one of your comments that -- lost my train of thought.

Let me come back to that.

Can we talk about the international margin for a second.

Obviously you're being helped in the near-term by some currency issues.

How sustainable on kind of an annual basis is where we are -- let's call it 10 percent overall for margins right now in international -- how sustainable is that going forward?

Do you think this is kinda' a new base going forward and it can improve from here or do we give some of this back, you know, step back before you go forward in the longer-run?

I think there's no going back, Ed, in my mind.

I think we've shown great progress and I think as we continue to add packages to our airplanes and take cargo off, that's gonna improve the margins.

As I said, for a couple years now we expect the international margins to move towards the domestic levels and we still believe that.

So we do not look at going back you know, long-term below that 10% margin level.

Okay.

The question I meant to ask before, Kurt had mentioned that as part of the contract, when he was listing why domestic margins should begin to improve, that there are certain issues regarding the contract that cycle through beginning in third quarter.

Can you give a little more specifics to, you know, I wasn't aware there was anything specific other than the cycling out of bodies you know, into the contract over time.

Is there something specifically that starts in third quarter that went away in the first and -- second quarter?

Well, the nature of a new contract, every employee in the company gets an increase on the date of a new contract.

Where as on the normal course of the year that happens if they hit their anniversary.

That clearly drives costs up.

There was also moderate expansions of benefit coverage for part-timers and some other things.

It was a one-time pop.

So it's more of six months after the contract ends specifically to those timeframes?

No, -- well, some of that cycles through each quarter over the next year and some will be a direct year to year comp that will finally overlap in August.

Is it is there any way to quantify the range of what the savings might look like for that?

Nothing specific for you right now.

I didn't expect so.

Thanks, guys.

Thank you.

Your next question is coming from Gary Yablon.

Just want to follow back up on a comment Scott made earlier.

This goes back to next-day air.

I'm sure you're thrilled for another question on the next-day air yields.

We're thrilled with the next-day air.

Yields are a little different issue.

So you talked about the letters and all that, weight per package down 5%, pricing probably neutral and next-day air market -- if I wrote that down correctly.

Is that neutral meaning flat or rate of change the same?

I'm not sure exactly what that meant.

I'd say flat to slightly up.

You know.

If you take out the mix and the weight issue.

Okay.

Because we have -- so revenue up 3.8%, yields down 4.%.

This is just the next-day air.

And volume plus 9%.

And within the context of that you're saying flat to up slightly in pure price?

You know, Gary, the next-day letter carries less than half the revenue of a typical package.

So it's more than a subtle change.

It's a dramatic difference in receiving a letter versus --

I think Kurt what people might be confused about -- at least I am -- is going to the first quarter and looking at the relationship between change in rev and yield in the next day air business, did the refi market -- was it that much stronger in Q2 than Q1?

It was.

In fact it was single-digit increases in the letter market for us in Q1, so much stronger in the second quarter.

A lot of that is the big campaigns of some of our customers in the second quarter.

Yeah, okay.

You know, that market could be volatile.

As we talked about earlier with interest rates, but we continue to feel real good about our position in the next-day air.

We've been steadily growing it.

We have not changed policy, and we just got a very strong boost from the strong benefit of the refinancing.

Okay.

And just sneaking ahead for a question here.

Third quarter '03 you quoted volume gain domestically 2% to 3%.

How does that parse out between air and ground?

As I said, we'll see ground improving.

We haven't broken down the components, but ground will improve.

Ground and deferred air will show the bigger improvements in the third quarter.

Next-day air, it will be hard to stay at 9%, but we think it will still be very solid.

Thanks.

We have time for one more question.

Thank you.

Your next question is coming from Greg Burns of JP Morgan.

Hi.

Scott, just a question on the cash issue.

There's been a lot of activity in the lessened truckload space, which is quite a large market and fed ex-has a presence there.

I know you guys have been happy with the hundredweight program.

I'm curious, is there a strategic reason why it makes no sense to get more involved, or are you sort of undecided and you know, in view of your excess cash flow why not, you know, build a bigger footprint in that segment?

Greg, you know, we still compete in the LTL market with a hundredweight offering and we're one of the largest LTL companies out there.

We also use LTL in supply chain units to provide solutions for heavy shipments to our customers there.

We think we got adequate coverage today.

Now, as I said before, 20 years ago we said we'd never be a freight forwarder, we were.

So I'll never say never, but right now I think we have adequate LTL coverage.

Great, thanks.

Great, I guess that's enough for today.

We appreciate all of your endurance for going through the details with us here.

You know, we continue to make good progress, we think.

We basically are executing along all three segments.

Clearly we would have loved a little more of a tail wind from the U.S. economy, which did not show up in the second quarter, but we feel increasingly confident that with the stimulus that's in the economy, things will pick up and clearly we'll be in a good position to take advantage of that.

So, look forward to talking to you all and perhaps see you in October at our conference.

Thank you.

Thank you.

This does conclude today's teleconference.

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