聯合包裹運送服務公司 (UPS) 2003 Q3 法說會逐字稿

Welcome to the UPS third quarter earnings conference call.

Today's call is being recorded.

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

To ask a question, please press 1, 4 on your touch-tone keypad.

Now, I would like to turn the call over to the Vice President of Investor Relations, Mr. Kurt Kuehn.

Please go ahead, sir.

Good morning, everyone.

Thank you for joining us today for our review of what we think are some pretty good results for the third quarter.

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

After that, we will both be glad to take your questions.

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

Now, please bear with me as I review the Safe Harbor language.

Some of the information you'll hear today may be considered forward-looking statements as defined by the private securities litigation reform act of 1995.

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

These include but are not limited to our competitive environment, economic and conditions in the markets in which we operate, strikes, work stoppages and slowdowns, government 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 document we've filed with the Securities and Exchange Commission, all of which are available from the SEC.

Before I turn the program over to Scott today, I'd like to comment on the gain we received in the quarter due to two events, one a divestiture and the other a tax benefit.

Back in July, we sold our aviations technology unit since it was not a strategic priority for the company.

This sale produced a gain of $24 million dollars, which showed up in the non-packaged segment, which then equaled $15 million after tax or about 1 cent per share.

Second item was a tax adjustment of $22 million dollars or 2 cents a share, resulting from a favorable ruling this quarter on the tax treatment for jet engine maintenance costs.

We had accrued for some potential liabilities in this, but with the favorable court ruling on the matter, we decided it was proper to adjust the accrual.

Well now, having covered these minor details as an opening act, I will turn the program at this time over Scott at this time for our main feature.

Thanks, Kurt.

I want to thank my fellow UPSers for producing a quarter that's both easy and enjoyable to talk about.

They did a great job in the third quarter.

Earnings of 65 cents per share exceeded the range we anticipated at the beginning of the quarter.

Of course, that number does include the two events Kurt described, without which earnings were 62 cents per share.

That's still at the high end of the range we had anticipated.

In fact, this quarter was quite strong, which is not typical for a third quarter in our business.

All our operations contributed to the 21% increase in operating profit.

International operations continued to be exceptional.

In our domestic business, we saw a broad strengthening with both ground and air growing faster than the market.

And our supply chain business made noteworthy progress on its road to increasing profitability.

We carried 27 million more pieces or over 400,000 per day this year than last.

We think that's just the beginning.

I want to start my review with the domestic package operations.

Average daily volume increased a solid 3.2%, exceeding our expectations of a 2 to 3% increase.

Contributing to this improvement, of course, is easier comparisons is last year's third quarter when volume diversion peaked.

However, not all of our improvement this quarter is due to easy comparisons.

We've realized a number of new customer wins and we're seeing a strengthening in the economy, evidenced by a pickup in volume, among many existing customers.

So, a substantial amount of the gains we achieved this quarter is new volume for UPS.

Next day air growth at over 10% far-outpaced industry growth.

We still saw a high level of letter volume due to mortgage refinancing but not quite as high as in the previous quarter.

At the same time, we saw broad strengthening in other customer segments, which helped give us the strong results.

The 8.5% increase in deferred volume was driven largely by new customer wins, by mortgage refinancing and by easy comparisons with last year.

This sector is the most volatile of our products since it is heavily influenced by large shippers who often switch between this service and ground.

The 2% increase in ground volume is a clear indication that our sales initiatives are paying off, as volume gains have accelerated over the last two quarters.

This engine is gaining steam.

To put this into perspective, a 2% increase in ground volume equates to almost 200,000 more pieces a day.

Overall, domestic revenue per piece was up 2.3%, led by strong yield on our ground packages.

While volume for air products were up nicely, revenue per piece on these products declined some.

And next day air, this is due primarily to a high teens increase in letters versus packages and to a slight decline in average weight per package.

In deferred, it was due to an unusually high revenue per piece in last year's third quarter.

Deferred air revenue per piece was actually up some from the second quarter, even though it is still facing some of the packaged letter mix issues.

Excluding these factors, pricing was stable for the air products.

The 3.2% revenue per piece increase in our ground products is indicative of a continuing rational market with firm pricing.

Profitability in the domestic segment was up a modest 2% for the quarter, beginning to reflect the help of volume growth.

However, we're still feeling the continuing impacts from increased pension, healthcare and other benefit costs.

Pension and healthcare costs alone increased over $100 million dollars in the quarter.

We do anticipate these increases will moderate some next year.

Now let's switch to the international business.

Once again, this segment turned in an exceptional performance with the best operating profit in company history at $176 million dollars.

This is especially remarkable since Europe is traditionally slower in the summer months.

Export volume is up over 8%, outpacing industry growth.

We saw double-digit growth out of Asia, Canada and the Americas.

Europe reported mid-single digit export volume increases and the U.S. reported export volume up 6.5% with growth accelerating during the quarter.

This was the best quarter for U.S. exports since the third quarter of 2000.

Non-U.S. domestic volume increased 1.3%.

Our emphasis on this product is on controlled growth and managing for improved yields.

Overall, yields were strong, even without the benefit of currency.

Revenue per piece improved an impressive 14.7%, or 6.7% when adjusted for currency.

This improvement was due to the strengthening of export versus domestic service mix, rate increases in several countries and effective revenue management.

Our cargo revenue declined 14%.

A significant portion of that decline came from the Americas, where we reconfigured the air network and eliminated several flights that were primarily cargo.

We also had tougher comparisons with last year's cargo volume out of Asia.

In addition, an increase in the package volume that displaced some cargo, but that's good news.

Now for the non-packaged business, where revenue was up 6% and profit increased 92%, giving us record profits.

The strong increase in operating profit during the quarter was partly the result of a $24 million dollar gain on the sale of our aviation technology subsidiary in July.

Even without that boost, we experienced a $46 million dollar or 60% increase in profitability for the segment overall, mainly by the UPS supply chain solutions operation.

This unit is the largest component of the non-package segment.

It continues to make excellent progress in streamlining this organization and selling business solutions to integrate many of the services in the UPS enterprise portfolio.

Revenue in this business increased by 6%, lower than has been the norm that what appears to be better than industry growth.

This reflects a bit slower growth in air and ocean freight services as we overlap tougher comps in Asia, a still tentative U.S. market and some less pruning of less profitable business.

A particular relevance is the fact that the sales pipeline is increasing steadily.

Therefore, we expect increased revenue growth in the future, although we will have tough comparisons next quarter, which benefited from the west coast dock shutdown.

More important at this point, in my opinion, is that profitability increased significantly.

The operating margin for SCS was in the mid-single digit range.

Putting the unit today where we anticipated it would be by the end of the year.

Expense controls continue to contribute to improved profitability.

The restructuring of this business is about 90% complete domestically and almost that far along internationally.

We've made excellent progress integrating the 20 or so companies UPS has acquired in this business sector over the last four years.

Bottom line, we're very pleased with the progress being made.

To update you on our share repurchase program, during the third quarter, we purchased 2.1 million shares and we still have $905 million dollars authorized for continued share purchases.

At the end of the quarter, about 48% of the 1.1 billion outstanding shares were B shares.

It wouldn't be a complete report from us if I didn't include some remarks on cash flow.

UPS continues to generate significant free cash flow.

Year to date, free cash flow, which we define as operating cash flow less Cap Ex but before dividends, net share repurchases and debt repayment, came in at $2.7 billion dollars.

Since the beginning of the year, we've paid down $600 million in debt, repurchased $350 million in stock, increased the dividend 32%, reinvested $1.5 billion and still increased cash and marketable securities by over $1.1 billion dollars, leaving a balance of $4.1 billion.

So, all is well on the cash flow front.

Now for some concluding remarks on our outlook for the fourth quarter.

It's been 12 of these investor calls over three long years since I've had anything upbeat to say about the economy.

But I'm pleased to report now that alas, we're seeing a pervasive strengthening pretty much throughout our customer base.

And we're seeing an increase in the amount of new business opportunities we can bid on.

This time, I have the sense that the pickup in the economy is real and will be sustained going forward.

In our domestic business, we anticipate volume will be up 3 to 4% with margins expanding year-over-year.

This improvement reflects a combination of increasing momentum in this business and a continuation of economic strengthening.

Ground volume should be up about 3%.

Air volume should also increase but not at the rates seen in this quarter, since the refinancing boom is stabilizing.

We expect the air volume to increase slightly more than ground.

Pricing should remain firm and next day air yields should stabilize as the exceptional letter growth moderates.

We expect the international business will continue the growth trends we've seen throughout the year.

Results next quarter should be somewhat better than last year, even with the $35 million dollar benefit from the west coast shutdown last year.

In the non-packaged segment, we anticipate revenue growth comparable to this quarter with continued healthy gains in profitability.

All in all, this translates into an expectation of earnings per share in the range of 65 to 70 cents for the quarter, compared with 59 cents last year.

Achieving earnings per share within this range will ensure we post an earnings increase for the year in the 10 to 15% range we've put forth at the beginning of the year.

Normally I'd share some insights with you now on our outlook for 2004.

However, I am going to save that for our investor meeting next week in New York.

The other members of our management team who will be in New York as well as Kurt and I, are looking forward to seeing you and talking in depth about one of our favorite subjects, UPS.

The event of course, will also be webcast for those of you who are unable to attend.

Thanks for your attention.

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

Thank you.

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

If you would like to ask a question, please press 1, 4 on your touch-tone keypad.

We will take as many questions as time permits and we will take them in the order in which you signal us.

One moment while I poll for questions.

Your first question is coming from Jordan Alliger of Lazard.

Please go ahead with your question.

Yeah, hi, morning.

Starting to get some real good volume and -- and revenue increases coming through.

Question is: You've started to see some stablization in the domestic margin.

As you look forward into the fourth quarter and beyond, you know, what's the inflection point where you start to see that dropping down to year-over-year domestic margin improvement rather than just stablization?

Good question, Jordan.

I think as we said last quarter, we did expect domestic operating profits to improve in the third quarter.

They did only by 2%, but they did improve.

In the fourth quarter, we see that turning around where domestic operating profits will be up more and margins will actually outperform fourth quarter margins of a year ago.

We've certainly battled benefit -- high benefit costs all year long, we will see those starting to moderate.

Some of the in the fourth quarter, more so next year.

We're also cycling through the wage increases from the contract last year and we think the effective wage rate will come down some in the fourth quarter.

Obviously, the increased volume will help drive productivity for us, so, we're very optimistic going forward.

Thank you.

Thank you.

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

Please go ahead with your question.

Hey, good morning, guys.

Hi, John.

A couple of things.

Number one, Scott, can you give us a status on the tax refund from the government?

It's a pretty big slug of cash you're due.

It's a lot of cash and it's a slow process, John, but we would anticipate probably getting our first installment relating to the 1984 year some time in the next two or three months.

That's going to approximate $160 million dollars.

The next piece will come when we resolve the 1985 through 1990 years and I would guess we would expect that sometime in the mid to latter part of next year and that's probably another 3 to $400 million dollars.

And beyond that, I'd say the balance would be coming in the next -- within the next couple of years we will get the rest of it.

Okay.

And where do you stand in terms of, you know, closing the books on your tax returns through what year?

I mean -- are you done through '83?

You're working on '84 and then you've got '85 through '90 and they haven't even gotten to '90 yet?

No, '85 through '90, we've pretty well resolved all the issues.

I've got maintenance issues.

The '91 through '98, we have one or two small items that's in appeals with the IRS, but we would expect to resolve that in the next 12 months.

When we get up to the '98 and get much closer.

Okay.

Secondly, in terms of pricing, in the market, has there been, I -- I accept your explanation of the mix change and that kind of thing, but have you seen any signs of irrational behavior in the pricing market that you've been forced to respond to in any piece of your business?

No, I think it's -- you know, as I've said all year, I think most people were concerned about the ground market and being a price war in ground.

Clearly the ground pricing has remained stable throughout the year, we expect that to continue going forward.

On the air side, you know, the mix has been a big driver.

Again, almost 18% increase in letters in this quarter -- it started to fall off some in the latter part of August and September.

Going forward on the air side, you will see better mix, I think, as you see less refinancing, as we saw -- we saw a little jump in manufacturing late in the third quarter.

That will help our mix and the weight of the packages.

So, I think you take away the -- the mix issue or next day revenue piece would have been somewhat flat with last year and two-day deferred was anomily with last year's comparison.

Okay.

Lastly and I will turn it over, can you provide us any update on the status of negotiations with the pilots?

And mainly, I know you can't say much, but mainly do you still anticipate finishing negotiations by December 31st?

We'd like to finish them by December 31st.

I can't predict that right now, John.

I think we're on target and moving along at the pace we hoped for.

As you get into the monetary matters at the end, you can drag out at times, but we're optimistic to get it done on a timely basis.

John, the airline negotiations are a little different.

They typically go on beyond the date.

So, it's not quite the deadline we have with our traditional teamster negotiations.

Okay.

Thanks for your time.

Thank you.

Your next question is coming from Jeff Kauffman of Fulcrum Global Partners.

Please go ahead with your question.

Thank you very much.

Congratulations, glad to hear some optimistic views of the future here.

It's been a long time, hasn't it, Jeff?

I'd like to drill down into that.

Really just two quick hitters.

First of all, can you give us a little more granularity?

You're talking about increased activity across-the-board, a little more optimism, some more RFPs out there.

Incremently, can you identify where you're seeing a bigger change now versus what you were seeing say 6 to 9 months ago?

And second question has to do with non-package and then I will be off.

I would say that, you know, the brightest light probably in this third quarter for us was manufacturing.

You know, for three years we have not seen any sign of life in manufacturing.

We saw some -- some -- certainly some increases in manufacturing in September and early October.

We expect that to continue.

We saw that both in our ground and in our air business.

So, that's a very good sign for us.

Retail has held steady.

We had a weak first quarter in retail, but really the second and third quarters have both been very strong and shown good growth.

On the services and financial sectors, outside of the refinancing, which certainly led the area in the last couple of years, has stayed very strong.

Clearly the second half of the third quarter we saw the refinancing slow down and we expect that to continue.

That's good for us if it means the economy is getting better.

Okay, that's good news.

On the non-package business, now that you're -- sounds like you're feeling a little bit more confident about the integration of all the acquisitions.

Now that they're settling, where do you think the margins in this business can go?

If you change your view either higher or lower than what you were looking at previously and kind of refresh those targets?

I think we're where we thought we'd be at this point in time, which would be mid-single digits.

But over the past couple of years we've been clear in saying that we think we can get to upper single digits and 10% margins in non-package.

Nothing changes our mind on that at this point in time.

We won't be there next year, but we will be there in the next couple of years.

Thanks a lot.

Thank you.

Your next question is coming from Jon Langenfeld of Robert W. Baird.

Please go ahead with your question.

Good morning, nice quarter.

Thanks, Jon.

Thank you.

A couple of things for you, first on the domestic employee base.

I know you talked about previously the -- the low levels of turnover.

Could you -- and that obviously props up the -- the average worker cost that you're dealing with or wage rate.

Can you just give us an update on that and how that has trended over the last couple of months?

I think in general the turnover has still been lower than normal than what we've seen.

And again, part of that is the job market still is not strong.

There's some signs of maybe improving out there.

The expectation is that will improve early next year.

I say that the turnover is still lower than normal, but as we get the volume growth, we will bring on new employees and that will bring down the effective wage rate.

We saw some of that in the latter part of the third quarter, but more of that will be in the fourth quarter.

Okay, good.

Good.

And then on the next day air and the letter volume growth you're talking about, sounds like you saw that taper off at the end of the quarter.

I mean some of the industry numbers we look at out there show refinancing down by 75%, comparing the first part of Q3 to the last part of Q3.

Doesn't sound like you saw that dramatic of a drop in letter volumes.

Wondering if you, you know, have any thoughts on o that, you know, given the fact that the refinancing has dropped off significantly over the last three months?

I think you will see pretty significant drop-offs in the latter and I think as we look on to 2004, which we will talk about more next week at our conference, you know, very tough comps next year on the letter side of it.

On the other hand, we think that the package side is going to be strong.

We saw good growth in the package in the third quarter -- in next day package.

So, you think your volumes there are kind of reflecting what that refinancing activity is doing?

Yes, John, this is Kurt.

You know, the next day letter is just one part of the overall next day air.

The re-fi is just a part of that.

It clearly tapered down.

I think probably the best way to look at the whole phenomena of the re-fi was that is it was a mid-second quarter through mid-third quarter phenomena with the real unprecedented growth.

Okay, good.

And last thing, kind of getting into the weeds here, but it might help me understand the cost structure a little bit better.

If you look at the domestic side, dealing with seasonality, I understand, but moving Q2 to Q3, revenue is up roughly 2%, yet the profit side, Q2 to Q3 is down 1%.

Again, I know that's pretty detailed, but just trying to understand the cost structure.

What's driving that discrepancy?

I think generally seasonality of the company, if you go back and look for, you know, many years back, you will see the third quarter for us is not as strong as the second quarter profitability-wise.

I think it's the vacations in July, it's the downtimes in July and August timeframes.

So, it's pretty much the trends we've seen for many years.

Okay.

All right, good.

Thanks again.

Thank you.

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

Please go ahead with your question.

Hey, Scott.

Hey, Kurt.

Hey, Ed.

You talked a bit about pension and healthcare costs and that they're going abate.

Could you discuss specifically -- have you set your pension assumptions for the next year?

What those are going to look like?

And why you think the healthcare and pension will abate going forward?

We have not finished up with the actual assumptions yet for 2004.

We're very confident you won't see anywhere near the increase you saw in '04 in pension expense.

We saw about a $140 million dollar increase in '03 over '02.

It will be much less than that in '04 as we go forward.

The discount rates still may come down a little bit from what we saw last year because interest rates have come down.

Earnings have certainly looked better.

We funded the plans, which will help it.

And I think overall the pension expense will be much less an issue for us next year.

If you had to give a range, would you say in $50 million range or something like that?

It's in that range, maybe a little less.

That's a best guess right now.

We will talk more about '04 next week.

The healthcare is still going to be a challenge for us.

Obviously the base is up there, but we still see fairly sizeable healthcare increases next year.

So, that will still be a challenge, but I don't think you will see the delta you saw this year, but you will still see some increases next year.

Okay.

One last question -- when I look at the other expense line item, the kind of catch-all expense line item as a percentage of revenue, it's the best at 10.1, or that's off the top of my head, something like that, 10.1% of revenue.

The lowest it's been since you've been a public company and it's down from 11.2% just last quarter as a percent of revenue.

Is there something particularly driving that?

Or is it a bunch of things driving that?

Is it sustainable?

You're saying the other other expense line?

Yes.

One of the things in there is the gain on the sale of the aviation technology properties built into that.

The $24 million dollar gain.

So, that's part of it.

But other areas we've seen strong improvements in are our bad debt expense for one.

We've had some write-offs in that area last year.

This year, our day sales outstanding is down to below 25 days.

We're turning receivables very well.

We're don't have too many bad debts.

We're doing a great job managing those.

Those are a couple of key points.

One other one, Ed, that jumps out, is that we've cycled through some of the big increases in depreciation expense with the world port and some of the ramp up at the air fleet, so the rate of growth of that has slowed a little bit.

So, you know, all in all we think things will be pretty stable in that arena.

So, you know, other than the $24 million, that should be ongoing, that stuff?

Absolutely.

Thanks a lot for the time, guys.

Sure.

Thank you.

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

Please go ahead with your question.

Sure.

Hi, guys.

Hi.

Scott, I was surprised at your guidance.

I guess you're a conservative guy and you're sounding pretty bullish there!

And I'm curious how the quarter progressed from a volume acceleration standpoint?

I suspect you started the quarter well below 3% and started wondering if you finished September sort of 4% plus, and how October is looking.

In other words, did you see sort of a linear acceleration month over month as the quarter progressed?

It's difficult to do that comparison in this quarter, Greg, because July can move an awful lot based on when 4th of July falls.

This year it fell on a Friday, which benefits, I think, all the transportation companies.

Last year was a Thursday and Friday was kind of a down day.

So it changes your volume comparisons.

We also had heavy diversion last year in the first part of July.

So, tough comp.

I would say we saw our greatest strength in September and early October.

So, I would say it's fairly firm during the quarter, but some strengthening at the end of the quarter.

And just following up on your comment about air pricing being flat, if you adjusted for mix, given your natural inflationary costs and what we're seeing across transportation, should I read that as essentially you're somewhat discounting the product line to gain share and that you're not raising prices when pretty much every transportation product is going up right now?

I don't think so, Greg.

I mean we continue to, you know, be very rational in pricing.

We have an annual rate increase process and we'll be making announcements next month on rates for next year.

We do continue to gain share and in some cases the volume that other carriers have is lower revenue than ours as we bring in lighter weight packages and so we're continuing to be rational and -- and we think the rest of the market looks pretty good.

Okay.

Thanks a lot, guys.

Thanks, Greg.

Thank you.

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

Please go ahead with your question.

Good morning, I have two questions.

The first is did I hear you correctly when I -- I thought I heard that domestic operating profit margins will be higher in Q4 than they will be in Q3?

You heard me correct, yes.

Okay.

So -- so really because margins there typically fall a bit in Q4 because of kind of overtime around Christmas, it's actually even more positive than it sounds?

I think it's positive, but again, we will benefit from the volume increases we expect to see in the fourth quarter.

Great.

And then my second question was talking about non-package, you said something about 10% over the next few years.

Were you talking about revenue growth or non-package margins?

Yeah, Jennifer, he was actually referring to the supply chains solutions margins.

Total margins for the sectors are well in excess of that because of the other businesses in there.

Good, I was --

That was margins for the the logistics freight fowarding sector.

The section inside non-package.

Right.

Correct.

Okay, great, thanks.

Okay, great.

Thank you.

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

Please go ahead your question.

Hi, thank you, good morning.

Hi, Ken.

Just on the currency benefit, I think you -- you quickly mentioned that it would have been 6.7% upside without the currency.

Is there a dollar amount you can put on the currency gain?

Yes, Ken, we had less currency benefit this quarter than we had in the first two.

We came in at about $18 million dollar of currency benefit in the third quarter.

I think it was $32 million in the second quarter and $27 in the first.

So, it's -- it's tapering down some, primarily because you have tougher comparisons with last year.

We still expect a minor currency benefit in the fourth quarter, but not as much as we probably saw earlier in the year.

And Ken that was on the profit side.

On the revenue side, the year-to-year currency changes accounted for a little less than $80 million of revenue.

Great.

And two other quick ones if I can.

I want to make sure I understand the $100 million dollar or so increase in -- in healthcare benefit costs and -- and your move toward higher margins in the fourth quarter.

Scott or -- or Kurt, can you kind of clarify where -- what kind of increases should we look for in the fourth quarter?

And into '04, I know you want to hold off some '04 comments until next week, but with respect to the healthcare?

How should we understand the increase?

And then secondly, and on the overnight, are the gains coming from market share gains or are you increasing penetration with current customers?

If you can quantify that.

The $100 million dollar increase we saw in the third quarter in healthcare and pension, probably will not change dramatically in the fourth quarter.

Healthcare may come down a little bit in the fourth quarter.

Pension is pretty well locked for the year when you do your assumptions at the start of the year.

You won't see as much of a change there.

You will see more of that change in '04.

We do see some benefits in workers comp and some of those will come we'll see costs come down some in Q4.

Ken, at least on the air growth, I think it's a mixture of, you know, us being very successful in -- in capturing this mortgage re-fi benefit which seems to elude some of the rest of the market.

Certainly some share gain and also, you know, we are seeing some tradeup to premium services and that's another one of the elements that gives us a little more optimism on the economy.

So, you got a couple of different factors kicking in.

It even seems like the UPS store, generates an awful lot of next-day air volume.

Some of the additions we've done this year with the retail access channels has helped in the market.

Great.

Are you able to breakdown any segments of the economy?

Or just kind of manufacturing overall?

Well, I would say, I mean the manufacturing and the retail were the ones that we were most pleased with in the third quarter.

Again, financial services, services in general, stayed strong.

Refinancing fell off, but the rest of that market stayed strong in the quarter.

Great.

Thanks a lot.

Sure.

Thank you.

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

Please go ahead with your question.

Hi, guys, how are you?

Hi, Gary.

Hi, Gary.

Scott, international margin, if you could talk about a little bit, that's been, you know, it's been beating your projections historically.

So, directionally it's been really going in the right way by a fair amount.

I know you've talked about over time narrowing that gap with the domestic margin.

I'm not sure you have given us an exact time frame when you think you could do that, but it sounds like maybe it's around the corner.

Could you give us your take on that?

Maybe an update on when you see that gap closing?

Yeah, well step one is we want to get a better domestic margin.

We will do that first to make it harder for international to catch.

But I think we've said it was reasonable for international to get to the mid-teen margins.

We talked about that the last two or three years.

We've said, you know,a 10-year timeframe, I'm pretty confident we can get there quicker than that based on the progress we've seen in the last couple of years.

You know, the business has shown tremendous momentum, you know, over the past 12 months.

We've shown great growth acrossed all the regions, you know, Asia up 14%, within that, China up 40.

Canada, Latin America, double-digit growth.

Europe, up mid-single digits.

U.S. export, which is helping us, we talked all along, we improved these margins for the first couple of quarters without much help out of the U.S.

As the U.S. kicks in, you know that can really help to enhance the margins, we're confident we're going in that direction, soon.

Scott, has it been more adding units or cost management?

I know these things are a little of both?

It's a combination.

But obviously you can see that, you know, our basic yield was up almost 7% without the currency impact in the quarter.

So, they've done a wonderful job throughout the world doing revenue management.

So, I think we're getting paid well for the -- for the services we're providing, the very good services that we're providing.

We've also done some things on network and operations management that have helped bring down the cost.

So, you're seeing the revenue cost with very little cost increases.

Our air feed costs have come down as a percentage of revenue this year.

We're seeing just a combination of the two.

Gary, we will talk about that in more detail next week to really try to pull back the curtain a little bit on the value drivers and what's happening there.

Can I ask a question Cap Ex going forward as you feel better about the world at large or is that a next week issue as well?

It's a next week issue, but I say in general that our Cap Ex is goign to be in the lower percentage of, you know, the 5 to 8% area that we've talked about in the past.

But we will get in more detail on that next week.

We've got to have a reason for you come next week, Gary.

No, I hear you.

I hear you.

Thanks, that's all I have.

Thank you.

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

Please go ahead with your question.

Yeah, good morning.

Hi, Scott.

Couple of questions, and I know that you all have answered this a couple of different ways, but I guess I was interested in how you described the yield environment, air versus ground, where you typified ground as being strong and again, maybe I'm parsing hairs here, but you talked about air being stable.

Am I to sort of take away something in from that?

Obviously, not that the air markets are necessarily bad, but perhaps not as robust as the ground markets as you look at the yield environment?

I think that, you know, one thing that has surprised some people is to see that air market growing as well as it has.

A lot of people said the express market will not grow nearly as fast as ground going forward.

With some of this pickup in the economy, we're seeing, you know, good growth in the package business and next-day package.

So, I think that that, you know, the express market is still going to be strong going forward.

And stronger than a lot of people think.

So, I think that it's a rational market in both the ground and the air.

And I think the mix issue is just distorted this thing.

All right.

And obviously you've been working some of the servicing initiatives and tightening transit times and obviously working, I guess certainly in the most visible and some of the intermodal providers to try to tighten transit times.

In rejiggering the network, how much cost push will there be?

Or is this a scenario when with working with process efficiencies and intermodal among other things that you're doing in the network, this is one of those quality-free type of scenarios where in tightening the transit time, it actually doesn't significantly rejigger your domestic cost structure?

It does not significantly rejigger our cost structure.

There are some costs to the thing, but obviously we take a very good look at the cost benefit to analysis and thought we've spend the money in the right places in to generate additional volume.

All right.

And just one last very quick one.

Could you give us a quick update on how the UPS Store pull-in is going?

Is it going as planned?

Better than planned?

As you look at the track records in terms of turning the stores over to UPS brand?

It's been working wonderfully well.

Again, the test studies that we did back when we launched the program, we showed 70% volume -- UPS volume increases in the stores.

We've actually, you know, surpassed those numbers in the months since we've done this.

We're very pleased with the progress.

We really think these access channels are going to help us for many years to come.

It is a big market.

The retail market is 2.5 million pieces a day.

We have a lot of upside in the market.

We have a small piece of it today.

Got it.

Thanks very much.

Thank you.

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

Please go ahead with your question.

Great, thanks.

Good quarter, guys.

A few questions.

First, if I understand that the accrual reversal was in depreciation it suggests your depreciation went down sequentially by 5 to $10 million dollars.

Is there something going on there in terms of your Cap Ex -- still spending Cap Ex, why would that be going down?

Jim, that tax accrual would not hit depreciation, it would just hit the tax item.

There was another cost in the quarter, I thought it was in other, but when answering Ed, you said that's where the benefit was.

Ed asked the question I think about the total other expense, not the other other.

So, we got a little confused on how many others were in there.

In general, yeah, depreciation has moderated a bit.

And -- but that's in the broader category.

The other other expense has more to do with the bad debt and the gain on sale.

Okay.

If we just go through your original guidance for the year and you clearly look like ours track to hit that, maybe even the higher end of the 10 to 15% EPS growth rate.

But it was also based on trying to understand the composition and what's changed?

Maybe to help us think forward in terms of forecasting, that your non-package, you guys thought it would grow about 100 million.

I think it's going to be double that in terms of growth.

And international you thought would be up 20% or better.

Looks like it's going to be up 100% or better.

So you've probably got another 250 to $300 million there, which would imply that either you had very conservative guidance of 10 to 15% or ground isn't quite where you need it to be.

I'm trying to understand, if there is a head win in ground here in the first three quarters, what specifically do you see kind of changing here to give you -- to be bullish here on your guidance in terms of the 65 to 70 cents in the fourth quarter?

Clearly when we started the year, we thought the economy would come back a little quicker than it did.

We've said all along how we ended up in the range would be on the economy, Jim.

We said if the economy was weaker than we thought, we'd be at the low end of the range.

If it was stronger than we thought, the higher end of the range.

And I think we're a just quarter behind where we thought we'd be in the economy at this point in time.

So that's really had an impact on the domestic operating profit piece of that puzzle.

It sounds like international and non-package came in better than you expected, helping out what was a fairly soft domestic economy, then.

I'd say that fair.

Clearly we've not been thrilled with domestic margins in the first half of the year.

We said we're going to improve them and we're making good progress, but we're looking forward to expansion in the margins going forward.

Good.

Good.

The final point, I know you're having a meeting next week and someone over Germany is having one in a few weeks.

Any thoughts on DHL Airborne case?

Or the competitive landscape here in the U.S. now that they've combined their operations?

I think the first -- as far as the case is concerned, I think the herrings have been completed and now it's up to the administrative lodge, which was supposed to come out with a ruling the first of December and they'll give that ruling to the D.O.T.

I think the D.O.T. would probably make decisions by early next year.

Obviously we're optimistic that it will be a favorable ruling, from our perspective.

As far as the competitive front, they've got some integration challenges and there may be a window of opportunity for us in the short term.

But they're a good competitor and we will respect that competitor.

Are you seeing any -- I mean you've had some decent volume here in the third quarter.

Are you seeing any competitive threat to new business being lost them for any reason?

I'd say probably no major threat at this point in time and there are certainly opportunities where in their integration they might give us few opportunities to win some business.

Great, thanks, guys.

Thanks.

Thank you.

Our next question is coming from Joanna Shatney of Goldman Sachs.

Please go ahead with your question.

Good morning.

You guys are pretty optimistic on the manufacturing turn finally coming domestically.

Are you see any incremental positives coming out of the European region at this point?

I would say we saw a little bit of firming particularly in Germany in the latter part of the quarter.

Germany is certainly a big country for us operating-wise in Europe and it struggled for the last 12 months.

But we saw some hope for improvement late in the third quarter.

Joanna, one way to see that is, you know, the non-U.S. domestics did show a bit of a rebound and clearly that reflects to some extent some of the economics in Europe.

Okay, I wasn't sure if that was UPS specific or industry.

It sounds like it's industry.

And then when you guys talked about the current conditions here domestically, you talked about increasing business from your current customers and also talked about a big opportunity from new customers.

Just as you add those guys on, can you talk about where they're coming from?

Are they wins from somewhere else so they might be a actual negative to yield?

Or is this business that's basically gone away over the last threeors and is finally coming back and may actually enhance the yields?

It's a mixture.

There is no one clear shot at that.

We're going to really benefit from expanding relations with existing customers and also we think benefit from the firming economy, which should also be a nice cushion.

But it's not all wins from other customers -- other competitors, right?

Not all of it, by any means.

Thanks.

Thank you.

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

Please go ahead with your question.

Good morning, Scott, Kurt.

Good morning, Dan.

Scott, considering I guess maybe your -- your bullish view of the economy and -- and the fact that you've dealt with your dividend policy recently, is it fair to say that you'd be, I guess potentially juggling your priorities for uses of cash going forward?

Well, it's -- it's, you know, it's not going to change our priorities.

Obviously our first priority is always to reinvest in the business.

Right.

We have the needs -- I still think, though, you know, where our capacity is right now, even for this growth, you know, we will probably still be in the low end of our Cap Ex for at least for the next year or two as far as normal trends.

I wouldn't say it would be a dramatic shift in our philosophy.

Also, thanks for the compliment of being called a bull.

No one ever calls me a bull these days!

And maybe just a follow-up to the earlier some of the earlier comments on the UPS Stores.

Do you have any sense of which competitors you are facing most often in this infrequent market?

I would say that, you know, the retail market, certainly the post office, is the primary competitor.

We think they probably have 75% of the market.

So, clearly that's an area where there's upside with our new access channels.

And I guess your belief then is the combination of rebranding the stores is giving you a greater exposure to that competitor, is that right?

I think rebranding the store, obviously bringing down the rates.

The whole test was to get the UPS name out in front of it and bring down the rates a little bit, had a big difference in volume.

Dan, one other factor is we're just trying to ease access broadly, you know, with the use of Internet shipping and those capabilities, it's easier and easier for consumers to, you know, generate shipping labels, pay for it and drop it off at a UPS Store or a number of other good access points and authorized outlets.

So, just in the broadest sense are our goal is to improve access to our services.

Thank you very much.

Thank you.

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

Please go ahead with your question.

Asked and answered.

Thank you very much.

Great, thanks, Ed.

Thank you.

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

Please go ahead with your question.

Mr. Burns, your line is live.

Yes, just following up on the international margins.

Scott, it looks like your -- your international margins are up sequentially even though you actually got a less of a currency gain and, you know, historically the third quarter has been your toughest international margin.

I'm just curious whether we're now at a more -- more enlarged footprint so we're not going to see the usual seasonality we see between 2Q and 3Q there.

I think some of that came from our some of our operations management.

We took down a few flights in South America and Canada and reconfigured those, which helped overall in our cost effectiveness.

So, I -- I think there will still be some seasonality in the third quarter.

Europe still shuts down somewhat in August.

That will be a challenge going forward.

I think what helped us in the third quarter versus the second quarter was just more effective cost management.

Great, thanks.

And the U.S. export, which helped us.

Great.

We know it's -- it's a busy day for a lot of you.

It seems like everybody's picking this day to do calls.

We will go ahead and wrap up our call at this point.

I would like to remind you about our investor meeting in New York on Thursday next week.

So, if you haven't registered, please give us a call and we will make sure you get a good seat.

At that meeting, you will hear from Michael Eskew, our CEO, John Bystander, who heads up our world-wide sales and marketing group will discuss domestic operations in depth.

David Apney, who heads up our international operations.

And of course, last but not least, my boss, Scott.

We will webcast it, also, but would love to see you face-to-face if we can.

So, look forward to seeing you all there.

Other than that, talk to you at some point in the future.

All right.

Thank you.

This does conclude today's teleconference.

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