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Operator
At this time, I would like to welcome everyone to your UPS Investors Relations earnings release third-quarter conference call. [OPERATOR INSTRUCTIONS] It is now my pleasure to turn the floor over to your host, Miss Theresa Finley.
Ma'am, you may begin your conference.
Theresa Finley - VP, IR
Good morning.
We're delighted with the results we reported earlier today.
All of our business segments contributed to an excellent quarter, which Scott will discuss in a moment.
First, however, I will read the Safe Harbor language.
Some of the comments we will make today are forward-looking statements that address our expectations for the future performance or results of operations of the Company.
These anticipated results are subject to risks and uncertainties which are described in detail in our 2004 Form 10-K and 10-Q reports.
These reports are available on the UPS Investor Relations website or from the Securities and Exchange Commission.
Speaking of the IR website, this call is being webcast and will be available on that site for a few weeks.
I want to point out that in Scott's remarks today, he will refer to adjusted results for earnings in last year's third and fourth quarters.
In the third quarter of 2004, we recorded a 99 million credit to tax expense related to the settlement of various tax matters with the IRS for the years 1991 through 1998, including such items as aircraft maintenance and various state tax issues.
The credit to tax expense increased diluted earnings per share by $0.08.
During the fourth quarter last year, we recorded an aircraft impairment charge, a charge to pension expense and to net credits to income tax expense, all of which increased diluted earnings per share by $0.06.
The reconciliation for the third quarter items can be found in the schedules distributed with the earnings announcement earlier this morning as well as on the Investor Relations website.
The reconciliation related to the fourth-quarter earnings per share number is also available on the IR website.
I also want to highlight a change to our financial reporting structure.
We've renamed our third business segment, supply chain and freight.
It includes freight services and logistics, which is our forwarding brokerage and distribution business, Overnite, which is obviously our new freight business, and other, which includes our mail unit and a few other smaller businesses.
This structure will provide visibility into the performance of our freight operations.
You will also notice in our web schedules that we intend to provide quarterly statistics related to the Overnite business.
However, in the third quarter, Overnite was part of UPS for only two months.
Going forward, you will have full quarterly information each quarter with comparisons beginning in the fourth quarter of 2006.
With that, I will turn the program over to Scott.
Scott Davis - CFO, SVP, Treasurer
Thanks, Theresa, and good morning.
In the third quarter, UPS again posted exceptional results; revenue up 18%, operating profit up 19%, earnings per diluted share up 23%, and all segments contributed.
We're particularly excited about the momentum in our small package business.
Global volume increased by 41 million packages in the quarter, driven by a 4% increase in U.S. domestic volume and another double-digit increase in international export volume.
Strong growth, firm pricing and industry-leading margins resulted in an 18% gain in operating profit in the U.S. domestic small package business and a 19.5% gain in the international business.
Our supply chain and freight business benefited from acquisitions which helped generate operating profit growth of 37%.
We continue to invest in our global enterprise.
In fact, in the third quarter, we closed on two more acquisitions, Overnite and LYNX Express.
While we're talking about investing, let's turn to our domestic operations.
As we described in our investor conference last May, this business is a workhorse and a significant value generator for the Company.
Furthermore, the U.S. small package business has been the financial engine which provides resources for global expansion, including continuous growth here in the U.S.
And grow we will.
During the third quarter, all U.S. domestic product categories experienced strong volume gains.
Total domestic volume increased 4%, for almost 0.5 million packages each day.
Next-day air gained 6.1%, deferred was up 5.8%, and ground increased 3.6%.
Clearly we're reaping the benefits from many of the initiatives we put into place at the beginning of the year, including a focus on middle market customers.
They see the change and tell us, UPS is more responsive.
Technology is a differentiator and they're excited about UPS's new LTL capabilities.
We believe the sales momentum will continue as we emphasize a one-to-one customer experience.
In addition, we will continue to reinvest some of our domestic profit right back into the business to maintain this growth momentum, developing solutions that meet a wide range of customer needs.
Let's focus now on our international operations, which continue to benefit from the expansion of globalization.
I'm often asked why UPS's international business is so successful, with double-digit volume growth and industry-leading profitability.
There are four drivers of this success.
Our unique integrated network, technology, supply chain capabilities, and the strength of the UPS brand.
And we continue to capitalize on these attributes, but we're not sitting still.
We're constantly improving in all four areas.
All international regions, Europe, Asia, and the Americas, are experiencing excellent growth.
Total export volume increased 12.5%.
And international domestic volume grew 10.3%, aided by recent acquisitions.
While so much of the world's attention has been on Asia, Europe continues to be a remarkable story for UPS.
Many years ago, UPS laid the groundwork to capitalize on a single European market.
We created an integrated ground to air network with a broad transporter portfolio that's unmatched.
We're making it easy for customers to rely on one provider to meet local, regional, and international shipping needs.
Our business in Europe grows faster than the overall economy there.
Acquisition of local networks, for example, Stolica, in the second quarter, and LYNX Express in the third enhances our already strong presence.
LYNX brings a well-developed small-package delivery network in the U.K. and a broad suite of logistics and critical parts services.
It expands the UPS customer base in this important market and provides a full spectrum of UPS domestic and international services to meet their needs.
In Asia, we experienced robust gains with export volume up 26%, led by China with 34% growth.
Our activities to invest in and grow our Asian presence continue at a brisk pace.
By the end of the quarter, we'd completed the transfer of all 23 metro areas from Sinotrans to UPS control.
This will enable us to improve already high levels of reliability and expand our brand presence.
On the technology front, we're rolling out our DIAD IV handheld computers for our drivers in Asia, the same device used by U.S. drivers.
It enhances our ability to offer reliable, one-to-one customer service by putting up-to-date information about each customer's delivery at the driver's fingertips.
We're expanding our supply team services presence, too.
Many of our U.S. customers have outsourced manufacturing operations to Asia.
They rely on our supply chain expertise to oversee the complexities involved in moving, tracking, delivering, even repairing goods, anywhere in the world.
Finally, during the quarter, UPS was selected as the official logistics and express delivery sponsor of the 2008 Olympic games in Beijing.
This sponsorship will help strengthen our brand presence in the fastest-growing market in the world.
As I said, the UPS network, technology, supply chain capabilities, and brand combine for a powerful advantage as we grow in Asia.
The Americas, too, benefit from these same advantages.
As a result, export volume out of the Americas was solid, posting high single-digit growth.
Our network and service capabilities are creating unique opportunities for the Company.
A great example is our Trade Direct.
This product consolidates multiple packages into one shipment for transport via ocean or air, or via truck from Canada and Mexico.
The shipment is then deconsolidated with packages sent directly to the consignees.
In the quarter, Trade Direct was enhanced and now enables the processing and tracking of freight movements, including LTL as well as small packages anywhere in the world.
The upgrade came just as retailers began their peak season inventory buildup for the holiday season.
Overall, operating profit in international operations, once again, was outstanding at $318 million.
In fact, for the first nine months, international operating profit topped the $1 billion mark.
We are extremely pleased with the way this business is going.
And yet, as successful as it has been, there still remains tremendous opportunity for growth as global trade continues to expand.
Now some comments on the supply chain and freight segment.
The substantial increase in revenue for this segment is due primarily to the inclusion of Menlo and to the addition of Overnite, our new LTL operation.
The increase in operating profit for the segment was driven by Overnite.
Let me take this opportunity to welcome our Overnite partners to the UPS family.
As anticipated, the Overnite culture meshes well with UPS and we're looking forward to our future together.
We're excited about the additional freight capabilities this acquisition brings.
And we're pleased with what we saw for the first two reporting months.
Strong operating profit with upper single digit shipment growth and firm pricing.
We've begun the transition process and anticipate the real benefit will come in the form of increased revenue for both the small package operations and for Overnite through cross-selling bundled services.
In the supply chain business unit, revenue gains in the ocean and road freight products were again above market growth rates.
International air freight, which has been hampered by high fuel costs, was a bit soft in the quarter.
Overall, integrated solutions continued to add value and attract new customers to the supply chain business.
These solutions combine multiple capabilities, such as supplier management, customs brokerage and network management, along with freight products.
Now a quick comment on Menlo.
Integration costs negatively impacted profitability in the quarter.
However, we're making progress and we're on schedule to open our new air freight facilities in mid 2006.
That's when we expect to begin realizing that 50 to $100 million in operational synergies for next year.
Before commenting on our outlook for the future, I want to talk about one of the most distinctive characteristics of UPS, the hallmark of our business that sets us at the top of our industry.
That is our exceptional financial position.
We ended the third quarter with $3.9 billion in cash and investments after paying $1.3 billion for Overnite.
For the first nine months of 2005, UPS paid 1.4 billion in dividends, spent $2 billion to repurchase shares, and invested 1.6 billion in capital projects.
Cash from operations for the first three quarters of 2005 was $4.5 billion.
UPS has repurchased almost 27 million shares since the beginning of the year, reducing our shares outstanding by 2.4% since the end of December.
We still have $1.9 billion authorized for share repurchase.
Now the future.
UPS is on track to achieve our targeted earnings per share for 2005 within the 18 to 20% range we projected over last year's adjusted $2.90.
This follows a 19% earnings gain in 2004.
Assuming current economic conditions prevail, and there's no significant change in retail sales or industrial production trends, we anticipate the fourth quarter will come in within the range of $0.90 to $0.96 per diluted share, compared with the adjusted $0.82 last year.
Our operations are primed and ready to execute well to provide superior service to our customers.
Looking ahead to 2006, we see a steady U.S. economy growing slightly below this year's projected GDP rate.
In that environment, we expect our global small-package business to continue its momentum.
U.S. domestic volume should increase at a rate commensurate with market growth and international volume should grow faster than market growth rates.
The supply chain and freight segment should make steady progress and improve its financial performance.
We anticipate a strong uptick in profitability beginning in the second half of the year once the air freight network is completed in mid-2006.
We anticipate Overnite will contribute nicely to profitability with some acceleration through the year as we capitalize on the synergies of cross-selling freight with our small-package services.
Therefore, you should expect the same consistent financial performance in returns from UPS that we've delivered over the years.
For 2006, we anticipate earnings growth will be within the range of 11 to 16%.
That follows two years of exceptional growth and is consistent with our 10-year CAGR of 13.4%.
We have a long history of profitably growing our business.
And we're dedicated to creating new catalysts for long-term growth.
You will hear more on this topic in 2006.
As I look back on the last three quarters, I'm pleased with the way UPSers handled the challenges that surfaced early in the year.
Initiatives were well-executed and continue to be.
The result, strong growth in all product categories.
We have a great deal of confidence in the position of our company and you should, as well.
Now we'd be happy to take your questions.
Operator
Thank you. [OPERATOR INSTRUCTIONS] Our first question is coming from Jordan Alliger with Deutsche Bank.
Jordan Alliger - Analyst
Hi, Jordan Alliger.
Yes, I mean the domestic margin 150 basis point improvement was very solid.
Can you talk about some of the drivers?
Is it the additional volume flow-through from ground?
Better productivity?
Maybe the package flow benefits are starting to take a little hold?
Can you just--?
Scott Davis - CFO, SVP, Treasurer
Jordan, thanks.
It was a good, solid improvement in domestic operating profit.
And frankly, the answer was kind of all of the above that you just mentioned.
I think that the volume helped an awful lot.
I think the yields were good.
And clearly the cost initiatives that we've employed throughout 2005 are helping us, the semi-variable costs, keeping those controlled, we're meeting our goals there.
Package flows continued to show good improvement on target.
I think it's a combination of all of the above.
Clearly that leverage from additional volume has helped us.
Jordan Alliger - Analyst
And just from a big picture standpoint, with the transfer of control with Sinotrans in China, can you just give a sense, how much does that impact or how much does that involve sort of intra-China type of shipments?
Is there a development along those lines as you gain control?
Or is that still more of an export-based/import-based story at this point?
Scott Davis - CFO, SVP, Treasurer
It's still primarily an export/import story at this point in time.
It clearly gives us ability to control the level of service and provide better service, better technology.
So I think the customers appreciate that.
And that's going to help us grow that business in the future.
The intra-China piece is at the beginning point.
Some of our multinational customers want that service.
So we see that growing, but at this point in time, Jordan, it's primarily that export and import piece.
Operator
Thank you.
Your next question is coming from Scott Flower of Citigroup.
Scott Flower - Analyst
Yes, good morning, all.
Theresa Finley - VP, IR
Good morning, Scott.
Scott Davis - CFO, SVP, Treasurer
Good morning, Scott.
Scott Flower - Analyst
Scott, I wondered if you could give us maybe a little more color.
I know you said package flow is on target, but give us a little more color about exactly the progress and the different buckets and some of the training and how that may have progressed?
If we could get maybe a little deeper on package flow and how you see that?
Scott Davis - CFO, SVP, Treasurer
We're pretty well where we set out at the start of this year is we retrained a lot of our dispatch supervisors, have been very successful at that.
Some of the areas we had problems on in 2004, we're seeing great improvement there.
The onroad, the drivers are showing improved productivity with this technology.
So we're really right on target.
Our goal this year was to get about 65% of the drivers deployed by the end of the year.
I think we are going to end up around 62%.
The reason for the shortfall is primarily construction issues and Katrina.
We had a couple of the sites that were impacted by the hurricane that we will wait until 2006.
And there's a few construction challenges we have got to get done so we put those off till January, February.
But overall, we're really pleased with the progress on package volume.
Scott Flower - Analyst
Can you just refresh us, what was the financial bogey?
It was 50 to 100 million?
Scott Davis - CFO, SVP, Treasurer
50 to $100 million, and it will be in that range for the year.
Scott Flower - Analyst
And then just my follow-up was just on international.
Obviously China was strong, but obviously not as strong as it has been, and then also just the results in terms of change -- help us understand a little bit about what's going on in China?
And was there a currency headwind to the operating income results in international this quarter overall?
Scott Davis - CFO, SVP, Treasurer
No, Scott, from the currency standpoint, we still had a slight benefit of about $10 million.
Less than we've seen, certainly in the last couple of years, but a slight benefit.
If you recall going forward, we are hedged, really, for the next 12 months on our currency.
So we will not have negative comparisons on currency, at least for the next 12 months, but about a $10 million gain.
As far as China, we had some large wins last year in the third quarter that we overlapped this year.
That's why you saw the numbers go from 30% to 100%, I think the latter part of 2004, the gains.
We're not disappointed at all with 34% volume gains in China.
Certainly outperforming, I think, the competition, growing faster than anybody.
The outlook is great.
You saw the GDP numbers out of China today, up over 9% again.
We've seen nothing in the future that's going to slow down that growth.
Operator
Thank you.
Your next question is coming from Ed Wolfe with Bear Stearns.
Ed Wolfe - Analyst
Hi, Scott.
Scott Davis - CFO, SVP, Treasurer
Morning, Ed.
Ed Wolfe - Analyst
Hey, can you talk a little bit about the pricing environment, the yield environment?
The volume side is great, but the yields, both international and domestic, were a bit below where we've seen them and where we expected them.
How much of this has to do with the competitive market capacity, your own approach?
And as your own approach of kind of tweaking the volume yield, is that where you want it to be right now?
Does that continue or do you start moving towards the yield a little more and a little away from the volume as we go out?
Scott Davis - CFO, SVP, Treasurer
No, I think we've done a very good job, Ed, of balancing the volume growth at good yield improvements.
I think the -- if you look at each of the sectors, there is probably an explanation for each one of them.
On the international side, still good yield improvement and extremely rational market.
But there were some mix changes.
We had strong growth in transporter, Europe, this last quarter, stronger growth there.
That -- which is a lower yield than certainly some of the U.S. to Asia, U.S. to Europe type shipments.
We had strong growth in U.S. to Canada, which, again, is a shorter distance and less revenue per piece.
We like that growth, great profitability, but it doesn't have the same revenue per piece as some of the longer range shipments do.
And then some of the Asia business we have is lighter weight technology projects, which are a little less than we saw one and two years ago.
But overall extremely pleased with the international marketplace, and it will be a rational pricing environment for some time to come.
Domestically, again, it's a different story for different products.
The next day yield, which was positive, but not as much as you'd like maybe, was really, again, driven by the mix change.
We're seeing our Saver product, a product that's not delivered at 10:30 in the morning, but delivered next day either after 3:00, up until the end of the day, is growing at a much faster pace.
That product is actually priced 10 to 15% less than the a.m. product.
And that is influencing the yield you're seeing there.
So I'd say primarily mix there as opposed to the incentive side of things.
And two days is a volatile product, as you know, we've been bouncing around on that quarter after quarter.
The last quarter, we saw real strong growth in retail in the same -- in the services sector.
Those are always lighter weight products.
So naturally you're going to see less yield on that.
We make good margins in that business.
I guess the other thing I would say is we did have mix on both next day and second day.
We had stronger letter growth this year than a year ago.
If you recall last year, we had 14, 15% declines in next-day letters.
This year, we actually showed gains in that.
Again, mix is a big piece of it.
Ed Wolfe - Analyst
You're talking a lot about mix but is there -- am I interpreting this wrong, that there's been kind of a mindset the last couple of quarters to -- obviously you're always balancing volume of yield, to maybe pull that volume cart a little harder?
If that is in fact the case to some degree, has that changed?
Or is your mindset feeling like this is working and we continue down this pipe?
Scott Davis - CFO, SVP, Treasurer
I think it's working fine.
I don't know that it's changed dramatically from where it was one and two and three years ago.
I think that, as I've said many times before, there's selected lanes you're going to be more aggressive on.
We will do that.
The competitors will do that.
I don't think it's changed dramatically, and our pricing policy has not changed dramatically.
Operator
Thank you.
Your next question is coming from Thomas Wadewitz of JP Morgan.
Thomas Wadewitz - Analyst
Yes, good morning and congratulations on a good quarter.
Scott Davis - CFO, SVP, Treasurer
Thanks, Tom.
Thomas Wadewitz - Analyst
Let's see, two questions here.
On the international margin side, you have seen some pretty amazing margin expansion the last couple of years.
It looks like that margin expansion slowed a bit, at least versus what we were expecting in the quarter.
Is it possible that you see that reaccelerate to where you might see a couple hundred basis points of margin improvement, looking at fourth quarter or looking at 2006, or should we just be a little more muted in the expectations for margin improvement in international?
Scott Davis - CFO, SVP, Treasurer
Tom, I think you have to put yourself -- and look at the third quarter.
The third quarter internationally is always our weakest quarter due to seasonality.
Europe, the month of August, is very slow as most of Europe goes on holiday.
So historically, it does bring down margins. 16.6% margins, the best third quarter we ever had, on top of a good one a year ago.
I think that that -- as you look forward, yes, that we will see better margins in the fourth quarter, but again, it's not because third quarter performed poorly.
It's seasonality.
So I would expect an improvement in the fourth quarter on what we saw in the third quarter.
When we get to the second-quarter margins, I'm not sure.
Second quarter had the benefit of the Easter comparisons, which helped that get to the 19.9%.
But I would expect them somewhere between the two.
Thomas Wadewitz - Analyst
In terms of year-over-year basis, could you see that pace accelerate again?
Scott Davis - CFO, SVP, Treasurer
As I said many times, our philosophy is to focus on maximizing international operating profit.
And that's still the philosophy.
Now, that doesn't say it might not increase from what we're seeing this year.
It certainly has the last several years.
Are we going to dial in the right number.
As I said, that right number is 16%, 18%, 20%, to maximize operating profit, that's where it will be.
Operator
Thank you.
Your next question is coming from Ken Hoexter of Merrill Lynch.
Ken Hoexter - Analyst
Great, good morning.
Scott, can you just talk a little bit about on the Express side, should we look at that sizeable increase?
I guess both you and FedEx posted some nice Express increases.
Is there something going on in that business, or is that most of the letter volumes that you're highlighting?
Scott Davis - CFO, SVP, Treasurer
No, the package -- the package business was strong, also, Ken, in the next day business.
Ken Hoexter - Analyst
Is that--?
Scott Davis - CFO, SVP, Treasurer
I think overall, the small package market, domestic package market is strong right now, and it is outperforming GDP.
It is pretty evident if you look at all the competitors' results.
But I think the manufacturing and IP is staying pretty strong.
That is certainly helping us and helps to drive next-day business.
And if you go back and look at history, you see that in past recoveries, the air market seems to strengthen later in recoveries.
We have looked back at previous cycles and we've seen that.
So it's not totally surprising to us.
But overall, the third quarter I think was a little better than you will see going forward, and primarily that is the letter comparison.
Last year we were down 14, 15% in letters in the third quarter, so we had easier comps.
So I think we'll see good growth in the fourth quarter in next-day, in deferred, maybe not quite the levels we saw in the third quarter.
Ken Hoexter - Analyst
Okay, so more so a strengthening in overall than anything like winning back from DHL or the post office?
Scott Davis - CFO, SVP, Treasurer
I think certainly the initiatives that we deployed this year, the focus on middle market has helped.
Certainly we've gone out and won some new accounts and grown this business.
But I think overall, the market is a little stronger.
And we're outperforming the market in the domestic air business.
That's clear.
Operator
Thank you.
Your next question is coming from John Langenfeld of R.W. Baird.
John Langenfeld - Analyst
Good morning.
Scott Davis - CFO, SVP, Treasurer
Hi, John.
Theresa Finley - VP, IR
Hi, John.
John Langenfeld - Analyst
A question on Express.
You're doing a great job on the volumes.
I just wanted to focus on the margin, though.
You look at the 150 basis points.
If I'm not mistaken, last year you had about a 70 or 75 basis point drag from package flow.
This year you're getting probably about 100 basis point positive impact from the management incentive program.
So I guess I'm just trying to understand where the negative drag is beyond those two that are keeping the margins intact?
Scott Davis - CFO, SVP, Treasurer
Well, I think one, we're pleased with the domestic operating margins, which are obviously the best in the business and like what we've seen.
And our goal, again, is to maximize that domestic operating profit increase.
We have had gains in some of the semi-variable cost areas of package flow, but there are other headwinds that are a drag in things like healthcare costs going up, some of the (indiscernible) railroad costs are going up.
Fuel costs, clearly, didn't help us this quarter.
As you know, long-term we think fuel is neutral to us with a surcharge, but in a period when costs -- when fuel costs ramp up quickly, your surcharge will lag that.
So that had an impact, too, in the quarter.
But overall pleased with the results.
John Langenfeld - Analyst
Yes -- no, it's still very strong.
Not to take away from that at all.
As you look out to '06, can you give us just a little bit of color, either quantitative or qualitative, on what you're expecting on package flow in terms of benefit?
And then do you also have some bit of a tailwind from the semi-variable cost controls that you've put in place here that didn't take effect until the second half?
Scott Davis - CFO, SVP, Treasurer
John, absolutely.
I think as far as the semi-variable costs that we've -- initiatives we've put in, you know, we're looking -- we've been working on 2006, really, since the start of this year.
And we will continue to focus on that and you will still see cost improvement from those initiatives.
What I plan on doing in the next call, the January call, we will take a -- certainly do a deeper dive on the segment profitability, on Overnite and on package flow.
We'll give you more information.
But we will dig into that in the January call.
Operator
Thank you.
Your next question is coming from Jason Seidl, Credit Suisse First Boston.
Jason Seidl - Analyst
Thanks a lot.
Hey, Scott, you mentioned fuel and the lag negatively impacting you during the quarter.
Also, you guys, if I recall, had your fuel surcharge cap still at 9.5% during the quarter.
Can you give us a sense as to sort of how that impacted your operating margins?
Scott Davis - CFO, SVP, Treasurer
Well, it -- we haven't quantified it, but it is always -- we don't get too focused on the fuel drag or the fuel plus.
Because it's going to -- if you don't get it this quarter, you're going to get it probably next quarter or the quarter after that.
When fuel prices come down some, we will get it back.
It had a slight negative.
I'm not going to quantify it, whether it's 20 basis points or 40 basis points of margin.
But whatever costs this quarter, we will get back in the next couple of quarters.
Jason Seidl - Analyst
Fair enough.
And if we look at your cash position going forward, where are you guys going to be focused on in terms of expansion?
Is it going to be -- is it going to be Europe?
Are you going to look to add some things on periodically here in the North American marketplace?
Scott Davis - CFO, SVP, Treasurer
I think that from an M&A standpoint, investment standpoint, I would think international is still going to be more of a focal point.
I think you're going to see, we've talked much about Europe and Asia are areas that we're interested in expanding both package and supply chain side.
Freight forwarding is still an area we've talked about in the past that we can enhance.
On the contract logistics side, again, that's more of a niche play.
When we have a vertical we want to enhance or a geographical we want to enhance, we'd be interested in it.
But I'd say more likely international; not to rule out North America or domestic, but I think much more likely on the international front.
Operator
Thank you.
Your next question is coming from James Valentine of Morgan Stanley.
James Valentine - Analyst
Great.
I just echo a great quarter on the domestic margins.
Scott Davis - CFO, SVP, Treasurer
Thanks, Jim.
James Valentine - Analyst
The question I had was for the whole air fuel surcharge issue and since that -- I know FedEx, at their recent analyst meeting, said they've been really surprised that the high fuel charges have not caused any slowdown in domestic air demand, and I guess I'm just wondering if you can give us your thoughts on how high you think that has to go before we will see the negative impact, or potentially negative impact, if ever?
And along those lines, kind of your thoughts about the 12.5% rate cap as you go into setting 2006 rates.
Scott Davis - CFO, SVP, Treasurer
I think -- that's a good question, Jim.
And I think none of us know exactly where that elasticity kicks in on fuel surcharges.
We've seen -- last year we thought we saw some trade-down to deferred and ground products, particularly ground products, with the higher surcharges.
We felt that as we put the surcharge back on the ground, it made sense to put a cap on the air side of things.
Is that one of the reasons maybe our air is growing faster?
Perhaps, in what we've seen in the last quarter.
But I think overall, at these levels, it seems that the customer is willing to pay for it and it's not really dramatically changed their shipping modes, if you will.
What changes that number is that -- is it oil at $75 a barrel?
I'm not sure.
At some level up there, it has got to get elastic and impact it.
We have not seen dramatic impact at this point in time.
But the cap probably gives us a little bit of an advantage, we think, going forward.
James Valentine - Analyst
Okay, good.
And just a quick update on the $200 million of discretionary cost savings, given the really good -- that it was originally your goal for this year, given how good of a margin you had for the quarter, I presume that's on track.
But I guess the follow-on or thinking about '06, given that those were, I thought, discretionary cost-cutting efforts, are those repeatable?
Do you think you are going to be able to either carry those on again or even have more in 2006?
Scott Davis - CFO, SVP, Treasurer
We think we will have more in 2006.
We've been looking at throughout our organization and how we're structured and how we run this business, and we think that there's always ways for us to get that magnitude of savings as we go forward.
We've done it many times before.
I think as we look at 2006, we have plans and we will give more detail in the January call as to where we stand.
But I would count on significant savings again in 2006.
Operator
Thank you.
Your next question is coming from Rick Paterson of UBS.
Rick Paterson - Analyst
Thank you, good morning.
Theresa Finley - VP, IR
Good morning, Rick.
Scott Davis - CFO, SVP, Treasurer
Hi, Rick.
Rick Paterson - Analyst
Can you talk about the competitive position of the U.S.
Postal Service?
Given your rising fuel surcharges, the price differential is growing.
I'm wondering if you're seeing any market share shift at the margin?
Scott Davis - CFO, SVP, Treasurer
We have not seen much evidence.
I know that the Postal Service numbers have looked better, certainly, in the last six or eight months.
We have really not seen -- but it's not been very visible to UPS as far as competitive wins or losses.
How much of that gain is in products or noncompetitive, I'm not sure.
A lot of -- about 80% of the U.S.
Postal Service, the volume is very lightweight, one to two pound type weight, and not an area that we play in an awful lot.
So we have not seen a lot -- at UPS, we have not seen evidence of them coming in and winning the business.
I still think it's -- our business is a value proposition, technology is important, service is important, and we still prevail in those areas.
Rick Paterson - Analyst
Thank you.
Operator
Thank you.
Your next question is coming from Scott Flower of Citigroup.
Scott Flower - Analyst
Yes, I had a couple of quick follow-ups and I know that it's in, I think mediation, but where is the pilot's negotiation?
If you could just give us an update on where that stands currently in-process?
Scott Davis - CFO, SVP, Treasurer
Sure, Scott, it's been a long session and we're still in it.
We're actually not in formal recess at this point in time.
We're I guess in an interim period, if you will.
The mediator has encouraged both the pilots and UPS to have discussions while we're in this interim period and frankly, we are having informal discussions with the pilots.
As I said before, we're optimistic we can get this thing settled.
We want to settle it at a contract that's reasonable for our crew members.
This also keeps us where we can compete, compared to the rest of the constituents of UPS.
And we're optimistic, we're having informal discussions; we're not in formal recess.
Scott Flower - Analyst
Follow-up was just on both Menlo and Overnite on integration.
I'm just curious -- have you seen attrition in the sales forces at all?
Maybe not at Overnite, but I guess there's some discussion that there's been ebb and flow in terms of Menlo, in terms of sales.
I'm just curious where you think you stand on that?
And are you getting the kind of retention that you want versus some churn that perhaps is unhelpful?
Scott Davis - CFO, SVP, Treasurer
No, I think overall we're pleased with where we are on the sales force.
The jobs are getting more difficult because as we start to bundle products, and there's certainly a lot of training to be done and we're in the midst of that training to get our sales forces to understand all the product offerings and communicate that to the customers.
So, I think overall we will find -- I don't think we have any major problems on retention, based on the acquisitions.
Operator
Thank you.
Your next question is coming from Ed Wolfe of Bear Stearns.
Ed Wolfe - Analyst
Yes, Scott, just a follow-up from before, where we were talking about pricing and kind of the volume yield tweak.
You had said that your thought was it was mostly mix and there wasn't a big change in your thoughts.
I just wanted to follow-up with the natural question, which was -- in terms of setting list prices, which I'm guessing is coming up in the near-term, should we expect, then, that ground and air list prices would be in a similar range to where we've seen them the last couple of years?
Scott Davis - CFO, SVP, Treasurer
Ed, you've seen our rate increases over the years and they don't vary tremendously.
They're kind of in a range and sometimes we surprise people in recessions and raise them on the higher end of that range.
But I think in this situation, we'll certainly announce the rate increase, probably in the normal timeframe, which is in a couple of weeks and I think that it won't be radically different from what we've seen in the past, but I wouldn't want to say any more until we make the announcements.
Ed Wolfe - Analyst
Okay.
Fair enough, thank you.
Scott Davis - CFO, SVP, Treasurer
Sure.
Operator
Thank you.
Your next question is coming from John Langenfeld of R.W. Baird.
John Langenfeld - Analyst
A couple of things, Scott, just on the economy, how do you feel today versus three months ago?
And then how did the monthly trends progress in the quarter?
Scott Davis - CFO, SVP, Treasurer
As far as the quarter, John, they're pretty steady.
I think we saw our volume levels pretty steady through all three months.
There wasn't a big -- maybe a little bit of a pickup in September, but not dramatic change throughout the quarter.
The economy is a difficult question.
I think that -- I think we're all amazed at how resilient the U.S. economy is.
It just takes these natural disasters and keeps on chugging.
I have no reason not to kind of go along with consensus and say that the economy is going to be okay, it's going to stay steady.
It may not be as robust as you saw in 2003 and 2004 and 2005, but it should not grow -- I mean it should grow somewhere around trend, which is in the low 3s, is what we think.
Industrial production is a very good barometer for us.
It still looks like it should grow slightly above GDP, which is a good sign for our business.
The numbers that came out in September were a little alarming with a negative IP, but you take out Katrina and you take out the Boeing strike and it actually grew in the mid-3s.
So, IP has stayed pretty strong.
Now, retail and Christmas is a question mark.
We talked to our customers, they're fairly optimistic on the Christmas season.
We all know there's going to be challenges with the consumer right now and their dollar's stretched with energy crunch, but overall, we think it's going to be -- again, not a robust Christmas, but an okay Christmas with an environment we can do well in.
John Langenfeld - Analyst
And then with that said, how does the planning look for the busy season?
What did you learn from last year that maybe you're going to carry into this year that you're going to do something different?
Or is it much of the same?
Scott Davis - CFO, SVP, Treasurer
I guess first point, I think, is that the last year was an outlier.
If we look at 9 of the last 10 peaks, we've executed extremely well and last year, a variety of things went wrong for us.
It wasn't very good planning, we had bad weather.
But overall, we have made some changes this year and we're paying a lot of attention because we don't want to run through a peak season like we did last year.
Some of the changes -- we've really -- we've centralized control over our purchase transportation and U.S. domestic operations.
So we've got more control on the outside contract, hiring.
We really improved our visibility throughout the Company on some of our key metrics to a daily basis, so we can watch every day exactly how we're doing.
And frankly, the package flow is going to be a benefit.
It's going to help make for smoother routes during the busy, busy peak season, the preloads more efficient.
So we think it's going to help us.
So we're optimistic, we think that we will do fine, execute well this fourth quarter.
Operator
Thank you.
Your next question is coming from David Campbell of Thompson, Davis & Company.
David Campbell - Analyst
Scott, David Campbell.
Scott Davis - CFO, SVP, Treasurer
Hi, David.
David Campbell - Analyst
Hi, how are you?
Scott Davis - CFO, SVP, Treasurer
Good.
David Campbell - Analyst
Europe has just seen a substantial international conglomeration get together, Kuehne & Nagel buying ACR Logistics.
That's a pretty big contract logistics operation in Europe and should have an impact, favorable impact on Kuehne & Nagel's forwarding business.
How does UPS see that as a competitive threat to your international business?
Scott Davis - CFO, SVP, Treasurer
We certainly pay attention to all the activity out there, and we don't think it's going to have a dramatic impact.
Certainly Deutsche Post Exel is a big change in the -- particularly in the contract logistics arena.
Kuehne & Nagel is a very strong competitor in the freight forwarding market.
I think overall, though, consolidation, we think, is probably going to be good for this marketplace.
I think you will see more consolidation as we move forward.
So we're not uncomfortable at all with consolidation.
David Campbell - Analyst
Okay, good.
And the second question is -- you, according to C&F, paid them $79 million in September to keep Menlo's employees on the C&F pension funds or something like that.
Is that cost in your third quarter P&L?
Scott Davis - CFO, SVP, Treasurer
I'm not sure of the timetable of that, but it would have been built into the acquisition price of the Company.
That would have been part of the acquisition price.
I have to go back and look at the details on that, David.
But it would be something that would be part of the purchase price of Menlo.
Operator
Thank you.
Your final question is coming from Helane Becker of The Benchmark Company.
Helane Becker - Analyst
Thank you very much, operator.
Hi and thank you very much for taking my question.
Scott, just two -- one is do you have any issues repatriating cash from international market?
And the second is, did you -- I got on the call late, did you say if there was an impact from Katrina and Rita?
Scott Davis - CFO, SVP, Treasurer
Helane, good talking to you.
As far as the impact of the hurricanes, there was certainly some impact in – obviously, it was a horrible event for our people and all the people in that part of the country.
As far as the impact on the business, we certainly had some property damaged and we're still trying to determine how much that is and we have insurance, obviously, we will file claims on it.
As far as the actual business, that -- the portion that was impacted by the hurricane represents about six or seven tenths of 1% of the GDP.
So it didn't have a dramatic impact on the shipping business and the volume.
But it certainly – it was a tragic event and the big impact, obviously, is energy prices and what that does to the economy going forward.
Regarding repatriation, it's not a major event for us.
We've been able to repatriate our cash over the years, tax efficiently.
There may be a minor repatriation in the fourth quarter, but it will not be dramatic to the financial statements.
Helane Becker - Analyst
Great.
Thank you.
Theresa Finley - VP, IR
Okay, that's all we have time for this morning.
Over the last few quarters, UPS has certainly demonstrated its ability to generate momentum in its businesses, and we're moving ahead vigorously on all fronts and we will capitalize on the opportunities of global trade.
Thank you for joining us today and we're looking forward to seeing all of you soon.
Operator
Thank you.
This concludes today's UPS conference call.
You may now disconnect and have a wonderful day.