聯合包裹運送服務公司 (UPS) 2006 Q1 法說會逐字稿

Good morning.

My name is Jackie and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the UPS Investor Relations first quarter 2006 earnings conference call.

[OPERATOR INSTRUCTIONS] Thank you.

It is now my pleasure to turn the floor over to your host, Ms. Teresa Finley, Vice President of Investor Relations.

Ma'am, the floor is yours.

Good morning, everyone.

Thank you for joining us today.

Shortly.

Scott Davis, our CFO, will provide insight into first quarter results and our expectations going forward.

Before Scott begins, however, I want to take a moment to let you know that UPS is holding an investor conference on November 8th at our corporate headquarters in Atlanta.

We'll provide more details in the coming months, but we want to alert you to the day so you can mark your calendars accordingly.

Also, I want to point out that during the quarter, we announced the rebranding of over Overnite to UPS Freight.

Going forward, references to Freight refer to the UPS Ground Freight operation, formerly Overnite.

Now, I'll briefly review the Safe Harbor language.

Some of the comments we'll make today are forward-looking statements that address our expectations for the future performance or results of operation for the company.

These anticipated results are subject to risks and uncertainties, which are described in detail in our 2005 Form 10-K report.

This report is available on the UPS Investor Relations website or from the Securities and Exchange Commission.

Today's call is being webcast and will also be available on our Investor Relations website.

Now I'll turn the program over to Scott.

Thanks, Teresa.

We're pleased to report solid results.

$0.89 for the quarter, up over 14%.

We came in at the high end of our expectations with strong revenue growth in all business units, impressive operating profit growth from a global small package business and, of course, another quarter of excellent free cash flow at $1.9 billion.

The small package market is robust across all major regions of the world.

And clearly UPS far outpaced market growth.

In the quarter, revenues from our small package business grew 11% to $9.6 billion, and volume was up 9%.

That's more than 1.2 million additional packages each day.

However, our supply chain and freight segment results were mixed.

The ground freight business performed very well, though results from our evolving forwarding logistics business were disappointing.

We have established some initiatives to get back on track, which I'll discuss later.

Let's start with the review of our domestic segment.

The growth of the U.S. small package market continues to outpace the economy.

And the pricing environment remains rational.

We performed exceptionally well during the quarter, with Ground volume up over 6% and Next Day Air volume up more than 9%.

Next Day volume growth continues to be driven by our Saver product, which has a guaranteed delivery by 3:00 p.m.

Deferred Air volume growth was also strong, posting nearly an 11% increase.

These two- and three-day products provide customers with flexibility in managing their businesses, and for UPS, the deferred products improve asset utilization and generate excellent returns.

In fact, during the quarter, we enhanced these offerings by expanding our 2nd Day Air portfolio.

In February, we accelerated the guaranteed commit time to 10:30 a.m.

and extended delivery area coverage for the industry's only 2nd Day Air A.M. service.

In addition, we added a Saturday delivery option to the two-day portfolio.

Total domestic operating profit increased over 15% with an 80 basis point margin improvement.

At a 15.9% operating margin, our model is clearly producing operating leverage on strong volume growth, despite various cost increases like pension expense.

During the quarter, we announced a significant upgrade to the U.S. Ground package delivery network.

The result?

Transit time was reduced by one day or more for a half million packages nationwide.

This upgrade impacted over 3 million zip code pairings.

The network enhancements in the first quarter improved service for 1.2 million customers nationwide.

Turning now to the international operations, once again this business posted an excellent performance in line with the consistent growth trends we've seen for the last few years.

Revenue increased over 17% to $2.2 billion.

Total daily volume was up 29%, with export volume up over 16%.

Non-U.

S. domestic volume grew 38%, aided by acquisitions.

Operating profit increased over 13%, resulting in a strong 18.3% operating margin.

Revenue per piece adjusted for currency decreased 5.9%, primarily the result of mix changes.

There are a few moving parts in the revenue per piece story which I'd like to explain.

First of all, our non-U.

S. domestic business is becoming a larger part of the overall international mix.

Non-U.

S. domestic packages stay within the borders of a country.

This growth is a result of acquisitions in Europe, as well as strong growth in Canada.

Remember, the average revenue per piece for non-U.

S. domestic products is $6.68 versus $37.18 per total export.

Second, our export business is experiencing a higher mix of European and North America transporter products.

These are package movements that cross borders within a continent.

Transporter has been growing very well in both Europe and Canada due to our excellent value.

Both the non-U.

S.domestic and transporter products have a lower revenue per piece but are nicely profitable.

We were able to leverage our integrated ground and air network, providing customers with a superior service just like in the U.S.

During the quarter, we introduced product enhancements and network improvements across our international business.

We rolled out UPS Trade Direct air and ocean services for export shipments from the U.S. and Canada to Europe, complimenting our successful Trade Direct cross-border service for Canada and Mexico.

The suite of Trade Direct products relies on our combination of transportation and brokerage capabilities.

Also earlier this month, we announced several enhancements to our international network that allows us to offer greater flexibility to our customers and gives us the capacity to meet firm demand across Europe and Asia.

First, we added three new frequencies connecting Shanghai to the U.S. This brings us to a total of 21 weekly flights, 15 for Shanghai and 6 for Guangzhou.

Second, we announced the start of UPS's first direct air service from Shanghai to Cologne.

Third, we strengthened our intra-Asia network by adding another flight between Qingdao, China and Inchon, Korea, bringing the total number of weekly flights between those cities to six.

In the quarter, we expanded our express package service to 110 additional cities in China.

Now express service is available in a total of 330 cities that account for about 85% of China's international trade.

Our goals for the combined U.S. and international small package business remain the same.

Grow revenue by improving or maintaining our market position in a growing global industry.

Generate returns by leveraging our model and increasing asset utilization.

Invest in our business to bring even more new and enhanced capabilities to our customers and create one-to-one customer relationships in order to determine the best solutions for their needs.

Now for the supply chain and freight segment.

The performance of our freight forwarding and logistics business was below our expectations while the ground freight unit produced solid results.

Domestic and international freight forwarding experienced a shortfall, due primarily to lost sales coupled with some additional integration expenses.

Our 18-month time frame was extremely aggressive for the development of a worldwide air freight forwarding network.

This complicated undertaking includes IT conversions, process changes, extensive training, facility construction, and network planning.

It impacted virtually every forwarding activity.

As a result, fewer resources were dedicated to sales efforts.

Nevertheless, we are on schedule to close the Dayton hub and transition air freight handling to Louisville and our other regional air hubs by the end of June..

There will be important benefits to customers when this integration is complete.

Earlier delivery times and utilization of the UPS on-time network will give customers superior service and reliability worldwide.

We still expect to realize $50 to $100 million in cost synergies this year and at least $200 million next year.

However, we are taking additional steps now to address the underperformance in the forwarding business.

We will strengthen revenue management practices, focus on operational excellence, reduce costs, improve the profitability of customer accounts, and most importantly, rejuvenate the customer experience to improve sales.

We're confident we'll see improvement in second quarter results and even more dramatic gains in the second half of the year.

Let me turn now to our newly branded UPS Freight business.

The freight unit turned in a solid performance for the quarter with total revenue up 14.6%, tonnage up about 8%, and shipments over 6%.

We are on schedule with our rebranding of the Overnite operations as UPS Freight.

Next month, you'll see a new website and rebranded tractors and trailers.

We have begun deploying Dyad 4's, and this month, we will complete the training of our U.S. package sales force in selling the entire portfolio of services to both small package and freight customers.

Now for a quick review of our use of cash.

In the quarter.

we purchased over 11 million shares, and we have just under $500 million remaining of the funds authorized for this purpose.

Additionally in February, we increased our quarterly dividend 15% to $0.38 per share.

This equates to an 81% increase in declared dividends in the last three years.

We also invested $596 million in Capex and still closed the quarter with $3.1 billion in cash and investments.

Our free cash flow for the quarter was $1.9 billion.

Once again an excellent quarter for cash generation.

Let me take a moment to reiterate our strategy for use of cash.

Our exceptional financial strength provides us with tremendous advantage and opportunity.

Our first priority is reinvestment in the business including acquisitions.

In addition, we will continue to evaluate increasing distributions to our shareowners through share buyback and dividends to further optimize our capital structure.

The goal, of course, is to generate economic returns over the long term, not to focus on short-term impacts to earnings per share.

Turning now to the future.

For the second quarter, we anticipate earnings per share within the range of $0.97 to $1.01, compared with $0.88 reported last year.

In the second quarter, we expect our U.S. small package operations to grow at market rates with air business growing about the same as ground.

The international export volume should grow faster than the market at a low double-digit rate, despite the impact of the Easter holidays in Europe.

Supply chain and freight profit should improve in the second quarter.

For the full year, we reaffirm our annual earnings per share growth target of 11% to 16%.

There are excellent growth opportunities in all three of our businesses.

Through technology, our broad service portfolio, and integrated network, we're creating business solutions that address our customers' supply chain needs.

We believe this positions UPS well to capitalize on the opportunities we see.

As I've stated in the past, our long-term goal is to grow annual earnings between 10% and 15%.

Looking toward our centennial year in 2007, we certainly believe this is a reasonable goal.

Now I'd be happy to answer your questions.

Thank you.

[OPERATOR INSTRUCTIONS] Your first question is from Jordan Alliger of Deutsche Bank.

Hi.

Morning.

Morning.

I guess the first question I have is when you look at the domestic operating leverage that you got and the year-over-year improvement in the drop-down, which was quite good, what were the main components of that?

Was the biggest chunk of it just the really strong volume growth, or was it some of the other stuff, like package flow and other operational things you're working on?

Jordan, I think it's all of the above.

Certainly the volume growth helped us a lot.

Package flow continues to produce good results.

The productivity numbers we've been looking for were seen out of package flow.

That's strong.

Our average labor rates are going down, as far as labor rate increases because the volume goes up.

I think the driver service providers averaged only like 1.6% increase in the quarter.

So again, very strong incremental margin in the first quarter.

And then just a quick follow-up.

On the air volume side, both Next-Day Air and Deferred, which were up as you noted, much more than the market, how much of that is you going after the business versus other so-called, I guess, revenue management or not wanting the business, so to speak?

I actually think that the market is strong.

The next day-package market really has stayed pretty strong.

Just-In-Time has really produced a lot of lean inventories out there, and people will always have a demand for the express product.

You're also seeing good growth in the B-to-C market, and our Saver product really has been leading -- it fits that market very well, and we've seen real strong growth in the Saver product.

The deferred product is a great product for us.

It doesn't drive assets, it doesn't drive airplanes.

Nicely profitable product.

So we get all that volume we can get.

Thank you.

Thank you.

Your next question is from Tom Wadewitz of JP Morgan Chase.

Yes, good morning.

Good morning, Tom.

I have a follow-up really, I guess, on the margin side.

It was impressive in terms of the volume growth, very impressive,and then the margin follow-through was good.

Do you think we can see that continue through the year, where you get further gains on the margin side, or is that likely to slow?

And I guess I'm referring to domestic package margin in particular.

We feel very good about the trends we're seeing.

So, as I said at the start of this year, we didn't see ourselves retreating in margins, either domestically or internationally.

As we move into the second quarter, typically the first quarter is a difficult quarter for to us get margins.

There's some seasonality in the business.

So, we see no reason why the second quarter margins domestically shouldn't be better than the first quarter.

You talked a little bit about 2007, 10% to 15% seems like kind of a reasonable high level number.

Is it possible that you could see better than that, given that you have some cost pressures this year which appear to be -- some of them are maybe somewhat one-time, with a little less cost pressure next year.

Could you actually see it better than 10% to 15%?

We'd certainly like to see it better.

I think that at this point in time, it's almost a year away.

I think we're going to point out, one, it's a very important year for UPS, our 100th year birthday that we've been focusing on for a long time.

We certainly see nothing in the fundamentals that says UPS shouldn't be able to perform as we've done historically in 2007.

So I just wanted to remind the market.

Very important year for UPS, fundamentals look good.

Okay.

Great.

Thank you.

Thank you.

Your next question is from Gary Chase of Lehman Brothers.

Good morning, guys.

Hi, Gary.

Just a quick question for you on inside across some of your customer segments.

Last quarter you'd noted business services strengths and you again referenced good strong market growth.

Any light you can shed on how that's developing and on how different customer segments are performing would be helpful.

I think, Gary, it's somewhat similar to what we saw in the fourth quarter.

The business services, the accounting, research, services type areas has stayed very strong.

Driven a lot of that deferred air business that you're seeing.

Manufacturing has stayed strong.

I think if you look at the IP numbers, the manufacturing portion is still remaining quite strong there.

And it's obviously good for our business.

Retail I think was good but it was a little bit mixed.

I think we all saw very strong January in retail.

Stayed okay in February and March, not quite as strong as in January, but clearly the B-to-C, the business to consumer, is helping the small package market.

The small package market is clearly outperforming the U.S. economy at this point in time.

Okay and just a quick one on Menlo in the quarter.

I think you'd anticipated there was going to be $20 million of impact initially.

You said you'd stepped up some efforts there.

Is that number materially larger than you'd anticipated?

How should we think about that?

The direct integration of costs were probably in that range.

What happens, when you have a major integration of this type, and really, it's a major integration in a short time frame, a lot of IT conversions, a lot of process changes, extensive training, building new facilities for the domestic air network, and really the network planning activity really impacted all forwarding for the company, so I would say that direct costs were probably in that range.

Indirect costs really resulted in some lost sales during the period, so we were disappointed both in the international air freight forwarding and the domestic air freight forwarding.

Part of that was really the operators.

Best guess, the employees spend so much focus on the process changes and technology changes that they had less time to spend with the customers.

Where we're at now is we're just about complete with the integration.

I think we've standardized our product offering throughout the world at this point in time.

The technology is working fine.

Our service is really at the highest levels we've seen I think in this sector.

We are starting to win some new business.

We lost some business in the end of the fourth quarter and the first quarter, so we have been winning new business recently.

The air freight facilities will be done by July 1, so we'll be able to move into it the UPS network, which will be a positive.

It will help us from a selling standpoint.

Better service, UPS on-time network.

So we're looking -- we look optimistically forward.

Second quarter, you're going to see better profits than we saw in the first.

In the second half of the year, dramatically better profits in S C S.

Thanks a lot.

Sure.

Thank you.

Your next question is from Edward Wolfe of Bear Stearns.

it's actually Matt Brooklier for Ed.

Good morning, guys.

Hey, Matt.

I just wanted to look out.

I had a couple questions regarding ground.

You guys posted another very strong quarter in terms of volume.

Wanted to know if you guys are benefiting from cross-selling in terms of now that LTL freight services are on board.

Maybe discuss a little bit in terms of the cross-selling progress in terms of both products.

I think -- first of all, I think the market's very strong.

Small package market is strong.

UPS performed very well in that marketplace.

We are finishing our training of our sales force as far as cross-selling this month.

I think it probably had some benefit both in the LTL side at UPS Freight and the package side, but we really expect more of those benefits prospectively.

Probably the latter part of this year and into 2007.

Okay, so it should come on later in the year.

I think more of the benefits in the joint selling will be later in the year.

Got you.

Secondly, you guys continue to pile up cash on your balance sheet, which is nice to see.

Wanted to kind of try to get a feel for your outlook on potential share repurchases going out, if you guys, during 2006, would be more aggressive in terms of share repurchases, or if it's kind of continued slow and steady share repurchase program.

I've been pretty explicit, Matt, in the fact that we are likely to get into a more efficient capital structure as we move forward.

How we get to that more efficient capital structure will be a combination, likely, of acquisitions and increased share and redistributions.

We have obviously in the last couple of years, increased our distributions, and even in the first quarter, you saw that we bought back over $850 million of stock, so it's a fairly aggressive.

But I think going forward it's likely that we will become more aggressive.

Whether it's in acquisitions and/or distributions, we'll announce at that point in time.

Yes.

Okay, thanks for the time, guys.

Thank you.

Thank you.

Your next question is from Ken Hoexster of Merrill Lynch.

Hi.

Good morning.

I just wanted to -- on the ground side, also very strong, you mentioned on the air that you were seeing some volume shifts, and I just want to talk about ground for a minute.

Just with your volumes up 6%, Fed Ex posting 11% growth in the quarter, are we seeing a large impact from the Postal Service price increase?

Is this still a DHL shift?

Or is the ground market itself also expanding significantly faster than GDP?

I just think it the's a real solid market right now.

I think we saw in 2005, we saw the small package market outperform the GDP numbers.

In 2006, we said we expected that to continue.

I think you're definitely seeing that as we move forward.

I don't think that that's -- it's really -- I think it's good for the market when the low-cost competitor, low-price competitor raises the rates, raises the floor, but I think that that probably is not what drove it.

I think B-to-C, as we talked about, some of the macro trends that we're seeing right now, is helping the small package market, is moving that from other -- maybe from truckload into small package, but I think it's overall macro trends are helping small packages now.

Great.

And then on the ground as well, is this -- did the shift of expediting the package delivery have anything to do with your move to remove some packages from the rail, or is that significantly just a process you've been working on for awhile and aided by, I don't know, package flow technology or something?

It's a combination.

I think, one, there were certain areas, time and transit-wise, that we wanted to improve the time in transit, and to do that we had to take it off the rail.

At the same time, with the service issues we've seen in the rails, we have evaluated alternatives, and some has come off the rail.

So I'd say it's a combination again.

Can you talk about what percentages has shifted off the rail?

I'd say it's still a minor percentage has shifted off the rails.

Great.

Thanks a lot.

Thank you.

Your next question is from Michael Halleran of Robert W. Baird.

Good morning.

When you look at the international side of things, are you guys experiencing any noticeable integration expenses or elevated expansion cost from the recent acquisitions you've made?

I think -- that's a good question.

I think if you look at the margins, and the margins are down slightly, they're excellent margins the first quarter, 18.3%, but slightly below last year's first quarter margins, part of that is the LYNX acquisition.

And the LYNX acquisition is really running at slightly below break-even.

Where we expected it to in the first year.

It's going to take us couple years to get that integrated and merged in with the UPS operations in the U.K. So that, frankly, brought down our overall operating margins by about 100 basis points between years.

So, you take the LYNX acquisition out, and you really would have shown another nice improvement in the international margins.

So nothing has changed in those trends in international.

Great.

And then sticking with the international, I know you touched on it a little bit earlier, but when you look at the pricing side of things, specifically for the export, how much of that weakness is mix versus more aggressive pricing on your part?

I'd say it's entirely mix.

We talked about -- I talked about it earlier on the overall international, if you take out currency, you get a slight increase on the export side of things, and it would have been up higher except the transborder products, the products moving from U.S. to Canada, the products moving across borders in Europe grew at a faster pace, and obviously those are shorter-range products and lower priced.

Nicely profitable, nice margin in those products, but certainly less expensive than Asia to the U.S. or Europe to the U.S. So that really is what impacted export.

Domestic, it was kind of a combination.

I think the Polish acquisition of Stolica had an impact.

We have some products there that are real short range.

Low revenue per piece products.

Still profitable, but it brought down the average.

And Canada also grew at a very fast pace and has a lower average revenue per piece than the overall foreign domestic, or non-U.

S. domestic products.

I appreciate it.

Thank you.

Thank you.

Your next question is from Jason Seidl of Credit Suisse.

Morning everyone.

Two quick questions here.

You said in the second quarter that you expect air and ground to grow the same.

Now, we saw a little bit of disparity in the first quarter in terms of the growth rates.

The reason for the parity in the second quarter would be?

I just think -- I think going forward that we think that the air market should grow somewhat comparable to the ground market.

So I think that it'll return to normalcy a little bit.

Also, there were -- in the first quarter a year ago we did have some negative comps on air, which I think helped the comparisons this year.

I think on longer term perspective we think that the air market should grow close to what the ground market is growing.

All right.

My follow-up question is, you mentioned a little bit that you expect both freight and supply chain solution to improve profits in 2 Q. Obviously your supply chain was a loss for you, so we're going see that in the black in 2 Q?

I think we're going to see that closer to a break-even in Q2, and the segment will certainly show profits in the second quarter.

By the time, as I said all along, by the time we get to the third quarter, we think we'll see significant improvement in the supply chain side, and in that entire segment.

Thank you.

Thank you.

Your next question is from James Valentine of Morgan Stanley.

Thank you.

Scott, you had mentioned a few times that UPS is going to make its capital structure more efficient, possibly through doing some more acquisitions.

But historically the amount of capital you spend on acquisitions has been relatively small, maybe with the exception of Overnite, but even that spending -- I think you said your free cash flow in the first quarter was more than you spent all on Overnite.

So , what I'm trying to understand is, is this pace going to pick up substantially?

Because my understanding of the company dating all the way back to the IPO is that you pride yourself on your corporate culture, the hiring people as frontline employees, promoting from within, promoting through the ranks, and that you don't want to buy something too big over the concern that you would dilute that corporate culture that's so strong.

Am I interpreting your statements here talking about more acquisitions to suggest that you might buy something bigger, much bigger than even an Overnite?

Well, I think, Jim, that clearly we would not rule that out.

I think I've said in the past that if we found the right acquisition, obviously UPS is in a position they could do an extremely large acquisition if it makes strategic sense for the company, if it meets our financial hurdle rates over the long term, and, I think that we probably would have done some of this recapitalization earlier if we didn't think that was a possibility.

So I would say we would not rule that out.

Okay.

Thanks.

And the second question is on the international package, and you may have answered this, sorry, I had to jump off for just a second, but the operating income grew at about 13.5%, your revenue grew at a faster pace, and also international's operating is -- is growing at a much faster pace in the past few years.

Is it that you're starting to now finish getting a lot of that operating leverage, because you had built out your network, you were filling it up, is it that most of it's done now, and so we're not going to see that same kind of leverage we've seen in the past, or are there unusually large costs that came through in the first quarter, and I'm thinking specifically like expansion in China or expansion in Japan, is there something going on that is more kind of nonrecurring that happened this quarter, that it's just -- once we get past that, we're going to see ourselves get back to 20, 25, 30%-type operating growth in that segment?

We think that we will continue to show significant operating profit growth going forward, Jim.

I think that the -- we were pretty well on our expectations in the first quarter.

The second quarter is going to be -- is challenging, somewhat also internationally, because of the Easter comparisons, but I think, as we roll through 2006, you'll see strong margins and strong operating profit growth going forward.

We have not maxed out the economies of scale that we have been talking about.

We have more room there.

Okay.

Great.

Thank you.

Thank you.

Your next question is from Scott Flower of Big Brown Research.

Yeah, good morning all.

Couple of questions.

I know that you said pricing was rational, but I guess if I look at some of the math and play with the figures it looks as if given maybe some of the strength in volume growth that pricing is firming.

Would you say that's fair or not?

I think pricing is firming, and as we said going into this year, we felt it was a slightly even more rational market than it's been in the past.

It's been rational in the past.

I think if you look at -- what I said at the end of the year is that we expected to have historical yield increases this year that will come from different reasons.

Last year a lot of it came from the surcharge increases.

This year more will come from the base right increases, I think.

And there was some concern on investors that we would not be able to retain those base rate increases, and I think you're seeing that in 2006, where surcharges are not up as much this year, and we're keeping more of the base rate increase.

Okay.

And then the second question.

I know you were asked about it previously, but I wanted to follow up, historically you've been able to grow your air product faster than ground because of the size of the air product and your ability to take share.

Is it fair, when you're talking about parity now, that's not historically the way I've looked at your volume growth between those two products.

Are things shifting?

Are you seeing actually a shift in the market to where customers are using more ground?

I just want to -- if you could, flesh that out a little bit more and understand that.

I think that historically at UPS, and we've always had the product offerings, the air and the ground, so you probably didn't see near as much diversion away from air to ground as maybe at the competitors, who really brought new product offerings, so I think that's probably why you've seen the air growth stay pretty strong.

I think a lot of people have been projecting the demise of the express market over the last several years, and we just haven't seen it.

We think there's always going to be a good strong air market.

Logically, though, I would think it's hard to expect the air market to grow faster than the ground market going forward.

So we think that -- we've always done a little better than the market, obviously, on air.

All right.

Would you say you're going to grow more in line with the market, then, in air, going forward?

I think we'll still outperform the air market, but the air market's going to be -- there will be pressure to grow at the ground market levels.

Okay.

Thank you.

Sure.

Thank you.

Your next question is from David Ross of Stifel Nicolaus.

Good morning.

Good morning.

I have a question about the bankruptcy of a large consolidator that happened in the first quarter.

How much in diversion of freight of the UPS network are you expecting out of that?

And what, if anything, are you going to do to ramp up a low-service offering product?

We have the basic service offering, which is the no-frills kind of low-price product offering.

As far as the volume has been added to our network, I would say there will be limited volume.

There's going to be some wins there, but we're going to be very much sticklers to getting the right price.

We're probably not going to be offering the same price that we're getting from the bankrupt carrier.

So we've been sticking to our guns.

We'll in some of that business but at our price.

Okay.

And then, next question, can you just give us an update on the pilot talks and where they stand at this point?

Pilot talks are still in recess.

They were put in recess in December.

Frankly, now it's up to the mediator to call the parties back.

The mediator has actually put a gag order on discussions.

I think they basically want these discussions to be private, and it's really up to the mediator to call us back to the table, and we're still waiting on that news.

Thank you.

Sure.

Thank you.

Your final question is from David Campbell of Thompson Davis & Company.

Yeah, hey, Scott, how are you?

Good, David.

How are you?

Good, thanks.

I just wanted to ask on the freight forwarding side of the business, most of my questions have been answered, but on the freight forwarding side of the business, it looks to me like the biggest problem is purchase transportation costs.

I suppose both domestic and international.

Because they were up $430 million in the quarter.

I don't know how much of that is a change in accounting from that -- from net to gross for the business, but it just seems like an extraordinary increase.

To the extent that you will be using your own network on July 1, I mean, that's certainly a major part of this solution of profits there, isn't it.

Absolutely, that'a a good observation.

I think that clearly we're going to be able to pull some of those costs out.

We've put up the UPS airplanes and take down the 32 dedicated aircraft.

Part of it is, David, the accounting change, going into the dedicated network , and taking air freight forward in revenues at gross versus net, and including that purchase transportation in the numbers, there's also though, other numbers, some of the acquisitions, Overnite certainly has purchase transportation, our international operations have a lot of purchase transportation.

Certainly [topsy's] been up, we've talked about [topsy] rail costs being up double digit, so that's part of it.

So it's a variety of things but it's certainly something we're focused on.

I think that putting the domestic freight forwarding network into the UPS network will certainly help that.

Is the freight forwarding costs out of line both domestic and international?

I mean, I'd say that it's something that we're focused on.

Clearly in the last quarter, our costs were higher than our revenue in freight forwarding operation, and that's something that's got to be fixed.

A lot of that was revenue issues but it's something we're certainly focused on.

Okay.

Thank you.

Thanks.

Thank you.

Before we conclude, just a reminder to save the day, Wednesday, November 8th, for our investor conference in Atlanta.

Details will be forthcoming in the next few months.

Thank you for joining us today, and we look forward to seeing you soon.

This does conclude today's teleconference.

You may now disconnect your line and have a wonderful day.