聯合包裹運送服務公司 (UPS) 2007 Q2 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the UPS Investor Relations second-quarter 2007 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.

With me on the call this morning are Mike Eskew, UPS's CEO, and Scott Davis, our CFO.

My first order of business is to review 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 2006 Form 10-K and first-quarter 2007 10-Q report.

These reports are available on the UPS Investor Relations website or from the Securities and Exchange Commission.

Today's conference call is being webcast and will also be accessible on our Investor Relations website for a few weeks.

Some of the results mentioned on the call today are year-to-date numbers, which include non-GAAP impacts from the first quarter of this year.

Schedules reconciling non-GAAP to comparable GAAP measures are available on the UPS IR website in the financial section, and the cash flow reconciliation is included with the news announcement this morning.

Now I will turn the program over to Mike.

Thank you, Teresa, and good morning, everyone.

Overall the Company performed reasonably well in the first half of 2007.

Our international small package business posted excellent results with exceptional performance from Asia and Europe.

In fact, for the first half of the year, international export revenue increased 13%.

UPS's balanced network around the globe supports a thriving small package business, even in the face of a sluggish US market.

Supply Chain and Freight segment reported improved profit by $130 million in the first six months this year, and we are encouraged by the trends in both our LTL and supply chain businesses.

Our long-term growth and profitability strategies are bearing fruit, and we will pursue our vision of synchronizing commerce for our customers.

This means we will build capabilities that provide new platforms for profitable long-term growth.

Recent and ongoing infrastructure expansions in Cologne, Louisville, the UK and Shanghai, as well as network acquisitions in Europe and Asia, are good examples.

Adding more services that broaden our product portfolio beyond small package such as heavy ground and airfreight and logistics allow us to meet the global needs of our customers.

Investments in technology also play an important role.

Our customers are unique, and we will meet their requirements by creating a wide range of adaptable solutions allowing them to better manage their supply chains.

I do want to emphasize that we will maintain a disciplined approach to investing.

We will enter new markets and add capabilities that are aligned with our strategies, and these investments should generate attractive returns for our shareowners.

We will also keep our focus on executing effectively everyday across all business units.

All of us at UPS remain constructively dissatisfied.

We are always looking to improve what we do and how we do it, providing superior service to our customers, and maintaining operating excellence will sustain our competitive advantage.

On August 28, UPS will celebrate its 100th anniversary.

So I would like to take this opportunity to congratulate all UPSers on this outstanding achievement and to thank our customers and our shareowners for their support.

And while it is a good time to reflect on the strengths and values that have enabled us to reach this milestone, we prefer to look ahead.

We're excited about the long-term potential we see as world trade expands and becomes more complex.

Our unmatched global infrastructure, broad service and product portfolio and leading-edge technology enable us to simplify this complexity for our customers.

Simply put our global opportunities are compelling.

Now to review UPS's second-quarter segment results, I will turn this program over to Scott.

Good morning, everyone.

A 7% increase in earnings is a respectable achievement in light of the slow growth US small package market.

Overall for the quarter volume increased 63,000 packages per day.

Pricing remained firm, and operating margin for the Company improved.

That said, let me address what I know is top of mind to you, the US small package market.

Consensus forecasts are predicting US GDP grew about 2% year-over-year in the second quarter.

However, we believe that industrial production trends are a better predictor of small package performance than GDP.

And IP rates year-over-year have grown less than GDP.

In fact, the IP growth rate is not expected to bottom out until sometime in the third quarter before beginning to rebound.

Also significant to the small package market is consumer behavior.

And the B2C market has experienced steady slowing growth over the last six months.

We believe that the steeper decline in the industrial production growth rate compared to GDP, combined with the weakening business consumer shipping, explains why the US small package market is currently underperforming the overall economy.

However, let me be very clear.

It is our view that the long-term fundamentals in the small package market are unchanged.

Direct to consumer models, just in time supply chain management and online purchasing are secular trends that will drive small package growth for years to come.

We anticipate the growth rate of this market will gradually resume toward the end of the year.

UPS intends to capture our fair share of this market growth.

In a challenging operating environment like this one, cost control becomes particularly important.

Our operations team adjusted well to the reduced volume levels, evidenced in a 15.7% operating margin for this business.

In addition, we did a good job of controlling semi-variable costs.

The first half of 2007 has been challenging for our US small package business.

As Mike said, we're very focused on execution.

We will manage the business as effectively as possible in the current economic environment.

Now turning to our high-growth international business.

Once again, this segment turned in terrific results.

International profit increased to $475 million for the period, up almost 15%.

This was the second strongest quarter for profitability that this segment has ever achieved.

And at 19% operating margin was outstanding.

We continue growing faster than the market through our high-quality product offerings and strong execution in Asia and Europe.

Total export volume increased over 10% with Asia up 25% and Europe up 11%.

Once again, UPS China had the highest volume growth rate in Asia.

In the quarter exports out of China to the US, to Europe and within Asia were all exceptionally strong.

In our international operations, we're clearly capitalizing robust world trade growth opportunities.

Now for the Supply Chain and Freight segment.

We're very pleased with the progress of UPS freight, which posted revenue and shipment gains in a tough LTL environment.

In fact, LTL revenue increased 10.5% to $526 million, and shipments were up 12%.

A third of our freight growth came from customers who had not previously used UPS freight.

The remainder was increased shipments from current UPS freight customers.

A number of factors came together to stimulate this momentum.

One, the servicing quality initiatives we put in place in the second half of 2006 are bearing fruit.

Two, UPS technology now available for freight shippers is attracting new business.

And three, our sales team is successfully cross-selling freight in a small package portfolio in the middle market.

We expect steady improvement in our freight operations to continue.

In the forwarding and logistics operations, the initiatives we put in place a few quarters ago are generating margin improvement.

These included reducing nonoperating staff, intensifying our focus on profitable new business and strengthening revenue management practices.

While these initiatives are producing benefits, our focus is now on revenue growth and international airfreight, ocean freight and distribution businesses in order to produce the sustained performance we're looking for.

Mindful that we still have work to do, we are encouraged by the progress this segment is making.

Before I talk about our outlook for the rest of the year, I want to review our financial position.

Year-to-date UPS generated almost $3.6 billion in cash from operations.

It invested $1.2 billion in CapEx.

Spent $1.5 billion to repurchase shares.

Paid dividends of $1.3 billion and still ended the first six months with $2.1 billion in cash and investments.

Our year-to-date free cash flow exceeded $2.3 billion.

Now for our outlook on the third quarter and the rest of the year.

For the third quarter, we anticipated diluted earnings per share will be within the range of $0.99 to $1.04 compared with $0.96 a year ago.

In the US we expect a gradual increase in volume and pricing to remain firm.

Also, remember we realized a sizable credit to worker's compensation expense in last year's third quarter that we don't expect to repeat this year.

However, margins should remain above 15%.

While we're on the US domestic business, let me make a few comments on our labor negotiations.

Although details about the negotiations will remain at the table, I want to assure you that Teamsters and UPS are working diligently to resolve some very complex issues.

We're optimistic that we can have a contract by the end of the year that will be good for our people and enable UPS to remain competitive.

In the third quarter, our international business should post strong results once again.

We should see double-digit export volume growth, a firm pricing environment and mid-teen profit improvement.

We expect that both the Supply Chain and Freight business units will continue to make progress in the third quarter.

For the year operating margin in this segment should exceed 3%.

Lastly, we still anticipate adjusted earnings per share growth will be within the 6 to 10% range we originally set for 2007.

We had a great first half in international, and the Supply Chain and Freight segment is turning the corner.

Obviously our US small package business was challenged.

So I want to complement UPSs around the globe for their efforts.

They did a great job of execution and cost-containment, both very important in today's slow growth environment.

Now we would be happy to answer your questions.

(OPERATOR INSTRUCTIONS).

Tom Wadewitz, JPMorgan.

I wanted to see if you could give some comments on the domestic market in terms of pricing trends, competitive trends, whether there is any change there or whether things are still pretty stable?

I think the domestic package market pricing is quite rational.

I think you saw a 3% yield improvement on ground for us, which was consistent with first quarter.

Good strong improvement I think in this environment.

Deferred Air showed a little bit of improvement.

Next Day Air was slightly negative, but again over 2% of that was a fuel surcharge decrease year-over-year, and the rest of it was really due to the same mix exchanges we have been seeing with the Sabre product is growing faster than the AM product.

So I feel very good about the pricing of the Domestic Package market.

Okay.

And then the second one is you mentioned in the Teamsters negotiation a little bit, do you have the same degree of confidence that you did before that you will get this gone by year-end '07, or is that more aggressive or less likely?

Is pension still really the key focus of the negotiations?

Well, pension is clearly the complex issue we are (technical difficulty)-- I think in the negotiations.

But I would say that we are extremely confident that we can still get this thing done this year.

I think if you ask the Teamsters and ask UPS, we're both working very hard on getting the contract done in 2007.

Ken Hoexter, Merrill Lynch.

Can you talk a bit about on Overnite, how I guess some of the technology that you are rolling out or what is really enabling that phenomenal growth that you are seeing in this environment that you noted was pretty rough?

Well, I think it's a variety of things.

It is really the investments we made in the last year and a half that are panning out.

Pretty much what we told you back in November, just that you had to see it, and I think you're seeing it in the first six months of this year.

Clearly the service and quality has improved dramatically I think since the acquisition.

A lot of effort by the UPS freight people.

Technology we have done a lot of improvements.

Our drivers now have a DIAD gives you the real-time tracking.

We think we have as good a visibility tools of anybody in the industry, and we've got a lot more to offer as we move forward.

And then on top of that, I think we talked about back in November the ability to cross-sell of our salespeople to sell both small package and LTL to that same 1.8 million customer base, and you are seeing the results of that at this point in time.

Yesterday there was a sizable announcement about reducing fuel surcharges by 25%.

Is that an impact you need to react to within that division?

I think the LTL market for the last year has been a competitive marketplace, and certainly the first six months of this year I think has been competitive.

You have seen some of the competitors show decreased yields and improving their volume.

I think we feel very confident that we are just in early stages of growing this market in a kind of unique position again where we have the 1.8 million customer base that we're really bringing the new service to it.

So I think we feel very good about it.

You have also got to mix surcharge changes with tariff rates too.

Not all the same competitors have the same tariff rates out there.

So you have to -- there's more to it than just surcharge rate changes.

Great performance on that side.

One last question on the ground side.

Are customers as you look into peak shipping season, are you starting to feel that you are seeing anything they gives you a hint of a pickup in the back half of the year as people look toward the peak season?

Well, I think speaking for UPS and the Domestic Package business we do see improvements as the year goes on.

I think part of this comparison is with the year ago.

If you remember, last year we grew from 7% first quarter to 5% second, a little over 3 in the third and a little under 3 in the fourth.

So comps alone will help UPS start to show better package growth as the year goes on.

We also think that manufacturing IP, everything says that it should start picking up in the fourth quarter which could help.

We're really just getting to the stage now where we're starting to talk to customers about their peak expectations.

It is a little bit early for that.

Ed Wolfe, Bear Stearns.

A couple of things.

Obviously you're doing a great job on turning around the supply chain side of things.

Can you talk a little bit more about if I look at the last three quarters of operating income going from minus 1 to 54 to 98, what has really been the, if you had to say two or three major drivers of that?

Is it LTL?

Is it forwarding an order, and is it on the cost side?

Is it they had count reductions?

Can you just talk about just within that what has been the driver from a product standpoint and from a cost versus revenue standpoint?

Clearly the freight forwarding and logistics have driven the improvement over the last three quarters.

We have shown a lot of improvement I think with the cost-cutting.

We have got cost reductions we made late last year.

Revenue management I think has been very effective where we are winning the right business as we go forward.

So I think we are seeing a lot of improvement.

On the LTL slide, we still have through the first half of the year negative year-over-year comparisons on operating income.

That is going to change in the second half of the year.

The market slowed down in the second half of last year.

We made a lot of investments.

So we are optimistic you're going to see improvements in the second half of the year look better than the first half of year as LTL kicks in.

Your guidance at 3% margin though would imply that things actually get worse in SCS.

Am I missing something there?

No, it is conservative guidance.

Second as a second question, you talked about GDP estimates at 2% and you guys are flat.

If I look at your largest competitor, they were up 8%.

So if you look at the total market, it seems to be growing 2%.

Is it possible you're losing share?

Just you've got so much of the market it is hard to maintain that share, and maybe you're looking at an uptick in the economy and looking in the wrong place?

I think that, first of all, all the information is not in in the second quarter, but we were kind of in the same position in the first quarter when we talked to you about it.

We thought we held market share.

And when all the information came in we, did.

So as one competitor won a lot of volume and another competitor lost a lot of volume in the first quarter, and actually the overall market was down 2 or 3/10 of 1% in the first quarter.

Revenue we see in the second quarter, we think it is somewhat the same situation.

We think the market is basically flat.

We think one competitor won some business.

We think another competitor probably eroded some business in the quarter.

Again, all the information is not in yet.

Jon Langenfeld, Robert W.

Baird.

Scott, on the ground volume side you had talked about, I was thinking that that was going to start to be positive in this quarter.

Was the delta just the economy being a bit weaker?

Yes, I think we did say in the first quarter we thought Q1 was going to be the low point for the domestic small package market.

I guess what I would say is we're probably a month or two off on that.

We did see improvement in the month of June, so June was the strongest month of the second quarter.

The first three weeks of July have also been positive.

So we do see -- starting to see some gradual improvement into the second quarter, into the third.

So I think that what we said maybe a month or two early on the low point but I'm still pretty confident that it is getting better.

As far as the economy, the headline for GDP which probably comes out Friday I think people were expecting a quarter-over-quarter improvement of maybe 3%.

But what is more important to us is year-over-year, the GDP changes, and frankly the second quarter is probably not going to be much different than the first quarter.

The first quarter grew 1.9% year-over-year GDP.

The second quarter is expected to be about 2%.

And on top of that, the manufacturing or the IP numbers were about 1.6% in the second quarter.

So again, the economy really did not improve year-over-year much from the first quarter.

Can you comment on the US export side what volumes are doing there and what you are seeing?

I'm assuming they have all done pretty well.

Yes, they are doing okay.

Certainly they are not the levels that we're seeing out of Asia and out of Europe, again 25% out of Asia and 11% out of Europe.

Mid single digits out of the US, which is pretty similar to what we saw in the first quarter.

So again we like to see more US export obviously, but mid single digits for the second quarter.

William Greene, Morgan Stanley.

I just have a quick question more on the balance sheet.

I know you said the Aaa rating is not sacred, but how far would you be willing to let that fall?

Obviously not below investment grade.

But one, two notches or whatever, how do you think about that?

Well, I guess the world has changed as far as what investors I guess place value on credit ratings.

Where 10 years ago a Aaa rating was important to investors, today it is not as important.

We realize that.

We also realize that the cost of debt through the A and Aaa is not all that much different, and the access to that is not a heck of a lot different.

So as a company we're willing to certainly add leverage to the balance sheet.

We're not going to say what debt rating likely will run the Company on a financial metric basis going forward.

Something like funds from operations to debt, that type of an approach.

And when we determine that metric, we will communicate that to the market.

Okay.

And then you mentioned B2C volumes were weak.

What did they grow at or fall at in the quarter?

You know they are weak relative to what we have seen in the last several years.

They are growing at about half the rate we have seen in the last several years.

Still growing faster than the economy, but not -- certainly not the rate we saw in prior years.

We were upper single digits the last couple of years, and we're about half of that.

Okay.

So then that would suggest then I guess the B2B is actually down year-over-year?

It would be down slightly.

And a lot of that is tied to the manufacturing side.

Scott Flower, Banc of America Securities.

I was just wondering -- and I know that there are lots of moving parts and pieces and it is complicated because things are evolving -- but even industrial (inaudible) somewhat instead of being flat versus that presupposes a different relationship between some of the macro variables.

And I'm just wondering are there any signs that some of the drivers that are still there just are either hitting a [wall] of numbers or just showing some maturation in relative growth rates.

I'm just wondering when you look at the market prospectively, is it US small package market just showing some of the trends maturing such as -- not mature but some of the growth drivers you are just not going to kick in quite as strongly?

No, I mean long-term, Scott, I'm extremely confident that small package market will outperform the US economy.

All the trends we've continually talked about, the macrotrends, are still here.

You know, the online purchasing, the direct to consumer models, the just in time, they are not going away.

So I have no doubts that we will see the market getting back.

I think right now we are just kind of tied up in manufacturing IP and the B2C sales, (inaudible) much less space than we saw a year ago as just combining the (technical difficulty)-- because of the aberration, if you will, that is in the package market.

We feel very confident that probably by late this year you will see us getting back to (technical difficulty)--

Okay.

And then the other question, I know that you mentioned this was the fact that your Analyst Day, it seems like a lifetime ago in November, but about some of the shared services opportunity on costs and some process changes and some more sort of, if you will, ways to take structural cost out, which obviously it was not going to happen over night, but I'm just trying to get a sense of what you might be able to share with us in terms of either plans or progress on that front?

I think that the shared services exercise is a long-term exercise.

We are seeing great improvement.

You can see that in our nonoperating expense we reported for the quarter.

You have seen (technical difficulty)-- there.

But this is a process that is going to be a several year process that I think each year you will see a little bit more benefit out of that.

(technical difficulty)-- a lot of operating initiatives.

We're also working on the container issue we talked about.

(technical difficulty)-- trailers (technical difficulty)-- containers on the rail is helping us right now.

Using more rail in the LTL (technical difficulty)-- helping us.

We will stay vigilant on that, but the shared services is something you're going to see some in '07, more in '08, more in '09, Scott.

John Larkin, Stifel Nicolaus.

I had a question regarding exports out of Asia.

Are you seeing kind of a softening in the traffic bound for the US and strength is really coming from traffic bound for Europe at the present time?

No, I think we're seeing pretty strong growth still on the package side as evidenced by the 25% export volume.

It is strong to Europe and out of Asia strong to the US.

I think the only area that there has been some weakness is really the heavy freight.

I think that we have seen for the first six months some weakness out of Asia on heavy freight.

And then with respect to your solid pricing on the ground, which I guess is about a 3% or so, how much of that would you attribute to some of the pricing initiatives you put into effect at the beginning of the year such as dimensional weight pricing and some of the [asesorials] changes versus what I would call just a core pricing increase?

I think it is a normal rate increase for us.

I think there's always a little bit of [asesorials] in it.

I don't know that it is dramatically more than it has been in the past.

I think this is sort of a typical year and you are seeing the typical yield returns that you have seen in the last 10 or 15 years for UPS.

So no change even with the softness in demand?

Right.

And then the last question relates to the terrific growth that yove had in the LTL side of the business.

I think you said it was up 12% year-over-year in the quarter.

Weatherwise it was probably a down quarter for LTL volume.

At what point do you run up against capacity constraints in the network, and have you thought through the capital investments necessary to continue to support that growth within the UPS freight network?

We are evaluating that.

I think we still have capacity.

Obviously throughout the nation you will have areas where you are tight on capacity, but some will evaluate.

We don't think it is going to have -- for the near-term have a dramatic impact on the CapEx spend out of UPS freight.

Certainly when it makes sense, we will make those investments.

I'm cautious not to get too much capacity in the marketplace.

Jason Seidl, Credit Suisse.

A quick question.

Scott, you talked a little bit about pricing domestically.

Can you talk about it internationally?

It looked like it ticked up a little bit for the first quarter.

Yes, I think it is as it should be.

It should be a rational market when you have as much demand out there, and it really limited global competitors, if you will, as far as having the global networks that are required.

So I think we're seeing good improvements.

Generally when you've seen what looked like weakness in international products and it was clearly a mix issue where our transborder, European transborder products have grown faster than maybe the transatlantic, transpacific business.

But I think generally overall it is quite a rational market.

I think we will get paid, have good value proposition and feel good about the state of that market.

Okay.

My follow-up question, you mentioned for UPS freight gains you mentioned improved service levels, improved technology that you brought to the old overnight and also cross-selling among your salesforce.

Now if you had to put it in buckets, is it evenly divided for the improvement, or is one stronger than the other?

Absolutely I think the quality and the reliability was critical, but we're seeing a lot of our customers using our Quantum View products now, the visibility products, so there is a big demand for the technology I think we're bringing to the table.

And that is only going to get better.

We're going to continue to invest and I think raise the bar in technology for LTL.

So you think it is more of a kind of service of technology and then cross-selling maybe 60% service in technology and 40 cross-sell?

Yes, it is that but then having the built-in customer base helps an awful lot too.

Okay.

To sum up, to echo Mike and Scott's remarks, we're very pleased with the consistently strong performance of our international operations and encouraged by the momentum in our Supply Chain and Freight business.

We will meet the challenges of the slow US market head-on with continued focus on execution by managing costs well and maintaining price discipline.

We expect US small package market to get back to long-term trends toward the end of the year, offering improved growth opportunities for UPS.

Thank you for joining us today.

Thank you.

This concludes today's UPS Investor Relations second-quarter 2007 earnings conference call.

You may now disconnect.