聯合包裹運送服務公司 (UPS) 2008 Q2 法說會逐字稿

Good morning.

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

We apologize for the technical difficulties.

At this time I would like to welcome everyone to the UPS investor relations second quarter 2008 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer period.

Please note we will take one question and one follow-up question from each participant.

Thank you.

It is now my pleasure to turn the floor over to your host Mr.

Andy Dolny, Vice President of Investor Relations.

Sir, the floor is yours.

Good morning, everybody, and thanks for joining us today.

Scott Davis, our CEO, and Kurt Kuehn, our CFO, are ready to provide insight into the Company's second-quarter results and our expectations going forward.

Before I turn the program over to them however, I want to 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 operations of the Company.

These anticipated results are subject to risks and uncertainties which are described in detail in our 2007 Form 10-K and first-quarter 2008 10-Q reports.

These reports are available on the UPS investor relations website or from the Securities and Exchange Commission.

This conference call is being webcast and will be available on our investor relations website for a few weeks.

In his remarks, Kurt will refer to UPS' cash flow which is a non-GAAP financial measure.

Reconciliation is included with the news announcement this morning and is available on the UPS IR website.

Now I'll turn the program over to Scott.

Good morning.

It's obvious to everyone in the business world that economic conditions in the US continue to slow.

Economists hold a bleaker outlook for the second half of this year than was the case even three months ago.

Soaring fuel prices, falling housing starts, increased unemployment, weaker consumer confidence -- all of this paints a picture of a faltering economy.

While GDP and industrial production may bottom out in the second half of this year, recovery is expected to be a slow, drawn out process.

Predictions are that it will be 2009 before improvement in the economy becomes apparent.

Deteriorating economic conditions and high fuel prices had a significant negative impact on our package business.

Volumes in our premium products declined at a greater pace than in the first quarter and our costs increased.

We're feeling the impact of higher energy costs throughout the Company, not just at the fuel pump.

This includes such items as purchased transportation and increased utility expense.

I assure you that we are pursuing a range of initiatives to address today's marketplace challenges and trends; some of these will have short-term benefits, others will take longer.

Kurt will provide details shortly.

Despite the difficult economic environment, UPS' focus is on long-term growth opportunities.

Our investment to develop supply chain and management capabilities, which is now paying dividends, is a good case in point.

Going forward the proposed contract with DHL is another such opportunity.

As a reminder, we're developing a 10-year agreement with DHL to provide airlift for their express, deferred, and international volume within the US and between the US, Canada and Mexico.

Both sides are working diligently and making good progress towards concluding this agreement.

This illustrates how UPS is looking outside the box to develop growth strategies that we might not have considered in the past.

Another great opportunity is China where we are the in-country sponsor of the upcoming Olympic Games in Beijing.

Starting three years ago UPS began working with the Beijing organizing committee to develop and manage the logistics for the games.

We're serving three Olympic villages, managing 35 game venues and four distribution centers, moving everything from kayaks to shot puts.

During peak operation UPS will have 2,000 people and 138 vehicles on site.

This is a complex undertaking that demonstrates our broad worldwide capabilities.

Our goal is to be the leading global package delivery, freight and logistics company in China.

This sponsorship is an important step in strengthening our brand presence in this key market.

Despite economic pressures our service levels are at all time highs and I am proud of the effort and dedication of the UPSers I see every day.

Often in our history we have dealt with challenging economic issues.

For example, in the 1930s UPS expanded its service area from the West Coast to the East at the height of economic turmoil.

And in the 70s we started to develop our international business in spite of the oil crisis.

In many ways tough economic times have provided a launching pad for innovation that led to years of growth.

Despite the current challenges we intend to do the same thing today, adapt our business to meet current conditions and position our company for long-term growth and success.

Remember, although these downturns in the economy are painful, the strongest companies, like UPS, will come out in the best competitive position.

Now I'll turn the program over to Kurt for comments on the second-quarter results and on our outlook for the rest of the year.

Thanks, Scott, and good morning, everyone.

As we look at the second quarter three major trends affected our global package business -- escalating fuel prices, volume declines and a sharper reduction in the use of premium products, the last two being related to economic conditions.

Fuel had a significant impact in the quarter, increasing $470 million or 67% over last year.

Fuel price increases had ramifications beyond just the direct cost; they caused our indirect expenses to accelerate, items such as purchased transportation, utilities and the cost for outside service providers around the world.

Crude prices increased from $100 a barrel in early April to $140 by the end of June.

This rapid increase during the quarter magnified the impact of our fuel surcharge lag.

As you know, there is a two-month delay in the application of fuel surcharges to capture this increased expense.

This factor alone accounted for over half of the profit decline in both the US domestic and international packages segments.

The 1.3% decline in total US domestic volume was a larger shortfall than we had expected.

All products posted declines, from 6% on Next Day Air products to a little less than 1% on Ground.

This is a good news/bad news story.

Due to the investments we've made in our broad product portfolio we have retained customers and kept them in the portfolio.

However, some of them shifted away from our premium products in an effort to control their own costs.

These trends pressured our operating results.

The international segment performed significantly below our expectations because of volume, mix and fuel price issues that I just discussed, and slowing economic conditions.

Also export volume and revenue growth were robust, it should be noted that the 10% export growth was aided by the timing of Easter.

Without this benefit export volume would have increased around 8%, this is market-leading growth.

Import volume into the US from every region of the world declined however, but strong intraregional activity continued outside the US.

The second quarter saw a rapidly changing business environment with export volumes posting slower growth with each successive month of the quarter.

The decline in the operating margin in this segment reflects those trends, although at almost 14% it remains the highest in the industry.

Costs in our international business are more fixed than in our domestic model making it difficult to respond quickly to changing conditions.

But we are executing initiatives to enhance profits in this business and expect to see benefits over the next few quarters.

If trade flows continue to change we will adjust our network to ensure that it is properly aligned with volume and revenue growth patterns.

While adapting to the current environment we are still investing to expand our global presence.

During the quarter we completed the network integration on Tamworth, our largest ground hub outside the United States.

This will greatly improve efficiency in that region.

We also assumed full control of our joint venture operation in Korea, announced plans to move our intra-Asia air hub to Shenzhen from the Philippines to reduce transit times, and began flying five weekly flights between Nagoya, Japan and Shanghai to enhance customer service in Asia.

Most of the headwinds in our package business stem from economic slowdown and skyrocketing fuel prices.

As Scott mentioned, we have established short-, medium- and long-term initiatives to identify actions and fundamental changes we can take to address the impacts of current economic realities.

Our short-term plans are focused on reducing costs for the rest of this year and next while still supporting growth initiatives.

For example we've eliminated hiring in non-sales positions, cut back on relocations and reduced travel among other things.

We're also focused on operational efficiencies in addition to numerous fuel conservation activities.

In the medium-term focus is on increasing revenue while refining our operating model to adapt to today's business climate.

This includes a range of initiatives such as -- first, developing new revenue growth activities and a focus on revenue management; Second, ensuring our global network is appropriately aligned with changing customer demand; and third, leveraging technology to both increase revenue and improve our efficiency.

These kinds of initiatives will take effect in the near future and throughout 2009.

Longer-term planning broadly addresses the structure of our network and fuel prices continue their dramatic escalation.

We're looking at three fundamental questions -- how will our customers and their business models change; how do we leverage our global integrated network to best serve our customers and their changing trade patterns; and what new growth opportunities exist?

This is a comprehensive scenario planning effort, as such it entails a longer-term view of our company and our industry from various what if perspectives.

And it will take some time before conclusions are reached.

However, I want you to know that we are always actively managing the business to control our destiny and continue to lead the industry.

Now turning to supply chain and freight, this segment again exceeded our expectations.

Revenue increased almost 11% with profits of over 50% led by forwarding and logistics.

The airfreight relaunch introduced in January has attracted new customers and many existing customers have also increased their use of our expanded range of freight services.

The logistics unit maintained its focus on profitable revenue growth and it has developed superior capabilities in healthcare and high tech and has new facilities coming online in Puerto Rico, the Netherlands and Canada.

In the freight business LTL revenue was up over 7% as strong yields continue to reflect the value of our service offering.

Shipments declined 2.3%, although results strengthened month over month throughout the quarter.

In addition, all productivity measures improved and technology, specifically WorldShip and Quantum View, is driving new customer wins and increasing repeat business.

During the quarter UPS Freight expanded its reliability guarantee to shipments moving in and out of Canada, an extension of the guarantee put in place for US shipments in January.

It's a clear signal to our customers of the confidence we have in the improvements made at UPS Freight.

The Freight unit also enhanced time in transit on nearly 1,000 lanes.

No quarterly update would be complete without touching on the Company's financial position.

For the first six months of 2008 UPS generated approximately $5 billion in cash from operations, invested almost $1.4 billion in capital expenditures and paid dividends of over $1.3 billion.

We also spent $2.4 billion to repurchase almost 35 million UPS shares.

The Company remains on pace with our repurchase program and has over $7.5 billion remaining of the $10 billion repurchase authorization.

Even with this financial activity we ended the first half of the year with $1.7 billion in cash and short-term investments.

Through the end of the second quarter free cash flow approached $3.4 billion; this includes approximately $1 billion in federal cash tax benefit related to the Company's withdrawal from the Central States Pension Plan.

Our CapEx budget at $3 billion for 2008 will be below 6% of our revenues.

This is towards the low end of our historical range.

We'll continue to look for opportunities to cut or defer investment if we can, but we'll continue to invest for growth.

The Worldport expansion, the Tamworth hub in England and expansion plans in Asia are only some of the investments under way to meet anticipated needs down the road.

Now let's look to the future, and I'll address my remarks to the second half of 2008 in its entirety.

Three months ago we told you that we anticipated the domestic market would be flat to down 1% and that our volume would track market behavior.

Current thinking is that the small package market will contract about 2% for the remainder of the year as will our US volumes and we'll see a continued decline in premium product.

On the positive side, in August we will begin operating under the economics of the new labor contract with its more moderate rate and hourly wage increases.

This obviously will have a greater effect in the fourth quarter.

Domestic operating margins will remain below last year; however, they should improve over the first half of '08.

The slow economic conditions that I mentioned earlier will cause our international segment to experience mid to high single-digit export volume growth with an operating margin in the mid teens for the year.

Remember the third quarter is generally lighter in Europe due to a slow August.

And we expect the supply chain and freight segment to continue to show profit improvements over last year with margins at or above 5%.

Given all of these factors, and assuming business conditions remain reasonably steady, we expect results in the second half of this year to improve modestly over the first half resulting in full-year earnings per share within a range of $3.50 to $3.70.

Comparisons to last year will be more difficult in the third quarter and moderate in the fourth.

In conclusion, I'd like to remind you that UPS is no stranger to economic adversity.

We have managed well through down cycles in the past and I'm confident that we will do so again.

Now Scott and I would be happy to answer your questions.

(OPERATOR INSTRUCTIONS).

Jon Langenfeld, Robert W.

Baird.

Good morning.

Can you just talk a little bit about the demand destruction -- a little bit more on the demand destruction on the domestic Express side?

First off, it looks like the surcharge is probably going to go from 24% in the second quarter to 34% in the third quarter; so I'm assuming there's more price elasticity you're going to bump up against here.

And then secondly, do you think historically, as customers have shifted away from Express, is that a permanent shift or do they typically -- is there some element that comes back with a better economy?

Jon, certainly that's been a topic that's had a lot of discussion lately.

First off, this behavior is a typical cyclical process and in slowdowns in the past we've seen that our Next Day Air products and most premium products are more economically sensitive.

Frankly, when the economy is hot there is more need to get goods urgently to their in destination.

So it's important to that in perspective, that there's a substantial amount of these current trends that are seasonal or cyclical.

On the other hand, clearly with fuel hitting unprecedented levels and the surcharges being high, there is increased pressure and customers are looking for ways to cut cost and so we are seeing some shifts in our products.

Our sense is that that's probably beginning to stabilize.

Clearly if fuel takes another run and we have a $40 increase over the span of the quarter like we did in Q2 it's very difficult to forecast.

But we expect overall our surcharges to be up on the year about 8% this quarter, not quite as dramatic as you quoted.

And our guidance clearly includes our outlook for continued declines in premium products.

John, we saw back in 2002 and 2003 that Express products were negative both years, came back in 2004 Next Day was 7% plus.

I'm not expecting 7% plus necessarily in the next year or two with the energy prices where they are, but (inaudible) that can't come back.

Okay, good color.

And then the follow-up question was on the international trends.

Did you see similar trends on the heavyweight freight side in your supply chain business as you commented on the parcel business?

A little bit, but not quite as dramatically I guess.

We have seen some recent numbers for May and June that suggest some slowing.

We had a good, solid quarter.

Clearly the freight coming into the US has been anemic.

On the small package side all regions of the world really were down as far as their shipments to the US and we did see some slowing on the freight side, but we've got a lot of new offerings.

The airfreight portfolio has been pretty well received and that may be helping to offset some of it.

And we continue to see strong growth in our Asia to Europe lanes although there's been some external discussions of that slowing.

Okay, thank you.

Tom Wadewitz, JPMorgan.

Good morning.

The first question on the competitive environment, can you give us a sense of whether the base rates have gotten more challenging -- base rate increases have gotten more challenging to achieve in light of how much fuel surcharge customers are paying and just whether the competitive dynamics have gotten a little bit worse or if they're still pretty stable?

Well, certainly with the surcharges in the air and as high as they are, the fuel surcharge has become a part of price negotiations in an increasing fashion.

So it is much more a part of those discussions than it was before.

And as a result it gets a little harder to isolate pure price taking versus real surcharge.

But in general the market is healthy, pricing is very rational.

Clearly this is a business where you've got to cover your costs and growth alone doesn't provide synergies if you're not getting value.

We are focused right now on making sure that we go through our customer base and that our rates and surcharges are appropriate.

In some cases there are caps on our fuel surcharge that seemed pretty benign back a year ago that now really don't fit the economics.

So we do have some initiatives underway to recalibrate some of those and make sure that we find an appropriate balance of price for customers.

Okay.

And then the follow-up question -- in terms of the margin performance, I know you highlighted fuel as being a pretty significant factor; I think you implied it was maybe $180 million in operating income impact is the number I came up with the way you characterized it.

And I'm wondering, do you think margins will -- year-over-year performance will be a lot better if we see fuel stabilize?

Or is it really much more about weakness in volumes and it's kind of hard to see margin trends improve at all without the volumes really changing?

Really this whole fuel phenomenon you really have to separate into two buckets, Tom.

One is the absolute level of fuel and the other is the rate of change.

In the second quarter the most notable difference was this rapid increase from crude of $100 to $140 by the end of the quarter, that's just unprecedented and that was the major impact that caused half of our operating profit declines in the package business.

So the rapid increase is a short-term issue that as fuel prices stabilize we'll see staying a head wind, and then if fuel prices drop significantly we'll have a tail wind and finally recover the substantial amounts that we've had shortfalls on as fuel has been on a run.

The second issue is the absolute high level of fuel and that is one that will impact customer demand, certainly it's driving cost both in our fuel line and, as I mentioned, a lot of other line items.

And there the issue is, A, our ability to recover that cost and, B, the impact of those fuel prices on the economy.

So the short-term issue, yes, things would stabilize, we would have less drag on our earnings as fuel stabilizes, although it would sure be nice to see a little decline in that net cost to get some real boost on the margins.

Okay, thank you for the time.

Edward Wolfe, Wolfe Research.

Let's assume that the overnight doesn't come back, not because of the economy but because of fuel, and so growth starts to be another less high yielding product set on a secular basis.

What can you do in your network and at what point could you improve domestic margins do you think given that context that the rest of the business is going to grow and the overnight air is on a secular decline?

And then maybe as a follow up, just what the DHL contract -- could you give an update and how that might play into the whole thing?

We've been looking for months and months, doing some scenario planning on what happens if oil is at $150, what happens if oil is at $200 a barrel.

How does that change the business, not only domestic air but international?

If we see prolonged very high oil you may see trade lanes change, you may see more near sourcing in the future, people building the goods closer to the end consumer.

So we certainly tend to look at a lot of scenario planning from that standpoint.

There will be some challenges, obviously some of the distances shipped may be shortened as we go forward, but there's going to be some opportunities out there.

We think that there's a -- I've talked a lot of CEOs who have company-owned fleets and have courier services that frankly are going to have a lot of trouble at these energy levels.

So we see new markets that we really don't participate in today, hopefully now with the efficiency of the UPS network we'll see an awful lot of revenue opportunities.

And again, that it's all about utilizing our network more efficiently which should help margins in the future.

So I think there are some challenges for us, but there are also some great opportunities as we move ahead.

But I'm not talking about the revenue side.

If you look at the cost side can you get the cost to a position where the network can work with a secular decline in air if other areas are growing (multiple speakers) DHL?

I'll guess I'll answer that with the DHL question.

Clearly as we look ahead there is some risk to the domestic express market as we look at the next four or five years.

We don't know if it's going to grow, be neutral but clearly we lessened our risk with the DHL line-haul contract.

It's something that we're not having completed the contract yet, the teams are working, making an awful lot of progress.

We think that's going to -- the additional volume of that will clearly make for more efficiency, better asset utilization of our air network -- not just airplanes but also the hubs for sorting purposes.

So that's one major step I think in the better utilization of our network and obviously helping the margins as we move forward.

What's the timing of when you'll know with that contract?

We said we'd have it done before the end of the year, we would like to get it done as soon as possible and hopefully get some volume in the network late in 2008.

And the goal is to have it fully implemented by the middle, latter part of 2009.

Is that a push back from what you said earlier?

No, same dates.

I think the teams are making great progress.

I think we said all along that we'd hoped we'd have the contract done in 2008.

The teams are working very hard to get it done as soon as possible.

Okay, thanks for the time.

William Green, Morgan Stanley.

Just to ask about the way you could maybe address some of these network changes as the freight flows change.

Would you ever reconsider now maybe upping the DIM weight on the ground from what you've currently got?

Upping the DIM weight meaning taking larger packages?

Meaning changing the -- basically making it as you charge for air, where it's all DIM weight as opposed to actual weight?

Certainly we look at all options, Bill, but on the ground the cubic size is not as big a driver of total cost of the product as it is in air.

So what our current DIM weight we really look for the outsized packages that are over 3 cubic feet, and those are the ones that we make sure we're charging appropriately.

So it's not something at this present time that we're evaluating, but we'll continue to look at revenue management opportunities and clearly our basic strategy and our pricing is to make sure that we price appropriately to reflect cost, so that's always an option.

Okay.

And then as you look at the changes that fuel is forcing on your customers, where is the weakness most pronounced?

Is it B2B that you're seeing it, can you parse it out from the economy, where's the big change?

I think proportionately it's similar in both segments.

B2C continues to have better performance than does B2B.

But it is sequentially, over the last three, four quarters it has seen actually a greater slowing than the commercial side.

So the consumer clearly is in question right now and we are watching those trends very carefully, both for our big retail companies that we're delivering to and then the end consumer business.

This was Curt.

Long-term I think that if you think about B2C, it really is much more efficient to have a UPS delivering a package to your house than it is for you to go to the mall and buy the package.

So I think that even high energy prices will probably drive B2C business over the long term and benefit the consumer.

Just lastly, what's your average domestic parcel length per haul?

Length of haul -- I don't believe we disclose that distance.

All right, thanks for your help.

Ken Hoexter, Merrill Lynch.

Good morning.

You talked about changes -- or I guess the high fixed structure of the international.

What kind of changes to that network do you envision that you can make to maybe make it more variable in nature?

Ken, clearly that's an area of very high focus for us.

We saw fairly substantial changes over the course of the quarter and, as you know, we've had an incredible run over the last five, six years on the international side.

But we did see some slowing from April to May to June, frankly, that caught us a little off guard.

One of the core issues around international is the big worldwide services where we have the major fights going across the oceans -- that is a more fixed cost unless we choose to take a substantial step down in capacity.

Frankly, if flows between the continents continue to slow then we will be looking very critically at perhaps reducing temporarily some selected flights between the continents.

And that assessment is underway right now looking at how we can take some cost out.

We continue to see though, very strong growth intraregion and both Asia and Europe showed high single-digit to low double-digit shipments within the regions.

And so in the short term we are seeing some of that regional trade flourish even as the worldwide trade is slowing.

So some of these things are recalibrating our network, some is perhaps taking out capacity.

Also in the international we don't have quite the same variable structure as we do in the US on the ground.

Labor laws and the nature of our employee contracts are different by country.

And some we actually pay monthly salaries to our employees rather than the typical hourly rates that we use in the US where we can adjust on a daily basis.

It's a large business with very many different moving parts, but we're on high alert right now and all of the regions are looking at local plans and global plans for how to stay ahead of the curve.

And then you made another comment earlier, Kurt.

You said that -- it actually was also in the release -- that you're going to see an improvement in the second half of results and obviously your targets indicate that with your second half EPS targets.

I'm just wondering, is that kind of just mostly on the fuel catch up on the surcharge?

And if so, what does the -- you keep highlighting the move from 100 to 140, what does the move back down to 130 -- is that significant at all in helping with that catch up and to that maybe you can further enhance your second half target?

There are some company specific issues, Ken, that we have been talking about and we're confident will begin able to provide us a little more of a tail wind starting in the second quarter.

Certainly the new labor agreement we have with the Teamsters is one that we feel will be favorable to us basically in any economic climates.

The inflation of wages will moderate substantially, the increases are split into two tranches, one each six months so our effective increase in August will be substantially less than it was in the previous year.

We have some more favorable language regarding eligibility for healthcare for our part-timers, still giving the best benefits in the industry for those part-timers that stay with us a year or more, but not necessarily giving eligibility after 60 days or 90 days.

So there are a number of specific issues there.

Also certainly the assumption we have is that fuel will stabilize I guess -- we're not counting on a precipitous decline, so at least that big head wind that frankly put us on our heels a bit in the second quarter will moderate.

And then we've got a lot of initiatives on the international to make sure we're reacting appropriately.

And then last but certainly not least, we're seeing great results in the supply chain and freight unit.

The LTL environment does seem to be stabilizing a bit and clearly UPS Freight should be able to benefit from that.

This outlook is really based on crude oil right around $140 a barrel.

So if it goes up that hurts us, if it goes down it helps us some.

Great.

Thanks so much for the time.

Justin Yagerman, Wachovia Cap.

Good morning, gentlemen.

I guess my first question is related to the international side.

I was curious -- you guys mentioned that you saw strength intraregionally, international -- intraregionally rather, international.

I was curious if you could quantify around whether or not you thought that was more market share growth and company specific driven.

Because we've begun to hear reports that Western Europe has slowed a little bit from some of the heavier industrial companies that have reported.

And then on the export growth side, you had mentioned in the release that you saw slowing throughout the quarter and I wanted to get some color on that, maybe you could detail the growth month by month in the second quarter?

First off, I guess, Justin, on the market share gain, we've been gaining market share in this international segment for 10 years now.

We're pretty confident we continue to have a superior business model with the integrated network and broad range of offerings in every geography.

But we did see some of those trends that you've seen externally.

And there was a significant slowing from April to May to June -- really with June being the weaker in most of the regions.

And so certainly Europe was a part of that.

Europe had a strong April, but partially because of the Easter distortion.

But we have seen some slowing.

The nice thing about our portfolio though is that we are continuing to see this regional trade pattern in Europe moving forward.

And as fuel prices get high our sense is that European companies are looking to Eastern Europe rather than the Far East perhaps a little more and so that helped offset things.

(multiple speakers) And I noticed in the freight division that the weight per shipment at LTL was down.

Many of your competitors in their early kind of notes on the quarter have mentioned that they're seeing an opposite trend.

And I was curious what you'd attribute the lower weight per shipment to.

Is that increased leveraging across the small packaging network and the freight networks as you get more -- as the labor is more organized within the freight division?

How are you guys viewing that trend within your freight business?

I wouldn't put too sharp a point on it, it's 5 pounds for a 1,000 pound average shipment.

No, I think the good news is that the weight per shipment has stabilized and that's a good sign economically.

And clearly our value proposition is working well and we're continuing to target medium size shippers and large shippers also.

But I think the weight stabilizing is good news and the other companies are validating that also.

What we are seeing great results on though is our continued success in our yield management and our revenue per hundredweight.

So that's more of a priority for us than focusing solely on the weight per shipment.

All right.

Thanks so much.

Gary Chase, Lehman Brothers.

Good morning, this is actually Brandon Oglenski.

Not to belabor the point on international, but you guys had mentioned that you're looking at intraregional growth as continuing, but global lanes are slowing a little bit more than anticipated.

How should we think about the profitability impact of this going forward?

Certainly both flows have good margins, but from an economic perspective at least in the short term the world wide flows have a much higher proportion of fixed cost.

Volume was negative coming into the US from all regions.

But frankly, we were able to take down any of those big jets coming in from those regions.

So in the short term, this shift is a headwind for us, because there is less variable cost in those worldwide products.

On the flip side, on the regional -- intraregional, we do have more options.

It is more variable, and so it behaves more like a typical US shipment would where we can adjust pretty well and adapt.

So it is the process of adaptation to these things, and as those trends continue it will mean we will have less lift going across oceans and more lift moving across the continent.

And that is some of the long-term issues that Scott spoke to.

We will end up the year with still midteen margins international, which is obviously the best of any of the competitors.

They're not as high as we would like them to be, but that is certainly solid margins.

Okay.

If you do decide to take down some of global and intercontinental capacity, is that going to place further pressure on the domestic network, because I'm sure that some of the export products are actually moving through the US networks.

So does that place a little bit more pressure on the flexibility of the domestic network?

We are going to put up lift for any packages that want to come into the US or anywhere else, so we will match capacity to demand.

We are not going to truncate demand with capacity reductions.

What you end up doing if you took planes down internationally, you'd probably move those to the US and then retire older classic aircraft in that situation.

Okay, thanks a lot, gentlemen.

Robin Byde, HSBC.

Good morning, everybody.

Just a few questions if that is okay.

On the European business, now that (technical difficulty) priorities expanding the European network.

And just on acquisition strategy, (technical difficulty) is consolidation in the sector.

So can you just update us on UPS' strategy on acquisitions?

Thank you.

Our strategy in acquisitions has not changed, I think, from what we've talked about in the last couple of years.

What I have said in the past is clearly we're not going to do anything domestically in the package business.

But Supply Chain and Freight, we said we wanted to have a couple of years of good execution and improving margins.

We're seeing that, we're seeing some good progress there.

The one area that we'd be most interested in still is the international package areas that makes sense, that's been the case for the last several years.

Certainly Asia and Europe are areas that we're interested in, particularly Central and Eastern Europe.

Thank you.

And just on Europe?

Robin, your first question wasn't really clear, the connection wasn't really clear.

Could you repeat it?

Yes, sure.

I was just asking you now that the Tamworth hub is fully integrated what are your next priorities in expanding the European network, I guess, from what you're saying or expansion in Eastern Europe?

Sorry, I didn't pick up the Tamworth.

Yes, the Tamworth is a very large ground hub that allows us to complete the operational integration of the acquisition we did at length several years ago.

And it was a big step and actually created somewhat of an operational challenge for us in the second half.

But we now have the ability to have one interlined operation, we've aligned the customer portfolio and so that really is the capstone on our UK acquisition.

And we'll be harvesting the benefits of that going forward.

We're continuing to benefit from the acquisition we did in Poland, that's been a great one for us and strengthens our position.

And clearly we would like to continue to strengthen the Central and Eastern Europe theaters, certainly because of their increased focus on regional trade.

So that's an area that we are investing in.

And we will certainly continue to do organic expansions with capacity.

We expanded our Cologne airport just a year ago and we'll keep looking for organic opportunities and certainly selective operations for acquisitions are not off the table either.

So a combined strategy of both organic growth, which has served us well in Europe, and then keeping our eyes open for opportunities.

Great, thank you.

John Larkin, Stifel Nicolaus.

Good morning, gentlemen.

I just had a question on the two-month delay in the fuel surcharge, is there any kind of structural impediment that prevents you from tightening that down a little bit so that you're doing a better job of matching the surcharge with the actual underlying fuel price?

And as a corollary to that, is there any kind of a delayed effect here because the big fuel prices really aren't probably kicking in until right about now?

Are you fearful that there could be an acceleration of a trade down from premium products here during the months of say July and August?

I think where we set this index, I think we want to be fair to our customers, give them advanced notice of what the rates would be.

We're going through an unusual phenomenon right now where oil has gone in one direction, it will not go up forever and when it comes down it will get equalized.

So I think the right thing to do for our customers is to give them that 45-day notice of what the surcharges will be.

And we continue to do some limited hedging activity, but frankly not within the bounds of the kind of moves we've seen to minimize the volatility.

Then just maybe one follow on here regarding the international business.

Have you seen much of a trade down from air to ocean?

And if so, have you been able to capture some of the ocean movements through your forwarding operation?

And if so, can you give us a sense for the relative profitability of that business?

Well, we've not seen a huge shift.

Clearly we're working with a lot of customers as we evaluate Supply Chains, and Scott referenced that too.

But actually ocean seems to be struggling perhaps more.

I know the recent data showed a 6% decline in ocean, that's not company specific but some external all numbers in the US.

So I think all modes right now are struggling.

And really the big message is the US engine that drives a substantial amount of imports into the US is slowing right now, so all of the theaters are seeing some sequential headwinds.

I think we would have expected more ocean freight growth with the fuel prices, but with the market data you're not seeing it, you're seeing negative -- certainly June market data showed negative growth.

Within our Airfreight portfolio we are seeing more rapid growth in the deferred and forwarding products as compared to the Express Freight.

So that easy choice we're giving customers to move from the guaranteed Express service down to deferred forwarding, we are seeing that flex back and forth.

It's just another example of our keep it in the portfolio strategy that we've been building towards.

Thank you, that's great color.

David Campbell, Thompson Davis.

Good morning, everyone.

Some of your competitors have mentioned an improving price control, improving revenue trends in June in the less than truckload and trucking business, that is the capacity to improve pricing better than in previous months.

Did you see the same thing and what does that tell you, if anything, about the economic growth?

I think we really have not seen the headwinds on pricing, David.

That's been one of the real positives with our new value proposition, with the guarantee we launched in January, with the deep integration into our WorldShip application for generating freight shipments.

Yield has not been a challenge for us.

We feel pretty comfortable with our yields.

What we have seen though, I guess to support the market anecdotes, is a firming of demand and also a stabilizing of weight per shipment which are both good leading indicators we think.

Looking at the economy we think that the second-quarter GDP is probably going to be the best GDP of the year helped obviously by the rebate checks.

I think that number will be a bigger number than most people expect.

But as you move ahead throughout the year we're not the leading indicators but certainly what you read and what you see we expect probably slightly, slightly positive growth in the economy but still anemic.

Really that -- probably an important barometer we follow is manufacturing IP, manufacturing IP was negative in the first half of the year, slightly negative and expected to be slightly negative for the year.

So it's not going to get a lot -- it's worse but (inaudible) a lot better for the rest of this year.

And the decrease in export yields in the second quarter after increasing in the first quarter, can you explain that, please?

Export yields have been fairly steady, both on a pre-currency and a post currency basis.

We've seen steady domestic increases and the overall export yields have been flat, slightly negative.

And then primarily a mix issue that we've talked about for a number of quarters with the transporter services growing faster than the worldwide services.

So trends are fairly stable there.

Okay, thank you very much.

Art Hatfield, Morgan Keegan.

Good morning, gentlemen.

Most of my questions have been answered, but Scott and Kurt, you've alluded to the fact that if things don't change and if say fuel is at these higher levels permanently you're going to have to make structural changes.

I know this is kind of a hypothetical, but do you have in your mind kind of a period of time that you look at to say if fuel is at this same level for say six months or a year there's kind of an inflection point in time where you decide you have to make major structural changes to the network?

I think, Art, it's just a long-term phenomenon.

I think it's an evolutionary process and we've done a lot of scenario planning on this topic.

And I think it's something that if companies decide they want to start building to get closer to the end consumer it's going to happen over many, many years.

It won't happen overnight.

It's a big shift for businesses.

So you may see a slow movement to near sourcing, but it won't happen very quickly.

We don't want to put too much emphasis on it.

It's prudent for us to stay in the future and think about the trends.

We thought it was appropriate to share some of our thinking to let you know that we're long-term players in this industry and we're going to stay ahead of the curve.

But as Scott said, these are evolutionary issues and we don't expect any rapid changes even if fuel stays high.

Thank you.

That's very, very helpful.

Thanks.

John Mims, BB&T Capital Markets.

Good morning.

I'm standing in for John Barnes.

Looking at CapEx going forward, if these current conditions persist could you all reach a point where you put some of the larger CapEx budgets on hold?

We continue to evaluate CapEx in an ongoing fashion and, frankly, we tightened it up prior to giving our guidance for 2008.

So we will be right at $3 billion which is below our 6% of revenue threshold that's typical.

But we've got a couple of major investments right now that are full speed ahead.

We're expanding our Worldport hub that will continue to pay dividends.

It allows us to optimize the air network, it allows us to sort faster and fly slower which saves air fuel -- fuel for our aircraft.

And should our contract with DHL be completed, having that extra sort capacity in Worldport is absolutely essential.

So domestically there are investments we're making and those will wrap up in the next year, year and a half or so that will continue.

And then globally, certainly we'll adjust air fleet appropriately, but we are continuing to build capacity.

China is a very busy place for us right now.

Scott gave you an extended tour of all the Olympics activity, but behind the scene also is a substantial amount of increase in our geographic coverage, browning up the country if you would and building an infrastructure there.

So a lot of work going on.

We do have a lot of control over CapEx, we have some committed aircraft in the future, but it's a modest amount.

And frankly, as 2012 comes around and some of the aging aircraft directives come in, it will be a natural transition for us to replace our DC8's with 767's.

So we feel real good about where we're at from a CapEx perspective and we'll be reacting, but we don't feel that it's going to hamper our capabilities at all.

We'll continue to make the right decisions for the long term for this company.

But rest easy that we'll be more vigilant about invested capital, we're focused on economic profits.

So we'll only do CapEx when it makes some of an awful lot of sense for the Company.

I appreciate the time.

Thanks a lot.

Matthew Troy, Citi Investments.

Just revisiting an earlier question, I was wondering -- the economic assumptions underlying your outlook, I understand the value of your network visibility is a coincidental economic indicator.

And form some forward-looking capability given delivery stocking and sell through of what you're actually moving to your customers.

But looking at the dashboard of your outlook you mentioned IP.

What are the other key metrics you evaluate in determining your broader outlook?

To what extent (multiple speakers)?

A lot of it is.

Certainly IP is probably the best barometer, but clearly retail sales I think combined with IP are the two that we'll look at closest as we move forward.

And again, the outlook that we see as we move through the rest of 2008 is retail sales got a bump in the second quicker with the rebates.

They'll moderate -- they're still growing below inflation levels at this point in time.

Manufacturing IP is going to be flat to slightly negative.

So we really are -- our economic assumptions for the rest of this year are just real slight growth in the US economy.

To what extent does that economic outlook incorporate customer dialog?

And really what is the visibility you've got?

Is it two months, is it three months out?

I'm just trying to get a good sense of how we should weight your economic read relative to some commentary we're hearing from other industries?

The macroeconomic really comes from consensus estimates out there.

But we talk to our customers all the time, get a feel for where their business is going, particularly as we head into peak season.

We have to plan our peak season months and months in advance.

So we talk to an awful lot of our shippers and get an idea of what they see as inventory stocking levels.

So it's a combination of the macroeconomic data available and certainly talking to our customers.

And I think the feedback we're getting from our customers today is somewhat -- just a macroeconomic outlook.

It's going to be anemic growth -- growth but anemic growth.

And follow-up question -- in times like this in service-based industry customers often lean on their suppliers, if not on price, then for greater value or more service.

Are you seeing -- you talked about the trade down from premium that's occurred in addition to some lower traffic levels.

Are customers asking you to do more for them, whether to commit your assets as rolling warehouses or put your balance sheet to work on their behalf?

Is there something that you see that the margin customers are asking you to do that might have been different than 12 months ago?

Thanks.

Yes, they're asking us to do more for them, but I think what it is is they want us to help them adapt.

And so, although there is certainly cost pressures, we've got a number of just great anecdotes where we're working with companies to realign their distribution as the balance of transportation costs and distribution expenses change.

So it's a very busy time for our customer solutions group working with customers to partner and help them figure out how to manage.

And in some cases we cannibalize revenue, in other cases we grow revenue substantially by broadening a relationship.

So it's a very busy time, but frankly an exciting one for our sales and solutions people.

Thank you very much.

Tom Wadewitz, JPMorgan.

I just had one follow-up question.

I know that it's a ways out from 2009, but if you look at the prior downturn, Scott, I think you had talked about air volumes being down a bid in either '01 or '02 or '02/'03.

And it seems that you don't necessarily get a quick recovery the second year after or the first year after a downturn.

Is it reasonable to think that margins could be up in '09 if volumes are kind of flat to slightly up given the Teamster contract, given DHL?

Or do you really need to see more meaningful volume growth in 2009 to get margins moving in the right direction?

We think with not a lot of growth we're still going to see a better 2009 than 2008.

We're optimistic about the outlook, we've done a lot of good things for the Company, including the contract which will benefit us, including the potential DHL contract which we hope to have signed here soon, that's going to help us as we move into 2009.

We feel good about the outlook.

We think that the business is solid in all areas.

And comparisons obviously get a little easier after 2008, so we're cautiously optimistic about 2009 at this point in time.

Clearly growth helps us.

If we see the volume grow it lowers our effective wage rate freight increases and that's also helpful.

Right now we're seeing certainly the effective wage rate increases (inaudible) to the contract increases through the July 31st period.

Now once we get into August that will be less painful as the rate increase goes down.

But I think that we can show improving margins without a lot of volume growth.

Certainly volume growth will help us in effective wage rates.

Okay, great.

Thank you.

Ed Wolfe, Wolfe Research.

Just a follow-up to the question I asked before on the timing of the DHL contract.

When you had announced it, and DHL announced it, you talked about $1 billion of potential annual revenue.

I was under the impression that was for 2009.

Is that still the thought process?

The discussion -- with the contract still being negotiated it is going to depend on their levels of business as we get into it.

So until we really sign the contract we can't really I guess determine that number.

Clearly though we were looking at full year -- the first full year would be 2010 I guess.

We have it fully implemented we hope by the second half of 2009 so the first full year will be 2010 when we're talking about those types of levels.

Ed, we said we'd be at a full burn rate after the ramp up in '09, but we did not suggest it was the full revenue for '09.

Okay.

And so the first full peak season when you would be doing this would be '09 though?

Yes, correct.

Okay.

Thanks, guys.

I guess I'll leave you with two points.

First, we expect full-year earnings per share to be within a range of $3.50 to $3.70.

And then second, while adapting to the current environment we are still investing to expand our global presence, ensuring we maintain our leadership role in the industry.

Thanks for joining us today.

Thank you.

This concludes today's UPS investor relations second-quarter 2008 earnings conference call.

You may now disconnect.