聯合包裹運送服務公司 (UPS) 2008 Q3 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the UPS investor relations third-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 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 all yours.

Please go ahead.

Good morning, everyone and welcome to our third-quarter earnings call.

I'm here this morning with Scott Davis, our CEO, and Kurt Kuehn, our CFO to discuss the Company's results and our future expectations.

But before we begin, I will 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 2007 10-K and 2008 10-Q reports.

These reports are 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.

In their remarks today, Scott and Kurt will discuss comparisons between the third quarters of 2008 and 2007, excluding the effect of the restructuring charge that occurred last year.

We believe that these results more accurately reflect UPS' true performance last year.

The adjustment stems from a $46 million restructuring charge and related expenses for supply chain business in France, which equated to about $0.03 per diluted share.

A reconciliation of these results is included with our earnings announcement this morning and appears on UPS' IR website in the Financial Information tab.

Now, to begin our review, I will turn the program over to Scott.

Thanks, Andy and good morning, everyone.

As everyone knows, the third quarter turned out to be one of the most challenging that the world's financial markets have seen in a long time.

I'm pleased to say that UPS performed well despite the difficult environment.

At the present time, we have a continuation of the same story.

Consensus GDP and IP growth keep getting lowered.

Economic recovery gets pushed out further into 2009, even possibly into 2010.

And leading indicators continue to reflect slowing global economic activity.

Expectations are that the next few quarters will be challenging.

Industrial production was negative in the third quarter and is now expected to be negative for the year.

As we've said many times in the past, industrial production is one of the best barometers for our U.S.

Domestic Package business.

Retail sales growth has also slowed and is expected to remain weak.

Forecasters anticipate that consumer spending will be worse in the current slowdown than in the prior two downturns.

I know this sounds somewhat somber, but despite these daunting challenges, there is much within UPS to be pleased about.

Our international export volume growth increased 7% per day, significantly more than the market.

The performance of our Supply Chain unit continued the momentum we have seen all year, with operating profit up over 30%.

We managed our Domestic Package operations well in response to lower-than-anticipated volumes with service levels at all-time highs.

Once again, the Company posted industry-leading operating profit and margins and generated substantially increased free cash flow.

And finally, UPS' strong balance sheet ensured we had ready access to commercial paper at very favorable rates.

All in all, UPSes around the world performed well in today's difficult business environment and we're benefiting from our extensive global presence and expanded product portfolio.

In fact, 40% of revenue this quarter came from the International and Supply Chain & Freight segments.

This compares to only 25% in 2003.

Let me switch gears now and touch on a topic I know all of you are interested in, our airlift contract with DHL.

We are still in negotiations with them on this contract and hope to conclude an agreement before the end of the year.

That said, we have not stopped competing with them.

We will continue to do so as we do with all competitors and we made that clear from the start of the negotiations.

Now, I want to recognize some recent achievements.

UPSers did a magnificent job responding to the destruction caused by recent hurricanes.

In spite of the personal challenges they faced, our people had small package and freight operations up and running within days of each storm.

That was no small accomplishment UPS has contributed over $1 million in monetary and in-kind disaster relief for Gulf Coast residents.

In addition, we are actively involved in Haiti, supporting CARE International, deploying logistics experts to work with the World Food Programme there and providing supplies to make clean water available for over five million people.

Another group of UPSers deserving recognition is our logistics team responsible for the behind-the-scenes support of the Olympic Games of China.

Several thousand UPSers literally delivered the Games, moving 19 million items, including everything from kayaks to canoes, to the 2000 drums you all saw in the opening ceremonies.

I congratulate them for their dedication, organization and flawless execution.

Lastly, I want to remind you that UPS published our sixth annual corporate sustainability report in the quarter.

We were the first in our industry to produce such a report and then annually benchmark progress against long-term goals.

Before I turn the program over to Kurt, I want to reiterate my firm belief that adverse times test the mettle of an organization that good companies can emerge better and stronger for having had that test.

I'm confident that UPS' mettle is resilient, flexible and adaptable.

UPS is and will remain a financially-sound and well-run business.

Now, for details on the quarter and our thoughts on the future, I will turn the call over to Kurt.

Thank you, Scott and good morning, everyone.

Against the backdrop of economic slowing and financial turmoil, UPS performed well in the third quarter.

Revenue was up a healthy 7.4%, and earnings per share came in at $0.96.

We made good progress on our cost initiatives, but these were more than offset by economic deceleration and the high cost of fuel, which drove product mix changes.

In fact, fuel expense was up 65% compared with a year ago, driven by higher prices.

However, since average fuel prices declined rapidly throughout the quarter, the two-month lag in the fuel surcharge did provide a benefit of about $90 million for the US domestic operations.

Three months ago, we told you that we anticipated the US small package market would contract about 2% in the second half of the year.

However, economic conditions worsened more than expected and our results reflect that.

We saw volume declines across our entire domestic portfolio.

July and August volume continued second-quarter trends.

But in September, we saw precipitous declines.

Most notable were the Next Day products where letter volume declined more than package volume, largely due to significant softness in the services sector.

Revenue per piece increased 5.8%, led by Next Day Air at 11%.

Gains were due to focused revenue management efforts in both the air and ground products and to the impact of higher fuel surcharges.

These were offset somewhat by lower weights and less favorable mix characteristics.

New, lighter weight, competitive wins in our deferred product constrained revenue per piece improvement.

We believe the pricing environment continues to be rational.

Domestic operating margin was down 200 points; although we still generated an industry-leading margin of 14.2%.

In the quarter, we implemented a number of cost-control initiatives.

While absolute costs are up year-over-year due to higher fuel expense, wage and benefit expense moderated as a result of our success in adapting our network to lower volume levels.

For example, operating hours were down 3.4%, same as package volume.

Miles were also reduced about 3%.

The benefit of the new labor contract, however, was mitigated somewhat by the reduction in volumes.

We also made adjustments to our air network.

Block hours were reduced without degrading service.

In fact, throughout the Company, service levels were at an all-time high.

Even though cost control is particularly important today, we will not sacrifice investment for the future.

As part of our constant effort to enhance the product portfolio, UPS improved air package pickup service for more than a quarter of all US businesses.

The enhancements provide more flexibility to meet critical deadlines for customers who do not have a daily scheduled pickup.

Now to our international business.

This segment posted solid results despite global economic challenges, illustrating the competitive advantage of our integrated global operations.

Average daily export volume increased 7%, well beyond market growth rates.

This is due in part to our broad global offering and the technology tools we've developed to simplify international shipping, like paperless invoice and international returns.

All regions of the world experienced mid to high single-digit growth.

US import volume growth from all regions of the world did remain negative, however, but non-US lanes were strong.

Transborder volume within Europe, for example, was up 10% and Asia to Europe increased over 15%.

Although revenue per piece increased more than 11%, operating results were negatively impacted by mix change, particularly in Europe, and by the decline in US imports.

Nevertheless, just as in our US operations, this segment generates the industry's best operating margin.

And remember, this 13.1% operating margin reflects the traditional slowing in Europe in the summer.

Across the globe, we continue investing to support future growth opportunities.

In the fourth quarter, UPS will open its new hub in Shanghai, which will link all of China to UPS' international network and tomorrow, we will break ground on our new intra-Asia air hub in Shenzhen, China.

This hub will reduce transit time for almost 200 city payers in Asia and it will play an important role in facilitating robust intra-Asia trading activity.

Let's turn now to the Supply Chain & Freight segment, which continued to demonstrate the positive momentum we've seen in previous quarters this year.

Revenue increased 9% and profitability improved over 30%.

Operating margin of 5.6% was in line with our target for the year.

International and North American airfreight drove significant profitability improvements.

The expanded air freight service portfolio that we introduced early in the year continues to attract new customers.

UPS Freight posted 7.8% LTL revenue improvement, but tonnage was flat and shipments declined, reflecting the tough economic conditions and a more competitive pricing environment.

Productivity and service metrics continued to improve and we are attracting and retaining customers with our WorldShip and Quantum View-managed technologies.

Earlier this month, UPS Freight announced the third round of network enhancements this year.

Time-in-transit improvements have been made to over 12,000 lanes in the past 18 months, offering faster service for two-thirds of all US zip codes.

These enhancements are part of a continual process to add value for customers by improving the velocity of our network.

Before I talk about the fourth quarter, I do want to comment on our solid financial position.

For the first nine months of this year, UPS generated approximately $7 billion in cash from operations.

With that, we invested $2.1 billion in capital expenditures, spent $3.3 billion to repurchase 48.5 million shares, paid dividends of $1.8 billion and still ended the nine months with $1.8 billion in cash and investments.

Through the end of the third quarter, free cash flow reached $4.6 billion, reflecting the strength of our business model.

This does include approximately $1 billion in US federal tax refunds related to the Company's withdrawal from the Central States Pension Plan.

As a point of comparison, a year ago, free cash flow was $3.1 billion.

UPS also continues to experience ample liquidity in the commercial paper market at very favorable rates.

In these turbulent times, investors exhibit a flight-to-quality mentality and our strong balance sheet is very attractive.

In addition, we have bank credit lines well in excess of our outstanding commercial paper.

We did see a $23 million reduction in this quarter's investment income, due to an impairment on certain auction rate securities, primarily Fannie Mae and Freddie Mac.

In the quarter, we spent over $800 million to repurchase almost 13 million shares.

This was a somewhat slower pace than in the first half of the year.

As credit markets became chaotic, we thought it prudent to pull back a bit.

We intend to continue repurchasing shares, but the pace will depend on market conditions, which we will continue to monitor.

We've also reduced our 2008 capital expenditure budget by $200 million to $2.8 billion.

All in all, UPS' financial position remains very strong and we intend to preserve our ability to maneuver and to take advantage of whatever opportunities we may identify.

Now for the fourth quarter.

With consumer confidence approaching new lows, we are concerned that Santa's sleigh may be a bit lighter than usual this year.

We expect domestic volumes to be down about 4% for the quarter, reflecting the economic slowing.

We intend to execute an effective and efficient peak operating plan, diligently matching the network to volume levels.

Given current economic conditions, we believe it will be several more quarters before any turnaround will become evident.

In the international arena, several European economies are on the brink of recession.

Most of Asia's economies are expected to grow at a slower rate than in the past.

With a strengthening dollar and US trading partners experiencing weaker economies, US export growth is also expected to slow.

Nonetheless, we expect export volume growth should increase by approximately 5% with a mid-teen operating margin for the segment.

In the global small package operations, yield growth will moderate due to a substantial decline in fuel surcharge revenues.

However, we anticipate base pricing to remain firm.

The Supply Chain & Freight segment should continue the growth trends we've seen all year.

Operating margin in this segment is expected to be at or above 5% for the full year, constrained somewhat by the tough conditions in the LTL freight business.

And lastly, earnings per share for the year should be towards the lower end of the $3.50 to $3.70 range that we provided midyear.

It is no secret that 2009 will be challenging.

We intend to pursue long-term growth opportunities and be opportunistic in extracting growth in today's tough environment.

In addition, UPS will implement a wide range of cost initiatives in both the US and abroad to match our business to volume levels.

This will include network modifications, lower capital expenditures and reductions in staffing levels.

UPS has a long history of managing through all kinds of economic scenarios.

We are confident in our business model and in our ability to adapt it to match market conditions, both good and bad.

We will invest for the future while managing conservatively through the near term.

Now, Scott and I will be happy to answer your questions.

Ladies and gentlemen, we will now begin the question-and-answer session of our conference.

(Operator Instructions).

Gary Chase, Barclays.

Good morning, guys.

If you take literally, Kurt, what you said about the trends' progression through the quarter in terms of what happened in September on the volume side, sounds like September was a pretty bad month, like probably down double-digit in air, solidly double-digit in air and sort of mid-single digits in ground if you take that statement literally.

Is that the case?

And then, it feels like the fourth-quarter guidance on the domestic volume side, while it's not good, it certainly looks good relative to what that September comment would suggest, so can you just give us a little color there?

Yes, Gary, if you look at what we said on our last earnings call, May and June both were fairly sluggish and we saw those two months down a couple percent.

That trend basically continued through July and August.

And then in September, that rate of decline more than doubled, and so we did see slower trends, especially starting the second and third week of September and basically that pace has continued through October so far.

The good news is we do see some stability in that, but the bad news is it does generate, then, our best guess of volume growth of 4% for the fourth quarter.

Clearly, the fourth quarter will be heavily dependent on the Christmas holiday, and it's anybody's guess exactly how that comes out.

Although, frankly, we do think that people will be conservative this year.

And I understand that there is a lag, but the fuel surcharge component is going to come down dramatically as I think you mentioned in the prepared remarks.

What kind of impact do you think that is going to have?

Do you think you've seen more of the volume weakness already because the surcharges were so high?

Well, certainly the surcharge had a dramatic effect on shipping behavior.

We do know that it did cause additional pressure on our premium products and a significant amount of tradedown into the deferred and the ground products.

Right now at least, fuel has come down dramatically, and we'll see where it goes from here, but if the conditions continue, we are hopeful that really there will be some benefit both on the premium products picking up a little more and also we will get some benefit in the fourth quarter from the two-month lag.

Gary, we've built our guidance for the oil -- be in the mid-80s, forward curve in the 80s, so there's maybe a little bit of upside there.

Okay.

Appreciate it, guys.

Jon Langenfeld, Robert W.

Baird.

Good morning.

When you look at the domestic express margin and even if I back out the $90 million of fuel, it looks like you've made some progress there in the year.

How much of that is related to the Teamster contract going in in August 1 and how much of that is related to just your ongoing efforts to control costs?

I think, Jon, the majority really is our cost initiatives.

We have moved pretty quickly to adjust the network to trim out discretionary spending and just make sure we right-size and let our people know that, at least at this point, we don't anticipate much change to the better.

The labor contract certainly has some favorable attributes, but the effect of that was muted because of the very low growth.

We really aren't bringing as many new employees in and you get a magnifying effect as you do that.

We've always said that we should be able to ride through these downturns better than most.

We said that half of our costs are directly variable, and you really saw that in the third quarter where our volumes were down 3.4% and hours were down 3.4% and block hours were down in that area.

So we do a pretty good job managing through the downturns.

And then the margin for the fourth-quarter domestic, you're just summing all your pieces together.

It kind of seems like you're looking at a low double-digit operating margin on the domestic side to get to your guidance range.

Is that true, even inclusive of the fact that your fuel benefit, assuming fuel stays where it's at today, is probably double what it was in the third quarter here for domestic?

Well, as Scott said, we do have an estimate of fuel in there that is a little above where prices are at today, so there is certainly some potential there.

But frankly, with negative 4% volumes, this is a challenging quarter.

The holidays are always an exciting time for us.

You really have to forecast and commit assets and resources far ahead of time.

So there is more exposure, certainly, during December to volume changes than in most times of the year.

Thank you.

Ed Wolfe, Wolfe Research.

Thanks.

Good morning, Scott.

Good morning, Kurt.

Just a little more flavor on the DHL contract.

You said you're still hopeful of closing it.

Do you have a little bit more insight?

It seems like they've hemorrhaged a lot of business and you certainly won your fair share of that recently.

Do you think it is still a billion a year or is that number going to be a lot smaller should the line haul agreement occur?

Ed, as I said earlier, the negotiations are continuing and we hope to get [recent] agreement before the end of the year.

But realistically, the scope and size of the deal may be changed based on the customers' reactions to their announced restructuring and downsizing in the US.

On top of that, the weakening economy is certainly going to have an impact on them as it does everybody.

So I think it's fair to say that we are still negotiating, but the scope and the size of that deal could change.

Does there come a time period where if it's not done by this time, it is kind of too late from that perspective?

I think it is something that we've got to look at from our perspective and they've got to look at from their perspective.

I think both parties are negotiating in good faith at this point in time, but I think sooner is better than later.

Okay, last thing, on the share repurchase, now that the stock is sitting here with a four handle in front of it, it is quite accretive to go in there and I understand the credit markets aren't great, but you're certainly not having a lot of trouble with access, it seems, to capital.

How do we think about those two conflicting things as we go forward in the near term, the stock down here and the markets, in terms of your guidance of $5 billion a year of share repurchase?

Yes, Ed, this really has been an unprecedented time for turbulence in the debt markets especially, and we've been fortunate in that we've really had as much access to commercial paper as we need and at very beneficial rates.

So, the liquidity is there.

On the other hand, the long-term debt market still shows some very sizable spreads, and ultimately, our share repurchases will manifest themselves in longer-term debt.

On the other hand, as you say, UPS stock is on sale today at a great price and certainly we intend to be buyers.

The exact pace of it will depend on conditions both in the debt markets and the equity markets, but we do intend to be in their buying stock.

Yes, we love the stock, obviously, at this price.

We would like to see it get up to a higher price, but I think that Kurt said it right.

The long-term debt markets need to stabilize.

There has not been a lot of corporate debt issuance over the last two or three months and we need to see that stabilize.

Thank you for the time.

Robin Byde, HSBC.

Hi, good morning, guys.

Just on trading in European package, can you provide some more color on current market conditions perhaps by country?

Are you still seeing volume growth at your Cologne and Tamworth hubs?

Thank you.

Yes, Robin, we have continued to see good growth in our intra-European shipments.

As we mentioned, products moving across borders within Europe grew at 10%.

So even with a somewhat stagnant European economy, the network we built has allowed us to continue to gain share.

Some of the individual domestic markets clearly are seeing some headwinds, and the UK, most notably, and then certainly Germany, which is one of our largest markets, has slowed a little bit.

But the export market within Europe, especially the eastern part of Europe, Poland and some of those, is continuing to show great results.

And I might note also that, at least in the third quarter, we continued to see shipments from Asia to Europe move along very strong.

So one of the fun things about us having built this balanced network is it gives us a view into how some of these trade flows are moving, and in some sense, diversifies our international results to not be quite so dependent on any one area.

Great, thank you.

And just a quick follow-up.

On the Shanghai hub opening in Q4, could you or would you want to delay this if Asian markets get a lot worse?

Absolutely not.

That hub is a positive move for us, it improves our air network, allows us to improve our service and manage our costs better.

So we are full speed ahead with that.

Yes, and the developing economies are slowing down, but they are still growing to a nice pace.

And again, China is supposed to grow at 9% next year, so it's not 11 or 12%, but still 9% is not bad.

Great, guys.

Thanks very much.

Tom Wadewitz, JPMorgan.

Yes, good morning.

I wanted to see if you could give a few comments on how we should think about 2009?

I know that is probably tough to do in light of perhaps not even visibility to peak season in fourth quarter.

But you mentioned some significant cost initiatives.

If you bear those in mind and assume we do have a recession for a couple of quarters, do you think margins are down substantially in '09 and earnings are down substantially, or are there enough additional levers that you can push on in terms of cost and whatever else that you could have some kind of stability in margins and kind of flattish earnings?

Just perhaps some broad comments for how we might think about that.

Tom, I will start it off.

And just as we look at the economy, and again, just perhaps that we are not a leading indicator, so we kind of go on consensus estimates.

I think generally, people are looking for the economy in the US to be negative probably in the third and fourth quarter of '08, and probably the first quarter of '09.

Beyond that, maybe stabilizing some, but there are certainly risks into 2009.

When you get into a recession after a financial crisis, it is usually more of a U-shape than a V-shape, so it may be a little bit longer.

But I think generally, our best barometers again are industrial production and retail sales.

And industrial production will probably be negative throughout a good part of 2009.

Retail sales will grow, but probably less than inflation.

But saying all that, I think we still feel pretty good about UPS' prospects for 2009.

I think that the first quarter may be one of the tougher comps for us, but the rest of the year I think we stack up pretty good versus 2008.

So we are fairly optimistic.

We will get into more detail, obviously, in January in our next call.

But Kurt may want to add to that.

No, I think we are working hard to right-size our network for '09.

We do have the toughest comps in the first quarter.

But, you know, the labor contract continues to take more effect as we move farther into that, and we're not gloomy on the US; we just think we've got a couple more quarters that we have got to manage.

And also we are continuing to see decent momentum and our Supply Chain & Freight arena.

So we still have a little bit of a bumpy ride, we think, Tom, for a couple of quarters, but hopefully after that, we will be able to show some more positive results.

Okay, appreciate that.

And then one follow-up or I don't know if it's really a follow-up, but on the pension side, you know, in this market, obviously, downward pressure on assets.

And I think within the Central States Plan, there is speculation about some risk that one of the big participants there eventually could have liquidity issues and that fund could get in a lot worse shape.

Can you tell us what -- is there any risk that you could get drawn back into that fund in the next couple of years; that it could deteriorate sufficiently?

Or what are the protections that you don't somehow get drawn back into Central Sates?

Yes, I think, Tom, that somebody made a statement like that and that statement really was inaccurate.

There is a three-year look-back on this fund, but it's only in case that there is a mass withdrawal of the 2500 employers in that fund, which is extraordinarily unlikely for all 2500 companies to pull out of it.

Even if a large company goes bankrupt, they are not released of their contribution requirement until they liquidate and that is only one company out of 2500 companies.

So we have about a little over two years left of that claw-back look and it's extraordinarily remote that we could ever get tied up in any problems they would have.

Overall, on the pension situation, it is something that I think we've all got to watch and manage.

From the single employer plans, I think right now you're seeing that the investment results are down, but the discount rates are up, which can help offset it.

In UPS' own plan, we were well overfunded going into this year.

I think we are still, even today, 100% funded on it.

Okay, thanks for the time.

William Greene, Morgan Stanley.

Yes, good morning.

Can I ask you to talk a little bit about how the pricing discussions are going with customers?

Obviously, the economy would, I would think, would lead them to sort of push back a bit on some of the list rate increases you have tried to put three.

On the other hand, one of your big competitors is struggling so much here that maybe you'd have more success in that regard.

So how are those discussions going?

Challenging, but stable, I think, Bill.

Clearly with the fuel surcharges at record heights, there was increased pressure on our customers and on us to find ways to take their costs down.

And as I've stated in some earlier calls, the fuel surcharge really became a part of overall price negotiation.

We've been working through that and trying to make sure we keep those two separate, but there has been pressure.

If anything, with fuel coming down, we anticipate a little firmer environment as we start to see the results of $70 fuel kick in and the fuel surcharges get back down to more reasonable amounts.

The market is competitive.

Clearly, DHL was a very aggressive pricer in the market, and they are a bit distracted right now, but costs are up and that is why we did put in a solid rate increase for next year, a net 4.9 on the air and 5.9 on the ground, and certainly, we intend to negotiate and keep the majority of that.

Okay.

And then, Kurt, with regard to the volume comments that you made, can you talk a little bit about where you're seeing the weakness?

You mentioned the overnight envelope business, but maybe like in terms of B2C, has that slowed dramatically since the last time we spoke?

Yes, it has.

It has seen the most sequential slowing.

Having said that, it is still moderately positive, but it was -- we've seen double-digit growth in B2C for quite some time and clearly, that is down to low double-digits now.

On the B2B side, there has been some deterioration, not as dramatic, although it has continued to be negative.

US imports, as I mentioned, is another area that has gotten very, very weak and US exports have been pretty strong, although they did moderate to the mid-single digits this quarter, although we continue to see just great gains in our international business across the world.

So, right now at least, the major change in the economy, the largest change seems to be on the consumer side.

Okay, and just one quick question, Kurt.

Last call, you mentioned you were doing a strategic review of your network because of fuel prices.

Have you stopped that with them coming down, or if so, what was the conclusion?

Well, thankfully, oil 200 seems a little more distant at this point, Bill.

But no, this is all part of our long-term strategy.

We create scenarios and we've developed some insights around how the world would begin to change if fuel prices get back up to where they were and even higher.

And so it has us just evaluating opportunities, thinking about acquisitions, thinking about how our network would change.

In light of the fact that we are so far away from that right now, it doesn't really make sense for me to get into any details, but this work will be ongoing, so we are ready if and when it bounces back up.

Thanks for your help.

Ken Hoexter, Merrill Lynch.

Great.

Good morning.

Scott, in the past, you've talked about the percent of expenses that are variable, semi-variable to kind of highlight how quickly you can react in a downturn.

Can you kind of update us on where that stands?

And what I want to dig into a little bit is on the employee side.

You don't really give employee numbers, but just wondering is a reduction of employees part of this process and where do you stand today on your base?

Clearly, I think the numbers haven't changed much, Ken.

50% of our costs are daily variable and then we say probably 30% to 40% are semi-variable.

When it comes to employees, really we've reduced 3000 employees this year, over the last year or so.

So again, it moves pretty closely with the package volume, and nothing has changed as far as our ability to manage the business on a daily basis and react to what we are seeing in volume.

And right now, we are certainly a big focus on the semi-variable things, some of the network issues, management overhead, some of those indirect costs.

Meanwhile, the operations people clearly are highly attuned to make sure that that direct labor is matched to volume also.

And as Scott said, we've had pretty good results on that.

Generally, the semi-variable takes, as we said before, a couple weeks to a few months to get implemented.

Every quarter that goes by, you will see more of those kick in.

And what is the total employee base now?

We have over 400,000 employees, around 300,000 in the US where most of the changes have been made.

And then just a follow-up on capacity utilization.

You talked about 7% international growth, export growth.

Did that kind of rapidly decline toward the end of the quarter as well?

You kind of highlighted the domestic before.

Just wondering what your international looks like and can you talk in that frame of reference what your capacity utilization of the aircraft is looking like?

Yes, no, the international did not see the dramatic decline in September that the domestic did.

We did see it trending down moderately over the course of the quarter, but nowhere near as volatile.

Part of that is why we are still guiding to showing 5% growth in an environment where most of our competitors are flat or down.

So we feel pretty good that the value proposition is still there.

We are seeing some slowing.

We are seeing trade flows move, but at least so far we have been able to stay on top of that.

And the capacity utilization?

I don't have any specific numbers to share with you.

I will say one thing, though, that we are working very hard at, and I think it is part of how we have been able to manage this deep integration of our freight portfolio.

We have express freight with small package.

It is allowing us really to build a load plan for every major country-to-country lane and be able to take advantage of our fixed capacity for our freight when we have excess.

So this whole freight alignment is a great benefit for customers because they can easily choose from deferred forwarding activities all the way up to express freight.

And it's also very good for us operationally as we learn to operate simultaneously as both an airline and a forwarder.

So those things are kicking in right now and helping to improve utilization.

And frankly, the reduction in US imports increased and exports have helped balance out some of those loads too.

Great.

Scott, Kurt, thanks for the time.

Justin Yagerman, Wachovia Capital Markets.

Hey, guys.

How are you doing?

You mentioned the fuel 200 strategy and I was just kind of curious, when we were talking on the second-quarter call and before that, when you guys had announced in June or July that things were going to be worse than expected, you said that shippers' behavior had changed dramatically as fuel escalated towards peak.

I was just curious to what extent you've seen shippers' behavior change back when it comes to consolidating loads or potentially moving down in terms of the margin product that they are using with you.

I wanted to get a sense of -- are you seeing those changes in shippers' behavior, or is the weak economy still pushing people towards the lower margin product towards consolidating freight?

Has there been any shift that is notable?

Well, there are a lot of moving parts to that question, Justin.

I guess the behavior we saw most notably was really just the tradedown behavior, and we went back and have looked at a couple of different economic slowdowns and most of the tradedown behavior is typical in an economic slowdown.

We think there has been some exaggeration of tradedown, especially into ground, because of the high fuel prices.

On the more strategic changes, the redesigning of your supply chain, I think we said in Q2 there was a lot of discussion and interest in it, but we have not seen a lot of big changes by companies.

Our guess is it may make a difference on the increment.

If you're going to add another factory somewhere in the world, maybe you think about adding one closer to home, so Latin America, maybe.

Central and Eastern Europe makes more sense than Asia, but not a big shift and clearly with the volatility right now, it is awful hard to peg.

So it is an interesting time and one with our solutions people staying real busy to help customers try to navigate a good long-term course.

And some of that near sourcing issue that Kurt is talking about, some was driven by energy, a lot of it was driven by inflation, perhaps in China or maybe changing labor laws, just a variety of things that were driving manufacturers to evaluate those decisions.

Certainly, energy is one of them.

Yes, FedEx announced domestic Mexican service in the quarter and I think Southeastern Freight Lines just went down there on the LTL side and a bunch of other truckload and LTL carriers do some business in Mexico.

Can you guys talk about how you're positioned there and if you have seen any increased interest from customers in terms of cross-border Mexican moves or setting up manufacturing and distribution in Mexico?

Yes, Justin, we've clearly been in Mexico for quite some time with the domestic offering.

And so we are pretty well-positioned and we are seeing some uptick.

Probably more notable is the focus we've had really for the last four to five years on the whole North American trading block, with a big focus on our transborder products and our trade direct, which allows Mexican manufacturers to move stuff across the border in mass and then distribute it into our small package network.

So those transborder products moving between the US, Canada and Mexico continue to be very robust.

Trade flows move back and forth.

Clearly, with the Canadian dollar changing so dramatically, we may see some changes, but those continue to be more and more important and that North American trading block remains very strong.

That's helpful, guys.

Thank you very much.

David Ross, Stifel Nicolaus.

Morning, gentlemen.

When you first bought UPS Freight, there was a lot of talk about bundling the small package offering with the LTL service.

Can you just give us an update on where that is and if that is helping to mitigate some of the lower volumes you're seeing either on the ground package side or the LTL side?

Yes, it is and we've kind of got a tail of two parts on this LTL industry right now.

Clearly, the environment is tough.

Growth is negative, and pricing has gotten a little more intense.

So we have become a little less aggressive than perhaps our initial plans were so as not to be chasing volume in a tough environment.

On the flipside, as we brought our technology, our operating methods and our visibility services to customers, there has been a tremendous adoption of them, and being able to manage and process LTL shipments through our WorldShip shipping platform, be able to track them and get predictive information from our visibility systems, is a huge value proposition.

So there is macro issues that are very tough, but at the same time, we are steadily embedding our technology and our processes into that segment.

And over the long term, we feel very optimistic.

It is just a tough market right now.

Yes, I think we are extremely well-positioned when we come out of this downdraft we're in today.

We've made a big investment.

The LTL market will recover.

We're not sure who all the players will be when we get out of there, but we're going to be in a very good competitive position when we come out of this economy.

If I can just maybe pile on a little bit.

One of the things that is happening, and you're seeing it in the LTL, is we have taken our WorldShip platform, which, for many years, has been a small package domestic application, and at this point now, we have upwards of 600,000 installed users across the globe.

So it's an international application and in the last couple years, we've gone beyond package to include fully automated processing for LTL and deeply integrating airfreight.

So we have really created, we think, a pretty unique technology platform that is global and multimodal and we see a lot of excitement about that and we're going to continue to press that.

That sounds good.

Also just one other question, given the current environment and kind of the near-term negative outlook, the 32 aircraft you have on order right now, is that still pretty much in the plans?

Going to go through or are you going to rethink how many aircraft you might need given the current volumes?

No, at this point, we have not made any announcements on changing that.

Clearly, with Boeing being distracted a little bit and production down, we will have to see how their delivery schedules come.

But that is a fairly modest amount spread over five years, and over time, we will be retiring our DCH also as the aging aircraft directive is to move forward.

So it's a natural replacement cycle.

Timing may move a little bit.

And again, the economy is troublesome today.

We are all looking -- there is a lot of fear out there, but there are positives out there.

I think the lower energy price is going to help consumer confidence as we move forward.

I think the credit situation is beginning to improve.

I think whenever the central banks can collaborate together, it is a powerful tool.

We haven't had time yet to see the benefits of those lower interest rates.

The fiscal stimulus is out there.

So I know we are all wrapped up in what we are seeing today.

We will get through this weak economy and get back to a normal economy.

Great.

David Campbell, Thompson Davis.

Yes, thank you very much and good morning, everybody.

I just wanted to ask you whether you had any fuel benefit in the international operations, like the $90 million number you cited in domestic results.

Yes, there was a modest amount.

It's a fraction of what we saw in the domestic, but it is not significant in the international.

Is that because it is a smaller component of expenses, or just what -- there was less of a lag or what?

There is a wider array of different fuel surcharge schedules that aren't as responsive to that.

So we did have a tailwind, maybe $0.01 or so from the international side, but it was not a large amount.

Okay, thanks.

And second question is you have a very big range in earnings in the fourth quarter, basically $0.82 to $1.02.

What would it take to earn at the upper end of that range?

Obviously, some maybe lower fuel prices and better volumes.

Some things you just can't see, so therefore your -- but $1.02 is still a possibility?

Well, I think that the fourth quarter is always the most difficult for us to forecast because so much of it is tied to the Christmas season and I think that not knowing -- you see forecasts out there that say retail sales are going to grow this Christmas season.

You see forecasts that say it's going to be the worst since 1991.

And so there is a lot of different thoughts out there, so I think we need to be cautious as far as the outlook for the fourth quarter.

Again, so much of it is driven by the Christmas season.

Two or three weeks before Christmas, it is difficult to forecast.

Yes, David, we did say that it's likely we'll be at the lower half of the range.

Although clearly, as Scott said, there is opportunity and uncertainty in the fourth quarter.

Okay, thank you.

John Mims, BB&T Capital Markets.

Hey, good morning, guys.

Can you talk about the European ground network and like what you've done or what you can do to rationalize some costs there if volumes continue to decline?

Well, so far, they haven't declined.

They are continuing to grow, but we are being prudent on that and it's just good network planning.

Within country, it's important because there is very much more economic sensitivity within our domestic products.

Whereas, the transborder, we have still got this secular growth story of the European economy.

But, we are looking at how we adjust routes.

We have air and ground collaborating and coordinating.

Some of the skills we've learned after trying to do this for 100 years in the US serve us pretty well as we've done this in Europe.

There is still some good catalysts.

Eastern Europe, Central Europe continue to be showing good solid growth and the European economy continues to adapt.

So, we are very focused on it.

As in the US, the air networks are less flexible than the ground networks, so that is where we have to be the most diligent, but in general, we have similar structures as we do in the US.

Yes, that's a good point because I think the European ground network is very similar to the US ground network where we have a high degree of variable costs to manage through a downturn.

Great, that's helpful.

Thank you.

And just a follow-up, some housekeeping.

Do you have an average share cost for the repurchases in Q3?

Well, we spent about $800 million in the third quarter and bought about 13 million shares.

So it's a little above $60.

$63.

Okay, and you said -- the guidance, obviously, it is affected by market conditions and whatnot, but the annual repurchase spend guidance was how much?

Our original target was to purchase $10 billion over the next couple of years and in the first half of the year, we have been clicking right at that steady rate.

We did pull back a bit, although we still spent $800 million and we are still committed to our repurchase program.

On the other hand, we don't want to be having to go out to the debt market right now where there are 400 and 500 basis point spreads.

So we are leveraging commercial paper and will continue to buy and the speed will depend on how the credit markets look.

Understood.

Thanks for the time, guys.

Chris Ceraso, Credit Suisse.

Thank you.

Good morning.

Follow-up on the question about the fuel benefit in some of the different businesses.

Do you have a number for the Supply Chain & Freight?

No, it's not as significant there.

There is a lot of flow-through fuel surcharges on the supply chain arena, so it's not as notable there.

Clearly, we've got to stay on top of it to make sure our surcharges match the rapidly changing environment, but I don't have a number on that.

The lag is not nearly as important as it is on the package side.

Yes, the LTL is much more rapid and certainly that's real-time for a lot of the air freight.

Okay, and then you've gone through a few of the different trade lanes and how things were.

Asia, Europe you said was still strong.

Intra-Europe still strong.

Can you just comment on intra-Asia and then Asia to US?

I know you said US imports were weak, but if you could quantify those two lanes?

Intra-Asia continued to be strong, certainly above our average growth, upper single digits.

US overall was, as far as exports, was mid-single digits.

The intra-Asia, we think, is going to continue to have lags.

That is why we are investing and will break ground tomorrow on our intra-Asia hub to help speed up that network and reduce its costs.

So countries are trading with each other in Asia even as the US takes a break.

Asia to US?

Asia to US was down.

All of the import markets were down mid-single digits, I guess.

Every region of the US we mentioned were negative.

Thank you very much.

Mark McVicar, Dresdner Kleinwort.

Just a quick question.

Some parts of the international freight markets, not specific to yours, are reporting issues and concerns around the availability of letters of credit that, obviously, sit behind a lot of the international trade flows.

Have you seen any of that?

Or are you hearing any of that from your cross-border customers?

Not as a huge issue.

Clearly, I've read some anecdotes about that.

We do have some products that can help customers with very short-term transactions if they are using our supply chain services.

But, in general, that hasn't been a big issue yet.

It is probably a bigger factor on some of the ocean shipments.

Yes, it feels like it is more related to sort of heavy shipments at sea rather than the air-based products, but I just wondered whether you'd seen anything.

Okay, that's great.

Thank you.

Art Hatfield, Morgan Keegan.

Thank you.

Morning, everybody.

Just one question.

One of the things I struggle with, and believe me, I struggle with a lot of things.

So do we.

And I can appreciate that these days.

We hear a lot of comments that people think we start to see the beginning of a recovery kind of midpoint of next year, second half of next year.

Can you kind of put your finger on what you think needs to happen or what you think will be the catalyst to get consumers spending again?

One, and two, if this thing drags on into 2010, or even farther than that, at what point are you kind of really restricted on working down the costs?

Do the variable aspects of your business that you talk about get reduced as the length of time has slowed down increases?

I think as far as the economy, I think there is -- I mentioned earlier there were a couple of positives.

One is that energy prices have dropped dramatically.

Two, I think we are beginning to thaw the credit issue out.

I think the central bank collaboration has been a big move.

We have to get credit flowing again to get these economies recovering.

Now the negative of that is the employment side of it is still probably going to get worse before it gets better and that is going to hurt consumer confidence.

Perhaps as we get credit reestablished, the mortgage rates will drop a little bit and that will help the housing problem.

We need to get to the bottom of that.

So I think there are a couple bright lights.

I think the energy and the credit is looking better.

We need to get those healed up before we recover.

So we are optimistic that maybe the latter part of next year we will see some recovery.

We will continue to, obviously, manage our Company very carefully.

As Kurt said in his comments, we are going to manage conservatively, but still invest for the future.

I guess the bottom line of this whole thing is the more pain there is out there, we don't want more pain, but if there is more pain, we're going to be a survivor and we will come out of this thing in a great competitive position.

We'll keep that in mind.

We will invest so that when we come out of this economy, whether it is 6 months, 12 months, 24 months, we are going to be positioned to gain marketshare and grow this business.

Thank you.

Okay.

Just three key points before we shut down the call.

First, UPS turned in a good performance in the quarter despite the weakening global economic environment.

Second, UPS continues to have a very strong balance sheet, and third, we expect earnings per share for the year toward the lower end of $3.50 to $3.70 range we provided midyear.

Thanks for joining us today.

Ladies and gentlemen, today's conference call will be available for replay from today at 10:30 a.m.

Eastern time and until October 30, midnight of that day.

You may access that conference by dialing 1-800-475-6701 and entering the access code 962127.

That dial-in number once again is 1-800-475-6701 and the access code is 962127.

I would like to thank you for your participation on behalf of today's panel and I would like to thank you for using AT&T.

Have a great day.

You may now disconnect.