聯合包裹運送服務公司 (UPS) 2008 Q4 法說會逐字稿

Good morning.

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

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

All lines have been placed on mute to prevent any background noise and 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, everyone and welcome to our fourth-quarter earnings call.

I'm here this morning with Scott Davis, our CEO, and Kurt Kuehn, our CFO, to discuss the Company's results for the quarter and our outlook for 2009.

Before we begin however, 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 Company's future performance or results of operations.

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 compare results for 2008 against 2007, excluding the effects of adjustments that occurred in both years.

This comparison is more reflective of UPS' true performance.

There were two adjustments recorded in the fourth quarter of 2008.

The first was a $548 million goodwill impairment charge in our UPS Freight unit, which is part of the Supply Chain and Freight segment.

This charge resulted from a number of factors.

We acquired Overnite in 2005 when the economy was much stronger and valuations were higher.

We then invested in technology and operational improvements to enhance service and performance and expand product offerings.

Unfortunately, the current freight environment has been a challenging one for new investments and customer focus is primarily on price.

Long term, we believe our strategy is sound and will be viable when market conditions improve.

But we felt it prudent to reevaluate the goodwill associated with this acquisition and make a reduction based on current market comparisons and cash flow outlook.

The second adjustment recorded in the quarter was a $27 million write-down of intangibles in the UK domestic operations included in the International Package segment.

This relates to a domestic customer list, which was part of an acquisition.

With the weak conditions in the UK and our emphasis on the export market, this domestic customer list proved to be of less value than estimated.

In the fourth quarter of 2007, if you remember, we recognized a $6.1 billion charge in the US Domestic Package segment to withdraw employees from the Central States Pension Plan as part of our long-term labor contract with the Teamsters.

Any reference Scott and Kurt make to full-year results excludes the impact of these adjustments, as well as other charges in 2007 totaling $335 million.

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

Just a quick reminder, in December, based on customer considerations, we decided to suspend pickups on the day after Christmas.

So we had one less operating day in the quarter than we had originally planned.

We believe there was little, if any, volume lost in total.

That is why, when we talk about volume today, we are speaking about overall totals, not average daily.

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

What a difference a year makes.

A year ago on the heels of momentum from our historic contract with the Teamsters, we were optimistic about our prospects.

Economists were predicting slow but growing US GDP and industrial production.

It was debated whether we were in or headed into a recession.

Globally, experts questioned the decoupling theory.

Very few saw what was about to unfold.

2008 was very difficult; however, we responded well.

Our operations team in the US continued to adjust the network as package volume deteriorated under worsening economic conditions.

In our International segment, export volume increased 6.8% as we benefited from the industry's most diversified global network.

The Supply Chain and Freight segment posted a 5% annual operating margin.

This was at the top of the range we provided at the beginning of the year.

Our strong balance sheet and ability to generate cash enabled us to weather the financial market meltdown.

Clearly, we didn't meet all the goals we had set at the beginning of 2008; yet we still finished the year with an industry-leading small package operating margin of 13%.

Conditions in the fourth quarter of 2008 continued to worsen.

Industrial production fell.

Consumer spending dried up and economic hardships spread throughout the world.

In previous recessions, consumer spending remained steady, helping keep recessionary periods relatively short.

This time, however, the consumer is not spending.

Consequently, experts predict that this recession will be worse than any we have seen in several decades.

We are adapting our Company to the current environment.

We are looking at everything -- organizational structure, compensation, network configurations, products and services, how we do business, why we do it that way, what do we really need, what can we do without.

We have made changes in the last six months in the way in which we operate.

One of those changes involves revenue enhancement initiatives.

Perhaps the most significant revenue opportunity stems from DHL's departure from the US domestic market.

We went after that business vigorously with a well-executed plan.

We gained significant new volume as a result and we have more opportunities in 2009 as we compete globally with them, particularly on volumes in and out of the US.

As for the airlift contract we and DHL have been working on, negotiations are continuing, but with the reduced scale of the airlift need, we are finding it very difficult to reach an agreement.

Other changes we have made include reduction of nonoperating expenses through district and corporate consolidations and we have made adjustments in our ground and air networks worldwide to reduce costs and adapt to the market conditions.

These initiatives total over $500 million and will partially offset the impact of continued economic weakness.

In addition, we are freezing management wages, reducing other forms of compensation and suspending the Company's 401(k) match and other benefits.

However, I want to be clear.

We will still make strategic investments that provide worldwide opportunities to grow UPS and strengthen the services and solutions we bring to our customers.

We believe our strategy and business model are sound and that UPS offers a vastly better value proposition to the marketplace than any of our competitors.

Plans are in place to manage our costs while insuring that we maintain high quality service to our customers.

In times of economic difficulty, like today's environment, there is one certainty in business.

When trends improve and they will, the landscape will be different.

Some companies will be gone.

Others will still be viable, but damaged and no longer competitive leaders.

UPS will emerge stronger, later and more customer-focused and well-prepared to benefit from improving trends.

Now I will turn it over to Kurt for a review of fourth-quarter results.

Thanks, Scott and good morning, everyone.

Well, in short, UPS' results clearly reflected the fourth-quarter economic conditions.

All of our businesses were negatively impacted.

Earnings per share of $0.83 for the quarter, however, did enable us to achieve overall EPS of $3.50 for the year, within the range we provided to you over six months ago.

I will begin today's review with the Domestic Package operations.

The 4.4% decline in total quarterly volume reflected a worsening of the economic trends we saw last year.

UPS captured significant new volume as a result of DHL's departure from the US domestic market.

That volume, however, was not enough to offset declines from the economy.

Revenue per piece was up marginally at 0.6% because of the shift away from premium products and lower average weights.

Weight per piece declined almost 10% for air products and over 5% for ground packages in the quarter.

This is by far the largest decline in weight we have seen this decade.

The benefit we realized from the two-month lag in the fuel surcharge was more than offset by reduced volumes, lighter weights and declines in premium products.

When we provided guidance back in the third quarter, there was an implied fuel surcharge lag benefit based on the forward curve.

This lag actually provided an additional benefit of $0.10 per share over what we had expected.

During December, we experienced a peak season that was very similar to last year with shipping concentrated during the last week and a half prior to Christmas.

Based on what we learned in 2007, we have brought on peak season helpers later this year, which allowed us to better manage the process.

Our operations continue to adapt to the new environment.

For the quarter, block hours were down mid single digits, direct labor hours were down over 5% and miles driven declined by 4.5%, while service metrics continued at all-time highs.

During the quarter, we proceeded with numerous restructuring and network changes.

We announced the closure of six district offices and the elimination of night sort operations at our regional air hubs in Dallas, Texas and Columbia, South Carolina, all as part of a rigorous realignment of our inner network.

We also announced the closure of a large office facility in Georgia in an effort to consolidate our corporate functions.

These moves are a part of an ongoing program to resize the organization to match the changed business environment.

Now for a look at the International business.

UPS benefits from very strong regional networks in all major areas of the world, tied together by a global air network.

This balanced presence is a competitive differentiator and one that we will continue to nurture with future investments.

Export volumes increased by 1.6%.

This is significantly below the 5% growth we had anticipated for the quarter, but it remains market-leading.

We saw weakness in the US with mid single digit export volume declines.

Asia was also down slightly; although China achieved double-digit growth.

Europe posted a mid single digit improvement based on continued strong intraregional growth and Latin America experienced a double-digit volume gain.

International operations are experiencing the same impacts as the US small package business, declining average weight per package and a shift away from premium products.

This shift was much more pronounced in the fourth quarter than we had seen in prior quarters as we helped our customers trade down, not out, of our comprehensive portfolio.

These factors, along with the currency impact, contributed to a revenue per piece decline of over 8%.

Removing currency, revenue per piece was down 3%.

International operating margins declined to 14.9%.

The positive impact on operating profit from fuel was more than offset by weakening global economic activity.

For the quarter, the fuel surcharge lag provided a benefit of $0.02 per share over what we had expected when we provided guidance.

We pointed out in the past that there are higher fixed versus variable costs in our international network and we are addressing this issue vigorously.

We have identified opportunities to reduce block hours in our worldwide air network during 2009 without sacrificing service or footprint.

In Europe, we are optimizing our ground network opportunities and have identified changes to be implemented in management and compensation of our outside service providers.

At the same time, we will continue to move forward.

Non-US domestic expansion will occur where there is minimal investment required.

An example is our recently announced expansion of domestic express pick-up and delivery service to 16 additional countries in Europe, Africa, the Middle East and Latin America.

In the quarter, UPS also continued investing to support long-term growth opportunities.

We opened our air hub in Shanghai and broke ground on our new intra-Asian hub in Shenzhen, China that will be operational in 2010.

Now let's look at the Supply Chain and Freight segment.

Revenue declined 6.5%.

Operating margin was 2.6% for the quarter, but came in at 5% for the year, at the high end of the range we had targeted at the beginning of 2008.

As Andy mentioned, we did take a $548 million impairment charge in UPS Freight, which experienced a disappointing fourth quarter.

Declines in revenue and shipments reflected the very slow environment in the LTL sector.

This poor performance severely impacted the operating profit for the segment, but for the year, UPS Freight did post a slight profit.

Weight per shipment improved slightly; although shipments per day were down.

And price has become a major headwind today as excess capacity causes carriers to pull the pricing lever to defend share.

Market watchers are of the opinion that this is one of the worst LTL environments ever.

To combat this situation, we are intensifying our focus on cross-selling the freight portfolio to our small package customers.

We have rolled out an enhanced WorldShip platform that allows customers to seamlessly optimize the selection between our hundredweight package service and LTL.

This tool can help save a customer 10% to 15% in shipping costs.

Global Forwarding experienced a step-down decline in revenue in November and December, reflecting the economy-driven decreases in demand for customers' products.

However, profitability for this unit improved in the quarter as compared to last year.

Weight per shipment declined and lower fuel surcharges had a negative impact on revenue for the quarter, a trend that we expect to continue into 2009.

Our Logistics operation performed quite well.

Revenue increased in high-tech and healthcare, but was down in retail and industrial sectors.

Service levels in this business remain very high and profits continue to improve.

Over the past several years, UPS has built a comprehensive supply chain management capability focused on the healthcare industry.

Merck's selection of UPS to operate a significant portion of its US distribution demonstrates the success that we are achieving in this market sector.

Now for a recap of our end-of-year financial position.

Even in the midst of the toughest environment in our careers, UPS remains rock-solid.

UPS generated cash flow from operations of $8.5 billion for the year.

Our capital expenditures for 2008 were $2.6 billion, about $400 million less than we had anticipated at the beginning of the year.

This equates to approximately 5% of revenue at the low end of our historical range.

We paid $2.2 billion in dividends and $3.6 billion to repurchase 53.6 million shares.

We did slow our 2008 stock repurchase program when the long-term debt market became volatile.

With the dramatic changes in the economy during the year and continuing economic uncertainty, we will be particularly prudent in our financial management.

We will continue repurchases, but at a significantly reduced rate.

One of the defining characteristics of our business has always been UPS' ability to generate cash flow.

2008 was no exception with free cash flow of $5.7 billion.

Now, a quick update on our funds flow from operation to total debt metric.

We targeted a range of 50% to 60% that we would reach by the end of 2009 and we finished 2008 at 68%.

We will continue working towards that range.

As Scott said, everything is being evaluating from a financial, as well as an operational perspective.

We will manage the business in light of today's realities, but also to make sure that we are in position to capitalize on opportunities as they materialize.

Now for some insights into 2009.

We have our work cut out for us this year, which will likely be even more difficult than 2008.

With forecasters not anticipating any real economic recovery until 2010, UPS earnings for 2009 will suffer.

Because of the amount of uncertainty surrounding global economic conditions, it is premature to give full-year guidance.

If we did, it would have to be a very wide range, which in our opinion is not helpful.

Instead, we will provide earnings guidance for the first quarter of this year, which we expect will be between $0.52 and $0.68 per share.

The first quarter will be weak with slight improvements later in the year as initiatives take hold.

At the end of 2008, our pension plan funding levels were down substantially from the previous year in concert with the declines seen in the investment markets.

Although these plans remain well-funded, we will experience a pension expense increase that will have a drag of approximately $0.10 per share for the year.

Another impact on the year involves fuel surcharges.

When they were rapidly escalating, in some cases, we discounted base rates in order to preserve the surcharges.

Now, as they have fallen, it will take time to cycle through the contract negotiation process to pull back some of those base rate discounts.

We believe this will be an impact throughout 2009.

For the first quarter, average daily volume in the Domestic operation is expected to decline between 3% to 5%.

We anticipate package weight will remain lighter than our historical averages until the economy begins to rebound.

International export volume should be down somewhat for the quarter.

The Supply Chain and Freight segment should post an operating margin similar to that of the fourth quarter with UPS Freight particularly challenged through 2009.

Over the longer term, we are evaluating operational changes that would leverage our small package, forwarding and freight ground assets in the US in an effort to capitalize on network economies of scale.

Ultimately, it is our plan to generate operational changes through both better alignment of our networks and asset utilization.

With respect to capital expenditures, our budget for 2009 will be $2.2 billion, some $400 million less than 2008's total.

At less than 5% of revenue, this will be the lowest we have seen this decade.

So while the current outlook is sobering to say the least, we are taking measures to strengthen the Company while focusing on helping our customers survive today's economic difficulties.

These steps will help UPS preserve its financial strength and enhance its leadership position in the industry.

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

(Operator Instructions).

Justin Yagerman, Wachovia Capital Markets.

Hey, good morning, guys.

This is Rob Salmon on for Justin.

Hey, guys, could you guys give us a sense of the -- in the prepared remarks, you had indicated that the pricing trends were stable in the domestic small parcel.

Could you give us a sense of how the pricing trends were throughout the quarter, particularly after DHL had made their announcement, if you guys had seen a step-up in terms of pricing and if you could give us the actual price per package for each month, as well as January, it would be helpful?

Yes, I won't get into that granular a detail, but certainly we do see over time improved pricing power in the industry.

At the same time, the dramatic changes in fuel surcharges are creating a lot of moving parts, so it is going to be challenging I think externally to fully be able to map all of those factors.

In general, we do feel that the pricing environment is very rational.

Certainly the DHL exit has a big impact on the market.

Their volume is, however, lighter weight than average and most likely, a lower average revenue per piece.

Although clearly as we have priced these DHL customers, we are extracting an appropriate premium for UPS' service and quality.

So it will be a year of transition, but overall, we remain resolute in being disciplined for pricing and as the fuel surcharge impact filters through, we think that it will be evident that the market is very rational.

Thanks, guys.

That's helpful.

And then shifting gears a little bit to the capital expenditure side of things, could you give us a sense in terms of your share repurchase plan?

You had indicated that you would scale it back significantly.

Kind of what that means and how we should be thinking about the repurchases throughout 2009, as well as if you could give us a sense of what your thoughts are on the dividend here as well.

I will talk a little bit about CapEx and then Scott will talk to dividend policy.

I mean right now, the mantra has been conserve capital.

Given the current uncertainty, our balance sheet remains a thing of beauty and is an absolute strength for us that we intend to protect.

So we are being prudent.

We did slow the stock repurchases.

We do remain committed to repurchasing and retiring shares over time, but we also want to make sure that we preserve our liquidity and flexibility.

We did, as you can see, take aggressive steps to reduce capital expenditures, pulling back really to just committed deliveries of assets, completing our Worldport hub expansion, which is one of the things that is allowing us to make such dramatic improvements in our air network.

So we will be very prudent and cautious on that, but still with a strong AA rating, we have got plenty of horsepower and I'll turn it over to Scott.

Well, I think, Kurt, you said it pretty well.

We continue -- our intent is to continue to reward our shareowners via dividends and share repurchase in 2009, even in this economic environment.

I think Kurt said earlier that likely share repurchase will be at a smaller amount.

I think that is prudent based on what has gone on in the credit markets.

We are seeing some stabilization in the credit markets recently.

As far as dividend policy, it is determined at the discretion of our Board of Directors.

But I will remind you that, despite earnings being down about 15% in 2008 versus 2007, that our free cash flow is outstanding at $5.7 billion.

So the cash position is great.

We will take a look at that.

The Board meets actually next week and normally looks at dividend policy at that point in time.

All right.

Thanks a lot for the time, guys.

Gary Chase, Barclays Capital.

Good morning, guys.

I wondered if you could just shed a little bit more light on the change in weight per package.

Kurt, you said DHL was a lower weight competitor.

How much of what you are experiencing is just mix and picking up that volume and how much of it is customer mix?

And what should we expect looking forward?

I mean with industrial economy doing what it is doing, should we expect the weight problem to get worse during the first quarter?

It's one of the first times I've heard a weight problem being losing weight, but in this case I guess it may be.

The majority of it is the economic cycle and we have been talking to that the last three or four quarters.

So clearly, in slow economic times, there are just plain less widgets per box and so the average weight of each package does tend to drift down.

Having said that, we did see an acceleration in that in the fourth quarter and certainly, we think some of that acceleration is marketshare gain from DHL.

It is still a moving target.

DHL really has just wrapped up their domestic operations.

So it is too soon for us really to characterize that or give you any specifics on the impact, but we do think that that will continue to bring volume to our network, but in some cases, lower weight than average.

We did see the same trends internationally where the weight shifts were substantial and certainly that is primarily economically driven right now.

And as you think about the actions that you are taking to resize the networks -- segment reductions, compensation changes, etc.

-- is there a way for us to think about how much of that was completed and in place within the fourth-quarter results that we have already seen and how much is yet to come?

Yes, the $500 million in network changes, operational changes, some of those, the majority of that is still rolling out.

Certainly, there was some portion of that towards the end of the year, but I would say the majority is still to be realized.

The compensation changes that we announced that are in addition to that really don't begin to kick in until March, which is our normal annual pay cycle.

So there is certainly still benefits to come from that and we will both extract the benefits out of that and frankly, we are busy working on continued reviews of initiatives all across the Company.

It is a top priority for us and we are going to make sure the Company stays in good shape.

And we have had a hiring freeze on throughout most of 2008 and all that benefits with attrition.

As people leave the payroll, we don't replace those people.

And Kurt mentioned in his earlier comments that, remember, that we are managing our workforce every day and you saw that in the last quarter where direct labor hours were down more than volume, 5.1% versus 4.4%.

So we'll continue to manage the variable costs on a daily basis.

We are -- some of the organizational structure changes, we made some of them last year, we made some of them effective in January when we took down six more district offices, which will help our organization moving forward.

So I think some of it you saw in 2008, but a lot of it is coming in 2009.

And is this sizing into the current economy or something a bit deeper?

Well, we certainly expect the first half of this year to be worse than what we saw in 2008.

And as a result, we're going to manage the Company to those levels.

We don't know when it is going to turn around, but we are going to manage it as if it is going to stay down for certainly all of 2009.

I appreciate it, guys.

Thank you.

Edward Wolfe, Wolfe Research.

Good morning.

Scott, when you think about right-sizing the network and let's call it you are giving guidance of negative 3% to 5% in Domestic and slightly negative in International, let's call it negative low something for the rest of the year, can you catch up by third or fourth quarter, assuming you don't go from negative 3% or 5% to negative 10% if it just stays in that range?

Can you start to see the margin year-over-year improve or do you just -- that is impossible the way the network is over that period of time?

I think it is going to be very difficult to improve the margins, Ed, if we have a declining economy.

We're going to do everything we can to hold the margins the best we can, but it is -- with the mix of the products and as Kurt talked about, the huge drop in weight in the products we saw in the fourth quarter, it is likely to continue the first half of the year.

I think it is going to be a challenge for us to do that.

We're going to do everything in our power and we're going to presume the economy keeps getting worse.

Frankly, I think the economy is going to -- you're going to see the biggest drop in the first quarter of '09, even worse than down 3.8% and down 6% IP numbers we saw in the fourth quarter.

The second quarter is probably negative, not quite as bad and it is not unrealistic to say it is going to flatten out at the end of the year -- the economy.

But we're going to manage it as if it is going to stay at the first or second-quarter levels.

If Domestic and International volume are both negative, should we assume International margins deteriorate more given the fixed cost nature of it and that they are coming from higher places?

Edward, we are really not in a position to go too far on outlook right now.

Clearly, there is a higher portion of fixed costs, but we are taking some pretty dramatic steps to take that cost out.

I guess one silver lining, if you will, since you are mining for some good news I guess, the dramatic reduction in fuel surcharges from up in the 30% plus down to what will be only a 1% surcharge in February we think will have a beneficial effect on our premium products.

Certainly, in a tough economy, it is not going to come booming back, but we do think that we will begin to see more of a balanced growth between our ground and air and our deferred products and our premium air.

So that will certainly be a positive as we begin to reverse some of those negative headwinds.

And as challenging as the economy has been, including Europe, we still showed pretty good transporter growth in Europe and expect to continue that growth in 2009.

Sure.

One last one about mix.

The deferred air yields have really weakened this quarter.

Is that DHL stuff coming towards deferred more than other products or is there something you are doing in particular there?

That is always a very volatile segment and yes, plus or minus a few big customers can make a big difference in that.

So it's -- you will see that one jumps around, Ed.

I wouldn't draw too fine a point on that.

I would say, Ed, the majority of DHL volume is heading towards ground also.

Thanks for the time, guys.

Jon Langenfeld, Robert W.

Baird.

Good morning, all.

Can you talk about the balance sheet and primarily the shareholder equity?

I am assuming there is probably a pension hit in there and you've got the write-down.

But essentially shareholder equity down by about $4 billion sequentially, can you walk me through the puts and takes there?

Yes.

Certainly, the big factor on that was the declines in our pension.

We did -- we had a fairly substantial pension asset at the end of last year.

That basically has been eliminated and actually we did show an increase in liability of a couple billion on that side.

In addition, we did repurchase $3.6 billion of shares this year.

So in aggregate, the combination of the loss on the pensions, the repurchase of stock and we did have one extra dividend payment in '08 due to us tightening up the calendar so that we really paid the November dividend before the end of the year combined.

So those were really the three primary factors.

The pension thing was a difficult issue for all companies with defined benefits.

What happens, obviously, everybody had investment losses in 2008.

Then at the end of the year, the discount rate actually came down, so it increased the liability.

So it is one of those things -- hopefully, you can see that turn around the next year or two.

Yes, we do -- our pension plans are still in pretty good shape.

They are about 90% funded and that is with us coming into the year with about 130% funding, something like that.

The combination of investment reductions and expenses produced that.

So it is an issue for us.

It is adding about $0.10 a share headwind on costs this year.

But we are going to continue to manage that and we think the strength of our pension plan remains an asset for the Company.

Absolutely right.

I think, even in this environment where we saw that kind of drop in asset value and pension plans, we are still well-funded.

A lot of other companies in the US are not well-funded and will use their free cash flow to fund pensions in future years.

Yes, no, I would definitely agree.

How big was the pension charge to shareholder equity in the quarter?

What was it?

About $3.3 billion?

Yes.

$3.3 billion, okay.

And then the fuel benefit --

$3.5 billion.

$3.5 billion.

After-tax.

And that is after -- remember, that is the hit on equity.

Yes, yes.

And then the fuel side, you quantified it in the call relative to your expectations that it was $0.10 more, $0.02 more in Domestic and International.

What was it in total relative to just the total benefit, excluding your expectations?

Yes, there are a lot of moving parts on that, Jon.

We tend -- you have to factor in expenses, direct and indirect, and all of that.

So we have -- really the guidance we have been giving is the relative impact of the month-over-month changes with the two-month lag.

So that is really all that we are comfortable saying today.

Okay.

But you had some expectations in your original guidance.

The numbers you gave on the call were incremental to that.

Absolutely.

And that is what we tried to provide some clarity on.

Okay.

And then the final question is on the International side, how much of the cost initiatives and revenue enhancement initiatives, two different things, are targeted on the International side versus Domestic?

There is a significant amount of focus on the International.

It is maybe a half a step behind the Domestic.

Frankly, our growth has remained very strong just up until this fourth quarter.

So we are digging in very heavily on that, looking at our air network, making sure that we are being prudent in the amount of capacity we have in the air.

We are also looking at operational models.

I mentioned our European ground network, looking for opportunities to better align our large forwarding operation in Europe and our package operations.

So there is plenty of opportunities.

It is, as I said, a little behind the progress in the Domestic where we have been facing reduced demand for some time.

Great.

Thank you.

Tom Wadewitz, JPMorgan.

Yes, good morning.

I wanted to try to get a sense of how you are thinking about the pace of operating expense increase when you look at 2009.

You have got some pretty significant cost reduction actions, but I know you have some inflation in your Teamster labor contract and so forth.

So if you take out the impact of fuel and you consider some of the cost savings and maybe your volume outlook, what is the magnitude of operating expense change in 2009?

Do you have any sense of that?

Is it down a couple percent, is it down mid single digits, can it be down 10%?

Well, we're -- as you know, we are very focused, really always focused on making sure that we adjust our hours to match the demand and our operations people I think did a superb job in the fourth quarter reducing direct labor hours in excess of volume.

So we are going to continue to have high expectations from them to adapt and react and make sure that we are eliminating and reducing hours wherever possible.

Tom, as you correctly pointed out, we do have a labor increase that becomes a little more challenging in a no-growth environment because the average seniority moves up and with the very favorable contract we got, we get the full benefit really with moderate growth.

So there are some headwinds in that area.

Pension expense, as we mentioned, will be up.

But we are very focused across the Company to right-size and match.

The management compensation and variable comp plans are changing, our operators are reinventing the wheel as it is to make sure that, as volume continues to be down and this will really be two years as we wrap some of these other declines, those are substantial changes.

We are rejiggering the network and doing everything we can.

So the goal is to have our direct hours move in concert with the volume reductions and then we're working very hard on all the other expenses.

Okay, so if you consider the inflation and the union agreements and then you consider your cost reductions, are you essentially just kind of offsetting the inflation in the union agreements with the specific cost reduction measures you have?

Well, if we can fully offset expense increases, we are doing great.

I mean we do expect real revenue per piece to continue to increase.

So that would be an admirable goal if we can really hold cost per piece absolutely flat in a tough economy with shrinking volume.

So I am not sure we can get all the way there, but clearly that is the kind of thing we are working towards.

Okay.

And just one last one and I'll pass it along to someone else.

On the pricing side, you sounded -- rational pricing, which obviously is good, but you also said maybe base rate is down because the optics of what you had done to preserve fuel surcharge mechanism might hurt you going forward.

So if you take out weight per piece impact and take out fuel surcharge, do you think, on a comparable basis, that base rate is actually down in 2009?

No, we don't.

No, we have gone back and done some extensive look at this over the last eight or nine years and there is clearly an inverse relationship between fuel surcharges and base rate retention.

When fuel surcharges go up, we do see a very clear reduction in our ability to keep more of the base rate.

Conversely, as that corrects, we do see better base rate retention.

So actually over the course of '09, we should see better base rate retention than '08, but it does -- there is a little bit of a lag as we go back, renegotiate contracts.

Our air customers will see dramatic reductions in expense this year because of the precipitous declines in the fuel surcharge.

We think that will allow over time better base rate keep.

So it is a transition and it needs to be rational and sensitive to our customers' needs, but we do feel good over the longer term that you will see solid and continued base rate potential.

Okay, great.

Thanks for the time.

Chris Ceraso, Credit Suisse.

Thanks, good morning.

Just a follow-up on that actually.

In the first-quarter guidance, how much have you assumed on a per-share basis from fuel or from the squeeze on base rates?

Well, if you look at our fuel surcharges, you are going to see some pretty dramatic surcharge reductions versus last year.

Ballpark for the quarter, based on what is in the bank and where the forward curve looks at, we will probably have about a 15% lower fuel surcharge Q1 of '09 versus Q8 on the air and probably a 3% headwind on the ground.

So those are some fairly significant shifts year-over-year.

Now not all of that goes directly to what the overall revenue per piece will be.

Compliance is not 100% and we do think we will have some compensation on the base rate side.

So it will be a very volatile series for you to track as we have these very significant year-over-year changes.

We will get a slight benefit of the fuel lag, certainly nowhere near what we saw in the fourth quarter, but the predominant issue we will be facing is to make sure that we are working with our customers and beginning to balance the appropriate rates now that the fuel has come way back down.

So just to clarify, on a net basis then, is fuel -- does it turn to a negative in Q1 or do you still have some lag benefit?

No, there is still a slight benefit in Q1.

Net net, still a benefit in Q1?

Okay.

What was the effect in Q4 of exchange at a total Company level bolt-on revenue and on operating profit?

Can you break that out for us?

Yes, exchange rates were relatively neutral.

We do fortunately have some favorable hedges in place that actually cost us some profits as the euro and the pound were at very high rates because we sold away some of the top end, but now that they are plummeting, we are able to stabilize it and that is really the intent of the hedges, to stabilize earnings volatility.

So there was a benefit to the hedges and a slight benefit for some revaluation of assets, but you are talking small amounts.

So we were very pleased for the International that the hedges worked as we expected.

And we are well-hedged through '09 for the euro and for the pound through the first half of the year.

Last question.

You're bringing down CapEx, you are slowing down the share repurchases, so I would assume you will still generate significant cash flow.

Is the first priority to start paying down some of the debt or where else would it go?

Well, clearly, UPS is always a company that generates great free cash flow.

You saw that in 2008 and you will see it again in 2009.

We are working on -- we are still going to make distribution to shareowners via dividends and via the share repurchase.

Share repurchase not at the same level probably as we saw in 2008.

We are going to be looking -- there will be opportunities out there for us too.

We think great companies get stronger in down economies and we think there will be opportunities for UPS to buy assets and/or companies at below market value in the year or two ahead of us.

So we think this is a great opportunity to keep our powder dry and look for opportunities to make UPS a stronger company for the future.

No emphasis on debt repayment at this point; you are happy with the current leverage?

We are happy.

Our funds from operations to debt -- it was above the 50% to 60% level we had targeted and we will keep it probably in that level for the future.

Thank you very much.

William Greene, Morgan Stanley.

Yes, good morning.

As we looked at the fourth quarter, economic activity obviously slowed.

Can you give a little bit more color maybe around how your volumes trended by month in the quarter?

Yes, it was an interesting quarter that way.

We saw sequential worsening from October to November and so the discussion we had in the October, things actually began trending down even worse in November.

There is the impact of when Thanksgiving fell, but makes the November, December results a little tangled.

But we actually were somewhat pleased by the way the holiday turned out.

Volume overall for the holiday season was close to flat with last year.

Although, as we mentioned earlier, it was the wait till the last week and a half syndrome that we had that does make things a little challenging.

So we did see firming up of our volume trends during the holidays.

Certainly some of that is most likely customers that decided to jump over to UPS in light of the dramatic uncertainty at DHL during the holidays.

So trying to separate exactly what was that transition and what was true strength in the economy is tough.

We do think though based on our guidance we gave you that trends are going to return back closer to what they looked like in October and maybe November than what we had in December.

One interesting note, on the Internet shipping this year, we did see much more modest growth and really the Internet shippers did not outperform the rest of the bricks and mortar this year.

Although certainly there were a few notable exceptions like Amazon, but it was a little different peak as far as the mix of customers.

So was your B2C trend, was it much slower than you have seen in the past because you had been I think adding a point or so in terms of total percentage of the domestic volume?

I think we were around 30% or so.

It certainly continued to outgrow, but we have seen big sequential changes, back to Scott's comments about the consumer, in B2C volume slowing.

But the consumer did come through and we did see B2C increases in the fourth quarter or at least in December.

And in January, the trends that you gave for the quarterly guidance, January trends were roughly in line with that?

Pretty much.

It has been a noisy January with substantial weather events, with the inauguration.

So in general, we think that, based on what we are seeing in January, that guidance is appropriate.

All right.

Thanks for your help.

John Mims, BB&T Capital Markets.

Good morning, guys.

Looking at that CapEx budget, what is your kind of minimum maintenance CapEx level?

I mean we have had a number of discussions on that.

Probably the best approximation we have for maintenance CapEx is our depreciation expense.

And so we are still modestly above that, but we have been fairly rigorous this year in looking at CapEx.

We do have some growth CapEx in for next year -- the completion of the Worldport hub and additional receipts of some aircraft, 767s and 747s.

But certainly we have tightened up in most areas and are really restricting to maintenance on our facilities and our vehicles at this point.

Having said that, the Worldport expansion is both an expansion of capacity and also a tremendous efficiency move, as I mentioned earlier, where, because of having such an amount of capacity in one location, we are able to reduce the number of regional air sorts we have, making much better utilization of our aircraft.

So we will continue to invest where it makes sense.

We have the capital, but we are going to be prudent right now.

Right.

I guess what I was getting at is if you break down stuff like the aircraft delivery, what is scheduled for '09 of the 767s and the 400s?

Three 767s and three 747s come in '09.

In '09.

So the 24 -- I guess 26 other planes are 2010 and beyond.

I was trying to see if it is possible to push this back, especially with fuel -- is not as big an issue now.

If flying the 200s and some of the older planes is more attractive, if you can kind of hold off on those purchases.

Yes, we are looking at that.

At the same time, we are -- we do intend over time to migrate the DC-8 fleet out.

With aging aircraft directives, it is likely in the next three to four years that most of those will become uneconomic.

So we are just balancing that.

We do have cash.

We think we have got favorable terms and if it makes sense to defer out, we will certainly talk with Boeing and any other providers.

(Operator Instructions).

Ken Hoexter, Banc of America.

Good morning.

Kurt, Scott, can you -- Kurt, you were talking a bit about pricing before and the contract.

I guess I just want to understand that a little bit better.

So if you have got contracts with customers and as fuel was running up, did you go back to them and reduce the base rate in that in order to keep them, so obviously you felt some competitive pressure to do that if that is exactly what you were highlighting?

So does the contract not kind of automatically revert if fuel fell as dramatically as it has?

I just want to understand the process and the time that it is going to take to retest some of those base rates.

Yes, Ken, maybe the simplest way to think of it is more that, as we do our annual rate change and go to customers with a rate increase, we negotiate how much of that to retain in their expenses.

When you have got fuel at 20%, 30% plus, it is very difficult to retain much of that base rate increase.

So it is more over the course of last year.

In some cases, we did sacrifice base rate increase because of the extreme costs that our customers were facing for fuel.

As that moderates then we do begin to recover and get more back onto a normal approach keeping the base rate increase.

And that shouldn't really be a surprise.

We have talked about that over the last two years because of the impact that fuel had on base rate.

It is one of the reasons -- it is very difficult to just purely pull the fuel surcharge out of our overall rate changes as far as what the real pricing is going on.

That's fine.

That is it, Scott.

I was just trying to see if there was a timing impact on that.

Just a follow-up on the UK, it sounded like on this write-down that you are taking, are you shifting from providing domestic services in the UK or is that -- did I misinterpret what you were saying there?

No, what that is is we did make a domestic acquisition in the UK several years ago and over the last couple of years have been busy integrating that with expanded hub in the domestic area.

As we reviewed the operations there and looked at the impact of the economy, most notably on the domestic UK business, it was clear that the value we had assigned to their existing customer base really was not appropriate.

Many of those customers had churned out.

Certainly, we brought domestic services to a lot of our import/export customers.

So in general, the business is healthy.

But as part of the acquisition, we attributed a value to the customer base and as we reviewed that, it was clear, given where the economy is and the migration in our customer base, more from the ones we had from the acquisition to our existing customers with Express, that it made sense to adjust it.

David Ross, Stifel Nicolaus.

Good morning, gentlemen.

A question on UPS Freight.

It looks like you've lost some money there in the fourth quarter and it is a pretty challenging LTL environment out there, as you mentioned.

With the network you currently have in place, after integrating Overnite, Motor Cargo, have you had to rationalize that at all?

Have you closed any terminals or are you tweaking that network?

Well, we really did quite a bit of that as part of the integration of the Motor Cargo group and the Overnite group.

So we don't see dramatic changes in the physical assets.

We do believe we are going to continue to gain share.

You can see that our growth did slow substantially.

Frankly, some of that is, in some cases, losing some big customers that we have just decided not to chase.

So we still feel pretty confident that we will get back on a very strong growth curve with marketshare gains.

But it has been a tough year and we are still trying to strike that balance of helping our customers save money as we bring them more value.

As I said though, one of the things that is proving most successful now is what we call our Freight Rate Calculator that allows shipping managers to see rates in an LTL format for both our small package and our freight services.

So it has been very successful of us going to customers, helping them reduce their spend by 10% to 15% frankly without a lot of rate pressure because we can find the best mode for each shipment individually and show that in a way that is apples-to-apples.

So we are going to continue to enhance service, invest in technology, but at the same time, in this environment, we have got to make sure that we don't get ahead of ourselves and we will continue to be cautious on that.

Clearly, UPS Freight is on a cost reduction campaign also.

But long term, we are optimistic.

But given the current environment, we just thought it was prudent to take the impairment.

And just to follow up on that with the cross-sell between LTL and parcel, where are you in penetration I guess of parcel customers with the LTL business?

I know it has been targeted for a while, but any color on -- is there -- is that just scratching the surface or you have a ways to go?

We are still in the early innings.

Frankly, we have been a little disappointed that that has taken us longer than we had hoped.

I think some of the economic uncertainty and chaos has distracted our customers and maybe even our salespeople a little bit.

But that is a priority for us this year and we are very confident it is a unique differentiator.

Yes, I have just come back from visiting all of our domestic region locations and I will make it real clear, that is a high topic, a big priority for our company in 2009 and our people are going to pay a lot of attention to that cross-selling and bundling opportunity.

Robin Byde, HSBC.

Good morning, everybody.

Just on DHL and your Q1 earnings guidance, just to clarify, does the range you have given assume volume gains from the DHL shutdown or is this guidance just on the underlying business?

Thank you.

No, Robin, this guidance is our best guess of what will come through in Q1.

As I said, it is still a little bit of a moving target as operations just ceased there I think last week.

So we have a number of customers that came onboard in the fourth quarter.

Certainly there is more that we are bringing onboard in January, but until the dust settles, we are hesitant to give you any specific information.

So clearly we will talk more about DHL in the next quarter's call.

One note I do want to make though is that this is not just a domestic US event.

Within the US, we are also seeing a number of customers come to us related to their import/export needs.

As DHL reduces their service footprint, we think our value proposition for our International network is compelling.

And also we are seeing frankly increased interest outside the US in customers coming to UPS.

So we intend to press the advantage across the globe.

Okay, thank you.

And can I just follow up with a question on your European forwarding operations?

Can you just tell us what you're seeing in terms of slowdown on Asia to Europe trade?

I mean are market trends getting weaker or flattening out?

They are certainly getting much weaker, yes.

I think the areas of continued strength -- although maybe strength is stretching it -- we are continuing to see intra-Europe trade remain more vibrant.

Although that is primarily small package and clearly Asia to Europe is close to flat now where we have seen very strong growth.

Probably the biggest change we might have seen in the fourth quarter was Asia to Europe was growing at a fast pace until the fourth quarter and it really moderated.

David Campbell, Thompson, Davis & Co.

Yes, good morning.

I am surprised how much money you made internationally in the quarter given the fact that revenues, International revenues were down substantially from the third quarter.

You made almost the same amount of money as the third quarter.

In fact, you made a little bit more on an adjusted basis.

Other than fuel consumption, is there anything else going on there?

There is seasonality there to a certain extent and we expect to make normally more money in the fourth quarter than we do in the third.

If you recall, the third quarter in Europe, there are so many holidays there in August, it almost shuts down.

It's just a tough quarter for us.

So we did a nice job internationally.

We'd still like to see more profits in the fourth quarter than what we made.

Yes, but you wouldn't expect that same situation in the first quarter?

Certainly Q3 to Q4 is always an increase and as Scott said, we are looking to continue to improve margins.

We do see challenging comps Q1 over Q1 and that is booked into our guidance.

So the International though is changing more rapidly frankly than the Domestic.

Domestic, we have been fairly stable over the last quarter or two.

Although month-to-month it can change.

The International, we are staying on our high alert to make sure we right-size the network.

Right, right, right.

Well, thanks.

All my other questions were asked.

Scott?

Just let me wrap up with a few comments.

Nobody is escaping pain in this financial crisis.

Our employees feel it, our customers feel it and certainly our shareowners feel it.

But I want to remind you that we are a great company that is just operating in a bad economy right now.

Great companies do weather the storm and they come out stronger.

What it comes down to is the strength of our balance sheet, the power of our brand, the value of our services, the contributions of our people and the quality of our leadership.

UPS has all of these strengths and we will prosper as we move into the future.

Thanks so much.

Thanks for joining us this morning.

Ladies and gentlemen, that does conclude your conference for today.

Thank you for your participation and for using AT&T's executive teleconference.

You may now disconnect.