聯合包裹運送服務公司 (UPS) 2009 Q1 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the UPS investor relations first-quarter 2009 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 all yours.

Good morning, everyone.

Thanks for joining us today.

In a moment, Scott Davis, our CEO and Kurt Kuehn, our CFO, will discuss first-quarter results and expectations going forward.

Before they begin however, I'll briefly 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 risk and uncertainties, which are described in detail in our 2008 Form 10-K report.

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

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

Before I turn the program over to Scott, I want to point out that there was an aircraft impairment charge of $181 million in the quarter that reduced operating profit in the US Domestic Package segment.

This resulted from the earlier-than-planned retirement of UPS' entire DC-8 fleet of 44 aircraft.

Retiring these aircraft will give us the most modern, fuel-efficient and noise-compliant fleet in our industry.

The after-tax impact of this charge was $116 million, or $0.12 per share.

Excluding the impairment, adjusted earnings per share are $0.52.

This is the amount that Scott and Kurt will refer to in their comments this morning.

Reconciliation of this adjustment to comparable GAAP measures is explained in the schedules that accompanied our earnings news release this morning.

The schedules are also available on the UPS IR website in the financial section.

For the quarter, you will also notice our effective tax rate was a little higher than expected.

This was due to a valuation allowance we recorded during the quarter, which should have no impact on our expected tax rate of 36% for the remaining quarters in 2009.

To begin our review of the quarter, I will turn the program over to Scott for opening comments.

Thanks, Andy and good morning, everyone.

In the first quarter, the global economic downturn intensified.

In fact, forecasted GDP growth in 2009 for the top UPS markets is now expected to be less than last year and is negative in all but two -- China and Poland.

Looking at the US, of most interest to us is industrial production, which, for the first quarter, fell 20% quarter to quarter and 11.7% year over year.

The second quarter is expected to be modestly weaker than the first.

We anticipate second-quarter GDP will also decrease quarter over quarter, but at a much slower rate than the decline we saw in the last two quarters.

Hopefully, we will hit bottom later this year and begin seeing growth at the end of the year or early next year in the US.

On the international front, Asia should see improvement in the same timeframe, but certainly at different degrees in different countries.

Europe most likely will lag the rest of the world in the pace of its recovery.

Against this background, I am pleased to say UPS is managing its operations effectively.

While we are certainly not happy with the declines in revenue and profit, we do have a number of bright spots.

Both our US Domestic and International Package businesses gained marketshare and continued to generate industry-leading margins.

Our revenue enhancement and cost-containment efforts are bearing fruit.

Service levels in all our businesses are at all-time highs.

Our financial strength proved beneficial in support of a very successful debt offering during the quarter.

And many of the operational and process changes we are implementing to meet today's challenges are producing results now and will remain effective when the business environment improves.

All in all, UPS will emerge from these difficult times as a more efficient, finely-honed enterprise.

In the midst of this worldwide recession, no one should lose focus on the importance of global trade.

It is one of the most important tools we have to help lift us out of this financial crisis.

In fact, at the risk of oversimplifying, it may be the most important tool.

The fragile global economic conditions we are all dealing with raise a serious danger of increased protectionism as individual countries seek to bolster their own economies without regard to broader implications.

Global trade has sponsored two decades of dramatic growth and increased prosperity in countries everywhere.

Now is not the time to back away from the progress that has been achieved in the mistaken belief that any one economy can regain strength independently of the rest of the world.

Now for a few comments on our dealings with DHL.

In light of DHL's reduced airlift needs, we were unable to reach an agreement that made financial sense to UPS.

Therefore, we mutually agreed to terminate the negotiations.

However, UPS has been successful in our efforts to attract former DHL customers in the US domestic market.

Kurt will provide details shortly.

The changing competitive environment offers UPS significant growth opportunities.

Our balanced worldwide presence, broad product portfolio, financial strength and knowledgeable, dedicated personnel are a combination no other player in this industry can match.

Customers, both present and future, will benefit from this unique value proposition.

Before I turn the program over to Kurt, I want to take a moment to thank UPSers for their dedication and hard work.

They are achieving exceptional service levels throughout all areas of the Company, continuing to strengthen our customer relationships.

This is particularly important in a business environment like the one we have now.

Here is Kurt to review the quarter's results.

Thanks, Scott and good morning, everyone.

Our earnings per share of $0.52 were at the low end of the range we provided last quarter, reflecting today's tough economic environment.

I will begin my review with the US Domestic Package operations.

First-quarter package volume continued to be weak with little sign of the typical seasonal buildup prior to Easter.

Volume gains from the departure of DHL from the US domestic market only partially offset the impact of worsening economic conditions.

Package volume for the quarter declined 4.3% with ground down 5% and air down less than 1%.

Although we believe trade-down in premium products has slowed a bit, DHL wins exaggerated the improvement.

In fact, excluding DHL gains, Next Day Air volume declines would have been only moderately better than in the fourth quarter.

The drop in revenue per piece resulted from the significant reduction in fuel surcharges as the lagging index caught up with declining fuel prices.

This was particularly apparent in the air products where fuel surcharges were down more than 15% year over year in the quarter.

As I told you three months ago, when fuel surcharges rapidly escalated, we did discount base rates in some cases to preserve the surcharge.

We are cycling through the contract negotiation process to pull back some of these discounts.

However, today's economic environment does make this a bit challenging.

Lighter average weight per package and changes in our product mix also contributed significantly to the revenue-per-piece decline.

For example, Domestic Package weights dropped 8% with Next Day Air down almost 14%.

The shift in mix away from premium products negatively impacted yield as well.

These trends, along with a decrease in volume, eroded margins across all products.

And even though we have made substantial adjustments to our network, margins will remain under pressure until economic conditions improve.

We are managing our operations well in the face of declining volume.

For example, labor hours and miles driven were both down over 5% and domestic block hours decreased about 6%.

Our cost initiatives are producing results also.

Excluding fuel, other operating expenses declined over 10%.

Our US workforce has been reduced by more than 10,000 employees.

80% of whom are from the direct labor workforce.

However, savings in direct labor hours are being mitigated by the fact that wage inflation for this group has increased due to a higher percent of our employees at the full seniority rate.

In the quarter, UPS expanded our service offerings to help customers better address their transportation needs.

We extended the guaranteed early morning delivery territory in the United States to more than 23,000 zip codes.

UPS now delivers overnight by 10.30 or earlier to more businesses in zip codes than any other transportation carrier.

Additionally, we also announced a new flexible returns program that allows consumers to return items shipped via UPS by placing them in their own mailboxes for pickup by the U.S.

Postal Service before eventual transfer to UPS.

There is strong customer interest in this program.

Before I move on to the International segment, I want to shed a little more light on the impact of DHL's departure from the US domestic market and then comment on the retirement of our DC-8 fleet.

We are pleased with the results of our sales efforts targeted at winning DHL domestic business.

UPS captured a little more than half of their revenue with the remainder split among our competitors.

Although we pursued all DHL volumes aggressively, we put less focus on the lightest weight, very low revenue packages.

Even so, DHL volume wins had an average weight that was just a little more than half the UPS average package weight.

Because the market recognizes the greater value we deliver to customers, we added this new volume at rates 10% to 15% higher than typical DHL rates.

We did see some former DHL customers manage their shipping costs down by changing modes.

And as a result, UPS actually saw a greater increase in ground volume than air.

DHL volume came onstream throughout the quarter and there is still opportunity for additional DHL wins as we focus more on US imports and exports, leveraging our tremendous advantage in the US.

Turning now to the early retirement of our entire DC-8 fleet.

Basically, our air network requirements have changed.

Package volumes have declined due to the economy.

Our Worldport expansion allows more volume to be processed through this centralized hub and optimization of our network has reduced gateways and allowed us to close regional sorts.

These factors, combined with the decision to not provide airlift for DHL packages, have made the DC-8 aircraft unnecessary.

Therefore, we are retiring the fleet earlier than planned, which will result in operating cost benefits going forward.

This is part of our ongoing efforts to modernize our air fleet, which have given us the youngest, most fuel-efficient air fleet in the sector.

Now let's look at the International segment.

Volume declined 1% with domestic volume essentially flat and export volume down 1.8%.

The timing of Easter aided both products by about 2%.

Compared to the double-digit market declines, UPS again realized significant marketshare gains.

Revenue per piece though was down over 15% with currency having the most significant impact although currency had a minimal impact on International operating profit as a result of our hedging activities.

Excluding currency, revenue per piece was off 9.3%, the result of mix changes, reduced fuel surcharges and lower weights.

Package weight declines accelerated during each month of the quarter and this was evident in all regions, all industry sectors and across all products.

We anticipate that these trends will continue throughout the year.

Operating margin for the segment was 13.1%.

Although lower than our historic levels, it is the best in the industry by far.

As we have mentioned in the past, our International cost structure is somewhat less variable than our US network.

Therefore, cost control in International is a very high priority.

The initiatives that we discussed in the last quarter are starting to produce cost savings in our network.

For example, international block hours dropped over 12% in the quarter, the largest reduction in our history without impacting our service footprint.

Also, our nonoperating costs declined over 5%.

At the same time, we are aggressively pursuing the advantages created by our balanced global network and that is why we are seeing high bid volume and bid wins among new customers while retaining current customers.

Our extensive product portfolio, paperless invoice and robust returns capabilities and one contact person for all service types are driving our successful market penetration efforts.

Turning now to the Supply Chain and Freight segment.

Revenue was down almost 20% with all business units experiencing declines.

The operating margin of 2.3% was about what we saw in the fourth quarter despite the fact that both the global freight and LTL markets deteriorated during the quarter.

Forwarding and logistics experienced only minimal impact on operating margins as they successfully reduced costs commensurate with the decline in their revenues.

New wins in the healthcare and high-tech sectors helped to bolster the logistics unit.

Our continued investment in healthcare and expansion of our product offerings in this sector are paying off as we continue to attract new customers.

In a worsening LTL environment, UPS Freight posted declines in revenue and tonnage, but shipments per day were basically flat.

Growth did strengthen sequentially through the quarter; although pricing did not improve.

We did capture new business through cross-selling activity and leveraging our investment in UPS freight technology.

We are experiencing increases in WorldShip deployments and in the number of daily shipments that are managed via our Quantum View visibility tools.

All in all, UPS Freight realized share gains in the quarter; although this is certainly a case of less bad than most.

Before addressing our expectations for the second quarter, I want to review our financial position.

Free cash flow for the quarter was $1.9 billion, an increase of more than $200 million over last year, excluding the impact of tax refunds in 2008.

This increase was achieved through a significant reduction in capital expenditures and through excellent management of working capital.

In the quarter, UPS invested $382 million in capital expenditures, spent $113 million to repurchase 2.5 million shares, and paid dividends of $449 million, maintaining our $0.45 per share dividend.

Our intent for 2009 is to repurchase shares at a rate that will at least offset dilution from stock-based compensation.

At this point, sustaining the dividend is a higher priority than expanded share repurchases.

Another financial highlight of the quarter was our successful $2 billion debt offering.

We offered $1 billion each in five-year and ten-year debt, both of which were substantially oversubscribed at coupons of 3 7/8% and 5 1/8% respectively, reflecting UPS' broad access to markets at a low cost of capital.

Proceeds will be used primarily to retire commercial paper.

And now for our outlook.

Current consensus forecasts project economic conditions will worsen slightly in the second quarter with both GDP and industrial production expected to be a bit weaker than in the first quarter.

In addition, the timing of Easter will have a negative impact on second-quarter results, most notably in the US and Europe.

We anticipate that US Domestic Package volumes will decline 4% to 6% versus last year, with the lighter weight trends continuing until industrial production rebounds.

Domestic Small Package margins will be challenged due to mix shift, lower weight packages and reduced volumes.

International export volume is expected to decline about 3%, but we should see some margin expansion over the first quarter as a result of the segment's cost initiatives.

The Supply Chain and Freight segment is anticipated to show improvement in revenue and operating margin over the first quarter, but will still be below last year's results.

We remain vigilant about taking costs out of our operations.

In fact, we have identified additional initiatives that will produce approximately $300 million in savings, bringing total savings from our initiatives to well over $1 billion for 2009.

These initiatives span the entire enterprise and involve operational changes that increase efficiency, procurement improvements and better use of facilities.

And they are in addition to the way that we manage our business on a daily basis.

We have also further reduced our CapEx budget for the year by over $200 million, bringing the total to just below $2 billion.

This budget still provides for capital investments in strategic growth opportunities like China, Worldport and our healthcare facilities in Puerto Rico and Europe.

Given all this, earnings per share should be within a range of $0.45 to $0.55 for the quarter.

This range reflects our expectation that the second quarter will be a bit more challenging than the first.

Clearly, these are extraordinary times.

We are making the difficult decisions and implementing changes to respond to these unprecedented conditions.

At UPS, we have managed through 20 recessions over the past 100 years and we are confident that we will emerge stronger and more competitive when the economy turns around.

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

(Operator Instructions).

Gary Chase, Barclays Capital.

Good morning, guys.

Just a couple on the progression from the first quarter into the second.

How would you define what the biggest challenge was?

Has it been the weight erosion through the quarter because it looks like volumes came about in line with where you thought?

You are towards the bottom end of the range.

At one point, you thought the second quarter would look up relative to the first.

So it feels like something sequentially changed as you moved through the quarter.

Was that just the weight issue or was there more to it?

Really, Gary, the trends across the first quarter were fairly stable.

January, there was some challenges with weather.

It is a little noisy because the Easter holiday had a much bigger impact in the first quarter last year; whereas, it will hit the second quarter this year.

So all in all, domestic trends I would characterize as very low, but fairly stable.

We do think the economic statistics will show a slight decline from Q1 to Q2; although the rate of rapid decline clearly seems to be stable.

So the Easter impact puts a little bit of a headwind into Q2 versus Q1 and that is really the major difference in why we think Q2 will be modestly more challenging than Q1.

The industrial production numbers, Gary, were obviously horrible in the first quarter and while the quarterly declines won't be nearly as bad in the second quarter, we still expect them to decrease.

So whenever industrial production decreases, it will continue to challenge the weight of our packages, which does put pressure on us.

Gary, one other comment, I guess, is, as I mentioned in my prepared remarks, we did complete a $2 billion bond issuance late in March and we are very pleased with the coupon rates we got, but we are going to see going from 30 or 40 basis points with the very attractive commercial paper rates, a 400 plus basis point increase and interest expense on that.

So that alone adds another $25 million or so expense on the P&L side; although clearly it locks in some great rates for a long time.

Okay and then if you just -- if you look at the line items, the cost line items that weren't affected by fuel, so you take out purchased transportation and obviously fuel expense, it looks like those were down somewhere in the 5% to 7% range on a revenue decline of 13%, 14%.

How far through the cost-reduction process are you and what might that look like as you have more time to address this?

Gary, let me reframe that just a little bit.

We were down 6% or 7% in those nonfuel elements.

Although if you take out the write-off of the DC-8s, it is actually about 10%.

So that is implicit in the other category.

But this is against a decline in volume of about 4%.

So yes, revenue is down dramatically, but a big piece of that is fuel.

But we are working diligently on these cost trends and they do continue to get more significant over time.

We did freeze management salaries.

That kicked in in March.

We did show a dramatic reduction in block hours both domestically and internationally.

Much of that happened at the end of February.

So we are running full speed to match our network and our costs to demand.

And as things stabilize, clearly we will catch up to some of that.

But it is a challenge when you see these kind of really unprecedented changes in the economic conditions.

Is there any way to say you are 50% through it, Kurt?

60%, 70%, 20%?

I would be hesitant to put a number on it.

We are going to continue to pursue it and match whatever we can to the conditions.

What is really going to drive the improvement I think is as we start seeing volume growth again, which will impact our effective labor wage rate.

As we talked about many times in the past, two years ago, we were running with an effective wage rate of 2% increases on much higher contract increase than we have today.

Today, we are pushing more like 5% effective wage rate increases because of the, as Kurt mentioned in his comments, the seniority levels.

I think 88% of our employees now are at high seniority levels.

Okay, thanks, guys.

Jon Langenfeld, Baird.

Good morning.

On the International side, you talked about maybe slightly better margins in the second quarter.

How does that balance off of the fact that it sounded like weight per shipment dropped throughout the quarter and then you also have Easter?

I guess would have anticipated maybe a little bit more challenging second quarter on the margin side versus first.

Well, clearly, the dramatic changes we have made in the air network, Jon, will continue to pay dividends.

Typically, the second quarter is stronger than the first quarter internationally; although the Easter holiday has something to do with it.

So we are not looking for breakthrough quarter-to-quarter improvements.

We just feel that, on balance, the reduction in expense and the management of our network will help to offset the slightly weaker volume demands.

But we are working hard in that arena and as we said, we have been very focused on managing costs in the last couple of quarters internationally because, for the past decade, we have had just nothing but very strong growth.

So we have had to shift gears a little, but we are very pleased with the progress.

Okay, good.

And then on the additional cost savings side, is there anything -- is there anything new there or is it more of the same just at different levels of the organization?

No, it is just continuing to look for opportunities.

With the unprecedented declines we have seen over the last couple of quarters and the economic conditions, it just brings us to looking at new areas and further adjustments in the network with the air business probably being the best example.

As we take down the regional, night sorts, concentrate volume through our automated building in Worldport, we find more and more opportunities.

And then the last question I have is just on the Supply Chain side, when do you think the LTL business can get back to profitability?

Does it need a better environment?

If things stay where they are at for the next 12 to 24 months, will it continue to incur operating losses?

Well, Jon, I guess we are kind of -- in the LTL right now, I guess to paraphrase Charles Dickens, it is the best of times and the worst of times.

We did take a large impairment last quarter and clearly very disappointed at the need to do that.

But we saw substantial improvement over the course of Q1 as our initiatives, as our technology integration with our customers really demonstrated to them that they can improve processes.

So as I said, we did get -- shipments where actually up moderately in March and that is swimming against the tide we think because almost everyone of the competitors that have reported have talked about double-digit declines, at least in tonnage.

So we feel pretty good that we're building some momentum.

We think we have a very unique value proposition and ease of use and so we are not just waiting for the economy to improve in LTL.

We think we have got a company, specific opportunity that will show improving results; although clearly in today's environment, it is more challenging than it would normally be.

Got you.

Thank you.

Tom Wadewitz, JPMorgan.

Yes, good morning.

Wanted to get your sense of -- a little more on the cost side.

It seemed like you were a little reluctant to talk about how much you realized in first quarter.

But is there a time in the year when you would expect to be at closer to the full run rate on those cost initiatives?

Is that -- do you reset in second quarter or does it take a bit longer to get to that?

Tom, it is just a series of successive initiatives.

We initially built $500 million of specific operational initiatives.

Most of those rolled out by the end of Q1.

We did make compensation changes that began to kick in in March and then this additional set of initiatives will be happening over the next couple of quarters.

So if things continue to drop, we are going to continue to find new ways to adapt to take costs out of our network so we operate effectively and can offer customers the best opportunity for value.

And Tom, there will be more initiatives as we go along.

As we mentioned in the past, in the latest labor contract we agreed to with the Teamsters, we have a competition committee that allows ourselves and the Teamsters to get together and look at more flexibilities that make us more competitive.

And I think the relationship has never been better.

So I'm confident that that team of people will come up with more ideas, better ideas as we move forward.

Okay.

So how do you think about the -- how much of what you are taking out is fixed costs that won't come back when volumes improve?

And also the type of operating leverage you could show and margin improvement you could show if you look out a number of quarters and volume stabilizes and then begin to improve?

Is it the type of thing where it is easy to see this type of sharp margin deterioration, but then when you regain it, it will be very slow?

Or given some of the wage inflation, maybe it works the other way.

When you add part-time people and lower fixed cost base, that type of thing?

You could really show some strong margin leverage coming out?

Tom, those are a lot of the things we are talking about in our forecasting meetings.

There is a lot of moving parts.

Some of the things are permanent changes.

The expansion of Worldport that allows us to operate a more efficient air network is a keeper.

We have added capacity there.

It has reduced the number of aircraft in the sky.

It has allowed us to retire these 40 plus DC-8s.

Those are structural changes that will allow us to have both better service and substantially less cost.

Some, like the wage rates, depending on the rate of growth as it comes back could kick in reasonably quickly.

Our seniority employees are seeing about a 2.5% wage increase.

So the inherent inflationary concepts inside this contract are very favorable, but as your growth slows and you don't bring in new employees, it mitigates the benefit of that.

So that will come in reasonably quickly and we have also made structural changes in our organization -- reducing the number of districts we have and just trying to become more streamlined in our organization.

So all of those will come over time.

And that is half the equation, Tom.

The other half is the revenue side and clearly, we have never seen industrial production numbers as bad as we saw in the last quarter and they won't be probably great this quarter.

But inventory levels are getting down to a bare minimum right now and you're going to start seeing manufacturing, you're going to start seeing heavier products.

Whether it is end of second quarter or third quarter, I can tell you exactly, but it is going to be a combination.

You are going to see the revenue mix get better and the labor mix get better.

I guess there is one economic perspective that we also believe in, even though we are being pretty cautious right now.

But there is a high correlation between the severity of a recession and the speed of the improvement and given the dramatic declines, into Scott's comments about the inventory reductions, we think there is certainly a lot of latent potential for some rapid improvements when things start to turn the corner.

Okay.

If I can -- one more wrinkle on that.

Is it possible to see -- I think you said inflation in wages up 5% when volumes are down so sharply on the seniority.

Is it possible to see a quarter where volumes were up significantly that you could have wages effectively down due to mix?

You could paint probably a scenario there, but that is probably at the extreme.

Right, okay.

Certainly, a dramatic decrease from what we are seeing today.

Okay, good.

Thank you for the time.

(Operator Instructions).

Edward Wolfe, Wolfe Research.

Thanks.

Good morning.

Why is your guy's domestic air business stronger than your ground right now?

You said it is not DHL; that stuff is moving towards ground overall.

I mean FedEx is seeing such a different experience.

Why is it that you are seeing that experience and then why is that mix hurting you so much?

Because you gave the weight -- a lot of different numbers for weight, but I thought I heard you say Domestic Package weights down 8%, but that was before the DHL, which is 50% lighter.

So I am guessing the economy is not bringing it down 8%; it is a combination of those things.

So within that question I guess I am asking you is why, for you -- are you focused on air?

Is that something that is going on or why such a different experience from FedEx?

And then talk about the weight in terms of what you gave versus if you adjusted that for the DHL mix?

Okay, let me try to separate those moving parts, Ed.

The stronger results in Q1 for the air are significantly impacted by the DHL wins.

Granted, we won more net.

After customers migrated their shipping patterns, we showed more volume increase to ground than air, but the size of our relative operations -- we have over 10 million ground shipments a day and only 2 million air shipments.

So on a percentage basis, the air was much more heavily impacted by DHL.

So it is not anything dramatically unique there.

Having said that though, we are very comfortable with the value proposition we can offer in the air.

I referenced today that we have expanded zip code coverage, so we offer earlier deliveries than anybody else in the industry.

We have got a broader set of drivers that are out everyday being able to cover middle market and extended areas earlier than our competition.

So the DHL impact clearly boosted the air results and that is why we wanted to be careful not to say that the challenges of the air are over; it is just the relative impact was greater.

The substantial reductions in weight we saw were also impacted by the DHL wins.

I don't have an exact number for you, but we saw a substantial pick-up in weight reductions.

Maybe a little less than half of that weight impact was probably driven by the DHL volume coming into the network.

So it is a lot of moving parts right now and we did our best to capture the majority of the DHL opportunity.

We feel very comfortable that we got more than half of the revenue.

We did not focus as intensely on the very lightweight packages, many of which might have come from airborne@home, but we do feel pretty good that the volume we got is profitable.

And as I said, we were able to show improvements in yield for the volume that we brought across.

Yes, Ed, our manufacturing sector was down about 9% in the quarter, which clearly has a big influence on weight and relates directly to the IP numbers we were talking about.

But I mean your total domestic volumes were not that weak considering what happened with DHL and yet, with your guidance, your domestic margin is going to be even worse next quarter and this is worst we have seen it as a public company other than probably the worst since the strike before you were public.

So it implies that maybe you are taking the wrong mix or something is going on with this DHL.

How do we think about -- your volumes are down 4% and your margins have deteriorated dramatically more than that would imply.

Is there a pricing scenario as well that is out there that is getting more competitive?

No, I think pricing is reasonably stable.

I did make some references to the fact that we do have still an ongoing process to kind of recalibrate following the spikes in the fuel surcharges and so there is some work going on to reestablish base rates that may have been deteriorated a bit with the pressure from 30% plus fuel surcharges.

Ed, the second quarter is a combination of a modestly weaker economy.

We are now into a condition of a couple of years of negative growth, which creates some challenges.

We do have Easter hitting April that was not in there last year.

And with the substantial declines in our growth, the wage rate headwind is offsetting some of the productivity.

Most of those things we can work our way through over time, but we are cautious for the second quarter.

Thanks, Kurt.

Thanks, Scott, for the time.

William Greene, Morgan Stanley.

Yes, just a couple of quick detailed questions.

Kurt, can you tell us what the B2B trends versus the B2C trends were?

We saw challenges in both.

The B2C remains modestly positive and the B2B continues to be negative.

So those are really trends that are fairly steady from what we have seen the last couple of quarters.

I think it was in -- I don't remember if it was 2007 or 2008, you talked about B2C being about 30%.

Is that still a safe percentage?

Bill, it has been growing typically about 1% of the pie per year.

So maybe it's 31%, 32% at this point in time.

Okay, got it.

And then you mentioned the package weights fell in Domestic; how did they do in International?

I realize DHL didn't affect that, but did the economic changes affect that?

Absolutely.

Virtually the exact same trends domestically and internationally, lighter weight, customers coming to us asking how can I reduce my budget.

So in some cases, we are helping them find ways to trade down within our portfolio.

So all of those factors are very similar and the scale of the changes are fairly similar too.

Okay.

Was the LTL, was it profitable in the first quarter?

No, it wasn't.

It was underwater.

We have got to get some continued momentum like we saw late in the quarter to get this thing back on track.

But we do expect improvements throughout the year in the LTL profitability.

Okay.

And then just one last question.

US import volumes, how did they trend in first quarter?

The trend wasn't dramatically different from January through March, although it was fairly weak.

We did see in aggregate for international a softening over the course of the quarter both in Asia and Europe.

(multiple speakers) the one change I think we saw in the first quarter in imports, we did see China exports to the US improve which we -- we had seen some weakness last year and we didn't see actually double-digit export increases out of China.

Ken Hoexter, Merrill Lynch.

Great, good morning.

Kurt, can you talk a bit about -- you mentioned the employees being down 10% -- I'm sorry, 10,000.

If I remember, you still have something -- a couple hundred thousand, that seems to be what, 2% or 3%.

Can you give an update on the total employees and why are we not seeing that come off a little bit more as far as in-line with kind of volume reductions over time?

Well, we have reduced hours actually in excess of volume reductions, over 5% reductions in hours against a 4% volume decline, Ken.

So the headcount numbers are a little more moderate, but the 10,000 for the US operations would be 3% to 4% easily.

And in the direct labor, it would be closer.

No, I think we are moving pretty quickly on that.

One of the nice things about how we operate is we do reduce the hours worked on a given day if volume is lighter.

It is not all a matter of just taking people off the payroll.

So we flex and float and that is a nice attribute for both the Company and our employees.

But I would imagine there is still a pretty sizable then fixed benefits and pension and other expenses associated with it.

My follow-up is on the restructured operations.

You mentioned that you have closed some regional hubs.

Anything major closing?

New York or any major cities that you are shutting down that is a big part of the restructuring or are these small branch offices?

Well, the biggest changes were in the elimination of two of our air night sorts in Dallas, Texas and in Columbia, South Carolina.

In effect, we, with our expanded capacity in Louisville and the slow economy, were able to concentrate a much higher proportion of our volume through one hub.

So you have one aircraft going from a city rather than that city having to send volume to two or three hubs.

So substantial benefits from that.

And then there is a number of operational changes all across the country and really the world, Ken, but not anything headlining that would stand out as much like that.

Chris Ceraso, Credit Suisse.

Thanks, good morning.

Can you give us a feel for the total capacity in your air network, however you want to measure it, and where you think it goes post taking these planes out and maybe net of whatever new aircraft you are going to add back?

And then as a follow-on to that, what does that mean for your capital plan on a normal basis as we go forward?

Does this mean you can spend less on a go-forward basis because you are effectively shrinking the air business?

It is very difficult for us to respond to total capacity because each lane is different and we certainly pay a lot of attention to the capacity of each lane and that is why we are adjusting and downsizing the network.

We are able to do it without reducing service and still save an awful lot of costs.

So I know many times in the years past we been asked the total capacity question.

It is very difficult because each lane is different, import/export is different.

You can fly multiple rotations.

I guess really the big thing that we have done is, over the last seven or eight years, we have taken out over 100 aircraft that are smaller and less efficient.

So we have retired the 727 fleet that we had years ago frankly and the DC-8s, which are also at the smaller end of capacity and we have been replacing those.

We started the 757 replacement plan almost 20 years ago to take 72s out and we have 767s coming into the network that are taking the place of the DC-8s.

So really what we have done is we are way ahead of the curve on that.

As we said, we have got the most modern, youngest fleet in the industry.

The future capital requirements for replacements are nil frankly.

The age of our fleet is in the low teens as far as years and any new aircraft we bring in have larger capacity.

Because we have invested $1 billion in expanding Worldport, we can fly substantially less aircraft, but the aircraft are much bigger, much more efficient and much more environmentally-friendly.

So it is a capital investment we have made over the past several years that allows us to get lower CapEx in the future and substantial operating and environmental benefits.

So a major change, tremendous benefits long term.

It is a great long-term investment for us and for the environment.

Thank you.

Justin Yagerman, Wachovia Capital Markets.

Hey, good morning, guys.

I wanted to just get a better sense of the International Package yield.

Can you give us a breakout of how much of the decline was currency, fuel and mix?

And maybe go into a little bit of detail on where the currency fluctuations were that impacted that and how you hedge against them?

Yes, the currency was a substantial factor and on page three of the Web schedules, we do break out, hopefully with enough transparency there, our results for yield without the currency.

So whereas our overall International yields were down 15.3%, net of currency, that is 9.3%.

And you can see the impact it had on both our non-US domestics and export.

So the currency on revenue was substantial and it also had an impact with in our forwarding group.

We have hedged much of that though with some favorable timing on hedging primarily the euro and the sterling a couple years ago.

So the P&L impact of this precipitous decline in currency is modest.

It's still a little bit of a headwind, but it has not impacted the P&L severely.

Certainly, the fuel surcharges that have plummeted also reduced our revenue in the International.

So there are the same pressures in our International yields of lighter weight and to some extent tradedown to lower service levels that we see in the US.

But in general, we are in pretty good shape and our relative value proposition is very high internationally.

And the currency hedge, that just gets netted up into the EBIT number?

Well, it is actually in the reduction of costs, which ends up coming into the operating income number, correct.

Right.

Okay.

And then I guess on the LTL side, you guys talked about this a little bit, but tonnage was -- at least the tonnage decline was not as bad as many of your competitors have come out with and it looks like you guys are gaining some traction there.

Can you talk about some of the initiatives that you have taken with that product?

How you are competing in this marketplace, what types of benefits you may be seeing from a large ailing competitor and what is going on maybe with length of haul in that segment?

Yes, we were less bad than most, I guess, to torture that phrase.

No, we have been working very hard to find the right value proposition in LTL that really brings something unique to customers.

And we think we are getting to the point where we can work with LTL shippers, help them really get the best of both worlds.

The technology that is so productive in the small package environment has been harmonized to work easily in the LTL environment.

Our new WorldShip allows customers to rate shipments both in small package terms and in LTL terms very easily and then the visibility is there.

So the value proposition is getting to be very strong and we are pretty pleased.

We did see substantial market share growth, as we talked about.

We believe we are at about 8% market share.

So over the last several years, we have gained a couple hundred basis points of market share.

We still want to be prudent though.

This is a tough environment.

Our revenue per hundredweight net of fuel is positive, but it is very tough out there and so we are trying to strike a balance between market share gain and being disciplined and recovering the costs that we have put in for the big investments.

And Justin, our package salesforce, which is a large force, has done an excellent job of selling freight and that job has been a lot more effective over the last couple of quarters and is helping to drive that improvement and help performance.

David Campbell, Thompson, Davis & Co.

Yes, hi, good morning.

You mentioned that China was having a favorable impact on exports to the US in the first quarter.

What about their import activity, which would have been the result of their own stimulus plans?

Have you seen any growth or any improvement in tonnage or shipments going into China?

In general, David, I think that clearly the exports showed some improvement.

We have not seen much move on the import side yet.

I think we hopefully will see a little bit more as that stimulus program takes place.

But generally our US export numbers were disappointing in the first quarter and probably fell off dramatically from where they were the first half of last year.

I think that is typical of the export market right now out of the US.

The second question is, I guess, Europe though is, of course, a bigger concern for you since you are bigger there and Europe is expected to recover or is behind the United States in your opinion?

I think that likely -- I think they are a little bit slower on the stimulus programs.

From what I understand, maybe a little more bank debt exposure than even the US has.

So I think there is some risks in the recovery in Europe.

At the same time, we've performed pretty well in Europe.

Our transborder products were still relatively strong in the first quarter.

Our domestic products weren't bad.

Really the international domestic though was driven mostly by Canada in the first quarter, but Germany wasn't too bad.

So I think there is going to be some challenging times there, but our business still seems to be growing in Europe.

Thank you.

John Mims, BB&T Capital Markets.

Good morning, guys.

When you look at -- I know you have said a lot about DHL on the domestic side, but can you add some color on what you have seen as far as either core pricing or just marketshare gains on the international, just based solely on kind of going after DHL customers is, I guess, picking on their weakness?

Yes, John, thanks for that question.

That is a top priority for us now and something that our people across the globe are very excited about, that UPS really has a unique capability these days with a substantial integrated presence in Asia, Europe and the US and the rest of the Americas.

And so the value proposition we can bring to customers is the strongest it has ever been.

As I made brief reference to, we are seeing an increased number of successful bids and so we are pursuing our advantage across the globe and that is a chapter that is just now being written.

So we do feel very good that we can uniquely help customers reduce their costs and improve their global distribution.

And that is part of the reason you are seeing these outsized marketshare gains.

Well, thank you.

And just as a follow-up, looking at the debt issue and the cash flow, you generated so much cash and had such a large debt issue this year, could you tell me again what the impact on interest rate, the interest expense is going to be and what you are going to do with that $4 billion that you have sitting on your balance sheet now?

Yes, the end-of-quarter balance sheet is a little bit exaggerated because we did secure the $2 billion of term debt at very favorable rates.

We also had a substantial commercial paper line and much of that commercial paper was 30-day plus term, so we are ramping that down.

The intent wasn't to load up on cash.

We will use that $2 billion of term debt to retire the commercial paper.

We just ended with some of that still terming through the end of the quarter.

What is not exaggerated though is the $1.9 billion free cash flow, which really is outstanding and as Kurt mentioned earlier, really $200 million more than a year ago, ignoring the tax refund and that is despite a 40% reduction in income.

So that is outstanding free cash flow.

David Ross, Stifel Nicolaus.

Good morning, gentlemen.

A question on the International side.

You talked about -- in Domestic, the tradedown is pretty easy, next day to second day, second day to ground.

You also talked about tradedown in the international portfolio.

Is that air to ocean, is that in Europe anyway air to ground?

How do you look at that and what has been, I guess, the biggest tradedown offering you have seen?

Yes, I think, within the forwarding, there is some tradedown between air to ocean.

That is not as significant for us.

We do actually offer a forwarding portfolio of express freight, direct freight and consolidated.

So even within our forwarding platform, we do offer different levels of service.

But the bigger, the more material impact for us is within our express network.

Because we have an integrated air and ground capacity, we really can offer customers an array of choices.

If you are flying from Asia to Europe for example, we don't have ground routes yet, but we will be working on that in the future, but you can fly to Europe and it can go that same night through our Cologne hub and be delivered at 8 in the morning.

It can be slower, but still by air and then it can also get integrated into our transborder Europe network on ground.

So a lot of levers that can be pulled and also every one of those express premium products has a time-of-day commitment.

So it is that seamless ability to move up and down both in North America and Europe that are really offering customers a way to adapt and save costs if that's a priority.

And then last question is I think, Scott, you mentioned protectionism risk at the beginning of the call and essentially called for a continuation of global trade.

Is there any areas around the globe that you see as more of a risk to protectionism than others?

Well, I think that maybe we are our own worst enemy with that Buy America proposal that we came out within the stimulus program and we backed off of that an awful lot.

And so I think it was not protectionist, but it sent bad signals to the rest of the world.

So clearly, there are a variety of countries around the world that can look at the US and say, if they are going to talk protectionism, we are going to do the same thing.

I am not going to name countries right now, but I think that there are a variety of countries, both in Asia and Europe, there is some concerns about it.

But I do think common sense prevail and people will realize how valuable global free trade is and protectionism will go away.

Let's hope so.

Thanks.

Let me wrap up by saying that, and Kurt mentioned earlier that UPS has managed through a remarkable 20 recessions in our history.

That is a remarkable number.

But we are absolutely confident that we will emerge from this economic downturn stronger, leaner and more customer-focused than ever before.

In addition, we are now the only company with a truly integrated global network, giving us frankly the best competitive position we have had in years.

So with that, thanks for joining us today and we will talk to you next quarter.

Ladies and gentlemen, on behalf of today's panel, I would like to thank you for your participation and thank you for dialing in today.

Have a good day.

You may now disconnect.