聯合包裹運送服務公司 (UPS) 2009 Q2 法說會逐字稿

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  • Operator

  • Ladies and gentlemen, good morning; my name is Steven and I will be your conference facilitator today.

  • At this time I would like to welcome everybody to the UPS Investor Relations second-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 from each participant.

  • Thank you.

  • It's now my pleasure to turn the floor over to host, Mr.

  • Andy Dolny, Vice President of Investor Relations.

  • Sir, the floor is all yours.

  • Andy Dolny - VP, IR

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

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

  • Before I turn the program over to them, however, I want to review the Safe Harbor language.

  • Some of the comments we'll make today are forward-looking statements that address our expectations for the future performance or results of operations of the Company.

  • These anticipated results are subject to risks and uncertainties which are described in detail in our 2008 Form 10-K and first-quarter 2009 10-Q reports.

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

  • This conference call is being webcast and will be available on our Investor Relations website.

  • In our earnings announcement today you'll notice that there was an after-tax charge of $48 million.

  • This non-cash charge was for the remeasurement of certain foreign currency obligations which did not qualify for hedge accounting treatment.

  • It had no impact on operating income or cash flow.

  • However, it did reduce diluted earnings per share by $0.05.

  • Excluding this charge EPS for the second quarter was $0.49.

  • 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.

  • When Scott and Kurt discuss second-quarter performance they will refer to results excluding this charge.

  • During the question-and-answer session I remind you that you will be limited to one question and a follow-up; this will ensure that all will have an opportunity to participate.

  • I'll turn the program now over to Scott.

  • Scott Davis - Chairman, CEO

  • Thanks, Andy, and good morning, everyone.

  • On our last call we told you economic conditions for the second quarter would be slightly worse than the first and UPS performance would reflect those conditions.

  • And that's what happened.

  • The results we announced today are a clear indication of the tough economic environment.

  • As you're aware, the rates of decline of some key economic indicators, like GDP and industrial production, have slowed.

  • Other indicators, like manufacturing and service sector indices, are exhibiting signs of improvement.

  • Most forecasters are saying that we may be at the bottom.

  • Whether or not we're at the bottom is not the main issue; what is important is how long we remain here and what type of recovery we will have.

  • Remember, all these indicators are still well into negative territory, illustrating the challenges that lie ahead.

  • We will continue to manage the Company under the assumption that the economy will stay at this level until definitive signs of improvement materialize.

  • Looking at UPS' results for the quarter, everything played out pretty much as we had thought, with the exception of international volume which declined more than we had anticipated.

  • Our cost initiatives are exceeding target levels.

  • However, these savings were not enough to fully offset the impact of global economic weakness.

  • Nonetheless UPS is continuing to be alert and investing in growth opportunities to assure we're ready when economic activity revives.

  • During the quarter we expanded our global footprint in Eastern Europe and the Middle East with acquisitions in Slovenia and Turkey.

  • We also formed a joint venture headquartered in Dubai as a springboard to grow package, freight and contract logistics services in 21 countries across the Middle East, Turkey and Central Asia.

  • Turkey has become a vital link in global commerce.

  • We see it as the transportation bridge between Asia and Europe.

  • In the logistics arena we established a field stocking location network in India to address critical parts service in that country.

  • We opened two healthcare logistics facilities, one in the Netherlands and one in Puerto Rico, expanding our global presence in this sector with state-of-the-art certified capabilities to serve pharmaceutical, medical device and biotech customers.

  • Prudent investment even in challenging economic times not only helps our customers, but it also helps UPS remain positioned to capitalize when trends improve.

  • We are a company that will weather this recession and emerge even stronger.

  • Just after the quarter ended we released our 2008 corporate sustainability report.

  • This is the most data rich and global report we have ever produced and it has been well received.

  • We disclosed both our direct and indirect emissions, a level of reporting that is unusual for our industry.

  • Because of our innovative network, most modern aircraft fleet and extensive use of the rails, UPS is the environmental leader in the US package delivery industry.

  • Nonetheless we have committed to reduce our airlines' carbon emissions by an additional 20% by 2020 for a cumulative reduction of 42% since 1990.

  • To us sustainability isn't just corporate jargon; it's a commitment to our customers, employees, shareholders and the communities we serve to remain a transparent and follow responsible business practices.

  • Before I turn the program over to Kurt I want to thank UPSers around the world for their efforts and dedication in managing through these tough economic times.

  • We will not only create better leverage in our operations, but UPS will be a stronger organization when the economy recovers.

  • Now Kurt will provide detail on our second-quarter results.

  • Kurt Kuehn - CFO

  • Thanks, Scott, and good morning, everyone.

  • Stagnant economic activity around the world negatively affected all of our business units.

  • Although we exceeded our targeted cost savings, they were not enough to offset revenue declines in the quarter.

  • Operating expense declined almost 10% excluding fuel and diluted earnings per share were $0.49, in the middle of the range we provided.

  • UPS is ahead of plan on our cost reduction initiatives and we expect to come in 20% to 25% higher than our initial target.

  • Therefore we anticipate realizing between $1.2 billion to $1.3 billion from our cost control efforts for the year.

  • Our compensation and staffing initiatives coupled with our continued productivity improvements allowed us to reduce direct payroll by almost 5%.

  • This was partially offset by healthcare inflation and increased pension expenses.

  • Total block hours in our airline were down 11%, enabling us to reduce fuel consumption by 14 million gallons.

  • Our consolidated quarterly margin was 8.3%, which is low for UPS, but is still the best in the industry.

  • Now let's start our review with the US package operations.

  • For the quarter package volume declined 4.6%, a little more than in the first quarter.

  • Ground volume was down 5.4% while air volume was essentially flat with last year and slightly better than in the first quarter.

  • Let me remind you that the apparent strength in air volumes is attributable to DHL's exit from the US domestic market.

  • Revenue per piece was down about 8%; the decline was driven by the reduction in fuel surcharges on air and ground products of 24% and 5% respectively.

  • Lighter average weight per package and changes in product mix also contributed to the decline.

  • These trends, along with the decrease in volume, eroded margins.

  • As we've said in the past, margins in this segment will remain under pressure until economic conditions improve.

  • During the quarter we launched the UPS Advantage sales program.

  • It aims to build awareness among customers of our comprehensive value proposition based on reliability, speed, technology and service.

  • The current pricing environment continues to be very challenging driven by the economy and our customers urgent need for help in reducing their transportation spend.

  • But the pricing environment remains rational.

  • While we're working with our customers to address their needs, we believe in the value offered in our superior service and reliability and do not compete on price alone.

  • In fact, our solutions can often reduce overall supply chain costs without necessarily leading to direct price reductions.

  • As the economy improves we expect pricing to improve as well.

  • UPSers are managing operations well in the face of reduced volume.

  • For example, labor hours were down almost 7% with productivity improvements across the board.

  • In addition, miles driven were down 5% and domestic block hours decreased almost 6%.

  • The full benefit from these improved operating metrics is being reduced however by a higher direct average hourly wage rate, healthcare inflation and increased pension expense.

  • Notwithstanding today's weak economy we have continued with our $1 billion expansion of the Worldport air hub in Louisville.

  • In early July we announced the completion of Phase 1 of that expansion, which increased sorting capacity 15% to 350,000 packages per hour.

  • The final phase of this expansion will be completed next year, bringing our sort capacity to 416,000 pieces per hour.

  • Maximizing the volume that flows through Worldport allows us to optimize our network, flying fewer but larger and more efficient aircraft.

  • This is a great example of UPS' long-term strategy.

  • We're keeping one eye on the economic challenges of today and the other on the opportunities of tomorrow.

  • Let's move now to the international segment.

  • Weakness was apparent in all regions of the world.

  • Volume declined 5.5% with export volumes down 7.3% and domestic down 4.3%.

  • Excluding the impact of the timing of Easter export volume would have been down about 5%.

  • Reduced revenue and volume reflect our customers' lower levels of business activity.

  • In spite of this reduced volume UPS continues to gain market share in contrast to double-digit volume declines in the marketplace.

  • Excluding the effects of currency revenue per piece declined 11.4% as a result of reduced fuel surcharges, changes in product mix, lower weight packages and volume shifts across global trade lines.

  • Despite the reduction in both volume and revenue operating margin for the segment was 13%.

  • This is essentially flat with last quarter and only 80 basis points below last year and is still the best in the industry.

  • Aggressive cost control contributed to maintaining our strong margin.

  • For example, international block hours dropped almost 16% in the quarter without impacting our service footprint and indirect operating expenses declined almost 8%.

  • As Scott indicated, UPS is committed to controlling our costs while still making the strategic investments that will enable growth when economic conditions improve.

  • Turning now to the supply chain and freight segment.

  • Revenue was down over 23% with all business units experiencing declines.

  • However, the 7% operating margin reflected successful cost management in each business.

  • Logistics posted a solid performance with improved revenue management and targeted growth, particularly in the healthcare and high-tech sectors.

  • Forwarding margins improved as cost initiatives successfully took hold.

  • Despite very weak market condition UPS Freight posted increased revenue, LTL shipments and tonnage over first-quarter results.

  • Effective cost control and productivity gains enabled UPS Freight to break even for the quarter.

  • This business continues to take market share while remaining disciplined on yields.

  • Its 1.9% decline in shipments year over year was in sharp contrast to severe market declines.

  • Our no fee guarantee for both regional and long-haul shipments continues to be a competitive advantage and we are also benefiting from leveraging our small package sales force and further penetrating the key middle-market customer sector.

  • This quarter we did mark down certain preferred shares and auction rate securities to their market value.

  • The write down was $17 million and is reflected as an offset to our investment income.

  • In spite of the earnings decline free cash flow for the first six months of 2009 increased by $195 million over last year excluding the impact of the tax refund in 2008.

  • An intense focus on capital expenditures and working capital enabled UPS to generate a total of $2.7 billion in free cash flow.

  • For the first six months UPS also invested $671 million in capital expenditures; spent $248 million to repurchase 5.1 million shares; paid dividends of $876 million maintaining our $0.45 dividend; and ended the first half of the year with $3.3 billion in cash and marketable securities.

  • Clearly strong cash flow remains a hallmark of the UPS business model.

  • Now for our outlook.

  • We expect business conditions in the third quarter will be similar to those in the second.

  • In our US domestic operations average daily volume should decline at a pace similar to the second quarter.

  • Operating margin will remain weak due to seasonal trends and the continued challenge of lighter average weight, mix shift and lower volumes.

  • In the international segment export volume is anticipated to decline about 4% to 6% with operating margins similar to the second quarter.

  • The supply chain and freight segment should see trends similar to the second quarter with operating margins slightly less than last year.

  • Our ongoing cost control initiatives will continue to provide benefits across all business units.

  • Considering all of this, earnings per share should be within a range of $0.45 to $0.55 for the quarter, the same range we provided for the second quarter.

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

  • Operator

  • (Operator Instructions).

  • Gary Chase, Barclays Capital.

  • Gary Chase - Analyst

  • Good morning, everybody.

  • Just two quick ones here.

  • On the outlook, Kurt, as you talked about business conditions remaining the same, could you talk about what you're seeing and what you expect in terms of weight per package and how that's been trending?

  • Do you expect that's going to continue to decelerate or just kind of bounce along at these lows, what's kind of embedded there?

  • Kurt Kuehn - CFO

  • Gary, I think the real theme that we're seeing right now is that the negative trends have stabilized.

  • So year-over-year weights and product mix are down, but if you look sequentially really over the last three or four months we're seeing the trends stabilizing.

  • So we're in a flat period right now, certainly very negative to last year, both in trends and statistics.

  • But we don't see any increase in negative momentum.

  • So weight trends should be very similar to Q2.

  • Scott Davis - Chairman, CEO

  • Gary, I think you've just got to look at industrial production too and when it turns, and it will at some point in time here in the future, you'll start seeing the manufacturing sector kick in more and that will certainly help weights.

  • Gary Chase - Analyst

  • Okay.

  • And then secondly, the supply chain was surprisingly good for the quarter; you wouldn't have expected that kind of performance after the first, or at least I wouldn't have.

  • Was the variance there that broke -- freight broke even or was it more on the logistics side?

  • And should we be considering this a sustainable level or was there something unique about the second quarter for you there?

  • Kurt Kuehn - CFO

  • Yes, no, it was really improved performance across all three of the primary sectors.

  • Certainly UPS Freight has done a good job of continuing to have relative momentum, we've successfully gained share across all sectors, but most notably in the middle-market.

  • And even though pricing is challenging our revenue per hundredweight, after you take out fuel, is pretty stable.

  • So Freight did show substantial benefits over the last three quarters and the earnings bringing it back to breakeven was important.

  • Logistics though has been very successful in the last couple quarters of tightening its focus.

  • We think we've created some very unique solutions for high tech and, of course, healthcare which we've talked a lot about.

  • And we've been very disciplined in adding capacity just where we know there's good sustainable business that will generate good margins.

  • So we have seen good results, we've trimmed down some locations and really streamlined that business, so you're seeing the benefits of a couple years of hard work.

  • And then in the forwarding, clearly the growth is challenged, but we were very successful really managing cost in all fronts.

  • The purchased transportation opportunities are pretty good right now and you've seen other forwarders talk about improving margins in that sector, but we've also done a pretty comprehensive review of our operating expenses, the number of facilities we need and our indirect expenses.

  • So good cost management on all fronts there helped us to create pretty good profits even in a tough environment.

  • Having said that, we're not necessarily going to be at 7% margins all quarters, Q3 will be a little more challenging.

  • We do expect that some of the great yields in forwarding may tighten up a little bit as rates begin to reverse, but we feel very positive on all three fronts.

  • Operator

  • William Greene, Morgan Stanley.

  • William Greene - Analyst

  • Good morning.

  • I'm wondering if we can talk and little bit about your -- when you talk about your outlook, sort of saying we stabilized but we don't really see much in the way of improvement.

  • If this is the new normal, a level off of which we'll have gradual growth, is the network right sized or is it over resourced or how do you think about where you are if this is kind of the level off which we'll be for a while?

  • Kurt Kuehn - CFO

  • We've still got work to do, Bill.

  • Clearly we're not thrilled with the results we had in Q2.

  • We've been chasing the market down.

  • We've been making we think some pretty dramatic changes in our network, taking block hours down 16% in the quarter for international is a great example.

  • But no, if things stabilized at this level we've still got work to do.

  • Our network changes in some cases lag.

  • We've still got plenty of opportunities to leverage this expanded Worldport capacity, taking a large number of aircraft out of the air.

  • So, on all fronts if it stabilizes at this level we're going to continue to work real hard because we're not happy with where we're at.

  • Scott Davis - Chairman, CEO

  • And Bill, I wouldn't call this the new normal.

  • I think that you still go back and look at the second quarter and we've had industrial production drop 13.2% year over year which is a staggering number.

  • And I guess the issue going into the third quarter is we think that the big drops are over with, but we're still going to have tough year-over-year comparisons.

  • But it will come back, industrial production will grow again and so this isn't necessarily the new normal.

  • William Greene - Analyst

  • Okay, that's helpful.

  • Just two quick data questions.

  • Can you give us B to C growth, what it was in the quarter?

  • And also, can you tell us or remind us what the fuel headwind is for the third quarter?

  • Kurt Kuehn - CFO

  • Yes, B to C was close to breakeven, maybe very slightly positive which is quite a difference from the double-digit trends we've seen.

  • And fuel was a bit of a headwind in the second quarter and clearly the third quarter we don't know how it's going to end up, but our guess is it won't be a big factor either way.

  • William Greene - Analyst

  • But you had a tail wind last year -- you made money on fuel, is that right, just because of the timing?

  • Scott Davis - Chairman, CEO

  • We made about $90 million in domestic last year.

  • William Greene - Analyst

  • $90 million?

  • Okay.

  • Thank you.

  • Operator

  • Edward Wolfe, Wolfe Research.

  • Edward Wolfe - Analyst

  • Thanks.

  • Just again on the outlook, when you gave the guidance a quarter ago you had talked about second quarter, which is normally a seasonally better quarter than first, being impacted by the timing of Easter and the year-over-year Easter.

  • Now you're giving third-quarter guidance and saying it's the same as second which was the same as first.

  • But we don't have those Easter issues, you have more cost savings under your belt and things seem to be stabilized.

  • It feels kind of conservative, what am I missing here?

  • Kurt Kuehn - CFO

  • Well, you're missing the fact that, as you said initially, Q3 is typically one of the weakest quarters of the year and so certainly there are challenges.

  • Europe tends to take a lot of the month off for vacation, our trends so far in July show no material uptick in growth, so we are cautious frankly.

  • We don't think things are getting dramatically worse, but we don't have any confidence that either demand or activity is going to pick up substantially.

  • And for that to happen in Q3, which is typically one of our weakest quarters, leads to the guidance that basically those things will offset the Easter impact in the second quarter.

  • Edward Wolfe - Analyst

  • Can you talk about the domestic volumes and export volumes, how they trended from April through July so far directionally in the quarter if you couldn't give exact numbers?

  • Kurt Kuehn - CFO

  • Yes, it's that same kind of flat trend we're talking about that really April was a little distorted because of the Easter impact, so April was worse than the following months.

  • But if you filter that out, basically we've seen trends across domestic transactions very negative but steady I guess all the way through the current time.

  • And also internationally, no huge changes in trends, although clearly the overall total international did weaken sequentially from Q1 to Q2.

  • But within that we still see that relatively stable also.

  • So we're sitting here at this bottom and that's why, as Scott said, the real question is how do we and when do we work out.

  • Edward Wolfe - Analyst

  • Thanks, Kurt.

  • Operator

  • Tom Wadewitz, JPMorgan.

  • Tom Wadewitz - Analyst

  • Good morning.

  • I wanted to ask you a bit more about the revenue per piece and if you could give us a sense of perhaps on the domestic air and ground side what the breakout looks like in terms of how much is fuel, how much is price, how much is weight per piece?

  • And if you don't want to be specific at least directionally.

  • And talk maybe a little bit about the pricing environment, if that's gotten any better or if it's still pretty challenging?

  • Kurt Kuehn - CFO

  • Yes, Tom, I'll be glad to.

  • Clearly this is a challenging time for all businesses to show substantial yield increases and our industry sector is no exception.

  • Although I would say that the small package environment remains much more rational than certainly the LTL environment where it is very challenging.

  • The big pressure, as I mentioned in my prepared comments, is that customers are urgently looking for ways to reduce their expenses.

  • And so we do see tremendous requests from our customers to find a way to take costs down.

  • Certainly our first approach is let's look at your supply chain, let's see how we can help you optimize.

  • In some cases we are driving trade down to help customers trade off speed for cost and that's keeping us very busy; all of our salespeople and solutions people are actively engaged.

  • The overall competitive environment, though, remains rational but challenging.

  • So we see the primary pressure coming directly from customers rather than any specific competitors.

  • The net -- if you factor out fuel and some of the characteristics changes like weight, basically we show slight increases in base rates for the ground business and basically flat base rates for the air.

  • So those are not great numbers, clearly historically we've seen better trends but it is stable.

  • Tom Wadewitz - Analyst

  • Okay.

  • And then just a follow-up on that.

  • Is there a time -- you probably have contracts that reprice through the year, but when might be the timing when you think you've lapped the repricing pressure and when you maybe get beyond that kind of resetting the tougher contracts down a bit?

  • Is there any timing when you think you'll get to that or are we close to that?

  • Kurt Kuehn - CFO

  • I think you'd have to see a little bit of a boost in the economy really to change that balance.

  • So there's some lapping, but I think it's more driven by economic conditions.

  • As long as the trends are flat or year-over-year comps are dramatically negative customers are going to be very cautious about speeding up their supply chains.

  • Tom Wadewitz - Analyst

  • Think you.

  • Operator

  • Ken Hoexter, Bank of America.

  • Ken Hoexter - Analyst

  • Great, good morning.

  • Kurt, you talked a bit about the 16% reduction on the international block hour side as a way of really controlling costs on the international side.

  • Can you talk about maybe what opportunities that are on the domestic side to really look at some additional cost cutting and getting those margins back up or is it just simply the volumes turning?

  • Kurt Kuehn - CFO

  • No, work continues.

  • I guess, Ken, we have been thrilled.

  • If you remember a couple quarters ago I mentioned that one of our biggest challenges was creating a very intense cost control focus in our international business.

  • And certainly for the last decade we've seen great growth trends.

  • I do want to commend our international network and operations people for very quickly reassessing the network and making changes that keep our customers happy but also have trimmed down expenses dramatically.

  • So we've been very pleased, I know Scott has been pleased also with our progress on the international.

  • Domestically we've had no less intensive a focus and we have taken block hours down 6%.

  • But you were starting from a much more well tuned and refined base.

  • So the low hanging fruit perhaps is a little harder to get to.

  • But we have made dramatic changes in our domestic environment; we're going to continue to leverage this expansion of capabilities of Worldport.

  • As you know, we shut down two major air hubs and we're significantly reducing the number of aircraft.

  • So it's a little harder work there but we have made substantial benefits.

  • I also mentioned that our direct labor hours are down 7% against less than 5% volume decline.

  • So we're working very hard there.

  • Much of that though is being offset by some of the indirect expenses of our pension increases and healthcare increases and the adverse wage mix impacts that we have a more senior workforce since much of our growth has disappeared and we don't have as many junior drivers in the mix.

  • So there are great productivity trends going on.

  • We will, towards the end of the year, begin to lap some of that wage pressure, so that will moderate, and then as we get growth we should see some real benefits.

  • Scott Davis - Chairman, CEO

  • Yes, I think that we know the volume will come back and we're positioned extremely well, Ken.

  • The network efficiencies that Kurt talked about will certainly improve dramatically with the volume, increased densities will reduce our costs and obviously, as talked about, the effective wage rate for our drivers will drop.

  • And so a lot of leverage there when we get some volume back.

  • Ken Hoexter - Analyst

  • Great, great response.

  • Just to follow up on the DHL side on domestic air, can you still quantify how much you believe of that gain is -- or change in volumes is still coming from DHL?

  • And then just to wrap up, Kurt, there's no legacy way the union can pull in any kind of cost is there on the multi-employer pension plan?

  • Kurt Kuehn - CFO

  • Okay, I'll squeeze both those in, Ken.

  • No, we do think certainly the conditions have stabilized and the flat growth in the air sector is certainly helped by the DHL exit.

  • I guess one data point we do see, if you factor out DHL wins then our ground business and our next day air business actually are growing about the same, which we see as a good data point.

  • It shows, as we had mentioned earlier, that some of the trade down has probably stabilized.

  • And I'll ask Scott maybe to talk a little bit on the -- any legacy issues on the multi-employer.

  • Scott Davis - Chairman, CEO

  • Well, I think in general, Ken, we talked a little bit last quarter that we're very active working with the Teamsters and the competition committee to look for flexibility and ways to help manage our cost through this tough economy.

  • So I'd say both parties are working aggressively together to figure out flexibilities.

  • Ken Hoexter - Analyst

  • Okay, but there's nothing they can pull you in on is what I'm asking on that -- the plan you've already left?

  • Scott Davis - Chairman, CEO

  • On the Central states?

  • Ken Hoexter - Analyst

  • Yes.

  • Scott Davis - Chairman, CEO

  • It's extraordinarily remote.

  • Pretty much all of the employers would have to withdraw from the plan between now and the end of 2010.

  • Operator

  • Helane Becker, Jesup & Lamont.

  • Helane Becker - Analyst

  • Thank you very much, operator.

  • When you look through this economic downturn, Scott, and you look ahead to where you want UPS to be positioned internationally, can you just address -- you talked a little bit about the acquisitions you're thinking about in the Middle East and Dubai and so on.

  • But can you just talk about how your expansion in that -- in those areas either extends your footprint, lowers your cost, does -- helps you worldwide?

  • Scott Davis - Chairman, CEO

  • I think first of all, Helane, we're really proud of our track record internationally because we've really grown market share pretty much every quarter for the last several years in all regions of the world.

  • So we're pleased.

  • Doesn't mean there isn't for improvement and, as we said before, we're clearly focused on Central and Eastern Europe and Asia where there's more room for us to take advantage of opportunistic investments and continue to fill out our network which, again, I think is still the most complete global network in the world.

  • So I think there are opportunities.

  • We've talked before about down the road one of the challenges will be domestic China and we're going to keep looking for opportunities there.

  • It's going to be a market with a lot of consumers over the next 20 years and we need to be positioned there.

  • But I think what we've done recently in Eastern Europe and Turkey, for example, our most successful contractor was out of Turkey and we made that acquisition and we're going to use his expertise to help develop the Middle East.

  • So I think, again, overall we're positioned extremely well internationally but we're certainly not complacent, there are areas we can still invest in.

  • Helane Becker - Analyst

  • Okay, thank you.

  • And then just a follow-up question for Kurt.

  • When I look at the sequential numbers on other expenses going from $1.2 billion to $953 million, is there something nonrecurring in there or is that just where all your cost cutting is coming to?

  • Kurt Kuehn - CFO

  • You're looking quarter to quarter?

  • Helane Becker - Analyst

  • Yes.

  • Kurt Kuehn - CFO

  • Well, the $1.2 billion was impacted because the impairment on the DC-8.

  • Helane Becker - Analyst

  • Thank you very much.

  • Kurt Kuehn - CFO

  • Although we're still making good progress, Helane, but I can't take credit for that on an ongoing basis.

  • Operator

  • Art Hatfield, Morgan Keegan.

  • Art Hatfield - Analyst

  • Good morning, everybody.

  • Hey, I apologize if you already addressed this, but looking at the quarter-to-quarter changes in yields, domestic yields across the board were down in Q2 relative to Q1 and I assume a lot of that is fuel and some of the other issues you talked about.

  • But internationally they were up.

  • Can you talk a little bit about why the difference in the trend in the two areas?

  • Kurt Kuehn - CFO

  • International has the additional moving part of the currency impact.

  • And then we're also seeing some continued changes in the Lane mix.

  • Our worldwide traffic, the Asia to Europe, Asia to US continues to show more pressure.

  • And so there is some shifting there with more regional trade patterns than global.

  • We had been talking about how strong the Asia to Europe Lane was, that's changed over the last couple quarters.

  • So you do get a lower weighted average revenue per piece, although frankly we've been able to offset that with substantial block hour reductions.

  • So it's our job to try to match those changing trade patterns with our network.

  • Scott Davis - Chairman, CEO

  • And Art, on the domestic side we averaged only 0.33% fuel surcharge on air and 2.5% on ground, so pretty dramatically lower than previously.

  • Art Hatfield - Analyst

  • Right, right.

  • Thank you.

  • And just as a follow-up into an other area.

  • Can you talk a little bit about what you're doing in the LTL business to see how you're -- what you're doing to perform better than what we've seen some from some of the other carriers so far this quarter?

  • Kurt Kuehn - CFO

  • Yes, we've been working hard for the last couple years to build a sustainable, differentiable service in the LTL industry.

  • We've spent a lot of money and done a lot of work on creating technology integration that's fairly unique in the LTL service, our half a million WorldShip customers now have the ability to do transactions in an automated fashion and to have visibility with our -- inbound visibility, outbound visibility tools.

  • So the technology and ease-of-use is a big differentiator.

  • We have spent a lot of time training the sales forces on both sides to help customers do real-time optimization between what should be in small package, what should be in LTL.

  • We've sped up our network and improved time in transit, we've made substantial enhancements in service.

  • And so you bring all that together and we think we offer a very compelling value proposition that allows customers to get better service, better control and also lower cost with optimizing what should happen on a day-to-day basis.

  • It's kind of a mouthful, but this has been a work in progress and we did have to take a big impairment a couple quarters ago, but we were very confident and are very confident in the momentum of the business.

  • Operator

  • David Ross, Stifel Nicolaus.

  • David Ross - Analyst

  • Good morning, gentlemen.

  • A question on the international side.

  • If you could talk a little bit about what percentage of your international volume say is generated over in the Europe.

  • And then also talk about the competitive environment over in Europe since it's a more mature market, has more competitors actually than the US?

  • Kurt Kuehn - CFO

  • Yes, in general Europe represents about half of our international revenues.

  • The vast majority, 80% plus, of export shipments that originate in Europe stay within the European continent and that's really been our big focus, building an integrated pan-European capability.

  • So we continue to see good results although, frankly, this quarter we didn't see growth in any region of the world.

  • But as customers look to save money and have more streamlined operations in Europe our value proposition is pretty strong.

  • So we think we've still got great opportunity to help European companies operate more effectively.

  • And even though it's a mature market for us it's been one heck of a great platform really for a decade.

  • David Ross - Analyst

  • Is the pricing environment much different over there in this downturn than it is in the US or is it fairly rational in Europe as well?

  • Kurt Kuehn - CFO

  • It's more fragmented.

  • Clearly there are different competitive groups in every country and so it's hard to characterize.

  • But in general, it's a challenging pricing environment, maybe a little less rational than in the US.

  • But we feel pretty confident that we can differentiate ourselves and as the market matures we'll continue to make progress.

  • Scott Davis - Chairman, CEO

  • But the economic pressures aren't a lot different in Asia and Europe than they are in the US right now, so you have the same pressures with the customers there as you do in the US.

  • I do believe Asia and the US are going to come out of this a little quicker than Europe, but also we probably haven't dropped as much in Europe as we have in the other two continents.

  • Kurt Kuehn - CFO

  • And I guess one other point on Europe, one of the reasons we are so focused on Eastern Europe, or Middle Eastern Europe anyway, is the linkage of low-cost sourcing in the region.

  • So that's why you've heard acquisitions in Slovenia, Romania, this Turkey joint venture and acquisition have all been a part of linking that part of the East back into Western Europe.

  • So we think continuing to execute that way is a good value proposition.

  • Operator

  • Chris Ceraso, Credit Suisse.

  • Chris Ceraso - Analyst

  • Thank you, good morning.

  • I think you guys had once said that a positive sign that you look for to gauge an economic turn was small businesses opening new accounts with UPS.

  • Are you seeing any of that yet?

  • Scott Davis - Chairman, CEO

  • I don't think we've seen any big movement there at all at this point in time.

  • But I think we certainly feel we're at the bottom of this economy but I haven't seen a big change in small business as of yet.

  • Chris Ceraso - Analyst

  • And then maybe just a comment if you could on your expectations about the back-to-school season.

  • I think you mentioned that Asia to US still looks weak, but broadly what are you expecting for the back-to-school seasonal upturn?

  • Scott Davis - Chairman, CEO

  • I think we're hopeful that we're going to have a back-to-school session.

  • But it's really too early to tell.

  • We've not seen a lot of signs yet based on the air freight market and ocean freight market.

  • But I think that we're hopeful that things will go back.

  • I saw I think yesterday that Wal-Mart is going to I think increase its computer inventories by 40%, that's a good sign.

  • So there are some signs out there that maybe the back-to-school season will be better.

  • Kurt Kuehn - CFO

  • And I think there's some data, this whole question of when the inventory work off is going to finally stabilize and most of the inventory sales ratios are still pretty high, although some of the latest data on the retail side suggests they're getting close to more of a new normal, which may begin to kick loose some shipments and get the flow of goods moving a little more.

  • Operator

  • David Campbell, Thompson Davis & Co.

  • David Campbell - Analyst

  • Thanks.

  • You mentioned several times your growth in international packages is better than market, that is the decrease is less than the market.

  • And I just am curious if some of this might be due to the fact that DHL is less competitive at their domestic ability to bundle services.

  • Do you have any indications that that's part of the reason for your better than market share over in -- particularly in Europe?

  • Kurt Kuehn - CFO

  • Yes, David, absolutely.

  • Although clearly our market share gains have been a story over the last decade, not just the last couple quarters.

  • But, no, DHL's decision to withdraw the vast majority of its people and assets from the US has left them with a much smaller network for their import/export coverage.

  • And that really gives us a significant point of differentiation for European and Asian customers that are doing business in the US.

  • So that is one of our highest priorities for our international sales people.

  • And frankly, in many markets they are the market leader.

  • So our ability to differentiate ourselves as being the only player that really has a strong presence in all major theaters is a great boost for our sales people and we think will continue to pay dividends.

  • David Campbell - Analyst

  • Okay, thanks.

  • And the second question is -- I'm not sure the data is correct, but there are published reports out there that you and FedEx are spending record amounts of money trying to convince congressmen and administration people about various issues.

  • And I don't know if the data is correct, but given the focus on cost savings, wouldn't it make more sense to cut back substantially talking to these guys who don't understand probably anything you're talking about?

  • Scott Davis - Chairman, CEO

  • Well, David, I appreciate your comments there.

  • I don't think our lobbying efforts are any higher than they've been in the past.

  • We have a PAC that spends money through the employees contributions and that's where the spending is, so it's not coming out of the Company's coffers.

  • I think in general that it's an important issue for us; it's a matter of basic fairness that workers performing the same job should be covered by the same law.

  • So it's something we're very interested in, and not just us, but I think the entire transportation industry, we all should be governed under the same laws.

  • But I think as far as spending money, it's not a distraction -- I guess, frankly, more of a distraction for our competitors than it is us.

  • Operator

  • Nate Brochmann, William Blair & Co.

  • Nate Brochmann - Analyst

  • Good morning.

  • Just wanted to go back a little bit to talking about the international network at little bit and talking about how there's been some low hanging fruit in terms of flexing that network and taking the block hours out.

  • What have you learned from the initial phases of that because we knew that was going to be a challenge because you had never done it before.

  • And how much more low hanging fruit is there to go?

  • Kurt Kuehn - CFO

  • I guess, Nate, we've learned that even though we've been primarily on a growth run for the last decade we still have those muscles of cost control that are inherent in the Company that relate across the globe.

  • It's just shifting gears a little bit and the top priority isn't keeping up with rapid increases, it's with optimizing the network to the current levels.

  • So it's looking at the balance of air and ground movements, we've got this unique integrated portfolio, we're now starting to really look at how do we keep aircraft out of the air, keep stuff on the ground but still have guaranteed services.

  • It's streamlining our freight forwarding operations, there's been a lot of changes in that in the last three or four years.

  • We're now integrating and finding how do you manage the benefits of being both a freight forwarder and an airline and an express company.

  • So tremendous synergies across those that allows us to better utilize our assets and also offer customers better choice.

  • So a lot of hard work on that front; I think there's more to come.

  • Hopefully this won't be the top priority for too many quarters to come in the future because we'd love to get back on a growth curve, but it has been I think reassuring to see us be able to hang on to margins even with some of the worst economic conditions any of us have seen.

  • Nate Brochmann - Analyst

  • Thank you for that.

  • And then intra China -- entering the latter reports in terms of the China stimulus kind of working a little over there to reenergize a little bit of growth and we see some internal GDP forecasts going up.

  • What are you seeing in that market and what's the near-term opportunity there in terms of maybe intra China and also in and out of China?

  • Scott Davis - Chairman, CEO

  • Clearly our focus has been on the import and export out of China over the last few years.

  • We do have a domestic Express offering but we're still working on that, it's an area we're looking to invest in as time goes on.

  • Because we do think over the next 10 to 20 years that's a big market.

  • We are seeing good signs of increased imports into China and that's something that we have not seen a lot of over the last few quarters but we're seeing a better, higher amount of imports into China.

  • Exports out of China are still a little weak and a lot of that's because US imports are so weak.

  • A lot of China exports go to the US, so until the US starts importing again that's going to cause some pressure to China.

  • Nate Brochmann - Analyst

  • And just to follow up on that, where are you seeing the imports into China coming from?

  • Is that from the US or --?

  • Scott Davis - Chairman, CEO

  • There are some from the US, but Japan is big, I think Japan is big.

  • We're also seeing -- we're seeing some from the US, some from Europe, but Japan right now probably has got the best results there.

  • Operator

  • Justin Yagerman, Deutsche Bank.

  • Justin Yagerman - Analyst

  • I wanted to follow up on that.

  • I mean, just bigger picture, I guess one of my questions was where do you think the leadership will come bringing us out of this global economic downturn?

  • Do you think -- there's a school of thought that things we may see domestic emerging market demand actually pull us out first rather than the US.

  • But are you guys of the opinion that we need to see US consumer demand pick up before we start to feel an improvement in the overall environment?

  • Scott Davis - Chairman, CEO

  • I think we need to see some US consumer demand pick up.

  • Chairman Bernanke yesterday said though a lot is going to rely on the rest of the world, the rest of the world has got to start spending money.

  • It can't be all done by the US.

  • So I think it's both, to answer the question, Justin.

  • Justin Yagerman - Analyst

  • Are you seeing any seeds of that domestic emerging market improvement outside of the imports that you noted into China?

  • Scott Davis - Chairman, CEO

  • I think we're seeing some.

  • I think you're seeing some of the countries in Asia starting to turn around.

  • Countries that were really negative like Singapore are starting to put up better numbers, Korea a little bit better.

  • So we're starting to see some turnaround there, not as fast as we'd like.

  • Justin Yagerman - Analyst

  • And I guess another bigger picture question, just thinking about domestic demand with auto production scheduled to improve in the back half of this year, what are your thoughts on what that does to GDP and freight demand and how that affects your different business lines?

  • Scott Davis - Chairman, CEO

  • I think it affects the LTL business probably the most because I think the LTL business in general has been hurt more by the weak auto production.

  • So certainly it helps small package, but I think you'll see the most dramatic change in the trucking industry, the LTL industry.

  • Operator

  • John Barnes, RBC Capital Markets.

  • John Barnes - Analyst

  • Good morning.

  • I think during the call in the first quarter you indicated that your debt levels were a little bit elevated because you had taken on some nicely priced fixed debt, but you still -- you had yet to pay down the commercial paper program, yet it looked like the debt levels were still kind of elevated from there.

  • Is there something I'm missing there?

  • Did I misread that?

  • Kurt Kuehn - CFO

  • Well, we did create $2 billion of new debt last quarter.

  • We paid down about $1 billion of commercial paper, John.

  • And so, net to net you see that $1 billion net.

  • And then we do show a substantial increase in cash and marketable securities.

  • So not a big deal either way on that.

  • We are in the process of swapping some of our fixed debt to floating, which over time hopefully will show some benefits on reducing our interest expense, although that wasn't a material impact in the quarter.

  • But cash flow continues to be a great story.

  • I mean, clearly we are very disappointed with the substantial earning declines we're seeing.

  • But we are determined to adjust the business to reflect that and we've cut CapEx by almost half so far year to date.

  • We've been very diligent with our customer receivables and bad debt so cash flow actually has improved and that's a silver lining to an otherwise gray economy for us that we've been able to sustain cash flow and keep that in very good shape.

  • So that does help us on the cash and marketable securities.

  • Scott Davis - Chairman, CEO

  • Yes, on that, Kurt, I don't think it's emphasized enough.

  • There are not many companies that can show a 40% reduction in net income and yet grow free cash flow.

  • So again, hats off to our people for managing the working capital and the CapEx.

  • Kurt Kuehn - CFO

  • Bottom line, the debt is just a transitional issue where we've got a little extra marketable securities and cash.

  • But we did take half of that debt down in the quarter.

  • John Barnes - Analyst

  • Okay.

  • All right and then just two clean up points.

  • One, could you give us your CapEx guidance for the full year 2009?

  • And then working days for the third and fourth quarter, could you just give us clarification on that?

  • Kurt Kuehn - CFO

  • Yes, the CapEx we did say last quarter that we have pulled CapEx down and are confident it will be below $2 billion, which would put us at the lowest percent of revenue really that we've seen since going public.

  • So we are being very aggressive on that front.

  • And we review that at least once a month and more frequently as we review capital projects.

  • Having said that though, as Scott mentioned, we are being opportunistic.

  • And whether it's buying hard assets, whether it's buying facilities or whether it's buying companies to increase our global footprint we are spending money where we see opportunity.

  • So --

  • Scott Davis - Chairman, CEO

  • Working days, I think, John, there's one more working day in the third quarter, I think 65 working days, one more than a year ago and 61 in the fourth I think is the same --- is it one more than last year?

  • Kurt Kuehn - CFO

  • Yes.

  • Scott Davis - Chairman, CEO

  • So both the third and fourth quarter one more day than last year.

  • Operator

  • That does conclude our Q&A session.

  • I would now like to turn the conference back over to Mr.

  • Dolny and Mr.

  • Davis for any closing remarks they may have.

  • Scott Davis - Chairman, CEO

  • Yes, let me just wrap up by I guess reminding the audience of a point I made earlier, that UPS really is poised to realize better leverage in our organization.

  • As volumes increase, and I mentioned before they will, network efficiencies will improve, increased densities will reduce costs, and new drivers will come on moderating average wage increases.

  • Longer term we're extremely confident that we will see margin improvement.

  • With that I thank all of you for joining us today.

  • Operator

  • Ladies and gentlemen, that does conclude our conference call for today.

  • I'd like to thank you on behalf of today's panel for your participation.

  • Have a wonderful day.

  • You may now disconnect.