聯合包裹運送服務公司 (UPS) 2010 Q3 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 third-quarter 2010 earnings conference call.

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

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

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

Thank you.

Now it is my pleasure to turn the floor over to your host, Mr.

Andy Dolny, Vice President of Investor Relations.

Sir, the floor is yours.

Good morning, everyone.

Thanks for joining us today.

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

Before they begin, however, I want to 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 2009 Form 10-K and 2010 10-Q reports.

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

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

In our earnings announcement today, you will notice that we recognized a gain of $109 million on the sale of real estate.

This provided an after-tax benefit of $61 million or $0.06 per share.

Excluding this transaction, diluted earnings per share for the third quarter were $0.93.

In their remarks today, Scott and Kurt will refer to UPS's third-quarter 2010 results excluding the impact of this gain.

Additionally, all 2010 full-year references and comparisons to 2009 will refer to adjusted results.

We believe this is the most accurate picture of the Company's performance.

Reconciliations to comparable GAAP measures and free cash flow, which is a non-GAAP financial measure are explained in the schedules that accompanied our earnings news release.

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

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

Thanks, Andy, and good morning, everyone.

The results that UPS announced today are another step in getting back to peak earnings and historical margins.

Considering the slow growth economic environment that exists, I find it extremely encouraging to see our three segments hitting on all cylinders.

UPS's were on top of their game, generating significant operating profit improvement.

This validates our comprehensive supply chain strategy.

As for the economy, over the past few months experts have reduced expectations for fourth-quarter economic output including their outlook for US GDP, where modest growth is still expected.

When it comes to inventory levels, there's a lot of debate.

Some inventory building has occurred this year, but due to low inventory to sales ratios and other indices, it appears there may still be room for additional restocking.

During the quarter, we announced a new global communications platform.

Given the complexities of today's marketplace, we designed our advertising campaign to spotlight the power of logistics.

Our experience and worldwide capabilities make UPS uniquely qualified to provide solutions to our customers throughout their supply chain.

We don't just talk about global trade, we make it happen.

UPS provides new tools to customers to help them expand their business, like UPS Import Control, a solution that allows them to better manage inbound shipments.

In addition, we continue to enhance our paperless invoice technology.

UPS introduced this to the market more than two years ahead of the competition.

This tool now provides expedited customs clearance in 92 countries, more than any competitor.

Not only have we added tools to help businesses compete on a global basis, but we are growing our footprint so they can grow theirs.

UPS continues to expand in important emerging markets, announced in a joint venture in Indonesia with JNE this quarter.

That is on the heels of the alliances announced earlier this year in Malaysia and Vietnam.

In the US to help our customers better manage returns, we now offer UPS Returns Flexible Access, a low-cost, high-quality service that provides unmatched alternatives to customers.

As you can see, UPS is never standing still.

In fact, just this month, we opened our first Olympic logistics center in London.

This gives UPS an excellent opportunity to showcase our capabilities to the world.

As the official logistics provider for the 2012 Olympics, UPS will insure the world's largest logistics event goes off without a hitch.

Now I would like to take a moment to talk about the UPS team.

During the quarter, we suffered the loss of two UPSers in a tragic plane crash.

On behalf of UPS employees around the world, I wish to extend our deepest sympathy to their families.

I also want to personally thank UPS employees for providing the best service in the industry.

Going the extra mile to ensure our customers continue to trust UPS with their business.

No matter where I go, people comment on how they appreciate the professionalism of UPSers around the world and the quality of our service.

Many times customers talk about our drivers as an extension of their Company.

Let me tell you, that makes me very proud of the great team we have here at UPS.

Not only are UPSers committed to providing great service, they are also dedicated to their communities.

In July, the United Way recognized UPS and our employees as the first Company ever with donations of more than $1 billion.

This generosity of our active and retired employees is unmatched.

Overall, another great quarter for UPS.

We continued to achieve results that exceed expectations.

Even though our operating margin is the best in the industry, we are not satisfied.

I am confident in our ability to return them to pre-recession levels.

We are on the right track.

Now let me turn it over to Kurt.

Thanks, Scott, and good morning.

Well, we had another tremendous quarter with earnings up almost 70%.

Revenue continued to reflect strong growth, up 9% over last year even with one less working day.

These are impressive results considering the slow pace of the economic recovery.

UPS's operating margin expanded 410 basis points to 12.4%, continuing our rebound toward historic levels.

Keep in mind current margins do reflect reinstated merit increases and growth and incentive compensation that is due to solid business performance.

For the quarter, total comp and benefits increased only 1% on volume growth of 3.3%.

This clearly reflects the impact of greater volume, productivity improvements, network enhancements, and the US restructuring announced earlier this year.

Now let's start our review of the segments, beginning with US Domestic.

Total revenue increased 6.2% to $7.3 billion on average daily volume growth of 3.6%.

Daily volume comparisons did benefit somewhat from the Fourth of July operating schedule.

Ground volume increased 3.9% per day and UPS Next Day Air was up 3.2%.

This is the third consecutive quarter of domestic volume growth, each quarter showing greater year-over-year improvement.

Total revenue per piece grew 4% with UPS Next Day Air up 7% and Ground improving 3.2%.

Yields benefited from our ability to retain a greater portion of the general rate increase and rising fuel surcharges.

Air products also benefited from a more favorable package to letter mix and weight per piece, which has continued to improve and is in the latter stages of recovery.

Operating margin was 12.5%, an increase of 500 basis points due to volume growth, yield gains, and significant productivity improvements across the UPS network.

Expense was held in check due to effective management of direct labor hours, miles driven, block hours, and non-op expense, all in all a great job by our UPS team.

In July, UPS issued our most recent sustainability report and announced an ambitious new target for increasing the fuel efficiency of our US automotive fleet by 20%.

In September, we purchased an additional 130 hybrid electric vehicles to help us reach that goal.

This brings UPS's fleet of alternative fuel vehicles to over 2000, one of the largest private fleets.

When it comes to our air fleet, it remains one of the most fuel-efficient in the industry, more than 10 years ahead of any US competitor.

Now for the International segment, where operating profit climbed 34% to $419 million on 11% growth in revenue.

This profit is within $9 million of our highest third quarter in UPS history in what is typically our most challenging quarter due to the European summer holidays.

Total package volume per day improved over 13% with exports up 12.5% and non-US domestic up 14%.

Domestic growth slowed from the previous quarter's space as a result of lapping last year's acquisition in Turkey.

However, organic growth still remained robust at 11%.

Export volume growth remains strong in all regions with Asia once again leading the way with 34% growth.

In addition, European export daily volume continued to perform well, increasing 12.5% with balanced growth to all regions of the world.

Export yields improved about 1% as the positive impact of base rate increases and higher fuel surcharges were offset by currency.

On a currency-neutral basis, export rates improved over 3%.

The in-country operations cost per piece declined 2.5% as a result of greater scale, improved productivity, and density improvements.

Overall operating margin increased to 15.7%, up 280 basis points, although the euro to dollar relationship was a slight drag.

During the quarter, in our growth through global trade seminars, UPS worked to help small and medium-sized enterprises grow their business and expand their footprint through exports.

Now for the Supply Chain & Freight segment, where UPS had great quarter, hitting a new high in both operating margin and operating profit for this developing segment of our business.

Revenue increased 19%, led by 23% growth in Forwarding and Logistics and continued growth in UPS Freight.

Driven primarily by our Forwarding and Logistics businesses, operating profit jumped to over 70% to $177 million, with margins reaching 8%, an increase of 250 basis points.

The power of our broad portfolio was once again demonstrated in our Forwarding unit.

The revenue management initiative and block space agreements we put in place continue to provide benefits.

We experienced strong revenue growth as we helped customers manage their supply chains, offering solutions that include both Airfreight and Small Package.

Margins in the Logistics business approached double digits as a result of our global capabilities, technology, and the strength of the UPS brand.

Logistics revenue benefited from high single digit growth in healthcare and high-tech.

UPS Freight continued to make progress with more than 14% increase in revenue.

Growth in revenue per hundredweight was again one of the highest in the industry.

During the quarter, we also saw improvements in gross weight hauled, weight per shipment, and shipments per day.

In the Ocean Freight area of the Forwarding business, we introduced UPS preferred less than container load service.

This service provides up to 20% improvement in time and transit for our customers.

Early reaction from the marketplace has been positive.

You know, a key strength of the UPS operating model is the ability to generate significant cash.

For the first nine months of 2010, our free cash flow was $3.5 billion.

This after UPS invested $1 billion in capital expenditures and made pension contributions of more than $1 billion.

We also paid dividends of $1.36 billion, reflecting a 4.4% increase and spent $589 million to repurchase 9.3 million shares.

As a testament to our strong financial performance, S&P recently reaffirmed our rating and revised their outlook for UPS to stable.

This enables greater flexibility as we develop our capital allocation strategy.

It goes without saying that our first priority is to invest in the business followed by a combination of dividends and share repurchases.

We will also consider accelerated contribution to UPS's pension plans.

Regarding share repurchases, by the end of the third quarter, we have reached our original target of offsetting the dilution in stock-based compensation.

We do intend to go beyond that target and will continue to purchase stock in the fourth quarter.

For 2011, our plan is to ramp up share repurchases as we increase distributions to shareowners.

We will provide more details on expectations for next year during our fourth-quarter earnings call.

While I am on the topic of 2011, as a result of our continued momentum, yesterday we announced to our employees that next year UPS will reinstate our 401(k) match.

Next I would like to discuss our fourth-quarter guidance.

Expectations for economic output have declined from where they were three months ago, but modest growth is still expected.

Looking towards peak season, customer sentiment is mixed but leaning towards cautious optimism.

For the US domestic segment, we expect the revenue year-over-year growth rate to be slightly better than what we saw in the third quarter.

Year-over-year volume trends however will be muted by one more working day between Christmas and New Year's compared to last year.

As a result, we expect average daily volume growth in the fourth quarter of about 1.5% to 2%.

We anticipate that the fourth-quarter operating margin will remain strong at or above the third quarter.

In the International segment, we expect volume growth rates to outpace the market, although they will moderate somewhat.

Last year if you recall, peak season capacity in the Airfreight market was extremely tight coming out of Asia, benefiting our International segment in both profit and volume growth.

Against these year-over-year comparisons, we expect high single-digit growth in topline revenue and an operating margin approaching 18%.

We do expect a slight currency headwind.

In the Supply Chain & Freight segment, we anticipate the pace of revenue growth to slow due to comparisons to the strong Airfreight market conditions that existed last year, but margins will remain strong, approaching 7% for the quarter.

Based on our continued momentum, we have raised our full-year 2010 guidance from the previous range of $3.35 to $3.45 up to a new range of $3.48 to $3.54 per share.

This represent more than a 50% increase over last year's results.

As you can see, UPS is on our way back to the high levels of profitability that we have demonstrated in the past.

The goals and long-term strategies that we have put in place will further widen the gap between UPS and the rest of the competition.

Thanks for your attention and now Scott and I will be happy to answer your questions.

(Operator Instructions) Gary Chase, Barclays Capital.

Good morning, everybody.

I wondered if you could maybe address what's going on in SCS and obviously you talked a little bit about it, but at least the way we look at it, there was a very significant uptick in the profitability of that especially when you look at normal seasonality.

Can you walk us through what is driving that and then maybe talk through obviously the advertising campaign, now it makes the timing of it seems a little more -- or it makes more sense.

What is changing that is driving this?

How is your outlook changing about how you might invest in that business looking forward?

Hey, Gary, we are certainly pleased with the progress we've made in the Supply Chain & Freight segment.

It's been a long time coming.

We began investing deeply in this back in 2000, but what we are seeing basically is the work we've done to create highly aligned capabilities across all modes and across activities is really paying dividends.

Year-to-date this is the most profitable period we have had for Supply Chain & Freight.

Actually it's also that case for International.

We were helped certainly in the Forwarding arena with strong demand and also moderating rates.

So we reversed some of the margin squeeze that we saw earlier in the year, so that was a great sign.

We are also seeing good momentum in our Ocean Freight.

We mentioned the launch of this less than container load service and all of those pieces together really give us some good capabilities.

Logistics really is hitting its stride with us finding those unique services we can bring to high-tech and healthcare.

And then UPS Freight had a good solid quarter.

Clearly it's not up to the margins we would like, but it continues to generate strong revenue growth and great yields.

So we are seeing improvement on all fronts.

Gary, I think Kurt said it well.

I think we are quick pleased with the Forwarding and Logistics margins.

They are at the levels we like to see them at.

Clearly the LTL piece is not there yet and as that market improves, as we continue to make progress, you're going to see enhanced margins long-term Supply Chain & Freight.

The overall advertising campaign geared to Logistics but it's geared to everything we do.

It's about contract Logistics, it is about Freight Forwarding.

It's about brokerage capabilities.

It's about Package Transportation.

So it's about everything we do.

Should we expect that the way you said Forwarding and Logistics must be at the kind of returns that you do like and you always talked about?

Is your outlook on capital deployment into that segment different as a result of the progress that you have made?

Gary, clearly we love Logistics.

And we will look for prudent ways to expand the business, although we have invested a tremendous amount to build a global platform.

So we don't need acquisitions for growth.

We've got an incredible access to customers, but there may be some areas, developing countries and others, where it makes sense to do tuck-in acquisitions.

And perhaps verticals, there may be a vertical we want to enhance something in the healthcare area, so certainly that's on the drawing board.

Jon Langenfeld, Robert Baird.

Good morning.

When you have conversations with your customers, how much do you think you are benefiting on the Express side, both Domestic and International, from the fact that inventories are lean and so despite the slow economic growth, you continue to show volume growth?

Particularly thinking about the Domestic side.

I think, Jon, we've been pleased with what we've seen in the Next Day package business this year.

The business -- the growth has been strong, mid to upper single digits, which is better than we thought.

I think certainly some of that is driven by the lean inventories and I still think even though the inventories -- inventory to sales ratios are higher than they were during the recession, they are still low relative to what we've seen in the last 10 years.

So I think generally there is still some room to rebuild inventories going forward.

I also think seeing the manufacturing segment start to improve and grow over the last couple of quarters helps drive that business also.

Okay, great.

Can you just look ahead to 2011 and talk about the cost buckets that may serve as headwinds for you?

You mentioned one, the 401(k), but any other cost headwinds we should think about?

And any sort of dollar amount on the 401(k) would be appreciated.

Thank you.

Yes, I think as we look at 2011, and clearly we will talk much more extensively about that on the next call, we've got both some great tailwinds that are going to provide benefits and we've got some headwinds.

Let me start with the positives.

The positives as we began to look towards 2011 are the great balanced momentum across all our businesses.

Year to date, we are showing 50% profit improvements across all three segments, so we like the momentum we see.

We are continuing to focus on yields and they are getting firmer and we are pleased with the environment and the full benefit of the US restructuring will kick in.

So those are three of the positives.

On the flipside, there are some headwinds for 2011.

We did reinstitute the 401(k).

Probably the biggest issue that we're looking at right now is with the incredibly low discount rates we are seeing, really the lowest in recent history, they will create a headwind for pension expense, so that number will be volatile.

Clearly we won't know where it is until the end of the year, but that could provide some significant impact at least temporarily to the earnings statement.

That will impact most of corporate America.

Yes, so that's a big issue right now with historically low interest rates.

And then I guess the last issue -- this is another wild card -- is where currencies are going.

Clearly the US dollar has been weakening lately, which won't hurt us but depending on where the euro comes, if it begins to drop again as it was earlier in the summer, then that could be a significant headwind.

Ed Wolfe, Wolfe Trahan.

Thanks, good morning.

How do we think about compensation and benefits?

If I just look sequentially third quarter over second, you are 1.5% lower in third quarter despite I assume a union increase in August and your revenue is actually up sequentially.

Are you at a sustainable level now at compensation and benefits or was there something that's going to be going up as we look out going forward?

Ed, I think we did have a real good third quarter.

Clearly the increased volume growth has helped substantially.

You know, the volume got a bit of a boost from the way the Fourth of July fell last year was unfavorable.

But in general, seeing solid growth back in the network, we have substantial operating leverage and on a unit basis, that definitely helps us lower the cost.

We are also seeing -- beginning to see the emerging benefits of the restructuring.

If you recall in the second quarter, we had substantial added expenses for relocations and training.

Still a little bit of that going on in the third quarter, but that's beginning to mitigate.

And then I guess we have -- some of the network changes we have made, the maximization of volume flowing through World Port, all of those things have begun to help.

But the growth is certainly the big one.

That has also helped moderate our rate of increase in wages.

So you put all of those together and we are starting to see the synergies of both the actions we have taken and a moderate growth environment.

Ed, I got to take a moment too just to praise our operators, because we have done a wonderful job of improving productivity over the last couple of quarters.

Even more so I think in Q3 than we saw in Q2.

But the production is getting better and better both on road, in the hubs, on the feeder.

A lot of that is due to the technology investments we've made and we're still getting better and better in our routing and scheduling.

So I think that productivity is from building inaudible off a lot of that improvement.

Thanks, and then as a follow-up, Jon Langenfeld had asked about the 401(k) reinstatement and what the impact might be.

I am assuming this is the non-management or management non-union 401(k).

Can you give a sense of what the magnitude of what's going on there?

About $75 million, Ed.

$75 million over what period?

For the next calendar year, so if it is effective, January of next year.

Thank you.

Ken Hoexter, Merrill Lynch.

Great.

Good morning.

Kurt, can you just talk on the International a bit.

I understand the seasonal, but you were talking about the weakness this quarter.

We saw a 500 basis point improvement last quarter.

This quarter you noted it was 280.

Before the downturn we saw margins in that 17% to 19% range.

So just is there something else going on on the International side?

Is there pricing?

Are there costs coming back online?

Can you talk on the International side for a couple of minutes?

Yes, Ken, we were pleased with our Q3 results.

Clearly Q2 was an exceptional quarter for us, very strong growth out of Asia.

We were over 40% growth in all of Asia last quarter.

That moderated to over 30%, so a little bit of tempering in the rate of growth.

The currency also clearly if you look at what the euro has done in the last three months was a bit of a drag.

But this is -- we are within $9 million of the most profitable quarter ever for Q3 in International.

So we are still showing some substantial profit improvements.

They were up 34%.

We won't continue to compound it 50% growth forever in our profits, but we feel pretty good.

We think the yields are stable.

As we said, currency was a little bit of a headwind and Q3 is always a little dicey, but we do see -- we're looking for a margin approaching 18% in the fourth quarter.

We did warn you last quarter that comps get a little tougher especially into Q4 because of some of the disruption that happened in November and December last year with international supply chains.

We are always, Ken, going to have the weaker margins in Q3 with so much of our business in Europe.

And Europe, as you know, pretty well shuts down the month of August.

So we are pleased.

We are right on target where we thought we would be.

Ken, just maybe one other point, I guess.

We've talked a little bit about this alignment of our Forwarding and Supply Chain International, and what you saw this quarter was the Forwarding group excelling in an environment of softening rates and perhaps a less profit to the airline which shows up in our package for cargo carrying.

So there is that give-and-take as market rates go up and down.

In one quarter the International package will benefit.

Perhaps in the next quarter as rates moderate, we capture that on the Forwarding side.

That makes a lot of sense.

Thank you for that.

Lastly, a follow-up on yields overall.

You know, your ground yield is up over 3%.

I know pricing was a big focus for you.

How far along in this process do you think you are in terms of at least that first go round on touching those contracts where you kind of said to your salesforce, price now matters including revenue and volume.

So let's go readdress some of those contracts we had looked at during the downturn.

How far along in that process do you think we are?

I think we are in the middle innings.

Clearly we talked about this as a priority, but it also takes time to work through.

Every customer is different, but we feel very good about it.

It has been a priority.

Clearly Scott has reinforced that through the salesforce and our operating units.

And we are pleased to see our ability to execute it and also customers understanding that there is a need for improved rates after the last couple of years we've had.

I think the progress has been impressive considering the economy has been moderate at best, so it has not been an easy economy to do this in.

Tom Wadewitz, JPMorgan.

Yes, good morning and congratulations on the great results.

Let's see, the pricing -- Ken asked you a little bit about the pricing.

I wonder if you could get maybe a little bit more granular in terms of I don't know if you want to talk in sequential what your pricing might have been, in ground and domestic ground and air third quarter versus second.

Obviously there are a lot of moving pieces in the yield numbers in fuel and mix and weight and so forth.

But I don't know if you want talk sequentially or year-over-year but can you give us some numbers behind the based pricing in ground and air?

In absolute terms, we are seeing good, solid growth in based pricing for both ground and air.

Air has actually improved more substantially since that was flat just a couple quarters ago.

Fuel surcharge, it was less of an impact this quarter, whereas in Q2 it was significant for the year anyway.

So there has been a significant reduction at least in the year-over-year change for fuel surcharge.

So we see this really as a gradual story, Tom, that we are seeing not dramatic changes quarter-over-quarter but continuous changes in base rates, and it's great to see the air business a little firmer and at the same time, we are seeing sustainable increases in the ground.

Okay, let's see, when you look to the 2011, you mentioned a couple of different items that were maybe the bigger items on the cost side, pension and then 401(k).

What about I guess inflation in the wage side and then the incentive comp?

Are you close to 100% payout on the incentive comp this year so there's not much of a further step up, or is that an issue that is material to consider an incentive payout in 2011?

I would say, Tom, that that is one of the things that's impressive about this profit growth we are showing this year is we have accrued certainly normal incentive pay, so you wouldn't expect a big change in incentive pay in 2011.

In fact, we will be announcing that internally today, but we are back to a normal burn rate.

I think wages will increase, but if we get moderate growth, then the impact of a mix of employees, new employees, actually helps to mitigate those increases.

So we feel pretty good that actually wages will be a tailwind for us next year unless growth really grinds to a halt.

We are still, to Ed's question earlier, running about a 3.6% average wage rate increase in the third quarter and still showed, due to the productivity, that comp and benefit is up only 1%.

So we're doing a good job.

If we get growth as Kurt referred to, we certainly will bring that average wage rate deal down.

Scott Malat, Goldman Sachs.

Good morning, thanks.

I wanted to ask you about one of your competitors talking about adjusting their dimensional weight pricing.

Are you making any similar changes and what could be the impact for that?

We have not announced any changes for pricing yet.

Clearly, we are evaluating the whole range of our rate strategies going into next year.

It's likely we will announce that either in late October or early November.

Cubic space does drive capacity substantially in our aircraft.

The vast majority of lanes are cubic limited rather than weight limited, and on the ground it's a little less of an issue.

But we are looking at a wide array of cost drivers and trying to decide what's appropriate for rate changes.

Okay, thanks.

Just as a follow-up, in the past you've helped us think through things in terms of in domestic pricing about talking retention bids versus new business conversion bids.

Have you been seeing less retention bids in domestic package or just what have the trends been there, and how should we think about this?

I would say clearly as the economy has gotten better we are seeing less retention bids and certainly more conversion bids, so that's a healthy trend for UPS.

Bill Greene, Morgan Stanley.

Just a couple of detail questions.

First, just in terms of the trend on the domestic side, B2C, could you just kind of go through with us kind of quickly the growth rates there versus B2B?

Yes, we are seeing B2C continue to outperform the B2B.

Both were positive in the quarter, but the consumer is continuing to take advantage of remote distance-based purchasing.

The Internet component of a lot of retailers continues to show good growth whereas the bricks and mortars is a little more stagnant.

But this is also in some ways also a B2B-led recovery and so we are seeing good activity in some of the industrial sectors; the technology sectors have been particularly strong.

So on the commercial side, that is moving well and the real validation of that is the strong growth in our Next Day package, which is very strongly B2B related.

Correct me if I'm wrong.

The growth rates in B2B were faster in the first half, right, not B2C?

No, but they converged, basically.

They were very close.

Now that is good.

Okay, got it.

Then UPS Basic, how big a deal is that for you guys now in terms of size?

I don't know the relative size of it.

Yes, we don't release the exact details on it.

It's part of a comprehensive solution but the Basic is most attractive for the lightweight residential shipments and that is where we inject into the post office.

So that is an area of strong growth but typically it's related to a much broader contract with the customer.

It is an important piece in the puzzle.

David Campbell, Thompson, Davis & Company.

Good morning.

I heard what you said about International profitability and how satisfied you are with it, but it's down from the first quarter.

Exchange rates have an impact on costs as well.

So I am just trying to figure out first of all in the International, what's going on?

As it continues to be flat, pretty soon you're not going to have -- be satisfied with that.

Yes, David, I wouldn't worry about that.

I mean, Q3 for us anyway with the strong concentration in Europe has always been the weakest quarter.

There is a lot of businesses that go on holiday for several weeks in August.

So that's a very typical historical trend.

Our profits were up over 30% year-over-year.

I think that's more the indication.

Clearly the currency is a bit of a headwind right now and especially with the euro plummeting and then gradually coming back, it has been a little disruptive.

But no, we don't see things stagnating by any means in the international arena.

An example, David, of the currency, though, currency in Europe, all the revenue would be in euros.

A big piece of the costs are airplane-related, line haul related, which are in dollars.

So it's a contribution between euro-denominated revenue and euro-denominated costs.

There was a big gap there.

So it does have more of an impact.

Plus we are very profitable in International.

The second question in International, how do you feel about the fourth quarter in Forwarding?

Do you see a tonnage peak versus the third quarter?

How does the usual seasonal peak look at this point?

You are almost through October.

I think, Q3 was primarily an Ocean peak issue and we did see a decent Ocean peak, although frankly it didn't last quite as long as normal.

So that wrapped up a little earlier in the summer than is typical.

We do expect to see a seasonal peak for the Airfreight certainly, although we don't think it will reach some of the frenzy that it did in Q4 of last year, where there were pallets of freight left on the runways in some cases because of increased demand and reduced capacity.

What could change that, obviously, is consumer demand.

If consumer demand is a little stronger than the customers are thinking right now, then that could obviously drive Airfreight.

Robin Byde, HSBC.

Good morning, guys.

Just a follow-up on International pricing.

I just noticed your domestic yields were pretty weak again as at Q2, so my guess there that it doesn't look seasonality related.

Is this still the dilution impact from the Turkey acquisition?

Thank you.

Certainly, yes, Turkey is still a piece of that.

We did have the July was before the Turkey overlap, so that was a significant piece.

Yields are basically stable in the Domestic.

We had been growing substantially.

Profits are good, so the market we think is stable in Domestic, although it's hard to drive any broad-based because it's a wide array of countries.

But we are seeing, Robin, substantial, almost surprising continued growth in Europe both on the domestic and the export side.

Canada and Mexico, both of our domestic operations there continue to show good results.

So customer by customer, there are some challenging pricing environments, but we feel pretty good that the market is stable.

Thank you and just a follow-up.

The weakness in your International export yield this quarter, is that just all about seasonality or is there something else going on there?

No, if you adjust out currency, actually export yields are up 3%.

There is some seasonal cyclicality but if you look year-over-year, we're up 3%.

So I think things once again are pretty stable on the pricing across the globe.

UPS's value proposition continues to get stronger with our balanced capabilities across the globe, we can really bring things to customers that others can't.

And that allows us to have some pricing power.

We saw a little stronger mix of strategic accounts in the quarter where some of the bigger multinationals probably shipped a higher portion -- and that drives obviously a little bit of impact on yield.

Jeff Kauffman, Sterne, Agee & Leach.

Thank you very much.

Two questions on the cost side.

If I look at depreciation expense, whether I'm looking at it on a percent of revenue basis or a per package basis and other expense on the same basis, those came a little lower than expected.

I think the other expense was down almost $170 million sequentially.

The questions are, are there gains on sale offsetting the depreciation or is that more of a sustainable run rate?

On the other expense, I know you mentioned the restructuring, but how much of this is going to be a permanent change and this is the run rate of that expense level or should I think of it something maybe closer to $900 million, $950 million?

Jeff, the schedule that we have on other expense, the other other that shows the $170 million decline is directly impacted by the gain of sale of real estate that we had.

That was $109 million before tax.

Okay, so, I net that out, it's more like $60 million, $70 million.

And are there increased sales?

Because I know the PP&E sales are up this year.

That was the most notable.

We have retired quite a few vehicles, which has impacted the balance sheet a little bit.

So we are in the process of taking part of our CapEx to take older vehicles out of the fleet.

But in general, no, the only major blip in that segment was the sale of the real estate.

But some of the benefits, some of the costs tightening that we have done, bad debt is down substantially.

That shows up there.

Supply reductions, some of those things.

Depreciation has been at a pretty stable rate I think if you go back and you look at the last few quarters.

There's nothing in there to influence.

That's a good run rate, Jeff, for that.

Justin Yagerman, Deutsche Bank.

Good morning, gentlemen.

I wanted to dig in a little bit on your commentary around Q4 Airfreight peak and get a sense of what you guys are seeing right now.

How does the capacity situation in terms of lift out of Asia stack up versus last year?

And then in the event that we did get a boost in consumer demand, I guess is there enough capacity right now to move that demand or do you think that we would find ourselves in a similar situation to last year?

I would say generally, Justin, there is more capacity than there was a year ago.

I wouldn't say a lot more capacity, but there's more capacity.

For example UPS, we have added several flights, a couple flights per day from China to the US and to Europe.

So we have done that.

Some of our competitors have done that, but I still think there's not certainly excess capacity by any means.

And if there is more consumer demand, we will still see it could be a spike later in the year.

And I think back to Scott's comments on inventory, I think one of the recurring themes we've seen is that at least at the retail side, inventories remain pretty tight.

Customers decided not to move everything via Ocean early.

There was some that did but I think there is a real -- there is some potential leverage there.

If this holiday season comes in a little better, it could end up being a pretty good blooming rate for the growth.

Okay and then a related question.

Given the logistics that it would take to move things in an expedited fashion if that were to occur, do you have customers that are talking to you about how their CapEx plans or their ordering trends might change if midterm elections go the way that people are expecting them to go?

Do you have any insight into the thought process of the corporates you do business with post that time period?

I think clearly businesses are watching the elections, are concerned about tax policies and some of those things.

As to whether it would have a rapid impact on capital plans or inventory levels, probably not.

I think that will be more consumer demand-driven.

Nate Brochmann, William Blair & Co.

Good morning, everyone.

Great quarter.

I wanted to ask kind of a similar question but a little bit bigger picture regarding Asia.

Obviously the other day there was a lot of talk regarding currency, interest rates, etc., and what that does in terms of growth out of that region.

It still seems to me that regardless of what happens, there's going to be a lot of activity.

I was wondering kind of what you are seeing bigger picture from your perspective -- and I know you are making some additional investments over there and if you could talk a little more in detail with that.

I see a lot of the trends we've seen in the last several years continuing.

I think that although when you get towards midterm elections in the US, you hear a lot of talk of protectionism.

I think the administration supports trade and I think that when we get Congress back together, we will support trade and we will solve these issues with China.

So I'm very bullish on the outlook for Asia moving forward.

I think that there will blips along the way, where people will talk of trade wars, but I don't see it happening.

I look at again at the US, US businesses, 96% of their consumers are outside of the United States.

We need to promote trade going forward.

So I see there will be ups and downs.

There will be times when China will be challenged, but I think in general we see strong growth across Asia moving forward.

Clearly our strategies are to capitalize on that.

We continue to expand our infrastructure, increase our capabilities in Supply Chain & Freight, and look for growth opportunities.

The unknown is how fast the consumer base will grow in places like China and India.

We know they are going to grow but will it grow over the next five years, next 10 years, next 20 years?

We will see, but clearly there will be more consumption done in that part of the world moving forward.

And kind of just to follow up on that, how do you think about your strategy then in terms of that unknown consumer demand in that region?

And as manufacturing moves from the coast and inland, how do you think strategically about your rate of investment to kind of tackle that movement?

We are going to be aggressive there.

Again, we've got a wonderful balance sheet and we look for those opportunities to invest.

Most of our business is portable anyway and a lot of it is airplanes and you move where the business is.

So I think that as more and more moves to Western China, we will be there right with the customers.

Yes, it's a good example.

We are the only major competitor in our segment that has two air hubs in China.

So we are very well positioned with Shanghai and the Shenzhen hubs to distribute goods around China.

We are continuing to expand our alliances and do deeper investments.

We are in the process of opening a healthcare distribution facility in Singapore.

So clearly we are focused on that.

We will do it in typical UPS fashion, which is with a mind towards both growth and return on capital.

But it is a high priority for us.

Matt Brooklier, Piper Jaffray.

Thanks, good morning.

A quick question.

Pilot furloughs, where are you in that process?

What was the impact on third quarter and how should we think about cost impact from pilot furloughs into fourth quarter?

Well, where we are at right now, Matt, we are at about 109 pilots furloughed.

Right now the announced goal is 230 but we've actually taken what we call a time out, a break in this.

One, we want to see how business as it is improving, the International business has been getting better.

There's also some proposed rulemaking out there regarding pilot rest hours, pilot fatigue that we really want to understand the impact of that.

It's not going to take place immediately, but we want to work with the industry and with our pilots and with the government to figure out what will those rules be?

Will that change staffing requirements?

So it really made an awful lot of sense at this point in time to just halt, put a stop to the furlough until we understand the implications of the rulemaking and then probably by first of the year, early into 2011, we will have a better view on where we go from here.

Okay.

Second question, Domestic Ground Packages, you guys saw a nice uptick in terms of the volume growth rate.

I wanted to know if there's anything strategically that you are doing different in terms of driving volume growth in that business?

I also noticed that sequentially your yields were down modestly in that product.

I don't know if I'm reading too deeply into that data point, but could you talk a little bit about that?

We are continuing to work as hard as we can to add value to customers.

Clearly we have a big focus on -- with the deployment of our field marketing groups to understanding unique industries and unique customer needs and bringing them more comprehensive logistics solutions.

So we think that is a great catalyst for growth.

On the yield side, really the core base rate trends actually are stronger.

The fuel surcharges accounts really for the totality of any revenue per piece differences.

Art Hatfield, Morgan Keegan & Co.

Good morning, guys.

Just a quick question.

I don't recall hearing you mention what CapEx was in the quarter.

If you did I apologize.

Secondly, can you say anything about how we could think about that over the next year or so?

Yes, basically CapEx year-to-date is a little over $1 billion.

We've got it for the year to be at about $1.8 billion.

We're probably going to come in at a little below that.

But we are continuing to invest wherever it makes sense.

As I mentioned in my prepared remarks, our cash position continues to be strong.

We are generating a substantial amount of free cash flow.

It's one of the reasons we decided to extend our share repurchases.

With the S&P change in their outlook to stable, we are very comfortable continuing to reduce our cash to repurchase shares along with investing in the business.

So from a cash perspective, all systems are go.

We are going to continue to buy aircraft and do targeted investments in those areas we need added capacity, but we do expect CapEx to remain below its historical normals based on the fact that we have really got a modern new air fleet.

We've retired all of our older generation aircraft.

We've got a world port hub that's complete.

We've got major hubs in China.

We've got good capacity in Europe.

So we are in a great position to look for new growth opportunities and invest in those when they come around.

Great, thanks.

That's all I have today.

David Ross, Stifel Nicolaus.

Good morning, gentlemen.

First question on export growth for small to medium-sized businesses.

You said you were working with those customers to try stimulate more exports from them.

Wondering what kind of segments that would benefit most at UPS?

Would that be their International Freight Forwarding segment, your International Package segment, you Domestic Package segment?

I would say all of the above, but I think clearly the International Package that would be the biggest beneficiary right now and we're making good progress.

We have identified 9000 customers and shipped to just one -- export to one country.

We are trying to get those 9000 customers to go to at least a second country.

We're making some good progress.

We did show double-digit US export growth again in the last quarter.

Trends remain strong there.

But it's helping to educate the small and medium-sized enterprises of the value and the ease.

And there's a lot of our Logistics campaigns trying to also to educate the SMEs on they can use UPS as a partner to handle some of the business differences, cultural differences, custom regulation differences of other countries.

It seems to be working.

And then at UPS Freight, you mentioned you were still unhappy with the margins there.

To get them to where you want them, is it a function of you need more volume because you have excess capacity in the network?

Is it just yield?

Do you need price or is it improving the overall operations and productivity still?

The majority of it is the environment.

LTL is still a very tough place to be.

The price environment is beginning to firm, but there were a couple of years there where it was extremely challenging.

We've tried to stick to the high road because we are making deep investments in technology and in the network enhancements.

So we have been focused on pricing and targeting those markets that make sense to us.

So I would say the vast majority of the Freight headwinds are market related.

We do continue to see great results though in bringing technology and ease-of-use to the middle market for the LTL segment.

We think that really this industry has been underinvested in.

We know that one of our big competitors is getting ready to go through some restructuring and realignment.

We've already heard from some customers that are concerned about that.

So we are going to stay focused.

Our operations are working well.

We have got an integrated regional and long-distance network national, so we've already done the hard work of providing a single carrier that can cover any geography across the continent.

So we feel pretty good where we are.

It would be nice if the overall segment was in better shape.

That does, though, give us a great tailwind over the next couple of years for Supply Chain & Freight.

When the Freight segment really begins contributing, we've got even better results ahead.

That's all.

Thanks.

Chris Ceraso, Credit Suisse.

Okay, thanks.

Good morning.

I wanted to come back to the comment about the other expense.

You said maybe some lower bad debt in there.

Even after you strip out the real estate gain, though, it does look like it's running at a lower rate than normal especially as a percent of revenue.

Is that something you expect to continue?

Well, I think in a modest sense.

The year-over-year comparisons, there's a slight expenses last year that were one-time but it's $20 million, $30 million.

No, it's just a comprehensive reduction of expenses.

Our claims expenses are down as our quality continues to improve.

Negotiation through our procurement on supplies, telecom expenses, you name it, we've been -- some of that is just the fruit of a lot of hard work.

Certainly the one-time event of the sale of the real estate did give us a big boost, but it's an area we're going to continue to focus on.

It does fluctuate a little bit but there's nothing outsized as far as anything that distorted it other than what we've talked about.

Okay, and then maybe one bigger picture question.

We've heard from a number of the trucking companies that the freight market broadly seemed to slow down toward the end of the third quarter and has slowed still into October.

Have you sensed that in any of your businesses either domestically or internationally?

I don't we've seen any change at all from what we saw in the third quarter.

I think October is moving along at a steady pace.

Again, we're in a moderate economy, we in a probably 2%, 2.5% type of economy and I haven't detected any change over the last several months.

Yes, I think the most notable thing just looking at our reported results is you do have some gains with the calendar.

That third quarter did get a benefit from the overlap against the Fourth of July last year and our fourth-quarter volume that we will report will on an average daily basis be muted by the fact that we have one extra day between Christmas and New Years without much added volume.

So if you take those two out, then I think you've got a pretty core, stable trend, and that is what we are seeing in the market.

Okay, thank you.

I would now like to turn the conference back over to your Vice President of Investor Relations, Mr.

Andy Dolny, for any closing remarks.

Yes, I'm going to turn it over to Scott for some closing comments.

Thanks, Andy.

Thanks for everybody attending the conference today.

But I am really pleased that we've shown superior results across all segments and we did this in a modest economy.

And year to date operating profit in both International Package and Supply Chain & Freight were the best ever.

And that says an awful lot in an economy that really is not recovering at a fast pace.

Despite some of the questions on International today, we have had the best nine months we've ever had in International.

I'm extremely bullish going forward in that segment.

In the US, Domestic operating profit was up 50%, 77% for the quarter, so extremely strong growth in that area.

As Kurt mentioned, we generated $3.5 billion of free cash flow for the first nine months, extremely strong.

We raised our full-year guidance to more than 50% growth over last year and so we are expecting a good, strong fourth quarter.

And I'm extremely confident we are on our way back to the high levels of profitability that we have demonstrated in the past.

So we have a lot of confidence we're going in the right direction.

Thanks so much for attending today.

Ladies and gentlemen, this concludes the UPS third-quarter's earnings teleconference call.

We would like to thank you for your participation.

You may now disconnect.