聯合包裹運送服務公司 (UPS) 2011 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

My name is Stephen and I will be your teleconference facilitator.

At this time, I would like to welcome everyone to the UPS investor relations second-quarter 2011 earnings conference call.

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

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

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

Thank you.

It is now my pleasure to turn the conference over to your host, UPS Treasurer and Vice President of Investor Relations, Mr.

Andy Dolny.

The floor is yours, sir.

Good morning, everyone.

Thanks for joining us today.

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

These anticipated results are subject to risks and uncertainties, which are described in detail in our 2010 Form 10-K and first-quarter 10-Q reports.

These reports are available on the UPS investor relations website and 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 recorded a net gain of $33 million as a result of two nonrecurring real estate transactions.

This provided an after-tax benefit of $20 million, or $0.02 per share.

Excluding these transactions, diluted earnings per share for the second quarter were $1.05.

Although the overall impact is small compared to total earnings, we felt the adjustment was necessary to provide a better view of segment performance.

In their remarks today, Scott and Kurt will refer to UPS's second-quarter 2011 results, excluding the impact of this gain.

Additionally, all 2011 full-year references and comparisons to 2010 will refer to adjusted results.

We believe this is a more 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.

These schedules are also available on the UPS investor relations website in the financial section.

Before I turn it over to Scott, I want to remind everyone of our investor conference on September 14 and 15 in Louisville, Kentucky.

You should have received an e-mail recently informing you of the details.

Attendees will be provided tours of UPS's small package and supply chain facilities, as well as demonstrations of our industry-leading operational and customer-facing technologies and solutions.

There will be multiple opportunities for interaction with the management team and sufficient time for informal Q&A.

A limited block of rooms at a discounted rate are available, so please visit the UPS investor relations website to register.

We look forward to seeing you there.

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

Thanks, Andy and good morning, everyone.

Today, UPS reported another quarter of impressive results.

However, it was not without some difficulty given the uneven nature of the global economy.

While fuel prices have come down some and Japan appears to be recovering, high unemployment and weak consumer confidence continue.

The end of the second round of quantitative easing and the government debt issues only add to the uncertainty.

2011 has been a difficult year to forecast economic growth.

For example, according to the Wall Street Journal, back in February, in the middle of the quarter, 51 leading economists expected first-quarter US GDP to grow 3.6% and as you know, it ended up at only 1.9%.

The current forecast called for second-half GDP growth of more than 3%.

Given all the uncertainty that exists in the US economy, it could end up being anywhere from 1.5% to 3.5%.

Bottom line, economic growth expectations have slowed from where they were at the start of 2011 and as I said last quarter, increasing US exports is a key component in creating jobs here at home and helping our economy grow.

I am hopeful that Congress will act soon on the pending trade agreements with South Korea, Colombia and Panama, but clearly they are not acting fast enough.

I can assure you that UPS is not sitting back waiting for the economy or trade agreements to keep us growing.

We are creating our own opportunities to ensure UPS keeps moving in the right direction.

For example, in June, UPS held its sixth annual healthcare forum.

More than 85 senior-level healthcare executives from 60 companies attended the Washington, DC event to discuss key supply chain issues and opportunities.

Events like these give us insight into the challenges and opportunities in the industry.

We continue to invest in the expansion of our healthcare capabilities.

Last month, UPS made a significant announcement in this space, the global broadening of our relationship with Merck.

We have been working closely developing a deep understanding of their needs and have a strong network in place to support them.

The relationship with Merck will expand to include Europe, Asia and Latin America.

UPS will provide a broad range of services, including distribution, warehousing, and transportation.

UPS's industry-leading technology, unmatched breadth of solutions and strong global presence were some of the many factors that allowed us to win this business.

A year ago, we strengthened our presence in Asia by opening our Shenzhen facility.

Since this has opened, we have significantly improved time in transit for more than 100 intra-Asia lanes, enhancing service levels for UPS customers in key business centers like Beijing, New Delhi, Mumbai and Seoul.

We just announced another recent development in Asia, the expansion of the UPS air network to serve the important western China city of Chengdu.

This new flight provides express services to Europe and the Americas from this rapidly emerging center of technology and manufacturing.

Not only did UPS expand its global network, we added to our unmatched portfolio of solutions.

We introduced UPS Returns Exchange, another tool in our reverse logistics portfolio to support the needs of our customers.

They are excited about how this product will improve visibility and inventory management and enhance the post-sales experience for their customers.

Overall, it was a good quarter for UPS.

In fact, it was our highest second-quarter EPS ever.

Despite slowing economic growth expectations, I am encouraged by the progress we are making.

Our strategy is sound and the hard work of UPSes around the globe is paying off.

Now let me turn it over to Kurt.

Thanks, Scott and good morning, everyone.

Another solid quarter for UPS with earnings up 25% on revenue growth of more than 8%.

We had over 30% improvement in US domestic profit, strong international export volume growth and the best quarterly profit ever in Supply Chain & Freight.

In fact, the $1.05 earnings per share set a new high for UPS in the second quarter.

Operating margin expanded 110 basis points to 12.6% despite higher fuel costs and an increasingly challenging global economic environment.

UPS growth strategies, combined with our focus on quality of revenue, as well as network efficiencies, produced these results.

Now let's take a look at how the segments performed for the quarter.

US Domestic operating profit climbed 31% on revenue growth of more than 6%.

Domestic volumes were flat as a result of the slow US economy and our continued focus on revenue management.

Operating margin expanded by 240 basis points to 12.7% demonstrating the leverage inherent in our integrated network.

Revenue per piece climbed more than 6%, due primarily to stronger base rates and higher fuel surcharges.

In fact, stronger base rates contributed roughly half of the improvement.

Technology solutions continue to improve our network efficiency, delivering big operational savings, as demonstrated by reductions in both direct labor hours and miles driven.

These savings partially offset cost increases associated with wage inflation, pension and the 401(k) match.

The lag in the fuel surcharge had a minimal impact on profitability as energy prices did moderate during the quarter.

As high energy costs continue to prevail, we are vigilant in the pursuit to reduce usage and UPS continues to evaluate a wide array of solutions, including various operational technologies, alternative fuels and new vehicle designs.

One example is our new prototype composite package car.

The weight of this vehicle is 1000 pounds lighter than a traditional vehicle and it is 40% more efficient.

We are testing five of these vehicles to determine if they can stand up to our demanding needs and we will have one of the vehicles on display at our investor conference in Louisville on September 14.

Now let's turn to the International segment.

Revenue was up more than 13% on strong volume growth of 6.2%.

Export volumes increased over 8% with growth around the world.

Europe and China continued their momentum of solid growth; although we did see slowing in the rest of Asia.

Non-US domestic volumes improved 5%, led by double-digit growth in France and Turkey, along with solid increases in Canada, Germany and Mexico.

International package yields were up 4% on a currency neutral basis driven by higher fuel surcharges and base rates.

Our International operating margin of 15.8% was up 40 basis points compared to the first quarter and remains industry-leading.

Operating profit was $497 million.

This is down $24 million from last year.

Currency translation and hedging programs had a negative impact on operating profit of more than $50 million.

And fuel was also a slight drag for the quarter.

Remember when comparing to last year, the second quarter of 2010 presents a very challenging comparison.

For example, International operating profits were up about 80% over 2009, driven in part by a 40% growth rate in UPS Asian exports.

We continue to invest for growth and have significantly increased air network capacity in Asia since the beginning of 2010.

While this additional lift does create a temporary drag on operating margin, it positions us very well for future growth.

In addition to the new Chengdu flight that Scott mentioned earlier, during the quarter, UPS made other moves to improve service and increase capacity in our global air network.

In Latin America, UPS upsized 19 weekly flights, effectively increasing our payload capacity in key markets by more than 50%.

Now for the Supply Chain & Freight segment.

Revenue was up 7% to $2.3 billion led by UPS Freight's 19% gain.

Operating profits increased more than 40% to $187 million while margin expanded 200 basis points to 8.1.

Both are new highs for this developing segment.

Clearly, the long-term investments we have been making over the years are paying off.

The increase in operating profit was driven primarily by the forwarding business with UPS Freight also contributing.

Forwarding revenue growth was muted by tonnage decreases; although operating profit improved significantly due to revenue management initiatives and market conditions.

Capacity increases outpaced demand, pushing our buy rates lower.

UPS Freight's [jump-in] revenue was driven by strong LTL tonnage and shipment growth.

Revenue per hundredweight was up 11% driven by both higher fuel surcharges and increased base pricing.

As expected, UPS Freight improved profitability this quarter.

Our strategy of focusing on the middle market, leveraging the small package salesforce and driving operational efficiencies are paying off and continue to move us in the right direction.

The distribution business continued to see solid growth in the healthcare sector.

Operating profit growth was relatively flat due to our substantial investments as we expand our global capabilities in this strategic vertical.

UPS recently opened three dedicated distribution facilities in Canada, Brazil and Singapore, bringing the total healthcare compliance space to more than 4 million square feet across 30 facilities around the world.

Now let's talk about cash flow.

UPS continues to excel in this financial metric.

For the six months ending June 30, free cash flow was more than $2.3 billion, even after making accelerated pension contributions of $1.2 billion.

We continue to reinvest in the business with first-half capital expenditures approaching $1 billion.

UPS has taken delivery on six additional aircraft.

The capacity created by the four 767s and two 747-400s allows UPS to further expand the reach of its networks to markets across the world.

With respect to distributions to share owners, for the six months ended June, UPS paid dividends of more than $1 billion, a 10.6% increase per share.

In addition, we repurchased 14.4 million shares for approximately $1.1 billion, more than double last year's level.

Regarding our outlook for the remainder of 2011, we are reaffirming our earnings per share guidance of $4.15 to $4.40 a share.

Regarding the US Domestic segment, UPS will continue to benefit from its focus on yield and on improvements in operational efficiency.

Keep in mind, however, starting in the third quarter, we begin to lap the benefits of the US restructuring.

That being said, the shape of the next two quarters may not reflect typical seasonality.

Given the softness in the US economy, we expect third-quarter volume growth to be slow and operating margins to be similar to last year.

In the fourth quarter, we expect year-over-year operating margin expansion.

In International, we expect second-half operating profit growth of mid to upper teens compared to last year as the impact from our hedging programs is mostly behind us.

The Supply Chain & Freight segment will continue to see margin expansion and revenue growth as we expect to experience operating profit growth in Freight and strong operating margins in Forwarding.

To wrap this up, as Scott indicated, economic conditions have slowed since we last provided guidance.

A good example, US GDP growth expectation for 2011 was at 3.1%, was revised downward to 2.9% and now sits at 2.5%.

These trends may reverse as some are projecting or they may continue.

Clearly, economic conditions in the second half will impact where we fall within our range.

That being said, our guidance for full-year EPS growth of 17% to 24% remains unchanged and 2011 will be a record year for UPS.

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

(Operator Instructions).

Kevin Sterling, BB&T Capital.

Thank you.

Good morning Scott, Kurt and Andy.

Looking at International, as you expand your International network and you build out your International network, are there startup costs that are still incurring which could impact margins?

Well, certainly the addition of capacity does create some time period to get utilization back up to where it is and it is not just physical utilization, it is really the revenue maximization.

So especially in Asia, we have had fairly significant capacity expansions.

You've heard about us continuing to improve service through there.

And for the first few quarters anyway of a new flight, typically, there is a higher portion of cargo and freight on the plane, so the revenue yield is not quite as rich.

So it is a little bit of a headwind right now, but, in general, we feel pretty good and we expect International to show solid double-digit growth for the rest of the year.

And clearly, Kevin, going to areas like Chengdu, we are going there because our customers are asking us to go there.

We are going to see tremendous growth in Western China over the next five years and we think we are positioned very well to serve that market going forward.

Thank you.

And kind of a follow-up, and talking about adding to your Asia air network, are you shifting capacity around or is this new capacity you're introducing into your airline fleet?

It is primarily new capacity.

As we -- either upscaling aircraft, making additional stops or new aircraft, so we are doing it prudently.

We want to make sure we don't get ahead of the market, but as we bring some of these new efficient and large aircraft in, it does make sense to put them on the international flights.

Okay, thank you.

Scott Group, Wolfe Trahan.

Thanks, good morning, guys.

Scott, you gave a pretty wide range for GDP of 1.5% to 3.5% for the second half of the year.

Should we interpret that to mean that you can meet your guidance range even if it is only 1.5% GDP?

And then does that suggest kind of material upside to your guidance if second half is closer to 3.5% growth?

I think we have not narrowed our range for the year primarily because of the uncertainty in the economy.

So I think I am comfortable saying that we will be within the range at a 1.5% economy or a 3.5% economy.

Clearly where we are in the range will depend on how strong the economy turns out.

But as you know, we have some positives out there with the energy price decline and Japan's supply chain getting back on.

But obviously with the debt ceiling hanging out there, the uncertainty that causes, big issues.

I think last night's national media didn't give anybody more confidence that this is going to get resolved.

I think we expected it to be the last minute before it got resolved and will get resolved, but a lot of uncertainty.

Consumer confidence is down because of it.

Unemployment is still weak, so a lot of uncertainties right now, but we feel comfortable with the range we gave.

Okay, that's helpful.

And just the follow-up, I am just trying to understand why domestic package volumes are so soft.

We are certainly seeing better than flattish GDP and IP growth.

I am just wondering do you think you're losing share because of the pricing strategy, maybe a small package overall losing share because of high fuel and consolidating into larger shipments?

Just any color there would be great and any expectations you have specifically for volumes going forward.

Sure, I will talk to that a little bit.

I think over the -- maybe talk about the market in general first off, that, at any given point in time in an economic cycle, small package may outperform or underperform.

Typically, in a recovery phase, it may lag IP in some of those things.

But if you take a look over the last seven or eight years or so, really watching the full length of the cycle we have been through, small package growth has outperformed both GDP and IP.

Granted, the numbers haven't been exciting given where the US economy has ended up over that time period.

So I think as you smooth out over the cycle, we still feel pretty confident that the small package industry will continue to be a good place to be.

As we look at the overall industry, we think the overall small package environment has been relatively flat the last couple quarters if you look at all the players.

It is a multiplayer market and clearly, the post office continues to show some declines.

So we feel that we are holding on to share right now, frankly and that we are focusing on getting good strong yields across our entire portfolio.

That does require a level of discipline and patience in some cases and we are pleased with the results we are seeing.

Clearly, the yields continue to be strong and we feel confident that trend is going to continue.

I think certainly the fastest-growing market is the International package market and we've continually for the last 10 years grown faster than the market.

Any volume expectations going forward?

No, we just commented that we expect Q3 to continue to be fairly slow frankly unless there is a big catalyst, but we do expect to see a little stronger growth then moving into Q4.

Okay, great.

Thanks for the time, guys.

Jon Langenfeld, Baird.

Good morning.

This is Ben Hartford in for Jon this morning.

If I could start on the International side and get your sense on what some of the pressure on the margins were this quarter, it looks like, based on your expectation for mid to upper teen EBIT growth in the back half of the year, that the pressures start to normalize.

But can you talk a little bit about the pricing dynamic on the International lanes?

Yes, we feel pretty good overall on the pricing.

We warned you last quarter that there was going to be some real headwinds for our International business.

The currency in light of the hedging we did this year versus last year -- the euro plummeted last year and we did protect ourselves back then and sold away some of the upside.

So currency overall was about a $50 million headwind for us and fuel also was a headwind in International; although it was fairly neutral for Domestic.

If you add those two back in, you actually get a pretty darn good result with margins approaching 18%.

So I think those are two one-time events that did impact Q2 and I think we have been trying to warn you guys that that was coming.

Clearly, the fuel was an addition on top of that.

So that was the short-term issue that really created the decline in profits even with great growth and firm yields.

Looking to the second half of the year, we do expect to see double-digit profit growth again.

Overall, the macro environment internationally is moderating slightly.

We did mention that Asia has cooled; although China continued strong.

So there are some, I guess, a bit of mitigating factors a little bit.

Although clearly with us showing 8% export growth, we are still gaining share, as Scott said and creating good results.

So we see this as a solid period for International, but the market, we think, is maybe catching its breath a little bit and we will see what the next leg is.

Yes, Ben, I would say that the first half of the year International performed about exactly where we thought it would.

Probably the only surprise was maybe Asia being a little bit slower than we would have expected, Europe being a little bit stronger than we would have expected and Germany continues to just outperform.

I think Germany's GDP expectations have climbed dramatically from what we saw at the start of the year.

So Europe is staying strong and overall we are confident for the second half of the year.

Okay, great.

And then on the Supply Chain & Freight side, but just specifically looking at supply chain, very strong performance here, particularly on the Forwarding segment.

It looks like, if you exclude Freight, that EBIT margins in that segment on the Supply Chain side are approaching best-in-class levels.

So I am wondering if, one, you would agree with that statement and two, is this type of margin performance sustainable and where should we think about margins in that segment going forward from here?

A lot of pieces to the puzzle there you asked me, but, no, we are very pleased with the progress we've made in Supply Chain.

It is a great example of kind of our long-term perspective of investing for a decade, refining the business model and building the global footprint.

With our aligning it into all of our other capabilities and technology, we feel very good that we have built something that will last and will create shareowner value.

We do think we are approaching best-in-class margins.

The Forwarding group is clicking very well.

We did mention that actually distribution is investing deeply right now as we add these major healthcare facilities around the world.

That is clearly an investment, but even with that, they are holding in there well.

The Forwarding margins do cycle.

In periods of weak buy rates, the forwarder does well and the airline makes a little less money.

So you have seen that balance this quarter where, as some of the rates have come down, we are not making quite as much on our airline capacity, but we are doing great as a forwarder.

So margins will fluctuate, but having that balance of capabilities is great.

And there is still a lot of headroom on the UPS Freight side.

We have remained very disciplined.

We are showing both growth and very strong yields, and so I think that story is still there to be written and we look for good things for that.

Tom Wadewitz, JPMorgan.

Good morning.

I wanted to ask you I guess a thought on Domestic Package margin.

The first two quarters of the year, you have shown this nice formula of pretty significant Domestic Package margin improvement despite volumes, which were flattish essentially, I guess, maybe down slightly in first quarter.

And then in third quarter, I recognize you lapped some of the US restructuring, so that is a difference in the comparison on the cost side.

But is the formula still in place that you have nice margin expansion on pricing and cost or is your comment on third-quarter Domestic margin being flat, is the formula changing a bit again in terms of you are doing well despite flat volumes?

Tom I do think it is -- we do want to be pretty clear on what we see going on in Domestic.

We do expect, in Q3 anyway, for margin comps to be fairly flat to last year.

A lot of that is driven by our expectation of a continued extremely sluggish US environment, so that is the primary driver on that front.

But also as we look at our comps year-over-year, Q3 of 2010 was an exceptional quarter for us.

We did have good strong recovery growth and there were some -- the third quarter is usually the quarter in which we do some of our true-ups for workers' comp and some of the health trends, so that was an area where we benefited last year.

We don't expect to see quite as much benefit this year.

So a little bit of a breather in Q3.

But the operational efficiencies and the yield management and the focus on growing profits remains and we think you will see that back more clearly on a year-over-year basis in Q4.

So a little bit of tougher comps, certainly ramping the restructuring, what has been incredibly successful for us.

It has added at least $0.10 a share, so some of that tailwind mitigates as we lap that, but we still think the other two trends are strong and will continue to show good results, especially starting in the Q4 again on a comp basis.

So how much of that third-quarter difficult comparison and flat Domestic margin is -- you mentioned accrual.

How much of that story is kind of one-time and you would say, well, you hit that in third quarter and how much of it is, well, if you have flat volumes, then the margin kind of trends towards flat even though you are getting pricing?

Certainly the economic cycle is the biggest driver.

The one-time events of workers' comp and some of that which happened in Q3, typically is not a huge issue.

That is just one of the mitigating factors, but we are continuing to improve efficiency and effectiveness.

Clearly, if there is no volume and growth in the industry for an extended period, it will slow the rate of profit growth, but we anticipate that we will show increases in both margin and profit in Q4 given most scenarios that we have looked at.

Okay, and that is because your volumes get better in Q4 or what's -- I guess I still don't see what the difference is in the 3Q and 4Q views.

It is a combination both of some -- certainly some expectation of firming and also the comparisons become more normal.

Okay, great.

All right, thanks for the time.

Dave Vernon, Bernstein.

Hi.

Just a quick question on the strength that you are seeing in the LTL volume relative to the weakness in package.

This is sort of a follow-up to an earlier question, but do you see that maybe some of the volume is being pushed back towards LTL into ground?

It is a fluid process and we frankly try to make that as easy as possible, harmonize our shipping systems so customers on a daily basis can shift between LTL and package and clearly, in the last couple quarters, the LTL industry has shown much greater growth in the package industry.

So there may be some slight shifting on the increment.

We have seen actually though, even though LTL held up fairly strong in the second quarter, we have seen things begin to moderate a little bit in July.

So we are positive on the LTL as an industry, but clearly there is some risk I think also to growth there.

David, if you look at previous cycles, I think you do see where the LTL seems to come back a little bit quicker than small package and clearly, during the recession, we saw the small package market drop quite a bit, not as far as IP, but it always seems to lag coming back.

So it is not an unusual occurrence.

Okay.

And maybe just a follow-up on the LTL space, with respect to the fact that you are getting better rate, where do you guys stand relative to the industry in terms of driver pay?

Would you say you guys are sort of average, above average?

I am just trying to understand maybe how much of that rate increase you are going to be actually able to retain versus just going to flow through towards driver pay increases?

We have got a very reasonable contract in place that will show modest below inflation increases in wages, so that is an ongoing process.

We do have a contract and so we are not quite as volatile as perhaps the market rates, which I know are getting squeezed right now.

So we feel good that we have got a good outlook for the cost structure.

Clearly, the Freight business continues to get more effective and streamlined and we did accelerate the rate increase until August, which will also be beneficial on the yield side.

So we feel like the formula is good.

We have got a very high quality service, superior technology and the customers that are using a blend of Package and Freight to match shipment characteristics are the ones that are seeing tremendous savings.

So it is a win-win for us if we can keep it in the network and help customers choose on a daily or weekly basis.

All right, great.

Thank you.

Ken Hoexter, Merrill Lynch.

Great, good morning.

If I can just start off with kind of a follow-up on the International, the currency exchange.

Kurt, was that, the $50 million, was that all due to the currency exchange or can you kind of dig into that $50 million?

And then looking forward, what should we expect on the impacts into the second half, the third and fourth on the International side?

The $50 million is a combination of the direct currency impact and hedging losses frankly.

Back last year when the euro was in the mid $1.20s, we put some collars in place that protect us on the downside and capped the upside.

That creates a hedging loss, Ken, that was the primary impact for us in the second quarter and those hedging losses will mitigate dramatically in the third and fourth quarters.

So that was the biggest specific impact on us.

In fact, Ken, what will happen in 2012 is that we will actually benefit from currency hedging because of the price we paid this year is going to help our comparisons next year.

So going forward, probably the next six quarters or so, currency should not be a drag and probably will be a little bit of a help.

So including into the back half, you won't see any residual impact?

Right.

Okay.

And then as you look to the slowing economy, you made some comments on that earlier on looking at Next Day Air volumes being down.

You talked about adding planes domestically.

What signs do you look for to either slow the adds or postpone or go back to parking?

How dramatic does that step have to be where you then go into that cost-cutting mode again?

Well, I think on the Domestic side, really block hours are almost flat, so we have not been adding anything significant in the US.

Occasionally, if a lane gets heavy, we will upscale a plane and we have got a very highly compatible fleet, so it is very easy to move from like a 7-5 to a 7-6.

So it is always a balancing act of throwing the ball a little bit ahead of the runner so you catch the demand when it is there, but not getting ahead of yourself and we have been pretty pleased with our ability to keep high utilization.

Being a freight forwarder also helps fill it up.

In the domestic market specifically, clearly, the North American airfreight, we did have a competitor decide to exit that market, so that should be good for demand and for yields we think in the domestic airfreight.

So we watch all of those things very frequently and we get a lot of insights because we sit in virtually all the markets and can watch what is happening.

And Ken, as you recall, our CapEx is still only 4% of revenues, so our CapEx is at a historically low level at this point in time.

And you saw during the recession our ability to flex our fleet.

I think we have got probably the biggest [strength] of anybody in the industry by adjusting our fleet to the demand.

So we are very confident we are in good shape.

We still expect there will be some growth out there going forward though.

If I could just jump in on that, how do you think about peak shipping season and do you anticipate kind of that tighter season as we move deeper into August?

Well, I think, so far at least, looking at Asia, which is really where peak begins, we have not seen very strong indications, at least on the oceanfront.

So I know last year actually we had a little bit of an early blip on ocean and typically August is really your ocean peak and at least so far, our temperature checks don't suggest a very strong peak that way.

Now that may manifest itself into an airfreight boom later if demand picks up, but we are cautious.

Clearly you hear our tone on that.

But it kind of goes back to what I opened up with on the uncertainty of the economy right now.

If Congress and the President resolves this debt ceiling issue satisfactorily in the next week, the mood of the country could change pretty quickly; we could see demand picking up.

Europe has made some progress in their sovereign debt issues.

So the mood can change pretty quickly if we resolve some of these issues in front of us.

So I wouldn't say we're pessimistic about the issue.

There's just a lot we're uncertain about how much the economy will grow.

Scott Malat, Goldman Sachs.

Thanks, good morning.

The first is on -- the deferred and ground volumes were up a little bit more than Next Day anyway.

I think you tweaked the fuel surcharge program that did narrow the pricing gap between the modes, especially when the fuel prices rise.

But can you talk about what you're seeing in terms of tradedowns, how much of that you are seeing?

It is -- certainly the spread is much narrower than it was back in 2008 when we had 20% plus differences between the air and ground surcharges.

So we think this current environment is much healthier.

It allows customers to maintain their normal mix of premium products and standard products even in the rising fuel.

If you look back early in the quarter when fuel was bumping $110 or more, we did begin to see some real discussions and some revisiting of supply chains.

And so there is a threshold at which certainly it begins to more materially impact supply chains.

As it began to moderate and is now sitting below $100 at least, it seems to have settled down a little bit, so we watch that pretty carefully.

Our intent is not to make this disruptive to customers; it is just really to have a way for us to minimize our volatility.

And so far, it has worked pretty well.

Okay, thanks.

And then the other one was just -- I am not sure how much you will be able to say about this.

I know I have gotten a lot of questions on it and hopefully, you will speak in more detail at the Analyst Day, but I thought I'd give it a short.

Is there a way you can help us think about the long-term top-line growth rate for the Company?

A lot of people break it down and get to numbers of 7% or 6% or 7% or 8%, in those kind of ranges.

Is that too low and how much can you help us with that?

You're going to have to make the trek to Louisville to hear that, I am afraid.

We will clearly give some update on our long-term expectations and we are such a diverse company that you really have to break it down into seven or eight categories with Domestic Package, the International Package, the Freight Forwarding, the Distribution, the LTL and so we will speak in detail about our long-range outlook.

This really isn't the point to get into that.

Gary Chase, Barclays Capital.

Good morning, everyone.

I wanted to see if I could follow-up on this topic of customer response to some of the pricing initiatives.

If you look at places where you have been successful at say implementing significant price change, are you really not seeing anything different in terms of volume behavior there than you are seeing in the broader business?

It is a nuanced issue.

I think on the increment, certainly there are conditions or cases where we may win a little less volume or perhaps have the discretion to part ways on some negotiations.

We think, in aggregate, the market has been very realistic and realizes that the market -- the rates have been underperforming over the previous year.

So we are continuing to be very disciplined on that and it's discussions we have at the executive level anyway about strategies and how we fit together.

Ultimately, the way for us to assure strong yields is to keep improving our value proposition.

So the capabilities we build, the product enhancements, those are the ways we can do this in the long term and so far, we feel pretty good on the progress we are making.

I think a lot of the customer surveys that have been done over the last 12 months say that, that the customers are seeing a lot of value for what they are paying for.

So I think right now the customers are pleased with the value proposition, as Kurt said.

And then I wanted to see if you could give us a little bit of flavor for what is going on in terms of weight per package and if possible, if you could differentiate -- I don't know if your calculation includes like a rated weight factor given what you did with the dimensional weights earlier this year, and if you could maybe break that into sort of core weight gain and what's just sort of optics because of some of the pricing change?

Yes, it's a good question.

I think the best overview, I guess just to give you the cliff notes version here, is the ground is up slightly.

We are actually seeing slight declines in the overall air products if you adjust everything out, not anything dramatic, but we've seen a little bit of a slowing on the air package side anyway and a slight increase on the ground.

And that -- (multiple speakers).

-- the B2C movement we are seeing on the air side, more goods being shipped, B2C to people's houses, lighter weight products.

Okay, and that is core weight you are talking about, not rated weight, right?

Yes.

Okay, thanks, guys.

Nate Brochmann, William Blair & Co.

Hi, good morning, everyone.

Actually that's a great transition from that previous question in terms of a little bit bigger picture.

Obviously near term, we have a lot of uncertainty in the economy, but one of the drivers that I think we're talking a little bit more about over the next three to five years might be the impact of the e-commerce activity in the Domestic business.

And just wonder if you could talk a little bit about that and what you're seeing and how you are positioned there?

I will kick it off and then Scott may want to add a little more view for the longer term.

But -- no, the e-commerce component of our business continues to grow pretty robustly.

It is an increasing form of purchase for an increasing array and it is not just a US phenomenon.

Frankly, we are seeing strong trends on that across the globe.

So we continue to look for ways to best serve that model.

We have added or expanded our direct-to-consumer injection into the post office with our SurePost solution for very light weight, low value.

That is working very well.

Plus, frankly, we are looking across the globe at ways to help our customers create really global footprint for B2C and we think that is a long-term trend.

I think that is fair.

I think that is here to stay.

We think B2C will become, every year, become a little bigger piece of the pie.

We're working very closely with some of our bigger customers on how do we solve their problems.

I think we are very proud of our reverse logistics portfolio.

We talked about the new Returns Exchange program we are going to introduce later this year.

We continue to make it easier for our B2C players to be competitive.

We have to help them be competitive.

It has got to be a pleasing experience for their customers, which means they have to be able to return products if they don't work or they don't fit.

So I think -- and as for technology, that is a big advantage for UPS.

So we will be at the forefront of this and it is going to be a fast-growing market moving forward.

Thank you for that.

And then my follow-up would be, if we -- and I know that there is -- again, couching the uncertain environment -- but if we ended up at that lower end of that GDP forecast, does that start to impact some of the yield initiatives in terms of your ability to pass along those prices or as you had said just a moment ago, the value add that customers are seeing, does that offset that?

Yes, I think we have been at the lower end of that.

I think you're going to see the second quarter not much better than the first quarter, maybe not as good GDP.

So we have been there, done a very good job on revenue management and growing yields.

So I don't see that changing in the near term.

John Barnes, RBC Capital Markets.

Good morning, guys.

With the improvement in the results out of the Freight division now, I think you guys have done a fairly good job at kind of keeping that infrastructure or the status quo while you were going through this downturn.

Are you starting to see results at Freight now where you think maybe it's time to start investing more heavily there and trying to grow that footprint much more aggressively?

At least if you are speaking specifically of the UPS Freight segment.

We are doing prudent and incremental expansions as it is needed.

We will be likely increasing our investments a little bit in the fleet, but we don't see any huge step functions.

It is fairly inexpensive to put up freight terminals compared to package terminals because of the significantly reduced high-tech equipment in them.

So it is not a huge investment for us.

Probably the major area would just be fleet expansions.

Pay a lot of attention to the capacity in that marketplace too.

If that changes, that could change our answer.

Okay, all right.

That makes sense.

And then, lastly, given how public the Postal Service's problems have become and with all the rhetoric anywhere from getting rid of Saturday delivery to, 15 years from now, going to three-day delivery or whatever it may end up being, have you seen -- is that uncertainty around their service creating any further opportunities on the parcel side now or do you think that bears fruit two or three years from now?

I don't think it is a big issue in the short term.

Most of the very deep integrated B2B business is not with the post office and those are the ones where a long leadtime would make a big difference in supply chain.

So they are focusing on finding their strengths and working on the last mile.

We are collaborating with them and competing with them.

Clearly, the post office has to make dramatic changes to improve their financials, but I don't see that as a big issue for day-to-day customer decisions.

John, I think the Saturday delivery is probably the most imminent issue right now for customers and there are some looking for different solutions, so that could have a more immediate impact on us.

If they do go eventually down the road from five days to three days, now that changes the game pretty dramatically, but that is down the road.

Matt Brooklier, Piper Jaffray.

Thanks, good morning.

A question on Domestic Package.

If you could walk us through the quarter from a demand perspective -- April, May, June -- don't need numbers, but just generally how did the quarter progress and then maybe comp what you're seeing in July at Domestic Package versus June.

It has actually been relatively flat.

We had expected coming out of the very bad weather in the first quarter to see things pick up a little bit and that was kind of our guidance.

But as the dust settled on April and you factored out the holidays and all of that, we think the trends have been sluggish, but stable, all the way through to the present anyway.

So there is really not a big story there.

There hasn't been any change in July versus what you witnessed in June?

Not anything that we would consider to be statistically significant.

Okay.

And my second question, International Package, can you talk to the new aircraft that you received?

When do those aircraft go into service just generally?

And is that part of the improvement on the utilization on those new aircraft and routes?

Is that part of the story of the op margin improvement at International Package in the second half of this year?

Absolutely.

As we mentioned, we have added a number of planes and it is not just this year; we've certainly been taking a lot of 7-6s and the 747-400, which is the big workhorse for the long-distance flights.

And so as we have added those and there hasn't been any one specific date, they have been added ratably over the course of the last year or so, but we have added significant amounts of capacity.

And I guess the one sequential story we have seen is, in the last couple months, that clearly Asia has been slowing.

China continues to move pretty strong, upper single digits, but Hong Kong especially has seen some headwinds.

The comps are a little tougher, but we think still there is true sequential slowing there and we have been effective with our Forwarding capabilities of keeping our aircraft pretty full.

So if you look at the utilization reports, they are doing pretty well.

But as we said, the revenue yield on those assets is lower at that rate.

So as we continue to grow and we did see 8% unit growth for Package in the International, which is above any of our competitors, that revenue yield mix in our aircraft will improve.

So that is the story of -- there is a little bit of a step function in this and at least right now, we are kind of at a point at which we have added a lot of capacity and we have got to maximize the yield on that over the next few quarters.

Okay, very good.

Thank you.

Justin Yagerman, Deutsche Bank.

Good morning, guys.

I wanted to follow up -- on the LTL site, you called out a bit of moderation in July.

Is that beyond seasonal because typically July should be a weaker month and I was just curious if you are seeing something that is outside of what you would normally expect?

We think a little more than seasonal.

I don't want to draw too sharp a point on it, but it does look as though things may have moderated a little bit coming into July.

Okay.

And around your commentary on peak season and looking out at the back half, curious to just get a little bit more color what your customers are seeing from an inventory perspective.

We have generally heard inventory to sales still feel pretty low.

Obviously that has kind of been consistent throughout this recovery, but would belie, as you said, the potential for either ocean freight to pick up in a more normal seasonal timeframe where we see it kind of in the late summer into early fall or as you said, the possibility for airfreight to really pick up.

What are your customers telling you and have they given you any indication of timing or is your uncertainty based on the fact that they really haven't given you much of anything?

I think inventories, Justin, are tight.

I don't think anybody is building inventories.

In fact, that same overused word of uncertainty.

I think people, they are now quite sure what is going to happen.

They have been running on tight inventories.

If we can get confidence up a little bit, you may see that rebuild starting.

We have seen prior years where they went into the peak season with two low of inventory levels and got stuck and missed sales opportunities.

So we will watch, but I think there are things we have to do in this country, the US, to start with is get this debt ceiling resolved, get some of these things behind us, I think confidence will go up.

You'll see people starting to restock inventories.

I couldn't agree with you more on the debt ceiling.

Japan, curious as auto production comes back in the back half of the year, you guys indicated that you are seeing a return a bit more to normal.

How does that impact your business levels and where do you see that the most?

I am assuming on the International air side, but if you could give us a sense of where we could see that impacting volumes in the back half of the year, obviously predicated on the strength of any kind of autorecovery, but it would be helpful to get some color there.

I think the most dramatic impact on us that we saw in the last quarter and obviously next quarter is intra-Asia business and we have a real strong intra-Asia business that certainly involves Japan and I think that got slowed down dramatically in the second quarter and we expect that to pick up as we head into July and August.

And we are seeing some pick-up there.

So I think it is more dramatic on the intra-Asia for UPS.

Bill Greene, Morgan Stanley.

Hi, good morning.

I am just wondering if I can understand sort of the commentary on the third quarter.

I think about this year as being a pretty big year for a rebound in pricing given that we had a couple of rough years there.

And yet the fact that margins aren't likely to go up suggests that unit costs are also kind of rising in line with where the pricing per package is at least in the domestic market.

Am I missing a piece there or are we going to have an acceleration from here on pricing?

Why wouldn't be seeing pricing sort of trump everything at this point?

I think in general it is, Bill and if you look at the Q2 to Q3 trends, rather than year-over-year, it depends how you frame this, you will get a better view.

So no, we are continuing to see good results.

Our unit cost is expected to continue to grow at a rate below our net yields.

So we are not changing the whole story.

We have got a blip here in Q3 that we have talked to for the specific reasons of very sluggish growth and the tougher comps and some one-time events last year.

So that is why we are confident we will show both margin expansion and profit expansion getting back into Q4.

So if you frame it as quarter-over-quarter, it looks pretty smooth.

The year-over-year, that is why we have tried to be very clear on it.

So I wouldn't put too fine a point.

I don't drink Q3 domestically is much different than Q2 internationally.

In Q2 internationally, the trends didn't change.

The comps were very difficult and I think we are seeing the same thing domestically.

We will be back to expanding margins in the fourth quarter.

Okay.

And then if we look at the overall sort of guidance, you are sort of saying, look, we think things are slowing, but we'll still do our guidance.

Does that suggest that we should be more aggressive here on buybacks or are you sort of looking at the balance sheet saying, no, we are comfortable with the rate that we are sort of managing at and we have got to save some dry powder in case there is opportunities or how do you want to think about the balance sheet?

We ratcheted up the buybacks a little bit in Q3.

Clearly if the market gives us an opportunity to buy back shares at a bargain, we have got tremendous amounts of cash.

I mean you can see on our balance sheet even with the fact that, from early in the year, we used $1.2 billion to accelerate the pension funding, we are building back up very large reserves of cash, so that is the great story here.

We have significantly increased distributions to shareowners and we meter that a little bit based on what is going on in the market.

But we do intend to continue to purchase substantially and could accelerate it if need be.

Jeff Kauffman, Sterne Agee.

Thank you very much.

Congratulations, very solid quarter in a tough environment.

I want to follow up on the question John asked with respect to the post office.

There was an announcement just yesterday that the post office was going to close about 3600 locations.

On one hand, you compete with them on a number of services.

On the other hand, you utilize parts of their delivery network.

If the post office were to close 3600 locations, is this a net opportunity for you?

Would it be kind of a net push with some offset?

How do you think about that?

No, I think anytime a competitor pulls back capacity and access, it is an opportunity.

So clearly, we will look at the gaps that are there and we have got a wonderful footprint with the UPS Store and offering the consumers and small businesses good access.

So we will look for opportunities where it makes sense.

As Scott mentioned, the more dramatic their network changes, then the more opportunity.

At the same time, we will look for collaboration alternatives as the post office looks to outsource some parts of their network maybe where they are not best-of- class.

So it is a balancing of competing and cooperating.

Okay, all my other questions have been asked, so thanks, guys.

Chris Wetherbee, Citigroup.

Great, thanks.

Good morning, guys.

I guess maybe just a more general question on just your view on customers.

Scott, you mentioned a couple of times kind of clearing up some of the situation in Washington may help from a consumer sentiment perspective.

I guess do you get any sense from your customers that there is some pent-up demand that could start to be seen if we were to get a little bit more policy clarity going forward?

I think clearly we have seen the last year and a half that small business has not participated in the recovery like the multinationals, the big business and I think once they feel more comfortable with policies going forward that you will see them invest more money and hire more people.

And we have to get unemployment rates down in this country to get consumer confidence up.

So I think that nothing is more important right now than policy certainty for our small business customers.

And I guess speaking financially from the Company's perspective, certainly a stronger rebound in the middle market and mainstream would be very positive for us.

It is a healthy environment where there is a broad range of small and medium-sized businesses tendering volume to us.

So as Scott mentioned, the largest driver of growth has been multinationals, which is great for filling up the network, but not necessarily as good for yields and margins.

Sure.

So you could see some pickup on the domestic side would be my guess there.

And then just one final follow-up, just trying to understand -- parsing out a little bit in the Asian market slowdown relative to what you're seeing in Japan.

I know you have commented a couple of times on that.

I am just trying to get a sense of kind of how much of the slowdown you see?

Maybe still be some lingering intra-Asia effects here or if it's kind of domestic -- is the US, Asia or Europe-Asia type volumes that you are seeing that sequential slowing?

I think in Asia, I mean certainly China set it up themselves by tightening up reserves.

I think they are trying to control inflation, so some of that impact was obviously fiscally driven.

I think some of the impact is driven by lack of consumer confidence both in Europe and the United States.

I think that what we are seeing here in the lack of consumer confidence is they are not buying goods.

Imports were not very strong to the US in the second quarter.

So I think it is a combination of tightening in Europe, tightening in Asia and lack of consumer confidence both in the US and Europe.

Elliott Waller, Jefferies.

Hi, good morning.

It is Elliott Waller on for Peter.

Two quick questions.

First, the deferred air yields were especially strong and it didn't look like there was any volume shift from Next Day Air to Ground.

What do you think was happening there in terms of yield in deferred air and was it expedited shipments from Asia or some other factor and do you think these type of 8.7% yield improvements are sustainable?

Well, typically, the direct expedited shipments out of Asia would show up in our International products.

There is no real strong factor to call out on that.

I mean there is a little bit of moves both ways.

We have had some success in our revenue management impacts.

We do see the market being very stable on that area.

So I wouldn't -- there is not a real strong point either way, but we do feel confident that these yield management trends will continue.

So you may see blips a little bit plus or minus product to product, but in general we do feel very confident that the strength of revenue management is holding up even with a sluggish economy and that we are going to continue to execute.

Okay, good.

And second, how much of a drag do you estimate fuel was for the overall quarter?

I know you talked about the certain segments companywide.

And then also what do you expect in 3Q?

Has the surcharge caught up at this point?

Yes, it should.

Assuming that things stay relatively flat within a range of plus or minus $5 or so, we are probably in good shape.

Our guidance assumes upper $90s for fuel, so it should be less of a story.

Overall though because fuel kind of broke in the middle of May I guess and then dropped, for Domestic, the lag was not material.

Although there was a modest headwind on the International side.

And due to time constraints, our last question will come from the line of David Ross of Stifel Nicolaus.

Good morning, gentlemen.

Real quick, on the air and ocean buy rates, you mentioned the Forwarding business benefited from better buy rates in the quarter.

Can you just give a little more color around what you are seeing from the International air cargo markets, ocean markets?

Is one market looser than the other and are there specific lanes on which there is specifically good pricing for the forwarders?

I think certainly ocean right now is under a lot of pressure with the peak not showing up and there is plenty of anecdotes outside of our own experience.

So we do see quite a bit of capacity.

There have been a number of providers that have added capacity and at least right now, as Scott mentioned, imports into the US are not super strong.

Air is much more lane-specific, but in general, it is a little softer just because the level of activity is down.

Those things can change, but at least right now, those are the trends that we have seen.

So we are going to ramp this up pretty soon.

In some ways, this call has been as much about the economy as it has UPS.

I guess, at least from my perspective on this, the economy will come and go, the cycles will come and go and clearly, it has impacted our guidance, but the performance of the Company is continuing well and if there is anything you guys invest in with us, it is adapting to multiple cycles.

So we did feel it was important to be clear on the economic trends, but I just don't want to focus you back, but that's not all that UPS is about.

So Scott?

We are going to go to Scott for some final comments.

Okay, we reported strong numbers for the second quarter.

UPS, like others, have made difficult decisions over the last few years to get leaner, more customer-focused and clearly, we are benefiting from those decisions.

Unfortunately, as Kurt said, the US economy has not been recovering as quickly as most expected.

Gridlock in our nation's capital clearly is not helping this cause.

We need leadership in Washington to step up and solve the debt ceiling stalemate, approve the free-trade agreements and eliminate the uncertainty that is causing many companies to put their plans on hold.

As for UPS, I assure you that we are focused on providing superior service to our customers and great returns to our shareholders.

Thanks for joining us on the call today and we look forward to seeing you all in Louisville in September.

Thanks so much.

That concludes our call.

Thanks for joining us today.