聯合包裹運送服務公司 (UPS) 2012 Q2 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 second-quarter 2012 earnings conference call.

All lines have been placed on mute to prevent any background noise and after the speakers' remarks, there will be a question-and-answer period.

Please note that we will only take one question from each participant to accommodate more analysts during this call.

Thank you for your cooperation.

It is now my pleasure to turn the floor over to your host, Mr. Andy Dolny, UPS Treasurer and Investor Relations Officer.

Sir, the floor is yours.

Good morning.

Today I am joined by Scott Davis, our CEO, and Kurt Kuehn, our CFO, to discuss the Company's results for the quarter and future expectations.

Before they begin, 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 risk and uncertainties which are described in detail in our 2011 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.

In the second quarter of last year, UPS reported a net gain of $33 million as a result of two nonrecurring real estate transactions.

These adjustments resulted in an after-tax benefit of $0.02 per share.

In Scott's and Kurt's comments today, references to 2011 results will exclude the impact of this gain.

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.

As a reminder, any guidance that we provide will not include the results of TNT operations, nor any synergies or post closing integration expense associated with the acquisition.

As always, today's call is being webcast and is also available on the UPS investor relations website.

We are going to stick to our recent practice of allowing each person to ask one question and then get back into the queue for follow-up.

I thank you in advance for your cooperation.

Now let me turn it over to Scott.

Thanks, Andy, and good morning.

UPS's second quarter results were driven by the performance of our US Domestic segment.

We continued to benefit from the efficiency of our streamlined and integrated network.

Our unique portfolio of solutions has allowed UPS to adapt quickly to the evolving needs of e-commerce shippers and do it profitably.

On the other hand, our International segment results continued to be impacted by declines in exports from both Asia and the US.

Economies around the world are showing signs of weakening and our customers are increasingly nervous.

In the US, uncertainty stemming from this year's elections and the looming fiscal cliff, constrains the ability of businesses to make important decisions such as hiring new employees, making capital investments, and restocking inventories.

This will further restrict economic growth.

In fact, this is already evident as June's manufacturing ISM and growth in retail sales numbers were the worst we have seen since 2009.

In addition, employment gains have started to slow down, all of which had a negative impact on commercial volume growth.

Given these trends, we think current second-half economic forecasts for the US are too high and that GDP growth will likely be closer to 1%.

In Europe, the debt crisis lingers on as more countries struggle with austerity measures that are pushing them into recession.

Despite this, UPS export volume has continued to grow although at reduced rates.

While economies in Asia are still expanding, expectations have come down in the last three months.

Overall, GDP forecasts around the world are declining.

Historically global exports grow at a higher rate than GDP.

This is not the case today.

In fact, global trade is lagging GDP.

This has only occurred once in the past 10 years and that was during the last recession.

We believe this is temporary and that as GDP growth begins to accelerate, a more typical relationship between the two will exist.

Though the macro environment gives us concern, we have confidence in our strategy and remain focused on current objectives.

One strategy demonstrating the power of logistics will be on display during the 2012 London Olympic Games.

As the Official Logistics and Express Delivery Supporter, UPS is responsible for staging the largest peacetime logistical undertaking in the world, providing the warehousing, distribution, and logistics to produce the games while delivering 30 million items, everything from tennis balls to goal posts.

UPS is eager to demonstrate the industry's most advanced supply chain capabilities at this year's games and further strengthen our brand in Europe.

Now for an update on our offer to acquire TNT Express.

This transaction will diversify our global revenue, increase our portfolio of solutions, and expand our geographic footprint.

The complementary strengths of both companies will create a customer-focused platform delivering unparalleled access to the world while at the same time enhancing shareowner value.

During the quarter, UPS made significant progress towards completing the purchase including the announcement of our financing plan and the publishing of the offer memorandum.

Over a week ago, UPS announced that the review process with the European Commission will move to phase 2 as there are certain areas that require more time to analyze.

We expect to close the transaction during the fourth quarter.

Another recent development I'm pleased to note is that UPS and the Teamsters have agreed to get an early start to negotiations.

Formal talks are expected to begin soon.

This brings me to my final point.

As 2012 continues to progress, keep this in mind.

During our 105-year history, UPS has dealt with many different economic conditions and changing marketplaces and through it all we have proven our founder, Jim Casey right -- determined UPSers around the world working together can accomplish anything.

I assure you we will make the necessary changes to adapt and respond to the current challenges as we have done so many times in the past.

Now Kurt will review our results for the quarter.

Thanks, Scott, and good morning.

The second best results released this morning which produced earnings per share growth of 7.5% are solid considering the change of pace in the global economic environment that Scott alluded to earlier.

On a consolidated basis, UPS daily volume improved 2.7% and operating profit was up 4.6% with 40 basis points of margin expansion.

This points to the flexibility of our product portfolio and the efficiency of the UPS network.

We provided UPS customers with solutions needed in this challenging economic climate and were able to generate the industry's best margins.

Let's take a look at how the segments performed.

Starting with US Domestic, e-commerce in the US continues to expand, benefiting the segment.

Operating profit growth was up over 12% with margin expansion of 100 basis points.

Strong operating leverage resulted from the volume growth, base rate increases, and continued network efficiencies.

I also want to point out that the quarter did benefit by over $60 million from the fuel surcharge lag.

Daily volume was up 3.5%, driven entirely by B2C.

One concern of note was the lower manufacturing ISM numbers that point to lower purchasing activity.

This is contributing to a deceleration in our critical business to business volume growth.

Air products outpaced ground during the quarter with Next Day Air volume up 5% while deferred increased by 8.6% driven by growth in our saver and residential shipments.

UPS experienced gains in Next Day Air letters again this quarter reversing a long trend of declines.

Ground package volume was up 3%.

Over half of this growth was attributable to a 25% increase in lightweight products.

Revenue improved a little over 4%.

As expected, average revenue per package was up less than 1%.

Yields across all products benefited from base pricing but were offset by faster growth from large customers and changes in product mix.

We continued to see rapid growth in lightweight and saver products, both of which have lower yields.

Although they do have lower yields, this volume continues to contribute to our productivity gains.

Average daily volume was 3.5% higher while miles driven and direct labor hours were up only about 1% and block hours actually declined.

Savings in direct payroll costs were not enough however to overcome growth in benefit expense.

Healthcare jumped over 7% while pension-related expenses were up more than 10%.

Overall, a good quarter in the US Domestic, aided somewhat by the fuel surcharge lag.

Importantly, current trends such as the lack of B2B growth are concerning going forward but we are taking the necessary steps, implementing both revenue and cost initiatives, as well as making adjustments to the UPS network.

Now for a review of our International results.

Slowing global economies, shifting trade patterns, and negative currency translation resulted in a 4% revenue contraction.

Double-digit declines in high-yielding shipments from Asia to both Europe and the US produced a notable drop in profitability.

That is not surprising considering the infrastructure required to support Asia.

We made adjustments to our network during the first half of the year and are implementing additional cuts to mitigate this trend.

Operating profit in the International was down $51 million from last year.

Expenses related to M&A activity accounted for a drag of about $15 million.

However, our margin is still the industry's best at 15.1%.

In contrast to the significant decline in transcontinental demand, intra-regional shipments continue to increase.

Overall export volume was up by 1% as growth in Europe was mostly offset by the declines in Asia that I mentioned.

When faced with today's economic challenges, customers continue to trade down to less costly alternatives.

As a result, we experienced faster growth in our Transborder Standard Products and even saw some trade down from small package into freight.

Non-US Domestic volume was down 3.2% reflecting yield improvement initiatives in Germany and Turkey.

Fiscal austerity measures in Southern Europe contributed to double-digit declines there but keep in mind that although this is a fairly steep drop in volume it had only a small impact on segment profitability.

Export revenue per piece was down 3.5%, the primary factor being the year-over-year currency fluctuations.

In fact, currency-neutral revenue per piece was flat reflecting base rate increases that were offset by changes in trade lanes and product mix.

So it has been a challenging environment for our International group over the last 12 months but during this time we have implemented various revenue and cost initiatives including reductions to our network.

And we will continue to do so as we are planning another 10% reduction in our Asian Air network.

This will position us better for the future.

Now for the Supply Chain and Freight segment.

Operating profit increased by 3.6% and margin expanded 50 basis points to 8.9%, the highest margin this segment has seen.

Revenue declined 1.6% due to slowing International Air Freight demand.

Although the forwarding units saw an increase in tonnage, revenue was down as rate per kilo continues to be challenged in the key Asia outbound market.

Operating margin was still strong due to effective revenue management and cost controls.

In UPS Freight, revenue growth was flat as improvements in LTL pricing were offset by a decline in shipments.

Operating profit and margin increased during the quarter due to productivity gains.

Revenue in our Distribution business was higher primarily from continued growth in healthcare and UPS lightweight solutions.

Investments in technology and infrastructure to support the Company's healthcare initiative, did impact operating profit.

Looking now at cash in our balance sheet, for the six months ended June 30, UPS generated $3.0 billion in free cash flow, up more than $600 million.

Capital expenditures were $949 million which included the delivery of six 767s.

So far this year, UPS has paid dividends totaling $1.1 billion representing a 9.5% increase per share.

In addition, we have repurchased 11.3 million shares for approximately $870 million.

Regarding share repurchases, we are on track to spend $1.5 billion in 2012 and outstanding share count in the third quarter will be similar to the second.

As we prepare to complete the TNT transaction, you will notice that our cash and marketable securities on the balance sheet have reached over $7 billion.

Regarding guidance, the macro environment that we expect in the second half of 2012 calls for slower growth than originally anticipated when we set our initial guidance range back in January.

Given this we now expect 2012 diluted earnings per share of between $4.50 and $4.70.

This represents a 3% to 8% increase over 2011.

I do want to take a couple of minutes to provide more insight into the segments starting with the US Domestic, where we see some concerning trends.

Average daily volume growth is expected to moderate, reflecting the macro environment.

We anticipate some deceleration in premium product growth and B2B volume is expected to deteriorate further with pretty much all of our growth coming from B2C.

As a result, revenue will increase between 1% and 2%.

On a year-over-year basis, comp and benefit expense will be about 1% higher in the second half than what we saw in the first.

This is primarily a result of increases in healthcare costs.

The combination of the mix changes and higher benefit costs will result in operating margin being slightly above what we saw in the first half of the year but still less than last year.

Turning now to International, where daily export volume is expected to grow at a slightly faster pace than what we saw in the first half of the year.

This is not indicative of economic expansion but is more a result of beginning to lap last year's slowdown in Asia.

As previously mentioned, we have taken the necessary actions like air network capacity cuts and implementing in-country cost controls and as a result, we anticipate operating profit to grow at a mid to high single-digit pace with more growth in the fourth quarter.

Operating margin in the third quarter should be slightly below last year while the fourth-quarter margin will expand on a year-over-year basis.

Regarding Supply Chain and Freight, we expect mid single-digit revenue gains and operating profit growth will be in the mid teens with margins reaching 9%.

For a little more detail on the earnings per share for the second half of the year, we anticipate that in the third quarter they will be below last year.

Let me remind you that in 3Q '11, we recorded a 32.9% tax rate that added about $0.03 per share.

Fourth-quarter earnings should show solid improvements.

To wrap things up, our first-half results have been respectable with the US Domestic and Supply Chain and Freight segments performing well.

However, we are seeing indications of a weakening global economy creating challenges for companies in the quarters ahead.

Of course we at UPS are prepared to make the right moves in any economic environment to ensure the Company's long-term success.

UPSers around the world are working diligently to make the necessary changes to our network while providing the service excellence that UPS customers have come to expect.

Thanks for listening this morning and now Scott and I will be happy to answer your questions.

(Operator Instructions).

Tom Wadewitz, JPMorgan.

Yes, good morning.

I wanted to see if you could offer some thoughts on the time lag that you would typically experience in terms of taking out costs and adjusting to some of the changes in volume.

So if you could comment both on the time lag in your International operations where we think things are a little more fixed and then the time lag with respect to cost takeout in Domestic.

Great, Tom.

I think you are right on target with that.

As you know, we have been wrestling and working through the international trends for the last couple of quarters.

Frankly, the velocity of the declines being double digits in Asia both to Europe and the US were a little higher than we anticipated but we've been in the process of making network changes and expect another 10% to come out during the next quarter.

So we feel like we've pretty much caught up to the changes in International and that's why we're actually guiding for profit improvements in the second half of the year.

The weakening environment in the US and most notably with the B2C trends is a little more recent.

Frankly, we began to see that get more notable in the second quarter so we're a little bit behind as far as the time schedule on that and so there is probably a quarter, maybe two quarter lag for us related fully implement the changes and that's really the top priority right now.

Clearly on the Domestic side, the direct labor hours we react to very quickly as we adjust the workforce.

I think what takes a little bit longer on the Domestic side is also the revenue side of it.

It's not just looking at costs but do things on the revenue management side to improve that side of the ledger.

I think we are looking at things, looking at account strategies, we need to focus more on the middle market.

I think a lot of our growth first half of the year came from large customers.

So we've kind of rededicated ourselves to look at the middle market.

I think the small and medium-size enterprises are suffering right now with all the uncertainty in the country but they still have shipping needs and we will focus on them.

Okay, great.

Thanks for the time.

Kevin Sterling, BB&T Capital Markets.

Thank you, Operator.

Good morning, Scott, Kurt, and Andy.

You talked about customer behavior changing as we move around the supply chain trading down to more deferred products.

Where are you seeing the largest behavior changes?

Is it air to ocean?

No, probably most notable is within products going from perhaps an express to an afternoon delivery, the saver in our Next Day Air.

In Europe, we've seen significant trade down from our Transborder Express to Transborder Standard although we have seen a few structural changes on some of the global exporters perhaps moving away from express, moving freight movements and then distributing them once they get across the border.

Clearly we have products like Trade Direct to help address that.

But this is a period I think when we are seeing companies try different things.

I don't think it has been hugely material but there is some mode shift and some speed changes.

I think the surprising thing I talked about in my comments, Kevin, was just the global trade in general.

To have exports growing at a lesser rate than global GDP is really unusual and we think that is temporary and it will change going forward.

But in trying to figure out what's going on, I think the biggest driver of that is slow demand in the developed world.

I think there's a lot of people trying to analyze what's going on but I think frankly Europe and the US both have low demand right now and that's what's causing those negative numbers out of Asia.

The other areas that will be a challenge going forward is US exports to Europe.

I think Europe will not be a big consuming country for a while so US exports will remain quite weak to Europe.

Okay, thanks so much for your time this morning.

Justin Yagerman, Deutsche Bank.

Good morning, guys.

On the US small package business, I was curious what the trends looked like in the quarter -- April, May, and June.

You called out the uncertainty and it sounded like to Tom's question that you alluded to further actions that are going to have to be taken within that business to right size to what you are kind of expecting volumes on to B2B side to look like in the back half.

3.5% volume felt good and obviously there's mix stuff going on there but did we see any kind of precipitous falloff in June or are you seeing that as we've come into July that's got you guys worried?

I'm just trying to get a better sense of where we are going here.

I think kind of a soft landing maybe is the best way to think of it.

We have seen -- we were very pleased and a little surprised that the demand that picked up in the fourth quarter and burned through the second -- or the first quarter.

We saw over the course of the quarter and really into July just a gradual softening really with the B2B being the most notable change.

That's why you don't see it as much in our aggregate volumes because the B2C has continued to be very strong with our service offerings, but I think just kind of this continual moderate slowing in the rate of growth and then into the trends that we are seeing.

Justin, our macro concerns start with the fact that we saw lousy numbers in the last couple months and ISM manufacturing clearly was bad.

Retail sales was weak in June.

As we get closer to the fiscal cliff, there's just more uncertainty out there than ever and it's hard for me to see how that's going to turn around until we get some policymaking done in Washington.

We have a three-, four-, five-year horizon.

People cannot make decisions without that.

So I think it's going to get tougher before it gets better.

It will get better.

I was hoping for something more uplifting, but thank you.

Chris Wetherbee, Citi.

Thanks.

Good morning, guys.

Maybe a question just on Europe if you could just give us a sense of kind of what the trends were there?

It sounds like you had a little bit of growth on the volume side.

But I just want to get an overall sense of if you are seeing a deceleration in that region as well?

We saw a little bit of a deceleration, although frankly Europe continues to be a good story for us.

One of the macro shifts or at least changes in trends we are seeing is that the intra-regional shipments within North America, within Europe are continuing to show growth, intra-Asia continues to show growth and then the Intercontinental shipments are a little weaker.

So we are clearly seeing trade down in Europe, so the premium products are not doing as well but our trans-European shipments on the standard side are healthy.

We have seen some declines on the Domestic volumes within the EU although some of that is just revenue management activities.

But we do see the economic declines a little more in our Domestic segment, but Europe is continuing to trade within itself and that's why we continue to focus on it to help Europe become more and more efficient.

Okay, great.

Thanks for the time.

I appreciate it.

Ken Hoexter, Bank of America.

Good morning.

Kurt, you mentioned you are looking to decrease some costs.

Can you kind of walk us through -- it sounds like on the International move, you've made the move to pull out the 10%.

Maybe on the Domestic move during the downturn you had kind of shut down some regional facilities.

I don't know if they had reopened.

What kind of steps can we expect to make and what kind of cost leverage should we look for from that?

I think on the International side, we've really made the decisions and are making the big network changes although clearly there's a tremendous amount of in-country work that can still be done internationally.

It's just they are probably 70% to 80% on the way to getting it done.

Domestically I don't anticipate huge network restructuring although we are looking at our capacity and usage both in the air and the ground network to make sure we are adjusting appropriately.

We will be looking at a typical range of costs looking at initiatives, discretionary spending, really just making sure we've recalibrated the network.

And, Ken, if you really look over the last three to four quarters, we've seen a pretty dramatic mix shift, volume coming from different areas, going to different areas and so we're looking at this as an opportunity really to step back and adjust the network and our expenses to match conditions.

And at the same time, as Scott mentioned, also to revisit broadly where we are on the revenue and the management of that, both at the account level and also at the product level.

So this is a time in which we are going to take a hard look.

We are teeing up a significant number of initiatives to take a look given this slow patch that we are in right now to adjust and reposition ourselves to improve our competitiveness.

We're really going to take advantage of the decentralization of marketing where now we have the marketing teams in the districts who can look at the specific circumstances and adapt to it.

So it will help us as we come out of this.

Great, thanks.

Brandon Oglenski, Barclays.

Good morning, everyone.

I guess following up from the answer to Ken's question there, as you go through your account and your product review process, does that mean we're still going to see a lot of the focus on the B2C growth but maybe some better core pricing on the core business?

I wouldn't lead to any one specific result on that.

It's just been about a year or so since we've really broadened the portfolio and focused on expanding the footprint into the lightweight, migrating into that, so clearly the B2C issues, the product positioning will be important.

And then of course given -- looking at the entire part of the core portfolio will be a part also.

Thank you.

David Vernon, Bernstein.

Good morning.

Could you help characterize how much of the reduction in your guidance is from a slowing or less than expected recovery in International volumes versus a weakening Domestic picture?

Probably the bigger change in the quarter has been the Domestic outlook.

Clearly the International got a little bit worse than we thought.

We thought our export volumes would be up a couple of percent more and yes, the exports out of Asia really did fall off a cliff.

So there was some there.

But the more material issue really has been the deceleration in the core Domestic demand and some of the economic conditions I think that Scott has talked about.

Yes, exactly.

I think the second quarter clearly International was the biggest culprit but going forward, I think the challenge is going to be Domestic and as we've said before, it's just a lot of weak numbers over the last two months caused us concern for the next six months.

So the outlook has been more affected by the slowdown in Domestic?

The outlook in Domestic, correct.

Great, I will get back in queue.

Thanks.

Ed Wolfe, Wolfe Trahan.

Thank you.

There is a meaningful step down in your view obviously of the US economy and I'm trying just to understand, Scott, how much of this is reading the data that you are seeing coming out of the government and how much of this is specific to what you are either hearing from your customers or seeing in your volumes in June and July?

When did you kind of take this step down in your view of the world?

It's a combination as you would expect.

I think clearly the recent numbers have been disappointing that we've seen over the last two months but I think it's a combination of doing that and talking to customers and again the lion's share of our customers are small-business and you talk to them, they are very much concerned with all that's going to happen at the end of this year with the fiscal cliff.

And we all read the impact if all the Bush tax cuts go away and the sequestration hits, you could have a 4% impact.

Our customers read that.

So I'd say it's a combination of the two.

Customers are concerned.

They're not going to invest.

They're not going to hire people.

They're not going to stock inventory with all that uncertainty.

I think Bob Zoellick said the other day we are one debt ceiling deal away from getting this economy going again.

But we've got to get that done.

Is the 3.5% Domestic volume throughout the quarter much worse in June than it was in April or in July than it was in June?

Just slightly worse, I think.

Slightly worse.

Thank you.

Nate Brochmann, William Blair & Company.

Good morning, everyone.

I wanted to talk a little bit just on the pricing side.

Obviously there's a lot of uncertainty on the volume but kind of with some of the trade down and also just with the worsening kind of outlook for a lot of your customers, how are you seeing the pricing environment in terms of pushing through everything that you would have liked to?

We think the pricing environment remains fairly stable and firm and if you do dissect and decompose the mix changes and the customer size and all of that, the pricing is stable and we are seeing positive core pricing and base rate increases.

So we are not overly concerned on the pricing environment although clearly if the economy slows more there will be perhaps a little more pressure.

So I think for us it's more just a broad portfolio review and making sure that we are balanced and adapted to where we are seeing demand and adjusting where we are not.

Thank you.

Bill Greene, Morgan Stanley.

Yes, good morning.

Can I ask for a little bit of clarification on the comments that you made I think it was last week just that UPS does intend to bid on the postal service business, the priority mail contract.

I was always under the impression that one of the reasons FedEx had that business was because of the size of their air fleet.

Do you have the sort of underutilization in your air fleet that you could handle that or would it all go through the ground network?

How does this -- I don't know how that would fit into the UPS network.

I think clearly we have the air network and ground network to satisfy those needs.

The USPS has informed us they intend to solicit bids on these air services for September 2013 forward.

We have informed them that we are clearly interested in bidding on that business.

Today we already do well over $100 million of line haul with the post office.

We've got a strong, strong air network, world-class network.

We have proven logistics capabilities.

We think it would fit very well into UPS in the future.

So there's no capacity constraint for you?

We will have to do some adjustments to our capacity getting a lot of this done in the two-day network.

Maybe some things on the ground so we can make it fit.

Okay, great.

Thank you for the time.

Chris Ceraso, Credit Suisse.

Thank you, good morning.

You mentioned with regard to Asia that it is in large part a function of weaker demand in the US and Europe which suggests that it's cyclical.

But are you seeing any things that are more secular, any kind of relocation of supply chains out of Asia that suggests that even when economies recover, maybe Asia won't be quite as strong as it used to be for you?

I think that's overdone.

I think that there is some of that going on but it clearly is not the driving force right now between the gap between global trade and global GDP.

So I think we are seeing a little bit of it but we go out and talk to our customers.

You see very few instances where they have actually taken manufacturing and brought it back home or brought it back close to home.

I think that's more likely if energy prices were to get to the $150 level I think you'd look at that again.

But I think there's more dislocation in China going to West China and things like that going on than there is China back to US or to Mexico.

Okay, thank you.

John Barnes, RBC Capital Markets.

Good morning, guys.

Thanks for your time.

Just as you have provided down the outlook for the balance of this year, can you talk about just your CapEx outlook as well and if things were to decelerate further, how much more quickly could you take your CapEx down as well or is there things that you could put on hold or cancel out right and kind of reserve that cash?

Certainly we've got flexibility although frankly we are down to only 4% of revenue for CapEx this year and we have been for the last three or four years so we are at historically low levels.

I guess the other element at least looking at a couple of years is we have just got another two years of major deliveries of aircraft and then after that, we will be in pretty good shape we think for the medium term at least.

So CapEx will -- I wouldn't imagine dramatic changes although things like vehicles and some facilities we can react pretty quickly on.

So we are generating very strong cash flow, so right now that's the least of our worries.

As we mentioned, we've got $7 billion in cash and marketable securities.

Some of that is offset with some short-term liabilities but we are focused on building the appropriate balance sheet to be able to close the TNT deal really without having to go out and issue any long-term debt.

So we feel very comfortable with cash flow.

One of the attributes I think of UPS that makes us unique is even in tough times we remain extremely cash flow positive.

So we will look at capital expenditures.

We will reduce the things that aren't essential.

On the other hand, you look at investments like expanding Worldport through the midst of the recession, we are also going to continue to do those things that add long-term value no matter what the economic climate is.

All right.

Thanks for your time, guys.

Jeff Kauffman, Sterne, Agee & Leach.

Thank you very much and congratulations on a very challenging quarter.

Could you discuss the currency effects and how it's affecting you both topline and bottom-line and what this looks like for the rest of the fiscal year?

Jeff, it is a turbulent period for currency although it's funny with us moving towards the TNT closure, we're not sure which way to vote for the euro, frankly.

It had a very significant impact on revenue.

If you look at without currency adjustment, our yields in International were down 2.5%.

But if you look on our Web schedules on the next page, it shows if you currency adjust, they were up 2.1%, so that's an almost 4.5% impact of currency on our International revenues.

That doesn't include anything on Supply Chain and Freight.

So it is a turbulent period creating some challenges for year-over-year comps and also for profit planning.

We do have some hedges in place that are helping to mitigate the P&L impact and currency was just a minor negative in the quarter and frankly was more or less offset by a slight positive on fuel.

So it has not been a big deal so far although clearly over the time if the euro stays very low, then there will be some earnings translation impact.

On the flip side, we do have a pretty big check to write to complete the TNT acquisition and a low euro clearly makes that much less expensive in dollar terms.

That's what I was going to ask.

I guess it got about 14% cheaper this quarter.

It's dropped quite a bit and I think at the time that we announced the deal, it was $1.32, something like that, and so it has dropped almost 10% now, which certainly in dollar terms is good news.

David Campbell, Thompson, Davis & Co.

Good morning.

My question is on the Olympics.

You talked about that during your presentation talking in terms of 30 million packages.

You know, when I look at the potential international package count in the third quarter, it comes in around $150 million.

That sounds like a big increase but on the other hand, I didn't see any big revenue growth when you did the Beijing games four years ago.

So I am just curious as to where we will see and will we see the revenue benefit from that -- those games?

You won't see the revenue there.

You won't see the volume of the pieces.

It's a combination of partly sponsorship.

We get compensated for pieces of what we're doing there.

It's primarily about brand recognition.

We want to -- we did a great job in Beijing where I think brand recognition went up about 33% in Beijing.

We want to do the same thing in Europe and the timing is perfect with the TNT acquisition coming forward.

So it's primarily about brand.

You won't see it in the P&L.

Okay, thank you.

Ben Hartford, Robert W. Baird.

Good morning, guys.

I just wanted to get your perspective on inventories and the weakness, the volume weakness that you are seeing on the margin here in the United States.

Could you provide some sort of characterization on inventories, where we sit today, maybe retail versus industrial?

It seems as though industrial inventories on balance are slightly heavier than one might have expected to end 2Q.

Are we seeing inventory reductions?

Are we seeing a pause as shippers manage towards very, very tight inventories?

Could you provide any sort of context on that?

It's hard to really see the visibility of inventories, Ben.

I think it's hard for economists, it's hard for the government to see that.

I am always skeptical of those reports but I think in general from us talking to customers, I think inventories are quite low.

It's hard to imagine them getting much lower than they are today I think across the board both on the manufacturing side and the retail side.

Visibility tools and those technologies makes it easier to manage inventories but I would say from our vantage point, inventories are rock bottom right now.

Great, thanks.

Peter Nesvold, Jefferies.

Good morning, guys.

Comp and benefit as a percent of revenue, that ratio has been falling every quarter since 2009 and we're at record levels now.

Well, we were at first quarter.

This is the first quarter where that percentage was up.

It's been the biggest area of margin expansion since the trough in '09.

So I guess my question is are we kind of going into a one to maybe two quarter transition period where you realign the Domestic and International networks and then will you get further improvement in the comp and benefits line as a percent of revenue or are we starting to bump up against really where you end up maxing out?

That's a good question because clearly we are seeing, as I mentioned, some headwinds especially on the benefit side.

We have had a couple of years of good experience on our healthcare and just in the last I would say three, four months, we have started to see some trends of increasing expenses, increased number of lives handled per employee as perhaps more people latch onto UPS insurance perhaps if the second working spouse does not have insurance and some increased experience.

So that's the most notable cost change and we did guide that that may drive Domestic comp and benefit up almost 1%.

So there is some headwinds on that side.

Clearly that cycles a little bit and we are continuing to evaluate that and work on it.

Other than that I think with the continued work focus on productivity, the automation of our operations, the information-driven pickup and delivery that we've got, and the focus on lightweight, which certainly drives less direct hours, we should continue to see positive trends though, where we're able to manage that in line with comp and -- with volume levels.

But right now at least I think the health and welfare expenses, pension also is driving over $100 million this year and so that is an element that at least for the next couple of quarters is going to be an outlier.

Thank you.

Helane Becker, Dahlman Rose.

Thanks, Operator.

Hi, everybody.

Just a question on the declines that you are making in the capacity adjustments.

So it takes a couple of quarters to bring that down and then I suppose when things start to turn around, it will take a quarter or so to bring it back.

So by making these adjustments now, are you thinking that any downturn is kind of a four quarter event or how should we think about the potential if things do or when you think things do turn around?

It's a good question.

I think you almost have to separate the International and the Domestic.

Clearly we have made some fairly significant reductions in the Asian capacity to Europe and most notably to the US.

There is a lag there for planning schedules and all that.

We do think that we will see some uplift in the fourth quarter, though.

There are some major product launches coming in the fourth quarter and at least we do have some optimism that Asia export will pick up then.

And so we will plan accordingly and we can react with ad hoc flights and those things, although they are typically not as efficient.

We think in the US, this has been a gradual process and so we are adapting and clearly we will be responsive and flexible if the holiday season comes in stronger than planned.

But at this point, we are probably airing on the cautious side.

Helane, definitely in Domestic, we can take them up and bring them down quicker than we can internationally.

Okay, great.

Thank you.

David Ross, Stifel Nicolaus.

Good morning, gentlemen.

On the cost side, Kurt, most of the costs were held in check in the quarter but the other expenses line item rose over 8% year-over-year.

You mentioned that there were some costs related to the M&A activity but what were the other big contributors there?

One of the things, you do have the credit last year of over $30 million because of the real estate transactions.

That's the most notable.

And in the other other line anyway, that distorted things a little bit.

Other than that, the network is in pretty good shape.

Repairs and maintenance are moderated a little bit of an increase in depreciation as we have brought in a number of new aircraft.

So the only real notable expense is in the other other.

Part of it is the last year issue and frankly we do have some increased expenses that show up in that line, legal fees and some of those things, so your instincts are right that that is where some of the M&A expenses show up.

Excellent, thanks.

Anthony Gallo, Wells Fargo.

Good morning, thank you.

You mentioned the importance of B2C going forward.

Would you mind touching on some trends you are seeing their, maybe uptick in My Choice, any changes in package weight sizes and anything you're doing on the productivity front with B2C?

Thank you.

We are continuing to see just great success on that front.

I think we're up over 1.5 million unique My Choice customers now that have shipped over 13 million shipments and it continues to be one that there is a lot of interest in, kind of a viral issue.

Once people start getting used to these proactive notifications, their ability to redirect shipments and just know what's going on, it has been very well received.

So that has been a great product offering from the receiver or the buyer and then we are seeing increased interest frankly by some of the high quality Internet shippers in helping their customers become My Choice members because it really eliminates a lot of the "where's my package" phone calls.

So it offers a direct savings to Internet companies in support and also increases satisfaction.

So we remain very excited about that.

It still is a very unique and distinctive offering and that is a big part of our value proposition these days.

That's kind of the US focus.

We obviously have a global B2C focus too in the Kiala acquisition that we announced three or four months ago is making great progress also.

We are continuing to invest in technology there so we are excited about having the alternative delivery locations available for our customers.

So it will continue to grow.

We will continue to invest in it.

Can you put any color on what My Choice does for you operationally?

It sounds like there's benefits to you in there as well.

Yes, there is, there is.

One of the most frustrating things for any delivery company is when there's a package that needs to have a signature or monies collected and people aren't home, it creates a disconnect.

It drives an additional delivery attempt and added expense, added miles.

So with My Choice, people A, get a prediction of when the package will arrive and if they want a different time, they can select that for a premium charge or they can redirect it to another location.

So there is a direct operating savings also.

Tom Wadewitz, JPMorgan.

Yes, I wanted to ask you kind of a broader question.

When we think about Europe is -- seems to be in recession and if you look at 2013 and 2014 and you think about the TNT acquisition and integration and so forth, is it tougher to be successful in integrating and holding onto business and producing the results with TNT if the European economy is soft?

Or given that a lot of your activity is going to be cost take-out, is that actually an okay environment in terms if you think about complicated integration of putting two pieces together?

I would always pick a strong, growing economy, Tom, if I had my picks.

But frankly, I think Europe is not far different from what we thought when he announced this thing back in March.

I think it's about where we thought it would be, so no surprises.

We're going to work very well together I think and have a customer-focused integration.

I don't think what we are seeing right now changes anything.

I like a better economy.

I like a stronger economy but the numbers we set and quoted back in March are numbers that we still see as achievable.

Okay, great.

Thank you.

Justin Yagerman, Deutsche Bank.

I guess I just wanted to put some context around the 10% reduction in the Asian capacity.

Where were you guys as of now relative to plan at the beginning of the year in terms of level below on that air capacity?

Then I think, Kurt, you alluded to the potential for a product cycle on the tech side in the fourth quarter.

How quickly can you ramp back up and where does this 10% put you in terms of critical mass in that market?

How much further could you go down if you saw things deteriorate?

Just trying to get some ideas around this cut.

A couple of pieces of that one.

Clearly things are weaker than we thought when we developed plans for this year.

That 10% reduction was not anticipated.

We have -- we were reacting to the slowdown that began frankly about this time last year.

We seem to be jinxed with July business trends.

And so we had implemented that first 10% reduction and most of that was in reduced frequencies.

Maybe four days a week rather than six, that kind of a thing.

In some cases for cargo and for our deferred products we can catch up to those during the off days.

This latest series of reductions has been a tough decision for us because we have to adjust our costs but on the other hand as many of you have mentioned, with an anticipated product cycle that may drive capacity we have got to be ready for it.

So we had not anticipated those reductions but we have gone through and we still really -- we have held service fully intact across the continent.

So it's not that we've made dramatic changes in customer experience but we may have gone from three or four flights from a given airport down to two or three.

So once again, it's more a reduction in the service frequencies and the number of flights.

But we are getting pretty tight.

We are taking our network down to beginning to get to close to the point where we were at the low time in 2009.

So it is -- we are fairly lean right now.

On the other hand given the fact that we do expect to see some uplift in the fourth quarter, we are in position for that making sure we have the assets and can react accordingly.

On the tech side, yes, we do expect product launches.

We've talked to some of the major OEMs and so that's all built into our plans.

One of the reasons why, frankly, we are looking for stronger profit improvements in Q4 as compared to what will likely be a challenge in Q3 especially with Europe in August and the weak conditions in Europe, we think this will be a pretty soft August.

That's really helpful, thank you.

Bill Greene, Morgan Stanley.

Thanks for taking the second question.

I wanted to see if we could get just some broad commentary on the upcoming Teamsters negotiations.

So if we think back to the last contract that you signed, it sort of had this aspect of look, there are some pretty big changes that we've made here to gain on productivity but then of course we went into a downturn and didn't get the volume growth we expected.

So I think you can correct if you think this is a wrong characterization but I think perhaps it didn't get quite the savings you expected.

Are there any sort of changes in how you will sort of approach the ask this time around or is it more kind of a let's keep going down this path because we think eventually we will have an upturn and get the volume growth and the productivity?

Bill, I think the good thing is that formal talks begin soon but an even better thing is that we've been communicating regularly since the last contract and the competition committees that we have set up with the Teamsters and our own people, we address all the issues very frequently.

So when you look at competitive aspects, I think all the issues that are impacting us and the Teamsters have been on the table already.

When we get to the formal talks here in September, I think nothing is going to be a surprise for what's going on here.

So I am very optimistic that there's no surprises on either side as we get together in September.

But clearly we have to work together to adapt and change and it certainly will not be a business as usual discussion.

And so we are looking creatively for ways to allow UPS to grow and we've seen great examples of that and at the same time, also allow us to be able to generate profit improvements.

We just don't talk about the details in public, but as Scott said, we think the environment is very productive.

We talk about both the opportunities and the problems we face and do expect things to be favorably resolved.

But to your point, Bill, the world is lot different than it was five years ago so that certainly is part of the talks.

Right.

Just obviously it's a recognition of kind of things have changed from last time.

So I thought maybe there's scope for a bigger discussion but I appreciate the thoughts.

Thank you.

David Vernon, Bernstein.

So in the context of all the International Export volumes being under pressure, it sounds like you guys are going to be adjusting the network down but at the same time, it looks like DHL is actually adding aircraft into their international network.

Can you comment on the pricing environment in International Export, the long-haul trans-con stuff?

I think the package environment looks relatively stable.

We have seen some volatility I guess in pricing on the freight side in some of the heavy lift or the large shipments.

You've got to separate the wheat from the chaff a little bit on capacity increases and see how much is going on.

So we don't see huge amounts of capacity being added to the network no matter what the press releases say and we think the market is pretty rational.

So no slowdown in the heavyweight package pricing?

Clearly freight yields right now are weaker.

You saw that in our forwarding revenues that rates are lower right now on the forwarding and on the cargo side.

Our forwarder though has operated very effectively.

As I said, we hit peak margins for Supply Chain and Freight this quarter.

I know that there is a lot of other big stuff going on but that has been a great process for us and we are on both sides of the equation.

We see as having an airlift the package environment is stable but cargo and freight rates are certainly weak but then our forwarder has been able to capitalize on that and generate really the best margins we've seen.

All right, thanks.

Ed Wolfe, Wolfe Trahan.

Thanks, thanks for taking it.

Just on the LTL, there hasn't been much conversation about that.

Are you seeing slowing trends there and can you give some sense of what the operating ratio will look like at the LTL division?

You're right, there is yet another business that we haven't had a chance to chat about.

I guess we're getting too diversified.

Freight had a strong quarter on the profit side.

We had mid single-digit margins with significant improvements over last year.

We have seen growth moderating in the industry and clearly we were fairly disciplined on the pricing and the volume that we targeted.

So we do think that the industry is slowing a bit but we have been very pleased by the productivity, some of the operational technology we're putting in.

And so a good, solid quarter for the freight side but not -- it's not a super exciting time we think for shipment growth.

Thank you, that's helpful.

I appreciate it.

I would now like to turn the conference call back over to Mr. Andy Dolny for any closing remarks.

I just want to thank everybody for joining us this morning and have a great day.

Take care now.