聯合包裹運送服務公司 (UPS) 2012 Q3 法說會逐字稿

Ladies and gentlemen, good morning.

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

At this time, I would like to welcome everyone to the UPS investor relations third-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 we will only take one question from each participant to accommodate more analysts during the 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.

In addition, in an effort to increase access to UPS leadership, we have asked David Abney, our COO; Dan Brutto, International President; Alan Gershenhorn, Chief Sales and Marketing Officer; and Myron Gray, President of US Operations, to participate today and in future calls.

Before we begin, I want to review the Safe Harbor language.

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

These anticipated results are subject to risks and uncertainties, which are described in detail in our 2011 Form 10-K and 2012 10-Q reports.

These reports are available on the UPS investor relations website and from the Securities and Exchange Commission.

In August, we announced restructuring of the New England Teamsters and Trucking Industry Pension Fund.

As a result, in our third-quarter earnings, UPS recorded a non-cash charge of $896 million.

On an after-tax basis, the impact was $559 million, or $0.58 per share.

Excluding the effect of this transaction, diluted earnings per share for the third quarter were $1.06.

In our remarks today, we will refer to UPS third-quarter 2012 results excluding the impact of this charge.

Additionally, all 2012 full-year references and comparisons to 2011 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, along with a webcast of today's call, are available on the UPS investor relations website.

A couple of reminders.

Any guidance that we provide does not include any operating results, synergies or post-closing integration expense related to TNT.

Also, our outlook does not include any potential pension mark-to-market entry.

If interest rates stay as low as they are, UPS will likely record a sizable mark-to-market charge in the fourth quarter.

Keep in mind this will not affect cash flow or require funding.

While this charge would impact our GAAP earnings, it will be excluded in adjusted results.

Finally, each of you will be allowed to ask one question and then get back into queue for follow-up.

Thanks for your corporation.

Now let me turn it over to Scott.

Thanks, Andy and good morning.

Our third-quarter results reflect the ability of UPSers to meet the needs of our customers while making the necessary adjustments in an environment of shifting market conditions.

The US domestic business benefitted from e-commerce.

International results have rebounded as exports from Asia grew slightly.

Europe was steady; however, US exports remained weak.

The Supply Chain & Freight segment continued to deliver strong operating margins.

Now let's take a quick look at the global economy.

In Europe, more countries are slipping into recession as they impose austerity measures.

Though the economy there has contracted, the small package market has not.

In Asia, although projections have come down, economic growth there leads the world.

Although, as I said last quarter, exports continue to lag GDP growth.

Here in the US, though some of the recent economic indicators provide optimism, generally economists have lowered their expectations for the remainder of the year.

The lack of clear direction on future tax and spending policy has and will continue to slow business investment.

This will clearly impact the B2B small package market.

Regardless of the outcome in November, the US is on the edge of a fiscal cliff and there is concern whether our politicians can reach an agreement that solves these issues.

The lack of political will to fix our debt problem adds to the uncertainty in our economy.

Just what we don't need.

That is why we are supporting Fix the Debt, the organization founded by former US Senator, Alan Simpson and Clinton Chief of Staff, Erskine Bowles.

Our goal is to have a bipartisan debt reduction plan drafted when Congress returns in January and we believe it is realistic to have it passed in early 2013.

If solutions are in place to both reduce our deficit and eliminate the threat of a fiscal cliff, the US will be in a much better position for sustained economic growth.

During the quarter, UPS began formal negotiations with the Teamsters, more than 10 months early.

We believe an early start will lead to an early conclusion and this is beneficial for all stakeholders.

In addition, UPS successfully completed the largest non-military logistics event ever when the 2012 London Olympic and Paralympic Games closed.

I personally want to thank the thousands of UPSers who worked to ensure the success of these games.

Great job.

The logistics support of the London Olympics is a prime example of our transformation and the trust the international community has placed in UPS.

We have invested over the decades to build unique capabilities creating the world's leading logistics provider.

Further demonstrating the UPS strategy of investing to grow is our planned acquisition of TNT Express.

We recently received the statement of objection from the European Commission.

This is not uncommon.

We are evaluating this confidential document and we will respond in due course.

UPS still expects to close this transaction early next year.

We are committed to complete this acquisition and enhance our position in the logistics industry.

We are further strengthening the UPS brand and positioning the Company for worldwide growth well into the future.

Speaking of brand, earlier this month, Interbrand announced their 2012 list of 100 Best Global Brands and UPS once again ranked number one in our industry.

Finally, UPSers around the world are gearing up for the holiday rush and I am confident that no matter what mother nature throws our way, UPS will deliver.

Now Kurt will review our results for the quarter.

Thanks, Scott and good morning, everyone.

Given the economic climate, UPS executed well during the quarter with earnings per share of $1.06.

This is down slightly compared to last year, primarily due to a lower tax rate in 2011.

Total UPS daily volume grew 2.9%.

Revenue was down slightly due to one less operating day while operating profit and margin were flat with last year.

During last quarter's call, we discussed our concern for global economic expansion, particularly here in the US and we have taken the necessary steps with network changes and other adjustments.

Over the next few minutes, I will share with you what we have accomplished over the past three months.

Starting with US Domestic, the segment generated an operating margin of 13%.

Operating profits were down slightly compared to last year as the quarter was negatively impacted by $60 million in fuel surcharge lag, as well as the one less operating day that I just mentioned.

While business-to-business declined a bit, average daily volume growth was slightly higher than anticipated across all products advanced entirely by B2C.

Ground rose 3% fueled by both lightweight and traditional residential products.

Not only are e-commerce shippers leveraging our extensive Ground solutions, but they also continue to look to UPS premium products to enhance their competitive edge.

As a result, Next Day Air volume increased almost 6% and our Deferred Air products jumped more than 9%.

Total revenue per piece declined by about 1%.

Base rate improvement was more than offset by significantly lower fuel surcharges, as well as changes in both product and customer mix.

The rapid growth in lightweight B2C shipments continued to push average weight per package lower.

Ground revenue per piece was up slightly while Next Day Air and Deferred were down 4.6% and 5.1% respectively.

Next Day Saver growth continues to outpace AM products as shippers realize its value for residential deliveries.

Once again, UPS technology innovations contributed to better cost control and efficiency gains in the network.

In fact, paid hours, miles driven and aircraft block hours all increased less than volume.

While US Domestic results were solid, UPS remains constructively dissatisfied.

As B2C expands, we are continuing to adapt both our business model and revenue strategies.

UPS technology will ensure that our integrated network remains flexible, providing the ability to react quickly to evolving dynamics in the marketplace.

Now let's review our International results.

This segment rebounded after a few tough quarters in a row.

In fact, we had a record third-quarter operating profit of $449 million.

Clearly, the results of our initiatives are bearing fruit.

Network adjustments, combined with in-country cost management, resulted in operating profit growth of 7.7%.

Operating margin expanded 170 basis points to 15.3%.

Benefits derived from currency exceeded the headwind generated by higher fuel costs.

We also incurred about $20 million in acquisition-related expenses, which were offset by other one-time items, including a pension adjustment.

UPS average daily export volume was up 1.2% with slight increases in Asia and Europe while US exports continued to disappoint.

Non-US domestic average daily volume declined 2.7% due to the slowing global economy and UPS's revenue management initiatives in Europe.

Fluctuations in currency and the lower fuel surcharge drove the revenue decline of 3.7%.

When adjusted for these, third-quarter revenue was up slightly.

Looking at revenue per piece on a currency neutral basis, non-US domestic improved 3% and export was relatively flat, reflecting the continuing shift in trade patterns and customer migration to less premium products.

Now for Supply Chain & Freight.

This segment once again generated an operating margin in excess of 8%.

Although revenue fell $75 million, operating profit was down just $15 million.

Declines in our forwarding unit were partially offset by improved UPS Freight results.

UPS Freight revenue improved 3.6% due to growth in LTL tonnage and revenue per hundredweight.

UPS technology innovations like pickup notification have proven very popular with our customers.

Yield gains and productivity improvements contributed to another quarter of operating margin expansion.

Poor industry conditions due to overcapacity in the Asia air freight market pushed revenue and margin lower in the forwarding unit.

Meanwhile, in distribution, demand for UPS healthcare solutions was a strong contributor to revenue growth.

Although investments in healthcare, technology, infrastructure and facilities did weigh on margins.

Recently, UPS opened three new state-of-the-art facilities in China and Australia, adding more than 350,000 square feet of healthcare-compliant capacity in Asia.

Looking now at cash on our balance sheet, UPS generated more than $3.6 billion in free cash flow after capital expenditures of $1.6 billion.

The Company also paid $1.6 billion in dividends.

During the quarter, UPS took advantage of market opportunities to acquire more than 7 million shares.

Year-to-date, the Company has repurchased 18.5 million shares for approximately $1.4 billion.

Our target for full-year purchases remains unchanged at $1.5 billion.

Total outstanding shares for the fourth quarter are expected to be about 5 million shares lower than in the third quarter.

The financial quality of UPS was obvious during our recent bond offering, which was oversubscribed sevenfold.

The $1.75 billion in 5, 10 and 30- year notes is being used to replace debt maturing in January.

We made the decision to go to the markets a few months early given the historically low rates.

We achieved an average yield of 2.45% on debt with an average maturity of 13 years.

As a result of this issuance, and in anticipation of closing the TNT acquisition next year, UPS ended the quarter with more than $9 billion in cash and marketable securities.

And now to guidance.

The UPS business model performed well during the quarter and the macro environment was, for the most part, consistent with our assumptions.

Given our performance and greater confidence in fourth-quarter execution, we have enhanced our full-year earnings guidance to a range of $4.55 to $4.65 per share, an increase of 5% to 7% over last year.

We are basically reaffirming guidance around our previous midpoint, but narrowing the range to reflect a higher degree of earnings certainty.

If you remember, 4Q '11 was a record quarter for UPS.

That being said, in fourth quarter of this year, we expect all three segments to increase operating profits and to generate margins similar to or slightly above last year.

In the US Domestic segment for the quarter, we anticipate operating margin will once again exceed 15% and average daily volume growth should be about 3% driven by B2C in both lightweight and Saver.

For International, we expect mid-single digit operating profit growth in Q4 with slight improvement in average daily volume growth trends.

This guidance includes a similar amount of acquisition-related expenses to what we saw in the third quarter.

In Supply Chain & Freight, though we expect the challenging air freight environment to continue, for the fourth quarter, operating profit should increase moderately on relatively flat revenue.

Certainly consumer behavior during the upcoming holidays will affect where UPS earnings fall within the $4.55 to $4.65 range.

As we demonstrated during the 2011 peak season, UPS is ready and more than able to handle whatever comes our way.

But before I turn it over to Alan Gershenhorn for an update on peak season, I do want to encourage all of you consumers out there to indulge during the upcoming holidays, purchase lots of gifts and of course, have them shipped UPS.

Alan?

Thanks, Kurt.

As everyone knows, the holidays are a busy time around UPS.

Every peak season, millions of customers count on more than 400,000 UPSers to successfully manage the sharp and sudden increase in deliveries.

This surge will take our daily average of about 15 million packages up to $28 million on this year's peak day, the most ever in our 105- year history.

It is truly awe-inspiring and in my 32 peak seasons, I have always been impressed with how our people get the job done.

This year will be no exception.

The dramatic rise of e-commerce continues to alter consumer behavior and shipping patterns.

Historically, peak season volume ramped up from Thanksgiving to Christmas.

This year, we are planning for two peak periods -- one that revolves around Black Friday and Cyber Monday; the other compressed into the two weeks before Christmas.

Speaking to our global customer base about their expectations for this holiday season, they tell us they are cautious.

However, they also remain optimistic.

Economic uncertainty around the world has them uneasy about how their consumers will respond this year.

On another note, the retail inventory to sales ratio is still historically low, so their supply chains could strain to keep up if demand is more than predicted.

And although consumer confidence has increased recently, there is still concern relative to political and fiscal uncertainty.

According to a recent survey, 70% of Americans say the current state of the economy is impacting their spending plans and as a result, forecasts for holiday retail sales call for lower growth.

The National Retail Federation is projecting a 4.1% rise in holiday sales, which is below last year's 5.6%, but still above the 10-year average.

More importantly for UPS, e-commerce sales are expected to jump 12% over last year.

So demand for our lightweight and Deferred Air products is expected to be high.

As the season develops, UPS will be ready.

In fact, we already started the hiring process for temporary employees.

This peak, they will help deliver more than half a billion packages around the globe.

And to support both shippers and consumers during the holidays, UPS offers many unique solutions.

For example, UPS My Choice, which was launched at this time last year, is unmatched in the industry.

Almost two million households have signed up and are enjoying the benefits.

Advantages like providing delivery alerts by e-mail or SMS the day before your package is delivered, eliminating those "sorry we missed you" notices left on your door.

Or the ability to reschedule or reroute deliveries or one of the most popular features, authorizing UPS to deliver without a signature.

So if you haven't signed up for UPS My Choice yet, I strongly encourage you to join the almost 2 million who have and enjoy an exceptional package delivery experience this holiday season courtesy of UPS.

Thanks and now we will be happy to answer your questions.

Tom Wadewitz, JPMorgan.

Yes, good morning and congratulations on the good results, especially in International.

It looks like a strong performance.

I wanted to ask you about the Domestic side and a couple of things going on with mix.

Can you give us a sense of how much B2C was up and how much B2B was down?

And then also I guess in terms of that topic, how would you look at margins going forward if you continue to see that trend of B2C growth and slower I guess or modestly declining B2B?

Thank you.

Yes, Tom, thanks and good morning.

Yes, B2C has continued to show slight declines, so it didn't get significantly worse from Q2 to Q3, but clearly with some of the challenges in the industrial sector and some of those areas, we are just not seeing a lot of strength there.

So B2C was absolutely the primary driver of the volume growth.

And as we have said, this is one of the big market changes that we are adapting our business model to.

So the B2C is a little more challenging, but as you have seen both the operational technology side and the consumer side, we are focusing enhancements to address that.

Our long-term targets on domestic are 14% to 15% margins 2014 to 2016.

We are not backing off of those margins as we move forward.

Can you give the actual numbers of what B2B and B2C were, Kurt or you don't care to be that specific?

B2C was upper single digits and the B2B was slightly negative.

Okay, thank you.

Chris Wetherbee, Citi.

Great, thanks, good morning.

Maybe a question just on the International side.

You mentioned the Asia outbound picking up a little bit.

I just wanted to get a sense of whether that was specifically around product launches, maybe the sustainability of that and how we should think about that relative to capacity.

Do we get a sense that you kind of got to the right point of capacity relative to demand right now and how do you think about it in the fourth quarter?

Right, yes, it certainly was great to see Asia get into positive numbers again and I think it has a little bit of both of the issues that you mentioned.

I will have Dan Brutto talk about that a little bit.

Sure, I guess what I would say as far as the network cutbacks, certainly we have done that, but I would also say that we have also added in aircraft.

We just added our fifth gateway in China.

It started the middle of September in Hangzhou, primarily for the high-tech sector and that kind of coincides with what is going on in China, this whole Go West strategy.

So you have got a lot of manufacturers now in China that are moving off the East Coast to the West.

Last year, we opened up another gateway in Chengdu essentially for the high-tech.

So we are moving our equipment where the customers are and certainly it was good to see finally a small uptick in Asia this quarter.

We think this slow global trade is cyclical and it will come back.

I think one of the things we talk a lot about is the fiscal cliff in the US.

If we resolve that, get the US economy consumer going again, that will help demand I think US from Asia.

So we see it coming back some next year.

Ken Hoexter, Bank of America.

Great, good morning.

Can you just talk a little bit, Kurt, maybe about what gives you that confidence in the fourth quarter?

If I look at the target range, it seems like you're almost raising the fourth quarter by a nickel.

Are you expecting a break after the elections?

Do you already see that kicking in?

And then just on the confidential letter, was there any substantial in TNT or should that keep moving forward?

I think -- no, we are not expecting a significant rebound in the economy, so this outlook is for kind of steady as she goes economic conditions.

We have not seen a real change in momentum sequentially month-to-month and going into October.

We are looking for about 3% volume growth in aggregate for the fourth quarter, slightly less than the current momentum.

But I think based just on the progress and the execution across all of the business units, we have adapted to the challenging conditions.

Certainly you have seen it with International and Domestic continues to operate well, albeit in a changing environment.

So we feel a little more confident at least with narrowing the range and clearly being able to deliver a decent fourth quarter.

And there are also several positives out there, I think, for the holiday season.

Housing is starting to improve.

We have lower fuel costs, lower interest rates, stock market has been strong.

That usually correlates to good consumer behavior, so that helps.

Now there are negatives; I don't want to be repetitive on the fiscal cliff.

But sometime about the end of November after the election, the fiscal cliff will be front and center and that will cause some uncertainties.

So there are some risks.

Now on the question on TNT, the statement of objections is absolutely a normal step in a Phase 2 merger review.

It was expected, it happens in almost all Phase 2 reviews.

And it doesn't obviously -- it is basically the EC laying out their position, but does not prejudge the final outcome.

We have got a lot of work to do on it.

We've been working very closely with the Commission over the last several months.

We will continue the open dialogue.

We will respond in the next couple of weeks, but the document is confidential.

We can't share the details of it at this point in time.

Nate Brochmann, William Blair & Company.

Good morning, everyone.

I wanted to talk a little bit -- obviously you guys have been kind of doing this and showing great results on the margin side in terms of kind of quote/unquote adjusting the network to kind of compensate for the new shipping patterns.

Can you talk a little bit more in detail of exactly what you are doing and then longer term in terms of the strategy to take advantage of that?

And also how, with such a big network, how do you remain flexible as obviously we have seen that things change so quickly?

How do you make sure that you're always in the right competitive position to take advantage of the changes?

Well, a lot of pieces to that.

I guess for starters, the big focus that we have with the changing mix of B2C is really enriching our technology both for customers and operations so that we can keep the margins.

Myron, maybe you can talk at a high level on some of the things we have been doing.

Thanks, Kurt.

We are in a constant transformation of our business model here in the US to adapt to the changing mode of the market, particularly with B2C.

Our use of operational technology has real-time optimization that we will use moving forward.

As you've seen in the past, we have talked specifically about telematics, but moving forward, we will utilize new delivery route optimization that will give us real-time optimization of the routes that will allow us to reduce the miles driven and direct labor hours.

And I guess one other real component, if you talk to global network, is our fleet composition and our ability to -- we have a very harmonized young fleet.

So maybe, Dave Abney, you could talk a little bit about how the airlines are reacting to these trade flows.

Yes, certainly.

One thing I want to point out about the third quarter, block hours were down 5% on an export volume that increased 1% and that is certainly due to leveraging Worldport to the strategic composition of our fleet where we have continued to add 767s, bigger containers and our superior technology.

In fact, if you go back 2008 through 2011, you see that we have actually increased our packages per block hour by 15% and that just shows that we are leveraging this network.

And when it comes to the International side, we have reduced our Asia network, cut it down 10% year-over-year.

But as Dan said, as we do have trade lanes that demand it, we certainly will put up block hours as necessary.

And I think historically we have always shown the ability to perform, I think, in good times and bad times better than most of the industry because we have such a flexible workforce.

We can flex it based on the volume on a daily basis.

Jeff Kauffman, Sterne Agee.

Thank you and congratulations, everybody.

Normally the old rule of thumb used to be that you could get a read on the economy based on what was happening in average weight per piece.

Obviously, for reasons B2C, B2B, the lower weight per piece might not necessarily be as accurate an indicator as it used to be.

But what is your take on that and kind of if I look at your average weight per package, how do I segregate what is kind of a structural shift versus maybe cyclical weakness?

That is a great question, Jeff and some stuff we have been looking at ourselves and trying to isolate.

I think if you go back to the more traditional view of weight, which was kind of the indicator of how many widgets are in a box, you could see that packages would get lighter during lean times than heavier.

There is a slight weight drop if you look kind of at same-store sales on the B2B for similar industries.

So there is -- certainly things continue to get a little smaller and the economy isn't robust.

The vast majority of the weight declines, and we are continuing to see substantial ones, is really this B2B to B2C mix because we have all of that mixed in the same network and it does create some very big changes in average weight and also is the biggest single driver by far of the revenue per piece comps that can be challenging.

So our trick is to continue to find creative ways to manage through that and we are doing pretty well so far.

And Jeff, for the last 20 years, B2C has become 1% more of the pie each year.

In the last probably year, year and a half, that pace has picked up to maybe 2% a year or more of the pie.

So that evolution is speeding up as we speak.

Bill Greene, Morgan Stanley.

Yes, good morning.

I was wondering if you can just clarify something that is in the press release.

You talk about International benefiting from improving sort of exports I think you said out of Asia, product launches, etc.

But then supply chain got hurt by overcapacity in Asia.

So I am not sure why you would have differing trends in that regard and maybe you could talk about what has happened so far in October then.

Absolutely, and Dan Brutto clearly can fill you in a little more on the product launches, but also the balance of forwarding in our International Package business, so Dan, why don't you take that on?

Yes, sure.

I guess what is happening now primarily in the air freight market out of Asia is there's overcapacity in the market.

Whenever there is overcapacity, even though our kilos are up, certainly the rates are down and that is pretty much consistent across the whole forwarding industry.

On the positive side though, we did see an uptick in HACTL and PACTL in the month of September.

Year-to-date, they are still both down on the export side.

HACTL being much more down than PACTL, which is the Hong Kong index versus the Shanghai index.

So certainly we are seeing that.

Why the small package?

Small package is up because of use of our network and certainly some product launches that came out of Asia, as well as some easier comps last year in the third quarter.

Chris Ceraso, Credit Suisse.

Thanks.

Actually I wanted to follow up on that subject as well.

Is there marketshare gains that you can talk about in tech that maybe helped you disproportionate to your competitors?

And then maybe if you can say that the strength that you saw in September has carried into October.

Yes, we are continuing to execute.

Clearly, we have a very long history of continued share gains in the International sector.

The product launches in September clearly was a boost that made September the better growth month, so we are not trying to overplay this.

Plus we have seen sometimes there is a broader ecosystem around product launches.

We're peripheral suppliers in some of that launch.

So we like to think we are gaining share.

Clearly, the profitability was great this quarter, but it is too soon to say that either we or the industry is out of the woods as far as long term Asia exports.

Yes, I think we said all year we expect the third quarter to have easier comps and you start seeing better comparisons and you saw that.

So there's really no surprise.

I would not say that global exports out of Asia are growing at a fast pace.

We have got a ways to go there.

David Vernon, Bernstein.

Thanks.

So Kurt, with $9 billion of cash on the balance sheet right now, that's obviously a little in excess of the TNT acquisition price.

Can we assume that that is going to be 100% cash or will you actually be levering up a little bit to close that deal?

Well, no, we did do the debt issuance a few weeks ago and we were just thrilled to see the -- the demand for that, as I said, was more than seven times oversubscribed.

That $1.75 billion really was an early draw to replace debt that comes due in early January.

So basically a couple billion of that cash and marketable securities is just a pre-funding for that debt.

So you take that out and we are in pretty good shape.

We will use a little commercial paper, as we said.

We have some commercial paper outstanding, but we wanted to be in good position to address the cash needs to close that.

So our intentions remain the same, as we had said before, that we don't anticipate a need to do any long-term issuance to fund the TNT acquisition.

So the $5 billion in cash number, is that still a good number to think about or do you think it will be a little higher than that?

That is still a good number.

All right, great, thanks.

Art Hatfield, Raymond James.

Good morning, everyone.

Just a real quick follow-up on your comments on Europe.

You had talked about in the press release that while Europe has slowed, your small package growth remains positive.

Can you -- and you have talked in the past about how the market is shifting towards small package.

Can you talk about that and where you see yourself in the competitive environment and if any of that positive growth is marketshare gains within Europe?

Well, clearly, we are long-term observers of Europe and have operated there for a long time facilitating the Board -- transporter movements.

I will let Dan talk a little bit about the competitive climate there.

Yes, I would say that Europe is a very competitive environment.

We are slightly up, which is good, but just slightly above positive on the exports for Europe and certainly we've reported negative on the Domestics, primarily negative on the Domestic from the southern periphery countries that are going through austerity programs right now that they are going through difficulties.

So I would say the European market, we're very bullish on Europe, although it is a very competitive marketplace.

Great, thank you.

Peter Nesvold, Jefferies & Co.

Good morning.

I wanted to ask a question on the Deferred yields in the Domestic side of the business.

So they started to step down in fourth quarter of last year, presumably on Amazon Prime.

That starts the anniversary in now.

So I'm curious, optically, should we expect Deferred to continue to be down, the yield in that business to continue to be down year-over-year?

And if I can add a compound to that question, when you think about the increasing mix towards B2C, lower weights, lower lane density, how do you add this business on without it being dilutive to overall corporate average returns for the business?

Thank you.

Yes, I will talk about the returns issue and then maybe Alan can talk about the market trends and the customer mix change.

Clearly, we spent a lot of time focusing on adjusting our Domestic network, as Myron talked about, to extract and maintain by far the industry's highest returns on capital and by far, the highest aggregate margins.

This growth in lightweight Deferred packages, whether they are B2C residential or the premium residential packages, does create some different operational challenges, but the returns on capital are very high.

They tend not to consume as much in the way of assets and with our increased focus on the productivity at the last mile that we have been doing, clearly, we are continuing to generate good returns.

As far as the yields and the changing mix, we have talked about that a little bit, but Alan can give a little more color to it.

Yes, I guess, first, I wouldn't characterize the lightweight product as any specific customer.

We have a broad base of customers that are using the lightweight SurePost product, but it is a relatively new product and we are going to be lapping some very significant growth in that product, so I think that you should see some yields firm up into 2013 in that regard.

And by the way, on the previous question on weight in general, I think one of the things we have been able to accomplish with the SurePost product is we are now capturing a disproportionate share of that market.

That wasn't necessarily a market that we played in even with our Ground residential and now we are able to go after lightweight, less time-sensitive, economic-type products in the marketplace that we weren't necessarily competitive for in the past.

And Peter, we are, as Kurt said, focused on return on invested capital.

Our long-term targets have a minimum of 25% ROIC 2014 on and that is based on this mix of products.

So we are focused on return on invested capital, we will keep great ROICs going despite the mix we are looking at here.

Ed Wolfe, Wolfe Trahan.

Thanks, good morning.

Can you comment a little bit -- I mean this was the first quarter where Domestic Package's operating income was down for 10 quarters or so and yet the volume has been so strong.

Can you talk a little bit about how much of this has to do with mix with the B2C growing faster and how much of this has to do with maybe trying to take a little more volume and give up a little bit pricing?

And then what impact you saw, if any, on fuel.

It is hard to tell.

The expense is down year-over-year, but obviously is the fuel surcharge.

Yes, sure, Ed.

I will be glad to unfold that for you a little bit.

The two most notable issues that were headwinds in the third quarter and frankly, we guided at least some of those last quarter.

The first was the fuel surcharge lag, which I think we did estimate was about $60 million.

In addition, there was one less good working day this quarter, which, as a ballpark, we usually say that is about $50 million plus or minus per working day.

So if you factor those two in -- we did also say in Q2 we had a $60 million tailwind for fuel.

So if you average out those two quarters, you can actually see the business trends remained fairly stable and we have shown solid increases in profit.

So we feel that things are working pretty well.

We knew third quarter was going to be a challenge.

That is part of why we had to talk a little more about that last quarter.

The changing mix is a challenge that we are continuing to work through, but we feel pretty good so far.

So in general, we think the business is steady in the US.

The operational enhancements are helping to offset the challenges that we are facing with lighter weight packages and we expect that to continue.

And we expect obviously domestic operating profit improvement in the fourth quarter and a margin of 15% or over, so we feel like we are moving in the right direction there.

Justin Yagerman, Deutsche Bank.

Hey, guys.

Just on the US Domestic small package side, I guess from what I've heard at least, it sounded like the workaround on some of the large customer impact sounds more operational in terms of how you guys are thinking about this and taking cost out of the network to try to offset some of that negative mix impact.

But I mean when you think about that business, how actively are you pushing back or managing volumes with those customers to make sure that that mix is appropriate or does it really just take a reinvigoration, to your point, Scott, with fiscal cliff worries and all of that on the small to medium-sized customers to start coming back and adding growth to that mix in order to see a more I guess healthy yield profile coming on in that business?

Clearly, we have talked a lot about the costs and the technology enhancements, but equally important is the revenue management and extracting the value from all of this new capability.

So Alan, maybe you can talk a little bit about how we are enhancing on the revenue side.

Yes, so it is certainly noteworthy that on a year-on-year basis that the product and the customer mix continues to negatively impact the yields.

And again, I think a lot of those base rate improvements are being masked by the continued growth in lightweight products, but clearly the portfolio we have out there, whether it is for B2B customers or B2C customers allows them to certainly optimize their transportation and pick the service that they need that provides the service they need at the cost point they're looking for.

The other thing I would just add is that the core pricing certainly remains firm, around 2.5% base price increase, a little bit stronger on the air side.

Justin, your point on small and medium-sized enterprise is a focal point for UPS.

I know Myron and Alan's teams are looking for different ways to go to that market I think.

They have not been spending, they have not been stocking inventory, they have not been hiring because of all the uncertainty out there and they will get it going once the government makes some decisions.

But we are bringing a lot more solutions to this group.

I think solutions originally were focused to the larger companies, larger businesses.

Now we're bringing those solutions to the small and medium-sized companies, which will help us grow the middle market going forward.

Great, thank you so much.

Kevin Sterling, BB&T Capital Markets.

Thank you, good morning, everyone.

Kurt, I wanted to let you know that my wife has taken your advice and is indulging in some online holiday shopping these days.

That's great.

Just got to make sure she signs up for My Choice, Kevin.

Yes.

I'm kind of talking about this question of shifting International patterns.

Have you guys seen any major shifts in International shipping patterns say from the air to the ocean or is it mainly to Deferred products?

Certainly, we have seen shifts geographically quite a bit with some of the Intercontinental moves slowing, which we have talked about for a couple of quarters.

I will let Dan maybe add a little color on what we're seeing in our forwarding unit in Express.

Yes, I would say, to answer that, we have seen some non-traditional ocean customers and what I mean is some air freight and some Express taking at least a look at sending some of their lower margin products via ocean.

And we have made it easy for those customers certainly with our broad portfolio and also with our preferred less than containerload ocean product that lets the customer either from the high-tech or the medical field at least test out ocean in a way that is quick and certainly allows them to move along this product portfolio in an efficient manner, but nothing to a major extent yet in the marketplace.

In fact, the geography that Kurt talked about, clearly, the European demand is down and that is impacting Asia exports and US exports pretty dramatically as we move forward.

So hopefully we can get some European imports going again in the future.

Well, great.

Thank you for your time and congratulations on a nice quarter in a difficult environment.

Brandon Oglenski, Barclays.

Good morning, everyone.

You highlighted that you have already opened discussions with the Teamsters here.

So can you just talk about some of the objectives that you're looking to accomplish with this new contract around -- especially in the face of the shifting mix domestically to more B2C traffic, more of the lightweight, lower yielding packages?

I will let Dave Abney talk about that.

He probably won't be able to tell you an awful lot because we're keeping the negotiations at the table.

Yes, the negotiations did start in September and we do believe that an early start is good for the employees, customers and the shareholders.

In the past two negotiations, we have been able to reach early conclusions.

We have got a positive relationship with the Teamsters.

We both recognize that UPS success translates into jobs.

Many of the issues that come up have been discussed over the last couple of years through the competition committee.

As far as the particular issues, we just believe negotiations are best left to the bargaining table.

So won't reveal that today, but we are satisfied with the pace of discussions.

Thank you.

Helane Becker, Dahlman Rose.

Thanks, operator; hi, gentlemen.

Most of my questions have been asked and answered, but just one point of clarification.

Did you say how many people you would need to hire for the peak shipping season and how that compares to prior years?

No, we will be releasing more details about the peak season and the holidays in a couple of weeks or so.

As Alan said, we do expect over half a billion packages between Thanksgiving and Christmas, so we will be very busy and there will be plenty of temporary hires that start with the Company like myself during the holidays, but will give you more details in a couple of weeks.

Are you driving during the holidays?

If I need to.

I did that too when I was in school.

So thanks very much; I appreciate it.

That is it.

Everything else was really asked and answered.

David Campbell, Thompson Davis.

Hi, good morning, everybody.

I am just a little surprised that you are relatively optimistic about the fourth-quarter forwarding unit given the fact that you're a little unsure about September's volume growth continuing in the Asia-Pacific region.

What changed from -- what changes from the third quarter to the fourth quarter that allows you to be optimistic that earnings will be up in that division year-to-year?

That's a good question.

I wouldn't interpret our guidance to be optimism specifically around the International forwarding.

More important in that segment as far as contributing to profit improvements is our UPS freight and our distribution business.

No, we expect forwarding to have another challenging quarter.

Clearly, the buy rates are low, but the revenues are also being pushed down quite a bit.

So it is more an expression of optimism of the continued momentum in our freight and in our distribution business, which is benefiting from the healthcare growth.

Okay, thanks.

That explains it.

Thank you very much.

Ben Hartford, Baird.

Good morning.

Dan, I guess to that point, can you talk a little bit about gross profit per unit both on the air freight side and on the ocean freight side here in the third quarter relative to the second quarter and then maybe what the expectations are as we go into the fourth and then wrapping it in -- discussing the competitiveness of the forwarding environment in the light of available capacity, but continued weakness in volumes?

Yes, we did see some margin compression quarter-over-quarter.

Clearly, we didn't quite hit the overall segment margin we had hoped.

We had hoped to get to 9% this quarter and ended up coming in still at a healthy 8.3%.

And the biggest driver of that was the margins on the forwarding.

We don't disclose the exact margins of our ocean and air forwarding.

Clearly, the ocean has been actually doing a little better than the air forwarding since that is an industrywide trend.

And as Dan mentioned, with our less than containerload in expedited ocean, we are finding what we think is a profitable niche.

So we think the fourth quarter will again be a challenging one for all of the forwarders frankly.

That's helpful.

Thanks.

John Barnes, RBC Capital Markets.

Good morning, guys.

Nice quarter.

A quick question on the subject of B2B and B2C and that ratio.

Is there any seasonality in the fluctuation in those ratios of traffic or are you starting to see B2B or B2C, I'm sorry, being a more consistent level of your business?

I know, Scott, you said it was growing at 2% of the pie or whatever, but is that quarter-to-quarter very consistent or are you seeing some seasonality in it?

I think as far as the evolution, B2B to B2C, it is pretty steady, but, clearly, in the fourth-quarter holiday season, B2C is a bigger piece of the mix as it always through the Christmas season.

I'm sorry, but the other three quarters, 1Q through 3Q, is it still very consistent among those three quarters taking out 4Q?

Yes, it is pretty consistent.

Okay, all right.

Nice quarter, guys.

Thanks for your time.

David Ross, Stifel Nicolaus.

Good morning, gentlemen.

There is an article that came out highlighting Walmart's experimentation with same-day delivery a couple weeks ago and that they are using UPS to deliver to their customers' homes.

Could you comment a little bit on that project and whether or not you're doing same-day delivery with others and whether you think same-day delivery is actually a viable method that people are going to be using and if you're going to be able to charge enough to account for the delivery density problems with same-day delivery?

Great, good question.

I will let Alan talk about some of those areas of innovation.

Clearly, there is a heck of a lot going on in the B2C market.

Certainly SurePost postal injection is one of those areas.

What UPS is doing with UPS My Choice is another and certainly a lot of noise out there with same-day type delivery options.

And I think it is really too early to tell precisely how that is going to shape up, but that is really an incubating part of the market at this time.

I think more importantly is what the retailers are looking at out there and what UPS is helping them do in terms of what is being called like omnichannel out there.

So we are out there helping both e-tailers and e-tailers with brick-and-mortar leverage all the assets they have and what you're seeing now is retailers that want to fulfill directly from their store to consumer or fulfill from their dotcom directly to their stores and create an ecosystem out there where customers have the maximum access and the maximum number of options out there.

I think another area is, if you can fulfill from a store and provide a customer a late pickup, then you can get next day delivery or near same-day delivery with a late pickup.

Keith Schoonmaker, Morningstar.

Great, thanks.

I noticed you opened a few more healthcare distribution facilities and wondering if you can give some color on what portion of forwarding and logistics is in the healthcare distribution area.

And also sort of in the current laboratory of economic uncertainty, what sort of performance you are seeing from your healthcare logistics relative to the cyclicality and uncertainty of sort of the broader market.

Well, we did see healthcare grow approximately 20% from a revenue perspective, especially in those locations where we do a part of the distribution also.

We don't see our exact numbers, but I think the great thing about healthcare is that, as an industry, that really makes full utilization of the integrated network and the broad portfolio of UPS.

So Dan even mentioned, in some cases, healthcare customers that are using ocean.

Clearly, our air freight forwarding and temperature-controlled configuration in our express services all come together.

So it is an industry where we can really stretch our wings and take advantage of the entire portfolio.

And the revenue shows up in Domestic Package, International Package, obviously freight forwarding, distribution, so across the board.

And we have now 5 million square feet of healthcare facilities around the world in 36 facilities.

In just this last few months, we have opened three in Asia for around 400,000 square feet.

So it is a growing part of our business.

Tom Wadewitz, JPMorgan.

Yes, thank you.

Scott, I figured you might be disappointed if you didn't get at least a second question on TNT.

So I will try to give you one more on that.

I think there has been a lot of noise about what the EC is going to do and the idea that they are being really granular in how they are defining markets, that that might be a challenge.

Is there any kind of a high-level comment you can give us in terms of the SO.

Did this end up being a bit more challenging, more stringent than you would've expected?

Would you say at the end of the day it is pretty reasonable what you have in there?

Can you kind of shade it in terms of being a little better or a little worse than you would've expected on the SO?

No, I think it is a complex transaction and whenever you get into Phase 2, you spend a lot of time with the Commission and our team has spent a lot of time with the Commission.

I think it has been good open dialogue.

I think we are exchanging information.

We have got a ways to go and certainly -- we just got the SO Friday night, so we're obviously going through that right now over the next couple weeks.

We will spend a lot of time responding to that.

I know Dan Brutto has spent a lot of the last couple months in Europe on this project.

Any comments, Dan?

Yes, sure.

I think what I can say is we both have -- they have a case team, we have a team that is working constructively.

As Scott said, it is very complex, it is all of the 27 member states of the EU that they are tasked with taking a hard look at and it is just part of the process.

The SO is part of the process.

We will go through that.

We will have our response back, but the good news is the teams have open dialogue and certainly we are going to turn in the documents that is required by the Commission within the timeframe.

And we are confident we will get clearance and we will get it early in 2013.

We are committed to the transaction.

Great, thank you.

Bill Greene, Morgan Stanley.

Yes, thank you for taking the question.

I just wanted to ask, we used to talk about B2C being around a third of the business.

I am curious where it is.

You mentioned it has sort of accelerated as a percent of the pie.

Where does it ultimately top out at because I would think at some point you would rather say, look, let's just start raising prices on this stuff more aggressively because we don't want too much of it given the mix effect?

Yes, certainly, it is our goal to optimize the value to create the premium services either by speed or by My Choice and at the same time for those lightweight, low value products to keep prices down.

Right now, B2C is running about 40% and clearly, given the holidays, it will be significantly over 50%.

But we hope the core B2B economy also picks up and so the balance remains healthy.

Although we will take whatever the market gives us and find a way to be profitable and generate good returns for it.

And Bill, we adjust -- 80 to 90 years ago, B2C was 100% of our business, so it will adjust based on how the market changes.

Yes, okay.

Thanks for the follow-up.

I would now like to turn the floor back over to Mr. Andy Dolny.

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

Thanks, Andy.

Unfortunately, global trade continues to be slower than any of us would like at this point in time, but I think UPS has made the necessary adjustments.

You started to see it in the third-quarter results.

I think we did a nice turnaround in International going in the right direction.

But in the fourth quarter, we actually expect to hit on all cylinders.

Each segment anticipates operating profit improvement with margin equal to or better than last year.

This not only is a testament to the UPS business model, but also the capabilities and dedication of the UPS team.

Thanks so much for joining us today and we will see you next quarter.