聯合包裹運送服務公司 (UPS) 2013 Q2 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the UPS investor relations second-quarter 2013 earnings conference call.

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

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

Please note we will 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 and welcome to our second-quarter earnings call.

Joining me today are Scott Davis, our CEO, and Kurt Kuehn, our CFO, along with Chief Operating Officer David Abney, International President Jim Barber, President of US Operations Myron Gray, and UPS Chief Sales and Marketing Officer Alan Gershenhorn.

Before we 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 or results of operations of the Company.

These anticipated results are subject to risk and uncertainties which are described in detail in our 2012 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 our remarks today all full-year comments and comparisons will refer to adjusted results.

In addition, we will discuss UPS's free cash flow, which is a non-GAAP financial measure.

Reconciliations of free cash flow and adjusted results, along with a webcast of today's call, are available on the UPS Investor Relations website.

Finally, as a reminder, our goal is to allow as many as possible to participate on today's call, so please ask only one question and then get back in the queue.

Again, no multi-part questions, as we will select which part to answer.

Thanks for your cooperation.

Now let me turn it over to Scott.

Good morning.

UPS second-quarter results reflect the impact of customer behavior and market trends.

International Freight forward operating profits and margins continue to be influenced by moderating demand and changes in shipper preference.

Customers around the world continue to put greater emphasis on cost rather than time in transit, trading down in the UPS product portfolio.

We believe this trend is primarily cyclical.

Over the last few quarters there has been a trough in the innovation cycle.

Demand for new high tech products traditionally drives Express small package and Air Freight out of Asia.

On the other hand, some of the trade down is likely permanent.

More international trade is being conducted regionally and supply chains are becoming more efficient, so the need for the fast Express options may not grow quite as strong in the future.

Here in the US volume growth was a little less than we expected.

Some opportunities were missed due to labor negotiations.

Regarding labor, on June 25 we announced that the Teamsters National Master contract received majority approval.

We believe this agreement provides a fair and competitive wage and benefit package that rewards our employees, while also enabling UPS to remain competitive for the long run.

UPS and the Teamsters have committed to address unresolved local supplements in UPS Freight.

The supplements cover specific geographic areas and include topics such as bidding and local area work rules.

Until then, the current agreements remain in place including UPS Freight.

The Company and the Teamsters have agreed to contract extensions while we continue to discuss the remaining issues.

Looking forward at the macro picture, though global economic expansion for the second half of 2013 is still expected, forecasts have been lowered in 10 of the 12 largest economies, including here in the US.

One area the US continues to struggle with is exports, especially to Europe, so UPS strongly supports the Transatlantic Trade Investment Partnership.

This is a great opportunity for the US and the EU to set the standard for trade pacts.

Business cycles are creating short-term challenges similar to those we have faced many times before.

UPS still sees great growth prospects in B2C throughout the world, emerging markets, and healthcare solutions.

In healthcare, for example, during the quarter we announced the opening of two new distribution facilities in Hangzhou, China, and Louisville, bringing our total healthcare space to more than 6 million square feet worldwide.

At UPS the key to expanding operating profit is to adapt our integrated network and expand our portfolio to capitalize on changing market conditions.

In a moment David will provide details of several operational cost initiatives and growth opportunities, but first Kurt will take you through the financial results and updated guidance.

Kurt?

Good morning, everyone.

As Scott noted, we faced several trends during the quarter that continued to impact revenue and operating profit growth.

Total company revenue was $13.5 billion on volume gains of 2.3%.

A couple of weeks ago UPS announced our second-quarter results of $1.13 per share, slightly below our expectations.

The profit of our Forwarding business unit dropped significantly, and our International results were reduced as customers continue to choose lower yielding products.

In addition, we lowered guidance for full-year earnings per share to a range of $4.65 to $4.85, reflecting a 4% to 13% improvement for the back half of the year as economists around the world reduce their outlook.

Now let's review the segment results.

US Domestic total revenue was up 2.3% on average daily volume growth of 1.9%.

Operating profit was flat with last year and margin declined 40 basis points to 13.7% as productivity improvements did not fully offset higher driver wage and benefit costs.

Daily Ground volume increased 2.3% and Deferred was up 1.4%.

Our Next Day Air volume declined for the first drop in five quarters.

Next Day Package volume gained slightly; however, letter volume was down more than 5%.

During negotiations our ability to win new business was hampered.

Even though we received a handshake early, we missed some opportunities and did experience some minor volume diversions.

Our average revenue for Package was relatively flat, and though we see consistent base rate improvements, lower fuel surcharges and changes in mix and package characteristics weighed on reported yields.

Now for our International results.

Total International revenue was up 1.6%, while operating margin contracted 40 basis points to 14.7%.

Operating profit was down slightly to $451 million.

It was lowered by shifting customer preference for deferred products, especially out of Asia.

Network and in-country cost productions partially offset this revenue shortfall, and fuel and currency were also a drag of about $15 million more than we expected.

Daily Export shipments increased 5%, driven by gains from Asia and Europe, which were somewhat offset by lower US exports.

Local day comparisons aided the growth rate by about 1.5%.

Domestic products were up 5.1%, also aided by local day comparisons.

The emerging market of Turkey led the way with double-digit growth, while Canada and Italy also had solid improvement.

Currency neutral yields declined 2.8% as our nonpremium products, like Worldwide Expedited and Transborder Standard, jumped by more than 10%, while our Premium Express products were flat compared to last year.

Moving on to the Supply Chain & Freight segment where operating profit declined from the record levels achieved in the second quarter of 2012.

Total revenue dropped 3.2% and operating profit was down more than 20%.

Operating margin, though, still exceeded 7%.

The decline in revenue and operating profit was primarily due to the Forwarding business unit.

UPS experienced double-digit reductions in Forwarding revenue, driven by lower demand for Air Freight forwarding from Asia.

Revenue is heavily concentrated from large high-tech shippers whose business is down significantly from last year.

In addition, we did see large declines in the military sector.

Reduced operating costs could not offset these headwinds.

UPS is focused on diversifying our revenue base and David will tell you more about that in a moment.

In our Distribution business revenue was up about 4%.

Operating profit declined from last year as a result of continued investment in healthcare infrastructure.

The unit did generate a margin of approximately 8%.

UPS Freight revenue was $731 million, driven by LTL tonnage improvement and truckload revenue gains.

Operating profit growth was relatively flat as margin was negatively impacted by higher pension and healthcare benefit costs.

Now let's review our financial strength.

For the six months ended June 30, UPS generated $2.5 billion in free cash flow after capital expenditures of $990 million.

So far this year UPS has paid $1.1 billion in dividends, an increase of almost 9% per share.

In addition, we have repurchased 21.8 million shares for approximately $1.8 billion.

Note that our Q2 tax rate increased slightly to 35% due to a higher mix of profits from the US, and we do expect that rate to be between 35% and 36% for the rest of the year.

Speaking of guidance, earlier in July we provided new full-year expectations for earnings per share of $4.65 to $4.85.

This is based on the anticipation that the market trends experienced during the second quarter will persist through the remainder of 2013.

Our new range also reflects the latest forecast for economic expansion, and as Scott indicated, 10 of the 12 largest economies are now expected to grow a little slower than originally thought.

While we did bring down our numbers, it is important to note that UPS still expects improvement.

In fact, the midpoint of our range calls for about 8% earnings per share growth over the second half of 2012.

Looking at the remainder of 2013 for the segments, in our US Domestic segment we expect daily volume will increase between 2% and 3%.

Growth should get stronger as the year progresses as we convert missed opportunities from earlier in the year.

Revenue growth should be slightly higher than volume.

Package characteristics and lower fuel surcharges will continue to mask base rate improvements somewhat, and profitability will be up at a mid single-digit base.

For our International segment, in the back half of the year we expect revenue and daily volume growth of approximately 4% to 5%.

Yield improvement will be hampered by continued mix changes, as well as commodity fluctuations.

We expect currency to negatively impact profit comparisons by approximately $100 million.

However, we anticipate operating profit improvement in line with our revenue growth of 4% to 5%.

Third-quarter operating profit expansion will be relatively flat due to comparisons with last year.

Looking at Supply Chain & Freight for the remainder of the year, we expect revenue growth to be flat with an operating margin of approximately 8% driving mid single-digit profit improvement.

Before I turn things over to David, let me assure you UPS is focused on both our long-term strategies and on making the necessary adjustments to adapt to current market conditions.

Now David will take you through some of our key initiatives.

David?

Thanks, Kurt.

I want to spend a few minutes discussing how UPS is adapting to the conditions that Scott and Kurt just identified in their opening comments.

Economic cycles and consumer behaviors change creating challenges and opportunities.

The key to long-term success is adapting our model to capitalize on these changes.

This is something we have been doing for more than 100 years.

It goes without saying that we have already identified overhead and discretionary cost reduction opportunities.

I can assure you that I have an internal checklist of these items, but that is not all I want to discuss.

Today I'm going to provide insight into how UPS is making strategic changes to our network and portfolio to meet the evolving needs of the market.

In our US Domestic operations UPS is ramping up technology implementations like ORION, which takes route optimization to a new level.

To give you an idea of the scale of this project, we have assigned almost 500 people to this multi-year development.

At the same time, we are delaying some projects that don't deliver immediate results.

Additionally, we have identified opportunities to move more premium volume over the road, taking advantage of Worldport capabilities and the UPS integrated network.

To meet customer demand we are leveraging our relationships with retail shippers to develop more sophisticated distribution models that better utilize their store inventory.

The implementation of omni-channel fulfillment is still in the early stages and we are seeing great results, including B2B shipment growth.

In our International business margins do benefit from the adjustments we make to our Global Air network.

Maximizing aircraft utilization has always been important.

We have already cut our Asia capacity by about 20% and we will continue to reduce truck routes and scheduled frequencies, making adjustments from Asia to the US and Europe being mindful that we must remain nimble enough to react to surges in demand.

We are making changes to address the risk and opportunities of a changing marketplace, expanding our presence in emerging markets with an array of solutions for customers.

Notably, we expanded our worldwide expedited service to 145 new destinations and 60 new origins earlier this year.

We now provide shippers in these emerging markets with an economical alternative to Express shipping.

To increase more premium revenue into our aircraft, we introduced UPS Worldwide Express Freight.

This service offers shippers in key markets guaranteed, day definite, door-to-door Freight options.

In the Supply Chain & Freight segment our primary focus is on the Forwarding business unit.

To better manage our purchase transportation, we are implementing a system that optimizes buy rates to match real-time market conditions.

Additionally, we are diversifying our revenue base to take advantage of the trade-down trends in the Air Freight Forwarding market.

UPS expanded our ocean Freight capabilities, a business we have been in for over a decade.

For example, we extended the reach of our ocean less-than-container-load service to hundreds of new lanes around the world.

UPS Preferred LCO service accelerates ocean shipments and has been expanded to several key markets in Europe.

When customers seek less expensive Freight options, UPS offers a complete portfolio of solutions.

Also, across the entire Supply Chain & Freight segment we expect to reduce overhead and operating costs utilizing UPS technology.

Given our long history of adapting to changing conditions and the actions I just reviewed, we are confident that we will deliver a solid second half in 2013 and beyond.

Now back to Kurt.

Great, thanks, David.

Hopefully you can see that we do have a wide array of both opportunities and initiatives in motion to address current conditions.

Operator, I will turn it over to you now and we will take your questions.

(Operator Instructions) Brandon Oglenski, Barclays.

Good morning.

Thanks for taking my question.

So I wanted to talk about your Domestic growth.

Last year you had pretty good traction with the new Next Day Saver packages.

We can see that in the numbers.

But I am wondering if at this point in time have you reached a saturated point in the market where that new premium offering has met a level where you can't drive much more share with that.

And what are the type of innovative products that you can leverage the integrated network with relative to your competitor?

Yes, Brandon, the major driver of the reduction in our Next Day Air business for the quarter was a reduction in letters.

The actual package business, which is more related to the B2C, and certainly the omni-channel, continued to grow moderately.

But we did see a big decline in letters and we do see some cycle there with refinancing dropping a bit.

Also, it certainly was impacted by some of the uncertainty in the second quarter.

Thank you.

Art Hatfield, Raymond James.

Morning.

Just real quick, despite some of the slowing demand trends or some of the markets where there may be a little bit of excess capacity, are you seeing any irrationality in pricing in any of your markets?

In general, I think the small package market remains rational.

Clearly there is a desire for customers to trade down.

Probably the one area that has the most volatility is in the Freight Forwarding arena, most notably Asia.

And I will have maybe Jim Barber comment a little bit on the trends there.

I think that is right, Kurt.

Obviously you look at the International segment; we feel very strong about the Europe piece of the business.

Very solid foundations are good; pricing is rational.

As the market capacity moves, largely out of Asia, you get a lot of pressure through the network and pricing capacity with freighters coming out of the market and then belly space coming in, so we have got to manage to that.

But, in general, the pricing position within UPS we feel very good about.

Thank you.

David Vernon, Bernstein.

Good morning.

You guys have been very successful in offsetting some of the International small package yield headwind from trade downs by managing up the air network utilization.

I was trying to get a sense for what the level of utilization is right now in the trans-Pacific and how much more you might be able to offset ongoing yield headwinds if these trends continue.

Certainly, as David mentioned, we are doing a lot of work on the network changes.

So, David, maybe we will start with you.

I think that it is an area that we have done a great job over the years in managing that balance, matching capacity to volume trends.

In fact, since 2011 we have reduced our Asia capacity by 20%.

And even this last quarter, from an International standpoint, with export volume up 5% dock hours were down 1.2%.

That being said, though, it is an ever-changing environment and we have to watch it very closely.

For this next quarter we plan to reduce from 8 to 7.5 truck routes out of Asia.

We also are reducing one weekly frequency from Asia to Europe, but we also have the ability to plan in advance.

When we see days that are going to have less volume we will shut down lanes for particular days of the week, which we are having a lot of success with.

So it's something that we are actively managing.

This is Jim Barber.

To add on to what David said, obviously internationally I think if you look at the results over the years in our operating margin the network has a big play into it.

But the other factor that we believe we do very well in international is to manage our in-country operations.

You can see that come through in the margins and we feel like we have done it very well over the last couple of years as the economies have moved across the world.

So it is a balance of the network as well as our UPS leadership across the world to manage the in-country operations.

And the results of that, I think, as you can see, is our International margin, so we are pretty comfortable with that.

Thanks.

Tom Wadewitz, JPMorgan.

Good morning.

I wanted to ask you a little bit more on the trade down.

What do you think is timing?

I don't if you have product launches in mind.

That is one of the thing with -- weakness with tech shippers you mentioned on trade down.

But what do you think is potential timing where you would have some more evidence to, say, either we are right that this trade down is cyclically or you say maybe it is a bigger issue and it is more persistent?

Is that a couple of quarters out or is it just -- how would you look at the kind of visibility and timing for potential trade -- change in that trade down dynamic?

Tom, this is Scott.

I think I would start with the fact that clearly there is less need for speed in a soft global environment.

I think we have seen that and we have been in that environment, unfortunately, for a couple of years now.

But I do think that what gets it going again -- what gets Express going again -- is obviously innovative and high-value goods.

As I said earlier in my opening comments, we have been in a trough.

We will come out of the trough at some point in time in the future.

For me to say it's going to be two quarters or three quarters I am not sure, but we know there is going to be product launches coming up.

New innovation coming up.

We are not done innovating new products.

When that happens, again, you will see the Express product grow.

I am not sure you will see Express products grow as fast as you did 10 years ago, unless you get a strong economy, global economy and good growth in global trade.

But I do think the fact is that we talked five years ago about the Next Day Air market in the US being a market that was going nowhere.

Last two years we grew that market faster than the Ground, so again I think we sometimes overreact on these things and I do expect they will be back.

And I think, as David mentioned, we are doing a lot of product innovation and expansion, both to increase the yield on our aircraft and add some new product capabilities in the lower arena.

So maybe, Alan, you can talk a little bit about the portfolio and how we are adding products?

First, Scott alluded to high-tech launches.

We are certainly looking forward to some of the launches that should take place in late third, fourth quarter this year.

We have got a great portfolio there to help high-tech companies with those launches.

David talked about Worldwide Express Freight; it's surpassing our expectations.

Again, this is a new piece of the Express market that we have entered, so we are excited because there is a tremendous amount of upside for UPS there.

We are also able to bundle that to win other Express package.

Then on the yield management side, again David talked about the expedited expansion.

Again, a couple keys there is that utilizing our lower-cost integrated network we are able to utilize Ground -- Transborder Standard Ground network in Europe, as well as our Second-Day Air and Ground network in the United States, to lower the cost and keep the packages off the planes.

One interesting note there is that 75% of the new volume we are getting on those lanes are coming from shippers that never shipped on those lanes before.

So it is new business and it is not down trading from Express.

Great.

Thank you, I appreciate it.

Ken Hoexter, Merrill Lynch.

Great.

Good morning.

How is the -- Domestic margins took a bit of a downturn here year over year.

What was the growth of SurePost?

And how has the shift to SurePost in e-commerce impacting margins and how is that dealt with in negotiations?

Thanks.

I will take at least the pure growth part of that and then Myron can talk a little bit about our productivity and other issues.

We have wrapped a lot of the ramp-up of SurePost.

It is continuing to grow.

Clearly, B2C continues to outperform the B2B in our portfolio and we are doing fine with that.

The biggest issue, clearly, in the second quarter for domestic was the slowdown of volume growth below what we expected.

And, Myron, clearly you guys are adapting to that.

On the heels of slower growth than what we expected, when you look at the ramp of the basic product into SurePost we were able to improve our operating margins by deploying SurePost redirect.

Where in the second quarter, on average, we saw 17.5% of the packages that would have been delivered by the post office we were able to redirect through our package delivery drivers with matching them up with other stops that will go into residential -- to residences which drove density.

So we will see continued expansion of our productivity and moving into the third quarter, we will try to hone those productivity improvements.

Kevin Sterling, BB&T Capital Markets.

Thank you.

Good morning, gentlemen.

Can I dive a little bit more into your Freight Forwarding comments?

The weakness that you are seeing; is it mainly a mix issue, buy rates, volatile buy rates, volume?

Really what is driving that deterioration in Forwarding?

I think you mentioned, Kevin, all three of those points.

It is all of those together, quite frankly and some of the comments we started with.

We know that in our network right now we are really concentrated in a couple of ways.

We are out of -- the Asia lane is driving a lot of the growth historically.

It concentrates in high tech and Scott talked about some of the innovation trough.

You heard some comments about military and defense.

We have had some of those movements going on across the world.

So some of those pressures combine to where we are right now in the current quarter, but looking forward, as David said, we are pretty confident.

We have been investing in Freight, the UPS Freight Forwarding way, over the last couple of years.

We mentioned, David, kind of a go-forward new piece of go-to-market on how we are going to go to the procurement side of Freight, so we are comfortable that we can take that and continue the growth.

We also have to take a look at emerging markets.

And, quite frankly, we feel like the emerging markets announcements that we have had recently -- as the trade patterns in the world move it is going to provide us great opportunity to match our network with that emerging market investment and continue to grow all of those together.

At the end, even in these tough times, the margins weren't the worst you have ever seen so we are kind of holding those.

Year-over-year comps aren't the best, but at the end of the day we still have some pretty strong margins in Freight.

We continue to keep going down that path and we will manage them together.

Okay, great.

Thanks for your time this morning.

Chris Wetherbee, Citi.

Thanks.

Maybe a question just on the second half guidance.

When you think about the 8% midpoint, can you give us a little bit of some of the inputs and the expectations, I guess, of volume progression as you move throughout the year that kind of gets you to that point?

I guess maybe what I'm asking is how much is it reliant on maybe a somewhat more normalized peak or some product launches that go on later on in the second half of the year?

We are not basing our guidance on any significant kind of ramp-up economically.

As I think I mentioned, we are looking for basically a steady-state economy.

Unexciting, a little underperforming, clearly, from where we thought it would be at the beginning of the year, but not radically down.

We do expect the US business to ramp up a bit as we ramp up some of the customers, perhaps, that got deferred or delayed during the negotiation period.

So we expect to see volume growth strengthen with Q4 clearly being stronger than Q3.

On the International side, kind of steady as she goes on that.

Clearly, there is volatility in the Air Freight, but we feel pretty good that the core business is very strong.

Europe continues strong.

So no real unique shake to the rest of the year as far as economic conditions.

Okay, thank you.

Kelly Dougherty, Macquarie.

Thanks for taking the question.

I just wanted to follow up on Forwarding a bit.

You talk about Air Freight overcapacity.

Wondering if you can talk to some of the moving parts.

Are you seeing that in lower purchase transportation costs, or maybe you have to then pass that through more quickly from a pricing standpoint?

So if you could help us think about how that is working on the Air Freight side, and then maybe a little color on ocean as well please.

I think the major overcapacity in the Forwarding is that it is not so much on the dedicated cargo carriers, but the passenger airlines clearly have added capacity.

Our real strategy, as Jim said, is to adapt so we are as flexible as we can be to reflect buy rates.

Then, importantly also, to develop the portfolio to help customers move up and down as much as we do in our package environment.

So the forwarding market is volatile and cycles happen quite a bit.

We think we are reacting accordingly and building a good base.

Any color maybe on the ocean side?

Ocean remained solid and that is part of the reason we are building and expanding for it is we are profitable in ocean and looking forward to growing it.

Thanks.

Justin Yagerman, Deutsche Bank.

Good morning, guys.

In David's remarks you guys talked about moving from 8 to 7.5 truck routes; I think you were talking about the Asian market.

I think it's the first time you had given color around that and I was kind of curious, as I frame up the International small package business, can you give us a sense of how much of that business stays on the ground as opposed to actually flying in your owned or chartered aircraft?

That would be helpful, I think, in terms of getting an idea of the profitability of the business.

Okay.

Well, to just clarify, last quarter we were at 8 truck routes and this quarter we are moving to 7.5.

What that means is there will be some days of the week that are 8 and then there are other days that are 7. But these truck routes, of course, are the routes that are very important, connecting Asia to the US and Asia to Europe.

Clearly the issue it's more of a challenge for us coming out of Asia where we fly the goods.

When you look at CrossBorder in Europe you can obviously move between air and Ground and have flexibility.

The challenge for us, obviously, is when business slows down coming out of Asia you fly it.

Got it.

And so just in framing up the back half of that question in terms of the overall percentage of the international small package business that stays on the ground, any color on that?

So this is Jim.

Most of that question really pertains to our European operations because of the way we have been at it since we went over there in 1976.

The network that we have built that is both transborder air and Ground allows us to essentially keep about 85% of what we pick up in Europe to stay in Europe.

And the customer's choice, they can fly or they can put it on the ground.

And the power of that network allows them to do both.

So that kind of gives you a feel for I guess the materiality of the European (inaudible).

And you know that Europe is over half of our revenue in International so it is a big piece.

And Canada is also a decent size operation.

This is Alan.

I was just going to say that we have got a material business between US and Canada and we just recently launched a Ground business to Mexico.

So we now have US to Mexico standard and Mexico to US standard, which is again also exceeding our expectations in terms of growth.

Scott Group, Wolfe Research.

Morning, guys.

Maybe just an update on the Teamsters negotiations and the contract status there.

With the tentative deal on the package side are you starting to see any of the domestic volumes come back more than you thought in the second quarter?

And then on the LTL side are you seeing any of the volume start to go away given that you seem further away on a deal there?

Scott, I will start with that.

I would say, first of all, you are right, we have got the National Master Agreement done and the National Master covers the important things on the package side.

It covers the wages, the pension, and the health and welfare.

We do have some supplements open we have got to work our way through.

We are working with the Teamsters and our employees right now on those issues.

They generally involve work rules.

I would say that, as we said before, we are really not seeing additional diversion or any diversion at this point in time.

We missed some opportunities.

As we negotiated it took us a while to put these new wins on board to convert them.

I think we will see that and we will see more in the third quarter and we will see more in the fourth quarter, so I don't see any more losses from that perspective.

On the LTL side, still we have got to finish that agreement.

We do have an extension, which gives our customers a little bit of a calm feeling as we have the extension.

I would say currently we are really not seeing a lot of lost volume on the LTL side.

We think -- we feel pretty good about it, just need to get that agreement done.

Okay, thanks.

Bill Greene, Morgan Stanley.

Good morning.

Scott or Kurt, I am wondering if you could comment on something that we get asked a lot, which is when we look at sort of what appears to us as a duopoly in the US market it seems somewhat surprising that we don't see more stronger pricing power overall.

I realize there is always puts and takes and mix shifts and whatnot, but I'm wondering if you can comment at all about how you think about the progression of this market.

DHL has been gone for quite some time, so maybe talk a little bit about how you think about pricing.

Bill, this is Kurt.

First thing I have to do I guess is take issue with your framing of the market as a duopoly.

Clearly, this is a competitive market.

The Post Office is a very large player, in the Ground business especially, and there is a number of regional players.

In general, pricing is rational in this industry and that is one of the great elements, but I think some of the trends we have talked about do create some challenges and mask that.

That goods are getting smaller and lighter as the average weights are down 2% to 3% typically year over year and that there has been a transition of goods, to some extent, from business to business to business to consumer.

So pricing remains rational.

It is somewhat masked.

It is sometimes hard for you guys to see all the moving parts, but if you factor out the average weight and some of the other product changes, we are still looking at core base rates of over 2%.

Ben Hartford, Baird.

Good morning, guys.

I'm wondering if I can get some perspective on My Choice and where you think that technology is as it relates to capturing B2C benefits, both in terms of volume and utilization in the network.

Maybe just kind of framing where that product technology is and whether we are on the front end or back end of realizing the benefits.

Great.

I am sure Alan would be happy to talk about that.

First, I would say we are on the front end of that.

We have over 3.3 million consumers signed up right now and certainly by the end of this quarter we should approach or exceed 4 million enrollments.

We have 54 million deliveries that have taken place.

In about 14% of those deliveries the consumer actually takes action on them, so there is some real value being created there.

Certainly on the cost side for us we are reducing our send-agains.

We are making sure that more packages are being delivered on the first attempt.

Just recently we introduced the ability to upgrade your SurePost packages to UPS Ground, and that is also resonating well with our customers and exceeding our expectations.

We are the only provider out there in the marketplace now that enables all residential services to have consumer day before visibility and ability to reroute or reschedule.

The other exciting thing is we just launched the UPS My Choice Facebook app and that enables a Facebook login and also My Choice capability on Facebook.

It is just out just a couple of weeks and we have 120,000 new users that have linked their UPS My Choice or their MyUPS.com to Facebook, so we are excited about that.

We are also listed as one of the top 10 Facebook apps right now.

Just some other interesting stats.

We have 3.6 million downloads now on our iPad, iPhone, and Android apps, so a lot of traction with My Choice.

Also, really resonating with retailers.

Great.

So if you don't get it, we are moving well on My Choice.

And if you guys haven't signed up yet, you are missing a great service.

Thanks for the time.

Nate Brochmann, William Blair.

Good morning, everyone.

I wanted to talk -- just actually that is a great transition here to my question, which is you guys continue to get more B2C business and you are able to leverage more off of your drivers even by rerouting from SurePost into the regular Ground network.

What is that doing for your margins kind of in that B2C business?

And how much higher can that go as you continue to get more density and more business through those channels?

Yes, I think Myron, clearly, will fill you in on the redirect and also ORION.

In general, B2C is a bit more challenging, but through the innovation that we have done we are finding ways to grow very profitable with B2C.

Myron?

In David's opening comments he addressed ORION, but before we go there let me remind you that just last year we finished completion of deploying telematics in the US.

So in the quarter we were able to drive 1.6 million less miles on top of 1.9% volume growth.

Now couple on top of that -- you talk about the 500 people that we have deployed with ORION, which is an on-road integrated optimization system that will allow us to reduce additional miles.

Keeping in mind that for every average mile reduced there is a $50 million savings to UPS.

So we feel very confident that as we grow B2C volume we will deploy technology that will allow us to balance the cost, but as we get additional B2C we will also increase density, which obviously will help us improve margins.

I guess just to reinforce, ORION is a major deployment that is going to take us three to four years to get fully rolled out.

But it does create a very dynamic environment that allows us to do real-time adjustments.

Scott Schneeberger, Oppenheimer.

Scott or Kurt, could you speak to the back-half guidance.

What would be the two or three or four biggest swing factors to put you at the high end or the low end as you approach it?

Thanks.

Well, certainly the economic factors will be a big driver.

I think in the Domestic side making sure that this nascent recovery continues.

Our success, clearly, on bringing in customers to accelerate the volume growth and then normal execution.

Internationally the product launches I think in late Q3, Q4 have a big impact on demand conditions, although in Europe we are plugging along pretty strong.

We had growth upper-single digits in Europe and continue to see that work as our integrated network differentiates.

So biggest factors really would be the economic environment.

Scott, it is our job to adapt to whatever we face in the second half of the year and the team here will adapt to conditions.

Kurt said in earlier comments that we are assuming the same trends we saw come out of the second quarter.

Hopefully it will get a little bit better, but we will adapt to whatever we get.

Allison Landry, Credit Suisse.

I was wondering if you could talk a little bit about how much you expect to improve profitability at the Forwarding division once you are able to implement some of the initiatives that you were speaking about earlier.

Well, we had given guidance that the overall Supply Chain & Freight will have 8% margins for the rest of the year, so clearly that represents a very solid margin.

And we are comfortable that the actions we are taking will get us to that point.

And is there a longer-term expectation?

We have not laid out exact numbers for that sub-segment, but clearly, if that sector in the 8% to 10% margin over the longer term, we are generating economic profit and feel good.

Then it is just a matter of continuing to grow that sector.

We think International Air Freight is at a trough.

It's hard to imagine it getting much worse going forward.

Great, thank you.

Jeff Kauffman, Buckingham Research.

Thank you very much.

Not to beat the Forwarding question over the head here; I'm just trying to segregate what is more of a short-term issue versus a longer-term issue.

You mentioned weakness in the tech out of Asia and you mentioned weakness in the military.

How much of that do you believe is shorter term in nature or timing in nature versus how much do you think is more of a secular issue?

We will ask Jim to talk a little bit more about Forwarding since that seems to be the topic du jour.

But, Jeff, don't feel bad.

We have talked a lot about it here, too.

I appreciate that opportunity.

So I think Scott talked about the innovation trough in the beginning so that is obviously a piece of the drag on the high tech sector.

The military in the defense side, you can see what happens across the world and what is going on with that.

And I think our real opportunity is to reverse the concentration in what we have got.

We have been investing, for instance, in healthcare over the last couple years and we expand that footprint.

We are going to go down the path here into emerging markets, which, quite frankly, in their early years of development as trade continues to grow that is really a Freight need that they have to connect to the world as opposed to an Express product.

So all of those provide great opportunities for UPS in the years to come, so we are very comfortable.

We are glad we are in Forwarding right now.

It is a bit of a trough.

We hold the margins tight.

We continue to invest and we will continue to grow it as UPS should.

Thank you.

David Ross, Stifel.

Good morning, gentlemen.

UPS Freight showed an increase in density with shipment volume up nicely in the quarter and yields were up just a little bit, but margins it said in the press release declined slightly due to increases in compensation and benefit expense.

Can you explain if that is anything out of the normal annual increase in wages and benefits?

And then also why the increased density wouldn't have driven margin improvement?

Yes, there was a bit of a tough comp to the previous year that gave us a little bit of a headwind.

But, Myron, maybe you could talk about some of the deployment of UPS technology into Freight that should help us drive margins?

Yes, as Kurt noted, in the quarter, while we did see continued growth in revenue, we did see also continue to build these to attract additional market share, which boded well for us.

However, with the increase in health and benefit costs we were not able to improve margin expansion.

We will continue to deploy customer-facing as well as operational technology.

Customer-facing technologies like pickup notification utilizes UPS's World Ship that gives our customers an hour timeframe of when they will get the pickup.

And we will continue to deploy small package technology and Freight to get additional operational improvements.

Helane Becker, Cowen Securities.

Thanks very much, operator.

Thanks for squeezing my question in.

I just have a question, Scott or Kurt, on capital allocation and capital deployment.

I know you guys are very committed to the dividend and the share repurchase program and yet your share count is going down, your revenue growth is flat, and your earnings are going down.

So could you talk about your thoughts with respect to capital allocation within the context of flowing revenue growth environment?

I will start, Helane.

Clearly, we are committed to our distributions, committed to our dividends.

We are committed to the share repurchase numbers we have talked about in the past, but we are also committed to reinvesting in the business.

And we have a lot of opportunities out there right now for us to reinvest, particularly in areas -- emerging markets we talked about a little bit earlier.

There is all kinds of opportunities in healthcare that we are just tapping right now.

The B2C we have talked about throughout the call.

Around the globe there is just a lot of opportunities for us to enable our customers' growth in B2C.

So we see plenty of ideas and plenty of opportunities to reinvest in the business.

I think, Helane, I can't let you get off the phone here without taking issue with you.

I mean we are looking for profit growth in the next quarter and revenue growth, an 8% midpoint for profit growth.

We did hit a bit of a hiccup in the second quarter but we feel very confident in both the short-term and the long-term outlook for the Company.

Okay, that is fair.

Thank you.

Jack Atkins, Stephens.

Thanks for taking my question.

Just to go back to your comments earlier about Air Freight capacity, as an operator of your own assets I would be curious to hear your thoughts on the long-term outlook for Air Freight capacity, especially given the influx of passenger belly space we have seen here in the last several years.

Would just like to hear your broader thoughts on the capacity situation, both over the next 12 months and the next three to five years.

I think the first thing you certainly hit it right.

What has increased the capacity has been the belly space in all the passenger airlines at their aircraft that have been added.

What you are seeing us do, and other people in our marketplace, is to watch very closely the trade lanes and to make sure that we deploy those assets to match the volume in those trade lanes.

So when we need to pick up the lift in certain areas quickly you deploy that aircraft.

Then, on the other hand, when we need to pull back we show them we can effectively do that.

One of the things that is unique, I think, to our company right now is we have not ordered any aircraft after the 767s that we are receiving this year.

So that gives us a little more time to just hold firm and see what is going to go on in the marketplace in the next couple years.

Thanks for the color.

Keith Schoonmaker, Morningstar.

Thanks.

You have mentioned the double-digit revenue declines in Forwarding and, Scott, I have heard you say in the past all freight on board.

I would like to ask you to comment on volume shifts.

Mainly, do you see customers who shipped air in the past diverting all the way down to ocean, or are you seeing shippers simply shipping fewer shipments?

And as a corollary, are you margin neutral on these modes or does slower ocean demand fewer UPS resources?

Let's let Alan answer that.

I think, clearly, we are probably seeing all of the above but Alan will take a shot.

We are seeing some of our customers look for solutions that move the air Freight to ocean.

Certainly there are certain products, and as Scott talked about earlier, in terms of innovation and high value that just don't fit that mode.

We recently introduced, and David talked about, our preferred ocean LCL, which is really a combination of our ocean move and then using our integrated network to expedite those moves once they hit the destination, say, in the United States here.

And where we have got some nice margins on that; that is obviously higher than regular ocean.

It speeds up the time in transit to faster than ocean but still somewhat slower than Air Freight.

And that has been boding well for us.

Thanks.

About the margins, is ocean more or less attractive to you compared to air?

In the short term, if we have got premium volumes sitting in an aircraft, there is a higher incremental impact.

It is harder to adjust, especially flights out of Asia, than it is other integrated areas.

Over the long term we are very profitable in ocean.

In fact, we have major investments to help supply our management and to help accelerate ocean.

So we are building the portfolio, classic UPS approach, and we will make sure that the margins are appropriately compensatory for the investment.

Thank you.

David Campbell, Thompson Davis Company.

Good morning.

I don't want to overdo it on Forwarding, but I haven't heard, unless I missed it, how much Forwarding Air Freight tonnage was down in the second quarter.

It was down a little over 10% in the quarter.

As we had said before, the military was a big piece of that and that was certainly a very volatile group as movements happened.

Then the core underlying weakness also in high tech drove that, David.

Thank you.

David Vernon, Bernstein.

Kurt, I was just wondering if you could maybe give us a sense for what the right level of maintenance CapEx should be on the airline side once you lapped the new aircraft deliveries in this coming year.

We have got the youngest fleet in the industry so at least the day-to-day maintenance is pretty minimal, but we think, in general, depreciation is a reasonable representation of maintenance CapEx.

As David said, we are not real long on aircraft right now.

We are bringing in a couple of more 767s this year end and then the fleet is in great shape.

We will be flexible and decide what happens from there.

But we feel real good about our capital position.

Very few capital commitments and great cash flow for the Company going forward.

And depreciation, we think, really represents a pretty good shot at what maintenance CapEx is.

Okay, thank you.

Scott Group, Wolfe Research.

Thanks for the follow-up.

So just following up on those comments about free cash should be really good the next couple years.

What prevents you from being even more aggressive with the buyback or the dividend?

Because the stock so far this year you are below a 3% yield and you have got $6 billion of cash.

You used to run the business with closer to $1 billion of cash.

Why not be more aggressive?

We have a policy that we manage to fairly steadily, Scott, as you know of distributing approximately 100% of net income in the form of either dividends or share repurchases.

This year we are more aggressive with a stated target of $4 billion in share repurchase, partially to catch up for last year where we held back as we accumulated cash.

But we think a steady programmatic approach is the best way to do it.

We do buy it back and retire the shares that we commit, and so I think investors can count on a programmatic approach that is understandable and foreseeable.

At least for now that makes a lot of sense.

Clearly, if markets get crazy, we have got the cash if we want to become more aggressive in share repurchase, but right now we are very comfortable with our current approach.

Scott, as I said earlier, I think that even though it's a slow growth global economy we see a lot of opportunities to reinvest in ideas we have out there.

Kelly Dougherty, Macquarie.

Thanks for sneaking me in.

I just wanted to change gears and see if you could talk a little bit about the B2B side of things.

What you are seeing from perhaps a stabilization or when you think that maybe you will see grow re-accelerate and do you think the omni-channel might fit into that?

So maybe any color you could give on B2B would be helpful.

We did reference in our -- earlier a little bit of a slowing in the industrial base, so we saw some drag there.

But, Alan, maybe you could talk about what is happening in the retail sector.

Certainly.

Kelly, your comment about omni-channel that certainly does create B2B shipments.

We are really excited about helping brick-and-mortar retailers provide an omni-channel experience for their consumers that obviously merges the online with the brick and mortar.

We are finding that there is a lot of customers out there or consumers that want to order online and ship to store.

We are also enabling our retailers with our technology to be able to drop orders to their stores and ship to other stores or ship directly to consumers, which is a win-win-win for UPS, the retailer, and the consumers because the consumers are getting faster fulfillment of their orders, the retailer is getting it at cost-effective rates, and obviously we are getting new business.

We have got probably about 25 retailers that are engaged with us today on that and it is resonating well with them.

The other thing I would just add is the one driver really resonates well with the retailers because obviously the store personnel needs to stay focused on the in-store consumers.

Using our technology and one driver to pick up all the air and Ground and deliver all the air and Ground keeps those employees on track.

And do you think that this omni-channel driving that can lead to a stabilization in the B2B volumes anytime soon?

Yes, I think certainly it is going to help grow B2B.

Obviously, you wouldn't have thought in the past that B2C or online would generate B2B, but you are finding more and more that folks are getting packages delivered to their work, delivered to stores.

We certainly have our Kiala UPS access point model in Europe with 8,000 access points for consumers.

Many consumers are preferring to pick up those packages at businesses versus at home.

So, yes, we are excited about the prospects of a more balanced B2C market or online e-commerce market that generates more B2B than it has in the past.

Kelly, in the second quarter, if you watch the economic stats, the inventories got liquidated so inventories are pretty low level right now and US exports were really weak in the quarter.

So those two areas could really help B2B going forward get back to normal.

Great.

Thanks very much, guys.

That does conclude our Q&A session for today.

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

I'm going to turn it over to Scott for some final thoughts.

Thanks for joining us today.

First, let me say that I'm quite confident UPS will achieve the goals that we have discussed today.

And next, despite a slower global economic growth forecast and the trade down we are experiencing, I want to reiterate the comments I made on Helane's question.

I really can't remember a time in my 28 years at UPS when we had more opportunities in front of us.

Opportunities like the omni-channel and US retail that we just got done talking about, market share expansion, the fast-growing emerging markets, healthcare solutions to assist an aging population, and UPS enabling global B2C business growth around the globe.

Lots of opportunities ahead of us.

Thanks for joining us today.