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Executives

Andy Dolny – IR

Scott Davis – CEO

Kurt Kuehn – CFO

Analysts

Garrett Chase – Barclay’s Capital

Jon Langenfeld - Robert W. Baird

Edward Wolfe - Wolfe Research

Robin Byde - HSBC Securities

Tom Wadewitz - JP Morgan

William Green - Morgan Stanley

Ken Hoexter - Merrill Lynch

Justin Yagerman - Wachovia

David Ross – Stifel Nicolaus

David Campbell - Thompson Davis

John Mins - BB&T Capital Markets

Chris Ceraso – Credit Suisse

Mark McVicar – Dresdner Kleinwort

Arthur Hatfield - Morgan Keegan

United Parcel Service, Inc. (UPS) Q3 2008 Earnings Call October 23, 2008 8:30 AM ET

Operator

Good morning. I would like to welcome everyone to the UPS Investor Relation third quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Mr. Andy Dolny, Vice President of Investor Relations; sir you may begin.

Andy Dolny

Good morning everyone and welcome to our third quarter earnings call. I’m here this morning with Scott Davis, our CEO, and Kurt Kuehn, our CFO, to discuss the company’s results and our future expectations. But before we begin, I’ll 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 2007 10-K and 2008 10-Q reports. These reports are available on the UPS Investor Relations website or from the Securities and Exchange Commission.

In their remarks today, Scott and Kurt will discuss comparisons between the third quarters of 2008 and 2007 excluding the effect of the restructuring charge that occurred last year. We believe that these results more accurately reflect UPS’s true performance last year.

The adjustment stems from a $46 million restructuring charge and related expenses for supply chain business in France which equated to about $0.03 per diluted share. A reconciliation of these results is included with our earnings announcement this morning and appears on UPS’s IR website in the Financial Information tab.

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

Scott Davis

Thanks Andy and good morning everyone. As everyone knows the third quarter turned out to be one of the most challenging that the world’s financial markets have seen in a long time. I’m pleased to say that UPS performed well despite the difficult environment.

At the present time we have a continuation of the same story. Consensus GDP and IP growth keep getting lowered. Economic recovery gets pushed out farther into 2009 even possibly into 2010 and indicators continue to reflect the slowing global economic activity.

Expectations are that the next few quarters will be challenging. Industrial production was negative in the third quarter and is now expected to be negative for the year. As we said many times in the past industrial production is one of the best barometers for our US domestic package business.

Retail sales growth has also slowed and is expected to remain weak. Forecasters anticipate that consumer spending will be worse then the current slowdown then in the prior two downturns. I know this sounds somewhat somber, but despite these challenges there is much within UPS to be pleased about.

Our international export volume growth decreased 7% per day significantly more then the market. The performance of our supply chain unit continued the momentum we have seen all year with operating profit up over 30%.

We managed our domestic package operations well in response to lower then anticipated volumes but service levels at all time highs. Once again, the company posted industry leading operating profit and margins and generated substantially increased free cash flow.

And finally UPS’s strong balance sheet ensured we had ready access to commercial paper at very favorable rates.

All in all, UPS around the world performed well in today’s difficult business environment. We were benefiting from our extensive global presence and expanded product portfolio. In fact, 40% of revenue this quarter came from the international and supply chain of freight segments.

This compares to only 25% in 2003. Let me switch gears now and touch on a topic I know all of you are interested in, our airlift contract with DHL.

We are still in negotiations with them on this contract and hope to conclude an agreement before the end of the year. That said, we have not stopped competing with them. We will continue to do so as we do with all competitors and we made that clear from the start of the negotiations.

Now, I want to recognize some recent achievements. UPSers did a magnificent job responding to the destruction caused by recent hurricanes. In spite of the personal challenges they faced our people had small package and freight operations up and running within days of each storm.

That was no small accomplishment. UPS contributed over $1 million in monetary and in-kind disaster relief for Gulf Coast residents. In addition we’re actively involved in Haiti, supporting Care International, deploying logistics experts to work with the world food program there, and providing supplies to make clean water available for over five million people.

Another group of UPSers deserving recognition is our logistics team responsible for the behind the scene support of the Olympic games of China. Several thousand UPSers literally delivered the games moving 19 million items including everything from kayaks to canoes to the 2000 drums you all saw in the opening ceremonies.

I congratulate them for their dedication, organization, and flawless execution.

Lastly I want to remind you that UPS published our sixth annual corporate sustainability report in the quarter. We were the first in our industry to produce such a report and then annually benchmarked progress against long-term goals.

Before I turn the program over to Kurt, I want to reiterate my firm belief that adverse times test the mettle of an organization and that good companies can emerge better and stronger for having had that test.

I’m confident that UPS’s mettle is resilient, flexible, and adaptable. UPS is and will remain a financially sound and well-run business.

Now for details on the quarter and our thoughts on the future, I’ll turn the call over to Kurt.

Kurt Kuehn

Thank you Scott and good morning everyone. Against the backdrop of economic slowing and financial turmoil UPS performed well in the third quarter. Revenue was up a healthy 7.4% and earnings per share came in at $0.96.

We made good progress on our cost initiatives but there were more then offset by economic deceleration and the high cost of fuel which drove product mix changes. In fact fuel expense was up 65% compared with a year ago driven by higher prices.

However since average fuel prices declined rapidly throughout the quarter the two-month lag in the fuel surcharge did provide a benefit of about $90 million for the US domestic operations.

Three months ago we told you that we anticipated the US small package market would contract about 2% in the second half of the year. However economic conditions worsened more then expected and our results reflect that.

We saw volume declines across our entire domestic portfolio. July and August volume continued second quarter trends but in September we saw precipitous declines. Most notable were the next day products where letter volume declined more then package volume, largely due to significant softness in the services sector.

Revenue per piece increased 5.8% led by next day air at 11%. Gains were due to focused revenue management efforts in both the air and ground products and to the impact of higher fuel surcharges. These were offset somewhat by lower weights and less favorable mix characteristics.

New lighter weight competitive wins in our deferred product constrained revenue per piece improvement. We believe the pricing environment continues to be rational. Domestic operating margin was down 200 points although we still generated an industry-leading margin of 14.2%.

In the quarter we implemented a number of cost control initiatives. While absolute costs are up year-over-year due to higher fuel expense, wage and benefit expense moderated as a result of our success in adapting our network to lower volume levels.

For example operating hours were down 3.4%, same as package volume. Miles were also reduced about 3%. The benefit of the new labor contract however was mitigated somewhat by the reduction in volumes.

We also made adjustments to our air network, [lock] hours were reduced without degrading service. In fact throughout the company service levels were at an all time high. Even though cost control is particularly important today we will not sacrifice investment for the future.

As part of our constant effort to enhance the product portfolio UPS improved air package pick up service for more then a quarter of all US businesses. The enhancements provide more flexibility to meet critical deadlines for customers who do not have a daily scheduled pick up.

Now to our international business, this segment posted solid results despite global economic challenges illustrating the competitive advantage of our integrated global operations. Average daily export volume increased 7%, well beyond market growth rates.

This is due in part to our broad global offering and the technology tools we’ve developed to simplify international shipping, like paperless invoice and international returns. All regions of the world experienced mid to high single-digit growth.

US import volume growth from all regions of the world did remain negative however, but non-US lanes were strong. Transporter volume within Europe for example was up 10% and Asia to Europe increased over 15%.

Although revenue per piece increased more then 11% operating results were negatively impacted by mix change particularly in Europe and by the decline in US imports. Nevertheless just as in our US operations this segment generates the industry’s best operating margin.

And remember this 13.1% operating margin reflects the traditional slowing in Europe in the summer. Across the globe we continue investing to support future growth opportunities. In the fourth quarter UPS will open its new hub in Shanghai, which will link all of China to UPS’s international network.

And tomorrow we will break ground on our new intra Asia air hub in Shenzhen, China. This hub will reduce transit time for almost 200 city [payers] in Asia and it will play an important role in facilitating robust intra Asia trading activity.

Let’s turn now to the supply chain and freight segment, which continued to demonstrate the positive momentum we’ve seen in previous quarters this year. Revenue increased 9% and profitability improved over 30%.

Operating margin of 5.6% was inline with our target for the year. International and North American airfreight drove significant profitability improvements. The expanded airfreight service portfolio that we introduced early in the year continues to attract new customers.

UPS freight posted 7.8% LTO revenue improvement but tonnage was flat and shipments declined reflecting the tough economic conditions and a more competitive pricing environment. Productivity and service metrics continued to improve and see are attracting and retaining customers with our world ship and quantum view managed technologies.

Earlier this month UPS freight announced the third round of network enhancements this year. Time and transit improvements have been made to over 12,000 lanes in the past 18 months offering faster service for two-thirds of all US zip codes.

These enhancements are part of a continual process to add value for customers by improving the velocity of our network.

Before I talk about the fourth quarter I do want to comment on our solid financial position. For the first nine months of this year, UPS generated approximately $7 billion in cash from operations. With that we invested $2.1 billion in capital expenditures, spent $3.3 billion to repurchase 48.5 million shares, paid dividends of $1.8 billion, and still ended the nine months with $1.8 billion in cash and investments.

Through the end of the third quarter free cash flow reached $4.6 billion reflecting the strength of our business model. This does include approximately $1 billion in US federal tax refunds related to the company’s withdrawal from the central states pension plan.

As a point of comparison a year ago free cash flow was $3.1 billion. UPS also continues to experience ample liquidity in the commercial paper market at very favorable rates. In these turbulent times investors exhibit a flight to quality mentality and our strong balance sheet is very attractive.

In addition we had bank credit lines well in excess of our outstanding commercial paper. We did see a $23 million reduction in this quarter’s investment income due to an impairment on certain auction rate securities, primarily Fannie Mae and Freddie Mac.

In the quarter we spent over $800 million to repurchase almost 13 million shares. This was a somewhat slower pace then in the first half of the year. As credit markets became chaotic we though it prudent to pull back a bit.

We intend to continue repurchasing shares but the pace will depend on market conditions which we’ll continue to monitor.

We’ve also reduced our 2008 capital expenditure budget by $200 million to $2.8 billion. All in all UPS’s financial position remains very strong and we intend to preserve our ability to maneuver and to take advantage of whatever opportunities we may identify.

Now for the fourth quarter, with consumer confidence approaching new lows we’re concerned that Santa’s sleigh may be a bit lighter then usual this year. We expect domestic volumes to be down about 4% for the quarter reflecting the economic slowing.

We intend to execute an effective and efficient peak operating plan diligently matching the network to volume levels. Given current economic conditions we believe it will be several more quarters before any turnaround will become evident.

In the international arena several European economies are on the brink of recession and most of Asia’s economies are expected to grow at a slower rate then in the past. With the strengthening dollar and US trading partners experiencing weaker economies US export growth is also expected to slow.

Nonetheless we expect export volume growth should increase by approximately 5% with a mid teen operating margin for the segment. In the global small package operations yield growth will moderate due to a substantial decline in fuel surcharge revenues.

However we anticipate base pricing to remain firm. The supply chain and freight segment should continue the growth trends we’ve seen all year. Operating margin in this segment is expected to be at or above 5% for the full year constrained somewhat by the tough conditions in the LTL freight business.

And lastly earnings per share for the year should be towards the lower end of the $3.50 to $3.70 range that we provided midyear.

You know its no secret that 2009 will be challenging. We intend to pursue long-term growth opportunities and be opportunistic in extracting growth in today’s tough environment. In addition

UPS will implement a wide range of cost initiatives in both the US and abroad to match our business to volume levels.

This will include network modifications, lower capital expenditures, and reductions in staffing levels. UPS has a long history of managing through all kinds of economic scenarios. We’re confident in our business model and in our ability to adapt it to match market conditions, both good and bad.

We will invest for the future while managing conservatively through the near-term. Now Scott and I will be happy to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Garrett Chase – Barclay’s Capital

Garrett Chase – Barclay’s Capital

If you take literally what you said about the trends progression through the quarter in terms of what happened in September on the volume side, sounds like September was a pretty bad month, probably down double-digit in air, and mid single-digits in ground, is that the case and it feels like the fourth quarter guidance on the domestic volume while its not good, it certainly looks good relative to what that September comment would suggest, can you give a little color there?

Kurt Kuehn

If you look at what we said on our last earnings call, May and June both were fairly sluggish and we saw those two months down a couple of percent, that trend basically continued through July and August and then in September that rate of decline more then doubled and so we did see slower trends especially starting the second and third week of September.

And basically that pace has continued through October so far. The good news is we do see some stability in that but the bad news is it does generate then our best guess of volume growth of 4% for the fourth quarter. Clearly the fourth quarter will be heavily dependent on the Christmas holiday and it anybody’s guess exactly how that comes out, although frankly we do think that people will be conservative this year.

Garrett Chase – Barclay’s Capital

I understand there’s a lag, but the fuel surcharge component is going to come down dramatically as I think you mentioned, what kind of impact do you think that’s going to have? Do you think you’ve seen more of the volume weakness already because the surcharges were so high?

Kurt Kuehn

We’ll certainly the surcharge had a dramatic effect on shipping behavior. We do know that it did cause additional pressure on our premium products and the significant amount of trade down into the deferred and the ground products.

Right now at least fuel has come down dramatically and we’ll see where it goes from here but if the conditions continue we’re hopeful that there’ll be some benefit both on the premium products picking up a little more and also we’ll get some benefit in the fourth quarter from the two-month lag.

Scott Davis

We built our guidance for the oil to be in the mid 80’s, so there’s maybe a little bit of an upside there.

Operator

Your next question comes from the line of Jon Langenfeld - Robert W. Baird

Jon Langenfeld - Robert W. Baird

When you look at the domestic express margin and even if I back out the $90 million of fuel it looks like you’ve made some progress there in the year, how much of that is related to the teamsters contract going in on August 1 and how much of that is related to your ongoing efforts to control costs?

Kurt Kuehn

The majority really is our cost initiatives. We have moved pretty quickly to adjust the network to [print] out discretionary spending and just make sure we right size and let our people know that at least at this point we don’t anticipate much change to the better.

The labor contract certainly has some favorable attributes but the effect of that was muted because of the very low growth, we really aren’t bringing as many new employees and you get a magnifying effect as you do that.

Scott Davis

We’ve always said that we should built a right to these [inaudible] better then most, we said that half of our costs are directly variable and you really saw that in the third quarter where our volumes were down 3.4% and hours were down 3.4%, block hours were down in areas. We do a pretty good job managing to the downturns.

Jon Langenfeld - Robert W. Baird

The margin for the fourth quarter in domestic, you’re just summing all your pieces together it seems like you’re looking at a low double-digit operating margin on the domestic side to get your guidance range, is that true even inclusive of the fact that your fuel benefit assuming fuel stays where its at today, is probably double what it was in the third quarter for domestic?

Kurt Kuehn

We do have an estimate of fuel in there that’s a little above where prices are at today so there’s certainly some potential there. But frankly with negative 4% volumes this is a challenging quarter. The holidays are always an exciting time for us, you really have to forecast and commit assets and resources far ahead of time. So there is more exposure certainly during December to volume changes then in most times of the year.

Operator

Your next question comes from the line of Edward Wolfe - Wolfe Research

Edward Wolfe - Wolfe Research

On the DHL contract, you said you’re still hopeful of closing it, do you have a bit more insight, it seems like they’ve hemorrhaged a lot of business and you certainly won your fair share of that recently, do you think its still a billion a year or is that number going to be a lot smaller should the line haul agreement occur?

Scott Davis

The negotiations are continuing. We hope to reach an agreement before the end of the year, but realistically the scope and size of the deal may be changed based on the customers’ reactions to their announced restructuring and downsizing in the US. On top of that weakening economies are going to have an impact on them as it does everybody. I think its fair to say that we’re still negotiating but the scope and the size of that deal could change.

Edward Wolfe - Wolfe Research

Is there a time period where if its not done by this time, its kind of too late from that perspective?

Scott Davis

I think its something that we’ve got to look at from our perspective and they have to look at from their perspective. Both parties are negotiating in good faith at this point in time but I think sooner is better then later.

Edward Wolfe - Wolfe Research

On the share repurchase now that the stock is sitting here with a [for] handle in front of it, its quite accretive to go in there and I understand the credit markets aren’t great, but you’re certainly not having a lot of trouble with accessing capital, how do we think about those two conflicting things as we go forward in the near-term, the stock down here and the markets in terms of your guidance of $5 billion a year of share repurchase?

Kurt Kuehn

This really has been an unprecedented time for turbulence in the debt markets especially and we’ve been fortunate in that we’ve really had as much access to commercial paper as we need and at very, very beneficial rates so the liquidity is there. On the other hand the long-term debt market still shows some very sizable spreads and ultimately our share repurchases will manifest themselves in the longer-term debt.

On the other hand as you say UPS stock is on sale today at a great price and certainly we intend to be buyers. The exact pace of it will depend on conditions both in the debt markets and the equity markets but we do intend to be in there buying stock.

Scott Davis

We love the stock obviously at this price and we like it to get up to a higher price, but I think Kurt said it right, the long-term debt markets need to stabilize. There has not been a lot of corporate debt issuance over the last two, three months. We need to see that stabilize.

Operator

Your next question comes from the line of Robin Byde - HSBC Securities

Robin Byde - HSBC Securities

On trading in European package, can you provide some color on current market conditions perhaps by country, are you still seeing volume growth at your Cologne and Tamworth UPS?

Kurt Kuehn

We have continued to see good growth in our intra European shipments. As we mentioned the products within, moving across borders within Europe grew at 10% so even with a somewhat stagnant European economy the network we’ve built has allowed us continue to gain share.

Some of the individual domestic markets clearly are seeing some headwinds and the UK most notably and then certainly Germany which is one of our largest markets has slowed a little bit. But the export market within Europe especially the eastern part of Europe, Poland, and some of those is continuing to show great results.

And I might note also that at least in the third quarter we continued to see shipments from Asia to Europe move along very strong. One of the fun things about us having built this balanced network is it gives us a view into how some of these trade flows are moving and in some sense diversifies our international results to not be quite so dependent on any one area.

Robin Byde - HSBC Securities

On the Shanghai hub opening in Q4, could you or would you want to delay this if Asian markets get a lot worse?

Kurt Kuehn

Absolutely not, that hub is a positive move for us. It improves our air network, allows us to improve our service and manage our costs better so we’re full speed ahead with that.

Scott Davis

The developing economies are slowing down but they’re still growing at a nice pace and again China is supposed to grow at 9% next year.

Operator

Your next question comes from the line of Tom Wadewitz - JP Morgan

Tom Wadewitz - JP Morgan

I wanted to see if you could give a few comments on how we should think about 2009, I know that’s probably tough to do in light of perhaps not even visibility to peak season in fourth quarter but you mentioned some significant cost initiatives, if you bear those in mind and assume we do have a recession for a couple of quarters, do you think margins are down substantially in 2009 and earnings are down substantially or are there enough additional levers that you can push on in terms of cost and whatever else that you could have some king of stability in margins and flattish earnings?

Scott Davis

As you look at the economy and again just, we’re not a leading indicator so we kind of go on consensus estimates. I think generally people are looking for the economy in the US to be negative probably in the third and fourth quarter of 2008, probably the first quarter of 2009, beyond that maybe stabilizing some but there’s certainly risk into 2009.

When you get into a recession after a financial crisis, its usually more of a U shape then a V shape so it may be a little bit longer. But I think generally our best barometers again are industrial production, retail sales and industrial production probably negative throughout a good part of 2009. Retail sales will growth but probably less then inflation.

Saying all that I think we still feel pretty good about UPS’s prospects for 2009. I think that the first quarter may be one of the tougher comps for us but I think for the rest of the year, I think we stack up pretty good versus 2008. We’re fairly optimistic. We’ll get into more detail obviously in January on our next call.

Kurt Kuehn

We’re working hard to right size our network for 2009. We do have the toughest comps in the first quarter but the labor contract continues to take more effect as we move farther into that and we’re not gloomy on the US. We just think we’ve got a couple more quarters that we’ve got to manage and also we’re continuing to see decent momentum in our supply chain and freight arena. We’ve still got a little bit of a bumpy ride we think for a couple of quarters but hopefully after that we’ll be able to show some more positive results.

Tom Wadewitz - JP Morgan

On the pension side, in this market obviously downward pressure on assets and I think within the central states plan there is speculation about some risks that one of the big participants there eventually could have liquidity issues and that fund could get in a lot worse shape, can you tell us, is there any risk that you could get drawn back into that fund in the next couple of years, that it could deteriorate sufficiently or what are the protections that you don’t somehow get drawn back into central states?

Scott Davis

I think somebody made a statement like that and that statement really was inaccurate. There is three year look-back on this fund but its only in case that there’s a mass withdrawal of the 2500 employers in that fund which is extraordinarily unlikely for all 2500 companies to pull out of it. Even if a large company goes bankrupt, they’re not released of their contribution requirement until they liquidate and that’s only one company out of 2500 companies.

We have about a little over two years left of that claw back look and its extraordinarily remote that we could ever get tied up in any problems they would have. Overall on the pension situation it is something that I think we’ve all got to watch and manage from the single employer plans, I think right now you’re seeing that investment results are down but the discount rates are up which help offset it.

UPS’s own plan, we were well over funded going into this year and I think we’re still even today 100% funded on it.

Operator

Your next question comes from the line of William Green - Morgan Stanley

William Green - Morgan Stanley

Can you talk a bit about how the pricing discussions are going with customers, obviously the economy I would think would lead them to push back a bit on some of the list rate increases you’ve tried to put through. On the other hand one of your big competitors is struggling so much here that maybe you’ve had more success in that regard. How are those discussions going?

Kurt Kuehn

Challenging but stable. Clearly with the fuel surcharges at record highs there was increased pressure on our customers and on us to find ways to take their costs down and as I stated the fuel surcharge really became a part of overall price negotiation. We’ve been working through that and trying to make sure we keep those two separate but there has been pressure. If anything with fuel coming down we anticipate a little firmer environment as we start to see the results of this $70 fuel kick in and the fuel surcharges get back down to more reasonable amounts.

The market is competitive, clearly DHL was a very aggressive pricer in the market and they are a bit distracted right now. But costs are up and that’s why we did put in a solid rate increase for next year, at net 4 9 on the air and 5 9 on the ground and certainly we intend to negotiate and keep the majority of that.

William Green - Morgan Stanley

With regard to the volume comments that you made can you talk a bit about where you’re seeing the weakness, you mentioned the overnight envelope business but maybe in terms of B to C, has that slowed dramatically since the last time we spoke?

Kurt Kuehn

It has, it has seen the most sequential slowing. Having said that it is still moderately positive. But it was, we’ve seen double-digit growth in B to C for quite some time and clearly that’s down to low single-digits now. On the B to B side there has been some deterioration, not as dramatic although it has continued to be negative. US imports as I mentioned is another area that’s gotten very, very weak and US exports have been pretty strong although they did moderate to the mid single-digits this quarter although we continue to see just great gains in our international business across the world.

Right now at least the major change in the economy, the largest change seems to be on the consumer side.

William Green - Morgan Stanley

Last call you mentioned you were doing a strategic review of your network because of fuel prices, have you stopped that with them coming down, or if so what was the conclusion?

Kurt Kuehn

Thankfully oil 200 seems a little more distant at this point, but no, this is all part of our long-term strategy. We create scenarios and we’ve developed some insights around how the world would begin to change if fuel prices get back up to where they were and even higher and so it has us just evaluating opportunities, thinking about acquisitions, thinking about how our network would change.

In light of the fact that we are so far away from that right now it doesn’t really make sense for me to get into any details, but this work will be ongoing so we’re ready if and when it bounces back up.

Operator

Your next question comes from the line of Ken Hoexter - Merrill Lynch

Ken Hoexter - Merrill Lynch

In the past you’ve talked about the percent of expenses that are variable, semi variable to highlight how quickly you can react in a downturn, can you update us on where that stands and what I want to dig into is on the employee side, you don’t really give employee numbers but just wondering is a reduction in employees part of this process and where do you stand today on your base?

Scott Davis

Clearly I think the numbers haven’t changed much, 50% of our costs are daily variable and then we say probably 30 to 40% are semi variable. When it comes to employees, we’ve reduced 3000 employees this year, in the last year and again it moves pretty closely with the package volume and nothing has changed as far as our ability to manage the business on a daily basis and react to what we’re seeing in the volume.

Kurt Kuehn

Right now there’s certainly a big focus on the semi variable things. Some of the network issues, management overhead, some of those indirect costs. Meanwhile the operations people clearly are highly attuned to make sure that the direct labor is matched to volume also and we’ve had pretty good results on that.

Scott Davis

Generally the semi variable as we’ve said before will take a couple of weeks to a few months to get implemented. Every quarter that goes by you’ll see more of those kick in.

Ken Hoexter - Merrill Lynch

What is the total employee base now?

Kurt Kuehn

We have over 400,000 employees, around 300,000 in the US where most of the changes have been made.

Ken Hoexter - Merrill Lynch

On capacity utilization was there, you talked about 7% international growth, export growth, did that rapidly decline toward the end of the quarter as well, you highlighted the domestic before, wondering what your international looks like and can you talk in that frame of reference what your capacity utilization of the aircraft is looking like.

Kurt Kuehn

No, the international did not see the dramatic decline in September that the domestic did. We did see a trending down moderately over the course of the quarter but no where near as volatile and part of that’s why we’re still guiding to showing 5% growth in an environment where most of our competitors are flat or down.

We feel pretty good that the value proposition is still there. We are seeing some slowing. We’re seeing trade flows move but at least so far we’ve been able to stay on top of that.

Ken Hoexter - Merrill Lynch

And the capacity utilization?

Kurt Kuehn

I don’t have any specific numbers to share with you. I will say one thing that we’re working very hard at and I think its part of how we’ve been able to manage, this deep integration of our freight portfolio with express freight with small package is allowing us really to build a load plan for every major country to country lane and be able to take advantage of our fixed capacity for our freight when we have excess.

This whole freight alignment is a great benefit for customers because they can easily choose from deferred forwarding activities all the way up to express freight and its also very good for us operationally as we learn to operate simultaneously as both an airline and a forwarder. So those things are kicking in right now and helping to improve utilization.

Scott Davis

The reduction in US imports, increase in exports have helped balance out some of those [loads] too.

Operator

Your next question comes from the line of Justin Yagerman - Wachovia

Justin Yagerman - Wachovia

You mentioned the fuel 200 strategy and I was curious when we talking on the second quarter call and before that when you had announced in June or July that things were going to be worse then expected you said that shippers’ behavior had changed dramatically as fuel escalated towards peak and I was curious to what extent you’ve seen shippers’ behavior change back when it comes to consolidating loads or potentially moving down in terms of the margin product that they’re using with you, I wanted to get a sense of are you seeing those changes in shippers’ behavior or is the weak economy still pushing people towards the lower margin product, towards consolidating freight, has there been any shift that’s notable?

Kurt Kuehn

I guess the behavior we saw most notably was really just the trade down behavior and we went back and have looked at a couple of economic slowdowns and most of the trade down behavior is typical in an economic slowdown. We think there has been some exaggeration of trade down especially into ground because of the high fuel prices. On the more strategic changes the redesign of your supply chain I think we said in Q2 there was a lot of discussion and interest in it, but we’ve not seen a lot of big changes by companies.

Our guess is it may make a difference on the increment, if you’re going to add another factory somewhere in the world, maybe you think about adding one closer to home. So Latin America maybe central and eastern Europe makes more sense then Asia but not a big shift and clearly with the volatility right now its awful hard to peg. It is an interesting time and one with our solutions people staying real busy to help customers try to navigate a good long-term course.

Scott Davis

Some of the near sourcing issue, some was driven by energy, a lot of it was driven by inflation, perhaps in China, maybe changing labor laws, there’s a variety of things that were driving manufacturers to evaluate those decisions.

Justin Yagerman - Wachovia

FedEx announced domestic Mexican service in the quarter and I think Southeastern Freight Line just went down there on the LTL side and a bunch of other truck load and LTL carriers do some business in Mexico, can you talk about how you’re positioned there and if you have seen any increased interest from customers in terms of cross border Mexican moves or setting up manufacturing and distribution in Mexico?

Kurt Kuehn

We’ve clearly been in Mexico for quite some time with a domestic offering and so we’re pretty well positioned and we’re seeing some uptick. Probably more notable is the focus we’ve had really for the last four to five years on the whole North American trading block with a big focus on our trans border products and our trade direct which allows Mexican manufacturers to move stuff across the border in mass and then distribute it into our small package network.

So those trans border products moving between the US, Canada and Mexico continue to be very robust. Trade flows move back and forth clearly with the Canadian dollar changing so dramatically we may see some changes but those continue to be more and more important and that North American trading block remains very strong.

Operator

Your next question comes from the line of David Ross – Stifel Nicolaus

David Ross – Stifel Nicolaus

When you first bought UPS freight there was a lot of talk about bundling the small package offering with the LTL service, can you just give us an update on where that is and if that’s helping to mitigate some of the lower volumes you’re seeing either on the ground package side or the LTL side?

Kurt Kuehn

Yes it is and we’ve kind of got a tale of two parts on this LTL industry right now. Clearly the environment is tough, growth is negative and pricing has gotten a little more intense so we have become a little less aggressive then perhaps our initial plans were so as not to be chasing volume in a tough environment.

On the flip side as we’ve brought our technology, our operating methods and our visibility services to customers there’s been a tremendous adoption of them and being able to manage and process LTL shipments through our world ship shipping platform, be able to track them and get predictive information from our visibility systems is a huge value proposition so there is macro issues that are very tough but at the same time we are steadily imbedding our technology and our processes into that segment and over the long-term we feel very optimistic. Its just a tough market right now.

Scott Davis

I think we’re extremely well positioned when we come out of this down draft we’re in today. We’ve made a big investment, the LTL market will recover, not sure of who all the players will be when we get out of there but we’re going to be in a very good competitive position when we come out of this economy.

Kurt Kuehn

One of the things that’s happening and you’re seeing it in the LTL is we have taken our world ship platform which for many years has been a small package domestic application, and at this point now we have upward of 600,000 installed users across the globe. So its an international application and in the last couple of years we’ve gone beyond package to include fully automated processing for LTL and deeply integrating airfreight. So we’ve really created we think a pretty unique technology platform that’s global and multi model and we see a lot of excitement about that and we’re going to continue to press that.

David Ross – Stifel Nicolaus

Given the current environment and near-term negative outlook the 32 aircraft you have on order right now, is that still pretty much in the plans, going to go through or are you going to rethink how many aircraft you might need given the current volumes?

Kurt Kuehn

No at this point we have not made any announcements on changing that. Clearly with Boeing being distracted a little bit and production down, we’ll have to see how their delivery schedules come. But that’s a fairly modest amount spread over five years and over time we will be retiring our DC-8s also as the aging aircraft directives move forward. So it’s a natural replacement cycle, timing may move a little bit.

Scott Davis

And again the economy is troublesome today, we’ll all looking, a lot of fear out there but there are positives out there. I think the lower energy price is going to help the consumer confidence as we move forward. I think the credit situation is beginning to improve. I think whenever the central banks can collaborate together, it’s a powerful tool. We haven’t had time yet to see the benefits of those lower interest rates, fiscal stimulus is out there. I know we’re all wrapped up in what we’re seeing today. We will get through this weak economy and get back to a normal economy.

Operator

Your next question comes from the line of David Campbell - Thompson Davis

David Campbell - Thompson Davis

I just wanted to ask whether you had any fuel benefit in the international operations like the $90 million number you cited in domestic results.

Kurt Kuehn

Yes, there was a modest amount, it’s a fraction of what we saw in the domestic but its not significant in the international.

David Campbell - Thompson Davis

Is that because it’s a smaller component of expenses or just what, there was less of a lag or what?

Kurt Kuehn

There is a wider array of different fuel surcharge schedules that aren’t as responsive to that, so we did have a tailwind, maybe a penny or so from the international side but it was not a large amount.

David Campbell - Thompson Davis

You have a very big range in earnings in the fourth quarter, basically $0.82 to $1.02, what would it take to earn at the upper end of that range, obviously some maybe lower fuel prices and better volume, but $1.02 is still a possibility?

Scott Davis

I think that the fourth quarter is always the most difficult for us to forecast because so much of it is tied to the Christmas season and I think that that not knowing, you see forecasts out there that say retail sales are going to grow this Christmas season, but you see forecasters say its going to be the worst since 1991. So there’s a lot of different thoughts out there so I think we need to be cautious as far as the outlook for the fourth quarter and again so much of it is driven by the Christmas season, two or three weeks before Christmas, so its difficult to forecast.

Kurt Kuehn

And we did say its likely that we’ll be at the lower half of the range, although clearly there’s opportunity and uncertainty in the fourth quarter.

Operator

Your next question comes from the line of John Mins - BB&T Capital Markets

John Mins - BB&T Capital Markets

Can you talk about the European ground network, what you’ve done and what you can do to rationalize some costs there if volumes continue to decline?

Kurt Kuehn

Well so far they haven’t declined, they’re continuing to grow but we are being prudent on that. Its just good network planning within country it’s important because there’s very much more economic sensitivity within our domestic products whereas the trans border we still have this secular growth story of the European economy. We’re looking at how we adjust routes, we have air and ground collaborating and coordinating. Some of the skills we’ve learned after trying to do this for 100 years in the US serve us pretty well as we’ve done this in Europe. There’s still some good catalysts. Eastern Europe, central Europe continue to be showing good solid growth and the European economy continues to adapt.

We’re very focused on it, as in the US the air networks are less flexible then the ground networks so that’s where we have to be the most diligent but in general we have similar structures that we do in the US.

Scott Davis

The European ground network is very similar to the US ground network where we have a high degree of variable costs to manage through a downturn.

John Mins - BB&T Capital Markets

Do you have an average share cost for the repurchases in Q3?

Kurt Kuehn

We spent about $800 million in the third quarter and bought about 13 million shares, so its $63.00.

John Mins - BB&T Capital Markets

The guidance obviously its effected by market conditions and what not, but the annual repurchase spend guidance was how much?

Kurt Kuehn

Our original target was to purchase $10 billion over the next couple of years and in the first half of the year we’ve been clicking right at that steady rate. We did pull back a bit although we still spent $800 million and we’re still committed to our repurchase program and on the other hand we don’t want to be having to go out to the debt market right now where there’s 400 and 500 basis points spread. We are leveraging commercial paper and we’ll continue to buy and the speed will depend on how the credit markets look.

Operator

Your next question comes from the line of Chris Ceraso – Credit Suisse

Chris Ceraso – Credit Suisse

On the fuel benefit and some of the different businesses do you have a number for the supply chain and freight?

Kurt Kuehn

No its not as significant there, there’s a lot of flow through fuel surcharges on supply chain arena so its not as notable there. Clearly we’ve got to stay on top of it to make sure our surcharges match the rapidly changing environment but I don’t have a number on that.

Scott Davis

The lag is not nearly as important as it is on the package side.

Kurt Kuehn

Yes, the LTL is much more rapid and certainly its real time for a lot of the airfreight.

Chris Ceraso – Credit Suisse

You’ve gone through a few of the different trade lanes and how things were Asia to Europe you said was still strong, intra Europe still strong, can you comment on intra Asia and then Asia to US, I know you said US imports were weak but if you could quantify those two lanes.

Kurt Kuehn

Intra Asia continued to be strong certainly above our average growth upper single-digits. US overall was as far as exports was mid single-digits. So the intra Asia we think is going to continue to have legs, that’s why we’re investing in, breaking ground tomorrow on our intra Asia hub to help speed up that network and reduce its costs. Countries are trading with each other in Asia even as the US takes a break.

Chris Ceraso – Credit Suisse

Asia to US?

Kurt Kuehn

Asia to US was down. All of the import markets were down mid single-digits.

Operator

Your next question comes from the line of Mark McVicar – Dresdner Kleinwort

Mark McVicar – Dresdner Kleinwort

Some parts of the international freight markets not specific to yours, are reporting issues and concerns around the availability of letters of credit that obviously sit behind the glove of the international trade flows, are you seeing any of that or are you hearing any of that from your cross border customers?

Kurt Kuehn

Not as a huge issue, clearly I’ve read some anecdotes about that. We do have some products that can help customers with very short-term transactions if they’re using our supply chain services, but in general that hasn’t been a big issue yet. Its probably a bigger factor on some of the ocean shipments.

Operator

Your final question comes from the line of Arthur Hatfield - Morgan Keegan

Arthur Hatfield - Morgan Keegan

One of the things I struggle with and believe me I struggle with a lot of things is we hear a lot of comments that people thing we start to see the beginning of a recovery kind of mid point of next year, second half of next year, can you kind of put your finger on what you think needs to happen or what you think will be the catalyst to get consumers spending again? If this thing drags on into 2010 or even farther then that, at what point at you kind of really restricted on working down the costs? Do the variable aspect of your business get reduced as the length of time of slowdown increases?

Scott Davis

I think as far as the economy I think there’s a couple of positives, one is that energy prices have dropped dramatically. Two is I think we’re beginning to thaw the credit issue out, I think the central bank collaboration has been a big move and we have to get credit flowing again to get these economies recovering.

Now the negative of that is the employment side of it is still probably going to get worse before it gets better and that’s going to hurt consumer confidence. Perhaps if we get credit reestablished the mortgage rates will drop a bit and that will help the housing problem. We need to get to the bottom of that. So I think there are a couple of bright lights and I think the energy and the credit is looking better. We need to get those healed up before we recover.

So we are optimistic that maybe the latter part of next year we’ll see some recovery. We’ll continue to obviously manage our company very carefully. We’re going to manage conservatively but still invest for the future. I guess the bottom line of this whole thing is the more pain there is out there and we don’t want more pain, we’re going to be a survivor. We’ll come out of this thing in a great competitive position.

We’ll keep that in mind. We’ll invest so that when we come out of this economy whether its six months, 12 months, 24 months we’re going to be positioned to gain market share and grow this business.

Kurt Kuehn

Just three key points before we set down the call, first UPS turned in a good performance in the quarter despite the weakening global economic environment. Second UPS continues to have a very strong balance sheet and third we expect earnings per share for the year towards the lower end of the $3.50 to $3.70 range we provided midyear. Thanks for joining us today.

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Source: UPS Q3 2008 (Qtr End 09/30/08) Earnings Call Transcript
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