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United Parcel Service, Inc. (NYSE:UPS)

Q4 2012 Earnings Conference Call

January 31, 2013 8:30 a.m. ET

Executives

Andy Dolny - Vice President of Investor Relations

Scott Davis - Chairman, Chief Executive Officer and Chairman of Executive Committee

Kurt Kuehn - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Treasurer

Alan Gershenhorn - Senior Vice President of Worldwide Sales, Marketing and Strategy

Daniel Brutto - Senior Vice President and President of UPS International

Myron Gray - President of U.S. Operations

David Abney - Chief Operating Officer of UPS International

Analysts

Justin B. Yagerman – Deutsche Bank AG

Tom Wadewitz - JPMorgan

David Vernon - Sanford C. Bernstein

Benjamin J. Hartford –Robert W. Baird & Co. Inc.

Christopher J. Ceraso - Crédit Suisse AG

Ken Hoexter – Bank of America Merrill Lynch

Bill Greene - Morgan Stanley

Scott Group - Wolfe Trahan

Arthur W. Hatfield – Raymond James & Associates, Inc.

Christian Wetherbee – Citigroup Inc.

Kevin Sterling - BB&T Capital Markets

Nathan Brochmann - William Blair & Company

Jeff Kauffman – Sterne Agee

Brandon Oglenski – Barclays

Helane Becker - Dahlman Rose & Company

Peter Nesvold - Jeffries & Company

Tom Kim - Goldman Sachs

Operator

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 Fourth Quarter 2012 Earnings Conference Call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Mr. Andy Dolny, UPS Treasurer and Investor Relations Officer. The floor is yours, sir.

Andy Dolny

Good morning and welcome to our fourth 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, Dan Brutto; President of U.S. Operations, Myron Gray; and Alan Gershenhorn, UPS Chief Sales and Marketing Officer.

Before we begin, I want to review the Safe Harbor language. Some of the comments we'll make today are forward-looking statements that address our expectations for the future performance or results of operations of the company. These anticipated results are subject to risks and uncertainties which are described in detail in our 2011 Form 10-K and 2012 10-Q reports. These reports are available on the UPS Investor Relations website and from the Securities and Exchange Commission.

During our third quarter earnings call in October, I explained that if interest rates remain low, UPS would likely record a sizable pension mark-to-market charge in the fourth quarter. Interest rates did remain low and although the plans exceeded their expected rate of return, that benefit was more than offset by the 120 basis point decline in average year-end discount rates. Under GAAP, UPS is required to use portfolio of double A bonds to calculate our pension plan discount rates. In 2011, there were many double A bonds of financial institutions that were part of the portfolio calculation. In 2012, some of the bonds of financial institutions were downgraded and therefore excluded from our portfolio. While the spreads on the ones that remained compressed at a much greater rate than corporate bonds.

These two factors, the change in the bond portfolio mix and the compression in the spreads to treasuries resulted in a significant drop in our average discount rate. This led to a non-cash mark-to-market after-tax charge of $3 billion on our company sponsored pension and post-retirement benefit plans for 2012. As a result, on a GAAP basis, diluted earnings per share for the quarter were reduced by $3.15. Keep in mind this charge does not affect UPS cash flow, benefits paid to plan participants, or required pension funding. In fact, over the next three years, required pension contributions for UPS are significantly less than the previous three years.

Ignoring the impact of this charge, diluted earnings per share for the fourth quarter were $1.32. To provide additional information on the mark-to-market accounting process, we have posted a tutorial on the IR website which includes a sensitivity analysis that illustrates the impact of changes in discount rates. For example, a 100 basis point increase in discount rates could result in a mark-to-market gain.

In our remarks today, we will refer to UPS fourth quarter 2012 results excluding the impact of the mark-to-market charge. Additionally, all 2012 full-year references and comparisons to 2011 will refer to adjusted results. We believe this is a more accurate picture of the company's performance. Reconciliations to comparable GAAP measures and free cash flow which is a non-GAAP financial measure, are included in this schedules that accompanies our earnings news release. These schedules along with a webcast of today's call are available on the UPS investor relations website.

A couple of reminders. Any guidance that we provide for 2013 does not include expenses related to our attempted acquisition of TNT. And, finally, each of you will be allowed to ask one question and then get back into queue for follow up. Thanks for your cooperation.

Now, let me turn it over to Scott.

Scott Davis

Thanks Andy and good morning. I hope that everyone had a safe and happy holiday season.

Despite an environment of sluggish global trade that existed for most of 2012 and increase in uncertainty in the U.S created by the November elections and the fiscal cliff, UPS executed well. Although we fell short of our goals for the year, we did achieve record earnings per share. Our U.S domestic business led the way. We continue to see robust growth in residential shipments as the UPS portfolio provides a rapidly growing e-commerce market with unequaled solutions. Whether it’s putting goods in consumers’ hands the next day, or through more economical products like UPS SurePost, we are getting the job done.

Though we’ve been around for more than 100 years, things never stand still at UPS and 2012 was definitely a year filled with opportunities and challenges. Our bid to acquire TNT Express is probably the first to come to mind. It would be an understatement to say we’re disappointed by the decision of the European Commission to block the acquisition. UPS essentially put all hands on deck to get this deal done over the last year. I’d like to thank the many UPSers around the world who worked tirelessly on this project. We will of course continue to pursue growth opportunities, both organic and through acquisitions. While we view the TNT transaction as part of a compelling growth platform and it consumed a lot of internal resources, we are moving on.

Our financial strength enables UPS to evaluate future prospects as well as continue to invest in our portfolio. The UPS vision and focus centers on four transformative strategies; deploying technology enabled operations; providing unique industry specific customer solutions; expanding our global network; and finally, serving the needs of end consumers around the world.

In fact during 2012 and early 2013, we have launched powerful new, all enhanced services as we continue to invest for growth to support the needs of our customers. For example we expanded the footprint of UPS Next Day Air Service in the U.S and today, UPS delivers to more businesses and zip codes overnight by 8:30 a.m. and 10:30 than anyone. Our forwarding unit added innovative supply chain management technology like UPS Order Watch.

Most recently we launched the new UPS Worldwide Express Freight Service for heavy airfreight. It offers a seamless experience between shipping express packages and express freight. And finally, UPS further developed capabilities through new and expanded healthcare sites around the world and through operating facility expansions like our Cologne Hub, which is on track to be completed in 2013.

On the labor front, UPS started negotiations early with the Teamsters and we continue to be engaged in productive discussions. Things are progressing and we look forward to an early conclusion.

Regarding 2013, the global economic environment shows that we remain in a cycle of mixed growth and mixed signals. I’ve talked to a number of customers and it’s clear that fiscal uncertainty continues to erode business confidence and growth prospects. This will continue until Washington starts to compromise and make decisions in some key areas. Yet I must admit that in the U.S, we were off to a surprisingly strong start in January.

In Europe there has been some improvement. Forecast for Germany and the U.K are better, while the Netherlands and Poland are worse. But clearly, we’re starting 2013 in Europe in a more stable situation than last year. Asia’s GDP forecasts have also improved.

In the fourth quarter, global trade returned to more normal trends and expectations are for that to continue. I’m confident that whatever the global trade environment is, our people will deliver. UPS is made up of hundreds of thousands of dedicated employees. I want to thank UPSers for their efforts during 2012 and I’m proud of how our people rose to the challenges they faced. I want to give special recognition to those who went the extra mile in the aftermath of hurricane Sandy, UPSers stepping up to lend a hand in a time of crisis. Great job.

Regardless of external uncertainty, UPS is not waiting around for change. We are leveraging our growth strategies to adapt and prosper. We intend to maintain our high standard for earnings, return on invested capital and free cash flow. And UPS is confident in our ability to achieve the long-term targets we defined at our 2011 Industrial Conference. Now before Kurt covers the financials, David Abney will share information on our peak season.

David Abney

Thanks, Scott. Holiday retail sales came in slightly below expectations but UPS still hit a new high, delivering over 500 million packages globally during peak season. Our air business was especially strong and reflected the trust customers place on the speed and effectiveness of UPS. On our peak air day, Christmas eve, UPS delivered over 8 million air packages, more than 2.5 times our normal air volume and over 1 million pieces more than last year. Processing this many packages makes having the UPS integrated global network all the more beneficial.

Over the years, we have made strategic capital investments to expand Worldport, modernize our fleet, and develop state of the art technologies like telematics and next generation small sorts. These investments give UPS a competitive advantage and are one of the keys to success. Our innovative technologies combined with the best people in the business, enabled us to deliver peak season volume more efficiently than ever before. Offer innovative services like UPS My Choice, which increases operational performance and enhances the customer experience and manage complex operating plans during two distinct volume surges, Black Friday, Cyber Monday, and the two weeks before Christmas.

We are even seeing a third spike develop. One to manage the post sales process where the UPS returns portfolio is well positioned to capture growth. Since the financial community loves numbers, here are few more stats for you. Volume on peak day December 19, was almost 28 million packages. And on six days we delivered over 25 million. Our busiest tracking day was December 18, when more than 65 million tracking requests occurred. And my favorite as COO, efficiency metrics. In the U.S. where daily volumes grew by 3%, miles driven were up 1.2% and direct labor hours were up 2.3%.

On the air side, U.S. Next Day Air grew almost 8%, while block hours were up only 1.6%. International exports improved over 5% yet international block hours declined 1%. UPS efficiency is nothing new. For example, since 2008 U.S. domestic volume handled per block hour has increased more than 20%. This is just the way we run our business. We don’t wait to implement big operations initiatives. UPS seeks incremental improvements everyday year after year. So as you can see, UPS airline operations are as productive as ever and this positions us for growth and better returns to our investors.

Finally, I would like to take a moment to recognize the more than 20,000 employees of the UPS airline. You may not know this, but it was 25 years ago tomorrow that UPS airlines operated its first revenue flight when aircraft tail number, N880UP, a DC-8 flew from Louisville to Milwaukee. In August of that year, UPS announced plans to form its own airline. And it became the fastest startup in FAA history. So congratulations and thanks to all of you who made it possible. Now I will turn things over to Kurt to discuss the financial highlights.

Kurt Kuehn

Well, thanks David and good morning everyone. On a consolidated basis UPS fundamentals are strong as ever. We wrapped up the year with free cash flow of approximately $5.4 billion and although we feel short of our target for the year, UPS generated record earnings per share of $4.53. This was achieved in the face of weak global trade and in spite of superstorm Sandy which cost us about $0.05 a share.

UPS annual revenue of $54.1 billion was our highest ever, as were the 4.1 billion packages we delivered globally. Pricing improvements, along with the efficiencies that David highlighted, led to margin expansion. For the quarter, consolidated package volume grew 3% per day. Revenue of $14.6 billion set a record as did operating profit at $2 billion.

While the U.S domestic segment improved profitability, international experienced a slight decline and faced with a margin squeeze in forwarding, the supply chain and freight segment also exhibited lower profit.

Now let’s review our results in detail, starting with the U.S domestic segment. In the U.S, we fired on all cylinders. Operating profit was nearly $1.4 billion, a new high. Average daily volume grew 3% with Next Day Air up almost 8% and Ground up 3%, driven by expansion in B2C shipments.

Despite slightly weaker than forecast holiday retail sales, shoppers went online like never before. We experienced strong growth in Next Day Air Saver and traditional UPS Ground and of course our lightweight solution SurePost, was also popular this holiday season. We continued to see strong growth there, even though we wrapped last year’s rollout of this product.

Revenue for the segment grew 3%, with Next Day Air and Ground up 5.4% and 3.4% respectively. Revenue per piece increased 1.7%, driven by base rate improvements in both Ground and Air. As a result of increased demand for our Saver products, Next Day Air revenue per piece declined 60 basis points.

Operating profit of almost $1.4 billion was up 4.4% and operating margin expanded to 15.4%. Hurricane Sandy was a challenge in the quarter, but our operations expertise and integrated network mitigated some of its impact. In addition, rising healthcare benefit costs continues to be a headwind, but its impact on the quarter was partially offset by some onetime items.

Moving on to our international segment, UPS delivered 1.1 million export packages per day, up 5.5%, although that was boosted about 1% by global operating day differences. Leading the growth was Asia, where export volume grew in the mid-teens, aided strongly by tech sector product launches.

During the quarter, export revenue per piece declined 3.5% on a currency neutral basis. Typically, Asia growth would be a great story, but during the holidays this growth was concentrated in lower weight packages from high volume shippers using less premium products.

Europe exports improved as a result of growth in non-premium products. Companies there continue to streamline their supply chains and lever UPS solutions to meet their needs. Germany, Italy and the U.K all showed solid export increases. We are confident in the opportunities created by a developing European small package market and we’ll continue to aggressively pursue growth strategies there.

Domestic revenue in the international segment increased 1.3% on flat daily volume growth. Revenue per piece increased more than 4% on a currency neutral basis, reflecting our focus on revenue management.

Overall, total UPS international revenue grew 1.5% to $3.2 billion. Operating profit was $499 million, down slightly. Changes in customer and product mix lowered profits. However, operating margin of 15.6% continues to set the bar in the industry. Acquisition related expenses of approximately $30 million were higher than anticipated and negatively impacted earnings per share by about $0.01 more than originally expected.

Now for supply chain and freight. Revenue increased 4% over last year to $2.4 billion. Our forwarding and logistics group improved $40 million or 2.5%, while UPS freight revenue increased by $39 million or 6.2%. In the forwarding business, tonnage and yield improvements led to revenue growth, though this growth was somewhat offset by reductions in other transportation solutions. Increases in transportation expense were a challenge for profit. In the Asia air freight market there was a short term volume surge which exceeded capacities and drove up buy rates. As a result our margin was squeezed and profit declined. However, UPS Ocean products did very well.

Revenue and profit increased year-over-year and the popularity of our less than container load offering exceeded expectations. The UPS distribution business increased revenue by providing healthcare and high-tech customers effective solutions to better manage their supply chains. In fact, healthcare revenue increased by more than (inaudible). During the quarter we opened three new healthcare facilities and more are scheduled for 2013.

At UPS Freight, LTL revenue was up 6.5% and gross weight hauled increased by almost five. For the quarter, operating margin was similar to last year and overall for the year margin expanded by 70 basis points. Let me shift gears and spend a moment on pensions. First, a reminder that the mark-to-market charge that Andy spoke about does not affect UPS cash flow, benefits paid to plan participants or required pension funding. Funding requirements for UPS sponsored pension plans were modified by recent legislation and as a result UPS plans are fully funded and we have no required cash contributions in 2013.

As for pension expense in 2013, the lower discount rates do cause higher service and interest costs. As a result, we expect pension expense for these plans to increase about $225 million compared to last year. This will be a significant drag in 2013 although when discount rates go back up, we will see decreases in pension expense. Looking now at our cash and balance sheet.

During 2012, UPS generated $5.4 billion in free cash flow after capital expenditures of $2.2 billion. We ended the year with almost $8 billion in cash and marketable securities. Although keep in mind that $1.75 billion has already been used this month to pay up maturing debt. For the year, UPS paid $2.1 billion in dividends, an increase of 9.6% per share. In addition, we repurchased 21.8 million shares for approximately $1.6 billion. Looking ahead to 2013, UPS expects strong free cash flow to continue, again exceeding 100% of net income.

As a result of our strong financial position and reflecting our commitment to share on the distributions, UPS is increasing our 2013 guidance for share repurchases by an additional $2.5 billion, up to a total of $4 billion. As always, dividends will also continue to be a priority. Looking at guidance beyond cash, as Scott alluded to, the global economic shows that we remain in the cycle of mixed recovery with more improvement in some places than others. We are confident that the strategies outlined by Scott position UPS well. As a result, we expect another good year of earnings growth. We are anticipating earnings per share in the range of $4.80 to $5.06, an increase of 6% to 12%.

Looking at the segments. For the full year, U.S. domestic average daily volume is projected to grow around 2% to 3%, slightly above GDP estimates. Revenue is expected to be up mid-single digits with base rate improvements of 2% to 3%. We are pleased with the momentum in our domestic business although UPS does expect increased healthcare and pension expense to limit margin expansion. We anticipate an operating margin approaching 14%, resulting in profit growth at a mid-single digit pace. In our international business, UPS expects revenue to increase at a mid-single digit rate with domestic and export daily volume growing faster than global GDP.

Exports yields will continue to be pressured by both changing customer mix and increased reliance on non-premium products. We expect operating margin will expand slightly in spite of an estimated currency headwind of $125 million. In supply chain and freight, for the full year, we expect revenue to increase at a mid to high single-digit pace with some margin expansion, resulting in profit growth of approximately 10%. The segment is expected to maintain a strong operating margin of at least 8%, despite continued investments in healthcare solutions and facilities.

Looking specifically at expectations for first quarter, there are a number of items that will negatively impact year-over-year comparisons, most notably, one less operating day and the timing of an early Easter. Even though UPS expects full year earnings per share growth in the range of 6% to 12%, for the first quarter, we anticipate that earnings per share growth will be relatively flat. Reviewing segments for the first quarter, both U.S domestic and international are expected to generate results similar to Q1 of last year. Supply chain and freight profits end margins should be down on a year-over-year basis because of investments in technology and the gain recognized last year on the sale of the surplus facility.

To wrap up the income statement, our overall tax rate for 2013 should be between 34% and 35%. Regarding CapEx, for the full year, we expect our spending to be $2.4 billion, keeping us at approximately 4% of revenue.

In summary, 2012 had its challenges. UPS set some records, but we also fell short in some areas. We are always constructively dissatisfied at UPS, seeking to attain new highs and this year will be no different. Despite another year of mixed global economic conditions, and approximately $350 million in headwinds from pension and currency, UPS will continue to raise the bar, with expected full year earnings per share growth of 6% to 12%. And as Scott mentioned earlier, we remain confident in our ability to achieve the UPS long term target of 10% to 15% earnings per share growth.

Thanks and now we’ll be happy to answer your questions.

Question-and-Answer Session

Operator

Our first question will come from the line of Justin Yagerman of Deutsche Bank. Please go ahead.

Justin B. Yagerman – Deutsche Bank AG

Good morning guys. Wanted to reconcile the guidance and the commentary on the economy in the press release to Scott your early remarks behind how the economy is trending here in the beginning of 2013. It felt like guidance was potentially a little bit conservative here. Kurt, you did a good job running through some of the assumptions, but is it really just the weakness on international yields and the $350 million of headwinds that get you nervous? Or you do see anything else from an economic standpoint that really gives you some pause here in the early part of the year?

Scott Davis

Justin, let me start. I think that overall we still see 2013 as a slow growth economy. I think that the good signs that I talked about is I think you see a more stable Europe than we saw a year ago. We’re starting to see a pickup in global trade which is very important for us as we look forward. The second and third quarters of 2012 we saw global trade lag, the global economic growth which is very unusual. So it feels like that’s getting more normal. In the U.S, as I said I think we got off to a strong start in January. I think a variety of reasons for that. I think with the trends the last few years we’ve seen strong last weeks of December, early January due to I think gift card purchases after Christmas due to a lot of returns.

Yesterday’s GDP number said that obviously the inventories were very low. So I think we’re seeing restocking of inventories early in January. But I’m still cautious as we move through the year that I do think we’ll see growth in the U.S, though we still are going to be addressing the debt ceiling in the second quarter. More than likely that’s going to cause some uncertainty. So we have some challenges. As far as the guidance, the big number I think is the drag due to pension and currency and the pension is out of your control. Low discount rates, it had a big impact and that’s impacts earnings by about 5%. So you take that and add that to the 6% to 12% guidance, it would have been a very strong guidance without those headwinds.

Kurt Kuehn

Yeah. I think that the basic expectations are that the U.S economy will be somewhere around 2% and global GDP somewhere around 2.5%. So certainly not a barn burner year. We expect under trend performance and as Scott said, the pension could just as easily turn around next year and if we get 100 basis point increase in the discount rate that would be a $200 million tailwind.

Justin B. Yagerman – Deutsche Bank AG

What are you guys looking forward to get more excited this year in terms of economic signs? And what are you seeing out of Asian airfreight? That’s been a place of particular weakness. Didn’t hear too much on that.

Kurt Kuehn

We certainly some getting resolution in Washington to some extent will be a big deal. So consumer confidence pulling through with the activities in DC. I will turn it over maybe to Dan Brutto, our President of International, to talk a little bit about the trends we are seeing in Asia.

Daniel Brutto

Yeah, I guess the Asia trends really are -- right now you have got a lot of large hi-tech customers that have send out product launches. But after the first of the year, they are getting more positive in Asia. Also the area of somewhat concern is, is folks are using less premium products in Asia. The Chinese New Year is also later this year, it’s in the first week, almost the second week of February. So right now we are off to a good start, as Scott said, in January. So we expect Asia to come back. The tail of the tape will be how we will come back to customers in the middle market where we have provided a lot of solutions for start utilizing premium products to take care of this inventory shortage that we know is in the marketplace.

Kurt Kuehn

Let me just add, I think a more stable Europe will also aid in Asia exports which were very negative last year up until the fourth quarter and in U.S. exports. I mean, that certainly has had a big drag on U.S. exports in 2012. So, as Europe stabilizes and begin buying goods again, that will be good for exports.

Operator

Our next question will come from the line of Mr. Tom Wadewitz of JPMorgan. Please go ahead.

Tom Wadewitz - JPMorgan

I wanted to ask you the mix. So Dan, just talked about how that’s been of a headwind in international but can you help me think about mix both domestic, if you have growth in B2C. And how much that affects your margin view? Is that something that maybe makes you a little bit cautious on margin in domestic? And then from an international perspective, how material is that impact on your international margins? Can you deal pretty well with growth in less than premium products or is that a material factor to consider in our margin beyond international?

Scott Davis

Yeah, Tom, I think on the domestic side we have really saw all of 2012 as a year where B2C was really at the lead that our B2B business was relatively flat, just up slightly in the fourth quarter and really that continuing process of direct to consumer was a big factor. And even in that environment and even with the headwind of Sandy, we did show margin improvements in the U.S. So is B2C a little tougher than B2B, yes, it is. On the other hand, Myron, and the deployment of technology enabled operations has made us, we think, able to profitably grow with that.

On the international side, we have got -- in Europe we have got great Pan-European capabilities. The yields on our express volume certainly are higher than the standard. But we think we can manage through those things. The big product launch is certainly something that does distort margin a little bit because those are high revenue, relatively low yielding products. So those probably have more to do with any disruption that you saw in the trends.

David Abney

I guess on the international front as far as margins are concerned, if you take a look at the last quarter, we really take a close look at the domestic to make sure that we maintain our margins in the domestic business and we serve essentially those customers that are importers and exporters. For our export product internationally, we do very well with B2C as well as B2B. In fact, certainly even in the tough economy in the fourth quarter, a 15.6 margin continues to be industry-leading by a significant amount. We expect that to continue in the future.

Operator

Our next question will come from the line of Mr. David Vernon of Bernstein. Please go ahead.

David Vernon - Sanford C. Bernstein

So the increased guidance for buyback, so it’s $4 billion for 2013. It’s still going to leave you with quite a bit of cash on the balance sheet. Can you talk about kind of future plans for that capital as well as how you think about growth going forward in a world without the TNT acquisition?

Kurt Kuehn

Yeah, I guess if you are looking at the year-end balance sheet, clearly, we did payback a large debt issuance that came in due in January, as I referenced to. So about $1.75 billion of cash was used for that. Now, we are stepping back up our repurchase scenario. We pulled back on that in light of the big commitment of the TNT acquisition and we are certainly getting back on track with that. The $4 billion basically catches up the shortfall that we had in 2012 because of us being a little more conservative. As far as use of cash in the future, I will turn it over to Scott to talk about that.

Scott Davis

Well, I think, David, the game plan is we will keep a balanced use of cash going forward. We will continue to increase distributions to shareowners. We will review dividend policy here in a couple of weeks. So we had a board meeting for 2013 and clearly we will reinvest in the business. We think there are opportunities out there in the emerging new markets there’s opportunities out there and the supply chain world we’re doing a lot more in healthcare these days. So we’ll have opportunities to reinvest via acquisition route also.

David Vernon - Sanford C. Bernstein

So there is a possibility then for some other inorganic stuff to come up in priority?

Scott Davis

Yeah, absolutely there’s a possibility. We’re always looking for opportunities out there. There won’t be things the size of TNT likely, but there’ll be opportunities for us to reinvest in the business.

David Vernon - Sanford C. Bernstein

And would that be core package or would you think more supply chain and freight?

Andy Dolny

David, we’re going to try to limit the questions to get everybody on the call. We’ll answer this one and then I’ll ask to be your last question.

Scott Davis

I think we’ve always said that our priorities are international package looking as far as we can expand the network. That stays a priority. Certainly in the forwarding and distribution world we see opportunities, namely in healthcare. So I think nothing has changed as far as the outlook there.

Operator

Our next question will come from the line of Ben Hartford of Robert W. Baird. Please go ahead.

Benjamin J. Hartford –Robert W. Baird & Co. Inc.

Good morning. Dan, maybe you could address a little bit about international capacity on the airfreight side at the moment. I know you guys took delivery of seven aircraft in 2012. Are you expecting or can you talk maybe about the expected timeline of the eight remaining deliveries of the 767? And then more broadly, can you talk about the dynamics on capacity in these key trade lanes from a dedicated freight of perspective as well as from some of the passenger aircraft and maybe where we stand from an equilibrium perspective? Thanks.

Kurt Kuehn

I’ll turn it over to David Abney to talk about the airline deliveries and the overall global network.

David Abney

As far as the 767s that we’re receiving this year, we’re going to receive eight. We look to put seven of them in the domestic routes, one in international. As far as the international flying, just due to the fragile global economics, we’re managing the network very closely by bid period. So, we’re making those adjustments every eight weeks or so.

Daniel Brutto

I guess I would say on the international arena, our capacity and utilization of aircraft has never been better and certainly as David said, we want to utilize our planes. With our hybrid network, we actually on the forwarding business can move a lot of our freight into the commercial market. In fact for every five kilos that we pick up in our forwarding business, four kilos goes on another carrier’s aircraft. About one kilo goes on a UPS aircraft. That’s very good because when the economy flexes either up or down, we can move more premium or more freight into our own network to make sure that that’s fully utilized as well as optimizing the use of commercial aircraft.

Operator

Our next question will come from the line of Chris Ceraso of Crédit Suisse. Please go ahead.

Christopher J. Ceraso - Crédit Suisse AG

Good morning. Just wanted to get a clarification on the guidance and then a question about the pension. The guidance, does the 480 to 506 include the expected reduction in your share count associated with the $4 billion buyback?

Kurt Kuehn

Yeah, it would. That reflects the expected $4 billion spread over the year reasonably ratably and also includes the expectation of the pension increase and others. So that’s all in. what it doesn’t include is any expenses from the TNT, either the freight fee or the substantial amount of legal and internal resources that we’ve deployed.

Scott Davis

Just to remind you, the share buyback does benefit earnings growth by about 2%. The pension and currency drags earnings growth by about 5% in that guidance range.

Operator

Our next question will come from the line of Ken Hoexter of BofA Merrill Lynch. Please go ahead.

Ken Hoexter – Bank of America Merrill Lynch

Good morning. If we could just follow up on the international side again, as you noted you continue to improve efficiency, but how do you think about that as the international margins continue to fall? I know that you said they were at solid levels relative to industry, but are there things you can do to continue to get that back on track? Or is that as you watch these new super saver products continue to deteriorate that over time?

Scott Davis

Ken, certainly before Dan talks about it, I guess we do have to take the results of the international business with some perspective that we’ve been involved over the last couple of quarters with the largest projects in company history and a very large number of resources and people have been involved in the TNT acquisition. So as Dan takes a breath and his people get focused on the future, clearly there’s plenty of opportunity.

Daniel Brutto

Yeah. I’d just add onto that that certainly we had an extremely large team to work on the TNT transaction. That team now is coming back. A lot of that team was very much involved with our customers, which are value-added sales to customers and certainly now we have that team back in full force. So, that will be a big certainly element in us moving forward to get greater margins in the future.

Kurt Kuehn

And you know, Ken, in the fourth quarter we actually talked about, we had larger customers in the mix, we had lighter products, we had slower moving products that impacted it. But I think as you look forward, we are optimistic on global trade getting back to little more normal in the future. And there are things on. We talked about Europe. We talked about the U.S. making some progress in the fiscal cliff, long ways to go but that could help U.S. consumption. Energy, prices have somewhat stabilized compared with the ups and downs we saw in the last few years. Japan’s easing, it’s going to help the trade out of Japan. And I think the recent change in Chinese leadership is going to help stabilize things and cause quicker growth in China.

So things are starting to get us back where we feel that global trade will outperform the global economy, whether 125% to 150% over the growth of GDP, we don’t know. But it will get back to normal relationship.

Scott Davis

Yeah, I think one other thing maybe to add. Alan Gershenhorn talked a little bit about the product innovation too, because as we have said, we are not standing still and we do have a lot of initiatives that are adding more value in the marketplace.

Alan Gershenhorn

Yeah, so as Kurt said we have done a number of enhancements in new product introductions. We just announced the introduction of UPS Express Freight that Scott talked about in his opening comments. It’s in 37 origins to 41 destinations and it covers about 85% of world trade. And we are certainly excited about that. That product again provides a seamless transition between our express package services into express freight. We have also just enhanced our worldwide expedited service. We have added 145 destinations. And that’s really targeted at higher weight, higher yielding packages. We have also introduced U.S. to Mexico and Mexico standard ground service. And, I guess last but not least, we have enhanced our Paperless Invoice service which really does streamline the international process and creates a significant differentiation for our customers.

Operator

Our next question will come from the line of Mr. Bill Greene of Morgan Stanley.

Bill Greene - Morgan Stanley

Yeah, Kurt, I think you can hear from some of the questions there is a sense that the guidance is conservative in light of the commentary. And one piece of it that I am just curious about then is, do you make any assumption that there may be a shift of business as we approach the deadline for the Teamsters contract, or is that not expected at all? May be you can get it done even early.

Kurt Kuehn

No, I think, we feel very confident, as Scott said that we are making good progress and we are still almost half a year out, we have left to go on that, and we do expect that to get concluded successfully and early. The biggest issue really as you talk about the domestic is the headwind we have or the pension frankly was unexpected to some extent and does create about 5% headwind on the domestic results.

Operator

Our next question will come from the line of Mr. Scott Group of Wolfe Trahan. Please go ahead.

Scott Group - Wolfe Trahan

So just wanted to clarify, the $0.05 of Sandy impact, if you could break that out among the three segments. And then just kind of the longer-term question. The guidance for domestic package margins is pretty flattish year-over-year. Is that just a sense that the pension impact is going to be mostly felt there or do you think we are getting closer to peak on those domestic package margins? Any maybe within the margin commentary, if you can give some thoughts on -- if you have assumed any material changes in the economics with the Teamsters and anything with the priority mail contract with the post office.

Scott Davis

Okay, a lot of pieces to that one. I will try to unfold them. I will talk a little bit about some of the margin issue and the guidance and then Myron clearly can talk about Sandy and also some of the things that we are doing going forward. Basically, the issue for 2013, we are looking at a sub-trend U.S. GDP of about 2%. We have made good progress and we expect that. We do not think we are at peak margins but we do have $200 million, the vast majority of which is U.S. domestic. So it does hit primarily the domestic segment. So we do think we are continuing to make good progress but with that blip and with a muted U.S. economy, the guidance is appropriate that we do expect modest margin improvement and profits up in the mid-single digits. I’ll turn it over to Myron to talk about Sandy, how that impacted the segments and then a little bit about some of the operating initiatives we have.

Myron Gray

Good morning. Myron Gray. As you heard, Sandy did impact us probably by about $75 million in the fourth quarter, but despite that, as you’ve heard, we did have a good fourth quarter. Now looking forward, as Kurt and Scott have both alluded to, we do face a headwind of about $200 million of pension expected headwind. Without that, we’d be looking at a 10% growth in profit. However, despite the headwinds that we face, we have continued to attract profitable volume, both in B2B as well as B2C and with the deployment of world class technologies, we expect that we’ll get closer to the 14% margin. Actually if you look at full year ’12, margin was 13.8%. So we’re right at the expected number and really don’t expect not to make it.

Scott Davis

And then one last piece of the puzzle, you made a quick reference to the postal contract. I’ll let David Abney update you a little bit on that.

David Abney

We have responded to the USPS RFP to provide airlift services. We expect to hear back sometime next month. We’re confident we can support the postal services commitment to its mail customers, creating significant growth opportunities for UPS. We look forward to expanding our relationship with them.

Operator

Our next question will come from the line of Art Hatfield of Raymond James. Please go ahead.

Arthur W. Hatfield – Raymond James & Associates, Inc.

Morning everybody. Most of my questions have been answered, but just one quick question on Europe. Post TNT, do you see or anticipate or have you heard from any of your customers that the competitive landscape may change given what’s got on – what this potential acquisition now going away?

Scott Davis

Dan just came back from Europe last night. So I’ll let Dan give you an answer to that.

Daniel Brutto

Yeah. I guess I spent last week in Davos and had the opportunity to talk to many European multinational customers. They asked me about what our future plans are in Europe. Certainly there’s opportunity for us to expand in certain areas of Europe and Eastern Europe. We do have the best product portfolio right now in Europe with our transporter product and certainly our breadth of portfolio which goes all the way from ocean to certainly express air. I think for the most part we can provide the service. I think certainly TNT would have helped us get there faster, but there are still all kinds of opportunities for us and right now our ability just in the healthcare field to expand our healthcare operations across Europe. We spent a lot of time with healthcare customers who are very excited about getting out of the supply chain brick and mortar business and turning that over to UPS to handle the end to end supply needs that they have. So we’re very excited about the future in Europe.

Operator

Our next question will come from the line of Mr. Chris Wetherbee of Citigroup Global. Please go ahead.

Christian Wetherbee – Citigroup Inc.

Good morning guys. Maybe a question just on shipper behavior, particularly in the Asia outbound market. You mentioned some trade-down it sounds like. Is that more just a customer mix issue doing more for the larger players as opposed to more middle markets? Orr are you seeing more strategic changes on how your customers on the whole are treating or managing the supply chain, particularly in that region?

Scott Davis

We’ll turn it over to Dan to talk a little bit about that.

Daniel Brutto

Yeah, I guess what's happening is we saw in the last quarter, certainly as margins from some of our large customers gets squeezed in the high-tech area and I would argue in another areas, they look to more efficiency as far as using less premium products, even to the point of going all the way down to ocean. As Kurt mentioned before, we were very successful in ocean in the fourth quarter and actually for 2012, we had our most profitable year in ocean. So I don't suspect that that's going to happen forever, because innovation certainly in the world allows new products to come to market. Those new products have a higher margin and those are the products that fly in our planes and utilize the premium service.

Kurt Kuehn

I'm going to ask Alan maybe talk just a little bit. At the same time we're meeting the needs of very large customers. We have a number of initiatives enabling middle market customers to export. Alan?

Alan Gershenhorn

So we’re – I think you heard earlier that we're focusing our attention on industry-specific customer solutions. We've talked a lot about healthcare on the call in terms of investing in healthcare complying facilities and technology to enable these middle market customers. Also certainly on the retail side, really working on deploying end-to-end logistics solutions for them. Just switching gears a bit, I was just in Europe also and with our Kiala acquisition, we had a conference. We are watching UK UPS access points and had close to 100 retailers there excited about that opportunity. And that solution there turns those B2C packages into B2B shipments and provides a lot more convenience and accessibility to consumers enabling these retailers to grow their business.

Scott Davis

What fixes it faster than anything is increased demand out of Europe and the United States. And surely in the last couple of years we have had weak demand in both -- most of the developed world. So as that strengthens and we are projecting that, we will strengthen that. That will help this problem.

Operator

Our next question will come from the line of Mr. Kevin Sterling of BB&T Capital Markets. Please go ahead.

Kevin Sterling - BB&T Capital Markets

You guys have talked about the trade down with customers from doing economy service from a priority overnight service. What do you think reverses this trend? Is it simply an uptick in the economy or maybe that’s the new normal?

Kurt Kuehn

Well, I think it’s a combination of events. So I will let Alan talk maybe a little about what we see. You know all this talk about trade-down, we clearly are seeing some of that in the international arena in Europe probably most notably. At the same time we had an extra here, volume growth of 8%. So we are certainly not suffering too badly with our premium product up that strongly. One of the reasons we are seeing that is what we like to call this new Omni channel strategy that many retailers are adopting. So, Alan, maybe you could open that up a little bit?

Alan Gershenhorn

Yeah. And I think, Kurt, to your point, we have been gaining share in the air business for quite some time and a lot of that has to do with our success in the retail sector. Again whether it’s the B2C or B to the stores. And this Omni channel phenomena is really transformation of what's happening in the retail industry and our customers are out there looking for ways to manage between the online channel and the brick and mortar. And so you are seeing folks ordering online through the store, you are seeing folks fulfill online orders from the store, maximizing their inventories and enabling later pickups and so on and so forth.

And I think the key to this is having a broad portfolio of services out there and while we have certainly the phenomenon of folks looking for less expensible alternative, there is also still plenty of market out there for consumers that have an urgent need for product and so and so forth, that’s been driving really our air business to the degree that Kurt mentioned.

Operator

Our next question will come from the line of Mr. Nate Brochmann of William Blair & Company. Please go ahead.

Nathan Brochmann - William Blair & Company

I wanted to talk a little bit kind of this whole mantra of the trade down etcetera, but a little bit more specifically on the new Express Freight product. You know that kind seamlessly integrates this, I assume that’s driven by some of those hi-tech customers that are now packaging what used to be small parcel as more of freight shipments. And I was wondering how that’s kind of effecting, one, kind of your load balances. And, two, just kind of looking forward, whether that freight is more like the UPS traditional small parcel customers moving to that or whether you are gaining additional shares from what would have been more traditional freight customers. Thanks.

Scott Davis

Yeah, good question. I guess certainly we see a lot of opportunity for new and additional volume for this. But, Dan, why don’t you talk a little bit?

Daniel Brutto

Yeah, Nate, on this whole Express Freight product, first of all it’s not limited as we have seen to date to the hi-tech field. It’s in aerospace, it’s in high-end retail. It’s in diversified manufacturing, automotive as well as hi-tech. So it cuts across all. From a customer standpoint, many of the customers use UPS today but the confusion was how do I get this once a month or once every other month express freight shipment that hast to be there. And the unique part about this is they can use the same UPS technology, the same labeling, the same tracking, the same tracing, the same building, which allows them seamlessly to use express freight from us where many times they had to call a forwarder or someone different to do this. So we think it’s very exciting the product is off to a great launch. We think it cuts across multiple industries and it’s going to be a big winner for UPS this year and into the future.

Kurt Kuehn

And this is a premium product initiative. This will have yields much higher than our forwarding and are highly compensatory in the express arena. We just have not focused on that segment as much as perhaps we could have in the past.

Operator

Our next question will come from the line of Mr. Jeff Kauffman of Sterne Agee. Please ago ahead.

Jeff Kauffman – Sterne Agee

Thanks guys. Just one question. I'm going to focus a little bit on Europe and I know a couple of speakers have already asked that. In the wake of no longer being involved in TNT, but going through the diligence, were there practices or things you noticed about the way they were doing business in Europe or is something that would have happened as a result of that acquisition that makes you rethink the way you want to move going forward? I know you talked a little bit about Kiala. Does that change the importance of Kiala? Does that make you rethink say a road freight network or something like that?

Kurt Kuehn

Jeff, I think, probably the biggest impact of our TNT deal was that we put a lot of initiatives on hold. We've been very excited about Europe. We've got a great multi-decade story of growth in Europe, frankly, with the largest acquisition in Company history and one that would have taken us over 1,000 people to integrate at max. We were focused on that, and so we did slow down some of the initiatives. But we remain focused on growth there. Alan already mentioned the fact that we’re kicking off our Kiala offering in the U.K. Dan has mentioned that he's putting the scores of people that we'd have working on the integration planning back to work. So, it's really just kicking back into gear with some of growth strategies.

Scott Davis

Jeff, I'd just add that we understand Europe very well. We've been there since the mid-70s. We think we have, as Dan said, the best network over there already. We did learn that the regulatory process is a complicated process over there. So we learned a lot about the commission, but we think we know the market well over in Europe.

Operator

Our next question will come from the line of Mr. Brandon Oglenski of Barclays. Please go ahead.

Brandon Oglenski – Barclays

Good morning everyone and thanks for taking my question. When we look at domestic profitability in the fourth quarter, excluding the Sandy impact, it actually looked like close to a record margin and you've been closer to flat throughout the year. So can you talk about some of the initiatives that you've had to better leverage the B2C traffic in your network along with the flat outcomes in B2B?

Kurt Kuehn

Certainly as we’ve said, operations enhanced with technology is a big priority, and I'll let Myron talk a little bit about some of things that worked well to meet the B2C growth this year and then maybe David talk about some of our research and development for the future.

Myron Gray

For years we've talked about enhancing our operating leverage through packaged flow technology, and with that employment over the last few years has helped us totally control the number of base hours that we absorb from our employee base. New technologies like ORION and Telematics helped us reduce the miles driven, hold them flat to 1% while we saw volume growth of 3%. Now, while we have experienced a flurry of B2C growth, I think balance is the more appropriate way to look at it. When you balance B2C with B2B and a carrier like UPS that has an integrated network, it totally allows us to control our costs. So with base rate improvements of 1.7% in the quarter, it helped us balance yield with ops expense of 1.4%. So it really was a good quarter for us from a balanced approach.

Kurt Kuehn

Yeah and we are certainly doing a lot of research and development to continue this momentum. David, maybe you could talk a little bit about some of the things that's happening.

David Abney

Well, one of the technologies that we are very excited about is SurePost redirect, and what this gives us a capability to do is to route SurePost packages to the lowest cost network. For example, it could be that the final last mile delivery would be through USPS or if we have other packages that are going to be delivered through the UPS network, we can make the call or make that decision on a day-to-day basis and switch those packages over to the UPS network for the last mile of delivery. So it's these operational technologies that are not only reducing our cost, streamlining our network, but they also provide a platform for new customer solutions such as UPS My Choice that we have talked about.

Scott Davis

And I guess one lower tack issue that clearly continue to be a driver of positive momentum in the domestic is this growth in our next air products, that the integrated network allows us to deliver those next air products, particularly the saver products at a very reasonable rate and that’s part of why we are attracting that market so effectively.

Operator

Our next question comes from the line of Ms. Helane Becker of Dahlman Rose. Please go ahead.

Helane Becker - Dahlman Rose & Company

I just have a fleet related question. I thought you said that you are taking delivery of eight of the 767s this year, which is what you have on order. And then you've got something like a quarter of the fleet in three and four engine aircraft. And with fuel prices really not showing signs of going down, are you thinking about replacement aircraft? Are you thinking about next to add some more efficient aircraft for those 747s and MD-11?

Scott Davis

David, I'll let you talk about that. Yeah.

David Abney

Well, like you said, we did talk about the 767s that we are bringing into the network. One thing we have to remember that we have the most modern, most quiet, fuel efficient fleet in the industry. We are the only global integrator that is Stage IV compliant and the age of our aircraft is just much younger than any of our competitors. So, we feel real good about our aircraft and we've made changes for the last 10 to 15 years in updating our aircraft and now we are getting the benefit of such.

Scott Davis

Yeah, Helane, the fleet is almost a decade younger than our primary competitors. It also means, we don't have virtually anything in the way of replacement CapEx for aircraft for the next few years. And part of the great cash flow forecast we'll see is especially after this year that our needs for new aircraft will moderate for a while and certainly will be a great story for cash flow.

Kurt Kuehn

Low CapEx, no pension contributions for a couple years does equate to good cash flow.

Operator

Our next question in queue will come from the line of Mr. Peter Nesvold of Jeffries & Company. Please go ahead.

Peter Nesvold - Jeffries & Company

I think most of my questions have been answered. I guess just from a numbers standpoint, one thing that's still not perfectly clear to me. If you are guiding to 9% earnings growth at the midpoint for the year, but you're looking at flat year-over-year for 1Q, that would assume 12% on average through 2Q and 4Q and that's despite the 5% pension headwind. So what drives the step-up? Are there kind of two or three major factors that you can just outline briefly and why you see the earnings acceleration as we progress through the year?

Kurt Kuehn

Yeah, I think the outlier is more Q1. There is one less working day. That working day moves to Q3. Typically, that's $50 million or more that you would shift. And, also the early Easter hurts Q1 a bit. So, those are the seasonal issues that really drag down the Q1 scenario. Other than that, the year should be pretty balanced with the third quarter perhaps showing the biggest percent increase year-over-year primarily because of the working day. But other than that, no, we're expecting solid stable results. Perhaps the economy will pick up a little bit later in the year but we're not banking on a robust recovery. Clearly, you've heard that in our guidance.

Operator

Due to time constraints our last question for the day will come from the line of Mr. Thomas Kim of Goldman Sachs.

Tom Kim - Goldman Sachs

Can I ask you how backhaul volumes are trending both on the Trans-Pacific Europe back to Asia?

Scott Davis

Great. Yeah, I'll give it over to Dan to give us some updates on trends we're seeing right now.

Daniel Brutto

Yeah, I guess on the way back to Asia, primarily from -- I'll start with the U.S. Certainly, the U.S. export we all heard is relatively flat, but it was down at least for the first, second and third quarters and it got to flat in the fourth quarter. So, we don't see a tremendous uplift in U.S. exports and that's part of what Scott has guided to. As far as the European market, again, not a lot of robust growth. I will tell you though, on the positive side, the Asia consumer is very interested in buying goods from both the U.S. and from Europe. So, as Kurt said, we're hoping that in the second half of the year, we're going to see a little bit more of an uplift and some better balance with Asian consumers buying more European and U.S. products.

Kurt Kuehn

Yeah, and I think if you look longer term, that's clearly something that most economists are forecasting; that as consumption increases in Asia that the balance flows will begin to improve. Clearly, the lower cost of energy and other issues is bringing some manufacturing back to the U.S. So, that would be a long-term very positive for the air business to make sure that you get comparable loads both directions would be very highlight accretive.

Tom Kim - Goldman Sachs

Great. If I could just add a follow-up to that. Presumably then this should be margin enhancing, just given your air load factors, trends whether they have been, let's say, Q2, Q3, with that?

Kurt Kuehn

Absolutely. Putting volume on an empty plane is just wonderful for margins.

Tom Kim - Goldman Sachs

Right. If I could just ask one last question. Just with regard to DHL, they came out mid last year suggesting some pretty aggressive expansion plans in Asia. Have you seen anything to that effect that suggests some changes in the pricing dynamics in that market?

Scott Davis

Pricing remains very competitive although we haven't seen any dramatic change in the basic relationship. It's rational but competitive and certainly cycles somewhat with capacity and demand imbalances. So thank you all for the call and we'll talk to you later.

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