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United Parcel Service, Inc. (NYSE:UPS)

F1Q10 Earnings Call

April 27, 2010; 8:30 am ET

Executives

Andy Dolny - VP IR

Scott Davis - CEO

Kurt Kuehn - CFO

Analysts

Gary Chase - Barclays Capital

Nathan Brochmann - William Blair & Company

Ken Hoexter - Bank of America/Merrill Lynch

Edward Wolfe - Wolfe Research

Robin Byde - HSBC Securities

Tom Wadewitz - JPMorgan

Scott Malat - Goldman Sachs

Benjamin Hartford - Robert W. Baird & Co.

Bill Greene - Morgan Stanley

Helane Becker - Jesup & Lamont Securities

Justin Yagerman - Deutsche Bank

Matt Brooklier - Piper Jaffray

Chris Ceraso - Credit Suisse

David Campbell - Thompson, Davis & Company

David Ross - Stifel, Nicolaus & Company

Operator

Good morning, my name is Robert, and I’ll be your conference facilitator today. At this time, I would to welcome everyone to the UPS Investor Relations First Quarter 2010 Earnings Conference Call.

All lines have been placed on mute to prevent any background noise and after the speakers’ remarks there will be a question-and-answer period. Please note, we will take one question and one follow-up question from each participant. Thank you. It is now my pleasure to turn the floor over to your host, Mr. Andy Dolny, Vice President of Investor Relations. Sir, the floor is yours.

Andy Dolny

Good morning, everyone. Thanks for joining us today. In a moment, Scott Davis, our CEO; and Kurt Kuehn, our CFO will discuss first quarter results and expectations going forward.

Before they begin, however, I’ll briefly 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 risk and uncertainties, which are described in detail in our 2009 Form 10-K report.

This report is available on the UPS Investor Relations website or from the Securities and Exchange Commission. Today's call is being webcast and will also be available on our Investor Relations website.

I want to remind you about three adjustments we made to first quarter results. A $98 million pre-tax restructuring charge related to the reorganization of the U.S. Domestic Package segment. A $38 million pre-tax loss on a sale of the supply chain business and a $76 million, non-cash charge to income tax expense resulting from a change in the tax filing status of a German subsidiary.

These charges reduced net income by $175 million and diluted earnings per share by $0.18. In addition in last years first quarter there was a $181 million aircraft impairment charge which resulted from the retirement of our DC-8 fleet. The after tax impact of this charge was a $116 million or $0.12 per share. In their remarks today Scott and Kurt will refer to UPS results excluding the impact of these charges.

Since we believe this is a more accurate picture of the company’s performance. A reconciliation of these adjustments to comparable GAAP measures is explained in the schedules that companied our earnings news releases this morning. The schedules are also available on the UPS Investors Relations website in the financial section.

In addition during the call we refer to free cash flow which is a non-GAAP financial measure. A Reconciliation is included in the news announcement this morning and his available on the UPS Investors Relations website. To begin our review of the quarter I will turn the program over to Scott for opening comments.

Scott Davis

Thanks Andy and good morning everyone. Last quarter I mentioned that UPS was well positioned to take advantage of improving global economic trends. That we have the ability to manage effectively, in response to changing market conditions. This quarter UPS started to prove it, economies around the world are showing signs of recovery. Experts are providing more upbeat forecasts then they were a few months ago.

Conditions are slowly starting to improve and UPS’ first quarter results illustrated our ability to take advantage of these trends.

In the quarter, UPS achieved better than expected growth in volume, revenue and profit. In particular, the International Package segment really shined. You’re seeing how our global product portfolio provides benefits to our customers and our share owners alike. Our strong management team quickly capitalized on this growth, while still controlling costs and we saw the operating leverage inherent in the UPS network.

Also in the quarter, two significant infrastructure projects came to fruition, each strategically enhancing in our network. We opened the second phase of our Worldport expansion ahead of schedule and under budget. This enables UPS to continue to reduce operations in regional air hubs and fly a larger more fuel-efficient aircraft.

In addition, we began operating our new intra-Asia air hub in Shenzhen, China. This hub allows UPS to better serve our customers by reducing time in transit for 100s of city pairs in the area. These projects required significant capital commitment and will enhance customer service, provide better access to international markets and improve efficiencies for UPS around the globe.

In February, the administration announced the National Export Initiative, which UPS strongly endorses. It has always been our firm belief that increasing global trade is the best way to stimulate economic recovery and to create jobs. We intend to work with the President’s team in any way we can on this new important endeavor. Since the beginning of the year, UPS has received wide ranging recognitions. The company was named most admired in our industry by Fortune’s, one of the top ten most referable companies by Forbes, one of the hundred best corporate citizens and one of the top ten global companies in Climate Innovation.

UPS was also recognized for our work with women and minority owned companies. Now while words are gratifying what’s important to us is the scope of what’s being recognized. These accolades are testaments to the UPS culture that benefits all of our stakeholders. They are also a testament to our people and I want to take the moment to commend UPSers around the world for their focus during the quarter. Our U.S domestic restructuring is well under way and the new regional and district structure is operational.

Everyone is doing a tremendous job, managing the business through these changes. Let me also recognize our European and Airline partners for the outstanding work they did over the last two weeks, in response to the challenges caused by the volcanic eruptions in Iceland. Our product portfolio and extensive European air and ground network enabled us to modify operating plans and limit customer inconvenience. This was a job well done. Now I’ll turn the program over Kurt to review the operations.

Kurt Kuehn

Thanks, Scott, and good morning. Well it’s certainly enjoyable to have a quarter like this one to discuss with you. Revenue was up 7%, operating profit up 31% and earnings per share up 37% with margin expansion in every segment. The better than expected results stem from stronger operating performance in each segment than we had anticipated, yield improvement and operating leverage across the enterprise.

I’m pleased with our ability to manage cost and increase productivity as volume began to increase. Compensation and benefit expense increased only 1.7%, while our consolidated volume was up 2.7%.

Now, let’s look at the segments, starting with the U.S. domestic package operations. Operating profit jumped 17% on a 2% revenue gain. This increase was driven by higher yields, stabilizing volume, network enhancement and good execution. As a result, operating margin was 9.3%, an increase of 120 basis points.

Our average daily volume increased less than 1%. This was the first quarter, since the end of ’07 with positive year-over-year growth. The increase in U.S. domestic volume was driven entirely by ground, outperforming the air products as expected. The 2% improvement in revenue per piece was the strongest, since the third quarter of 2008. It reflects retention of a greater portion of the general rate increase and higher fuel surcharges.

Base pricing was up in both air and ground and we expect this positive trend to continue through 2010, especially in our air products. Once again, our operations team demonstrated our ability to further optimize our networks by reducing direct labor hours, miles driven and block hours and this was accomplished while going through a significant restructuring within our U.S. operations.

In the quarter, UPS continued using technology to improve efficiency and provide even better customer service with the introduction of UPS Smart Pickup. This industry first application ensures that UPS drivers stop for packages only when a customer actually needs that service. The process is easy, automated and transparent for customer and driver alike and will eliminate an estimated 8 million miles of driving annually.

Let's turn now to the international business, where operating profit soared 45% to $427 million on an 18% increase in revenue. Operating profit for this segment approached our historical first quarter peak.

In the quarter, UPS experienced balance growth across all geographies and products. A combination of higher volumes from existing customers and new customer wins. Total average daily volume was up 18% with export volume increasing more than 9%. All major regions of the world experienced export volume improvements. Asia led the way up over 20% followed by the U.S. and Europe both of which showed strong year-over-year gains.

During the quarter, we also experienced the lengthening of our trade lanes as inter regional trade picked up. As evidence by the 37% volume increase in our Asia to Europe lane. Yields improved 5% reflecting firm pricing, positive currency impact and increased fuel surcharges. The 24% gain in non-U.S. domestic volumes was helped by our acquisition in Turkey last August.

However, organic growth was 13% powered by strength in our core European markets. This strong improvement was against the backdrop of a weak euro zone economy.

UPS’s presence in domestic markets outside the U.S. also enables many opportunities to gain export volume. In fact the substantial percent of our non-U.S. domestic customers also use UPS for their export needs, taking advantage of our broad portfolio.

International operating margins increased 310 basis points, 16.2%. This resulted from leverage due to increased volumes and benefits from network and productivity improvements implemented last year. Good control of both operating and non-operating costs produced leverage in our results.

Now for the Supply Chain & Freight segment. Revenue increased 14% and operating profit more than doubled, the Logistics business was the primary driver of the profit increase, logistics continued to experience strong growth and profitability gains in healthcare and high-tech.

During the quarter we ware proud that data monitor recognized UPS, as number one in Supply Chain outsourcing for 2009. This award validates the progress that we've made in building our unique Supply Chain management capabilities.

Boarding experienced strong tonnage increases although demand moderated slightly from the fourth quarter, the industry capacity constraints did lessen slightly resulting in sequential improvements in operating margin. We implemented revenue management plans in the quarter which will improve margins going forward.

On the LTL front, UPS freight remains committed to its strategy at targeted growth in the middle market. As a result revenue per 100 weight increased 10% and LTL revenue was up almost 6%. Even with modest declines in both shipments and tonnage. This business unit showed solid improvement over last year although it still operated a slight loss. We expect it to be profitable for the year.

Now, as I usually do I want to emphasize the very strong financial foundation that supports to UPS. In the quarter we generated $1.3 billion in free cash flow even after $630 million in accelerated pension contributions over last year. UPS also invested $280 million in capital expenditures paid dividends of 470 million, reflecting a 4.4% dividend increase and spent $260 million to repurchase over 4 million shares. Lastly we ended the quarter with 3.1 billion in cash and marketable securities.

Because of the strong first quarter and improvement in the global economic outlook we raised our expectations for earnings per share this year to a range of $3.05 to $3.30. This is a 32% to 43% increase over last year’s results.

The year-over-year change in earning should remain fairly consistent across each quarter, with the fourth quarter showing a lower increase due to a more challenging year-over-year comparison.

Looking at the segments, for the full year U.S. domestic average daily volume should improve gradually with ground out performing air. We expect yields to strengthen as the year progresses, resulting in significant margin expansion for 2010.

Keep in mind now as we continue with the U.S. restructuring we will incur additional costs for relocation and training. Most of which will occur during the second quarter, these items which are included in our guidance will negatively impact earrings by $0.03 to $0.05 in the quarter, constraining margin improvement somewhat.

In our international segment we anticipate UPS export volume to continue outpacing market growth and non- U.S. domestic growth should remain strong but remember we will lap the date of our Turkish acquisition in August.

We expect international operating profit to show strong growth and reflect typical seasonal patterns. Our supply chain and freight segment should generate gradual sequential improvement in operating margins.

With the full year margin of at least 5% on about 10% revenue growth, to summarize we had an excellent quarter in which we successfully transitioned from a recessionary to a recovery environment.

Going forward we’re determined to sustain the enhancements we’ve made to our cost structure. We will continue to invest for the future while remaining focused on disciplined profitable growth and we’re very confident that our diversified global portfolio will help us capitalize on the many growth opportunities ahead. Thanks for your attention, and now Scott and I would be happy to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Gary Chase from Barclays Capital.

Gary Chase - Barclays Capital

Kurt, when you were talking about the yield outlook and Domestic Package you noted base gains on the air side and I think the comment you made was, you expect those to continue through the reminder of the year and you said especially in air wondered if you could just elaborate a little bit on what you think is driving that?

Kurt Kuehn

Well, Gary clearly as you know the stabilizing our yields and rationalizing our pricing it’s been a big priority of ours and it’s an activity that’s well underway and we feel pretty confident in the results, you are starting to see some of the benefits of that.

We have also seen in our Next Day Air business some strengthening on the weights and typically our Next Day Air package business is one of the most economically sensitive. So it also should add to the top line yields, but were continuing with, a disciplined process of looking at customers and making sure were pricing per value and at the same time growing the business. So we feel pretty comfortable that the environment on pricing will remain rational and clearly we’re executing towards that.

Gary Chase - Barclays Capital

Then on the expense side, if we take a look at the expenses you reported in the quarter and I’m assuming that the $38 million loss on sales from SCS was in the other expense line. It looked very low for the quarter and just wondered if you could give us a sense of what drove that and if it’s sustainable looking forward at, are we on a new run rate?

Kurt Kuehn

We implemented a number of initiatives those last 18 months or so in response to the economic conditions and so, we do feel pretty good that our other expenses are in good shape. Depreciation and amortization is up a little bit as we operated Worldport with some of the investments we’ve got.

The big growth areas in general and our other costs are purchase transportation and fuel, which is one related to the lot of expense in our freight forwarding and the other just a commodity cost.

The other expenses has a lot of line items, if you take out the one-time events, it’s probably down about 8%, and that’s things like expense accounts claims as our network runs very efficiently supplies. It may not maintain at that level, but we do certainly intend to sustain the reductions we’ve made and control all those cost items, so that’s the balancing act that we’re managing right now.

Scott Davis

Yeah last year Gary that other, other expenses had that aircraft impairment in it too if you’d recall that $118 million?

Operator

Thank you our next question comes from the line of Nathan Brochmann from William Blair & Company. Please go ahead.

Nathan Brochmann - William Blair & Company

I wanted to talk a little bit, you’d mentioned particularly in the air international business talking about benefits from both new customers as well as existing customers. I was wondering if you can give us a little bit of flavor in terms of the balance between the two and kind of what you’re seeing particularly on the trends of the existing customer base?

Kurt Kuehn

We’ve been thrilled with the substantial growth we have really seen early across the globe and we’ve really had two big initiatives in our sales execution internationally. One is focused more on conversion sales, then perhaps in the past, we still remain a small player typically 10% to 15% share in most markets.

So there is tremendous upside for us to help customers migrate over to UPS and we have seen great momentum there. And then the other is to increase our share wallet the advantage of our broad integrated portfolio as customers can move up and down that portfolio and that’s we have also seen that happening as things begin to turn.

So even with the economies still suspect especially in Europe we are seeing very good organic growth on existing customers as they began to use a greater portion of our portfolio.

Nathan Brochmann - William Blair & Company

Great and also next question in terms of just talking about, you could talk about what fuel surcharges can of added into the total yield for the quarter and also how you think that might impact the ability to special line those price increases how that you mentioned earlier?

Kurt Kuehn

Yeah fuel surcharges were a modest benefit to revenue really on the P&L side there was no benefit actually slight headwind because of the increase in the commodity cost. It will be more substantial in Q2, because actually at this time last year there were zero surcharges on the air side, so there will be much more substantial comps in Q2. But right now with the surcharges in the single digit it really isn’t the significant impact on demand or customer push back. Clearly couple of years ago when things spiked then it became a much bigger deal in the overall actuation. But right now we think its things are pretty stable on that front.

Operator

Next will go to the line of Ken Hoexter from Bank of America/Merrill Lynch. Please go ahead.

Ken Hoexter - Bank of America/Merrill Lynch

Kurt can you talk a bit about the maybe the pent up use of express and now that you’ve talked a bit about the transition. What levels could we see that express tampered down while you start to see that growth in the ground again?

Kurt Kuehn

Right now we are seeing some trade up, especially in our Next Day package environment, actually our Next Day letters is slightly negative things like refinancing and some of those activities are down. So, on the product side the express package we are seeing in pretty good growth and that we think as part of perhaps the beginning of some restocking and some increased urgency. So we feel that that will remain performing about the average of the product the package will.

The ground side is a little more coincidental we have seen that pickup sequentially, but it should move more in line with your overall economy.

Ken Hoexter - Bank of America/Merrill Lynch

I'm sorry maybe I didn't see it clear enough, because it sounds like you're saying that it was up, but Next Day was down almost 4%. Right, so?

Kurt Kuehn

The package performed much better the majority of that declined really was the letter impact with things like refinancing and some of the financial industry down.

Ken Hoexter - Bank of America/Merrill Lynch

Understood. My follow up question would be on the LTL side. Your yields were up your volumes were down in a period where you would have anticipated the ability to take significant share. Can you, but you also know the profitability was or would be there. Can you talk a bit about the strategy and how much volumes you can see in that market or what do you turned away, talk a bit about your strategy there?

Kurt Kuehn

Ken, we’ve been pretty consistent, I think following a very disciplined strategy of targeting what we consider to be the sweet spot of UPS, which is the broad middle segment of customers with ease of use technology access and so what you’re seeing is a mix shift in which the smaller customers are growing and some of the larger ones perhaps are not.

So yes, we are very proud of the revenue per 100 weight of 9.5% positive even with fuel surcharge, it’s still substantially positive. So we feel very comfortable this is not a time to aggressively gain share and as you’ve seen most of the players suffer from that.

So we’re going remain focused on the knitting, we think we’ve got a superior value proposition. We find the ability for customers to move seamlessly between our ground our 100 weight and our LTL services as a real value and allows them to save money. So we’re being careful in this industry and there’s risk if you get to aggressive.

Scott Davis

Yeah, certainly Ken the LTL industry has struggled and it’s still struggling. We see sings of it starting to stabilize and starting to improve, but we’re going to stay with rationale pricing and wait those markets start to stabilize.

Operator

Thank you and our next question comes from the line of Edward Wolfe from Wolfe Research. Please go ahead.

Edward Wolfe - Wolfe Research

Thanks, good morning. Kurt, just back to the last question, if I look at domestic air volumes are down 2.2 and they were up 3.5 and 1.2 in prior two quarters year-over-year. I know you are saying on the letter side, but did something change because it feels like the market if anything is getting less worse, maybe you’re getting more disciplined in calling some of that DHL business out or how do we think about that?

Kurt Kuehn

Well, Ed I wouldn’t put too finer point on one quarter data point, I mean we did successfully grow last year and gained share. We are being a little more disciplined. So on the increment, there may be some accounts that come or go as we look at that. But we feel very good about our positioning in the air market. We have lapped the DHL departure, so we do expect the overall air business to under perform the ground. So it’s a combination I think of yield management and also just the overlapping of the tailwind from the DHL departure.

Edward Wolfe - Wolfe Research

Okay, and share repurchases you’ve talked about having less CapEx and more free cash can you talk a little bit about the timing of when you might get more aggressive on buying back stock?

Kurt Kuehn

Yes, I mean our overall goal for this year is to buy enough shared to offset dilution. We did accelerate a little bit of purchases end of the first quarter and bought four little over 4 million shares which is above our burn rate but our goal still for this year anyway is basically to purchase at that level.

I think as we look towards the end of the year, clearly if the momentum continues the cash flow were generating and our earnings are increasing at a substantial rate and we clearly will revisit that policy. So it would be something we’d look towards the end of the year and perhaps get guidance in 2011.

Scott Davis

Both share repurchase Ed and dividend policy and reinvesting the business will balance all those as we move forward, but the cash flow outlook does look extremely good.

Operator

Thank you we will now go to the line of Robin Byde from HSBC Securities.

Robin Byde - HSBC Securities

Just on this issue of purchase transport patient costs, these were up 24% year-on-year. How much of this cost is that 540 related and what are you seeing in April, are buying rates starting to soften again after the mini boost?

Kurt Kuehn

Yes, the purchase transportation clearly the supply chain and freight is the majority of that 70% to 80%, probably and that’s the combination of increased tonnage and the substantial increase in buy rates as you mentioned Robin. We have seen rates stabilize I guess so at least some of the big spike we saw at the end of the fourth quarter has moderated, but I mean it’s still a very healthy market right now and we’re seeing the benefits of that on our asset based side and we’re managing through it on a forwarding side. So we aren’t really seeing a decline in rates and clearly the disruptions in Europe, perhaps of greater blimp in the short-term anyway on that front also, but we do expect the rates to remain fairly strong this year.

Scott Davis

Yes, the other side of the equation, Robin. We are doing a better job just getting the rates on the sales side and forwarding. So the other side of the equation, we’re seeing some strengthening also.

Robin Byde - HSBC Securities

So the balance is getting itself out?

Scott Davis

That’s correct.

Operator

Next moving to the line of Tom Wadewitz from JPMorgan. Please go ahead.

Tom Wadewitz - JPMorgan

I wanted to ask a question about, I guess the demand outlook. It seems that the transport data points have been pretty firm in first quarter and particularly an acceleration in March and a good outlook in April from a lot of the other transports. Wondering if you could talk about maybe the progression through the quarter and if you’re seeing a similar trend that would lead you to more optimism about the Domestic Package volume growth in second quarter?

Kurt Kuehn

Well as always Tom, there were a few blips during the quarter that make the trends a little harder to separate out, February had some fairly severe weather, especially in the Northeast that depressed it, some of that rolled into March. In general we’ve seen a gradual improvement over the course of the quarter and really that momentum has continued into April, but it isn’t a I wouldn’t call it a dramatic improvement. I think it’s just a slow recovery and I’m speaking primarily in the U.S. So we are seeing things firm, but at a fairly measured pace.

Scott Davis

In general, Tom, in the U.S., we’re still not in a robust economy. It’s getting better, you’re probably going to see 2.5% year-over-year GDP in the first quarter and probably similar on the IP side, but for the year were pretty optimistic, we think the industrial production should grow over 4%. So it should improve as the year goes on.

Kurt Kuehn

Conversely we have seen very strong results on the global trade side, our shipments out of Asia were up over 20% this quarter and exports for both U.S. and Europe remain strong, so we are very pleased to see the global trade linkage. I mentioned the dramatic increase almost 40% in Asia to Europe, so it’s good to see those lanes coming back strong, so we are going to adapt our network and be where the action is on those things and you’ve seen I think pretty dramatic demonstration of our ability to capitalize on this improving growth both within our domestic operations outside the U.S. and in our export operations.

Tom Wadewitz - JPMorgan

Okay, great and I guess the follow up on the yield side I know there are a number of moving parts in your yields which sometimes makes it a little trickier to kind of figure out what base price is doing. Can you give any sense on the air express yields in particular what was the greatest impact in terms of base price, fuel surcharge and mix?

Kurt Kuehn

Yeah, we are seeing positive base price trends on the both the air and the ground side so that is a improvement certainly on both and most notably on the air side. The weight was up modestly on the next day express I talked to that and that’s positive. So that contributed somewhat. And then fuel surcharge gave a bit of a boost probably between 1%, 1.5% something like that on the net fuel surcharge for the air.

We think all three of those trends, Tom, will continue stronger into the year. We think our revenue management efforts will continue to pay dividends we think weight will improve in the air and also we expect to see more weight on the ground and we have been very pleased with our progress on the revenue management side, so that’s why we feel pretty bullish on domestic pricing across all the products.

Operator

Thank you, we have a question now from the line of Scott Malat from Goldman Sachs please go ahead.

Scott Malat - Goldman Sachs

Good morning thanks, just if we take a step back it just seems that many are surprised you are able to leverage improving volumes as well as you are? Can you just help us put into perspective this cycle may be versus some historical where may be incremental margins might not have been a strong as you are seeing here?

Kurt Kuehn

Well I think it’s a couple of factors. I think frankly one is that we took a bigger hit this year, the recession we are coming out of was by far more severe than any in recent history. So the degree of the penalty was substantial and we also feel that as a result of that there is more bounce back. Also I think we have worked extremely hard to find all the areas of refinement we can in the network.

We’ve got new technology in place operationally, we’ve got new assets in place, the Worldport has done substantial improvements on our network and a very strong focus across the company. So we feel pretty confident that with a little bit of tailwind from the economy and our operational changes we’ll see great benefit.

Scott Davis

And you definitely saw in international, I mean clearly we showed tremendous leverage in the quarter nearing peak, first quarter of operating earnings in the first quarter so that’s great improvement domestically in the U.S. As I said earlier we’ve not seen that robust economy, we didn’t see a lot of volume growth. So I got some benefit on average wage rates that they will get a lot more as we get into bigger growth, so if IP does grow at 4% which leads to better domestic volume you’ll see lower effective wage rate increases which will obviously lead to better domestic margins down the road.

Scott Malat - Goldman Sachs

That’s helpful thanks, just the other one that I had was just on Asian regulatory, just been a number of signs that China policy is making it more difficult for foreign companies to work in China. Seems like the import, export business to be the one that the Chinese government would be less apt to over regulate, but can you talk about working in and around China, what are your expectations for regulatory environment?

Scott Davis

I think that it really has not changed much in the way in import and export. I think that we have had a good relationship working with the Chinese government in that area, as you’re seeing by the volumes that have been generated in express industry, I think all the multinationals are doing pretty well.

Kurt talked about our strong growth of 20% in the last quarter, it’s a little more difficult when you compete domestically, I think that there is more protectionism, if you will, when you compete within the borders of China, and that’s going to be a challenge. We talked about in the past we are going to go about that deliberately and patiently, but we will compete domestically down the road.

Operator

Next we will go to the line of Jon Langenfeld from Robert W. Baird & Co.

Benjamin Hartford - Robert W. Baird & Co.

Hi, this is Ben Hartford in for Jon. Wondering if we could just conceptually talk about the operating leverage this quarter, the way that you guys look at it. What was the primary driver that split evenly between pure volume growth pricing and the cost takeouts or did one have a greater impact this quarter than the other?

Kurt Kuehn

Certainly, this story is a little different in different business units. I think, for international it is, showing what strong volume growth does through a efficiently set up network and that’s where we saw really the breakthrough results there. Domestically, there was not as much of a tailwind on the volume side, so we made up for it with productivity and network refinements.

Our overall direct labor hours were down 4%, and that’s again slightly improved volumes. Our miles driven with our network alignments were down 3% and we had almost a 10% reduction in block hours in our domestic network. So a lot of changes, a lot of tightening and so we’re seeing substantial margin improvement even without the tailwind of substantial volume growth, And as Scott mentioned if the U.S. economy continues to firm then that just gives us another tailwind and we are able to leverage some other economies like the wage rate improvement in the growing environment.

Benjamin Hartford - Robert W. Baird & Co.

On the domestic side, I think you eluded to, you expect the shipping rates to improve through the balance of the year, was there a meaningful change during the quarter did we see a trend either way in shipment weights?

Kurt Kuehn

Really, the story for the quarter was stabilizing weights on the ground and firming rates in our express package environment. So we do expect that the ground will begin to show positive growth sequentially going forward.

Operator

Thank you, we have a question now from the line Bill Greene from Morgan Stanley.

Bill Greene - Morgan Stanley

Yeah, good morning. I just have a couple of questions on data points. Domestic growth in B2C, how much was that, how much was UPS basic up as well?

Kurt Kuehn

B2C modestly outperformed B2B. Bill, actually most notable as been the recovery of B2B and actually that’s one of the drivers of improved margins within our domestic business for the quarter.

Bill Greene - Morgan Stanley

Sorry, but you said B2C was up more then B2B, nonetheless.

Kurt Kuehn

Yeah, historically it has been by a substantial amount; that gap narrowed this quarter. So the combination of basic and our traditional residential services were up above average for the ground but the GAAP has in some cases been double digit and it was much tighter this quarter, so we are continuing to see modest growth on our B2C. That business is very well positioned, but more exciting for us is the commercial volume showing more signs of life.

Bill Greene - Morgan Stanley

When you talk to your customers about where their inventory levels are, do you sense that they are far along in their efforts to restock or where do you think they are in that process?

Scott Davis

Bill, this is Scott. I think there is quite a ways to go still. They are in the early stages of restocking and I think that just based on demand and based on some, we’re seeing that people are urgent to get shipments there. We’re seeing a little bit more demand on the express side. So I think we’ve got ways to go; we are in the early stages of restocking.

Operator

Next we will go to the line of Helane Becker from Jesup & Lamont Securities. Please go ahead.

Helane Becker - Jesup & Lamont Securities

Thank you very much, operator. Thanks gentlemen for taking my question. I have two very unrelated questions, one I was wondering if you could just comment on the volcanic ash in the closings in Europe, I didn’t see anything in what you put out this morning about that, so maybe you could comment on that.

And my other question is completely unrelated to that. Yesterday, the Wall Street Journal had an article or an editorial about Brown Bailout, with your competitor Brown Bailout. I was wondering if you could just comment on that at all and kind of your thoughts with respect to your position on what’s going on with FedEx being so aggressive in trying to get that provision changed? Thank you.

Scott Davis

Helane, this is Scott, I will start up with the volcanic ash and clearly the period from April 14 to April 20 was quite turbulent as we all know. We were able to continue to provide pick up and delivery service and re-routed open flights to other parts of Europe that we’re opened during that period.

And we really are blessed with having an extensive European ground network that allowed us to really continue to provide transporter domestic service with really minimal delays to our customers. April 21, we actually opened up our Cologne hub and actually had unprecedented volumes, above last year’s peak as you would expect trying to catch up for the period where you couldn’t get into and out of Europe.

At this point in time, we really are now caught up and we’re back on track. So I think we’ve done a very good job, our customers are pleased with the service offerings being able to help through to this period, but it was quite turbulent, to say the least. The actual financial impact is too early to tell, we think it’s somewhat immaterial to the company, but it's how much volume is lost, how much production was lost during that period of time, I think it’s going to take us a few weeks to figure that out and so we’ll talk about that in the next earnings call.

The second question, the RLA issue, I guess let me start out by saying UPS supports the passage of the FAA reauthorization bills quickly as they possibly can. This bill is important to the entire country. As you know it provides us funding for more than 150,000 jobs and also much needed safety in aviation system modernization initiatives.

So it's really important that we get this thing done for the country. Regarding the RLA amendment, I think this audience clearly knows the two companies, knows UPS, knows Federal Express, and knows that our companies provide similar services and provide services to similar customers and do a lot of the same things. It’s actually illogical that the two companies should be governed under different labor laws. Our point here clearly is that the expressed divers do the same jobs for both companies, they should be governed under the same law.

What will happen, what’ll be the outcome of this legislation, it’s still not clear whether it is going to a conference committee or will be handled differently through Congress, but certainly we are optimistic we will get this thing done but most important is that we get this FAA reauthorization bill passed.

Operator

Next we will go to the line of Justin Yagerman from Deutsche Bank. Please go ahead.

Justin Yagerman - Deutsche Bank

I guess the first question is on domestic restructuring. You talked a little bit about the potential impacts of the second quarter, but I was wondering, as we look out over the year whether there are other significant costs that we should be thinking about, as we move through the remainder of, this or does it basically curtail at the end of the second quarter?

Kurt Kuehn

Well, Justin, clearly the second quarter will be the big predominant expense. That’s really the time at which the vast majority of our people that we have repositioned will be relocating substantial amounts of retraining expenses and other realignments and facilities changes.

So that’s why we really pulled out second quarter and said that it would be about a $0.03 to $0.05 headwind in the second quarter. Having said that though, we, following that, the cost will begin to taper down and will not be as material and would likely not be called out it all and the savings for the third and fourth quarter will significantly offset any remaining expenses.

So it is a big deal for us in Q2. We were very pleased though with the fairly seamless process that happened in Q1, that was one of our areas of concern about our ability to operate through Q1 effectively and I know that there were some discussions about our guidance in Q1, so we have been thrilled with how smooth that went, how well our operations continued even with this major change going.

So, Q2 will be the time that we get the majority of the knitting done and the expenses and then after that we will be in good shape going forward and we do expect for 2011 that it will give us at least $0.10 share tailwind for our domestic business.

Justin Yagerman - Deutsche Bank

Alright and then looking at the LTL yield, obviously an impressive number given the environment, but just curious if you could comment around, weight per shipment was down 1.5%. So obviously that was somewhat helpful to the yield number and I am just curious you kind of alluded to the ability for customers to trade around between 100 weight product and your LTL product, so how much of domestic ground do you think is kind of making its way on the lighter end.

I’m on the heavier end of domestic ground and on the lighter end of LTL into the LTL network and may be providing some of that benefit there.

Kurt Kuehn

I don’t you know it moves both ways. Frankly, that’s the whole point as it gives the customer the ability to choose, so as you look at the very light end of the LTL business those shipments tend to not be very profitable or effective and LTL and there are much better served in package and conversely as you get shipments 500 pounds or more. In the package it frequently is better to move those in the palate. So not a real big pull either direction, I mean the issue of the yield is primarily that we are targeting small to midsize customers that we’ve been very disciplined frankly not chasing the market share grab that has created havoc in the industry and that we are creating some very substantial value, guaranteed shipments of superb visibility, integrated shipping systems. We really think we’re building a very high value process and it’s great to see the validation of it.

Operator

Next we’ll go to line on Matt Brooklier from Piper Jaffray. Please go ahead.

Matt Brooklier - Piper Jaffray

Hi, thanks Good morning guys. My question pertains to on the international package division and the operating margins there, if we look at the continuing out margin and international package in the first quarter, it was actually down very modestly from Fourth quarter and it looks like and it feels like volumes actually strengthened throughout first quarter. I was wondering if there was anything, any incremental cost that you guys incurred during first quarter potentially may be adding some flights into the network as volume strengthened or anything incremental from a cost side that would have hindered you know you guys doing a better margin than international package during first quarter versus fourth quarter?

Kurt Kuehn

So the biggest issue is just the normal seasonal fluctuation, I mean Q1 is not usually your bang up quarter for transportation and international is the same. So I would factor that out and I think comparing quarters-to-quarters, actually Q1 was higher performance as I think Scott mentioned, we got very close to peak operating profits in Q1, compared that to our strongest period, so we feel very good about that.

We did indeed add in some block hours, I think as our International block hours are up something like 8% over last year at this time, so that’s a good thing, that was our affiliate revenue and we’re happy to do it.

It’s a combination of some routine routes added back in and also a significant number of extra segments. As we talked about the crunch on demand for air cargo, fortunately, we’ve been able to take advantage of that.

Scott Davis

In fourth quarter has more dramatic business, the capacity squeeze out of Asia was real dramatic in November and December, which obviously helped the rates tremendously.

Matt Brooklier - Piper Jaffray

Just a follow-up question, what are your thoughts in terms of adding capacity with International Packages network, specifically on the export side going forward?

Scott Davis

We’re happy to do it when demand justifies, that’s part of this disciplined profitable growth strategy, we’ve got the assets if needed, we’re continuing to invest in the business and there is no better return for investors than a plane full of our international volume. On the other hand, we’re not going to get too far ahead of the game. So, we’ll continue our controlled approach growing as we see fit.

Operator

And we have a question now from the line of Chris Ceraso from Credit Suisse. Please go ahead.

Chris Ceraso - Credit Suisse

Good morning. This is Alison Landry in for Chris. I just had a couple of questions related to the implied year-over-year profit improvement for this year. How much of the profit growth or the incremental operating margins is related to the cost saving efforts as opposed to strengthening volume in yields?

Kurt Kuehn

I mean both of those are piece of it, although if have to pick one, I think it has more to do with the operational changes we’ve made during the declining time and now that the economy has at least stabilized, you’re starting to see some of the benefits.

So domestically, it’s clearly a story of operating leverage and the benefits of the big changes we’ve made and frankly we’re waiting for the tailwind of the economy to kick in. We’re looking for modest growth over the course of the year. So that is not betting on the come.

Internationally, it’s a positive. It’s a story of great operating efficiency and tremendous boost from both the economy and share gain across the globe. So we feel very positive, frankly in all of our segments. As you look across every segment of UPS right now, we’ve got good potential for improvements. The domestic business is seeing the benefits of improved productivity and streamlining the international businesses, enjoying strong growth.

Our forwarding business took a little bit of a hit in Q4 with the demand crunch, but we have stabilized that to done some revenue management and that’s in good shape. Our Logistics group is showing great momentum and even the UPS freight, which is in a very tough environment is showing substantial improvements year-over-year and profitability and we do expected it to be profitable this year even with the extreme challenges across that industry.

So it’s a combination of improving trends or at least lack of economic headwinds and a lot of hard work within the company.

Alison Landry

Okay and then I guess, my follow-up would be just to that point with given the network, restructuring and cost productivities, where do you see long-term consolidated operating margins during say in 2011 or 2012? Where do you guys think you can get there?

Kurt Kuehn

Yes, we are not ready to layout a hard forecast on that I mean it depends on certainly the shape of the recovery is there a new normal and economic activity were still holding back a little bit on that clearly our international is getting back closer to peak margins very quickly as we said at least our peak our earnings in the Q1 were close to our peak earnings.

Margins on international we’ll see were growing our domestic business internationally much more rapid. So the goal isn’t margins it’s maximizing operating profit, but.

Scott Davis

Alison, so far to say better.

Kurt Kuehn

But, were working hard to make sure we are taking full advantage of the environment that we’re in.

Operator

Our next question comes from the line of David Campbell from Thompson, Davis & Company. Please go ahead.

David Campbell - Thompson, Davis & Company

I just wanted to ask you about $0.03 to $0.05 charge in the second quarter that you mentioned. The first quarter you have the signal doubt the charge for voluntary retirement, severance payments and so forth. But I take it the, in second quarter you will not consider that to be non-recurring charge you want separate that out?

Kurt Kuehn

Absolutely no that’s just part of the operating earnings from here because that relates to repositioning active employees that’s not part of our one time exclusion the charges we took in the first quarter related to are enhance retirement offers and the costs related to employee benefits to a fleet the company maybe a little earlier than they planned but going forward from here it will all be kept into our guidance and operations.

David Campbell - Thompson, Davis & Company

Okay and the same question is then in the third and fourth quarter, some of these costs will continue but you feel that will be offset by savings from the repositioning?

Kurt Kuehn

The lions share of the reloads will be completed in the second quarter. So there will still be some expenses but it gets to be minimal and really not material so we’ll stop highlighting that as a head wind once we get through Q2 and talk more about the benefits and savings of it.

Operator

And our last question will come from the line of David Ross, Stifel, Nicolaus & Company, please go ahead.

David Ross - Stifel, Nicolaus & Company

Just have a question on the Worldport expansion you talked about increasing capacity 19% on the south side and you reduced I guess the slice in the network byproject and regional hubs loading up bigger air craft going into that a Worldport, can you talk about kind of where that leaves the network in terms of the capacity utilization whether there is I guess how much room is left to expand before you have to go back into those regional hubs and how for full those bigger planes are getting into that a little more.

Kurt Kuehn

Yeah we think it’s going to be a long time before we would need to use the regional hubs. We’ve added substantial amount of capacity reduce in the number air craft in the air improves our availability it improves the efficiency, so borrowing multiple years of very strong growth we’ve got a decent amount of time to enjoy this current capability in the network so this is not a short term benefit by any means and we’re continuing to find ways to better lever it and take advantage of it, so its been really a flawless opening and operated well through teak on about half the added capacity and then in the quarter then we brought it fully up to speed and now its able to do for 400,000 pieces an hour which is just tremendous and we did, spend over $900 million for this expansion but those benefits paid back very quickly with reduced air craft purchases and with reduced operating expenses in air so that’s been a great investment for us even in the midst of the worst procession in any of our carriers.

David Ross - Stifel, Nicolaus & Company

Maybe as new larger aircraft are maybe more fuel efficient reducing number of black hours and so you are already getting savings from using fewer aircrafts and those aircrafts still have a good amount of room to go on capacity in terms of adding more packages?

Kurt Kuehn

Absolutely, and we do have some additional 767s coming online over the next three to four years that will naturally slide in and scale up against some of our existing 75s and A300s. So it’s a very seamless and productive up scaling as growth comes in.

Scott Davis

Effective on fuel and certainly carbon efficient.

Operator

And ladies and gentlemen that concludes our question-and-answer for today. Now, I will turn the program back over to Andy.

Andrew Dolny

Yeah, I’m going to turn it over to Scott for some closing comments.

Scott Davis

Thanks, Andy. Let me say that I’m enthusiastic about UPS’s future. We made the right decisions and took the right actions last year to capitalize in today’s improving economic conditions. We’re on the right path, there’s certainly room for constructive dissatisfaction.

Still so much more we can accomplish. 2010 will be a better year for customers, for employers and for investors. It is only the first step in our recovery. Thanks so much for joining us today.

Operator

This concludes the UPS first quarter earnings call.

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Source: United Parcel Service, Inc. F1Q 2010 Earnings Call Transcript
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