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United Parcel Service Inc. (NYSE:UPS)

Q3 2007 Earnings Call

October 23, 2007 8:30 am ET

Executives

Andy Dolny - IR

Mike Eskew - CEO

Scott Davis - CFO

Analysts

Gary Chase - Lehman Brothers

Jon Langenfeld - Robert W. Baird

William Greene - Morgan Stanley

Tom Wadewitz – JP Morgan

Edward Wolfe - Bear Stearns

Scott Flowers - Banc of America Securities

Jason Seidl - Credit Suisse

Ken Hoexter - Merrill Lynch

David Ross - Stifel Nicolaus

David Campbell - Thompson Davis

John Mims - BB&T Capital Markets

Operator

Welcome to the UPS Investor Relations third quarter 2007 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Mr. Andy Dolny, Vice President of Investor Relations. Sir, the floor is yours.

Andy Dolny

Good morning, everyone and welcome to our earnings call. As you probably know, this is my first as Vice President of Investor Relations at UPS. Over the next few months, I'm looking forward getting to know all of you. Shortly Mike Eskew, our CEO, and Scott Davis, our CFO will discuss third quarter results and our future expectations.

Before they begin, let me cover 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 2006 Form 10-K and 2007 Form 10-Q reports. These reports are 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'm sure you've noticed, there was a charge in the quarter for restructuring the repair business and exiting a specialized road business in France. The activities of the road business were neither scalable nor core to our supply chain services. The pre-tax charge for the quarter was $46 million, or about $0.03 per diluted share.

In their remarks today, Mike and Scott will focus on results from operations excluding this charge, since we believe these results more accurately reflect UPS' true performance in the quarter.

Now to begin our review, I'll turn the program over to Mike.

Mike Eskew

Thank you, Andy and good morning, everyone. To most of you, the third quarter of 2007 was just another three months in the annual business cycle. However to us at UPS, it was a milestone. On August 28th, we celebrated our 100th anniversary. It was a time for us to reflect on our history and heritage, our successes and failures, our challenges and transformations. But more than that, it was a time for reinvigoration; to imagine where we will go from this threshold, where innovation might take us over the next 100 years. Wherever that might be, I know we're prepared, because the principles on which this company was founded will continue to guide us, whatever the future brings.

The third quarter was historic, not only for our centennial celebration, but also for a first in our 80-year history with the Teamsters, reaching a handshake agreement well ahead of the July 31, 2008 expiration date of our current contract. This is a testament to a lot of hard work by UPS and the Teamster leadership.

This is a fair contract from many perspectives. It enables UPS to adapt to the changing business environment; to respond to the needs of our customers; to aggressively grow the business; and to continue to create opportunities for our people. The contract obviously includes increases to wages, healthcare and pension plans. It also allows UPS to withdrawal from the multi-employer pension plan and establish a single employer plan for this group of employees. UPS will make a one-time, pre-tax payment of $6.1 billion in connection with this withdrawal. The net after tax amount will be approximately $3.9 billion. We'll make this payment in the fourth quarter upon ratification of the contract.

The ratification process has begun, and should conclude in December. If ratified, the new contract will run until July 31, 2013. Both UPS and the Teamsters leadership wholeheartedly endorse the contract and we're confident the majority of our employees will support it as well.

Turning now to another bright spot in the quarter, a year ago I explained the issues surrounding the supply chain and freight segment. I outlined the efforts to address the problems in each of these business units. We needed to make some tough, but necessary, decisions and I'm pleased to say today that the results speak for themselves. For the first nine months of 2007, this segment has improved operating profit by almost $250 million. All of the UPSers involved in making this happen are to be complimented for a job well done.

There is, of course, more to do to accelerate revenue growth, but clearly we're headed in the right direction, and I'm encouraged by the progress that's been made.

As you know a week ago, I announced that on December 31 I'll retire from the position of Chairman and CEO of UPS. In addition to introducing Scott as my successor, we also shared some changes in our management committee. I've been working with the board on this transition for over a year.

The announcement highlighted one thing very clearly: the strength of UPS is in its people. We have great bench strength with capable managers at the ready to take on positions of increased responsibility. I'm confident this talented senior management team will lead UPS to even greater heights than we've seen so far. These are exciting times to be at UPS.

I also want to personally thank all UPSers, our customers and shareholders for their support. It's been an honor for me to know and work with you throughout my career, and in particular in the last six years.

Now I'll turn the program over to Scott for a review of the quarter and insights into the remainder of the year.

Scott Davis

Good morning, everyone. UPS turned in strong results for the third quarter. Earnings per share were up over 9%. Operating profit increased more than 11%, with all three segments showing profit improvement. Consolidated operating margin improved 98 basis points to 14.4%.

Before I discuss the results, let me share our thoughts on the U.S. small package market, which has been growing slower than the economy. This was again the case in the third quarter. We believe however that market trends are starting to improve slowly. Economists estimate that industrial production numbers bottomed out in the third quarter and will begin recovering in the fourth.

Offsetting this somewhat is consumer spending. Retail sales growth is expected to remain weak and is a wildcard going into the holiday shipping season. Looking at the economy, experts anticipate GDP to grow about 2% for the year with industrial production about the same. It remains to be seen how quickly the U.S. economy will return to long-term growth trends.

So much for the economy; now let's get to our results, starting with U.S. package operations. As we told you, we expected a slight increase in package volume this quarter. In fact, volume increased almost 1% with gains in ground volume more than offsetting the slight decline in air. Revenue per piece remained firm. Ground revenue per piece was up 2.4%, with a slight negative fuel surcharge comparison. Air revenue per piece was down; however, adjusting for the year-over-year change in fuel surcharge, air revenue per piece actually improved.

Our U.S. operations team adjusted well to the low volume growth levels, as evidenced by the segment's 16.3% operating margin. In this type of challenging operating environment, cost control becomes particularly important. We did a good job of controlling semi-variable costs, which make up 30% to 40% of our domestic costs structure. We focused on reducing costs in all areas of discretionary spending.

Similar to last year, domestic results were positively impacted by our safety efforts and their effects on workers compensation expense. In the quarter we realized a year-over-year improvement in workers compensation expense of about $30 million. Our people have made major strides in this area. Work-related injuries have declined by about 50% since 2002. UPSers are to be congratulated for taking health and safety so seriously in their day-to-day activities.

We're also very pleased with across-the-board service improvements in the quarter, including gains in industry leading on-time deliveries. Such improvements show up in improved revenue and variable cost savings and filter through to the bottom line. At UPS, the pursuit of cost improvements is always a focus. This mindset will remain unchanged.

Now for our international business. Once again, this segment turned in good results. Operating profit increased over 10% to $428 million, with operating margin a healthy 16.9%. Export volume remains strong, well ahead of market growth rates. Asia and Europe reported double-digit volume increases, and U.S. export volume increased at a mid single-digit rate.

During the quarter, UPS put up another around-the-world flight, which supports our long-term growth plans. This flight, along with higher fuel expense, caused a slight decline in the international operating margin.

In the quarter, UPS also received the authority to operate six daily flights between the U.S. and Nagoya, Japan, in addition to our daily service to Tokyo and Osaka. Nagoya offers UPS significant opportunities to continue expanding our business in Asia. We will connect these flights to our new air hub in Shanghai on which we began construction in the quarter. The new hub will link all of China to our international network with direct service across the globe.

Just after the quarter ended, UPS introduced two industry firsts for international shippers: paperless invoice and international returns. To be launched in January, these new products will make it easier for our customers to expand their businesses to new markets around the world.

Now for the supply chain and freight segment. As Mike said, we're very pleased that this segment reported a profit increase of $117 million in the quarter and approximately $250 million year-to-date. Third quarter profits significantly improved in each of the main business units: forwarding, logistics and freight. Forwarding and logistics increased revenue 4.7%. The forwarding operations are beginning to show results from enhanced revenue management, improved asset utilization and better customer service.

In particular, international air freight posted volume and revenue gains while improving yields and profit. Our air forwarding volumes are now approaching market growth rates and we're confident that this trend will continue.

Logistics also performed well as a result of revenue management, cost reduction initiatives and selective targeting of new accounts.

UPS freight posted shipment, revenue and profit gains in a very difficult LTL environment. Shipments were up over 13%, continuing three quarters of accelerating volume growth. LTL revenue increased over 12% to $521 million with regional, interregional and long haul each showing double-digit gains. 60% of revenue growth is from existing UPS customers with the remainder coming from new customers who are attracted by our value proposition focused on improved reliability and technology.

In addition, increasing numbers of customers are using both UPS small package and freight shipment capabilities. We anticipate such traction will continue as we offer freight services to more of our small package customers. We're quite pleased with the turnaround in this segment. As we move forward, our focus is on growing top line revenue with improving profitability.

Before I talk about our outlook for the rest of the year, I want to review our financial position. For the first nine months, UPS generated over $5.2 billion in cash from operations, invested $2 billion in CapEx, spent $2 billion to repurchase 27.9 million shares, paid dividends of $1.7 billion, and still ended the first nine months with $2 billion in cash and investments.

Through the end of the quarter, free cash flow exceeded $3.1 billion. After the Teamster contract is ratified, we will initially fund our $6.1 billion withdrawal payment to the Central State's pension plan primarily through commercial paper. To accommodate the borrowing, we will increase our authorization for the commercial paper program and enter into an additional backup credit facility. We anticipate that a significant portion of the commercial paper will be replaced with longer maturity debt. Even after this payment, UPS will clearly still be in a financially strong position, with the ability to adapt to changing conditions and opportunities.

Now for our outlook on the fourth quarter. We expect domestic volume to increase, but it will be the slowest fourth quarter growth in the last four years. This stems from what we anticipate will be only a modest increase in retail sales. Pricing should remain firm, and as always, we intend to operate very effectively.

Once again, we expect our international business to post good results. Export volume growth should be strong, approximately 10%, with firm pricing and mid-teens profit improvement. The supply chain and freight segment should make more progress in the fourth quarter. For the year, operating margin in this segment should be around 4%, up from the original guidance we gave at the beginning of 2007.

For the full year, we have adjusted our planned CapEx down to $2.9 billion from the $3.1 billion originally forecasted. In addition, we expect to deliver adjusted earnings per share for the year between $4.13 and $4.19, in the middle of the range we had set at the beginning of 2007.

UPS has a 100-year history of managing well through all kinds of economic scenarios. We expect this one will be no different. The steps we're taking now -- cost containment, service improvements, new products -- will result in a stronger organization, ready to capitalize on opportunities that emerge as the U.S. economy strengthens.

Before we take your questions, I want to tell you how much I've enjoyed working with you as UPS' Chief Financial Officer. In addition, I want to thank Mike for his vision and leadership of the company. I take the reigns from his capable hands at an exciting time, and I'm humbled by the confidence he and the board of directors have shown by giving me this new responsibility.

Now we'd be happy to answer your questions.

Question-and-Answer Session

Operator

Your first question comes from Gary Chase - Lehman Brothers.

Gary Chase - Lehman Brothers

Congratulations, Mike and Scott, on the news. Scott, I wondered if you could just provide a little bit of color on what's going on by business segment? There seems to be a lot of concerns out there economically. Are you seeing anything that's troubling? The guidance would suggest that's not the case.

Scott Davis

Gary, it was still not a surprising quarter for us, the way the economy performed. I think we expected somewhat muted GDP growth and I think year over year the number is going to come in a little over 2%, which was pretty much the number for the year we're expecting. Industrial production, I think we expected would bottom out in the third quarter. That appears to be the case; I think most of the economist expect industrial production to improve in Q4.

As far as across the markets, I think that once again, the service sector was probably the strongest of the bunch. Beyond that, I think the manufacturing was fairly slow. Retail sales, consumer spending is certainly an area of concern for all of us as we go forward.

As I said earlier, we expect retail sales to be slow, yet they still should grow in the fourth quarter, as should our package volume. So again, a slow but not really declining from what we've seen in the past.

Gary Chase - Lehman Brothers

As you look within the supply chain, can you give us a little bit more color on how these results are being generated? Are you seeing down side on the freight side that you're able to offset at Menlo, or are you seeing upside on both sides of that?

Scott Davis

As we've said earlier Gary, that the first half of the year most of the operating profit, all of the operating profit improvement came from the forwarding and distribution side of the business. We expected in the third quarter to have the LTL kick in and help on comparisons, and it did; so really, all of the businesses in the third quarter showed year-over-year improvements.

We're quite pleased with the improvements, in forwarding and distribution. I think seeing the international air freight forwarding revenue grow close to market was a very important quarter for us, so we're optimistic on that going forward. So across the board, I thought we saw good improvement.

Operator

Your next question comes from Jon Langenfeld – Robert W. Baird.

Jon Langenfeld - Robert W. Baird

Scott, can you just talk a little bit about the semi-variable costs and how long you can keep those under control? Is that something that turns into a headwind here if the environment remains at this 2% type GDP growth?

Scott Davis

Jon, I think you've followed us for a long time, and I think year-in and year-out we are doing a very good job of controlling semi-variable costs. That's a big pull, as we said, 30% to 40% of our expenses was a big number.

We've done it for as long as I've been around here and I expect for as long as I will be around here, we'll see improvements. We've spent an awful lot of 2007 looking at 2008 and what could be better in 2008. Clearly we talked at the last year's investors’ conference about the shared services movement that we've got going. That is something that will generate improvements for many years to come. So I don't think we're anywhere near the bottom of semi-variable cost savings.

Jon Langenfeld - Robert W. Baird

Your long-term earnings growth that you talked about, the 9% to 14%, I'm assuming you need a better environment than 2% GDP growth to hit that? But if the current environment doesn't change, is mid single-digit or higher profit growth like you've been achieving here, is that sustainable?

Scott Davis

I think that obviously we've had a challenging year in 2007 with the economy. Not withstanding that, we're going to hit the middle of our 6% to 10% earnings guidance range we gave you, which isn't too far off the bottom of that 9% to 14%.

Clearly on the domestic side of our business, growing volume at flat to 1% puts a lot of pressure on our effective wage rate. We saw last year we averaged probably 1.7% effective wage rate increases. This year, we've averaged about 3.5%. That puts pressure on domestic margins. So you'll see more improvement in earnings performance as the domestic volume grows. But we're optimistic that with the improvement in supply chain and freight, with continued strength of international package that we can achieve those numbers going forward.

Operator

Your next question comes from William Greene - Morgan Stanley.

William Greene - Morgan Stanley

Scott, can you tell us how much of the improvement in ground yields came from dim weight?

Scott Davis

No, we wouldn't quantify. That's just one piece of the rate increases we did last year. I mean certainly it contributed, but I wouldn't say that's a primary factor in the ground yield increases.

William Greene - Morgan Stanley

The growth mainly is coming just from underlying list rate increases?

Scott Davis

Correct.

William Greene - Morgan Stanley

And when you look at it on a B2B or B2C basis, I assume the B2C is still growing faster than B2B? Is that correct?

Scott Davis

That is correct. It hasn't grown at the pace in 2007 that we saw in 2006. We said that's one of the factors in the overall small package market being closer to flat this year. It's still growing faster than GDP, but not at the pace we've seen in the last four or five years. We expect it will get back to that large growth in the near future.

William Greene - Morgan Stanley

So B2C is not growing faster than the economy is?

Scott Davis

B2C is faster than B2B, but not as much of a discrepancy as we saw in the last couple of years.

William Greene - Morgan Stanley

The $6.1 billion payment you'll make to Central State, are you going to fund all of that? In other words, when you roll it out of commercial paper, you'll keep all of it on the balance sheet, or you'll just do the post-tax portion of it?

Scott Davis

Initially, it'll be funded entirely with commercial paper, and then when the debt markets are right, we will go out and fund the after-tax portion with long-term debt, so about $3.9 billion of it will be funded as long-term debt, likely early next year.

Operator

Your next question comes from Tom Wadewitz – JP Morgan.

Tom Wadewitz - JP Morgan

Mike, congratulations on the contract and your retirement. Scott, congratulations on being named the new CEO. If you look at supply chain, you've seen quite a substantial improvement in '07. Can you give us any thoughts on whether that type of trajectory can continue in '08? In terms of margin, is 4% a pretty good level to be at for awhile, and it's more growth picking up as opposed to further margin expansion?

Mike Eskew

Tom, we did 4.6% in the quarter, I think for the year we'll come in at 4%. I mean it's been a game of focus and execution, and we really have implemented a number of initiatives. Scott talked about in this talk about revenue management, asset utilization, high tech services and those kinds of things and we're delighted. I think there's a whole lot of upside here, and we think we've got this model going in the right direction.

I don't want to put a lot of pressure on Scott and Andy, but I think there's a whole lot more we can do here.

Scott Davis

We're not satisfied at 4% margins. We've said all along that we need to get our margins into the 7% to 9% level to generate the economic profit we expect out of this segment. We're going to improve more in 2008 as we move to that 7% to 9% area.

Mike Eskew

If you look at the LTL segment, it's up. The regional, the interregional, the long haul, all showed double-digit growth in both shipments and revenue and the service is great, so I'd look for a lot of upside there.

Tom Wadewitz - JP Morgan

There's been a lot of movements in exchange rates. I know you are pretty leveraged in euros, and also movements in fuel. I wonder if you could just give some comments on the higher fuel prices and also how the significant moves in dollars versus the euro are affecting your business trends and perhaps reported results, as well?

Scott Davis

All three quarters, Tom, have shown the euro about 10 points above last year. So all three quarters, we've certainly had some favorable variances due to the weak dollar, strong euro. In the third quarter, we did show benefit from the currency, largely offset by the fuel cost increase we saw, so I think that there is a benefit internationally due to the currency, but a lot of it was offset by the fuel prices, the fuel surcharges. As prices climb quicker, the surcharge takes a while to catch up and that hurts you in the short term, it'll turn around eventually.

Operator

Your next question comes from Edward Wolfe - Bear Stearns.

Edward Wolfe - Bear Stearns

Congratulations, Mike and Scott. Just a little clarification. Is it a $6.1 billion initial payment on December 31, or whatever that day in December is, then over what period of time do you see the tax benefit from it? What's the interest rate that you're expecting to pay on that $6.1 billion, and then when you flip it over to $3.9 billion?

Scott Davis

In the short term it'll probably be a little over 5% on commercial paper. What the long-term debt markets are at in the January/February timeframe will probably dictate that, but probably in the upper 5% to 6% level is probably a good guess.

As far as how quick we get the money back on the tax refund, we frankly got some of it back already, because we didn't make our estimated tax payments in September, thinking we're going to get this deduction. We will make another one in January. Probably you can file for a quick refund, and get the money back in about four months.

Edward Wolfe - Bear Stearns

As a follow-up, I think you noted that exports out of the U.S. were only up mid single-digits below your total export volumes in third quarter, but you expect them to pick up in fourth quarter. Can you talk a little to the weak dollar? I assume that over time, export could be a positive. Can you talk a little about those trends?

Scott Davis

Absolutely. The weak dollar certainly should generate more exports out of the U.S. I think the small package market maybe hasn't shown as much of it as the overall export growth has been. A lot of the growth has been Boeing airplanes, that type of growth, commodities like grain, that type of thing; although we're still seeing solid growth in the U.S. small package export market.

I think the fact that you saw our export volume drop slightly, about 10% this quarter was actually more of a U.S. import issue. We've seen very strong growth out of Asia over the last several years, still great growth, in the upper teens this quarter, but that's below the 25% that we saw last quarter. That's primarily U.S. imports being a little weak due to the economy here.

Operator

Your next question comes from Scott Flower - Banc of America Securities.

Scott Flowers - Banc of America Securities

Congratulations, Mike and Scott both. In terms of the export rates, if I look at the currency adjusted rates, they were down about 1.5%. Is that a mix issue? What is going on when I look at some of the currency adjusted export rates on small package?

Scott Davis

Scott it's very similar to what you saw in the last couple of quarters. Rates didn't change much. It's primarily mix. It's the transporter business in Europe is growing at a real fast rate; a shorter distance and lower revenue per piece. As you would expect, Europe to the rest of the world is low due to the strength of the euro, and as we said, we didn't see quite as much growth out of Asia to the U.S. because of the weak U.S. economy. That's long range, high revenue piece product. But nothing other than a little bit of mix switch there.

Scott Flowers - Banc of America Securities

Obviously you talked about nudging down CapEx expectations for this year. Can you give us some sense of is that just going to roll into '08 from a deferral standpoint, or are there some things you actually did diminish in terms of where you wanted to invest in different businesses based on the economic outlook?

Scott Davis

I think the reduction was primarily vehicles in the U.S. for this year. That's obviously tied to the volume growth. The small package market has not grown very much in 2007 lessening our need for new vehicles.

As we go forward, as I said, I guess for a while now, we still expect our CapEx range to be at the low end of our normal 5% to 8% revenue spend. I don't see that changing dramatically in 2008.

Operator

Your next question comes from Jason Seidl - Credit Suisse.

Jason Seidl - Credit Suisse

Congratulations Scott and Mike. Scott, I think you mentioned that international margins were negatively impacted by both fuel and the new flights. If you exclude those two items what would the margins look like?

Scott Davis

Better. I haven't calculated it out, but certainly that would have had a fairly pretty dramatic impact on the margins.

Jason Seidl - Credit Suisse

Would you have been on par with last year?

Scott Davis

We would have been.

Mike Eskew

A big piece of it.

Jason Seidl - Credit Suisse

When you give your outlook for the full year for supply chain, you mentioned 4% margins. Are including or excluding that charge from France?

Scott Davis

We'll be excluding that charge from France.

Jason Seidl - Credit Suisse

Excluding the charge from France.

Scott Davis

Remember, we started the year looking at 2% to 3% margins, and last quarter we said 3%, at least 3%; so now we're at 4%.

Mike Eskew

We're 4% right now. We just hit 4.6%, excluding.

Jason Seidl - Credit Suisse

Fuel for the fourth quarter, I'm assuming you're factoring that in, how much of an impact do you think negatively that's going to have on the numbers?

Scott Davis

It depends on where the costs go in the short term. Clearly by December, with our fuel surcharge number it is going to be up much higher than it's been, due to the fact the fuel prices have been up the last couple of months.

Now what I can't tell is fuel going to be $100 a barrel or $70 a barrel by December? That'll drive the impact on P&L, where fuel costs will be. But currently the surcharge revenue is increasing due to the fact that cost have run up the last several months.

Operator

Your next question comes from Ken Hoexter - Merrill Lynch.

Ken Hoexter - Merrill Lynch

Good morning and congratulations as well to both of you. I don't think you mentioned, on the less than truckload side, on the overnight side, did you mention what the revenue per hundred weight had done? It sounded like had you said volumes were up double-digits.

Mike Eskew

It's up 9.9%.

Ken Hoexter - Merrill Lynch

Revenue per 100 weight was?

Scott Davis

Yes. A lot of that is the mix of the customers. We've won a lot of mid-sized companies as well as national accounts which has helped drive that revenue per hundred weight.

Ken Hoexter - Merrill Lynch

Revenue per hundred weight was up 9.9%, and tonnage was up double-digits?

Scott Davis

Tonnage was up 1.9%. Shipments were up 13%.

Ken Hoexter - Merrill Lynch

Tonnage was 1.9%?

Scott Davis

Weight per shipment is down.

Ken Hoexter - Merrill Lynch

Are you still not giving any contract details? You talked a bit about the employees. Can you talk about wages going forward, wages or benefits?

Mike Eskew

The ballots are out late this week. We're going to let our people take a look at it. That’s been our pattern, we let the people see it first.

Scott Davis

I know that everybody out there would like to have more of the details, but as Mike said really, it's only fair to our people to let them get the ballots and see the details first and make their decisions. After the ratification clearly we'll be able to communicate some of the financial impacts of the contract to all of you.

Ken Hoexter - Merrill Lynch

Can you tell us if there are any major differences than what we've seen in the past in term of wages and benefits?

Scott Davis

As we said, we'll let all the ballots be cast, and then we'll share the details with you.

Ken Hoexter - Merrill Lynch

Scott, when we were over in Japan you had said that there was always a need to get more routes into it and get more business, it sounds like you have some more flights going in. Are you going to start increasing spend or capital dollars in Japan to build out that network more?

Scott Davis

Nagoya routes will probably not be up and running until the summer of next year, it's going to take us a while to get the gateway ready, but we're very excited about the possibilities of the U.S. to Nagoya flights and tying that it into our new Shanghai hub.

So clearly we'll continue to make some infrastructure investments in Japan and throughout Asia. But we think it's going to be a great return by doing that.

Mike Eskew

We've been spending a lot of money in Japan the last couple of years are as we round out that operation.

Operator

Your next question comes from David Ross - Stifel Nicolaus.

David Ross - Stifel Nicolaus

Good morning, gentlemen. I wanted to ask a little bit about the growth in bundling. Do you have any numbers for the number of customers who currently use UPS freight and ground now versus they used only one of those services a year ago, and what the growth looks like?

Scott Davis

We talked about on the LTL side that of the growth, 60% came from existing customers and 40% from new customers. Most of those new customers are obviously UPS customers that are adding LTL services. That will quantify, but clearly that is where a lot of that growth is, and why we're outperforming the LTL markets so dramatically is the ability to bring this new service to the UPS customer base.

David Ross - Stifel Nicolaus

Also on the other operating expenses line item in the quarter, it declined about a $100 million year over year, showed a nice improvement. Is that part of the cost reductions you're going after? I just want to know the sustainability of that number.

Scott Davis

Well it's definitely part of those cost reductions. If you recall last year we had a wage hour settlement in the third quarter of 2006 of about $87 million. So you take that out, we were flat to down a little bit, but that was the biggest driver. Variable cost savings show up in that line.

Operator

Your next question comes from David Campbell - Thomas Davis.

David Campbell - Thompson Davis

This might be the first time that a CFO has been promoted to CEO at UPS. Maybe this means you're going to get better numbers going forward.

Mike Eskew

By the way, it's not the first time, David. But you're right, I hope the numbers get better going forward.

Scott Davis

Expect such, David.

David Campbell - Thompson Davis

I think it's great news. Congratulations. The bad news and the horrible impact on human life in Southern California with these fires. Do you have any thoughts on what it does to your business in the fourth quarter?

Mike Eskew

It's a little too early to tell right now. We've got some folks out of their homes, and we've been watching our people right now, and it's just hard to quantify the business aspects at this point.

David Campbell - Thompson Davis

Right. The third quarter tax rate was low, I thought. Do you think the fourth quarter will be back up to 38%?

Scott Davis

I think we've been running, David, at about 36.25% tax rate for probably the last year-and-a-half. We think the effective tax rate going forward is 36%, so a little bit lower then we've been running.

David Campbell - Thompson Davis

The $46 million charge in the third quarter, was that in compensation cost?

Scott Davis

$46 million is in mostly compensation and benefits, correct.

Operator

Your final question comes from John Mims - BB&T Capital Markets.

John Mims - BB&T Capital Markets

Good morning, guys. Real quickly, I know you've discussed Japan and China, but could you break down international business by region and highlight any pockets of strength, and particularly pockets of weakness you've seen, or where you expect to see the most growth going forward?

Scott Davis

We've had a pretty sterling record of strong growth in both Europe and Asia for many years. As we've talked about a lot of times, Europe since 1997 has only had four quarters we haven't grown double-digit in export volume growth , it showed again in the last quarter. So we're still seeing strength in Europe. Asia, we expect to see strong growth for many years to come out of Asia. The only softness growing out of Asia, upper teens as opposed to 25% the previous quarter. A little softer, but again that's driven by the U.S. imports being a little bit weaker this quarter.

I think going forward we're very confident that around the world we're going to see strong growth. We'd like to see a little better growth out of South America still, but we'll expect that going forward.

Operator

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

Andy Dolny

To summarize, here are the key points I'd like you to remember. Our financial strength is outstanding. We posted strong third quarter results with earnings per share up over 9%. All three business segments reported profit gains. For the year, we expect earnings per share to be between $4.13 and $4.19.

Thank you for joining us today, and we look forward to seeing you soon.

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Source: United Parcel Service Q3 2007 Earnings Call Transcript
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