Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Andy Dolny - Vice President, Investor Relations

Scott Davis – CEO

Kurt Kuehn - CFO

Analysts

Jon Langenfeld – Robert W. Baird & Company

Tom Wadewitz – JP Morgan

Edward Wolfe – Bear, Stearns & Company

William Green – Morgan Stanley

Scott Flower – Independent Research

Jason Siedl – Credit Suisse

Garrett Chase – Lehman Brothers

Ken Hoekster – Merrill Lynch

John Barnes – BB&T Capital Markets

David Ross – Stifel Nicolaus

David Campbell – Thompson, Davis & Company

United Parcel Service, Inc. (UPS) Q4 2007 Earnings Call January 30, 2008 8:30 AM ET

Operator

At this time I would like to welcome everyone to the UPS Investor Relations Fourth 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.

Andy Dolny

Good morning everybody and thanks for joining us today. In a moment Scott Davis our CEO and Kurt Kuehn our CFO will discuss fourth quarter and full year results and comment on our expectations going forward. Before we proceed I’d like you to mark March 12th in your calendars, on that date we will host an investor conference in New York with some of our senior management team. In addition to Scott and Kurt we will have David Abney our Chief Operating Officer and Alan Gershenhorn, Senior Vice President of Worldwide Sales & Marketing. More details will be forthcoming and we’re looking forward to seeing you there.

Now I’ll review the safe harbor language. Some of the comments we’ll make today are forward looking statement 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 2006 Form 10-K and 2007 10-Q Reports. These reports are available on the UPS Investor relations website or from the Securities and Exchange Commission. Additionally this conference call is being webcast and will also be available on our Investor Relations Website.

Before I turn the call over to Scott I want to comment on our Financial Statements. As you know a component of our recent labor agreement with the Teamsters, UPS’s withdrawal from the Central States Pension plans, as a result following ratification of the contract on December 26th we paid $6.1 billion before taxes to that plan. The entire payment was expensed to the US Package segment in the quarter. A new jointly trustee plan has been established that preserves pensions and restores benefits that were previously reduced for employees in the Central States Plan.

Despite the cost of restoring benefits the new plan will be cost effective. Resolving this issue brings stability to our pension planning and is expected to minimize our future expenses. On a stand alone basis withdrawing from the Central States Plan is positive from a net present value perspective. The Labor Agreement addresses all the issues we identified as significant when negotiations began. It does so with cost implications to UPS very similar to the 2002 contract including the payment to withdraw from the Central States Pension Plan. It gives us the flexibilities we need to remain competitive in the marketplace. There is a presentation on our Investor Relations website that provides more detail about this contract.

When Scott and Kurt discuss fourth quarter results today they are referring to results from operations excluding the impact of the charge to withdraw from the Central States Plan. Reference to full year results also excludes the impact of this charge and these other adjustments made in previous quarters. An impairment charge of $221 million on the accelerated retirement of certain aircraft, a $68 million charge for the special voluntary separation opportunity offered to come corporate employees and a $46 million charge related to the restructuring and disposal of a French operation in the Supply Chain & Freight segment.

A reconciliation of GAAP adjusted results can be found with the schedules accompanying our announcement this morning, as well as on the Investor Relations website. Now it’s my pleasure to turn the program over to Scott.

Scott Davis

Good morning everyone, 2007 was a good year for UPS; in fact, the company posted record results in terms of revenue, operating profit and EPS, despite sluggish economic conditions in the US. This is due to the strong performance of our International Small Package operations as well as excellent contributions from the Supply Chain & Freight units. Both segments produced healthy profit gains. In the US profits did decline but overall we operated well in an economic environment which worsened as the year progressed.

Our operations team raised service levels to new highs and continued our focus on cost control. Now let’s take a look at what we said 2007 would bring and how we actually performed. We expected the Global Small Package market to expand moderately, that’s what happened. With international strength offsetting slow growth in the US, we targeted a 15% operating margin in our Domestic Package segment and it came in at 15.4%. We said World Trade should remain strong, supporting a robust International Small Package market, we expected a 10% increase in export volume and that’s what happened.

Our International Small Package operations performed well with profit increasing to $1.9 billion. Operating margin came in at 18.5% just slightly below our guidance at the beginning of 2007. These are still results to be proud about. We anticipated that the Supply Chain & Freight segment would turn the corner on profitability with performance picking up in the second half of the year. This is what happened with performance improving sooner in the year than anticipated. This segment saw profit leap $330 million in 2007. While we targeted a 2% to 3% operating margin we actually achieved almost 4%.

For 2007 we came within the middle of the earnings range we had set a year ago, achieving 8% growth or earnings of $4.17 per share. I’m pleased to say that once again we did what we said we’d do. I’d like to thank UPS’s around the world for their efforts in a difficult environment. In addition, we celebrated the company’s 100th anniversary, reached an early labor contract with the Teamsters and developed a new financial policy to enhance shareholder value. All in all 2007 was a busy year in which we laid the groundwork for future success.

Looking forward UPS has always invested for long term growth and 2008 will be no different. Granted economic uncertainty will probably make 2008 more challenging than last year; however UPS has a long history of growth in many different economic environments. Building on a foundation already in place we will continue to expand our global presence. These investments will take the form of new products and services, technological innovations and infrastructure expansion.

For example, earlier this month we simplified our International and North American air freight shipping portfolios. As a result we created a unique global supply chain offering. On the technology front the 2008 release of World Ship offers the ability within a single application to process small package, air and ground freight shipments. This capability combined with a new reliability guarantee for UPS freight and improved service in technology are attracting new freight customers from virtually all of our major competitors.

On the International front we just introduced two new industry leading products; our paperless invoice and international returns. We will continue investing in growth opportunities around the world including service enhancements, new or expanded air hubs and expansion in China where we are strengthening our presence through sponsorship of the Beijing Olympics. We remain bullish about the long term dynamics driving our industry. Globalization, direct to consumer shipping, just in time inventory, outsource and supply chain management. These trends are firmly in place in all play to the strengths of UPS.

Now for comments on segment performance for the fourth quarter and insight into our 2008 expectations I’ll turn the program over to Kurt.

Kurt Kuehn

Good morning everyone. Before I begin I’d like to say that I’m looking forward to working with all of you in my new role at UPS. Both those of you that I worked with when I was part of the Investor Relations group in the past and those that I haven’t had a chance to meet yet.

For the fourth quarter diluted earnings per share were $1.13 up 8.7%. A healthy 6.1% revenue gain combined with a moderate 3.4% increase in compensation and benefit expense and good semi-variable cost control all helped to offset the substantial rise in fuel costs during the quarter. Results in the quarter also benefited from a lower effective tax rate of 33.8% compared to 35.4% for the year.

Let’s now begin our review with the Domestic Package operation. Overall volume increased 1.4% in line with expectations. Ground was up 1.5% and Next Day Air improved 2.2%. Pricing remained firm with revenue per piece up 2.3%. Deferred and Ground revenue per piece grew around 3% each. Next Day Air was flat as once again we saw strong growth in our Saver products and a greater percentage of lower weight packages during the holiday season.

Effective planning, execution and cost control helped offset some of the impact of rapidly rising fuel costs and wage rate increases resulting in a 14.5% operating margin for the quarter and 15.4% for the full year. Each year our peak shipping period become more compressed than in the past. In the seven days prior to Christmas we saw volume increase dramatically, however in contrast the first couple of weeks of December were significantly below plan. This lighter volume challenged our ability to efficiently use the additional assets and people we deploy each year to handle holiday shipping.

Operations functioned very smoothly in spite of the challenge that winter months often bring. Our integrated network provided great flexibility, we used our Ground network to many of our express packages and we operated a full global air network on the Sunday before Christmas, to provide our customers with outstanding service. The bottom line in December all of our customer service metrics improved over prior year results.

Turning now to the International Package segment, daily export volume increased over 12% with double digit improvements in Asia, Europe and the US. Revenue was up over 17% with a 19.4% operating margin. Pricing remained firm with revenue per piece adjusted for currency increasing 4%. Profit was somewhat impacted by fuel prices that increased rapidly during the quarter and the around the world flight that was launched in July. In the quarter we continued investing to extend our International presence, we expanded our reach in India through an alliance with AFL, this relationship will promote UPS’s International Express Delivery Service to AFL’s customers and function as a domestic service provider across India.

Turning now to the Supply Chain & Freight segment, revenue increased almost 8% and operating profit was $82 million resulting in an operating margin for the quarter of 3.7%. Forwarding and Logistics revenue increased 6.4%, service reliability improved across all products and customer churn continued to decline. UPS Freight posted another good quarter; LTL revenue increased nearly 13% with daily shipments up 7.8%.

Since this is well beyond industry growth UPS Freight clearly continued to take market share. Investments in operational technology have helped move the needle on performance improvement and better operating performance and continued investments in customer [inaudible] technology are clearly attracting new business. For example, Quantum View Manage continued to bring in new customers for both Freight and Small Package Shipping. In short, we are very pleased with the progress this segment has made in 2007.

Next I want to comment on UPS’s financial position at year end. Strong cash generation is a defining characteristic of the company. UPS continued to generate exceptional cash flow from operations, $1.1 billion for the year even with the impact of the one time payment of $6.1 billion to the Central States Pension Plan. In early January we issued long term debt of $4 billion to finance the withdrawal from the Central States Plan. We were very pleased that debt issue was substantially oversubscribed even in an unsettled debt market. This attests to the company’s reputation and financial strength.

Our capital expenditures for 2007 totaled $2.8 billion just 5.7% of revenue. We paid $1.7 billion in dividends and spent $2.6 billion to repurchase 35.9 million shares, clearly UPS continues to be financially strong. Before addressing our outlook I’d like to make a few comments on our new financial policy that UPS adopted in early January.

Going forward we will manage our balance sheet to a target ratio of 50% to 60% funds from operations to total debt. At December 31st that ratio was approximately 75%; we anticipate moving to the range over the next two years. As part of this financial policy in January our directors authorized an immediate increase in the amount of funds available for stock repurchases to $10 billion. We expect to complete those share repurchases over the next 24 months.

We’ve spent a great deal of time studying various scenarios for leveraging our balance sheet. We believe UPS has taken the right actions at the right time to ensure that we enhance share owner value over the long term. By lowering our cost of capital while still maintaining a great deal of financial flexibility.

Now for our outlook on 2008, forecasters are predicting US economic growth this year will expand at a slower rate than in 2007. The same holds true for industrial production and global GDP plus there are concerns that consumer spending may decline due to high energy costs and the slow housing market. That being said we still anticipate growing our global business through improving our customer supply chains.

The first quarter will be the most difficult one of the year. Because Easter falls in March we will have two less operating days in Europe and two lighter than normal days in the US. This will create a drag on volume growth in both Domestic and International operations which will reduce profitability in the quarter. In addition, we will have cost pressure from increased interest payments. Without yet realizing the full benefits of the new labor contract, as a result earnings for the quarter should be in the range of $0.94 to $0.98.

For the full year US Domestic performance should accelerate in the second half of 2008 as benefits from the new labor contract begin to materialize. Domestic volume should grow 1% to 2% for the year and we anticipate that operating margin will be approximately 15% as we remain highly focused on execution. In the second quarter our International business should recoup the volume shortfall from Easter. For the year we anticipate about a 10% increase in export volume growing faster than the overall market and operating profit growth in the low to mid teens.

We expect the Supply Chain & Freight segment to post improved results; operating margin should come in between 4% and 5% for the year as we focus on profitable growth. For 2008 our capital expenditure budget is projected to be $3 billion, at the low end of our historical range and our tax rate should approximate 36%.

For the full year we expect earnings per share to be in the range of $4.30 to $4.50, this guidance includes the $0.09 to $0.10 per share head wind that we disclosed in December. If you recall this represents the additional interest expense from financing the Central States withdrawal payment, partially offset by reduced pension expense. This range also assumes that we will make $5 billion of share repurchases over the course of the year. The timing of the repurchases will depend on market conditions.

To summarize, 2008 will be a year of both challenges and opportunities for the company, we will invest for long term growth and remain focused on execution and cost control as we were last year, ensuring that UPS continues to deliver regardless of the economic environment. Thank you for your attention and now we’d be happy to take your questions.

Question & Answer Session

Operator

[Operator Instructions] Our first question is coming from Jon Langenfeld from Robert W. Baird & Company.

Jon Langenfeld – Robert W. Baird & Company

When you think about the benefits of the Teamster contract and that layering in late ’08 early ’09 are you going to show the benefits of that or does that give you opportunities to reinvest in the business? I guess what I’m wondering is we kind of go back to the package flow analogy a couple of years ago where you had a lot of benefits from that but you used that to kind of invest in the business. I’m wondering how much of the benefits of that Teamster contract you’ll actually show as they materialize?

Kurt Kuehn

I think that will depend somewhat on market conditions but clearly we are excited about this new contract. We made a very large investment with the Central States buyout but we do expect to see benefits from that investment becomes cost neutral in ’09 and then begins to get benefits. In addition, there’s a range of really positive attributes and flexibilities that we think will allow us to both reduce costs and continue to operate competitively. It’s hard at this point for us to bake in exactly what the future may hold in that but we do feel very good about the structure of it. It certainly is baked into this years guidance, although frankly it’s a headwind this year that should begin to mitigate and then actually be a tail wind starting in 2010.

Scott Davis

I think that clearly the compensation benefits as time goes on will show less increase than we’ve seen in the past and obviously should benefit earnings in the years ahead.

Jon Langenfeld – Robert W. Baird & Company

I’m not looking for a specific numbers but I guess I’m expecting out of this contract, given that we’ve had this big lump sum payment I’m expecting that the benefits that might come out of that both directly from the pension and then from the flexibility on the work rules. I’m expecting that manifest itself in better margins over time in Domestic, am I thinking about that correctly?

Scott Davis

Certainly if we operate well there’s a lot of opportunity for that. The overall cost of this contract is very similar to what we did in ’02 even with that large payment included. There’s a lot of opportunities and it will clearly allow us to be competitive.

Jon Langenfeld – Robert W. Baird & Company

On the International side the pressure on the margins I’m assuming a lot of that had to do with fuel, same with the Domestic side but how come we are talking about fuel now when over the last couple of years we’ve seen some pretty big spikes in fuel and you guys have digested that pretty efficiently?

Kurt Kuehn

The absolute amount of fuel we’ve seen before but I think Q4 was almost unprecedented in the rate of increase, that’s really where our exposure is with fuel. Over time the surcharges calibrate and even out but it was a pretty dramatic increase in that Q4 and we did see fuel up over 30% so it was very hard for us to recover that in the short term and it did provide us with a head wind that dampened the margin a little bit on International.

Operator

Our next question is coming from Tom Wadewitz from JP Morgan.

Tom Wadewitz – JP Morgan

I wanted to see if you could give a little bit further perspective on the fuel impact in terms of you said it was probably a greater impact in International margin but was that half of the margin deterioration or how big was that impact? In terms of Domestic margin impact any thoughts for just the magnitude of that?

Kurt Kuehn

We generated a 19.4% operating margin in Q4 which is still very strong. We did have an exceptionally good margin last year, actually the highest margin we’ve ever shown at 21% so I wouldn’t overreact to the year over year comparisons too much on that. Fuel was absolutely a head wind and without that head wind our results would have been better and probably getting closer to the kind of rates we saw in Q4 of last year for the International.

On the Domestic side the combination of direct fuel costs and also costs we see through surcharges and [topsi] was a big head wind in our Domestic market would have shown a profit increase without that head wind.

Tom Wadewitz – JP Morgan

In terms of the volume outlook you’ve given I think you 1% unit growth domestically or so that seems pretty similar to what you had on a full year basis in ’07 and your fourth quarter volumes were pretty constructive yet your qualitative comments you’re saying well things got weaker in fourth quarter and were tougher. Do you think the market is actually slowed in small parcel and you’ve offset that with greater traction in the market or are you just concerned that it may slow further going forward because it doesn’t really look like we are seeing a sharp slowing in your volume numbers?

Scott Davis

I think as we look at 2008 we’re kind of planning our outlook on a slower growth economy in 2008 than we saw in 2007. Caveat again we are not a leading economic indicator so we are going on basically on consensus information out there. I guess what we are seeing right now though is, I think you saw in the fourth quarter the GDP numbers come out just a few minutes ago, GDP was up 6/10th of a percent, our volume was up 1.4% domestically. I think you are starting to see the small package market get back to at least economic growth levels and we are expecting that in 2008 that small package market should perform at least as well as the economy moving to 2008. We are expecting a weak economy, probably 1% to 2%, still expect growth in the economy but real slow growth in ’08.

Tom Wadewitz – JP Morgan

You didn’t see a market slow down in the quarter it’s just kind of a little bit of caution within the forecast?

Scott Davis

I think we are expecting a little bit slower overall economy in 2008 than we saw in 2007. Improving small package market relative to the economy.

Kurt Kuehn

I think we are also fairly comfortable with the fundamentals of UPS’s progress in the Domestic market, clearly resolving the contract issues seven and a half months early is a plus and the company’s executing well.

Operator

Our next question is coming from Edward Wolfe from Bear, Stearns & Company

Edward Wolfe – Bear, Stearns & Company

I just want to make sure I heard what you said occurred in response to Tom’s question about the fuel impact. Did you say that the International OR would have been equal to a year ago and that the Domestic operating income would have been flat without the difference in fuel lag?

Kurt Kuehn

The International would not have quite reached those levels but certainly would have looked better, but yes the Domestic operations would have been flat to slightly profitable had the rapid increase in fuel not hit us.

Edward Wolfe – Bear, Stearns & Company

That’s the EBIT that you are saying not OR?

Kurt Kuehn

EBIT yes.

Edward Wolfe – Bear, Stearns & Company

DHL has been in the news a lot and taking a big write down in the US just in a lot of ups and downs about that. Can you talk to if you are seeing any opportunity because of uncertainty there and the anti-trust issues if you see any between either yourself or your largest competitor purchasing DHL?

Scott Davis

As far as the impact in the marketplace I think it’s too early to tell. These market rumors have been out there for just a few weeks so I think it’s early on there. As far as what DHL is going to do, you’ll have to talk to DHL; we are not going to comment on those rumors. Anti-trust, that’s something that we’d have to look at. We’ve not evaluated that at this point in time.

Edward Wolfe – Bear, Stearns & Company

When you look at the extra operating or the fewer operating day in the quarter is there any way to quantify the impact of having 61 days versus 62 a year ago and what are the correct operating days for first quarter given what you said about Easter versus a year ago?

Kurt Kuehn

We are showing 61 operating days in ’07 compared to 62 in ’06 and we will have 61 in ’08 also but there will be two working days in the first quarter Good Friday and Easter Monday frankly that are below typical operating levels. In the US, although the working days aren’t significantly impacted you do have those soft days that would normally fall into April.

In Europe business does shut down around those time periods so Europe actually has two less working days in real terms. It is a material impact, certainly will be heavier impact to the International than the Domestic maybe all in all add maybe $50 million to the company.

Edward Wolfe – Bear, Stearns & Company

The fourth quarter impact of one fewer days, can you quantify that impact.

Scott Davis

The typical rule of thumb for us for one less operating day in the US is $50 million; I think that’d be the rule of thumb.

Operator

Our next question is coming from William Green from Morgan Stanley

William Green – Morgan Stanley

I’m wondering if you could talk a little bit about B to B versus B to C in the Domestic business? How did those two growth rates compare?

Kurt Kuehn

Really the trends have continued much as we’ve talked about though in the last year and a half or two years. The B to C has certainly exceeded the rate of B to B though we have seen significant slowing really over the course of ’07. That was probably the biggest story as far as the overall volume changes in ’07, still positive but slower on the B to C side perhaps as the consumer has a little less additional money to spend. The B to B is very driven by industrial production and some of those other statistics and we’ve seen the B to B really be flat for a number of quarters frankly.

William Green – Morgan Stanley

B to C was it noticeably weaker in December year over year versus how it had been in prior months of the quarter?

Kurt Kuehn

Not so much throughout the quarter in the year but I think B to C throughout 2007 did not show the growth we saw in the previous years. It still grew nicely better than the economy but not at the pace we saw the last several years.

Scott Davis

I think the real story for December as I mentioned in my prepared comments was the timing, that frankly the first couple weeks of December were slow for us we were concerned and then at the last minute we got substantial amount of volume. On average December came in pretty well but it’s a tale of two halves of the month.

William Green – Morgan Stanley

The list rate increases you announced for 2008 how well have you been able to push that into yield and not give it back in discount given the slowness?

Kurt Kuehn

We see the pricing environment continuing to be stable. It’s competitive out there and we continue to perform and execute on service and quality. So far no real difference than previous years I guess. The rate increases are covering our costs and its all part of negotiation.

William Green – Morgan Stanley

Typically we think of you sort of keeping in the range of three quarters of what you announced so if you announced 3% to 4% maybe keep 2% to 3%. Is that about the range you are suggesting here?

Scott Davis

Yes, I wouldn’t hang a number our specifically but we do feel that the trends are continuing very steadily in the market and our value proposition is holding up pretty well.

Operator

Our next question is coming from Scott Flower from Independent Research

Scott Flower – Independent Research

A couple questions, one I just wanted to get a little more color on International, I’m not quibbling with the absolute level of margins as those are obviously stellar but I guess one of the things you mentioned was that ‘x’ fuel margins would have been close to last year but yet one of things I’ve always sort of felt, obviously the Euro being quite strong in fourth quarter that should have been an additional tail wind. I’m trying to understand was there any mix effect, is the around the world flight more of a drag? If we strip out fuel I understand that the Euro strengthened should have helped you? I’m trying to understand what other dynamics are going on in International?

Kurt Kuehn

Certainly all of those were factors, the fuel did more than offset any currency benefits in Q4 and the round the world flight, although it’s a great investment for the company it continues to be a bit of a head wind for us. We’ll lap that in the second quarter and then be able to show more benefits from that. The International business is still doing well; we’ve guided to mid to upper teens profit increases so we are looking for another good year.

Scott Flower – Independent Research

If you look at the ground market, I know that Ed Wolfe said that also obviously your other competitor has some issues in the structure of their company and that may not have dribbled down operationally yet. Are you seeing any impact in the Ground market between some of the things that DHL is trying to do just to improve profitability as well as some of the issues that the contractor model at FedEx or have things been pretty stable in the Ground market?

Kurt Kuehn

I think as Scott said so far the market has been stable, I think clearly UPS’s position is good right now. Both of those competitors were selling against our labor negotiations and so that fact that we’ve got both a long contract and one that makes us very competitive is good news. We’re just continuing to execute effectively aligning all of the new capabilities to the company and the market. No dramatic shift in competitive balance at this point although certainly we feel pretty good about where we are at this point.

Scott Davis

I think that the shoe is on the other foot right now. Most people thought we’d be battling late into 2008 on a new contract so we really have no distractions for our customers so we are in a great position to compete as we move forward.

Operator

Our next question is coming from Jason Siedl from Credit Suisse.

Jason Siedl – Credit Suisse

A couple quick questions, if I can look at the LTL I noticed great numbers but the weight per shipment was off a lot, is that just because your business mix is shifting a little bit?

Kurt Kuehn

I guess the most direct factor on weight per shipment is the economic conditions. We find that shipments grow when things are good and shrink when they’re not. We’re also having great success selling in the middle market and bringing value to the very broad array of UPS customers that haven’t tried our LTL service. These trends have been fairly consistent actually if you look over the last three quarters. We are seeing good growth, we are growing in all sectors but certainly the weight has reflected the slower economic conditions.

Jason Siedl – Credit Suisse

When you say middle market you mean mid sized customer’s not middle length haul?

Kurt Kuehn

Yes, mid sized customers, the bread and butter of hundreds of thousands of customers of UPS.

Jason Siedl – Credit Suisse

You are growing in all lanes, are you growing faster in three/four day versus next day?

Kurt Kuehn

Not a dramatic difference, part of what’s unique about our value proposition is that we are able to offer very competitive local and regional service and also have a comprehensive integrated highly aligned national network. The paradigm for us is we can handle whatever the customer needs us to handle.

Jason Siedl – Credit Suisse

Regards the share repurchase any thought to trying to get most of it out of the way in one lump sum versus just sort of market conditions?

Kurt Kuehn

Not at this point, the guidance we’ve given is that we intend to make those repurchases over the next 24 months and so we will be watching the market and making our best calls based on conditions and what our thoughts are. I can’t give any specific guidance on that, we did assume in our guidance that we would repurchase about half of that $5 billion worth in ’08 but beyond that I can’t really give you much.

Operator

Our next question is coming from Garrett Chase from Lehman Brothers

Garrett Chase – Lehman Brothers

A question on Supply Chain first, you noted that things are turning faster than you thought and certainly the outlook there is better than what you anticipated a few quarters back. It sounds like the expectations for ’08 are similar with a 4% to 5%, I’m just curious have your expectations overall for the business risen in 2008 or is there a little bit of caution in there relative to the economy. Related to that are we talking about maybe 4% to 5% margin on more revenue?

Kurt Kuehn

Clearly we are looking to improve margins and revenue, in the US the LTL market is very challenging and so clearly we want to be prudent on a reasonable forecast for that although we do intend to continue to gain share and profit. The outlook for global forwarding we expect to grow with market at market and our logistics group is complement to those and we’ll grow that as makes sense. We feel like we’ve made tremendous progress in the last year and a half two years and we are going to be stretching a little bit but still in this environment we think it’s prudent to manage our capacity in line with the market.

Scott Davis

We did see a little slowing in the International Air Freight market in the fourth quarter also; we think that it may not grow quite as fast as we saw in 2007 with concerns on the overall global economy. Those trends will come back and we certainly expect to grow at or above market in International Air Freight.

Garrett Chase – Lehman Brothers

On the Domestic business where you hinted towards a 15% margin I wondered if maybe you could give us a little color on how much tail wind is going to be in there from just shifting some of the pension burden out of the operating line into the financing line and it seems like with that you are implying a decent margin decline in Domestic for 2008. Is that all economic or is there something else there we should be aware of?

Kurt Kuehn

Clearly they are in aggregate, there’s a $0.09 to $0.10 head wind from that. We’ll move, to your point, from operating expenses into interest expense but we also, for the first seven months of 2008 we are still on the old contract, frankly, so we are a little bit in between state there with increased expenses on the interest side and the continual cost pressures of the contract as the new one comes into place and the benefits will be more manifest.

Garrett Chase – Lehman Brothers

Is there not some at least pension change in the Domestic margin the first part of the year or does that take until implementation?

Kurt Kuehn

There is some benefit in that earlier in the year but as we said the net expense overall to the company is $0.09 to $0.10 in light of the substantial increase in the interest expense.

Scott Davis

A lot of the key benefits out the contract that the longer progression, some of the full time job creation that health care waiting periods the split wages come with time. You’ll see more of that each year as we move into the contract.

Operator

Our next question is coming from Ken Hoekster from Merrill Lynch

Ken Hoekster – Merrill Lynch

If we look at other expenses it seemed after being down anywhere from 1% to 13% over the past couple quarters its jumped 6% this quarter. I’m wondering if any of those charges that I think Andy mentioned at the start of the call or anything was in there. I’m just trying to see if there was anything else that pushed Domestic margin up? If I look at fuel alone we kind of targeted that right in line with where it was so I’m trying to look at why other jumped so much?

Kurt Kuehn

You are talking other other I guess. That’s a multitude of various expenses and it grew more or less in line with revenue. We did have some auto liability insurance increases that kicked into that, some supplies and miscellaneous stuff but nothing super material on that.

Ken Hoekster – Merrill Lynch

If I remember the last couple quarters you’ve made comments on how odd it felt that the Small Package flows had really grown slower than GDP it sounds like you are one and a half percent growth this quarter versus I think you said it came out at .6%. It’s kind of returned to the normal trend, is there anything you feel or can see that’s driving that return to what you’d call normal?

Scott Davis

I’ve been saying all year that we’d get back there, the question was when would we get back there. As I said before the macro trends we’ve always talked about adjusting time, direct consumer shipping, online purchase are not going away they are going to be trends they are going to around a long time and that’s going to benefit Small Package. For whatever reason the first couple quarters, and it could have been a combination of the industrial production being weaker than the economy and maybe retail sales being a little weak. We certainly saw, it looks like based on the numbers we saw this morning that the fourth quarter Small Package getting back to where it should be. We expect that in 2008, we do not expect Small Package to lag the economy in 2008.

Ken Hoekster – Merrill Lynch

In your 1% to 2% target can you get a little more granular? I guess you gave first quarter guidance do you think we slip into a negative environment in the first half before rebounding to get to that 1% to 2% or are you thinking we stay in the positive territory straight throughout?

Scott Davis

I think we’ll stay positive territory throughout the year. I think January we are seeing positive growth so I don’t expect it to go negative.

Ken Hoekster – Merrill Lynch

On the Next Day Air, I guess somebody else was asking about the DHL before, do you feel like any of the Next Day Air which was so robust in this economy was any of that maybe some market share shift from perhaps DHL or the Post Office or do you think we’ve seen strengthening on the Next Day Air side?

Kurt Kuehn

Nothing specific that we would want to share in that case. I think we are just continuing to operate and execute and with some of the head winds removed from customers concerns I think it puts us in a better position.

Ken Hoekster – Merrill Lynch

You think those concerns about the contract really started that early?

Kurt Kuehn

It certainly made it harder to close deals with an uncertainty so it’s not that we were seeing diversion but certainly it was an issue that was a concern in customer’s minds and that along with continued good execution is something to bring in business.

Operator

Our next question is coming from John Barnes from BB&T Capital Markets

John Barnes – BB&T Capital Markets

Given your comments about your longer term strategy with the balance sheet and the fact that you’re going to get to those debt levels primarily through share repurchases. Is this any signal to us that from an acquisition standpoint that you are kind of done on that side or that there’s nothing of size out there? Maybe there are some smaller things you can do and you don’t need debt but there is nothing of size that really moves the needle that you need to maintain some cushion in your debt levels to buy?

Scott Davis

I think when we did the 50% to 60% funds from operations to debt that gave us plenty of capacity. We are still very strong, have a strong financial statement. We are still one of the top 45 rated companies in the country. We have that fire power to go out and do acquisitions if we feel the right and led value to share owners. I think clearly when we made the announcement on the recapitalization we made it clear that we’ll still be reinvesting in the business.

John Barnes – BB&T Capital Markets

On your capex, how do you look at capex right now in this kind of environment? I hear what you are saying in terms of the economy is going to be a little bit slower but you are looking for a little bit better package environment. Are there any projects that have been shelved right now that could force capex higher this year if the economy were to improve or on the other side, if things were a little bit worse than you expected, what magnitude of declines would we see in capex if things don’t materialize the way you hope?

Scott Davis

We are always focused on return of invested capital so we are always going to do the capex when it’s necessary. A lot of the capex we do is for the long term, when looking at airplanes we are looking a the next 30-40 years, so you make commitments earlier so you are not going to change those capex requirements in the short term based on two or three slow quarters. Buildings we’ve got a World Port expansion going on which is tight into both our Domestic and our Global trade which is growing at a fast pace. We are going to keep doing that. China, we are building up in Shanghai, it’s very important to the future of this company.

There are areas like vehicles where you can look at the unit volume you are bringing in and you can slow those down and we’ll do that. I think the major expenses we are making are things that are important for the future of the company, the growth of the company.

Operator

Our next question is coming from David Ross from Stifel Nicolaus.

David Ross – Stifel Nicolaus

I have a question on the Rail [Topsi] business, a pretty big spend. Has there been any talk about lightening that up or where does that stand year over year as far as volume and are you looking to move to more container based system there.

Kurt Kuehn

We are evaluating and constantly evaluate the network and what the best way to operate is. With the rail service is the key and as long as we are able to see good quality service and good speed we are very happy to use the rails. We’ve got good relationships with them and we are able to manage those rails to offer guaranteed service. On the other hand though we are constantly experimenting with other approaches, we are constantly looking at different lanes. We are doing some work looking at the changes in the containers both in size and in formats so we’ll be constantly looking at that trying to find better ways to utilize it. One area of focus where we’ve increased the use of rails is in the LTL industry. Starting to leverage some of the skills and processes we’ve developed to move our ground package business for LTL also.

David Ross – Stifel Nicolaus

One follow up question on the International Round The World Flights, you said its probably about a 10-12 month drag on earnings before it become a profitable, how many of those round the world flights to you have now and how many you are targeting over the next couple of years?

Kurt Kuehn

We have really three comprehensive around the world flights now and at least at this point haven’t announced any specific plans to extend that but it is giving us great connections. As long as Global Trade continues to grow those are just tremendous investments for us and we’ll keep pushing them.

Operator

Our next question is coming from David Campbell from Thompson, Davis & Company.

David Campbell – Thompson, Davis & Company

I just want to try and understand this 50% to 60% cash in operations to debt balance. It seems like for example in ’07, 50% of the cash flow would have been about a $4 billion that would bring you up to what $8 billion of long term debt and you are $7.5 billion now. That means you have $500 million left.

Scott Davis

The funds from operations you’re probably thinking in the Central States payment. It would have been more like well over $6 million without the one time Central States payment, that’s the way you have to look at it. We’re probably 75% or so funds from operations to debt at the end of the year. That’s funding capacity.

Kurt Kuehn

We can take you through the line items offline if you want but we are pretty comfortable that there’s a significant amount of capacity remaining.

David Campbell – Thompson, Davis & Company

The impact of the tax rebate that’s going through congress right now is that included in your economic forecast or are don’t you have any thoughts about impact on that?

Kurt Kuehn

We’ve built the forecast based on what the consensus is saying out that because the consensus is looking at that because they look at the outlook for ’08. I’d say to a certain extent yes, it’s built in.

Operator

I have a follow up question from Tom Wadewitz from JP Morgan.

Tom Wadewitz – JP Morgan

I just wanted to follow up I guess two things on the cost savings in the past when you’ve hit periods of more challenging economic conditions you’ve been able to come up with some pretty significant cost savings initiatives and I’m wondering if you already have specific large cost initiative in place for ’08 or if not, if you’ve kind of got something in your back pocket that you can bring out that would be pretty significant if the volume slowed down. How might we think about the cost opportunity in ’08?

Kurt Kuehn

We’ve been very busy certainly the last couple of months as the increased economic uncertainty is highlighting that there’s risks to our forecast and to other economic forecast so we’ve been very focused across all the business units and all the functions to highlight those areas of discretionary costs and to create flexibility for us to react when we need to. We will be as responsive as we need to be going forward.

Tom Wadewitz – JP Morgan

Is there kind of an order of magnitude of pretty straight forward belt tightening type things that you can do and get cost savings is that $50 million is that $100 million, how might we think about that in terms of magnitude?

Kurt Kuehn

Not at this point, we don’t want to make manifest but as you know we have a long history of making costs variable and sustaining our ability to reduce both totally variable and semi-variable costs, no specific number that we’d want to quote at this time.

Scott Davis

You’ve heard many times that 50% of our costs are adjusted on a daily basis so are truly daily variable and 30% to 40% are semi-variable and that’s really the basis you’ve got to react to on slow the economy gets and we’ll be vigilant on those costs.

Tom Wadewitz – JP Morgan

On the Shanghai hub opening can you give an update for what that is and when that comes online if that’s going to drive some new flights and some impact we might see in the international export volume numbers.

Scott Davis

I think its late fall that we are going to open that hub and certainly we think that’s going to increase our competitiveness particularly in the US to Asia but also inter Asia flights its going to give us a lot more better time to transmit, help us in China quite a bit.

Operator

Your final question is coming from Scott Flower from Independent Research.

Scott Flower – Independent Research

I just had a couple of quick follow ups. I know that we’ve sort of given some qualitative, could you give us some sense of even if qualitatively how volumes trended in the quarter and then into January. I appreciate your comments about the first couple weeks in December and then I’m trying to get a sense has the rate of growth slowed is it about the same we’ve gone over the last three and a half months or so?

Scott Davis

I think overall its gotten better through the second half of the year. First half we were slightly negative for the first two quarters and it got a little better in the third quarter, slightly better in the fourth quarter and throughout the quarter with that late rush before Christmas it helped December it would be the best month of the three. January has showed slow growth but growing so I’d say it stayed pretty steady.

Scott Flower – Independent Research

The other quick question I had is on the labor contract around is there any in terms of some of the relative to whether the economy is slow. Obviously I know this contract is different but obviously some of the turn over rates on part time is slowed, etcetera and so there was some impact economically to what saves you could achieve and so I don’t know what the second half growth is going to be in the US but let’s say its slower. Is there any potential impact to some of the saves you might achieve with the new contract with a slower growth economy?

Scott Davis

Certainly our contract and our whole company benefit from growth and this is no different. This contract is not heavily levered to high growth rate so clearly if we are able to grow the business and bring in new employees that work through progression there is a benefit but its not going to make a huge difference as far as some of the progression rates and some of that. Clearly we are going to operate in a growing environment where we have a nice mix of junior and senior employees.

Scott Flower – Independent Research

Will you lose the efficiencies period if you just have a very slow growth environment?

Scott Davis

We’d have to really talk through that really but that said we get a lower effective rates if we’ve got a mix of new and old employees as volume slows and there’s a negative impact in the effective rates go up. I’m not really ready to comment as to whether that would undo all the benefit to the contract. I don’t think it would but it would depend on your assumptions.

Operator

You have no further questions.

Andy Dolny

To summarize the key takeaways from this call, first UPS delivered what we said 8% growth in earnings per share, second for 2008 we expect earnings per share of $4.30 to $4.50 and third we are looking forward to seeing you in New York City on March 12th. Thanks for joining us today.

Operator

This does conclude today’s UPS earnings investor relations fourth quarter 2007 earnings conference call.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: United Parcel Service, Inc. Q4 2007 Earnings Call Transcript
This Transcript
All Transcripts