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United Parcel Service, Inc.

Q1 2008 Earnings Call

April 23, 2008 8:30 am ET

Executives

Andy Dolny - Vice President Investor Relations

Scott Davis – CEO

Kurt Kuehn – CFO

Analysts

Garrett Chase – Lehman Brothers

Jon Langenfeld – Robert W. Baird & Company

Tom Wadewitz – JP Morgan

Ed Wolfe – Wolfe Research

John Barnes – BB&T Capital Markets

Ken Hoekster – Merrill Lynch

William Green – Morgan Stanley

David Ross – Stifel Nicolaus

David Campbell – Thompson, Davis & Company

Robin Byde – HSBC

Donald Broughton – Avondale Partners

Operator

At this time I would like to welcome everyone to the UPS Investor Relations First Quarter 2008 Earnings Conference Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host Mr. Andy Dolny, Vice President of Investor Relations.

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 risks and uncertainties which are described in detail in our 2007 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.

Before I turn the program over to Scott and Kurt I want to point out that there were two charges in last year’s first quarter that reduced operating profit in pre-tax income. The first was an aircraft impairment change of $221 million. The second was a $68 million charge related to the special voluntary separation opportunity. The after tax impact of these charges was $184 million or $0.18 per share resulting in earnings per share of $0.78 a year ago.

Without these charges adjusted earnings per share would have been $0.96. This is the amount to which Kurt will compared current results in his remarks today. The impacts from these adjustments are explained in the schedules that accompanied our earnings news release this morning. The schedules are also available on the UPS IR website in the financial section. They reconcile non-GAAP to comparable GAAP measures. To begin our review of the quarter I’ll turn the program over to Scott for opening comments.

Scott Davis

Good morning everyone. UPS first quarter results illustrate the dramatic slowing in the US economy. At our investor conference on March 12th we told you that volume growth in January had been up 3%. In the six weeks prior to the conference it had been negative. We also said if these trends persisted through March we would not achieve the earnings guidance we had provided for the quarter. Those trends did continue. In fact, many indicators are pointing to a contraction in the US economy and that become sharply more negative in the last two months.

For example, GDP in industrial forecasts for both this year and next have been revised down significantly. Manufacturing and service sector indices are contracting, nominal retail sales are growing slower than inflation and consumer confidence is at its lowest point in more than 15 years. The great unknowns are the severity and the duration of the current economic slow down.

Many of our customers have tightened their belts resulting in a shift away from our premium air products to ground shipments. Our broad service portfolio provides customers the flexibility to select the most appropriate level of service and manage their costs. In these tough economic times we remain focused on enhancing profitability. We intend to maintain our outstanding service levels, remain disciplined with respect to pricing, control costs with an emphasis on semi-variable and capitalize on growth opportunities as they become available.

Before turning the program over to Kurt let me reiterate that I am still focused on the three goals that I shared with you at the investor conference.

Lead the company effectively in executing our strategy and growing the business.

Create a better global balance for our enterprise with a steadily increasing proportion of profitability generated outside the US.

Sharpen our focus on economic profit, return on invested capital and long shareholder value.

The challenges of today’s business environment underscore how critically important these goals are. With that I’ll turn the program over to Kurt.

Kurt Kuehn

Good morning everyone. Let’s begin our segment review with the US Domestic Package operations. While revenue increased nearly 2.5% package volume was slightly negative. Next day and deferred air experienced volume declines of 3.8% and 2.9% respectively. Ground volume however did increase slightly. These results reflected a noticeable trade down in service levels from express to saver, saver to deferred, and deferred to ground, as customers worked hard to reduce their costs.

Trade down was evident across all customer sectors but was most prevalent in retail. This is a tell tale sign of progressively worsening economic environment. In addition, the timing of Easter had a negative impact on average daily volume. US Domestic revenue per piece growth was 3% or more for all service levels so clearly pricing remained rational. Fuel costs rose substantially in the quarter even though this additional expense is passed along to our customers there is a two month delay between when we incur the expense and when it is reflected in the fuel surcharge. Therefore, with constantly rising fuel costs we’ve been playing catch up.

The combination of lower volumes, trade down within the product portfolio and higher fuel costs all put pressure on Domestic operating profit. As Scott mentioned we have put an action plan in place to address the impact of economic slowing on our US business. We will:

Use the expansiveness of our service portfolio to help our customers navigate through these challenging times.

Exercise discipline with respect to investment supporting only those projects that are essential.

Remain diligent in managing variable and semi-variable costs.

With regard to the last point, we have a number of initiatives in place. We are restricting hiring except in the sales arena. We are stopping all non-critical projects and limiting discretionary spending including business travel, relocations and consulting services. The objective is to run the business as tightly as we possibly can while not reducing expenditures in areas that will provide future growth.

Now let’s move on to the International segment. If you’ll recall three months ago we told you that we expected the first quarter would be the most difficult one of the year for our International operations. Export volume growth was 7.8% using US days which is how we typically report international volume. However, since Easter occurred in the first quarter there were two fewer operating days in many European countries.

From the perspective of local operating days Europe, Asia, and the US all posted double digit volume increases with overall export volume up 10%. The decline in International Domestic volume was also impacted by the timing of Easter. Adjusting for this, volume growth would have been up 1.5% for the quarter. However, our Canadian Domestic business was weak due to that countries slowing economic environment.

All in all, International revenues increased almost 16% driven by export volume growth and favorable currency trends. Revenue per piece adjusted to reflect the impact of currency increased 4.4%. Operating profits however declined 4.3% as a result of the reduced number of operating days, the cost impact of our latest around the world flight and higher than expected fuel expense. We fully expect the performance of this business segment to return to more normal results in the second quarter.

For the year we are confident we can achieve a 10% increase in export volume and low to mid teens operating profit growth. We will continue investing in International expansion and new products and services that help customers better meet their global shipping needs. For example, in China we are proceeding with plans to initiate air service between Shanghai and Nagoya next month in conjunction with expanding our presence at Pudong International Airport at Shanghai.

We’ve added express morning deliver to five new countries and are adding over a thousand morning postal codes in existing express locations. We’ve also made expedited service available in nine Middle Eastern countries. As you know, UPS raised the bar when we rolled out paperless invoice and return service for International shippers in January. These services have been extremely well received and we’re expecting great things from these industry leading offerings.

Now for the Supply Chain and Freight segment. This segment posted a substantial profit improvement, more than doubling on a nearly 11% revenue increase. Forwarding and Logistics drove most of the positive performance in the segment, with revenue up almost 13%. We are very pleased with the positive reactions to the streamlined UPS Airfreight portfolio that we launched in January and customers are responding very well to this enhanced product offering.

In addition, service levels in Forwarding are at an all time high and we’ve seen a significant reduction in turn rates compared with previous years. In the Logistics units both distribution and post sales performed well, controlled growth and revenue management are driving consistent profit gains. UPS Freight results slowed in the quarter in reaction to the economy. Although LTL revenue increased 4% both shipments and weight per shipment declined. Such declines are typical in a soft economic environment.

Revenue per 100 weight increased over 13% helped by fuel, customer mix and a general rate increase that went into effect in February this year versus late March last year. We remain discipline in the face of a more competitive pricing environment. Going forward we intend to expand market share while maintaining a balance between growth and yield improvement. UPS Freight has developed one of the best value propositions in the industry through a combination of improved service levels and superior technology all backed up by a no fee guarantee. We anticipate this business will pick up momentum as the economy stabilizes.

Now I want to review our use of cash in the quarter starting with share repurchases. We have accelerated our share repurchase activity in line with the $10 billion that the Board authorized in January supporting our new financial policy. In the quarter we purchased over 17 million shares for about $1.25 billion. At this pace we are on track to complete the repurchases by the end of 2009. In February our Board raised the quarterly dividend 7% to $0.45 per share. Dividends per share have more than doubled in the last five years and in the first quarter we paid $893 million in dividends.

The payout ratio has gradually increased to about 40% in 2007 and the UPS dividend yield was approximately 2.5%. We also spent $661 million in capital expenditures and closed the quarter with $1.5 billion in cash and investments. Free cash flow for the quarter was $1.6 billion; this amount excludes the $850 million received as a Federal tax refund related to the Central states pension plan withdrawal.

Turning now to our outlook for the second quarter and the rest of the year. At this point we see no immediate signs of economic improvement. In addition, most forecasters are not predicting economic recovery until 2009. In that scenario we expect the US Small Package market to be flat to down 1% this year with the third quarter being the weakest. UPS volumes should follow a similar pattern which means Domestic margins will be under pressure for the rest of the year.

On the International front cross border trade remains robust despite pockets of economic slowing. Therefore we are confident that we can maintain our goals for the year of 10% growth in export volume with low to mid teens operating profit growth. We believe this is possible because of our well balanced global presence and extensive portfolio. For the Supply Chain and Freight segment we are reconfirming our guidance of an operating margin in the 4% to 5% range even with the slowness in the LTL market.

Taking all this into consideration we anticipate earnings per share for the second quarter to be within a range of $0.97 to $1.04. We are also revising our annual earnings guidance to a range of $3.90 to $4.20 per share. This range reflects the significant uncertainty that currently exists in the economic environment. Managing a tight ship through these stormy seas will take both vigilance and dedicated effort. UPSers have shown in the past that we can rise to the challenge and we’re confident that we can do so again.

Scott and I will now be happy to answer your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Garrett Chase of Lehman Brothers.

Garrett Chase – Lehman Brothers

I wanted to ask, you had sized the impact of fewer operating days in Europe but I think at about $50 million similar to what you were looking at in the Domestic business.

Kurt Kuehn

Yes, about that in total for the Easter impact.

Garrett Chase – Lehman Brothers

We do get those back so that’s part of the double digit growth, I assume, we get a three day good guy in the second quarter and then I think an additional two days through the remainder of the year, that’s part of the op profit growth you’re forecasting, right?

Kurt Kuehn

Yes, and that’s part of the reason we communicated those numbers in local days also to show that the momentum is continuing steadily there, we’ll recover most of that in the second quarter and we remain confident that over the course of the year we will be able to deliver the numbers that we’ve said.

Garrett Chase – Lehman Brothers

Given the day changes and I’ve heard your commentary on it, what I’m curious about is does the 12% to 15% goal for International, does that suggest that we’re not going to see a slow down in that arena or is that consistent with a decoupling where the brunt of recession is felt here in the US and not beyond?

Kurt Kuehn

We’re seeing certainly changing trade flows and US imports are slowing but at the same time US exports are increasing. Asia to the US is perhaps not as robust as it was but Asia to Europe remains robust. There are clearly moving pieces to the puzzle and part of why our strategy has been to build a comprehensive balanced network so that we can catch the ball whichever direction it’s going.

Scott Davis

In Europe, even though there has been some weakening of the economy our transporter products there are staying strong. We see no declines there whatsoever.

Garrett Chase – Lehman Brothers

You think there’s some offset here to the potential weakness, is that fair?

Scott Davis

Absolutely, US export will help offset the slower imports into the US from Asia.

Kurt Kuehn

Clearly if there’s a global economic slowing we’re not immune to that but it’s a matter of one theatre changing a little bit and the other picking it up then we feel pretty good.

Operator

Your next question comes from Jon Langenfeld of Robert W. Baird & Company.

Jon Langenfeld – Robert W. Baird & Company

You talked about the initiative in place to manage the semi-variable costs, can you give us some idea what the progression of that looks like? If we go back to the early 2000s when you did that it took a quarter or two to kick in but then when it did kick in you were able to recover quite a bit in terms of lessening the downside of profit year over year. Could you talk a little bit about how long it takes to manage some of those things through?

Kurt Kuehn

We try to aggressively manage variable costs really on a daily basis. Adjusting our dispatch, the hours our people work and realigning the network and certainly the more persistent the slowdown is the better we get it back. Then on the semi-variable side it does take us a quarter or two and it’s a broad range of issues. One thing we have done this year is we did reduce the number of operating locations within the US, our districts, leveraging technology to increase our people’s span of control a bit.

We’ve done some traditional work with constraining relocations and minimizing travel. Those things kick in over time and it’s not an immediate reaction but we’ve done this a few times and we’re pretty confident that we can right size the expenses.

Scott Davis

The other benefit we have this year is the labor contract on the operating side, it kicks in, in August. We’ll start seeing the benefits from this new contract in August which will add to help with the non-operating savings.

Jon Langenfeld – Robert W. Baird & Company

Is there any reason to think that at least at this point that the down turn and how you manage the down turn domestically is any different than how you did in early 2000? I know fuel is different here but I’d be interested in your thoughts.

Scott Davis

I think the wild card if fuel. The down turn we’re in right now, none of us know where we’re going to end up. My own opinion is we’ll probably end up being slightly positive or slightly negative from the economy for the year. We’re predicting slightly negative in Domestic volume for the year. It’s pretty similar to what we saw in 2001. In 2001 and 2002 we saw negative next day air volume growth both those years snap back in 2003 to 7% growth so I don’t see any difference about this one other than the energy costs which is still a wildcard for all of us.

Operator

Your next question is coming from Tom Wadewitz of JP Morgan.

Tom Wadewitz – JP Morgan

I wanted to ask a little more about what you’ve got in the guidance. If you look at the first quarter earnings decline off about 9% and then you compare that to, I think on a continuing basis if you take the mid-point of your full year guidance its off about 1.5%. Do you have any improvement in volumes later in the year baked in or is the improvement that’s implied in this purely the cost side action and maybe if you could give some comments on that?

Kurt Kuehn

We have clearly ramped down the view for the remainder of the year. We’re expecting basically kind of a steady state but sluggish view which seems to be the increasing consensus with most economists not looking for significant a recover until ’09. A significant amount of the improvement is the cost adjustments we’re making. As Scott mentioned the benefits of the new labor contract begin to kick in. There is a view that industrial production will bottom out in Q3 clearly that’s a big driver of our volume. There may be a little bit of bump up in Q4 based on the economic statistics we’re looking at. This isn’t a hockey stick forecast.

Scott Davis

The other wildcard is we talked about International. International is going to get better for the rest of the year. We had penalize with Easter this year we’ll see International turn around and get back to normal growth trends which obviously will help the overall company results. Supply Chain and Freight should continue to show improvement as we move through the year.

Kurt Kuehn

Fuel remains a wildcard, it continues to break through to unprecedented levels and as I said we’re playing catch up so there’ll be a little bit of volatility with that. That’s kind of where we sit.

Tom Wadewitz – JP Morgan

On the cost side you talked a little bit about it in response some of the earlier questions but can you give us any further thoughts on the magnitude of some of the bigger cost savings initiatives. Is it $100 million that you are looking at from some of the items you talked about or is there room for a lot more than that when you look at your cost reduction activities?

Scott Davis

We’ve got plenty of opportunities we think. It’s a big base of expense. We’re not really ready to hang a specific number out at this point but there are a lot of activities and we’ll remain constructurally dissatisfied until we do the best we can.

Operator

Your next question is coming from Ed Wolfe of Wolfe Research.

Ed Wolfe – Wolfe Research

As follow ups to questions that have been asked a couple times, the cost savings target when we compare this to what you did in ’02 does it feel like it’s a tighter clamp down or does it feel similar or is it just different? On the International side I wasn’t clear; you said there’s $50 million from the two days, does that include Domestic and International or just at International?

Scott Davis

That’s both Domestic and International, although International fuels the impact more than the Domestic side did.

Ed Wolfe – Wolfe Research

Even if you gave them the full $50 million at International you would have had 7% EBIT growth and you are projecting 12% to 13% kind including that 7%. What’s so exciting in International besides those two days, why are you so confident in that? The last thing that I would throw at you is interest expense occurred at $134 million with a lot of moving parts can you comment give or take what we should be modeling for that going forward?

Kurt Kuehn

Maybe I’ll start off with the International. Certainly the Easter impact was a material one. We’ve got a couple other headwinds that we see mitigating. Number one the around the world flight begins to cycle over in the second quarter. That flights moving along well but it certainly has added a cost base that’s substantial. The continued chasing the fuel on its way up has also created a headwind. Some of those things we think we can manage pretty well and we do remain quite confident.

We know this is a big swing Q1 to the rest of the year. We did have a similar condition like this several years ago and I think we had the same case that market was concerned about our performance in Q1 but the calendar showed that it was just a transitory issue. On the interest expense clearly we’ve increased our debt with the issuance we did the second week in January with $4 billion increased debt levels. Those are levels we would expect going forward and that’s all part of the recapitalization plan we are doing with repurchasing shares and we did mention that we repurchased 17 million shares in the quarter. That’s a natural outgrowth of that.

Scott Davis

The cost cutting environment doesn’t seem that dissimilar to what we saw in 2001 and 2002.

Kurt Kuehn

We do feel that the margins in the Domestic also will be improving over the course of this year for Q1 forward. You’ll see the impact of some of those things over time.

Operator

Your next question is coming from John Barnes of BB&T Capital Markets.

John Barnes – BB&T Capital Markets

Following up on your comments on some of the cost base of these new growth initiatives like the around the world flight. At what juncture do you get concerned enough about the economy kind of lingering at this pace that some of those growth initiatives you may have to pull back on? Would you consider pulling back on the number of the around the world flights you are doing and trying to shrink the cost base that way or do you view growth initiatives like that as too important and its just something you’re going to have to deal with in the near term?

Kurt Kuehn

When it comes to International growth initiatives we see no reason to pull back. We feel like we’re doing great. We feel like we built a superior value proposition. We raised the bar as I said with several new to industry capabilities with paperless invoice, international returns. There’s a whole bunch of stuff that keeps the momentum going. A little bit of a headwind for a few quarters with added capacity is a good investment for us.

On the Domestic side clearly with our size the economy is going to impact us and that’s where we’re going to be the most cautious.

John Barnes – BB&T Capital Markets

You made the comment about significantly ramping up the share repurchase activity and that type of thing. Can you give us order of magnitude what you are talking about in terms of a significant ramp up. Do you have a dollar amount in mind that you’re committed to spending every year or have you shortened the duration of the buy back in order to complete it much earlier than originally anticipated?

Kurt Kuehn

We purchased about 17 million shares in the first quarter about $1.25 billion which puts us right on target to complete the repurchase by the end of ’09. That’s fairly steady state, we reserve the right to speed up or slow that down based on either market conditions or other factors but we’re on target and we’ll keep you posted.

Operator

Your next question is coming from Ken Hoekster of Merrill Lynch.

Ken Hoekster – Merrill Lynch

Can you clarify when you talk about cutting out some of these expenses are you looking to reduce capital expenses in any way. I guess you’ve still got a $3 billion target out there.

Kurt Kuehn

Yes we do, certainly capital is a critical part of running the business and we remain very focused as Scott mentioned on returns to capital. We already did give the capital budget a bit of haircut prior to our $3 billion guidance but we will continue to really scrutinize that. Most of the aircraft we have are committed and also the one’s we’ll be taking primarily the 747-400s which are primarily for International capacity, that will continue.

Another large expense we have for 2008 that won’t be mitigated is the expansion of the Worldport hub that’s expanding capacity there, that’s another great lynch pin in our global capabilities. Then also the opening of the Shanghai hub which will allow us to have more frequencies and more access in China. We mentioned that we’re linking Shanghai to Norita in Japan also. A lot of the CapEx right now is focused internationally.

On the Domestic side certainly there are a number of capacity expansions. Additional vehicles that we will scrutinize very carefully and those we’re more flexible with. We’ll keep moving along to the extent we think we will. We do go back and revisit all projects. We are doing, I guess what you might call value engineering in our IT looking at projects and rather than perhaps totally canceling them, challenging the users to go back and strip out the 20% of the project maybe that adds the least amount of value. It’s across company, its something we’ve done a few times through a few cycles and we’ll remain diligent.

Scott Davis

In total we’re still going to be below the 6% of revenue which is low compared to the historical spend. Keep it below 6%. Also, we improved our return on invested capital in the quarter despite the anemic earnings.

Ken Hoekster – Merrill Lynch

If I can get my follow up on the currency exchange, I just want to understand this a bit, maybe a pure pricing if you can on the export side which I think your printed number was about a 7.5% yield increase. If I look at your currency adjusted page it might have been about .3%. Is that with fuel surcharges and if we strip that out can you give us a look at that and then a minor technical question I hope its not a follow up question but you keep talking about these two Easter days are you also adjusting somehow for the fact that you got the bonus Leap Year day, is it actually three days or is it two day impact.

Kurt Kuehn

Its two day impact, that’s just total days to total days working days.

Ken Hoekster – Merrill Lynch

Shouldn’t it be one if you get the extra day for Leap Year in there?

Kurt Kuehn

Not if you add up calendar. It’s the way it works. Its total days in the quarter we did see a couple less and that’s why we gave numbers both with or without those days. We grew 7.8% in exports including the total quarter but if you look at it using the proper working days in each of the major regions then we show 10% in each of those regions.

Ken Hoekster – Merrill Lynch

Got it, so it’s a working day.

Kurt Kuehn

Fuel is in the yield numbers although certainly in the P&L it’s a drag. The trends we’re seeing in our yields internationally we feel pretty good about. The overall average for export did show just modest increases and that continues to be the factor we talked to a few times which is a little bit of a mix issues where we’re seeing the fastest growth in our transporter products that move within continents and that has certainly a lower revenue per piece.

Each of the products on their own are doing quite well and just like in the US where customers mix up and down, move through premium to standards we’re also doing the same thing across the world to help customers optimize. We feel very comfortable, we’re managing that and we expect margins to continue to look great in the International theatre.

Operator

Your next question is coming from William Green of Morgan Stanley.

William Green – Morgan Stanley

Just one quick question, you mentioned the retail weakness, how are BC volumes in the quarter?

Kurt Kuehn

Still positive but certainly slower than they have been over the last couple of years. The consumer’s definitely feeling it and both our direct to retail business volume and our direct B to C is showing the impact. It’s a tough environment out there right now and we’re doing a lot of specific work with the big retailers and finding ways to manage the businesses. Hopefully the rebate checks on the taxes will give consumers a little bit of extra spending money and should provide a boost if it works right.

William Green – Morgan Stanley

Domestic volumes in the first few weeks of this quarter, they’re down I assume following similar trends as the end of the first quarter?

Kurt Kuehn

Yes, it’s a little wacky because of the Easter impact. Just as we had a headwind with Easter being early and in the first quarter we’re seeing some comps that are easier in April. In general we don’t see any real trend changes right now.

Operator

Your next question is coming from David Ross of Stifel Nicolaus.

David Ross – Stifel Nicolaus

A question first on the ground side, we’ve seen a shift from the premium product down to the ground, tough economic times but I also know that you’ve taken a lot steps in your Ground product to reduce transit times and increasing liability of the ground shipment. What percentage of your packages in the Ground network in the US you said delivered next day, what percent would be two day deliveries and what percent are three day?

Kurt Kuehn

I don’t have the exact percentages handy but clearly the majority of volume moves within a one to three day configuration. For competitive reasons we’ve in the past not disclosed the details there.

David Ross – Stifel Nicolaus

A follow up, the repairs and maintenance expense line item declined year over year on an absolute basis, is this due to fewer vehicles in the fleet, a newer fleet, fewer miles, something else going on there?

Kurt Kuehn

No, its part of effective cost management. We do have a little bit of a benefit because we’re overlapping the first quarter in which we still had some repairs on the 727s that we retired. There’s a little bit of a comp benefit there. I wouldn’t expect that to continue to decline, its just there was a little bit of a boost in Q1 from that.

Operator

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

David Campbell – Thompson, Davis & Company

I just wanted to ask about the International picture and particularly the Asia/Pacific region. It seems to be significantly better growth there in March in the industry than there was in January and February some attribute it to the China weather and loss of traffic in January and February from that situation. There also seems to be a fairly big pick up in imports from Asia/Pacific and the United States in March. I’m wondering if first if you had seen that and two is that one of the reasons why you’re more optimistic about the second quarter International results.

Kurt Kuehn

It has been a little bit of a bumpy ride in Q1 and certainly the unprecedented weather in Asia did delay some capacity or some goods coming to market. If you factor that out and you also have the Chinese New Year that bucks around. We don’t see that as a change in trends, we see those more as just short term distortions. We’re seeing actually more strength in the China and Asia to Europe arena where their currency remains strong and the Asia to US is steady and strong but it’s not really driving he show right now.

Scott Davis

I think it will take the US economy to strengthen to really get back to the robust growth rates we saw the last several years. As Kurt said, Asia to Europe and Intra-Asia both have been quite strong.

Kurt Kuehn

We are seeing a great pick up also with our new freight portfolio that’s allowing us to help customers no matter which direction they are moving the goods. Pretty seamlessly pick the level of service and the lanes that they need, so that’s coming in handy for us as things shift a little bit.

David Campbell – Thompson, Davis & Company

The air freight forwarding business seems to be significantly better than small package business particularly in the Asia/Pacific region, is that true and of course you’re attributing it to individual initiatives in your case but in the industry it seems to be better do you have any explanation for that?

Scott Davis

I think we’re doing very well in both the package and the heavy freight side out of Asia still. We’re not disappointed with Asia results, they’ve been strong. Maybe we’re not growing at 40% to 50% out of China like we were but we’re still growing at very high rates, still double digit export package growth rates out of Asia. As Kurt said, I think of the freight forward and heavy freight side I think our new offering has helped our business grow dramatically in the last quarter.

Kurt Kuehn

One of the most notable things in the quarter was the substantial enhancement improvement in the Supply Chain and Freight segment. We’re pretty excited that we’ve found the sweet spot and our strategy is starting to execute with this new portfolio with the alignment organizationally across the world, the integration of our management teams, and the visibility in the technology linkages. We saw a great result in the Supply Chain and Freight on both the top line and the bottom line so it’s a firm market out there but we also feel like we’re making some headway.

Operator

Your next question is coming from Robin Byde of HSBC.

Robin Byde – HSBC

Just a question on pricing in Domestic and International package, with the slowing trading environment is the company starting to likely to start to compete on price and what did you see on pricing back in 2001 and 2002?

Kurt Kuehn

Clearly we are very sensitive to the pricing environment and to the behavior that can happen in weak economic times. Probably the most notable area with pricing pressures is the LTL arena. I think you’ve seen a number of carriers talk about that. We were pretty fortunate in sticking to our guns and start to leverage the value proposition so we showed a substantial improvement in yields in the first quarter although that certainly was helped by the earlier rate increase that overlapped in the first quarter. We’re going to strike a balance on the LTL side of continuing to grow share but also improvements on the pricing side.

On the Package side the market continues to be rational. One thing we have seen in the air especially that has impacted the yields a little bit is that the average weight of our packages is reduced. In next day air it’s down 5% to 6% as there’s less widgets per box. That is mitigated the yield increases a bit and also we see some trade down from our AM service to our PM service and from the next day to deferred. These are all natural reactions and actually this is where we can help customers if we work through this.

In general we seem to feel that both Domestic and International the pricing market is rational, I think all the players in this industry are seeing significant cost pressures and high variable costs of fuel. We’re going to be disciplined and we expect the market will.

Operator

Your next question is coming from Donald Broughton of Avondale Partners.

Donald Broughton – Avondale Partners

I heard you at the beginning say how focused you were on cost control as demands slows. With the softness in Domestic Package and in Domestic Freight have you furloughed or laid off any workers and if not how weak and for how long would that weakness have to last before you would begin to chip away at what is your largest line item.

Kurt Kuehn

On a daily basis we do adjust the number of employees in our operations and the hours they work so certainly we have some of the more junior employees that are perhaps just working a couple of days a week if demand is there. We are adjusting the hours on those people also. From the overhead perspective, as I mentioned we have done some realignment to reduce the non-op costs in the field with realigning some of our districts and regions. That reassigns people or we aren’t replacing them as some of our UPSers retire or move on. We’re being very careful on that side.

Also, across the globe, as we mentioned we’ve done a fairly significant alignment of our freight, our distribution and our package management structure that’s beginning to show some real synergies. Over the longer term another big priority that we’re working on as the dust settles with the new expanded capabilities we’ve got is beginning to drive all of the non-operating process into a major shared services environment to really get the economies to scale and to line our global processes. There’s short term, there’s medium term and there’s long term activities.

Donald Broughton – Avondale Partners

I guess this is more of a philosophical question, I was going back to the releases and company presentations you made during the last economic slow down and what struck me was how much you pointed to the flexibility of your model, the non-cyclicality of your ability to produce results and indeed, for the most part turned out to be the case. Now the economy is slowing and it is directly hurting your ability to produce results so what’s changed, is it you, is there something structurally about the company that’s changed, is the competitive environment or is this a different slow down than we saw in the 2000, 2001 timeframe.

Scott Davis

I think one of the things that changed is energy prices. Energy prices keep cranking up and that put pressure on us in the first quarter that we didn’t see in 2001. Clearly the Easter comparison hurt us a little bit Domestically and Internationally in the quarter. Some of its calendar, some of its energy, some of it’s a little bit of a surprise in how fast the volume declined in February. You saw us at the March conference we were growing in volume pretty nicely in December and January and it fell off pretty quickly. Particularly in the semi-variable area it’s harder to react quickly when volume falls that quickly.

Kurt Kuehn

If you go back to ’01 and ’02 during tough times we show some margin compression and I think if you look at our guidance for this year we’re going to continue to execute. There will be some margin compression but it’s certainly not highly volatile.

Operator

We have a follow up question from Garrett Chase of Lehman Brothers.

Garrett Chase – Lehman Brothers

A quick one on Supply Chain, in response to a question a little while ago you were describing how that was really starting to hit on all cylinders and at least as I look at it the first quarter was a very good performance feels like almost acceleration despite the tough environment. If memory serves you’ve not really changed the outlook for the full year. I’m just wondering if you had any additional color on what might be behind that, is that conservatism or is there something there that you’re more concerned about?

Kurt Kuehn

I guess if there’s anything we’re concerned about it would be the LTL environment. It’s a tough sector right now. We’re very excited about the company specific story with the no fee guarantee, we’ve integrated LTL into world ship to give shippers ability to move seamlessly between package and freight. Long term we’re very bullish about the LTL but certainly in the near term it’s a tough market. That is embedded in that Supply Chain and Freight segment and we remain cautious there.

We feel pretty good that we’re starting to hit on all cylinders in the forwarding and logistics arena and it’s been a long path with a lot of investment and hard work. We’re starting to see great response from our customers.

Operator

We have a follow up question from Tom Wadewitz of JP Morgan.

Tom Wadewitz – JP Morgan

My follow up is on fuel. You’ve obviously talked about this quite a bit on the call. I didn’t catch any kind of a quantification of year over year impact to fuel on earnings in the first quarter. Is it in broad terms are we talking a $0.01 or $0.02 or was it more like a $0.05 or $0.06 a share impact when you consider fuel surcharge and increase in expense year over year.

Kurt Kuehn

Probably $0.02 to $0.03, although if you take a little more expansive view if you add in toxic surcharges and utilities and some of those other things you can get to a pretty big number. There’s both the direct fuel, there’s things like purchase transportation which you’ll see is up substantially, and that’s largely driven by fuel. It’s clearly a headwind and at least $0.02 to $0.03 as far as our calculation and could be more if you take a little more aggressive view of the indirect impact.

Tom Wadewitz – JP Morgan

If you look at the impact on yields, I know it would be different for Ground and Air but if you count on each of those how much do you think fuel surcharge booted yields year over year in lets say Air Express overall and in Ground Package?

Kurt Kuehn

The Ground impact is more mitigated a couple percent. On the Air there is a lot of moving parts, we are seeing it impact in a benefit from the surcharge, somewhat offset by the 5% to 6% reduction in weight which directly drives revenues and some of the trade down factors. Certainly as fuel gets to these high levels and the surcharges reach 20% and more it is very large factor and to some extent has become a part of the negotiation process so it is an area our customers worry about, we are concerned about and we’re trying to find the best way we can to help them deal with that.

Tom Wadewitz – JP Morgan

In terms of the Ground you’re saying something like two percentage points impact on yield something like that?

Kurt Kuehn

Yes.

Operator

We have time for one question is a follow up from David Ross of Stifel Nicolaus.

David Ross – Stifel Nicolaus

I wanted to follow up on UPS Freight; you talked about the soft LTL market while a significant decline in shipments but heavy yield improvement. Can you talk about a little where the pricing pressure is; are you actively just calling accounts that are asking for price reductions, just a little more color on what’s going on there?

Kurt Kuehn

Some of it is just our customer mix is changing a little bit also. Clearly the ease of use and the value proposition we have put out there is very compelling for small and mid size customers. Being able to use the same world ship environment that they’ve used for years to process transactions and with the flick of the wrist manage their LTL in the same environment is a pretty good arrangement. As customer mix shifts and the middle market grows faster than some of the larger accounts there is a benefit on average yield.

We’re trying to find a balance on this. We’re certainly working with our customers to reduce their costs and we’re not actively calling customers at all but at least for now we showed some great results and we’re going to continue on the yield side. Although clearly we’d love to show better growth so we’re going to continue to manage that. We feel confident in the long term but there is a lot of noise in the industry right now and we don’t want to get too caught up in it.

Operator

I would like to turn the floor over back to your host Mr. Andy Dolny for any closing remarks.

Andy Dolny

Just to summarize, we expect second quarter earnings per share within a range of $0.97 to $1.04. For the full year earnings per share are expected to be within the range of $3.90 to $4.20. We intend to watch our cross diligently while continuing to invest in the business to capitalize on global growth opportunities. Thank you for joining us today and we look forward to seeing you soon.

Operator

This concludes today’s UPS Investor Relations First Quarter 2008 Earnings Conference Call. You may now disconnect.

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Source: United Parcel Service, Inc. Q1 2008 Earnings Call Transcript
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