United Parcel Service, Inc. (UPS) Q2 2012 Earnings Report, Transcript and Summary

Andy Dolny - Vice President of Investor Relations D. Scott Davis - Chairman, Chief Executive Officer and Chairman of Executive Committee Kurt P. Kuehn - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Treasurer

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division Kevin W. Sterling - BB&T Capital Markets, Research Division Justin B. Yagerman - Deutsche Bank AG, Research Division Christian Wetherbee - Citigroup Inc, Research Division Ken Hoexter - BofA Merrill Lynch, Research Division Brandon R. Oglenski - Barclays Capital, Research Division David Vernon - Sanford C. Bernstein & Co., LLC., Research Division Edward M. Wolfe - Wolfe Trahan & Co. Nathan Brochmann - William Blair & Company L.L.C., Research Division William J. Greene - Morgan Stanley, Research Division Christopher J. Ceraso - Crédit Suisse AG, Research Division John L. Barnes - RBC Capital Markets, LLC, Research Division Jeffrey A. Kauffman - Sterne Agee & Leach Inc., Research Division David P. Campbell - Thompson, Davis & Company Benjamin J. Hartford - Robert W. Baird & Co. Incorporated, Research Division H. Peter Nesvold - Jefferies & Company, Inc., Research Division Helane R. Becker - Dahlman Rose & Company, LLC, Research Division David G. Ross - Stifel, Nicolaus & Co., Inc., Research Division Anthony P. Gallo - Wells Fargo Securities, LLC, Research Division

Good morning. My name is Stephen, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the UPS Investor Relations' Second Quarter 2012 Earnings Conference Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Mr. Andy Dolny, UPS Treasurer and Investor Relations Officer. Sir, the floor is yours.

Good morning. Today, I'm joined by Scott Davis, our CEO; and Kurt Kuehn, our CFO, to discuss the company's results for the quarter and future expectations. Before they begin, I want to review the Safe Harbor language. Some of the comments we'll make today are forward-looking statements that address our expectations for the future performance or results of operations of the company. These anticipated results are subject to risk and uncertainties, which are described in detail in our 2011 Form 10-K and first quarter 10-Q reports. These reports are available on the UPS Investor Relations website and from the Securities and Exchange Commission. In the second quarter of last year, UPS reported a net gain of a $33 million as a result of 2 nonrecurring real estate transactions. These adjustments resulted in an after-tax benefit of $0.02 per share. In Scott and Kurt's comments today, references to 2011 results will exclude the impact of this gain. We believe this is a more accurate picture of the company's performance. Reconciliations to comparable GAAP measures and free cash flow, which is a non-GAAP financial measure, are explained in the schedules that accompanied our earnings news release. These schedules are also available on the UPS Investor Relations website in the Financials section. As a reminder, any guidance that we provide will not include the results of TNT operations, nor any synergies or post-closing integration expense associated with the acquisition. As always, today's call is being webcast and is also available on the UPS Investor Relations website. [Operator Instructions] I thank you in advance for your cooperation. Now let me turn it over to Scott.

Thanks, Andy, and good morning. UPS's second quarter results were driven by the performance of our U.S. Domestic segment. We continue to benefit from the efficiency of our streamlined and integrated network. Our unique portfolio of solutions has allowed UPS to adapt quickly to the evolving needs of e-commerce shippers and do it profitably. On the other hand, our International segment results continue to be impacted by declines in exports from both Asia and the U.S. Economies around the world are showing signs of weakening, and our customers are increasingly nervous. In the U.S., uncertainty, stemming from this year's elections and the looming fiscal cliff, constrains the ability of businesses to make important decisions, such as hiring new employees, making capital investments and restocking inventories. This will further restrict economic growth. In fact, this is already evident as June's manufacturing ISM and growth in retail sales numbers were the worst we've seen since 2009. In addition, employment gains have started to slow down, all of which had a negative impact on commercial volume growth. Given these trends, we think current second half economic forecasts for the U.S. are too high and that GDP growth will likely be closer to 1%. In Europe, the debt crisis lingers on as more countries struggle with austerity measures that are pushing them into recession. Despite this, UPS export volume has continued to grow, although at reduced rates. While economies in Asia are still expanding, expectations have come down in the last 3 months. Overall, GDP forecasts around the world are declining. Historically, global exports grow at a higher rate than GDP. This is not the case today. In fact, global trade is lagging GDP. This has only occurred once in the past 10 years, and that was during the last recession. We believe this is temporary and that as GDP growth begins to accelerate, a more typical relationship between the 2 will exist. Though the macro environment gives us concern, we have confidence in our strategy and remain focused on current objectives. One strategy, demonstrating the power of logistics, will be on display during the 2012 London Olympic Games. As the official logistics express delivery supporter, UPS is responsible for the staging the largest peacetime logistical undertaking in the world, providing the warehousing, distribution and logistics to produce the games while delivering 30 million items, everything from tennis balls to goal posts. UPS is eager to demonstrate the industry's most advanced supply-chain capabilities at this year's games and further strengthen our brand in Europe. Now for an update on our offer to acquire TNT Express. This transaction will diversify our global revenue, increase our portfolio of solutions and expand our geographic footprint. The complementary strengths of both companies will create a customer-focused platform, delivering unparalleled access to the world, while at the same time, enhancing shareholder value. During the quarter, UPS made significant progress towards completing the purchase, including the announcement of our financing plan and the publishing of the Offer Memorandum. Over a week ago, UPS announced that the review process with the European Commission will move to Phase 2 as there are certain areas that require more time to analyze. We expect to close the transaction during the fourth quarter. Another recent development I am pleased to note is that UPS and the Teamsters have agreed to get an early start to negotiations. Formal talks are expected to begin soon. This brings me to my final point. As 2012 continues to progress, keep this in mind: During our 105-year history, UPS has dealt with many different economic conditions and changing marketplaces. And through it all, we have proven our founder, Jim Casey, right. Determined UPSers around the world working together can accomplish anything. I assure you, we'll make the necessary changes to adapt and respond to the current challenges as we've done so many times in the past. Now Kurt will review our results for the quarter.

Well, thanks, Scott, and good morning. The second quarter results released this morning, which produced earnings per share growth of 7.5%, are solid, considering the change of pace in the global economic environment that Scott alluded to earlier. On a consolidated basis, UPS daily volume improved 2.7%, and operating profit was up 4.6%, with 40 basis points of margin expansion. This points to the flexibility of our product portfolio and the efficiency of the UPS network. We provided UPS customers with solutions needed in this challenging economic climate, and we're able to generate the industry's best margins. Let's take a look at how the segments performed, starting with U.S. Domestic. E-commerce in the U.S. continues to expand, benefiting the segment. Operating profit growth was up over 12% with margin expansion of 100 basis points. Strong operating leverage resulted from the volume growth, base rate increases and continued network efficiencies. I also want to point out that the quarter did benefit by over $60 million from the fuel surcharge lag. Daily volume was up 3.5%, driven entirely by B2C. One concern of note was the lower manufacturing ISM numbers that point to lower purchasing activity. This is contributing to a deceleration in our critical business-to-business volume growth. Air products outpaced ground during the quarter with Next Day Air volume up 5% while deferred increased by 8.6%, driven by growth in our Saver and the residential shipments. UPS experienced gains in Next Day Air letters again during this quarter, reversing a long trend of declines. Ground package volume was up 3%. Over 1/2 of this growth was attributable to a 25% increase in lightweight products. Revenue improved a little over 4%. As expected, average revenue per package was up less than 1%. Yields across all products benefited from base pricing but were offset by faster growth from large customers and changes in product mix. We continue to see rapid growth in lightweight and Saver products, both of which have lower yields. Although they do have lower yields, this volume continues to contribute to our productivity gains. Average daily volume was 3.5% higher, while miles driven and direct labor hours were up only about 1%, and block hours actually declined. Savings in direct payroll costs were not enough, however, to overcome growth in benefit expense. Health care jumped over 7%, while pension-related expenses were up more than 10%. Overall, a good quarter in the U.S. Domestic, aided somewhat by the fuel surcharge lag. Importantly, current trends, such as the lack of B2B growth, are concerning going forward. But we are taking the necessary steps, implementing both revenue and cost initiatives, as well as making adjustments to the UPS network. Now for a review of our International results. Slowing global economies, shifting trade patterns and negative currency translation resulted in a 4% revenue contraction. Double-digit declines in high-yielding shipments from Asia to both Europe and the U.S. produced a notable drop in profitability. That's not surprising considering the infrastructure required to support Asia. We made adjustments to our network during the first half of the year and are implementing additional cuts to mitigate this trend. Operating profit in the International was down $51 million from last year. Expenses related to M&A activity accounted for a drag of about $15 million. However, our margin is still the industry's best at 15.1%. In contrast to the significant decline in transcontinental demand, intra-regional shipments continue to increase. Overall export volume was up by 1%, as growth in Europe was mostly offset by the declines in Asia that I mentioned. When faced with today's economic challenges, customers continue to trade down to less costly alternatives. As a result, we experienced faster growth in our transborder standard products and even saw some trade-down from small package into freight. Non-U.S. Domestic volume was down 3.2%, reflecting yield improvement initiatives in Germany and Turkey. Fiscal austerity measures in Southern Europe contributed to double-digit declines there. But keep in mind that although this is a fairly steep drop in volume, it had only a small impact on segment profitability. Export revenue per piece was down 3.5%, the primary factor being the year-over-year currency fluctuations. In fact, currency-neutral revenue per piece was flat, reflecting base rate increases that were offset by changes in trade lanes and product mix. So it's been a challenging environment for our International group over the last 12 months. But during this time, we've implemented various revenue and cost initiatives, including reductions to our network, and we will continue to do so as we are planning another 10% reduction in our Asian air network. This will position us better for the future. And now for the Supply Chain & Freight segment. Operating profit increased by 3.6%, and margin expanded 50 basis points to 8.9%, the highest margin this segment has seen. Revenue declined 1.6% due to slowing international airfreight demand. Although the forwarding units saw an increase in tonnage, revenue was down as rate per kilo continues to be challenged in the key Asia outbound market. Operating margin was still strong due to effective revenue management and cost controls. In UPS Freight, revenue growth was flat as improvements in LTL pricing were offset by a decline in shipments. Operating profit and margin increased during the quarter due to productivity gains. Revenue in our Distribution business was higher, primarily from continued growth in health care and UPS lightweight solutions. Investments in technology and infrastructure to support the company's health care initiative did impact operating profit. Looking now at cash and our balance sheet. For the 6 months ended June 30, UPS generated $3.0 billion in free cash flow, up more than $600 million. Capital expenditures were $949 million, which included the delivery of 6 767s. So far this year, UPS has paid dividends totaling $1.1 billion, representing a 9.5% increase per share. In addition, we've repurchased 11.3 million shares for approximately $870 million. Regarding share repurchases, we are on track to spend $1.5 billion in 2012, and outstanding share count in the third quarter will be similar to the second. As we prepare to complete the TNT transaction, you will notice that our cash and marketable securities on the balance sheet have reached over $7 billion. Regarding guidance, the macro environment that we expect in the second half of 2012 calls for slower growth than originally anticipated when we set our initial guidance range back in January. Given this, we now expect 2012 diluted earnings per share of between $4.50 and $4.70. This represents a 3% to 8% increase over 2011. I do want to take a couple of minutes to provide more insight into the segments, starting with the U.S. Domestic where we see some concerning trends. Average daily volume growth is expected to moderate, reflecting the macro environment. We anticipate some deceleration in premium product growth, and B2B volume is expected to deteriorate further with pretty much all of our growth coming from B2C. As a result, revenue will increase between 1% and 2%. On a year-over-year basis, comp and benefit expense will be about 1% higher in the second half than what we saw in the first. This is primarily a result of increases in health care costs. The combination of the mix changes and the higher benefit costs will result in operating margin being slightly above what we saw in the first half of the year, but it's still less than last year. Turning now to International, where daily export volume is expected to grow at a slightly faster pace than what we saw in the first half of the year. This is not indicative of economic expansion but is more a result of beginning to lap last year's slowdown in Asia. As previously mentioned, we have taken the necessary actions like air network capacity cuts and implementing in-country cost controls. And as a result, we anticipate operating profit to grow at a mid to high single-digit pace with more growth in the fourth quarter. Operating margin in the third quarter should be slightly below last year, while the fourth quarter margin will expand on a year-over-year basis. Regarding Supply Chain & Freight, we expect mid-single-digit revenue gains, and operating profit growth will be in the mid-teens with margins reaching 9%. For a little more detail on the earnings per share for the second half of the year, we anticipate that in the third quarter, they will be below last year. Let me remind you that in 3Q '11, we recorded a 32.9% tax rate that added about $0.03 per share. Fourth quarter earnings should show solid improvements. To wrap things up, our first half results have been respectable, with the U.S. Domestic and Supply Chain & Freight segments performing well. However, we are seeing indications of a weakening global economy, creating challenges for companies in the quarters ahead. Of course, we at UPS are prepared to make the right moves in any economic environment to ensure the company's long-term success. UPSers around the world are working diligently to make the necessary changes to our network while providing the service excellence that UPS customers have come to expect. Thanks for listening this morning, and now Scott and I will be happy to answer your question.

[Operator Instructions] Our first question will come from the line of Mr. Tom Wadewitz of JPMorgan. Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division: I had wanted to see if you could offer some thoughts on the time lag that you would typically experience in terms of taking out cost and adjusting to some of the changes in volume. So if you could comment both on the time lag in your International operations, where I would think things are a little more fixed, and then the time lag with respect to cost takeout in Domestic.

Yes. Great, Tom. I think you're right on target with that. As you know, we've been wrestling and working through the International trends for the last couple of quarters. Frankly, the velocity of the declines, being double digits in Asia both to Europe and U.S., were a little higher than we anticipated, but we have been in the process of making network changes and expect another 10% to come out during the next quarter. So we feel like we've pretty much caught up to the changes in International, and that's why we're actually guiding for profit improvements in the second half of the year. The weakening environment in the U.S. and, most notably, with the B2C trends is a little more recent. Frankly, we began to see that get more notable in the second quarter. So we're a little bit behind as far as the time schedule on that. And so there is probably a quarter, maybe 2-quarter lag for us, really, to fully implement the changes, and that's really the top priority right now.

Now, Tom, clearly, on the Domestic side, the direct labor hours, we react to very quickly as we adjust the workforce. I think what takes us a little bit longer on the Domestic side is also the revenue side of it. So it's not just looking at cost. We have to do things on revenue management side to improve that side of the ledger. I think we're looking at things, looking at account strategies. We need to focus more on the middle market. I think a lot of our growth, the first half of the year, came from large customers. So we have kind of rededicated ourselves to look at the middle market. I think the small and medium-sized enterprises are really not -- are suffering right now with all the uncertainty in the country, but they still have shipping needs, and we'll focus on them.

Our next question will come from the line of Mr. Kevin Sterling of BB&T Capital Markets. Kevin W. Sterling - BB&T Capital Markets, Research Division: You talked about customer behavior changing as they move around the supply chain, trading down to more deferred products. Where are you seeing the largest behavior changes? Is it air to ocean?

No. Probably most notable is within products going from, perhaps, an express to an afternoon delivery, the Saver and our Next Day Air. In Europe, we've seen significant trade down from our transborder express to transborder standard, although we have seen a few structural changes on some of the global exporters, perhaps moving away from express, moving freight movements and then distributing them once they get across the border. Clearly, we have products like Trade Direct to help address that. But this is a period, I think, when we're seeing companies try different things. I don't think it's been hugely material, but there is some mode shift and some speed changes.

Yes. I think the surprising thing, and I talked about it in my comments, Kevin, was this -- the global trade in general. To have exports growing at a lesser rate than global GDP is really unusual, and we think that is temporary and it'll change going forward. But trying to figure out what's going on, I think the biggest driver of that is the slow demand in the developed world. I think there is a lot of people trying to analyze what's going on. But frankly, Europe and the U.S. both have low demand right now, and that's what’s causing those negative numbers out of Asia. The other areas that will be a challenge going forward is U.S. exports to Europe. I think Europe will not be a big consuming country for a while, so the U.S. exports will remain quite weak to Europe.

Our next question will come from the line of Mr. Justin Yagerman of Deutsche Bank.

On the U.S. Small Package business, I was curious what the trends look like in the quarter, April, May and June. You called out the uncertainty, and it sounded like, to Tom's question, that you alluded to further actions that are going to have to be taken within that business to right-size to what you're kind of expecting volumes on the B2B side to look like in the back half. 3.5% volume felt good, and obviously, there's mix stuff going on there. But did we see any kind of precipitous fall-off in June? Or are you seeing that as we've come into July that's got you guys worried? I'm just trying to get a better sense of where we're going here.

Yes. I think kind of a soft landing maybe is the best way to think of it. We've seen -- we were very pleased and a little surprised that the demand have picked up in the fourth quarter and burned through the second -- or the first quarter. We saw over the course of the quarter, and really into July, just a gradual softening, really, with the B2B being the most notable change. That's why you don't see it as much in our aggregate volumes, because the B2C has continued to be very strong with our service offerings. But I think just kind of this continual moderate slowing in the rate of growth and then into the trends that we're seeing.

Now, Justin, it was clearly -- clearly, our macro concerns start with the fact that we saw lousy numbers in the last couple of months, and ISM manufacturing, clearly, was bad. Retail sales was weak in June. As we get closer to the fiscal cliff, there's just more uncertainty out there than ever. It's hard for me to say how it's going to turn around until we get some policymaking done in Washington. We have a 3- or 4- or 5-year horizon, and people cannot make decisions without that. So I think it's going to get tougher before it gets better. It will get better.

Our next question will come from the line of Mr. Chris Wetherbee of Citi.

Maybe a question just on Europe, if you could just give us a sense of kind of what the trends were there. Sounds like you had a little bit of growth on the volume side, but I just want to get an overall sense if you are seeing a deceleration in that region as well.

Well, we saw a little bit of a deceleration, although, frankly, Europe continues to be a good story for us. One of the macro shifts, or at least changes in trends, we are seeing is that the intra-regional shipments within North America, within Europe are continuing to show growth. Intra-Asia continues to show growth, and then the intercontinental shipments are a little weaker. So we're clearly seeing trade-down in Europe, so the premium products are not doing as well. But our trans-European shipments on the standard side are healthy. We have seen some declines on the Domestic volumes within the EU, although some of that is just revenue management activities. But we do see the economic declines a little more in our Domestic segment. But Europe's continuing to trade within itself, and that's why we continue to focus on it, to help Europe become more and more efficient.

Our next question will come from the line of Mr. Ken Hoexter of Bank of America.

Kurt, you mentioned the -- you're looking to decrease some costs. Can you kind of walk us through? It sounds like on the International move, you've made the move to pull out the 10%. Maybe on the domestic move during the downturn, you had kind of shut down some regional facilities. I don't know if they had reopened. What kind of steps can you -- can we expect to make, and what kind of cost leverage should we look for from that?

Yes. I think on the International side, we've really made the decisions in -- and are making the big network changes, although, clearly, there's a tremendous amount of in-country work that can still be done internationally. It's just they're probably 70% to 80% on the way to getting it done. Domestically, I don't anticipate huge network restructuring, although we are looking at our capacity and usage, both in the air and the ground network, to make sure we're adjusting appropriately. We'll be looking at a typical range of costs, looking at initiatives, discretionary spending, really just making sure we've recalibrated the network. And, Ken, if you really look over the last 3 to 4 quarters, we've seen a pretty dramatic mix shift, volume coming from different areas going to different areas. And so we're looking at this as an opportunity, really, to step back and adjust the network and our expenses to match conditions and, at the same time, as Scott mentioned, also to revisit broadly where we are on the revenue and the management of that, both at the account level and also at the product level. So this is the time in which we're going to take a hard look. We've -- we're teeing up a significant number of initiatives to take a look, given this slow patch that we're in right now, to adjust and reposition ourselves to improve our competitiveness.

We're really going to take advantage of the decentralization of marketing, where now we have the marketing teams in the districts who can look at the specific circumstances and adapt to it. So it will help us as we come out of this.

Our next question will come from the line of Brandon Oglenski of Barclays.

I guess following up from the answer to Ken's question there. As you go through your account and your products review process, does that mean we're still going to see a lot of the focus on the B2C growth, but maybe some better core pricing on the core business?

I wouldn't lead to any one specific result on that. It's just -- it's been about a year or so since we've really broadened the portfolio and focused on expanding the footprint into the lightweight, migrating into that. So clearly the B2C issues, the product positioning will be important. And then of course, given -- looking at the entire part of the core portfolio will be a part also.

Our next question will come from the line of Mr. David Vernon of Bernstein. David Vernon - Sanford C. Bernstein & Co., LLC., Research Division: Could you help characterize like the -- how much of the reduction in your guidance is from a slowing or less-than-expected recovery in International volumes versus the weakening Domestic picture?

Probably the bigger change in the quarter has been the Domestic outlook. Clearly, the International got a little bit worse than we thought. We thought our export volumes would be up a couple of percent more, and yes, the exports out of Asia really did fall off a cliff. So there were some there, but the more material issue really has been the deceleration in the core Domestic demand and some of the economic conditions I think that Scott has talked about.

Yes, exactly. I think in the second quarter, clearly, International was the biggest culprit. But going forward, I think the challenge is going to be Domestic, and as we said before, just a lot of weak numbers over the last 2 months caused us concern for the next 6 months. David Vernon - Sanford C. Bernstein & Co., LLC., Research Division: So the outlook has been more affected by the slowdown in Domestic?

Outlook in Domestic, correct, yes.

Our next question will come from the line of Mr. Ed Wolfe of Wolfe Trahan. Edward M. Wolfe - Wolfe Trahan & Co.: There is a meaningful step-down in your view, obviously, of the U.S. economy. And I'm trying just to understand, Scott, how much of this is reading the data that you're seeing coming out of the government and how much of this is specific to what you're either hearing from your customers or seeing in your volumes in June and July? And when did you kind of take this step-down in your view of the world?

Ed, I think it’s a combination, as you'd expect. I think, clearly, the recent numbers have been disappointing that we've seen over the last 2 months, but I think it's a combination of doing that and talking to customers. And again, the lion's share of our customers are small business. And you talk to them, they are very much concerned with all that's going to happen at the end of this year, with the fiscal cliff. And we all read the impact if all the Bush tax cuts go away and the sequestration hits. And you could have a 4% impact. Our customers read that. So I'd say it's a combination of the 2. They're -- customers are concerned. They're not going to invest. They're not going to hire people. They're not going to stock inventory with all that uncertainty. I think Bob Zoellick said the other day even, "We're one debt ceiling deal away from getting this economy going again." So we got to get that done. Edward M. Wolfe - Wolfe Trahan & Co.: Is the 3.5% domestic volume throughout the quarter much worse in June than it was in April or in July than it was in June?

Just slightly worse, I think, slightly worse.

Our next question will come from the line of Mr. Nate Brochmann of William Blair & Company. Nathan Brochmann - William Blair & Company L.L.C., Research Division: I wanted to talk a little bit just on the pricing side. Obviously, there's a lot of uncertainty on the volume. But kind of with some of the trade-down and also just with the worsening kind of outlook for a lot of your customers, how are you seeing the pricing environment in terms of pushing through everything that you would have liked to?

We think the pricing environment remains fairly stable and firm, and if you do dissect and decompose the mix changes and the customer size and all of that, the pricing is stable, and we are seeing positive core pricing and base rate increases. So we're not overly concerned on the pricing environment. Although, clearly, if the economy slows more, there'll be, perhaps, a little more pressure. So I think for us it's more just a broad portfolio review and making sure that we're balanced and adapted to where we are seeing demand and adjusting where we're not.

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

Can I ask for a little bit of clarification on the comments that you made, I think it was last week, just that UPS does intend to bid on the postal service business, the priority mail contract? I was always under the impression that one of the reasons FedEx had that business was because of the size of their air fleet. Do you have the sort of underutilization in your air fleet that you could handle that? Or would it all go through the ground network? How does this -- I don't sort of know how that would fit into the UPS network.

Bill, I think, clearly, we have the air network and ground network to satisfy those needs. USPS has informed us the intent to solicit bids on these air services for September 2013 forward. We've informed them that we're clearly interested in bidding on that business. Today, we already do well over $100 million of line haul with the post office. We've got a strong, strong international air network, world-class network. We have proven logistics capabilities. We think it fit very well into UPS in the future.

So it wouldn't -- there's no capacity constraint for you.

No, I mean, we'll have to do some adjustments to our capacity, getting a lot of this done in the 2-day network. We can do some things on the ground. So we can make it fit.

Our next question will come from the line of Mr. Chris Ceraso of Crédit Suisse. Christopher J. Ceraso - Crédit Suisse AG, Research Division: You mentioned with regard to Asia that it's, in large part, a function of weaker demand in the U.S. and Europe, which suggests that it's cyclical. But are you seeing any things that are more secular? Any kind of relocation of supply chains out of Asia that suggest that even when economies recover, maybe Asia won't be quite as strong as it used to be for you?

I think that's overdone. I think that there's some of that going on, but it, clearly, is not the driving force right now between the -- the gap between global trade and global GDP. So I think we're seeing a little bit of it. But we go out and talk to our customers, you see very few instances where they've actually taken manufacturing and brought it back home or brought it back close to home. I think that's more likely if energy prices were to get to the $150 level. Then I think you look at that again. But I think it's -- there's more dislocation in China going to West China, things like that going on, than there is China back to U.S. or to Mexico.

Our next question in queue will come from the line of Mr. John Barnes of RBC Capital Markets.

Just as you've revised down the outlook for the balance of this year, can you talk about just your CapEx outlook as well? And if things were to decelerate further, how much more quickly could you take your CapEx down as well? Or is there things that you could put on hold or cancel outright and kind of reserve that cash?

Yes, John, certainly, we've got flexibility, although, frankly, we're down to only 4% of revenue for CapEx this year, and we have been for the last 3 or 4 years. So we're -- we are at historically low levels. I guess the other element, at least, looking out a couple of years, is we just got another 2 years of major deliveries of aircraft. And then after that, we'll be in pretty good shape, we think, for the medium term, at least. So CapEx, we'll -- I wouldn't imagine dramatic changes, although things like vehicles and some facilities, we can react pretty quickly on. So we're generating very strong cash flow. So right now, that's the least of our worries. As we mentioned, we've got $7 billion in cash and marketable securities. Some of that's offset with some short-term liabilities, but we are focused on building the appropriate balance sheet to be able to close the TNT deal, really, without having to go out and issue any long-term debt. So we feel very comfortable with cash flow. One of the attributes, I think, of UPS that makes us unique is, even in tough times, we've remained extremely cash flow positive. So we'll look at capital expenditures. We will reduce the things that aren't essential. On the other hand, you look at investments like expanding Worldport through the midst of the recession. We're also going to continue to do those things that add long-term value no matter what the economic climate is.

Our next question will come from the line of Jeff Kauffman of Sterne Agee & Leach. Jeffrey A. Kauffman - Sterne Agee & Leach Inc., Research Division: Could you discuss the currency effects and how it's affecting you both top line and bottom line and what this looks like for the rest of fiscal year?

Yes, Jeff. It is a turbulent period for currency. And although it's funny with us moving towards the TNT closure, we're not sure which way to vote for the euro, frankly. It had a very significant impact on revenue. If you look at -- without currency adjustment, our yields in International were down 2.5%. But if you look on our web schedules at the next page, it shows that if you currency adjust, they were up 2.1%. So that's almost 4.5% impact of currency on our International revenues, and that doesn't include anything on the Supply Chain & Freight. So it is a turbulent period, creating some challenges for year-over-year comps and also for profit planning. We do have some hedges in place that are helping to mitigate the P&L impact, and currency was just a minor negative in the quarter and, frankly, was more or less offset by a slight positive on fuel. So it has not been a big deal so far, although clearly, over the time, as -- if euro stays very low, then there will be some earnings translation impact. On the flip side, we do have a pretty big check to write to complete the TNT acquisition, and a low euro clearly makes that much less expensive in dollar terms. Jeffrey A. Kauffman - Sterne Agee & Leach Inc., Research Division: No, that's what I was going to ask. I mean, I guess it got about 14% cheaper this quarter.

It's dropped quite a bit. And I think at the time that we announced the deal, it was 1 32, something like that. And so it has dropped almost 10% now, which, certainly, in dollar terms is good news.

Our next question will come from the line of Mr. David Campbell of Thompson, Davis & Company. David P. Campbell - Thompson, Davis & Company: My question is on the Olympics. You talked about that during your presentation, talking in terms of 30 million packages. And when I look at the potential international package count in the third quarter, it comes in around 150 million. That sounds like a big increase. But on the other hand, I didn't see any big revenue growth when you did the Beijing games 4 years ago. So I'm just curious as to where we'll see and will we see the revenue benefit from that -- those gains.

David, you won't see the revenue there. You won't see the volume of pieces. It's a combination and partly sponsorship. We get compensated for pieces of what we're doing there. It's primarily about brand recognition. I think we did a great job in Beijing, where like our brand recognition went up about 33% in Beijing. We want to do the same thing in Europe, and the timing is perfect for the TNT acquisition coming forward. So it's primarily about brand. You won't see it in the P&L.

The next question will come from the line of Mr. Ben Hartford of William -- or excuse me, Robert William Baird. Benjamin J. Hartford - Robert W. Baird & Co. Incorporated, Research Division: I just wanted to get your perspective on inventories and the weakness, the volume weakness that you're seeing on the margin here in the United States. Could you provide some sort of characterization on inventories, where we sit today, maybe retail versus industrial? It seems as though industrial inventory's on balance or slightly heavier than one might have expected to end 2Q. Are we seeing inventory reductions? Are we seeing a pause as shippers manage towards very, very tight inventories? Could you provide any sort of context on that?

It's hard to really see the visibility of inventories, Ben. I think it's hard for economists. It's hard for the government to see that. I'm always skeptical on those reports. But I think in general, from us talking to customers, I think inventories are quite low. It's hard to imagine them getting much lower than they are today, I think, across-the-board, both on the manufacturing side and the retail side. Now visibility tools and those technology, that makes it easier to manage inventories, but I would say from our vantage point, inventories are rock bottom right now.

Our next question will come from the line of Mr. Peter Nesvold of Jefferies. H. Peter Nesvold - Jefferies & Company, Inc., Research Division: Comp and benefit as a percent of revenue, so that ratio has been falling every quarter since 2009, and we're at record levels now. Well, we were at first quarter. This is the first quarter where that percentage was up. It's been the biggest area of margin expansion since the trough in '09. So I guess my question is, are we kind of going into a 1 to maybe 2-quarter transition period where you realign the Domestic and International networks and then we get further improvement in the comp and benefits line as a percent of revenue? Or are we starting to bump up against really where you can -- where you end up maxing out?

Well, that's a good question, because, clearly, there's -- we are seeing, as I mentioned, some headwinds, especially on the benefit side. We have had a couple of years of good experience on our health care. And just in the last, I'd say, 3, 4 months, we've started to see some trends of increasing expenses, increased number of lives handled per employee as perhaps more people latch onto UPS insurance, perhaps if the second working spouse doesn't have insurance, and some increased experience. So that's the most notable cost change, and we did guide that, that may drive domestic comp and ben up almost 1%. So there is some headwinds on that side. Clearly, that cycles a little bit, and we'll -- we're continuing to evaluate that and work on it. Other than that, I think with the continued focused on productivity, the automation of our operations, the information-driven pickup and delivery that we've got and the focus on lightweight, which certainly drives less direct hours, we should continue to see positive trends. So we're able to manage that in line with comp and -- with volume levels. But right now, at least, I think you have the health and welfare expenses. Pension also, is driving over $100 million this year. And so that is an element that, at least, for the next couple of quarters is going to be an outlier.

Our next question will come from the line of Helane Becker of Dahlman Rose. Helane R. Becker - Dahlman Rose & Company, LLC, Research Division: Just a question on the declines that you're making in the capacity adjustment. So it takes a couple of quarters to bring that down. And then I suppose when things start to turn around, it will take a quarter or so to bring it back. So by making these adjustments now, are you thinking that any downturn is kind of a 4-quarter event? Or how should we think about the potential if things do or when you think things do turn around?

Helane, that's good question. I think you almost have to separate the International and the Domestic. Clearly, we have made some fairly significant reductions in the Asia, capacity to Europe and, most notably, to U.S. There is a lag there for planning schedules and all that. We do think that we'll see some uplift in the fourth quarter though. There are some major product launches coming in the fourth quarter, and at least, we do have some optimism that, that Asia export will pick up then. So we'll plan accordingly. And we can react with ad hoc flights and those things, although they're typically not as efficient. We think in the U.S., this has been a gradual process. And so we're adapting, and clearly, we'll be responsive and flexible if the holiday season comes in stronger than planned. But at this point, we're probably erring on the cautious side.

Right, right. Helane, definitely, in Domestic, we can take them up and bring them down quicker than we can in International.

Our next question will come from the line of Mr. David Ross of Stifel, Nicolaus. David G. Ross - Stifel, Nicolaus & Co., Inc., Research Division: On the cost side, Kurt, most of the costs were held in check in the quarter, but the other expenses line item rose over 8% year-over-year. You mentioned that there were some costs related to the M&A activity, but what were the other big contributors there?

Well, one of the things, you do have the credit last year of over $30 million because of the real estate transactions. That's the most notable, and in the other-other line anyway, that distorted things a little bit. Other than that, the network's in pretty good shape. Repairs and maintenance are moderated, little bit of increase in depreciation as we've brought in a number of new aircraft. So the only real notable expenses in the other-other part of it is the last year issue, and frankly, we do have some increased expenses that show up in that line, legal fees and some of those things. So your instincts are right that, that's where some of the M&A expenses show up.

Our next question will come from the line of Anthony Gallo of Wells Fargo.

You mentioned the importance of B2C going forward. Would you mind touching on some trends you're seeing there, maybe uptake in My Choice, any changes in package weight sizes and anything you're doing on the productivity front with B2C?

Yes. We're continuing to see just great success on that front. The -- I think we're up over 1.5 million unique My Choice customers now that have shipped over 13 million shipments, and it continues to be one that's -- that there's a lot of interest in, kind of a viral issue. Once people start getting used to these proactive notifications, their ability to redirect shipments and just know what's going on, it has been very well received. So that's been a great product offering from the receiver or the buyer. And then we are seeing increased interest, frankly, by some of the high-quality Internet shippers in helping their customers become My Choice members, because it really eliminates a lot of the where-is-my-package phone calls. So it offers a direct savings to Internet companies in support and also increases satisfaction. So we remain very excited about that. It still is a very unique and distinctive offering, and that is a big part of our value proposition these days.

And that's kind of U.S. focused. We obviously have the global B2C focus, too, and the Kiala acquisition that we announced 3 or 4 months ago is making great progress also. We're continuing to invest in technology there, so we're excited about having the alternative delivery locations available for our customers. So it'll continue to grow. We'll continue to invest in it.

Can you put any color on what My Choice does for you operationally? I mean, it sounds like there's benefits for you in there as well.

Yes, there is. There is. The -- one of the most frustrating things for any delivery company is when there's a package that needs to have a signature or monies collected and people aren't home. It creates a disconnect. It drives an additional delivery attempt, an added expense, added miles. So with My Choice, people, A, get a prediction of when the package will arrive. And if they want a different time, they can select that for a premium charge or they can redirect it to another location. So there is a direct operating savings also.

Our next question will be a follow-up from the line of Mr. Tom Wadewitz of JPMorgan. Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division: Yes. I wanted to ask you kind of a broader question. When we think about Europe as -- seems to be in recession, and if you look at 2013 and 2014 and you think about that TNT acquisition and integration and so forth, is it tougher to be successful in integrating and holding on to business and producing the results with TNT if the European economy is soft? Or given that a lot of your activity is going to be cost takeout, is that actually an okay environment in terms of if you think about complicated integration of putting 2 pieces together?

I'd always pick a strong, growing economy, Tom, if I had my picks. But frankly, I think Europe is not far different from what we thought when we announced this thing back in March. I think it's about where we thought it'd be, so no surprises. We're going to work very well together, I think, and have a customer-focused integration. I don't think what we're seeing right now changes anything. I like a better economy. I like a stronger economy. But the numbers we said and quoted back in March are numbers that will still see as achievable.

And we have a follow-up from the line of Mr. Justin Yagerman of Deutsche Bank.

I guess I just wanted to put some context around the 10% reduction in the Asian capacity. Where were you guys, as of now, relative to plan at the beginning of the year, in terms of level below on that air capacity? And then I think, Kurt, you alluded to the potential for a product cycle on the tech side in the fourth quarter. I mean, how quickly can you ramp back up? And where does this 10% put you in terms of critical mass in that market? And how much further could you go down if you saw things deteriorate? Just trying to get some ideas around this cut.

Okay, a couple of folder -- a couple of pieces to that one. Clearly, things are weaker than we thought when we developed plans for this year. That 10% reduction was not anticipated. We have -- we were reacting to the slowdown that began, frankly, about this time last year. We seem to be jinxed with July business trends. And so we had implemented that first 10% reduction, and most of that was in reduced frequencies, maybe 4 days a week rather than 6, that kind of a thing, in some cases, for cargo and for our deferred products, we can catch up to those during the off days. This latest series of reductions has been a tough decision for us, because we have to adjust our costs. But on the other hand, as many of you have mentioned, with an anticipated product cycle that may drive capacity, we've got to be ready for it. So we had not anticipated those reductions, but we've gone through and we still really -- we've held service fully intact across the continents. So it's not that we've made dramatic changes in customer experience, but we may have gone from 3 or 4 flights from a given airport down to 2 or 3. So once again, it's more reduction in the service frequencies and the number of flights, but we are getting pretty tight. We're taking our network down to -- beginning to get to the -- close to the point where we were at the low time in 2009. So it is -- we're fairly lean right now. On the other hand, given the fact that we do expect to see some uplift in the fourth quarter, we're in position for that, making sure we have the assets and can react accordingly. On the tech side, yes, we do expect product launches. We've talked to some of the major OEMs then, so that's all built into our plans, and one of the reasons why, frankly, we are looking for stronger profit improvements in Q4 as compared to what will likely be a challenging Q3. Especially with Europe in August and the weak conditions in Europe, we think this will be a pretty soft August.

And we have a follow-up question from the line of Mr. Bill Greene of Morgan Stanley.

I wanted to see if we could get just some broad commentary on the upcoming Teamster's negotiations. So if we think back to the last contract that you signed, it sort of had this aspect of, look, there are some pretty big changes that we've made here to gain on productivity, but then, of course, we went into a downturn, and it didn't get the volume growth we expected. So I think -- and you can correct me if I think this is a wrong characterization. But I think, perhaps, it didn't get the quite the savings you expected. Are there any sort of changes in how you'll sort of approach the ask this time around? Or is it more kind of a let's keep going down this path, because we think, eventually, we will have an upturn and get the volume growth and the productivity?

Bill, I think that the good thing is that the formal talks begin soon, but even better thing is that we've been communicating regularly since the last contract. And the competition committees that we have set up with the Teamsters and our own people, we address all the issues very frequently. So we look at competitive aspects. I think all the issues that are impacting us and the Teamsters have been on the table already. When we get to the formal talks here in September, I think it's -- nothing is going to be a surprise of what's going on here. So I'm very optimistic that there's no surprises on either sides as we get together in September.

Yes. But clearly, we have to work together to adapt and change, and it will not be a business-as-usual discussion. And so we're looking creatively for ways to allow UPS to grow, and we've seen great examples of that and, at the same time, also allow us to be able to generate profit improvements. We just don't talk about the details in public. But as Scott said, we think the environment's very productive. We talk about both the opportunities and the problems we face and do expect things to be favorably resolved.

But to your point, Bill, the world is a lot different than it was 5 years ago. So that certainly is part of the talks.

Yes, right. I mean, just, obviously, it's a recognition of kind of things have changed from last time. So I thought maybe there's scope for a bigger discussion, but I appreciate the thoughts.

Our next question will come from the line of David Vernon of Bernstein. David Vernon - Sanford C. Bernstein & Co., LLC., Research Division: So in the context of all the International export volumes being under pressure, and it sounds like you guys are going to be adjusting the network down, but at the same time, it looks like DHL is actually adding aircraft into their international network. Can you comment on the pricing environment in International exports, the long-haul transcon stuff?

I think the package environment looks relatively stable. We have seen some volatility, I guess, in pricing on the Freight side and some of the heavy lift of the large shipments. You've got to separate the wheat from the chaff a little bit on capacity increases and see how much is going on. So we don't see huge amounts of capacity being added to the network, no matter what the press releases say, and we think the market's pretty rational. David Vernon - Sanford C. Bernstein & Co., LLC., Research Division: So the -- no slowdown in the heavyweight package pricing?

Well, clearly, Freight yields right now are weaker. You saw that in our Forwarding revenues, that rates are lower right now on the Forwarding and on the cargo side. Our forwarder, though, has operated very effectively. As I said, we had peak margins for Supply Chain & Freight this quarter. I know that there's a lot of other big stuff going on, but that has been a great process for us, and we're on both sides of the equation. We see as -- having an airlift, the package environment is stable. But cargo and Freight rates are certainly weak, but then our forwarder has been able to capitalize on that and generate the -- really, the best margins we've seen.

Due to time constraints, our last question will come from the line of Mr. Ed Wolfe of Wolfe Trahan. Edward M. Wolfe - Wolfe Trahan & Co.: Just on the LTL, there hasn't been much conversation about that. Are you seeing slowing trends there? And can you give some sense of what the operating ratio look like at the LTL division?

Yes. Ed, you're right. That's yet another business that we haven’t had a chance to chat about it. I guess we're getting too diversified. No, Freight had a strong quarter on the profit side. We had mid-single-digit margins with significant improvements over last year. We have seen growth moderating in the industry, and clearly, we were fairly disciplined on the pricing and volume that we targeted. So we do think that the industry is slowing a bit, but we've been very pleased by the productivity, some of the operational technology we're putting in. And so a good, solid quarter for the Freight side, but not -- it's not a super exciting time, we think, for shipment growth.

I would now like to turn the conference call back over to Mr. Andy Dolny for any closing remarks.

Yes. I just want to thank everybody for joining us this morning, and have a great day. Take care now.