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Operator
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 first-quarter 2014 earnings conference call.
(Operator Instructions).
It is now my pleasure to turn the floor over to your host, Mr. Joe Wilkins, Investor Relations Officer.
Sir, the floor is yours.
Joe Wilkins - IR
Good morning and welcome to the UPS first-quarter 2014 earnings call.
Joining me today are Scott Davis, our CEO and Kurt Kuehn, our CFO, along with Chief Operating Officer, David Abney; the International President, Jim Barber; President of US Operations, Myron Gray; and UPS Chief Sales and Marketing Officer, Alan Gershenhorn.
Before we begin, I want to review the Safe Harbor language.
Some of the comments we will 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 2013 Form 10-K, which is available on the UPS Investor Relations website and from the Securities and Exchange Commission.
Although there were no adjustments to first-quarter 2014 results, there was an adjustment related to the attempted acquisition of TNT that increased first-quarter 2013 diluted earnings per share by $0.04.
As a result, in our remarks today, all quarterly and full-year comments and comparisons will refer to adjusted results.
In addition, we will discuss UPS's free cash flow, which is a non-GAAP financial measure.
The webcast of today's call, along with a reconciliation of free cash flow and adjusted results, are available on the UPS Investor Relations website.
Before we review the details of the quarter, I want to announce that we plan to hold an investor conference later this year.
The 2014 UPS investor conference will be held at the Grand Hyatt Hotel in New York on November 13.
We look forward to updating you on our strategy, demonstrating our technology and sharing our plans for the future.
You will be receiving a save-the-date invitation soon with more details.
And just as a reminder, as on previous calls, please ask only one question so that we may allow as many as possible to participate.
Thanks for your cooperation.
Now I will turn it over to Scott.
Scott Davis - Chairman & CEO
Thanks, Joe.
Welcome to your first call and good morning, everyone.
UPS's first-quarter performance produced mixed results.
International demonstrated strong volume growth and margin expansion on an 8% increase in export shipments.
Supply Chain & Freight delivered results that were about as we expected.
However, our US Domestic segment fell short due to the unusually harsh weather during the first quarter.
We pride ourselves on being an all-weather company, but the intensity of this year's winter storm season produced challenging conditions.
Buildings across the UPS network were forced to cease operations somewhere in the US on 34 days during the quarter.
These weather events not only led to increased cost, but also influenced UPS product and customer mix contributing to lower yields.
We saw business-to-business shipments slow as manufacturers, distributors and retailers closed shop.
On the other hand, snowbound consumers took to the Internet to make their purchases.
Clearly, UPS results in the US reflect both the lost revenue and the additional costs associated with these storms.
And Kurt will provide more details in just a moment.
While we have yet to see the first-quarter US GDP numbers, it is safe to say that growth will be slower due to weather.
The good news is that spring has arrived and we expect the pace of US economic growth to pick up as 2014 progresses.
In Europe, the economy is showing signs of recovery and faster growth.
Yet if the situation in the Ukraine deteriorates, that pace may slow.
Economic expansion in Asia has remained steady with mid-single digit growth and in Latin America, expectations call for increased merchandise exports.
The economic benefit of global trade is clearly visible in both established and emerging economies.
Trade promotes economic expansion, creates jobs, makes companies more competitive and lowers prices for consumers.
Congress now needs to act to pass a trade promotion authority bill, or TPA, that supports economic growth and job creation in the US.
TPA gives the administration authority to pursue trade agreements that meet objectives laid out by Congress.
We strongly encourage swift passage of TPA as there are currently three important trade pacts pending that provide real economic benefits and TPA will clearly increase their chances of success.
The expansion of global trade is an important catalyst to the UPS growth strategy.
Recently, our Management Committee Board of Directors conducted a detailed review of UPS's long-term strategic initiatives and identified key opportunities that bring long-term value to both customers and shareowners.
The updates we received were encouraging.
UPS is on the right path to ensure that our solutions meet the ever-changing needs of the marketplace.
We will continue to stay focused on providing industry-specific solutions as we invest in our healthcare capabilities and develop omnichannel solutions for the retail industry.
In addition, we reviewed the implementation of the operational technology projects, Orion and hub automation.
On the international front, Jim Barber will bring you up to date this morning on how we are expanding the UPS global network in both developed and emerging economies, as well as what we are doing to serve end consumers around the world.
In support of our healthcare strategy, UPS announced several investments during the quarter, including the acquisition of Polar Speed.
This addition to our global healthcare network will provide improved access to the important UK market, as well as unique cold chain transportation capabilities.
Also, UPS opened new healthcare distribution facilities in Canada and Mexico and announced plans to expand with additional facilities in Brazil and Chile later this year further increasing our capabilities in Latin America.
Adding to these industry-specific solutions, we have expanded our distribution network in North America for retail and manufacturing clients.
These investments add almost 500,000 square feet to our footprint at three key distribution sites in Kentucky, California and Alberta, Canada.
Now before I turn it over to Kurt, I want to give you a quick update on what we've been doing regarding peak season.
During the last couple of months, we have met with UPS's largest customers.
We are working collectively to improve forecasting accuracy, increase visibility of shipments and improve mutual planning capabilities.
Our shared goal is to enhance the end consumer's experience.
In addition, David Abney and his team are on track with the system changes, facility automation and capacity enhancements we discussed last quarter.
These improvements will provide better flexibility at peak and will deliver service and productivity gains throughout the year.
As we continue to implement these enhancements, we will keep you updated on our progress.
Now Kurt will take you through the details of the quarter.
Kurt Kuehn - CFO
Well, thanks, Scott and good morning, everyone.
Our goal today is not to make this call all about weather, but unfortunately it did significantly weigh on earnings, so we will have to spend a minute or two talking about it.
The difficult weather environment this quarter created severe operational challenge that increased cost and also pressured demand.
But fortunately due to our diversified portfolio, weather is not the only story.
Most notably, we are encouraged by the strong momentum in International and the positive results in the Supply Chain & Freight segment.
We expect both of these to continue.
Now let's review the segment results.
Our US Domestic operating profit was $927 million, down $158 million with margin contracting 220 basis points.
Clearly, the impact of weather was reflected in the bottom line.
We estimate that profitability was lowered by almost $200 million.
This includes the additional expense from lost productivity, snow removal, increased utilities.
In addition, it was a drag on revenue due to perishable demand and increased service refunds.
UPS experienced service disruptions in the network on more than half of the operating days in the quarter, materially increasing network costs as we attempted to navigate around the many storms.
For example, a substantial rise in the number of delayed trailers slowed network operations and pushed direct labor hours up 5.4%, including a 20% increase in overtime.
US Domestic revenue increased 2.6% to $8.5 billion.
We were encouraged to see strong demand in the US as daily volume was up 4.2%.
Ground products were up 4.4% driven by SurePost, which grew more than 50%.
UPS Deferred products grew 6.3% and Next Day Air was 1.5% higher due to increases in Next Day Air Saver package.
B2C shipping contributed broadly to gains across all products while B2B improved slightly primarily from e-commerce, including omnichannel customers.
Average revenue per package declined by 1.5%.
Base rate increases were more than offset by changes in customer and product mix.
Slightly lower fuel surcharges and weather also contributed to yield declines.
A couple of interesting things we noticed.
Customer mix shifted a bit as large accounts were able to more effectively manage around storms.
Also, B2B volume was clearly reduced by weather events.
Whereas in contrast, B2C growth remained robust as consumers were able to continue shopping online pushing our residential delivery mix to almost 44%.
Next, the International segment results.
We are encouraged by the positive business trends we are seeing, especially in Europe.
UPS International revenue was up 5% to $3.1 billion.
Operating profit increased 12% and operating margin expanded 90 basis points to 14%.
Over the last several quarters, we have been making adjustments to optimize network efficiencies.
These improvements, coupled with the increased shipments, contributed to margin expansion during the quarter.
Our International export volume was 7.7% higher with Europe leading the way with growth to all regions of the world.
Strong demand for UPS Transborder products increased intra-European exports by more than 15%.
Non-US Domestic volume jumped more than 8% led by Germany, Poland, the UK and Canada.
Export yields on a currency-neutral basis were down 3.2%, negatively impacted by shorter trade lanes and changing product mix as non-premium products grew by 13% with premium up 4%.
Looking now at Supply Chain & Freight, operating profit was up 3.5% to $148 million led by the Forwarding and Distribution business units.
Operating margin expanded 30 basis points to 6.8%.
In Forwarding, shipments and tonnage increased while market conditions drove revenue per kilo lower.
The Ocean Forwarding and Brokerage businesses both experienced solid revenue gains and improved profitability.
The Distribution unit continued to expand its footprint with the facility openings that Scott mentioned earlier.
The Retail and Healthcare sectors combined to produce mid-single digit revenue growth.
Operating margin expanded 80 basis points to 9% despite the expansion costs.
UPS Freight saw both pressure on demand and higher operating costs due to weather.
Revenue was up slightly due to a 3% improvement in LTL revenue per hundredweight that was offset by a 2% tonnage decline.
Operating profit was lowered by increased network costs associated with the difficult conditions.
Looking now at cash on our balance sheet, the ability to generate free cash flow on a consistent basis is a hallmark of UPS.
This quarter, UPS once again had a conversion rate well in excess of 100%, generating $1.9 billion in cash.
Capital expenditures were about $320 million.
The pace of investment will accelerate as the year progresses.
We expect capital expenditures to reach $2.5 billion for 2014.
Many of the network enhancements and operational technology projects will ramp up during the second and third quarters.
Regarding share owner distributions, UPS paid $596 million in dividends reflecting the 8.1% increase announced by the Board in February.
In addition, the Company repurchased 6.8 million shares for approximately $660 million.
On the labor front, we are pleased with the progress that has been made, and while we have not yet received final word from the Teamsters, we feel it is an appropriate time to share with you some key elements of the new agreement.
A detailed presentation will be made available on the IR website upon implementation of the contract.
The new agreement includes reasonable wage and benefit increases, as well as flexibilities that will improve service and profitability.
UPS has devoted substantial time and effort working to help the Teamsters better understand our cost structures and the changes needed to provide attractive benefits in the future while remaining competitive in the industry.
Sponsorship of healthcare plans has become expensive, largely due to high healthcare inflation trends and legislation like the Affordable Care Act.
After much evaluation, we determined that the best path for UPS was to move our union employees to multi-employer healthcare plans.
In simple terms, UPS is moving from a defined healthcare benefit plan to a defined contribution environment with the contribution set for the duration of the contract.
Once the new contract is implemented, the responsibility for providing medical coverage will be assumed by Teamster plans.
As a part of this settlement, UPS will also remove existing post-retirement healthcare liabilities from our balance sheet.
This obligation for future retirees, as well as ongoing coverage for active employees, will become the responsibility of the multi-employer plans.
When we transfer this liability to the union, UPS expects to make a significant cash payment to these plans and record a one-time charge.
As I said, more details will come in the future when the contract is finalized.
Looking now at our expectations for the rest of the year, while we took a hit in the first quarter, our expectations for the remainder of the year are unchanged.
In US Domestic, we still anticipate operating margin of approximately 14% for the remainder of the year.
We expect a little higher package growth, somewhere between 4% and 5%, resulting from the gains in UPS SurePost.
Looking more closely at the quarters, as we discussed back in January, we will be incurring at least $100 million in extra operating expense.
This expense is related to network and systems enhancements, as well as the accelerated deployment of Orion.
The lion's share of this expense will weigh on the second and third quarters by about $0.02 to $0.03 each.
Our expectations for International and the Supply Chain & Freight segments remain unchanged.
So overall, we are encouraged by the positive trends we've seen across the business and anticipate the remaining three quarters to perform as we originally guided.
However, due to the challenging start to 2014, we expect to be at the low end of our earnings-per-share guidance range of $5.05 to $5.30.
Now Jim will take you through our International business.
Jim Barber - President, UPS International
Thanks, Kurt.
I would like to take a few minutes to update you on the key components of our International strategy and the positive momentum we are experiencing.
The International segment delivered our best volume growth since the third quarter 2010, up almost 8% per day.
This growth, combined with our network and operating efficiencies, drove our industry-leading margin to 14%.
As we look at the business around the world, UPS experienced high growth in many developed economies during the first quarter.
For instance, in large European markets like Germany, the UK, France and Spain, exports were up more than 17%.
Meanwhile, large Asian markets like Hong Kong and Japan saw export growth of more than 6%.
We continue to align our networks to market conditions and regional trade patterns.
Europe has been the foundation for UPS International investment and growth.
Our customers continue to value the capabilities and solutions that we provide to support the single market economy.
One of the most rewarding components of our Europe growth is to see the success of our recent acquisitions.
Some examples of that success are Turkey with revenue up 18%, the UK was up 11% and Poland was 15% higher.
UPS operational methods and systems facilitated the successful integrations of these key acquisitions.
Our intra-Europe air and ground networks are proving attractive to customers looking to optimize their supply chains.
We recently invested $200 million in the UPS Europe air network with the expansion of our Cologne air hub.
This increased our sort capacity by 70% coupled with state-of-the-art security screening and improves our air and ground network performance.
The value of our extensive ground network in Europe was also evident as cross-border shipments were up 15% in the first quarter.
Recent investments such as our Kiala acquisition and the UPS access point rollout in Europe are further strengthening our e-commerce proposition escalating our ability to serve the end consumer around the world.
UPS My Choice continues to be a great success in the US.
As part of our global retail strategy, we are evaluating expansion opportunities for this end consumer solution in markets around the world.
In 2012, we changed how we interact with our middle-market customers across our International business.
We understand their needs better and are tailoring industry-specific solutions that add value for them.
This initiative is paying dividends as we achieved double-digit gains in four important verticals -- retail, healthcare, industrial and automotive.
UPS capabilities and solutions resonate well in these verticals giving us confidence that recent trends are sustainable.
Emerging markets are the next logical step in the UPS International expansion strategy and will contribute to growth as we enhance our capabilities in these underserved markets.
We are in the early stages of the UPS emerging market strategy.
The realignment of the International business units is allowing us to concentrate our efforts and leadership teams in these developing economies.
As we progress, we will keep you updated.
In closing, I am proud of the dedication and hard work of UPSers around the world that produced these results.
In fact, I see our most important competitive advantage as the UPS culture and how it integrates with local communities in our diversified portfolio.
No matter where I go, UPS people speak the language of dedication and commitment to exceeding our customer expectations.
Thanks.
Now I will turn it back to you, Kurt.
Kurt Kuehn - CFO
Well, great.
Thanks, Jim and we look forward to a lot of great future events in the International segment.
Operator, we will turn it back over to you then to open up the lines.
Operator
Scott Schneeberger, Oppenheimer.
Scott Schneeberger - Analyst
Thanks.
Good morning, guys.
Yes, I'll address the weather and the guidance first off here.
You are maintaining that you can hit the low end of the previously stated guidance range despite the tough first quarter.
I'm just curious what are the two or three main drivers that give you the confidence?
You mentioned some strong package growth in SurePost, but just the two or three broadly that you think will help you and maybe some trends here into the second quarter that support your confidence in those things.
Kurt Kuehn - CFO
Yes, Scott, it has been a challenging time and our operations people in the US faced clearly extraordinary conditions and really storm after storm.
And as you heard, over half the days we had some significant network operations with facilities shut down.
So it was a very tough quarter.
Beneath that though, we do feel that the initiatives we've rolled out and the core momentum of the Company is continuing steadily.
So if you peel away that exclusion, basically our guidance remains unchanged.
We are seeing a little better volume on the lightweight side and the operations, now that the skies have cleared, have worked a little better.
So Myron, maybe you could talk a little bit about how you guys I guess survived Q1 and the momentum coming into Q2.
Myron Gray - President, US Operations
Yes, Scott and Kurt both have alluded to in their opening comments on 34 of the 63 operating days in the quarter, we experienced severe weather conditions prompting many of the Governors in the states that were affected to issue level 3 emergency conditions that prohibited us from working.
We also saw a tremendous uptick in the number of trailers that were impacted by weather rising over 400%.
As a result of it, our direct labor hours, as well as overtime expense, went up significantly.
Overtime hours were impacted by more than 20%.
I don't think there is a person in the country who is more happy about seeing spring weather return and as a result of it, in April, both our productivity and service has returned to normal levels.
So as Kurt has alluded to, we don't see an issue moving forward.
Scott Davis - Chairman & CEO
I'd just add the macroeconomic environment looks decent as we move forward.
I think both the global GDP and US GDP will be a little better than they were last year, not robust, but better than they were a year ago.
And what excites me is I think we are going to see all three segments producing good growth.
We saw International and we saw Supply Chain & Freight accomplish what they were supposed to in the first quarter.
That momentum is going forward.
In Domestic, we started to see improvement at the end of March and we are seeing it in April.
So we feel very good about the 14% margins in Domestic.
Scott Schneeberger - Analyst
Thanks.
Operator
Bill Greene, Morgan Stanley.
Bill Greene - Analyst
Hi, good morning.
Thanks for taking the question.
Kurt and Scott, I'm curious if you can talk a little bit about pricing.
Scott, given the comments you just made about GDP and given the experience in the fourth quarter where we kind of ran out of capacity would seem to me we have got maybe an increasingly positive backdrop for pushing harder on price.
Can you talk a little bit about how you think about that and are we entering a period where maybe pricing gets a bit better?
Kurt Kuehn - CFO
Well, we do think that pricing is very stable, and I will have Alan talk about it a little bit.
Clearly, the significant change in our mix does mask what we think is a core base rate pricing of about 2%, plus or minus and so with the substantial mix shift, it has made it hard to see.
But we feel pretty good that we are making investments and we will be compensated fairly for it.
Alan, maybe you could expand a little bit on pricing.
Alan Gershenhorn - Chief Sales, Marketing & Strategy Officer
Yes, I mean I would just add that the base rate increases of about 2% we have been experiencing for quite some time certainly masked by customer and product mix changes that were certainly exacerbated by some of the weather trends that Kurt alluded to in the opening comments.
As far as peak season goes, our goal is to ensure we are appropriately compensated based on our customers' shipping characteristics and also their seasonal patterns.
And we are certainly working with each customer and their specific contracts on an individual basis to make sure that we are compensated fairly for the services that we are providing.
Bill Greene - Analyst
Thanks for the time.
Operator
Ken Hoexter, Merrill Lynch.
Ken Hoexter - Analyst
Great, good morning.
If I can just follow up on the pricing commentary there and maybe just get a little bit more specific on that.
Do you plan to use price to then adjust behavior in terms of getting it away from the December 23 kind of peak day and kind of maybe shifting the behavior a little earlier to help the network?
And I guess following on that, what additional projects -- it sounded like you are doing things to accelerate shipments, maybe some more automation.
Can you maybe dig into that a little bit in terms of where the $100 million and $500 million of investments are going?
Kurt Kuehn - CFO
Ken, I will take your first question anyway and I am going to let Alan expand a little bit on our real priority with customers.
Our top priority this year is to provide superior service and quality operations to help our customers succeed during peak season.
So we will talk a little more in the future about the network enhancements.
But, Alan, this is nothing new; you guys work with customers and plan out very specifically peak season and you spoke price and strategy to manage that.
Alan Gershenhorn - Chief Sales, Marketing & Strategy Officer
Yes, so just to add a little bit of color on that, we've met with all of our major and certainly our largest customers to increase the collaboration.
Very, very productive meetings that we've had.
We are working on improving mutual planning capabilities with obviously the ultimate goal of enhancing their end consumers' customer experience.
We are working on areas with these customers, splits, bypasses, direct ships, late multiple, weekend pickups, special operating plans and then we are obviously communicating the plans that we are working on unilaterally in the areas of forecasting, capacity planning, visibility and communication.
Scott Davis - Chairman & CEO
And Ken, I'd just add that pretty much all options are still on the table.
It's early in the process.
We said last quarter we really want to be able to meet customer expectations, but also meet our financial objectives at peak.
So we are still evaluating alternatives out there.
Ken Hoexter - Analyst
Thank you.
Operator
Nate Brochmann, William Blair & Company.
Nate Brochmann - Analyst
Yes, good morning, everyone.
I wanted to talk a little bit about maybe some of the network adjustments that you are making in terms of as you are getting more of the SurePost revenue, one of the benefits on the Ground network had been getting the better density on that local delivery on the B2C-type front.
And if more is shifting over to the SurePost, which is probably great for the overall network in terms of the revenue streams, but like you had to do on the International side, are you having to make any network adjustments because of that flowing into SurePost?
And then secondarily to that, and I know it is probably too early to talk specifics, but does the new contract with the Teamsters give you greater flexibility to maybe handle more SurePost away from the Direct Ground business?
Thank you.
Scott Davis - Chairman & CEO
I will take the Teamster question, I guess the contract question first and then we will move it over to probably David.
The news just broke last night on this contract being ratified.
We have not yet been formally notified by the Teamsters.
Once we get formal notification, as Kurt said, we will do a webcast with the details of the contract.
So really don't want to get into the flexibilities of the cost until we get the formal notification, which hopefully is coming soon.
David Abney - COO
Okay.
As far as the changes in the system and effects that it could have by additional SurePosts, really it is the same technology that we use in the rest of our business.
It certainly helps us here, so SurePost Redirect is about as good an example as you can have in how our technology allows us to accommodate this change.
So very late in the process we can determine if there are additional packages going to the same stop and then we can redirect that and then we will actually deliver it, it will be much cheaper than tendering it to the post office.
If it is a single package, then we would do just the opposite, let it go ahead and flow.
There is other -- the technology where we can scan and make those decisions and the automation that we have placed in our hubs we also have in our preloads.
So yes, we see a change in types of packages and the flow of the packages, but we certainly have the automation and we certainly have the technology to adjust to that.
Kurt Kuehn - CFO
Yes, I guess maybe one high-level recap on that is that the goal for us is to make the investments to get our variable costs down extremely low and these packages drive very little capital and low operating expense as they flow through our automated system.
So we are confident that we understand the operational changes and we are making the investments to be able to profit off of this growth for a long time.
Nate Brochmann - Analyst
Great, thanks.
Operator
David Vernon, Sanford Bernstein.
David Vernon - Analyst
Good morning and thanks for taking the question.
Could you give us a little bit of an update on the rollout of the Orion system and maybe talk at the micro level about what types of productivity impact this is having in terms of stops per under an hour or any type of metric that could give us some better sense for how impactful this rollout can be going forward?
Kurt Kuehn - CFO
Right.
Well, other than the fact that we had some of our core Orion people out in three feet of snow trying to chart out routes, I think it is moving pretty well.
Myron, what do you think?
Myron Gray - President, US Operations
David, we are certainly encouraged by the results that we are seeing thus far and as we alluded to in the last call, we've certainly added 200 resources to help us with our implementation.
To date, only approximately 20% of our drivers have been implemented.
We would expect that to approach nearly 45% by year's end, but it is too early to give you any numbers at this point even though we are encouraged and at the November investors conference, I think we will have more information to divulge to you.
Scott Davis - Chairman & CEO
But very encouraged by the progress we are seeing so far and as Myron said, in November, we will probably give you the metrics.
David Vernon - Analyst
Okay, great.
Thanks.
Operator
Scott Group, Wolfe Research.
Scott Group - Analyst
Hey, thanks.
Good morning, guys.
So I wanted to ask a little bit about the buyback and if you see some flexibility now that the Teamsters contract is about to get approved to ramp that up?
Maybe do you feel comfortable putting some broad numbers in terms of the payment to the multiemployer plans?
And then as debt comes off the balance sheet, is that an important metric you look at or consider when you think about how much stock you do want to buy back?
Kurt Kuehn - CFO
Okay, Scott, I will try to piece all that together into one question I guess.
Our capital distribution policy we guided this year of repurchasing $2.7 billion in stock.
You can see that we are well along the way on that in the first quarter and the increased dividends.
So the settlement of the contract is not a material impact on our capital policies.
We remain very strong on free cash flow and we will distribute accordingly.
We will be sharing a lot more information on the migration of the retiree healthcare liability off our balance sheet and are always looking for ways to use our low cost of capital and our quality balance sheet to minimize volatility and improve returns.
So this is no different.
Scott Davis - Chairman & CEO
And those information should be forthcoming soon.
If the reports are accurate from last night, we should have the information hopefully in a couple days and share that with you.
I guess the one thing I would add, Scott, is even though obviously net income was impacted dramatically by the weather, our cash flow again was extraordinary in the first quarter, over $1.9 billion of free cash flow.
So we will obviously consider that in our decisions going forward.
Operator
Brandon Oglenski, Barclays.
Brandon Oglenski - Analyst
Good morning, everyone.
Kurt or Jim, I wanted to talk a little bit about International margins because I know there are a lot of moving pieces this year and you did have a good outcome in the first quarter year on year, but the comps get a little bit more difficult in the second and fourth quarters.
So what are some of your assumptions around margin improvement for the remainder of the year?
Are you assuming sequential demand improvement and yield improvement?
Can you talk a little bit more about that?
Kurt Kuehn - CFO
Yes, we have guided to profits growing 12% to 14% this year.
Clearly, they are off to a good start, so I think you will continue to see improvements and hopefully you got a sense that we do think that things are moving well.
So Jim, maybe you could expand a little bit on some of your guys' results and outlook?
Jim Barber - President, UPS International
Yes, so, Brandon, obviously the comments in the opening gave some framework to it.
I think that we should keep in mind that International we keep talking about momentum.
This is really the fifth quarter in a row it has come up.
I think we have to also keep in mind it has been a year since the TNT situation ended; let's put it that way.
And the business itself has really kind of gotten back to the basics of what we are supposed to do; you can see that.
And so the leadership teams are in a good place right now.
And I think the other comment that I would tell you is we have also looked at the International business and not only investing today, what you are seeing today, but in some of the guidance, some of the emerging market investment the teams are restructuring is coming forward.
So we are actually I think in a very good place internationally and all the confidence in the world to the guidance we have given you so far.
Brandon Oglenski - Analyst
Thank you.
Operator
Chris Wetherbee, Citi.
Chris Wetherbee - Analyst
Thanks, good morning.
Just following up on the International question.
When you think about sort of the re-acceleration of volumes that we are seeing particularly in Europe, does it bring to the table anymore opportunity to start thinking a bit more about price?
It seems like sort of the underlying base rates are still pretty good, just getting a rough sense though of how maybe there could be some leverage there or this is more going to be a volume opportunity as you look forward over the course of the next couple of quarters?
Kurt Kuehn - CFO
Yes, well not all volume is created equally and I think that, Jim, maybe you can expand a little bit on our focus there.
Jim Barber - President, UPS International
Yes, a couple things that are also going on.
I think you have to recognize certainly in Europe the supply chains are moving too.
They don't remain static.
So some of the big supply chains around the world, the customers are trying to optimize their networks.
We work with them to do that, so the zones move, the distribution patterns move.
Our Transborder growth in Europe, a lot of that was to support moving distribution patterns that shorten up zones.
That affects the yield of the package.
But our job is to create the margins in the new networks.
So we are very comfortable with that.
I also made an opening comment that I think is important, which is our middle market acceleration.
We've seen in the last couple quarters and we really haven't seen this in the past is our middle market is now outpacing some of our larger global enterprise accounts.
And then the other thing that is going on I think of material nature is the high-tech industry and those product launches have kind of laid down.
So in the middle of all that, some of our internal optimization investments seem to be paying dividends and they will move forward and we will leverage all that together.
Scott Davis - Chairman & CEO
You know what was encouraging Jim in the quarter too is while we still saw the slower products grow at a double-digit pace, we still saw Express grow at a 4% to 5% pace internationally, which is a good sign to see the Express market still growing.
Operator
Allison Landry, Credit Suisse.
Allison Landry - Analyst
Hi, thanks, good morning.
I wanted to ask about growth in Europe and specifically the strength that you've seen in the Pan-European business.
Can you give us a sense of the contribution of this segment to International profit margins and returns on invested capital?
And do you think Europe as a whole will be able to achieve margins that are similar to the US at some point?
Kurt Kuehn - CFO
Yes, as you know, we don't break down margins specifically by area of the world, but clearly the International business has been a great business for us and Europe is our flagship.
Over half of our revenues are European-based.
So we won't get into more detail, but we do think Europe is here to stay and that the business model, Jim, that you are managing is in pretty good shape.
Jim Barber - President, UPS International
Yes, I think the underpinning, as Kurt said, I think margins, our products will keep away from it.
I think it is more about the network and its capability to react to the market, the single market that is there today and we have been building that effectively from my perspective since about 1996.
It is in great shape and we continue to invest in it and we are very happy with the returns on capital and we will keep investing where that makes sense for us and for our customers.
Scott Davis - Chairman & CEO
That is absolutely right.
I think that the European networks are built a lot like the US network and we are getting excellent returns on invested capital in that network.
Allison Landry - Analyst
Fantastic.
Thank you so much.
Operator
Kevin Sterling, BB&T Capital Markets.
Kevin Sterling - Analyst
Thank you.
Good morning, gentlemen.
Just kind of dive and maybe taking a different look at International, you talked about the strength we saw in the first quarter.
I think it sounds like April is off to a good start.
I think you also cited some improvements in your Forwarding business on a net revenue basis.
Maybe you could talk about a little bit what is going on there.
Is that just kind of strength you are seeing in the overall International economy or maybe you are getting some marketshare gains there as well?
Jim Barber - President, UPS International
So as the opening comments alluded to, yes, we are.
Our tonnage is up; we know that.
The yield is really kind of still pressured.
And when I say that, what I mean is, a few quarters ago, I talked about concentration in high-tech and military and making sure that we tried to diversify through that.
The team is doing a good job with respect to that.
In some lanes, the markets still are tough to actually get the buy/sell just right.
We are very, very happy with the Ocean product, with the Brokerage product, with the North American Air Freight product.
So we are just very focused on and have some projects in the pipeline right now to kind of get at that Air Freight so we continue the momentum there.
So we feel like we are hitting on three of the four cylinders with the fourth one being worked on in a pretty good way right now.
Kevin Sterling - Analyst
Okay.
Thanks for your time this morning.
Operator
Ben Hartford, Baird.
Ben Hartford - Analyst
I think Scott had said that the International outlook was more or less unchanged.
Total volume growth in the quarter up 8%, above I think the target that you had provided for the beginning -- for the full year of 4% to 6%.
I am wondering if we should expect that rate of growth to decelerate through the year to converge toward that target.
And then I am also -- in conjunction with that, can you provide any context to how you see the growth between non-premium and premium products trending through the year as well?
Thanks.
Kurt Kuehn - CFO
Yes, great.
A couple of pieces there.
But I think we did show very strong growth in the first quarter.
Surprised us to the positive just a little bit.
There is a little bit of a benefit of the Easter timing I think in the first quarter.
Easter was right at the break between Q1 and Q2.
Scott Davis: Last year.
Kurt Kuehn - CFO
Yes, last year.
So there may be a little extra beef in Q1 that would put a little drag on Q2.
As far as the trends on premium versus standard, I will let Jim talk to that a little bit.
Jim Barber - President, UPS International
Yes, I think -- again, I think, as I mentioned a minute ago, four or five quarters of growth and I would combine that with the acquisition comment I made in the opening in the UKs and the Polands and the Turkey markets for example, a lot of -- there's some good solid growth in the Domestic product now four or five quarters in a row.
So you start to get lapping yourself quite frankly from that perspective.
Therefore, the end of the year looks a little bit different than the first, but we keep talking about that on a momentum basis.
So what that kind of outlook that you see on paper is certainly -- we want to focus on the export and then combining that with the Domestics in the markets where we currently or will in the future have the great capabilities.
Ben Hartford - Analyst
Thank you.
Operator
Thomas Kim, Goldman Sachs.
Thomas Kim - Analyst
Hi, I had a couple questions just related to the Europe part.
One was can you parse out the organic growth related to Europe if you are able to parse out the harvesting of the recent investments?
And then I guess just one of the other sort of comments or questions is I was wondering if you could elaborate on the mix shift change that is happening in Europe where your non-premium is growing more than premium and should we be thinking about that mix shift change similar to the way that we have been seeing it sort of evolve over in Asia where you have had an increase in Deferred impacting the overall mix and pricing?
Thanks.
Kurt Kuehn - CFO
Yes, let me piece the parts of that that I can combine for you here.
First off, the issue of the organic is everything is organic right now.
The acquisitions were several years ago, so there is no material acquisitions if at all.
Really the only notable acquisition is in the healthcare space and that did not impact the results at all.
The whole issue of managing the mix changes, it makes a big difference that you are seeing tradedown against the same asset.
That has been the challenge in Asia where you have gone from Express to slower modes and if you don't adapt then you are stuck with lower revenue on a fixed asset.
But the whole nature of the UPS network is to allow customers to move up and down and I will tell you there is a huge difference in capital employed between a package moving from Asia to Europe in a 747 versus a package moving across Europe in our integrated Ground network.
So the capital required and the returns are substantially different.
And so we are very happy to see robust growth through our integrated network.
And then to Jim's point, as we grow the Domestic business, what that does is it lowers the pickup and delivery cost for all products.
So that is the benefit of the portfolio that these products reinforce themselves and we get both economy of scale as we get bigger in each country and economy of scope as we have complementary products.
So as Scott said, Europe is very much following the lessons we have learned from the US capital returns and investment and we are happy to get standard volume there or premium.
Operator
Rob Salmon, Deutsche Bank.
Rob Salmon - Analyst
Hey, good morning.
Thanks for taking my question.
Kurt, a quick housekeeping item.
Can you give us a sense if the new Teamster contract is incorporated into the current guidance, because it is not yet finalized?
And then, Jim, two quick follow-ups with regard to the European network.
With the stronger than expected growth that we've been seeing to date, are there any sort of necessary incremental capital investments within the Ground network?
And can you talk a little bit about the density within your linehaul network in Europe and how that compares to the US currently?
Thanks.
Kurt Kuehn - CFO
Okay, I will break ranks and answer two questions because the answer to the first one is one word, and that is yes, it's in our guidance.
Jim, maybe you could talk about the capital expansion for Europe and whether it is material.
Jim Barber - President, UPS International
Yes, so I would say that certainly in the network today as part of the ongoing process and the numbers we give you every year, the capital is in there.
But I would also say yes to the question, is we have to keep investing in that network.
We talked about Cologne today, but our big hubs in Germany and the UK.
We are investing in Turkey hubs as we speak.
So yes, there is continued capital requirements, but again that is all baked into the overall network and bringing the customers in that they choose the network.
So we are very, very comfortable with that.
As far as density and linehaul network question, they are really different networks, to be honest with you.
The way we run the networks European-wise versus US is they are different, and the mix of the carriers and how we actually take those products across the single market in the UPS or partnership or contractors is different.
So you really can't compare the two networks from my perspective, but again I think the networks in Europe are performing across the business beautifully and they will continue to do so.
Kurt Kuehn - CFO
Yes, I guess one comment on Europe, that clearly we cycled through -- this is the one-year anniversary of us bidding goodbye to the attempt to purchase TNT.
During the period of negotiation and work with TNT, we clearly put some projects on hold, both strategic projects and opportunities and also capital expansion, until we were sure how we'd optimize the new asset.
So we certainly are in a period right now of, to some extent, facing the next five years with an aggressive organic approach and we are thrilled to make investments to grow our integrated Ground network in Europe.
Thomas Kim - Analyst
I appreciate the time.
Operator
Keith Schoonmaker, Morningstar.
Keith Schoonmaker - Analyst
Yes, a quick follow-up on the capital investment.
Given the growth in Europe and the mix realized, do you anticipate making adjustments to the air fleet or is this where you need it for now?
Kurt Kuehn - CFO
No, the air fleet is in great shape.
As we said, David and the airline finished purchasing 767s last year and David, I think at least as far as the foreseeable future, we don't expect any major capital additions.
David Abney - COO
No, we don't have any plans to buy any aircraft in the next few years.
We have, of course, been able to increase our load factor and then the biggest focus is just on improving the quality of the revenue that is in our aircraft.
And with the fact that expedited volume has grown, it has given us a lot of flexibilities on how do we actually put that in our aircraft, do we do something else with it or do we hold it for a day to more fully utilize the aircraft.
So it is given us a lot of flexibility.
Jim Barber - President, UPS International
And this is Jim.
I would add one comment to it in parallel to the opening comments.
The network in Europe as an intra-European fleet is in great shape as everybody is saying.
The fun part of this right now given where we are is through the emerging markets is to adapt and connect it globally across the world in a different way.
The teams are working on that and as we go forward, that would probably be likely where the adaptations come to the network to connect to the European network versus changing the core of it.
Keith Schoonmaker - Analyst
Thanks.
Operator
John Barnes, RBC Capital Markets.
John Barnes - Analyst
Hey, good morning, guys.
Just trying to keep track of the kind of investment that you were talking about in terms of being prepared for peak season and understanding that -- I went and looked at -- 9 of the next 10 years have the normal days between Thanksgiving and Christmas, not the compressed period.
Just trying to get a sense of what percentage of the investment is being made with capital dollars to address network maybe deficiencies on a long-term basis versus what percentage may be addressed using operating dollars maybe through temporary employees or something like that?
How are you trying to balance that investment?
Kurt Kuehn - CFO
I will start off and then David can fill you in maybe on the status of it.
We've really quoted a couple of numbers.
One, that we are expanding our capital investments in general broadly to expand capacity in the US and automate facilities.
Those are long-term investments that stand regardless of the peak issue.
The other is we are doing some things on the technology side, on the customer alignment side and on the flexible capacity side and that is really driving that $100 million expense headwind this year.
That is more of a one-time issue and Dave, maybe you could expand a little.
David Abney - COO
Certainly.
Our peak planning committee has been focusing all this year, made solid progress and when it comes to capacity, we are taking two approaches.
The permanent capacity will help us throughout the years and Kurt referred to that a little bit, but the North Bay automation refit retrofit project as an example of that.
We are also increasing the capacity of CACH, our Chicago consolidated hub and we are also adding some trailer capability in Worldport both from an unload and a load standpoint.
But then the other thing we are doing is temporary, what we call mobile capacity that we can move from peak to peak, from building to building and it is adding -- we are going to add nearly 10% car positions this year.
It is over 6,000 car positions and it is in what we call mobile distribution units and these will be addressing specific temporary needs, but if those needs change next year, we just simply move that capability from year to year.
John Barnes - Analyst
All right, thanks for your time.
Operator
David Ross, Stifel.
David Ross - Analyst
Yes, good morning, gentlemen.
Real quickly on the Ground side, US Domestic Ground volumes ex-Smartpost, what did they grow year over year in the first quarter and how are they trending in April?
Kurt Kuehn - CFO
They were up moderately and I think trends in April, as we have said, once -- now that the weather has cleared continue very steadily.
That is why we feel pretty good on the US economic outlook.
Operator
Kelly Dougherty, Macquarie.
Kelly Dougherty - Analyst
Good morning.
Thanks for taking the question.
I just wanted to follow up on the mix conversation.
Should we think about these mix trends as secular trends that will accelerate or do we expect some kind of normalization if only from easier comps?
And just wondering if you can give us a sense of what yields might look like after you incorporate your base rate increases and then what is going on on the mix side of things.
Kurt Kuehn - CFO
Yes, there is a couple of big dimensions and I will have Alan talk a little bit about it, that some of them are cyclical and some of them are long-term trends.
Certainly the continuing growth of B2C both in the US and globally is something that is here to stay.
But things like weight increasing or decreasing or near-shoring versus far-shoring are things that come and go a bit.
Scott Davis - Chairman & CEO
Yes, let me just add before Alan gets at it.
Certainly the first quarter was exaggerated though with the weather.
Kurt Kuehn - CFO
Right.
Scott Davis - Chairman & CEO
It hit commercial manufacturing harder than it hit obviously e-commerce.
So what you saw in the first quarter was exaggerated.
Alan Gershenhorn - Chief Sales, Marketing & Strategy Officer
I think certainly we are going to continue to see strong residential growth and I think you will see it across all of our residential products, whether it is Air, Ground or SurePost as retailers are out there offering a wide variety of services to their customers to meet the varying needs.
Certainly these last few quarters, we've seen our commercial growth turn positive on the ground, which is a good sign also.
And I think that while there has certainly been a significant amount of down trading in the marketplace, we believe that the Express market will come back as the economy gets better and global trade increases.
Scott Davis - Chairman & CEO
And we are not uncomfortable with these trends.
We still think, for the last nine months of this year, we'll generate 14% margins in the US.
We did that really in 2012 and the first three quarters of 2013.
So with our technology, with our network, we can still generate good margins on B2C.
Kelly Dougherty - Analyst
Is there any way to think about once you incorporate mix though what yield may look like?
Kurt Kuehn - CFO
That's a bit speculative for right now and we will move on to the next question.
Kelly Dougherty - Analyst
Thanks.
Operator
Jack Atkins, Stephens.
Jack Atkins - Analyst
Good morning, guys.
Thanks for the time.
So I guess focusing on the International Air Freight side of things for a moment, trends thus far in 2014 seem to indicate that we are seeing some modest sustained improvement there for the first time in a couple of years.
So I guess could you comment on what you think is really driving that?
Is it a better global economic picture?
Do you think maybe it's inventory restocking or is it something else and do you feel like these trends are sustainable for 2014 and maybe beyond?
Kurt Kuehn - CFO
Great.
I will let Jim talk about that.
Jim Barber - President, UPS International
I would say it was all of what you just mentioned plus one and that is that our customers don't stay static with their supply chains and they move them and they are trying to optimize their supply chains and they are moving from small package at times to Air Freight and Air Freight to Ocean and Ocean to a Domestic on another continent.
So our job is to be ready for that and be one step or right in lockstep with them.
And I think the other thing that you should keep in mind is that that is kind of the power of the UPS offering is we don't run a pure freight network; it is a hybrid.
We have got a lot of options depending on how the customers choose to come to us.
So there's a lot of factors going on and we have just got to make sure we are supportive of really the needs and the requests of our customers.
Kurt Kuehn - CFO
Yes, and I guess one of the nice things is we did see and are seeing some rebound in exports out of Asia on the Freight side, but, Alan, we are also seeing quite a bit of strength South of the border, right?
Alan Gershenhorn - Chief Sales, Marketing & Strategy Officer
Yes, so on the US-Mexico lane there, we've launched on the package side a standard ground service to and from Mexico, which, on a small base right now, is experiencing very, very significant growth on a percentage basis, so we are real excited about that.
We have got our CrossBorder Connect product on the Freight side that is also experiencing good growth.
And I would just add to Jim's comment that the portfolio that we are positioning with our customers is also I think allowing us to penetrate the Air Freight market in a bigger way and I think you are going to see some broader gains in that area for us.
And the other last thing I would just say is Worldwide Express Freight we haven't talked about today, that has been launched I guess a little bit over a year ago now in a big way and we are experiencing very, very high growth in that area again on a small base right now, but very well-resonating with our customers.
Jack Atkins - Analyst
Okay, great.
Thanks for the time.
Operator
Helane Becker, Cowen.
Helane Becker - Analyst
Thanks very much, operator.
Thanks for the time.
You might have talked about this and I just missed it, but can you just talk about why the tax rate went up so much in the first quarter on a year-on-year basis?
Kurt Kuehn - CFO
Yes, Helane, we did guide this year that we would be seeing an increase in the tax rate.
We ratcheted it up in the middle of last year from the 34.5% that we had in January of last year first quarter and it is now at 36%.
So we have seen an increase and yes, this is the last quarter at which we will have this big of a gap, but it clearly was an increase.
It just has to do with the mix of profits around the world.
Our Forwarding unit that struggled last year and some of those things impacted our marginal rate.
So certainly there is no company more eager to see US tax reform and some rebalancing of rates around the globe than us and we continue to make that a priority and are working with Washington to ensure that the US remains competitive.
Scott Davis - Chairman & CEO
Helane, we did build the guidance in at 36%.
So it's as expected.
Helane Becker - Analyst
Right.
I figured you did that, but I was just kind of wondering -- it was 30.4% last year going to 36% I think this year, so okay.
Kurt Kuehn - CFO
The 30.4% -- no, I'm sorry, Helane, that was distorted because of the nature of the TNT settlement.
Some of the payments were taxable, some weren't.
The core rate for last year on the adjusted is 34.5%.
Helane Becker - Analyst
Got you.
Okay, thanks for your help.
Operator
Jeff Kauffman, Buckingham.
Jeff Kauffman - Analyst
Thank you and thank you for taking my question.
I just wanted to touch base, the cash on the balance sheet is back over $7 billion.
I know you mentioned it will cost you some money to exit these remaining pension liabilities, but could you talk a little bit about how much cash you think you need on the balance sheet because this is almost double what it was at the bottom of the recession here?
And just kind of longer-term thoughts on capital deployment.
Kurt Kuehn - CFO
Yes, and as Scott said, we had just a huge free cash flow quarter in Q1.
Capital expenditures were a little low.
Clearly, it is hard to build buildings in the blizzards.
So we will ramp some of that up and use some of that cash for capital improvements, Jeff.
But we do expect to continue strong distributions.
The Company has no agenda to hoard cash.
At the same time, we like to have a strong balance sheet.
So we are going to continue with our basic targets of distributing near 100% of net income in the form of dividends and share repurchases and keep a little powder dry for M&A and other strategic initiatives.
Scott Davis - Chairman & CEO
In Q1, Kurt, I think we distributed 140% of net income.
So Jeff, it will be a balance.
We will continue the strong distributions.
We will continue to reinvest in the business.
Jeff Kauffman - Analyst
Okay.
Thank you and congratulations.
Operator
I would now like to turn the call back over to Mr. Wilkins.
Please go ahead, sir.
Scott Davis - Chairman & CEO
This is Scott.
I will just do a quick recap.
Clearly, the first quarter was a challenge, but again as we talked about the rest of 2014 looks quite promising.
The economy though still not robust, it will be better than what we saw last year, both here in the US and globally.
What I am excited about is at UPS we are going to be hitting on all cylinders as all three segments of our business will show nice improvements in operating profit over the last nine months of this year.
And frankly, we have not seen all three segments improve at the same time since 2010.
So look for good things ahead from UPS and thanks for being on the call today.
Operator
Ladies and gentlemen, that does conclude our conference call for today.
On behalf of today's panel, I'd like to thank you for your participation in today's conference call and thank you for using AT&T.
Have a wonderful day.
You may now disconnect.