聯合包裹運送服務公司 (UPS) 2014 Q2 法說會逐字稿

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 2014 earnings conference call.

(Operator Instructions).

Thank you for your cooperation.

It is now my pleasure to turn the floor over to your host, Mr. Joe Wilkins, Investor Relations Officer.

Sir, the floor is yours.

Good morning and welcome to the UPS second-quarter 2014 earnings call.

Joining me today are Scott Davis, our CEO; Kurt Kuehn, our CFO; along with Chief Operating Officer, David Abney; International President, Jim Barber; President of US Operations, Myron Gray; and UPS Chief Commercial 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 and first-quarter 10-Q reports.

These reports are available on the UPS Investor Relations website and from the Securities and Exchange Commission.

As previously announced during the quarter, UPS completed the transfer of post-retirement liabilities for certain Teamster employees to defined contribution healthcare plans.

As a result, the Company recorded an after-tax charge of $665 million reducing earnings per share by $0.72.

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.

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 we will turn it over to Scott.

Thanks, Joe, and good morning, everyone.

UPS experienced robust second-quarter revenue and volume growth across the portfolio and we are encouraged to have all three segments improving operating profit, the first time since 2011.

Customers chose UPS solutions at an increasing pace confirming the value of our portfolio.

However, our results also reflect the challenge of today's evolving marketplace and earnings were somewhat less than we expected.

The accelerated growth and peak season preparations are driving implementation costs, as well as increased investments in automation and new capacity.

David will provide you details on these efforts in a moment.

The initiatives we are pursuing today will enable UPS to provide enhanced solutions for our customers to secure their business and build their trust.

At the same time, we look for opportunities to improve revenue management, driving more bottom-line growth and industry-leading margins well into the future.

The expansion of dim weight pricing is a change we are making to ensure UPS is properly compensated for network consumption.

During the quarter, we saw economies around the world pick up a bit.

The US economy did rebound as expected from the weather-related problems in the first quarter.

Solid economic fundamentals have driven retail sales higher, especially e-commerce.

In Europe, the economic outlook has remained steady with growth from larger countries offsetting slower, smaller ones.

While growth in Asia remains relatively stable, they are seeing an acceleration of overall exports.

One way to increase economic growth is through free trade.

Recent efforts by the Administration to proceed with the next phase of a national export initiative will develop opportunities for US small and medium-size customers to reach new markets.

This platform includes sections on trade facilitation, border clearance reform, free trade agreements and infrastructure investment.

Expanding free trade agreements will provide employment opportunities here at home.

Speaking of employment opportunities, to support the Joining Forces initiative, we pledge to hire 50,000 veterans by 2018.

Military veterans have a long tradition at UPS and bring valuable skills that provide great benefits for our Company.

Also during the quarter, because of our progress with ORION, CIO magazine recognized UPS as one of 100 companies that demonstrates excellence and achievement in information technology.

This breakthrough routing technology represents a decade-long effort to develop tools that reduce miles driven, cut fuel consumption and improve the customer experience.

Recognition like this is rewarding, but more importantly the capabilities we receive from this technology puts UPS in a better position to respond to changing market dynamics.

Before I turn it over to David, I want to take a moment to congratulate him on being named UPS' 11th CEO.

I know he is excited to lead UPS and I'm confident David will bring his extraordinary passion and commitment to the job.

David?

Thanks, Scott.

I speak for everyone at UPS when I say that we are a better company as a result of the inspired leadership you have provided.

You led the Company through one of the more turbulent global economic periods in history, transforming UPS into the world's leading logistics provider.

On behalf of the 400,000 UPSers around the world, we say thank you.

On a more personal note, Scott and I have worked closely for more than a decade.

During that time, he has been an inspiring mentor, and I look forward to working with him as Chairman.

As part of the transition, Scott will remain in his current role until September.

This allows me to spend most of my time out with customers and employees to better understand their needs and listen to their ideas.

From what I have heard so far, I am more encouraged than ever about the future of UPS.

One frequent topic of discussion has been our preparation for peak season.

We have had meaningful conversations with customers about our plans.

These discussions provide the foundation for a joint commitment of forecast volume, enabling UPS to better manage how large accounts impact our network.

We have made changes to UPS technology that will improve communication with customers.

Solutions have been implemented to provide better information on package location and shipment status, ultimately benefiting customers and UPS.

The accelerated ORION deployment is progressing.

Mileage reductions have come in higher than planned and we expect to have about 45% of our drivers using the routing technology for peak.

The facility automation and expansion projects are moving ahead as expected.

Several new buildings and retrofit projects in California and Texas will come online later this year providing additional capacity and flexibility.

To increase sort capacity, we are opening about 50 new hub source in existing buildings.

This will add 5% to our capacity with minimal capital investment.

UPS is focused on staying ahead of the holiday shipment surge that starts during cyber week.

We have always had limited operations on Black Friday.

However, this year, we will expand to a full operating day.

While this benefits the network by leveling volume fluctuations, it will drive additional operating costs.

As we looked more closely at preparing for peak and the implications of the accelerated volume growth, we have expanded the scope of several projects I just reviewed.

Though these projects will weigh on 2014 earnings, they will pay for themselves in the long run.

Overall, we are ahead of our peak readiness plan and I am confident UPS will deliver a great peak season this year.

Now looking across the portfolio, I will provide some details on other strategic investments UPS is making.

Here in the US, we opened our new automated facility in Laredo, Texas.

This is a key location to support the rapid growth along the US and Mexican border.

Also in the US, we recently opened 36 healthcare-compliant field stocking locations to reduce delivery time for medical device shipments.

These sites will provide customers the ability to reach over 80% of US hospital beds within four hours.

In Europe, UPS announced the opening of a new package center in Southampton, UK.

This 150-car facility nearly doubles the capacity of two other buildings it replaces.

Meanwhile, in Asia, we opened a distribution facility at the Beijing airport to serve UPS customers' high tech, retail and healthcare supply chain needs.

Also, in Asia, we added our rail service option for UPS Forwarding customers shipping from China to Europe.

This low-cost full container offering is up to 50% faster than ocean freight and 70% less costly than air freight.

And in Latin America, we announced a significant expansion of our small package operations in Brazil.

The opening up nine facilities will allow UPS to service more than 200 cities in the country.

As you can see, UPS has been busy expanding our reach, creating supply chain capabilities and building out our small package infrastructure.

These investments are part of our long-term strategy for growth and will improve returns going forward.

This will be apparent in 2015 as we benefit from dim weight pricing and operational improvements from ORION.

UPSers around the world are implementing these innovative solutions to meet customer needs.

UPS is positioned to benefit from the continuing acceleration of global trade and the economic growth of emerging markets.

I can assure you creating value for customers and shareowners remains a top priority for the senior leadership team at UPS.

I look forward to meeting many of you at the investor conference in November where we will share more details on our plans for the future.

Now I will turn it over to Kurt to update you on the quarter's results.

Kurt?

Well, thanks, David and good morning.

The UPS portfolio is hitting the mark with customers, resulting in global shipment growth of 7.2% and driving revenue up 5.6% to a total $14.3 billion.

Certainly the pace of growth exceeded our expectations.

However, increased demand for low-cost deferred solutions has put pressure on yields and margins.

Second-quarter earnings per share increased by 7.1%, but was below our expectations.

We continue investing in new capabilities and expanding our network, adapting our business today to ensure that we can capitalize on future growth opportunities.

Now for some details on how the segments performed.

Starting with US Domestic where revenue increased 5.2% to $8.7 billion driven by a 7% jump in package volume.

UPS Ground products contributed 8% growth while deferred improved over 5%.

Retailers continue to select UPS SurePost for their lightweight residential shipments, accounting for about half of our volume growth this quarter.

However, we do expect this growth to slow a bit as we wrap wins from last year.

In addition, during the quarter, a retail customer upgraded its catalog distribution to UPS Ground from the US Mail contributing to our Ground growth.

Beyond B2C, our B2B growth was the highest we have seen in several years, primarily due to the retail sector.

We also saw improvements in the industrial and manufacturing sectors.

Combined, these changes in product and customer mix led yields lower by 2% driven primarily by a more than 60% jump in UPS SurePost shipments.

Operating profits increased by $34 million to $1.2 billion while operating margin declined slightly to 13.5%.

A couple of key factors created operating expense headwinds.

First, we continued to experience very poor rail performance during the quarter.

In order to maintain service commitments, alternative operating plans were put into place.

This drove higher purchase transportation expense, as well as excess UPS network costs.

In addition, hiring and training costs increased in Q2 due to the accelerated volume growth and the peak-related projects that David mentioned.

However, we were able to offset much of the higher cost through improved productivity.

Our direct labor hours were up 6% and miles driven were up 4 compared to average daily volume growth of 7.4%.

Expense per package declined by 1.7%, a good result, but not quite enough to offset the yield decline.

Now for the International business where revenue was $3.3 billion, up 6%.

Total shipments increased by 6.6%, led by higher export product growth for Europe and Asia.

Export shipments jumped 9.1% with Europe up 13% and Asia up about 6%.

Non-U.

S. Domestic volume increased by 5% led by strong growth in Europe.

Currency-neutral revenue per piece declined 1.7% as our export product yields dropped by 4%.

Strong non-premium growth of 13% continued to outpace premium products, although they were also up by 4%.

Yield was also lowered by shorter trade lanes as our intra-Europe volume was one of the fastest-growing lanes.

Operating profit improved by 4.4% to $471 million.

However, operating margin did contract 20 basis points to 14.5%.

During the quarter, we continued to experience rapid shipment growth as changing volume distribution patterns developed in Europe.

These trends push network capacity above ideal levels in a few areas and as a result, we were forced to pay a premium for short-term capacity.

This contributed to higher delivery and network expenses, ultimately driving in-country costs up by 8.9%.

In the near term, our team in Europe is implementing a number of changes to operations while pursuing revenue management initiatives aimed at improving yields.

In addition, we are finalizing our capital investment plan designed to add capacity and improve operating leverage.

We are confident in our ability to pull growth through the bottom line.

Looking now at Supply Chain & Freight, which performed well this quarter with revenue growth of 6.5% up to $2.3 billion.

Operating profit increased 11% and margin expanded by 30 basis points to 7.5%.

The Forwarding unit experienced substantial revenue growth and expanded operating margins slightly driven by improvements in Ocean Forwarding and Brokerage.

International Air Freight experienced double-digit growth in both shipments and tonnage, although the pricing environment out of Asia continued to weigh on profitability.

In distribution, customers continue to seek our unique solutions to their supply chain needs.

Revenue increased by high single digits lifted by improved demand from retail and healthcare clients.

UPS Freight revenue grew 5.5% primarily due to a 4% improvement in LTL revenue per hundredweight.

Pricing benefited from the acceleration of the rate increase and tightening market capacity.

The unit improved both operating profit and margins.

Now for an update on our cash position.

For the six months ended June 30, UPS generated $1.0 billion in free cash flow.

This number was impacted by the transfer of union post-retirement liabilities that we discussed last quarter.

Excluding non-recurring items, cash flow improved by over $400 million over last year.

So far this year, UPS has paid $1.2 billion in dividends, up more than 8% per share.

We have also repurchased 13.7 million shares for approximately $1.4 billion.

Looking at our expectations for the rest of the year, UPS growth around the world has picked up and we are investing in capacity and automation today and will provide excellent returns down the road.

The peak preparation efforts that David mentioned, like the additional sorts, facility enhancement projects and the expansion of our Black Friday operations, will drive costs higher.

During the ramp up and implementation, these projects are expected to increase 2014 operating expense by a total of $175 million.

This represents another $75 million on top of our original estimates.

As a result, we now expect earnings per share to be in a range of $4.90 to $5 a share representing a 7% to 9% increase over 2013.

We do anticipate a strong second half of 2014 with earnings-per-share growth of 12% to 17% over the back half of 2013 with all three segments increasing operating profits.

In the US, treating Black Friday as a full operating day this year will lower reported daily volume growth in Q4 by about 160 basis points.

Nonetheless, we expect average daily package growth to be a little over 5%, slightly higher than previously guided.

Revenue per package is projected to decline by about 1%.

Operating margin is expected to expand to approximately 14%.

We also expect to see strong second-half improvements in our International results with shipment growth between 4% and 6%.

Yields will continue to be challenged by the changing product mix.

Operating profit is estimated to grow at low double digit rates with some margin expansion.

Our expectations for Supply Chain & Freight remain positive with mid-single digit revenue improvements and mid-teens operating profit growth.

So as you can see, we are experiencing some growing pains right now.

This is a great problem to have as long as we successfully adapt our network and facilities to effectively bring this growth through to the bottom line.

This completes our prepared remarks and we are ready to take your questions.

I will turn it back to the operator.

Kevin Sterling, BB&T Capital Markets.

Thank you, good morning and Scott, congratulations on a successful tenure.

I wish you the best in the future.

Thanks, Kevin.

I appreciate it.

My question, you guys, you continue to talk about the growth in non-premium products continuing to outpace premium products.

Are we seeing that delta shrink at all as volumes improve across the board, whether it's international or domestic and maybe are you starting to see some customers possibly move back to premium products given the strength in the economy?

Yes, clearly, there is some view of that, that in the International, for example, we saw a solid 4% growth in those premium products.

It is just dwarfed by the transborder growth in shipments.

So I think generally we are seeing life in all parts of the portfolio, although we expect a continued spread where the deferred products and standard products will continue to grow in excess of the premium ones, Kevin.

And it does seem that it has plateaued.

Certainly the last couple of quarters, we are not seeing that gap get any bigger.

So it feels like we're -- as long as we can see that growth, and if you see some new technology introductions later this year, that might help the Express also.

Got you.

Okay, thank you.

Scott Schneeberger, Oppenheimer.

Thanks, good morning.

Curious about the US on your rail disruption and then if I can throw in a second part and go International and just curious about the China/Europe rail capacity and how much that can ramp to.

Thanks.

Yes, I think certainly the rail disruption and the congestion this quarter was significant, driving both added expense and creating some real challenges on the service side.

So I don't know, Myron, maybe you could talk just a little bit about what we are doing there.

So yes, Scott, along with disruption caused by the rail network, what that does it certainly increased our purchase transportation costs in the quarter.

And as a result of that, we also saw a significant increase in hiring and training needs to offset the abilities of the rails to adhere to our expectations on our customers to meet on-time commitments.

So we are in the process of adding additional feeder drivers to offset that cost.

So clearly, we are adapting and adjusting.

As it was happening, it created some challenges, but we have transitioned some of the volume off in the most congested lanes.

As far as the Asia to Europe lane, that is still a relatively small amount right now, but we think over the long term it will be an opportunity, although certainly some of the disruptions as you cross borders there may be a challenge for a while.

Congratulations, Scott and David.

Thank you.

Thank you.

Ken Hoexter, Merrill Lynch.

Great, good morning.

Just if we can talk about your new guidance, the $4.90 to $5, it seems that it is much larger than the $175 million expense maybe even over $200 million to $400 million in terms of a decrease.

Is that due to -- is there anything going on other than just your increase in expenses and maybe can you talk in the same vein about margins on the e-commerce?

Is that changing the dynamics of the margin capability at Ground at all or can you maybe just delve into what the margin potential on e-commerce volumes are?

Thanks.

Yes, I think, Ken, certainly a portion of the guidance change is the Q2 results and I think if you factor that out, then really what we are looking for comes very close to the overall investments and added expense that we have made.

So clearly, the challenges of us keeping up and training quickly as part of this ramp up does create some headwinds, but the Q2 contributed a bit of the adjustment.

We had some excess cost with the rails and then if you look forward, the primary difference from what we have been discussing is just the current investment.

So we are looking for 12% to 17% increase in the back half of the year and think all of those pieces of the puzzle fit together.

And we really, after the weather in the first quarter, our last quarter, we guided to the bottom of the range, which was really $5.05.

So I think that is your starting point.

David Vernon, Bernstein.

Hey, good morning and thanks for taking the question.

Kurt, could you maybe talk a little bit about the added $175 million.

How much of that you guys have already spent, how much remains to be spent?

And then, David, if you could talk a little bit about sort of how you look at those costs next year and what kind of actions you can take to make sure that those actually come out of the P&L next year.

Yes, so if you look at the change in our description of the investments, as we have really dug in and made better forecasts, the big amount of the change is going to occur primarily in the fourth quarter.

We are adding operations the day after Thanksgiving.

That does add expense.

Over time, it may generate more revenue, but the real purpose is to smooth out operations.

And then also our IT resources and -- we are going to open almost 50 new hub sorts to handle capacity.

So the majority of the change in the added expense is in the fourth quarter.

We spent about 15% of the total in the second quarter.

That will get up to 30% or so in the third quarter and then the residual kicking in in the fourth quarter.

And David, maybe you can talk a little about how all this fits together.

I certainly can.

First, I think the point is that many of the projects and investments that we are making in this year will provide benefits not only this peak, but throughout next year.

A good example is the additional IT expense that we are experiencing.

We are working on 30 different projects and those projects will help us for peak, but they also will help us next year and we won't have that additional expense, so that's one good example.

The second one is running a full operations day on Black Friday.

That is additional expense, but what we have to realize, it smoothes out the cyber week volume, allows us to better manage e-commerce demand and some of that cost will be offset by more efficient operations for the following week.

And while we haven't determined exactly what we would do next year for the Black Friday, we do expect that we would operate on a pretty extensive basis.

And then the ramp up costs for these 50 additional hubs, a lot of the expense is just getting those hubs ready and then getting them staffed.

Many of those hubs, some of them will continue to run through next year; others, it will be much easier to ramp them up next year for peak just because we have done all the work this year.

So I would say a considerable amount of the cost would not be next year's numbers.

Yes, just to add to that, David, I think as we look at next year, we expect OpEx not to be near as dramatic for this purpose as we saw in 2014.

If something drives that, then we will have to evaluate pricing at peak season again.

If we have to do this again, we will have to evaluate how we price at peak season.

All right, thanks very much for the time.

Nate Brochmann, William Blair & Co.

Good morning, everyone and want to echo my congratulations, Scott and David.

Thank you, Nate.

So kind of going along with that question, but a little bit bigger picture in terms of -- like from a strategic focus, we've kind of been through the decrease from premium to non-premium products and the lower volumes out of Asia and whatnot and then we had the peak season issue where you are clearly adjusting for.

And then we had the rail issues early this year.

It seems like, give or take, the overall freight environment and supply chains are so dramatically changing quarter to quarter, how do you maintain that flexibility longer term as we get through these different volume swings and different movements in terms of how do you think about the business and how do you have to react to that?

Well, Nate, I think what you've seen is us reacting strongly over the last few years.

One of the things we are doing to make us more capable to adjust to these changing conditions is reinvesting in the network heavily and focused on IT with data-driven operations, increased automation and a lot of creative applications from the market side.

So this has been a part of the transformation that we've been talking about for several years now.

And right now, certainly preparing the network and lowering our variable costs to handle this continued growth in B2C is the midst of the investments we are making.

So we think we are on top of this.

I mean it doesn't always come out as smooth as you would like and clearly we would've liked to had a little stronger quarter, but the demand is there.

I think UPS quality and service is great and so we feel very good that we are building this Company for the long term no matter how the market changes.

Kelly Dougherty, Macquarie.

Hi, guys.

Thanks for taking the question.

Just wanted to focus on the International business.

I believe you said Europe is about 50% of that.

So just wondering how much of your growth expectations internationally are macro-related versus what you are doing to some internal initiatives, network adjustments, acquisitions, things like that.

Trying to get a sense of how the macro environment in Europe might impact the International business.

Yes, well, clearly, the UPS growth is far outpacing any definition of market -- either market or GDP growth in Europe, which remains I guess we would say steady, but sluggish.

But, Jim, maybe you could talk a little bit about what is going on over there.

Sure.

I would say back to those points is that, in this quarter, obviously, with revenues up at 6 and exports in double digits in some places, that is clearly above any macro environment.

We will continue to focus in those places like Europe that we've talked about on the previous calls.

I think going forward though, Kelly, I think you will also see more in the emerging markets from us.

That's where a lot of the investments are at this point, as well as capabilities like access points that will enable us to continue to accelerate this.

So as far as organic versus inorganic, this is just about growing the business as we historically have and we think in all parts of the business right now we are doing a nice job of growth.

Is there any way to think about maybe not actual numbers, but the profitability differences between Europe and maybe the rest of the world, kind of order of magnitude even?

No, we really don't break out regions.

These regions are all interconnected, but certainly we are pleased to make investments in Europe and do expect to continue doing that going forward.

And we do well in all regions.

Ben Hartford, Robert W. Baird.

Good morning, guys.

If I could circle back to supply chain specifically on the Forwarding side, I think you made the comment that, maybe it was Scott, that overall exports out of Asia were accelerating.

You guys have some relatively easy comparisons from some Company-specific efforts, but yields overall, you had made the comment as well, still are pressured some.

Could you provide some perspective in terms of how to look at the back half of the year within that segment specifically on the yield front given some of the capacity management efforts in Asia across the industry into what appears to be an accelerating export environment, but still a very competitive yield dynamic?

Can you provide some perspective there?

Sure, Ben.

It sounds like you have got a pretty good handle on it, but, Jim, maybe you could flesh it out a little bit and talk about our look going forward.

Sure.

I think we should start with the fact that Air Freight is just one of the products, Ocean Brokerage North America, it is really doing well in many, many parts of the business.

With respect to Air Freight out of Asia, yes, we do see the market tightening; yes, it is a competitive market.

You can see in our growth rates we just talked about that we are actually bringing new customers on with the capabilities in the network.

We are evaluating increases as the market tightens; we will do that.

We will continue forward.

We talked about a year ago making sure that we relied less on a couple of concentrations.

I think we have done a great job across the industries to get us where we are today and we will continue to manage that in a very dynamic environment.

And of course, in the back half of the year, oftentimes product launches appear that help us manage through this and balance that as well.

So good stuff coming out of the Air Freight business all around.

William Greene, Morgan Stanley.

Hi, good morning.

Congrats, David and Scott.

All the best to you.

Thanks, Bill.

I have a question on B2C and of course, you folks have seen the post office's moves on pricing.

Can you talk about how that will affect your efforts and what it means from a dim weight perspective or from a pricing dynamic and the US perspective?

I realize B2C is getting to be a big part of the business now, over 40%, so I am not sure how to think about what dynamics are with the post office if they take actions how it affects you.

Well, Bill, this is Scott, I will start off.

I think, first off, it's not unusual to see our competitors adjust rates.

The USPS though really does not offer the same level of service and capabilities that we do at UPS.

I think the technology is a differentiator, our integrated service offerings are a differentiator, our guarantees are different.

Yet, at the same time, we work very closely with the post office.

We appreciate their universal service mandate where customers of theirs are customers of ours, but there is some concern as we go forward in how they price competitive products.

There is some concern about cross-subsidization that we are going to be working with the Postal Regulatory Commission to ensure they don't cross-subsidize the competitive products.

An example I guess is only 55% of the USPS costs are actually attributed to products.

The rest of those costs are institutional costs and only 5% of those go to the competitive products while 20% of the revenue is from competitive products.

So there are inconsistencies there that we are going to work with the Postal Regulatory Commission on and will pay attention to as we go forward.

At the same time, we will go out and compete with the post office.

Scott Group, Wolfe Research.

Hey, thanks.

Good morning, guys.

So I wanted to follow up on pricing and maybe the answer is just the post office, but clearly there are some capacity issues here.

You had them in peak.

The rails are struggling.

I am wondering why aren't you guys talking more about pricing and getting more aggressive with pricing.

And then beyond the dimensional pricing on Ground, are there other specific things you can do like that to start seeing some better pricing and to offset some of the mix?

Yes, clearly, and certainly the dim weight was a good example of pricing that helps to match our costs to our rates and we clearly look at that.

We have said in general that 2014 is the year of investing for the customer and creating unparalleled service and that was a higher priority than short-term price issues.

But, Alan, clearly, you guys do a lot of thinking and activity on this front.

Maybe you could talk.

Yes, so obviously the market continues to change with the B2C volume making up a bigger concentration of our business and we all see that that results in lower yields due to lighter weights and the mix between the products and the customers that are using those services.

We are continuing to calibrate our pricing models to make sure that we are aligning to the service that we provide and the price and the long-term strategy remains to achieve that 2% to 3% annual base price increase.

Certainly the dim weight initiative that will begin the beginning of 2015 will help bring us to the higher end of that base rate increase.

That will also encourage our customers to take a look at their packaging practices and we are already working with lots of customers in that regard right now so that they understand the impact of the dimensional weight changes and either way, if they change their packaging, UPS gets a nice cost advantage as do our customers or they will pay for the size of their packaging.

But given some of the cost issues and tighter capacity, you don't see an opportunity to go above 2% to 3% in this environment?

We aren't looking for dramatic changes.

We make sure that over time we are appropriately compensated.

Certainly next year will be a little different story than this year.

Our primary focus this year is capacity and service.

So we will see -- we will talk about that more going forward.

Okay, thanks, guys.

Brandon Oglenski, Barclays.

Good morning, everyone.

Scott, congratulations.

Hopefully, you will get some more time on the golf course going forward.

I will give it a try, Brandon.

Thank you.

David, welcome to the spotlight.

I guess my question is going to be a little difficult here, but I mean, over the years, we've all come to think of UPS as really geared for growth.

If you go back talking about how your domestic business should grow around GDP if not above it, well, we are in that environment now.

The last couple of Teamster contracts, we have always discussed how they are geared for that incremental growth, the incremental package in the network and now with the deployment of ORION, obviously that could be a gamechanger.

And yet here we are in our third year of sub double-digit EPS growth, I mean is this just a structurally different phase for UPS as we transition away from the previous B2B model to B2C or maybe for the next few years, we are not going to be able to hit that 10% to 15% EPS growth target that you guys put out a few years ago?

Brandon, I will start and then David can certainly add some perspectives.

The challenges you highlight are real and we have been talking about adapting and migrating our model to profitably grow with B2C volume.

If you look at 2012 and 2013 up until the fourth quarter, we showed expanding margins driven by B2C growth.

So I don't think it is quite as bleak as you are painting it and clearly, the challenges remain, but we think we are well on those.

So we will clearly talk about the long-term and the future in November a little more, but right now we feel like we are doing the right things to build for the future.

David?

What we see now with the accelerated volume trends, we probably should have been investing at a slightly faster pace.

We do see changing distribution patterns for customers around the world and we are ramping up investments this year by about $500 million primarily in capacity projects.

And this additional CapEx is mostly of projects that we already had planned, we already knew we were going to do them.

We are now just simply advancing them from the outer years due to the accelerated volume.

So even with this acceleration in capital projects, we still expect CapEx to remain in the 4% to 4.5% range during the next few years.

Chris Wetherbee, Citigroup.

Thanks, good morning, guys.

Maybe a question around peak season and the planning.

Obviously the conversations have been ongoing for several months now around customer behavior.

And I guess I just want to think, without using price necessarily as a strong or blunt instrument around customer behavior in the peak season, how do you sort of adapt and get customers to focus on shipping at the right times when the network has a little bit more flexibility and a little bit more capacity?

How are those conversations going in sort of the absence or I guess not necessarily using price as the key tool to adjusting that behavior?

Yes, great.

Certainly we said one of the key components of our peak preparation was increased visibility with customers and improved planning and collaboration.

Alan, you guys have been on that very much these days.

Yes, we obviously have a long history of collaborating and communicating with our customers, but, as you said, due to these changing trends, the importance of us getting closer to our customers and working jointly on collaborative operating plans is the order of the day.

So we are working with our customers on special weekend operations.

One of the areas that we are working very closely with them on is their omnichannel strategies and whether or not they should be fulfilling from their DCs or fulfilling from their stores and that certainly helps us manage their business better and also do it at a more effective cost.

And one of the parts of our peak planning has been joint commitment sessions with our customers certainly focusing on the highest peak periods and making sure that we have capacity that is needed and if there is volume in excess of that then there may well be a yield adjustment for that incremental volume.

All right, that was very helpful.

Thanks.

Congrats, Scott and David.

Art Hatfield, Raymond James.

Thank you.

Good morning, everyone and congrats, Scott and David.

I want to go back to this pricing thing.

A lot of questions about pricing today, but it seems like, as you've said, 2014 is the year of investing for the customer.

Is it possible that 2015 is going to be the year of charging the customer?

And a couple questions about that as we think about -- as I think about some of the comments you've made today, do you feel like you need to have a clean peak season from a service perspective before you can start to move price?

And secondly, is a potential peak season surcharge in the offing for this year?

This is Scott.

First of all, we definitely are planning and expecting a clean peak season.

We have invested heavily this year as we've talked about at length.

We think we are prepared, we are working very well with the customer, so we certainly expect a real strong peak season in 2014.

As I said, this year is about investing for the customers and as mentioned earlier, I don't think you will see the level of OpEx required in 2015 that we saw in 2014.

But if e-commerce conditions change again in 2015 to drive more OpEx, I think we will have to evaluate everything.

Everything is on the table and that could include a surcharge in peak in the future.

Jack Atkins, Stephens.

Hey, guys.

Thank you for the time.

David, it sounds like you have had some very extensive conversations with your customers here over the course of the last several months as you assumed your new role.

I was just curious if you could give us a sense for how you are expecting peak season to unfold both in terms of International Air Freight and then on the Domestic side, just from your conversations with those customers, are you expecting to see some tech product launches beyond what we've seen in the past couple of years?

Just trying to get a sense for the order of magnitude relative to what we've been seeing call it over the last three or four years.

All right.

Well, as far as the tech launches, every year, in the third and fourth quarter, we normally do see tech launches and we expect that that will continue again this year.

In fact, we have heard some pretty good indications of that and we have shown in the past where we can ramp up rapidly and we handle these tech launches really as good as anybody could out there.

So we look forward to it.

As far as the International Freight, Jim, as it goes to peak season, I will turn it over to you.

Well, I think that's the great part about the network and the way we've got it set as they launch.

In both the Air Freight side, as well as the small package side, the network is able to handle that and as David said, we do have some information about launches coming.

We work with those typically a couple months out to make sure the customers and we satisfy their needs and their consumer.

So I would say to the specific question we kind of see the next couple quarters similar to the past couple years and some tech launches coming and our ability to participate in those accordingly.

David Ross, Stifel.

Yes, good morning, gentlemen.

Kurt, you mentioned in your earlier comments about changing distribution patterns in Europe and David, you also mentioned that distribution patterns were generally changing around the world.

Can you expand on those comments specifically on how distribution patterns are changing for Europe, how well UPS is positioned to handle that and how those changes of operations or the additional capacity ramping up is looking to address this?

Yes, I will start off at a high global level and then have Jim maybe talk a little more granularly.

We are continuing to see transborder shipments, regional shipments grow at a faster rate than transocean shipments.

So intra-Europe, intra-North America certainly seems to have a higher velocity and you can see that in our mix change and our yield change.

So that is one of the big themes.

Europe has been a strong story for intra-Europe shipments with the convergence of the EU, but we are seeing some areas show a little more growth than others.

So Jim, maybe you could talk.

So I think it really just comes down to the fact that Europe as a single market is continuing to evolve.

Your distribution centers where they are placed there move and as that economy grows and it moves out to the east, the distribution models move with it.

The inventories move with it.

Our transborder network will support it in a different way.

Those patterns change and that is a good thing for us to have our network.

I think the investments that we are talking about quite frankly are more on the hubs now and our hubs are -- the growth patterns you've seen in International now are forcing us just like the US to continue to force in our hubs to keep that network flowing appropriately and that is what we plan to do over the next couple years.

So that is really what is behind the trade pattern question.

And does Cologne have enough capacity to handle it as you expected or are there other hubs that need to pop up to kind of supplement it?

It will be a great day when we build the next Cologne because it has got -- we built it quite frankly for about 10 more years of growth in the most recent investment and can continue to scale.

We love that investment and it will serve us well for a long time to come.

Excellent.

Thank you very much.

David Campbell, Thompson Davis & Co.

Yes, thank you for taking the question.

Back to Europe a little bit, there is obviously a lot of economic and political hotspots over there -- Russia, the Ukraine, Israel, Iraq.

Any impact on your business from any of these disputes, the wars, disputes, whatever you want to call them?

That's a -- I mean straight up I would say those business markets for us right now, we are obviously in those markets.

I think we have done a good job to kind of manage through those and have an operating model that is flexible and variable depending on what happens.

I think most of those markets for us are still what we would call emerging markets and we've kind of kept back some of the big investments there to be tailored to the trade that we talked about earlier and the way that we are ready to invest.

So at this point, we feel like we have adjusted that adequately and results in the International business you can see haven't been affected at all.

Not much impact yet.

We still pay attention to what could happen to Ukraine, could that impact Poland or Syria could impact Turkey and those type of things, so we pay a lot of attention to it.

So far no damage.

And from an airline standpoint, we closely, closely monitor world events and make sure that we make the appropriate changes to our air network.

Last question, is your International airlift capacity down?

I see that the tonnage is down from last year.

Is your capacity down too?

Our block hours are pretty much flat with last year.

Maybe slightly down, but not much.

Thomas Kim, Goldman Sachs.

Good morning, thank you.

I have a long-term question on your Asian network.

Based on the aircraft order book, cargo, capacity and passenger belly hold is likely to grow faster than air freight demand structurally.

First off, would you agree with that and if so, do you have opportunity to become or to rely much more extensively on third-party capacity?

And in that vein, does that mean that you need to expand your freight forwarding capacity much more significantly than what you are capable of today?

Thanks.

Well, I will start out.

Asia to US, our network is built around 7.5 trunk routes and that changes a little bit and we've watched it closely.

It is down 20% from 2011.

We have also placed larger aircraft, so that is one of the things that has helped us in that area.

So yes, especially with the growth of Worldwide Expedited products, that does give you a lot more options to move the freight.

You can hold it to take advantage of capacity.

It is less capital-intensive and we can utilize common carriage more for that product and we certainly do.

Just as a note, I think we did foresee this.

That is part of why we made a big investment into a forwarding capability back in 2001.

Thanks.

Rob Salmon, Deutsche Bank.

Hey, good morning.

Thanks for taking my question.

With regard to the SurePost growth that we saw in this quarter, could you elaborate a little bit on where that is coming from and what your expectations are looking forward?

It has been over 50% the past couple quarters and I was hoping to get a little bit more color on that line.

Sure, Alan, do you want to take us through?

Yes, so the growth is certainly concentrated, but it is concentrated in one industry and that is retail.

However, it is wide scale throughout our enterprise customers and also our middle-market account.

And really what you are seeing that shippers are choosing UPS because of the array of solutions we provide, not just the SurePost product and as you heard earlier, really all of our Air and Ground products, residential products are growing, our commercial products are also growing, but certainly SurePost grew at that 60%.

Allison Landry, Credit Suisse.

Thanks for taking my question.

Just on the cash flow and some of the expense headwinds you have coming through in the second half, I was just wondering if there was any update on your plans to repurchase 2.7 billion of shares this year, which I think you outlined in your fourth-quarter conference call.

Are you guys still expecting around that level?

Yes, absolutely.

Our commitment to shareowner distributions remains unchanged.

Actually our CapEx, although reoriented more towards Ground and technology facilities and vehicles than airplanes, remains quite low.

So we will be in the 4% plus or minus category and so yes, our share repurchases continue.

We are pretty much right on pace for completing our $2.7 billion commitment for this year.

Okay, that's great.

Thank you.

Jeff Kauffman, Buckingham Research.

Thank you very much and congratulations to both Scott and David.

Hey, Jeff, I've got to say that, on my first call in 2000, you asked my first question.

Today, you get to ask the last question.

We are coming full circle.

A lot of my questions have been answered.

I just wanted to focus a little bit on the maintenance expense.

It is not your largest expense, but I was a little surprised.

It was up 10%, particularly with block hours kind of flat.

Did we see any deferred maintenance this quarter from first quarter?

Is there any reason why it would be at this level?

The biggest driver of it is just the cycle of aircraft maintenance.

Clearly, there is some expense in there as we began doing some retrofits and buildings, but it is really driven by just the normal large B&C checks for airlines and we do expect that to continue for a couple of quarters.

Yes, it's really the aging of some of the new aircraft that we bought over the last few years.

They are in for their first real maintenance check now and that is what driving it.

It is just block hours and a time issue.

Very good.

Well, Scott, please enjoy.

Guys, thank you.

Thanks, Jeff.

I would now like to turn the conference call back over to Mr. Wilkins and panel for any closing remarks they may have.

Thank you.

I will now turn the call over to Scott Davis.

As I said, this is my 14th year of hosting these calls as either the CEO or the CFO and we have delivered a lot of different messages over those 14 years, but this quarter, believe it or not, was our largest Domestic volume increase, 7.4%, that we saw in those 14 years.

So it is something -- that is pretty impressive to get that kind of growth.

So the markets are moving in the right direction.

But clearly 2014 is a year that we are investing for the customer, but we expect an excellent peak season and in the future, these investments will clearly benefit not just the customer, but also our employees and our shareowners.

Thanks so much.

I enjoyed the call.