聯合包裹運送服務公司 (UPS) 2016 Q3 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 third-quarter 2016 earnings conference call.

(Operator Instructions)

It is now my pleasure to turn the floor over to your host Mr. Scott Childress, Investor Relations Officer. Sir, the floor is yours. Please go ahead.

Good morning and welcome to the UPS third-quarter 2016 earnings call. Joining me today are David Abney, our CEO; Richard Peretz, our CFO; along with International President Jim Barber, President of US Operations Myron Gray and Chief Commercial Officer Alan Gershenhorn. Also joining us today is Kate Gutmann, our Chief Sales and Solutions Officer.

Before we begin I want to review the Safe Harbor language. Some of the statements we will make today are forward-looking statements that address our expectations for the future performance or results of operations of our Company.

These statements are subject to risk and uncertainties which are described in detail in our 2015 Form 10-K. This report is available on the UPS investor relations website and from the Securities and Exchange Commission.

The webcast of today's call, along with a reconciliation of non-GAAP financial measures, are available on the UPS investor relations website. Webcast users can submit live questions during today's call. We will attempt to answer questions of a long-term strategic nature. Callers are asked to submit only one question so that we may allow as many as possible to participate.

Thanks for your cooperation. Now I will turn the call over to David.

Thanks, Scott, and good morning everyone. I'm pleased with our performance and happy to report another quarter of solid UPS earnings.

These results demonstrate increased demand for our products and disciplined execution of our initiatives. I will provide an update of our Q3 highlights and then Kate will give you an update on peak season.

During Q3 the International segment increased operating profit by 14% on more than 7% package volume growth. Our International strategy's achieving outstanding results. This was the seventh consecutive quarter of double-digit operating profit expansion. Yes, I said seven consecutive quarters of International operating profit growth.

The US Domestic business produced higher-than-anticipated package volume, driven by strong demand for our portfolio of e-commerce solutions. We continue to see increased demand for our Air Products and this quarter was no exception. Shippers are choosing UPS Air Products because our value is a differentiator.

The Supply Chain & Freight segment is navigating prolonged weak market conditions. They are making progress in adapting their business model and focusing on capturing the right revenue opportunities. We are confident in our long-term strategies and as a result of our performance this quarter we remain on plan for this year's guidance.

Turning now to the economy where global growth has continued to be modest. In the US consumer fundamentals remain healthy and account for most of the economic expansion while the outlook for industrial production remains weak.

Overall, global GDP forecasts are slightly down. For the balance of 2016 we continue to see mixed economic signals across some industrial markets. Under these conditions our diversified business model and our winning strategies still enable UPS to take advantage of high-growth markets such as cross-border trade and e-commerce.

To facilitate growth we are adding capacity and increasing efficiency in our globally integrated network. Trade lane and product portfolio enhancements are important components of our plans. We have significantly improved time in transit from several cities in the US and Canada based on increased export opportunities.

We have also dramatically improved service times for cross-border shipments between several major European cities. During the quarter we strengthened our portfolio of urgent delivery options by expanding our worldwide Express Plus product. We have doubled the number of countries served and are now reaching 90% of the world's GDP by the next day.

We've also expanded solutions for specialized shippers by strengthening our clinical trials service used by pharmaceutical companies. We see excellent opportunities for growth in this part of the healthcare segment. Our actions are providing more delivery options faster transit times and earlier guaranteed deliveries helping UPS customers achieve their growth objectives.

In addition, we are following a disciplined capital approach to invest in our business. In 2016 we announced 12 highly automated facility upgrades as part of our multiyear strategy and we plan to announce several significant new projects before the end of the year. These projects will help us to increase operating efficiency while simultaneously better serving our customers.

Expectations in the e-commerce sector and specialized markets like healthcare logistics have continued to shift to faster delivery options. As a result, demand for both Domestic and International Air post has been strong. Since we took delivery of our last new plane in 2013 UPS Air Products have increased more than 15%.

Clearly over the last several years UPS has expanded market share in the air segment and we expect these trends to continue. In response, we are announcing the purchase of 14 Boeing 747-8 jumbo freighters along with options to buy 14 more in the future. We will take delivery of the first two at the end of 2017.

This is a net add to our fleet. These new 747s will enable UPS to begin a cascade of aircraft route assignments that will add significant capacity in our busiest lanes. This will optimize global air network capacity well beyond the impact of adding these new cargo jets.

All of these investments are aligned to meet expanding customer needs and produce positive financial returns. Looking now at the upcoming holiday season we have created extensive peak season plans and built the foundation for another successful holiday for our customers and share owners.

Our strategy is to follow the same framework outlined last year. It's the four Cs: collaboration, capacity, control and commitment.

To conclude, I want to recognize the hard-working and dedicated UPSers around the world for the progress we have made year to date and to thank them in advance for their commitment to another successful peak season. Now Kate will update you on our peak plans.

Thanks, David, and good morning everyone. It's my pleasure to review our 2016 peak season plans with you.

The dramatic growth of online shopping and subsequent returns is expected to lift UPS package levels to a record high during this upcoming holiday period. Between Thanksgiving and New Year's Eve 2016 there are two additional operating days. And we expect to complete over 700 million deliveries worldwide, about 100 million more than last year.

In the overall US market the National Retail Federation expects total holiday retail sales to increase 3.6%. They are also estimating non-store retail sales growth between 7% and 10%.

At UPS our peak strategies are focused on executing the four Cs that David mentioned earlier. To begin with, we've deepened the level of collaboration with even more customers. We started earlier and are communicating more frequently.

This better aligns our UPS solutions and capacity with their seasonal promotion plans and fulfillment strategies, helping customers shift demand, sell inventory earlier and optimize their operations. Customer experience continues to gain importance in the marketplace, making collaboration a shared objective for both shippers and UPS. Whether you are in healthcare, retail or any industry our work together is creating consumer loyalty and a preference for the UPS delivery experience.

Looking at our second area of focus, capacity, UPS customers will benefit from several key automation and expansion projects. We've opened new automated facilities and updated existing hubs in the US and Europe in cities such as Chicago, Los Angeles, Paris and London.

In the US we are supplementing out capacity with the addition of temporary facilities. These investments in technology and capacity make our integrated network more flexible and efficient.

This peak our partners at Coyote Logistics will be supporting our entire Domestic operation, helping UPS solve customer needs during this high demand period. In addition, our driver dispatch will be even more effective. I'm pleased to announce that we've completed Phase 1 of the ORION implementation in the US ahead of schedule. 100% of eligible US drivers will be utilizing this dispatch technology during peak, up from 70% last year.

The third focus area is control, both control of deliveries for UPS customers and control of the UPS network. UPS My Choice will provide greater control to 30 million global members, an increase of 10 million from last year. My Choice enables members to exert preferences with their inbound UPS shipments and take action on their packages when desired.

They can choose to redirect deliveries to alternate delivery locations including a UPS Access Point location. In fact, this year we've expanded our reach and we will have over 27,000 convenient Access Point locations open around the world with approximately 8,000 in the US.

Looking at the UBS network we are exercising real-time control to ensure our customers can properly respond to peak demand and one important tool we use is the UPS control tower. This decision-making body enables us to say yes to more customer request, leveraging the flexibility of our operations to accept volume surges when possible. It also ensures that our capacity, value, cost to serve and price are appropriately aligned throughout peak season.

The final area of focus where UPS is commitment. The 450,000 UPS employees together with 95,000 temporary hires will be working diligently to provide world-class value and service during this upcoming holiday season. Each year the needs of peak season create special memories for all UPSers.

Last year I had a chance to visit the building I started in 27 years ago. The same energy, determination and customer focus that I was drawn to day one was clear in everyone I met. Spending time making deliveries really reinforced to me how the peak planning and collaboration with customers resonates throughout the entire organization.

Thank you for your time today and I want to assure you that the UPS team is ready to deliver another successful peak season. Now I will turn it over to Richard.

Thanks, Kate. UPS performed as we projected this quarter with total reported revenue up about 5% and daily shipments up almost 6%. The International segment produced another quarter of double-digit profit expansion and the US Domestic delivered results as we had anticipated while Supply Chain & Freight results were somewhat below expectations.

UPS third-quarter earnings per share were up about 4%. In 2016 the EPS change across the enterprise was lowered by headwinds in the US Domestic business and approximately $0.02 due to discrete tax credits taken in 2015.

This was a good quarter. UPS generated strong top-line revenue, great momentum in our International business and solid results from the other segments.

Now for a closer look at how the segments performed. US Domestic revenue increased 4.8%, driven by daily package gains of 5.7%. All products contributed to volume growth with Deferred Air up more than 10%, Next Day Air up almost 6% and Ground up 5.2%.

Growth was balanced from enterprise and middle market customers. High demand for online retailers was evident as B2C deliveries were up 11%. Despite negative industrial production B2B deliveries were up 2% with the majority of the increase driven by our e-commerce return portfolio.

Base rate improvements were able to somewhat offset lower fuel surcharges and the drag from a changing product mix. As a result, revenue per package was up about 1%.

E-commerce customers are helping drive higher daily shipments across our entire portfolio of services from high single-digit growth in Air Products to a 20% jump in our most economical product SurePost. Even with the accelerated growth of e-commerce, our investments in ORION continue to allow UPS to bend the cost curve lower and create positive returns.

ORION added efficiency again this quarter. Delivery stops and volume were both up 5.7%, yet ORION held package miles to only 1.4% increase.

Direct labor hours also grew slower than the average daily volume growth. As we guided operating profit growth comparisons with 2015 were restrained by one less operating day in 2016 and higher casualty credits realized last year. Excluding these profit headwinds operating margins expanded as we took advantage of the benefits of our investments.

Now for some details on the International segment where we had another record with double-digit operating profit growth for the seventh consecutive quarter. Profit jumped 14% as shipments climbed 7.5%. Revenue was up more than 3% on a currency neutral basis and fuel surcharge did decline, lowering the growth rate by about 70 basis points.

US Export packages per day rose over 7%. Growth was well-balanced on solid shipments out of Asia and across Europe. The non-US Domestic product increased 7.8% as we transition through pricing actions we took in 2015.

This quarter it shows it's about getting the right volume in our network. Our International segment is delivering balanced results with great growth and superior returns.

Let's turn and look at Supply Chain & Freight segment now. The segment produced top-line growth of 8.1%, primarily driven by the Coyote acquisition. Economic conditions in the US Truckload and LTL markets as well as the International Air Freight business continue to place downward pressure on demand.

The Forwarding unit remained disciplined on revenue management and cost controls. Gains from the small- and medium-size customers reduced the year-over-year shortfall in total tonnage.

UPS Freight has been adversely impacted by industry conditions in total tonnage dropped. However, they are executing a disciplined middle-market strategy which has resulted in revenue per hundredweight pricing improvements of 3.7% this quarter.

Turning to our Distribution group, revenue growth was broad-based with contributions from almost all sectors. The business unit maintained its industry-leading margins in the mid to upper single digits.

Now to update you on our cash position, UPS again generated healthy free cash flow. Through the first nine months we've produced $3.6 billion after investing over $1.8 billion in capital expenditures.

Please note that we accelerated our plan discretionary pension contribution to September. This allows us to capture additional financial benefits in 2016.

UPS also repurchased 19.5 million shares for $2 billion and paid out another $2 billion in dividends, up 7% per share over the last year. As we move into the fourth quarter we anticipate total operating profit growth to be slightly higher than our full-year guidance of 6% to 8%.

Supply Chain & Freight is continuing to manage through industry challenges and is expected to produce modest low single-digit revenue expansion by holding operating margin flat with last year. For the full year the macroenvironment is suppressing revenue growth. Therefore, Supply Chain & Freight operating profit is anticipated to be slightly below 2015 levels.

We are projecting an effective tax rate for UPS of 35% in the fourth quarter. Due to the unknowns related to the mark-to-market at year-end we are not able to provide guidance on our GAAP earnings per share. However, we are affirming our full-year adjusted earnings per share guidance of $5.70 to $5.90.

In summary, on a year-to-date basis our business is adapting to the opportunities and challenges presented by the high-growth digital economy. We continue to produce the industry's best margins and create great free cash flow. As we look at the fourth quarter we are confident in our ability to deliver another outstanding peak season for both our customers and our investors.

Before we take your questions I want to take a moment to announce our plans to hold an Investor Conference in early 2017. On February 21 in New York we will have a half-day conference. David along with the senior leaders and myself will be on hand to lay out our recent progress and update you on our strategy.

We will plan to allow ample time for your questions. Later today the IR team will send out invitations with further details.

Thank you. And now I'll ask the operator to open the line. Operator?

(Operator Instructions) Tom Wadewitz, UBS.

Good morning and congratulations on the strong volumes and solid results in the quarter. I wanted to ask you about the new plane order. It's an interesting topic given you haven't ordered planes for quite a while.

I wanted to get your thoughts on maybe the implications of that and some of the assumptions you make when you ordered long-lasting long-lived assets like that. So does this imply that you would think that that strong growth in Air volumes would continue and if you look at the next five years, is that a reasonable implication?

And also in terms of your largest customer who has been adding aircraft, is there an implication that you are not particularly concerned about share with that customer? Just wondered if you could talk about the assumptions underlying that sizable plane order that you announced this morning? Thank you.

Good morning Tom, this is Myron. When you look at it on balance, since 2008 the International export volume has grown over 40%, US Domestic has had 20% growth and our block hours are actually down over 3%. It actually speaks to our abilities to optimize our networks around the world and accommodate the tremendous growth that we've seen.

So going with the larger aircraft which is the Dash 8 really was a smart choice for us. Obviously given the ability to put a larger plane on the lanes that have greater needs allows us to reduce the number of frequencies for those routes.

In addition to that, the Dash 8 will give us an ability to cascade capacity throughout our entire network. We plan to deploy these first aircraft into our International segments and it will allow us to bring back our current 747-400s to the US that will give us capacity throughout the entire system.

In addition to that, it is a much smarter choice because it allows us to take the current Dash 4 pilots who will require a very minimum amount of additional training who can then fly the Dash 8. So we believe it was a very smart choice for us. And I will hand it off to Alan who can talk about growth.

Hey, Tom, thanks for the question. As you know, Next Day Air was up 6% this past quarter and Deferred was up double digit. And our Next Day Air growth here in the US has been growing mid-single digit for the last five quarters, and certainly the 2nd Day Air has grown double digit this quarter and last year this same quarter, and you already heard from Myron about the International growth.

We've been investing significantly in our Express product in terms of enhancements. As you know, this past quarter we expanded our Express Plus time of day to 53 countries and over the year we've expanded our Express time of day to 117 countries and we've also expanded UPS Next Day Air and UPS Next Day Air Early coverage here in the United States and in addition also worldwide express rates. So we are investing significantly in the product, both domestically and internationally, and it is resonating with our customers.

This is David. Just to wrap that up, in some places or in some cases you'd be adding aircraft because you are retiring aircraft. This is really about opportunity.

This is a testament to what we have done in our International business and in our Domestic business as far as growing our Air business. Our customers are asking us for additional capacity and that's what this initiative is about. So we are really excited about it and thank you for the question.

Ken Hoexter, Merrill Lynch.

Great, good morning and I will echo the nice job in scaling with the volumes. Richard, you gave insight and an outlook for the supply chain but, unless I missed it I don't think you gave it on the Domestic or the International outlook. So aside from the peak prep, in your targets can you talk about your expectations for growth and cost and pricing?

And then really I want to focus on the ability to improve margins domestically given the e-commerce growth. Thanks.

Sure. So I think, Ken when you first look at it you have to start with where we are year to date and right now our earnings per share are up almost 7%. We expect our fourth-quarter operating growth profit to be slightly higher than the overall range we gave for the year, which means we expect a very solid great fourth quarter.

The investments that we've made across all the segments are bringing in those returns and we are balancing that against the mixed macroenvironment as we talked about in the Supply Chain & Freight. At the end, when you look at what's happening and where we are going with it, it really is about an International continuing to deliver on what they've really done for seven quarters and in the Domestic we will see margin expansion for the year. We have, as I mentioned last quarter, some change because of work days and some year-over-year comp issues in the third quarter, but we expect for the whole year that we will see a margin expansion.

We will take an online question next. This comes from Jack Atkins at Stephens and Jack really asks can we speak a little bit more about the long-term capital spending over the next few years, both with the hub automation and the aircraft?

So, again, this is Richard, and Jack I think the first thing you have to remember here is that our capital policy remains consistent and unchanged. Our number one priority for many years had continued to be to reinvest in the business. And you see that in our ROIC, having the highest return on invested capital is not only good for the enterprise but it's also good for the shareholders.

We continue to see strong returns for all the investments we've made. Over the last few years we've talked about not only what we are doing with the hubs but also ORION. And, again, this quarter we continue to see the benefits of almost a 6% volume growth and muted miles growth.

So all that comes to the bottom line. We are always evaluating ways to look at can we accelerate some of this investment because there is such high return on these investments we are making.

I talked about in my talk that we are going to actually bring everyone together in early February to really talk about where the enterprise is going, what great opportunities we have, where we will see growth come from and what our plans are for next year. And we think at that time it you will see that the future is very bright. We continue to have year-over-year improvements in margin and that's our plan going forward, as well.

Ben Hartford, Baird.

Good morning. I guess, Richard, just to follow up on that point and not to belabor the CapEx question, understanding that you will probably provide more context in February, but could you clarify whether these aircraft purchases were included in that 4.5% to 5% revenue CapEx target that you guys had outlined in 2014? Or is this above and beyond with that initial target had contemplated?

Sure, Ben, when you think about how we look at how we plan out our multiple years there are several different realistic scenarios of what could happen. For example, it was a perfect time to bring together both Boeing and UPS because there was availability and when continue to see such strong demand in our business that the aircraft timing came a little faster than we had thought. However, we are not guiding any different for 2016.

It's in the $2.8 billion we've been talking about because a portion of it is paid this year. And the most important thing to remember here is we are great stewards of capital. We have not bought a plane in 2013 until today, but since 1989 that was the very first time since we've been an airline that we were able to continue to create efficiencies within our network.

So when you take what David had mentioned, a 15% increase in demand, it was time to look at what is the next thing we needed to do and at the same time we continue to have above-market growth in these products and we will have a positive return. But we will update you further as we bring the entire enterprise story together in the next few months.

David Vernon, Bernstein.

Stephen, if you can move to the next caller please.

Chris Wetherbee, Citi.

Great, thanks, good morning guys. I want to stick on the topic of the planes for just a moment and think about how you do the math between new owned aircraft and available belly space. I'm guessing there's parameters of control and service that probably weight a little bit in favor of owned capacity.

But just want to get a sense of maybe how you guys think about that. You've done a great job over the years using third-party aircraft. Kind of want to get a sense of what the incremental change is for the owned aircraft going forward.

Sure. When we think about the holistic network, and Myron actually mentioned that there is a cascading effect, we run a very broad network across the entire globe. And we are going to put those planes where the highest demand is.

We also use a lot of belly space in different pieces of our enterprise, in Supply Chain & Freight where we use a combination of brown tails and commercial lift. But the real important thing is we tend to look at all the scenarios and determine what's the best economic return. And it goes right back to the return on invested capital, when is the right time to put new assets in, how are we going to fill them, are we already filling them because of our growth rate?

And when you have all of that put together that's why in 2013 we paused and it made sense and we could adjust and cascade around our own network. Because there was many changing dynamics within the market over the last three years but now it's time. And that time is because it will give a very positive return.

So Chris, this order matches the needs of our network and gives us greater flexibility moving forward. And when you think of it, this aircraft, the Dash 8, gives you 70,000 pounds more capacity than the 777. It also gives you 16% more capacity than our current aircraft type which is the Dash 4.

It allows you to have 34 containers on the main deck as well as 14 in the lower compartments, plus space for above cargo. So we believe, again, as I alluded to earlier that this is a smart choice for UPS.

We are going to take a question from the Internet and this is from Helane Becker. And it's talking about the question is about Amazon, and when you think about e-commerce going forward how do you think about competing in a market where Amazon may at some point start to convince shippers to use its fulfillment by Amazon Services?

So I will start with this answer and then I will turn it over to Alan Gershenhorn. And, of course, I will begin that Amazon is a good customer of ours, and we do have believe we have a strong, mutually beneficial relationship and that our integrated network creates efficiencies and really gives them and our other customers a value proposition that we believe is unmatched.

So going back to an earlier question about the aircraft and tying into Amazon, I don't think that we wrapped up at that point. Amazon and all of our other shippers will get the benefit of this cascading capacity that we are adding with this aircraft. So we think it's very good news for all of our customers.

When it comes to the fulfillment by Amazon, Alan, will you address that please?

Thanks, David. As we all know our customers, and specifically our e-commerce customers have a number of different channels that they can access in order to market and transport their goods. And there is fulfillment by Amazon, there are marketplaces out there and then, obviously, direct from their website.

And we really support our customers in all three of those areas. And I think like David said, our e-commerce value proposition is really second to none, and it's convincing both the bricks and clicks type of e-tailers and e-commerce pure plays to give more and more of the business to UPS. So we are excited about the overall prospects of e-commerce in the marketplace and we are making the necessary adjustments to essentially support all the various channels that our customers use to bring their goods to market.

Scott Group, Wolfe Research.

Thanks, good morning guys. So I wanted to follow up on the US package margins or incremental margins. Obviously really good volume growth but not seeing it leveraged to the bottom line.

I know you talked about an operating day and one other item. But are there other -- is ORION, are we still dealing with implementation costs are or is there something else here that's restraining the operating leverage? And I guess maybe the question is what can you start to do to see some better incremental margins, and along those lines is dimensional pricing an option for 2017 like FedEx is doing?

So, Scott, the first thing is the way we look at the quarter we had a good quarter, we are right where we expected to be in the US. We did call out last quarter as well as in my talk today, this is a scale business and it was a change in work days and that change in workdays has a big impact on the quarter just as next quarter while we called out that we will actually perform a little better than our range for the year is because there's an extra work day, and then that high casualty credit in 2015 that we called out at that point.

And so you remove all that, we actually saw operating margin improvement year over year. And we actually expect the whole year to continue to see that. 2016 really is part of a deliberate strategy.

We are seeing the benefits from the investments. We are reinvesting, so we are not getting all of the benefits but we are getting the benefits that we actually have been talking about and we said it would be a multiyear process.

But we are delivering on those targets. We expect to continue to see that steady progress year over year and that's why I mentioned earlier that we will see margin expansion in the US for all of 2016, as well. I'm going to turn it over to Myron to talk a little bit about the actual operations and what he has seen.

So in addition to Richard's comments you heard Kate allude to the fact that we had 100% completion of the deployment of ORION in September. And we are very happy with the results that we are seeing. And actually we are in the early stages of deploying additional automation projects that should bring more profit to the bottom line.

We've actually already begun the Phase 2 deployment of ORION. It will impact another 1,300 drivers who were in extended centers that didn't have the package flow technology deployed in those sites. And we expect to finish that midyear next year.

In addition to that, our automation strategy is well underway and we are happy with the results that we are seeing. We're seeing 25% improvement in productivity.

As a matter of fact, we have announced 12 new automated facility deployments this year as well as four here just in the third quarter. So we are well underway to implementing that long-term strategy and are seeing the results.

Hi, this is Alan. Just a final follow-up there on the dim weight part of that question.

First, we don't comment on competitors' pricing actions. As you know, we review our pricing on a regular basis including the base rates and the accessorials. We are achieving our strategies of base rate increases between 2% and 3%.

We are at the higher end of that. Also we announced our GRI in September. We also announced that any additional rate changes, including the retail rate posting in a SurePost rates we will post it on November 18 of this year. Thanks for the question.

Scott Schneeberger, Oppenheimer.

Thanks, good morning everyone. I will stay on US Domestic Package and specifically in B2B, a two-part question.

It sounds like B2B grew and you've cited in the press release the online retail return. So the first part is could you give us an idea of how strong that is trending and just thoughts on maybe the seasonality around the holidays and impact in the fourth quarter versus the first quarter? And then also just the B2B part that isn't pertaining to that, what type of business environment are you seeing and where is the momentum there?

Alan, why do we start with you about B2B and then maybe, Kate, talk a little bit about the seasonal trends you are seeing.

As we said our B2B is up about 2%. It's the best growth we've had there in five quarters. As you know, the B2C is very strong at double-digit.

Specific to your question, on the returns, returns growth in e-commerce is also very strong. It's growing in the mid-teens. Again, you've got to keep in mind that returns is a small part of our B2B market, but it's a large part of the growth that we are seeing today.

As concerns the remainder of the B2B market we are still seeing the softness in industrial production out there. We are seeing B2B growth across many of our segments, although it's relatively muted. Do you want to talk a little bit, Kate, about the peak season?

Yes, thanks, Alan. This is Kate and as Alan mentioned strong B2B growth despite the downward pressure of industrial production and we expect that continue through peak season.

I do want to emphasize the UPS Access Point turning commercial -- I'm sorry, residential business into commercial business. And with 25,000 locations worldwide, 8,000 of which in the US, we're really seeing the solution resonate with our customers and also the convenience for consumers so that they can go to their local shop and pick up their packages.

So that will help to fortify that continued B2B growth. Thanks.

David Vernon, Bernstein.

Hey, guys, thanks for coming back to me. Apologies for the connection problem before. Richard, maybe could you talk a little bit about International and the underlying performance there?

Obviously, you are still getting some of that currency benefit. I'm just trying to make sure that the business ex- the hedge gain is still chunking along and if you could give us some commentary on how that growth outlook looks for the fourth quarter that would be helpful. Thanks.

Great so I'm actually going to start and then turn it over to Jim to talk a little bit about the underlying business. But we did have another great quarter. Seventh quarter in a row.

But the International operating margin was pushed a little higher because of the multiyear hedge strategy that we employed, we have been employing for many years. We've been talking about that all year and one of the challenges, of course, is the volatility of the euro and sterling is at historical rates and it's brought it down. So we expect 2017 to have a transition where we will see just over $300 million impact to the growth in the profit.

That being said, when you step back for a moment we continue to see the operating margin expand. Even adjusting for the hedge we are talking about an operating margin between 16% and 17%, which is industry-leading for International business.

It's broad-based. It's because of the revenue growth, getting the right volume in our network and managing our cost efficiently. And so when we think about the fourth quarter we expect that there will continue to stay at the high end of their range and I'm going to ask Jim to talk a little bit about specifically the business.

Yes, David on the point about I guess chunking along and moving forward I think what you're seeing right now in International is the output of a couple of years of investment in the network and work in strategies across the globe. We mentioned, David did in the beginning, that a couple of pockets across the world from Asia-Pacific, Asia-Pacific and specifically China and Hong Kong for us right now are growing at rates we've never seen before but more importantly it's coming from our middle markets there.

Historically we've had big enterprise growth as supply chain has expanded across the world. But we are really becoming more local in a lot of these markets or some of those bigger markets like China we're seeing middle-market growth rates at 20% and 30% year over year. So that's great for us.

Europe continues to speed itself up. Again, in some of the opening comments we've taken a look at the network and continue to speed it up and, obviously, we have, we're up to about 80% of the cities in Europe we can reach by two days in the ground network there and we will continue to invest there. So all in all, we think the fourth quarter will be great and we will continue on absent the currency headwinds that Richard has mentioned to continue the growth in the International segment.

So the macroenvironment in Europe is holding together and you're not seeing any big negative implications from Brexit or anything like that?

Well, I think Brexit is one of those issues and I think the whole European economy is probably wider than just Brexit, no question. But we continue to see growth in that market as we have for many years.

Nate Brochmann, William Blair.

Yes, good morning. I wanted to talk a little bit about just what some of your e-commerce customers are doing in terms of strategy where certainly today they are competing in terms of the two-day shipping against Amazon and hence the need to probably add some of that air capacity.

But we also talk about moving a lot of goods closer to the customer and one of the reasons why you are doing the automation in terms of the regional sort facilities. Just wondering if you could talk about those trends a little bit in terms of the long-term strategy of where you need to put that capacity in order to meet those shifting needs?

This is Kate and we have the deep collaboration with our customers, as you can imagine, and we help them through changes in the marketplace. So specifically to B2C and getting closer to their customers, we have a full portfolio of omnichannel solutions. And I will say it's not just resonating with retailers but more and more we are seeing this translate throughout other industries such as healthcare and even high-tech, for sure, and industrial manufacturing.

But it's enabling any of their locations and turning those into direct shipping points would be the focus of a lot of the solutions. They are not just physical, they are also information-based and we find that it helps them to capture their share of the growth in the market. Thanks for the question.

So our next question we will take another online question and we've got multiple questions on this topic. The question is how do we think about automation affecting our business model both from a drones, a platooning and an automated vehicle standpoint moving forward?

Well thank you, this is Myron. I will start with automation first. We are continuing to make good progress with our long-term initiatives to add more capacity, offer greater efficiency in our integrated network by introducing automation throughout our top-tier 30 hubs across the US where we process as much as 60% through those locations.

I mentioned earlier that we had announced 12 automated facilities this year including four this quarter. We are on pace and we are making great progress and those include retrofitting, expansion and in some cases new facilities and, again, we are getting as much as 25% production improvements in those locations. This, of course, allows us to have additional flexibilities and reduce handle in the network.

When it comes to the use of drones as well as vehicles that allow us to have autonomous trucks on the road we have experimented with drones with a number of vendors. You should have seen an announcement when we launched our first try in the Northeast earlier this year. It was very successful as well as our use in delivering medications in Africa. So we will continue to experiment until we get the ability to use it.

As it pertains to vehicles we are continuing to work with a number of vendors to explore what works best for us. We have what we term as a rolling laboratory.

We have over 6,500 vehicles in the US right now that are considered CNG, LNG and the sort. Of course, all of this will require the approval from the National Highway Traffic Association. So when it becomes available to us we certainly expect to be ready.

Stephen, let me just remind the callers asking live questions to make sure that they only ask one question so that we can get through the remainder of the calls for the time remaining.

Brandon Oglenski, Barclays.

Good morning everyone and I will be sure to keep it to one. So as I look at your Domestic profitability the past six years your margins have been around the low 13%s to mid-13%s. And we know that we've seen a lot more B2C growth in that same time period.

So as we look forward I think everyone is expecting e-commerce to continue to outperform. Is there a change in that dynamic where we can actually start to get stop density? Or has competitive factors like the post office, maybe even Amazon doing more on their own, just impacted the ability for you guys to take higher margins?

So I guess I would start by saying all of it. When you think about what's happening with density, Kate talked about the Access Points and taking what was a B2C to B2R and that's helping on density. And we are seeing an improvement on B2C density that we hadn't seen in many, many years.

On top of that, we continue to invest in the automation, both of the hubs, ORION that Myron talked about. And all of that really is about improving the margin. We talked about our investor conference a few years ago and throughout each year that we are investing and year over year we are having to reinvest to get to the endpoint. And all of that together along with things like SurePost Redirect and the ability to take almost a third of the volume that is destined to be delivered by the post office and we put it in our system because we are already going to those stops.

Those are all key components of how we are going to continue to improve the margin and really it's a long-term story that we are talking about. Earlier I mentioned, and perhaps I said the wrong year, that we do expect margin expansion for the entire year of 2016. And that's why we guided the way we did for the fourth quarter.

Expect a little bit better performance in the fourth quarter. And we will have three of the four quarters in 2016 with margin expansion that all adds to margin expansion for the year.

Allison Landry, Credit Suisse.

Hi good morning, this is Danny Schuster on for Allison. I just wanted to ask a little bit more about SurePost. I know you saw some nice volume growth in that segment, up 20% year over year.

I was just wondering what the progress is on SurePost Redirect and whether you see that improving density as well as potential density improvements coming from increased returns through the B2B segment? Thank you.

This is Alan, thanks for the question. Yes, so the SurePost Redirect program continues to work. As Rich just stated when we redirect we've already got a package going to that particular consumer.

So it's very, very accretive to us to reroute that package back through the UPS network and avoid having to pay any postal fees at that particular point and we are up around 30%. We are continuing to investigate new and better ways to improve that, and then we've also got other methodologies like UPS Access Point that Kate mentioned to build density as well as our Synchronized Delivery Solution. So it's all really about bending the cost curve and increasing the density on our B2C shipments.

David Ross, Stifel.

Yes, good morning everyone. I wanted to talk a little bit about the e-commerce portfolio you mentioned or the return portfolio you said is growing mid-teens. What percent of your shipments today are returns and is that a better yield than average on the shipments or how would you characterize that in terms of attractiveness relative to the average box?

So when you look at the e-commerce market it could be one in five or one out of every six packages that are shipped to a consumer get returned. So the growth in that particular market tracks very closely to the growth in e-commerce on that 1 to 5, 1 to 6 ratio. Those packages are highly profitable.

First of all, many of those packages get dropped off and don't have to be picked up because the consumer finds it more convenient to drop them off at UPS stores or UPS Access Points or hand them to a UPS driver. So there is very little cost when it comes to pick up.

And then, obviously, the deliveries are going back to businesses and we could be delivering tens or hundreds of packages back to these businesses. So it's highly profitable B2B delivery with very little pickup cost.

So we are going to take another online question. This question comes from Scott Group, and Scott just asks noticing the new language that we have regarding the mark-to-market pension, accounting outlook and would like to know can we give a little preliminary outlook for what the pension expense is for 2017?

So I think the first thing everyone should understand the language change was really meant to ensure that we are following a new report that was published by the SEC around interpretive guidance around both the GAAP, non-GAAP and ensuring that we had equal prominence. And the way the rules work is you have to have certain information you need to convey around the GAAP side.

It really is too early and that's why there wasn't anything in the report about what we thought the mark-to-market would be because there's so many things that aren't even finished yet for us to know where we would be, for example return on assets and discount rate. And if you go back last year at this time and where we are today and where we ended the year, the discount rates changed a lot and, of course, last year the market changed the other direction, unfortunately. So there are so many unknowns right now that it's really impossible to sit here and say this is what we think it's going to be.

That all being said, what we were doing and what we put in the press release was if you look at the underlying core business we are confirming that our adjusted earnings per share guidance is right in where we expected it to be. And that's because the investments that we put in the last few years are creating the return and that's why we are going to see the margin expansion and that's why we've guided the way we have.

Helane Becker, Cowen and Company.

Thanks, operator, thanks for squeezing me in guys. There's been a lot of talk about wage rates going up on part-time workers and warehouse workers and the fact that it's harder and harder to find them.

I know that at UPS you guys have a lot of people come back every year for the peak and they are happy to do that. But what about longer term as you think about hiring out those 95,000 people? Can you just address how that affects your thought process after the peak?

This is Myron. We are actually on plan for peak season hiring to date. 37% of our peak hires since 2014 have actually become permanent hires.

I'm happy to tell you that I was actually a peak higher from 1978. So we think the best value proposition is the ability to attract and retain people who are looking for long-term opportunities for growth at UPS who began with us as peak hires. There are some selected locations where we will use bonuses to attract employees, but overall we don't think there will be any issues. Thank you.

Due to time constraints our last question will come from the line of Bascome Majors, Susquehanna.

Thanks for squeezing me in here. So 2016 has been a year where really impressive profit growth in your International business led the overall franchise, and you talked a little bit and gave us an update on 2017's FX headwinds. And without potentially walking back over a year of growth in the International segment, do you think the other two segments can pick up that slack by delivering the high single-digit and low double-digit profit growth that you put out in your long-term targets?

This is Richard, and I think the important thing to remember on all three of our business segments is we are working a five-year plan with each year getting and making progress on our ultimate goals. So the answer is it's a little too early to talk about 2017 and we actually talked about that we are going to bring everyone together in February to really give you a full picture of the enterprise strategy, where we are headed, where we have great opportunities and where growth is coming from. And I think that that will help you to see why we are so optimistic about the future.

But at the same time, all three segments are part of the five-year plan. When we created the plan we saw that the year was already starting to fall, not quite as much but we actually came back and talked about that. So we will update you, but it was all part and each segment is part of that plan overall.

I would like to turn the conference back over to Mr. David Abney. Please go ahead, sir.

Yes, I would like to just make some closing comments. And one of the words that you've heard a little bit today is commitment and I just want to use that for the next few minutes and just talk about how we are committed to our business. Obviously, we are committed to achieving our EPS guidance that we gave just about a year ago and we have affirmed that for the fourth quarter and feel real good about that.

We are committed to delivering another successful peak season. You heard from Myron and you heard from Kate, and we've been working the last 10 months here and through this collaboration and cooperation with our customers we have a good peak season set up for us.

We are committed through our strategic initiatives and our investments to continue to build the long-term future of UPS. The aircraft addition is our longer-term initiative, but also what we are doing internationally in Europe with the $2 billion worth of CapEx that we are spending, we are getting a lot of returns in that and we are going to continue to focus on those growth markets. Then, of course, we are committed to our shareholders, our customers and our employees.

So we've had a good year so far. We have good momentum going into the fourth quarter and we look forward to having a very successful fourth quarter. Thank you very much for your time.

Ladies and gentlemen, that does conclude our call. Have a wonderful day.