聯合包裹運送服務公司 (UPS) 2018 Q4 法說會逐字稿

Good morning.

My name is Steven, and I will be your conference facilitator for today.

At this time, I would like to welcome everyone to the UPS Investor Relations Fourth Quarter 2018 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.

Good morning, and welcome to the UPS Fourth Quarter 2018 Earnings Call.

Joining me today are David Abney, our CEO; Richard Peretz, our CFO; along with Chief Operating Officer, Jim Barber; Kate Gutmann, our Chief Sales and Solutions Officer; our Chief Information and Engineering Officer, Juan Perez; and Scott Price, our Chief Strategy and Transformation Officer.

Before we begin, I want to review the safe harbor language.

Some of the comments we'll make today are forward-looking statements and address our expectations for the future performance or results of operation of our company.

These statements are subject to risks and uncertainties, which are described in detail in our 2017 Form 10-K and other reports filed with the Securities and Exchange Commission.

These reports are available on the UPS Investor Relations website and from the SEC.

During the quarter, UPS recorded a noncash after-tax mark-to-market pension charge of $1.2 billion dollars.

The charge includes the effects from lower-than-anticipated asset returns, partially offset by higher discount rates.

It also includes a partial liability from the performance of the Central State's pension fund.

In the prior year period, UPS recorded a noncash after-tax mark-to-market pension charge of $607 million dollars.

The charge resulted from lower discount rates, partially offset by higher asset returns.

Also in 2017, we recorded a onetime income tax benefit of $258 million, due to the adoption of new tax legislation.

More details on the mark-to-market accounting will be available in the presentation on the Investor Relations website later today.

GAAP diluted earnings per share for the fourth quarter 2018 was $0.52.

Adjusting for the impact of the mark-to-market pension charge, earnings per share for the quarter was $1.94.

Fourth quarter 2017 GAAP diluted earnings per share was $1.26 and adjusted earnings per share was $1.66.

Unless stated otherwise, discussions today will refer to adjusted results.

The webcast of today's call, along with the 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 on a long-term strategic nature.

Callers are asked to submit only one question so that we may allow as many as possible to participate.

Thank you.

And now I'll turn the call over to David.

Thanks, Scott.

I welcome this opportunity to share our positive fourth quarter results and our plans for continued improvement throughout 2019.

On today's call, I'll share highlights for the quarter, our transformation progress and our views on the macro business environment.

Jim Barber will discuss our peak in Q4 results and our drive to improve operating leverage.

Richard will then review the financial details of the quarter and 2019 outlook.

First, I want to take a moment to applaud the newly 500,000 UPSers, who completed a successful peak season.

Thanks to their hard work and commitment, we delivered industry-leading, on-time service and solid earnings growth.

We also thank our customers as we work together for our mutual advantage by optimizing UPS' network utilization to ensure reliable service to their customers.

During peak, we produced good volume and revenue gains as well as orchestrated improved revenue quality.

But most important, we effectively managed the total network and drove productivity improvements while processing high peak volume levels.

As a result, we successfully delivered on our consolidated financial targets for our earnings growth.

We realized the benefit of several transformation initiatives, including strong SMB growth and yield management in the highest B2B growth in several quarters.

For the total company, we lifted revenue by 5.2% on a currency-neutral basis; generated solid operating margins; had excellent free cash flow; and in 2018, rewarded share owners with $4.2 billion in dividends and share buybacks.

I'm pleased with the improvements we've made across the company and with our strong Q4 EPS growth of 17% to $1.94.

Our Domestic business performed as planned, successfully processing the record volume that came into our network.

International grew both top line and bottom line in a changing economic environment, while Supply Chain & Freight delivered strong results in the forwarding, logistics and Coyote units.

UPS remains the industry leader by identifying and capturing opportunities, managing macro risks and delivering results to support our customers and reward share owners.

Beyond the strengths of the UPS business model, our transformation will deliver even better performance in the future.

At our conference last September, we outlined a three-pronged strategic approach to transformation.

We've made great progress.

And in a few moments, Jim will provide an update.

You will hear that we have generated higher-quality revenue growth, greater efficiency to improve operating leverage, and actions to shift our culture to greater urgency in continuous transformation.

As mentioned in my discussion on peak, we are realizing the benefits of transformation in our financial results.

We remain committed to elevating EPS by an incremental $1 to $1.20 by 2022.

We began our transformation in late 2017, and by doing so, we put UPS on a structured path to enhance performance, future proof the company, and take advantage of growth opportunities.

Looking ahead to 2019, external forecasts are calling for somewhat softer export in GDP growth across major economies due to uncertainty over trade policy.

Our diverse portfolio, global revenue base, and flexible network help to buffer the potential impact of these factors for UPS and our customers.

We continue to see growth opportunities in targeted business segments and in markets where we're well positioned to accelerate local, domestic, and cross-border trade.

I recently met with industry and government leaders at the World Economic Forum.

While both economic headwinds and tailwinds were discussed, I left more convinced than ever that we are on the right track.

Investments in our strategic growth imperatives, especially to support SMBs, along with our network automation, will enable profitable UPS growth.

These actions will ensure our success today and well into the future.

As we look forward to 2019 and beyond, UPS is uniquely positioned to deliver long-term value creation for customers and shareholders.

Our 2019 guidance demonstrates the early results of our multiyear actions to improve leverage in our domestic business.

Before I close, I want to welcome Philippe Gilbert to my leadership team.

Philippe was recently appointed President of UPS Supply Chain Solutions and is a member of the Management Committee.

He has extensive global industry experience, and will lead the next phase of growth and operating improvements across our supply chain and freight business units.

His appointment is another step in our transformation focus realignment of the UPS Management Committee.

In a little more than a year, 6 to 12 Management Committee members have been appointed to new positions, including 3 members who have joined us from other companies.

We are enhancing our culture and transformation by blending internal and external leadership talent.

This approach is adding new perspectives in taking advantage of our broader experiences.

Now Jim will take you through details on peak, the actions driving revenue and revenue quality, greater operating efficiency and our evolving culture.

Jim?

Thanks, David.

I want to reinforce your comments on the work of the UPS team during peak.

The dedication to customer service that is ingrained in our culture was on full display.

Several factors led to our service and performance success.

We coordinated closely with customers for improved forecasting; expanded air and ground capacity with higher levels of automation; refined staffing and training plans; introduced new technologies to align incoming volume with available capacity; and finally, we implemented pricing actions to better control shipment characteristics.

We developed comprehensive peak plans and executed successfully.

I am very proud of the entire UPS team.

Most important, these and other actions will carryforward into our normal daily operations throughout 2019.

As David mentioned, we realized benefits from several transformation efforts during the quarter.

As noted previously, the U.S. Domestic segment will be the greatest beneficiary of our enterprise-wide transformation.

The first major transformation strategy is growth and higher-quality revenue.

Our commercial actions to align pricing, volume and mix were very successful.

In Q4, RPP increased nearly 5% in the Domestic segment and 4.6% overall on currency-neutral basis.

That's the best RPP gain we've generated in many years.

We also simplified pricing and enabled our sales force to provide small and medium-sized customers with quicker quotes often on the spot, and we generated strong digital marketing results with streamlined product offerings and pricing programs aimed at small and occasional shippers.

These commercial actions also helped drive SMB growth, the best in recent history.

B2B deliveries grew by about 3%, reflecting our customers' favorable reactions to our marketing and pricing strategies.

In addition, to better connect buyers and sellers in today's digital world, we recently partnered with 2 new B2B and B2C e-commerce platform companies, Inxeption and ShopRunner.

With Inxeption, UPS offers attractive shipping rates to Inxeption customers and is positioned as the preferred shipping choice during checkout.

ShopRunner, a popular B2C e-commerce membership platform, offers 2-day shipping and other benefits when member shop at participating retailers.

As a result of our partnership in the near future, UPS My Choice members will have access to ShopRunner services.

There are more than 56 million My Choice members, and we expect even greater participation as a result of the ShopRunner alliance.

Partnerships such as these are proven catalyst for future B2B and B2C e-commerce growth.

We plan to announce more creative alliances and fulfillment offerings in 2019.

The second transformation strategy is using technology to drive greater efficiency in operations and our back-office, while making the company more agile and flexible.

During 2018, we opened 22 new or retrofit facilities globally, including 5 new super hubs, which employed the latest automation and productivity tools.

We also rebalanced volume flows and equipment across our global air network, which enhanced on-time performance and improved efficiency.

As we start 2019, 18 additional new and retrofit facility projects are underway with completion dates ahead of peak of this year.

In addition to facility automation, we also are enhancing UPS' own road network.

We've launched UPSNav, which provides turn-by-turn navigation to loading docks and receiving areas for every stop on our driver's routes.

In 2019, we will provide UPSNav to more than 40,000 additional drivers in areas where route density is greatest to increase final mile efficiency.

We also began rolling out UPS' Network Planning Tools, or NPT, which was a valuable asset during peak.

Part of NPT is our Peak Volume Alignment Tool, or PVAT.

Using advanced analytics, we are better matching incoming volume flows and available network capacity for increased capacity utilization and operating efficiency.

Full implementation will continue into 2019 as we add more digital connections across our network.

Adding technology and automated capacity is absolutely the right approach for the future of our more efficient and flexible network.

Finally, there are many other revenue and efficiency transformation initiatives that will improve performance in 2019.

These include continued working capital gains from procurement as well as cost reductions throughout sourcing activities that had traditionally been handled within UPS.

Transformation is prompting us to think differently.

I'm excited about the progress we've made throughout our global operations in 2018.

And as we turn into 2019, we have momentum, and we'll execute additional strategies that expand our competitive advantage.

Now Richard will take you through the results.

Richard?

Thanks, Jim, and good morning.

Today, my prepared remarks will cover 2 areas: First, the quarterly performance of our segments; and second, our 2019 outlook.

In the quarter, UPS demonstrated great execution.

We delivered industry-leading, on-time performance, improved revenue quality, and we generated excellent free cash flow.

As a result, fourth quarter 2018 EPS grew 17% and full year EPS was up nearly 21%.

Moving into the segments.

In the U.S., we delivered on average more than 21 million packages a day, and our growth was led by Next Day Air.

Revenue was robust, up more than 6%.

Early in the quarter, we experienced some softening of package demand due to labor negotiation headlines.

As we moved into December, we saw sequential improvements in our financial results while maintaining outstanding service levels.

The strong peak performance offset the majority of the labor headwinds, producing a full quarter profit result, slightly below our own expectations.

Our strategy is to better align pricing with the value we create to push base rates up 3.3%.

In addition and most noteworthy, we saw positive trends in product and customer mix.

The combination drove revenue per package to expand by almost 5%, as we leaned in to create higher-quality growth.

As Jim discussed, we accelerated our SMB and business-to-business deliveries with the best gains in recent history.

This is a strong proof point that our initiatives are working.

Virtually every industry verticals showed volume improvements and higher revenue per package.

U.S. Domestic operating profit was about $1 billion.

As expected, this quarter's profit was lower by the planned opening of 14 new facilities, 1 less operating day and higher pension operating cost.

Now turning to the International segment.

We posted strong results, demonstrating the strength of our business model and the value that UPS solutions offer to global buyers and sellers.

Currency-neutral operating profit increased by nearly 10%.

On a 2-year stack, currency-neutral operating profit is up about 25%.

Operating margins were over 20% and expanded 60 basis points this year.

International revenue rose 5.4% on a currency-neutral basis to $3.9 billion.

We grew revenue in all regions during this period and flexi network to take advantage of opportunity on multiple trade lanes.

Export shipments grew 2.4%, with a 2-year stack at nearly 18% growth.

Exports in Europe and the Americas led the segment.

Most link out of Asia were positive, with exports from Asia to the U.S. down due to the changing trade environment.

International revenue per package increased 4.2% on a currency-neutral basis, with excellent yield growth on both international domestic and exports.

Product mix was favorable, driven by strong growth in B2B and premium solutions.

Operating profit in the segment reached $781 million, up nearly 10% on a currency-neutral basis.

It's highest ever.

This demonstrates our ability to grow and adapt to changing conditions across the globe and execute a disciplined approach to control cost.

Now let's turn to the Supply Chain & Freight segment.

The Supply Chain & Freight grew -- produced a solid quarter of financial performance when you consider the approximately $60 million in loss profit related to the contract ratification process at UPS Freight.

To protect our customer's business, we proactively cleaned out our network.

On November 12, we resumed operations with ratified contract and started welcoming back our customers.

At this point, the overwhelming majority of our customers have returned.

And as we execute win-back and growth strategies, we will continue to rightsize our freight network in line with the current needs.

Looking at the other business units in Supply Chain & Freight, performance was excellent.

The 14 group generated outstanding profit growth, driven by International Air and Ocean Freight, Coyote and the brokerage group.

For example, in the fourth quarter, Ocean Freight produced its best results this year, double-digit shipment growth, great cost control and expanding margins.

Distribution and logistics increased revenue by almost 7%, with all regions of the world contributing.

The health care, aerospace, retail and manufacturing sectors all grew in the period and the unit achieved good operating growth.

Overall, Supply Chain & Freight team had another outstanding year with double-digit profit growth.

In fact on 2-year stack, we have grown profits in this group by almost 37%.

Now let's turn to the balance sheet.

Our financial strength has continued to be a hallmark of UPS.

In 2018, UPS generated $6.1 billion in adjusted free cash flow.

It was aided by benefits from the tax refunds in the first quarter and improvements from working capital initiatives throughout the year.

On an adjusted basis, we made $6.6 billion of capital investments during the year, in line with our expectations.

UPS returned to $4.2 billion in 2018 to shareholders, with $1 billion of share buyback as well as almost $3.2 billion in dividend distribution.

That represents a nearly 10% increase per share this year.

Our effective tax rate was slightly over 22% for the fourth quarter, primarily due to the discrete tax benefit related to the final resolution of uncertain tax positions.

In 2019, we estimate our effective tax rate to be between 23% and 24%.

The estimate could change based on this final resolution of the new tax regulations.

Let's cover the rest of guidance.

We view 2019 as a year of real progress.

It's built from transformation momentum, investments in our network and the advancement of our strategies that have been developed over the last few years.

UPS will generate substantial increases in operating profit this year.

We expect total operating profits to grow in the low teens with all 3 segments up double-digit, including the operating profit results is an update to our short-term stock compensation program, which reduces the vesting period from 5 to 1 year.

It brings UPS' annual incentive program for almost 40,000 management employees in line with peers and align to today's mobile workforce.

In our guidance, this is an increase to our expense of about $250 million.

The vesting is a noncash timing event with no real economic impact.

The drag will face over the next 5 years.

Also in the results is a benefit from lower service cost, driven by a higher discount rates, and it mostly offsets the best in headwind.

(inaudible) segments.

In the U.S., we expect revenue to increase 4% to 6%, driven in part by revenue quality initiatives.

We're playing for improvements in customer and progress while there's an expansion in base rates.

We anticipated growth of the air shipments to be in the mid-to high single digits and ground in the low single-digit range.

Operating profit is projected to grow between 10% and 13%, coupled with margin expansion.

We expect the International segment to have another strong year with average daily shipments up 3% to 5%.

Product mix will increase revenue yields.

And as a result, revenue will increase 5% to 7%.

We will maintain our industry-leading margins and expect to generate operating profit growth of 10% to 12%.

Finally, in the Supply Chain & Freight segment, we will continue to executive the disciplined strategy.

We expect operating profit to increase in the low to mid-teen range.

During the first half of the year, we anticipate some headwinds to remain from the great contract ratification process.

Breaking out some of the key drivers of 2019 guidance, let's start with the 2018 adjusted earnings per share of $7.24.

First, the strong underlying segment performance year-over-year growth is anticipated to be up between 10% and 14%.

The outstanding profit gains will be partially offset by the external factors affecting the below the line items, more specifically pension and tax.

The major driver of other pension income and expense is the higher interest cost and lower asset return.

Pension assets returns were below our historical norm due to the turbulent 2018 financial market late in the year.

Moving to tax.

Last year, we enjoyed tax benefits from discrete items that are not anticipated to repeat.

Combining the below-the-line pension and tax, year-over-year adjusted EPS growth will be muted by about $0.51 or 700 basis points.

Putting it all together, we expect full year adjusted diluted earnings per share to grow in the range of $7.45 to $7.75.

Looking at the seasonality of the EPS across the quarters.

In the first quarter, results will be muted, driven by 1 less operating day, each moving to April and the 2018 tax benefits that will not repeat.

We expect earnings per share to be about 19% of the full year adjusted EPS midpoint.

We expect the distribution of EPS to be approximately equal across the remaining 3 quarters in the range of between 26% and 28% of the full year adjusted EPS midpoint.

Transformation charges are not part of our 2019 guidance.

We expect charges this year, and we provide additional information as initiatives are launched.

We affirm our guidance on CapEx of between 8.5% and 10% of revenue for 2019.

These investments, which include automated buildings and technology, continue to expand the efficiency and flexibility of the UPS market global logistics network and were instrumental in our success this peak season.

Additionally, we plan to reward shareholders with growth in dividends subject to board approval and anticipate share buybacks of around $1 billion in 2019.

We also expect the diluted share count to be about 870 million shares throughout the year.

Adjusted free cash flow is anticipated to be between $3.5 billion and $4 billion, with potential for additional upside based on our working capital initiatives.

We view 2019 as a year or real progress, with UPS generating a substantial increase in operating profit.

We expect total operating profit to grow in the low teens, with all 3 segments up double-digit.

Thank you.

And now I'll ask the operator to open the line.

Operator?

(Operator Instructions) I will now turn the program back over to our IRO, Mr. Scott Childress.

Please go ahead, sir.

Thank you.

We're going to take an online question this morning.

We've got multiple questions.

Fadi Chamoun from BMO, Scott Schneeberger from Oppenheimer, Jack Atkins from Stephens.

They've asked, it appears UPS did not experience the full impact to the economic headwinds.

Can you elaborate a little bit on what you're seeing in terms of demand in your international business?

Okay.

This is David, and thank you all for that question.

And there are many more questions about International.

I think we could spend an entire call along international.

I would just say, the way we look at headwinds is from our perspective.

And do we see global headwinds?

Absolutely.

We see many of the ones that's been identified by others.

But let's not talk about new as much as the tailwinds and the opportunities that we believe are out there, and those tailwinds are really our strategic imperatives.

And those that we're going to make our investments continue to make our investments and take advantage of this opportunity.

So we still think, with all the trade discussion, that there are global growth markets that we can certainly expand.

E-commerce is providing all kinds of opportunities, small and midsized businesses that don't get talked about nearly as much as larger [retailers] are certainly playing a big role in this market.

And then health care and life sciences.

So all of those, we think are just good, good opportunities.

And when you look at our fourth quarter results as was briefly mentioned, currency-neutral, our operating profit and our International business was up 10% and our operating margins over 20%.

This is our best performance International ever, and it is steering some of these headwinds and opportunities that we talked about.

So that -- we'd like to discuss a little bit more about Europe specifically.

Jim, would you like to do that?

Sure, I'd love to.

So [2 old comments], I guess, is we continue to see International and not just express business, but supply chain as well as a growth and diversification engine, no question about that.

I think we've seen that over time.

Europe, obviously, is one of those parts of the world that Brexit seems to win the day, and certainly from our perspective, we want that to be sold properly.

But in the midst of that, our European business managed to grow revenue in the high single digits, keep expense to about half that growth, and growth profits about 15%.

David talked about some of these factors.

Obviously, some years ago, when we didn't win our way with the TNT merger, we had a choice, and we moved on to a $2 billion organic investment strategy.

We stay absolutely true to do that.

Our job is to win in both organic or inorganic moves in the market.

Right now in Europe, it is very much an organic growth story.

And in the end, our job is to be able to create leverage in almost any environment that we're dealt.

I mean macro changes will come and go over time.

And at very end, our job is to run the business and create leverage.

In Europe, we feel like we had a nice quarter.

We talked about in the third quarter that we continue forward.

Fourth quarter did that, and we can see similar actions and initiatives going forward in 2019.

So that's the International and European from our perspective.

We're going to take another question from multiple analysts: Brian Ossenbeck from JPMorgan; Ben Hartford from RW Baird; and Kevin Sterling over at Seaport Global.

Can the U.S. Domestic segment grow volume and expand margins?

And are the -- or are the 2 mutually exclusive given headwinds of B2C?

So this is Richard, and I'll start and then I'll turn it over to Jim as well.

I think you look at the fourth quarter, and it's indicative of some of the transformation around growth that we've talked about.

We had revenue per piece in the U.S. up almost 5%...

During my talk, I mentioned and Jim mentioned about the SMB, the small and medium-sized business and also the positive product and customer mix.

We do see 2019 as a pivot point.

If you go through the numbers, you'll see that operating profit is growing, which means that we are creating leverage and it really is the start of something that we talked about.

What happened is we had our investments come online, transformation as well as improving operations throughout the country.

With that, I'll turn it over to Jim.

Yes, yes.

I have a few key points to it.

I think when you sit down and you think about the year that we've just entered, you've heard a lot about revenue quality obviously throughout the call.

In your case, we're going to talk about that more.

But the continued focus on that, and Kevin obviously knew he's going to support that as well, non-op leverage and procurement savings coming through, as Scott will talk about that today some more as well in the call.

But at the end of the day, we haven't talked since much about the capacity adds.

One will also do that as the call goes on, but certainly the 22 facilities that we built last year.

The 18, we're going to add this year really allowed integrated network to perform and to perform at much higher levels, which is the key to success at peak as well.

How we execute peak in 2019?

We're going to continue to refine that strategy and move that forward.

There's Saturday ground for us.

We've expanded it.

We added about 100 buildings in 2018.

So as we enter '19, we're in 323 buildings in the U.S. And quite frankly, the operating leverage that we saw in the fourth quarter of '18, we see moving to south and starting to '19 and going forward.

So that really is the pillars underpinning the dialogue and the turn as we move into '19, and we're anxious to get on with it and move through the quarters, as Rich described.

We have a question from the line of Tom Wadewitz of UBS.

I wanted to ask you and you just commented a bit on domestic.

I wanted to ask you a little bit more on that.

Richard, first, if you could just kind of review the comments you made about the vesting change and impact and then kind of the, I guess, the lower discount benefit.

If you could just review those comments.

And then within domestic package, how do we think about the impact of that favorable mix and the SMB, B2B?

Is that going to continue?

And then productivity, how much flows in?

So I think just a number of things to understand how we would think about the drivers of domestic package margin performance in 2019.

Tom, what I'm going to do is I'm going to cover the MIP and the discount rate and the operating, and then I'm going to turn over to Kate to talk a little bit about where we're headed with some of the initiatives around our customer and product mix.

Specifically around the vesting, it really is about a short-term stock equity program that 40,000 employees participate in.

The legacy was it was a 5-year vesting, and it wasn't meeting the market.

And transformation, we continue to look at how do we make UPS attractive place to work, get the right talent and also make sure we're delivering appropriately from a compensation standpoint.

So part of that was making the change.

It really is no overall impact when you go through the 5 years.

There's a little bit heavier charge now and then slowly dissipates to 0 by the fifth year.

In terms of the discount rate, that $250 million is pretty much offset by the benefit we saw in the operating line on discount rate.

So during the press -- in the press release, we called out the below-the-line portion.

And though it's not entirely the same as the MIP, large portion of the MIP is offset by that.

And that's because the service cost portion is accrued differently when the discount rate rises.

So that's all inside the operating line.

But most importantly, I think, when you look overall, the operating growth in the low double digits is a big improvement for the U.S. and it's not just what's happening in the operating leverage, but what we're doing with revenue, and Kate will talk about that.

And Tom, I'll just add both customer and product mix with positive in the quarter, and yes, tied to our strategy of revenue quality, and we continue to align value price and cost and going further with different industries, different segments further with slow, medium-sized businesses and being more selective with large customers.

So the strategy is playing out, and we'll continue to do so.

We have a question from the line of Scott Group, Wolfe Research.

So I wanted to ask the guidance for profit is low teens.

If I heard you right, Richard, for first quarter, it sounds like it implied more like low to mid single digit.

So maybe help us think about why -- what's changing, and why it doesn't shop in the beginning of the year and why it comes more in the back half of the year?

And then can you just walk us through the pieces, $6 billion of free cash flow last year and $3.5 billion to $4 billion this year?

What are the drivers for the delta?

Okay, Scott.

I'll start with the guidance.

Specifically, I think you called out the first quarter.

The 2 big factors in the first quarter are: first, the work days at Easter moved from the first quarter to the second quarter.

So if you go back and look in history, there's a volume runup prior to Easter, and that plays into it.

And then just the work day.

There's 1 less work day in the first quarter.

And when you do the math to the third quarter, you'll see the pickup because there's an extra work day in the third quarter.

In terms of when you think about the free cash flow, we had called out some working capital initiatives that we're going to continue, and we talked about that.

But also we know in 2018, there were some tax benefits that we called out in March, both for the tax rate change as well as a big refund.

So when you kind of normalize for that, we're going to have an excellent year of free cash flow again.

We're going to continue to try to build that, and we'll talk about additional opportunities to grow it through some of the initiatives.

And as we do (inaudible) 2018, we'll share those accomplishments and what it means to free cash flow as the year goes.

Just a follow-up on the first quarter, there are no business fundamental issues for the first quarter.

Rich certainly pointed out the 2 things about the calendar.

The other thing is these discrete tax items that hit the first quarter of last year that don't this year.

So other than that, we say the first quarter with the same momentum as the rest of the year.

We're going to take an online question here.

This comes from Scott Schneeberger from Oppenheimer.

Did you progress in your pursuit of growing share with small and medium-sized businesses this peak season?

So thanks, Scott, for the question.

This is Kate.

And the answer is yes.

Our strategy is working.

Our small and medium-sized business growth was the best we've seen in recent history in the U.S. as well as throughout the world and across different industries.

And you can see that demonstrated in our notable B2B and B2C growth.

The sales and marketing teams continue to work very well together to win more in the market.

And it is notable that we're the market leader already in small and medium-sized businesses, but we're delivering more solutions to go even further.

Just to give you a little flavor, Ware2Go, we've talked about, but there's strong demand as we build out our merchant network.

UPS My Choice just hit an amazing $56 million of happy consumers, and we're going to be extending that to UPS My Choice for business later this year.

So very excited about that.

And then also the alliance, as Jim mentioned in the opening, the Shopify integrating UPS services into that system, ShopRunner bringing 2-day delivery across the country for different retailers, Inxeption and then Optoro on the return side, and continuing to enhance how we reach these small and medium-sized businesses globally through digital solutions.

So SMBs are the growth engine for economies throughout the world, and we are very well positioned to continue our success in that segment.

Thanks so much.

This is David.

Just a quick summary about the importance of SMBs.

They're 95% of firms and they're 50% of U.S. GDP.

So when Kate talks about all these initiatives, it's because that's such an important sector, and of course, it is one of our strategic imperatives.

We're going to take another online question.

This question is from Ravi Shanker from Morgan Stanley and Amit at Deutsche Bank.

What percent of U.S. volume is being sorted manually today?

And what do you see going forward?

As well as, can you give us an update on the 22 facilities you brought online this year?

Great.

This is Juan Perez.

Thanks for the questions.

We continue to make significant progress in expanding our automated capacity across the network.

And just as a reminder, that is a key component of the build-out of our Smart Logistics Network, which we're really proud of the progress we'd be making up to this point.

To tell you how that progress has materialized, at the end of 2018, we had nearly 70% of our ground eligible volume going through these automated facilities.

In 2019, we expect that number to grow to almost 80%.

And to put it in perspective, back in 2017, we were only at about 50%.

So continued progress in that area.

Now to do that, we successfully -- and Jim mentioned it, we successfully completed our 22 automated facility projects in 2018.

That was a global project footprint.

They accounted for more than 5 million square feet in capacity across the network, 4 million of those were in the U.S., 1 million was international.

That added 400,000 packages per hour of capacity in 1 year across the network.

The regionals in Atlanta, in Salt Lake City, in Phoenix, they just provided excellent capacity support in these areas.

And on top of all that, we added 2,300 car positions to the U.S. network, again, giving us additional capacity to support the Smart Logistics Network.

In 2019, that will be another busy year for us in building capacity.

We're excited about it again.

Jim mentioned 18 U.S. facilities that will be coming online.

In total, we'll have 20 because we have some international facilities as well coming online, 7 automated small sorts.

We will be adding an additional 400,000 packages per hour of capacity.

And critical areas where we see significant growth, we'll see additional capacity as well: Tennessee, California, Kentucky and Ohio.

So we continue to move forward, but our strategy, we feel pretty solid about it.

We have a question from David Vernon of Bernstein.

So Richard or David, I wanted to talk a little bit about the returns on this CapEx program.

We're about 1.5 years, 2 years in.

CapEx has stepped up.

It's going to go on for another 2 years.

And it feels like within the guidance, we're -- you guys are getting some of the productivity that you're expecting, some of the return on these investments but they're being offset by below-the-line pension.

They're getting offset by this change in the stock comp at $0.51 that you've called out.

Should we -- I mean, how should we be thinking about the return on this investment program?

Should we be expecting that $0.51 to maybe not be there in 2020 and you're going to get that catch-up into that next year?

Or will there be additional sort of assets that are coming up?

I guess, what I'm trying to figure out here is when does the benefit that you guys are getting from these investments going to shop actually in the EPS number?

Sir David, this is Richard.

And I think the first thing that we have to think about is, if you just look at what happened in the, really, the stock market in the last 6 weeks of the year, that's predominantly what's driving a tremendous amount of the pension below-the-line impact.

So I'd love to sit here and tell you that we're not going to see -- we're going to see a positive market that's X, Y or Z, but I do understand that what we look at -- what December looks like, it was a stock market that was for the month were -- since, I believe, the depression.

And so they had a big impact at the end of the year that wasn't expected.

I don't expect that to repeat.

And because of that, I do believe -- and if you think about the underlying real story here, it is that we have double-digit low-teens growth in all 3 segments, and it's been many years since you've seen that.

We're at the pivot point of the benefits from transformation, the investments.

And most importantly, our return on invested capital remains within our range.

So if you think about sort of like the 2020 build, right, we are -- you're getting the return on the investments you've been making, it's just getting offset a little bit and then that should still latter up into that 2020, '21 time frame.

Is that right?

That's right.

I kind of think of the below-the line is some things we have to deal with, but at the end of the day, it's about what we're doing on the top -- in the operating profit and continue to improve that year-over-year.

And let me -- this is Jim, I just have to add this up.

I mean the question that we're kind of dancing around a little bit, Tom asked (inaudible) are we getting the productivity improvements in these investments?

And the answer is yes.

In fact, there's other investments in this integrated network that come to life.

Once you get these hubs effectively moving the way they are and you saw coming that in peak and you'll see that in the years to come as well.

All right.

And then maybe just as a quick follow-up.

You guys talked in the past about the CapEx.

We're actually back down to that 6% range.

Following this facility build-out, is that still kind of how you're looking at the world at a post sort of '21 frame?

So Dave, we obviously expect that it will eventually come down as we've talked about.

We'll guide the -- out our years as appropriate, but we know for the next few years, the advantages from the investments are getting the return, and we'll come back to that and I'll cover some of that with you offline as appropriate.

Thanks, David.

Just make sure that we're following only one question, so we can move on.

Our next question is an online question from Brian Ossenbeck, JPMorgan.

There were -- there was a mention on Central States during the prepared remarks.

Can you give us the latest update on that from the UPS standpoint?

This is Richard again, and I'll start.

And I think that David will finish up on this one.

But the first thing to remember here, when we were through from Central States in 2007, and today, it was the right decision.

In 2014, some legislation passed that allows for pension reductions, and it opened up new accounting considerations.

We had to look at as we disclosed that a few years ago when that law passed.

If you look at the requirements under GAAP, we have to evaluate outcomes based on the current legislation.

When you look at the multiemployer area on pension, there's over a million participants in 5,000 employers that are impacted by plans and are in declining status.

The industries are vast.

In fact, UPS is less than 2%.

That being said, we continue to work with all the appropriate parties to find the right solution, and I think David wants to talk a little bit about some of those efforts.

Thank you, Richard.

In 2018, the Joint Select Committee, made up of equal members of democrats and republicans, equal numbers from the House and the Senate, and they made very good progress in finding solutions for these failing multiemployer pension plans.

We're talking about Central States here, but this problem is much bigger than the Central States.

There's hundreds of these plans that we are not involved in as a company that are in this critical and declining status.

So that's why this is a nationwide issue.

While they made good progress, they did not meet the statutory deadline of bridging a bipartisan solution by the end of year.

I really believe that the Congress does understand the sense of urgency, and that they will continue to make this a priority this year.

And we are certainly going to continue to advocate with both the Congress and the administration on why this needs to be addressed, how it affects many employees throughout the country and how can also have an affect on employers and not as much on the big companies as there is a lot of smaller companies out there that have employees that needs plans.

And if the situation doesn't get fixed, they could certainly have a negative effect on that.

So it's an important issue we'll continue to work on.

We're going to take an online question here.

This question comes from Chris Wetherbee at Citi as well as Todd Fowler from KeyBanc.

The question is about an update on transformation.

Is transformation mostly a cost-reduction initiative or from the high-growth side, a strategic standpoint?

How is UPS getting at this?

Thanks, Chris and Todd, for the questions.

So as we mentioned in the Fall Investor Conference, transformation supports and funds the business strategy.

So it's a combination of both cost and growth.

And you would heard that as each one of the speakers have explained the progress in their areas is the transformation very much is supporting all sides.

On the cost end, we've made some really good progress: the Voluntary Retirement Program, we have a very good great take rate; our centralized global procurement to leverage our global scale and buying power; and we're moving back office work and transactional work to our global business services and BPO to reduce our overall cost in investing those back in technology.

We're investing a lot of growth.

Kate mentioned quite a bit about SMBs and the platforms and the partnerships that we're building to support B2B e-commerce.

We're capturing international, as Jim touched on.

Health care is an important area for us, and we see an opportunity for helping our customers who increase -- see increasing regulatory compliance challenges, cost pressures.

We think that our network is well positioned.

We have home health care opportunity, direct-to-patient, lab specimen, clinical, and then, of course, we're building on our synergies with Marken.

We set aggressive goals in 2018, we achieved them.

We have many new initiatives in 2019 with just as aggressive goals.

I'm a little over a year now with the company, and I continued to be impressed by how the organization is able to adapt and agilely transform itself while also continuing to deliver our very, very high levels of customer service as you saw on peak.

And we have a question from the line of Allison Landry of Crédit Suisse.

I wanted to ask about the operating penalties and where they came in for the full year '18.

And then also in terms of the domestic cost per piece, if you could parse out what the efficiency gains were during the quarter, maybe the operating penalties themselves and [fuel] and any the other components?

And then how should we think about cost-per-piece inflation in 2019?

Sure, Allison, this is Richard.

I think the first thing, we did call out a number for the year for operating penalty.

It came in pretty close to where we had expected.

We had called it out during the quarters.

And if you look at December while we're slightly below where we expected to be, mostly because of what happened in November with a really strong December, those penalties that we expected, they came.

We expect some penalties again this coming year because we're opening up almost the same number of buildings, but it's not going to be as much of a drag because we're getting the benefits, and we talked about the year-over-year.

In terms of the cost per piece and the changes.

I think with what we've given you, you can calculate the cost per piece, you can see the inflation numbers or the increase is coming down.

You can even look at our operating expenses this quarter, and it was among the lowest that we've had in the last 2 years.

With that, I think past getting into the model and the numbers, I think we can take this conversation offline and talk about the incremental pieces that you're asking.

We're going to take an online question from Scott Schneeberger as well as Tom Wadewitz from UBS.

The question is, can you give us an update on your returns that you saw around peek and how they affected your business as well as how you view your pricing as you think out into 2019?

Absolutely.

This is Kate.

I will start with overall peak because returns is one component that comes along with the business.

But with the quality revenue that we delivered, as you've noticed the last few quarters, we have delivered base pricing over 3% as we further align our value that we're delivering to customers with our pricing, gaining that leverage and ensuring that we're addressing our cost-to-serve.

So we do see that continuing.

That is absolutely the strategy.

And then as you say, enhancing our customer and product mix, returns is a key component of that.

It is a very valuable business with high-density delivery, and we saw notable growth.

We also have the most extensive returns portfolio in the marketplace, and we are furthering that.

So we've got everything from mobile returns where small, medium-midsized businesses can actually manage their own returns policies than to consolidate returns for large customers and an alliance with Optoro, which helps them to turn their returns dollars into revenue dollars.

So that in the moment, selling of returns really helps them to reclaim the value and for us to then leverage that to ensure higher value equals higher price.

So we're confident about our strategy, and we will continue to deliver on that.

We have a question from the line of Chris Wetherbee of Citigroup.

I wanted to ask you about transformation benefits and sort of understand if we're getting transformation benefits in 2019 and the guidance from the VRP or other initiative that you have?

And then beyond 2019, how we should expect the cadence of that $1.00 to $1.20 that's a type of attitude whirlwind post 2019?

Sure, Chris.

This is Rich.

I'll start and then Scott will talk a little bit about some of our plans and where we're headed.

But inside transformation, we talked about the VRP and the full run rate happening in the last half of the year.

That is, in essence, what's in the guidance.

We had a successful program.

We're making the adjustments.

On the revenue side, both Kate and Scott have talked about the growth side of transformation.

You see it in our revenue per piece, you see it in our growth in SMB, and you see it in our customer and product mix, which, let me remind you, was positive contribution to revenue per piece.

And that's really the first we've had that in a number of years.

And so if the foundation of transformation is not just about how do we reduce costs, but it's the customer mix and making sure we have that appropriate.

Scott?

So I think you can look on the shape of the 2019 guidance, but there's a very significant amount of activity going on in terms of the transformation program.

We're talking hundreds of initiatives.

And I think that you're seeing is a reflection of those initiatives funding significant investments in technology and capability and as well platforms and partnerships to drive that next change.

We've made that guidance in terms of -- by 2021, and we continue to confirm that.

In the shape of 2019, you're seeing a pretty important [2 notable] years for us to continue to drive down these costs and change the shape of our growth in revenue mix through many of the savings being reinvested back into the business.

Okay.

But to be clear, it's the European 2019 specifically, that's really what we should be focused on?

Yes.

The 2019 VRP absolutely does continue to flow through, and we continue to use those savings for investments in other areas.

Kate mentioned Ware2Go, that is an area that we're investing in to be able to drive SMB e-commerce.

So it's a combination of cost-reduction programs.

We're using those to invest in as well to ensure that there's a flow through to the bottom line.

One area that I also would highlight is the 2018 program.

You're also seeing, in 2019, was the progress we're making in procurement, centralizing our global buy and really leveraging that spending power as we reduce our cost to operate and reinvest.

We're going to take an online question.

This question is coming in about our fulfillment partnership.

And can you please provide some color around UPS' long-term strategy around what we're doing to help mid and small customers?

Thanks for the question.

This is Scott.

So if you look at the transformation programs in terms of the overall approach, we do see that there's an enormous opportunity to leverage the mega trend of small and midsized businesses both in the B2B, but as well B2C e-commerce.

Kate mentioned a couple of the relationships that we've established in Inxeption, ShopRunner.

Those are beginning to support our customers, and we see that as an enormous opportunity for us to continue to build SMB B2B market share, which is part of our overall revenue mix.

We will see those platforms in the future coming together and creating quite a powerful proposition.

Kate?

I would just add there [tides] and fulfillment.

We see the macro trend with small and medium-sized businesses for taking an e-commerce needing help with that fulfillment option in the marketplace.

And we have both our e-fulfillment strategies, where the smaller customers can grow into out of their garage or what have you, and then graduate to what Scott's talking about with Ware2Go.

So we do intend to meet the full spectrum of needs for our small and medium-sized businesses to ensure that we stay market leader.

I'd add some to both what Scott and Kate just mentioned is that, remember in David's opening remarks, we have just brought Philippe Gilbert on to really help us look now from an outside perspective at things like an LLP provider and how that works in distribution these days, how supply chains are moving across the world.

And ultimately, that's his first task with us is to help us make sure that our distribution strategy continues to be and stay connected to the core businesses and create value going forward.

So we're happy to have Philippe onboard to help us assess those going forward as well.

That concludes our Q&A session for today.

Now I will turn the program back over to Mr. Childress.

Please go ahead, sir.

Oh, yes, please.

Thank you for joining us today.

And David if you got any closing remarks?

I do Scott, just a few.

Our plan going in today's show that UPS is on a different path than some other companies, our transformation initiatives are underway, well underway.

They're enabling our strategy.

And we made great progress this quarter, strong, strong international results.

The revenue yields the expansion that was led by our U.S. business and how they performed during peak from a service and a cost standpoint, and really how our investments are just really timed the way they should be, and their adding efficiency and flexibility to our network.

So we continue to see strong growth opportunities.

And again, I'm more convinced that UPS is on the right track to create that value that's so important for our shareholders and for our customers and, of course, for our people.

So again, thank you very much for joining us.

Ladies and gentlemen, that does conclude our conference call for today.

We'd like to thank you for your participation.

Have a wonderful day.

You may now disconnect.