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United Parcel Service, Inc. (NYSE:UPS)

Q4 2013 Earnings Call

January 30, 2014, 8:30 am ET

Executives

Andy Dolny - Treasurer and Investor Relations Officer

Scott Davis - Chairman of the Board, Chief Executive Officer

David Abney - Chief Operating Officer, Senior Vice President

Kurt Kuehn - Chief Financial Officer, Senior Vice President

Myron Gray - President, U.S. Operations

Alan Gershenhorn - Chief Sales, Marketing and Strategy Officer

Jim Barber - President of UPS International

Analysts

Ben Hartford - Baird

Tom Wadewitz - JPMorgan

Brandon Oglenski - Barclays

David Vernon - Bernstein

Ken Hoexter - Bank of America Merrill Lynch

Bill Greene - Morgan Stanley

Christian Wetherbee - Citi

Justin Yagerman - Deutsche Bank

Scott Group - Wolfe Research

Kevin Sterling - BB&T Capital Markets

Nate Brochmann - William Blair & Company

Helane Becker - Cowen & Company

David Ross - Stifel

Thomas Kim - Goldman Sachs

Scott Schneeberger - Oppenheimer

Allison Landry - Credit Suisse

Cleo Zagrean - Macquarie Capital

Jeff Kauffman - Buckingham Research

Operator

Good morning. My name is Steven and I will be your conference facilitator today. At this time, I would like to welcome everyone to the UPS Investor Relations fourth quarter 2013 earnings conference call. All lines have been placed on mute to prevent any background noise, and after the speakers' remarks, there will be a question-and-answer period. Please note, we will only take one question from each participant to accommodate more analysts during the call. Thank you for your cooperation.

It is now my pleasure to turn the floor over to our host, Mr. Andy Dolny, UPS Treasurer and Investor Relations Officer. Sir, the floor is yours.

Andy Dolny

Good morning and welcome to UPS fourth quarter earnings call. Joining me today are Scott Davis, our CEO, and Kurt Kuehn, our CFO. Along with Chief Operating Officer, David Abney, International President, Jim Barber, President of U.S. Operations, Myron Gray and UPS Chief Sales and Marketing Officer, Alan Gershenhorn.

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

These anticipated results are subject to risks and uncertainties, which are described in detail in our 2012 Form 10-K and 2013 10-Q reports. These reports are available on the UPS Investor Relations website and from the Securities and Exchange Commission.

Although there were no adjustments to fourth quarter 2013 results, there was a mark-to-market pension adjustment that reduced fourth quarter 2012 diluted earnings per share by $3.15. As a result, in our remarks today all quarterly and full year comments and comparisons will refer to adjusted results. In addition, we will discuss UPS' free cash flow, which is a non-GAAP financial measure.

The webcast of today's call along with the reconciliation of free cash flow and adjusted results are available on the UPS Investor Relations website. Finally, please ask only one question so that we may allow as many as possible to participate on today's call.

Thanks for your cooperation. Now, I will turn it over to Scott.

Scott Davis

Thanks and good morning. I would like to start my comments today by saying UPS fourth quarter results fell far short of our expectations. However, I do want to reinforce that the core business strategies of UPS remain sound and appropriate for the future.

Given the compressed calendar between Thanksgiving and Christmas, UPS knew this holiday season will be one of the most challenging ever. Shipments produced by e-commerce significantly exceeded even our most optimistic forecasts as more and more Americans shopped online. In addition, we experienced a much later peak day than expected as purchasing decisions by consumers shifted closer to Christmas.

The surge in volume and inclement weather strained our network causing delays. We took extraordinary measures and deployed additional people and equipment, placing a greater emphasis on service and cost, yet we did not meet the service standards the UPS historically does at Christmas. Moving forward, UPS will make the necessary investments and operational improvements to ensure we effectively manage peak demand in the future.

Looking at U.S. Domestic fourth quarter results, clearly, we are not satisfied. At UPS, we conduct a thorough review of peak performance following Christmas, and this year I can assure you we would identify a number of areas to improve and in a moment David Abney will take you through them.

Turning to the International segment, UPS experienced operating margin expansion on strong growth in export volume. In Supply Chain and Freight, challenges in forwarding negatively impacted results. Reflecting back on 2013, let's start on the economic front. U.S. business activity was constrained by political uncertainty in Washington.

Now, on a positive note, Europe began to emerge from recession. Also, cross border trade improved in 2012, express shipments out of Asia remains sluggish. Looking specifically at our business, two themes were prevalent in the marketplace. First, e-commerce continues to evolve at a rapid pace, not only here in the United States, but around the world.

Second, customers put greater emphasis on cost rather than time in transit. UPS has and will continue to adapt our business model and service portfolio to meet their needs. Throughout the first three quarters, UPS adjusted to these market dynamics. We managed our network efficiently, produced an operating profit growth and margin expansion. Clearly, in the fourth quarter, we did not anticipate the magnitude of volume growth and results suffered.

Looking at 2014, economists around the world are forecasting a slightly brighter outlook. In the U.S., projections call for a stronger GDP, up 2.7%. While in the Eurozone, GDP is expected to grow 1.2% off a relatively flat growth year in 2013. The outlook for Asia calls for continued solid growth with China standing in line with last year about 7.5%. More importantly, global exports are projected to slightly outpace global GDP.

Another prospect for economic development is the WTO Trade Facilitation Agreement passed just last month. To expedite the movement of goods globally by decreasing red tape and promoting more efficient supply chains. While areas remain where additional progress is necessary, this agreement is proof that debate and compromise can produce tangible results. History has shown that economic development benefits from free trade and more should be done to encourage it.

As I stated at the opening, I am confident in our core business strategies. In the area of operations technology, UPS is ramping up hub modernization efforts. We are seeing the benefits from telematics and route optimization and as a resulted the company is expediting the rollout of Orion. These investments will help UPS become more efficient and responsive to customer needs.

In addition we are accelerating how UPS data can be used to improve our application of analytics across the network. These models not only of application within our operations but also across our entire business. Serving end consumers around the world, B2C is a critical part of both our heritage and our future and by far the most rapidly changing. We have lead the industry with innovations such as UPS my choice, UPS Access Points and Omnichannel solutions. While we have accomplished a lot, there is still much more to do.

Regarding industry specific solutions, we have enhanced our healthcare capabilities such as the introduction of UPS Temperature True Saver and UPS Proactive Response. In addition, we will add to our already 6.4 million square feet of healthcare distribution space with several openings planned worldwide in 2014. In the emerging markets, in order to focus on the potential of India, the Middle East and Africa, we structurally separated those markets from Europe in 2013 and established a dedicated team to focus on growth. Expect to see increased investment by UPS in the next year.

Before turn it over to David, I would like to thank UPS-ers around the world for their exceptional efforts under some fairly difficult peak season conditions. The lessons learned from peak will enable UPS to improve the customer experience, network efficiency and capacity management. We recognize and hold in highest regard the vital role we play in linking 1.1 million shippers to their 8 million customers every day.

Now I will turn it over to David.

David Abney

Thanks. As Scott mentioned, UPS has been working around the clock to determine how to improve peak operations and service performance, ensuring we do not have a repeat of 2013. I am leading a team of senior UPS executives with deep experience in all areas of the business. We have identified areas for improvement and will make the necessary adjustments to our operating plans. This is the first step in an ongoing process.

Let me begin by providing insight into the major issues that impacted our operations which can be categorized into three main areas. First, e-commerce shipments far exceed peak projections starting with a strong cyber week. Typically volume slows the following week but this year it continued to rise. In fact on eight days during December U.S. delivery volume exceeded our previous company high which was set in 2012. Additionally delivery volume per day during peak was up more than 14% a growth rate almost twice what we planned. Second, last-minute promotions by online retailers drove extraordinary volume growth leading up to Christmas. This helped create the latest peak day ever for UPS, six days after it was expected.

Another indication of the growing acceptance of e-commerce, there were more than 70 online retailers promoting guaranteed next-day delivery on purchases made as late as 11 PM on December 23rd. Finally, weather events throughout the country, especially in the Southwest further contributed to network disruptions.

Operations in Texas and Oklahoma were shut down for three-and-a-half days following the ice storms there. Stranded volume became a priority and UPS responded, deploying over 1,000 team members to the area. Ultimately, we had our planned that was based on a very optimistic level of e-commerce shipment growth, but actual results came in significantly higher.

When the network is stressed to those levels it becomes vulnerable, add to the wave of last-minute online orders, along with significant weather disruptions and processes starting to break down and errors occur. Unfortunately, that's exactly what happened.

Now, let me share how we would prevent this from happening again. We have identified four key areas that UPS must address before peak season next year. First, UPS volume forecasting methods were challenged. The paradigms for planning no longer apply due to the rapidly evolving marketplace.

The first step, we will begin with increased collaboration with high impact customers to further develop predictive models that incorporate changing consumer behavior and sales promotions. With a better understanding of the impact, these customers we have on our network, UPS will be prepared to make the necessary adjustments.

That brings me to the second issue we need to address. UPS network capacity. We are in the process of identifying ways to enhance the throughput of our network. We will make appropriate investments such as facility expansions, process automation, job simplification and the acceleration of the technology implementations.

For example, we plan to expedite the progress of updating our legacy buildings with automation to streamline the thought process. This multiyear undertaking will pay dividends for years to come. In addition, to improve the efficiency of our delivery network, we are expediting the rollout of ORION. This technology has improved UPS routing efficiency.

As a result, we are accelerating the rollout and we plan to have 45% of the driver rout using the technology by the end of 2014. To do this, we are adding approximately 200 additional dedicated resources to the ORION team, bringing the team headcount to almost 700.

One final element of capacity management is to better manage the impacts certain customers have on our network during peak. The goal is to ensure we can meet both, customer expectations and our financial objectives.

A third area for improvement is timely and accurate visibility of shipments. As more customers work with UPS to optimize their supply chains, a growing number of trailers were dropped at our facilities with limited visibility to their contents.

We will collaborate with customers to obtain package visibility on all trailers before arrival. This will improve UPS tracking and exception reporting and is critical to provide accurate visibility to our customers. Lastly, improved communication with our shippers and receivers is needed.

UPS must enhance our processes and standards necessary to ensure timely and accurate communication, especially during periods of peak demand and network disruptions. Along with improve visibility for our customers, new package exception codes will be rolled out to improve tracking messages ultimately providing more clarity on shipment progress. In addition proactive notifications will make it possible for our customers to adjust their plans. So clearly our entire team is intensely focused on using the learnings from this peak season to ensure we are prepared for 2014. We have recognize that the UPS brand is a valuable asset to be protected. The steps I just mentioned will allow UPS to build upon our reputation for reliability and service quality.

Now Kurt will take you through the details of the quarter and guidance for 2014.

Kurt Kuehn

Thanks, David. As already noted, fourth quarter results fell short of UPS expectations. For the first time in years, UPS did not achieve the typical benefits that we have seen from operational efficiency. As evidenced, compensation and benefit expense increased 7.5% on a daily package volume growth of 6%. Also additional costs were incurred to react to the unprecedented level of volume growth as we attempted to meet service commitments.

Now I want to review the business segment results for the quarter. In the U.S. domestic, the challenges that David reviewed were detrimental to the segment's financial results. Operating profit declined $178 million and margin contracted to 12.9%. The U.S. incurred unplanned expense this quarter to handle the volume surge. This included hiring and training costs, overtime hours and additional weekend operations. Thousands of extra ad hoc trailer moves drove purchase transportation costs up. In addition with 85,000 seasonal employees, UPS productivity declined driving of 6.2% increase in direct labor hours. Clearly, we didn't operate as smoothly as we normally do.

The estimated impact of the peak season efforts increased operating costs by $125 million to $150 million. Also revenue was lowered by approximately $50 million in service refunds for missed delivery commitments. UPS did experience strong daily volume growth of 5.6% led by our deferred and ground products. Revenue per piece declined 1.3% as base rate improvements were more than offset by lower fuel surcharges, a 34% growth in UPS SurePost and the service refunds that we mentioned. During the period, the benefits of our route optimization efforts, though, were obvious as miles driven increased a little more than 2% compared to the daily volume growth of 5.6%.

Looking now at international results. The segment demonstrated continued momentum during the quarter with revenue gains of 5.3% driven by 8.8% package volume growth. Operating profits rose 7.6% to $537 million and operating margin expanded 30 basis points to $15.9 million. Operating profit growth would have been up over 12% when excluding negative currency comparisons. Export daily volume jumped 9.5%, the largest year-over-year gain we have seen in some time. UPS experienced robust demand in Europe, driven by e-commerce, capitalizing on the capabilities of our recently expanded hub in Cologne. In addition, transborder daily volume increased over 18% during peak. Non-U.S. domestic volume increased 8.2% with Poland, Italy and Canada leading the way.

Now turning the supply chain and freight. Total segment revenue declined by 5.8% directly related to our freight forwarding business unit. Operating profit was flat overall at $171 million as improvements in distribution were offset by declines in forwarding and UPS freight. Operating margin overall expanded 30 basis points to 7.4%. UPS freight forwarding revenue declined as international air freight experienced decreases in both tonnage and revenue per case. On a positive note, our brokerage in ocean and forwarding groups both demonstrated good growth and improved profitability.

In distribution, mid-single-digit revenue growth resulted from improvements in healthcare, retail and UPS mail services. Operating margin expanded slightly as the business unit continues to absorb cost for technology and healthcare facility expansions.

UPS Freight, LTL revenue increased 2.3% as a result of increased LTL tonnage and pricing improvements. Revenue per hundredweight increased by 1.6% this quarter as pricing remained stable.

Now, for an update on our cash flow for the year. UPS generated $5.3 billion in free cash flow during 2013, converting over 120% of net income to cash. This was after making capital expenditures of approximately $2.1 billion. Also during the year, the company distributed over $6 billion to shareowners, including dividends of $2.3 billion and share repurchases of approximately $3.8 billion.

Looking now at 2014, UPS expects to make share repurchases of $2.7 billion. This will result in over 2% net reduction in outstanding shares and reflects the company's long-term philosophy of returns to shareowners. Capital expenditures are expected increase to $2.5 billion.

Our allocation of investments will be meaningfully different this year, with much less devoted aircraft. This will be offset though by additions to vehicles and operating technology as well as over $500 million of increased investments in capacity expansion and hub modernization.

The combination of a slightly improved economic environment and our execution of UPS core business strategies gives us confidence in our 2014 guidance of earnings per share growth of 11% to 16%. We expect the tax rate of 36% in 2014, higher than reported in the first half of last year.

Regarding guidance for the segments, U.S. Domestic average daily volume is expected to grow between 3% and 4%, moderately above 2014 GDP estimates. Revenue should improve at a slightly faster pace than volume. Increases in base rate rises will remain steady between 2% and 3%. However, they will continue to be masked by customer preference for non-premium products, including continued growth in UPS SurePost.

Operating margin is expected to be around 14%. Due to higher discount rates, total pension expense will be reduced by approximately $180 million. The majority of this will be reflected in the domestic segment. However, the savings for this segment will be offset by higher healthcare costs. In addition, implementing the network improvements that David described will increase cost by well over $100 million, while providing payback for years to come.

We expect the positive momentum in the International segment to continue in 2014, with export average daily volume growth between 4% and 6%. Revenue is expected to improve at a slightly slower pace than volume as non-premium export products continue to outpace premium. Operating profit is forecast to grow between 12% and 14%.

For the Supply Chain and Freight segment, UPS expects mid single-digit annual revenue growth. Operating profits are expected to grow at a low-teen rate with margin expanding to approximately 8%. In the first quarter though, revenue and profit growth will be relatively flat to last year, due to the challenges in our international airfreight. As we look at the first quarter overall, earnings per share growth will be slightly below 10%, due to the higher tax rate and the continued headwind and supply chain and freight.

In summary, the outlook for 2014 at UPS is positive as improving global economic conditions and the explosive growth of e-commerce provide optimism at UPS. We are going to take the challenges that we faced in the fourth quarter to serve as a springboard to improve our service levels and our productivity going forward. As a result, UPS expects earnings per share to grow within a range of $5.05 to $5.30.

With that, operator, please open the line for questions.

Question-and-Answer Session

Operator

Our first question comes from the line of Ben Hartford of Baird. Please go ahead.

Ben Hartford - Baird

Scott, I wonder if you can just continue down the path on guidance. Obviously when results were previewed earlier this month, you were looking for 10% to 15% earnings growth. I acknowledge it was a preliminary number. Now the range has taken up slightly, but the buyback is being reduced. You are making infrastructure related investments, which I think are appropriate, but when we do think about, it looks like the core assumption is greater than expected. Can you talk about some of the drivers there? It sounds like the cadence is for accelerating improvement through the year, but you can talk about the decision to take the full year guidance up, even with the buyback that is coming down slightly for 2014?

Kurt Kuehn

Yes, as we dug through took a little closer look at the momentum of the business units, sharpened our focus on the investments we were going to make and took a hard look at that, it looks like a very competent range that we have got. I will make one comment, though, and that is that the buyback is in line with what we been communicating. Clearly 2013 was a catch-up year because we had the held back in 2012 on repurchases but that 2.7% gets us right in the line with the $8 billion or so that we had committed to three years ago. So at least for the numbers we have provided and I think the communication that buyback is right in line.

Scott Davis

Ben, I would add also that, the thing we feel good about, 2014, is we see strength in all three segments. It has really been since 2010 that we saw balanced growth at all three segments. We have had some weakness in cross border trade in 2011 and 2012. We see that improving in '14. Supply Chain & Freight is going to show good growth in domestic. It has performed quite well for the last several years, with the exception of fourth quarter '13.

Ben Hartford - Baird

That's helpful. Thank you.

Operator

Our next question will come from the line of Tom Wadewitz with JPMorgan. Please go ahead.

Tom Wadewitz - JPMorgan

Good morning. So I understand, obviously it's a little bit disappointing in terms of just that there is some of the operational issues but it is the high cost problem to have that much volume coming in and I suppose you could say, maybe there is a silver lining in terms of highlighting the customers that there are constraints on the network and perhaps the value of your network. So I guess what I want to ask you is, do you think this provides an opportunity to guys get more value from the customers in terms of pricing? And if so, what type of timeframe would it take to see that come in?

Kurt Kuehn

Well, Tom, I think David did a pretty good job of walk through how we are going to approach next peak, but clearly as a team we are going to evaluate many options to make sure we don't ever repeat the 2013 peak. Now I would say it is safe to say that we are going to evaluate every alternative out there. We haven't made all the final decisions as of this point in time that we know we need to manage the impact customers have on us during the peak. But the overall objective for us, we have to meet customer expectations and we have to meet our financial objectives. So over the next few months we will make more decisions in this area.

Scott Davis

And clearly, Tom, the top priority is adding capacity and investing in this growth business. So we are happy to do that.

Tom Wadewitz - JPMorgan

And is there any impact on the pricing dynamic? I am really to ask about pricing and whether it is in your positive effect on pricing from what happened?

Scott Davis

Well, that is something we are evaluate as we are really early on this process. David is leading this committee to evaluate next peak. Every thing is on the table and that will be one of the things that will be on the table to look at.

Tom Wadewitz - JPMorgan

Okay. Thank you.

Operator

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

Brandon Oglenski - Barclays

Hi, good morning, everyone. I want to talk about what was that, seems to be a pretty good outcome in your international segment and if I look at your guidance, I actually think you are guiding to up the margins for international. So can you talk about how the mix has changed on the export front and within the continent in Europe and what you are doing to drive those better profit outcomes or at least expectations for better profit outcomes in 2014?

David Abney

Yes, clearly as we have been saying over the last couple quarters, we are improving momentum. Each quarter has gotten stronger and stronger. As we get past the currency headwinds we are looking for great things to come out of the international segment. So I will have Jim Barber fill you a little more on Europe and what's going on there.

Jim Barber

Okay. So, Brandon, I think the core underlying response has to be that that network in Europe for us continues to perform very, very nicely. You heard in some of the opening comments, the expansion of Cologne. We could see the benefits of that through peak season. We have also continued to enhance the ground network and quite frankly put some new solutions in the market for some of our global customers that are really driving the growth today. That's a lot of what underpins some of the growth you see today and then we will valuate going forward what's next. But effectively, that network in Europe continues to mature and pay long-term benefits for all investment over the years. So we absolutely see that continuing and you can see in some of the countries where the investments we make some two, three years ago continue to pay off today. So we are very bullish on that.

Brandon Oglenski - Barclays

Thank you.

Operator

Our next question will come from the line of David Vernon of Bernstein. Please go ahead.

David Vernon - Bernstein

Good morning, guys. Kurt, when you mentioned the guidance for domestic, you talked about $100 million of extra cost. I am assuming that's OpEx. Could you talk a little bit about the nature of that and whether that's going to be kind of a one-time addition for the year as you are rolling out ORION, and it may come back a little bit or if it's going to be just an added level of spend within the operation to keep the network little more resilient.

Kurt Kuehn

Certainly the lion share in 2014 will be operating expense that's involved in the rapid expansion and one-time costs, so we don't see this as a major structural cost addition, but clearly there are some things we are going to do teeing up the teams, having 700 people deploying ORION and other things are going to accelerate both, cost but should provide great benefits in the years to come.

Maybe I could have Myron talk a little bit about ORION and why we are doubling our bets on the pace of rollout on that.

Myron Gray

Good morning, David. As you heard David Abney alluded to earlier, we actually saw a great benefit from ORION at peak season. While ORION grew almost 6%, our miles driven were down to 2%, so we are going to ramp up our ORION team and move the total number of drivers deployed from just over 10% to up to 45% for this year.

Along with that, David also alluded to the hub modernization project, which actually kicks off this coming Friday in North California, so we are looking forward to this investment yielding dividends for years to come.

David Vernon - Bernstein

Excellent. Thank you.

Operator

Our next question will come from the line of Ken Hoexter of Bank of America Merrill Lynch. Please go ahead.

Ken Hoexter - Bank of America Merrill Lynch

Great. Good morning. Scott, I guess, I want to come back to Tom's question on the pricing. I guess, when you talk before about better managing certain customer impact on the network, just given that you have kind of kept stressing the financial objectives, if we are going to see e-commerce continue to push that peak season later and later and obviously December 23rd, it sounds like that's about as latest you can physically get with your physical network. It is the [answer] have to be that you raise pricing incrementally until that peak day to alter customer behavior to move it earlier in this season or is there something else you can do. I guess, I just want to understand, does it have to be price or are there other things you can do to handle that level of an increase the last minute.

Scott Davis

Clearly, Ken, it doesn't have to be price, so we are going to look at all the alternatives. Obviously, we are trying to move shipments forward doing earlier pickups. It is something that will help us. We as you would expect spend a lot time with customers, and since the peak season working with them. The Omnichannel is becoming more prevalent every day. I work of several brick-and-mortar people who were evaluated next year perhaps that are having their big sale the 23rd on the website. People will do it in the store that will allow people to go in the store and pick it up, so in other words you get 50% off in store 40% off on the website. There is a variety of alternatives out there that could change it.

We know that there is still going to be an issue. I mean, every year there is going to be e-commerce is bigger at Christmas, so we have got to adapt our systems, so I think it's all the above. Alan, you may want to add some?

Alan Gershenhorn

Yes. I would just say that there is tremendous amount of planning that goes on between us and certainly our largest customers, but we are going to need to take that to a whole new level to ensure that we are keeping our promises and they are able to keep theirs, so I think [heard] from David earlier and what our customers are looking for right now is commitment and insurance that we will take the necessary actions to make sure this won't happen again and that's really where our focus is right now and you heard some of the things that David was talking about in terms of capacity management, visibility and investing in the business to make sure that we are going to handle the business. Again, part of that is better communication with our customers, so that we are very well aligned in terms of being able to make the service that their customers expect.

Operator

Our next question will come from the line of Bill Greene of Morgan Stanley. Please go ahead.

Bill Greene - Morgan Stanley

Hi. Good morning. Thanks for taking the question. Kurt, can I ask you for a little bit more color on how to think about the impacts in the fourth quarter from each one of these items, so when we think about the challenges from the peak and the resources you had to deploy last-minute and the weather, if you try to tease it out, what do you think the right level of earnings would have been. Would it have been the original guidance, or is the mix you are sort of going to repeat? Because, I am not sure how to think about what core earnings - like things got better, but maybe the cost have to repeat in ways in the fourth quarter that we need to keep in mind as we model going forward. So any color around kind of how to think about those buckets would be helpful.

Kurt Kuehn

Bill, certainly, it's something we have looked at very closely and you know we did have a significant amount of excess cost somewhere between $125 million and $150 million. Plus, as I mentioned in my prepared remarks, about another $50 million of service refunds that lowered revenue. So we certainly would have been within our guidance without those conditions. When the network gets stressed and there is that much of an increase after years of fairly modest growth, clearly some weak areas showed up and that did snowball for us. So clearly, the fourth quarter was a tough one for us. If you look at the October, November, October was pretty much on target. We did see November a little below our plans but I think that that's primarily the issue of the later Thanksgiving and the fact that the holidays started later. In fact, if you recall I even mentioned in our last quarterly call about both the risks and the opportunities of a compressed peak season and for better or worse we ended up seeing opportunity with tremendous compression of demand but the risk of operations, especially with some of the incredible ice storms in the Southwest that was really the worst area for us. So we are putting this one in the history books. I think you heard David give a sense of our absolute determination to learn from this and to create flexibility and capacity. We are substantially increasing our investments in our facility modifications. Myron mentioned hub modernization. That's something we are very excited about. The technology has come long ways and we can, we think, very effectively retrofit a number of our buildings. In fact, maybe I could have David talk just a little bit about the technology and why we are feeling like this is a great time to invest in it.

David Abney

Yes. This technology is something we have been utilizing. The difference now is that the capacity, so the speed of the technology and the footprint is such that it will now fit into our existing footprint. So real excited about that. Myron mentioned the first one in North Bay in California but there will be others that will be progressing right behind that one. But you know, there's other things we are doing to increase capacity too. We are automating more of the small sorts and increasing input capacity in some of our main transit hubs and we are doing facility expansions on some that we already have the books. We are just speeding up and a lot of job simplification where we can do next generation small shorthauls where it takes some of the intellectual capital out and it allows us to make changes more as this peak when we had some of those most fluctuations and changes we had to make.

Bill Greene - Morgan Stanley

Great. Thank you.

Operator

Our next question will come from the line of Christian Wetherbee of Citi. Please go ahead.

Christian Wetherbee - Citi

Hi, thanks. Good morning. Just on the back of the last question, just trying to think about the core operating of the business or co-operations and profitability of the business. Post what we saw in the fourth quarter of last year, does the dynamic of profitability would indeed see some sort of change at all when you think about what ultimately the volume potential of this segment of your business could be? Does that skew things, either more positively or negatively when you look at it? It would seem, based on the guidance, where all the puts and takes that maybe there is an assumption of slightly less profitability in B2C but just want to make sure I understand.

Scott Davis

Yes, I think generally we feel good about the direction of B2C. You have seen the progress UPS has made over the last two or three years in improving the margins in the B2C business. We are going to use this technology to help create density in the area of B2C. So I think this is an outlier for what you saw in December of this year. Again we have been through over 100 successful peaks and this is an outlier. You will not see another one of these hopefully for the next 100 years at UPS. We have a lot of intensity there. But I feel good about the direction of B2C and what we are doing with technology to improve the profitability there.

Kurt Kuehn

Yes, and certainly its not only about B2C. We are investing and creating a wide array of capabilities for healthcare, for technology, you name it and a lot of the investments we have made create flexible network are paying dividends there. So as always, we have got a great array of different customers and the B2C clearly was a challenge in December but we feel pretty good going forward that the mix of business will be profitable.

Christian Wetherbee - Citi

Okay. Thank you.

Operator

Our next question will come from the line of Justin Yagerman of Deutsche Bank. Please go ahead.

Justin Yagerman - Deutsche Bank

Good morning, guys. I am just trying to walk through the cadence of how things have transpired over the last couple of quarters and now making sense at where we are, so I mean back half of last year was clearly a story of profitability being masked by pension and currency.

It sounded like when you were giving your guidance that healthcare slipped in there as a problem. I know that you guys took steps to kind of mitigate some of that increased inflation that you were expecting in the back half of last year, so I would be curious how that's playing in. Obviously this difficult peak also played in, so I guess I am trying to get a sense of what you think underlying growth looks like for '14 when you strip some of that stuff out.

Are you just being conservative in terms of the underlying growth of the overall business? Because it puts you well below kind of run rate when I do all those puts and takes. Then when I think about the decisions that you made last peak and how those inform earnings growth this year, so it feels like to have another year where you choose servicing the customer over profitability in terms of capping volumes to make sure that as shareholders get the growth that they need as well, so I am just trying to understand.

I mean, maybe '15 or you guys are good at what you do, you are able to translate that into very profitable growth and I think that's what a few of the questions before were trying to get at, but it doesn't sound like you are confident in that for '14, so I know there is a lot of there. I am just trying to get a better sense of how you feel about the cadence of the next kind of 24 months here.

Scott Davis

Great. You have given me a wide array of choices to pick which question I am going to answer, Justin. I think, we are seeing '14 as a year in which we are going to absolutely address the issues that popped up in the fourth quarter, so that is job one. There is no question.

We are going to spend extra money operationally. We are going to accelerate investments and we are little cautious about exactly how the next peak turns out. It is another compressed holiday season although we get one extra day.

On the other hand, we are not in any way anticipating or forecasting in a major problem, so is the balance right now more on reinvestment and refinement of the network? Absolutely. Hopefully, all of this will come together and we will have great results going forward, but we are happy to reinvest right now and accelerate some things that have been on the drawing board. As a result, yes, 2014 is a little muted in the domestic side anyway compared to where it might have been, but will be a passing phase.

Kurt Kuehn

Yes. As that reflect back on the 2012 or 2013, frankly that the primary headwind excluding pension expense and currency was international air freight. We had some challenges, cross-border trade grew less than GDP last year, little bit better in 2013. Forwarding side, international freight forwarding was weak due to too much capacity. We try to see those things level out in '14, so I feel pretty good.

As I said earlier I feel good about the balance. That we see a good domestic, we see good international package and we see good supply chain and freight performance in 2014. 11% to 16%, again, is back up in our long-term target area where it should be the margins of kind of what we told you a couple years ago in our long-term targets, but we have room for improvement. Unfortunately, we can't keep all the pension benefit this year because of healthcare cost.

David Abney

Just one thing I want to react to, Justin, and this is David Abney, but I don't want to speak from the cross functional theme and we are still early in the process, where we have made a lot of progress in identifying all of the contributing factors and we are also are much further along than I thought in putting the answers together, what we need to do to ensure the 2014 is not going to be a repeat of 2013, so I thought I heard just a little indecision that in your voice about how we would do for 2014.

We believe, we don't believe. We are very confident that we have a plan put in place that's going to take care of the volume on 2014. We are not hoping that maybe it comes indifferent, but it's not only about capacity it's about increasing our forecasting methods with our customers. It's about improving visibility and it's about the communications back and forth with our customers, so the overall plan and as Kurt said earlier, there will be some operating costs into this year but it's going to pay dividends in years to come and when you increase the funnel, you increase the capacity then that takes care of a lot of challenges that could come in the future.

Justin Yagerman - Deutsche Bank

All right. Thanks a lot. I appreciate the answers, Kurt.

Operator

Our next question will be from the line of Scott Group of Wolfe Research. Please go ahead.

Scott Group - Wolfe Research

Hi, thanks. Good morning, guys. So I wanted to ask about the buyback expectations. I know it's in line with what you guys have been talking about and it looks like you are using about 100% of the free cash flow for buyback and dividend but I guess I am just wondering why you don't feel comfortable being more aggressive in sort of ease into that $6 billion plus of cash. I guess, there is something you are saving that for? So Scott, are you any more and less hopeful about finding a better place for that cash this year?

Scott Davis

So Scott, I do think that we have been consistent with our distribution policy and again we are going to have big shareholder distribution in 2014, as you said over 100% of net income, is the plan. But we still do see opportunities to reinvest in the business. As I talked about earlier, there's lot of opportunities for us in the healthcare arena, in emerging markets as we go forward, in the B2C area. So I think there will be a mixture of acquisitions as we move forward.

Operator

Our next question will come from the line of Kevin Sterling of BB&T Capital Markets. Please go ahead.

Kevin Sterling - BB&T Capital Markets

Thank you. Good morning, gentlemen, and I hope you survive in the deep freeze of Atlanta.

Scott Davis

I have, as a matter of fact, a story to tell you. I slept in the floor of a hotel lobby the night before last. Pretty glamorous being a CEO.

Kevin Sterling - BB&T Capital Markets

Kurt, I think as you talk about some of your network enhancements for this year to deal with the growth of e-commerce, it sounds like a lot of infrastructure enhancements. So I think you indicated you guys weren't really going to invest in your aircraft fleet. So does that mean, as we get into the peak season, you will continue and maybe rely more on outsourced providers of aircraft during the holiday season? Am I thinking about that right?

Kurt Kuehn

Well, it will be a slight increase but we did take a number of 767s this year completing our multiyear purchase. So we are in great shape as far as air capacity. We always have to rely on third-party to top off the excess demand during peak. So that won't be dramatically different, but no, we are in great shape. We have got, by far, the youngest fleet in the industry. We will, at least for the immediate, the next several years, don't anticipate needs for any aircraft purchases. So that's part of why we are in such good shape cash wise and are happy to now begin to reinvest in some of this hub modernization and automation.

Scott Davis

And they are all saying, you don't build a church for Easter. It's a little bit way it is for airplanes for December 23. You really can't buy an airplane just for one day. We will manageable this properly. We lease aircraft where necessary and we will make sure we have proper capacity.

David Abney

With those eight additional 767s, the number of leased aircraft was not a primary factor at WorldPort. It was much more about unload doors for trailers that were coming in and that is something that we can certainly correct.

Kevin Sterling - BB&T Capital Markets

Okay, great. Thanks for your time this morning. Scott, I hope you get to sleep again in bed tonight.

Scott Davis

You got it. Thanks.

Operator

Our next question will come from the line of Nate Brochmann of William Blair & Company. Please go ahead.

Nate Brochmann - William Blair & Company

Good morning, everyone. Hi, Scott, by the way, we really appreciate the dedication. I am pretty sure of their value by sleeping on the floor so that's got to drop right through the bottomline.

Scott Davis

I think it was a good deal. Yes.

Nate Brochmann - William Blair & Company

We are spending a lot of time, obviously talking about the domestic challenges and a little bit of time in terms of a lot of the opportunities in Europe. Obviously, some of that network adjustments seem to keep going on in terms of Asia to U.S. Could you guys feel that you are well balanced there and as we get maybe a little bit of a slowdown in the emerging markets that everybody is worried about recently? Does that impact your vision on global trade and how you allocate your resources or where the growth comes from?

Scott Davis

Jim why don't you go ahead and talk a little bit about the areas outside of Europe.

Jim Barber

Sure, so I guess, and the last question we talked about the network and this question, they are very linked responses. First of all, we like our assets that are out there but when you get back to some of the opening comments about Bali, what's going on now and where these trade agreements are going to us, one of obligation, just to be able to take a look at these networks. I am really specifically talking about Asia now in the Americas. To align those to where the puck is going, so it doesn't necessarily mean new asset, but it might mean redeploying them in different ways based upon what the consumers are telling us and our customers from across the globe, so we are in the middle of that piece of work right now. We are very happy with our networks and the way they are performing. You can see that in some of the results, but we also think we have to keep one step ahead based on where these trade agreements are going and some of the decision these countries will make in the next couple years.

I think that the fact that as you look at 2014, solid growth is projected for the developing world, developed world I should say, so the United States and Europe, and I think that also bodes well for UPS.

Looking at almost 8% to 10% increase is consensus for the U.S. this year and the global economy the same, so I think as you get into more stable I just wouldn't call it robust economy, but a more stable economy. See in Europe and U.S. strengthens is going to help us a lot. (Inaudible), so we are going to continue to invest in emerging markets, big part of our future, but for the short to medium-term developed world going - good for us.

Operator

Our next question will come from the line of Helane Becker of Cowen & Company. Please go ahead.

Helane Becker - Cowen & Company

Thanks very much. Hi, guys. Thank you very much for the time. Most of my questions have been answered more than once, so thank you very much. I just had one thing I wanted to understand. When you talk about having to hire people kind of at the last instance, I am not sure I understand the timing of that. When do you bring on those additional people to handle the extra volume.

I mean, I sort of think that those 1,000 or so people you move to the Southwest, coming from other parts of the company, but as you got closer to the peak, how do you really get those people from or how does that work, so could you just explain that one for me?

Scott Davis

Certainly, hiring that number of people in the span of a month-and-a-half or so is a big challenge, especially when we have to react late, but Myron can talk a little bit about the joys and challenges of bringing on such a large workforce.

Myron Gray

Helane, it's like a delicate ballet. We are constantly assessing where the volume is and bringing all resources to meet those challenges. As has been talked about many times, we actually added 30,000 people above where we planned.

Let me also allude to the fact that we believe that our operating strategy is sound, and remind you that through the first three quarters of last year, we were able to balance average daily volume with ours and have the appropriate spread, so we are bringing on these people as needed and it's a challenge because you had a 16% increase in our peak day over last year, but we believe that those are good peak season jobs. We got all the required people in place on time, but were [by] a significant storm that we saw, not only in the Southwest, but the Midwest and Northeast, so I think we are in good shape.

Kurt Kuehn

Helane, on the economic impact of that, there is a point of diminishing returns and trying to bring that many people on and have them be productive quickly clearly was one of the drags in the quarter, especially when we had to get so much more because of the volume increase, but those are great jobs. Many of us started as the company as Christmas hires myself included.

Helane Becker - Cowen & Company

Me too. Although I am not with you anymore I could do that in college.

Kurt Kuehn

Great. Hopefully, we worked too hard.

Helane Becker - Cowen & Company

Yes. I would say so.

Kurt Kuehn

Okay.

Helane Becker - Cowen & Company

Thank you.

Kurt Kuehn

Great. Thanks.

Operator

Our next question will come from the line of David Ross with Stifel. Please go ahead.

David Ross - Stifel

Yes. Good morning, gentlemen. Why don't you just a little bit rising healthcare costs. You mentioned, they are going to eat up most of the pension benefit expected for 2014. I wanted to see if that $100 million rough increase in healthcare cost is expected every year through the new union labor agreement or if it's one-time for some reason. It can't be all due to any back problems comes with sitting on the floor.

Scott Davis

That's not work-related any way. No. The biggest impact is and we have talked about this than in prior calls that certainly the rollout of some of the additional parts of the Affordable Care Act is adding over $100 million for us, so that's the biggest one-time issue. Of course, healthcare inflation is an issue that is certainly a concern for many of us. So that's been an area also that's been discussed and are in our discussions with our employees but the biggest impact is some one-time additional expenses with the added cost per head and some of those things that's driving up costs for a employee intensive company like UPS.

Scott Davis

In this year, we saw more, in 2014 more of it, because of things like the reinsurance fee per employee that you didn't see last year. So I think it is going to be quite as dramatic as you move forward.

David Ross - Stifel

Okay, so one time step up in cost but not just one time cost that is going to go away next year.

Scott Davis

One time step up in cost. Right.

David Ross - Stifel

Got it. Thank you.

Operator

Our next question will come from the line of Thomas Kim of Goldman Sachs. Please go ahead.

Thomas Kim - Goldman Sachs

Hi. Good morning. I just wanted to ask you with regard to your net exposure to foreign currencies and if you could share a little bit about the UPS sensitivity to a potential 10% change in some of those currencies? Thanks.

Kurt Kuehn

Yes, we are actually pretty well hedged for 2014. So for the major currencies of the Euro, the Pound, the Canadian Dollar, we have got spreads in place pretty well with the floor not to far off where the markets are today and some upward potential. So that is a different story than last year. One area that presents some challenges though is some of these emerging market currencies are showing quite a bit of volatility. So that is a little bit of a risk to us but it is likely to be offset by the benefit in the developed markets that we are seeing.

Thomas Kim - Goldman Sachs

Okay. Thank you.

Operator

Our next question will come from the line of Scott Schneeberger of Oppenheimer. Please go ahead.

Scott Schneeberger - Oppenheimer

Thanks. Good morning. I just wanted to clarify what's implied in guidance specific to the U.S. domestic, you mentioned $125 million to $150 million added cost that is a weather, incremental hires, seasonal hires mix and the $50 million of service refunds and then I think you just answered, the $100 million is above that. So is what's implied in your guidance that you are going to have about the same seasonal staffing next year and just if we can hone in a little bit more on that, please? Thanks.

Scott Davis

No, we do not expect to have to hire that many people. I mean a part of that was the catch-up and the challenges of some of the unexpected volume. Looking at the peak for next year, there is one additional day in the period. Christmas as a day later. So the volume that builds up over the weekend in the late surge will be a little smoother. So, hopefully we do hire a lot of employees because of good robust demand but as I said, there is a point of reduced benefit as some of the stresses hit the network that caused us to hire more people than was optimal. So we would expect to have less hiring this year unless there is just incredible growth beyond the current expectations.

Scott Schneeberger - Oppenheimer

Thanks. And that increases predominantly, Orion, the $100 million?

Scott Davis

For the added cost for this year, you would see acceleration of Orion. It is some of the operating changes as we are automating buildings. It is a number of things. IT expense will also be involved as we make some investments especially collaborating with customers to get detailed package information even on trailers that haven't reached UPS yet. So it's a laundry list of things that we will be working on to enhance our capabilities and ultimately make us more productive and streamlined.

Scott Schneeberger - Oppenheimer

Okay. Thanks.

Operator

Our next question will come from the line of Allison Landry of Credit Suisse. Please go ahead.

Allison Landry - Credit Suisse

Thanks for taking my question. Based on the acceleration of the Orion rollout, is it fair to assume that you can complete the full implementation to all of the U.S. drivers by the end of 2015? And I was wondering if you could give us some broad parameters for how to think about the cost savings, once the initiative is fully rolled out? For example, you said, each driver was able to drive one less mile per day per year, what would that mean for annual cost savings? Just trying to get some broad strokes on that.

David Abney

Yes, the time line, and there will still be several more years that we will be ramping well through 2016 for the full rollout of Orion. It is a major undertaking. In general, as a ballpark number, saving a mile per day per driver generates about $50 million of reduced operating expense for the company. And as we get a little farther along then we will fill you in more on the very specific experience that we are seeing because we are getting better and better at doing it and the benefits are kicking in quicker. So this is a net investment year, though as we ramp up and next year will also be a year with significant velocity. So it's a little early for us to lock in on any specific external targets, but so far so good on that front.

Allison Landry - Credit Suisse

Thanks. Fantastic. Thank you.

Operator

The next question is from the line of Cleo Zagrean with Macquarie Capital. Please go ahead.

Cleo Zagrean - Macquarie Capital

Good morning. Could you please share some insight into freight forwarding? What happened this quarter versus the market and maybe make some of the comparison as to the outlook for '14. Thank you very much.

Scott Davis

Sure. I will have Jim talk about that.

Jim Barber

If you look at forwarding, a couple of quarters ago I talked about concentration in a couple of verticals as well as military. We said, we needed to change that obviously in a business like UPS doesn't change in a dime and so we take a prudent approach to that. We have worked through that in the last couple of quarters.

We feel like the first quarter, as the opening comments alluded to, will be the wraparound for us. Two-fold will be nice growth quarters for us in both, tonnage as well as revenue quality, so we have been working through this. I would say that on the international air freight side, but there's three other pieces to that business that we feel like are performing very nicely. That being the North American forwarding piece, the brokerage piece and our Ocean Freight business and we built for a couple of years, so we feel like we are turning the corner on it along with the small package side and you will see that the as each quarter rolls out in '14.

Cleo Zagrean - Macquarie Capital

Any specific guidance in terms of growth versus market? How do you expect your positioning to change compared to last year?

Jim Barber

Well, I would only say, the guidance we have put out is pretty solid and we will stick with that in each quarter. we will kind of update as we go.

Kurt Kuehn

Yes. We are looking for a mid single-digit revenue growth for the segment in aggregate and margins of about 8%, so we have got a lot of good stuff going on, the ocean is performing very well and we are helping customers find that balance of ocean and air forwarding, so that you should see more good stuff coming from that.

Cleo Zagrean - Macquarie Capital

Overall, the headwind from industry overcapacity, would you see that easing or how do you see it trend compared to last year.

Jim Barber

Yes. This is Jim. We have to move on. We have others on the line, so we are running out of a little time here, so we will save that for our individual call.

Operator

We have a question from the line of Jeff Kauffman with Buckingham Research. Please go ahead.

Jeff Kauffman - Buckingham Research

Thank you. I got a question on cash deployment. You basically have one times your EBITDA and debt on the books maybe a little less. Historically $6.5 billion is that the right amount of cash for you guys to keep on the books is probably closer to the $2 billion to $3 billion range?

I heard the answer, we are thinking of making some acquisitions, but the number of acquisitions I can think of that require that much cash is a very short list. Why aren't we thinking about continuing to share repurchase or continuing to plough more of this cash back to investors?

Scott Davis

Well, Jeff, we continue to talk about that, and the balance sheet we do show about $5 billion at year-end 2013, so we did deploy quite a bit of cash as we said over $6 billion to shareowner's last year. We will continue to look at that.

Clearly, we are here to do what's right for investors and customers and we will continue to look at that. We are basically fulfilling our commitment of returning at least 100% of net income to shareowners and the discussion of whether to accelerate when to accelerate that, that clearly is something that we talk about frequently, so for now we will keep doing what we said we would do and living up to our commitment, so you guys can anticipate and if there will likely be time to impress, we get even more aggressive.

Jeff Kauffman - Buckingham Research

Okay. Thank you.

Operator

I would like to turn the conference back over to Mr. Dolny.

Andy Dolny

Yes. I will turn it over to Scott for some closing comments.

Scott Davis

Thanks, Andy. Before we go, I want to just take a minute to recognize one of our team members who was participating on our final earnings call. Andy Dolny has announced his retirement after almost 32 years as a dedicated UPS-er. Those of you on the call have come to know him in his investor relations role over the last several years. And as I speak, the rest of our team, in thanking Andy for his wonderful service to our company, he keeps our meetings quite interesting and he always represents the investors' perspective well.

Andy, all of us around this table and obviously UPS will miss you and we thank you for your contribution. By the way, Andy will be in the office for next several weeks. I am sure he will be in touch with most of you before he leaves.

With that, thanks so much for listening to the call today and we will talk to you next quarter.

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