Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

United Parcel Service, Inc. (NYSE:UPS)

Q1 2014 Earnings Conference Call

April 24, 2013 08:30 AM ET

Executives

Joe Wilkinson - IR

Scott Davis - CEO

Kurt Kuehn - CFO

Jim Barber - SVP; President, UPS International

David Abney - COO, SVP

Alan Gershenhorn - SVP, Worldwide Sales, Marketing and Strategy

Analyst

Scott Schneeberger - Oppenheimer

Bill Greene - Morgan Stanley

Ken Hoexter - Merrill Lynch

Nate Brochmann - William Blair & Company

David Vernon - Sanford Bernstein

Scott Group - Wolfe Research

Brandon Oglenski - Barclays Capital

Chris Wetherbee - Citi

Allison Landry - Credit Suisse

Kevin Sterling - BB&T Capital Markets

Ben Hartford - Robert W. Baird & Co.

Thomas Kim - Goldman Sachs

Rob Salmon - Deutsche Bank

Keith Shoemaker - Morningstar

John Barnes - RBC Capital Markets

David Ross - Stifel Nicolaus

Kelly Dougherty - Macquarie Capital

Jack Atkins - Stephens Inc.

Helane Becker - Cowen & Co.

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 First quarter 2014 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 your host, Mr. Joe Wilkinson, Investor Relations Officer. Sir, the floor is yours.

Joe Wilkinson

Good morning and welcome to the UPS first quarter 2014 earnings call. Joining me today are Scott Davis, our CEO; and Kurt Kuehn, our CFO; along with Chief Operating Officer, David Abney, 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'll 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 2013 Form 10-K which is available on the UPS Investor Relations website and from the Securities and Exchange Commission.

Although there were no adjustments to first quarter 2014 results, there was an adjustment related to the attempted acquisition of TNT that increased first quarter 2013 diluted earnings per share by $0.04. As a result in our remarks today, all quarterly and full year comments and comparisons were referred 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 a reconciliation of free cash flow and adjusted results are available on the UPS Investor Relations website.

Before we review the details of the quarter I want to announce that we plan to hold an Investor Conference later this year. The 2014 UPS Investor Conference will be held at the Grand Hyatt Hotel in New York on November 13th. We look forward to updating you on our strategy, demonstrating our technology and sharing our plans for the future. You will be receiving a same day invitation soon with more details. And just as a reminder, as on previous calls please ask only one question so that we may allow as many as possible to participate.

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

Scott Davis

Thanks Joe. Welcome to your first call and good morning to everyone. UPS first quarter performance produced mixed results. International demonstrated strong volume growth and margin expansion and a 8% increase in export shipments. Supply chain and freight delivered results that were about as we expected, however our U.S. domestic segment fell short due to the unusually harsh weather during the first quarter.

We pride ourselves on being an all-weather company, but the intensity of this year’s winter storm season produced challenging conditions. Buildings across UPS network were forced to cease operations somewhere in the U.S. on 34 days during the quarter. These weather events not only led to increased cost but also influenced UPS product and customer mix contributing to lower yields. We saw business to business shipments slow as manufacturers, distributors and retailers closed shop.

On the other hand snowbound consumers took to the Internet to make their purchases. Clearly UPS results in the U.S. reflect both the loss revenue and the additional cost associated with these storms and Kurt will provide more details in just a moment.

While we are yet to see the first quarter U.S. GDP numbers, it’s safe to say that growth will be slower due to weather. The good news is that spring has arrived and we expect the pace of U.S. economic growth to pick up as 2014 progresses. In Europe the economy is showing signs of recovery and faster growth. Yet as the situation in Ukraine deteriorates, that pace may slow. Economic expansion in Asia has remained steady with mid single digit growth and in Latin America expectations call for increased merchandise exports. The economic benefit of global trade is clearly visible in both established and emerging economies. Trade per modes economic expansion creates jobs, makes companies more competitive and lowers prices for consumers.

Congress now needs to act to pass a trade promotion authority bill or TPA that supports economic growth in job creations in the U.S. TPA gives the administration authority to pursue trade agreements that meet objectives laid out by Congress. We strongly encourage swift passage of TPA as there are currently three important trade packs pending that provide real economic benefits and TPA will clearly increase their chances of success. The expansion of global trade is an important catalyst to the UPS growth strategy. Recently our management and board of directors conducted detailed review of UPS’ long term strategic initiatives and identified key opportunities that bring long term value to both customers and shareowners. The updates we received were encouraging. UPS is on the right path to ensure that our solutions meet the ever changing needs of the marketplace. We will continue to stay focused on providing industry specific solutions as we invest in our healthcare capabilities and develop omni-channel solutions for the retail industry.

In addition we review the implementation of the operational technology projects or ORION and Hub Automation. On the international front Jim Barber will bring you up today this morning on how we’re expanding the UPS global network in both developed and emerging economies as well as what we’re doing to serve end consumers around the world.

In support of our healthcare strategy UPS announced several investments during the quarter including the acquisition of Polar Speed. This addition to our global healthcare network will provide improved access to the important UK market as well as unique cold chain transportation capabilities.

Also UPS opened new healthcare distribution facilities in Canada and Mexico and thus plan to expand with additional facilities in Brazil and Chile later this year, further increasing our capabilities in Latin America. Adding to these industry specific solutions, we've expanded our distribution network in North America for retail and manufacturing clients. These investments add almost 500,000 square feet to our footprint at three key distribution sites in Kentucky, California and Alberta, Canada.

Now before I turn it over to Kurt, I want to give you a quick update on what we’ve been doing regarding peak season. During the last couple of months we have met with UPS’ largest customers. We are working collectively to improve forecast and accuracy, increase visibility of shipments and improve mutual planning capabilities. Our shared goal is to enhance the end consumers’ experience. In addition, David Abney and his team are on track with the system changes, facility automation and capacity enhancements we discussed last quarter.

These improvements will provide better flexibility of peak and will deliver service and productivity gains throughout the year. As we continue to implement these enhancements, we’ll keep you updated on our progress.

Now Kurt will take you through the details of the quarter.

Kurt Kuehn

Well thanks Scott and good morning every one. Our goal today is not to make this call all about weather but unfortunately it did significantly weigh on earnings. So we’ll have to spend a minute or two talking about it. The difficult weather environment this quarter created severe operational challenge that increased cost and also pressured demand. Unfortunately due to our diversified portfolio, weather is not the only story. Most notably we’re encouraged by the strong momentum in international and the positive results in the supply chain and trade segment. We expect both of these to continue.

Now let’s review the segment results. Our U.S. domestic operating profit was 927 million down 158 million with margin contracting 220 basis points. Clearly the impact of weather was reflected in the bottom line. We estimate that the profitability was lowered by almost $200 million. This includes the additional expense from loss productivity, snow removal, increased utilities, in addition it was a drag on revenue due to perishable demand and increased service refunds.

UPS experienced service disruptions in the network on more than half of the operating days in the quarter, materially increasing network costs as we attempted to navigate around the many storms. For example, a substantial rise in the number of delayed trailers slowed network operations and pushed direct labor hours up 5.4% including a 20% increase in overtime.

U.S. domestic revenue increased 2.6% to $8.5 billion. We were encouraged to see strong demand in the U.S. as daily volume was up 4.2%. Ground products were up 4.4% driven by SurePost, which grew more than 50%.

UPS deferred products grew 6.3% and Next Day Air was 1.5% higher due to increases in Next Day Air Saver package. B2C shipping contributed broadly to gains across all products, while B2B improved slightly primarily from ecommerce including omni-channel customers. Average revenue per package declined by 1.5%, days rate increases were more than offset by changes in customer and product mix slightly lower fuel surcharges and weather also contributed to yield declines.

Couple of interesting things we noticed. Customer mix shifted a bit as large accounts were able to more effectively manage around storms. Also B2B volume was clearly reduced by weather events whereas in contrast B2C growth remained robust as consumers were able to continue shopping online, pushing our residential delivery mix to almost 44%.

Next, the international segment results. We are encouraged by the positive business trends we’re seeing especially in Europe. UPS international revenue was up 5% to $3.1 billion. Operating profit increased 12% and operating margin expanded 90 basis points to 14%. Over the last several quarters, we’ve been making adjustments to optimize network efficiencies. These improvements coupled with the increased shipments contributed to margin expansion during the quarter. Our international export volume was 7.7% higher, with Europe leading the way with growth to all regions of the world. Strong demand for UPS transporter products increased intra-European exports by more than 15%.

Non-U.S. domestic volume jumped more than 8% led by Germany, Poland, The UK and Canada. Export yields on a currency neutral basis were down 3.2% negatively impacted by shorter trade lanes and changing product mix as non-premium products grew by 13% with premium up 4%.

Looking now at supply chain and trade, operating profit was up 3.5% to $148 million led by the forwarding and distribution business units. Operating margin expanded 30 basis points to 6.8%. In forwarding, shipments and tonnage increased while market conditions drove revenue per kilo lower. The ocean forwarding and brokerage businesses both experienced solid revenue gains and improved profitability. The distribution unit continued to expand its footprint with the facility openings that Scott mentioned earlier. The retail and healthcare sectors combined to produce mid-single digit revenue growth. Operating margin expanded 80 basis points to 9% despite the expansion cost. UPS freight saw both pressure on demand and higher operating cost due to weather. Revenue was up slightly due to a 3% improvement in LTL revenue per 100 weight that was offset by a 2% tonnage decline. Operating profit was lowered by increased network cost associated with the difficult conditions.

Looking now at cash in our balance sheet, the ability to generate free cash flow on a consistent basis is a hallmark of UPS. This quarter, UPS once again had a conversion rate well in excess of 100% generating 1.9 billion in cash. Capital expenditures were about 320 million. The pace of investment will accelerate as the year progresses. We expect capital expenditures to reach 2.5 billion for 2014, many of the network enhancements and operational technology projects will ramp up during the second and third quarters. Regarding share under our distributions, UPS paid 596 million in dividends reflecting the 8.1% increase announced by the board in February. In addition, the company repurchased 6.8 million shares for approximately $660 million.

On the labor front, we are pleased with the progress that’s been made and while we’ve not yet received final word from the Teamsters we feel it’s an appropriate time to share with you some key elements of the new agreement. A detailed presentation will be made available on the IR website upon implementation of the contract. The new agreement includes reasonable wage and benefit increases as well as flexibilities that will improve service and profitability. UPS has devoted substantial time and effort working to help the Teamsters better understand our cost structures and the changes needed to provide attractive benefits in the future while remaining competitive in the industry.

Sponsorship of healthcare plans has become expensive largely due to high healthcare inflation trends and legislation like the Affordable Care Act. After much evaluation, we determine that the best path for UPS was to move our union employees to multiemployer healthcare plans. In simple terms, UPS is moving from a defined healthcare benefit plan to a defined contribution environment with the contribution set for the duration of the contract. Once the new contract is implemented, the responsibility for proving medical coverage will be assumed by Teamster plans.

As a part of this settlement UPS will also remove existing post-retirement healthcare liabilities from our balance sheet. This obligation for future retirees as well as ongoing coverage for active employees will become the responsibility of the multi-employer plans. When we transfer this liability to the Union, UPS expects to make a significant cash payment to these plans and record a one-time charge. As I said, more details will come in the future when the contract is finalized.

Looking now at our expectations for the rest of the year. While we took a hit in the first quarter our expectation for the remainder of the year are unchanged. In U.S. domestic, we still anticipate operating margin of approximately 14% for the remainder of the year. We expect a little higher package growth somewhere between 4% and 5% resulting from the gains in UPS share post.

Looking more closely at the quarters, as we discussed back in January we will be incurring at least 100 million in extra operating expense. This expense is related to network and systems enhancements as well as the accelerated deployment of ORION. The lion's share of this expense will weigh on the second and third quarters by about $0.02 to $0.03 each.

Our expectations for international and the supply chain and freight segments remain unchanged. So overall we are encouraged by the positive trends we’ve seen across the business and anticipate the remaining three quarters to perform as we originally guided. However, due to the challenging start to 2014, we expect to be at the low end of our earnings per share guidance range of $5.05 to $5.30.

Now Jim will take you through our international business.

Jim Barber

Thanks Kurt. I would like to take a few minutes to update you on the key components of our international strategy and the positive momentum we are experiencing. The international segment delivered our best volume growth since the third quarter 2010 up almost 8% per day. This growth combined with our network and operating efficiencies drove our industry leading margin to 14%.

As we look at the business around the world, UPS experienced high growth in many developed economies during the first quarter. For instance, in large European markets like Germany, The UK, France and Spain exports were up more than 17%. Meanwhile large Asian markets like Hong Kong and Japan saw export growth of more than 6%. We continued to align our networks to market conditions and regional trade patterns.

Europe has been the foundation for UPS international investment and growth. Our customers continue to value the capabilities and solutions that we provide to support the single market economy. One of the most rewarding components of our Europe growth is to see the success of our recent acquisitions. Some examples of that success are Turkey with revenue up 18%, the UK was up 11% and Poland was 15% higher. UPS operational methods and systems facilitated the successful integrations of these key acquisitions.

Our intra-Europe air and ground networks are proving attractive to customers looking to optimize their supply chains. We recently invested $200 million in the UPS Europe air network with the expansion of our Cologne Air Hub. This increased our sort capacity by 70% coupled with state of the art securities screening and improved our air and ground network performance.

The value of our extensive ground network in Europe was also evident. As cross border shipments were up 15% in the first quarter. Recent investments such as our Kiala acquisition and the UPS Access Point Rollout in Europe are further strengthening our ecommerce proposition escalating our ability to serve the end consumer around the world.

UPS My Choice continued to be a great success in the U.S. As part of our global retail strategy we are evaluating expansion opportunities for this end consumer solution in markets around the world.

In 2012 we changed how we interact with our middle market customers across our international business. We understand our needs better and are tailoring industry specific solutions that add value for them. This initiative is paying dividends as we achieved double-digit gains in four important verticals; retail, healthcare, industrial and automotive. UPS capabilities and solutions resonate well in these verticals, giving us confidence of recent trends are sustainable.

Emerging markets are the next logical step in the UPS international expansion strategy and will contribute to growth as we enhance our capabilities in these underserved markets. We are in the early stages of the UPS emerging market strategy. The realignment of the international business units is allowing us to concentrate our efforts and leadership teams in these developing economies. As we progress we will keep you updated.

In closing, I am proud of the dedication and hard work of UPS' around the world that produce these results. In fact I see our most important competitive advantage as the UPS culture and how it integrates with local communities in our diversified portfolio. No matter where I go, UPS people speak the language of dedication and commitment to exceeding our customer expectations.

Thanks, now I’ll turn it back to you Kurt.

Kurt Kuehn

Thanks Jim and we look forward to lot of great future events in the international segment.

Operator we’ll turn it back over to you then to open up the lines.

Question-and-Answer Session

Operator

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

Scott Schneeberger - Oppenheimer

I trust the weather and the guidance first off here. You’re maintaining that you can hit the low end of the previously stated guidance range, despite the tough first quarter. I am just curious what are the two or three main drivers that give you confidence, you mentioned some strong package growth in SurePost, but just the two or three broadly that you think will help you and may be some trends here into the second quarter that support your confidence in those. Thanks.

Scott Davis

Yeah Scott it has been a challenging time and our operations people in the U.S. faced clearly extraordinary conditions and really storm after storm and as you heard, over half the days we had some significant network operations with facilities shut down. So it was a very tough quarter.

Beneath that though we do feel that the initiatives we’ve rolled out in the core momentum of the company is continuing steadily. So if you peel away that exclusion basically our guidance remains unchanged. We’re seeing a little better volume on the light weight side and the operations now that skies have cleared have worked a little better. So Myron may be you could talk a little bit how you guys I guess survived Q1 and the momentum coming into Q2.

Myron Gray

Scott and Kurt both have alluded to in their opening comments on 34 of the 63 operating days in the quarter, we experienced severe weather conditions prompting many of the governors in the States that were effected to issue a level three emergency condition that prohibited us from working.

We also saw a tremendous uptick in the number of trailers that were impacted by weather rising over 400%. As the result of it, our direct labor hours as well as overtime expense went up significantly. Overtime hours were impacted by more than 20%, I don’t think there is a person in the country who is more happy about seeing spring weather return and as a result of it in April, both our productivity and service has returned to normal level. So as Kurt has alluded to you, we don’t see an issue moving forward.

Scott Davis

Can I just the macro-economic environment looks decent as we move forward. I think the both the global GDP and U.S. GDP will be a little better than they were last year, not robust, but better than they were a year ago. And what excites me is I think we’re going to see all three segments producing good growth. We saw international, we saw supply chain and freight accomplish what they’re supposed to in the first quarter, that momentum is going forward. In domestic we saw (currency) [ph] improvement in to the March and we’re seeing it in April, so we feel very good about the 14% margins in domestic.

Operator

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

Bill Greene - Morgan Stanley

Good morning. Thanks for taking the question. Kurt and Scott I am curious if you can talk a little bit about pricing. Scott, given the comments you just made about GDP and given the experience in the fourth quarter where we kind of ran out capacity which seemed to me we’ve got maybe an increasingly positive backdrop for pushing harder on price. Can you talk a little bit about how you think about that and are we entering a period where may be pricing gets a bit better?

Scott Davis

Well, we do think that pricing is very stable and I’ll have Alan talk about it little bit. Clearly the significant change in our mix does mask what we think is a core base rate pricing of about 2% plus or minus. And so with the substantial mix shift, it’s made it hard to see but we feel pretty good that we’re making investments and we’ll be compensated fairly for it. So, Alan may be you could expand a little bit on pricing.

Alan Gershenhorn

Yes I mean I would just add that the base rate increases of about 2% we’ve been experiencing for quite some time certainly masked by customer and product mix changes that were certainly exacerbated by some of the weather trends that Kurt alluded to in the opening comments. As far as peak season goes, our goal is to ensure we are properly compensated based on our customer shipping characteristics and also their seasonal patterns. And we’re certainly working with each customer and their specific contracts on an individual basis to make sure that we’re compensated fairly for this services that we’re providing.

Operator

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

Ken Hoexter - Merrill Lynch

Great. Good morning. If I can just follow up on that, the pricing commentary there, may be just get a little bit more specific on that. Do you plan to use price to then adjust behavior in terms of getting it away from the December 23rd kind of peak day and kind of may be shifting the behavior a little earlier to help the network and I guess following on that, what additional projects, it sounded like you’re things to accelerate shipments. It may be some more automation, can you may be dig into that a little bit in terms of where the 100 million and 500 million of investments are going?

Scott Davis

Ken I’ll take your first question anyway and I’ll let Alan expand a little bit on our real priority with customers. Our top priority this year is to provide superior service and quality operations to help our customers succeed during peak season. So we’ll talk a little more in the future about the network enhancements. But Alan this is not the new, you guys work with customers and plan operation specifically peak season and use both price and strategy to manage it, right?

Alan Gershenhorn

Yes, so just to add a little bit of color on that. We’ve met with all of our major and certainly our largest customers to increase the collaboration, very-very productive meetings that we’ve had, we’re working on improving mutual planning capabilities with obviously the ultimate goal of enhancing their end consumers' customer experience. Working on areas with these customers splits, bypasses, direct ships, late multiple, we can pick up special operating plans and then we’re obviously communication the plans that we’re working on unilaterally in the areas of forecasting, capacity planning, visibility and communication.

Scott Davis

And Ken I'll just add there, pretty much all options are still on the table, it’s early in the process. We said last quarter, we really want to be able to meet customer expectations, but also meet our financial objectives at peak. So, we’re still evaluating alternatives out there.

Operator

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

Nate Brochmann - William Blair & Company

Yes, good morning everyone. I wanted to talk a little bit about may be some of the network adjustments that you’re making in terms of as you’re getting more of the SurePost revenue, one of the benefits of the ground network had been getting the better density on that local delivery on the B2C type front and if more shifting over the SurePost which is probably great for the overall network in terms of the revenue streams, but like you had to do on the international side, are you having to make any network adjustments because of that falling in to SurePost and then secondarily to that and I know it’s probably too early to talk specifics, but does the new contract for the Teamsters give you a better flexibility to may be handle more SurePost away from the direct ground business? Thank you.

Scott Davis

I’ll take the Teamster question, I guess the contract question first and we’ll move over to probably David. The news just broke last night on this contract being ratified. We have not yet been formally notified by the teamsters. Once we get formal notifications as Kurt said, we will do a webcast of the details of the contract, so really do want to get into the flexibilities of the cost until we get the formal notification which hopefully is coming soon.

David Abney

Okay, as far as the changes in the system and effects that it could have by additional SurePost, really it’s the same technology that we use in the rest of our business, certainly helps us here. So SurePost redirect is about as good an example as you can have and how our technology allows us to accommodate this change.

So very late in the process, we can determine if there are additional packages going to the same stop and then we can redirect that and then we will actually deliver it. It will be much cheaper than tendering it to the post office. If it’s a single package, then we would do just the opposite, let it go ahead and flow. There is other, the technology where we can scan and make those decisions in the automation that we have placed in our hubs, we also have in our preloads. So yes, we see a change in the types of packages and the flow of the packages but we certainly have the automation and we certainly have the technology to adjust to that.

Scott Davis

Yes I guess may be one high level recap on that is that the goal for us is to make the investments to get our variable cost down extremely low and these packages drive very little capital and low operating expenses they flow through our automated system, so we’re confident that we understand the operational changes and we’re making the investments to be able to profit off of this growth for a long time.

Operator

Our next question comes from the line of Mr. David Vernon of Sanford Bernstein. Please go ahead.

David Vernon - Sanford Bernstein

Good morning and thanks for taking the question. Could you give us a little bit of an update on the rollout of the ORION system and may be talk at the micro level about what types of sort of productivity impact this is having in terms of [indiscernible] an hour or any type of metric that can give us some better sense for how impactful this rollout can be going forward?

Scott Davis

Right, well other than the fact that we have in some of our (ORION) [ph] people out in three feet of snow trying to chart out route, so I think it’s moving pretty well. Myron what do you think?

Myron Gray

David we’re certainly encouraged by the results that we've seeing thus far and as we alluded to in the first -- in last call, we certainly added 200 resources to help us with our implementation. To-date only approximately 20% of our drivers have been implemented, we will expect that to approach nearly 45% by year’s end but it’s too early to give you any numbers at this point even though we’re encouraged and at the November investors conference, I think we will have more information to divulge to you

Scott Davis

But we’re very encouraged by the progress we’re seeing so far and as Myron said in November we’ll probably give you the metrics.

Operator

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

Scott Group - Wolfe Research

So wanted to ask a little bit about the buyback and if there if you see some flexibility now that the teamsters’ contract is about to get approved to ramp that up and may be do you feel comfortable putting some broad numbers in terms of the payment to the multi-employer plans and then as debt comes off the balance sheet, is that an important metric you look at or consider when you think about how much stock you do want to buyback?

Scott Davis

Okay, Scott I’ll try to piece all that together into one question I guess. No, our capital distribution policy, we guided this year of repurchasing 2.7 billion in stock you can see that we’re well along the way on that in the first quarter and the increased dividend, so the settlement of the contract is not a material impact on our capital policies. We remain very strong on free cash flow and we’ll distribute accordingly. We’ll be sharing a lot more information on the migration of the retiree healthcare liability off our balance sheet and are always looking for ways to use our low cost to capital and our quality balance sheet to minimize volatility and improve returns, so this is no different.

Kurt Kuehn

And that those information will be forthcoming soon. If the reports are accurate from last night we should have the information hopefully in a couple of days and share that with you. I guess the one thing I'd add Scott is, is even though obviously net income was impacted dramatically by the weather, our cash flow gain was extraordinary in the first quarter of over 1.9 billion in free cash flow. So, we’ll obviously consider that in our decisions going forward.

Operator

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

Brandon Oglenski - Barclays Capital

Good morning everyone. Kurt or Jim, I want to talk little bit about international margins, because I know there is a lot of moving pieces this year and you did have a good outcome in the first quarter year on year, but the comps get a little bit more difficult in the second and fourth quarter. So what are some of your assumptions around margin improvement for the remainder of the year, are you assuming sequential demand improvement and yield improvement, can you talk a little bit more about that?

Kurt Kuehn

Yes, we have guided to profits growing 12% to 14% this year, clearly they’re off to a good start, so I think you’ll continue to see improvements and hopefully you got to sense that we do think that things are moving well. So, Jim may be you could expand a little on some of your guys' results and outlook.

Jim Barber

Yes so Brandon obviously the comments in the opening gave some framework to it. I think that we should keep in mind that international, we keep talking about momentum. This is really the fifth quarter in a row, it’s come up. I think we have to also keep in mind it’s been a year since the (TNT) [ph] situation ended, I must put that way. And the business itself has really kind of gotten back to the basics of what we’re supposed to do, you can see that. And so the leadership teams are in good place right now and I think the other comment I would tell you is, we’ve also looked at the international business and not only investing today what you’re seeing today but in some of the guidance, some of the emerging market investment, the teams are restructuring this coming forward. So we’re actually I think in a very good place internationally and all the confidence in the world to the guidance we've given you so far.

Operator

And we have a question from the line of Mr. Chris Wetherbee of Citi. Please go ahead.

Chris Wetherbee - Citi

Just following up on the international question, when you think about sort of this re-acceleration of volumes that we’re seeing particularly in Europe. Does it bring to the table any more opportunity to start thinking a bit more about price, it seems like sort of the underlying base rates are still pretty good, just getting a rough sense though of how maybe there could be some leverage there. This is more going to be a sort of volume opportunity as you look forward over the course of the next couple of quarters.

Scott Davis

Yes, well not all volumes are created equally and I think that Jim maybe you can expand a little bit on our focus there.

Jim Barber

Yes, a couple of things that are also going on, I think that to recognize certainly in Europe, the supply chains are moving too, they don’t remain static. So some of the big supply chains around the world the customers are trying to optimize their networks, we work with them to do that, so the zones move, the distribution patterns move, so our trans-border growth in Europe, a lot of that was to support moving distribution patterns that shorten up zone, that affects the yield of the package, but our job is to create the margins in the new networks. So we’re very comfortable with that.

I also made an opening comment that I think is important which is our middle market acceleration we’ve seen in last couple of quarters and we really haven’t seen this in the past as our middle market is now outpacing some of our larger gold enterprise accounts. And then the other thing that’s going on I think of material nature is the high-tech industry and those product launches have kind of laid down. So in the middle of all that, some of internal optimization investments seem to be paying dividends and what they’ll move forward and we’ll leverage all that together.

Scott Davis

What encouraging Jim in that quarter too is while we still saw the slower products grow at double-digit pace, we still saw express grow at 4% to 5% pace internationally which is a good sign to see express markets still growing.

Operator

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

Allison Landry - Credit Suisse

I wanted to ask about growth in Europe and specifically the strength that you’ve seen in the Pan European business. Can you give us a sense of the contribution of this segment to international profit margins and returns on invested capital? And do you think Europe as a whole will be able to achieve margins that are similar to the U.S. at some point?

Kurt Kuehn

Yes, as you know, we don’t breakdown margins specifically by area of the world. But clearly the international business has been a great business for us and Europe is our flagship over half of our revenues are European based. So we want to get into more detail, but we do think Europe’s here to stay and that the business model Jim, that you’re managing is in pretty good shape.

Jim Barber

Yes, I think the underpinning as Kurt said I think margins by product will keep away from. I think it’s more about the network and its capability to react to the market, the single market that’s there today and we’ve been building that effectively from my perspective since about ‘96. And it’s in great shape and we continue invest in it and we’re very happy with the returns on capital and we’ll keep investing where that makes sense for us and for our customers.

Kurt Kuehn

That’s absolutely right. I think the European networks are built a lot like the U.S. network and we’re getting excellent returns on invested capital in that network.

Operator

And we have a question from the line of Mr. Kevin Sterling of BB&T Capital Markets. Please go ahead sir.

Kevin Sterling - BB&T Capital Markets

Just kind of dive in and maybe taking a different look at international. You talked about the strength we saw in the first quarter. I think, it sounds like April’s off to a good start. I think you also said there is an improvement in your (forwarding) [ph] business on a net revenue basis. And you could about a little bit what’s going on there? Is that just kind of strength you’re seeing in the overall international economy? Or maybe you’re getting some market share gains there as well?

Scott Davis

So as the opening comments alluded too, yes we are. Tonnage is up, we know that, the yield is really kind of still pressured. And when I say that, what I mean is, a few quarters ago I talked about concentration in hi-tech in military and making sure that we try to diversify through that. The team is doing good job with respect to that in some lanes the markets still are tough to actually get the buy sell jokes right. We’re very, very happy with the ocean product, with the brokerage product, with a North American air freight products. So we’re just -- we’re very focused on and have some projects in the pipeline right now that kind of get up that air freight so we continue the momentum there. So we feel like we’re hitting on three of the four cylinders with the fourth one being worked on in a pretty good way right now.

Operator

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

Ben Hartford - Robert W. Baird & Co.

So, I think Scott had said that the international outlook was more or less unchanged, the total volume growth in the quarter up 8% above I think the target that you had provided for the beginning -- for the full year 4% to 6%. I am wondering if we should expect that rate of growth to decelerate through the year to converge towards that target. And then I am also, in conjunction with that, can you provide any context to how you see the growth between non-premium and premium products trending through the year as well? Thanks.

Scott Davis

Yes great couple of pieces there, but I think we did show very strong growth in the first quarter, but surprised us to positive just a little bit. There is a little bit of a benefit of the Easter timing I think in the first quarter. Easter was right at the break between Q1 and Q2 last year so there may be a little extra beef in Q1 that would put a little drag on Q2. As far as the trends on premium versus standard, I’ll let Jim talk to that little bit.

Jim Barber

Yes I think again I think as I mentioned a minute ago, four-five quarters of growth and I would combine that with the acquisition comment I made in the opening in the UK’s and the Poland’s and the Turkey markets for example. A lot of this is from good solid growth in the domestic product now four-five quarters in a row so you start to get lapping yourself quite frankly from that perspective. Therefore the end of the year looks a little bit different than the first, but we keep talking about that in a momentum basis. So, what that kind of outlook that you see on paper is certainly, we want to focus on the export and then combining that with the domestics in the markets where we currently are will in the future have the great capabilities.

Operator

And we have a question from the line of Thomas Kim of Goldman Sachs. Please go ahead.

Thomas Kim - Goldman Sachs

I had a couple questions just related to the Europe part, one was just, can you parse out the organic growth related to Europe, if you were able to parse out the harvesting of the recent investments.

And then I guess just one of the other sort of comments or questions is, wondering if you could elaborate on the mix shift change that’s happened in Europe where your non-premium is growing more than premium and should we be thinking about that mix shift change similar to the way that we’ve been seeing it sort of evolve over in Asia where you’ve had increase in deferred impacting the overall mix and pricing? Thanks.

Kurt Kuehn

Yes let me piece the parts of that so I can combine for you here. First off the issue of the organic is everything is organic right now. The acquisitions were several years ago, so there is no material acquisitions above all, really the only notable acquisition is in the healthcare space and that did not impact the results at all. The whole issue of managing the mix changes, it makes a big difference if it’s -- that you’re seeing trade down against the same asset. That’s been the challenge in Asia where you’ve gone from express to slower modes and if you don’t adapt, then you’re stuck with lower revenue on a fixed asset.

But the whole nature of the UPS network is to allow customers to move up and down and I’ll tell you there is a huge difference in capital employed between a package moving from Asia to Europe in a 747 versus a package moving across Europe in our integrated ground network. So the capital required and the returns are substantially different and so we’re very happy to see robust growth through our integrated network.

And then to Jim’s point, as we grow the domestic business, what that does is it lowers the pickup and delivery cost for all products. So that’s the benefit of the portfolio that these products reinforce themselves and we get both economy of scale as we get bigger in each country and economy of scope as we have complementary product. So as Scott said, Europe is very much following the lessons we’ve learned from the U.S. capital returns and investment and we’re happy to get standard volume there or premium.

Operator

Our next question will come from the line of Rob Salmon of Deutsche Bank. Please go ahead.

Rob Salmon - Deutsche Bank

Good morning. Thanks for taking my question. Kurt a quick housekeeping item can you give us a sense if the new Teamster contract is incorporated into the current guidance because it’s not yet finalized and then Jim two quick follow ups with regard to the European network. With the stronger than expected growth that we’ve been seeing to-date, are there any sort of necessary incremental capital investments within the ground network and can you talk a little bit about the density within your line haul network in Europe and how that compares to U.S. currently? Thanks.

Kurt Kuehn

Okay Teamster I’ll break ranks and answer two questions because the answer to the first one is one word, and that is yes in our guidance. Jim may be you could talk about the capital expansion for Europe and whether it’s material.

Jim Barber

Yes so I would say that certainly in the network today, part of the ongoing process and numbers we give you every year the capital is in there, but I would also say yes to the question is we have to keep investing in that network. We talked about Cologne today but our big hubs in Germany and the UK, we’re investing in Turkey hubs as we speak, so yes there is continued capital requirements, but again that’s all baked into the overall network and bringing the customers in that they choose the network. So we’re very, very comfortable with that.

As far as density and line haul network question, the really different networks to be honest with you, the way we run the networks European wise versus U.S. is the different and the mix of the carriers and how we actually take those products across the single market in the UPS or Partnership or contractors is different, so you really can’t compare the two networks from my perspective, but again I think the networks in Europe are performing across the business beautifully and they’ll continue to do so.

Kurt Kuehn

Yes I guess one comment on Europe that clearly we cycled through this as the one year anniversary of us bidding good bye to the attempt to purchase TNT. During the period of negotiation and work with TNT, we clearly put some projects on hold, both strategic projects and opportunities and also capital expansion until we were sure how we’d optimize new assets. So, we certainly are in a period right now of to some extent facing the next five years with an aggressive organic approach. And we are thrilled to make investments to grow our integrated ground network in Europe.

Operator

And we have a question from the line of Keith Shoemaker of Morningstar. Please go ahead.

Keith Shoemaker - Morningstar

Yes, a quick follow up on the capital investment. Given the growth in Europe and the mixed realized, do you anticipate making adjustments to the air fleet or is this what you needed for now?

Kurt Kuehn

No the air fleet is in great shape, as we said, David in the airline finished purchasing 767s last year and David, I think at least as far as the foreseeable future, we don’t expect any major capital additions.

David Abney

No we don’t have any plans to buy any aircraft in the next few years. We have of course been able to increase our load factor and the biggest focus is just on improving the quality of the revenue that’s in our aircraft and with the fact that our expedited volume has grown, has given us a lot of flexibilities on how do we actually put that our aircraft, do we do something else with it or do we hold it for a day to more fully utilize the aircraft. So it’s giving us lot of flexibility.

Jim Barber

And this is Jim, I would add one comment to it parallel to the opening comments is the network in Europe as an intra-European fleet is in great shape as everybody is saying. The real -- the fun part of this right now given where we are is through the emerging markets is to adapt and connect it globally across world in a different way and the teams are working on that and as we go forward that would probably be likely where the adaptations come to the network to connect to the European network versus changing the core of it.

Operator

We have a question from the line of John Barnes of RBC Capital Markets. Please go ahead.

John Barnes - RBC Capital Markets

Just trying to keep track of the kind of investment that you were talking about in terms of being prepared for peak season and understanding that when you look at not in the next 10 years have been normal days in Thanksgiving and Christmas not the compressed period. Just trying to get a sense of what percentage of the investment is being made with capital dollars to address network, maybe deficiencies on a long-term basis versus what percentage may be, you're going to address using operating dollars, might be for temporary employees or something like that. How are you trying to balance that investment?

Kurt Kuehn

I’ll start off and then David can fill you may be on the status of it. We’ve really quoted a couple of numbers; one that we’re expanding our capital investments in general broadly to expand capacity in the U.S. and automate facilities. Those are long-term investments that stand regardless of the peak issue. The other is we are doing some things on the technology side, on the customer alignment side and on the flexible capacity side and that’s really driving that 100 million expense headwind this year, that’s more of a one-time issue. And Dave maybe you could expand a little.

David Abney

Certainly well, our peak planning committee has been focusing all this year made solid progress. And when it comes to capacity we are taking two approaches. The permanent capacity will help us throughout the years and Kurt referred to that a little bit but the North Bay Automation retrofit project is an example of that. We’re also increasing the capacity of CACH, our Chicago Consolidated Hub and we’re also adding some trailer capability in Worldport, both from an unload and a load standpoint.

But then the other thing we’re doing is temporary what we call mobile capacity, that we can move from peak to peak, from building to building. And it’s adding, we’re going to add nearly 10% car positions this year, it’s over 6,000 car positions. And in general we call mobile distribution units and these will be addressing specific temporary needs. But if those needs change next year, we'll just simply move that capability from year-to-year.

Operator

And we have a question from the line of Mr. David Ross of Stifel. Please go ahead.

David Ross - Stifel Nicolaus

Real quickly on the ground side, U.S. domestic ground volumes ex-SmartPost, what do they grow year-over-year in the first quarter and how are they trending in April?

Scott Davis

They were up moderately and I think trends in April as we said once now that the weather has cleared continue very steadily, it’s why we feel pretty good on the U.S. economic outlook.

Operator

We have a question from the line of Kelly Dougherty of Macquarie. Please go ahead.

Kelly Dougherty - Macquarie Capital

I just wanted to follow up on the mix conversation. Should we think about these mix trends as secular trends that will accelerate or do we expect some kind of normalization if only from easier comps. And just wondering if you can give us a sense of what yields might look like after you incorporate your base rate increases and then what’s going on the mix side of things?

Scott Davis

Yes, there is a couple of big dimensions and I’ll let Alan talk a little bit about it. That some of them are cyclical and some of them are long-term trends, certainly the continuing growth of B2C both in the U.S. and globally is something that’s here to stay. But things like weight increasing or decreasing or near shoring versus far shoring are things that come and go a bit.

Kurt Kuehn

Yes, let me add a point before Alan gets in. It’s only the first quarter exaggerated though with the weather. And we hit commercial manufacturing harder than it hit obviously ecommerce, so what you saw in the first quarter was exaggerated.

Alan Gershenhorn

I think certainly the -- we’re going to continue to see strong residential growth and I think you’ll see it across all of our residential products whether its air, ground or SurePost as retailers are out there offering wide variety of services to their customers to meet the varying needs. Certainly these last few quarters, we’ve seen our commercial growth turned positive on the ground which is a good sign also. And I think that while there's certainly been a significant amount of down-trading in the marketplace, we believe that the express market will come back as the economy gets better and global trade increases.

Scott Davis

And we’re not uncomfortable with these trends. We still think for the last nine months of this year will generate 14% margins in the U.S. We did that really in 2012 in the first three quarters of 2013. So with our technologies, our network we could still generate good margins on B2C.

Kelly Dougherty - Macquarie Capital

Is there any way you think about once you incorporate mix, so what yield may look like?

Scott Davis

That’s a bit speculative for right now and we’ll move onto next question.

Thomas Kim - Goldman Sachs

Thanks.

Operator

And we have a question from the line of Jack Atkins of Stephens. Please go ahead.

Jack Atkins - Stephens Inc.

Good morning guys. Thanks for the time. So I guess focusing on the international airfreight side of things for a moment, trends thus far in 2014 seem to indicate they were seeing some modest sustained improvement there for the first time in a couple of years. So I guess could you comment on what do you think is really driving that. Is it a better global economic picture? Do you think maybe it’s inventory restocking or is this something else and do you feel like these trends are sustainable for 2014 and may be beyond?

Jim Barber

I would say was all of what you just mentioned plus one and that is that, that our customers don’t stay static with their supply chains and they move them and they’re trying to optimize their supply chains and they’re moving from small package at times to airfreight and airfreight to ocean and ocean to a domestic on another continent. So our job is to be ready for that and be one step or right in lock step with them, so that is -- and I think the other thing that you should keep in mind is that, that’s kind of the power of the UPS offering is we don’t run a pure freight network, it’s a hybrid and we’ve got a lot of options depending on how the customers choose to come to us. So there is a lot of factors going on and we just got to make sure we’re supportive of really the needs and the request of our customers.

Scott Davis

And I guess one of the nice things is, we did see and are seeing some rebound in exports out of Asia on the freight side, but Alan we’re also seeing quite a of strength south of the border, right?

Alan Gershenhorn

Yes, so on the U.S. Mexico lane there, we’ve launched on the package side a standard ground service to and from Mexico which on a small base right now is experiencing very, very significant growth on a percentage basis, so we’re really excited about that. We’ve got our cross border connect product on the freight side, that’s also experiencing good growth. And I would just add to Jim’s comment that, the portfolio that we’re positioning with our customers is also I think allowing us to penetrate the airfreight market in a bigger way and I think you’re going to see some broader gains in that area for us. And the other last thing I would just say is worldwide express freight we haven’t talked about today, that’s been launched I guess a little bit over a year ago now in a big way and we’re experiencing very, very high growth in that area again on a small base right now, but very well resonating with our customers.

Operator

And our next question will come from the line of Ms. Helane Becker of Cowen. Please go ahead.

Helane Becker - Cowen & Co.

Thanks very much operator. Thanks for the time. You might have talked about this and I just missed it, but can you just talk about why the tax rate went up so much in the first quarter on a year on year basis?

Scott Davis

Yes, Helane we did guide this year that we would be seeing an increase in the tax rate. We retched it up in the middle of last year from the (34 or 35) [ph] that we had in January of last year first quarter and it is now at 36. So we have seen an increase and this is the last quarter at which we’ll have this big of a gap, but it clearly was an increase that just has to do with the mix of profits around the world, our forwarding unit that struggled last year and some of those things impacted our marginal rate. So certainly there is no company more eager to see U.S. tax reform and some rebalancing of rates around the globe than us and we continue to make that a priority and are working with Washington to ensure that U.S. remains competitive.

Kurt Kuehn

Helane we did build the guidance in a 36%, so that was expected.

Helane Becker - Cowen & Co.

Right, well I figured you did that but I was just kind of wondering is 30.4% last year going into 6 I think this year, so, okay.

Kurt Kuehn

The 30.4, I’m sorry Helane, that was distorted because of the nature of the TNT settlement, some of the payments were taxable some weren't, but the core rate for last year on the adjusted is 34.5.

Operator

Due to time constraints our last question will come from the line of Mr. Jeff Kauffman of Buckingham. Please go ahead.

Jeff Kauffman - Buckingham Research

Thank you, and thank you for taking my question. Just wanted to touch base, the cash on the balance sheet's back over 7 billion. I know you mentioned it will cost you some money to exit these remaining pension liabilities. But could you talk a little bit about how much cash you think you need on the balance sheet, because this is almost double what it was at the bottom of the recession here, and just kind of longer-term thoughts on capital deployment.

Kurt Kuehn

Yes, and as Scott said, we had just a huge free cash flow quarter, in Q1 capital expenditures were little low, clearly it’s hard to build buildings in the blizzards. So we’ll ramp some of that up and use some of that cash for capital improvements Jeff, but we do expect to continue strong distributions, the company has no agenda to hoard cash. At the same time we like to have a strong balance sheet. So we’re going to continue with our basic targets of distributing near 100% of net income in the form of dividends and share repurchases and keep a little powder dry for M&A and other strategic initiatives.

Scott Davis

In Q1 Kurt, I think we distributed 140% net income, so Jeff it will be balance. We’ll continue the strong distributions, we’ll continue to reinvest in the business.

Operator

I would now like to turn the call back over to Mr. Wilkinson. Please go ahead sir.

Scott Davis

Well let me just -- this is Scott, I’ll do a quick recap. It was clearly the first quarter was a challenge, but again as we talked about the rest of 2014 looks quite promising. The economy though is still not robust, it’ll be better than what we saw last year, both here in the U.S. and globally. What I am excited about is the UPS we’re going to be hitting it on all cylinders as all three segments for business will show nice improvements in operating profit over the last nine months of this year. And frankly we’ve not seen all three segments improve at the same time since 2010. So look for good things ahead from UPS and thanks for being on the call today.

Operator

Ladies and gentlemen, it does conclude our conference call for today. On behalf of today’s panel, I’d like to thank you for your participation in today’s conference call and thank you for using AT&T. Have a wonderful day, you may disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: United Parcel Service's CEO Discusses Q1 2014 Results - Earnings Call Transcript
This Transcript
All Transcripts