United Parcel Service, Inc.

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 2019 earnings conference call. All lines have been placed on mute to prevent any background noise, and after the speaker's remarks, there will be a question and answer period. It is now my pleasure to turn the floor over to your host, Mr. Scott Childress, Investor Relations Officer. Sir, the floor is yours.

Good morning, and welcome to the UPS First Quarter 2019 Earnings Call. Joining me today are David Abney, our CEO, Richard Peretz, our CFO, along with Chief Operating Officer Jim Barber, Kate Gutman, our Chief Sales and Solutions Officer, our Chief Information and Engineering Officer, Juan Perez, and Scott Price, our Chief Strategy and Transformation Officer. Before we begin, I want to review the Safe Harbor language. Some of the comments we'll make today are forward-looking statements and address our expectations for the future performance or results of operation of our company. These statements are subject to risk and uncertainties, which are described in detail in our 2018 Form 10-K and other reports filed with the Securities and Exchange Commission. These reports are available on the UPS Investor Relations website and from the SEC. During the quarter, UPS recorded a pre-tax charge of $123 million, or 11 cents per share, on an after-tax basis. The charges resulted primarily from transformation-related activities. The webcast of today's call, along with a reconciliation of non-GAAP financial measures, are available on the UPS Investor Relations website. Unless stated otherwise, financial performance discussed today will refer to adjusted results. Webcast users can submit live questions during today's call. We will attempt to answer questions of a long-term strategic nature. Callers are asked to submit only one question so that we may allow as many as possible to participate. Thank you, and now we'll turn the call over to David.

Thanks, Scott, and good morning, everyone. Today I will share results from the first quarter and update you on our transformation partners. I will also discuss the strength it's building in our strategic growth imperatives and share our views on the external business environment. During the first quarter, we executed well on our strategies and are bending the cost curve, creating momentum for future quarters. All business units generated improved revenue quality and successfully executed cost management strategies while building on high levels of service. As our smart global logistics network becomes even more flexible, I'm pleased to say that we're achieving the efficiency goals we expected by automating more of our network. As we open new highly automated facilities, we remain confident that we will achieve our goal of 30 to 35% efficiency improvement when compared to more traditional buildings. With the progress we've made, we are reaffirming adjusted diluted EPS guidance in the range of 745 to 775 for 2019. Turning back to our results, we achieved another quarter of consolidated volume growth, generated high-quality revenue, and expanded network efficiencies for improved financial performance. Supply chain and freight delivered outstanding operating profit, highlighting the agility and power of our asset-light business models. International achieved record first quarter profit and increased volume, currency neutral revenue per piece, and operating margins. And the U.S. domestic segment generated improved revenue quality and grew average daily volume across all products led by our air services. More customers in retail and manufacturing are demanding faster delivery times. Building quality growth from SMB customers is one of our strategic growth imperatives. We continue to see solid yields led by customers in healthcare and those engaged through our digital marketing programs. In addition, returns with SMB grew by double digits, driven by strong holiday e-commerce returns that lasted into February and March. UPS is the industry leader with innovative return solutions that enable our customers to reduce complexity and deliver a positive customer experience. Looking forward, our aim with SMB is to anticipate and quickly respond to the changing needs of our customers, creating solutions that are easier to use, easier to understand, and quicker to implement will increase our share of high-quality volume and revenue from this key market. To that end, we've recently introduced UPS e-fulfillment. Our new platform gives more insight and control to SMB shippers selling across multiple marketplaces and web stores. Our solution allows them to streamline order fulfillment, inventory management, and UPS shipping. In the coming months, we plan to launch other new platforms and innovative solutions along the value chain to further grow SMB revenue. We continue to recalibrate our network to strengthen our market position in the fastest-growing economies around the world, which is another of our strategic growth imperatives. we see ongoing growth potential internationally with the middle market outpacing the enterprise segment, especially in B2B. As the trade environment changes, we regularly identify opportunities to adjust our network for increased efficiency and flexibility. For example, we recently announced the deployment of new aircraft, to service major trade routes between Hong Kong and Europe. These larger aircraft enable growth on this important trade lane and unlock greater efficiencies and capacity within our global network. Serving the needs of the healthcare industry is another important growth strategy for UPS. We are accelerating the launch of innovative solutions for the most complex and most urgent healthcare needs. We're particularly excited about our latest announcement. A few weeks ago, we made history with the first FAA-sanctioned use of a drone for revenue flights when UPS and our partner, Matternet, successfully delivered medical samples across the Wake Med Hospital campus in Raleigh, North Carolina. UPS continues to operate multiple daily drone deliveries at Wakeman, eliminating transit delays for time-sensitive medical samples. This solution opens the door for how drones can be used to improve transport services at hospitals and other large campuses around the world. Turning to the external business environment, Forecasts for global growth are not expected to be as strong as 2018. However, the economy is still growing and creating opportunities. We're seeing continued growth in areas of the world less affected by the trade relationship between the U.S. and China or by the uncertainty surrounding Brexit. The flexibility of our smart global logistics network is uniquely tailored to help customers adapt to changing trade dynamics, minimize supply chain disruptions, and deliver high-quality growth for UPS. Forecasts for the U.S. economy in 2019 remain in a growth mode, but at a slower pace. Importantly, consumer confidence continues to be strong, bolstered by a healthy job market and low inflation. But signs are mixed with industrial production forecasts to soften in the back half of the year. UPS is well positioned to benefit from consumer and macroeconomic trends as we are focused on attracting higher quality revenue and share growth. Our unmatched and diverse portfolio of services and increasingly agile network help our customers counterbalance the effects of macro trends. Before I close, I want to congratulate the 1,436 UPS drivers recently inducted into the UPS Circle of Honor. We now have more than 10,000 drivers that are accident-free for 25 years or more. Congratulations to each of you for your achievement, and thank you for your commitment to safe driving. UPS is on a structured path to enhance performance, create the future of the company, and take advantage of growth opportunities. We remain steadfast in successfully executing our transformation initiatives. We made great progress in 2018. 2019 is a year of continued transformative investment in facilities and technology in our smart global logistics network. which enable even greater efficiency. 2019 will also be a year of high-quality revenue growth as our transformation efforts will free up resources to gain share in the most attractive markets. Now, Richard will take you through our financial performance for the quarter.

Richard? Thanks, David, and good morning. Let's begin the first quarter call by talking about our strategies and initiatives that are driving additional network efficiency and flexibility and are having a positive impact on our revenue quality. We see additional opportunities for growth across the segments in all of our businesses, combining our expanded portfolio of services and flexible, integrated network to continue to deliver unmatched value to our customers. I'll begin with a summary of our consolidated performance and highlights from each of the segments. In the first quarter, our earnings per share was $1.39. This includes 23 cents of expected year-over-year headwinds we had previously guided. Additionally, we experienced an unexpected impact from severe weather of about 7 cents earnings per share. Considering this, performance of the U.S. domestic segment was just above our plans. We had good cost control in the quarter. and limited the increase in cost per piece growth to about 2.7%, including an impact of fuel of about 30 basis points. In addition, we made positive gains in revenue quality. International performance in this dynamic environment was strong. In fact, we expanded operating margins by improving currency neutral revenue yields and leveraging the flexibility of the network. Supply chain and freight outperformed our expectations with great execution that generated outstanding gains and operating profit. We achieved the highest first quarter profit in the segment's history. Now I'll turn to the segments and give you greater detail. In the U.S., weather impacted all three months of the quarter and was a drag on both the top line and the bottom line results. Nonetheless, volume and revenue for all products grew in the quarter. Average daily volume growth was led by the air services at nearly 8%. Total revenue quality improved on a year-over-year basis, driven by continued growth in B2B volume and gains from smaller customers that we targeted with digital engagement strategies. UPS ground revenue per piece increased almost 3%, driven by the balance of growth in B2B and B2C deliveries that we saw this quarter. While air volume was up, package characteristics, customer mix, and whether lowered revenue per piece yields. Overall, we continue to make progress in transitioning to a higher quality revenue mix from targeted growth industries like healthcare, manufacturing, and e-commerce. On the expense side, investments in our network are starting to pay off, reducing growth in expense compared to recent periods. As a result, the U.S. domestic segment achieved its lowest unit cost growth in many quarters. U.S. domestic operating profit was $694 million. We estimate that weather diminished this quarter's operating profit by about $80 million, impacting operating margin by about 70 basis points. We are making progress with our investments in the U.S. as the new automated facilities brought online in late 2018 delivered increased efficiency to the network. Now let's take a look at the international segments. We delivered strong profit results by facing headwinds from changes in global trade and significant prior year growth. International delivered its best first quarter operating profit of $612 million in part due to the efforts of managing costs tightly. High growth in export daily volume in the first quarter of last year created tough comparisons. On a two-year stack basis, international exports achieved volume growth of nearly 12% led by Europe and the Americas. Europe's growth was primarily driven by inter-region volume, although results were impacted by the uncertainties around Brexit, as well as revenue management initiatives we implemented on low-yielding volume. Asia also delivered positive volume growth, driven by gains on virtually all lanes except the Asia to U.S. trade line. On a currency-neutral basis, Revenue per piece improved by 2.2% for export packages and 3.9% for international domestics. These improvements were driven by Asia and the Americas through disciplined yield management and specific actions we took to shift customer mix. Most importantly, operating margins expanded to 17.7% when compared to last year, and on a currency-neutral basis, margins expanded to 17%. Our results were a great balance of three things. First, our ability to help customers adapt to the changing conditions. Second, our efforts at flexing our global network. And finally, our success in controlling cost, together enabling great improvements in our bottom line results. Now let's look at the supply chain and freight segment. The strong execution of our strategy, which includes many asset-light services, enabled supply chain and freight to expand its margin by 150 basis points on lower year-over-year revenue. The segment delivered excellent financial performance. Operating profit jumped more than 24% to $211 million. Profit contributions were broad among the units, with particular good results from forwarding. Looking at the individual business units, the forwarding unit as a whole exhibited terrific execution of cost management strategy. International air freight revenue was down in the quarter primarily on outbound lanes from Asia, through the slow recovery from the Lunar New Year. However, the team successfully expanded the buy-sell spread, both sequentially and year-over-year, resulting in stronger profits. Additionally, Coyote Truckload Brokerage proactively adjusted their strategy due to the current capacity in the market by continuing to deliver high-quality service to our customers. Market rates on purchase transportation expense were down for the quarter, In response to the changes in the market conditions, Coyote implemented a disciplined approach to cost management, leveraged the use of technology, and continued to focus on high-quality loads to produce outstanding profit growth. For UPS Freight, improved revenue quality and growth in middle market segments drove unit increase in revenue per hundredweight up by 5.4%. Overall, the supply chain and freight team delivered robust profit to the company by leaning in on our asset light model to tightly control costs, which help offset volume and revenue softness. Now let's turn to the balance sheet. UPS generated $2.3 billion in cash flow operations and about $760 million in free cash flow during the quarter. And that is with capital investments of about $1.5 billion, which mainly support network enhancements. We are on track to meet our free cash flow target of $3.5 to $4 billion in 2019. with potential for additional upside produced from our working capital initiatives. It should be noted, as part of transformation, we have adjusted the seasonality of free cash flow based on our working capital initiatives that we implemented throughout the last year. In fact, payments from the fourth quarter of 2018 have shifted somewhat into the first quarter of 2019. We saw the benefits in the fourth quarter of 2018, and we expect this pattern to continue moving forward. UPS distributed $867 million in dividends, which represents about 5.5% increase on a per share basis over the same period last year, and we repurchased 2.4 million shares for about $250 million. Our effective tax rate for the quarter came in at 23%. We expect our tax rate will be between 23% and 24% for the rest of 2019. Now moving on to guidance. As a reminder, Our transformation charges are not included in guidance. 2019 is a year of investments in our network and executing our strategies to improve operating costs and deliver higher quality revenue growth despite uncertain conditions. Full-year EPS is expected to be in the range of 745 to 775, as we have previously announced. We view 2019 as a year of real progress. with operating profit growth in all three segments up by low double digits. Turning to quarterly guidance, we want to help you better understand our plans and how they unfold across the year. For example, last year we brought over 90% of our new U.S. capacity online during the fourth quarter, but this year we expect to bring nearly half of our new sort capacity online by the end of the third quarter, giving us the ability to deliver more benefits in the second half of the year. We optimized our plans to enable us to open about 30% of our new capacity for 2019 within the second quarter. In comparison, during the same period last year, no new facilities were open. The year-over-year expense related to the opening of these new facilities will affect second quarter results and will provide benefits throughout the remainder of the year. Operating profits should grow in the mid-single digits, and adjusted EPS is expected to be relatively flat to last year, largely due to the planned pension financing costs, which sit below the line. Third-quarter EPS is expected to be elevated due to a variety of material tailwinds, including one additional operating day worth approximately $60 to $70 million of profit. Additionally, we expect benefits from first the automated facilities that come online this year, along with the escalating deficiencies from the 2018 investments in facilities. Second, the year-over-year international benefits from 2018 commodity headwinds that should not repeat. And finally, transformation gains from programs like the Voluntary Retirement Plan that hits its full run rate in July. The combination of these positive items will lift EPS to around 28% of the full-year guidance midpoints. In summary, During the first quarter, we made progress in our plans, and each business unit demonstrated gain in our strategies, which improved efficiency and revenue quality. And our investments in our smart global logistics network are starting to pay off, providing enhanced productivity and more real-time flexibility. As the year unfolds, we expect to expand margins and improve profits as we build on our momentum. Thank you. And now I'll ask the operator to open the line. Operator?

As a reminder, please ask only one question so that we may accommodate more callers. Feel free to get back in the queue, and we will take a second question time permitting. I will now turn the program over to our IRO. Mr. Childress, please begin.

We're going to take an online question starting off here. This question comes from Scott Schneeberger of Oppenheimer. Please share your view of the U.S.-China trade dynamic and its influence on global trade in your business.

All right. Thanks, Scott. This is David. And then I'm going to hand it over to Jim to talk about some specifics. UPS, like most other U.S. multinationals, we certainly advocate for fair and balanced trade. And the China-U.S. trade uncertainty is prompting softer industry forecasts in the region. We certainly encourage leaders of the two countries to find solutions that support increased two-way trade, but also by ensuring many U.S. companies have access to export to China. Some of our customers have adjusted their supply chains using the flexibility of the UPS global network to adapt to changing trade dynamics. And, Jim, I'm going to ask you to talk about a couple of specific instances. Okay, David, thanks.

So I think David hit on it a couple times on this uncertainty word, and I think that's an issue when you run a global network that you've got to balance and deal with. With regard to China specifically... David also talked about in his opening remarks our addition of one of the 747-8s from Hong Kong into Europe. We still believe in China. We're going to trade in and around China and how China evolves in the world. We'll move our network to support it. Keep in mind we're still bringing in the 747-8s, and very specifically as well, I'd like to add that the position of our South China hub, in the Guangdong province, connecting to Hong Kong, connecting to the other growth markets, really continue to power our APAC network across the globe. In fact, this quarter that we just finished, we actually had 3% more express on our airplanes out of APAC than we did last year in the same quarter to the U.S., and 2% more to Europe. So we adjust the network. We get the utilization rates right. We're putting the right volume in the right network, and we'll continue to adjust that. as trade develops in the world in front of us. So appreciate the question.

We're going to take another online question. This question comes from multiple people, including Ben Harper at RW Baird. Given UPS's recent introduction of marketplace shipping systems, can you give us an update on where to go and the other initiatives?

Thanks for the question. Scott here. So as we announced last year, e-commerce is one of our four strategic imperatives for growth. It's focused upon supporting B2B growth as well as improving our profitability of B2C e-commerce, focused on the SMB segment and supporting marketplace growth. We've announced a number of important initiatives. I'll quickly cover two in the B2B and then pass to Kate for one recent announcement on B2C. So Shopify and Where to Go are both in early stages of the rollouts but progressing well in line with our expectations. They both provide unmatched experience for our customers in the B2B and segment SMB. Shopify is one of the new shipping integration solutions. It covers 1 million SMB companies with its webshop tech solution, serving mainly B2B and B2C-type merchants. And overall, we have added over 100,000 new customers to UPS with this tool. Where to Go, which we announced, yes, last year, is progressing very well. We call it the Airbnb of warehouse and fulfillment. So it's progressed now. The platform allows online technology that matches excess capacity of warehouse to merchants who are looking for transparent inventory and fulfillment and final mile through UPS. Initially, this is focused on serving B2B customers. We have a lot of interest from warehouses around the United States and are quickly building a national two-day fulfillment network. I'll now pass it to Kate to talk about a B2C initiative.

Thanks. I'll start with the customer. Our small and medium-sized customers really needed help with managing the complexities of bringing their product to market as they brought it through different channels and marketplaces. So UPS eFulfillment, which we announced recently, actually connects them to 21 marketplaces through just one easy UPS login. We bundle the fulfillment and transportation services, and give them two-day time in transit, which helps them better compete in the market. It also opens up opportunities for us as a company in different revenue streams. So this, along with what Scott covered, has given us a wide array of offerings for the customers, and we have additional exciting new products coming soon.

Yes, so all of these products that Scott and Kate talked about, and then the ones in the future that Kate kind of inferred, All of these are about giving our small and mid-sized customers a platform to really punch above their weight. So it allows these smaller businesses to actually compete with larger e-tailers, but without having all the infrastructure and the costs that would burden them. So this is really where we can give them an alternative solution. It is a big focus of our SMB imperative. and we're really excited about it and have gotten excellent participation and feedback so far. So thank you for the question.

We have a question from the line of Tom Wadowitz. Please go ahead.

Yes, good morning. I wanted to ask you about your view on domestic package and kind of how you think things will play out this year. Your second quarter guidance is, flat earnings is different from what the street has been looking for. But I don't know if that reflects any change in your view of how domestic package is going to perform during the year or if that's just kind of a timing difference the street didn't recognize. So I just wondered if you could talk about that and also about visibility to improvement in domestic package margin if you look at the second half. Thank you.

Sure, Tom. This is Richard. I'll start the question and then Jim will talk a little bit about it. If you look at the actual guidance, we do see 2019 as a year of real progress. The quarters are changing a little bit, but they were in our plans that way. But we wanted to make sure that you had the right visibility and understanding. With transformation, the quarters change because we're opening new buildings in the second quarter that drive benefits in the second half of the year. In the third quarter, we've got those new buildings. We see escalating efficiency in the buildings we opened in late 2018. We have the extra workday. We have the commodity tailwind versus last year, and we have the VRP at full run rate in the third quarter. Those are all good proof points of why the year sets up well, and the second half operating profit growth will lead to the double-digit operating growth that we expect for 2019 in the U.S.

Thomas, Jim, let me add something to what Richard opened with, and just to remind you that This year, when we came out of the gate, we said 2019 in the U.S. was about creating operating leverage. And you can start to see that in the first quarter if you look at the cost structure. To remind you of a couple other points that are beneath that that we think are important, first of all, hand in hand with that comes our service. Our service is at very high levels. relative to the competition and even to ourselves over the last couple of years. We're pretty proud of the service. And, by the way, that leans into cost as well because when you do things right the first time, it's actually cheaper when you provide the customers a great service. We'll keep on the revenue quality. Kate and others will talk about that as we go forward. The transformation non-ops is coming through. The efficiencies are coming through. We're focused on almost 80% of our network touching automation by the end of this year, which is very good going forward. Remember, we've got 323 ground Saturday operations running in full flight this year, and you just keep going, and then you'll hear more in the future about peak season. So for us, as we move forward and took the margins Rich talked about, you should start to see us perform better and better and better on operating leverage in the U.S., and that's our commitment to our shareholders this year. Great. Thank you.

We have a question from the line of Ken Hexter, Bank of America. Please go ahead.

Hey, good morning. If I could just follow up by, I guess, digging into that a little bit further. Can you talk about the cost of of those new centers, maybe the magnitude. And I guess in that vein, I just want to understand, I know Amazon's always a topic of discussion, but they've been getting bigger and bigger in sourcing. And we've heard from whether New England Motor Freight or XPO that they brought business in. Is that any part of pulling volumes in as to why ground was up less than call it GDP levels in the quarter? Is any of that starting to have an impact or is that related to other items?

So I'll first talk a little bit about the unpacking of the guidance and the revenue. And let's actually start with the revenue, and then David's going to talk a little bit on the second part of your question. When you look at the revenue, especially in the U.S., what we see is underlying growth of about 4.5%. But we recognize we had weather and operating costs. day change as well as the movement of Easter. So the organic growth was strong. When you look at what we're doing in opening new buildings, we've called out in the past as we open buildings, we do have certain startup costs that go into those buildings. By opening that 30% in the second quarter and a total of 50 by the end of the third quarter, what we're really doing is making sure that as we move into the fourth quarter, the efficiency gains that we're seeing right now in the new buildings, we're also seeing in this year, in the second half of the year, as we especially go into third and fourth quarter. Those startup costs are around the things that you would expect as we hire and train people, as we put in the last bit of supplies that are needed, things like that. So those are all part of what we put into the second quarter, what we expect out of the third quarter and fourth quarter. It's very deliberate that in the third quarter you see benefits from these new buildings as well as the other things I've called out. And with that, I think that kind of tells you about why guidance and why we believe 2019 would be so well. And I'll turn it over to David.

Yes, Richard. When it comes to Amazon, we have to remember a very large company. They insource and outsource different portions of their transportation network. As they grow, they continue to change and add those vendors. We do not believe that there's been a decrease in our volume levels due to them making a switch from one company to another. We still have a mutually beneficial relationship with Amazon, and we feel that while we continue to focus on serving their needs, that there is so much more to e-commerce than Amazon. And we also have shared how we're focusing on working with these other companies, SMBs. And so we've shared that at the end of last year, and it's just a continued focus on improving the revenue quality. And we're going to continue to do that. Thank you for the question. Thanks, Dave. Thanks, Rich.

We're going to take a live question or an online question. This question comes from a multiple of analysts, Fadi Shimon from BMO, Kevin Sterling from Seaport, and Chris Weatherby from Citi. The question is, can you discuss the regional demands of what you're seeing in the international business related to Europe? and anything, any dynamics that you're seeing from the customer side in that marketplace?

Let me start, and then I'll give it to Kate, too. I mean, certainly, as we mentioned a minute ago, the trade setup for this year has changed a little bit coming in, when we saw it coming in, but that's our job to adjust to that. So we've got situations in all the regions that we're adapting our global network. Out in Asia, as I talked about a minute ago with David, It's moved. Keep in mind, what I didn't mention at that time is that our block hours are down. So that's how we end up creating operating leverage. Ultimately, Rich talked about the margins, and we talked about the movement of that. I mean, when you really get behind international and how we are in our maturity, we've got great options to continue to grow no matter what products our customers choose from us. They'll migrate between products based upon their needs and growth aspirations, our job is to get the network right. We did manage some customers, as Rich talked about, some low-yielding ones in Europe, this quarter that kind of masks some of the results and put some of that intra-region growth in the mid-single digits. Absent that, you look to the bottom line, profitability in the margins. It was a really good quarter for us, and we plan to continue that. I'll ask Kate to add a few comments to that.

I'll just add that for the 14th consecutive quarter, we did see export growth in our international regions. And also, as Jim mentioned before, in Asia, as an example, more express on the airplanes and Again, exports in Europe continuing. So our portfolio allows the customers to trade up and down, and many are doing some of each. Thanks.

And we have a question from the line of David Vernon. Please go ahead.

Hey, good morning. Thanks for taking the time. I have a general question on revenue quality. It looks like the top line came in a little bit lighter, certainly than the street was expecting. And I think in your commentary also, maybe there was a little bit of a lighter start to the year on revenue. Can you talk a little bit about how maybe core price or shipment weights have been shifting in particularly around the express and the deferred products? where the RPU was kind of down a little bit year over year. And that's just kind of a surprising result. I'd just like to see some added color on the mixed trends within Express.

Yes. Hey, David, this is Kate. I'll take that. So, overall, we improved the revenue quality. And, again, I'll just note the changes or points that Richard made on weather impact and the underlying performance. That also impacts revenue per piece. But ground RPP was actually at 2.9% in the U.S., strongest quarter we've had, first quarter growth in four years. And then if you look to air, to your question, we had above-market air growth rates, which we actually saw a broad base of customer usage, small and medium-sized business, health care related, as well as, of course, retail. And, yes, to the question on mix, saw more saver growth specifically within the NextAir product, and that can impact revenue per piece, as well as a shortened zone, which impacts that, but it's just less of a flight path that the package takes. So that's what we see. We do continue our focus unchanged and remain committed to both quality revenue as well as maintaining market share. Thanks.

Is there any sort of metric around sort of distance-neutral, weight-neutral pricing that you guys kind of track or can talk to to help us kind of understand that?

So we do look at that, Ed. You know, over one quarter doesn't define how that product is moving. Generally speaking, if I take the last four quarters combined, the characteristics haven't been as pronounced as this quarter. But I think you have to also remember weather has an impact. Because when you start having weather impacts, your small and medium sized customers, lose that day of business where your larger customers, when it gets to customer mix, can move it around the country and avoid the weather. And we saw some of that in the numbers this quarter. If it's appropriate at the right time, if it's really changing, we would give you that color as well. All right.

We're going to take an online question. This online question comes from Scott Schneeberger over at Oppenheimer. Please address the progress in your recent completed of automated facilities, and can you provide an update on Orion, NPT, and the other technologies you're bringing online?

All right, Scott. Good morning. Juan Perez here. Thank you for the questions. Let me start first with the first part of the question related to automation. A couple of parts to that question. In 2018, to your point, we opened 22 new or retrofit automated facilities globally. That represented an addition of about 5 million square feet globally, 4 million in the U.S., 1 million in international markets. And we ended up opening a number of regional sortation facilities that provided great benefit to the organization this past peak. And we continue to see that now in Atlanta, Salt Lake City, and a couple of other parts of the organization. In 2019, we will be bringing on an additional 20 new or retrofit automated facilities globally. That also represents roughly 5 million square feet or 400,000 packages per hour of automated sortation capacity in the organization. And these expanded automated facilities are in Tennessee, in California. We'll have some in Kentucky and Ohio as well. And we'll go to Germany as well this year. Now, looking at the benefits of that technology, certainly we're seeing significant improvements in our productivity in those automated facilities as they continue to reach maturity. The second part of your question related to some of the operational technologies we've implemented, we are on track on getting the expected benefits of our ops technology. They are all part of the smart logistics network strategy that we've defined in the organization. We're already in deployment of Orion Dyad navigation in almost 10,000 drivers across the network, seeing significant benefits in terms of miles reduction related to the technology. When it comes to edge, the edge initiatives are in deployment. We're now seeing improvements in consolidation of operations, reducing expense, work simplification. And lastly, as we look at the future, we continue to find other opportunities to continue to improve our network, We're well on our way on our smart package initiative. That is going to provide great benefit to UPS in the years to come. New automation solutions as well. And by the way, I don't want to forget about these. We're also very excited about the types of customer technologies that we're bringing onto the mix. New solutions that we're deploying today, but as Kate alluded earlier, we're also building new solutions to support our customers across the network. Thank you.

We have a question from the line of Scott Group. of Wolf Research. Please go ahead.

Hey, thanks. Good morning, guys. So I wanted to go back to the third quarter guidance, if we could. So, Richard, so second quarter, you're guiding to mid-single-digit profit growth. And it looks like implied for the third quarter now is like mid-20% profit growth. So, I mean, I get the operating day gets you like four points of extra growth, but can you bridge the rest? Like is there any way to quantify the commodity tailwind you're talking about and the headcount reductions you're talking about? Can you put some numbers around that so we can get a little bit more comfort with that guidance? And then maybe it will be helpful if you can sort of directionally talk about third quarter by segment if you can.

Scott, I think the first thing is, and let's knock out the easiest one first. We called out a specific number around commodity FX headwinds in the third quarter, principally driven by the Turkish lira last year that lost something like 60% during the third quarter and came back a lot of it in the fourth quarter. And we called that out as well. In terms of the workday, we've given you the information on that. And then the VRP full run rate is also something we gave the range of annual savings in the low 200s. And so now we get a full quarter of that run rate. So those are all very specific dollar amounts. And then when you look across the international business, separate from the commodities, you also are wrapping the benefits we saw from some market activity based on some cyber attacks that occurred once one of our competitors. And so this first and second quarter, we're still wrapping that year over year, but in the third and fourth, we don't. And then in supply chain and freight, we continue to see the benefits we're seeing in this quarter. We do expect to continue to see, you know, mid-double-digit growth there, as we called out in the first quarter. So third and fourth quarter are better returns, and they're better returns for very specific reasons that we have set out both in the U.S. because of what we're doing. And today I actually mentioned that the third quarter earnings per share should be about 28% of the annual guide number. that we called out earlier this year. Thanks.

We're going to take an online question. This question comes from Allison Landry over at Credit Suisse. She wanted to ask about the growth rates of B2B and B2C. Last quarter we called the growth rates out. Can you provide an update this quarter in the growth rates on the B2B side?

Hi, Alison. This is Kate. I'll take that question. So B2B growth, as you noted, was strong in the best first quarter growth in several years, as well as we saw similar rates of growth with B2C, so a nice balance between the two. When we look further into it, we continue to enhance our leadership position in B2B, and our solutions are resonating with healthcare customers For instance, hospitals and labs and seeing the growth there throughout all of the segments. And then also in retail, extensive returns, shipments going through, say, the UPS store and our other access points to distribution centers and return centers grew quite well. So we continue to focus on growing both and just will continue to fortify the mix that we see.

We have a question from the line of Chris Weatherby of Citigroup. Please go ahead.

Hey, thanks. Good morning. You know, I wanted to ask a question, I guess, on free cash flow and CapEx and maybe how you're thinking about sort of excess cash for shareholders as you move through the rest of the year. So I think, Richard, you mentioned that the cadence of free cash flow is changing to some degree. The guidance is the same. You've mentioned that there's potential upside from working capital initiatives. I guess, you know, When will you have a little bit more confidence or color around the ability to maybe see some upside there? And then how do you think about sort of CapEx this year? Is the cadence of CapEx changing? Do you think that there's potential upside or downside to what the guidance you've given us? Just want to get a sense of kind of how you're thinking about all of that.

Sure. So I think the first thing we look at is, you know, UPS generates strong operating cash flow. We think 2019 will be another good year. Last year, we started doing initiatives around working capital, and we saw that benefit. Those working capital initiatives, we have additional ones on the list that we're continuing to complete, and as we complete those, we will share the results and the go-forward look of that. Now, you did hit on this permanent shift, and what that means is we actually have better cash flow in the fourth quarter going forward because of the long-term value of the transformation initiatives we put in place. But most importantly, as we do see upside potential, we're implementing initiatives, and as they come through, we'll start sharing that a little bit more. In terms of the CapEx side of it, Our CapEx really is about improving the efficiency of our network, and at the heart of that is both the technology and the buildings that we're creating. And so this year, we expect to spend about $7 billion. We spent $1.5 billion in the first quarter, which is right in line with where we expected. And we'll continue to lean into that. We talked about this year's level being about where we just talked about a moment ago, and it is really about driving efficiency and lowering costs in the network over the long term. And we do expect, and we are seeing some of that now, and we'll see even more of it in the second half of the year.

And no real change to the way you think of it, the long-term capex, I guess, through the next couple of years, your guidance range or the percent of revenue that hasn't changed.

Well, I think we've given you guidance for the – we're in the middle of the three-year process and an appropriate time, and we continue to look at that and evaluate that. We'll come back to you with the right numbers.

We're going to take an online question here. This question comes from Elaine Becker over at Cowens Incorporated. How is the economy looking from your perspective, and can you speak to pockets of growth that you're seeing?

Yes, Elaine, this is David. Let's start with the U.S. And U.S. forecasts reduced slightly. There's a few mixed signals, but we still see growth and we see opportunity there. So starting out with what's driving the economy and the solid consumer spending and inventory replenishment. And so we're certainly focused on those two areas. When I said mixed, the manufacturing activity has slowed a little bit, and we're predicting a little bit lower industrial production in the second half. And while ESMO, the percent of increase has been reduced for 2019, still plenty of opportunity there, and that's where our e-commerce strategic imperative is focused. And then let's switch to the global market. economic environment, it remains in a growth mode, slightly slower pace. And in Europe, the Europe GDP has been lowered for 2019, in part because of manufacturing slowness. And then Brexit, of course, remains a risk. We certainly have plans in place to handle however that turns out. So we are prepared to assist our customers. In Asia, China is still strong, maybe not as strong as in previous years. But Jim talked about some of those opportunities we see. They're including into the U.S. and from the U.S. to China, but also China and the rest of the world. And so there's a lot of developments there that sometimes gets lost in the China-U.S. discussion. So... That's where we save the economy, and we think that it gives us plenty of opportunities to focus and to apply our strategic imperatives. We feel good about the economy for the rest of the year.

We have a question from the line of Allison Landry of Credit Suisse. Please go ahead.

Thanks. Good morning. could you tell us how much the efficiencies from the facilities that opened up last year helped first quarter domestic margins or cost per piece? And when would you expect the productivity benefits from the automation and new store capacity to begin to outpace the startup costs from the, from the newer facilities? And is this something that could occur by the end of this year? Thank you.

Yeah. So Allison, um, We are in the middle of really three years of opening some large amount of additional capacity. The timing across quarters is going to be a little different because what we're seeing is the benefits are apparent. Our cost per piece ex-fuel grew about – just under 2.5%, and if you adjust the weather, it's actually around 2% growth, which is the lowest it's been in several years. That's principally driven by the efficiencies that we're getting out of the network. We now have somewhere between 55% and 60% of eligible volume going through automated facilities. That will keep growing. We called out not only the facility automation, but we're in the middle of implementation of the Orion 2. And I'm actually going to hand it off to Juan to talk a little bit about it. But it's all part of what we laid out is our margin growth and getting to double-digit operating profit growth for the U.S. for 2019.

So, Rich, I'm going to take it from Juan because I think I want to package it together with some of what Juan mentioned on the first time he spoke. I think it's important to remember that when we went into transformation, You hear Scott and us talk a lot about non-op and procurement and the other benefits. But make no mistake, as we invest in this network and put the capital in, there are efficiency gains that are material in this business that will come through between now and this run rate of 2022 as we go forward. And they are not insignificant. And we are in the early endings of that. 2018 peak was step one. You start to see the cost mitigate in Q1. And the leverage we're talking about in this pivot year, there's a material piece on the cost side. It's not just revenue quality. And you'll see that unfold as we go quarter by quarter by quarter, Allison. And it's in all facets of the business. That's the thing, is when you get the hub and spoke open back up, the efficiencies come on the inbound side, in the hubs, in the network, on the road, then you put Orion and you put Edge and you put all the other Technology One talks about. It is material. And as we go quarter by quarter and we actually put this on paper for you, I think we'll do a really good job of laying it out for you, more probably in a cost-per-piece example than we are right now in the first quarter.

We're going to take an online question here. We've got multiple analysts asking about the drone program that is we launched and some of the activity that we're doing around these innovative solutions.

Yeah, thanks for the question. Scott here. We're really very proud to have the very first FAA-sanctioned use of a drone for routine revenue flights, which, as David mentioned, took place at the WakeMed medical campus. That certification from the FAA is very important, and we're really pleased to see that they've quickly begun to embrace the other opportunities with subsequent approvals. But we're early in the process in the United States. We announced yesterday that we have launched a continuation of a 13,000 program that we had launched in Rwanda, taking medical samples across the country. And today now in Rwanda, 30% of Rwanda's blood supply is are done through these drones. We will continue to see in the United States opportunities to expand this to campuses, in particular focusing upon healthcare. The economics we do see in the future to be positive, and we will scale these and see that the opportunity to reduce our costs on these type of campus programs is quite positive. There's a supporting platform value to this as well. Juan?

Great. Thank you, Scott. You know, we've learned a lot through our tests with drone technology. One-off drone solutions are not scalable. To complement our already robust delivery network, with drone deliveries requires an effective ecosystem of solutions. So what we're doing for that is we're bringing the great expertise we've built over the years in analytics and operations research to be able to do a few things to support this ecosystem. The first one is we're using analytics to identify how to best utilize this technology. We're applying operations research expertise to determine how to maximize the value of this solution within the network that we already have, which is very efficient. And lastly, we definitely believe that these are required to have a solid approach to optimizing the value of this technology in the future, and we believe we have that.

We have a question from the line of Brandon Ogledsi of Barclays. Please go ahead.

Hey, good morning, everyone, and thanks for getting my question in. I want to come back to the longer-term CapEx outlook because I think at prior events you guys have spoken about spending in the 8.5% to 10% of revenue range for the next few years. And I really want to put that in the context of these facility investments you're making. You've said that you have somewhere between, like, 30 to 35 major package hub facilities in the U.S. I was wondering if you could update us on just how many of those have actually been updated with the automated technology, and then what is the outlook over the next couple of years for how many should get retrofitted looking forward?

So, Brandon, this is Richard, and I think on the CapEx side, I'll take that part, and then I'll have Juan talk a little bit about the actual buildings. But on the CapEx side, you're right. We talked about a three-year – uh peak of capex and then it's moderating down we're still on plans for that it's just a little early to give you what we're going to do in in 2020 and 2021 but we continue to look at different options and alternatives based on the flow of packages and really the benefits we're getting out of these buildings which are slightly better than we originally thought even so it's a little too early to give that but at the same time what we've guided in terms of three years and then coming down that uh moderation will And if the appropriate time will give a better feel for that. But I'll turn it over to Juan to talk about the actual building.

Sure, Richard. You know, close to 60% of our planned building automation projects by 2022 are already completed. That's on the large building automation type projects. And as David alluded earlier, we're already seeing the types of benefits that we get from this automation in the network. Close to 65% of our small sort automation projects that we targeted by 2022 are also completed. And in both scenarios, we're actually on track to get to the targets that we defined to have solid automation across our network to provide benefits to the organizations.

That concludes our Q&A session for today. I would now like to turn the program back over to Mr. Childress. Please go ahead, sir.

Thank you very much, Stephen. So we'll leave with closing comments from David.

So as you heard during the call, UPS is adding innovative solutions and using technology to enrich our integrated network. Our transformation initiatives are improving efficiency and revenue quality. And we made good progress this quarter in a dynamic environment. Strong execution in supply chain and international. U.S. domestic investments are driving momentum. Our facilities are coming online earlier this year, creating earlier benefits. And we continue to see growth opportunities that Kate has talked about earlier. So in summary, we had a good start to the year. And we have momentum to embrace our future performance. And thank you for joining us this morning.