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 fourth 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 Fourth Quarter 2019 Earnings Call. Joining me today are David Abney, our CEO, Brian Newman, our CFO, Kate Gutman, our Chief Sales and Solutions Officer, along with International President Nando Cicerone, President of U.S. Operations George Willis, our Chief Information and Engineering Officer Juan Perez, and Scott Price, our Chief Strategy and Transformation Officer. Before we begin, I want to remind you that some of the comments we'll make today are forward-looking statements within the federal securities laws and address our expectations for the future performance or operating results of our company. These statements are subject to risk and uncertainty, which are described in detail in our 2018 Form 10-K and other reports filed with the Securities and Exchange Commission. These reports, when filed, are available on the UPS Investor Relations website and from the SEC. During the fourth quarter of 2019, U.S. GAAP results included a non-cash after-tax mark-to-market pension charge of $1.8 billion. an after-tax transformation charge of 39 million, and U.S. domestic after-tax legal contingency and expense charges of 91 million, predominantly related to the New York cigarette case. The after-tax total for all three items is $1.95 billion, an impact to fourth quarter 19 EPS of $2.23 per diluted share. The mark-to-market pension charge includes the effect of notably higher-than-anticipated asset returns and the unfavorable movement to lower discount rates. It also includes an updated estimate of potential benefits related to the central state's pension fund. In the prior year period, the company's GAAP results included a non-cash after-tax mark-to-market pension charge of $1.2 billion or $1.42 per diluted share. More details on the mark-to-market accounting will be available in a presentation posted to the Investor Relations website later today. Unless stated otherwise, discussion today referred to adjusted results. The webcast of today's call, along with a reconciliation of non-GAAP financial measures, are available on the UPS Investor Relations website. Webcast users can submit live questions during the 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 I'll turn the call over to David.

Good morning, everyone. I'd like to welcome Nando and George to the call. They oversee our two largest segments, Each have deep knowledge of our business through more than 30 years of UPS experience. This morning, I'll share my thoughts about the fourth quarter and the year ahead. Brian will then review the financial details of the quarter and 2020 guidance. During the fourth quarter, we continue to successfully execute our strategies and deliver on our commitments, revenue growth, improved network efficiency to drive operating leverage, and continuous transformation to stay ahead of market changes. Our multi-year investment strategy is positioning us well to support the needs of our customers, generate profitable revenue growth, reward our shareholders, and create opportunities for our employees. I want to thank the 495,000 UPSers around the world for their efforts during peak. We delivered more than 1.6 billion packages in the fourth quarter, including a record level of residential packages. This exceeded our expectations and resulted in a near 8% increase in volume over last year. Also, we were recognized by third parties for providing industry-leading on-time service for this remarkably high peak volume. Our execution over the holidays benefited from increased capacity and automation throughout the network, effective use of proven tools and enhanced technology, and deeper collaboration with our customers to align volume with network capacity. Our operating teams took advantage of the 20 new aircraft and the additional 10 million square feet of automated capacity we added to our network in 2018 and 19, which enabled us to provide great service for our customers for the last two peak seasons. And many of the technologies and processes we employed during peak will carry forward to make our normal daily operations more efficient year round. For the company in the fourth quarter, revenue grew 3.6%, Operating profit was up nearly 14%, and margins expanded in all segments. As a result, fourth quarter adjusted EPS was $2.11, a nearly 9% increase over last year. We're continuing to focus on our strategic growth imperatives, SMBs, e-commerce, health care, and international growth markets. Our transformation strategies and investments anticipated the growing significance of global e-commerce and position UPS well to capture opportunities from all customers. We're embracing the e-commerce structural shift to faster delivery, which brought a surge in next-day air volume of more than 22% in 2019, an increase we were well equipped to handle with greater efficiency. Our investments drove productivity gains and lowered unit costs on a year-over-year basis, generating positive operating leverage in the fourth quarter and for the year. We also proved that our integrated network provides UPS and our customers tremendous flexibility to more efficiently respond to the fast pace of change in the market. Now, looking ahead to 2020, I just returned from the World Economic Forum in Davos, where discussions with customers and policy leaders reinforced our current outlook for this year. The 2020 economic backdrop will provide opportunities for UPS. Consumer demand remains healthy globally and in the U.S., and we're positioning solutions to grow commercial deliveries despite weakness in the industrial sector. Global GDP estimates call for slower growth than the first half of the year, with four-year growth at 2.5 percent, finishing about the same as last year, which is below what many consider a normal growth rate. On a positive note, advancements with U.S. trade are encouraging, with the President's recent signing of the USMCA and the US-China phase one trade agreement, an historic event I had the privilege to witness. Each is a big step in the right direction for global trade. Amid dynamic economic conditions and structural shifts in the market, UPS is taking aggressive steps forward by investing for growth, speeding up our network, and introducing new SMB-centric solutions that help them compete and grow. Our customers rely on speed to market as a competitive differentiator, and we believe there's additional growth opportunity for UPS as we accelerate our network and further broaden weekend operations. This year, we're significantly expanding extended hours pickup for next day ground to cover an industry-leading 98% of the U.S. population. We're also expanding weekend delivery services. For Saturday deliveries, we're bringing online more operations, doubling the amount of volume we handled in 2019 to reach an additional 40 million U.S. consumers. Plus, we remain the only integrated carrier that offers commercial and residential pickup and delivery on Saturday. We're initially launching Sunday delivery to the majority of the U.S. with an economy product and will expand throughout the year to provide our customers a wide range of delivery options covering all seven days of the week. We will also further expand our integrated network by adding more than 5 million square feet of new automated capacity. Most notably, we recently announced plans for a super hub in Harrisburg, Pennsylvania, unlocking opportunities in speeding up the network in the Midwest and Northeast corridor. We see tremendous opportunities, and we're taking advantage now by reinvesting a portion of our transformation savings to speed time in transit and introduce unique new products and services. These actions generate long-term revenue growth and enable further diversification among our growing SMB customer base. Yesterday, we announced several new solutions to continue to help our SMB customers. We're expanding My Choice for Business in 30 countries, and by the end of 2020, 96 percent of UPS's global small package volume will be eligible to be tracked and controlled through My Choice for Business. And we're enhancing UPS.com to simplify cross-border trade. The website will guide customers through estimating duties and taxes and determining customs requirements, making it easier for SMBs to ship internationally. We also introduced several next-generation technology expansion. Drone delivery service from UPS flight forward will soon begin at the University of California San Diego Health Campus. We will soon close on an equity investment in Arrival, a leading electric vehicle manufacturer, along with a commitment to purchase 10,000 advanced EV delivery vehicles. And we are deploying Dynamic Orion, continuously optimizing routing in the U.S., as we progress to make the fastest, most technology-enabled company in the industry. We have made great strides expanding and further automating our smart global logistics network and in creating new solutions to grow revenue. The impacts of our transformation are becoming more visible in our operating performance, even as we invest in new capabilities. All of the network investments and SMB initiatives we're discussing reinforce our confidence in achieving our transformation EPS commitment of $1 to $1.20. The decisions and investments we're making, especially with our SMB initiatives and pulling forward actions to speed up our network, will uniquely position UPS in the industry and are designed to ensure continued success well into the future. Now, Brian, we'll take you through our results.

Thanks, David, and good morning. Today, my remarks will cover our quarterly performance and the full year for 2019. Then I'll finish with our 2020 outlook. Both our fourth quarter and full year results were enabled by UPS's strategies, execution, and investments in our smart global logistics network. Our diversified growth is the result of making the right tradeoffs as we continually adapt to the changing environment. During the quarter, we generated positive operating leverage and grew operating profit and margins across all segments. As a result, for Q19, diluted EPS grew nearly 9%, and full-year EPS was 753 per diluted share. Moving into the segments, in the U.S., we continued to see strong volume growth. The additional aircraft capacity and automation we added enabled our operators to adjust the network and efficiently meet the surge in demand for our services, allowing us to take on new customers during the height of peak season. U.S. domestic revenue increased nearly 7%, driven by volume growth across all products. Next day air volume increased nearly 26%, deferred was up almost 16%, and ground volume rose more than 6%. Growth came from B2C and B2B shippers, producing the fifth consecutive quarter of B2B growth. Customer and product mix dynamics decreased revenue per piece by 2%, driven by lower average weight per piece and larger e-commerce customers' adoption of faster delivery options. Most importantly, unit cost was down 3.2%, which in turn generated positive operating leverage, the result of productivity improvements from the investments we have made over multiple quarters. U.S. domestic operating profit was more than $1.2 billion, a significant increase of more than 20%. Now, looking at the international segment, strong execution and continued cost management enabled another quarter of profit growth and margin expansion, which helped to counter a 1.7% decline in revenue, primarily due to conditions in the macro environment. Total export volume was down slightly in the quarter as gains on intra-Europe, intra-Asia, and U.S. export trade lanes did not fully offset the declines into and out of the U.K. and on the Asia-U.S. lane. We adjusted global air capacity to match demand where and when needed, driving high levels of asset utilization. We lowered international block hours by about 3%, and in total, unit costs decreased by 2.8%. While navigating within the challenging environment, we grew operating profit nearly 4% and expanded margins 110 basis points, reaching 21.5%. Our performance further demonstrates our ability to leverage our capabilities and continuously adapt to grow profit. Now let's turn to supply chain and freight. Even with the macro challenges in forwarding, operating profit was up 17% and margins expanded 120 basis points. primarily due to the diversity of our portfolio, our continued focus on SMBs, and lapping last year's profit impact during labor negotiations for the freight business. Looking at the individual business units, logistics, UPS Freight, and Markin were bright spots. All three grew revenue with profit up double digits, helping to offset the softer business conditions faced by Coyote and forwarding. Now let's turn to cash and shareholder returns. UPS continues to generate strong cash from operations, enabling further investment and rewards for our shareholders. As I guided last quarter, we lowered our 2019 CapEx due to increased capital efficiencies. The result was capital investments of $6.5 billion. Additionally, we returned $4.3 billion to shareholders, including about a billion of share buybacks and $3.3 billion in dividend distributions. Now let me comment more broadly on 2019. We made strong progress with our transformation. We closely monitored market changes and made quick and prudent adjustments throughout the year. For example, we continually adjusted our integrated network, aligning our capacity with changes in market demand, resulting in a lower cost structure that drove strong operating leverage across our business. We launched numerous innovative solutions to help grow B2B and B2C volume, as well as win new SMB customers. and we took advantage of structural changes in the market, like the rapid adoption of faster delivery driven by e-commerce, a benefit to UPS in 2019. The strength of our network allowed us to capitalize on the structural shift in the market for next day delivery and help all customers embrace this trend. UPS was also able to increase our business with Amazon through competitive wins and the structural shift to next day delivery. When combined with the revenue declines in the international and supply chain and freight segments, Amazon's percentage of total company revenue rose to 11.6% for the year. On the whole, we managed a nearly 6% increase in annual volume. And at the same time, we generated double-digit increases in operating profit and expanded margins. And we were able to deliver EPS within our guidance range despite a dynamic market environment. Now looking to 2020. We expect full-year adjusted diluted earnings per share to be in the range of 776 to 806. Our outlook reflects forecasted year-over-year declines in U.S. industrial production and other global softness. However, there is growing optimism due to the recent trade agreements that could move us higher. Another external factor that will affect our results is lower pension discount rates. For this reason, operating profits specifically in the U.S. will be muted. However, benefits below the line in other income and expense will more than offset the impact to operating profit. We provided a new table in our financial information that holds pension discount rates neutral on operating profit on a year-over-year basis, giving investors additional transparency in this area. Now, let me review the key drivers of our 2020 EPS guidance at the total company level, starting with 2019 EPS of 753. First, strong underlying segment performance is anticipated to produce year-over-year EPS growth between 6% and 10%. Supporting this growth are several company-specific tailwinds, including growing adoption of our new solutions, increased efficiencies from our expanding automation, and the proven value of our integrated network that provides us and our customers flexibility to adapt to a changing environment. Working against us this year is the impact to operating profit from lower pension discount rates I mentioned earlier. This is equivalent to a drag on EPS of 26 cents. In addition, there is a 33 cent EPS headwind from the SMB network initiatives. We have elected to implement SMB initiatives to speed up our network across multiple lanes and broaden our weekend operations. This will result in tripling the rate of improvement we made in 2019, making time in transit faster for 80% of residential and commercial customers in the U.S. Clearly, this will improve UPS's competitiveness and further diversify revenue, creating more opportunities for SMB growth. These initiatives will drive both startup cost and revenue growth in 2020. And in the coming years, revenue is expected to grow significantly. In 2021, we expect EPS and margin accretion from these initiatives. Turning below the line, total other income and expense will be a positive for the company, primarily because in 2019, we generated more than 17% returns on pension assets, leading to a favorable impact in 2020. And lastly, in 2019, we enjoyed tax benefits from discrete items that are not anticipated to repeat, muting EPS by 10 cents. The 2020 tax rate is expected to be between 22.5% and 23.5%. Pulling it all together, Full-year 2020 adjusted diluted earnings per share will be in the range of $776 to $806, another year of solid EPS growth. The strong underlying segment performance builds on prior year gains and gives us confidence in our ability to deliver our long-term targets, which includes an incremental $1 to $1.20 of EPS by the end of 2022 from transformation initiatives. Diving deeper into the segments, in the U.S., we forecast revenue to increase 4% to 7%. driven in part by continued adoption of faster delivery services and the new solutions we've introduced. We anticipate ground will grow in the low single-digit range with healthy growth in air shipments, keeping in mind that we will be lapping elevated next-day growth over the last three quarters. We're also planning for improvements in customer and product mix, as well as growth in base rates. As I mentioned, we are further broadening our customer base through network and product initiatives. We also expect incremental efficiencies throughout the year from previously opened and new automated facilities that come online during 2020. Given all these factors, U.S. domestic operating profit on a pension discount rate neutral basis should grow in the low single-digit range. This includes the impact from the SMB initiatives that we chose to accelerate and expand in 2020 to capture the tremendous growth opportunity. Moving to international, We will continue to adapt to changing conditions, target high growth market opportunities, and adjust the network to balance capacity with demand. Average daily shipments will increase in the low single digits and revenue will increase four to six percent. We will maintain our industry leading margins and we expect to generate operating profit growth in the mid to high single digits on a pension discount rate neutral basis. Finally, the supply chain and freight segment will continue to execute its SMB and cost management strategies. The diversity of our supply chain and freight business unit will again help us manage through cyclical moves in the market. We expect gains within our healthcare unit and truckload brokerage should rebound in the second half of the year. For the segment, revenue is anticipated to grow between 4% and 6%. and operating profit is projected to grow between 5 and 7 percent on a pension discount rate neutral basis. Looking at the shape of EPS across the quarters, we expect 2020 to somewhat resemble 2019. In the first quarter, we expect EPS to be in the range of 17 to 18 percent of full-year adjusted EPS midpoint, driven by tougher year-over-year supply chain and freight comps, softer macro conditions, as well as the significant initial cost associated with our SMB initiatives. The remaining quarters will be fairly balanced in a range between 27% to 28% of the full year adjusted EPS midpoint, with the fourth quarter at the top end of the range. CapEx for 2020 is planned to be around $6.7 billion. These investments, which include automated buildings and technologies, continue to expand the efficiency and flexibility of the UPS smart global logistics network Adjusted free cash flow is anticipated to be between 4.3 and 4.7 billion. We plan to reward shareholders with growth and dividends subject to Board approval and anticipate share buybacks of around $1 billion for 2020, similar to the last few years. In conclusion, the transformation investments we are making and the actions we are taking better position UPS to capitalize on growth opportunities. And if macro conditions turn more positive, we could see additional upside potential for the year. And now, I'll ask the operator to open the line. Operator?

Mr. Vernon, this is AT&T Teleconference. We just want to let you know how to ask a question if you will be pressing 1 and 0. I'll place you back. This is Scott Childress with UPS.

Please allow, we're only going to allow one question from each speaker so that we may allow as many as possible to participate. Our first question is an online question. We've got multiple analysts, Todd Fowler from KeyBank as well as Fadi Shimon from BMO. You mentioned that you are fast-tracking initiatives in 2020 to capitalize on market opportunity. Can you elaborate on this?

I certainly can. This is David. And I would say we are faster fast-tracking initiatives in 2020. We've had positive momentum in 2019, and we see it in the underlying performance in 2020. We have clear visibility to some structural shifts that we really want to take advantage of next day and in seven days. And so we just see tremendous opportunity, especially with our SMBs. So we have elected, made a conscious decision that we wanted to pull forward some transformation initiatives into 2020 that would speed up our network significantly and take advantage of these opportunities that are being presented. And so we're focusing in two areas, two main areas. Our time in transit, and we started improving time in transit, making it quicker in 2019. We're going to triple that rate of improvement in 2020. In fact, the UPS network, we will be faster by the end of this campaign for 80% of the U.S. population than we were before we started. So 80% significant improvements. And then, of course, weekends, seven-day deliveries, just so important to consumers today. And we're going to double our delivery volume. And in weekends, on Saturdays, we're going to reach 40 million new consumers. And what's important is seven days is important not just for residentials but for commercial deliveries too. We have SMBs saying, what about us? We need seven-day delivery, and we're focusing in that regard, too. And then Sunday, we started out with an economy service that's over the majority of the population, and we're going to expand Sunday offerings throughout 2020 to give a wide, wide range of delivery options. So these are two structural shifts that we see that run hand-in-hand for our SMB strategy. And the good thing about these is they're not CapEx heavy. They are OpEx at cost that we'll be putting in OpEx in 2020. But these initiatives, when you look at them together, are going to be accreted in 2021. It's going to give us much higher asset and lane utilization. It's going to give us better competitiveness and more pricing power. It's going to give us additional business. It's going to allow us to continue at a lower cost, and we're just really excited about this opportunity. Now is the time. We seized the moment, and we believe investors expect us to seize these kinds of opportunities, and that's what we're doing. Brian would talk a little bit more about the effect for 2020, and then, of course, we've already said accretive in 2021. So, yes, fast, faster, and we're going to continue to be speeding up our network for our customers. Thanks for the question.

Our next online question comes from Ben Hartford of RW Bayard. As transformation has progressed, how confident are you in UPS's ability to either realize the stated $1 to $1.20 or get it earlier or even exceed the initial estimates?

I'll take that, Scott. Thanks, Ben, for the question. It's Brian. Look, we're confident in the $1 to $1.20 incremental EPS, given the investments we've made are already returning. We're looking at margin expansion across all three segments in 2019, and it's just building on the momentum. So I think by choosing to invest, accelerate, and expand the investments in SMB that David referenced, we see opportunity to capture accretive growth going into 2021 and beyond.

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

Yes, good morning. Wanted to get your thoughts about competitive environment. You know, I think FedEx has, you know, accelerated their kind of, you know, quickly doing six-day and seven-day, so it seems that they're you know, competing harder in e-commerce. Obviously, you're, you know, you're getting a lot of traction in the market, getting strong growth in domestic package and, you know, investing more aggressively as you announced today. Do you think that these investments accelerate your volume growth looking forward or is this something where you just have to spend more to compete and kind of keep the momentum? You know, how do you think about competitive dynamic and, you know, how that translates to volume? Thank you.

Yeah, we will, Tom. This is David, and I'll let Kate follow up. Boy, I can tell you, we're focused on serving the entire e-commerce ecosystem, and that includes large e-tailers, that includes the large retailers, and that includes the SMBs, the thousands and thousands of SMBs that we help to compete and to punch above their weight with the with the larger companies. Just a few things to point out. When it comes to the major retailers, over 90% of the larger retailers utilize our innovative services, and we've seen their business grow. I'll just give you a few examples of that. Target, Curate Retail Group, Macy's, Gap, Kohl's, Best Buy, Overstock. All of those companies have seen our innovative solutions and we have grown. But where our real passion is in this area is allowing and enabling small and mid-sized businesses to compete against the bigger companies. And that's where you saw just a string of announcements yesterday. We made more product and service announcements in 2019 than we've made in my entire career at UPS, and we are following it up this year. And, Kate, I'll turn it over to you to highlight a few that you want to focus on.

Yeah, absolutely. And so clearly we are the e-commerce provider of choice, and David just brought life to that and focused on the SMBs. The exciting part of our solutions is that we actually are leaning in both on B2B and B2C. The speeding of the time in transit helps both. And fast means through the weekend. UPS only has the commercial offering for our customers, helping the SMB to actually speed through the weekend and also replenish inventory. So very impactful. And, you know, these customers have told us it's about pace. speed and ease. And the ease is helping them to connect where they're already existing. And that is with digital access. That's exactly what that does. It brings together the community of buyers with the S&B sellers and attach My Choice for Business on that. It helps them to control not only their outbound, but their inbound. And the more you can do that, you save staffing, you save cost, and then that helps them to reinvest into their businesses So we do see these investments as accelerating growth, and we're excited that it is with this structural shift in the air, also the speed on the ground, and very excited.

Yeah, there is just two that I want to highlight. One is we've been the e-commerce ship of choice for years. This is something that we concentrated on six, seven years ago, and we have put the network in place and will continue. But just two things I think is worth drawing out is we talk a lot about the structural change of next day air and next day in general and our extended hours next day program where we can pick up, give late pickups, and we can actually serve 98% of the population for our brick-and-mortar retailers that within 150 miles of their locations, we can cover 98 percent. That is industry-leading, and that is giving them a competitive advantage. It allows them to hit next day through their ground network. And then, so that one's very important. The other one that we've made a lot of announcements about, but we are just speeding through, and that's access points. And we are adding in the press release another 1,500 access points through package express centers. What makes this unique is this is in a lot of rural areas, people that don't have a lot of options. And by the time these get implemented with the others we've announced, 92% of the population of the U.S. will be within five miles of our access points. That just gives you some good examples of what we're doing to maintain our status as the e-commerce shipper of choice. Thank you.

And we have a question from the line of Ken Hexter of Bank of America. Merrill Lynch, please go ahead.

Hey, Greg, good morning. Dave, or I guess Brian, that was great information on the breakdown in terms of the 6%, 10% outlook, but then with the pension and other network rollouts. So looking at that $380 million or so pre-tax expense you're spending on accelerating the network, can you maybe talk about the split between rolling out weekend delivery and what the other actions that you're spending money on? And then within that shift from two-day to next day to now intra-region that Dave was just talking about, how do you play in that world? Does that require any additional network shifts or investment as you do that?

So thanks, Ken, for the question. Look, we're looking at the SMB initiatives in total as I broke it out. It's a 33-cent total investment with two objectives. We're trying to accelerate the time in transit. We're going to reach over 80% of our customers. And then in addition, expand the weekend coverage. So rather than break out the 33 cent, we're looking at it in totality as a program. We see it accretive to 2021 and beyond. Maybe I'll let Juan take a stab at sharing some of the details of the two programs. Yeah, thanks, Brian.

And as we think about the expansion of the weekend delivery services, we started that already in the Q4. The advantage that we have is that we have a well-defined integrated network that gives us unprecedented capabilities to be able to enable these services. We are going to leverage the relationship that we have with the USPS. David made a reference to the access point network that we have. It's a network that's in place. We've already built the technology that supports the integration between UPS and the access points. That will make it really easy for us to be able to expand as well in those areas. And again, we will continue to provide services through the network that we've already built with the great people that we have supporting those operations.

Our next question is an online question coming from Scott Schneeberger of Oppenheimer. Please address UPS's progress in driving U.S. domestic B2B share growth and the potential to further expand in 2020.

Thanks so much. This is Kate. So first, we're proud to be the B2B market leader and also to say that we grew B2B for the fifth consecutive quarter. This quarter's B2B growth was fueled by retail and returns, returns growing 6% with our unmatched portfolio. So you can actually have the flexibility of returns, whether it be label-less, package-less, and also write available on your mobile application. So very excited about the progress that we've seen in that space. And then B2B, a critical component of that is our healthcare strategy as well as our SMB with a large majority of B2B tied to those. Also, David mentioned the structural shift. Structural shift comes with businesses speeding and that also impacts B2B. So everything you see us doing with speeding time in transit through the weekend, all of that nets to continuing our success with B2B. Thank you.

Our next question will come from the line of Jordan Olinger of Goldman Sachs. Please go ahead.

Yeah, hi. Good morning. Just sort of wondering, can you talk a little bit, and I know there's the pension headwinds, but a little bit about your thoughts on managing the cost per piece and the revenue per piece in the domestic business and managing to sort of that spread differential and what we should think about in terms of cost per piece going forward. Thanks.

Okay, sure. I'll start with revenue per piece. First of all, we were excited to deliver the positive operating leverage, and George will speak more about that, aligning cost per piece with revenue per piece. As we've noted, revenue per piece was affected by weight per piece. and customer mix as we leaned into this structural shift that's going on in the market, and we will continue to do so. With that, we're seeing speeding, whether it be in the air services. You saw our air growth very strong, three consecutive quarters over 20%, with this past quarter at 26% for next day, and double-digit for deferred, a lot of which, by the way, is coming from a very broad customer base. heavily SMB in that area. And then David mentioned that ground solution that we have, which is our extended hours next day ground and the coverage that we gain 98% of the population by activating brick and mortar. That will continue, so shorter zone, some less weight, but solutions that gain the whole portfolio air and ground from our customers, which will help RPP And then we remain committed to growing price as aligned to our value and our cost per piece.

Jordan, this is George Willis, and thanks for the question. So as far as the cost per piece goes, our investments have significantly lowered our structural costs. So in answer to your question, do you think that it's going to continue to drop? We continue to see it improving as well. We're driving productivity gains and we're lowering our unit costs. We did that last year, and we expect to do the same thing this year. We're creating excellent leverage, as Kate just talked about earlier, and it was actually exhibited last quarter in the fourth quarter. This was evidenced by our cost per piece actually going down 3.2% in the fourth quarter. So we see the benefits in our new facilities. We're going to continue that. We also see the continuous improvement on on-road and in our air network driven by the new technology and automation.

Our next online question comes from Scott Group of Wool, as well as a few of the other analysts. Please provide an update on your relationship with your major customer. There is always much discussion of their plans and how that could impact UPS's business over the next few years.

Okay, this is David, and I will. And our business did increase with them over 2019, and part of which was due to a structural change in this focus on the next day. And we foresaw that change, and we had the lift available, and we really took advantage of that, not only with large retailers, but with other companies that are matching that same structural change. We also had competitive wins with large retailers and others. And we saw a little bit of a muted growth top line from international and supply chain due to macro conditions. And of course, that made the percent revenue a little bit larger. But one of the things we want to focus on is at the same time that we took on additional volume that we did bring our cost per piece down significantly in the U.S. operations for the fourth quarter. In fact, on an adjusted basis by more than 3% from the year before. And also that other customers are able to take advantage of some of this capacity and structure. So other retailers and small and mid-sized companies have been able to take advantage the same way. As long as there's, with any of our big customers, as long as there's a mutually beneficial relationship, then we will continue and we will find ways to win together. But we also find ways to continue to help our small and mid-sized companies and others to compete against those large opportunities, whether it's through where to go or e-fulfillment or access points or other options. So, That's kind of a rundown about where we stand. Thank you.

Our next question will come from the line of Chris Weatherby of Citi. Please go ahead.

Hey, thanks. Good morning. It looks like the guidance for the first quarter suggests basically flat earnings, although you're expecting growth throughout the rest of the year. Can you talk a little bit about the cadence of the investment that you're making, the SMB initiatives and others? And is that sort of front-end weighted? And is that a driver of that sort of weaker than average first quarter? Or do we think that there is sort of introducing new seasonality to the business? Is it potentially sort of the growth in your largest customers percent of revenue? I just want to get a sense of sort of how we should be thinking about the cadence of the growth and the expenses, particularly in the first quarter.

Yeah, it's Brian. Thanks very much for the question. So it has less to do with the changing of the seasonality. It's more about the phasing and cadence of the investments we announced. The 33-cent OPEX investment or EPS headwind that we're putting in, the revenue lags those startup costs. So as you think about Q1 and launching the investments, Revenue comes a bit later, and that's why we're muting the EPS. In addition, in the supply chain and freight business, given the macro backdrop, we're expecting some rebound in the middle to late part of the year. So those are the two elements impacting the phasing of the guidance. Thanks.

Our next question is an online question that comes from Allison Landry of Credit Suisse. Can you discuss the announcement of the construction of a super hub in Pennsylvania in Is the construction embedded in your three-year CapEx? And can you tell us how the super hubs will differ from your other major sort facilities?

Yeah, Alison, this is Juan Perez. Thank you for the question. Just a couple of points. Let me first clarify the $1.4 billion that we announced is for not just one facility in Pennsylvania. It's a total of four facilities in Pennsylvania. The largest of those is the super hub we will be building in Harrisburg, Pennsylvania. By the way, you've heard us talk about the Smart Logistics Network a number of times. Part of the Smart Logistics Network is building critical capacity to support the needs of our e-commerce customers. We continue to build that capacity. We've been very effective. That capacity is yielding the expected results. Your question next talks about how we continue to improve the facilities that we build. We have this philosophy at UPS that every time we build a new facility, that facility is going to have the next generation of advanced technologies that will help us continue to build capabilities, improve our automation, reduce our hours. In this particular building, we expect to see some really neat technologies, more data analytics that will provide better insights on how the facility is running, of course, how it can help the overall network. And we also expect this new facility to use the latest and greatest automation technologies that we have. The CAPEX is included in our three-year plan. So this is something that we have been planning all along as we continue to build our smart logistics network. We're excited about what we're building in the northeast critical corridor for UPS.

We have a question from the line of David Vernon of Bernstein. Please go ahead.

Hey, guys. Good morning. Brian, maybe could you talk a little bit about how the $0.33 is going to be kind of earned back into 2020, 2021? Is this something that we should be expecting to be, you know, basically just go away as a one-time item, or is this going to take a little bit of time to grow through? And as you think about the next three-year view on CapEx, obviously these investments announced in the last couple days have been have been significant, but it sounds like they're part of the capital envelope. Has your thinking on reinvestment changed at all as far as kind of the next three-year view on CapEx going forward? Thanks.

All right. This is David. I'll take the first part of that question, then I'll turn to CapEx over. So from an OpEx standpoint on speeding up the initiatives, this is really about how to increase the asset and lane utilization of our transportation network. It's about competitiveness. It's about pricing power. When you have a much faster network, you don't have to discount as much. We also don't have to have customized solutions, so we're going to be able to take some of those that we have put over the years to help speed the network. We're going to be able to take that up. But we really see that we're going to get additional business. And that was the thing that got our attention so much last year is when we put these first ones in, we way exceeded the return of additional packages that we were going to get. So when you put this infrastructure in place, it's not fully utilized at first. It takes a while to grow. But based on what we've seen last year and what we expect to see this year, then the revenue – and the pricing power from this move is going to more than take care of the operating costs. That's why we are boldly saying that this is a creative and it's creative in 2021, and we've got so far the examples to show that. So let's turn it over to the CapEx side, and that's to you, Brian.

Thanks, David. And, Dave, thanks for the question. So with respect to CapEx, you're right. The investments we talked about this morning, Carisberg, et cetera, those are all embedded within our capital guidance and envelope. David talked about the OPEX investment. But in terms of where we're headed on CapEx, you saw we're guiding to about 6.7 in 2021. That's really coming from a lot of efficiency being driven, as we saw in 2019, as well as 2020. We see a glide path eventually moving down towards our historic average of 7%. And ultimately, we look at the ROIC, which is among the leading industry, and really it's a good investment for the company in terms of the return. So hopefully that gives you a little insight on the CapEx guidance.

We've got a couple of questions on international markets. Tom Wadowitz from UBS, as well as Scott Schneeberger from Oppenheimer. UPS realized 150 basis point margin improvement in international package in 21, despite small declines. Is there room left for further margin improvement? And does the recent phase one of the China deal help in that regard?

All right, I'll talk about phase one of the China deal, and then Nando will go further than that. We think the U.S.-China phase one was a historic agreement, as much for what it kept from happening with additional tariffs being implemented, plus what was covered in the actual agreement, and certainly look forward to working with governments on both sides for phase two. But a positive start there. When you take a look at that and you also take a look at the terminal dues change that is going into effect this year, which is going to allow us with our worldwide economy service to really compete in cross-global e-commerce, cross-border, I should have said, e-commerce shipments, that we hadn't been able to do before because of the very low cost of terminal dues. So that's gotten addressed. And so we do see some positive momentum. And I'll turn it over to you, Nando, to talk about the business unit.

Sure. Thanks for the question. Of course, when we look at trade, obviously concerns exist. We focused, you know, really strongly on making sure that we were growing our operating profits Regardless of the macro backdrop, we were able to execute industry-leading margins, create positive leverage, and, of course, continue our profit growth during the quarter. I also want to just thank the international staff globally for the work and how they accomplished all of those things in a very challenging environment. While we saw the volume coming in a little bit differently, of course, we feel very comfortable about the cost reductions and the cost control and how we manage expense, namely the network efficiency, our revenue quality, but also cost efficiency, we executed 2.8% decrease across all cost categories in international. Long-term targets are 16% to 19%. We're at 21%. Higher margins are not exactly the primary goal, but maximize our profit certainly is. So thanks for the question. Appreciate it.

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

Hey, thanks. Morning, guys. So can you just share what the air and ground volume expectations are for this year? And then on the $1.10, I just want to make sure I understand the numbers of how much you think you got in last year, what's assumed for this year. I just want to know what's left for 2021.

Sure. So I'll take the first part of that and kick over to Kate to talk on the air outlook. So from a dollar to $1.20 in terms of what's in there, we basically anything over the 7.5% in terms of 5% to 10% guidance is think about putting a deposit down. So we posted pretty strong operating growth in the 2019 results. We basically earned about 25% to 30% of that EPS upside. So the balance would be left to come in 2021 and 2022. So, Kate, do you want to take the airpiece?

Of course she does, though. And we talked about when transformation started that we had targeted $800 million to a billion of cost savings in 2019. in our Smart Logistics Network initiatives. And we are certainly on track. We may get another question on that, and we can talk about that. But we're on track there, too. So then, Kate, you want to talk about the AIR side?

Yeah, absolutely. I think it's a good starting place to say that we are the AIR market share leader. And we saw this and anticipated this change, a structural change going on in the market. and leaned into it with our solutions. And as a result, you've seen the strong air growth, three consecutive quarters, over 20%. We do expect to continue to see healthy air growth. Alongside, related to what Brian was saying, the ground comes hand in hand. So we're seeing next-day air, two-day air, resonating across our customer base, whether it be from healthcare, SMB, e-tailers, large retailers. We have expanded capacity, additional planes, all of that tying together to this strategy. And then we've talked about the unmatched UPS network and the ability to cover 150 miles of one-day ground, really activating our retailers and our SMBs brick and mortar to help them to better compete in the market. So flexing where their inventory is and then using whichever of our products fits for that need. So a healthy future as well.

Key point that Kate brought up, our air volume really, and we gained significant market share last year in our U.S. air network. We've been gaining market share in that sector at least four of the last five years, if not five of the five years. So we've been constantly investing in aircraft and and have 11 more that we're putting in this year that benefit the international, but then it cascades to the domestic. So this is something that we offer a clear, differentiated value advantage to our customers, and they are rewarding us, and it's going very well for us. Okay.

We'll take another online question. There's multiple analysts asking this. How did your peak season returns compare this year to last year? And please discuss UPS's process to handle this.

First of all, I'd like to thank all of our partners and service providers in the U.S. for a very good peak season. It was driven primarily because of several things. First, our collaboration with our customers. Second, the efforts of our people. And third, the use of technology in our automated facilities. As a result of this, through third parties, we led the industry again in service for the second consecutive year. We delivered over 32 million packages, 16 of the 18 delivery days between Thanksgiving and Christmas. Majority of our volume, as you heard us talk about investments and handle that growth year over year, was done in our automated facilities. Our network responded and was very responsive, and we continue to be agile. Our operators made good decisions during peak. And now for the technology part, John.

Just a couple of quick statements, folks. The first one that I think it's important for you guys to know is that at the end of 2019, 75% of our U.S. eligible ground volume was actually sorted through automation. In addition to that, we had completed the rollout of UPS Orion navigation. That gave us significant benefits, especially as we bring seasonal workers on, and they needed that type of technology to improve their overall delivery capabilities. And, of course, you now know that we're introducing additional technologies on the dispatch and delivery side that are going to continue to help us throughout peak season. The benefit of automated facilities cannot be understated. We actually exceeded throughout the year and certainly throughout peak season the expected production improvements that we get from automation. We introduced new solutions as well in terms of autonomous guided vehicles in our automated facilities to support the movement of bulk. All those solutions proved extremely valuable in executing a successful peak season, and we're already planning for 2020. That's the way that we've now approached our peak season for a number of years.

We're going to take one more online question, and then we'll close it out. The question is from multiple analysts asking about what technologies are in front of us, as well as our drone technologies, how we see that playing out.

Thanks for the question. So as we mentioned, transformation helps us bend the cost curve to help us invest in growth. Some of the growth opportunities we see, in particular in support of our customers, is in the area of leverage of drones. So UPS Flight Forward, which was launched last year, a number of trials. We announced the San Diego, where we're able to move across campus, speed up for critical care, our support to customers. We also announced the Waymo, and Waymo is an interesting opportunity for us. It allows us to test a new model for later pickups at UPS stores. That supports our SMB customers who get then a later cutoff and a competitive ability to do late orders and fulfillment for next day. So all of these technologies are helping us to grow and at the same time bend our cost curve. Thank you.

That concludes our Q&A. I will now turn the program back over to Mr. Scott Childress.

Thank you, Steven. David?

Good, Scott. Yeah, I'm sure you could see on this call that we're making significant progress in executing our strategies. The U.S. was certainly an excellent example of that through the fourth quarter. We are leaning into SMBs. You know, the great majority of the solutions, innovative solutions that we've announced 2019, 2020 is to assist these SMBs to be more effective and to be able to compete with the larger companies. And our transformation initiatives, they're driving efficiency and they're allowing us to provide these new innovative solutions. These things are interrelated. They go together. And the last thing I wanted to hit about our call today is we are absolutely speeding up our network and expanding our weekend. We see a unique opportunity here in the market, and we are going to take advantage of it. We're going to make those investments from an OPEX standpoint, and we do feel strongly it will be accreted in 2021. And we absolutely are convinced it's the right thing to do. So we're going to continue to accelerate, move at a faster pace for the benefit of our customers, our shareholders, and our people. So thank you for joining us today.

That concludes our conference call for today. Thank you for your participation. Have a nice day. You may now disconnect.