United Parcel Service, Inc. (UPS) Q4 2015 Earnings Report, Transcript and Summary

Good morning. My name is Steven and I will be your conference facilitator for today. At this time, I would like to welcome everyone to the UPS Investor Relations Fourth Quarter 2015 Earnings Conference Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Mr. Joe Wilkins, Investor Relations Officer. Sir, the floor is yours.

Good morning and welcome to the UPS fourth quarter 2015 earnings call. Joining me today are David Abney, our CEO; Richard Peretz, our CFO, along with International President, Jim Barber; President of U.S. Operations, Myron Gray; and Chief Commercial Officer, Alan Gershenhorn. Before we begin, I would like to review the Safe Harbor language. Some of the comments we will make today are forward-looking statements that address our expectations for the future performance or results of operations of the company. These statements are subject to risks and uncertainties, which are described in detail in our 2014 Form 10-K and 2015 10-Qs. These reports are available on the UPS’ Investor Relations website and from the Securities and Exchange Commission. Before we begin, I would like to make you aware of a few adjusting entries that impact our reported results. UPS recorded a non-cash after-tax mark-to-market pension charge of $79 million. The charge resulted from lower asset returns that were partially offset by higher discount rates. Investment returns on planned assets were negatively affected by the overall market performance. The impact of the shortfall was mostly offset by increased interest rates used to calculate the planned discount rate. In the prior year period, the company reported non-cash after-tax charge of $692 million. The charge related to pension on mark-to-market was $670 million and the amount of the healthcare liability transfer was $22 million. More details on mark-to-market accounting are available in the presentation that is on the IR website. Excluding the impact of these charges, adjusted diluted earnings per share for the fourth quarter 2015 were $1.57 and GAAP earnings per share were $1.48. While fourth quarter 2014 adjusted diluted earnings per share were $1.25 and GAAP earnings per share were $0.49. In our remarks today, all quarterly and full year comments and comparisons will refer to adjusted results. In addition, we will discuss UPS’ free cash flow, which is a non-GAAP financial measure. The webcast of today’s call along with the reconciliation of free cash flow and adjusted results are available on the UPS Investor Relations website. And just a reminder as on previous calls, please ask only one question so that we may allow as many as possible to participate. Thank you for your cooperation. Now, I will turn the call over to David.

Thanks, Joe. Good morning everyone. Our results make it quite a good morning here at UPS. I am pleased to report a very positive fourth quarter, capping our strong full year performance. A year ago, we laid out a plan for successful peak in 2015. This year, through the extraordinary efforts of UPS’ around the globe, we delivered the high quality service that customers deserve and the financial discipline that shareowners expect. This was the fourth consecutive quarter that UPS exceeded financial expectations. In this quarter, we expanded margins and produced double-digit operating profit growth in all three business segments. That’s worth repeating, all three segments demonstrated excellent operating profit growth. In fact, the International segment achieved its best quarterly and full year results ever, exceeding $2 billion in annual operating profit. UPS ended 2015 with record fourth quarter earnings per share and the highest operating profit ever reported. Full year 2015 diluted earnings per share increased 14% to $5.43, an all-time high. Although the industrial side of economy has slowed, the explosive growth of e-commerce continues to create great opportunity. I want to spend some time discussing how we capitalized on our peak season opportunity by managing the challenges it creates. I can sum it up in three words: collaboration, control, commitment. Expanded collaboration with customers combined with key investments were central to our success. We worked together with a shared interest in fully utilizing UPS network capacity while simultaneously maintaining excellent service. UPS implemented certain pricing controls and maintained disciplined operating plans to ensure our peak package [volume] [ph] did not jeopardize the overall integrity of the network and could be delivered on time. For example, we optimized available capacity during the weekend prior to Christmas and collaborated with customers to tender shipments ahead of the original schedule. This moved our peak day up to December 21 and smoothed volume for the rest of the week, ensuring our customers’ packages reached their customers’ doorsteps before Christmas. This year, our customers worked more closely with us than ever and I want to thank them for making adjustments and being flexible. Together, we delivered a successful peak season. Again, working closely with our customers, we delivered a successful peak season. Turning to control, our actions to tighten dispatch, reduce special sorts, and implement just-in-time hiring resulted in significant cost benefits for UPS as we exercised more precise control over the network. We also expanded capacity, opened more than 8,000 UPS Access Points in the U.S., and completed several automation projects across the network. These investments provide year-round benefits. In fact, our automated air facilities were essential in servicing nearly 13% growth in U.S. domestic air volume during the quarter. The flexibility of our integrated network also gave us the control needed to seamlessly move volume between air, rail and ground to maintain excellent on-time service. This year, we again implemented a management process called the control tower in the U.S. and expanded it to Canada and Europe. We handled customers’ unplanned volume surges by efficiently utilizing available UPS network capacity. Our goal was to find a solution that worked for our customers and UPS. Working together, we were able to service more than 90% of these last minute requests. Another aspect of control is managing outside transportation cost, which spikes dramatically during this time of year. Our recent acquisition of Coyote Logistics helped manage this expense. They played an expanded role this peak season and provided truckload brokerage service for UPS and its customers. Coyote’s synergies remained on plan. The final C is commitment exemplified by the actions of our employees to deliver on-time service during a period when our volume nearly doubles. There are numerous examples of UPSers going the extra mile everyday for our customers and they again demonstrated that commitment this peak season. I want to take a moment to say thank you to all the UPSers around the world whose enthusiasm and extraordinary efforts during the holiday season produced these great results. I am proud of their determination, dedication and hard work. While peak season 2015 helped drive strong fourth quarter results, we have turned our attention to 2016. Our business is more diverse than retail in peak season. Customers continue to choose UPS because of our broad portfolio of solutions across many industries like healthcare, aerospace, high tech and manufacturing. We will continue to capitalize on opportunities within these market segments by further expanding our network, improving operational efficiency and focusing on high growth and adjacent markets. Looking at the global economy, conditions remain uncertain with the first half of 2016 continuing the mixed economic trends from the last half of 2015. Across Europe and Asia, GDP growth was modest in 2015. However, slight improvements are expected this year. At the same time, we continue to see challenges in emerging markets in 2016. Global macroeconomic conditions reinforced the need for nations to continue making progress on free trade agreements such as TPP and TTIP. While the U.S. GDP growth outlook is muted for the first half of 2016, it is expected to gain strength in the second half. Further, the U.S. remains dependent on a consumer based economy for growth, while industrial manufacturing continues to be held down by a strong dollar and lower global demand. Through this uncertain backdrop, UPS will continue to implement our investment in growth strategies in 2016. Our strong execution of these strategies will enable UPS to continue to create excellent shareowner value. Now, Richard will give you more details.

Thanks David. It’s good to be with you this morning and report on an outstanding fourth quarter. All three segments performed better than expected. They achieved solid results by focusing on revenue management and operational execution. These efforts expanded operating margins and increased shareowner value. Total fourth quarter revenue was up slightly to $16.1 billion. On a currency-neutral basis, it was up 2.4%. Changes to currency and lower fuel surcharges reduced revenue by more than $600 million. Overall, UPS produced fourth quarter earnings per share for 2015 of $1.57, up 26% from last year. Full year 2015 earnings per share were $5.43, a 14% increase over 2014. These results included discrete tax credits of about $0.07 for the quarter and $0.10 for the year. Excluding these on an annual basis, earnings per share grew more than 12%. Now turning to details within the business segments, In the U.S., we had a great quarter. Revenue was up 2.6% to $10.3 billion. Lower fuel surcharges reduced revenue growth by about 250 basis points. Average daily volume increased 2.4%, led by deferred air products up 15% and Next Day Air up 10%. Clearly, UPS customers are choosing the value of our air products to meet their customers’ expectations. Both business and residential deliveries grew in the quarter with B2C outpacing B2B two to one. E-commerce continued to drive higher residential shipments, in fact in December more than 60% of our deliveries were to consumers. Revenue per package increased slightly as strong base rates and product mix improvements were somewhat offset by lower fuel surcharges and changing customer mix. Operating profit jumped 18% to more than $1.3 billion and margin expanded 170 basis points to 13.1%. Solid execution of the peak operating plan and our network investments led to productivity gains. Average daily direct labor hours declined about 1%, with package deliveries increased 2.4%, some of the best results we have produced. The growth of e-commerce continues to increase delivery stubs in our network. During the fourth quarter, delivery stubs increased 5.1%. That’s more than twice as fast as our volume growth. Technology investments such as ORION are enabling us to reduce the cost of residential stubs. As a result, we held package delivery miles flat and reduced cost per piece. These results demonstrate our ability to adapt. We are bending the cost curve and the U.S. team is delivering high quality service while improving efficiency and cost. Looking now at the International segment, we had a record-setting quarter and year, achieving a 16% improvement in our fourth quarter operating profit of $624 million, delivering greater than 10% profit growth every quarter in 2015. Our results are driven by two efforts. First, rate actions that began late in 2015 resulted in losing some low-yielding accounts, predominantly affecting the international domestic volume. And second, network management improvements continue to contribute to bottom line results. As we modified international block hours to match volume and trade lane demand. Revenue in the fourth quarter was $3.2 billion. Base rates increased across all regions, although they were offset by about a 350 basis points drag from lower fuel surcharges. Total export shipment growth slowed, reflecting the execution of previously mentioned pricing initiatives along with varying market growth rates around the world. Imports from Europe into the U.S. were strong for the fourth consecutive quarter, aided in part by the appreciating U.S. dollar. The International business continues to demonstrate the ability to adjust in an unsteady economic environment. Turning to the Supply Chain & Freight group, operating profits grew more than 11% with an expanded operating margin. Overall, revenue growth increased 6% with the addition of Coyote. However, organic revenue growth declined due to two factors; First, ongoing weakness in both forwarding and U.S. LTL markets. And secondly, the continuation of our targeted revenue management actions. Both the forwarding and UPS Freight units are executing initiatives that are driving change into customer mix to improve profitability. The forwarding unit improved operating margins as the group held firm with rates, achieving their highest buy/sell rate spread in the last few years. In UPS Freight, LTL revenue per hundredweight improved 2.1% with a drag of about 550 basis points from lower fuel surcharges. However, market conditions continue to challenge UPS Freight as they saw tonnage decline about 12%. The distribution unit saw double-digit revenue growth from targeted industries, healthcare and aerospace, particularly in the U.S. and in Europe. Now let’s turn to our cash flow. Throughout 2015, UPS continued to generate healthy free cash flow, producing over $5 billion after $2.4 billion in capital investments. Once again, we returned more than 100% of net income to shareowners as UPS purchased 27 million shares for approximately $2.7 billion and paid out another $2.5 billion in dividends, up 9% per share over last year. Looking at our tax rate, as previously mentioned during the quarter, UPS resolved a few outstanding tax items. Together, these resulted in $63 million of discrete credits or about $0.07 per share. For 2016, we expect our tax rate to be 35.25%. Now, I will cover the rest of our guidance. We expect 2016 to be another good year at UPS. Revenue should increase between 6% and 8%. Looking more closely at the segments, in the U.S., the domestic segment average daily volume should increase about 2% to 4%, driving revenue up 4% to 6%. Operating margin is forecasted to expand and operating profit should grow 5% to 9%. In the International business, shipments per day are projected to increase 2% to 4%. Growth rates will be held down during the first half of the year due to the revenue management actions we discussed earlier. We anticipate a drag of about 150 basis points from non-hedged currencies and lower fuel surcharges. As a result, revenue will grow at a similar pace as volume. Operating profit is expected to be up 8% to 12% with some margin expansion. In the Supply Chain & Freight segment, revenue should be up 15% to 20% with Coyote adding for the full year. The segment’s organic revenue growth is projected between 3% and 5%. Operating profit growth is forecasted between 6% and 10%. However, first quarter growth will likely be down about 8% to 12% from last year due to the continued softness in the LTL, freight brokerage and freight forwarding markets. As a reminder, the West Coast port strike provided some benefits in 2015. Operating margin for the Supply Chain & Freight segment should be around 7%. For the total company, we expect our 2016 operating profit distribution by quarter to be very similar to 2015. From a cash flow perspective, investment in the business remains our first priority with CapEx expected to be about 4.5% of revenue or $2.8 billion. Next, we remain committed to paying the strong dividend. Finally, we have about $2.7 billion in share repurchases planned. As we have mentioned in the past, we will continue to follow this framework and make necessary adjustments if new opportunities arise. Overall, we expect 2016 to be a solid year for UPS. We will continue to execute on our investments as planned and the network improvements we are banking are producing financial benefits. As a result, we are projecting diluted earnings per share to increase within the range of $5.70 to $5.90, a growth rate of 5% to 9%. And when excluding the 2015 tax credits, our growth rate is 7% to 11%. In closing, despite the unsteady economic climate, we are well-positioned to make significant progress again in 2016. Thank you for your attention. I will ask the operator to open the lines so we can take your questions. Operator?

Our first question will come from the line of Tom Wadewitz of UBS. Please go ahead.

Yes, good morning, and congratulations on the strong results and the best of peak season. I wanted to – I guess it’s one question, but it’s really focused on your volumes within fourth quarter in Domestic Package. It was, I know you have had a spread of strong air volumes on, driven by e-commerce, but it seems that spread versus ground widened out. I was just wondering if you could give a sense of what were some of the key drivers of the Domestic Package volume and that spread in fourth quarter, what was B2B like in ground, what was the impact of your controls to have a peak, was that a big factor on the softer ground, and just was there a weakness of the economy? What were sort of the key drivers for the net domestic volume? Thank you.

Hey, Tom, this is Alan. Yes, certainly, it was a solid peak season. We delivered more than 612 million packages over the peak period. It’s the most in the company history, up about 7%. And as you said, the air volume was well above our expectations in the quarter with the deferred growing almost 15 and Next Day at 10. The ground volume, yes, was a little bit below our estimates. Certainly, the soft industrial production that David mentioned and certainly some of the revenue management action on some of the low yielding accounts earlier in the year for peak had some impact. Our B2B growth was positive. If you remember last quarter, it went negative, but it rebounded last quarter. And as Rich mentioned, our resi grew at about a 2:1 ratio to the commercial. Thanks.

Tom, this is David. When it comes to volume, I think it’s worth taking the time to look at the – over the 2 years, the stock volume for the fourth quarter. And if you compare ‘13 to ‘15, you see that our total volume was up 9% and our ground volume was up 7.6%. So, when you look at it over a 2-year period, what you see is the ‘14 had a tremendous increase in ground and then we added to that, but the 2-year [stag] [ph] gives a pretty good picture of where we have been the last couple of years.

Okay.

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

Hey, thanks. Good morning, guys. So, one quick housekeeping question and then one broader question. Is there anything in the fourth quarter or the guidance related to this spot rate pension accounting that a lot of companies are doing? And then just bigger questions on the volume growth outlook, so forecasting an acceleration in volume growth and I think you kind of said it will be more back-end loaded, should we think about the – I guess what gives you confidence in that reacceleration in volume growth in the back half of the year? And then should we expect the earnings growth then to also be back-end loaded?

This is Joe. Just before we get started, we are just going to do one question, because we get a lot of people, but we will take this dual-part question out, but Richard why don’t you...

Sure. Scott, so the question you asked around pension is that we currently use a mark-to-market, it’s on a – there is a deck presentation on our website, it explains the mark-to-market and we use that corridor approach for that. And I think that’s – goes through the process and we have done that each year the last few years whenever we make an adjustment. This year, it was a much smaller adjustment. And I think once you go through that, after some more questions, we can handle that appropriately. In terms of the volume and the guidance on volume, we did have solid top line growth this year. In fact, it was 5% growth this year and we really see 2016 as the continuation of what we did in 2015. It does have some cycles through the quarters. Obviously, we talked about each quarter kind of looking similar to the previous year. And so when you think about how our volume grows, our revenue and our profits, I would point you back to that, but we feel real good about where we are at. We think it’s not just what’s happening outside externally on the macro environment, it’s also all the initiatives and the things that we are doing inside UPS right now that are gaining traction and are actually the reasons that the results were so good for the fourth quarter and for all of 2015.

And on the volume, just a little bit more on that. In 2015, we said all along due to peak cost and to other cost that we are going to have to focus on yield which we did. And for 2016, we just want to make sure that we have the right balance and I am absolutely confident that the team will between maintaining yield and increasing our volume. So, with the initiatives that we have, feel comfortable that we are going to maintain the air volumes the way they are and felt like that we will improve the ground volumes.

Yes, thank you, guys.

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

Thank you. Good morning gentlemen and congratulations on a nice quarter and outlook in a challenging environment and my wife thanks you for a successful peak season. Real quick on ORION, how much more do you have to implement across your driver network? And is it possible to quantify the cost savings in Q4 from ORION?

Good morning, Kevin. This is Myron.

Hi, Myron.

During the year, we increased the deployment for ORION from 45% in 2014 to up to 70% by year’s end. We expect to be completed with the deployment of ORION by the first day in January of ‘17 and we are extremely pleased with the results that we are getting today.

And Kevin, this is David. I would want you to tell your wife we really appreciate her efforts to increase our volume. So, thank you for that.

I will, thank you.

Next question will come from the line of Nate Brochmann of William Blair. Please go ahead.

Yes, good morning. Thank you for taking the question. I was curious a little bit just about the Coyote acquisition in terms of how that’s progressing so far and where you have seen the most benefits in terms of how you utilize that in terms of moving some of your own package freight throughout the network in the fourth quarter and also two in terms of just kind of seeing that business organically in terms of still working with their kind of core customer base?

Yes, Nate, this is Alan. Coyote certainly performed well during peak and we are going to continue to expand that role. They were certainly one of the difference makers. They are playing a crucial role in our ability to manage our outside transportation services and cost, certainly year round, but very, very integral during the peak season. So, they provided the flexible capacity to meet the demand surges and they also helped us to improve our capacity utilization. On an overall basis, as David said in his opening comments, the synergies are on track. I would also say that we are getting some good purchase transportation procurement benefits and those are exceeding our expectations.

Thanks.

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

Great. Good morning and I echo a great job through the peak season, great to see. But I think you mentioned that you turned away 3% of volumes given the control tower, I just want to understand some of the economic commentary as you look ahead to your outlook, ground volumes remain up pretty slight, so are you still seeing a trade-up to Next Day Air and deferred just given the strength there or is this just an economic difference of e-commerce versus what you are seeing on the ground side?

Yes. First of all, we didn’t turn away 3% of our volume with the control tower. The control tower was an absolute success this year from both a customer and a UPS perspective. And I would also say from an e-commerce, retail and also a year round customer perspective, all the other industry segments that we serve, so a real success. And the primary goal there was to optimize the network capacity and find solutions that worked for our customers and UPS. And in fact, between Cyber Week and Super Weekend, we were able to accommodate all the customer requests. And during those final few days, there was a few that we needed to turn down. But even then, some of those were some dual source customers who chose not to make longer term business commitments to UPS. So we thought it was a resounding success. We had a very disciplined approach to the volume, the capacity and managing the yields to produce the excellent fourth quarter that we had.

Great. I am sorry and the trade up down commentary?

Yes. So look, I think that the – the air products are resonating really well with our customers and certainly, the just-in-time nature, so our deferred was up 14% and the Next Day Air overnight products mainly the Saver was up about 10%. And I think customers are choosing the services that they need based on the time in transit that they are looking for.

Alright. Thank you for the time.

Our next question will be from Ben Hartford of Baird. Please go ahead.

Thanks. Good morning. Jim, maybe this question is for you. I am a bit curious in your perspective on business inventories generally from customers, there has been a lot of discussion on some de-stocking, whether that has taken place in the fourth quarter, curious on your view on the International side what you are hearing as it relates to inventory de-stocking during fourth quarter, any planned de-stocking in 2016? And then any perspective that you can provide on the domestic side would be helpful as well? Thanks.

Yes. This is Alan, I am going to take that first and pass it over to Jim. Certainly, what’s happening, international has a forward impact on the U.S. but as you probably all know, the U.S. inventory sales ratio has come down slightly but it still remains elevated, certainly indicating we got continued overhang of inventories in the economy. And customers are obviously attempting to work them down. We expect the strong U.S. dollar to continue to influence the trade lanes. And I guess the last thing I will say is that our omni-channel e-commerce strategies like ship from store, enabling retailers to burn some of that off effectively.

I guess, Ben I would add the comment probably from the forwarding perspective because that tends to be the kind of front end of some of these inventory moves. If you look at about the last year, what we have seen is a continued gap of demand and capacity, but I would say in the last two months of data, what we started to see is some load factors turning up. So as that moves forward, now we also have Chinese New Year coming on us right know, so that will give us our second read. But from that perspective, I think as some of the guys mentioned earlier, the buy/sell spreads, which is reflective of capacity and demand have been at its widest point through 2015. But early indications, there is a little bit of turn towards the end of 2015. But we don’t see anything that spikes in a great way just yet, but that will lead us to further evaluation of the inventory. So appreciate the question.

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

Hi, good morning and thanks for taking the question. Richard, great to hear the guidance on the domestic margin expansion, but I have a question for you on International. How much are we – how much are you guys seeing benefit from the currency gains in the fourth quarter, how should you expect that sort of hedge gain to play out in ’16 and then should there be a cliff on the hedge roll-off in ’17. We have got a lot of questions about how that International play out over the course of the year in terms of reporting gains on the currency hedge?

Sure. We use our currency hedge program that really is about protecting our profits. But when you separate that out, right now we do have protection for all of ‘16. And at different points through the last few years, we have gone in and made the necessary adjustments. But when we looked at the operating margin, it has improved a little bit because of the hedge and it’s about 200 basis points or just over 200 basis points in the margin that you should be thinking about that’s really driven because of the hedge program that’s really meant to allow the operators to look at the business and step away from what’s happening with the currency and come straight on growing the business. I am actually going to ask Jim to talk a little bit about the record setting year that international has had.

Okay, thanks David and thanks Rich, I think. With respect to currency, that’s going to work through in the hedges as Rich pointed out is how we manage it. I do want to point you back to what we consider to be a very solid year in International, a couple of obviously record breaking points. But I think the key for us is to continue to lean into the networks. We have talked to you in late 2014 at the investor conference about efficiencies and continuing to invest in the networks specifically up to about $2 billion in Europe. We continue on that path. Our Europe team continues to execute. We keep – we get revenue management initiatives to go with it. So all that really keeps us at the really end of the story, which is industry leading margins in the International business. And we will manage that and currencies will do what they will do and we will continue to grow the business internationally and manage to the top of the industry margins. So appreciate the question.

So just to kind of clarify, should we then be expecting that, that 200 basis points of margin to roll-off in ’17 or are you guys making progress on mitigating that impact?

It’s a little early to start guiding you on ‘17, but there are certain actions that we are taking on. And as it becomes more appropriate to cover and things are more complete, we will give you a better story on that.

Alright. Thanks very much for the time.

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

Good morning. Thanks. I wanted to follow-up on an earlier question on pension and if you could provide or quantify what’s embedded in your guidance in terms of the year-over-year expense tailwind or headwinds?

Sure. Thank you, Allison. When we look at the pensions overall, we are expecting our expense to actually be flat this year with 2015 and that’s what’s embedded in the guidance. The activities around pension are an important area for UPS, we continue to actively managing that area. And as I said for the year, it’s going to be flat, so there won’t be any increase in expense for 2016.

Our next question will come from the line of Jack Atkins of Stephens. Please go ahead.

Great. Thanks for taking my questions, guys. So I guess just to focus here on Amazon for a moment, we saw several media reports late in the fourth quarter that the company is planning to leave a number of 767s and perhaps 737s to operate in both U.S. and Europe. If this is indeed the case, what impact do you think this move will have on the competitive pricing dynamics in the domestic and European express market?

Okay. This is first David, and first let me make sure and express that Amazon is a good customer of ours. We have a mutually beneficial relationship. And our goal with Amazon or any other big customer is to continue to show our value to – through the integrated network and through our technologies and to have a value proposition that’s difficult to match. We do add capacity and for large customers such as Amazon, we do it though we ensure we have the proper economic return. And at the same time, we also ensure the integrity of our network for all customers by planning and forecasting our volumes. So I didn’t read anything that in the last quarter that we felt like is in – on any kind of substantial basis is going to affect our pricing, our pricing in the market. We just believe we need to continue to focus on our values, stay on our strategies and our technologies and we feel that we will have another good year this year as far as return to investors.

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

Hey, good morning guys and again congrats on the better outcome this year, totally different from 12 months ago. But can I just ask you, what’s your general perception of industrial exposure in your Domestic Package network? Because if I look back historically when we saw IP contracting, I think it’s been very difficult for UPS to get earnings. So, can you talk to some of the risk that the outlook has if the industrial economy keeps weakening? And then maybe some of the counter proactive or positive things are happening in the network that are giving you this positive outlook?

Yes, Brandon, this is Alan. Look, I mean, I think the story with industrial production has been happening now for quite a while. Certainly, it’s trending more negative than it has been. Our business today, as Rich said, even at peak season, we were up to 60% residential, so about half of our business is on the retail e-commerce side now. And I think we are going to be able to manage through that real well. I think the value proposition that we have in place for both retail and the other industry segments, including industrial manufacturing, high-tech and healthcare bode well. So, we feel pretty good that we have embedded these trends into our 2016 plans and are very confident in achieving those results.

And this is Richard and just a few other things I think that’s important to think about when you think about what’s embedded in our guidance is that the volume is based – is not just based on what’s happening externally, it’s also what’s going on within UPS. And so we started out externally and look at various scenarios of what we think could happen. And so embedded in the range is different volume assumptions and that’s why there is a range. But also it’s the story about the economies that we are getting out of the ORION project and the adjustments we are making in the air network. You bring all that together and that’s why the range is as we put it out there. So, we feel very confident that what we are putting out there is the expectation based on both the external and the internal efforts we are doing here at UPS.

Just last – and this is David. Just the last comment on industrial production, if you are going to look at our results 5 years ago, I think there was a tighter correlation. Now of course, with our e-commerce and residential business growing as fast as it is, I think that maybe it’s not quite as direct. And if you look at the fourth quarter, industrial production was down all 3 months of the fourth quarter and we had record results. And I think part of that was because consumer confidence is still high. And so, I wouldn’t draw too much of a connection there if I was you, but thanks for the question.

Thank you.

Our next question will come from the line of Art Hatfield of Raymond James. Please go ahead.

Thank you. Hey, thanks for taking my question. I hope I get this out appropriately or word this right. I think you have touched on this a little bit, but obviously e-commerce is going to continue to grow at a very rapid pace. And it seems to me that as we move forward, you are going to have more and more difficult decisions during peak with regards to having the potentially turn-away business. How do you think about that decision-making process going forward? And how do you balance all of your customers’ needs?

This is David. I will start that question and then I will hand it over to Alan. The key to remember this year though is our focus was not on capping or turning away customers, but the control tower. Our focus is to pull volume in, work with our customers and find ways to utilize sources or areas of our network that aren’t kept such as we were very successful in pulling volume into the weekends. It’s how we were able to actually move up peak date from the December 22 to the 21. So one of the ways that we addressed what you were just referring to is the way that we do manage [indiscernible]. We also had substantial capacity this year for peak and from our CapEx plans that’s going to continue. And the increase in technology, ORION that you heard Myron talk about, over 70% utilized and Access Points and other technologies like that. So, I don’t think we have a future of just seeing how much volume we can cap. It’s just the opposite of how we can increase our capacity and how we can increase our effectiveness. Alan, from a customer standpoint?

I would just say, look, we have talked for a while now about bending the cost curve and David talked about some of the things we are doing there with ORION. But UPS My Choice, Access Points, SurePost Redirect and SurePost this year, we redirected over 35% of our SurePost packages back into the network, where we were able to create a two-piece stop, our omni-channel strategy so on and so forth. I mean, all these things are working in concert to help us be able to manage peak at levels today, where this year our peak volumes will almost double what they are during the remaining part of the year. Keep in mind that as we work with these – all these projects here, a lot of them are focused in on delivery density. And one-tenth piece per stop increased creates about $200 million of operating profit improvement. So, we feel like the things that we are doing to our network now are going to enable us to handle bigger and bigger peaks.

Our next question comes from the line of Chris Wetherbee of Citi. Please go ahead.

Thanks. Good morning. One last question about pricing, wanted to get a sense of maybe on the domestic side, how the core pricing looked and maybe how mix looked and whether or not we saw sort of an acceleration into the fourth quarter, I am just trying to get a sense that during peak is pricing stronger, are there other mix offsets that we should be thinking about? Thanks.

Yes, hey, this is Alan. Thanks for the question. Certainly, we had strong base rate pricing improvements throughout 2015. The fourth quarter was no exception. We came in at the higher end of the 2% to 3% long-term target range. It’s really – the GRI, the dim weight, some of the tactical pricing decisions as well as disciplined and prudent revenue management. For 2016, our expectation is to achieve again within 2% to 3% of the range for base rate improvements going forward.

Our next question comes from the line of John Barnes of RBC Capital Markets. Please go ahead.

Hey, thanks. Let me echo my congratulations as well. Nice quarter. Hey, real quick, you talked a little bit in your guidance about some revenue management actions you have taken in Europe. It seems like LTL volumes continue to be a little bit weak there. I am just kind of curious, I mean, is – are there any other revenue management areas that you are attacking right now? Is LTL one or is this isolated to Europe? Can you elaborate on that just a little bit? Thanks.

Sure. This is Richard. And John, I think the last few quarters we have talked about the revenue management initiatives and David mentioned improving the yield in some of his comments. And the thing to keep in mind is it’s really broad-based. We are doing it in small package. We are doing it in the international air freight market and the LTL. It’s really about making sure we have the right customers and the right yields in each of our networks.

We have a question from the line of David Ross of Stifel. Please go ahead.

Yes, good morning gentlemen. Question on the peak season volumes, the last couple of years, in ‘13, ‘14, the peak period was about 72%, 73% over a normal week period or a normal period. Alan just said it was nearly twice this year. So, was that 75%? Was that 95%? And in addition to that kind of what can you do in 2016 to make the network run even better during peak than it did this year? Thank you.

Sure. And this is Richard again. When you look across peak, obviously, peak is a little different at different weeks of it. But when you go across the entire peak period, it was slightly elevated from where it was last year and we move the peak day up by one because the available capacity over the weekends and the customers collaborating with us made the necessary adjustments. I am going to ask Alan to talk a little bit about it specifically, but what’s going on with volume, Alan?

Look, my point was that during peak, we handle almost double on any given day, but the spike occurs on an ongoing basis between Cyber Monday and Christmas Day. Throughout the quarter, our volume between October and November was softer and December on a secular basis continued to rise.

Our next question will come from the line of Alex Vecchio of Morgan Stanley. Please go ahead.

Good morning. Thanks for taking the question. I wanted to ask about the LTL environment, broadly speaking, it’s been several quarters now that volumes have been challenged not just for you but for the entire industry. And I guess I want to get a sense from you guys to the extent to which you are seeing increasingly competitive or aggressive pricing behavior from your peers, are you starting to see any of that or would you kind of characterize the industry as still broadly holding discipline on price?

Alex, this is Myron. If you go back to the fourth quarter of ‘14, each corresponding quarter, we have continued to see softness in the market and it’s adversely affected each of the carriers in the market. However, base rate improvements have remained steady and we are not seeing any adverse actions to the negative that are being taken by any carriers that we would expect that to remain that way moving forward.

The next question will come from the line of Matt Troy of Nomura. Please go ahead.

Good morning and thanks for taking my question. I just had a pretty straightforward inquiry on CapEx, I was wondering if you could talk about your CapEx budget for 2016, I know you guys have had a lot of irons in the fire in terms of optimization and modernization programs across the network. So just wondering what the capital budget is for 2016 and what are some of the major projects and allocations from that budget we can expect you guys to make progress on in 2016? Thanks.

Sure, Matt. This is Richard. Our CapEx, as I mentioned in my talk, is expected to be about $2.8 billion right now. The model that we built at UPS in the network is very unique and we are continuing to make the necessary adjustments in automating our Tier 1 buildings, but we are going at a measured pace because we also have to make sure that we continue to provide the service that our customers expect. In fact, in the last few years, we have actually doubled the spend in our buildings and facilities and we expect that, that will continue and that’s probably the area where we will be spending the most money next year. But the results of this quarter were really driven by the investments we made in the last few years and that’s helped us to achieve the margins and the profit level that we got for 2015. Thank you.

Thank you.

Our next question will come from the line of Kelly Dougherty of Macquarie. Please go ahead.

Good morning guys. Thanks for the time. I just wanted to think about the different macro outlooks throughout the world and can you give us a sense of how much of your revenue you would estimate touches the U.S. at least at one end, so whether it’s generated domestically or imports or exports. And then also maybe you could give us a similar estimate for Europe as well?

Yes. Kelly, this is Richard again. When you think about the total company, obviously the U.S. is a very large piece of our business and we have talked about the importance not only of the U.S. but also both imports and exports coming into and leaving the U.S. And today of course, the imports into the U.S. are stronger and that’s really something we have seen because of the strength of the dollar, so exports coming out of the rest of the world coming into the U.S. are much higher. And we have talked about in the past that Europe is a very large part of our international. It’s about 50% of the International business. So together, those two are a large – very large part of the company, but the other pieces of the network are important because the customers are sending packages all over the world back and forth.

Is there any way to kind of quantify 75, 80 whatever that number is percent of your revenue actually touches the U.S. in some way, shape or form?

Kelly, this is Joe. We can take that detailed question offline when we talk later on today.

Okay.

Thanks.

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

Hey, good morning guys. And thanks for squeezing me in here. With regard to the margins in Q4, U.S. domestic package got back to in line margins for the full year and I think it’s a testament to a lot of the internal initiatives that you guys were calling out as well as the strength on pricing, how are you guys thinking about margins looking out next year and it appears that within domestic, are the international initiatives enough where that we will start to see fourth quarter margins again be better despite the greater concentration of home deliveries and B2C shipments or should we kind of think about it roughly in line with the broader full year overall margin in U.S. domestic package?

Rob, again this is Richard. I think you have to look at 2016 and David actually made a comment earlier that this is going to be a balanced year. So there is both volume growth and making sure that we align the revenue with the resources that are used in UPS, that’s very important. As well, in the last few years, we have been down this road of improving our internal operations. You saw that because for the first time, you actually see stops going growing twice as fast as volume, yet your cost per stop came down. And that’s a testament to the technology and the U.S. operations it had a good quarter. And I will actually ask Myron to comment on that.

So Rob, let me begin by thanking the thousands of UPSers who help to execute on the well designed plan. We will continue to deploy technology, tighten our direct labor hours and add capacity where necessary to take advantage of this expedited growth in residential deliveries. Deployments like ORION that helped us control our miles actually they were flat in the fourth quarter. Our direct labor hours were down from last year and the service was exceptional. And we continued to deploy Access Points that gave control and convenience to our customers. So, we believe that this expedited growth and residential deliveries don’t pose any support moving forward. Thank you.

Our next question will come from Helane Becker of Cowen and Company. Please go ahead.

Thanks very much operator. Hi gentlemen. Thank you also for the time. As you guys think about the CapEx you are spending on improving the technology in the buildings, are you actually able to grow without adding additional headcount? And I think Myron, maybe you just started to address that question with respect to improving margins without increasing either headcount or salaries that much?

I think our automation strategy will allow us to not add headcount. And our automation strategy moving forward is to either deploy technology in the existing footprint that we have when we build new buildings or where we may need to add capacity that would help us reduce handles. In the fourth quarter, our direct labor hours were flat. Now we hired what we expected in terms of people that 90,000 to 95,000. But because of this automation, we were able to bring them on much later at peak and our actual hours were down 8%. So we don’t see a need to add headcount. Thank you.

Yes, this is David. Just to put a recap on that. Each of these automated facilities we see about a 20%, 25% efficiency. So it gives you an idea of what they mean to us. Thank you. Next question.

Next question will come from the line of Jeff Kauffman of Buckingham Research. Please go ahead. Mr. Kauffman your line is open. We will move on to our next question from Bascome Majors of Susquehanna. Please go ahead.

Thanks for squeezing me in here guys. Just to kind of step back, if you are going to have to design a parcel network from scratch to serve e-commerce customers, leverage the residential deliveries, can you talk a little bit about how are we different from the network that you have today?

Look, I think that the network that we have today, the air and ground integrated network is second to none and the enhancements we are making to that network, whether it’s the operational efficiencies that Myron talked about with ORION and hub automation or whether it’s some of the customer-facing technologies that we are putting in place that also help reduce cost to make us more efficient and to make us attractive to both consumers and retailers is really the best network in the business. And again, when you think about this e-commerce ecosystem that we are putting in place with our base ground and air package network adding on the UPS My Choice, UPS Access Point, the Synchronized Delivery Solution, the SurePost and the SurePost Redirect, our returns portfolio, i-parcel, combining that with some of the efficiencies really makes UPS network the e-commerce network of the future.

And due to time constraints, our last question will come from the line of Scott Schneeberger of Oppenheimer. Please go ahead.

Thanks for taking me guys in there. Congratulations. Just back to B2B domestically, if you could address it in U.S. package and Supply Chain & Freight, just how did you see the trend as you ended fourth quarter and into first quarter? And if you could speak a little bit to end markets that were most impacted good or bad? Thank you.

Yes, hey, this is Alan, thanks for the question. So, certainly, in the U.S. here, our B2B business was positive all year with the exception of a slight dip in the third quarter growing at or about half the pace of B2C. And like we said, it rebounded back in the fourth quarter, but mainly driven by retail. Certainly, on the Supply Chain & Freight side of our business, the vast majority of that business is in fact B2B. And in the International business, a much larger preponderance of our business is B2B, so the growth you are seeing in there would impact also B2B.

I would now like to turn the conference back over to our Investor Relations Officer, Mr. Joe Wilkins. Please go ahead.

Thank you, Steven. Appreciate it. I will now turn it over to David Abney for closing comments.

Good. Thanks, Joe. We are successfully executing our strategies and capitalizing on our investments. Due to the strong peak, the fourth quarter, the four consecutive quarters of 2015 where we exceeded expectations are all evidence of our execution. We are carrying this momentum into 2016. We feel good about the year even with a little less certain environment around us and we expect once again to deliver strong earnings growth this year. Thank you for your time and see you next quarter. Thank you.