United Parcel Service, Inc. (UPS) Q2 2020 Earnings Report, Transcript and Summary

Good morning. My name is Steven, and I will be your facilitator today. I would like to welcome everyone to the UPS Investor Relations Second Quarter 2020 Earnings Conference Call. [Operator Instructions] 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 second quarter 2020 earnings call. Joining me today are Carol Tomé, our CEO; and Brian Newman, our CFO. 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 expectation for the future performance or operating results of our company. These statements are subject to risks and uncertainties, which are described in detail in our 2019 Form 10-K, subsequently filed Form 10-Q’s and other reports we 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 quarter, GAAP results included a pretax charge of $112 million, equivalent to $0.10 on an earnings per share. The charge resulted from transformation-related activities in the international and U.S. domestic segments. In the prior year period, GAAP results included a pretax charge for transformation cost of $21 million, equivalent to $0.02 on an earnings per share. Unless stated otherwise, our comments will refer to adjusted results, which exclude transformation costs. The webcast of today’s call, along with the reconciliation of non-GAAP financial measures, are available on UPS Investor Relations website. Following our prepared remarks, we will take questions from those joining us via the teleconference. [Operator Instructions] And now I’ll turn the call over to Carol. Carol Tomé: Thank you, Scott and good morning. I’m honored to be hosting my first UPS earnings call. Before I begin, I would like to thank David Abney, who after 46 years of service to UPS passed the baton to me on June 1. We wish David all the best. UPS is a special company with a unique culture powered by more than 528,000 UPSers around the world. Through this time of global pandemic and social unrest, UPS is keeping the world moving. We have taken measures to ensure the safety of our people, while delivering critical shipments and everyday essential, where and when they are needed. I am extremely proud of the efforts of our people to serve our customers, our communities, and each other. To all UPSers, thank you. During the quarter, our team did a great job adjusting the network to respond to the needs of our customers. At the beginning of the second quarter, we assumed demand would slow. Instead, we saw just the opposite. Due to ongoing COVID-related sheltering in place, retail store closures and changes in U.S. consumer spending fueled by the economic stimulus, we experienced unprecedented demand and record high volume levels. As a result, our second quarter performance was stronger than we expected. Consolidated revenue rose 13.4% from last year to $20.5 billion. Operating profit grew 7.4% from last year to $2.3 billion, led by outstanding results in the international segment, while our U.S. operating margin declined by 170 basis points from last year, largely due to certain expense items that Brian will explain. We were pleased with 580 basis points of sequential improvement from what we reported in the first quarter. Let me share with you how I’ve been spending my time since onboarding as CEO. I thought, I knew UPS after 17 years on the board, but I’ve been diving in and believe me, when you get to dive deeper, this company is even more impressive than I imagined. Our global network is best-in-class and our people are the hardest working people I’ve ever met. We also have many opportunities. In our 113 year history, UPS has become a trusted global logistics leader. But what got us where we are today will not get us to where we need to go in the future. Our customers are changing, our competitors are changing and the rate of change is accelerating. As we evaluate new market realities, we will be making decisions faster based on data and analytics with an emphasis on optimizing our existing network and the investments we’ve made. We will have a laser focus on creating value for our shareowners, with the goal of increasing the rates of return on the capital we invest. It’s all about becoming better, not bigger. We have five core UPS principles that underpin our actions. Our first principle is our values. These values were established by our Founder, Jim Casey, and give us an enduring foundation for success. Our values include integrity, safety, teamwork and service, and are the core of who we are and what we do. Our second principle is our dividend, which is a hallmark of our financial strength. We are committed to continuing nearly 50 years of stability and growth in the dividends we pay. Our third guiding principle is retaining a strong investment grade credit rating, ensuring that we have financial flexibility needed to competitively run our business. Next is brand relevance. And by relevance, we mean leading by example, taking actions to support our customers and communities, promote diversity and inclusion, sponsor racial equality and shape a healthier planet. And finally, our fifth principle is the importance of employee ownership, which supports valuable and lasting employee and retiree engagement. Outside of these five core principles, everything else in our portfolio is under review, and I mean everything. While it is early in the process, the good news is that we already have the right strategy in place. Customer first, people led, innovation driven. Customer first is about removing friction when doing business with UPS. Speeding up time and transit and improving the moments that matter. So we create greater loyalty to be measured by gains and our net promoter score. In support of this effort, we have accelerated our plans to improve time and transit, making the U.S. ground networks faster and thousands of the most important lanes by the end of this year. Further, we are continuing our expansion of weekend operations, including Sunday share post and our market leading Saturday commercial delivery and pickup services. Before our 2020 peak season, nearly 75% of the U.S. population will get Saturday ground residential service. By our estimate, both our time and transit and weekend enhancements drove roughly $100 million of incremental revenue in the second quarter. People led is at the core of our success, measure it through the employee experience and specifically how likely an employee is to recommend UPS as a place to work. We are focused on diversity and inclusion and fighting for racial justice and reform. I cannot say enough about the power of our people, including the nearly 40,000 new UPSers, we’ve added to our U.S. Small Package business in recent months. During this time, we’ve provided additional sick leave benefits to UPSers who may have been impacted by COVID-19. And to further invest in our full time management teams for their extraordinary efforts, we are providing additional financial incentives. Moving to the last leg of our strategic platform. Innovation driven will be measured by the value we create for our shareowners. We will leverage our technology and portfolio of services to drive greater cash generation and higher returns on invested capital. Today, we are focused on increasing network efficiency, as well as more permanent actions to improve revenue quality, including pricing that reflects the value we create. For example, on May 31, we introduced new surcharges of certain volumes. We are developing specific actions and metrics against our strategic efforts. And once finalized, we’ll share them with you, so that you can measure our progress. Looking to the back half of the year. Most scenarios suggest continued uncertainty, which is likely to yield a more gradual economic recovery. This is due in part to the recent surge in COVID-19 cases, new containment measures and the status of fiscal stimulus program. While we would expect continued strong B2C demand, it’s hard to know how our B2B demand will unfold. The recovery will continue to be extremely difficult to predict until the spread of the virus is better controlled and a vaccine is widely available. I’ve led through difficult economic cycles before, and I know the power of making the right decisions to pivot toward opportunity. Our leadership team is focused on enabling success for all UPSers and creating value for our shareowners. We will control what we can control, while taking action to write the next chapter of the UPS story. We look forward to updating you on our progress. And with that, I’ll turn the call over to Brian.

Thanks, Carol and good morning. Today, I will discuss our quarterly performance and current trends in our business, which the teams are navigating well. Before I start, I want to point out the expanded disclosure in our web schedules. To improve transparency, we brought the 10-Q balance sheet and cash flow statements forward and have included them in the materials released today. Through the second quarter, we face challenges from the coronavirus pandemic and resulting recession. Global real GDP and global industrial production are estimated to be down 9.3% and 14.6% respectively. And in the U.S., real GDP and industrial production declined with unemployment reaching historic highs. In response, we adjusted our network to support our customers’ needs. We manage costs and leaned into three significant changes in demand in the markets we serve. First, our ability to shift air capacity to where it was needed enabled us to meet the strong demand out of Asia, using both our own assets and asset-light solutions. We met the demand for more capacity by flying about 635 extra flights using both brown tail and third-party aircraft. Next during the quarter, the U.S. e-commerce market jumped 34.4% and SMB is quickly adapted to participate. In fact, through our digital access program, we captured 120,000 new customer accounts, a significant increase from recent trends. And finally, our healthcare expertise and global portfolio of services enabled us to meet the urgent need for PPE and COVID-19 testing supplies, and provide support for vaccine and treatment studies. All of which, contributed to our results in each of our three segments. For the quarter, consolidated revenue increased 13.4% to $20.5 billion. Net income rose 8.8% to $1.9 billion and operating profit totaled $2.3 billion or 7.4% higher than last year. The operating margin for the company was 11.4% below last year by 60 basis points, diluted earnings per share was $2.13, up 8.7% from the same period last year. Now moving into the segments. In U.S. Domestic, market demand for residential delivery surged in the quarter, driving total average daily volume up to 21.1 million packages, an increase of 22.8%. SurePost increased 96.6% and represented 53% of our total U.S. Domestic volume growth. Volume approached peak like levels with May and June, significantly above April. The surge created some network constraints and some regional dips in service levels. However, the additional 39,000 employees, we hired together with our expanded weekend operations enabled us to process the increase in volume. Ground residential volume, excluding SurePost was up 63.8%, without exception, all industry sectors grew the residential volume. In fact, B2C volume jumped 65.2% year-over-year, which is 5.8 million additional pieces per day, and B2C represented 69% of total volume. Conversely, given the downturn in the industrial sector, B2B volume declined 21.9% or 1.8 million pieces per day from the same period last year. However, we did see B2B volume begin to recover in the quarter. As a percentage of total volume, B2B shipments were 27% in early May. And at the end of the quarter, B2B shipments had climbed to 37% of total U.S. volume. For some context, the full year 2019 split was 46% B2B. While average daily volume growth was led by many of our larger customers, SMBs rebounded over the quarter, from a decline of 7.2% in April to growth of 17.8% in May and 22.4% in June. Revenue was up 17.3% to $13 billion, driven primarily by ground products. Revenue per piece declined 4.4% or 440 basis points, driven by two significant factors, lower fuel prices, which were a negative impact of 180 basis points, and the magnitude of SurePost growth pulled revenue per piece down 410 basis points. Excluding SurePost and the fuel surcharge, revenue per piece was higher than last year, and was also a sequential improvement from the first quarter. Our expenses increased in the quarter by 19.5% and we’re in line with activity levels, including volume growth. Our expenses also includes several items that we did not have last year, which I’ll cover in a moment. Cost per piece was down 2.7% year-over-year and decreased sequentially 8.4%, driven by lower fuel costs and our ability to scale and flex the network as volume surged. The U.S. generated $1.2 billion in operating profit, which was $11 million or 0.9% below last year. Operating margin declined 170 basis points year-over-year. However, sequential margins improved 580 basis points. U.S. Domestic operating profit includes the following expense items, coronavirus direct expenses, minus the CARES Act, federal excise tax benefit lowered profit by $44 million. A lower pension discount rate decreased profit by $63 million. Additional employee incentives reduced profit by $51 million, and working in our favor were lower fuel cost for a net fuel benefit of $61 million. We are operating in a very difficult environment and we have more work ahead of us to increase profit per piece, which was down 19.3% on a year-over-year basis. Moving forward, our focus is on improving network efficiency, optimizing the volume we bring in and better aligning pricing with the value we provide. Moving to International, I’d like to take a moment to congratulate our entire international team for delivering a very strong quarter, despite a tough operating environment. Our performance demonstrates the agility of our global integrated network. Asia was the first region to face the pandemic and was also the first to reopen, which led to a strong increase in export volume and revenue as we came out of the first quarter. Asia outbound volume rose in April, peaked in May, and moderated in June. Overall, Asia outbound volume grew 46.8% in the quarter and went up by double digits to all major regions of the world. Total export volume grew 11.4% driven by two factors. First, we quickly leaned into the opportunity created by the reduction of passenger belly space. We also added capacity surcharges to help us manage demand. In total, we added 335 flights and utilized our higher capacity fleet of 747 aircrafts, which enabled us to handle more volume on fewer flights versus other carriers in the market. The second factor was the 95% increase in residential volume, led by cross border B2C in Europe, doubling our B2C volume, while expanding profits is an encouraging sign for the future. Revenue rose 5.7% to $3.7 billion. Revenue per piece was down 3.9% and included a decline of 480 basis points from fuel, and 100 basis points from currency. On the expense side, cost per piece declined 8.2%, primarily due to lower fuel costs and greater network efficiencies. International generated operating profit of $842 million, an increase of 26.6%, and our operating margin expanded 370 basis points. Looking at Supply Chain and Freight, results across the business units were mixed. Total revenue grew 8.5% to $3.7 billion, and expense rose 9.4% to $3.4 billion. Profit declined $6 million or 2.2%. In general, the parts of our business that aligned to sectors with elevated demand did very well. For example, air freight led the segment due to the surge in market rates out of Asia, sparked by the sharp decline in passenger belly space. The team was responsive to our customer’s needs, including FEMA and resourceful in securing about 300 charters out of Asia. We also saw gains from COVID testing in vaccine and treatment studies. The portions of the Supply Chain and Freight segment, more aligned to industrial activity saw weakness during the quarter. LTL and truckload brokerage faced excess capacity and reduce demand early in the quarter. Both markets began to see some recovery later in the quarter, but remain under pressure. Looking at the overall enterprise, UPS generated operating profit of $2.3 billion up 7.4%. A few other items on the income statement include, other pension income, which was $327 million driven by last year 17.5% return on pension assets and lower discount rates. We also had $183 million of interest expense. And lastly, our effective tax rate came in at 25% compared to 23.5% in the second quarter of last year and is higher mainly due to unfavorable changes in our uncertain tax positions. Now let’s turn to cash and shareholder returns. Our cash flow remains strong. For the first six months of the year, we generated $5.9 billion in cash from operations, and about $3.9 billion in free cash flow, included in our results is $370 million from the federal payroll tax deferral. Capital investments totaled $2.1 billion in the first half of the year. We expect full year CapEx of $5.6 billion and remain on track with our automation targets for this year. So far this year, UPS has distributed $1.8 billion in dividends, which represents a 5.2% increase on a per share basis over the same period last year. Now I’ll make a few comments regarding the back half of the year. First, we remain unable to predict the extent of the business impact or the duration of the coronavirus pandemic or reasonably estimate UPS 2020 revenue and diluted earnings per share. There are however, a few items that are likely to occur in the second half of the year that we want you to know about. U.S. Domestic average daily volume growth is expected to be lower than what we saw in the second quarter. We expect demand for residential packages will continue in the U.S. and around the world. We also expect Asia outbound demand and yields to be positive year-over-year, but we’ll continue to moderate versus the second quarter. For modeling purposes, our Teamster employees will get their annual wage increase in August. And in the third quarter of 2019, we had a $40 million gain on a land sale in the international segment that will not repeat. And in the second half of 2020, U.S. Domestic will face difficult year-over-year comps, including the impact of our new hires anticipated to receive full benefits, time and transit, and weekend operations expense, preceding the full run rate of revenue, and other gains from last year that will not repeat. The economic recovery remains uncertain. We are paying close attention to the consumer financial health, unemployment levels and the continuation of fiscal stimulus programs. Given all these factors, the U.S. Domestic margin could be lower in the second half of the year, relative to the first half. International, Supply Chain and Freight will continue to adapt to market dynamics. Meanwhile, as Carol said, we will focus on controlling what we control. Among the positive and negative effects ahead of us, we remain confident in our ability to improve U.S. margins on a long-term basis. Our liquidity is very strong. We ended the quarter with more than $8 billion in cash and equivalence on the balance sheet, which is enabling us to invest through this unique environment and navigate the economic uncertainty. Thank you. And operator, please open the lines.

Thank you. We will now conduct the question-and-answer session. [Operator Instructions] Our first question will come from the line of David Ross of Stifel. Please go ahead.

And Carol, you’ve picked a good call to start off with. Carol Tomé: Good morning.

Wanted to see how you guys are thinking about peak season. In the quarter, you talked about a mini peak or peak-like conditions, where you had some network constraints. If some of that strength continues and then we have on top of that, a holiday surge, how are you talking about it with your customers? What are you thinking about it from a network investment standpoint, any bottlenecks that may emerge there? Carol Tomé: Yes. Thanks for the question on peak. As a leadership team, we’ve agreed, we are going to have an outstanding peak season. I participated in my first peak planning committee several weeks after I joined the company and very impressed by how we are planning to manage through, what could be a very peaky season, is about making sure that we’ve got our network aligned both on the high end and on the low end, because it’s uncertain out there. So we’re building an optionality, in terms of how we’re going to run the network. And then Kate with her team are talking to our customers customer-by-customer and how we will best manage through peak.

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

Hey, thanks and congrats, Carol. So first, if you can just clarify that the second half margin comment is that lower than the second quarter or lower than the full first half. And then just Carol, just bigger picture, I wanted to just get your perspective on how you’re thinking about the growth algorithm for UPS in the U.S. business. So the last few years, it’s been volume outpacing revenue and margins falling. Do you think we see more or less volume growth going forward than what we’ve seen? You’ve historically talked about 2% to 3% price. Does that meaningfully change? And then I guess, do you think you can – when do you think you can get back to a double digit margin? I know there’s lot there, but any perspective would be great. Thank you. Carol Tomé: Yes. Absolutely happy to share some perspective. As Brian said, it’s – our operating margin in the U.S. domestic business could be lower in the back half of the year than what we reported in the first half of the year. Lot of uncertainty in the marketplace, of course, but we thought it was helpful for Brian to kick out some of the expense related items that we’re pretty sure will happen, because we’re not terribly sure about the demand side. Now longer term, this is where we’re very excited about what we’re going to do with our company. In my prepared remarks, I’ve talked about, it’s all about being better, not bigger. What do I mean by that? Well, just a couple of things. This may be a longer-winded answer then you’re looking for. But I’ll go ahead and take the opportunity to share with you, what I mean by that and what we mean by that. First, we are an engineering-driven company, you would expect us to be. But like any company who was 113 years old, we’ve over engineered much of what we’ve done. And I’ll give you an example of that, depending on how you define products, we have between 400 and 500 products. We kicked off a task force to say, really, are we selling all of those products? Because when you think about it, if you have between 400 and 500 products, you have to build systems and technology to support those products, you have to build accountants to account for those products. You have to have auditors who audit for those products. And then you have to have salespeople who sell those products. As we looked at it, and it’s very early days, we found that last year, there were over 100 of those products that we didn’t even sell. So we’re going to rationalize our product offering to make it simpler for our customers and reduce expense here. As we think about optimizing the network to your specific question on volume, it’s about being better, not bigger. What we have done in the past is built capacity or bought capacity, and the hope that demand would follow. And we would take demand at any cost or any price, if you will. Not necessarily nutritive demand. So let me give you an example of a change, that we’ve just launched this year. We love our air fleet and in fact, about 11% of our air fleet are wide-body planes, these are 747 planes. And we took advantage of those wide bodies in the second quarter. We were able to fly demand out of Asia at a very effective cost, because they’re wide bodies. We didn’t have to fly as many planes. So we had an opportunity to buy more of those 747s because they’re coming up production. And the question that we asked ourselves is, well, won’t that create excess capacity? And won’t we find that we’ll need to fill that capacity at perhaps non-nutritive ways. And the answer to that question was, yes. So we passed on that investment that in the past we might have made. So we’re going to really look to sweat the assets that we have to get more off of that investment that we’ve made over time. We will look to pivot the customer and the way we go-to-market to optimize the network. And I hope that answers your question.

Chris Wetherbee of Citi. Please go ahead.

Hey, great. Thank you very much. I really wanted to kind of make sure I understood sort of how that answer pertains to sort of profit growth on the domestic side. So lots of revenue, lots of demand, as it stands right now. Is there a clear path and maybe the next couple of quarters, maybe not necessarily the third quarter, this heap profit growth in the context of the revenue growth that we’re seeing, because the revenue is obviously spectacular in the second quarter on the domestic side, we actually saw profits down a little bit? So just want to kind of get a sense of what are the sort of steps that you need to take to be able to get that profit, to grow in line with revenue or at least closer. Carol Tomé: Yes. The easy way to think about profit growth is of course with pricing increases. And as you know, we did take some short surcharge increases at the end of May, but it’s much more than pricing. It’s really about optimizing the network and leaning into the customer segments that value the end-to-end network that we offer. And one of those segments is small and medium-sized businesses. And you heard Brian talk about the growth that we saw in that space in the second quarter up 11%. As I look at our small and medium-size customer base, we divide it into four big segments D1 through D4, that’s based on customer size. D1 and D2 customer segments, we’ve got pretty good market share there. But in D3 and D4, we’re underpenetrated relative to our competitors. We have an opportunity to grow into that space, but we need some enabling capabilities. The number one enabling capability to grow into that space is time and transit. So when I came onto the company and I looked at our time and transit activities we used to call that Panthera. We now called our fastest time – our Fastest Ground Ever. I saw that, we were planning to conclude that investment in June of 2021. I asked the team, well, what’s getting in the way. What’s getting in the way of going faster and they said money, I’m like, well, we’ve got money. So we’ll accelerate the investment. We pull that investment into 2020. We will complete time and transit by October of this year. And that’s a big deal because 46% of our SMB customers or potential customers tell us, time and transit is the number one thing on their mind. When we’re done, we will be at parity or better in 20 of the 25 markets that matter in the U.S. We will reach 90% of the U.S. population in three days, 75% of the U.S. population will have Saturday delivery. And then of course, we have Sunday delivery through our SurePost product. This matters. And why am I focusing on SMB? Because the SMB customer values are end-to-end network and they pay us for it. As we think about leaning into SMBs, it’s not just about time and transit, however. It’s also about a better customer experience. This goes back to being better, not bigger. We had a couple of pilots that we launched to really understand that customer and what their wants, needs and desires were. We listened to them. We operationalized what they wanted. And in the pilots, we saw 2 percentage point reduction in churn. Now that matters because in this segment, for every reduction in churn, it’s $170 million in revenue. And that revenue is a much better quality than other revenue. So as we think about moving the U.S. operating margin up, there’s a real opportunity to lean into a different customer segment and to make sure that we’re getting value for the services we provide. That’s on the revenue side. But I must talk about the cost side too, for a moment, because we have opportunities there as well. We’ve talked to you in the past about Transformation 1.0. And we’re well down the path of Transformation 1.0. And in fact, if you look at it life to date, on a net basis after investing, we have delivered over $1 billion of savings in Transformation 1.0. That’s on a cumulative basis. If you tax effects that and use the outstanding shares, it’s about $0.95 of EPS on a cumulative basis. We’re not done. Productivity and efficiency must be the hallmark of UPS. So we have initial plans for Transformation 2.0 and 3.0, which when they are finalized, we will share those with you. We also are using technology to drive productivity and efficiency in our operations. And I can just give you a comment on how we’re seeing that perform. We’ve talked to you in the past about ORION. We have ORION 3.0 out. We’re seeing a reduction in the miles that our drivers are driving and a reduction in the per piece cost. Now this is virtuous, it’s continuous, but the combination of rightsizing the revenue and driving productivity and efficiency gives us a path to drive operating margin expansion in the U.S. This is a big company to turn. You can’t do it overnight, but if you look through 2020 into 2021 and beyond, you should expect the margin to start to go in the right direction.

Jordan Alliger of Goldman Sachs. Please go ahead.

Yes. Thanks. International may have had a strongest margin quarter ever, and I know there are obviously outsize gains in Asia and what have you. I’m just curious, how do we think about the longer term margin in international, or maybe even as we move forward from here, given the strong performance in the second quarter? Thanks. Carol Tomé: We were thrilled with our performance in our international segments and we expect them to have a very good back half as well. That model is a very different model than the one we run in inside the United States. It’s an asset-light outside service provider model. So the margins will always be stronger outside of the United States than they are inside the United States. And we view that as a competitive opportunity for us, candidly. We’ve identified 10 growth markets that we will grow into. We’ll be updating you as those opportunities present themselves. In the second quarter, we did enter into an alliance with a firm in Mexico. We’re very excited about that, because that’s one of our top 10 growth markets and we will now have the leading capabilities in Mexico, both inside Mexico and exporting out. So look for good things to come out of our international.

And Jordan, if I can just add, the B2C growth in Europe in the quarter or in international in the quarter was up 95%. And so I think the combination of the shift towards B2C and their ability to expand margins was another proof point of why we’re confident in that model.

Thank you.

Ravi Shanker of Morgan Stanley. Please go ahead.

Thanks. Good morning, everyone. Carol, would love, if you could share any learnings or takeaways from your prior stent as CFO at an e-commerce/consumer retail focused company that it can bring to UPS? And also in the context of customer concentration, you have a pretty large number one customer, kind of what are your thoughts on that? And how do you see that evolving over time? Thanks. Carol Tomé: I’m happy to do so. First, let me talk about my learnings during the last recession, which was housing-led recession. And my former employer, we felt it hard. They lost 25% of the top line during that recession. Two key learnings during that time. One, invest through the crisis. No better opportunity, if you have the financial wherewithal to do so, to invest through the crisis. So that when things settle down, you are positioned to take share. And that’s what we’re doing with time and transit. Our time and transit investment this year is $750 million. We could have canceled that. But we said, no, we’re going to pull that board. And we’re going to invest through the crisis. My second learning is to invest in your people. Now it doesn’t mean that you don’t have a fewer people in a downturn, but for those people that you have, you need to invest in. And if you looked at our population of UPSers, actually we’re down in Supply Chain and Freight, as you would expect, because the demand softened up there. But for the people who are left behind, we are investing in them, because it creates loyalty and better experience and better service for our customers. So we’re investing in incentives for our people. We’ve been promoting people. It pays huge dividends if you stay true to your people. Those are very good learnings in a downturn. Learnings as a retailer, is that when cost increases come your way, if you are a large retailer, you can pass those costs increases across the SKU base, and the customers don’t know. So while retailers may squawk at price increases that come their way, large retailers have a way to spread that across. And nobody knows. So there’s an opportunity here on the pricing side to do what we need to do. From a customer concentration perspective, I looked at our top 20 customers and their performance in the second quarter and of those top 20 customers, all but one group, the only one that didn’t grow was government. And I can’t tell you why, but it didn’t grow. But if I look at our top 20 customers who are retailers, who were predominantly store-based retailers, who when their stores closed and demand shifted online, well for those customers, they had triple-digit growth in the second quarter. Our largest customer did not have triple-digit growth. So that gives you some perspective on how we manage through customer concentration and how we’re thinking about optimizing the portfolio long-term.

Thank you.

Allison Poliniak of Wells Fargo. Please go ahead.

Good morning. You had mentioned or talked about a little bit about the mix between B2B and B2C. But within B2C, could you talk about any mixed challenges that you face in the quarter and how they may have progressed that could have hindered margins there as well? Carol Tomé: Well, maybe I’ll start. Brian, you can chime in. I just looked at our ground business and we break our ground business into four segments. There’s 100 weight in commercial, so that’s more industrial. Then there’s ground resi, which is going to be predominantly B2C and SurePost. If I look at the profitability of ground resi, which now makes up 44% of our total ground business in the U.S. The profitability was up year-on-year. We’re taking actions actually to drive profitability in the business. And Brian, do you want to add any more color to that?

Yes. I just say, as we peel that business apart, I think I had mentioned it in my script. But as we extract the SurePost product, it gives us some encouraging signs for the underlying pricing health of the business within B2C. Because pricing, if you exclude SurePost, Carol, and fuel, we were up 1.5%, and that’s better than the last three or four quarters. So it’s encouraging signs for how we’re managing B2C.

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

Thanks very much, good morning. I’m curious, I know the visibility is not great, but specifically in B2B, U.S. and frankly, everywhere, just how did you see that evolve through the quarter? What are you seeing in this quarter? How are you managing and competitively positioning to try and be well positioned as hopefully that comes back. And then the discussion of end markets that are particularly strong or weak over in that category. Thank you.

So maybe I’ll take that one, Scott. And Carol can chime in. The B2B growth was down 22% in the quarter. In terms of the evolution, we actually saw that number get better. It was still down overall. But April, May, June, as it progressed, we started the quarter down 38%. Got a little better down 20%, finished June at down 8% in terms of how we’re seeing it play out in this next quarter that we’re holding at about the June levels down, 9-ish in the month of July, as we think about the B2B business. So SMBs, which we’re also very focused on, they were up 11% in the quarter. So as we think about our small and medium businesses, we’re seeing those June trends of growth continue into July in the high teens range. Carol, anything to add? Carol Tomé: I think the stability invest new, it’s not getting worse, not getting better, but it’s not getting worse on the pure B2B.

Brian Ossenbeck of JPMorgan. Please go ahead.

Hi, good morning. Thanks for taking the question. Just had one on capacity in U.S. domestic. With this type of volume, essentially at the same holiday peak because a couple of years ago, how close is the U.S. network to maxing out capacity? I know you said, you expect volumes to moderate a bit in the back half of the year. But can you focus on revenue quality to help some of that moderation? Or do you think there’s a multiyear potential capital investment program around the corner? And I guess in general, can you just talk about what you think of the capital intensity rather of incremental B2C from here in the U.S. Thank you. Carol Tomé: So again, our theme is better, not bigger, optimizing the capacity that we have. And we have capacity to handle the peak volume that we are anticipating this year. There are capacity constraints in the United States, which gives opportunity to manage through with pricing, also opportunities to manage with our customers. As a former retailer, I know this very well, how to manage through, when you have promotions, how long you have promotions, how you use your store base, how you use our access points. Don’t forget that we have over 15,000 access points that we can be used to address the capacity issues. So we are feeling very good about peak this year. And as we look forward, it’s about right-sizing optimizing the investments that we had before we think about continued investments in capital. It’s about being better, not bigger.

Carol, maybe I’ll just add on the CapEx piece. We spent the last three years building capacity in automation. And so we’re now reaching 85% in the U.S. system. So we feel pretty good about our ability to manage that volume. And as we’re not chasing any volume or any package at any price, we think we’ll be selective in terms of what goes through the network.

Thank you very much.

Ben Hartford of Baird. Please go ahead.

Hey, good morning. Carol, just interested in your perspective on the multiyear transformation efforts. What you may or may not change, what you like or don’t like about what’s been undertaken to date. And just the pathway as you kind of finish up here over the next year and a half. And related to that, maybe Brian, could you provide any perspective on the previous guidance that you had provided in terms of the incremental EPS benefit by 2022 of $1 to $1.20, where that may sit given some of the changes here particularly year to date, and what changes or improvements could come to affect that number? Thank you. Carol Tomé: Well, on transformation 1.0, I think that’s what you’re referring to. We began that in 2018 and on a gross basis life to date, we recognized $2.5 billion of savings. We have reinvested a good piece of that. On a net basis $1.1 billion in savings and tax effected, it’s about $0.95 of EPS on a cumulative basis. That’s not enough, candidly. It’s great. Take credit for that. It’s not enough. We have initiatives underway, we’re calling it, Transformation 2.0 and 3.0 to drive continued productivity and efficiency in our company. Part of this will be enabled by technology. We are moving from my company as an example, that what was really stuck in a static business logic environment. And that resulted in a lot of overhead doing a lot of reports, looking through the rear view mirror to drive the company. We’re moving to analytical decisions science as Juan and his team, build out our digital factory, and that’s going to free up productivity. That will absolutely free up productivity. Until this year, believe it or not, we only had two IT releases a year. We now are moving into a continuous release as we move into a more agile environment. And that’s critically important in terms of taking costs out of this company. We used to code everything ourselves. We had every application running on a mainframe. We now only have four applications running on our mainframes, and we’re moving everything up to the cloud. We have 25 systems or applications in the cloud, another 20 in flight and more to do. This will get rid of some of the tech debt that we carry and free up expense dollars. There’s a lot going on. And the ability to transform the way we run our business. The thing that I’ve observed that haven’t quite cracked and we’re quite good at, we have absolutely no leverage in our [indiscernible] we need to drive more leverage and our payroll given it’s the largest expense that we have. Now, IT will help with that. And it certainly has helped, but we need to double down on how we can automate the inside of our facilities to drive more productivity. For example, I recently saw an automated label application by a robot. It was pretty cool. It’s not ready for prime time, the cost curve isn’t right. But it was pretty cool because the productivity of that arm was 50% higher than a human being. So imagine what we could do if we could drive some productivity and leverage in our payroll, it would be transformative. So expect to hear us talk about that over time.

And Ben just to follow-up, I think Carol answered it, the second half of your question on the $1 to $1.10. We’re approaching $1 we have a year left in that Transformation 1.0 program. So we’re on track to deliver. I think the more exciting focus now is Transformation 2.0 and 3.0, how do we really change the game on a profit per piece, linking back to the productivity.

Amit Mehrotra of Deutsche. Please go ahead.

Thanks operator. Good morning, everybody. Carol, congrats on the appointment as CEO. If this sounds like it’s TSR for UPS, which may be the case. Just in that context, I was hoping you can expand on the commentary of excess cost that can be removed. Is it $500 million, is it $1 billion, just any sense of how much is being left on the table, so to speak because of the over-engineering and whatever the commentary you just mentioned actually. And how fast can you adjust the cost structure, given the size and scope with UPS? And then also capacity and capital, it’s a big focus area for you. Should we expect near-term cuts in CapEx intensity? Capital spending for UPS is, I don’t need to tell. You have increased $5 billion in the last four years, but the domestic margins have contracted 500 basis points. So is that something we should also expect. Can you address those points, please? Carol Tomé: Yes. I’m happy to do so. TSR for UPS is the name of the game. We are all in. And as a leadership team, this is what we talk about as we get together on a weekly, hourly basis. How can we get more out of the assets that we have invested? So thank you for mentioning that, I came to UPS for a few reasons. One, because I love this company; two, because I want to make an impact on our people and three, I want to get the stock price moving. It’s all about creating value for our shareholders. And you do that through effective capital allocation. It starts with how you allocate capital. And I will say that we have not gotten the returns that we should have delivered on some of the capital investments that we made. For all whole kinds of reasons, and it’s not – we don’t need to look back for those reasons, but looking forward, it’s just we’re going to have a different lens on how we allocate capital. As we’ve talked this morning, I gave an example of not buying aircraft to have excess capacity, that would have been value destroying. So we opted not to make that capital investment. We will get the network righted before we think about investing more dollars in the network. That suggests lower capital intensity going forward. To your question about, well, okay, great, I get the capital, which is the denominator side. How do you fix the numerator? Or how much cost can you take out? How you’re going to fix the revenue? How are you going to get the cost out? I don’t like anything unless it starts with a B, because it’s just not worth our time. We’re focusing on the wildly important here. So if it’s not worth – if it doesn’t start with a B, we’re not doing it. So that gives you a sense of the cost that we’re looking to take out.

Allison Landry of Credit Suisse. Please go ahead.

Good morning. Thanks for taking my question. So I wanted to ask a little bit more of a follow-up question on the conversation of capital efficiency and specifically your thoughts on the returns on incremental invested capital. So you mentioned that at least for the near-term to mid-term you’re to try to more with less at an that should translate into perhaps some lower CapEx levels. But maybe you think about longer-term and what could be the requirements of the business for that technology or for something for speeding up the network. Do you think relative to what UPS has historically delivered from a return on incremental invested capital standpoint? Can you get back to maybe prior peak or that not the right way to think about that? So any thoughts on capital efficiency would be great. Thank you.

Well, Allison I’ll start that. From a return on invested capital, look, we’ve gone down about 400 basis points as we look back the last couple of years on ROIC. We’re very focused on moving that in the opposite direction, moving it up. We’re down in the low 20’s right now. I think you’re referring to the peak where we were in the high 20’s. It’ll take some time to get back in towards that trajectory. But there’s a base level of CapEx that we’re going to need to spend, call it $2.5 billion to $3 billion on maintenance and that’s ongoing. But everything above that that we’ve been spending on capacity and growth is getting looked at through a different lens. And Carol alluded to it, from a TSR we’re very focused on the cash returns and looking at the annual payback and how long the payback is. So I think you can look for us to drive improved ROIC. I think the pace will give you some more clarity on that when we come out with guidance. Carol, would you add anything? Carol Tomé: The only thing I would add is that value is defined by what the customer is willing to pay for. And if we’re spending on capital on enabling capabilities or services or products that they’re not willing to pay for, I don’t know why we would spend that capital. So we are bringing a different lens. It’s value defined by what the customer is willing to.

Thank you so much.

Ken Hoexter of Bank of America. Please go ahead.

Hey, great. Good morning, Carol, again, congrats and welcome. And Brian, look forward to working with you both. You mentioned – just real quickly, you mentioned the weaker domestic in the second half. You mentioned some longer-term thoughts international. Did I hear you say that international will stay at these levels in the second half? I just want clarity on that. And then digging into the second half domestic margins, Brian, is that time in transit, is that – are these kind of the startup costs and that’s going away? Or are you looking maybe – Carol, your thoughts on your long-term thoughts on getting back to that double digit margin or is it beyond that given these moves you’re talking about?

So, Ken, thanks for the question. I’ll start with the domestic piece in terms of the back half. Yes, Carol alluded to the investments in time and transit, and we think that’s a critical investment to continue to invest to drive the service for our customers and speed up time and transit. We’ve got a handful of one-off items that I think I alluded to. There’s a land sale, fuel excise tax, management incentive. Those are all laps, but they add up to a couple hundred million dollars. So it’s a meaningful number. There’s also a benefit catch up in terms of expense. We put on about 40,000 heads to handle the volume surge in the second quarter. So that will be coming back in terms of benefits, if you’re full time, your benefits kick in at 30 days, if you’re part time, it kicks in about six months. So you’ll see those creep up. But that’s why I provided the caution on the back half of the year. Longer-term though, I think the steps we’re taking will drive the overall improvement in domestic margins. On the international side, I think you saw a large peak in the middle of the quarter coming out of Asia with the additional flights. And so I think that would moderate balance of the year. And Ken, as we’ve talked before, I think the focus in international it’s on EBIT dollars, because I think the team really have an opportunity to drive their share at those elevated margin levels. So margin may not stay at this level, but as you think about the future EBITDA will and there are certainly 2x the domestic margins, a very attractive growth. Carol, anything to add on domestic and international? Carol Tomé: Just perhaps on the growth side. Our volume will be up in the back half. It’s just the growth rates won’t be the same. And I just want to make sure we’re really clear on that. I don’t want to have any confusion there. And on the international side, I think our margin will be quite healthy in the back half.

Thanks, Ken.

Thanks. Appreciate that.

Jack Atkins of Stephens. Please go ahead.

Hey, good morning and thank you for taking my question. So I just wanted to focus on the growth that you’re seeing within B2B and e-commerce in your international markets. And maybe e-commerce adoption in the international markets as well. To what degree is this potentially a headwind to profitability and margins internationally as we sort of look forward, as we sort of see e-commerce and B2C grow there? Or are there some differences in terms of how that market is structured or how you’re network is structured that would make that not the case. Thank you. Carol Tomé: Yes. Our international business is quite different than the domestic business. It’s an asset light outside service provider in many of the markets in which we serve. We actually like this cross border opportunity to grow B2C business, and the margins are quite healthy.

This is Scott. We’ve got time for one more question before we wrap up.

Our final question will come from the line of Bascome Majors of Susquehanna. Please go ahead.

Yes. Carol, in your 17 years on the UPS board, you’ve witnessed several substantial changes in the competitive landscape for the company. And you’ve been part of steering the board strategy to bring in some more outside perspectives and the senior management, which has certainly seemed to reach a new level, appointing you as CEO here. Can you give the investors some board level perspective on that evolution and thinking UPS is a storage strategy from promoting from within. And any thoughts on where the cultural shift that UPS has headed over the next several years with you at the helm? Thank you. Carol Tomé: Yes. We’re a big believer as a board and the company’s culture, because we think it is a competitive point of differentiation. As the board looked at CEO succession, they came up with a qualification, if you will, of what the next CEO should possess in terms of experience, in terms of just knowledge in certain areas. And they map that up against both internal and external candidates. Obviously, I wasn’t part of that, but there was a search committee that was formed and they looked at, here are the qualifications of the next CEO. And they looked at our internal team as well as external team and decided to go outside for the role. And I was delighted that they asked me to take the role. It’s because of the time that we’re in. As I look to the future of UPS, my goal is to get CEO succession ready candidate. So then when it’s time for me to move on and actually retire, because I have been retired. But when it’s time for me to move on, we have ready now candidates inside the company to promote. The big believer and investing in people to help them get to their highest potential, whatever it may be. So don’t expect to see a big cultural shift just because I came in for this time. And I am delighted to be here. It’s an awesome leadership team. They’re in the room with me today, giving me support just for answering your questions. We really do appreciate all the thoughtful questions that came to Brian and me today. So thank you for that. And Scott, I’ll turn it back to you.

Final comments, we just want to thank you for joining us today. We wish you a very good remainder of your day. And then we look forward to speaking with you next quarter. And that concludes the call. Thank you.