Oct 27, 2016
Executives
Scott Childress - United Parcel Service, Inc. David P.
Abney - United Parcel Service, Inc. Kathleen M.
Gutmann - United Parcel Service, Inc. Richard N.
Peretz - United Parcel Service, Inc. Myron A.
Gray - United Parcel Service, Inc. Alan Gershenhorn - United Parcel Service, Inc.
James Jay Barber, Jr. - United Parcel Service, Inc.
Analysts
Thomas Wadewitz - UBS Securities LLC Kenneth S. Hoexter - Bank of America Merrill Lynch Benjamin J.
Hartford - Robert W. Baird & Co., Inc.
(Broker) Chris Wetherbee - Citigroup Global Markets, Inc. (Broker) Scott H.
Group - Wolfe Research LLC Scott Schneeberger - Oppenheimer & Co., Inc. (Broker) J.
David Scott Vernon - Sanford C. Bernstein & Co.
LLC Nate J. Brochmann - William Blair & Co.
LLC Brandon Oglenski - Barclays Capital, Inc. Danny C.
Schuster - Credit Suisse Securities (USA) LLC (Broker) David Ross - Stifel, Nicolaus & Co., Inc. Helane Becker - Cowen & Co.
LLC Bascome Majors - Susquehanna Financial Group LLLP
Operator
Good morning. My name is Steven and I will be your conference facilitator today.
At this time, I would like to welcome everyone to the UPS Investor Relations Third Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise, and after the speakers' remarks, there will be a question-and-answer period.
It is now my pleasure to turn the floor over to your host, Mr. Scott Childress, Investor Relations Officer.
Sir, the floor is yours. Please go ahead.
Scott Childress - United Parcel Service, Inc.
Good morning, and welcome to the UPS third quarter 2016 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 Office, Alan Gershenhorn. Also joining us today is Kate Gutmann, our Chief Sales and Solutions Officer.
Before we begin, I want to review the Safe Harbor language. Some of the statements we'll make today are forward-looking statements that address our expectations for the future performance or results of operations of our company.
These statements are subject to risk and uncertainties, which are described in detail in our 2015 Form 10-K. This report is available on the UPS Investor Relations website and from the Securities and Exchange Commission.
The webcast of today's call along with a reconciliation of non-GAAP financial measures are available on the UPS Investor Relations website. Webcast users can submit live questions during today's call.
We will attempt to answer questions of a long-term strategic nature. Callers are asked to submit only one question so that we may allow as many as possible to participate.
Thanks for your cooperation. Now I will turn the call over to David.
David P. Abney - United Parcel Service, Inc.
Thanks, Scott, and good morning, everyone. I'm pleased with our performance and happy to report another quarter of solid UPS earnings.
These results demonstrate increased demand for our products and disciplined execution of our initiatives. I'll provide an update of our Q3 highlights, and then Kate will give you an update on peak season.
During Q3, International segment increased operating profit by 14% or more than 7% package volume growth. Our International strategy is achieving outstanding results.
This was seventh consecutive quarter of double-digit operating profit expansion. Yes.
I said seven consecutive quarters of International operating profit growth. The U.S.
Domestic business produced higher than anticipated package volume, driven by strong demand for our portfolio of ecommerce solutions. We continued to see increase demand for our air products, and this was quarter was no exception.
Shippers are choosing UPS air products because our value is a differentiator. The Supply Chain and Freight segment is navigating prolonged weak market conditions.
They're making progress in adapting their business model and focusing on capturing the right revenue opportunities. We're confident in our long-term strategies, and as a result of our performance this quarter, we remain on plan with this year's guidance.
Turning now to the economy, where global growth has continued to be modest. In the U.S., consumer fundamentals remain healthy and account for most of the economic expansion while the outlook for industrial production remains weak.
Overall, global GDP forecasts are slightly down. For the balance of 2016, we continue to see mixed economic signals across some industrial markets.
Under these conditions, our diversified business model and our winning strategies still enable UPS to take advantage of high-growth markets such as cross-border trade and ecommerce. To facilitate growth, we're adding capacity and increasing efficiency in our globally integrated network.
Trade lane and product portfolio enhancements are important components of our plans. We have significantly improved time in transit from several cities in the U.S.
to Canada based on increased export opportunities. We have also dramatically improved service times for cross-border shipments between several major European cities.
During the quarter, we strengthened our portfolio of urgent delivery options by expanding our Worldwide Express Plus product. We've doubled the number of countries served and are now reaching 90% of the world's GDP by the next day.
We've also expanded solutions for specialized shippers by strengthening our clinical trial service used by pharmaceutical companies. We see excellent opportunities for growth in this part of the healthcare segment.
Our actions are providing more delivery options, faster transit times and earlier guaranteed deliveries, helping UPS customers achieve their growth objectives. In addition, we're following a disciplined capital approach to invest in our business.
In 2016, we announced 12 highly-automated facility upgrades as part of our multiyear strategy, and we plan to announce several significant new projects before the end of the year. These projects will help us to increase operating efficiency while simultaneously better serving our customers.
Expectations in the ecommerce sector and specialized markets like healthcare logistics have continued to ship to faster delivery options. As a result, demand for both domestic and international air products has been strong.
Since we took delivery of our last new plane in 2013, UPS air products have increased more than 15%. Clearly, over the last several years UPS has expanded market share in the Air segment, and we expect these trends to continue.
In response, we're announcing the purchase of 14 Boeing 747-8 jumbo freighters along with options to buy 14 more in the future. We will take delivery of the first two at the end of 2017.
This is a net add to our fleet. These new 747s will enable UPS to begin a cascade of aircraft route assignments that will add significant capacity in our busiest lanes.
This will optimize global air network capacity well beyond the impact of adding these new cargo jets. All of these investments are aligned to meet expanding customer needs and produce positive financial returns.
Looking now at the upcoming holiday season, we have created extensive peak season plans and built a foundation for another successful holiday for our customers and share owners. Our strategy is to follow the same framework outlined last year.
It's the four Cs: collaboration, capacity, control and commitment. To conclude, I want to recognize the hard-working and dedicated UPSers around the world for the progress we've made year-to-date and to thank them in advance for their commitment to another successful peak season.
And now Kate will update you on our peak plans.
Kathleen M. Gutmann - United Parcel Service, Inc.
Thanks David, and good morning everyone. It's my pleasure to review our 2016 peak season plans with you.
The dramatic growth of online shopping and subsequent returns is expected to lift UPS package levels to a record high during this upcoming holiday period. Between Thanksgiving and New Year's Eve 2016, there are two additional operating days and we expect to complete over 700 million deliveries worldwide, about 100 million more than last year.
In the overall U.S. market, the National Retail Federation expects total holiday retail sales to increase 3.6%.
They're also estimating non-store retail sales growth between 7% and 10%. At UPS, our peak strategies are focused on executing the four Cs that David mentioned earlier.
To begin with, we've deepened the level of collaboration with even more customers. We started earlier, and are communicating more frequently.
This better aligns UPS solutions and capacity with their seasonal promotion plans and fulfillment strategies, helping customers shift demand, sell inventory earlier, and optimize their operations. Customer experience continues to gain importance in the marketplace, making collaboration a shared objective for both shippers and UPS.
Whether you're in healthcare, retail or any industry, our work together is creating consumer loyalty and a preference for the UPS delivery experience. Looking at our second area of focus, capacity, UPS customers will benefit from several key automation and expansion projects.
We've opened new automated facilities and updated existing hubs in the U.S. and Europe in cities such as Chicago, Los Angeles, Paris and London.
In the U.S., we are supplementing our capacity with the addition of temporary facilities. These investments in technology and capacity make our integrated network more flexible and efficient.
This peak, our partners at Coyote Logistics will be supporting our entire domestic operation, helping UPS solve customer needs during this high demand period. In addition, our driver dispatch will be even more effective.
I'm pleased to announce that we've completed Phase 1 of the ORION implementation in the U.S. ahead of schedule.
100% of eligible U.S. drivers will be utilizing this dispatch technology during peak, up from 70% last year.
The third focus area is control, both control of deliveries for UPS customers and control of the UPS network. UPS My Choice will provide greater control to 30 million global members, an increase of 10 million from last year.
My Choice enables members to exert preferences with their inbound UPS shipment and take action on their packages when desired. They can choose to redirect deliveries to alternate delivery locations, including a UPS Access Point location.
In fact this year, we've expanded our reach and will have over 27,000 convenient Access Point locations open around the world, with approximately 8,000 in the U.S. Looking at the UPS network, we are exercising real-time control to ensure our customers can properly respond to peak demand, and one important tool we use is the UPS control tower.
This decision-making body enables us to say yes to more customer requests, leveraging the flexibility of our operations to accept volume surges when possible. It also assures that our capacity, value, cost to serve and price are appropriately aligned throughout peak season.
The final area of focus for UPS is commitment. The 450,000 UPS employees, together with 95,000 temporary hires, will be working diligently to provide world-class value and service during this upcoming holiday season.
Each year, the needs of peak season create special memories for all UPSers. Last year, I had a chance to visit the building I started in 27 years ago.
The same energy, determination and customer focus that I was drawn to day one was clear in everyone I met. Spending time making deliveries really reinforced to me how the peak planning and collaboration with customers resonates throughout the entire organization.
Thank you for your time today. And I want to assure you that the UPS team is ready to deliver another successful peak season.
Now I'll turn it over to Richard.
Richard N. Peretz - United Parcel Service, Inc.
Thanks, Kate. UPS performed as we projected this quarter, with total reported revenue up about 5% and daily shipments up almost 6%.
The International segment produced another quarter of double-digit profit expansion. And U.S Domestic delivered results as we had anticipated, while Supply Chain and Freight results were somewhat below expectations.
UPS third quarter earnings per share were up about 4%. In 2016, the EPS change across the enterprise was lowered by headwinds in the U.S.
Domestic business and approximately $0.02 due to discrete tax credits taken in 2015. This was a good quarter.
UPS generated strong topline revenue, great momentum in our International business, and solid results from the other segments. Now for a closer look at how the segments performed.
U.S. Domestic revenue increased 4.8%, driven by daily package gains of 5.7%.
All products contributed to volume growth, with Deferred Air up more than 10%, Next Day Air up almost 6%, and Ground up 5.2%. Growth was balanced from enterprise and middle-market customers.
High demand for online retailers was evident, as B2C deliveries were up 11%. Despite negative industrial production, B2B deliveries were up 2%, with the majority of the increase driven by our ecommerce return portfolio.
Base rate improvements were able to somewhat offset lower fuel surcharges and a drag from a change in product mix. As a result, revenue per package was up about 1%.
Ecommerce customers are helping drive higher daily shipments across our entire portfolio of services, from high-single-digit growth in Air products to a 20% jump in our most economical product, SurePost. Even with the accelerated growth of ecommerce, our investments in ORION continue to allow UPS to bend the cost curve lower and create positive return.
ORION added efficiency again this quarter. Delivery stops and volume were both up 5.7%, yet ORION held package miles to only 1.4% increase.
Direct labor hours also grew slower than the average daily volume growth. As we guided, operating profit growth comparisons with 2015 were restrained by one less operating day in 2016 and higher casualty credits realized last year.
Excluding these profit headwinds, operating margins expanded as we took advantage of the benefits of our investments. Now for some details on the International segment, where we had another record with double-digit operating profit growth for the seventh consecutive quarter.
Profit jumped 14% as shipments climbed 7.5%. Revenue was up more than 3% on a currency neutral basis and fuel surcharge did decline, lowering the growth rate by about 70 basis points.
U.S. export packages per day rose over 7%.
Growth was well-balanced on solid shipments out of Asia and across Europe. The non-U.S.
Domestic product increased 7.8% as we transitioned through pricing action we took in 2015. This quarter, it shows it's about getting the right volume in our network.
Our International segment is delivering balanced results with great growth and superior returns. Let's turn and look at the Supply Chain and Freight segment now.
The segment produced topline growth of 8.1%, primarily driven by the Coyote acquisition. Economic conditions in the U.S.
truckload and LTL market as well as the International Air Freight business continued to place downward pressure on demand. The Forwarding unit remained disciplined on revenue management and cost controls.
Gains from the small and medium sized customers reduced the year-over-year shortfall in total tonnage. UPS Freight has been adversely impacted by industry conditions, seeing total tonnage drop.
However, they're executing a disciplined middle-market strategy, which has resulted in revenue per hundredweight pricing improvements of 3.7% this quarter. Turning to our distribution group, revenue growth was broad-based with contributions from almost all sectors.
The business unit maintained its industry-leading margins in the mid- to upper-single digits. Now to update you on our cash position.
UPS again generated healthy free cash flow. Through the first nine months, we've produce $3.6 billion after investing over $1.8 billion in capital expenditures.
Please note that we accelerated our planned discretionary pension contribution to September. This allows us to capture additional financial benefits in 2016.
UPS also repurchased 19.5 million shares for $2 billion and paid out another $2 billion in dividends, up 7% per share over the last year. As we move into the fourth quarter, we anticipate total operating profit growth to be slightly higher than our full-year guidance of 6% to 8%.
Supply Chain and Freight is continuing to manage through industry challenges and is expected to produce modest low-single digit revenue expansion by holding operating margin flat with last year. For the full year, the macro environment is suppressing revenue growth.
Therefore, Supply Chain and Freight operating profit is anticipated to be slightly below 2015 levels. We are projecting an effective tax rate for UPS of 35% in the fourth quarter.
Due to the unknowns related to the mark-to-markets at year end, we are not able to provide guidance on our GAAP earnings per share. However, we are affirming our full-year adjusted earnings per share guidance of $5.70 to $5.90.
In summary, on a year-to-date basis our business is adapting to the opportunities and challenges presented by the high-growth digital economy. We continue to produce the industry's best margins and create great free cash flow.
As we look at the fourth quarter, we are confident in our ability to deliver another outstanding peak season for both our customers and our investors. Before we take your questions, I want to take a moment to announce our plans to hold an Investor Conference in early 2017.
On February 21 in New York, we'll have a half-day conference. David, along with the senior leaders and myself, will be on hand to lay out our recent progress and update you on our strategy.
We'll plan to allow ample time for your questions. Later today, the IR team will send out invitations with further details.
Thank you. And now I'll ask the operator to open the line.
Operator?
Operator
Ladies and gentlemen, we'll now begin the question-and-answer period. Our first question will come from the line of Tom Wadewitz of UBS.
Please go ahead.
Thomas Wadewitz - UBS Securities LLC
Good morning and congratulations on the strong volumes and solid results in the quarter. I wanted to ask you about the new plane order.
It's an interesting topic, given you haven't ordered planes for quite a while. I wanted to get your thoughts on maybe the implications of that and some of the assumptions you make when you order long lasting, long lived assets like that.
So does this imply that you would think that the strong growth in Air volumes would continue? And then if you look out the next five years, is that kind of a reasonable implication?
And also in terms of your largest customer who has been adding aircraft, is there an implication that you're not particularly concerned about share with that customer? So just wondered if you could talk about the kind of assumptions underlying that sizable plane order that you announced this morning.
Thank you.
Myron A. Gray - United Parcel Service, Inc.
Good morning, Tom. This is Myron.
When you look at it on balance, since 2008 the International export volume has grown over 40%. U.S.
Domestic has had 20% growth, and our block hours are actually down over 3%. It actually speaks to our abilities to optimize our networks around the world and accommodate the tremendous growth that we've seen.
So going with the larger aircraft, which is the Dash 8 really was a smart choice for us. Obviously given the ability to put a larger plane on the lanes that have greater needs allows us to reduce the number of frequencies for those routes.
In addition to that, the Dash 8 will give us an ability to cascade capacity throughout our entire network. We plan to deploy these first aircraft into our International segment, and it will allow us to bring back our current 747-400s to the U.S.
that will give us capacity throughout the entire system. In addition to that, it's a much smarter choice because it allows us to take the current Dash 4 pilot, who will require a very minimum amount of additional training, who can then fly the Dash 8.
So we believe it was a very smart choice for us. And I'll hand it off to Alan, who can talk about growth.
Alan Gershenhorn - United Parcel Service, Inc.
Hey, Tom. Thanks for the question.
As you know, Next Day Air was up 6% this past quarter and deferred was up double-digit. And our Next Day Air growth here in the U.S.
has been growing mid-single digit for the last five quarters, and certainly the Second Day Air has grown double-digit this quarter, and last year this same quarter. And you already heard from Myron about the International growth.
We've been investing significantly in our Express product in terms of enhancements. As you know, this past quarter we expanded our Express Plus time of day to 53 countries and over the year, we've expanded our Express time of day to 117 countries, and we've also expanded UPS Next Day Air and UPS Next Day Air Early coverage here in the United States and in addition also Worldwide Express Freight.
So we're investing significantly in the product both domestically and internationally, and it's resonating with our customers.
David P. Abney - United Parcel Service, Inc.
And this is David. Just to wrap that up, in some places or in some cases, you'd be adding aircraft because you're retiring aircraft.
This is really about opportunity. This is a testament to what we have done in our International business and in our Domestic business as far as growing our Air business.
Our customers are asking us for additional capacity, and that's what this initiative is about. So we're really excited about it.
And thank you for the question.
Operator
Next question will come from the line of Ken Hoexter of Merrill Lynch. Please go ahead.
Kenneth S. Hoexter - Bank of America Merrill Lynch
Great. Good morning.
And I'll echo the nice job in scaling with the volumes. Richard, you gave insight and an outlook for the Supply Chain, but I don't – unless I missed it, I don't think you gave it on the Domestic or International outlook.
So aside from the peak prep, in your targets, can you talk about your expectations for growth and costs and pricing? And then really I want to focus on the ability to improve margins domestically given the ecommerce growth?
Thanks.
Richard N. Peretz - United Parcel Service, Inc.
Sure. So I think, Ken, when you first look at it, you have to start with where we are year-to-date, and right now our earnings per share are up almost 7%.
We expect our fourth quarter operating growth profit to be slightly higher than the overall range we gave the year, which means we expect a very solid great fourth quarter. The investments that we've made across all the segments are bringing in those returns, and we're balancing that against the mix macro environment, as we talked about in Supply Chain and Freight.
At the end, when you look at what's happening and where we're going with it, it really is about an International continuing to deliver on what they've really done for seven quarters. And in the Domestic, we will see margin expansion for the year.
We have, as I mentioned last quarter, some change because of work days and some year-over-year comp issues in the third quarter, but we expect the whole year that we will see a margin expansion.
Scott Childress - United Parcel Service, Inc.
We will take an online question next. This comes from Jack Atkins at Stephens.
And Jack really asks, can we speak a little bit more about the long-term capital spending over the next few years, both with the hub automation and the aircraft?
Richard N. Peretz - United Parcel Service, Inc.
So, again, this is Richard. And Jack, I think the first thing you have to remember here is that our capital policy remains consistent and unchanged.
Our number one priority for many years has continued to be to reinvest in the business. And you see that in our ROIC (26:39), having the highest return on invested capital is not only good for the enterprise, but it's also good for the shareholders.
We continue to see strong returns for all the investments we've made. Over the last few years we've talked about not only what we're doing in the hubs, but also ORION.
And again this quarter we continue to see the benefits of almost a 6% volume growth and muted miles growth. And so all that comes to the bottom line.
We're always evaluating ways to look at, can we accelerate some of this investment because there's such high return on these investments we are making? I talked about in my talk that we're going to actually bring everyone together in early February to really talk about where the enterprise is going, what great opportunities we have, where we'll see growth come from, and what our plans are for next year.
And we think at that time you'll see that the future's very bright. We continue to have year-over-year improvements in margin, and that's our plan going forward as well.
Operator
Our next question will come from the line of Ben Hartford of Baird. Please go ahead.
Benjamin J. Hartford - Robert W. Baird & Co., Inc. (Broker)
Hey. Good morning.
Yeah, I guess, Richard, just to follow up on that point, and not to belabor the CapEx question, understanding that you'll probably provide more context in February. But could you clarify whether these aircraft purchases were included in that 4.5% to 5% of revenue CapEx target that you guys had outlined in 2014?
Or is this above and beyond what that initial target had contemplated?
Richard N. Peretz - United Parcel Service, Inc.
Sure. Ben, when you think about how we look at – how we plan out our multiple years, there's several different realistic scenarios of what could happen.
For example, it was a perfect time to bring together both Boeing and UPS, because there was availability, and we continue to see such strong demand in our business that the aircraft timing came a little faster than we thought. However, we're not guiding any different for 2016.
It's in the $2.8 billion we've been talking about, because a portion of it is paid this year. And the most important thing to remember here is, we're great stewards of capital.
We had not bought a plane in 2013 until today. But since 1989, that was the very first time since we've been an airline that we were able to continue to create efficiencies within our network.
So when you take what David had mentioned, a 15% increase in demand, it was time to look at, what is the next thing we needed to do, and at the same time, we continue to have above market growth in these products, and we'll have positive returns. But we will update you further as we bring the entire enterprise story together in the next few months.
Benjamin J. Hartford - Robert W. Baird & Co., Inc. (Broker)
Understood. Thanks, Richard.
Operator
Our next question will come from the line of David Vernon of Bernstein. Please go ahead.
Mr. Vernon, your line is open.
Scott Childress - United Parcel Service, Inc.
Steven, if you can move to the next caller, please.
Operator
Our next question will come from the line of Mr. Chris Wetherbee of Citi.
Please go ahead.
Chris Wetherbee - Citigroup Global Markets, Inc. (Broker)
Hey, great. Thanks.
Good morning, guys. Want just to stick on the topic of the planes for just a moment, and kind of think about how you do the math between new owned aircraft and sort of available belly space.
I'm guessing there's parameters of control and service that probably weight a little bit in favor of owned capacity, but just want to get a sense of maybe how you guys think about that. You've done a great job over the years using third-party aircraft.
Kind of want to get a sense of what the incremental change is for the owned aircraft going forward.
Richard N. Peretz - United Parcel Service, Inc.
Sure. When we think about the holistic network, and Myron actually mentioned that there's a cascading effect, we run a very broad network across the entire globe.
And we're going to put those planes where the highest demand is. We also use a lot of belly space in different pieces of our enterprise; in Supply Chain and Freight, where we use a combination of brown tails and commercial lift.
But the real important thing here is, we tend to look at all the scenarios and determine what's the best economic return. And it goes right back to the return on invested capital, when's the right time to put new assets in, how are we going to fill them, are we already filling them because of our growth rate?
And when you have all of that put together, that's why in 2013 we paused, and it made sense, and we could adjust and cascade around our own network, because there was many changing dynamics within the market for over the last three years. But now it's time.
And that time is because it will give a very positive return.
Myron A. Gray - United Parcel Service, Inc.
So, Chris, this order matches the needs of our networks and gives us greater flexibility moving forward. And when you think of it, this aircraft, the Dash 8, gives you 70,000 pounds more capacity than the 777.
It also gives you 16% more capacity than our current aircraft type, which is the Dash 4. It allows you to have 34 containers on the main deck, as well as 14 in the lower compartments, plus space for bulk cargo.
So we believe again, as I alluded to earlier, that this is the smart choice for UPS.
Chris Wetherbee - Citigroup Global Markets, Inc. (Broker)
Great. Thank you very much.
Appreciate it.
David P. Abney - United Parcel Service, Inc.
Okay. We're going to take a question from the Internet.
This is from Helane Becker. And it's talking about questions about Amazon.
And when you think about ecommerce going forward, how do you think about competing in a market where Amazon may at some point start to convince shippers to use its Fulfillment by Amazon services? So I'll start with this answer, and then I'll turn it over to Alan Gershenhorn.
And of course I'll begin that Amazon's a good customer of ours. We do believe we have a strong, mutually beneficial relationship, and that our integrated network creates efficiencies, and really gives them and our other customers a value proposition that we believe is unmatched.
So going back to an earlier question about the aircraft and tying into Amazon, I don't think that we've wrapped up at that point. Amazon and all of our other shippers will get the benefit of this cascading capacity that we're adding with this aircraft.
So we think it's very good news for all of our customers. When it comes to the Fulfillment by Amazon, Alan, will you address that please?
Alan Gershenhorn - United Parcel Service, Inc.
Yeah, thanks, David. Yeah, as we all know, our customers, and specifically our ecommerce customers, have a number of different channels that they can access in order to market and transport their goods.
And there's Fulfillment by Amazon, there are marketplaces out there, and obviously direct from their website. We really support our customers in all three of those areas.
And I think, like David said, our ecommerce value proposition is really second to none, and it's convincing both the bricks and clicks type of etailers in the ecommerce pure plays to give more and more of their business to UPS. So we're excited about the overall prospects of ecommerce in the marketplace, and we're making the necessary adjustments to essentially support all the various channels that our customers use to bring their goods to market.
Operator
Our next question will come from the line of Scott Group of Wolfe Research. Please go ahead.
Scott H. Group - Wolfe Research LLC
Hey. Thanks.
Morning, guys. So, wanted to just follow up on the U.S.
Package margins, or incremental margins. Obviously really good volume growth, but not seeing it kind of leverage to the bottom line.
I know you talked about an operating day and one other item, but are there other kind of – is ORION – are we still dealing with implementation costs? Or is there something else here that's restraining the operating leverage?
And I guess maybe the question is what can you start to do to see some better incremental margins? And along those lines, is dimensional pricing an option for 2017 like FedEx is doing?
Richard N. Peretz - United Parcel Service, Inc.
So I think, Scott, the first thing is the way we look at a quarter, we had a good quarter. We're right where we expected to be in the U.S.
We did call out last quarter as well as in my talk today, this is a scale business, and there was a change in work days. And that change in work days has a big impact on the quarter just as next quarter, while we called out that we'll actually perform a little better than our range for the year is because there's an extra work day.
And then that high casualty credit in 2015 that we called out at that point. And so you remove all that, we actually saw operating margin improvement year over year.
And we actually expect the whole year to continue to see that. 2016 really is part of a deliberate strategy.
We're seeing the benefits from the investments. We are reinvesting, so were not getting all of the benefits, but we're getting the benefits that we actually have been talking about.
And we said it would be a multiyear process. But we're delivering on those targets.
We expect to continue to see that steady progress year over year, and that's why I mentioned earlier that we will see margin expansion in the U.S. for all of 2016 as well.
I'm going to turn it over to Myron to talk a little bit about the actual operations and what he's seen.
Myron A. Gray - United Parcel Service, Inc.
So in addition to Richard's comments, you heard Kate allude to the fact that we had 100% completion of the deployment of ORION in September, and we're very happy with the results that we're seeing. And actually, we're in the early stages of deploying additional automation projects that should bring more profit to the bottom line.
We've actually already begun the Phase 2 deployment of ORION. It'll impact another 1,300 drivers who were in extended centers that didn't have the package flow technology deploys in those sites.
And we expect to finish that mid-year next year. In addition to that, our automation strategy is well underway, and we're happy with the result that we're seeing.
We're seeing 25% improvement in productivity. As a matter fact, we've announced 12 new automated facility deployments this year as well as four here just in the third quarter.
So we're well on our way to implementing that long-term strategy and are seeing the results.
Alan Gershenhorn - United Parcel Service, Inc.
Hey, this is Alan. Just a final follow-up there on the dim weight part of that question.
First, we don't comment on competitors' pricing actions. And as you know, we review our pricing on a regular basis, including the base rates and the assessorials.
We are achieving our strategies of base rate increases between 2% and 3%. We're at the higher end of that.
Also we announced our GRI in September. We also announced that any additional rate changes including the retail rate posting in our SurePost rates will be posted on November 18 of this year.
Thanks for the question.
Operator
Next question will come from the line of Scott Schneeberger of Oppenheimer. Please go ahead.
Scott Schneeberger - Oppenheimer & Co., Inc. (Broker)
Thanks. Good morning, everyone.
I'll stay on U.S. Domestic Package, and specifically, in B2B, kind of a two-part question.
It sounds like B2B grew and you cited in the press release the online retail returns. So the first part is could you give us an idea of how strong that's trending and just thoughts on maybe the seasonality around the holidays and impact in the fourth quarter versus the first quarter?
And then also, just the B2B part that isn't pertaining to that, what type of a business environment are you seeing? And where's the momentum there?
Thank you.
David P. Abney - United Parcel Service, Inc.
Alan, why don't we start with you about B2B and then maybe Kate, talk a little bit about the seasonal trends you're seeing.
Alan Gershenhorn - United Parcel Service, Inc.
Yeah, so as we said, our B2B is up about 2%. It's best growth we've had there in five quarters.
As you know, the B2C is very strong at double-digit. Specific to your question, on the returns, returns growth in ecommerce is also very strong.
It's growing in the mid-teens. Again, you got to keep in mind that returns is a small part of our B2B market, but it's a large part of the growth that we're seeing today.
As concerns the remainder of the B2B market, we're still seeing the softness in industrial production out there. We are seeing B2B growth across many of our segments, although it's relatively muted.
Do you want to talk a little bit, Kate, about the peak season?
Kathleen M. Gutmann - United Parcel Service, Inc.
Yes. Thanks, Alan.
This is Kate. And as Alan mentioned, strong B2B growth despite the downward pressure of industrial production.
And we expect that to continue through peak season. I do want to emphasize the UPS Access Points turning commercial – or I'm sorry, residential business into commercial business.
And with 25,000 locations worldwide, 8,000 of which in the U.S., we're really seeing this solution resonate with our customers and also the convenience for consumers so that they can go to their local shop and pick up their packages. So that will help to fortify that continued B2B growth.
Thanks.
Operator
Our next question will come from the line of David Vernon of Bernstein. Please go ahead.
J. David Scott Vernon - Sanford C. Bernstein & Co. LLC
Hey, guys. Thanks for coming back to me.
Apologies for the connection problem before. Richard, maybe could you talk a little bit about International and the underlining performance there?
Obviously you're still getting some of that currency benefit. I'm just trying to make sure that the business ex the hedge gain is still chunking along.
And if you could give us some commentary on how that growth outlook looks for the fourth quarter, that'd be helpful? Thanks.
Richard N. Peretz - United Parcel Service, Inc.
Great. So I'm actually going to start and then turn it over to Jim to talk a little about the underlying business.
But we did have another great quarter, seventh quarter in a row, but the International operating margin was pushed a little higher because of the multi-year hedge strategy that we employed, we have been employed for many years. We've been talking about that all year.
And one of the challenges of course is the volatility of the euro and the sterling is at historical rates and it's brought it down. So we expect 2017 to have a transition where we'll see just over $300 million impact to the growth and the profit.
That being said, when you step back for a moment, we continue to see the operating margin expand, even adjusting for the hedge. We're talking about operating margins between 16% and 17%, which is industry leading for an international business.
It's broad based. It's because of the revenue growth, getting the right volume in our network and managing our cost efficiently.
And so when we think about the fourth quarter, we expect that they'll continue to stay at the high end of their range and I'm going to ask Jim to talk a little about specifically the business.
James Jay Barber, Jr. - United Parcel Service, Inc.
Yeah, David, on the point about, I guess, chunking along and moving forward, I think what you're seeing right now in International is the output of a couple years of investments in the network and work and strategies across the globe. We mentioned, David did in the beginning, that a couple of pockets across the world from Asia-Pacific, Asia-Pacific and specifically China and Hong Kong for us right now are growing at rates we've never seen before but more importantly it's coming from our middle markets there.
Historically, we've had big enterprise growth as supply chains expanded across the world, but we're really becoming more local in a lot of these markets or some of those bigger markets like China, we're seeing middle-market growth rates at 20% and 30% year-over-year. So that's great for us.
Europe continues to speed itself up. Again, in some of the opening comments, we've taken a look at the network and continued to speed it up, and obviously we have.
We're up to about 80% of the cities in Europe we can reach by two days in the ground network there, and we'll continue to invest there. So all in all, we think the fourth quarter will be great and we'll continue on absent the currency headwinds that Richard has mentioned to continue the growth in the International segment.
J. David Scott Vernon - Sanford C. Bernstein & Co. LLC
So the macro environment in Europe is still kind of holding together and you're not seeing anything big negative implications from Brexit or anything like that?
James Jay Barber, Jr. - United Parcel Service, Inc.
Well, I mean I think Brexit is one of those issues and I think the whole European economy is probably wider than just Brexit, no question. But we continue to see growth in that market as we have for many years.
J. David Scott Vernon - Sanford C. Bernstein & Co. LLC
All right. Thanks very much for the time.
Operator
Our next question will come from the line of Nate Brochmann of William Blair. Please go ahead.
Nate J. Brochmann - William Blair & Co. LLC
Yes. Good morning.
Wanted to talk a little bit about just kind of what some of your ecommerce customers are doing in terms of strategy where certainly today they're competing in terms of the two-day shipping against Amazon and hence the need to probably add some of that air capacity. But we also talk about moving a lot of goods closer to the customer and one of the reasons why you're doing the automation in terms of the regional sort facilities.
Just wondering if you could talk about those trends a little bit in terms of the long-term strategy of where you need to put that capacity in order to meet those shifting needs.
Kathleen M. Gutmann - United Parcel Service, Inc.
Yeah, thank you. This is Kate, and we have the deep collaboration with our customers, as you can imagine, and we help them through changes in the marketplace.
So specifically to B2C and getting closer to their customers, we have a full portfolio of omni-channel solutions and I will say it's not just resonating with retailers but more and more we're seeing this translate throughout other industries such as healthcare and even high-tech for sure and industrial manufacturing. But it's enabling any of their locations and turning those into direct shipping points would be the focus of a lot of the solutions, and they're not just physical.
They're also information based and we find that it helps them to capture their share of the growth in the market. Thanks for the question.
Scott Childress - United Parcel Service, Inc.
So our next question we will take another online question, and we've got multiple questions on this topic. The question is how do we think about automation affecting our business model both from a drones, a platooning and an automated vehicle standpoint moving forward?
Myron A. Gray - United Parcel Service, Inc.
Thank you. This is Myron.
I'll start with automation first. We are continuing to make good progress with our long-term initiatives to add more capacity, offer greater efficiency in our integrated network by introducing automation throughout our top tier 30 (46:21) hubs across the U.S.
where we process as much as 60% through those locations. I mentioned earlier that we'd announced 12 automated facilities this year including four this quarter.
We're on pace and we're making great progress. Those include retrofitting, expansion and in some cases new facilities.
And again, we're getting as much as 25% production improvements in those locations. This, of course, allows us to have additional flexibilities and reduce handles in the network.
When it comes to the use of drones as well as vehicles that allow us to have autonomous trucks on the road, we have experimented with drones with a number of vendors. You should've seen an announcement where we launched our first try in the Northeast earlier this year.
It was very successful, as well as our use in delivering medications in Africa. So we'll continue to experiment until we get the ability to use it.
As it pertains to vehicles, we're continuing to work with a number of vendors to explore what works best for us. We have what we term as a rolling laboratory.
We have over 6,500 vehicles in the U.S. right now that are considered CNG, LNG, and the sort.
Of course, all of this will require the approval from the National Highway and Traffic Association. So when it becomes available to us, we certainly expect to be ready.
Scott Childress - United Parcel Service, Inc.
Steven, let me just remind the callers asking live questions to make sure that they only ask one question, so that we can get through the remainder of the calls for the time remaining.
Operator
And our next question will come from the line of Brandon Oglenski of Barclays. Please go ahead.
Brandon Oglenski - Barclays Capital, Inc.
Hey. Good morning, everyone.
And I'll be sure to keep it to one. So, as I look at your Domestic profitability the past six years, your margins have been around the low 13%s to mid 13%s.
And we know that we've seen a lot more B2C growth in that same time period. So, as we look forward, I think everyone's expecting ecommerce to continue to outperform.
Is there a change in that dynamic where we can actually start to get stop density? (48:40) Or has competitive factors like the post office, and maybe even Amazon doing more on their own, just impacted the ability for you guys to take higher margins?
Richard N. Peretz - United Parcel Service, Inc.
So, Brandon, I guess I would start with saying, all of it. When you think about what's happening with density, Kate talked about the Access Points and taking what was a B2C to B2R, and that's helping on density.
And we are seeing an improvement on B2C density that we hadn't seen in many, many years. On top of that, we continue to invest in the automation, both at the hubs, ORION that Myron talked about, and all of that really is about improving the margin.
We talked about, in our Investor Conference a few years ago and throughout each year, that we're investing, and year over year we're having to reinvest to get to the endpoint. And all of that together, along with things like SurePost Redirect, and the ability to take almost a third of the volume that's destined to be delivered by the post office and we put it in our system, because we're already going to those stops.
Those are all key components of how we're going to continue to improve the margin. And really it's a long-term story that we're talking about.
Earlier I actually mentioned, and perhaps I said the wrong year, that we do expect margin expansion for the entire year of 2016. And that's why we guided the way we did for the fourth quarter.
Expect a little bit better performance in the fourth quarter, and we'll have three of the four quarters in 2016 with margin expansion, that all adds to margin expansion for the year.
Operator
Our next question will come from the line of Allison Landry of Credit Suisse. Please go ahead.
Danny C. Schuster - Credit Suisse Securities (USA) LLC (Broker)
Hi. Good morning.
This is Danny Schuster on for Allison. Just wanted to ask a little bit more about SurePost.
I know you saw some nice volume growth in that segment, up 20% year over year. Just wondering what the progress is on SurePost Redirect, and whether you see that improving density, as well as potential density improvements coming from increased returns to the B2B segment?
Thank you.
Alan Gershenhorn - United Parcel Service, Inc.
Yeah. This is Alan.
Thanks for the question. Yeah, so the SurePost Redirect program continues to work.
As Rich just stated, when we redirect, we've already got a package going to that particular consumer. So it's very, very accretive to us to reroute that package back through the UPS network and avoid having to pay any postal fees at that particular point, and we're up around 30%.
We're continuing to investigate new and better ways to improve that. And then we've also got other methodologies, like UPS Access Point that Kate mentioned, to build density, as well as our synchronized delivery solution.
So it's all really about bending the cost curve and increasing the density on our B2C shipments.
Danny C. Schuster - Credit Suisse Securities (USA) LLC (Broker)
Great. Thank you.
Operator
Our next question will come from the line of David Ross of Stifel. Please go ahead.
David Ross - Stifel, Nicolaus & Co., Inc.
Yes. Good morning, everyone.
Wanted to talk a little bit about the ecommerce portfolio you mentioned, or the return portfolio that you said is growing mid-teens. What percent of your shipments today are returns?
And is that a better yield than average on the shipment? Or how would you characterize that, in terms of attractiveness relative to the average box?
Alan Gershenhorn - United Parcel Service, Inc.
Yeah, so when you look at the ecommerce market, it could be one in five or one out of every six packages that are shipped to a consumer get returned. So the growth in that particular market tracks very closely to the growth in ecommerce on that one to five, one to six ratio.
Those packages are highly profitable. First of all, many of those packages get dropped off and don't have to be picked up because the consumer finds it more convenient to drop them off at UPS stores or UPS Access Points or hand them to a UPS driver.
So there's very little cost when it comes to pick-up. And then obviously, the deliveries are going back to businesses, and we could be delivering tens or hundreds of packages back to these businesses.
So it's a highly profitable B2B delivery with very little pick-up cost.
Scott Childress - United Parcel Service, Inc.
So we're going to take another online question. This question comes from Scott Group, and Scott just asked – noticing the new language that we have regarding the mark to market pension accounting outlook, and would like to know, can we give a little preliminary outlook for what the pension expense is for 2017?
Richard N. Peretz - United Parcel Service, Inc.
So, I think the first thing everyone should understand is, the language change was really meant to ensure that we're following a new report that was published by the SEC around interpretive guidance around both the GAAP, non-GAAP and ensuring that we had equal prominence. And the way the rules work is, you have to have certain information you need to convey around the GAAP side.
It really is too early, and that's why there wasn't anything in the report about what we thought the mark to market would be because there's so many things that aren't even finished yet for us to know where we would be. For example, return on assets and discount rate.
And if you go back last year this time and where we are today and where we ended the year, the discount rates changed a lot. And of course last year, the market changed the other direction, unfortunately.
So there are so many unknowns right now that it's really impossible to sit here and say, this is what we think it's going to be. That all beings that, what we were doing with – and what we put in the press release was if you look at the underlying core business, we're confirming that our adjusted earnings per share guidance is right in where we expected it to be, and that's because the investments that we put in the last few years are creating the returns.
And that's why we're going to see the margin expansion, and that's why we've guided the way we have.
Operator
Our next question will come from the line of Helane Becker of Cowen & Company. Please go ahead.
Helane Becker - Cowen & Co. LLC
Oh. Thanks, operator.
Thanks for squeezing me in, guys. There's been a lot of talk about wage rates going up on part-time workers and warehouse workers and the fact that it's harder and harder to find them.
And I know that at UPS you guys have a lot of people come back every year for the peak, and they're happy to do that. But what about longer term as you think about hiring out those 95,000 people?
Can you just address how that affects your thought process after the peak?
Myron A. Gray - United Parcel Service, Inc.
Yeah, Helane, this is Myron. We're actually on plan for peak season hiring to date.
37% of our peak hires since 2014 have actually become permanent hires. I'm happy to tell you that I was actually a peak hire from 1978.
So we think the best value proposition is the ability to attract and retain people who are looking for long term opportunities for growth at UPS who began with us as peak hires. There are some selected locations where we will use bonuses to attract employees, but overall we don't think there'll be any issues.
Thank you.
Operator
And due to time constraints, our last question will come from the line of Bascome Majors of Susquehanna. Please go ahead.
Bascome Majors - Susquehanna Financial Group LLLP
Yeah, thanks for squeezing me in here. So 2016 has been a year where really impressive profit growth in your International business led the overall franchise.
And you talked a little bit and gave us an update on 2017's FX headwinds. And with that potentially walking back over a year of growth in the International segment, do you think the other two segments can pick up that slack by delivering the high-single digit and low-double digit profit growth that you put out in your long-term targets?
Richard N. Peretz - United Parcel Service, Inc.
This is Richard. And I think the important thing to remember on all three of our business segments is we are working a five-year plan with each year getting and making progress on our ultimate goals.
So the answer is it's a little too early to talk about 2017, and we actually talked about that we're going to bring everyone together in February to really give you a full picture of the enterprise strategy, where we're headed, where we have great opportunities and where growth is coming from. And I think that that will help you to see why we are so optimistic about the future.
But at the same time, all three segments are part of the five-year plan. When we created the plan, we saw that the euro was already starting to fall, not quite as much, but we actually came back and talked about that.
So we'll update you, but it was all part, and each segment is part of that plan overall.
Operator
I would like to turn the conference back over to Mr. David Abney.
Please go ahead, sir.
David P. Abney - United Parcel Service, Inc.
Yes. I'd like to just make some closing comments.
And one of the words that you've heard a little bit today is commitment, and I just want to use that for the next few minutes and just talk about how we're committed to our business. Obviously, we're committed to achieving our EPS guidance that we gave just about a year ago, and we have affirmed that for the fourth quarter and feel real good about that.
We're committed to delivering another successful peak season. You heard from Myron, you heard from Kate, and we've been working the last 10 months here, and through this collaboration and cooperation with our customers, we have a good peak season set up for us.
We're committed through our strategic initiatives and our investments to continue to build the long-term future of UPS. This aircraft addition and the longer-term initiative, but also what we're doing internationally in Europe with the $2 billion worth of CapEx that we're spending, we're getting a lot of returns in that.
And we're going to continue to focus on those growth markets. And then of course we're committed to our shareholders, our customers and our employees.
So we've had a good year so far. We have good momentum going into the fourth quarter, and we look forward to having a very successful fourth quarter.
Thank you very much for your time.
Operator
Ladies and gentlemen, this does conclude our call. Have a wonderful day.