UPS - NYSE

Good morning. My name is Steven and I will be your facilitator today. I would like to welcome everyone to the UPS Investor Relations First Quarter 2023 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. [Operator Instructions] It’s now my pleasure to turn the floor over to our host, Mr. Ken Cook, Investor Relations Officer. Sir, the floor is yours.

Thanks, Carol, and good morning. In my comments, I’ll cover four areas, starting with the macro environment, then our first quarter results, next I’ll cover cash and shareholder returns, and lastly, I’ll review our updated financial outlook for 2023. Okay, let’s start with a macro. In the first quarter, the macro environment was challenging from both a commercial and consumer perspective. The growth rate for U.S. manufacturing production fell throughout the quarter and was down 0.9% in March year-over-year. On the consumer side of the U.S. economy, the growth rate on services spending is continuing to outpace the growth rate on good spending, and within the goods bucket, consumer spent more on essential items like groceries, which tend to be purchased in store. These factors plus a five point drop in consumer sentiment from February to March contributed to the reduction in our volume levels. Outside the U.S. in the first quarter, Asia exports remained weak while Europe narrowly avoided a winter recession. In the face of all this, we responded with agility and remain focused on controlling what we could control to deliver great service for our customers and bottom line results for shareholders. In the first quarter, consolidated revenue was $22.9 billion, down 6% from last year and slightly below our base plan expectations. Operating profit was $2.6 billion, a decrease of 22.8%, however, we achieved our base plan operating profit. Consolidated operating margin was 11.1%, a decline of 250 basis points compared to last year. For the first quarter, diluted earnings per share was $2.20 down 27.9% from the same period last year. Now, let’s look at our business segments. In U.S. Domestic, revenue quality initiatives nearly offset the decrease in volume and as the decline in volume accelerated toward the end of the quarter, we responded quickly by adjusting the network to eliminate costs while maintaining our industry leading service levels. In the first quarter, we expected average daily volume to decline between 3% and 4%. For the quarter, average daily volume was down 5.4% year-over-year, primarily because volume in March moved lower than we expected. Looking at mix in the first quarter, we saw lower volume across all industry sectors with the largest declines from retail and high-tech. B2C average daily volume declined 5.5% compared to last year, and B2B average daily volume declined 5.4%. A bright spot in B2B in the quarter was returns, which was up 6.8% year-over-year. In the first quarter, B2B represented 42.7% of our volume, which was unchanged from a year ago. Additionally, the shift in product mix from air to ground that we saw in the fourth quarter of 2022 continued in the first quarter as customers made cost tradeoffs and took advantage of the speed improvements we made in our ground network and further leveraged our SurePost product. Compared to the first quarter of last year, total air average daily volume was down 16.7%, ground declined 3% and within ground SurePost grew 1.8%. Looking at customer mix, SMB average daily volume declined significantly less than our enterprise customers in the first quarter. SMBs, including platforms made up 29.6% of our total U.S. volume, an increase of 120 basis points year-over-year. For the quarter, U.S. Domestic generated revenue of $15 billion down 0.9%. Revenue per piece increased 4.8%, nearly offsetting the decline in volume. The combination of base rates and customer mix increase the revenue per piece growth rate by 500 basis points driven by strong keep rates from our general rate increase and increased SMB penetration. Fuel drove 200 basis points of the revenue per piece growth rate increase. Remaining factors reduced the revenue per piece growth rate by 220 basis points driven by the combination of negative product mix with ground packages outpacing air growth and lighter package weights. Turning to cost, total expense was relatively flat with an increase of 0.6% or $80 million in the first quarter. Higher union wage and benefit rates increased expense by over $300 million, primarily from a 6.1% increase in average union wage rates driven by the annual pay increase for our Teamster employees that went into effect in August of 2022. The U.S. Domestic team did an excellent job pulling cost out of the network in response to lower volume. We managed hours down 5.6%, which was more than the decrease in average daily volume, and we reduced headcounts throughout the quarter as volume growth rates decline. Together, these actions reduced expenses by more than $220 million, partially offsetting the increase in wage and benefit rates. Additionally, we reduced purchase transportation by $100 million, primarily from utilizing UPS feeder drivers to support our Fastest Ground Ever and from continued optimization efforts, which enabled us to reduce trailer loads per day by 7.5% compared to the same period last year. The remaining variance was driven by multiple factors including maintenance and depreciation. The U.S. domestic segment delivered $1.5 billion in operating profit, which was slightly above our base plan and down 12.7% compared to the first quarter of 2022. And operating margin was 9.9%. Moving to our international segment, we expected the macro environment to be bumpy and it was. Looking at Asia, export activity started off very weak due to the extended lunar New Year holiday. It gradually recovered through the quarter, but at a slower pace than we anticipated. In Europe, the macro environment was a little better than we expected, which helped offset the weakness in Asia relative to our base plan. In the first quarter, international total average daily volume came in as expected and was down 6.2% year-over-year. Domestic average daily volume was down 9.5%, which drove three quarters of the total average daily volume decline. Total export average daily volume declined 2.8% on a year-over-year basis driven by declines in retail and high tech market demand. Asia export average daily volume was down 8.9% and included a 20% year-over-year decline on the China to U.S. lane. Through the first quarter, we remained agile and we flexed the network to match demand. Reduced Asia block hours by more than the decline in Asia export volume and delivered excellent service to our customers. In the first quarter, international revenue was $4.5 billion, down 6.8% from last year due to the decline in volume and a $161 million negative revenue impact from a stronger U.S. dollar. Revenue per piece was relatively flat year-over-year, but there were a number of moving parts including a 370 basis points decline due to currency and a 180 basis points decline from demand related surcharges. These were offset by an increase in the fuel surcharge of 230 basis points and an increase of 330 basis points due to the combination of a high GRI keep rate and a favorable product mix as export volume outperformed domestic volume. Operating profit in the international segment was $806 million, down $314 million from the same period last year, primarily due to the decline in exports out of Asia and included a $97 million reduction in demand related surcharge revenue and a $51 million negative operating profit impact from currency. Operating margin in the first quarter was 17.7%. Now looking at supply chain solutions. In the first quarter, revenue was $3.4 billion, down $983 million year-over-year. Looking at key drivers. In forwarding, softer global demand, especially out of Asia, drove down market rates and volume resulting in lower revenue and operating profit. We are continuing to manage buy/sell spreads and have taken steps to reduce operating costs in this business. Logistics delivered revenue growth driven by gains in our healthcare logistics and clinical trials business and increased operating profit. In the first quarter, supply chain solutions generated an operating profit of $258 million and an operating margin of 7.6%. Walking through the rest of the income statement, we had 188 million of interest expense. Our other pension income was $66 million and our effective tax rate for the first quarter was 24.8%, which was less than we anticipated in our base plan due to lower tax impacts from our employee stock awards. Now let’s turn to cash and shareholder returns. In the first quarter, we generated $2.4 billion in cash from operations. Free cash flow for the period was $1.8 billion, including our annual pension contributions of $1.2 billion that we made in the first quarter. Also, in the first quarter, we issued $2.5 billion in long-term debt that we are using to pay off debt maturing in 2023. And in the first quarter, UPS distributed $1.3 billion in dividends and completed $751 million in share buybacks. Moving to our outlook for the full year 2023. In January, we provided a range for our 2023 financial targets due to the uncertain macroeconomic environment we saw at that time. Since then, the volume environment has deteriorated, especially in the U.S., driven by continued challenging macro conditions and changes in consumer behavior. As a result, we expect full year revenue and operating margin to be at the low end of the previously provided range. For the full year 2023, we expect consolidated revenues of around $97 billion and consolidated operating margin of around 12.8% with about 56% of our operating profit coming in the second half of the year. In U.S. domestic, we expect full year volume to decline around 3% versus 2022 with revenue per piece growth yearly offsetting the decline in volume and operating margin is expected to be around 11%. In international, we anticipate both volume and revenue to be down by around 4% and we expect to generate an operating margin of around 20%. And in supply chain solutions, we expect full year revenue to be around $14.3 billion, and operating margin is expected to be around 10%. We have proven our ability to adapt in a dynamic environment. We have many levers to pull on the cost side and we will continue to control what we can control by delivering industry leading service and remaining disciplined on revenue quality. We will also continue investing in growth and efficiency initiatives like international DAP, healthcare and Smart Package smart facility, which will help us come out of this economic cycle faster and stronger. Specifically, now that our volume is trending at the downside of our range, we are executing our plan to take out semi variable and fixed costs. Including in the U.S. air network, we are adjusting package flows to maximize utilization on our next day flights, which enables us to reduce block hours in our two-day operation. On the ground, we are pulling more volume into our large regional hubs, further leveraging the automation in those buildings and enabling us to eliminate sorts in smaller buildings. Driving more consolidation on the ground could potentially allow us to reduce our overall building footprint in the U.S. Internationally, based on the volume levels over the last couple of quarters, we’ve further reduced scheduled flights to reflect lower market demand while ensuring we maintain agility in the network to quickly add flights where needed if volume returns more strongly than we expect. Across our global business, we will continue to manage headcount with volume levels. And in terms of overhead, we see opportunities to further reduce costs by leveraging technology. Now let’s turn to capital allocation. Our plans have not changed. We will continue to make long-term investments to support our strategy and capture growth coming out of this cycle. We still expect 2023 capital expenditures to be about $5.3 billion, including investments in automation, and we’ll add 2.3 million square feet of healthcare logistics space to our global network this year. We’ll also complete the deployment of the first phase of Smart Package Smart Facility in the U.S., expand DAP internationally and continue building out our logistics as a service platform. We are still planning to pay out around $5.4 billion in dividends in 2023 subject to Board approval. We still plan to buy back around $3 billion of our shares. And lastly, our effective tax rate for the full year is expected to be around 23.5%. In closing, despite the challenging macro backdrop, we will continue to provide industry leading service to our customers and we will stay on strategy. We are investing to make our network even more efficient and to strengthen our customer value proposition to enable us to capture growth coming out of this cycle. Thank you. And operator, please open the lines.

Thank you. We’ll now conduct a question-and-answer session. Our first question will come from the line of David Vernon of Bernstein. Please go ahead, sir.

But it is a change in culture. I don’t think Carol, we’ve actually closed buildings outside of the non-op side. So it’s a pivot to be more optimized and focused.

Our next question will come from the line of Amit Mehrotra of Deutsche Bank. Please go ahead.

Thanks, operator. Good morning, Carol and Brian. So Brian, the volume environment is obviously weaker and the weakness seems – seem to have accelerated towards the end of the quarter. So I’m just trying to understand, where are we now? I mean, they’re obviously – you’re obviously confident about achieving the low end of the guidance. I’m just trying to understand, that confidence in the context of the volume uncertainty. And then just as a follow-up if I could, Carol, it’s great that you think a win-win-win is still achievable, but the rhetoric is getting like really bellicose. And so, I’m wondering if you’d give some color on that dynamic because it seems like it’s costing you guys some volume right now. And I know you made an acquisition last year with Delivery Solutions that gives you access to a lot of contingent capacity. So talk about the win-win-win against the rhetoric, against the investments you’ve made. There’s a lot in there, but I’ll let you answer it however you want. Thanks.

Our next question comes from the line of Allison Poliniak of Wells Fargo. Please go ahead.

Hi, good morning. Just want to go back to the productivity side that the hours deployed, the spread between hours deployed and the volumes certainly narrowed this quarter. I know you talked about some stabilization in April and certainly some cost outs going forward. Just any color on how we should think of that spread? Should it remain positive and maybe expand as we get towards the back half of the year? Thanks.

Yes. So look – but we’re going to need to take cost out balance a year. It’ll be a big reduction in CPP. We were mid-single digit Allison in the U.S. And candidly, if you had told me wages were going to be up 6% and volume was going to be down 5%, I would’ve expected something like a double-digit CPP about three or four years ago. Nando and the team have done extraordinary job of driving that 6% that we saw in the quarter, but we are expecting low-single digits for the balance of the year. As you think about CPP, it’s going to come from four areas. One, Carol talked about total service plan, and that’s that reducing hours more than volume and managing the headcount. The second is our network. We deal with both ground and error, as you know, and in the ground side, how do we consolidate volume and automated facilities, closed sorts and really focus on the efficiency there. On the air side, it’s changing the package flows to better utilize the one day network. And in fact, domestic block hours they were down about 4% in the first quarter, we would expect to exit the second quarter at 2x [indiscernible] The third piece that we’re focused on is overhead and following the technology group delivering technology efficiency to allow us to do our jobs on the non-op side more efficiently and will continue to reduce headcount as volume warrants. And lastly, fuel. We expect fuel prices to be down double-digit year-over-year in the balance of the year 2Q and 2H. So that will reduce both RPP and CPP. But those four things combined drive a high amount of confidence in a low-single digit CPP balance a year.

Understood. Thanks for the color.

Yes.

Our next question comes from the line of Tom Wadewitz of UBS. Please go ahead, sir.

Yes, good morning. That was really helpful, Brian, in terms of the cost per piece framework, do you have a kind of a comparable thought for looking forward on revenue per piece? And maybe also some – just some commentary on how the pricing environment’s holding up. I think your primary competitor’s pretty focused on margins, cutting cost, cutting capacity. Obviously, you’re doing a good job managing cost and capacity as well. So I think there’s a lot of potential for a good pricing environment, but any thoughts on that? And also just how we think about the drivers of revenue per piece. Thank you.

Yes. Tom, I’m happy to. And I assume you’re talking about the domestic business. We had guide….

Yes. Domestic, thanks. Yes.

Okay. Great. Thank you.

Thanks, Tom.

Our next question comes from the line of Jordan Alliger of Goldman Sachs. Please go ahead, sir.

Yes. Hi. You talked a little bit about what’s going to drive cost per piece back after the year, but maybe can you talk a little bit about some of the specific buckets notably that other expense was quite a bit higher and is it more opportunity purchase transport? Just trying to get a sense for what – where it’s going to be impacted the most. Thanks.

Yes.

Thank you.

Thanks, Jordan.

Our next question comes from the line of Ken Hoexter of Bank of America. Please go ahead.

Hey, good morning, Carol and Brian. You talked about the sharp decline in mid-February. I guess you’ve seen this before where we’ve had some stabilization and then the sharp decline inventory still seem high. Maybe your thoughts on the backdrop, and maybe Brian a little more international, you talk about getting to 20% margin on international, but seems like pre-COVID you were operating maybe 16% to 19%. Did something structurally change or the mix change that, that you think that that is the new floor versus in a shifting environment it goes a little bit lower? Thanks.

Thanks, Carol. Thanks, Brian.

Thanks, Ken.

Our next question comes from the line of Mr. Scott Group of Wolfe. Please go ahead.

Hey, thanks. Good morning. Brian, just a couple follow-ups on the guidance, the 11% U.S. margin. How does that trend throughout the course of the year? And then the volumes were down – the volumes down 3% for the year, how should we think about Q2? And is the back half sort of flat to positive? Is that what you’re expecting? Thank you.

Yes. I would say the – in terms of shaping the year, Scott, maybe that helps. We don’t manage in quarters, but to help you shape, I referenced in the prepared remarks, 56% of our full year operating profit coming in the second half for the company. If you look at the U.S. domestic business, I’d expect ADV year-over-year growth rates to bottom in Q2 and then improve from there to your point. And that relates to the actions we’re – as we think about margin, the actions we’re taking on semi variable costs and margins will improve sequentially in Q2 and then throughout. Fuel PPG will reduce both RPP and CPP. So it’s not a material profit impact but I would expect operating margins to be better in the second quarter than in the first. On the international side, I think ADV will gradually improve through the year. And as I mentioned, we’ll have to see consistency of the op margin for the next three quarters of around 20% in the balance of the year. And then finally it’s supply chain. Revenue should be marginally better in Q2 than Q1, and you can hold that 10% as a full year op margin.

Thank you.

Yes.

Our next question will come from the line of Bruce Chan with Stifel. Please go ahead, sir.

Our next question will come from the line of Brian Ossenbeck of J.P. Morgan. Please go ahead, sir.

Our next question comes from the line of Chris Wetherbee of Citigroup. Please go ahead, sir.

Yes. Hey, just wanted to you maybe hit on the cadence question again and about sort of how this year progresses on the guidance. I think 56% of the profit on the back half of the year implies around $2.9 billion or so in 2Q. And just any thoughts around the step up we would might see between domestic and international? And then I guess just Brian on the RPP, CPP point, do you have a line of sight? Does the guidance include a flip back to RPP outperforming or outpacing CPP by the end of the year? Is that a volume function? Is that more of a cost function? Just want to make sure I understand sort of how you guys are thinking about that.

So we’re longer term, Chris, as we’ve talked to you. We’re always going to drive for RPP to outpace CPP. We’re a bit of an extraordinary environment right now with the macros and everywhere they are. So we don’t have margin expansion this year based on the guide. So you won’t see that likely return until 2024. But we feel good about the taking cost and CPP down to low single digit as RPP does come back. So feel okay about that. And then your math is fairly accurate in the second quarter, you’re doing the squeeze the right way.

Okay. Thank you very much.

Yes.

Our next question comes from the line of Ari Rosa of Credit Suisse. Please go ahead.

Our next question will come from the line of Helane Becker of TD Cowen. Please go ahead ma’am.

Thanks very much, operator. Hi everybody. And thank you very much for the time. I wonder, Brian, if you could talk a little bit about what margins in the stores are like, I feel like you were hinting at their – one of your most profitable business lines. So I’m kind of wondering if you could put some more color to that.

Excellent. Steven, we have time for one more question.

Our last question will come from the line of Stephanie Moore of Jefferies. Please go ahead ma’am.

Hi, good morning. Thank you. Hi, Carol and Bryan. I just wanted to kind of look through your updated guidance, particularly your consolidated margin outlook. It certainly understand it’s a very fluid environment as it relates to volumes and appreciate the additional color of you guys executing on what’s in your control. But could you talk a little bit about your ability to maybe still hit that margin target and volumes were to deteriorate worse than you expected? And how you kind of framed that in your outlook as you kind of looked at the puts and takes for it. What is a pretty volatile year? Thank you.

Yes. So well, I’m not sure anything’s fixed anymore, Carol. So we do about a third variable on the 70% in the semi and the fixed bucket and we’re really redefining that. As we talked earlier, we don’t have a history of closing or selling buildings per se, but everything’s on the table because in the new world there has been a growth over a 100 years of a bunch of buildings located around. And so Nando’s ability to go and shut down some sorts and drive, we’re going to match the volume. The one thing Carol I would add is, when volume returns and make no mistake, volume will return to this business, we will be positioned very well to throw off cash, because we’ll have positioned the cost structure in a good way.