UPS - NYSE

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

Thanks, Carol, and good morning. Let me begin by echoing Carol's comments on how pleased we are no achieving a win-win-win labor agreement covering our more than 300,000 Teamster employees. This contract provides UPS a significant measure of certainty around labor, gives us operational flexibility to increase productivity and continue providing industry-leading service to our customers, and it will help us attract and retain the best employees in the industry. Now in my comments today, I'll cover 4 areas. I'll start with the macro, followed by our second quarter results. Next, I'll cover cash and shareholder returns. And lastly, I'll provide some comments on the second half of the year. In the second quarter, the overall macro conditions in the U.S. were in line with our expectations. Internationally, conditions were a little worse than we expected due to lower growth in both real exports and industrial production. Moving to our financial results. For the quarter, consolidated revenue was $22.1 billion, down 10.9% from last year. All 3 of our segments demonstrated agility and on a combined basis, drove down total expense by $2.1 billion in the second quarter year-over-year. This enabled us to deliver $2.9 billion in operating profit, which is the target we communicated to you last quarter and was a decrease of 18.4% compared to last year. Consolidated operating margin was 13.2%, a decline of 120 basis points compared to the same period last year, with all 3 segments achieving double-digit operating margins. For the second quarter, diluted earnings per share was $2.54, down 22.8% from the same period last year. Now let's look at our business segments. In U.S. domestic, our disciplined approach to revenue quality partially offset the decrease in volume. As volume declined throughout the quarter, the team did an excellent job adjusting the network to match demand and drive out cost in real-time, all while maintaining industry-leading service levels. We expected volumes to decline in the second quarter, and it did, but we saw more volume diversion than anticipated as noise levels around our labor negotiations increased. We estimate the impact of volume diversion, combined with a slowdown in our sales pipeline pull-through, reduced volume in the second quarter by approximately 1.2 million packages per day. For the quarter, total average daily volume was down 9.9%, with June down 12.2%. Moving to mix. In the second quarter, we saw lower volumes across all industry sectors with the largest declines from retail and high tech. B2C average daily volume declined 11.5% compared to last year, and B2B average daily volume was down 7.7%. In the second quarter, B2B represented 43.7% of our volume, which was an increase of 100 basis points from a year ago. Also in the second quarter, we continued to see customers shift volumes out of the air onto the ground. Total air average daily volume was down 16.5% year-over-year, and ground average daily volume declined 8.6%. In terms of customer mix, in the second quarter, SMB average daily volumes declined less than volume from our enterprise customers. SMBs, including [Audio Gap] quarter. U.S. domestic generated revenue of $14.4 billion, down 6.9%. Revenue per piece increased 3.3%, partially offsetting the decline in volume. The combination of strong base rates and improved customer mix increased the revenue per piece growth rate by 670 basis points. Changes in fuel prices decreased the revenue per piece growth rate by 220 basis points. The remaining 120 basis point decline was due to multiple factors, including package characteristics and product mix. Turning to costs. The U.S. domestic team took out $889 million of expense year-over-year, which is the largest year-over-year cost reduction in our history. How did we do it? We leveraged our technology and the agility of our integrated network. Let me walk you through some of the levers we've pulled. We continued to execute our total service plan and reduced labor hours by nearly 10% to maintain our high levels of productivity. We leveraged the power of our network planning tools to optimize package flows and pull volume out of smaller nonautomated buildings and flow it into our larger automated facilities. While total volume was down 9.9%, we reduced the volume in our nonautomated building by 18%. This enabled us to close door and reduce operations headcount by 7% compared to last year. We reduced feeder movements by continuing to manage cube utilization in our trailers and brought on more UPS feeder drivers to support our fastest ground-ever lane. Looking at air volumes, we pulled more activity into WorldPort, our global AirHub in Louisville. This enabled us to move more volume via our next day flight and reduced second day flights. As a result, domestic block hours were lower by 6.5% versus last year, and we exited the second quarter with block hours down more than 10%. And lastly, we reduced management headcount by over 2,500 positions year-over-year. All of these actions helped us reduce U.S. domestic expense in the second quarter. Specifically, compensation and benefits was down $205 million year-over-year, despite a 6.5% increase in average union wage rates. Purchase transportation declined $207 million. Fuel expense was lower by $394 million and there were multiple factors that drove the remaining $83 million reduction in expense. Our results are proof of our agility. And in the second quarter, we took out a record amount of cost and held the cost per piece growth rate to 3.7%, while volume was down nearly 10%. The U.S. Domestic segment delivered $1.7 billion in operating profit, in line with our expectations and down 9.4% compared to the second quarter of 2022. Operating margin was 11.7%, an increase of 180 basis points from the first quarter of this year. Moving to our International segment. Macro conditions remained sluggish in the second quarter. In Europe, persistent high inflation and tight financial conditions weighed on the consumer. And in Asia, the slow recovery we experienced in the first quarter stalled in the second quarter. In the quarter, International total average daily volume was down 6.6% year-over-year. About 2/3rd of the decline came from lower domestic average daily volume, which was down 8.7%, driven primarily by declines in Europe. On the export side, average daily volume declined 4.5% on a year-over-year basis. Looking at Asia, export average daily volume was down 10.1%. Export volume on the China to U.S. lane was down 7% year-over-year, which was an improvement from the first quarter. In the second quarter, International revenue was $4.4 billion, which was down 13% from last year due to the decline in volume and a 5.7% reductions in revenue per piece. The decline in revenue per piece was primarily driven by a 570 basis point decrease from fuel surcharge revenue. Additionally, a reduction in demand-related surcharge revenue contributed 240 basis points to the decline. And there was an 80-basis point decline in revenue per piece due to a stronger U.S. dollar. Partially offsetting the decline, multiple factors increased the revenue per piece growth rate by 320 basis points, including strong base rate and favorable volume mix as export volume outperformed domestic volume. Moving to cost. In the second quarter, total international costs was down $356 million, primarily driven by lower fuel expense. We leveraged the agility of our integrated network to match capacity with demand and focused on controlling what we could control. These actions included flight reduction, which drove international block hours down 9.4% compared to last year, which includes a 15.5% block hour reduction on Asia-outbound Transcontinental flights. We also reduced headcount in operations and overhead functions by a total of more than 1,700 positions and we did all of this while continuing to deliver excellent service to our customers. Operating profit in the International segment was $902 million, down $302 million year-over-year, which included a $123 million reduction in demand-related surcharge revenue. Operating margin in the second quarter was 20.4%, in line with our expectations. Now looking at Supply Chain Solutions. Our teams continued to navigate a challenging macro environment and executed our plans to reduce cost. In the second quarter, revenue was $3.2 billion, down $990 million year-over-year. Looking at the key drivers. Forwarding continued to be impacted by softer global demand, especially out of Asia, which drove market rate and volume lower. This resulted in a decline in revenue and operating profit. In response, we cut operating costs and are continuing to manage buy-sell spreads. Logistics delivered revenue and operating profit growth, including gains in our health care business. In the second quarter, Supply Chain Solutions generated operating profit of $336 million and an operating margin of 10.4%. Walking through the rest of the income statement. We had $190 million of interest expense, our other pension income was $66 million, and our effective tax rate for the second quarter was 23.5%. Now let's turn to cash and shareowner returns. Year-to-date, we generated $5.6 billion in cash from operations, and free cash flow was $3.8 billion, including our annual pension contribution of $1.2 billion that we made in the first quarter. Also this year, in the first quarter, we issued $2.5 billion in long-term debt. We've used $1.6 billion to pay off debt maturities in the second quarter, and we plan to use $900 million to pay off debt maturities in the second half of this year. And in the first half of 2023, UPS paid $2.7 billion in dividend. We also completed $1.5 billion in share buybacks at an average price of around $178 per share. Now I'll share a few comments about our outlook. As Carol mentioned, with the contract out for ratification, we have updated our consolidated revenue and adjusted operating margin guidance. For the full year 2023, we expect consolidated revenues of about $93 billion and consolidated operating margin of around 11.8%. Now let me provide some color to help you update your models for the second half of the year. The U.S. Domestic segment is navigating a couple of unique factors in the back half of the year. First, in the second quarter and into July, we experienced more volume diversion than we anticipated because of this, our volume ramp-up for the second half of the year is starting from a lower base. We're already executing our initiatives to win back diverted volume and accelerate the pull-through from our sales pipeline while remaining disciplined on revenue quality. As a result of our efforts, by the end of the year, we expect our average daily volume level to be about even with December of last year. And overall, for the second half of 2023, we expect U.S. average daily volume to be down by a mid-single-digit percentage year-over-year. And second, looking at expense in the U.S. Domestic segment. The union wage rate increases included in our new labor agreement for the first year are higher than we originally planned. We started to accrue for the terms of the tentative agreement on August 1, while the contract is out for ratification. Further, we will address wage compression that resulted from the new labor contract. These additional labor costs in the back half of the year will be partially offset by the network adjustments we made in the second quarter. Turning to the International segment. In the second half of the year, we expect the year-over-year volume growth rate to be similar to what we saw in the second quarter and revenue per piece growth to be flattish compared to the same period last year. And in Supply Chain Solutions, we expect second half revenue to be down by a high single-digit percentage year-over-year, with full year revenue approaching $14 billion. Moving to capital allocation. Our 2023 full year targets have not changed. We will continue to stay on strategy and invest in both efficiency and growth opportunities. Capital expenditures are still expected be about $5.3 billion, which includes completing the deployment of the first phase Smart Package Marketability in the U.S., continuing to expand our health care logistics footprint globally, expanding DAP internationally and investing in 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. And for the full year, we still plan to buy back around $3 billion of our shares. With negotiations behind us, we are moving our business forward. For our people, we have a platform for the future that continues to reward our employees, which helps us to deliver industry-leading service to our customers and enables us to win that volume and drive revenue quality. We will control what we can control, which means continuing to manage costs as we scale up the network with volume. And we are staying on strategy and investing through this cycle, which will enable us to grow in the most attractive parts of the market, make our integrated network even more efficient and continue to reward our shareholders. Thank you, and operator, please open the line.

[Operator Instructions] Our first question will come from the line of David Vernon of Bernstein.

Yes, Carol. I'm going to host the call, Dave, and go a bit deeper on it, but it's sort of a barbell type effect. We've got a majority of the increase or not majority, over 40% in year one, and then years 2, 3, 4 quite reasonable from an inflation standpoint, and then with another step-up in year 5. But I'll go into more details on that when we host a call following the ratification.

Our next question will come from the line of Ken Hoexter of Bank of America.

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

Brian, can you help us on the guidance change, just attribute that guidance change to volume diversion and then maybe the difference in terms of what you accrued on the wages. And I don't know if you provided this in your prepared remarks, but the monthly cadence of domestic volumes in June and July? And then lastly, Carol, we started the year at 12% margin expectations for domestic. We went down to 11%, now we're probably around 10%. Obviously, we're in a completely different world, and you have a new wage deal. Just provide your thoughts around 3.3% inflation, doesn't seem like an enormous hurdle. Has what's happened over the last 7 months changed kind of your view on what you think the return profile of this business is from an operating margin perspective in the domestic business? And when we can get back to like a positive trajectory in that? Thank you.

Our next question will come from the line of Allison Poliniak of Wells Fargo.

Our next question will come from the line of Brian Ossenbeck of JPMorgan.

Just wanted to see if disagreement now behind you and out for ratification. Has that changed any of your thinking about the timing and magnitude of GRI or pricing in general? Maybe, Brian, you can give more detail on RPP trends and mix in the U.S. And then, Carol, I wanted to see, you mentioned the SurePost Advantage. Can you just give some context around the USPS Ground Advantage product that just launched? And if you see that as a competitive threat now that it's been out there for a month or so, maybe some initial impressions of that service and what they're able to deliver and what it means for you. Thanks.

Our next question will come from the line of Ravi Shanker of Morgan Stanley.

Our next question will come from the line of Chris Wetherbee of Citi.

Our next question will come from the line of Jordan Alliger of Goldman Sachs.

I was wondering if you could give a little more color. I think I have a good sense on the domestic margin. It looks like there's a small piece in your profitability guide that's Supply Chain and International. So can you maybe talk about or unpack a little bit sort of the margins expectations for the full year on that? And if indeed, the U.S. margin should be at or around the 10% level, give or take. Thanks.

So from a margin perspective, Jordan, we'd expect International full year to be 19% to 20%, SCS should be at 10%. And as you think about the International business, the second half ADV, we're expecting to be down around 6.5%, RPP should be flattish. And really, it stems from some of the challenging macro situation. We've got weak real export growth. Germany is in recession. And then I would say, Europe and Asia ADV growth would bottom in Q3. Kate and the team are very focused on controlling what we can control, both on the air side and the headcount side to protect that. You saw she printed north of a 20% margin second quarter. SCS, I would expect full year revenue to approach $14 billion with a margin of about 10%. Forwarding rates and volume is stabilizing but down year-over-year. The team does a good job of managing the buy-sell spreads, as you saw. Obviously, expanding health care is a strategic priority for the company, and they're also executing the cost initiatives.

Our next question will come from the line of Jeff Kauffman of Vertical Research Partners.

I just wanted to ask a little bit about the labor contract economics. I know you said, we'll have a call on this after ratification. But you noted a number of about 3.3% CAGR on the economic benefits. And just off the wage, we're calculating a little higher than that. So could you do your best to break down the components that help us get to that 3.3%?

Our next question comes from the line of Tom Wadewitz of UBS.

And just on shaping the multiyear, Tom, as Carol mentioned, we'll come back in the spring and give you multiyear targets. Obviously, year one of the labor contract is the most expensive piece. That's in August-to-August. So 1H of '24 would expect to be under some pressure, the back half, less inflation. So we'll walk that for you in the early part of next year.

Our next question will come from the line of Bruce Chan of Stifel.

And then, Brian, just on the e-commerce demand trends, any broad commentary there?

Our next question will come from the line of Scott Schneeberger of Oppenheimer.

Brian, I believe you said you're expecting a bottoming in Europe and Asia in the third quarter. Just want to get a sense of cadence and your optimism that it will improve in fourth quarter, just what you're seeing in trajectory on both there. And then also, if you could put into perspective just the domestic cost per piece, how you see that trajectory on that metric specifically? Thanks.

So on the bottoming, we have thought we would have seen the bottom in Asia in Q2, which I would say, it didn't recover. It stalled. In Europe, we think the bottom will be more in Q3, but there could be an elongated period here. So we're not putting in a lot of recovery into the international business going forward. On the CPP basis, we're still calling from a U.S. basis, we would look from a full year standpoint to be about 11.24, which is about a 1.4% change from the 11.08 we had previously.

Our next question will come from the line of Stephanie Moore of Jefferies.

Our next question will come from the line of Brandon Oglenski of Barclays.

Our next question comes from the line of Amit Mehrotra of Deutsche Bank.

So I just had a couple of quick ones. So Brian, I think you said the labor deal is $500 million headwind in the back half relative to what you accrued for estimated in the prior guidance. I wasn't sure if that was a gross number, or there was some productivity against that. And then, Carol, I wanted to ask about M&A, because it doesn't get enough attention. But I think you guys have done some interesting strategic acquisitions from Delivery Solutions. You also took a stake or a board seat on CommerceHub. These are small, but I view kind of as important deals kind of long-term view. Can you just talk about what they give you? And is there more in the pipeline? Because you're generating oodles of cash flow and wondering if there's an opportunity to tack on more deals even on the health care vertical, which is such a big vertical for you guys. If you can just expand on that. Thank you.

Our last question will come from the line of Jon Chapell of Evercore ISI.