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Presentation

United Parcel Service, Inc. misses on earnings expectations. Reported EPS is $2.2 EPS, expectations were $2.21.

Operator: 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. It’s now my pleasure to turn the floor over to our host, Mr. Ken Cook, Investor Relations Officer. Sir, the floor is yours.

Ken Cook: Good morning, and welcome to the UPS first quarter 2023 earnings call. Joining me today are Carol Tomé, our CEO; Brian Newman, our CFO; and a few additional members of our executive leadership team. Before we begin, I want to remind you that some of the comments we’ll make today are forward-looking statements within the federal securities laws and address our expectations for the future performance or operating results of our company. These statements are subject to risks and uncertainties, which are described in our 2022 Form 10-K and other reports we file with or furnish to the Securities and Exchange Commission. These reports, when filed, are available on the UPS Investor Relations website and from the SEC. Unless stated otherwise, our discussion refers to adjusted results.

For the third quarter of 2023, GAAP results include after-tax transformation and other charges of $9 million or $0.01 per diluted share. A reconciliation to GAAP financial results is available on the UPS Investor Relations website along with the webcast of today’s call. Following our prepared remarks, we will take questions from those joining us via the teleconference. Please ask only one question so that we may allow as many as possible to participate. You may rejoin the queue for the opportunity to ask an additional question. And now, I’ll turn the call over to Carol.

Carol Tomé: Thank you, Ken, and good morning. Let me begin by thanking UPSers for once again delivering industry-leading service to our customers. Service defines UPS. It is one of our values and I’m proud of our team who continue to make it a key priority. Another company value is safety. UPS drivers are among the safest in the industry and every year we invest millions of dollars in safe driving education and training. Our Circle of Honor program recognizes drivers who have achieved 25 years or more of accident-free driving. This year we inducted more than 1,200 UPS drivers into the Circle of Honor, bringing the total to more than 10,400 around the globe. Congratulations to these drivers on their achievement. Turning to our results.

2023 is proving to be an interesting year. In the U.S., relative to our base plan, volume was higher than we expected in January, close to our plan in February, and then moved significantly lower than our plan in March as retail sales contracted and we saw a shift in consumer spending. For example, food as a percentage of household budgets reached 9% in the first quarter compared to 7% a couple of years ago. U.S. discretionary sales are lagging grocery and consumable sales and disposable income is shifting away from goods to services. Outside of the U.S., export activity out of Asia remained weak, which negatively impacted revenue in both international and supply chain solutions. In response, we focused on controlling what we could control.

We remained in disciplined on price. We increased penetration in the most attractive parts of the market. We managed the network with agility, we drove productivity and we stayed on strategy. Looking at our first quarter financial results versus last year, consolidated revenue was $22.9 billion, down 6%. Operating profit was $2.6 billion, a decrease of 22.8% and consolidated operating margin was 11.1%, a decline of 250 basis points. While revenue fell short of our base plan due to a relentless focus on productivity both operating profit and operating margin were in line with our base plan. Moving to our strategic update, through our Customer First, People Led, Innovation Driven strategy, we are investing to improve the customer experience and drive efficiency.

Starting with Customer First. Key investments here are driving growth in targeted customer segments like SMBs and healthcare. Looking at SMBs, we continue to invest in the international expansion of our Digital Access Program or DAP. We now have 16 countries producing DAP revenue. In the first quarter, total DAP revenue was up 51.5% compared to last year, and we are on track to generate around $3 billion in DAP revenue this year. Did you know that in the U.S. about one out of every four DAP packages enters our network through a UPS store with more than 5,100 locations in the U.S., UPS stores are strategic assets. In fact, 85% of the U.S. population is within 10 miles of a store, giving customers ultra convenient entry points to the UPS network, whether they’re in SMB shipping and item they’ve sold online or a customer returning an item they buy.

Given the strategic importance of these stores, we are leaning into investments here to improve the customer experience. For example, the stores are rolling out self-service kiosks that enable customers to bypass the counter when they have shipments and returns, even returns with no box or no label. These kiosks make it easier for customers to get in and get out of the store. We’ve rolled out nearly 200 kiosks so far and we’ll deploy 1,000 by the end of October this year and we’re not stopping there. Another area of focus is improving the claims process, which used to be a hassle for both customers and franchisees. In March, the UPS store launched an online claims portal to all U.S. locations that’s designed specifically for the needs of the store shipper.

With this portal, claims that used to take weeks for resolution are now resolved within an average of about two gains. One final comment on SMBs. In the first quarter, SMBs including platforms made up 29.6% of our total U.S. volume. This is the 11th consecutive quarter of increased SMB penetration and it’s the highest level we’ve seen in more than seven years. Turning to healthcare. In the first quarter of 2023, we expanded our global footprint by opening nearly 1 million square feet of dedicated healthcare space, including our first facility in Germany. This facility provides customers a broad range of temperature sensitive and handling solutions. Its location in the center of Germany connects our customer shipment, the fast growing European healthcare market.

The facility is also closed to our European air hub in Cologne, enabling customers to leverage the speed and reach of our global network. As a reminder, in the fourth quarter of 2022, we completed the acquisition of Bomi Group and to date, revenue and cost synergy are running ahead of target. Further, we are continuing to invest in the global expansion of UPS Premier, which is now available in 45 countries with four more to be added this year. Our goal is to become the number one complex healthcare logistics provider in the world to help us get there who plan to open a total of seven dedicated healthcare facilities this year. In the first quarter, revenue from our healthcare portfolio reached $2.4 billion and we expect to generate over $10 billion in healthcare revenue in 2023.

Turning to People Led, let me discuss the progress of our negotiations with the Teamsters. Negotiations on a new contract with the Teamsters are underway and good progress has been made on many of our local supplemental agreements. Together, we’ve set up five subcommittees at the national bargaining table to take on key areas of the contract, which enables us to move faster. We are aligned on several key issues like solving the staffing needs for weekend deliveries and ways to mitigate the summer heat in our package delivery vehicle. While we expect to hear a great deal of noise during the negotiation, I remain confident that a win-win-win contract is very achievable and that UPS and the Teamsters will reach agreement by the end of July. Now let’s move to the last leg of our strategy Innovation Driven.

We have the best, most efficient global integrated network in the world, and we are getting even better. Today, we operate our network with more agility than ever before, and when it comes to productivity, we are relentless about creating a virtuous cycle of improvement in our network. For example, our total service plan, which addresses running a predictable on-time network has delivered continued productivity improvements since being introduced last year. Our massive and highly complex network naturally generates efficiency when volume increases. But when volume levels drop, historically, it’s been harder to generate productivity improvement. With total service plans, we have driven productivity even with declining volume. In the first quarter, U.S. volume declined by 5.4%, but ours declined even further, which resulted in improved productivity as measured by pieces per hour.

As we’ve discussed last quarter, we’ve accelerated investment in our Smart Package Smart Facility RFID solution and plan to complete deployment in more than 900 buildings across the U.S. by the end of October. Throughout the process, we’ve continued to learn and improve, which has enabled stronger results than we originally expected. In the facilities where we have this technology, we’ve cut the frequency of misloads from around 1-in-400 packages to one-in-1,000 packages, which reduces miles, handles and costs and it improves, but the customer and employee experience. Innovation driven is also about combining digital capabilities with our integrated network to improve the customer experience and efficiency. Our upstream delivery density solution checks both boxes.

This month, we are onboarding our second large national retailer, which gives us more opportunity to increase density as we can match volume in the UPS network with orders of participating customers. It’s still early days of this initiative. As we learn, we continue to adjust the match rate algorithm and we are happy with the results. Lastly, our innovation driven initiatives are moving us towards our 2050 carbon neutrality goal. We are focused on the decarbonization of our global supply chain. In 2022, our Scope 1, 2, and 3 CO2 emissions declined by 6.9% from 2021. We’ve been investing in alternative fuel for more than 20 years and operate more than 15,600 alternative fuel and advanced technology vehicles. Recently, we took delivery of 10 fully electric class 8 semi trucks in California.

These trucks are quiet and they are the first zero emission semis to run in our UPS fleet. Our 2022 sustainability report was published on April 12. This is our 21st annual sustainability report, and you can find it on about.ups.com. Moving to our outlook for 2023, last quarter, we provided a range for our 2023 financial target. As we’ve discussed, there’s been a deceleration in U.S. retail sales growth in certain non-U.S. markets remain challenged. As a result, we now expect to be at the low end of our previously provided revenue and operating profit margin range. Brian will share more detail in a moment. I’ve led three difficult times before and I’ve seen the power of making the right decisions and the pitfalls of making wrong decisions.

In uncertain market conditions, it’s easy to fall into the trap of managing the business for the short-term. While we will control what we can control, we will also stay on strategy. Over the past three years, we have fundamentally improved nearly every aspect of our business and we are just getting started. UPSs are the best in the industry, and because of them, I am convinced we will come out of this cycle faster, stronger, and with a wider lead on our competition. With that, thank you for listening, and now, I’ll turn the call over to Brian.

Brian Newman: 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.

Operator: 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.

David Vernon: So Carol, I wanted to follow up on your commentary around the productivity in lighter volume. As you guys think about the way the business is performing against the lower volume outlook right now, how confident are you that if we get into a better volume environment, say 2024, 2025, that some of those productivity gains are going to be able to be held? And then Brian maybe is just a follow-up. Can you give us a sense for what sort of magnitude of facility reductions you might be able to pull off here in the next couple of years? Thanks.

Carol Tomé: Well, David, thank you for your question. First, as it relates to productivity, we introduced our total service plan last year. That’s not one and done. That’s the way we’re going to operate our business forever. Productivity is a virtuous cycle here at UPS. And Nando and the team continue to find opportunities to drive productivity in down markets as well as up markets.

Brian Newman: And on the second part of the question, Dave in terms of the scope of building consolidation, et cetera, Nando and the team are doing a nice job working a project called network of the future, still early days. We do have some facility sales planned in the second quarter of the back half of the year, but that doesn’t really ramp up in terms of the opportunity to consolidate until 2024, 2025 in that timeframe.

Carol Tomé: Just a little bit more color on that perhaps if you think about how we grew up as a company, if we build up a facility, we spun off a building and then we would build up another facility and spin off a building. As Nando and his team have looked at it, we found that, huh, we might be able to consolidate some of those spinoffs into highly automated buildings, drive productivity and not lose any drive time, not impact our customer service in any negative way. So we’re looking at that, it’s pretty exciting.

Brian Newman: 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.

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

Amit Mehrotra: 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.

Brian Newman: Yes. The biggest change in terms of the base case versus downside is the volume. We were looking at volumes of down 1% in the base case, and now we’ve pivoted to the downside of down 3%. The first quarter was an evolution about where we expected in January, February a little bit lighter, but March was the trail off. And so as we’ve seen the macros to deteriorate, we look at things like IP manufacturing and ESMO , those have continued to devolve. And so we’ve basically adjusted the volume outlook for the first half of the year. And so two reasons, we’re confident that the full year in the case of the domestic business will be at 11%. We have confidence that the volume will come back post the summer related to customer conversations and some of the macro which we think will trough in the middle part of the year.

And also cost we can go into more detail, but our ability to control cost and take more of the semi-variable out will help us deliver that 11% in the U.S.

Carol Tomé: And maybe just a little more color on volume, and then I’ll go to your question about Teamsters. As we – as Brian detailed, the rate of acceleration in the year-over-year decline caused us pause because we were down around 3% in January, 5% in March – February and 7% in March. As we look at April, April has stabilized relative to how we exited March. So we feel very good that volume has stabilized. If we look at the year-over-year decline in the U.S. a little over 1 million packages today, we would attribute over 60%, nearly 62% of the decline due to macro and a plan decline with our largest customers. We’re declining with them in a mutually agreed way. So it’s really a macro story here and we’re delighted to see that the volume has stabilized.

To Brian’s point, then, what gives us confidence that the volume will come back in the back half of the year. I’ll share with you our strategy as it relates to sales. And this is a multifaceted strategy. It starts with keep to your point about volume diversion, which all by the way wasn’t very much in the first quarter. We’ve assigned 127 high impact executives to over 380 customers representing about one third of our total volume. The role of the high impact executive is to meet with our customers, update them on our ongoing negotiations with the Teamsters and to keep them with us. The next element of our strategy is protect in the unlikely event of a work stoppage. And we’re not counting on that because we are confident we’re getting our contract.

But in the unlikely event, we do have contingency plans to protect. The third leg of our strategy is to win back for any volume that has diverted. And we did have some it would be unreasonable to expect that we wouldn’t have any for volume that has diverted. We are going to win it back because they’ve told us they’re coming back. In fact, one customer just signed on the dotted line that they’re coming back once we have a handshake. The third is to continue to sell. We are selling in the environment and we want to sell and close and pull through those new customers. And then finally is work the pipeline. We have a pipeline that’s greater than $6 billion. That’s hard to sell into right now because of that Teamsters negotiation. But we are going to go hard at it once we have that handshake deal.

And we’re going to go at it in a way that we’ve never done before because we will be using our dynamic pricing model. This is a very different way to go to market because we are creating value propositions for our customers that we haven’t done before. Using the architecture of tomorrow pricing model that we’ve created, which creates the modifiers to base price it’s a win for our customer and our win for UPS. So that’s really how we’re getting competent in the volume projections that we shared with you this morning. Now to your question about the Teamsters. It – we told you from the beginning that it was going to be noisy and that’s turning out to be true. But let me just comment on the recent rhetoric. There was some noise about supplemental agreements.

We have over 40 supplemental agreements with the Teamsters. We have been negotiating in good faith with the Teamsters on those supplemental agreements and have made very good progress. In fact, Teamsters leadership and UPS leadership were in Washington D.C. last week, both given in opening comments regarding the Master agreement. So I feel like we are very much on track as to our timeline to accomplish a win-win-win. And why am I competent about a win-win-win? Well, first of all, we are aligned on the Northstar. And the Northstar is that a thriving, growing UPS is good for Teamsters, it’s good for UPS and it’s good for our people. And when you are aligned on the Northstar, everything else can get worked out on some of the issues that Teamsters have been very public about.

And we talked about it’s the last time we had an earnings call. We’re aligned. For example, we all agree that weekend delivery is table stakes because that’s what consumers are expecting. We all agree it’s how we go about doing that from an operating model perspective, that we need to work it out. Because of restrictions in our contract, in some instances, we have Teamsters working six days a week. Teamsters don’t like that. I don’t like that. If you want to work six days a week, that’s fine with me, but if you don’t, we shouldn’t force you. So we’ve got to work that out. And there are a number of other issues just like that when we get to the bargaining table, we’ll figure out a way to work it out. I’m highly confident that we’re going to get a win-win-win agreement.

But like any negotiation, it’s going to be a noisy and a few bumps along the way. And I just had this argument with my husband about a puppy. It was noisy, it was stuffy . But in any negotiation, that’s going to be the case and it’s certainly the case here. And that’s why I go back to our sales strategy of these high impact executives putting their arms around our customers and making sure they’re comfortable with us because we are confident we’ll deliver our contract.

Amit Mehrotra: Got it. Thank you. Good luck with the puppy.

Carol Tomé: Thank you.

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

Allison Poliniak: 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.

Brian Newman: 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 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.

Allison Poliniak: Understood. Thanks for the color.

Brian Newman: Yes.

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

Tom Wadewitz: 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.

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

Tom Wadewitz: Yes. Domestic, thanks. Yes.

Brian Newman: Originally to an RPP growth of about 3% this year. Carol mentioned volumes are coming in a bit softer, but we’re holding on to that RPP and the RPP composition, we actually saw close to 5% RPP growth in the first quarter. That was driven by a tailwind in fuel about 200 bps that flips around Tom in the back end of the year where we expect double-digit decline in fuel price. So the way I think about the GRI and the customer mix piece, that should be mid-single digit about 5 points. And then we’ll have about a 200 bps decline from fuel. That gets us right into that, that that 3% range. We did see some headwinds in the product mix, the air to ground in the first quarter, that’ll moderate as we go into Q2 in the back end of the year. So that’s the composition.

Carol Tomé: Yes. May be just a comment on the pricing environment, the keep rate on the GRI is the high as it’s been. In the United States, it’s north of 60%. It’s even higher outside of the United States.

Tom Wadewitz: Okay. Great. Thank you.

Brian Newman: Thanks, Tom.

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

Jordan Alliger: 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.

Brian Newman: Yes. was we were able to take cost out of that. And as you look at the back end of the year from another perspective, we’re certainly getting after a lot of the non-operating costs. We’re taking consulting spend out of the business. We’re taking headcount out of the business. So we’re really driving from a non-ops perspective down to something closer to a 4% of revenue from a cost perspective.

Carol Tomé: And maybe just a comment on that other expense line item because it does look out of sorts, we are moving to Software-as-a-Service. It’s a line item move, right, Brian, you’re the finance person here, but rather than depreciation’s it’s going to move into expect.

Brian Newman: That’s exactly right.

Carol Tomé: So there’s a little bit of a difference if you have Software-as-a-Service for your technology deployment versus what you build.

Brian Newman: Transition of buckets.

Carol Tomé: Thank you.

Brian Newman: Yes.

Jordan Alliger: Got it. And then just a quick follow-up, talked a lot about the domestic environment and stabilization perhaps in April, but what about the Asian export business? Is there anything on that front that, that gives a little confidence right now? Thanks.

Carol Tomé: Well, here’s what we’re seeing in the business, week after week it’s better. It’s still down year-on-year, but it’s better slowly coming out of this negative year-over-year decline of almost 20% in the first quarter. And Kate and her team are doing a masterful job of managing through that. In fact, if you look at productivity outside the United States, our Asia export business down 8.9%, our block hours were down 14% and she’s taking more block hours out in the second quarter even with improvements just to optimize VR network.

Jordan Alliger: Thank you.

Brian Newman: Thanks, Jordan.

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

Ken Hoexter: 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.

Brian Newman: Yes, Ken, happy to start. You taking the last piece first, on international, we had guided a couple years ago when we went out with three-year guidance to a 21.5% in international, obviously the world’s changed a lot since then. But the mix of Kate’s business that she’s running and the agility on the network in terms of managing the airflow has I don’t know about a floor, but I think we’re comfortable with the 20%. You’ll see that 20% margin can fairly consistently Q2 through Q4. So we feel comfortable about that in terms of how the business evolves.

Carol Tomé: And on the volume question, again, it goes back to our sales strategy. We have pretty good visibility into the pipeline. We’re just going to pull that pipeline through. In today’s environment with the contract negotiation about a 100 days out to completion, it’s kind of hard to get it pulled through, but we’re going to pull it through when we get that handshake deal.

Ken Hoexter: Thanks, Carol. Thanks, Brian.

Brian Newman: Thanks, Ken.

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

Scott Group: 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.

Brian Newman: 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.

Scott Group: Thank you.

Brian Newman: Yes.

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

Bruce Chan: Yes, thanks, and good morning, everyone. Just want to ask here on the share shift issue if you’re able to quantify or even qualify the attrition that you’re seeing. And I just ask because I think there’s been a lot of focus on your upcoming negotiations, but just based on your service investments and what are some pretty major, I think, operational changes at your largest competitor. I’m wondering if you’re actually seeing any business wins. Appreciate it.

Carol Tomé: We are definitely seeing business wins. And I’m – I have to give a hat off to our sales team for selling through this environment. We are delivering packages for customers that we’ve never delivered before. Why? Because our service is the best in the industry. But what we see with some of our long-term existing large customers is that their business is changing. And I can give you a few anecdotes if that’s helpful. One of our large customers reports publicly every month their same-store sales. This is a customer who for 80 quarters in a row had positive same-store sales and in the month of March saw negative same-store sales. One of our other customers who has both in-store sales as well as online sales has seen a shift in their customer shopping behavior from online to stores.

So they’re shutting down shifts inside of their warehouses, which make sense for them. So they receive generally macro and a change in consumer behavior impacting our volume, but we’re winning and we just got to go win faster and we will win faster when the uncertainty is behind us. I’m quite convinced of the Teamster negotiation. Customers say, we’d like to ship with you, we’re just going to sit on the sidelines till you’re done. So we just need to get done. And we will.

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

Brian Ossenbeck: Hey, good morning. Thanks for taking the question. So Carol, you just gave some commentary about some of the volume trends from some of the customers. Are you seeing anything that you would attribute to perhaps demand destruction from parcel rates going up with capacity constraints, with some of the disruptions and surcharges including on fuel? Do you attribute any of the volume weakness to that? And then Brian, maybe you can elaborate a bit more on returns. You mentioned it was a pretty good growth driver in the quarter, but your largest customers also floating the idea of perhaps charging for some returns in the future. I wanted to see if that was some consideration we should think about in terms of what that could do for that volume driver, which seems to be a pretty good one, at least for the time being. Thank you.

Carol Tomé: So to your first question, we don’t see volume disruption because of pricing. We do see product change however. If you looked at our air product in the quarter, it was down year-on-year, more than ground. We see customers moving out of air to ground. Why? Well, we’ve really worked to improve our time in transit. So we’ve got the fastest time in transit now, so you can get your package where it needs to go quicker than before. And people are looking for value. So I can watch customer by customer moving out of air to SurePost, by the way. SurePost is up in the quarter, almost 2%.

Brian Newman: And on the returns business, it’s a great business. The margins are attractive. We saw positive growth in the first quarter as I called out. And a big piece of that is the – over 5,000 stores, we have UPS stores across the country. Carol mentioned 7% of the volume originates in those stores. And it’s a great easy way for consumers to with the returns that are going on as the e-comm economy pursues. So we feel good about that and something we’re building capability in every day.

Carol Tomé: And convenience matters from returns. If you want to get that package back so you get credit back into your wallet, you want a convenient place to return. And with our locations near 85% of the U.S. population within 10 miles of 85% of the U.S. population were extraordinarily convenient.

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

Chris Wetherbee: 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.

Brian Newman: 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.

Chris Wetherbee: Okay. Thank you very much.

Brian Newman: Yes.

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

Ari Rosa: Hey, good morning, Brian. Good morning, Carol. So I just wanted to understand, how do you think about the softer economic environment potentially impacting your discussion with the union? Is there any dimension on which it maybe makes negotiations a little bit easier or gives you a little bit more leverage vis-à-vis that discussion? Thanks.

Carol Tomé: So we look out – we don’t look in the current moment. We look out for where we both want to go as growing and thriving UPS is in the best interest of Teamsters, UPS, and our people. So the current economic environment, it is what it is, but our negotiations are all about the future.

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

Helane Becker: 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.

Brian Newman: You’re talking about the UPS stores? So it’s a great foundation for volume origin. We have a royalty relationship that generates a royalty stream that comes in from the stores as far as what income comes into UPS. And as that volume grows, our royalty grows.

Carol Tomé: We do look at the profitability of stores. Because I’m curious, I’m an old retailer. So are the stores profitable? The stores are very profitable, which means franchisees are happy. We add about 100 new stores every year, because this is a great small business to own. And in terms of the royalty fee that comes into our company, there’s some expenses against that. But if you look at the margin against that royalty fee, I would say, it’s the highest margin business that we’ve got.

Ken Cook: Excellent. Steven, we have time for one more question.

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

Stephanie Moore: 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.

Brian Newman: Yes, happy to. And the whole reason we went out at the beginning of the year with two scenarios is we didn’t know what was going to happen with the macros and the macros to continue to deteriorate in the first half of the year. So we had a playbook which was the downside scenario. We pulled that off the shelf and our executing the TSP, the network changes for ground and air, the overhead the fuel. And so from a line of sight perspective, what we control I feel good about the 12.8 that we’ve got in for the downside scenario. Obviously, the top line is what it is, but Carol said we’ve got the largest pipeline of sales that we’ve had in about five years, which is a very big number, $6 billion. And so our ability to pull that in posted negotiation with the labor that gives us confidence on the top line.

Carol Tomé: Well, you might share the split of variable, semi variable and fixed.

Brian Newman: 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.

Ken Cook: Thanks, Brian. And I want to thank everybody for joining us this morning. Look forward to talking to you next quarter. And that concludes today’s call.