United Parcel Service Inc Q3 FY2023 Earnings Call

Good morning. My name is Steven and I will be your conference facilitator today. I would like to welcome everyone to the UPS Investor Relations Third 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 is now my pleasure to turn the floor over to your host, Mr. PJ Guido, Investor Relations Officer. Sir, the floor is yours.

Good morning and welcome to the UPS third quarter 2023 earnings call. Joining me today are Carol Tome, 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 filed with, or furnished 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 an after-tax charge of $219 million, or $0.26 per diluted share, comprised of a one-time payment of $46 million to certain US-based non-union part-time supervisors, transformation and other charges of $70 million, and non-cash goodwill impairment charges of $103 million. 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.

Thanks, PJ, and good morning. Let me begin by thanking UPSers for their hard work and effort. Our US labor contract wasn't fully ratified until early September and I'm proud of our UPSers for staying focused during the entire labor negotiation and for providing industry-leading service to our customer. We expected conditions in the third quarter to be challenging and they were. The global macroenvironment remained weak, with some countries in recession, which pressured international and freight forwarding volume. And in the US, labor uncertainty negatively impacted volume for most of the quarter. From a demand perspective, August proved to be the most challenging, as some customers waited for the ratification of our Teamster contract before returning volume to our network. Since contract ratification, we've been gaining volume momentum. We exited the last week of September with US average daily volume or ADV down 7.4%, a marked improvement from the rest of the quarter. Our salespeople have produced record results and the combination of win-back and new customers. To date, we've won back roughly 600,000 ADV of diverted volume and we are working to win back all diverted volume by the end of the year. And looking at our sales pipeline, we're pulling through new customers that value our superior on-time performance, and want to come to UPS prior to the busy peak holiday season. Moving to our financial results, our third quarter performance while down considerably from last year, was in line with our expectations, and factored in both the timing of contract ratification, and higher labor costs resulting from the new labor contract. Consolidated revenue in the third quarter was $21.1 billion, down 12.8% compared to last year. Operating profit was $1.6 billion, a decrease of 48.7% from last year, and consolidated operating margin was 7.7%. Brian will provide more details on our performance in a moment. With the third quarter behind us, we are laser-focused on restoring volume in our network, and executing our strategy to deliver shareholder value. So let me turn to our strategic update. Our customer-first, people-led, innovation-driven strategy is enabling us to stay focused on our core business, and invest to grow in the most attractive parts of the market like healthcare and with SMB. Starting with customer first, under our better and bolder framework, we recently announced two acquisitions that will further drive growth in healthcare logistics and in end-to-end returns solution. One of our strategic objectives is to become the number one complex healthcare logistics provider in the world and we are making bold moves to get us there. Last year's acquisition of Bomi, and our recently announced pending acquisition of MNX Global Logistics are two examples of bold moves in healthcare. MNX is an industry leader in time-critical and temperature-sensitive logistics, tailor-made for the complex needs of global healthcare. By combining MNX with UPS Express Critical and our Global Integrated Network, we will enhance the speed and reliability of our healthcare portfolio. With MNX, UPS will be able to reach new healthcare markets like in Asia, and new customers like the radiopharmaceutical sector. To further support our healthcare strategy, this year, we've opened seven dedicated healthcare facilities in Europe and in the US. And the acquisition of Bomi further strengthens our healthcare footprint in Europe and Latin America. Since 2020, we have more than doubled our healthcare distribution space globally. These efforts and more are keeping us on track to reach our $10 billion healthcare revenue target this year, and we're just getting started. Turning to returns, with the explosion of e-commerce demand, our returns business has been a key area of growth over the last several years. What we've seen over this time is an increasing desire on the part of both our customers and our recipients, for a frictionless and simple end-to-end returns experience. We've been building out this experience. But to help us get there faster, we just entered into an agreement to acquire Happy Returns, a technology-focused company that enables frictionless, no-box, no-label returns. By combining Happy Returns' easy digital experience and established drop-off point with UPS's small package network and footprint of both 5,200 UPS store locations, box-free, label-free returns will soon be available at more than 12,000 convenient locations in the US. But our plans for returns don't stop at convenience. For our enterprise retail customers, we plan to provide a consolidated return solution that will lower their costs and improve their experience. And for UPS, Happy Returns expands our returns portfolio with an innovative solution that will generate profitable B2B volume and help drive pickup and delivery density. For us, customer first isn't just about growth, it's about meeting customer needs. To that end, we are continuing to improve the delivery experience, with the expansion of UPS delivery photo. 92% of our residential stops globally include a photo that shows exactly where the package was delivered. Not only does delivery photo provide peace of mind to the recipient, but we get fewer calls about missing packages. With delivery photo, UPS has seen a reduction in US delivery-related support requests of more than 15%. We're also harnessing our data to deliver more agile and targeted products that meet our customers' needs. Our latest example is a new product we call hyperlocal, which leverages the footprint of our US facilities to provide select customers with a fast next-day delivery option within a metro area. Hyperlocal enables us to capture new profitable B2C and B2B volume and was launched in October as a new service offering. Let me quickly touch on DAP, our digital access program. We are continuing to grow SMB volume with DAP. In the third quarter, we launched 10 new partners in time for peak. In the first nine months of this year, we generated $2.1 billion in DAP revenues, and we expect to deliver $3 billion in DAP revenue for the year. Let's turn to innovation driven. UPS has been a technology company since our founding, and we are adding transformative technology in our operations that will increase efficiency and improve the employee experience. Smart package, smart facility, our RFID solution, is one way we're driving efficiency, and I'm pleased that we are wrapping up our Phase 1 rollout in our US facility. The improvements we are seeing in our preload operations are even better than we expected, with nearly 200 of our buildings seeing load rates of one and 2,500 packages that are better. Deployment of Phase 2 is already underway, which will equip our package cars with RFID readers. Over time, this will allow us to virtually scan smart packages during pickup, and eliminate delivery scans during bulk delivery stops, both of which will enhance customer visibility and make our drivers more efficient. Another example of transformative technology is robotics. Specifically, starting in Supply Chain Solutions, we are implementing robotics unload technology inside our trailers to unload packages more efficiently. These robots navigate the inside of the trailer and can unload multiple box types and sizes autonomously. Now, it's still early days with this technology, but we are seeing many opportunities to further expand the use of robotics across our networks. Turning to the fourth quarter, we are preparing for peak. Over the past five years, our service during peak has been better than our closest competitor by an average of 310 basis points. Service matters all the time, but especially at peak. So to prepare, we are collaborating with customers on volume projections and the timing of their promotions. We will also leverage technology, like our network planning tools, to control how the volume comes in, utilize available capacity, and adjust the networks to operate as efficiently as possible. Regarding peak hiring, our people-led strategy enables greater flexibility to serve our customers during the holiday rush. For example, our experienced part-time employees have now become seasonal support drivers. This enables them to deliver packages using their own vehicles before or after their regular shifts. In addition, we plan to hire over 100,000 seasonal employees to help process and deliver holiday volume. This year, we've made it even easier and faster to apply for a job, as we shortened the digital process to less than 20 minutes, and built out an online application to receiving a job offer. Regarding our financial outlook, we made changes based on what we're seeing in the market. We still expect to have healthy peak volume in the fourth quarter. So based on what appears to be slowing demand in all business segments, we are revising our guidance accordingly. Brian will share more detail in a moment. Back in January, I said that 2023 would be a year of resilience, and it has been. Our founder Jim Casey said determined people working together can do anything. During the year, we accelerated the deployment of smart package, smart facility and made strategic acquisitions to grow in the best parts of the market. We delivered a labor agreement that provides certainty for the next five years. We are operating with greater speed and agility, controlling what we can control, and we are staying on strategy. With that, thank you for listening and now I'll turn the call over to Brian.

Thanks, Carol, and good morning. In my comments today, I'll cover four areas. I'll start with the macro, followed by our third quarter results. Next, I'll cover cash and shareholder returns. Then, I'll provide detail around our updated guidance. The macro environment in the third quarter was challenging. The weakness we saw in the second quarter continued into the third quarter, especially in Asia and Europe. Real exports and industrial production moved lower due to falling demand, and global consumer conditions did not significantly change. In the US, we faced tough conditions due to several factors. To begin, the volume diversion we experienced in the second quarter continued into the third quarter, which led to more volume diversions than we anticipated. Next, some customers that diverted waited until our Teamster contract was fully ratified in September before returning volume to our network. And lastly, we incurred higher labor costs associated with the new contract, and added headcount earlier than normal to ramp-up for peak so that we can ensure we maintain our industry-leading service levels. Through the end of the quarter, we adjusted our integrated network to support our customers' needs, managed cost, and stayed focused on bringing volume back into our network. Looking at our financial results for the quarter, consolidated revenue was $21.1 billion, down 12.8% from last year. Consolidated operating profit was $1.6 billion, down 48.7% compared to the same period last year. Consolidated operating margin was 7.7%. For the third quarter, diluted earnings per share was $1.57 down 47.5% from the same period last year. Now, let's look at our business segments. In US Domestic, we knew the third quarter would be a challenge, and it was, due to our labor negotiations, higher costs, and a dynamic economic backdrop. As we discussed on our last call, we ended the second quarter with an average daily volume in June down 12.2%. As contract negotiations became later and louder, we saw more volume diversion than we anticipated. August represented the low watermark when average daily volume was down 15.2% year-over-year. Post ratification, we exited the third quarter half that way, and we're continuing to see our week-over-week volume levels improve despite a challenging retail backdrop. In the US, in the third quarter, average daily volume was down 11.5%, and we estimate the impact of volume diversion reduced our volume by approximately 1.5 million packages per day. Moving to mix, in the third quarter, we saw lower volumes across all industry sectors, with the largest declines coming from retail and high-tech. B2C average daily volume declined 13.4% compared to last year, and B2B average daily volume was down 9%. In the third quarter, B2B represented 44% of our volume, which was an increase of 120 basis points from a year ago. Also in the third quarter, we continued to see customers shift volumes out of the air and onto the ground. Total air average daily volume was down 15.8% year-over-year, with about half of the decline coming from our largest customer, as anticipated. Ground average daily volume was down 10.7%. In terms of customer mix, in the third quarter, SMBs, including platforms, made up 28.5% of our total US volume, an increase of 20 basis points year-over-year. For the quarter, US Domestic generated revenue of $13.7 billion, down 11.1%. Despite lower volume, we remained disciplined on revenue quality. In the third quarter, revenue per piece increased 2%. Looking at the key drivers, the combination of strong base rates and improved customer and product mix increased the revenue per piece growth rate by 410 basis points. Changes in fuel prices decreased the revenue per piece growth rate by 190 basis points. The remaining 20 basis points of decline was driven by multiple factors including package characteristics. Turning to costs, total expense was down 5.1% in the third quarter. Compensation and benefits decreased the total expense growth rate by around 50 basis points. Total union wage rates were up 11.5% in the third quarter, primarily driven by the contractual wage increase that went into effect on August 1st. Additionally, we began network preparations for peak. Offsetting the total increase in compensation and benefits, we leveraged our total service plan and network planning tools to reduce total hours in the third quarter by 11.4%. We reduced the expense growth rate for purchased transportation by around 190 basis points, primarily from lower volume levels and our continued optimization efforts. Lower fuel costs contributed 170 basis points to the decrease in total expense growth rate. The net of all other expense items and allocations reduced the expense growth rate by 100 basis points. The US Domestic segment delivered $665 million in operating profit, down 60.6% compared to the third quarter of 2022, and operating margin was 4.9%. Moving to our International segment, macro conditions were uneven in the third quarter with some regions of the world being challenged more than others. Continued falling demand pressured Asia, and in Europe, consumers continued to contend with high inflation and tight financial conditions. In response, we adjusted headcount and block hours in our global networks to match changes in geographic demand. In the quarter, international total average daily volume was down 6.6% year-over-year. Nearly three-quarters of the decline came from lower domestic average daily volume, which was down 9.1%, driven primarily by declines in Europe. On the export side, average daily volume declined 4.1% on a year-over-year basis. Looking at Asia, export average daily volume was down 8%, and export volume on the China to US lane, which is our most profitable lane, was down 10.3% year-over-year. One bright spot was the Americas region, where export average daily volume grew 4.7%, led by Canada and Mexico, leveraging our cross-border ground service. In the third quarter, International revenue was $4.3 billion, which was down 11.1% from last year due to the decline in volume and a 1.4% reduction in revenue per piece. The decline in revenue per piece was driven by several factors. Lower fuel surcharge revenue contributed 230 basis points to the revenue per piece growth rate decrease, a reduction in demand-related surcharge revenue contributed 200 basis points to the decline, partially offsetting the decline multiple factors increased the revenue per piece growth rate by 290 basis points, including strong base rates and a weaker US dollar. Moving to costs, in the third quarter, total international costs were down $203 million, primarily driven by lower fuel expenses. In response to lower demand, we adjusted our integrated network and cut costs, which included reducing international block hours by 13.9% compared to last year and reducing headcount in operations and overhead functions by a total of 2,300 positions, and we did all of this while continuing to deliver excellent service to our customers. Operating profit in the International segment was $675 million, down $329 million year-over-year, which included a $98 million reduction in demand-related surcharge revenue. Operating margin in the third quarter was 15.8%. Now looking at Supply Chain Solutions, in the third quarter, revenue was $3.1 billion, down $854 million year-over-year. Looking at the key drivers, let's start with forwarding. In international air freight, softer global demand and lower volume resulted in a decline in revenue and operating profit. On the ocean side, demand flipped positive, driven by the retail sector, and generated volume growth. However, excess market capacity pressured revenue and operating profit. In response to the dynamic forwarding market, we cut operating costs. Within forwarding, our truckload brokerage unit continued to face pressure from excess capacity in the market, which drove revenue and operating profit down. Logistics delivered revenue and operating profit growth. In the third quarter, Supply Chain Solutions generated operating profit of $275 million and an operating margin of 8.8%. Walking through the rest of the income statement, we had $199 million of interest expense. Our other pension income was $66 million, and our effective tax rate for the third quarter was 12.6%, which benefited from certain discrete items, including tax credits and global audit resolutions. Now, let's turn to cash and shareholder returns. Year-to-date, we generated $7.8 billion in cash from operations, and free cash flow was $4.9 billion. And so far this year, UPS has paid $4 billion in dividends, and we've completed $2.25 billion in share buybacks. Now, I'll share a few comments about our outlook. We expected 2023 to be a bumpy year, and it has been. We've navigated record-high inflation, rising interest rates, disruptions in China, a war in Eastern Europe, now a humanitarian crisis in Israel and Gaza, and the disruption around our US labor negotiations. Through all of this, we remained focused on controlling what we can control, and are continuing to adjust the network to match volume levels and deliver industry-leading service to our customers. Since our last earnings call, the global demand environment has slowed, and macroeconomic conditions remain challenging. As a result, we've lowered our full-year guidance, and have provided a range to reflect the uncertainty in the market. We now expect consolidated revenue to be between $91.3 billion and $92.3 billion, and consolidated operating margin to be between 10.8% and 11.3%. Let me walk you through our assumptions for the guidance range. In the US, we are winning back volume at a rapid pace, but we've also seen demand softness due to several factors, with many of our customers who did not divert. Additionally, while consumer spending has been resilient in 2023, headwinds are mounting for the consumer in the fourth quarter, and looking at estimates for holiday retail sales this year, increases range from over 4% to 12%. Moving to international, a further downturn in exports and lower consumer spending in some of the largest European markets, including Germany and the UK are negatively impacting volume. And exports on our most profitable trade lane, which is China to the US, are not improving at the pace we had expected. Finally in forwarding, air and ocean capacity has increased, which is putting additional downward pressure on market rates. In fact, in ocean, there was extreme overcapacity versus demand in the market, and the forwarding demand outlook in the fourth quarter remains weak. Turning to capital allocation for the full-year, capital expenditures are still expected to be about $5.3 billion. We are still planning to pay out around $5.4 billion in dividends in 2023, subject to Board approval. We have repaid $1.6 billion in debt this year as planned and expect to repay an additional EUR700 million of debt in the fourth quarter. We now expect $2.25 billion in share buybacks in 2023, which we have already completed. In the fourth quarter, we're redeploying cash back into the business for growth initiatives, such as strategic acquisitions to drive shareholder value. And lastly, we expect the tax rate for the full-year to be approximately 22%. In closing, while navigating a very challenging macro environment, we remain focused on the job at hand. For the past five years, we've held the record as the industry leader in service during peak. We intend to do it again this year. Thank you. And operator, please open the lines.

Steven, we're ready for our first question.

We will begin the question-and-answer period and our first question will come from the line of Chris Wetherbee of Citigroup. Please go ahead.

Hey, thanks, good morning guys. Maybe to start on the guidance, and specifically for the fourth quarter, so I think it implies a pretty meaningful step-up in operating profit, and we understand that, you know, I'm guessing ADV probably has a significant piece to do with that improvement in the operating profit for how low it was in the third quarter, but maybe you could help us bridge from how we're going to get from the third quarter, which, obviously, was quite challenged to what is a significant improvement sequentially. In that context, maybe if you could give us with the help of with what October ADV looks like on the domestic side. I think it's a very important number, so kind of curious if you can help us with that too.

Sure, happy to, Chris. Good morning. In Q3, we reported $665 million in operating profit. To reach the lower end of our guidance, we would need about $800 million in profit. The main factors driving this are volume and revenue quality. The productivity generated by the teams, particularly Nando in the US, is balancing out the impact of the new labor contract. As you know, we have three months in the third and fourth quarter, and we had two months under the new labor contract in the second quarter. Regarding volume, both volume and revenue quality are key contributors to the $800 million increase. Comparing our position in August to where we are in October, we've noticed increasing momentum. As I mentioned in my prepared remarks, we experienced a low point in August with a 15% decrease in average daily volume, or ADV, which amounted to about 16 million pieces. However, in October, we observed that number rising to 19 million pieces. I reviewed last year's data, and the increase from August to October was 1.5 million pieces, while this year it has grown by 2.7 million pieces in the same timeframe. This trajectory indicates positive momentum, with overall levels rising, which is the basis for our guidance.

Okay, thank you.

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

Hi, good morning. Just want to go back to the comments on the recapture trends. I think you mentioned it's really starting in September in terms of that recapture rate. Is that like a huge acceleration in terms of what you're seeing in October? Is it from that recapture? And then, also related to that, is there any cost associated with that volume you're recapturing today? Thanks.

So we're really pleased with how we're recapturing volume back in our business. We have recaptured over 600,000 pieces per day of the volume that was lost and I will say, 50% of that recapture is coming from our largest competitor. The recapture continues day by day, but it's not just about recapturing what we lost, it's about growing new business. You may recall, Allison, at the end of the second quarter, we said we had about a $7 billion pipeline of new business. Today, we've won about 25% of that pipeline. Now, that $7 billion is an annualized number. So, all those packages and volume haven't come into the network yet, it will come in over the next year. So, I couldn't be more pleased with how our sales team is performing, and winning new accounts, and winning back volume that deferred.

Got it. And then, just as a follow-up to the recapture, any cost associated with that recapture that you have to make?

There's no material costs associated with the recapture. Customers are coming back because of our superior service.

Great. Thank you.

Yes.

Our next question will come from the line of David Vernon of Bernstein. Please go ahead.

Hey, thanks for taking the question, guys. So, Brian, you mentioned the $800 million step-up. That's incremental sequential from 3Q to 4Q. I just want to make sure that I heard that correctly. That's the low end of your guidance range assumption?

That's right, Dave.

Okay. Looking at the exit rate indicated in the guidance, it seems to suggest a decline of around 20% year-over-year at EBIT. How should we anticipate a recovery in 2024? In the first half of the year, we have inflation, which you have the GRI to counterbalance. Should we expect a gradual improvement in the rate of change, leading to a rebound, or will there be a significant improvement in the first or second quarter? How should we perceive the progression of 2024 and the recovery in domestic margins?

So two big pieces of sort of forward momentum, Dave. One is the exit rate on volume. Carol just talked about the win-back, and also the pipeline of new business. So going into next year, getting back on level footing with a system that has higher ADV will help us certainly from a cost and margin perspective, the revenue per piece we announced a 5.9% GRI, so that will be coming in. We talked to you recently about the cost overhang of the contract, that goes from August to August, so I would tell you from a shape, certainly the first half of the year will be more challenged than the back half of the year. Back half of the year, we get into a two to three-year glide path with lower inflation per year, and then pricing and productivity can help expand the margins. But those are the pluses and minuses as we look into 2024. Obviously, we'll go into a lot more detail March when we get together with you all for our next Investor Day.

And that rate of change in the first half better than 4Q?

Let me come back to you, Dave, but we're certainly building momentum.

Let's finish off the year, Dave, and then we'll give you some color about 2024.

So always about 2024. Thanks for the time.

Thanks, Dave.

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

Yeah. I was wondering if you could give some color on your confidence level on the new revenue range. How much certainty do you feel the visibility, and what frames the high end, low end? Thank you.

So thanks, Jordan, for the question. Look, we feel good about the revenue range. We've narrowed it to $1 billion, and I think the thing that's going to drive the upper end versus the lower end, really has to do with the retail backdrop. I mentioned in my script, there's sort of the broad range of the online retail sales for the holiday period. To the extent it's in the higher end of that, we'll have more volume, and more revenue, to the extent it comes in with some of the risks we're seeing is towards the lower end.

Thank you.

Thanks, Jordan.

Our next question will come from the line of Tom Wadewitz of UBS. Please go ahead.

Yeah. You made a couple of comments on the volume that you're recapturing, and I just want to make sure I understand it. I guess, it's an important point. So, I think, Carol, you said 600,000 pieces a day have been recaptured. But then, Brian, you said kind of last year, the August to October was 1.5 million and it's 2.7 million increase this year. So that implies, I guess 1.2 million increase. So, I just wondered if you could give a little more perspective of kind of where we're at in October, and how much of that lost business has been recaptured, and then, I guess, another way you framed it was December. You were going to get back to flat volumes before. I think it was a prior comment. Do you still think you can do that, or are we thinking December volumes are down? Thank you.

Yeah, Tom. So, to frame it up for you, we were trying to get December back to flat versus prior year. I think the guide now implies from a low-single-digit to a mid-single-digit in the month of December, and that's pending some of the backdrop I just talked about in terms of the retail outlook. So, from a momentum perspective, I gave in August to an October number, but as Carol mentioned, we lost 1.5 million packages or we had diverted 1.5 million pieces. We've seen 40% of that, roughly 600,000 pieces already come back to the system. We're also pushing forward with new business that Carol referenced as well. Thanks.

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

Hi. Good morning. Thank you for the questions. This is Joe Hafling on for Stephanie Moore. I had maybe a conceptual question on sort of the recapture, looking at the near term. Given its peak season, and customers are focused on their own execution right now, does this limit your ability to win back volumes in the near term, and shippers don't want to disrupt any of the plans that they've already got in place? Obviously, you've highlighted the capture rates sort of September-October, but just wondering if that slows down as we kind of get into November-December, just as shippers don't want to disrupt their own operations right now?

Actually, it's accelerating. Customers want to come back into our network before peak because of our superior service that we've exhibited over the past five years.

Got you. Thank you so much and helpful.

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

Hey. Great. Good morning. If I could just clarify one thing on the step-up, I think to Allison, do you say you're not using increasing pricing as you get towards the tail end of that volume gain? And then, my question is on international, right. You're looking, I guess, Brian, to really snap back closer back to that 20% range. Is that kind of what you are still looking at in terms of margins at international as we move into the fourth quarter? I just want to understand the shift from peak versus belly space coming back on, and the impacts to margin there?

Yeah. On the first question, Ken, obviously, you've got volume and pricing. I was talking to with Allison about the volume component. We have announced a 6% to 7% peak season surcharge. So that's, obviously, flowing through from a revenue standpoint in the fourth quarter as well.

I think Allison's question was, are there costs associated with winning back volume. And as I responded, not meaningful. Ken, from time to time, we have found customers who diverted, and they entered into longer-term contracts, and we might help them to exit those longer-term contracts, but it's not a meaningful discount. It's just we might help them. It's nothing measurable.

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

Thank you, good morning. Brian, you addressed the previous question about the transition from Q3 to Q4 by explaining the low end of the range. Should we consider that lower end to be your base case? I would like to gain more clarity on that. Additionally, can you elaborate on your margin expectations for each segment in Q4? I'm unsure about what you're anticipating for each business in terms of margin or profit.

I have a walk in front of me for the high end and the low end, so I can give it to either range, and I think it's retail backdrop uncertainty that drives the delta in volume, which drives the delta in profit. So, it's the same levers. It's the volume and the revenue quality, really driving the majority at a higher component, at the high end versus the $800 million I referenced at the lower end. So net-net, I think from a margin shape standpoint, we finished Q3 mid-single-digit in the US. Obviously, that's a very low watermark, driven by the volumes we saw in the quarter. We're looking in the fourth quarter to step back up into that high-single-digit, low-double-digit range. And so, getting back to the trajectory, and then from an international perspective, we were at 15.8% in the third quarter. I think Kate and the team have planned largely through controlling what we can control, whether it's block hours, whether it's headcount. Taking that and they've done a good job of demonstrating that Q1 was an 18% margin International, Q2 was a 20%, so we're probably in the middle of that range for the fourth quarter. Hopefully that helps.

Thank you.

Yeah.

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

Thank you, operator. Hello, everyone. I have a straightforward question regarding when we can expect margin expansion in the domestic market. The RPP and CPP spread was significantly negative in the third quarter, and I assume that while it's still negative in the fourth quarter, it's less so. Are we likely to see year-on-year margin expansion by early next year, or will we need to wait until August when inflation decreases significantly?

Well, maybe just an observation on the US margin in the third quarter. Recall that we had $500 million of expense related to our Teamster contract in the third quarter. If we back that out, the US margin would have been 8.5%. 8.5% on volume down an 11% is not a bad margin. So, we've got a bit of pressure on the margin that we shared with you because of our new contract. The contract is front-end loaded. We're bearing the pain of that front-end load. For a five-year contract that's very attractive. The compounded annual growth rate on the five years is 3.3%. So once we get through this first front-end load with 46% of the cost in the first year, once we get through that, the margin is going to grow. It's going to grow in a big way. So hopefully, that's helpful.

I mean, it kind of is helpful, but I mean, I guess, the question is that, are we stuck in this return profile through the first half of next year, and then we see a step function improvement, or can we see improvement as you guys maybe rip off some of those seasonal costs in the first quarter, and we can get back to year-on-year growth in the first quarter even?

Absolutely fair question, Amit. Let us finish this year. Then we will provide guidance for 2024 and can break it down by quarter if that would be helpful.

Okay. Thank you.

Yep.

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

Good morning, everyone. This is Christyne McGarvey filling in for Ravi. I wanted to take a moment to discuss the path toward the longer-term targets you outlined at your last Investor Day, particularly regarding the macro assumptions needed to achieve those goals. Over the past 18 months, we've observed some subdued consumer spending, but it hasn't completely collapsed. What level of increase in consumer spending do you think is necessary to reach those targets, or how much of that do you believe is within your control?

As we examine the small package volume in the United States, we are essentially observing a return to normal levels, similar to what we experienced before the pandemic. Our takeaway is that if the pipeline surges due to any particular event, it will eventually stabilize back to the average. The projected growth rates for the small package market in the U.S. are in the low single digits for the next few years. We intend to grow not just with the market, but ahead of it, thanks to our investments in new products, capabilities, and acquisitions, which we are very enthusiastic about. One of the initiatives I want to highlight is Happy Returns, which we announced recently. Our returns business has experienced significant growth due to the rise of e-commerce, expanding by 25% since 2020. We value this business highly, but we recognize that we can enhance the experience for our retailers since it can be costly. Retailers estimate that around 20% to 30% of all online orders are returned, with an average processing cost of about $33 per return. Happy Returns will offer consolidated returns for our customers, helping to lower their handling costs and improve delivery efficiency, which benefits everyone involved. We are committed to expanding our returns business because it’s strong and necessary for our customers. Additionally, I’m excited about our acquisition in healthcare. Our healthcare business is expected to reach $10 billion this year while addressing a market that exceeds $100 billion. We plan to grow within this market, which boasts double-digit margins, because it is crucial for the world and for humanity. Our capabilities put us in a prime position for market share growth without relying on consumer spending, focusing instead on our investments in essential areas such as cold chain capabilities, among others.

Really helpful. Thank you.

Yeah.

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

Thank you very much. I would like to discuss the macro comments related to the domestic situation. I believe it's fairly clear regarding your comments about Europe and Asia. However, could you elaborate on your concerns about the weaker consumer due to student loans and other factors? It appears that we are headed for a decent holiday season. Where are you noticing the weaknesses, whether in a specific industry or consumer segment? What worries you about e-commerce and the domestic consumer?

There has been a clear shift from goods to services as people started returning to work, taking vacations, dining out, and visiting amusement parks during the pandemic. Consumers are choosing to spend their money differently. It's not that consumers are not in good shape; they are just reallocating their spending. Many of our retail customers have a genuine desire to bring shoppers back into physical stores, which are their biggest investment. Retailers are now offering options like buy online pick up in-store, which they hadn't done before. I can provide numerous examples of customers, although I won't name them, that are in our top 20 who are experiencing a decline in same-store sales year-over-year as they compare to the peak during COVID. Their online sales are decreasing even more due to this shift back to in-store shopping. This reflects the softening demand that Brian mentioned, as we observe some of our larger customers who, even without a diversion in their overall business, are reporting declining sales and are guiding for softer performance.

Thank you for the clarification.

Yeah.

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

Hey, good morning, and thanks for taking my question. Brian, you did talk about revenue quality initiatives. I know folks have brought up price quite a bit on this call, but can you talk about not just your pricing outlook. But maybe the mix impact from some of these initiatives you've had in the past on small and medium enterprises.

Yeah, SMBs, Brandon, are very attractive part of the business and we've continued to penetrate that market. So that's been favorable from a mix perspective. We are seeing customers trade down though from air product to ground. And so we've seen that in the numbers. Air was down more than ground volume. So there's a bit of a headwind there from a customer mix perspective. So overall, we have a customer mix impact as well that's going on, we're gliding down with our largest customer. So there is a shift there. That tends to help from an RPP perspective.

No, it's interesting if you go back to 2019, our volumes by the same as in the third quarter as it was back in 2019. But our SMB mix has moved from 23% to 29%. And our net revenue per piece has moved from $9.99 to $12.54. So we've been laser-focused on improving the revenue quality in our business and we will continue to do that. Value is defined by what the customer is willing to pay for and we are improving our experience every day. A good example of that is delivery photo. We're now at 92% of all of our residential drops are photographed which is creating a better experience for our recipients for our customers and for us candidly. We're leaning into simplifying the experience of how does that work with us and we'll talk to you about the widgets that we have with DAP or improvements that we've made in our claim process. You see our net promoter score now in the high 40s, so we believe that experience because it helps grow the revenue quality and we're going to continue to do that.

Thank you.

Thanks, Brandon.

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

Hey, good morning. Thanks for taking my questions. Maybe just two quick follow-ups actually. Can you talk about the pace of getting the share back, is you go into the fourth-quarter. Do you think, perhaps, you have the lower-hanging fruit easier ones to convert back, do you think that those came back sooner and maybe the pace from here just little bit harder? And then on the buybacks, you mentioned you're cutting your list your staffing the buyback for the quarter. You've got two acquisitions targeted. I just wanted to make sure I was clear in terms of what these are, if those were the Happy Returns and MNX or if there is potentially something else that was on the horizon.

We have nothing else planned, Brian, today. So we'll be buying MNX and Happy Returns this quarter, and it's about $1.3 billion in total that we'll be spending on those two companies. In terms of the pace of getting share. As I mentioned earlier is accelerating because of the fact that the peak is nearly on us. So people want to come into the network. Here's the truth though. It does take time to come back in. I get weekly updates Fernando and the team, from Kate and the team about how is the volume coming back in. And I see that, oh, we've gotten a handshake. We've got an agreement from a customer that's coming back in. And then I see it takes 30 days to get it back into on-car. And so now I'm like I want photos when it's on car because I want to make sure that's actually in the network. And that's what we're getting. We're having some fun with that actually because we're seeing it picked up from our competitors. That's always done when you're picking up volume from your competitors. So it accelerates.

Okay. Thank you.

Steven, we have time for one more question. Okay, with no further questions. Thank you for your time and have a good day.

Ladies and gentlemen, that does conclude our call for today. Thank you for your participation. You may now hang up.

Thank you.