United Parcel Service Inc Q1 FY2024 Earnings Call

Good morning. My name is Stephen Dye, and I will be your conference facilitator today. I would like to welcome everyone to the UPS Investor Relations First Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's 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 first quarter 2024 earnings call. Joining me today are Carol Tome, our CEO; Brian Newman, our CFO, and several 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 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 2023 Form 10-K and other reports we file with or furnish to the Securities and Exchange Commission. These reports are available on the UPS Investor Relations website and from the SEC. Unless stated otherwise, our discussion refers to adjusted results. For the first quarter of 2024, GAAP results include a total charge of $110 million, or $0.13 per diluted share, which consists of after-tax transformation and other charges of $75 million and a non-cash after-tax impairment charge of $35 million, due to plans to consolidate certain acquired brands within our healthcare portfolio. A reconciliation to GAAP financial results is available on the UPS Investor Relations website and also in 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 to allow as many participants as possible. You may rejoin the queue for the opportunity to ask an additional question. Now, I'll turn the call over to Carol.

Thank you, PJ, and good morning. Let me begin by thanking UPSers for doing what they do better than anyone, and that's deliver industry-leading service. Through the first quarter, UPSers continued to execute our strategy by focusing on growth and efficiency and exemplified our purpose of moving our world forward by delivering what matters. Moving to our results, the first quarter turned out as we expected, starting with a decline in average daily volume. U.S. average daily volume, or ADV, declined year-over-year, but the rate of decline slowed as the quarter progressed, ending with March down less than 1%. And on a sequential basis, the ADV decline rate in the first quarter showed marked improvement compared to the fourth quarter of 2023. This improving performance is primarily due to the efforts of our sales team to win and pull through new volume into our network. Outside of the U.S., the ADV decline rate also improved sequentially compared to the fourth quarter of last year, and we saw pockets of export growth in certain markets and lanes. For the first quarter, consolidated revenue was $21.7 billion, a decline of 5.3% versus last year. Operating profit was $1.7 billion, down 31.5% compared to last year, due for the most part to higher labor costs associated with the first year of our Teamster’s contract. Consolidated operating margin was 8%. Our operating profit performance was a bit better than we expected due to higher productivity. At our Investor and Analyst Day last month, we shared our three-year targets and how we intend to reach them under our Better and Bolder approach. We are reimagining our network through Network of the Future, and we are leaning into the parts of the market that value our end-to-end integrated network. For example, we recently announced that UPS will become the primary air cargo provider for the United States Postal Service. Under this contract, we will move most of the USPS’ air cargo within the United States. The USPS air cargo business fits beautifully with our strategy to grow our B2B business. To win, we put together an innovative and differentiated solution that leverages our integrated network and existing assets. The USPS air cargo business will contribute to top-line growth and be accretive to consolidated and U.S. domestic operating margins. Brian will share more details, including what to expect during the transition period and where this will show up in our financial reporting. Moving to our strategic update, through our customer-first, people-led, innovation-driven strategy, we are investing to grow in the premium parts of the market and drive efficiency. Let me give you a few recent examples. Starting with customer-first. Through our on-demand network, we are expanding our addressable market with capabilities like no-box, no-label returns through Happy Returns, and the convenience of our more than 5,200 UPS store locations. During the first quarter, our overall returns volume in the U.S. increased 1.4%, and Happy Returns more than quadrupled its ADV in the first quarter. Returns are attractive to us for a couple of reasons. First, they are typically B2B movements, and as a result, they drive pickup and delivery density. Second, our frictionless offering creates customer loyalty and repeat business. We are also expanding our addressable market with capabilities like big and bulky deliveries through Roadie. In the first quarter, we launched RoadieXD, which adds cross-dock capabilities to RoadieXL. Our cross-dock solution brings the digital and physical together for long-zone deliveries of bulky items, such as grills and furniture, that do not fit in the UPS small package network. This is enabling us to unlock additional revenue opportunities in the highly fragmented $60 billion big and bulky market in the U.S. It's still early days, but this is a large opportunity for us to grow quality revenue and profit and serve the needs of our customers. As we laid out at our Investor Day, our long-term target is to grow our U.S. S&D volume penetration to 40%. DAP, our digital access program, is one of the tools we will use to reach this target. Recently, we enhanced our DAP pricing capabilities by launching a solution we call Fast Lane. With Fast Lane, we can optimize rates and target attractive volume growth, whether it be by partner, by product, or by customer segment, all of which can drive revenue per piece growth. We can even target volume growth by geography to drive density. Prior to Fast Lane, rate and other adjustments in DAP could take months. Now we can make them in a matter of days or even hours. In terms of results, in the first quarter, DAP revenue grew by 3% year-over-year. And in 2024, we expect to generate over $3 billion in global DAP revenue. Speaking of S&D, over the last year, we've gained traction on improving the customer experience across 16 journeys. Take pickups. We redesigned our process and deployed new driver dispatch technology. This resulted in a 74% reduction in pickup concerns and a Net Promoter Score, or NPS, of 48 for this journey, which is an all-time high for UPS. And for our international customers, our next-gen brokerage solution is making it easier for S&Ds to navigate the ins and outs of exporting, as evidenced by a 40% decline in customs brokerage holds since April of 2023. Turning to healthcare, we aim to become the number one complex healthcare logistics provider in the world. Healthcare companies are innovating, and so are we. Our latest example is the opening of LabPort at Worldport, our global air hub in Louisville, Kentucky. LabPort is unique. It's an end-of-the-runway, state-of-the-art facility built specifically for lab customers. By being at Worldport, we can deliver urgent air packages to our lab customers well before the sun comes up, so they can provide diagnostic results by early morning. And in terms of healthcare revenue, in the first quarter, revenue from our healthcare portfolio reached $2.6 billion. Outside the United States, we're continuing to enhance our network to grow our premium international business. Our most recent example is the launch of next-day flights between Shenzhen, China, and Sydney, Australia. The addition of these flights enables faster import and export movements between 11 Asian markets and Australia. And now, exports from Australia can even reach Europe by the next business day. This enhancement further enables us to serve our customers, particularly those that are in high-tech manufacturing and healthcare, as they are shifting their supply chains in response to changing international trade flows. Now, let's turn to innovation-driven. As we've discussed, Network of the Future includes physical and digital changes that will deliver benefits in the short-term and the long-term. Smart Package, Smart Facility, our RFID solution, is a great digital example. We are moving from a scanning network to a sensing network. Following last year's Phase 1 deployment to our preload operations, this year, we are installing RFID readers in over 40,000 U.S. package cars, with a balance to be completed in 2025. Package car readers will enable us to further reduce our misloads, which will improve efficiency and the customer experience. The physical aspect of Network of the Future has launched, and in the quarter, we continue to close sorts and flow more volume into automated facilities. Most of the Phase 1 major projects we outlined during our Investor Day have begun and are in the contracting and execution phases. Innovation-driven is also about achieving carbon neutrality by 2050. We recently published our 22nd Sustainability Report, and we are well on our way to achieving our goals. In 2023, our Scope 1, 2, and 3 CO2 emissions declined 8.1% compared to 2022. We operate more than 18,000 alternative fuel and advanced technology vehicles in our rolling laboratory. And the use of alternative fuels in our ground operations reached 28.8% last year, keeping us on track to achieve our target of 40% by 2025. Moving to our outlook, we are reaffirming our previously announced 2024 consolidated financial goals. In 2024, we expect to generate consolidated revenue ranging from approximately $92 billion to $94.5 billion and a consolidated operating margin ranging from approximately 10% to 10.6%. Versus last year, we still expect first half earnings to decline and second half earnings to grow as we lap the first year of the Teamster’s contract, and we still expect to exit the year with a U.S. operating margin of 10%. As we move forward, we are staying on strategy and under our Better and Bolder approach, we are pursuing our declarations to become the premium small package provider and logistics partner in the world. With that, thank you for listening. And now I'll turn the call over to Brian.

Thanks, Carol. Good morning. In my comments, I'll cover four areas. First, I'll review our first quarter results followed by our 2024 financial outlook. Then I'll provide some comments on our business with the USPS. And lastly, I'll close with a recap of our 2026 targets. While the macro environment in the first quarter showed improvement in some areas, continued soft demand pressured all three parts of our business. Through the quarter, we adjusted our integrated network to match volume levels and drove out expense while maintaining industry-leading service levels. Moving to our financial results, our overall quarterly performance was in line with our expectations. In the first quarter, consolidated revenue was $21.7 billion, down 5.3% compared to the first quarter of 2023. All three of our segments demonstrated cost agility and on a combined basis, drove DAP expense down by $414 million in the first quarter. This enabled us to deliver $1.7 billion in consolidated operating profit and maintain a consolidated operating margin of 8%. Diluted earnings per share was $1.43, down 35% from the first quarter of 2023. Now let's look at our business segments. In U.S. Domestic, we remained focused on controlling what we could to improve volume growth and drive productivity. In the first quarter, average daily volume was down 3.2% year-over-year. When looking at ADV sequentially, the growth rate showed strong improvement compared to the third and fourth quarters of 2023. B2B average daily volume was down 5.5% compared to the first quarter of last year, primarily driven by declines in the retail and manufacturing sectors. B2B represented 41.6% of our volume. Looking at product mix and in line with recent trends, we continue to see a shift from air to ground as customers prioritize cost savings over transit times by taking advantage of our ground services. Compared to the first quarter of 2023, total air average daily volume was down 8.3%. Ground declined 2.3% and within ground, sure post volume grew 10.8%. For the quarter, U.S. domestic generated revenue of $14.2 billion, down 5%. Revenue per piece was relatively flat year-over-year. Looking at the key drivers, base rates increased the revenue per piece growth rate by 240 basis points. This was offset by a couple of factors. First, changes in customer and product mix due to growth in sure post combined with changes in package characteristics decreased the revenue per piece growth rate by 180 basis points. And second, changes in fuel prices decreased the revenue per piece growth rate by 90 basis points. Turning to cost, total expense was down 0.8% or $104 million in the first quarter. Union wage rates increased 13% driven by the contractual increase that went into effect last August. Leveraging technology and the agility of our integrated network, we took several actions which more than offset the increase in compensation. We leveraged total service plan and network planning tools to reduce total operational hours by 6.6%, which was more than the decline in average daily volume. We closed 18 sorts and reduced operational resources by 4.8% compared to last year. We lowered block hours by 15.2% versus last year. We reduced management and support staff by approximately 5,400 positions year-over-year. In addition, we reduced purchase transportation by 17%, primarily from our continued optimization efforts. And lastly, lower fuel costs contributed to the decrease in total expense. The U.S. domestic segment delivered $839 million in operating profit, down 43.6% compared to the first quarter of 2023, and operating margin was 5.9%. Moving to our international segment, the macro environment remained challenged, primarily in Europe and Asia. However, volume growth in the Americas region showed early signs of nearshoring. In the first quarter, international total average daily volume was down 5.8% year-over-year. About two-thirds of the decline came from lower domestic average daily volume, which was down 8.1%, driven primarily by declines in Canada and major markets in Europe. On the export side, average daily volume declined 3.6% year-over-year primarily due to weak manufacturing activity in Europe. In Asia, export average daily volume was down 4.8%, which was an improvement from the fourth quarter of 2023. Within Asia, export volume on the China to U.S. lane increased 12.8% and showed steady growth for the second consecutive quarter. More than offsetting the overall decline in Asia, nearshoring became evident as export average daily volume in the Americas region increased 3.8%. This was led by SMB customers in Canada and Mexico, leveraging our cross-border ground service. In the first quarter, international revenue was $4.3 billion, down 6.3% from last year, primarily due to the decline in volume. Revenue per piece increased 2% and included a number of moving parts. Strong base pricing drove a 360 basis point increase in the revenue per piece growth rate, while a decline in fuel surcharge revenue, combined with a stronger U.S. dollar negatively impacted the revenue per piece growth rate by 80 basis points. Lastly, lower demand-related surcharge revenue decreased the revenue per piece growth rate by another 80 basis points. In the first quarter, total international expense was down $163 million, a decline of 4.4%. Similar to previous quarters, we leveraged the agility of our integrated network to reduce block hours by 6.6%. Operating profit in the international segment was $682 million, down $124 million year-over-year. Operating margin in the first quarter was 16%. Now looking at Supply Chain Solutions, in the first quarter, revenue was $3.2 billion, down 5.3% year-over-year. Looking at the key drivers within forwarding, market rates in international airfreight continued to drive down top-line revenue. On the ocean side, excess market capacity continued to pressure market rates and drove a decrease in revenue despite volume growth. And our truckload brokerage unit continued to face soft demand and market rate pressures. Logistics delivered revenue growth and increased operating profit driven by gains in healthcare. In the first quarter, Supply Chain Solutions generated operating profit of $226 million, down $32 million year-over-year and an operating margin of 7%. Walking through the rest of the income statement, we had $195 million of interest expense. Our other pension income was $67 million, and our effective tax rate for the first quarter was 26.8%. Now let's turn to cash and shareholder returns. In the first quarter, we generated $3.3 billion in cash from operations. Free cash flow for the period was $2.3 billion. We finished the quarter with strong liquidity and no outstanding commercial paper. Also in the first quarter, UPS rewarded shareholders with $1.3 billion in dividends. Turning to our outlook. As Carol mentioned, we are reaffirming our 2024 consolidated financial targets. For the full year 2024, on a consolidated basis, revenues are expected to range between $92 billion and $94.5 billion, and we expect to generate a consolidated operating margin ranging from approximately 10% to 10.6%. Looking at the shape of the year, in the first half of the year, we expect consolidated operating profit to be down between 20% and 30%. In the back half of the year, we expect volume and revenue growth to accelerate as we lap the diversion we experienced as a result of our labor negotiations. Additionally, our labor cost growth rate will drop substantially. We will also see the majority of the $1 billion in savings from Fit to Serve. We still expect revenue per piece to outperform cost per piece. And lastly, in U.S. domestic, we expect to exit the year at a 10% operating margin. Looking at cash flow and capital spending, for the full year in 2024, we still expect capital expenditures to be within our target of around 5% of revenue or $4.5 billion. We're reviewing certain aspects of our pension strategy, and so we expect free cash flow to be within a range of approximately $5.9 billion to $6.7 billion before reflecting any pension contributions. Now let me share more detail about servicing Air Cargo for the USPS. This is good business for us, and we are moving quickly to begin onboarding this cargo. We will leverage our integrated network and existing assets, and we expect the majority of the volume will fit within our current U.S. domestic daytime flight operations. Our operators and engineers are already planning the network to support the complete transition to UPS in the third quarter. In terms of financial reporting, the revenue and expense associated with USPS Air Cargo will show up in the SCS other line in our financial reporting. Adding the USPS air cargo volume to our existing network will result in a higher share of the network cost being allocated to SCS, indirectly benefiting our U.S. domestic segment. We expect to see a benefit to operating margins this year at both the consolidated level and within the U.S. Domestic segment. To wrap up, we are also reaffirming our three-year consolidated revenue and operating margin targets we put forth at our March Investor and Analyst Day. Specifically, we aim to grow revenue to be between $108 million and $114 billion by 2026. The high end of the range includes inorganic opportunities, primarily in healthcare and international. Additionally, we expect to expand our consolidated operating margin to more than 13% by 2026, which includes expanding our domestic operating margin to at least 12%. And I'll note that the USPS volume is consistent with our Better and Bolder approach to grow in the parts of the market that leverage our integrated network, and it gives us a strong start to our 2026 targets. With that, thank you, and operator, please open the lines.

Thank you. We will now conduct the question-and-answer session. Our first question will come from the line of Brandon Oglenski of Barclays. Please go ahead.

Hey, good morning. This is Eric Morgan on behalf of Brandon. Thanks for taking the question. I just wanted to ask about the guidance in the first half. I know you mentioned 1Q kind of coming in line with your expectations, but you did call out the 40% decline expectation at the Investor Day. So just wondering if anything happened late in the quarter that drove EBIT above your expectations in the first quarter? And then, are there anything negative going on in 2Q that led you to maintain the first half guidance rather than raise it similar to the 1Q beat? Thank you.

Morgan, good morning. It's Brian. Happy to take this one. Look, our guidance for the first half of the year remains the same, declining in profit down 20% to 30%. So that's consistent. I did call out at the tail end of the quarter, expected minus 40%. I said consistently that Q1 would be the tougher quarter in the first half of the year. There were two elements that contributed to beating that 40%. One, on the top-line, we did see positive volume momentum going into the end of the quarter. In fact, the last couple of weeks were basically breakeven from a volume perspective. I think the last week was about zero percent thereabout. So sequentially, we were seeing improved volume. But the bigger component was just some cost trading between April and March, things like occupancy and maintenance cost shift in terms of when they hit the P&L between March and April. So no change from a guide perspective; still down 20% to 30%, some cost timing at the end of the quarter there, but the positive was the trajectory of volume momentum. Thanks, Morgan.

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

Thanks. Carol, Brian, can you just provide a bit more detail on the contribution margins associated with the USPS contract? This was a zero margin business that your direct competitor and somewhat surprisingly is now moving from your direct competitor to you. It kind of harkens back to pre-2020 when UPS was less price disciplined. And so can you just wage concerns that this wasn't one on price and just talk a little bit in more detail. I know you're obviously raising some block hours to fund to service this volume. But what other costs do you kind of expect to bring on to service this $1 billion, $1.5 billion of incremental revenue? Thanks.

Well, thanks very much for your question, Amit. And we're delighted to have won the air cargo business from USPS. Our team put together an innovative solution using our integrated network. And as in contrast to traditional hub-and-spoke models, we don't have to run all of the air volume through our main air hub at Worldport. Of course, we will use Worldport, but we will also use our regional gateways. That allows for splits to occur outside of the network, so they'll be built in origin and then we will bypass the main hub and go point to point. This is an integrated solution that's very different than I think the former provider offered. We also will use all of the assets of our integrated network, and that will allow us to actually optimize block hours. Now in terms of the investments that we need to make to service volume, we have plenty of space on our existing aircraft. So we won't be purchasing any aircraft. We will be hiring some pilots, but less than 200 pilots, and we factored all of that into the cost model that we built. So this will be margin accretive. It will be EPS accretive beginning in year one and through the life of the contract.

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

Hi, good morning. I wanted to see Brian or Carol if you could walk through what are the key pieces of the 2Q versus 1Q ramp in EBIT. And then I guess the same thing for the second half. Obviously, you've got Fit to Serve as a significant cost benefit versus 1Q. But I think just trying to figure out how much of the improvement sequentially is based on volume that you have visibility to and how much would be based on anticipation of improvement in the broader parcel market kind of macro improvement. Thank you.

Hey, Tom, happy to take that. So listen, from a Q1 to Q2 perspective, the shape, if we look at the U.S., we would expect marginal growth from a volume perspective, which relative to past trends, normally Q1 steps down to Q2 from an absolute volume level. So by maintaining that will be a natural accretion from an EBIT perspective. The big component, though, full year on a run rate basis, the Fit to Serve program will generate $1.3 billion in savings, and we're ramping that up in Q2. So that will be a big driver as well as we think about it. And then from a Q1 to the back half of the year, it's the same three components: Fit to Serve, the volume lift along with the drivers of RPP and then it's the labor contract lapping, which is the big piece in the back end of the year.

And maybe just a few more comments on RPP since our RPP in the U.S. was flat in the first quarter. We expect RPP growth as we head towards the back half of the year. Why? Well, first of all, fuel prices were a drag on the RPP in the first quarter. The projection for fuel is that is going to increase. We are also announcing a fuel surcharge later today. So those two components of fuel will be a bonus to RPP as we head towards the back half. We also are going to have a pretty peak, we anticipate for fewer operating days this year than last, which means the demand surcharge should be pretty strong this year compared to last year. And then we brought in a lot of SurePost product into our network. We're meeting our customers where they want to go; we'll be anniversarying a lot of that in the back half of the year as well. So we don't expect we love by the way, but we don’t expect to see the drag on the RPP I’m sure costs in the back half, like we said, in the first quarter. Any other color you’d like to provide?

I think all those that you stated, Carol, and then the volume growth, obviously, with the comps, it’s going to be a big help to us.

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

Hi, good morning. Sort of curious, you mentioned some actions taken in the first quarter, like closing sorts and working on peak purchase transport, et cetera, amongst other things. Can you maybe talk to some additional actions that are helping to drive the profit uplift from here, not related to the volumes and maybe the headcount reduction? Thanks.

Well, productivity is a virtuous cycle here at UPS domestically and outside of the U.S. And I just can’t say enough good things about how our team is running our business. Ours are running under the volume declines, higher productivity and cull utilization packages per hour. We measure productivity in minutes, miles, and packages per hour and all across the board, we’re seeing record levels. One different callout that we’ve been talking about for a while is safety. Our safety stats, if you will, are the best they’ve been in five years. And of course, if you haven’t run a safer business, where you don’t have as many claims for work comp and auto liability. So a real shout out to our operators. And I certainly might say, why is the productivity getting better? One reason is because our turnover is down. And as people stay in place, we are just more productive. And let me throw it over to Nando. Is there anything you’d like to add on the productivity side?

No, I’m actually quite impressed with our engineers and our operators; I think they’re the best in the business. And we’re continuing to follow our game plan that we reviewed with you at the investor conference, which is keenly focused on closing down stores, moving volume to our automation and our automated facilities. And in fact, when I talked about pieces per headcount at our conference, we’re actually up 2.7% in March. So we are pushing all of the things that help us be more productive and less reliant on labor.

And Kate, outside the United States in your word talk about product.

Yeah, absolutely. It is a consistent value at UPS and something that all of us work very hard toward every day. So when you look at the major regions around the world, we’re setting records on our cube utilization both on the ground and in the air. As our margins show, we have a very good handle on expense management, and as we’re unlocking more of this segment growth, healthcare specifically, SMB around the world, it only fuels that further.

We have a question from the line of Ken Hoexter of Bank of America. Please go ahead.

Hey, great. Good morning. Just international margins were a bit lower than we expected. Just maybe thoughts on increased costs. It sounded like you threw out some impacts of near-sourcing. And then, I guess, Brian, just a clarification. You said you’re moving the U.S. Postal Services will be listed in SCS and benefiting domestic. I just want to understand, are you shifting costs then out of domestic into SCS? Or maybe just clarify that comment there.

Well, first on the international margin, I think our team did a terrific job of managing costs in an environment where demand was down. There was a one-time item that we didn’t call out in our prepared remarks. But if you back out that one-time item, the international margin would be at 17%. The first quarter is usually our lowest margin quarter, so we anticipate that the international business and our planning for the international business to be in the high teens as we had told to.

And then on the tonnage in terms of USPS comes in through SCS other. But because we’re using a lot of the U.S. assets, we allocate cost to that business, and that will have a positive benefit on the domestic margin.

And can you clarify what the one item was there?

It was a cleanup really in our revenue data markup, we just had some accounts we wrote off.

Thanks a lot for the time. Appreciate it.

Yes.

We have a question from the line of David Vernon of Bernstein. Please go ahead.

Hey, good morning. I got a couple of quick commercial questions for you. Can you talk about how the volume outlook outside of SurePost is shaping up? I think you mentioned in a couple of pockets, the second derivative is getting better. But if you could talk about whether you feel better or worse about where volumes are going to end up in the year today versus when you started the year? That would be helpful. And then the second question would be on SurePost, 10% demand for anything in small package is a very high number. When are you going to have a chance to maybe address pricing in that product? Because it does sound like you have what looks like a relative advantage in terms of marketing against the lower end of the e-commerce small package market?

So from a volume mix perspective, if I look at the volume that’s in our pipeline, I would say the volume that’s in our pipeline is not SurePost. We’ve got commercial volume in our pipeline, additional enterprise volume in our pipeline. So we’re going to be our customers where they want to go. But the mix is looking very different as we look ahead than it was in the first quarter. And in terms of pricing, I don’t think we’re going to talk pricing on this for this call, but we always look for opportunities to optimize our pricing.

And the headwind we saw from a mix perspective, Carol alluded to this in the back end of the year, we are anniversarying a fair amount of SurePost from last peak. And so the overlaps won’t drive as big of a headwind.

We have a question from the line of Scott Group of Wolfe Research. Please go ahead.

Hey, thanks. Good morning. Brian, the second quarter guide, I guess, implies EBIT down anywhere from 10% to 30%. So any more directional color there? And then on this revenue cost allocation thing with the post office? Is there any way to just quantify what the benefit is to the U.S. margin as you're doing this? And is that already sort of captured in the 10% margin comment for Q4? Or does this now take it up versus what you previously thought?

Well, maybe I’ll talk about the full year guidance and then you can talk specifically about the second quarter. One of the questions may be, well, why aren’t you changing your guidance now that you won this air cargo business and you say it’s going to be margin accretive? We were highly confident of the range of guidance that we provided at the end of the year, and we're even more confident now, but it's just too early in the year to change the guidance. So once we get through the second quarter, we'll tell you what we think the back half of the year will be. On Q2 alone, why don’t you talk about?

Sure. We're maintaining our forecast for the first half at a profit decline of 20% to 30%. You can focus on any part of that range. For the domestic average daily volume, we expect Q2 to show slight improvement. Revenue per package should remain stable, similar to what we experienced in the first quarter, as we start to overcome some mix-related challenges. As mentioned, fuel and the PSS later this year will assist us. We anticipate that our cost per piece will improve in Q3 when we recognize the cost of the labor contract, but it will be fairly consistent in Q2 within the U.S. Internationally, we expect the average daily volume to improve as the year progresses. Therefore, I would guide you towards the 20% to 30% range. We've been consistent in our profit outlook for the first half, and you can refine your estimates from there.

And then any thoughts on that the postal shift and the margin benefit for Q4?

So this is what I’d like to do is out, let's get through the second quarter, and then we'll come back and give you more color. I like to get some of it into the network. We’ve modeled it out. I want to actually see how it performs. So we’ll give you more color at the end of the second quarter.

We have a question from the line of Ravi Shanker of Morgan Stanley. Please go ahead.

Thanks, good morning, everyone. Carol, in your opening comments, you mentioned that returns were a good business because they were B2B. I'm a little surprised to hear that because it seems like a C2B type business with pretty high fragmentation in the last mile. So if you can just unpack how that works through the supply chain and the profit contribution of that, that would be great. Thank you.

We aim to facilitate a lot of returns for businesses. Typically, consumers go to a UPS store to initiate their returns, which we then consolidate and send back to the shipper. For instance, with our largest customer, we manage thousands of returns at our UPS locations and package them into a single consolidated return. This is a profitable business for us. With Happy Returns, we can now provide a similar service without needing a box or a label. The consumer comes in, makes the return, and we handle the consolidation and return process. This is how we view it as a B2B offering, and we find the margins to be very appealing. The efficiency from density is a key factor in those healthy margins.

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

Thank you for taking my question. I have one for Carol and one for Brian. Carol, could you discuss the increase in the fuel surcharge by another 50 basis points, following the 125 basis points in December? I'm curious about your thoughts on how the market might handle this increase given the excess capacity, and if you still see it as a lever for overall pricing. Brian, could you provide more detail on the pension contribution strategy? It seems that the cash contribution may be on hold while other options are considered. Any additional insights would be appreciated. Thank you.

So on the fuel surcharge as we look to the rest of the year, fuel prices are increasing. And this is not atypical for us to adjust our surcharge on the base of rising fuel costs. You also should know that, that doesn't impact all of our customers. Clearly, some are exempted from this. So in terms of the ability to stick, we think it will stick. And just a comment on the capacity at our Investor and Earnings Day, we said there was about $12 million ADV excess capacity in the market, and that equilibrium is about 6%, you need about 6%. So really, the excess capacity is around 6 million today, and we think that will be fully absorbed by 2025. Now you may say why. Well, we're part of that excess. And so we're closing stores. We're taking capacity out of the market, and our Network of the Future initiative is capacity neutral. Also with our large competitors' consolidation efforts, capacity will be leaving the market. And then another player headquartered in Seattle on the regional, I think the capacity will be taken out of the market. So we think all that capacity will be absorbed and the pricing environment is actually very rational.

And Brian, regarding your question about the pension, I mentioned that our free cash flow excluding pension is projected to be between $59 million and $67 million. We have annual service costs around $1.4 billion, so you can use that figure for modeling purposes. However, it's still too early to discuss strategic options related to the pension. We'll provide more insight later in the year on the actions and initiatives we are exploring.

Our pensions are very well funded, exceeding 90%. This provides us the chance to reassess our asset liability strategy and funding approach. Therefore, we believe it's a good time to pause and evaluate the situation, and any decisions we make will be communicated to you.

Thank you.

Our question will come from the line of Conor Cunningham of Melius Research. Please go ahead.

Hi, everyone. Thank you. I am interested in your expectations regarding volume changes soon. Could you elaborate on your expectations for volumes as you transition from the first half to the second half? Previously, you mentioned a forecast of flat to up 2% in the U.S. domestic market, and then you slightly exceeded that. I am trying to gauge how the latter half is looking beyond just easy comparisons. Thank you.

So from an ADV perspective in domestic, I think that's where you're headed. With a little bit of a slight tick up in positive volume in the second quarter, we will likely finish low single-digit decline in the first half; second half we'd expect that to be low single-digit increase. And you can look at it through various different lenses. We're building momentum ever since August, with each month basically getting sequentially better each quarter from Q3, Q4, and then Q1 improves. We'd expect to see slight positive volume trends in the second quarter. And then, just from a comp standpoint, I mean if I go back from a trend perspective, over the last 10 years, our Q3 is generally about close to 300,000 ADV better than Q1. And even if we assume flat from a Q3 to Q1, that would be a 4.5% growth. So any way you cut it, we see the back end of the year and most importantly, it's the visibility on the sales pipeline that we're pulling through and the volume levels we're seeing going into Q2.

Super helpful. Thank you.

Our next question will come from the line of Jonathan Chappell of Evercore ISI. Please go ahead.

Thank you, good morning. Brian, you'd mentioned the $1 billion of productivity that you expected to see in the full-year '24 guide. Can you just tell us where that stands after the first quarter and how we think about the cadence throughout the rest of the year? Is it front half loaded? Or is it kind of extrapolated evenly by quarter?

Yeah. The initiative is progressing slightly ahead of plan. Reductions began in March and will continue through Q2. We’d expect more than 80% of the resource reductions to be complete by Q2. We’re on track to that $1 billion that I mentioned. And at a full annual run rate going into next year, we’d expect $1.3 billion. So there’ll be some benefit early part of next year.

Our next question will come from the line of Daniel Amaro of Stephens Incorporated. Please go ahead.

Yeah. Thanks, good morning, guys. Thanks for the questions. Wanted to follow up on the USPS contract. Carol, the air cargo, I think, should come into your network in the fourth quarter. I think first, any business coming in sooner than that, just to clarify, and then looking at Q4 in the outlook, are there any minimum volume component to the agreement? I mean, obviously, that customer has moved a lot of freight out of the air network as it looks to save costs by using ground. It still looks like ground is cheaper out there. So how do you protect for more of that volume leaving the air cargo market into maybe slower transit time similar to the rest of your business? Thanks.

Well, clearly, we want to get all the volume onboarded before peak. That’s in their interest and our best interest. We will onboard the volume as we can. Our teams are in Washington, D.C. working with the postal service hand-in-hand as we build our operating plan.

Our next question will come from the line of Bascome Majors of Susquehanna. Please go ahead.

Yeah, thanks for taking my questions. As you work on cash flow with the pension strategy stuff you've talked about that we might hear more about late this year. Can you talk a little bit about the dividend? If you look at your payout guidance, it implies roughly $13 in earnings at the dividend level that you're paying now. Is there an opportunity to start to raise it more meaningfully before the earnings power of the business gets there? Or do you think we need to wait and get more increases like we saw this year until the business is supporting that more literally? Thank you.

We have a disciplined approach when it comes to capital allocation. The first use of our cash, as you know, is to invest back into our business, and the second is to pay our dividend. We have a targeted dividend payout ratio of 50%. We are higher than that. It's our intent to earn back into a 50% payout ratio over time. We have no intent to cut the dividend to make that math work. We're going to earn back into it, and the dividend is an important part of the value proposition. So we just raised the dividend and we look to, of course, subject to board approval, we look to raise the dividend every year. Any color you’d like to add here?

Just, Carol, this year marks the 15th consecutive year we've increased the dividend, and we're committed to a stable and growing dividend. So we will earn back into that, but certainly committed to it.

And I feel to respond to Daniel's question about minimum levels within the USPS contract. I'd like to throw that over to Matt. Matt, did you answer your question?

Yeah, absolutely. So thank you, Carol. First off, yes, we do set minimums in the contract. As we built this, we identified a win-win for both the USPS and for us it's just imperative that, one, we not only have it on the protection for our side and our business on what we're bringing on but also for the USPS because we want to make sure, as Carol mentioned, that we're onboarded before peak season, and we're bringing this on as quickly as possible, and we're working collectively with them. Nando and the team have done a great job with their operational team. And to Carol's point, we're meeting with them every week in D.C. to continue to onboard that volume to make sure it's a smooth transition.

Thanks, Matt.

Stephanie Moore of Jefferies. Please go ahead.

Hi, good morning. Thank you. I wanted to touch back on the volume commentary. If you can maybe discuss in your eyes, what drove the improvement as the quarter progressed and your expectations into 2Q. How much of this was from actions within your own control? And then at the same time, maybe areas where the underlying environment is improving some over kind of what we've experienced over the last year. And in that case, where you've seen that improvement in the macro. Thank you.

Well, I give a shout out to our sales team. The improving volume trends are in large part due to their hard work and efforts. You may recall at the beginning of the year, we said the growth in the market wasn't going to be very strong this year. So the fact that we're able to see sequential improvement in the magnitude that we're seeing is really because of our sales team. We are winning new; we are gaining additional penetration of existing customers. We are meeting customers where they want us to be. And our sales team will continue to do that around the world. And that's one reason that we're confident in the volume projection that Brian did share.

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

Hey, thanks. Good morning everyone. Carol, regarding your comment about DAP from the start of the call, I know it plays a significant role in your S&D growth initiatives. You mentioned a 3% growth in the first quarter, but I noticed that this is significantly lower than what you previously indicated. You mentioned a plan exceeding $3 billion and at the Investor Day, you stated it would be considerably over $3 billion. I'm curious if there’s something causing a slower growth outlook for DAP.

Yeah. Thanks for the question. And I think I got it; you broke up a bit, but it’s generally about DAP. So last year, in the first quarter, our DAP revenue grew 51% and our volume grew 61%. So we didn’t expect to repeat that kind of growth in the first quarter of this year. And so we were very pleased with how the DAP portfolio performed in the first quarter because it was in line with our expectations. We had anticipated a slower growth in the first quarter because there were a couple of our partners that we were working on amending the fees and charges. So we expected the growth rate to be slower and then to pick up as we move into the second quarter and the rest of the year. The projections for the DAP around the world, and we’re seeing great growth outside the United States, by the way. The projections for the DAP portfolio by the end of the year are in excess of $3 billion.

Okay, that’s very helpful. Thank you.

Yes.

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

Thanks very much. Good morning. Carol, could you give us an update on your SMB progress? Curious how you're trending towards the long-term target domestically? And then also, how does international compare? You've spoken in the past about making nice progress there. Just curious, how does that compare to domestic right now? And what type of aspiration can you achieve longer term? Thanks.

Yeah. So we're right now at about 29% as of the end of the first quarter. And as we look towards the end of this year, we should be over 30 in the low 30s. So we're trending nicely. And Kate outside the United States how's SMB performance?

Yeah. Our history outside the U.S. is in SMB. So we have a 62% share of SMB, and this is now where we're implementing debt. So we're only going further. As Carol said, our DAP program and small package around the world is resonating with our SME shippers as they look for ease and access. So that's excellent. And then I'll just also say in our freight business, we have a DAP like service, which is our forwarding hub, and it's actually well ahead of plan as well. So SMBs are showing that they really need access through the digital platforms, and it's resonating very well.

Hey, Stephen, we have time for one more question.

Our last question will be a follow-up from the line of David Vernon of Bernstein. Please go ahead, sir.

Thank you for getting back to me. I wanted to ask about the pricing environment, which you've described as rational. Could you provide more details on how well the GRI has performed this year? What is the retention rate? Additionally, as you consider the underlying performance in domestic yields, excluding some of the mix challenges, could you discuss the trend or rate of change throughout the quarter?

We anticipated a keep rate of about 50%, and we experienced a 240 basis point increase in the first quarter, which aligns with our expectations. We expect this base rate to persist throughout the year. Carol highlighted some key aspects of pricing, including the fuel component, PSS during peak season, and the focus on commercial, SMB, and healthcare segments. Together, these factors give us confidence in achieving low single-digit RPP in the second half of the year.

Okay. Thank you.

Thank you.

I will now turn the floor back over to our host, Mr. P.J. Guido. Please go ahead, sir.

Thank you, Stephen. This concludes our call. Thank you for joining, and have a good day.