Earnings Call Transcript
United Parcel Service Inc (UPS)
Earnings Call Transcript - UPS Q3 2025
Operator, Operator
Good morning. My name is Matthew, and I'll be your facilitator today. I'd like to welcome everyone to the UPS Third Quarter 2025 Earnings Conference Call. It is now my pleasure to turn the floor over to your host, Mr. PJ Guido, Investor Relations Officer. Sir, the floor is yours.
PJ Guido, Investor Relations Officer
Good morning, and welcome to the UPS Third Quarter 2025 Earnings Call. Joining me today are Carol Tomé, our CEO; Brian Dykes, 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 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 2024 Form 10-K and other reports we file with or furnish to the Securities and Exchange Commission. These reports, when filed, are available on the UPS Investor Relations website and from the SEC. Unless stated otherwise, our discussion refers to adjusted results. For the third quarter of 2025, GAAP results include a net charge of $164 million or $0.19 per diluted share, comprised of after-tax transformation strategy costs of $250 million, which were partially offset by an $86 million benefit from the reversal of an income tax valuation allowance. A reconciliation of non-GAAP adjusted amounts to GAAP financial results is available in today's webcast materials. These materials are also available on the UPS Investor Relations website. Following our prepared remarks, we will take questions from those joining us via the teleconference. And now I'll turn the call over to Carol.
Carol Tomé, CEO
Thank you, PJ, and good morning. I want to express my gratitude to all UPS employees for their dedication and hard work. The third quarter saw many tariff changes, both expected and unexpected, and our team managed these challenges with great skill and resilience. We also made progress on our network reconfiguration, which is essential for the future of our U.S. business. I remain impressed by UPS's determination and commitment to serving our customers and building a more agile company. In terms of results, our consolidated revenue for the third quarter was $21.4 billion, with an operating profit of $2.1 billion and an operating margin of 10%. The cash flow pressures we experienced in the second quarter eased in the third quarter, bringing our year-to-date free cash flow to $2.7 billion. We maintained our focus on revenue quality, though our U.S. average daily volume declined compared to last year. The primary reasons for the U.S. volume decline included a planned reduction in Amazon volume and a decrease in lower-yielding e-commerce volume. However, we saw a 9.8% growth in U.S. revenue per piece during the third quarter. By achieving solid revenue growth and excellent expense control, we improved our U.S. operating margin by 10 basis points, despite a decline in average daily volume of $2.3 million or 12.3%. Conversely, our international business experienced a 4.8% growth in total average daily volume. Our priority remains with our customers, and we efficiently managed our international network, redirecting resources to meet their needs. Export average daily volume rose by 5.9%, marking five consecutive quarters of growth, although changes in trade policy led to a decline in export volume in higher-margin lanes while increasing it in lower-margin lanes. This shift impacted our international operating margin and forwarding business. On a positive note, our healthcare segment showed strong revenue growth year-over-year, supported by our health care logistics solutions. As Brian will delve into the financial performance, I'll share some operational updates. The focus on international trade and supply chain intricacies has intensified, particularly with significant trade policy shifts expected in 2025. At UPS, we connect businesses and customers across over 200 countries, ensuring goods flow smoothly across borders. We are among the largest customs brokers, managing millions of entries annually, powered by our expertise, talent, and advanced technology. Our next-generation brokerage capabilities use AI to process more than 90% of cross-border transactions, ensuring speed and accuracy. Following the removal of the de minimis exemption for U.S. imports, we saw a tenfold increase in daily customs entries. We quickly upgraded our systems to meet the new data requirements. To handle the increased volume and complexity, we enhanced our customs brokerage capabilities with Agentic AI, streamlining formal entry processes. We don't just transport goods; we also reduce friction. By managing regulatory complexities, we help our customers minimize disruptions to global commerce. Thanks to investments in our brokerage sector, we can handle these challenges without incurring additional costs that aren't balanced by revenue. Our goal is to become the top complex health care logistics provider globally. We're making significant strides toward acquiring Andlauer Healthcare Group, which will enhance our capabilities in global healthcare logistics, especially in North America, and we expect to finalize this acquisition in early November. Regarding our digital access program, we currently serve over 8 million small and medium-sized businesses, generating over $2.8 billion in global DAP revenue during the first nine months of the year, a 20% year-over-year increase. We anticipate delivering over $3.5 billion in global DAP revenue for the full year. In relation to our Amazon glide down efforts, we are on track. In the third quarter, Amazon's total volume declined by 21.2%, up from a 13% decline in the first half of the year. In conjunction with this, we are reconfiguring our U.S. network and have closed 19 additional buildings this year, bringing the total to 93. We also completed a successful voluntary retirement program for long-serving drivers wishing to retire. Overall, our network reconfiguration and cost-saving initiatives are on course, and we expect profit improvements from our Amazon glide-down efforts. Moving on to Ground Saver, our average daily volume dropped by 32.7% year-over-year, mainly due to actions taken regarding Amazon and the reduction of lower-yielding e-commerce volume. We've reached an initial agreement with the United States Postal Service to support last-mile delivery for Ground Saver, and we remain confident in finalizing an agreement that maintains our high service standards. Regarding peak season, our top 100 customers generate about 80% of our peak surge, which we expect again this year. Early indications show that they are preparing for a strong peak, which should result in significant volume increases. However, due to the Amazon glide down plan, we also expect overall peak average daily volume in the U.S. to decrease. Operationally, we are set for a robust peak season, influenced by several key factors. Strategic enhancements from our Network of the Future initiative have improved our efficiency, allowing us to reduce reliance on seasonal hires and cut leasing costs. A significant portion of this efficiency comes from automation. We have implemented new automated systems in 35 facilities over the past year and anticipate that 66% of our volume will move through automated processes in the fourth quarter, up from 63% during the same period last year. As we approach the peak shipping season, we will continue to utilize our proven technologies and scale our network as necessary while maintaining our focus on service quality. Our enhancements position us for the most efficient peak season in our history, building on seven consecutive years of industry-leading service. With more clarity on tariffs and strong peak forecasts from our largest customers, we are in a better position to provide guidance compared to the end of the second quarter. As I conclude, I will share our financial expectations for the fourth quarter. We anticipate consolidated revenue of about $24 billion and an operating margin of roughly 11% to 11.5%. Brian will provide additional details on our fourth-quarter outlook shortly. Amid a rapidly changing global environment, UPS is undergoing the most significant strategic transformation in our company's history. We are focused on excelling in critical areas, capturing high-value market segments, and accommodating customers with increasingly complex logistics requirements. Our company is in a strong position with ample liquidity to support our transformation and return value to shareholders. The changes we are implementing are aimed at delivering long-term benefits for all stakeholders. Thank you for listening, and I’ll now turn the call over to Brian.
Brian Dykes, CFO
Thank you, Carol, and good morning, everyone. This morning, I'll cover 3 areas, starting with our third quarter results. Next, I'll discuss progress with the Amazon volume glide down and our network reconfiguration and cost-out efforts. Then I'll close with our expectations for the fourth quarter and capital allocation for the full year. Moving to our results. Starting with our consolidated performance. In the third quarter, revenue was $21.4 billion and operating profit was $2.1 billion. Consolidated operating margin was 10%. Diluted earnings per share were $1.74. $0.30 of EPS came from a sale-leaseback transaction involving 5 properties completed in the third quarter, which resulted in a $330 million pretax gain on sale. This transaction was part of a broader strategy aimed at freeing up capital for reinvestment as we reconfigure our network. The leases are structured to maintain operational continuity for our business. And as a result, we have not adjusted this gain on sale in our non-GAAP presentation. Now moving to our segment performance, starting with U.S. Domestic. In the third quarter, we continued to improve the mix of volume in our network and our disciplined approach to revenue quality meaningfully offset the impact lower volume had on revenue. Additionally, the team did an excellent job managing expense throughout the quarter, resulting in an improvement in U.S. domestic operating margin. For the quarter, total U.S. average daily volume was down 12.3%, primarily due to the glide down of Amazon volume and our focus on improving revenue quality. Total air average daily volume was down 13.9%, mainly due to Amazon. Health care and high-tech customers both showed growth in air average daily volume in the third quarter, which was the third consecutive quarter of positive momentum from these key industries. Ground average daily volume was down 12% year-over-year. Within Ground, Ground Saver ADV declined 32.7% due primarily to the actions we've taken with Amazon and to trim lower-yielding e-commerce volume. As a result, our more premium ground commercial and residential services made up over 84% of our total ground average daily volume in the third quarter. That's the highest percentage we've seen in more than 5 years. Now moving to customer mix. SMB average daily volume was down 2.2% versus last year. However, we continue to see bright spots in SMB health care and automotive as well as growth from DAP, our digital access program. In the third quarter, SMBs made up 32.8% of total U.S. volume, which is about a 340 basis point improvement compared to last year. In the third quarter, B2B average daily volume finished down 4.8% compared to last year due to softness in retail and in manufacturing activity. B2B represented 45.2% of our U.S. volume, which was a 350 basis point improvement versus last year. B2C average daily volume was down 17.6% year-over-year. Moving to revenue. For the third quarter, U.S. domestic generated revenue of $14.2 billion, which was down just 2.6% year-over-year against an ADV decline of 12.3%. Our revenue performance reflects strong growth in revenue per piece and air cargo. In the third quarter, revenue per piece increased 9.8% year-over-year, which was the strongest revenue per piece growth rate we've seen in 3 years. Breaking down the components of the 9.8% revenue per piece improvement, base rates and package characteristics increased the revenue per piece growth rate by 350 basis points. Customer and product mix improvements increased the revenue per piece growth rate by 400 basis points. The remaining 230 basis point increase was from fuel. Turning to costs. In the third quarter, total expense in U.S. domestic was down 2.7%. The decline in total expense was primarily driven by our actions to reduce hours and operational positions with volume. Looking at cost per piece, we were up against a tough comparison from last year. This comparison, together with the costs associated with delivering Ground Saver volume and the contractual union wage increase that went into effect on August 1, resulted in a cost per piece increase of 10.4%. The U.S. Domestic segment delivered $905 million in operating profit and operating margin was 6.4%. Moving to our International segment. Through ongoing shifts in trade patterns spurred by changes in U.S. trade policy, we are continuing to operate our global network with agility to serve our customers. As a result, in the third quarter, International delivered its fourth consecutive quarter of growth in average daily volume and revenue. In the third quarter, total international ADV increased 4.8%, led by Europe and the Americas regions. International domestic average daily volume increased 3.6% compared to last year, led by Canada. On the export side, average daily volume increased 5.9% year-over-year, driven by the agility of our network to adjust to changing trade lanes and led by strength between European countries. As the third quarter played out, we saw a decline in U.S. imports, led by an ADV decline on the China to U.S. lane of 27.1%. Turning to revenue. In the third quarter, international revenue was $4.7 billion, up 5.9% from last year. Operating profit in the International segment was $691 million, down $101 million year-over-year, reflecting pressures from trade lane shifts, product trade down and lower demand-related surcharges. International operating margin in the third quarter was 14.8%. Moving to Supply Chain Solutions. In the third quarter, revenue was $2.5 billion, lower than last year by $715 million, of which $465 million was due to our divestiture of Coyote in the third quarter of 2024. Within Supply Chain Solutions, demand softness in Air and Ocean Forwarding resulted in lower market rates, which drove a decline in revenue year-over-year. Logistics revenue was down year-over-year, driven by a decline in Mail Innovation. This was partially offset by revenue growth in Healthcare Logistics. And UPS Digital, which includes Roadie and Happy Returns, grew revenue by 9.5% year-over-year. In the third quarter, Supply Chain Solutions generated operating profit of $536 million. Operating margin was 21.3%. Our results in Supply Chain Solutions this quarter include the impact of the sale-leaseback transaction, which generated the $330 million one-time gain that I mentioned earlier. Turning to cash and shareowner returns. Year-to-date, we generated $5.1 billion in cash from operations and free cash flow of $2.7 billion. We finished the quarter with strong liquidity and no outstanding commercial paper. And so far this year, UPS has paid $4 billion in dividends. Now let me provide an update on our cost out and network reconfiguration efforts. In conjunction with our actions to significantly reduce the amount of Amazon volume in our network, we are executing the largest network reconfiguration in our history and will remove approximately $3.5 billion in related costs this year. We've made a lot of progress since our last earnings call. Let me walk you through the details. Total Amazon volume was down 21.2% compared to the third quarter of last year. We achieved our reduction target in the portions of the Amazon volume we are exiting, and we grew the portions of Amazon volume that we are continuing to serve. Now let's look at the savings we've generated so far this year. As a reminder, we are tracking our savings within 3 cost buckets. They are variable costs, which primarily capture operational hours, semi-variable costs, which reflect operational positions and fixed costs, which include closing buildings and reducing expense from support functions through our efficiency reimagined initiative. Looking at variable costs. Total operational hours continue to move down with volume. So far this year, we are down more than 16 million hours, and we are on track to reach our reduction target of approximately 25 million hours for the year. Moving to semi-variable costs. Attrition and operational positions accelerated each month during the quarter, and we finished down nearly 34,000 positions year-over-year, which includes a reduction from our driver voluntary separation program. Nearly 1/3 of the reductions occurred in September. In our fixed cost bucket, year-to-date, we have completed the closure of 195 operations, including closing 93 buildings. As we are closing buildings, we are also investing through our Network of the Future efforts. And as Carol mentioned, we've deployed additional automation in 35 facilities. And while we expect to be busy processing volume during peak, we also plan to deploy automation projects in 7 additional buildings in December. Lastly, savings from our efficiency reimagined initiatives continued to accelerate in the third quarter. Pulling it all together, we are making meaningful progress executing our strategy. So far this year, we've reduced expense by $2.2 billion, and we're on track to achieve our 2025 expense reduction target of approximately $3.5 billion. Now moving to our outlook. At the consolidated level, we expect fourth quarter revenue of approximately $24 billion and an operating margin of approximately 11% to 11.5%. Looking at the segments in the fourth quarter. Starting with U.S. Domestic, we expect revenue to be around $16.2 billion in the fourth quarter, driven by the continued volume reduction with Amazon and strong revenue per piece growth. And we expect an operating margin of approximately 9.5% to 10%. In terms of peak, in the U.S., we expect heavier volume earlier in the peak period, and we have 1 additional delivery day compared to last year, which gives us more flexibility. The network reconfiguration and additional automation we deployed through Network of the Future set us up to deliver a more efficient peak and another year of industry-leading service for our customers. In short, we're ready for peak. Turning to International. We expect the dynamic environment we've experienced throughout the year will continue. With this in mind, we expect fourth quarter revenue to be approximately $5 billion, and we expect an operating margin of between 17% and 18%. In Supply Chain Solutions, we expect revenue in the fourth quarter of around $2.7 billion and an operating margin of approximately 9%. Looking at capital allocation for the full year, we expect capital expenditures to be approximately $3.5 billion. We are planning to pay out around $5.5 billion in dividends, subject to Board approval, and we have completed the targeted share repurchase of about $1 billion of our shares. Lastly, we expect the tax rate to be approximately 23.75% for the full year 2025. Before I close, let me comment on our financial condition. UPS is rock solid strong, and we have plenty of liquidity to continue executing our strategy and return value to our shareowners. And following the completion of our acquisition of Andlauer, we expect to end the year with around $5 billion in cash. So with that, operator, please open the lines for questions.
Operator, Operator
Your first question is coming from Chris Wetherbee from Wells Fargo.
Christian Wetherbee, Analyst
Maybe we can start on domestic margins. So obviously, some improvement, but we had a lot of RPP growth in the quarter. So I guess as we think forward, I know there's a mix of cost as well as yield management that we're going to see. And I know you've given us some ranges for the fourth quarter. But generally speaking, where you think you are in the glide down, can you give us a little sense of maybe what we can start to think about for 2026 from a domestic margin perspective?
Brian Dykes, CFO
Thanks, Chris. I appreciate it. And look, I think we're very pleased with both the revenue quality we saw in the third quarter as well as the progress that we're making with the Amazon glide down, and we laid out the activity metrics around that. On 2026, look, we'll update 2026 on the January call when we report fourth quarter. But there are a few things that I think are worth kind of keeping in mind. Remember, we're 3 quarters into a 6-quarter drawdown. So as we lap the year, we kind of come through the first 3 quarters of this year, we will see a sequential increase in Amazon volume as we go into peak because everybody peaks. And then we'll continue to draw down as we go through the first half of next year and the cost takeout will continue as we go through that. The second is, as Carol mentioned, we're taking strategic actions around Ground Saver that will start to take hold next year, and we'll see economic benefit in the back half of next year for that as well. We do anticipate closing Andlauer in November of this year, and we'll update you on the financials as we wrap that into next year, but that's an exciting acquisition to accelerate our health care strategy. And look, we're continuing to focus on growing in the parts of the market that will help us continue to drive revenue per piece growth as well as higher margins as we go into the back half of '26 and complete the Amazon glide down.
Operator, Operator
Our next question comes from the line of David Vernon from Bernstein.
David Vernon, Analyst
So Brian, can you talk a little bit about the exit rate on cost per piece coming out of the third quarter? It seems like this was kind of an inflection quarter where with the buyout and everything else, you probably came out a little bit better than you started and whether we should expect that to accelerate into 4Q? And then it sounds like you guys are saying you found a way to work with the USPS on Final Mile for some of the residential lower rate e-commerce type of stuff. Can you kind of be more specific in terms of what that looks like and how that changes cost per piece?
Brian Dykes, CFO
Sure. Well, first, let me talk about exit rate on Q3 cost per piece, and I'll let Carol comment on the USPS. And there's a couple of things on cost per piece. Look, the cost per piece is on a tough comp year-over-year because this is probably the largest year-over-year comp related to the e-commerce volume that we're exiting. So it has a big mix impact both on rev per piece and cost per piece. As we've gone through the quarter, though, we are seeing some of the best production metrics that we've seen certainly on our inside; I think it's in 12 years, on a preload in 20 years. The investments that we're making in automation that we're deploying through Network of the Future are certainly showing benefits, and we're seeing that come through the cost per piece. The other thing that I'll point out, and I'm sure you saw it in the non-GAAP reconciliation is that we executed on our driver voluntary severance program in the quarter. About 90% of those drivers exited on August 31. And so those savings will start to materialize in the fourth quarter as well. Carol, do you want to comment on Ground Saver?
Carol Tomé, CEO
I'm happy to. David, it's nice to hear from you. To revisit the driver piece, the total cost of the buyout is $175 million, and the annual payback is $179 million. This means the payback period is under one year, which positively impacts our cost per piece. Now, regarding the USPS, as you know, the Postal Service has a new Postmaster General. When Mr. Steiner joined, he immediately began discussions on how we could establish a mutually beneficial relationship among the postal system, UPS, and our customers. The strategy is to utilize their strengths in final mile delivery while we focus on the middle mile. I’m pleased to inform you that we have reached a preliminary agreement regarding volume and rates. We are currently working out the details, which we expect to finalize in the coming weeks and months. By the end of the fourth quarter, we will provide more information. I'm very pleased with our progress and this renewed relationship with the USPS.
David Vernon, Analyst
Is there any way to kind of talk a little bit more about timing and how that kind of affects the domestic margin for 2026? Or is it still too early?
Carol Tomé, CEO
It's too early. We don't expect any benefit in the fourth quarter. It will start, we hope, knock on wood, we can knock it all down by the beginning of the year. And it's not just for our Ground Saver product, which is in our U.S. small package business, but also for Mail Innovations. And we're excited about what that's going to mean to our Mail Innovations margin looking forward. So at the end of the year, we'll give you more color.
Operator, Operator
Our next question comes from the line of Todd Wadewitz from UBS.
Thomas Wadewitz, Analyst
So I wanted to ask, let's see, I mean, I think on your comments in 2Q, you talked about concern on SMB stepping down. I think this was the impact of the elimination of the de minimis exemption that that would have a meaningful impact and then it became a global elimination, not just China and Hong Kong. So can you give us a bit more perspective on how SMB played out versus what seemed to be a lot of concern in 2Q? And then also, when we look at September, how is the impact different in the international business when it became a global elimination versus China, Hong Kong? So yes, on those 2 things.
Carol Tomé, CEO
Sure. If you look at our SMB results for the quarter, we were down slightly year-on-year. But as we look at our performance relative to the market, we took share both in volume and value. So we were pleased with our performance relative to the market and the decline year-on-year wasn't as dramatic as we thought it could be. We are watching the SMBs very closely, though, Todd. Some are doing just fine and managing through the changes in trade policy and some of them, candidly, are challenged. So we've got a close attention to these customers. And let me just give you some data, which is amazing how many shippers are looking for help. In the third quarter, we had 12 trade webinars with more than 8,300 participants. And we've reached out and had conversations with 61,000 customers trying to help them navigate through these changes in trade policy. It's complicated. It’s super complicated. And to your point about the elimination of the de minimis exemption. Well, it certainly played some havoc on some of these shippers, and I'll just make that real for you too, just some data. Back in March, we had 13,000 packages that came into the United States every day that required some sort of a dutiable clearance. And we handled that about 21% was handled with technology, so cleared without any manual intervention. If you fast forward to September, when now it's a global elimination, 112,000 packages a day required some sort of dutiable clearance. And thank goodness, we invested in technology. So we were able to clear 90% of those packages without any manual intervention, which is great, but 10% needed some help. And where they needed some help, they really needed some help because when the global exemption went into place, you might have seen that some mail systems like Royal Mail or Deutsche Post really stopped shipping into the United States, which meant shippers, predominantly consumers who used to use those mail carriers as a way to get packages in the United States came into carriers like UPS or FedEx or others. And many of those shippers, consumer-to-consumer, were naive, and you wouldn't expect them to understand the intricacies of trade policies and they shipped in packages that didn't have the information necessary to clear. And so Kate, you might want to talk about how we worked with those shippers because it was a lot of hard work and effort to work with those shippers.
Kate, Executive
Yes, absolutely. We have been in regular contact with the consumer-to-consumer shippers to assist them in understanding the essential information they need to provide. A significant part of this involved shipping food items. Many families were sending food to each other, which contributed to the challenges during the initial three-week surge in international shipping. Eventually, an exception was made, allowing food and low-value consumer goods to return to the postal service. Since then, we have managed to achieve up to 97% same-day clearance of our goods over the past week and a half. Our focus has been on helping our valued shippers comply with U.S. government requirements.
Brian Dykes, CFO
And Todd, if I could just maybe dimensionalize the impact of that. In the third quarter, that had about a $60 million impact for us. And we estimate in the fourth quarter, the direct impact will be $75 million to $100 million. A lot of this is demand related, right, because the technology allows us to scale our brokerage operations, but there is a demand impact.
Carol Tomé, CEO
And let's be clear on what that cost is. It's really not the cost of clearing. It's the change in trade lanes because as you know, our most profitable trade lane is that between China and the United States. And we saw an over 20% decline in that in the third quarter and expect that will continue into the fourth quarter. Now there's a big meeting coming up this week. So maybe we'll have a little bit more certainty about trade between our two countries, but we're right now forecasting a decline in those trade lanes in the fourth quarter.
Thomas Wadewitz, Analyst
And just to revisit the topic of SMB, do you believe that we have reached a point of stability now, where we shouldn’t be as concerned about a potential drop-off going forward as we were in the second quarter?
Carol Tomé, CEO
As we examine the peak forecast, it provides a clear indication of our current status. Our top 100 customers, primarily enterprise clients, represent 80% of our peak surge. These large customers anticipate a peak surge of about 60% compared to their current volume, consistent with the surges we've experienced over the last three years. They are prepared for peak with sufficient inventory. In contrast, our small and medium-sized business (SMB) customers are slightly behind where they were a year ago. If we consider effectiveness as 100%, our enterprise customers are fully effective at that mark, while the SMB customers providing forecasts are at 99%. There has been some stabilization, but it's crucial to monitor the situation as we move into next year, when the impact of tariffs on SMBs will be fully realized. We are assisting them in adjusting their sourcing and transportation strategies. However, it is wise to remain cautious about the outlook since it's still early in the process.
Operator, Operator
Our next question comes from the line of Ari Rosa from Citigroup.
Ariel Rosa, Analyst
So it was really nice to see the step-up in free cash flow. Carol or Brian, I was hoping you could talk about how you think about kind of the sustainable level of free cash flow after some of these cost-cutting initiatives occur and kind of as you work through some of these shifts in revenue mix?
Brian Dykes, CFO
Yes. Great. Thanks, Ari. It's great to hear from you. Yes, look, we saw the Q3 free cash flow bounce back. There were some timing issues in our Q2 versus Q3 that have kind of worked themselves out, and we expect Q4 to look similar to Q3. Now on your question, though, I think you're exactly right. This is why we're leaning into the parts of the market that we're leaning into is because you'll see that our penetration in B2B was up 350 basis points. Our penetration in SMB was up 340 basis points. We're seeing growth in the areas of the markets where we want to grow. That allows us to drive better returns and better margins. And with the cost takeout and the network efficiency that we're creating through our automation investments, we do expect the business to generate significantly more free cash flow over time. Clearly, we've got a dividend of around $5.4 billion to $5.5 billion, and we expect it to be above that in the very near future.
Operator, Operator
Our next question comes from the line of Jonathan Chaplin from Evercore ISI.
Jonathan Chappell, Analyst
Just kind of a 2-parter. I'm sorry to do 2pers here. But Amazon glide down, I said you're kind of running on track here. You said down 21%. I thought we're supposed to be around 30% at this point. So maybe just help us understand where you are as we think about exit rate in 4Q? And then secondly, it really looks like you're on track with the cost takeout associated with that volume glide down. Can you speak to the cost alignment with the rest of the business ex Amazon? Just given all these changes that you've spoken about already with Rest of World de minimis, maybe some of the SMBs being a little bit lighter in the peak, do you feel like you're on track there as well? Or is there a little bit more catch-up to do on ex-Amazon cost alignment?
Carol Tomé, CEO
Well, on the Amazon glide down, we're winding down the volume that we don't want, and we're right on our plan. But we're growing the volume that we do want. And so that's why the year-over-year decline wasn't as much as we had anticipated at the end of the second quarter. So we're really pleased with that, growing the volume that we want, like returns is good for our business. On the question about cost out, I would say excellent job managing through the Amazon glide down, but we're also driving a heck of a good business. And Abbott, you might want to talk about your production numbers, the best that we've seen in 20 years, 10 years, talk a little bit about that.
Unknown Executive, Executive
Yes, sure. And I think it's really exciting as we look at our network. We're not looking at everything exclusively or uniquely, but as one big network. And of course, we keep finding opportunities for us to bring costs down. So if you think about the buildings we've closed, the operations we've closed, also the 34,000 positions that we've eliminated, that's part and parcel, of course, driven by some Amazon, but also our productivity. So if you think about production across the network, Brian mentioned that our inside operations are demonstrating the best process rates in 12 years. Our hub process rates in 20 years, and then we can go down the list with safety in the decade and other items related to cost. I guess what should give everybody comfort is what we've displayed in the first 9 months, we've also started the stage next year in 2026. So this continues, and we will hit our Amazon targets and our drawdown in terms of cost and productivity just gets enhanced as we first, introduce more Network of the Future projects, but also all the peripheral buildings that we had supporting those upgrades will start to fall off as well as we start to implement Network of the Future. A great example of that is Mesquite, 48,000 hub per hour for us, just opened up 2 weeks ago and prior to that, a similar hub in Texas in SweetWater. So really excited about those additions to the network and, of course, more to come.
Brian Dykes, CFO
And Jonathan, just to put a number to that because I think the third quarter really shows a testament. We started the year saying that we were going to focus on getting the right volume in the network and drive efficiency, and volume was down 12.3%, and we expanded operating margin, and we'll look to continue that trend...
Operator, Operator
Our next question comes from the line of Scott Group from Wolfe Research.
Scott Group, Analyst
I have a follow-up regarding the Amazon situation. When you initially mentioned this, you indicated that it would be reduced by about half by the middle of next year. Is that estimate changing in any way, either increasing or decreasing? Additionally, as we anticipate the next wave of Amazon volume, is there a different mix to consider, and is it more or less challenging to handle from a decremental perspective? Related to that, I'm aware of the $3.5 billion cost reduction this year. What would be the appropriate figure to consider for cost reduction next year?
Brian Dykes, CFO
Thank you, Scott, it's great to connect with you. Regarding Amazon, a portion of the volume is being shifted as they insource their outbound operations. This transition is planned and occurs in a systematic manner. We'll be handing over buildings, and there’s a coordinated effort involving vehicles and personnel that will happen simultaneously, location by location. Everything is on schedule, and we are collaborating closely with them. This strong partnership is reflected in our service performance for both our operations and theirs. Additionally, Amazon will continue to be a significant customer with opportunities to enhance their supply chain, especially in areas like returns and supporting small business sellers on their platform. Though we anticipate a decrease in volume next year, the overall transition will unfold over time. We will reassess cost reductions in January as we progress, and Nando's team is effectively managing the transition of these operations, consolidating efforts, and investing in our network, allowing us to maintain similar efficiency levels in the upcoming year.
Carol Tomé, CEO
The cost categories will remain the same: variable, semi-variable, and fixed costs. You can expect this to continue into the next year. We will provide further details at the end of the fourth quarter.
Operator, Operator
Our next question comes from the line of Jordan Alliger from Goldman Sachs.
Jordan Alliger, Analyst
Just wanted to come back to international. Maybe some additional thoughts around your international trade flow analysis. Now that the rest of de minimis has gone, when we sort of lap Liberation Day next year, could we get back to more normal sort of trajectories or patterns? Or is it permanent shifts? And then just along with that, what does it take to keep international margin more sustainably in that high-teen level you guys have been used to? And that's with an eye towards 2026 as well.
Brian Dykes, CFO
Sure. Thanks, Jordan, it's good to hear from you. Regarding international trade flows, as Carol mentioned, we noticed a slowdown during the third quarter, especially in September with de minimis. There is still considerable change happening globally, with lots of movement occurring. We are experiencing significant growth outside the U.S., but trade is not impacting the U.S. as it used to. Looking ahead to next year and considering margins, we anticipate some lasting changes until the system stabilizes and a new equilibrium in trade flows is established. I believe that achieving a mid- to high-teen margin for international operations remains the target, but we need trade flows to stabilize in order to reach that goal.
Carol Tomé, CEO
Well, what Kate and her team have done is really operationalize the change in trade flows. In the third quarter alone, you did 100 different operational changes to make sure that we could meet the needs of our customers as trade flows are changing. And we're investing ahead of some of this. You might talk, Kate, about what you're doing in Asia. We've mentioned this before, but just remind everyone what we're doing in Hong Kong and in the Philippines.
Kate, Executive
Yes, absolutely. And so to unlock that growth, we're a global network with a global portfolio, and we're seeing the return on the investments we made in Asia, expanding our service, fastening our time in transit. So if you look at, say, the top 20 export lanes, non-U.S., 16 of them are growing and growing very nicely. A lot of them are Asia to either Asia, Asia or Asia to Europe and reverse. So that's really the expansion. Customers have needs. They are shifting trade. And within there, I will tell you, we see the small and medium-sized businesses in international growing 9% in many regions of the world. So that also will help us with momentum for next year.
Operator, Operator
Your next question is coming from the line of Bruce Chan from Stifel.
Bruce Chan, Analyst
Nice to see the results in the guidance here. And maybe just on that last point, I'm guessing that since the books closed and since you built your guidance in fourth quarter budget, we've got yet another variable with the government shutdown. Wondering if that is contemplated in the guidance? And if not, is there any downside to the range in terms of demand or service or operations, especially with regard to ATC and payrolls and consumption?
Carol Tomé, CEO
Yes. So we don't have a real crystal ball here. We're watching this closely, obviously, particularly as it relates to the airlines. So far, we've seen no disruption of service, but we're watching this very closely because we all are reading the stories about what's happening with people not showing up to work. From a volume perspective in the United States, here we are at the end of October, and we're right on where we thought we would be, if not a little bit better. So we haven't factored in any significant impact to the peak season because we rely on what our customers are telling us and our customers are telling us those from peak that they're going to have a good peak. So we haven't factored any of that in. But of course, it's smart to always think about what could happen. Hopefully, there will be a resolution soon as we should hope for.
Operator, Operator
Our next question comes from the line of Ken Hoexter from Bank of America.
Ken Hoexter, Analyst
It appears that the 300 basis points improvement in domestic performance is perhaps slightly higher than usual, particularly regarding the target of reaching 9.5% to 10%. I'm trying to grasp your perspective on the possibility of accelerating cost-cutting benefits beyond the typical trend as we approach the fourth quarter and into 2026. Additionally, as we head into next week, the Supreme Court hearings on tariffs will begin. What are your initial thoughts regarding the potential impact on de minimis? Is there a chance that this could reverse, affecting areas outside of China, like Hong Kong Lane? Any insights you have on the Supreme Court process would be appreciated.
Brian Dykes, CFO
Sure. Well, let me talk about the sequential impact first. So Ken, if you go from Q3 to Q4, remember, as Carol said, we have been working closely with our customers, and we expect peak to be in similar shape as it has in the last 4 years, right? So we'll see about a 20% step-up in sequential ADV in the U.S., about 10% in international. Now also, there will be holiday demand surcharges that have been announced. Our take rate on those has been good. Even though there's one incremental day in the peak season, we're still balancing demand and expect to see good take on the holiday demand surcharges. On the cost side, remember, we've been investing in deploying automation throughout the year, with the Network of the Future. There have been 42 new automation projects live by the time we start peak. And part of the function of bringing down the water level in the total U.S. network is it allows us to run more efficiently. So you need less variable capacity, fewer leased aircraft, fewer rented vehicles, fewer seasonal workers that allows you to run a much more efficient network. And we're excited. We think it's going to be one of our best service and production peaks that we've had in a long time.
Carol Tomé, CEO
On the Supreme Court question, we will be monitoring it closely. However, we are not in a position to speculate on the outcome.
Operator, Operator
Your next question comes from Brian Ossenbeck from JPMorgan.
Brian Ossenbeck, Analyst
Just one quick follow-up, first on the USPS. In the last quarter, Carol, you mentioned some density challenges. It seems those are likely still affecting us in the third quarter, and I would assume they will continue into the fourth quarter. Could you clarify that? And then, Brian, can you provide more insight into how you anticipate revenue per piece will perform in the fourth quarter and as we end the year? There are many factors at play, including changes in product services and mix dynamics, but it appears there is still some positive momentum from base rates and a slight benefit from fuel. Insight into those three aspects of the trend would be appreciated.
Carol Tomé, CEO
On the Ground Saver product, density continues to be a challenge. We just can't seem to get more packages per stop on these residential deliveries. This is one reason why we're very excited about our renewed relationship with USPS. We estimate that the cost drag in the third quarter was about $100 million.
Brian Dykes, CFO
We have successfully overcome additional costs to drive margin expansion. Regarding your point on revenue per piece, we are seeing robust improvements in our base rate for revenue per piece. We anticipate that for the fourth quarter, it will be slightly over 6%. Initially, we had projected a full year rate of 6%, so we are coming in higher than that expectation. This increase will be reflected in the base rate and slightly less improvement in the mix for the third quarter as we overlap with some actions we took last year concerning Chinese e-commerce shippers, along with strong demand during the holiday season.
Operator, Operator
Our next question comes from Ravi Shanker from Morgan Stanley.
Ravi Shanker, Analyst
So you obviously had a lot of traction with headcount reduction in both the building side and the driver side. The union is saying that kind of you guys have committed to net job increases through the course of the contract. So how do you see that playing out in the remaining 2.5 years of the contract? And would you have to start hiring again to make up for that difference?
Carol Tomé, CEO
We are in compliance with the terms of our contract. And Brian, you might want to give a little bit more color there.
Brian Dykes, CFO
Sure. And Ravi, part of the terms of the contract allow us to offer full-time positions to part-time employees in order to give them the ability to go part-time to full-time, which look is, quite frankly, that's the best outcome for us, right? We want to create lifetime jobs and good careers with people who can earn a solid income with benefits at UPS. So the way the contract works is we offer full-time positions to part-time employees. From a net headcount standpoint, it doesn't really change things, but it's a way for us to create career pathing. It's good for the union. It's good for our people. It's good for us. It helps us have more trained workers that are committed to UPS.
Carol Tomé, CEO
And sometimes there's messaging that's confusing on this point. So if you read something that's confusing, just call us, and we'll clarify it.
Operator, Operator
Our next question comes from Stephanie Moore from Jefferies.
Stephanie Moore, Analyst
I wanted to discuss the add-backs, particularly in the U.S. domestic segment for the quarter. Could you break down the difference between the add-backs that went from $66 million to $302 million during the quarter, specifically focusing on the major components of those add-backs?
Brian Dykes, CFO
And Stephanie, just to clarify, you're talking about the non-GAAP adjustments.
Stephanie Moore, Analyst
That is correct.
Brian Dykes, CFO
As Carol mentioned, we implemented our driver voluntary separation plan during the quarter. Approximately 90% of the drivers exited on August 31. About 80% of that charge is related to the severance included in this plan. In the second quarter, we provided a range of $400 million to $650 million for the total network reconfiguration and efficiency reimagining program. We are still within that range.
Carol Tomé, CEO
And I think just to make it real, we had $166 million of cost in the third quarter for the driver buyout against a total cost of $175 million. So we won't see that same amount in Q4.
Operator, Operator
And Matthew, we have time for one more question.
Conor Cunningham, Analyst
So I think you said you had 195 operations that have been reduced and then 93 buildings that have been closed. I was hoping you could talk about how that may trend into 2026. Like are we expecting that to continue to ramp up? Or it seems like there's further opportunities. So if you could just talk about the opportunity just in terms of getting more efficient on the network.
Carol Tomé, CEO
Sure. Well, the Amazon glide down continues. We're 3 quarters in a 6-quarter glide down. So the Amazon glide down continues, which means there will be further consolidation of buildings. At the end of the fourth quarter, we'll provide guidance for 2026 or our outlook for 2026, where we can be more specific on what that looks like.
Operator, Operator
Thank you. I will now turn the floor back over to your host, Mr. PJ Guido.
PJ Guido, Investor Relations Officer
Thank you, Matthew. This concludes our call. Thank you for joining, and have a good day.