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

Good morning, and welcome to the UPS Second Quarter 2023 Earnings Call. Joining me today are Carol Tome, our CEO; Brian Newman, our CFO; and a few additional members of our executive leadership team. Before we begin, I want to remind you that some of the comments we'll make today are forward-looking statements within the federal securities laws and address our expectations for the future performance or operating results of our company. These statements are subject to risks and uncertainties, which are described in our 2022 Form 10-K and other reports we filed with or furnished to the Securities and Exchange Commission. These reports, when filed, are available on the UPS Investor Relations website and from the SEC. Unless stated otherwise, our discussion refers to adjusted results. For the second quarter of 2023, GAAP results include after-tax transformation and other charges of $106 million or $0.12 per diluted share. A reconciliation to GAAP financial results is available on the UPS Investor Relations website, along with the webcast of today's call. Following our prepared remarks, we will take questions from those joining us via the teleconference. [Operator Instructions]. And now I'll turn the call over to Carol. Carol Tomé: Thank you, Ken, and good morning. Let me begin by commenting on our agreement with the Teamsters. We believe this contract is a win-win-win. Together, we reached agreements on the issues that were important to Teamster leadership, to our employees and to UPS. We have the best people, and our new contract continues to reward our employees with the best pay and benefits in our industry. I'll share some highlights of the new contract in a moment. The second quarter was challenging, and I'd like to recognize the more than 500,000 UPSers around the world for their hard work and effort and…

Thanks, Carol, and good morning. Let me begin by echoing Carol's comments on how pleased we are no achieving a win-win-win labor agreement covering our more than 300,000 Teamster employees. This contract provides UPS a significant measure of certainty around labor, gives us operational flexibility to increase productivity and continue providing industry-leading service to our customers, and it will help us attract and retain the best employees in the industry. Now in my comments today, I'll cover 4 areas. I'll start with the macro, followed by our second quarter results. Next, I'll cover cash and shareholder returns. And lastly, I'll provide some comments on the second half of the year. In the second quarter, the overall macro conditions in the U.S. were in line with our expectations. Internationally, conditions were a little worse than we expected due to lower growth in both real exports and industrial production. Moving to our financial results. For the quarter, consolidated revenue was $22.1 billion, down 10.9% from last year. All 3 of our segments demonstrated agility and on a combined basis, drove down total expense by $2.1 billion in the second quarter year-over-year. This enabled us to deliver $2.9 billion in operating profit, which is the target we communicated to you last quarter and was a decrease of 18.4% compared to last year. Consolidated operating margin was 13.2%, a decline of 120 basis points compared to the same period last year, with all 3 segments achieving double-digit operating margins. For the second quarter, diluted earnings per share was $2.54, down 22.8% from the same period last year. Now let's look at our business segments. In U.S. domestic, our disciplined approach to revenue quality partially offset the decrease in volume. As volume declined throughout the quarter, the team did an excellent job adjusting the network…

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

So Brian or Carol, I just want to understand kind of at a high level, what we should be expecting about the shape of inflation over the course of the contract. I know we're probably not going to get into too many of the details today, but I'd love to understand kind of from a CAGR perspective how you're set up for inflation over the life of this contract. Carol Tomé: Well, maybe I'll just start with some observations about the contract. And then Brian, you can provide details on the shape of the curve. As we got into the negotiations, David, it became very clear to me that we were negotiating on behalf of a number of stakeholders. We were negotiating on behalf of our people. We were negotiating on behalf of our customer. We were negotiating on behalf of our country. We were negotiating on behalf of our shareowners, and we were negotiating on behalf of UPS. And as I look at the handshake agreement that we achieved, I think we have a win-win-win for all stakeholders. I'll make that real for you. First, in terms of our people, they will continue to be paid the highest wage and benefits in the industry. We'll have better work-life balance, and the working conditions will also be improved as we'll be adding air conditioning among package cars starting January. For our customers, we avoided a work stoppage, and that would have been disruptive for them and for their customers. So I think that's a win. For our country, as you know, we move 6% of the U.S. GDP every day, and there was no place for this volume to go. So we avoided a disruption to the economy with this handshake agreement. For our shareowners, I would say we also have a win, because as I look at the economic package over the 5 years, the compounded annual growth rate of this economic package is 3.3%. So I say that's a win. And for UPS, we retain the flexibility we need to take care of our customers to provide seasonal health during the holidays to add technology to drive productivity and efficiency. So I think it's a win-win-win. And maybe, Brian, you can talk about the shape.

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

All right. And thanks for that. And maybe just as a quick follow-up. Can you talk about what you need to do to win back some of the volume that you might have lost a contract uncertainty? I'm just wondering kind of how quickly you guys are expecting that to come back as we look into the -- what's baked into guidance. Carol Tomé: So it's all hands on deck to win back the volume that was diverted as a result of the labor negotiations. The first thing we did is that we stood up a control tower. This is the same kind of control tower that we use during peak to ensure that we can onboard this volume coming back without disruption. So that is up and running, and I'm very pleased with what I'm seeing in that regard. We have, of course, mitigated all the risk that was still remaining because we didn't know the outcome of the contract. So those high-risk customers are now shipping with us without any risk. From a marketing perspective, we're doing a number of things. The first thing we're doing is we're amplifying our service message because we do have the best service in the industry. We are also amplifying our SurePost advantage because this is a very attractive product that you're shipping low-weight packages. We are expanding our speed campaign because we are faster than our largest competitor in many, many markets. So we are amplifying our speed campaign. We are also expanding our weekend pickup to four markets. We are expanding our Saturday delivery by 890 postal codes. And we are launching new offerings inside Deal Manager, which is the tool that we use to win new small- and medium-sized businesses. There's a lot of effort underway to bring back this business that we lost and to win new business. Now I will tell you, it's not all going to happen at once. And so we understand that. We're working with our customers to bring it in as it can, but also as smoothly as we can for them as they've diverted. Looking at our volume in July, I will say that it was still down year-on-year, but not as much as the decline that we saw in June.

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

Maybe just a little bit, Carol, your thoughts into the peak season here. Maybe outside of the diversion, what was underlying in your thoughts here? And I think Brian mentioned still expecting negative all the way through the end of December. So maybe just a little bit of thoughts on the backdrop and the differences between the contract and what's going on economically. Carol Tomé: Yes. We'll still have a peak even though we're winning back those volume that was diverted over time, we'll still have a peak. We are collaborating with the top 100 in customers that represent 87% of our peak surge. So we're already starting to work with them on their operating plans for peak. Peak will be 21 days this year, the same as it was last year. We expect to see search in the 60% area this year. So it's still going to pick up. It's just from a different volume level. And we're well prepared to take -- to have another peak for us. It's just another day with more volume.

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

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

Amit, thanks for the question. So from a guide perspective, we went from $97 billion to $93 billion in revenue. That's a $4 billion change. About $1 billion of that is from the softer volume Carol talked about in the second quarter, the higher diversion and about $3 billion is coming from the second half, as we think about volume and exiting the second quarter, down 12. You'll remember, in March and April, we were down 7, but June exited at minus 12. So if we take that minus 12 exit and you get to flat by the end of the year, that glide over the balance of the year is about -- it's down mid-single digit, down about 6%. From a profit standpoint, we dropped about $1.4 billion in profit to $11 billion or 11.8 margin. And most of that is coming from the domestic side, about $1 billion. That $1 billion, Amit, is split fairly evenly between wages and then also the lower volume I just referenced. There was a $400 million piece related to some inconsistent recovery in the euro inflation and interest rates. Germany's in a recession and a bit of Asia, but the vast majority is really split, half and half between wages and volume. Carol Tomé: And on the monthly cadence, we were down 12% in June. And down double-digit in July, but better than 12%.

Right. Right. Carol Tomé: On your question about margin. As we got into the negotiation with Teamsters, and this is true for any negotiation, there are some things that are very important. And one thing that was very important for Teamster leadership was to front-load some of the wage inflation. And we agreed to do that. So that does put a little pressure on the margin, as Brian pointed out. But that doesn't change the destination. It just changes the journey. We'll have a bit of pressure for the next year, through August of next year but then the inflation is very manageable. So I see a path back to 12% or higher margins in the U.S. because of all the investments that we're making to drive productivity. And a good proof point of that is what we did in the second quarter. So let me give you an example of just one of our initiatives, which is Smart Package, Smart Facility. We're now in over about 50% of the buildings in the United States. And 50% of those buildings have misload improvements from 1 in 400 to now 1 in 1,000. So as the buildings mature, they get better and more productive. As we think about the next phase of Smart Package, Smart Facility, we're moving from where the pre-loaders are scanning the package to where the car is going to scan package. So think about the productivity that we will enjoy then. So it doesn't change the destination, just the journey. We plan to have an investor conference in the spring of '24. We haven't landed on a date yet. But during that investor conference, we will lay out 3-year targets, so you can understand the journey to get to a 12%-or-higher margin in the U.S.

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

Carol, I just want to see if you can expand a little bit on the productivity efforts in Smart Package, how we should think about that? I know a lot of the investment was going into this year. You're talking about 900 facilities in by the end of October. Does that productivity start to accelerate from here? How should we think about that in terms of an offset to some of the wage inflation going forward? Thanks. Carol Tomé: Yes. So Smart Package, Smart Facility is just one of the levers in our productivity toolkit. Our network planning tools are powerful tools. They are powered by machine learning and AR. And if you think about it, we've just really completed the rollout of network planning tools in 2020. So every year, we get better because the tools get better. And think about what the tools were enabled us to do in the second quarter. When we saw the volume starting to slow down and actually divert, we were able through our tools to move volume away from unautomated hubs to automated hubs. And let me make that real for you. Last year, of the volume that was started by our hubs in the United States, about 53% went through an automated hub. This year, 57% of the volume went through an automated hub. So the tools are making us more effective. And then, we are introducing new technology inside of our buildings to make us more effective like automated label application and automated bagging and robotic small sort induction. And I can go on and on just kind of gig out on the tools, but it's a complement of tools that will help offset some of the wage pressure that we will see over the next year.

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

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

Yes, Brian. Thanks for the question. So look, every year, we evaluate the GRI to provide the right service at the right price for our customers. This year, we had guided to roughly a 500-basis point improvement in rate, and then we had expected about 200 basis point headwind in fuel to land at about 3%. So we're staying with that guide for this year. Brian, coming up here in the fall, we'll take a look at next year but the thing I would leave you with is we remain very disciplined on revenue management, and we'll continue to deliver value for the service we provide. Carol Tomé: And on our SurePost product, it compares very favorably to the [indiscernible] product, and we're going to continue to invest in that product. We like it a lot because of the delivery density associated with that product.

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

Carol, can you give us a little more color on the $7 billion sales pipeline? Kind of what kind of customers, what kind of end markets? I haven't heard you guys talk about a sales pipeline before too often. How is that kind of building up or kind of expect it to come through over time? And also, can you give us an update on your largest customer at least and kind of any changes to that relationship/volumes there over the course of the potential kind of union docks? Thank you. Carol Tomé: The sales pipeline is across all customer segments with a real focus in the commercial area, small and medium sized business, of course, health care and enterprise. You name it, we're going after it. Our sales team are really excited about selling the value that we have to offer, which is just the best service in the industry. We've also identified about 50 customers that are target customers for our new pricing architecture, which we call Architecture of Tomorrow. The new pricing architecture doesn't fit everybody, but it does fit some where based on their shipping needs, we could add pricing modifiers like day of week or Cube or ZIP code plus 4. So these pricing modifiers are very interesting to these targeted customers. And it won't be for everybody, but for some so we're going to lean into that in a big way. And as it relates to our largest customer, we have a very good relationship with our largest customer. And the businesses is operating as we would expect it to be. We're on a glide path, but not a glide out.

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

I was wondering if you could comment on the 1.2 million packages per day. And how you think that comes back? I guess maybe the bigger question is does all of it come back and maybe how long does it take to get there? And then, Brian, you've given us some help in the past on sort of quarter-to-quarter margin dynamics as we think about getting towards that full year number. Is there anything we should be thinking about 3Q versus 4Q? I know volatility volumes will be a little bit better in the second part of the back half of the year, but just curious about how that cadence might look. Carol Tomé: Well, the 1.2 million packages per day is about 1 million of diverted volume. In other words, volume that we had that diverted elsewhere, and about $200 million of sales that we couldn't pull through because of concerns about the outcome of the labor negotiation. As Brian commented, we think by the end of the year, we will pull back everything that diverted. And I think we're going to win that extra 200,000 packages as well. It doesn't happen overnight, of course. It's already starting to flow back in. But we think by the end of the year, we'll win it all back.

And Chris, just with respect to the phasing, we're really focused on the second half and the full year guide, but I would say both top line and profitability. Q3 will be more challenged than Q4 due to the ADV growth rates and seasonality. And we've got some one-time costs in the third quarter. So I would just think of Q4 being a bit stronger than Q3. Carol Tomé: And you might ask, well, where does that volume go? And so we don't have great intelligence there, but we do have some market share intelligence through a tool that we use from Nielsen IQ. And what that would tell us it's not perfect. But what I would tell us is that 1/3 went to the Post Office, 1/3 went to FedEx and 1/3 went to the regionals. So that actually directs our activities as when we think about how to win that set volume back.

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

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

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

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

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

Jeff, so 3.3% is an all-in number, so it includes wages and benefits of the two net together. Rather than go into a lot of detail on this call, I'm going to host a call shortly after ratification, and I'll take you through all the details at that point. Carol Tomé: We can go line by line at that.

I can go very deep then. Carol Tomé: But we want to respect the ratification products.

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

I wanted to see if you could help us to think about kind of volume versus price. It seems like both are important, but they're kind of related, right, if you go for more price to offset higher inflation, then it could be a headwind to what you do on volume. So how do you think about managing between those two? And then, I guess, that feeds into -- you've given us a lot to work with for 2023. But I think there's probably a lack of visibility for '24, whether should earnings be up in '24, obviously, we'd like to see that, but you've got through August, that headwind. So any broad commentary about how optimistic you might be on '24 in terms of domestic margin or earnings overall? Thank you. Carol Tomé: Well, we run the business as a portfolio. So we want both. We want volume and we want price, but price doesn't necessarily mean price increases. It means moving into segments that value our end-to-end network and have different products. So we run it as a portfolio. We want both. That's the easy answer to that question.

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

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

I appreciate the time here. Carol, the DAP rollout has been very successful this year. And I know it's early to start thinking about 2024. But as far as what the longer opportunity is, does growth start to slow for that channel now that you've kind of reached critical mass? Or do you still see quite a bit of opportunity there? And then, Brian, just to follow up broadly on e-commerce demand trends. Have we kind of turned the corner there, or are we still seeing a bit of an air pocket in terms of spending? Thank you. Carol Tomé: So thanks for your comments about DAP. We're very pleased with that product, and we see nothing but growth ahead. Global growth. We are just scratching the surface when we think about DAP outside of the United States. And we continue to add new partners here in the United States, now up to 27 partners. One thing we're doing to continue to grow DAP is to make it easier to onboard the platforms. So we are introducing widgets, which are basically pre-programmed applications that a DAP partner can put into its website and avoid the user interface and API onboarding that can slow things down. The first widget that we introduced is a locator widget. So our DAP partner can put the locator widget into its website, and then you push a button and up pops the closest UPS store to ship that package. So we're going to continue to make it easier to do business with as we continue to grow with this important part of our business.

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

Yes. We're looking at ESMO improving in the back end of the year. So from a macro standpoint, I think the trends are stable to improving in the U.S., obviously, under some more pressure internationally. Carol Tomé: I mean clearly, what happened with e-commerce is the blew up during COVID-19. It blew up. And so now everything is kind of reverting back to where it was before COVID. We see that around the globe, which makes sense. And so this is a great place to think about growth from here on out.

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

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

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

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

I'd want to touch a little bit on kind of your automation efforts as part of your ongoing productivity tools. I think you said last year, it was 53% went through some form of an automated hub, this year at 57%. Do you have kind of a line of sight on where that can go over time? Carol Tomé: We do. We're going to come back in the spray at our Investor Conference and give you our sense of what we're calling network of the future. It's a very exciting opportunity for us to really automate this business. The good thing is we don't have to integrate our network because we're integrated. But we can do a better job of automating, and so we'll come back and give you all of that in the spring of next year.

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

This is Eric Morgan on for Brandon. Thanks for taking my question. I just wanted to ask a follow-up on SurePost. Maybe could you give us an update on how much you're redirecting in the network today? And maybe you could fill us and if this was the topic of the labor negotiations. And if you did need to start in-sourcing more kind of on an accelerated basis, what kind of potential cost implications or inefficiencies there could be? And maybe some offsets there as well. Thank you. Carol Tomé: Sure. So we were redirecting a little under 40% at the end of the second quarter. It was a point of the negotiations. We'd agreed to redirect 50%. No problem at all with that. No concern about cost because the delivery density with SurePost is really, really good.

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

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

Hi, Amit. The barbell shape of the contract, the $500 million is a gross number. We had assumed originally about $500 million, so it's actually 2x, what we thought. Carol Tomé: And on the acquisitions that we've made, we couldn't be happier because they are giving us enabling capabilities from a Delivery Solution greeting product from us [indiscernible], which is creating cold chain logistics for us in parts of the world that we didn't have that. So I couldn't be happier. And I don't want to miss out any of the companies that we've acquired. So we're pleased with Rhodium, what it's providing for us as well. They're enabling capabilities. And as we look ahead, expect us to continue to acquire enabling capabilities, particularly in those areas that we really want to own. Health care logistics would certainly be one of those. Technology investments that give us platforms to accelerate the digital experience for our customers, absolutely expect us to lean into that space. And we'll be giving you updates as we go.

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

I just want to tie together a couple of things from before. As you think about regaining that 1 million packages that was diverted and you think about your pricing path going forward, do you have to lead with price in the next 6 months to win the diverted traffic and then think about pricing from a new starting point in 2024? Or do you think it's strictly service your relationships? And that package flow will come back to you without adjusting the way you think about the revenue management? Carol Tomé: We don't think we have to lead with price. Our customers did what they thought they had to do to protect their customers, but they're very happy with us. So it's about operating plans, making sure they come back to us without disruption to their business. That doesn't happen overnight. It's going to take a while, but we can bring that business back because of what we provide to them.

All right. I want to thank everybody for joining us this morning. We look forward to talking to you soon, and that concludes our call.