United Parcel Service, Inc.

Good morning and welcome to the UPS fourth quarter 2022 earnings call. Joining me today are Carol Tomei, 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 2021 Form 10-K, subsequently filed Form 10-Qs, 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. In less stated otherwise, our discussion refers to adjusted results. For the fourth quarter of 2022, GAAP results include a non-cash after-tax mark-to-market pension gain of $782 million, a one-time non-cash after-tax charge of $384 million, resulting from accelerated vesting of restricted performance units in connection with the change in incentive compensation program design. a non-cash after-tax charge of $58 million from a reduction in the residual value of our MD-11 aircraft, and after-tax transformation and other charges of $41 million. The after-tax total for these items is $299 million, a benefit to fourth quarter 2022 EPS of 34 cents per diluted share. Additional details regarding year-end pension adjustments are included in the appendix of our fourth quarter 2022 earnings presentation that will be posted to the UPS Investor Relations website later today. 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. If you wish to ask a question, press 1 and then 0 on your phone to enter the queue. Please ask only one question so that we may allow as many as possible to participate. You may rejoin the queue for the opportunity to ask an additional question. And now, I'll turn the call over to Carol.

Thank you, Ken, and good morning. Let me begin by thanking UPSers for delivering what matters to our customers this holiday season. In the quarter, we were faced with choppy demand, continued COVID lockdowns in China, a threat of a rail strike in the United States, and a bomb cyclone in North America. But no matter what came our way, our team delivered. We executed another outstanding peak and delivered industry-leading service for the fifth consecutive year. I am very proud of our team and what we accomplished, not just in the quarter, but for the entire year. Looking at our fourth quarter results, we expected volume levels to decline from last year, and they did, but more than we planned due to macro conditions that Brian will discuss. We responded by managing our network with agility and a focus on service. Consolidated revenue was $27 billion, down 2.7% from last year, and operating profit was $3.8 billion, a decrease of 3.3%. While our consolidated operating margin declined by 10 basis points from last year to 14.1% our US operating margin expanded to 12.8% and reached a level not seen in 10 years. Reflecting back on 2022 much changed from when we originally set our plans. We experienced geopolitical tensions, including a war, and global inflation drove food and energy costs higher. We saw both relief and concern as China pivoted away from its zero-COVID policy. Global supply chains continued to adjust, and demand and pricing for air and ocean freight softened accordingly. Consumers returned to pre-pandemic shopping behaviors as retailers have been successful in attracting consumers back into stores. And we won't even talk about the weather, which candidly presented challenges throughout the year. Even in the face of so much change, UPSers remain focused on controlling what we can control. And we delivered our full-year consolidated operating margin and return on invested capital targets. In 2022, consolidated revenue increased 3.1% to reach $100.3 billion. We missed our revenue target by about 2%, but as Brian will detail, nearly all of this miss was due to a stronger dollar than originally anticipated. Consolidating operating profit in 2022 totaled $13.9 billion, 5.4% higher than last year. and consolidated operating margin reached 13.8%. We generated $9 billion in free cash flow, and diluted earnings per share were $12.94, an increase of 6.7%. During the year, we stayed on strategy, customer first, people led, innovation driven. As we've discussed, customer first is about creating a frictionless customer experience targeted at certain customer segments, including SMBs and healthcare. Since its inception, we've had huge success with DAP, our digital access program, in making it easier for SMB customers to do business with UPS. In 2022, we generated more than $2.3 billion in DAP revenue, exceeding our target. We expect the momentum to continue. and plan to generate around $3 billion in global DAP revenue in 2023. And with the launch of DealManager in 2022, we've made progress toward dynamic pricing. DealManager digitizes the pricing process and applies pricing science to present the right offer to our SMB customers the first time, so we are able to close deals faster and with better revenue quality. In 2022, our US win rate with DealManager was 22 percentage points higher than the baseline. So we are moving quickly to expand access to DealManager to more than 40 countries in 2023. Additionally, we recently launched a pilot that enables systematic day of week pricing, which is good for our customers and good for UPS. Early feedback is promising. and we'll share more updates on this pilot on future calls. Looking at SMBs, they made up 28% of our total U.S. volume in 2022, an increase of 120 basis points compared to 2021. Turning to healthcare, in 2022, our healthcare portfolio reached $9.2 billion in revenue, and the quality of our offerings was best in class. Our goal is to become the number one complex healthcare logistics provider in the world. Today, we have nearly 17 million square feet of healthcare compliant distribution space globally with leading cold chain logistics capabilities. In 2023, we expect our healthcare portfolio to generate more than $10 billion in revenue. We don't just look at volume and revenue to measure our success. We also look at our net promoter score. In 2022 the improvements we saw in our net promoter score outpaced the competition, we made strong gains and all 16 customer journeys, including the three most important negotiate value reroute a package and resolve a claim, we are well on our way to our nps target of 50. Turning to people lead here we are focused on the employee experience and making ups a great place to work. For our frontline employees, we made organizational design changes to address certain work-life balance challenges. We've stepped up maintenance spending in our buildings, including updating break rooms and restrooms, refreshing paint, improving lighting, and adding cooling stations. And for our management employees, nearly 40,000 around the world, we've been laser focused on improving our likelihood to recommend score, or LTR. When I started with the company, LTR stood at 51%. It is now 60%, and we would like it to be 80% or higher. In looking at the drivers of dissatisfaction, the largest area of concern was pay. Not the total amount of pay, but rather the pay mix structure. So we've taken action to fix it. Beginning in 2023, we are changing the pay mix structure by increasing the cash component. This shift does not change total compensation for our management employees, but does increase cash. We also accelerated the vesting of stock awards associated with our annual bonus plans. This was a one-time non-cash charge. Beginning in 2023, management incentive plan annual bonuses, if earned, will be paid in cash. Regarding our upcoming labor contract negotiation, we are well prepared for negotiations and are focused on achieving an agreement that is a win for our employees, a win for the Teamsters, and a win for UPS and our customers. We have great jobs with industry-leading pay and benefits. Now I suspect many of you listening today would like details of our negotiating strategy. Well, we believe the best way to achieve a win-win-win outcome is for us to leave the details of the negotiations at the bargaining table. So let's move on to the last leg of our strategy, innovation-driven. We believe innovation is one reason we've been able to provide our customers with industry-leading service for five peaks in a row. By leveraging the agility and efficiency of our integrated network, our engineers and operating teams quickly make decisions to adjust the network and keep service levels high. This year, we supplemented our engineering tools with our total service plan, which further improved our on-time network and drove productivity. In the fourth quarter, hours deployed in the US dropped 5.3%, which was greater than the decrease in volume. And in terms of cube utilization, our efforts in the fourth quarter enabled us to eliminate nearly 1,500 trailer loads per day. We are relentlessly focused on making our network even more efficient. We were very pleased with the initial results of our Smart Package, Smart Facility RFID initiative, where we are seeing fewer misloads and higher productivity. As a result, this year we plan to complete the RFID deployment in the more than 900 remaining buildings across the U.S. In 2022, we created a new growth platform we call Logistics as a Service, which combines digital capabilities with our best in class global integrated network. Under this platform, we launched our delivery density solution, where we continue to add customers and are seeing positive results. Lastly, we can't talk about innovation without speaking to the progress we are making against our environmental sustainability targets. In 2022, we took delivery of over 2,300 alternative fuel and advanced technology vehicles, bringing our rolling laboratory to more than 15,600. And in 2023, we plan to add more than 2,400 vehicles as we move toward carbon neutrality by 2050. We think the best way to measure innovation driven is by delivering higher returns on invested capital. For the full year 2022, we delivered a return on invested capital of 31.3%, 50 basis points above 2021. Let me close with a few comments related to 2023. The outlook for economic growth is cloudy at best, Geopolitical tensions are rising, and we have a labor contract to negotiate. For us, it is a year of resilience. What does resilience mean? It means we will plan conservatively and pivot quickly. It means we will balance defensive and offensive moves. And it means we will execute what we call our wildly important initiatives. Specifically, we will balance efficiency moves with growth opportunities. Think of that as better and bolder. We will stop certain initiatives and accelerate others, thereby increasing investment in our business. Relative to 2022, we are increasing our 2023 expense and capital budget by over $900 million. Finally, we'll focus on three wildly important initiatives, improving the customer value proposition, increasing talent development and employee engagement, and leveraging our physical network with our digital platform to drive logistics as a service. Given the uncertainty ahead, we are providing a range for our 2023 revenue and profit outlook. Brian will provide the details. As a demonstration of confidence in our business going forward, and in concert with our capital allocation principles, the UPS Board has approved a 10-cent increase in the quarterly dividend from $1.52 per share to $1.62 per share. This is the 14th consecutive year we have increased the UPS dividend. Additionally, our Board approved a new $5 billion share repurchase authorization, replacing our existing authorization. In closing, over the past two and a half years, we have fundamentally improved nearly every aspect of our business, and we're just getting started. Uncertainty creates opportunity, and this team has proven that it's up for the challenge. So thank you for listening, and now I'll turn the call over to Brian.

Thanks, Carol, and good morning. In my comments, I'll cover three areas, starting with our fourth quarter results. Then I'll review our full year 2022 results, including cash and share owner returns. And lastly, I'll provide comments on expectations for the macro environment and our financial outlook for 2023. In the fourth quarter, the macro environment was challenging. In the U.S., inflation-sensitive consumers returned to more pre-pandemic shopping patterns and holiday retail sales were lower than expected, especially after Cyber Week. Internationally, demand in Europe remained under pressure. Ocean and air freight rates declined, and exports out of Asia worsened due to COVID conditions in China. Despite these conditions in the fourth quarter, we responded quickly and again delivered for our customers and share owners. In the fourth quarter, consolidated revenue was $27 billion, down 2.7% from the fourth quarter of last year, and operating profit was $3.8 billion, a decrease of 3.3% compared to the fourth quarter of last year. Consolidated operating margin was 14.1% for the quarter, down 10 basis points from the same time period last year. For the fourth quarter, diluted earnings per share was $3.62, up 0.8% from the same period last year. Now let's look at our business segments. In U.S. domestic, revenue quality initiatives more than offset the decline in volume and drove strong fourth quarter results. In the fourth quarter, average daily volume was down 3.8% versus the same time period last year, with about half of the decrease coming from our largest customer. per the mutually beneficial contractual agreement we reached some time ago. In the fourth quarter, volume in October and November came in as we expected, including a surge in late November from Black Friday through Cyber Week. In December, volume fell short of our expectations, reflecting consumer spending cutbacks at the height of the holiday season. B2C average daily volume declined 3% in the fourth quarter compared to last year. B2B average daily volume in the fourth quarter was down 5.2% year-over-year, driven by declines in retail and industry sectors that are more sensitive to rising interest rates, like manufacturing and distribution. In the fourth quarter, B2B represented 35.3% of our volume, which was down slightly from 35.8% in the same time period last year. Looking at customer mix, SMBs made up 26.5% of our total U.S. domestic volume in the fourth quarter, an increase of 70 basis points from one year ago, and the 10th consecutive quarter of increased SMB penetration. For the quarter, U.S. domestic generated revenue of $18.3 billion, up 3.1%. Revenue per piece increased 7.2%, driven by revenue quality, which more than offset the decline in volume. Improvements in base pricing more than offset a small decline due to product mix and together drove about half of the revenue per piece growth rate increase. The remaining half of the revenue per piece growth rate increase was driven by the combination of higher fuel price per gallon and our fuel pricing actions. Turning to costs, total expense grew 2.5%. First, higher fuel costs contributed about 150 basis points of the total expense growth rate increase. Second, higher wages and benefit expense contributed 150 basis points of the increase. Total union wage rates were up 5.6% in the fourth quarter, driven by the annual wage increase and cost of living adjustment for our Teamster employees that went into effect in August of 2022. Productivity initiatives help partially offset the increase in expense. For example, Total Service Plan has improved driver dispatch time by 7.9% since its launch in July 2022. This is helping us run an on-time network, and in the fourth quarter, we increased total productivity by 1.6%, as defined by pieces per hour. Lower purchase transportation expenditures reduced the total expense growth rate by around 140 basis points, primarily from utilizing UPS feeder drivers to support our fastest ground ever and continued optimization efforts. And the remaining expense growth rate increase was driven by multiple factors, including maintenance and depreciation. Looking specifically at our peak period, our sales, engineering, and operating teams planned and executed another successful peak. We used our technology to maximize the agility of our integrated network, including our newest regional hub in Harrisburg, Pennsylvania, all of which enabled us to respond to changes in volume levels and difficult weather as winter storms rolled across the country close to Christmas. Our network never stopped, and we provided industry-leading service to our customers for the fifth year in a row. The U.S. domestic segment delivered $2.3 billion in operating profit, up 7.5% compared to the fourth quarter of 2021. And operating margin was 12.8%, a year-over-year increase of 60 basis points. Moving to our international segment, the macro environment was challenging and resulted in lower volume than we anticipated in the fourth quarter. We leveraged the agility of our global network to quickly adjust capacity while delivering excellent service to customers. In the fourth quarter, international average daily volume was down 8.6%. The decline was primarily driven by a 12.9% decrease in domestic average daily volume and weakness out of Asia due to COVID. Total export average daily volume in the fourth quarter declined 4% on a year-over-year basis. Asia export average daily volume declined 10.3%, driven by lower global demand and disruptions to manufacturing output from the changes in China's COVID policy. In response, we quickly adjusted the network and canceled over 200 of our China and Hong Kong origin flights, maintained high service levels, and achieved a payload utilization of over 98% on our Asia outbound intercontinental flights. In the fourth quarter, international revenue was $5 billion, down 8.3% from last year, due to the decline in volume and a $321 million negative impact from currency. Revenue per piece was relatively flat year over year, but there were a number of moving parts, including a 660 basis point decline due to a stronger U.S. dollar, a 540 basis point increase from fuel surcharges, and the remaining increase of 100 basis points was due to the combination of multiple factors including favorable product mix, base price increases, and lower demand-related surcharge revenue. Operating profit in the international segment was $1.1 billion, down $240 million from last year due to a $139 million reduction in demand-related surcharge revenue and a $98 million negative impact from currency. Operating margin in the fourth quarter was 22%. Now looking at supply chain solutions, in the fourth quarter, revenue was $3.8 billion, down $846 million year-over-year. Looking at the key drivers, in forwarding, softer global demand drove down volume and market rates more than we expected, resulting in lower revenue and operating profit. Logistics partially offset the declines in forwarding and delivered double-digit revenue and operating profit growth, driven by gains in our complex healthcare business from cold chain and clinical trials customers. In the fourth quarter, Supply Chain Solutions generated an operating profit of $403 million and operating margin was 10.5%. Walking through the rest of the income statement, we had $182 million of interest expense. Our other pension income was $297 million, and our effective tax rate for the fourth quarter was 22.4%. Now let me comment on our full year 2022 results. In 2022, we remained focused on controlling what we could control and provided excellent service to our customers, which enabled us to deliver our consolidated operating margin and return on invested capital targets. A few consolidated highlights revenue reach $100.3 billion an increase of $3.1 billion over 2021 this was $1.7 billion below our $102 billion revenue target but included a $1.3 billion year over year negative impact from currency. In 2022, we generated operating profit of $13.9 billion, an increase of 5.4% over full year 2021. Consolidated operating margin was 13.8%, an increase of 30 basis points. We increased our ROIC to 31.3%, up 50 basis points compared to last year. We generated $14.1 billion in cash from operations and continued to follow our capital allocation priorities. We invested $4.8 billion in CapEx. Additionally, we acquired Bomi Group and Delivery Solutions and made an investment in Commerce Hub. We distributed $5.1 billion in dividends, which represented a 49% increase on a per share basis over 2021. We repaid $2 billion in debt that matured during the year, and our net pension liability decreased by over $3 billion, both of which helped us reach our targeted debt to EBITDA ratio of 1.4 turns, giving us ample financial flexibility to continue deploying capital to create value for our shareholders. Lastly, we completed $3.5 billion in share buybacks in 2022. And in the segments for the full year, in U.S. domestic, operating profit was $7.6 billion, up 12.8%. And we expanded operating margin to 11.8%, a year-over-year increase of 70 basis points. The international segment generated $4.4 billion in operating profit, and operating margin was 22.4%. and supply chain solutions delivered operating profit of $1.9 billion, an increase of $153 million, and operating margin was 11.3%, an increase of 150 basis points over 2021. Moving to our outlook for 2023, we expect 2023 to be a bumpy year due to rising interest rates, decades-high inflation, recession forecasts, a war in Eastern Europe, COVID disruptions in China, and our U.S. labor negotiations. While we anchor our plans to S&P Global's economic forecast, we have developed multiple plan scenarios that will help us quickly pivot in an uncertain macro environment. Further, given our financial strength and solid cash position, we are increasing strategic investments to enhance our ability to capture growth opportunities as we come out of this cycle. I'd like to share two of those scenarios with you now, which are the basis for the guidance we are providing this year. The first is our base case that delivers the high end of the target range, and the second scenario includes additional top-line risks and represents the low end of the range. Let's start with our assumptions for the base case at a segment level. In the U.S., we expect a mild recession in the first half of the year, with a moderate recovery in the second half of the year. In the U.S. domestic segment, we anticipate average daily volume will be down slightly due to our continued volume glide down from our contractual agreement with our largest customer, which will be nearly offset with growth from SMB and other enterprise customers. And we expect volume growth to be better in the second half of the year compared to the first. We also expect the revenue growth rate to be low single digits. On the cost side, while we will manage the network to match volume levels, we have increased both capital and operating expenses for projects that drive efficiency and growth. One example is the accelerated deployment of our Smart Package Smart Facility initiative to all remaining U.S. facilities, which we plan to complete by the end of the year. And on the growth front, we will continue to invest in improving the customer experience. Putting it all together, we expect to grow revenue per piece at a faster rate than cost per piece and expand full-year domestic operating margin to 12%. Turning to international in 2023, in our base case plan, we expect a recession in Europe in the first half of the year. And in China, we expect weak demand in the first quarter with recovery beginning in the second quarter. We are accelerating initiatives like international DAP to help us gain share and partially offset macroeconomic softness. We anticipate international average daily volume will decline by low single digits, with volume growth better in the second half of the year compared to the first. We expect revenue to decline by low single digits, including reductions in demand-related surcharges. We will continue to manage our costs with agility and expect to generate an operating margin of around 21%. Turning to supply chain solutions, we expect revenue to be around $14.6 billion as forwarding volumes will remain challenged and market rates will fall from year-end 2022 levels. We expect to partially offset declines in forwarding revenue from double-digit growth in our healthcare business, resulting in an operating margin of nearly 11%. In our downside plan, which represents the low end of our range, we start with our base case assumptions for all segments and layer in the following. In U.S. domestic, we reduced expected enterprise and SMB volume growth rates, resulting in a full-year volume decline of around 3% versus 2022. In international, we layer in weaker demand out of Asia for the entire first half of the year and a slower recovery in Europe in the second half of the year, resulting in a mid-single-digit decline in average daily volume. And in supply chain solutions, we lowered our assumptions for air and ocean freight forwarding market volume and rates, which reduced full-year revenue for supply chain solutions by around $200 million. Bringing it all together, for the full year 2023, we expect consolidated revenues to be between $97 and $99.4 billion, and consolidated operating margin to be between 12.8 and 13.6 percent, with more than half of our operating profit coming in the second half of the year. Now turning to pension, there are a couple of factors to keep in mind as you update your models. First, beginning in 2023, we froze our defined benefit pension plan for U.S. non-union employees and have replaced it with enhanced 401 benefits. Second, high discount rates at the end of 2022 will result in lower service costs in 2023. Above the line, we expect the combination of these two factors will reduce operating expenses by approximately $420 million in 2023, with around 90% of the reduction in the U.S. domestic segment. Below the line, we expect pension income of around $260 million for the full year 2023, which is $930 million less than in 2022, primarily due to higher interest rates resulting in an increase in pension interest expense and a reduction in the value of our pension assets from market performance in 2022. We've included a few slides in the appendix of today's webcast deck to provide you more detail. The webcast deck will be posted to the UPS Investor Relations website following this call. Now let's turn to full-year 2023 capital allocation. Our capital priorities have not changed and we will continue to make the best long-term investment decisions that will keep us on strategy and enable us to strengthen our customer value proposition and capture growth coming out of this cycle. We expect 2023 capital expenditures to be about $5.3 billion, and here are a few project highlights. We will invest $2.4 billion in buildings and facilities to add automated sort capabilities and increase efficiency across the network, and we'll add 2.4 million square feet of healthcare logistics space to our global network. We will invest $1.3 billion in vehicles, including adding more than 2,400 alternative fuel vehicles to our fleet. we will invest $745 million in our air fleet, including taking delivery of seven 767 aircraft in 2023. And in terms of IT, we will invest $830 million, which includes accelerating the rollout of smart package, smart facility in the US, continuing to develop our delivery density solutions and building out our logistics as a service platform. And lastly, across these projects and others, over $1 billion of investment will support our carbon-neutral goals. Now let's turn to our expectations for cash and the balance sheet. We expect free cash flow to be around $8 billion in our base case. Consistent with our policy of a stable and growing dividend, the Board has approved a dividend per share of $1.62 for the first quarter, which represents a 6.6% increase in our dividend. We are planning to pay out around $5.4 billion in dividends in 2023, subject to Board approval. We plan to buy back around $3 billion of our shares. And finally, our effective tax rate is expected to be around 23.5%, with the tax rate higher in the first quarter compared to the rest of the year due to the timing of our employee stock awards. In closing, we are focused on controlling what we can control. We will continue to invest in our business to balance efficiency and growth opportunities under our better and bolder framework. The fundamental changes we've made to our business, coupled with the continued execution of our strategy, will help us navigate what's ahead in 2023. Thank you, and operator, please open the lines.

One note before we do that, we did experience a technical difficulty with our webcast this morning, so apologies to those of you who missed a portion of our prepared remarks. We plan to post the full recording of today's call to our investor relations website shortly after the completion of our call. So Steven, please open the lines.

Thank you. We will now conduct a question and answer session. Our first question will come from the line of Amit Mehrotra of Deutsche Bank. Please go ahead.

Thanks, operator. Hi, everyone. Brian, that was really helpful guidance framework, so appreciate that. A couple just clarification points. I guess the net service cost benefit is zero in domestic. If I look at the service component, I'm just trying to understand how much of that margin uplift is actually a gross and net service. I don't know if you talked about, I might've missed it. Sorry. There are a lot of numbers there. If you talked about the financial impact from what you're assuming on a new labor deal. So if you could just talk about those two items and then Carol, you know, there's a lot of rhetoric that's heating up on a labor contract. It seems like every day we wake up, there's a new big article about it. Wondering what your message is to enterprise customers that may start to get a little bit uneasy with all the rhetoric that's heating up out there. Thank you.

Thanks, Amit. I'll get started. We had about $420 million benefit to our consolidated operating costs, and that, Amit, is being offset with investments. Of that $420 million specifically, I think you were talking about the domestic business, which is $380 million of the $420 million, which is worth about $0.07 on a CPP. about the investment we're going to make into the business, which are about $400 million, as I mentioned in my prepared remarks, that basically offsets the pension service cost impact to domestic. So it's more of a one-for-one. On the labor front, so we've modeled in rates in both our base and our downside scenario, and I'm not going to get into the wage and benefit component of that, but I guess there's a broader labor question in there.

and I'm happy to address the labor questions. Without getting into the details of what will take place at the bargaining table, I think it's important to remember that Teamsters have been part of the UPS family for more than 100 years. So over 10 decades, we've negotiated many, many contracts. This is not our first rodeo. Our approach with the Teamsters is win, win, win. Win for the Teamsters, win for our employees, and win for UPS and our customers. Now, I mean, to your observations, there have been a lot of articles and headlines recently that might cause someone to question whether or not a win-win-win is achievable. But I would submit that a win-win-win is very achievable because we are not far apart on the issues. And let me make this real for you by giving you a few examples. First, both Teamsters and UPS agree that a healthy and growing UPS is good, good for Teamsters, good for our people, and good for our customers. In fact, we've added more than 70,000 Teamster jobs since 2018. So we're aligned that a growing and healthy UPS is good. To be growing and healthy, we need to be competitive and make sure that our offerings meet the needs of our customers. And a lot has changed since the last time we negotiated our contracts. You know, recipients want their packages delivered when, where, and how they want them delivered, which means weekend delivery, well, it's become table stakes. Teamsters fully acknowledge that, but have worried about the pressures placed on our workforce with weekend operations. And they refer to that to the sixth punch, which is when people work six days a week, or 22.4 drivers. We share the same concerns. I don't want people working six days a week unless they want to. So we're aligned on this. We just need to get to the bargaining table and work it out. And candidly, we think with just a few tweaks to our existing contract, we can work this out. So we're not far apart. We're aligned. We just need to work it out. Another matter that's come up is heat. There can be no dispute, sadly, that the earth is heating up. And that puts an uncomfortable situation on our employees in the height of the summer. Safety is our number one priority for our people, so we're not apart on this issue. In fact, we're not waiting for the bargaining table. We've already kicked off a total revamp of our safety program, bringing in new technology, hydration, cooling systems, and a whole lot more to address heat. So we're not apart. We're going to do the right thing for our people. So those are just a few examples of where I see a win-win-win is achievable. In fact, I'm committed to delivering with the rest of the team a win-win-win contract before the end of July.

Very good. Thank you very much, everybody. Appreciate it.

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

Yeah, good morning. I wanted to ask if, Brian, if you could run through the productivity programs that And, you know, put some ballpark around the impact that you expect, you know, smart package, smart facility, TSP, if you have other programs that are notable so we can, you know, have a little more visibility in how to think about productivity in, and I'm thinking in domestic package in 2023. Thank you.

Sure, Tom. Well, look, Nano and the team have done a great job in pivoting and really driving productivity in the fourth quarter. They did an outstanding job, and we're calling for low single-digit TPP in 2023. I referenced some of the investments that I think you're talking about in terms of SmartPak, SmartFacility. Maybe if I unpack those, you'll get a sense of where we're investing. So SmartPak Smart Facility, that really drives productivity inside the buildings, but it also improves the customer experience by reducing misloads. I think misloads today are running about 1 in 400. Post the SmartPak Smart Facility, we'll be up at 1 in 800, and there's a path to something higher beyond that. And then there's accelerating pilots for phase two, which is smart package car. Another area we're investing in, probably the second largest, is health care. That's a great growth business for us. We're going to be adding about 2.4 million square feet in warehouse space next year. Some of that outside the U.S., half of it in the U, and half in America's. And then DAP has been a great performer for us. We're going to continue to invest in the DAP program, both domestically and internationally, enhancing the plug and play and adding brokerage and UPS access points in terms of capability. And then there's further investments into the customer experience and next-gen brokerage. So, Tom, I think we have a lot of confidence in terms of the ability to drive total service plan, the investments we're making in SmartPak, Smart Facility, healthcare, DAP, and that's what's contributing to the low single-digit CPP in 2023.

And maybe just to dimensionalize it a little bit more, in the fourth quarter alone in the United States, productivity reduced our expense by $271 million. I mean, that's a lot. That's a lot. I'm really proud of the team. And just on smart package, smart facility, because I'm just so enthralled with this project, we have, of the 100 buildings that we're in, we have 50 buildings where the misflows are now 1 in 1,000. That's six sigma perfection. So we're really excited about rolling it out to the 940 remaining buildings in the United States. And here's the cool thing. We're going to roll out the first part of those buildings with wearable devices. But then we've got plans to move away from the devices and actually make the car smart. And last week, I was able to load a package. This is in a laboratory. I was able to load a package onto a smart car and saw the car move. actually check in the package. No human being did that. So this is way cool technology, and we're excited about the productivity that that's going to be as a result.

And to Tom, just from a seasonality perspective, we have planned productivity gains year over year in every quarter in 23. And so now the team will be reducing hours more than volume in the U.S. through the programs. Carol and I just alluded to TSP and the automated capacity. So it's a balanced program.

Okay, great. Thank you.

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

Hey, good morning. And thanks for the time. So, you know, if we step back from the guidance at the midpoint, your EBIT number is down, call it 6% from 2023 levels. And obviously we are coming into a choppy macro. Carol or Brian, can you talk about, you know, the levers that you need to pull to kind of get re-accelerating growth and how much of that is going to be sort of macro dependent as we think about the bridge from wherever we end up in 23 to 24. I'm just curious to get your perspective on what are the catalyzing agents that would reverse the trend in overall EBIT growth?

Well, I think there are a number of catalyzing agents. We need to get through this choppy economic environment for sure. But you think about where we've had some huge home runs. Let's talk about our digital access program. We have seen enormous growth in this. When I started, it was less than $150 million, now over $2.3 billion in 2022, on its way to be $3 billion in 2023. And we're growing outside of the United States. It had been just a U.S. program. Now we're going outside the United States, and this is one area of investment for next year. So that's a catalyst for growth because we're investing in a customer that's underserved today. Another catalyst for growth is what we're doing on the customer journey. As we continue to move the needle on improving the experience with us, we see every year increasing penetration in our SMBs, Brian. That's part of the plan for next year. That's right.

So we'll be adding about 100 basis points, Carol, from a volume mix perspective on the SMB front, so that customer experience translating into continued growth on the SMB front. And from a macro perspective, obviously built into the guide is an improvement in the back half of the year, so we need to see a bit of a pickup in Asia and the U.S. rebounding somewhat from a backdrop perspective.

Another catalyst for growth, of course, is healthcare logistics. Couldn't be more proud of the progress that we've made in this space, and we're just getting started. There's a huge opportunity for growth here around the world, and Kate and her team are doing a matchable job of leading us there.

And as you think about the OPEX that you're putting in to offset some of the above the line sort of service cost, is that sort of one time in nature? Is that just project-based work around implementing RFID in the facilities? Is there some cost drag there that comes away? Or is that just cost drag that moves on to the next initiative? I'm just trying to think from a puts and takes perspective.

No, some of the investments, international DAP, for example, we're investing in the first part of the year. That will start to pay back latter part of the year. And then the deployment of SmartPak Smart Facility, that's probably more of a payback in 24 than 23 as we complete Phase 1 and start to move on to Phase 2.

To dimensionalize the investment that we're making in SmartPak and Smart Facility, it's about $140 million of expense this year, which will not repeat the following year, and about $106 million of capital.

That's super helpful. Thank you.

Yep.

Our next question comes from the line of Ken Hexter of Bank of America. Please go ahead.

Hey, great. Good morning. Carol, great to hear the target to have the contract done by the end of July. I think last you had talked, you weren't even planning on sitting down early, so I think that's encouraging to hear. Maybe you could talk a little bit about what the largest customer kind of represented full year for 22. Your thoughts. I know you talk about the pace of the loss of that business. But it sounds like it's accelerating into 23. Maybe you could talk a little bit about that in perspective of your countering SMB wins. And then on international, to maintain that 21%, Brian, what's the assumptions in there to maintain that level?

Sure. On the Amazon front, Ken, we finished up a year ago at 11.7 in terms of the percentage of Amazon as a percentage of our business. That came down to 11.3 in last year. So it was really a decline of about 40 basis points. We will continue on a mutually agreed path to glide that business down in 2023, and that's factored into our guide. So we feel good about being able to manage that down. On the international front, Ken, it was the second part of your question. So we've got an assumption that Asia comes back in the second half of the year. So they're going through some challenges right now in the early part of the year. There was a two-week lunar holiday. We had some COVID challenges, particularly out of China. So Kate and the team, they've done a masterful job in the fourth quarter and also the beginning of this year in terms of pivoting our air network. I think Kate took down about 200 flights in Asia, which was really remarkable that they were able to do that in such a short period of time. So managing the air network, seeing a little bit of a rebound in China, and then getting after the opportunities that we're investing in. International DAP was one I just mentioned, and then going after the premium side of the market. So lots of encouraging optimism for the back half of the year.

Yeah, you know, agility really is the name of the game, isn't it? Here it is. It's the end of January. I would say our crystal ball is pretty murky, but I can tell you what we're seeing in the business today. The U.S. is actually doing a bit better than the base case, and the international is doing a bit worse because we're in now a two-week Lunar New Year holiday. Who would have thought? But with herd immunity coming, we believe in China, things should get better outside the United States.

And just to clarify, that 11.3, I think, Carol, you had mentioned that you were targeting maybe less than 11% on Amazon for 22. So it sounds like maybe it's not drifting away as fast as an accelerating decline.

No, Ken, it's a function of currency. FX impacted our top line by $1.3 billion. So had we not had the pressure on the top line, the percentage would have been different. Does that make sense?

Yeah, absolutely, of course. Thanks for the clarification.

Yeah, thank you. Thanks, Ken. And then just a reminder, please limit yourself to one question so that we can get through as many participants as possible.

Our next question comes from the line of Scott Group of Wolf Research. Please go ahead.

Hey, thanks. Good morning, guys. So just want to make sure I'm understanding the guidance pieces here. So I think you said in the base case, Brian, the U.S. margin is 12%. Can you talk about where you see it in the downside scenario? And then you talked about more than half of the operating profit in the second half of the year. I mean, it's typically somewhere between 50 and 55%. Should we think anything differently? I don't know if you want to give us a little bit more color on first half or second half profit margins and any color there.

Scott, good to hear from you. So I'll start with the latter question first. We expect about 56% of our profit to come in the second half of the year relative to 1H. And then I would also just give you a little bit of color. There'll be a similar bathtub effect in the first half between 1Q and 2Q, stepping up in 2Q. From a domestic guide perspective, the other half of your question, Nando and the team are focused on 12%. That was actually the same number that we had guided to back in our investor day, and I'd say the world's changed a little bit since then, but we're getting after the 12% margin in 2023. The low end is based on 11%, and so there are a number of things that are factored in there. The biggest change would be a change in the top line relative to volume. If the macro doesn't come back as quickly as we think it might, there's labor negotiations going on, so we thought it was prudent to put a floor in.

Thank you, guys.

Thanks.

Our next question comes from the line of Todd Fowler of KeyBank Capital Markets. Please go ahead.

Hey, great. Thanks, and good morning, and thanks again for the detail. I wanted to ask on the expectations for revenue per piece in U.S. domestic. If I kind of, Brian, tease out kind of the comments, you've got revenue in the base case up low single digits, volume down slightly, so revenue per piece may be low to mid single digits. bit of a deceleration from where you've been over the last two years. You've obviously done a good job of moving that up. But can you talk about the ability to see continued improvement in revenue per piece as you move through 23? How much of that's base pricing and mix and then the opportunity longer term? Thanks.

Yeah, it's a great question. So the GRI, as you know, is 6.9%, and with the service range, we'll keep a decent amount of that. The guide for RPP that we're building in our base case is mid-single digit for RPP, and that is facing two headwinds off of that number. You've got product mix and fuel, which are each combined about 150 to 200 basis points off of that mid-single digit. So that's how we're thinking about it. The product mix is really less air, more sure post, so a shift in the product mix, And then the fuel component, fuel's not going to have a big net impact to the business in 2023, but obviously there's a cost component versus a revenue component.

Got it. That's helpful. Thanks a lot.

Yep.

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

Hi. Good morning. I just want to turn to healthcare. You're quickly approaching sort of that original target of $10 billion in revenue there. obviously investing some more this year in that vertical. Is there a way to think of what kind of outgrowth you're seeing in there, sort of what's the base market case growth for healthcare this year versus what you guys are seeing or growing above? Just any color there.

Well, I think Kate is here, and Kate, it would be great if you could just take that question, please. Yeah, absolutely. Thank you, Allison. So we've really been able to grow healthcare beyond even lapping the vaccine distribution that we did over a billion years. And that was because with that service that we're delivering and the capability around the globe, we're actually selling more into biologics and some of the developing treatments. So that continues to fuel us for the future growth. We've seen double-digit growth, and we're planning for double-digit growth this year as well with very strong margins.

Great. Thank you.

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

Yeah, hi, morning. Knowing that the S&B penetration continues to be an important part of the strategy, just sort of curious, in an environment that's tougher, does it get more difficult to penetrate them? And do you find that maybe when you do, they're sort of trading down in services? Just sort of curious, especially given your large customer will continue to sort of shrink over the coming years. Thanks.

Well, we've been investing in the experience because we think that's the way to not only grow but to keep that very important customer. And I couldn't be more proud of what the team has delivered in this regard. So if you think about customer journeys, if you will, there were three really big pain points. One was negotiate value. And that's why we're so thrilled with Deal Manager because Deal Manager is a huge foam run. Our win rate is 22% higher than we thought it would be with better revenue quality, and the customers are happy because they're getting a deal with us within seven days. It used to take weeks. So negotiated value is an important part of continuing to serve this customer. Another is reroute a package. We had some issues systemically that needed to be addressed, and we fixed that, so now we can reroute a package. resolving a claim. Here we had a broken link. So when you had a claim, it was not a good experience for our customers. And we've seen our net promoter score in this area alone improve dramatically. And the speed to pay if a claim needs to pay has improved by 10 days. So we continue to lean into the experience. And Brian, I know you want to add something here.

Thanks, Carol. Yeah, I would just follow up and say we're putting some OpEx investments, $400 million, into the business this year. We invested in a similar capacity in Fastest Ground Ever and SMBs, et cetera, a couple years ago. And as I think about the SMB journey, by investing in those customer experience points Carol's talking about, those investments are paying off. That's what gives us confidence. We are seeing 40% higher SMBs today than in 2019 when we started that journey and that investment. And we're actually – we've increased penetration, Carol, for the last 10 consecutive quarters. So it's a bit of a proof point on the SMB front in terms of the investment and the payoff.

Thank you. Our next question will come from the line of Chris Weatherby of Citigroup. Please go ahead.

I guess maybe I had a question on volume, wanted to understand a little bit better sort of the growth outlook for some of the SMBs, the non-Amazon businesses. It sounds like that's going to be up, so kind of curious about sort of what gives you confidence there, how much market share you've been able to win, sort of thoughts around that. And then, Brian, a quick point of clarification as well. I think you talked about sort of the first half, second half dynamic of profit being should we be using sort of similar numbers like, you know, 44, 56, somewhere in that ballpark is a reasonable way to think about that first half as well.

Maybe on the SMB question, let's look at our digital access program that's been a huge home run for us. Year over year, we saw $1 billion of growth in this program. Here's the important part. It's 3.5 million customers. It's These are very small customers who are shipping with us through the platform, and we see continued growth opportunities ahead for us. In fact, we think our DAT program will be over $3 billion in 2023.

On the seasonality, yes. So you should consider a similar step up in mix from a Q1 to Q2 perspective. From a Q1 perspective, Chris, you know, we've got some Q4 trends coming out from a consumer and a macro perspective that are challenged. We're seeing that product mix headwinds, and we're making some of these investments in the early part of the year. So you should apply that same bathtub effect for Q1, Q2. Thank you.

Thanks. And then, Stephen, we have time for one more.

Our last question will come from the line of Brian Asenbeck of JP Morgan. Please go ahead.

Hey, good morning. Thanks for the time. I just want to come back to pensions real quick. Brian, can you talk about maybe any changes to the sensitivities? A little bit different than what we thought, maybe not as big of an impact. Did you change expected returns, assumption, or anything along those lines? And then maybe you can just wrap up with a bit of commentary on pricing and yield and productivity and how all those really relate and can trend throughout the year in an environment where you're seeing volume decelerate. You talked about all the different sort of headwinds or uncertainties, some of which showed up in peak. So really just looking to see if you're seeing some demand destruction out there and if you're able to drive these productivity gains if the volumes don't necessarily show up where you think they could and surprise a bit to the downside. Thank you.

Happy to, Brian. So on the pension front, look, we've been on a path to de-risk the pension, and we actually feel good about the glide path there. We're up in the high 90s, about 98% funded level, which is great for our employees. From a liability perspective, we've taken that down from about $16 billion a couple years ago to $4 billion, $4.8 billion now. So overall, the glide path has been good. The challenge we have is that we've seen historic rise in interest rates, and so that That $900-plus million number that I gave you below the line, that is a non-cash number, but it moves up and down with the market. So we try to give you the transparency. We do tend to look through that as it's a non-cash number when we think about our capital allocation vis-a-vis the dividend, et cetera. So net-net, I think we're doing the right thing for the company. Given the volatility in the interest rates, it is a challenging environment, and we'll move up and down on a relative basis.

The way I think about productivity, it's a virtuous cycle here at UPS, and I couldn't be more proud of what our team has done quarter after quarter after quarter to drive productivity. And, Nano, maybe you could share a few of the action items in 2023 to continue that flywheel.

Sure. Just if you look at the shape of the volume, especially in the fourth quarter and quarters before that, we've shown tremendous agility, making sure we're matching the hours and the activity in our operations to the actual volume and the revenue. That will continue. And quite frankly, our people are masters of efficiency. So as we roll out the second iteration of our total service plan, which kicks off on March 3rd, we're learning a lot about our network. And there's cost to be had in not just on-road activity or inside our facilities, but across the entire network. laser focused on those initiatives. Whatever volume and how it comes into us in different shapes and sizes, we'll make sure that we're prepared to handle it effectively. Hopefully, we're building up a little bit of a track record to show that that's exactly what we have been doing. Appreciate it.

Excellent. I want to thank everybody for joining the call this morning. We look forward to talking to you next quarter. That concludes our call.