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.