United Parcel Service, Inc.

Good morning. My name is Steven, and I will be your conference facilitator today. I would like to welcome everyone to the UPS Investor Relations third quarter 2023 earnings conference call. All lines have been placed on mute to prevent any background noise, and after the speaker's remarks, there will be a question and answer period. Any analysts that would like to ask a question, now is the time to press the 1 then 0 on your telephone keypad. It is now my pleasure to turn the floor over to your host, Mr. PJ Guido, Investor Relations Officer. Sir, the floor is yours.

Good morning, and welcome to the UPS Third Quarter 2023 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 2022 Form 10-K and other reports we file with or furnish to the Securities and Exchange Commission. These reports, when filed, are available on the UPS Investor Relations website and from the SEC. Unless stated otherwise, our discussion refers to adjusted results. To the third quarter of 2023, DAP results include an after-tax charge of $219 million, or 26 cents per diluted share, comprised of a one-time payment of $46 million to certain U.S.-based non-union part-time supervisors. transformation and other charges of $70 million, and non-cash goodwill impairment charges of $103 million. 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, PJ, and good morning. Let me begin by thanking UPSers for their hard work and efforts. Our U.S. labor contract wasn't fully ratified until early September. And I'm proud of our UPSers for staying focused during the entire labor negotiation and for providing industry-leading service to our customers. We expected conditions in the third quarter to be challenging, and they were. The global macro environment remained weak, with some countries in recession, which pressured international and freight forwarding volume. And in the U.S., labor uncertainty negatively impacted volume for most of the quarter. From a demand perspective, August proved to be the most challenging, as some customers waited for the ratification of our Teamster contract before returning volume to our network. Since contract ratification, we've been gaining volume momentum. We exited the last week of September with U.S. average daily volume, or ADV, down 7.4%, a marked improvement from the rest of the quarter. our salespeople have produced record results from the combination of win-back and new customers. To date, we've won back roughly 600,000 ADV of diverted volume, and we are working to win back all diverted volume by the end of the year. And looking at our sales pipeline, we are pulling through new customers that value our superior on-time performance and want to come to UPS prior to the busy peak holiday season. Moving to our financial results, our third quarter performance, while down considerably from last year, was in line with our expectations and factored in both the timing of contract ratification and higher labor costs resulting from the new labor contract. Consolidated revenue in the third quarter was $21.1 billion, down 12.8% compared to last year. Operating profit was $1.6 billion. a decrease of 48.7% from last year, and consolidated operating margin was 7.7%. Brian will provide more details on our performance in a moment. With the third quarter behind us, we are laser-focused on restoring volume in our network and executing our strategy to deliver share owner value. So let me turn to our strategic update. Our customer-first, people-led, innovation-driven strategy is enabling us to stay focused on our core business and invest to grow in the most attractive parts of the market, like healthcare and with SMBs. Starting with customer first, under our better and bolder framework, we recently announced two acquisitions that will further drive growth in healthcare logistics and in end-to-end return solutions. One of our strategic objectives is to become the number one complex healthcare logistics provider in the world, and we are making bold moves to get us there. Last year's acquisition of BOMI and our recently announced pending acquisition of MNX Global Logistics are two examples of bold moves in healthcare. MNX is an industry leader in time-critical and temperature-sensitive logistics. tailor-made for the complex needs of global healthcare. By combining MNX with UPS Express Critical and our global integrated network, we will enhance the speed and reliability of our healthcare portfolio. With MNX, UPS will be able to reach new healthcare markets like in Asia and new customers like the radiopharmaceutical sector. To further support our healthcare strategy, This year, we've opened seven dedicated healthcare facilities in Europe and in the U.S. And the acquisition of BOMI further strengthened our healthcare footprint in Europe and Latin America. Since 2020, we have more than doubled our healthcare distribution space globally. These efforts and more are keeping us on track to reach our $10 billion healthcare revenue targets this year, and we're just getting started. Turning to returns. With the explosion of e-commerce demand, our returns business has been a key area of growth over the last several years. What we've seen over this time is an increasing desire on the part of both our customers and our recipients for a frictionless and simple end-to-end returns experience. We've been building out this experience, but to help us get there faster, we just entered into an agreement to acquire Happy Returns. a technology-focused company that enables frictionless, no-box, no-label returns. By combining happy returns, easy digital experience, and established drop-off points with UPS's small package network and footprint of close to 5,200 UPS store locations, box-free, label-free returns will soon be available at more than 12,000 convenient locations in the U.S. But our plans for returns don't stop at convenience. For our enterprise retail customers, we plan to provide a consolidated return solution that will lower their costs and improve their experience. And for UPS, Happy Returns expands our returns portfolio with an innovative solution that will generate profitable B2B volume and help drive pickup and delivery density. For us, customer first isn't just about growth. it's about meeting customer needs. To that end, we are continuing to improve the delivery experience with the expansion of UPS delivery photo. 92% of our residential stops globally include a photo that shows exactly where the package was delivered. Not only does delivery photo provide peace of mind to recipients, but we get fewer calls about missing packages. With delivery photo, UPS has seen a reduction in U.S. delivery-related support requests of more than 15 percent. We are also harnessing our data to deliver more agile and targeted products that meet our customers' needs. Our latest example is a new product we call Hyperlocal, which leverages the footprint of our U.S. facilities to provide select customers with a fast, next-day delivery option within a metro area. Hyperlocal enables us to capture new profitable B2C and B2B volume and was launched in October as a new service offering. Let me quickly touch on DAP, our digital access program. We are continuing to grow SMB volume with DAP. In the third quarter, we launched 10 new partners in time for peak. In the first nine months of this year, we generated $2.1 billion in DAP revenue and we expect to deliver $3 billion in DAP revenue for the year. Let's turn to innovation-driven. UPS has been a technology company since our founding, and we are adding transformative technology in our operations that will increase efficiency and improve the employee experience. Smart package, smart facility, our RFID solution is one way we're driving efficiency. And I'm pleased that we are wrapping up our phase one rollout in our U.S. facility. The improvements we are seeing in our preload operations are even better than we expected, with nearly 200 of our buildings seeing this load rate in one in 2,500 packages or better. Deployment of phase two is already underway, which equips our package cards with RFID readers. Over time, this will allow us to virtually scan smart packages during pickup and eliminate delivery scans during bulk delivery stops, both of which will enhance customer visibility and make our drivers more efficient. Another example of transformative technology is robotics. Specifically, starting a supply chain solution, we are implementing robotics unload technology inside our trailers to unload packages more efficiently. These robots navigate the inside of a trailer and can unload multiple box types and sizes autonomously. Now, it's still early days with this technology, but we are seeing many opportunities to further expand the use of robotics across our network. Turning to the fourth quarter, we are preparing for peak. Over the past five years, our service during peak has been better than our closest competitor by an average of 310 basis points. Service matters all the time, but especially at peak. So to prepare, we are collaborating with customers on volume projections and the timing of their promotion. We will also leverage technology, like our network planning tools, to control how the volume comes in, utilize available capacity, and adjust the network to operate as efficiently as possible. Regarding peak hiring, our people-led strategy enables greater flexibility to serve our customers during the holiday rush. For example, our experienced part-time employees can now become seasonal support drivers. This enables them to deliver packages using their own vehicles before or after their regular shift. In addition, we plan to hire over 100,000 seasonal employees to help process and deliver holiday volume. This year, we've made it even easier and faster to apply for a job. as we shortened the digital process to less than 20 minutes in filling out an online application to receiving a job offer. Regarding our financial outlook, we made changes based on what we are seeing in the market. We still expect to have healthy peak volume in the fourth quarter, but based on what appears to be slowing demand in all business segments, we are revising our guidance accordingly. Brian will share more detail in a moment. Back in January, I said that 2023 would be a year of resilience, and it has been. Our founder, Jim Casey, said, determined people working together can do anything. During the year, we accelerated the deployment of smart package, smart facility, and made strategic acquisitions to grow in the best parts of the market. We delivered a labor agreement that provides certainty for the next five years. We are operating with great speed and agility. controlling what we can control, and we are staying on strategy. With that, thank you for listening, and now I'll turn the call over to Brian.

Thanks, Carol, and good morning. In my comments today, I'll cover four areas. I'll start with the macro, followed by our third quarter results. Next, I'll cover cash and share owner returns. Then I'll provide detail around our updated guidance. The macro environment in the third quarter was challenging. The weakness we saw in the second quarter continued into the third quarter, especially in Asia and Europe. Real exports and industrial production moved lower due to falling demand and global consumer conditions did not significantly change. In the U.S., we faced tough conditions due to several factors. To begin, the volume diversion we experienced in the second quarter continued into the third quarter, which led to more volume diversion than we anticipated. Next, some customers that diverted waited until our Teamster contract was fully ratified in September before returning volume to our network. And lastly, we incurred higher labor costs associated with the new contract and added headcount earlier than normal to ramp up for peak so that we can ensure we maintain our industry-leading service levels. Through the end of the quarter, we adjusted our integrated network to support our customers' needs, managed costs, and stayed focused on bringing volume back into our network. Looking at our financial results for the quarter, consolidated revenue was $21.1 billion, down 12.8% from last year. Consolidated operating profit was $1.6 billion, down 48.7% compared to the same period last year. Consolidated operating margin was 7.7%. For the third quarter, diluted earnings per share was $1.57, down 47.5% from the same period last year. Now let's look at our business segments. In U.S. domestic, we knew the third quarter would be a challenge, and it was, due to our labor negotiations, higher costs, and a dynamic economic backdrop. As we discussed on our last call, we ended the second quarter with average daily volume in June down 12.2%. As contract negotiations became later and louder, we saw more volume diversion than we anticipated. August represented the low watermark when average daily volume was down 15.2% year over year. Post-ratification, we exited the third quarter at half that rate, and we are continuing to see our week-over-week volume levels improve despite a challenging retail backdrop. In the U.S., in the third quarter, average daily volume was down 11.5%. and we estimate the impact of volume diversion reduced our volume by approximately 1.5 million packages per day. Moving to mix, in the third quarter we saw lower volumes across all industry sectors with the largest declines from retail and high tech. B2C average daily volume declined 13.4% compared to last year, and B2B average daily volume was down 9%. In the third quarter, B2B represented 44% of our volume, which was an increase of 120 basis points from a year ago. Also in the third quarter, we continued to see customers shift volume out of the air onto the ground. Total air average daily volume was down 15.8% year over year, with about half of the decline coming from our largest customer, as anticipated. Ground average daily volume was down 10.7%. In terms of customer mix, in the third quarter, SMBs, including platforms, made up 28.5% of our total U.S. volume, an increase of 20 basis points year over year. For the quarter, U.S. domestic generated revenue of $13.7 billion, down 11.1%. Despite lower volume, we remained disciplined on revenue quality. In the third quarter, revenue per piece increased 2%. Looking at the key drivers, the combination of strong base rates and improved customer and product mix increased the revenue per piece growth rate by 410 basis points. Changes in fuel prices decreased the revenue per piece growth rate by 190 basis points. The remaining 20 basis points of decline was driven by multiple factors, including package characteristics. Turning to costs, total expense was down 5.1% in the third quarter. Compensation and benefits decreased the total expense growth rate by around 50 basis points. Total union wage rates were up 11.5% in the third quarter, primarily driven by the contractual wage increase that went into effect on August 1st. Additionally, we began network preparations for peak. Offsetting the total increase in compensation and benefits, we leveraged our total service plan and network planning tools to reduce total hours in the third quarter by 11.4%. We reduced the expense growth rate for purchase transportation by around 190 basis points, primarily from lower volume levels and our continued optimization efforts. Lower fuel costs contributed 170 basis points to the decrease in total expense growth rate. The net of all other expense items and allocations reduced the expense growth rate by 100 basis points. The U.S. domestic segment delivered $665 million in operating profit, down 60.6% compared to the third quarter of 2022, and operating margin was 4.9%. Moving to our international segment, Macro conditions were uneven in the third quarter, with some regions of the world more challenged than others. Continued falling demand pressured Asia, and in Europe, consumers continued to contend with high inflation and tight financial conditions. In response, we adjusted headcount and block hours, and our global networks matched changes in geographic demand. In the quarter, international total average daily volume was down 6.6% year-over-year. Nearly three-quarters of the decline came from lower domestic average daily volume, which was down 9.1%, driven primarily by declines in Europe. On the export side, average daily volume declined 4.1% on a year-over-year basis. Looking at Asia, export average daily volume was down 8%, and export volume on the China to U.S. lane, which is our most profitable lane, was down 10.3% year-over-year. One bright spot was the Americas region, where export average daily volume grew 4.7%, led by Canada and Mexico leveraging our cross-border ground service. In the third quarter, international revenue was $4.3 billion, which was down 11.1% from last year due to the decline in volume and a 1.4% reduction in revenue per piece. The decline in revenue per piece was driven by several factors. Lower fuel surcharge revenue contributed 230 basis points to the revenue per piece growth rate decrease. A reduction in demand-related surcharge revenue contributed 200 basis points to the decline. Partially offsetting the decline, multiple factors increased the revenue per piece growth rate by 290 basis points, including strong base rates and a weaker U.S. dollar. Moving to costs, in the third quarter, total international cost was down $203 million, primarily driven by lower fuel expense. In response to lower demand, we adjusted our integrated network and cut costs, which included reducing international block hours by 13.9% compared to last year, and reducing headcount in operations and overhead functions by a total of 2,300 positions. and we did all of this while continuing to deliver excellent service to our customers. Operating profit in the international segment was $675 million, down $329 million year-over-year, which included a $98 million reduction in demand-related surcharge revenue. Operating margin in the third quarter was 15.8%. Now looking at supply chain solutions, in the third quarter, revenue was $3.1 billion, down $854 million year over year. Looking at the key drivers, let's start with forwarding. In international air freight, softer global demand and lower volume resulted in a decline in revenue and operating profit. On the ocean side, demand flipped positive, driven by the retail sector, and generated volume growth. However, excess market capacity pressured revenue and operating profit. In response to the dynamic forwarding market, we cut operating costs. Within forwarding, our truckload brokerage unit continued to face pressure from excess capacity in the market, which drove revenue and operating profit down. Logistics delivered revenue and operating profit growth. In the third quarter, supply chain solutions generated operating profit of $275 million and an operating margin of 8.8%. Walking through the rest of the income statement, we had $199 million of interest expense. Our other pension income was $66 million, and our effective tax rate for the third quarter was 12.6%, which benefited from certain discrete items, including tax credits and global audit resolutions. Now let's turn to cash and shareowner returns. Year-to-date, we've generated $7.8 billion in cash from operations, and free cash flow was $4.9 billion. And so far this year, UPS has paid $4 billion in dividends, and we've completed $2.25 billion in share buybacks. Now I'll share a few comments about our outlook. We expected 2023 to be a bumpy year, and it has been. We've navigated record high inflation, rising interest rates, disruptions in China, a war in Eastern Europe, now a humanitarian crisis in Israel and Gaza, and the disruption around our U.S. labor negotiations. Through all of this, we've remained focused on controlling what we can control and are continuing to adjust the network to match volume levels and deliver industry-leading service to our customers. Since our last earnings call, the global demand environment has slowed and macroeconomic conditions remain challenging. As a result, we've lowered our full-year guidance and have provided a range to reflect the uncertainty in the markets. We now expect consolidated revenue to be between $91.3 and $92.3 billion and consolidated operating margin to be between 10.8 and 11.3%. Let me walk you through our assumptions for the guidance range. In the U.S., we are winning back volume at a rapid pace, but we've also seen demand softness due to several factors with many of our customers who did not divert. Additionally, While consumer spending has been resilient in 2023, headwinds are mounting for the consumer in the fourth quarter. And looking at estimates for holiday retail sales this year, increases range from over 4% to 12%. Moving to international, a further downturn in exports and lower consumer spending in some of the largest European markets, including Germany and the UK, are negatively impacting volumes. and exports on our most profitable trade lane, which is China to the U.S., are not improving at the pace we had expected. Finally, in forwarding, air and ocean capacity has increased, which is putting additional downward pressure on market rates. In fact, in ocean, there is extreme overcapacity versus demand in the market, and the forwarding demand outlook in the fourth quarter remains weak. Turning to capital allocation for the full year, Capital expenditures are still expected to be about $5.3 billion. We are still planning to pay out around $5.4 billion in dividends in 2023, subject to Board approval. We have repaid $1.6 billion in debt this year as planned and expect to repay an additional 700 million euros of debt in the fourth quarter. We now expect $2.25 billion in share buybacks in 2023, which we have already completed. In the fourth quarter, we are redeploying cash back into the business for growth initiatives, such as strategic acquisitions to drive share owner value. And lastly, we expect the tax rate for the full year to be approximately 22%. In closing, while navigating a very challenging macro environment, we remain focused on the job at hand. For the past five years, we have held the record as the industry leader in service during peak. We intend to do it again this year. Thank you. And operator, please open the lines. Steven, we're ready for a question.

We'll begin the question and answer period. And our first question will come from the line of Chris Weatherby of Citigroup. Please go ahead.

Hey, thanks. Good morning, guys. Maybe you'd start on the guidance and specifically for the fourth quarter. So I think it implies a pretty meaningful step up in operating profit. And we understand that, you know, I'm guessing ADV probably has a significant piece to do with that improvement in the operating profit, considering how low it was in the third quarter. But Maybe you could help us bridge from how we're going to get from the third quarter, which obviously was quite challenged, to what is a significant improvement sequentially. In that context, maybe if you could give us the help with what October ADV looked like on the domestic side. I think that's a very important number, so I'm kind of curious if you could help us with that, too.

Sure, happy to, Chris. Good morning. So if you look at the bridge, I'll take the low end. From Q3, we posted $665 million in operating profit. To get to the low end of the guide, it would require about $800 million in profit. The two biggest drivers of that are volume and revenue quality. The productivity that the teams are generating, Nando in the U.S., is offsetting the labor contract step-up because you'll realize we have three months in the fourth quarter and we had two months of the new labor contract in the second. Your question on volume, as we think about volume and revenue quality, those two alone provide a majority of the 800 step-up. But if you think about where we were in August and where we are in October, the momentum is increasing. We had a low watermark, as I mentioned in the prepared remarks, down 15%. in terms of ADV volume in August, that translates to around 16 million pieces from an ADV perspective. That's actually, in October, we're seeing 19 million pieces. So we've seen that step up. I went back, Chris, and looked at last year, and the August-October step up was 1.5 million pieces. This year, the August-October step up is 2.7 million pieces. So from a glide path and a trajectory, we're seeing momentum. The absolute levels are coming up, and that's what led to the guide.

Okay, thank you. Our next question will come from the line of Alison Poliniak of Wells Fargo. Please go ahead.

Hi, good morning. I just want to go back to the comments on the recapture trends. I think you mentioned it really started in September in terms of that recapture rate. Is that a huge acceleration in terms of what you're seeing in October? Is it from that recapture? And then also related to that, is there any cost associated with that volume you're recapturing today?

Well, we're really pleased with our capturing volume back in our business. We have recaptured over 600,000 pieces per day of the volume that was lost, and I will say 50% of that recapture is coming from our largest competitor. The recapture continues day by day, but it's not just about recapturing what we lost. It's about growing new business. You may recall, Allison, at the end of the second quarter, we said we had about a $7 billion pipeline of new business. Today, we want about 25% of that pipeline. Now, that $7 billion is an annualized number, so all those packages and volume haven't come into the network yet. It will come in over the next year. So I couldn't be more pleased with how our sales team is performing and winning new accounts and winning back volume that department.

Got it. And just for the follow-up, is the recapture, any cost associated with that recapture that you have to make?

There's no material cost associated with the recapture. Customers are coming back because of our superior service.

Great, thank you.

Yep, yep.

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

Hey, thanks for taking the question, guys. So, Brian, you mentioned the 800 million step up. That's incremental sequential from 3Q to 4Q. I just wanted to make sure that I heard that correctly. That's the low end of your guidance range assumption?

That's right, Dave.

Okay. And then maybe more bigger picture, right, as we think about the exit rate kind of implied in the guide, I think it works out to something like, you know, down 20% year over year in EBIT. How do we think about that build back in 2024? You know, the front half, obviously, you have inflation, but you've got the GRI to offset. Should we be expecting that sort of, you know, second derivative rate of change to slowly get better and then snap back? Or does it get, you know, meaningfully better in sort of 1Q, 2Q? How do we think about the shape of 2024 and how it's stepping up to recover in the domestic margin side?

So two big pieces of sort of forward momentum, Dave. One is the exit rate on volume. Carol just talked about the win back and also the pipeline of new business. So going into next year, getting back on level footing with a system that has higher ADV will help us certainly from a cost and margin perspective. The revenue per piece, we announced a 5.9% GRI, so that'll be coming in. We talked to you recently about the cost overhang of the contract. That goes from August to August. So I would tell you from a shape, certainly the first half of the year will be more challenged than the back half of the year. Back half of the year, we get into a two- to three-year glide path with lower inflation per year, and then so pricing and productivity can help expand the margins. But those are the pluses and minuses as we look into 2024. Obviously, we'll go into a lot more detail March 26th when we get together with you all for our next Investor Day.

And that rate of change in the first half, better than 4Q?

Let me come back to you, Dave, but we're certainly building momentum.

Let's finish up the year, Dave, and then we'll give you some color about 2024.

It's always about 2024. Thanks for the time.

Thanks, Dave. Our next question will come from the line of Jordan Alliger of Goldman Sachs. Please go ahead.

Yeah, I was wondering if you could give some color on your confidence level on the new revenue range. How much certainty do you feel the visibility and what frames the high and low end? Thank you.

So thanks, Jordan, for the question. Look, we feel good about the revenue range. We've narrowed it to a billion dollars. And I think the thing that's going to drive the upper end versus the lower end really has to do with the retail backdrop. I mentioned in my script there's sort of the broad range of the online retail sales for the holiday period. To the extent it's in the higher end of that, we'll have more volume and more revenue. To the extent it comes in with some of the risks we're seeing, it's towards the lower end. Thank you.

Thanks, Jordan. Maybe one other comment, if I could, Brian, on the volume range. We know which of our customers peak during peak. There are about 117 customers in the U.S. that make up about 86% of our peak volumes. we are sitting down with each of those customers understanding what their plans are as we work on our operating plans to make sure we deliver superior service. Having that insight, if you will, gives us a lot of confidence in the U.S. volume numbers that Brian shared with you.

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

Yeah, I... You made a couple comments on the volume that you're recapturing, and I just want to make sure I understand it. I guess it's an important point. So I think, Carol, you said 600,000 pieces a day have been recaptured, but then, Brian, you said kind of, you know, last year, the August to October was 1.5 million, and it's 2.7 million increased this year. So that implies, I guess, 1.2 million increase. So I just wondered if you could give a little more perspective of kind of where we're at in October, how much of that lost business has been recaptured. And then I guess another way you framed it was December. You were going to get back to flat volumes before. I think it was a prior comment. Do you still think you can do that, or are we thinking December volumes are down? Thank you.

Yeah, Tom, so to frame it up for you, we were trying to get December back to flat versus prior year. I think the guide now implies from a low single digit to a mid-single digit in the month of December, and that's pending some of the backdrop I just talked about in terms of the retail outlook. From a momentum perspective, I gave an August to an October number, but as Carol mentioned, we lost 1.5 or we had diverted 1.5 million pieces. We've seen 40% of that, roughly 600,000 pieces, already come back to the system. We're also pushing forward with new business that Carol referenced as well.

Okay. Thank you. Thanks.

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

Hi, good morning. Thank you for the question. This is Joe Hafling on for Stephanie Moore. I had maybe a conceptual question on sort of the recapture looking at the near term, given its peak season and customers are focused on their own execution right now. Does this limit your ability to win back volumes in the near term? if shippers don't want to disrupt any of the plans that they've already got in place. Obviously, you know, you've highlighted the capture rate sort of September, October, but just wondering if that slows down as we kind of get into November, December, just as, you know, shippers don't want to disrupt their own operations right now.

Actually, it's accelerating. Customers want to come back into our network before peak because of our superior service that we've exhibited over the past five years.

Gotcha. Thank you so much. It's helpful. Our next question will come from the line of Ken Hexter of Bank of America. Please go ahead.

Hey, great. Good morning. If I could just clarify one thing on the step up. I think to Allison, do you say you're not using increasing pricing as you get toward the tail end of that volume gain? And then my question is on international, right? So you're looking, I guess, Brian, to really snap back closer back to that 20% range. Is that kind of what you're still looking at in terms of margins at international as we move into the fourth quarter? Just want to understand the shift from peak versus belly space coming back on and the impacts to margin there.

Yeah, on the first question, Ken, obviously you've got volume and pricing. I was talking to you with Allison about the volume component. We have announced a 6% to 7% peak season surcharge, so that's obviously flowing through from a revenue standpoint in the fourth quarter as well.

I think Allison's question was, are there costs associated with winning back volume? And as I responded, not meaningful. And from time to time, we have found customers who diverted and they entered into longer-term contracts. And we might help them exit those longer-term contracts, but it's not a meaningful discount. It's just we might help them. Nothing measurable.

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

Hey, thanks. Good morning. So, Brian, one of the earlier questions about the bridge from Q3 to Q4, you answered it sort of, how do we get to the low end? So should we think that the low end of the range is more of your base case? I just want to understand sort of that answer, and then can you just maybe more explicitly just talk about what the margin expectations are for each of the segments in Q4? I wasn't sure what you were thinking for each business. Margin or profit, however you want to answer it.

I have the walk in front of me for the high end and the low end, so I can give it to either range. And I think it's this retail backdrop uncertainty that drives the delta in volume, which drives the delta in profit. So It's the same levers. It's the volume and the revenue quality really driving the majority. It's at a higher component at the high end versus the $800 million I referenced at the lower end. So net-net, I think from a margin shape standpoint, We finished Q3 mid-single digit in the U.S. Obviously, that's a very low watermark driven by the volumes we saw in the quarter. We're looking in the fourth quarter to step back up into that high single digit, low double digit range. And so getting back to the trajectory. And then from an international perspective, we were at a 15-8 in the third quarter. I think Kate and the team have plans. largely through controlling what we can control, whether it's block hours, whether it's head count, taking that, and they've done a good job of demonstrating that. Q1 was an 18 margin international. Q2 was a 20. So we're probably in the middle of that range for the fourth quarter. Hopefully that helps.

Thank you.

Yep.

Our next question will come from the line of Amit Marotra of Deutsche Bank. Please go ahead.

Thank you, operator. Hi, everybody. I guess maybe just a very simple question, I guess, is when do we return to margin expansion in domestic? I mean, RPP, CPP spread was really negatively wide in the third quarter. I assume it's still negative, albeit less so in the fourth quarter. Can we get to a situation where we get back to year-on-year margin expansion in early next year, or do we have to wait until August when the labor really, inflation really steps down?

Well, maybe just an observation on the U.S. margin in the third quarter. Recall that we had $500 million of expense related to our Teamster contract in the third quarter. If we backed that out, the U.S. margin would have been 8.5%. 8.5% on volume down 11 is not a bad margin. So we've got a bit of pressure on the margin that we shared with you because of our new contract. The contract is front-end loaded. We're bearing the pain of that front-end load for a five-year contract that's very attractive. The compounded annual growth rate on the five years is 3.3%. So once we get through this first front-end load with 46% of the cost in the first year, once we get through that, the margin is going to grow. It's going to grow in a big way. So hopefully that's helpful.

I mean, it kind of is helpful, but, I mean, I guess the question is that, you know, are we stuck in this return profile through the first half of next year and then we see a step function improvement, or can we see improvement as you guys maybe rip out some of those seasonal costs in the first quarter that we can get back to on your growth in the first quarter even?

Absolutely. Fair question. I mean, let us finish this year. Then we will give you guidance for 2024, and we can break it down by quarter if that's going to be helpful.

Okay, thank you.

Our next question will come from the line of Ravi Shankar, Morgan Stanley, please go ahead.

Hey, guys, good morning. This is Christina Garvey on for Ravi. I want to take a step back and ask about kind of the path to some of the longer term targets that you set out at your previous investor day, particularly just on some of the macro assumptions that you think you'll need to get there. You've seen definitely muted consumer spending in the last 18 months, but not a collapse. So, you know, how much of an uptick in consumer spending do you need to get there? Or maybe said another way, kind of how much do you feel is directly in your control?

So, as we look at the small package volume in the United States, what we're seeing is basically a reversion to the main. So, we're at pre-pandemic levels. And I think our learning, all of our learnings is that if time volume spikes because of an event, things are going to revert back to the main. If you look at the growth rates projected for the small package market in the United States, it's low single digit for the next couple of years. So we plan to grow not just at the market but ahead of the market because of the investments that we're making. with new products, new capabilities, and actually new acquisitions, which we're very excited about. And maybe I'll take a minute to talk about Happy Returns, which we just announced last night. You know, our returns business has been pretty growthy because of the explosion of e-commerce. It's grown 25% since 2020. And we like this business a lot. But we know we can offer a better experience for our retailers because it's expensive. Retailers estimate that between 20% and 30% of all online orders are returned. And it costs them, on average, about $33 to process that return. So it's happy returns. We're going to offer consolidated returns for our customers, which will reduce their handling costs, actually improve our delivery density. So it's a win-win-win. And so we're going to put the pedal to the metal in terms of growing the returns business because it's a very good business for us and one that our customers need us all for. So I'm excited about that. The other acquisition that I'm excited about is in healthcare. Our healthcare business will be $10 billion this year against an addressable market that's over $100 billion. We're going to grow that market. It's got double-digit margins. We're going to grow it because we need to grow it. It's important for the world. It's important for humanity. And we are the best in the world at this. So That doesn't require any consumer spending. That's just leaning into a market share capture with the capabilities that we are investing in, be it cold chain capabilities and more.

Really helpful. Thank you. Yes.

Our next question will come from the line of Jeff Kaufman of Vertical Research Partners. Please go ahead.

Thank you very much. I'd like to drill down a little bit on the macro comments as they relate to domestic. I think it's pretty... straightforward what you're saying about Europe and Asia, but can you help put some understanding around your concern for the weaker consumer with student loans and what have you? It does sound like we're going to be in for a reasonable holiday season. Um, what, where are you seeing the weakness, whether it's a, uh, an industry segment or a consumer segment? Um, you know, what concerns you on e-commerce and the domestic consumer?

Well, we've seen clearly a shift from goods to services. People through the pandemic started going back to work, taking vacations, eating out at restaurants, going to amusement parks. They're spending their dollars differently. It's not that the consumer's not healthy. They're spending their dollars differently. And what we're seeing with many of our retail customers is a real desire to bring people back into their stores. And they should bring people back into their stores because it's their largest investment. So you see retailers offering buy online, pick up in store where they hadn't offered that before. So I can give you example after example of customers, not by name obviously, but customers that are in our top 20 where they're seeing their same store sales down year on year because they're anniversarying the COVID peak, if you will. And they're seeing their online sales down even more. And part of that is because people are going back into stores. Part of that is they're shifting. So that's a comment that Brian made in his remarks about just some demand softening is that we do see that with some of our larger customers who didn't divert. but their overall business, and you can look at their guides. I'm not talking about anything that's not public. You can look at their guides where they not only have reported declining sales, but they're guiding softer.

Thank you for the clarification.

Yeah.

Our next question will come from the line of Brandon Oklinski of Barclays. Please go ahead.

Hey, good morning, and thanks for taking my question. Brian, you did talk about revenue quality initiatives. I know folks have brought up price quite a bit on this call, but can you talk about not just your pricing outlook, but maybe the mix impact from some of these initiatives you've had in the past on small and medium enterprises?

Yeah, SMBs, Brandon, are a very attractive part of the business, and we've continued to penetrate that market, so that's been favorable from a mixed perspective. We are seeing customers trade down, though, from air product to ground, and so we've seen that in the numbers. Air was down more than ground volume, so there's a bit of a headwind there from a customer mix perspective. Overall, we have a customer mix impact as well that's going on. We're gliding down with our largest customers, so there's a shift there that tends to help from an RPP perspective.

No, it's interesting. If you go back to 2019, our volume is about the same in the third quarter as it was back in 2019. But our S&B mix has moved from 23% to 29%. And our net revenue per piece has moved from $9.99 cents to $12.54. So we've been laser-focused on improving the revenue quality in our business, and we will continue to do that. Value is defined by what the customer is willing to pay for, and we are improving our experience every day. A good example of that is delivery photo, where now 92% of all of our residential drops are photographed, which is creating a better experience for our recipients, for our customers, and for us, candidly. We're leaning into simplifying the experience and how it is to work with us. And we've talked to you about the widgets that we have at DAP or the improvements that we've made in our claim process. We see our net promoter score now in the high 40s. So we are leading that experience because it helps grow the revenue quality, and we're going to continue to do that.

Thank you. Thanks, Brian. Our next question will come from the line of Brian Ostenbeck of J.P. Morgan. Please go ahead.

Hey, good morning. Thanks for taking the questions. Maybe just two quick follow-ups, actually. Can you talk about the pace of getting the share back as you go into the fourth quarter? Do you think perhaps you have the lower-hanging fruit, the easier ones to convert back? Do you think that those came back sooner, and maybe the pace from here is a little bit harder? And then on the buybacks, you mentioned you're cutting, or at least you're stopping the buyback for the quarter. You've got two acquisitions targeted. I just wanted to make sure it was clear in terms of what those are, if those were the happy returns in M&X, or if there's potentially something else that was on the horizon.

We have nothing else planned on the horizon today. So we'll be buying M&X and happy returns this quarter, and it's about $1.3 billion in total that we'll be spending on those two companies. In terms of the pace of getting shares, I mentioned earlier it's accelerating because of the fact that FECA is nearly on us. so people want to come into the network. Here's the truth, though. It does take time to come back in. I get weekly updates from Nando and the team, from Kate and the team, about how I'm coming back in. And I see that, oh, we've gotten a handshake, we've gotten an agreement from a customer that's coming back in. And then I see it takes 30 days to get it back on car. And so now I'm like, I want photos when it's on car because I want to make sure it's actually in the network. And that's what we're getting. We're having some fun with that, actually, because we're seeing it picked up from our competitors. That's always fun when you're picking up volume from your competitors. So it's accelerating.

Okay, thank you.

Steven, we have time for one more question. Okay, with no further questions, thank you for your time and have a good day.

Ladies and gentlemen, it does include our call. for today thank you for your participation you may now hang up