Good morning. My name is Stephen and I will be your facilitator today. I would like to welcome everyone to the UPS Investor Relations Fourth Quarter 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. And the after the speakers' remarks, there will be a question-and-answer period. [Operator Instructions]. It is now my pleasure to turn the floor over to your host, Mr. Ken Cook, Investor Relations Officer. Sir, the floor is yours.

Good morning, and welcome to the UPS fourth quarter 2022 earnings call. Joining me today are Carol Tome, our CEO; Brian Newman, our CFO; and a few additional members of our executive leadership team. Before we begin, I want to remind you that some of the comments we'll make today are forward-looking statements within The Federal Securities Laws and address our expectations for the future performance or operating results of our company. These statements are subject to risks and uncertainties, which are described in our 2021 Form 10-K, subsequently filed Form 10-Qs and other reports we file with or furnished to the Securities and Exchange Commission. These reports, when filed, are available on the UPS Investor Relations website and from the SEC. Unless stated otherwise, our discussion refers to adjusted results. For the third quarter of 2022, GAAP results include a non-cash after-tax mark-to-market pension gains of $782 million, a onetime 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 MD11 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 $0.34 per diluted share. Additional details regarding your 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. [Operator Instructions]. 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 a quarter, we were faced with choppy demand, continued COVID lockdowns in China, a threat of a work 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'm 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 U.S. operating margin expanded to 12.8% and reached the levels not seen in 10 year. Reflecting back on 2022, much changed from when we originally set our plan. 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 continue 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 and 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 remained focus on controlling what…

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 shareholder 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 shareholders. 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…

And Stephen, one note before we do that, we did experience a technical difficulty with a webcast this morning. So apologies to those of you who've 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 Stephen, 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 absolutely gross and net service. I don't know if you talked about -- I might have missed it. Sorry, there were 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, there's a lot of rhetoric that's heating up on a labor contract. 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. So that 420 specifically, I think you were talking about the domestic business, which is 380 of the 420, which is worth about $0.07 on a CPP. So when you think about the investment we're going to make into the business, which are about $400 billion, as I mentioned in my prepared remarks, that basically offsets the pension service cost impacted domestic. So it's more of a one for one. On the labor front, so we've modelled in rates in both our base and our downside scenario, Amit. 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.

Upon, I'm happy to address the labor question. 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 a win win win. Win for the Teamsters, win for 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 with my cost so much a 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 are 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. Then a lot has changed since the last time we negotiated our contract. Now recipients want their packages delivered when where and how they want them delivered, which means we can delivery well, it's become table stakes. Teamsters fully acknowledge that, but have worried about the pressures placed on our workforce with weakened 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…

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

Thanks.

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

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

Sure, Tom. Well, look, Nando 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 CPP in 2023. I referenced some of the investments that I think you're talking about in terms of smart pack smart facility, maybe if I unpack those, you'll get a sense of where we're investing. So smart pack 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 one in 400, post the smart pack smart facility we will be up in one in 800. And there's a path to something higher or beyond that. And then there's accelerating pilots for Phase 2 which is sort baggage car. Another area we're investing in, probably the second largest is healthcare. 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 that in the EU and half in the Americas. 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 in 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 smart pack smart facility, healthcare, DAP, and that's what's contributing to the low single digit CPP in 2023.

And maybe just to dimensionalize that 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 was just so enthralled with this project. We have of the 100 buildings that we're in, we have 50 buildings, where the misloads are now one in 1,000, that's six sigma perfection. So we're really excited about rolling 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 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 the laboratory. I was able to load a package onto a smart car and saw that car 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 if you step back from the guidance at the midpoint, your EBITDA number is down, call it 6% from 2023 levels. And obviously, we are coming into a choppy macro. And Carol or Brian, can you talk about, the levers that you need to pull to kind of get reaccelerating 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 at '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 if you think about where we've had some huge homeruns, 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, had been just a U.S. program, now we're going outside the United States. And this is one area of investments 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 through 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 masterful 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 costs. 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 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.

Now, some of the investments, international DAP for example, we're investing in the first part of the year, that'll start to pay back latter part of the year. And then the deployment of smart packs, smart facilities, that's probably more of a payback in '24 than '23 as we phase, complete Phase 1, and start to move on to Phase 2.

And to dimensionalize the investment that we're making in smart package 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.

Our next question comes from the line of Ken Hoexter from 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 year we had talked to you, 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 talked 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'll 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 that's -- 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 in 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 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.

And 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 International is doing a bit worse because we're in a now a two-week Lunar New Year holidays, 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 really is a function of currency. FX impacted our top line by $1.3 billion. So having 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, thanks, Ken.

Thanks Ken.

And 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 Wolfe Research. Please go ahead.

Hey, thanks. Good morning, guys. So I just want to make sure I'm understanding the guidance piece this year. So I think you said in the base case, Brian, the U.S. margin is 12%. And 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? Thank you.

Yeah, 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 will 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 has 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 KeyBanc 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 you teased out kind of the comments, you've got revenue in the base case up low single digits, volume down slightly. So revenue per piece maybe low to mid-single digits, a 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, was 6.9%. And with the service rates, 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. And the product mix is really less air, more sure post, so a shift in the product mix. And then the fuel component, fuel is 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.

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 health care. 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 there? Sort of what's the base market case growth for health care 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 $1 billion. 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 Alliger of Goldman Sachs. Please go ahead.

Yeah, hi. Good morning. Knowing that the SMB 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 it 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 we -- the team has delivered in this regard. So if you think about customer journeys, if you will, there are 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 home run. Iur 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. And then finally, 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 of years ago. And as I think about the SMB journey by investing in those customer experience points Carol was 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 in 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 Wetherbee of Citigroup. Please go ahead.

I guess maybe I had a question on volume. I wanted to understand a little bit better sort of the growth outlook for some of the SMBs, the non -- sort of Amazon business because 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 us 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 leading to the back half. And then again, in 1Q and 2Q, should we be using sort of similar numbers like 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. It'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 DAP 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, 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.

And then Stephen, we have time for one more.

Our last question will come from the line of Brian Ossenbeck of JPMorgan. Please go ahead.

Hey, good morning. Thanks for the time. Just want to come back to pensions real quick. Brian, can you talk about maybe any changes to the sensitivity? It's a little bit different than what we thought maybe not as big of an impact to change expected returns assumption or anything along those lines? And then maybe if you can just wrap up with a bit of commentary on pricing and yield and productivity. And how all those really relate and it 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 surprised a bit to the downside? Thank you.

Happy to, Brian. So on the pension front, look, we've been on a path to derisk 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 of 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 $900 million plus 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 will 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 Nando, 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 rollout the second iteration of our total service plan, which kicks off on March 3, 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. And we're laser-focused on those initiatives. And 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. And hopefully, we're building up a little bit of a track record to show that, that's exactly what we have been doing. So I appreciate it.

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