United Parcel Service inc (UPS) Q1 2023 Earnings Call Transcript

United Parcel Service inc (NYSE:UPS) Q1 2023 Earnings Call dated Apr. 25, 2023.

Corporate Participants:

Ken Cook — Investor Relations Officer

Carol B. Tome — Chief Executive Officer

Brian Newman — EVP & Chief Financial Officer

Analysts:

David Vernon — Bernstein — Analyst

Amit Mehotra — Deutsche Bank — Analyst

Allison Poliniak-Cusic — Wells Fargo Securities, LLC — Analyst

Tom Wadewitz — UBS — Analyst

Jordan Alliger — Goldman Sachs — Analyst

Ken Hoexter — BofA Global Research — Analyst

Scott Group — Wolfe Research — Analyst

Bruce Chan — Stifel — Analyst

Brian Ossenbeck — JP Morgan — Analyst

Christian Wetherbee — Citigroup Global Markets — Analyst

Ariel Rosa — Credit Suisse – North America — Analyst

Helane Becker — Cowen & Co. — Analyst

Stephanie Moore — Jefferies — Analyst

Presentation:

Operator

Good morning, my name is Steven, and I will be your facilitator today. I would like to welcome everyone to the UPS Investor Relations First Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. And after the speakers’ remarks, there will be a question-and-answer period. [Operator Instructions]

It’s now my pleasure to turn the floor over to our host, Mr. Ken Cook, Investor Relations Officer. Sir, the floor is yours.

Ken Cook — Investor Relations Officer

Good morning, and welcome to the UPS first quarter 2023 earnings call. Joining me today are Carol Tome, our CEO, Brian Newman, our CFO and a few additional members of our executive leadership team.

Before we begin, I want to remind you that some of the comments we’ll make today are forward-looking statements within the federal securities laws, and address our expectations for the future performance or operating results of our company. These statements are subject to risks and uncertainties, which are described in our 2022 Form 10-K and other reports we 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. For the first quarter of 2023 GAAP results include after tax transformation and other charges of $9 million or $0.01 per diluted share. A reconciliation to GAAP financial results is available on the UPS Investor Relations website, along with the webcast of today’s call.

Following our prepared remarks, we will take questions from those joining us via the teleconference. [Operator Instructions]

And now, I’ll turn the call over to Carol.

Carol B. Tome — Chief Executive Officer

Thank you, Ken, and good morning. Let me begin by thanking UPSers for once again delivering industry-leading service to our customers. Service defines UPS. It is one of our values, and I’m proud of our team who continue to make it a key priority. Another company value is safety. UPS drivers are among the safest in the industry, and every year we invest millions of dollars in safe driving education and training.

Our Circle of Honor program recognizes drivers who have achieved 25 years or more of accident-free driving. This year we inducted more than 1,200 UPS drivers into the Circle of Honor, bringing the total to more than 10,400 around the globe. Congratulations to these drivers on their achievement.

Turning to our results. 2023 is proving to be an interesting year. In the U.S. relative to our base plan, volume was higher than we expected in January, close to our plan in February, and then moved significantly lower than our plan in March, as retail sales contracted and we saw a shift in consumer spending.

For example, food as a percentage of household budget reached 9% in the first quarter, compared to 7% a couple of years ago. U.S. discretionary sales are lagging grocery and consumable sales, and disposable income is shifting away from goods to services. Outside of the U.S., export activity out of Asia remained weak, which negatively impacted revenue, in both international and supply chain solutions. In response, we focused on controlling what we could control. We remained disciplined on price. We increased penetration in the most attractive parts of the market. We managed the network with agility, we drove productivity, and we stayed on strategy.

Looking at our first quarter financial results versus last year, consolidated revenue was $22.9 billion, down 6%. Operating profit was $2.6 billion, a decrease of 22.8%, and consolidated operating margin was 11.1%, a decline of 250 basis points. While revenue fell short of our base plan, due to a relentless focus on productivity, both operating profit and operating margins were in line with our base plan.

Moving to our strategic update, through our customer first, people led, innovation driven strategy, we are investing to improve the customer experience, and drive efficiency.

Starting with customer-first. Key investments here are driving growth in targeted customer segments, like SMBs and healthcare. Looking at SMBs, we continue to invest in the international expansion of our Digital Access Program or DAP. We now have 16 countries producing DAP revenue. In the first quarter, total DAP revenue was up 51.5% compared to last year, and we are on track to generate around $3 billion in DAP revenue this year.

Did you know that in the U.S. about one out of every four DAP packages enters our network through a UPS store, with more than 5,100 locations in the U.S. UPS stores are strategic asset. In fact, 85% of the U.S. population is within 10 miles of the store, giving customers ultra-convenient entry points to the UPS network, whether they’re an SMB shipping an item they’ve sold online or a customer returning an item they bought.

Given the strategic importance of these stores, we are leaning into investments here, to improve the customer experience. For example, the stores are rolling out self-service kiosks that enable customers to bypass the counter, when they have shipments and returns. Even returns with no box or no label. These kiosks make it easier for customers to get in and get out of the store. We’ve rolled out nearly 200 kiosks so far and we’ll deploy 1,000 by the end of October this year. And we’re not stopping there.

Another area of focus is improving the claims process, which used to be a hassle for both customers and franchisees. In March, the UPS store launched an online claims portal to all U.S. locations, that’s designed specifically for the needs of the store shipper. With this portal, claims that used to take weeks for resolution are now resolved within an average of about two days.

One final comment on SMBs. In the first quarter, SMBs, including platforms made up 29.6% of our total U.S. volume. This is the 11th consecutive quarter of increased SMB penetration, and it’s the highest level we’ve seen in more than seven years.

Turning to healthcare, in the first quarter of 2023, we expanded our global footprint, by opening nearly 1 million square feet of dedicated healthcare space, including our first facility in Germany. This facility provides customers a broad range of temperature-sensitive and handling solutions. Its location in the center of Germany connects our customer shipment, the fast growing European healthcare market. The facility is also close to our European air hub in Cologne, enabling customers to leverage the speed and reach of our global network.

As a reminder, in the fourth quarter of 2022, we completed the acquisition of Bomi Group and to-date, revenue and cost synergies are running ahead of target. Further, we are continuing to invest in the global expansion of UPS Premier, which is now available in 45 countries, with four more to be added this year. Our goal is to become the number one complex healthcare logistics provider in the world, to help us get there. We plan to open a total of seven dedicated healthcare facilities this year.

In the first quarter, revenue from our healthcare portfolio reached $2.4 billion, and we expect to generate over $10 billion in healthcare revenue in 2023.

Turning to people led, let me discuss the progress of our negotiations with the Teamsters. Negotiations on a new contract that Teamsters are underway and good progress has been made on many of our local supplemental agreement. Together, we’ve set up fiev subcommittees at the national bargaining table to take on key areas of the contract, which enables us to move faster.

We are aligned on several key issues, like solving the staffing needs for weekend delivery and ways to mitigate the summer heat in our package delivery vehicle. While we expect to hear a great deal of noise during the negotiation, I remain confident that a win-win-win contract is very achievable and that UPS and the Teamsters will reach agreement by the end of July.

Now let’s move to the last leg of our strategy, innovation-driven. We have the best, most efficient global integrated network in the world, and we are getting even better. Today, we operate our network with more agility than ever before, and when it comes to productivity, we are relentless about creating a virtuous cycle of improvement in our network.

For example, our total service plan, which addresses running a predictable on-time network has delivered continued productivity improvements since being introduced last year. Our massive and highly complex network naturally generates efficiency when volume increases. But when volume levels drop, historically, it’s been harder to generate productivity improvement. With total service plan, we have driven productivity even with declining volume.

In the first quarter, U.S. volume declined by 5.4%, but hours declined even further, which resulted in improved productivity as measured by pieces per hour. As we’ve discussed last quarter, we’ve accelerated investment in our smart package smart facility RFID solutions, and plan to complete deployment in more than 900 buildings across the U.S. by the end of October. Throughout the process, we’ve continued to learn and improve which has enabled stronger results than we originally expected. In the facilities where we have this technology, we’ve got the frequency of misloads from around one in 400 packages to one in 1,000 packages, which reduces miles, handles and costs, and it improves both the customer and employee experience.

Innovation driven is also about combining digital capabilities with our integrated network, to improve the customer experience and efficiency. Our upstream delivery density solution checks both boxes. This month, we are onboarding our second large national retailer, which gives us more opportunity to increase density as we can match volume in the UPS network with orders of participating customers. It’s still early days of this initiative. As we learn, we continue to adjust the match rate algorithm, and we are happy with the results.

Lastly, our innovation driven initiatives are moving us towards our 2050 carbon neutrality goal. We are focused on the decarbonization of our global supply chain. In 2022, our Scope 1, 2 and 3 CO2 emissions declined by 6.9% from 2021. We’ve been investing in alternative fuel for more than 20 years and operate more than 15,600 alternative fuels and advanced technology vehicles.

Recently, we took delivery of 10 fully electric Class 8 semi trucks in California. These trucks are quiet, and they are the first zero-emission semis to run in our UPS fleet. Our 2022 sustainability report was published on April 12. This is our 21st annual sustainability report, and you can find it on about.ups.com.

Moving to our outlook for 2023. Last quarter, we provided a range for our 2023 financial targets. As we’ve discussed, there has been a deceleration in U.S. retail sales growth, and certain non-U.S. markets remain challenged. As a result, we now expect to be at the low end of our previously provided revenue and operating profit margin range. Brian will share more detail in a moment.

I’ve led through difficult times before, and I’ve seen the power of making the right decisions and the pitfalls of making wrong decisions. In uncertain market conditions, it’s easy to fall into the trap of managing the business for the short term. While we will control what we can control, we will also stay on strategy.

Over the past three years, we have fundamentally improved nearly every aspect of our business, and we are just getting started. UPSers are the best in the industry. And because of them, I am convinced we will come out of this cycle faster, stronger and with a wider lead on our competition.

With that, thank you for listening. And now I’ll turn the call over to Brian.

Brian Newman — EVP & Chief Financial Officer

Thanks, Carol, and good morning. In my comments, I’ll cover four areas, starting with the macro environment, then our first quarter results. Next, I’ll cover cash and shareowner returns, and lastly, I’ll review our updated financial outlook for 2023.

Okay. Let’s start with the macro. In the first quarter, the macro environment was challenging, from both a commercial and consumer perspective. The growth rate for U.S. manufacturing production fell throughout the quarter and was down 0.9% in March year-over-year. On the consumer side of the U.S. economy, the growth rate on services spending is continuing to outpace the growth rate on goods spending. And within the goods bucket, consumers spent more on essential items like groceries, which tend to be purchased in store. These factors, plus a five point drop in consumer sentiment from February to March contributed to the reduction in our volume levels.

Outside the U.S., in the first quarter, Asia exports remained weak, while Europe narrowly avoided a winter recession. In the face of all this, we responded with agility and remain focused on controlling what we could control, to deliver great service for our customers and bottom line results for share owners.

In the first quarter, consolidated revenue was $22.9 billion, down 6% from last year, and slightly below our base plan expectations.

Operating profit was $2.6 billion, a decrease of 22.8%. However, we achieved our base plan operating profit. Consolidated operating margin was 11.1%, a decline of 250 basis points compared to last year. For the first quarter, diluted earnings per share was $2.20, down 27.9% from the same period last year.

Now let’s look at our business segments. In U.S. Domestic, revenue quality initiatives nearly offset the decrease in volume. And as the decline in volume accelerated toward the end of the quarter, we responded quickly by adjusting the network to eliminate costs, while maintaining our industry-leading service levels. In the first quarter, we expected average daily volume to decline between 3% and 4%. For the quarter, average daily volume was down 5.4% year-over-year, primarily because volume in March moved lower than we expected.

Looking at mix in the first quarter, we saw lower volume across all industry sectors with the largest declines from retail and high-tech. B2C average daily volume declined 5.5% compared to last year and B2B average daily volume declined 5.4%. A bright spot in B2B in the quarter was returns, which was up 6.8% year-over-year. In the first quarter, B2B represented 42.7% of our volume, which was unchanged from a year ago. Additionally, the shift in product mix from air to ground that we saw in the fourth quarter of 2022 continued in the first quarter as customers made cost trade-offs and took advantage of the speed improvements we made in our ground network and further leveraged our SurePost product.

Compared to the first quarter of last year, total air average daily volume was down 16.7%, ground declined 3% and within ground, SurePost grew 1.8%.

Looking at customer mix, SMB average daily volume declined significantly less than our enterprise customers in the first quarter. SMBs including platforms made up 29.6% of our total U.S. volume, an increase of 120 basis points year-over-year.

For the quarter, U.S. Domestic generated revenue of $15 billion, down 0.9%. Revenue per piece increased 4.8%, nearly offsetting the decline in volume. The combination of base rates and customer mix increased the revenue per piece growth rate by 500 basis points, driven by strong keep rates from our general rate increase and increased SMB penetration. Fuel drove 200 basis points of the revenue per piece growth rate increase, remaining factors reduced the revenue per piece growth rate by 220 basis points, driven by the combination of negative product mix with ground packages outpacing air growth and lighter package weights.

Turning to cost. Total expense was relatively flat with an increase of 0.6% or $80 million in the first quarter. Higher union wage and benefit rates increased expense by over $300 million, primarily from a 6.1% increase in average union wage rates driven by the annual pay increase for our Teamster employees that went into effect in August of 2022.

The U.S. Domestic team did an excellent job pulling costs out of the network in response to lower volume. We managed hours down 5.6%, which was more than the decrease in average daily volume, and we reduced headcounts throughout the quarter as volume growth rates decline. Together, these actions reduced expenses by more than $220 million, partially offsetting the increase in wage and benefit rates.

Additionally, we reduced purchase transportation by $100 million, primarily from utilizing UPS feeder drivers to support our fastest ground ever and from continued optimization efforts, which enabled us to reduce trailer loads per day by 7.5% compared to the same period last year. The remaining variance was driven by multiple factors, including maintenance and depreciation. The U.S. Domestic segment delivered $1.5 billion in operating profit, which was slightly above our base plan and down 12.7% compared to the first quarter of 2022, and operating margin was 9.9%.

Moving to our International segment, we expected the macro environment to be bumpy and it was. Looking at Asia, export activity started off very weak due to the extended Lunar New Year holiday. It gradually recovered through the quarter, but at a slower pace than we anticipated. In Europe, the macro environment was a little better than we expected, which helped to offset the weakness in Asia relative to our base plan.

In the first quarter, international total average daily volume came in as expected and was down 6.2% year-over-year. Domestic average daily volume was down 9.5%, which drove 3/4 of the total average daily volume decline. Total export average daily volume declined 2.8% on a year-over-year basis, driven by declines in retail and high-tech market demand. Asia export average daily volume was down 8.9% and included a 20% year-over-year decline on the China to U.S. lane.

Through the first quarter, we remained agile and we flex the network to match demand, reduced Asia block hours by more than the decline in Asia export volume and delivered excellent service to our customers.

In the first quarter, international revenue was $4.5 billion, down 6.8% from last year, due to the decline in volume and $161 million negative revenue impact from a stronger U.S. dollar. Revenue per piece was relatively flat year-over-year, but there were a number of moving parts, including a 370 basis point decline due to currency and a 180 basis point decline from demand-related surcharges. These were offset by an increase in the fuel surcharge of 230 basis points and an increase of 330 basis points due to the combination of a high GRI at keep rate, and a favorable product mix as export volume outperformed domestic volume.

Operating profit in the International segment was $806 million, down $314 million from the same period last year, primarily due to the decline in exports out of Asia and included a $97 million reduction in demand-related surcharge revenue and a $51 million negative operating profit impact from currency. Operating margin in the first quarter was 17.7%.

Now, looking at Supply Chain Solutions. In the first quarter, revenue was $3.4 billion, down $983 million year-over-year.

Looking at key drivers in forwarding softer global demand, especially out of Asia drove down-market rates and volume, resulting in lower revenue and operating profit. We are continuing to manage buy/sell spreads and have taken steps to reduce operating costs in this business. Logistics delivered revenue growth, driven by gains in our healthcare logistics and clinical trials business and increased operating profit.

In the first quarter, Supply Chain Solutions generated an operating profit of $258 million and an operating margin of 7.6%. Walking through the rest of the income statement, we had $188 million of interest expense. Our other pension income was $66 million, and our effective tax rate for the first quarter was 24.8%, which was less than we anticipated in our base plan due to lower tax impacts from our employee stock awards.

Now let’s turn to cash and shareowner returns. In the first quarter, we generated $2.4 billion in cash from operations. Free cash flow for the period was $1.8 billion, including our annual pension contributions of $1.2 billion that we made in the first quarter. Also in the first quarter, we issued $2.5 billion in long-term debt that we are using to pay off debt maturing in 2023. And in the first quarter, UPS distributed $1.3 billion in dividends and completed $751 million in share buybacks.

Moving to our outlook for the full year 2023. In January, we provided a range of our 2023 financial targets due to the uncertain macroeconomic environment we saw at that time. Since then, the volume environment has deteriorated, especially in the U.S., driven by continued challenging macro conditions and changes in consumer behavior. As a result, we expect full year revenue and operating margin to be at the low end of the previously provided range.

For the full year 2023, we expect consolidated revenues of around $97 billion and consolidated operating margin of around 12.8% with about 56% of our operating profit coming in the second half of the year.

In U.S. Domestic, we expect full year volume to decline around 3% versus 2022 with revenue per piece growth nearly offsetting the decline in volume. And operating margin is expected to be around 11%. In International, we anticipate both volume and revenue to be down by around 4%, and we expect to generate an operating margin of around 20%, and in Supply Chain Solutions, we expect full year revenue to be around $14.3 billion and operating margin is expected to be around 10%.

We have proven our ability to adapt in a dynamic environment. We have many levers to pull on the cost side, and we will continue to control what we can control by delivering industry-leading service and remaining disciplined on revenue quality. We will also continue investing in growth and efficiency initiatives like international debt, healthcare and smart package smart facility, which will help us come out of this economic cycle faster and stronger.

Specifically, now that our volume is trending at the downside of our range, we are executing our plan to take out semi-variable and fixed costs, including in the U.S. air network, we are adjusting package flows to maximize utilization on our next day flights, which enables us to reduce block hours in our two day operation.

On the ground, we are pulling more volume into our large regional hubs, further leveraging the automation in those buildings and enabling us to eliminate sorts in smaller buildings. Driving more consolidation on the ground could potentially allow us to reduce our overall building footprint in the U.S.

Internationally, based on the volume levels over the last couple of quarters, we further reduced scheduled flights to reflect lower market demand while ensuring we maintain agility in the network to quickly add flights where needed if volume returns more strongly than we expect.

Across our global business, we will continue to manage headcount with volume levels. And in terms of overhead, we see opportunities to further reduce costs by leveraging technology.

Now let’s turn to capital allocation. Our plans have not changed. We will continue to make long-term investments to support our strategy and capture growth coming out of this cycle. We still expect 2023 capital expenditures to be about $5.3 billion, including investments in automation, and we’ll add 2.3 million square feet of healthcare logistics space to our global network this year. We’ll also complete the deployment of the first phase of smart package smart facility in the U.S., expand DAP internationally, and continue building out our logistics as a service platform.

We are still planning to pay out around $5.4 billion in dividends in 2023, subject to Board approval. We still plan to buy back around $3 billion of our shares. And lastly, our effective tax rate for the full year is expected to be around 23.5%.

In closing, despite the challenging macro backdrop, we will continue to provide industry-leading service to our customers, and we will stay on strategy. We are investing to make our network even more efficient and to strengthen our customer value proposition, to enable us to capture growth coming out of this cycle.

Thank you, and operator, please open the lines.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question will come from the line of David Vernon of Bernstein. Please go ahead, sir.

David Vernon — Bernstein — Analyst

So Carol, I wanted to follow up on your commentary around the productivity and in lighter volumes. As you guys think about the way the business is performing against the lower volume outlook right now, how confident are you that if we get into a better volume environment, say, ’24, ’25, that some of those productivity gains are going to be able to be held?

And then Brian, maybe just a follow-up. Can you give us a sense for what sort of magnitude of facility reductions you’d might be able to pull off here in the next couple of years? Thanks.

Carol B. Tome — Chief Executive Officer

Well, David, thank you for your question. First, as it relates to productivity, we introduced our total service plan last year. That’s not one and done. That’s the way we’re going to operate our business forever. Productivity is a virtuous cycle here at UPS, and Nando and the team continue to find opportunities to drive productivity in down markets as well as upmarkets.

Brian Newman — EVP & Chief Financial Officer

And on the second part of the question, Dave, in terms of the scope of building consolidation, et cetera, Nando and the team are doing a nice job working at project called Network of the Future, still early days. We do have some facility sales planned in the second quarter and the back half of the year, but that doesn’t really ramp up in terms of the opportunity to consolidate until ’24 or ’25 in that timeframe.

Carol B. Tome — Chief Executive Officer

Just a little bit more color on that, perhaps, if you think about how we grew up as a company, if we filled up the facility, we spun off the building and then we would fill up another facility and spin off a building. As Nando and his team have looked at it, we found that we might be able to consolidate some of those spin offs into highly automated buildings, drive productivity and not lose any drive time, not impact our customer service in any negative way. So we’re looking at that. It’s pretty exciting.

Brian Newman — EVP & Chief Financial Officer

But it is a change in culture. I don’t think, Carol, we’ve actually closed buildings outside of the non-op side. So it’s a pivot to be more optimized and focused.

Operator

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

Amit Mehotra — Deutsche Bank — Analyst

Thanks operator. Good morning, Carol and Brian. So Brian, the volume environment is obviously weaker and the weakness seems — seem to have accelerated towards the end of the quarter. So I’m just trying to understand, where are we now? I mean, there obviously — you’re obviously confident about achieving the low end of the guidance. I’m just trying to understand that confidence in the context of the volume uncertainty.

And then just as a follow up, if I could, Carol, it’s great that you think a win-win-win is still achievable, but the rhetoric is getting like really bellicose. And so I’m wondering if you could give some color on that dynamic because it seems like it’s costing you guys some volume right now. And I know you made an acquisition last year with Delivery Solutions that gives you access to a lot of contingent capacity. So talk about the win-win-win against the rhetoric, against the investments you’ve made. There’s a lot in there, but I’ll let you answer it however you want. Thanks.

Brian Newman — EVP & Chief Financial Officer

Yes. And I’d say the biggest change in terms of the base case versus downside is the volume. We were looking at volumes of down 1% in the base case, and now we’ve pivoted to the downside of down 3%. The first quarter was an evolution about where we expected in January, February, a little bit lighter, but March was the trail off. And so as we’ve seen the macros to deteriorate, we look at things like IP manufacturing at ESMO, those have continued to evolve. And so we basically adjusted the volume outlook for the first half of the year.

And so two reasons we’re confident that the full year in the case of the domestic business will be at 11%, we have confidence that the volume will come back post the summer related to customer conversations and some of the macro, which we think will trough in the middle part of the year. And also cost, we can go into more detail, but our ability to control costs and take more of the semi-variable out will help us deliver that 11% in the U.S.

Carol B. Tome — Chief Executive Officer

And maybe just a little more color on volume and then I’ll go to your question about Teamster. As Brian detailed, the rate of acceleration in the year-over-year decline caused us pause, because we were down around 3% in January, 5% in March — February and 7% in March. As we look at April, April has stabilized relative to how we exited March. So we feel very good that volume has stabilized.

If we look at the year-over-year decline in the U.S. a little over 1 million packages today, we would attribute over 60%, nearly 62% of the decline due to macro and a planned decline with our largest customer. As you know, we’re declining with them in a mutually accretive way. So it’s really a macro story here, and we’re delighted to see that the volume has stabilized.

To Brian’s point then what gives us confidence that the volume will come back in the back half of the year, I’ll share with you our strategy as it relates to sales. And this is a multifaceted strategy. It starts with Keith, to your point about volume diversion which by the way wasn’t very much in the first quarter. We’ve assigned 127 high impact executives to over 380 customers representing about one-third of our total volume. The role of the high impact executive is to meet with our customers, update them on our ongoing negotiations with the Teamsters and to keep them with us.

The next element of our strategy is protect, in the unlikely event of a work stoppage, and we’re not counting on that because we are confident we’re getting our contract. But in the unlikely event, we do have contingency plans to protect.

The third leg of our strategy is to win back for any volume that has diverted and we did have some, it’d be unreasonable to expect that we wouldn’t have any. For volume that has diverted, we are going to win it back as they told us they’re coming back. If that one customer just signed on the dotted line that they’re coming back once we have a handshake.

The third is to continue to sell. We are selling in the environment, and we want to sell and close and pull through those new customers. And then finally is work at the pipeline. We have a pipeline that’s greater than $6 billion. That’s hard to sell into right now because of that Teamster negotiation but we are going to go hard at it once we have that handshake deal. And we’re going to go at it in a way that we’ve never done before because we will be using our dynamic pricing model. This is a very different way to go at a market because we are creating value propositions for our customers that we haven’t done before, using the architecture of tomorrow, pricing model that we’ve created which creates some modifiers to base price to win for our customer and our win for UPS. So that’s really how we’re getting confident in the volume projections that we shared with you this morning.

Now, to your question about the Teamsters. If we told you from the beginning that it was going to be noisy and that’s turning out to be true. But let me just comment on the recent rhetoric. There was some noise about supplemental agreements. We have over 40 supplemental agreements with the Teamsters. We have been negotiating in good faith with the Teamsters on those supplemental agreements and have made very good progress. In fact, Teamsters leadership and UPS leadership were in Washington, D.C. last week, both given opening comments regarding the master agreement. So I feel like we are very much on track as to our timeline to accomplish a win-win-win.

And why am I confident about a win-win-win? Well, first of all, we are aligned on the North Star. And the North Star is that a thriving, growing UPS, it’s good for Teamsters, it’s good for UPS, and it’s good for our people. And when you are aligned on the North Star, everything else can get worked out. Some of the issues that Teamsters have been very public about, and we talked about at the last time, we had an earnings call. We’re aligned. For example, we all agreed that weekend delivery is table stakes because that’s what consumers are expecting. We all agree. It’s how we go about doing that from an operating model perspective that we need to work out.

Because of restrictions in our contract, in some instances, we have Teamsters working six days a week. Teamsters don’t like that. I don’t like that. If you want to work 6 days a week, that’s fine with me. But if you don’t, we shouldn’t force you. So we’ve got to work that out. And there are a number of other issues just like that. When we get to the bargaining table, we’ll figure out a way to work it out. I’m highly confident that we’re going to get a win-win-win agreement.

But like any negotiation, it’s going to be noisy and a few bumps along the way, and I just had this argument with my husband about a puppy. It was noisy on puppy. But in any negotiation that’s going to be the case. That’s certainly the case here. And that’s why I go back to our sales strategy of these high impact executives, putting our arms around our customers and making sure they’re comfortable with us because we are confident we’ll deliver our contract.

Amit Mehotra — Deutsche Bank — Analyst

Got it. Thanks you. Good luck with the puppy.

Carol B. Tome — Chief Executive Officer

Thank you.

Operator

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

Allison Poliniak-Cusic — Wells Fargo Securities, LLC — Analyst

Hi, good morning. Just want to go back to the productivity side that the hours deployed — the spread between hours deployed and the volumes certainly narrowed this quarter. I know you talked about some stabilization in April and certainly some cost that’s going forward. Just any color on how we should think about that spread? Should it remain positive and maybe expand as we get toward the back half of the year? Thanks.

Brian Newman — EVP & Chief Financial Officer

Yes. So look, we’re going to need to take cost out balance of year. It will be a big reduction in CPP. We were mid-single digits, Allison, in the U.S. And candidly, if you told me wages were going to be up 6% and volume was going to be down 5%, I would have expected something like a double-digit CPP about three to four years ago. Nando and the team have done an extraordinary job of driving at 6% that we saw in the quarter, but we are expecting low single digits for the balance of the year as you think about CPP.

It’s going to come from four areas. One, Carol talked about total service plan, and that’s that reducing hours more than volume and managing the headcount. The second is our network. We deal with both ground and air, as you know. And in the ground side, how do we consolidate volume into automated facilities, close sorts and really focus on the efficiency there. On the air side, it’s changing the package flows to better utilize the one day network. And in fact, domestic block hours they were down about 4% in the first quarter. We would expect to exit the second quarter at 2x that range.

The third piece that we’re focused on is overhead. And following the technology group are delivering technology efficiency to allow us to do our jobs in the non-op side more efficiently, and we’ll continue to reduce headcount as volume want. And lastly, fuel, we expect fuel prices to be down double digit year-over-year in the balance of the year, 2Q and 2H. So that will reduce both RPP and CPP. But those four things combined drive a high amount of confidence in a low single-digit CPP balance a year.

Allison Poliniak-Cusic — Wells Fargo Securities, LLC — Analyst

Understood. Thanks for the color.

Brian Newman — EVP & Chief Financial Officer

Yes.

Operator

Our next question comes from the line of Tom Wadewitz of UBS. Please go ahead, sir.

Tom Wadewitz — UBS — Analyst

Yes, good morning. That was really helpful, Brian, in terms of the cost per piece framework. Do you have a kind of a comparable thought for looking forward on revenue per piece and maybe also some — just some commentary on how the pricing environment is holding up? I think your primary competitor is pretty focused on margins, cutting costs, cutting capacity. Obviously, you’re doing a good job managing cost and capacity as well. So I think there’s a lot of potential for a good pricing environment, but any thoughts on that? And also just how we think about the drivers of revenue per piece? Thank you.

Brian Newman — EVP & Chief Financial Officer

Yes. So I’m happy too, and I assume you’re talking about the domestic business. So we had guided —

Tom Wadewitz — UBS — Analyst

Yes, domestic, thanks, yes.

Brian Newman — EVP & Chief Financial Officer

Originally to an RPP growth of about 3% this year. Carol mentioned, volumes are coming in a bit softer, but we’re holding on to that RPP. And the RPP composition, we actually saw close to 5% RPP growth in the first quarter, that was driven by a tailwind in fuel, about 200 bps. That flips around Tom, in the back end of the year where we expect double-digit decline in fuel price. So the way I think about the GRI and the customer mix piece, that should be mid-single digit, about 5 points, and then we’ll have about a 200 bps decline from fuel. That gets us right into that 3% range.

We did see some headwinds in the product mix for air-to-ground in the first quarter. That will moderate as we go into Q2 and the back end of the year. So that’s the composition.

Carol B. Tome — Chief Executive Officer

And maybe just a comment on the pricing environment. The keep rate on the GRI is the highest it’s been. In the United States, it’s north of 60%. It’s even higher outside of the United States.

Tom Wadewitz — UBS — Analyst

Okay, great. Thank you.

Brian Newman — EVP & Chief Financial Officer

Thanks, Tom.

Operator

Our next question comes from the line of Jordan Alliger of Goldman Sachs. Please go ahead, sir.

Jordan Alliger — Goldman Sachs — Analyst

Yes, hi. You talked a little bit about what’s going to drive cost per piece at back half of the year. But maybe can you talk a little bit about some of the specific buckets, notably, that other expense was quite a bit higher and is it more opportunity to purchase transport? Just trying to get a sense for what — where it’s going to be impacted the most? Thanks.

Brian Newman — EVP & Chief Financial Officer

Yes. CPP was — we were able to take cost out of that. And as you look at the back end of the year, from another perspective, we’re certainly getting after a lot of the nonoperating costs. We’re taking consulting spend out of the business. We’re taking headcount out of the business. So we’re really driving from a non-ops perspective down to something closer to 4% of revenue from a cost perspective.

Carol B. Tome — Chief Executive Officer

And maybe just a comment on that other expense line item because it does look out of source. We are moving to software-as-a-service, if the line-item move right. Brian, you’re the finance person here, but rather than depreciation, it’s going to move into expense. That’s exactly right. So there’s a little bit of a difference if you have software-as-a-service for your technology deployment versus what you build.

Brian Newman — EVP & Chief Financial Officer

Transition of buckets.

Carol B. Tome — Chief Executive Officer

Thank you.

Brian Newman — EVP & Chief Financial Officer

Yes.

Jordan Alliger — Goldman Sachs — Analyst

Got it. And then just a quick follow-up. You talked a lot about the domestic environment and stabilization perhaps in April, but what about the Asian export business? Is there anything on that front that gives a little confidence right now? Thanks.

Carol B. Tome — Chief Executive Officer

Well, here’s what we’re seeing in the business. Week after week, it’s better. It’s still down year-on-year, but it’s better, slowly coming out of this negative year-over-year decline of almost 20% in the first quarter. And Kate and her team are doing a masterful job of managing through that. In fact, if you look at productivity outside the United States, our ex-Asia export business down at 8.9%. Our block hours were down 14% and she’s taking more block hours out in the second quarter, even with improvements just to optimize the air network.

Jordan Alliger — Goldman Sachs — Analyst

Thank you.

Brian Newman — EVP & Chief Financial Officer

Thanks, Jordan.

Operator

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

Ken Hoexter — BofA Global Research — Analyst

Hey, good morning Carol and Brian. You talked about the sharp decline in mid February. I guess you’ve seen this before where we’ve had some stabilization and then a sharp decline. Inventory still seems high. Maybe your thoughts on the backdrop and maybe, Brian, a little more International, you talk about getting to 20% margin on international. But it seems like pre-COVID, you were operating maybe 16% to 19%. Did something structurally change or the mix change that you think that, that is the new floor versus in a shifting environment, it goes a little bit lower? Thanks.

Brian Newman — EVP & Chief Financial Officer

Yes, Ken. Happy to start, taking the last piece first. On international, we had guided a couple of years ago when we went out with a three year guidance to a 21.5% in international. Obviously, the world has changed a lot since then. But the mix of Kate’s business that she’s running and the agility on the network in terms of managing the airflow has, I don’t know about a floor, but I think we’re comfortable with the 20%. You’ll see that 20% margin Ken fairly consistently Q2 through Q4. So we feel comfortable about that in terms of how the business evolves.

Carol B. Tome — Chief Executive Officer

And on the volume question, again, it goes back to our sales strategy. We have pretty good visibility into the pipeline. We just got to pull that pipeline through. In today’s environment, with the contract negotiation about 100 days out to completion, kind of hard to get a pull through, but we’re going to pull it through when we get that handshake deal.

Ken Hoexter — BofA Global Research — Analyst

Thanks Carol. Thanks, Brian.

Brian Newman — EVP & Chief Financial Officer

Thanks, Ken.

Operator

Our next question comes from the line of Mr. Scott Group of Wolfe. Please go ahead.

Scott Group — Wolfe Research — Analyst

Hey, thanks. Good morning. Brian, just a couple of follow-ups on the guidance. The 11% U.S. margin, how does that trend throughout the course of the year? And then the volumes were down — the volume is down 3% for the year. How should we think about Q2? And is the back half sort of flat to positive? Is that what you’re expecting? Thank you.

Brian Newman — EVP & Chief Financial Officer

Yes. I would say the — in terms of shaping the year, Scott, maybe that helps. We don’t manage in quarters but to help you shape. I referenced in the prepared remarks, 56% of our full year operating profit coming in the second half for the company. If you look at the U.S. Domestic business, I’d expect ADV year-over-year growth rate to bottom in Q2 and then improve from there to your point. And then that relates to the actions we’re — as we think about margin, the actions we’re taking on semi variable costs and margins will improve sequentially in Q2 and then throughout.

Fuel PPG well, we’ll reduce both RPP and CPP. So it’s not a material profit impact. But I would expect operating margins to be better in the second quarter than in the first. On the International side, I think ADV will gradually improve through the year. And as I mentioned, we’ll have to see consistency of the op margin for the next three quarters of around 20% in the balance of the year.

And then finally in supply chain, revenue should be marginally better in Q2 than Q1, and you can hold that 10% as the full year op margin.

Scott Group — Wolfe Research — Analyst

Thank you.

Brian Newman — EVP & Chief Financial Officer

Yes.

Operator

Our next question will come from the line of Bruce Chan of Stifel. Please go ahead, sir.

Bruce Chan — Stifel — Analyst

Yes. Thanks and good morning, everyone. Just want to ask here on the share shift issue. If you’re able to quantify or even qualify the attrition that you’re seeing. And I just asked because I think there’s been a lot of focus on your upcoming negotiations. But just based on your service investments and what are some pretty major, I think, operational changes at your largest competitor, I’m wondering if you’re actually seeing any business wins? Appreciate it.

Carol B. Tome — Chief Executive Officer

We are — we are definitely seeing business wins. And I have to give a hat off to our sales team for selling through this environment. We are delivering packages for customers that we’ve never delivered before. Why? Because our service is the best in the industry. But what we see with some of our long-term existing large customers is that their business is changing. And I can give you a few anecdotes if that’s helpful.

One of our large customers reports publicly every month, their same-store sales. This is a customer who for 80 quarters in a row had positive same-store sales and in the month of March saw negative same-store sales. One of our other customers who has both in-store sales, as well as online sales has seen a shift in their customer shopping behavior from online to stores. So they’re shutting down shifts inside of their warehouses, which makes sense for them. So we see generally macro and a change in consumer behavior impacting our volume, but we’re winning and then we just — you’ve got to go win faster and we will win faster when the uncertainty is behind us. I’m quite convinced of the Teamster negotiation.

Customers say, we’d like to ship with you, we’re just going to sit on the sidelines still you’re done. So we just need to get done, and we will.

Operator

Our next question will come from the line of Brian Ossenbeck of JPMorgan. Please go ahead, sir.

Brian Ossenbeck — JP Morgan — Analyst

Hey, good morning. Thanks for taking the question. So Carol, you just gave some commentary about some of the volume trends from some of the customers. Are you seeing anything that you would attribute to perhaps demand destruction from parcel rates going up with capacity constraints with some of the disruptions and surcharges, including on fuel? Do you attribute any of the volume weakness to that?

And then, Brian, maybe you can elaborate a bit more on returns. You mentioned it was a pretty good growth driver in the quarter, but your largest customer is also floating the idea of perhaps charging for some returns in the future. I wanted to see if that was some of the consideration we should think about in terms of what that could do for that volume driver, which seems to be a pretty good one, at least for the time being? Thank you.

Carol B. Tome — Chief Executive Officer

So to your first question, we don’t see volume disruption because of pricing, we do see product change. However, if you looked at our air product in the quarter, it was down year-on-year more than ground. We see customers moving out of air to ground. Why? Well, we’ve really worked to improve our time in transit. So we’ve got the fastest time in transit now so you can get your package where it needs to go quicker than before and people are looking for value. So I can watch customer by customer moving out of air to SurePost by the way. SurePost is up in the quarter, almost 2%.

Brian Newman — EVP & Chief Financial Officer

And on the returns business, it’s a great business. The margins are attractive. We saw positive growth in the first quarter, as I called out. And a big piece of that is the over 5,000 stores, we have UPS stores across the country. Carol mentioned 7% of the volume originates in those stores and it’s a great, easy way for consumers with the returns that are going on as the e-comm economy pursues. So we feel good about that and something we’re building capability in every day.

Carol B. Tome — Chief Executive Officer

And convenience matters for returns. If you want to get that package back, so you get credit back into your wallet, you want a convenient place to return. And with our locations, we’re 85% of the U.S. population — within 10 miles of 85% of the U.S. population we’re extraordinarily convenient.

Operator

Our next question comes from the line of Chris Wetherbee of Citigroup. Please go ahead, sir.

Christian Wetherbee — Citigroup Global Markets — Analyst

Yes, hey, just wanted to maybe hit on the cadence question again about sort of how this year progresses on the guidance, I think 56% of the profit in the back half of the year implies around $2.9 billion or so in 2Q? And just any thoughts around the step-up we would — might see between domestic and international?

And then I guess just, Brian, on the RPP, CPP point, do you have a line of sight or does the guidance include a flip back to RPP outperforming or outpacing CPP by the end of the year? Is that a volume function? Is that more of a cost function? I just want to make sure I understand sort of how you guys are thinking about that?

Brian Newman — EVP & Chief Financial Officer

So we’re longer term — Chris, as we’ve talked to you, we’re always going to drive for RPP to outpace CPP. We are in a bit of an extraordinary environment right now with the macros and everywhere they are. So we don’t have margin expansion this year based on the guide. So you won’t see that likely return until ’24, but we feel good about the taking cost and CPP down to low single digit as RPP does come back. So I feel okay about that.

And then your math is fairly accurate in the second quarter, you’re doing the squeeze the right way.

Christian Wetherbee — Citigroup Global Markets — Analyst

Okay. Thank you very much.

Brian Newman — EVP & Chief Financial Officer

Yes.

Operator

Our next question comes from the line of Ariel Rosa of Credit Suisse. Please go ahead.

Ariel Rosa — Credit Suisse – North America — Analyst

Hey, good morning, Brian. Good morning, Carol So I just wanted to understand, how do you think about the softer economic environment potentially impacting your discussion with the union. Is there any dimension on which it maybe makes negotiations a little bit easier or it gives you a little bit more leverage vis-a-vis that discussion? Thanks.

Carol B. Tome — Chief Executive Officer

So we look out, we don’t look in the current moment. We look out for where we both want to go as growing and thriving UPS is in the best interest of Teamsters, UPS and our people. So the current economic environment, it is what it is. But our negotiations are all about the future.

Operator

Our next question will come from the line of Helane Becker of TD Cowen. Please go ahead, ma’am.

Helane Becker — Cowen & Co. — Analyst

Thanks very much operator. Hi, everybody, and thank you very much for the time. I wonder, Brian, if you could talk a little bit about what margins in the stores are like. I feel like you are hinting after one of your most profitable business lines. So I’m kind of wondering if you could put some more color to that.

Brian Newman — EVP & Chief Financial Officer

You talked about the UPS stores. So it’s a great foundation for volume origin. We have a royalty relationship that generates a royalty stream that comes in from the stores as far as what income comes into UPS. And as that volume grows, our royalty grows.

Carol B. Tome — Chief Executive Officer

We do look at the profitability of stores because I’m curious, I’m an old retailer, so are the stores profitable? The stores are very profitable, which means franchisees are happy. We add about 100 new stores every year because this is a great small business to own. And in terms of the royalty fee that comes into our company, there’s some expenses against that. But if you look at the margin against that royalty fee, I would say it’s the highest margin business that we’ve got.

Brian Newman — EVP & Chief Financial Officer

Yes.

Ken Cook — Investor Relations Officer

Excellent. Stephen, we have time for one more question.

Operator

Our last question will come from the line of Stephanie Moore of Jefferies. Please go ahead ma’am.

Stephanie Moore — Jefferies — Analyst

Hi, good morning. Thank you. Hi, Carol and Brian, I just wanted to kind of look through your updated guidance, particularly your consolidated margin outlook. Certainly, understand it’s a very fluid environment as it relates to volumes that appreciate the additional color of you guys executing on what’s in your control. But could you talk a little bit about your ability to maybe still hit that margin target and volumes were to deteriorate — were deteriorated worse than you expected? And how you kind of framed that in your outlook as you kind of looked at the puts and takes for what is a pretty volatile year? Thank you.

Brian Newman — EVP & Chief Financial Officer

Yes, happy to. And the whole reason we went out at the beginning of the year with two scenarios is we didn’t know what was going to happen with the macros. And the macros continue to deteriorate in the first half of the year. So we had a playbook, which was the downside scenario. We pulled that off the shelf and are executing the TSP, the network changes for ground and air, the overhead of fuel. And so from a line of sight perspective, what we control, I feel good about the 12.8% that we’ve got in for the downside scenario.

Obviously, the top line is what it is. Like Carol said, we’ve got the largest pipeline of sales that we’ve had in about five years, which is a very big number, $6 billion. And so our ability to pull that in post the negotiation with the labor that gives us confidence on the top line.

Stephanie Moore — Jefferies — Analyst

Well, you might share the split of variable, semi-variable and fixed?

Brian Newman — EVP & Chief Financial Officer

Yes. So well, I’m not sure anything is fixed anymore careful to. So we do about 1/3 variable on the 70% in the semi and the fixed bucket. And we’re really redefining that. As we talked earlier, we don’t have a history of closing or selling buildings per se, but everything is on the table because in the new world, there has been a growth over 100 years of a bunch of buildings located around. And so Nando’s ability to go and shut down some sorts and drive, we’re going to match the volume.

The one thing Carol, I would add is when volume returns and make no mistake, volume will return to this business, we will be positioned very well to throw off cash because we’ll have positioned the cost structure in a good way.

Ken Cook — Investor Relations Officer

Thanks, Brian. And I want to thank everybody for joining us this morning. Look forward to talking to you next quarter. And that concludes today’s call.