Q1 2024 United Parcel Service Inc Earnings Call

Participants

Brian O. Newman; Executive VP & CFO; United Parcel Service, Inc.

Carol B. Tome; CEO & Director; United Parcel Service, Inc.

Kathleen M. Gutmann; Executive VP and President of International, Healthcare & Supply Chain Solutions; United Parcel Service, Inc.

Matthew Guffey; Executive VP & Chief Commercial & Strategy Officer; United Parcel Service, Inc.

Nando Cesarone; Executive VP & President of U.S. and UPS Airline; United Parcel Service, Inc.

PJ Guido

Amit Singh Mehrotra; Director and Senior Research Analyst; Deutsche Bank AG, Research Division

Bascome Majors; Research Analyst; Susquehanna Financial Group, LLLP, Research Division

Brian Patrick Ossenbeck; Senior Equity Analyst; JPMorgan Chase & Co, Research Division

Conor T. Cunningham; Research Analyst; Melius Research LLC

Daniel Robert Imbro; MD & Research Analyst; Stephens Inc., Research Division

David Scott Vernon; Senior Analyst; Sanford C. Bernstein & Co., LLC., Research Division

Eric Thomas Morgan; Research Analyst; Barclays Bank PLC, Research Division

Jizong Chan; Associate VP & Equity Research Analyst; Stifel, Nicolaus & Company, Incorporated, Research Division

Jonathan B. Chappell; Senior MD; Evercore ISI Institutional Equities, Research Division

Jordan Robert Alliger; Research Analyst; Goldman Sachs Group, Inc., Research Division

Kenneth Scott Hoexter; MD & Co-Head of Industrials and Basic Materials; BofA Securities, Research Division

Ravi Shanker; Executive Director; Morgan Stanley, Research Division

Scott Andrew Schneeberger; MD & Senior Analyst; Oppenheimer & Co. Inc., Research Division

Scott H. Group; MD & Senior Analyst; Wolfe Research, LLC

Stephanie Lynn Benjamin Moore; Research Analyst; Jefferies LLC, Research Division

Thomas Richard Wadewitz; MD and Senior Analyst; UBS Investment Bank, Research Division

Presentation

Operator

Good morning. My name is Stephen Day, and I will be your conference facilitator today. I would like to welcome everyone to the UPS Investor Relations First Quarter 2024 Earnings Conference Call. (Operator Instructions)
It is now my pleasure to turn the floor over to your host, Mr. PJ. Guido, Investor Relations Officer. Sir, the floor is yours.

PJ Guido

Good morning, and welcome to the UPS First Quarter 2024 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 2023 Form 10-K 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 first quarter of 2024 GAAP results include a total charge of $110 million, or $0.13 per diluted share, comprised of after-tax transformation and other charges of $75 million and a noncash after-tax impairment charge of $35 million, driven by plans to consolidate certain acquired brands within our healthcare portfolio.
A reconciliation to GAAP financial results is available on the UPS Investor Relations website and also available in 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

Thank you, PJ, and good morning. Let me begin by thanking UPSers for doing what they do better than anyone, and that's deliver industry-leading service. Through the first quarter, UPSers continue to execute our strategy by focusing on growth and efficiency and exemplified our purpose of moving our roll forward by delivering what matters. Moving to our results. The first quarter turned out as we expected, starting with a decline in average daily volume.
U.S. average daily volume, or ADV, declined year-over-year, but the rate of decline slowed as the quarter progressed, ending with March down less than 1%. And on a sequential basis, the ADV decline rate in the first quarter showed marked improvement compared to the fourth quarter of 2023. This improving performance is primarily due to the efforts of our sales team to win and pull through new volume into our network. Outside of the U.S., the ADV decline rate also improved sequentially compared to the fourth quarter of last year and we saw pockets of export growth in certain markets in lane.
For the first quarter, consolidated revenue was $21.7 billion, a decline of 5.3% versus last year. Operating profit was $1.7 billion, down 31.5% compared to last year due, for the most part, to higher labor costs associated with the first year of our Teamsters contract. Consolidated operating margin was 8%. Our operating profit performance was a bit better than we expected due to higher productivity.
At our Investor and Analyst Day last month, we shared our 3-year targets and how we intend to reach them under our better and bolder approach. We are reimagining our network through Network of the Future, and we are leaning into the parts of the market that value our end-to-end integrated network. For example, we recently announced that UPS will become the primary air cargo provider for the United States Postal Service.
Under this contract, we will move most of the USPS air cargo within the United States. The USPS air cargo business fits beautifully with our strategy to grow our B2B business. To win, we put together an innovative and differentiated solution that leverages our integrated network and existing assets. The USPS air cargo business will contribute to top line growth and be accretive to consolidated and U.S. domestic operating margins.
Brian will share more details, including what to expect during the transition period and where this will show up in our financial reporting. Moving to our strategic update. Through our customer-first people-led innovation-driven strategy, we are investing to grow in the premium parts of the market and drive efficiency. Let me give you a few recent examples.
Starting with customer first. Through our on-demand network, we are expanding our addressable market with capabilities like no box, no label returns through Happy Returns and the convenience of our more than 5,200 UPS store locations. During the first quarter, our overall returns volume in the U.S. increased 1.4% and Happy Returns more than quadrupled its ADV in the first quarter. Returns are attractive to us for a couple of reasons.
First, they are typically B2B movements and as a result, drive pickup and delivery density. Second, our frictionless offering creates customer loyalty and repeat business. We are also expanding our addressable market with capabilities like big and bulky deliveries through Roadie. In the first quarter, we launched RoadieXD, which adds cross-dock capabilities to RoadieXL. Our cross dock solution brings the digital and physical together for long zone deliveries of bulky items such as grills and furniture that do not fit in the UPS small package network.
This is enabling us to unlock additional revenue opportunities in the highly fragmented $60 billion big and bulky market in the U.S. It's still early days but this is a large opportunity for us to grow quality revenue and profit and serve the needs of our customers. As we laid out at our Investor Day, our long-term target is to grow our U.S. SMB volume penetration to 40%. DAP, our digital access program is 1 of the tools we will use to reach this target. Recently, we enhanced our DAP pricing capabilities by launching a solution we call fast lane. With fast lane, we can optimize rates and target attractive volume growth whether it be by partner, by product or by customer segment, all of which can drive revenue per piece growth.
We can even target volume growth by geography to drive density. Prior to fast lane, rate and other adjustments in depth could take months. Now we can make them in a matter of days or even hours. In terms of results, in the first quarter, DAP revenue grew by 3% year-over-year. And in 2024, we expect to generate over $3 billion in global DAP revenue.
Speaking of SMBs, over the last year, we've gained traction on improving the customer experience across 16 journeys. Take pickup. We redesigned our process and deployed new driver dispatch technology. This resulted in a 74% reduction in pickup concerns and a Net Promoter Score, or NPS, of 48 for this journey, which is an all-time high for UPS.
And for our international customers, our next-gen brokerage solution is making it easier for SMBs to navigate the ins and outs of exporting as evidenced by a 40% decline in custom brokerage holds since April of 2023. Turning to healthcare. We aim to become the #1 complex healthcare logistics provider in the world. Healthcare companies are innovating and so are we. Our latest example is the opening of LabPort at Worldport, our global air hub in Louisville, Kentucky.
LabPort is unique. It's an end of the runway, state-of-the-art facility built specifically for lab customers. By being at Worldport, we can deliver urgent air packages to our lab customers well before the sun comes up so they can provide diagnostic results by early morning. And in terms of healthcare revenue, in the first quarter, revenue from our healthcare portfolio reached $2.6 billion.
Outside the United States, we're continuing to enhance our network to grow our premium international business. Our most recent example is the launch of Next Day flights between Shenzhen, China and Sydney, Australia. The addition of these flights enables faster import and export movements between 11 Asian markets in Australia and now exports from Australia can even reach Europe by the next business day.
This enhancement further enables us to serve our customers. Particularly those that are in high-tech, manufacturing and healthcare as they are shifting their supply chains in response to changing international trade flows. Now let's turn to innovation driven. As we've discussed, network of the future includes physical and digital changes that will deliver benefits in the short term and the long term.
Smart Packaged Smart Facility, our RFID solution is a great digital example. We are moving from a scanning network to a sensing network following last year's Phase 1 deployment to our preload operations. This year, we are installing RFID readers in over 40,000 U.S. packaged cars with the balance to be completed in 2025.
Packaged car readers will enable us to further reduce our missed loads which will improve efficiency and the customer experience. The physical aspect of Network of the Future has launched. And in the quarter, we continued to close sort and flow more volume into automated facilities. Most of the Phase 1 major projects we outlined during our Investor Day have begun and are in the contracting and execution phases.
Innovation-driven is also about achieving carbon neutrality by 2050. We recently published our 22nd sustainability report, and we are well on our way to achieving our goals. In 2023, our Scope 1, 2 and 3 CO2 emissions declined 8.1% compared to 2022. We operate more than 18,000 alternative fuel and advanced technology vehicles in our roaming laboratory. And the use of alternative fuels in our ground operations reached 28.8% last year keeping us on track to achieve our target of 40% by 2025.
Moving to our outlook. We are reaffirming our previously announced 2024 consolidated financial goals. In 2024, we expect to generate consolidated revenue ranging from approximately $92 billion to $94.5 billion and a consolidated operating margin ranging from approximately 10% to 10.6%. Versus last year, we still expect first half earnings to decline and second half earnings to grow as we lap the first year of the Teamsters contract, and we still expect to exit the year with the U.S. operating margin of 10%.
As we move forward, we are staying on strategy and under our better and bolder approach, we are pursuing our declaration to become the premium small package provider and logistics partner in the world.
With that, thank you for listening. And now I'll turn the call over to Brian.

Brian O. Newman

Thanks, Carol and good morning. In my comments, I'll cover 4 areas. First, I'll review our first quarter results, followed by our 2024 financial outlook. Then I'll provide some comments on our business with the USPS. And lastly, I'll close with a recap of our 2026 targets. While the macro environment in the first quarter showed improvement in some areas, continued soft demand pressured all 3 parts of our business. Through the quarter, we adjusted our integrated network to match volume levels and drove out expense while maintaining industry-leading service levels.
Moving to our financial results. Our overall quarterly performance was in line with our expectations. In the first quarter, consolidated revenue was $21.7 billion, down 5.3% compared to the first quarter of 2023. All 3 of our segments demonstrated cost agility and on a combined basis, drove down expense by $414 million in the first quarter. This enabled us to deliver $1.7 billion in consolidated operating profit and consolidated operating margin was 8%.
Diluted earnings per share was $1.43, down 35% from the first quarter of 2023. Now let's look at our business segments. In U.S. domestic, we remain focused on controlling what we could control to improve volume growth and drive productivity. In the first quarter, average daily volume was down 3.2% year-over-year. When looking at ADV sequentially, the growth rate showed strong improvement compared to the third and fourth quarters of 2023.
B2B average daily volume was down 5.5% compared to the first quarter of last year primarily driven by declines in the retail and manufacturing sectors and B2B represented 41.6% of our volume. Looking at product mix, and in line with recent trends, we continue to see a shift from air to ground as customers prioritize cost savings over transit times by taking advantage of our ground services.
Compared to the first quarter of 2023, total air average daily volume was down 8.3%, ground declined 2.3%. And within ground, SurePost volume grew 10.8%. For the quarter, U.S. domestic generated revenue of $14.2 billion, down 5%. Revenue per piece was relatively flat year-over-year. Looking at the key drivers, base rates increased the revenue per piece growth rate by 240 basis points. This was offset by a couple of factors. First, changes in customer and product mix due to growth in SurePost combined with changes in package characteristics, decreased the revenue per piece growth rate by 180 basis points.
And second, changes in fuel prices decreased the revenue per piece growth rate by 90 basis points. Turning to cost. Total expense was down 0.8% or $104 million in the first quarter. Union wage rates increased 13% driven by the contractual increase that went into effect last August. Leveraging technology and the agility of our integrated network, we took several actions, which more than offset the increase in compensation. We leveraged Total Service Plan and Network Planning Tools to reduce total operational hours by 6.6%, which was more than the decline in average daily volume.
We closed 18 sorts and reduced operational resources by 4.8% compared to last year. We lowered block hours by 15.2% versus last year. We reduced management and support staff by approximately 5,400 positions year-over-year. In addition, we reduced purchase transportation by 17%, primarily from our continued optimization efforts. And lastly, lower fuel costs contributed to the decrease in total expense.
The U.S. Domestic segment delivered $839 million in operating profit, down 43.6% compared to the first quarter of 2023 and operating margin was 5.9%. Moving to our International segment. The macro environment remained challenged, primarily in Europe and Asia. However, volume growth in the Americas region showed early signs of near-shoring. In the first quarter, international total average daily volume was down 5.8% year-over-year.
About 2/3 of the decline came from lower domestic average daily volume, which was down 8.1%, driven primarily by declines in Canada and major markets in Europe. On the export side, average daily volume declined 3.6% year-over-year primarily due to weak manufacturing activity in Europe. In Asia, export average daily volume was down 4.8%, which was an improvement from the fourth quarter of 2023. Within Asia, export volume on the China to U.S. lane increased 12.8% and showed steady growth for the second consecutive quarter.
More than offsetting the overall decline in Asia, nearshoring became evident as export average daily volume in the Americas region increased 3.8%. This was led by SMB customers in Canada and Mexico, leveraging our cross-border ground service. In the first quarter, international revenue was $4.3 billion, down 6.3% from last year, primarily due to the decline in volume. Revenue per piece increased 2% and included a number of moving parts.
Strong base pricing drove a 360 basis point increase in the revenue per piece growth rate. A decline in fuel surcharge revenue, combined with a stronger U.S. dollar negatively impacted the revenue per piece growth rate by 80 basis points. And finally, lower demand-related surcharge revenue decreased the revenue per piece growth rate by 80 basis points.
In the first quarter, total international expense was down $163 million, a decline of 4.4%. Similar to previous quarters, we leveraged the agility of our integrated network to reduce block hours by 6.6%. Operating profit in the International segment was $682 million, down $124 million year-over-year. Operating margin in the first quarter was 16%. Now looking at Supply Chain Solutions, in the first quarter, revenue was $3.2 billion, down 5.3% year-over-year.
Looking at the key drivers within forwarding, market rates in international airfreight continue to drive down top line revenue. On the ocean side, excess market capacity continued to pressure market rates and drove a decrease in revenue despite volume growth. And our truckload brokerage unit continued to face soft demand and market rate pressures. Logistics delivered revenue growth and increased operating profit driven by gains in healthcare. In the first quarter, Supply Chain Solutions generated operating profit of $226 million, down $32 million year-over-year and an operating margin of 7%. Walking through the rest of the income statement, we had $195 million of interest expense.
Our other pension income was $67 million and our effective tax rate for the first quarter was 26.8%. Now let's turn to cash and shareholder returns. In the first quarter, we generated $3.3 billion in cash from operations. Free cash flow for the period was $2.3 billion. We finished the quarter with strong liquidity and no outstanding commercial paper. Also in the first quarter, UPS rewarded shareowners with $1.3 billion in dividends. Turning to our outlook.
As Carol mentioned, we are reaffirming our 2024 consolidated financial targets. For the full year 2024, on a consolidated basis, revenues are expected to range between $92 billion and $94.5 billion, and we expect to generate a consolidated operating margin ranging from approximately 10% to 10.6%. Looking at the shape of the year. In the first half of the year, we expect consolidated operating profit to be down between 20% and 30%. And in the back half of the year, we expect volume and revenue growth to accelerate as we lap the diversion we experienced as a result of our labor negotiations.
Additionally, our labor cost growth rate will drop substantially. We will also see the majority of the $1 billion in savings from Fit to Serve. We still expect revenue per piece to outperform cost per piece. And lastly, in U.S. domestic, we expect to exit the year at a 10% operating margin. Looking at cash flow and capital spending. For the full year in 2024, we still expect capital expenditures to be within our target of around 5% of revenue or $4.5 billion. We're reviewing certain aspects of our pension strategy, and so we expect free cash flow to be within a range of approximately $5.9 billion to $6.7 billion before reflecting any pension contributions.
Now let me share more detail about servicing air cargo for the USPS. This is good business for us, and we are moving quickly to begin onboarding this cargo. We will leverage our integrated network and existing assets, and we expect the majority of the volume will fit within our current U.S. domestic daytime flight operations. Our operators and engineers are already planning the network to support the complete transition to UPS in the third quarter.
In terms of financial reporting, the revenue and expense associated with USPS air cargo will show up in the SCS other line in our financial reporting. Adding the USPS air cargo volume to our existing network will result in a higher share of the network cost being allocated to SCS, indirectly benefiting our U.S. domestic segment. We expect to see a benefit to operating margins this year at both the consolidated level and within the U.S. Domestic segment.
To wrap up, we are also reaffirming our 3-year consolidated revenue and operating margin targets we put forth at our March Investor and Analyst Day. Specifically, we aim to grow revenue to be between $108 billion and $114 billion by 2026. The high end of the range includes inorganic opportunities, primarily in healthcare and international. Additionally, we expect to expand our consolidated operating margin to more than 13% by 2026, which includes expanding our domestic operating margin to at least 12%. And I'll note that the USPS volume is consistent with our better and bolder approach to grow in the parts of the market that leverage our integrated network, and it gives us a strong start to our 2026 targets.
With that, thank you, and operator, please open the lines.

Question and Answer Session

Operator

(Operator Instructions) Our first question will come from the line of Brandon Oglenski of Barclays.

Eric Thomas Morgan

This is Eric Morgan on for Brandon. I just wanted to ask about the guidance in the first half. I know you mentioned 1Q kind of coming in line with your expectations, but you did call out the 40% decline expectation at the Investor Day. So just wondering if anything happened late in the quarter that drove EBIT above your expectations in the first quarter? And then are there anything negative going on in 2Q that led you to maintain the first half guidance rather than raise it similar to the 1Q beat?

Brian O. Newman

Morgan, it's Brian. Happy to take this one. Look, our guidance for the first half of the year remains the same, declining in profit down 20% to 30%. So that's consistent. I did call out at the tail end of the quarter, expected minus 40%. I said consistently that Q1 would be the tougher quarter in the first half of the year. There were 2 elements that contributed to beating that 40%. One, on the top line, we did see positive volume momentum going into the end of the quarter. In fact, the last couple of weeks were basically breakeven from a volume perspective. I think the last week was about 0% thereabout.
So sequentially, we were seeing improved volume. But the bigger component was just some cost trading between April and March, things like occupancy and maintenance cost shift in terms of when they hit the P&L between March and April. So no change from a guide perspective, still down 20% to 30%, some cost timing at the end of the quarter there, but the positive was the trajectory of volume momentum.

Operator

Our next question will come from the line of Amit Mehrotra.

Amit Singh Mehrotra

Carol, Brian, can you just provide a bit more details on the contribution margins associated with the USPS contract. This was a 0 margin business that your direct competitor and somewhat surprisingly is now moving from your direct competitor to you. It kind of harkens back to kind of pre-2020 when UPS was less price disciplined. And so can you just wage concerns that this wasn't one on price and just talk a little bit in more detail.
I know you're obviously raising some block hours to fund -- to service this volume. But what other costs do you kind of expect to bring on to service this $1 billion, $1.5 billion of incremental revenue.

Carol B. Tome

Well, thanks very much for your question, Amit, and we're delighted to have won the air cargo business from USPS. Our team put together an innovative solution using our integrated network. And as in contrast to traditional hub-and-spoke models, we don't have to run all of the air volume through our main air hub at Worldport. Of course, we will use Worldport, but we will also use our regional gateways. That allows for splits to occur outside of the network, so they'll be built in origin and then we will bypass the main hub and go point to point.
This is an integrated solution that's very different than I think the former provider offered. We also will use all of the assets of our integrated network, and that will allow us to actually optimize block hours. Now in terms of the investments that we need to make to services volume, we have plenty of space on our existing aircraft. So we won't be purchasing any aircraft. We will be hiring some pilots but less than 200 pilots, and we factored all of that into the cost model that we built.
So this will be margin accretive. It will be EPS accretive beginning in year one and through the life of the contract.

Operator

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

Thomas Richard Wadewitz

I wanted to see Brian or Carol, if you could walk through what are the key pieces of the 2Q versus 1Q ramp in EBIT. And then I guess the same thing for second half. Obviously, you've got Fit to Serve as a significant cost benefit 2Q versus 1Q. But I think just trying to figure out how much of the improvement sequentially is based on volume that you have visibility to and how much would be based on anticipation of improvement in the broader parcel market kind of macro improvement.

Brian O. Newman

Tom, happy to take that. So listen, from a Q1 to Q2 perspective, the shape, if we look at the U.S., we would expect marginal growth from a volume perspective, which relative to past trends, normally, Q1 steps down to Q2 from an absolute volume level. So by maintaining that will be a natural accretion from an EBIT perspective. The big component, though, full year on a run rate basis, the Fit to Serve program will generate $1.3 billion in savings and we're ramping that up in Q2. So that will be a big driver as well as we think about it.
And then from a Q1 to the back half of the year, it's the same 3 components, Fit to Serve. It's the volume lift along with the drivers of RPP and then it's the labor contract lapping, which is the big piece in the back end of the year.

Carol B. Tome

And maybe just a few more comments on RPP since our RPP in the U.S. was flat in the first quarter. We expect to see RPP growth as we head towards the back half of the year. Why? Well, first of all, fuel prices were a drag on the RPP in the first quarter. The projection for fuel is that is going to increase. we are also announcing a fuel surcharge later today. So those 2 components of fuel will be a bonus to RPP as we head towards the back half.
We also are going to have a pretty picky peak, we anticipate for fewer operating days this year than last, which means the demand surcharge should be pretty strong this year compared to last year. And then we brought in a lot of SurePost product into our network. We're meeting our customers where they want to go we'll be anniversary-ing a lot of that in the back half of the year as well. So we don't expect -- we love SurePost by the way, but we don't expect to see the drag on the RPP I'm sure costs in the back half, like we said, in the first quarter. Any other color you'd like to provide?

Brian O. Newman

I think all those that you stated, Carol, and then the volume growth, obviously, with the comps, it's going to be a big help to us.

Operator

Our next question comes from the line of Jordan Alliger of Goldman Sachs.

Jordan Robert Alliger

Sort of curious, you mentioned some actions taken in the first quarter, like closing sorts and working on peak purchase transport, et cetera, amongst other things. Can you maybe talk to some additional actions that are helping to drive the profit uplift from here, not related to the volumes and maybe the headcount reduction.

Carol B. Tome

Well, productivity is a virtuous cycle here at UPS domestically and outside of the U.S. And I just can't say enough good things about how our team is running our business. Ours are running under the volume declines, higher productivity and cube utilization packages per hour. We measure productivity in minutes, miles and packages per hour and all across the board, we're seeing record levels.
One different call outs that we've been talking about this for a while is safety. Our safety stats, if you will, are the best they've been in 5 years. And of course, if you haven't run a safer business, where you don't have as many claims for Workers' Comp and auto liability. So a real shout out to our operators. And I certainly might say, why is the productivity getting better? One reason is because our turnover is down. And as people stay in place, we were just more productive. And let me throw it over Nando. Is there anything you'd like to add on the productivity side?

Nando Cesarone

No, I'm actually quite impressed with our engineers and our operators, I think, the best in the business. And we're continuing to follow our game plan that we reviewed with you at the investor conference, which is keenly focused on closing down sorts, moving volume to our automation and our automated facilities. And in fact, when I talked about pieces per headcount at our conference, we're actually up 2.7% in March. So we are pushing all of the things that help us be more productive and less reliant on labor.

Carol B. Tome

And Kate, outside the United States, in your world talk about productivity.

Kathleen M. Gutmann

Yes, absolutely. It is a consistent value at UPS and something that all of us work very hard towards every day. So when you look at the major regions around the world, we're setting records on our cube utilization both on the ground and in the air. As our margins show away, we have a very good handle on expense management and as we're unlocking more of this segment growth, healthcare specifically, SMB around the world, it only fuels that further.

Operator

We have a question from the line of Ken Hoexter of Bank of America.

Kenneth Scott Hoexter

Just international margins were a bit lower than we expected. Just maybe thoughts on increased costs. It sounded like you threw out some impacts of near-sourcing. And then, I guess, Brian, just a clarification. You said you're moving the U.S. Postal Service or it will be listed in SCS and benefiting domestic. I just want to understand, are you shifting costs then out of domestic into SCS? Or maybe just clarify that comment there.

Carol B. Tome

Well, first on the international margin, I think we did a terrific job of managing costs in an environment where demand was down. There was a onetime item that we didn't call out in our prepared remarks. But if you back out that onetime item, the international margin would be 17%. The first quarter is usually our lowest margin quarter. So we anticipate that the international business and our planning for the international business to be in the high teens as we told you.

Brian O. Newman

And then on the tonnage in terms of USPS comes in through SCS other. But because we're using a lot of the U.S. assets, we allocate cost to that business, and that will have a positive benefit on the domestic margin.

Kenneth Scott Hoexter

And can you clarify what the onetime item was there?

Carol B. Tome

It was a cleanup really in our revenue data mark, we just had some accounts we wrote off.

Operator

We have a question from the line of David Vernon of Bernstein.

David Scott Vernon

I got a couple of quick commercial questions for you. Can you talk about how the volume outlook outside SurePost is shaping up? I think you mentioned in a couple of pockets, the second derivative is getting better. But if you could talk about whether you feel better or worse about where volumes are going to end up in the year today versus when you started the year? That would be helpful.
And then the second question would be on SurePost, 10% demand for anything in small package is a very high number. When are you going to have a chance to maybe address pricing in that product? Because it does sound like you have what looks like a relative advantage in terms of marketing against the lower end of the e-commerce small package market?

Carol B. Tome

So from a volume mix perspective, if I look at the volume that's in our pipeline, I would say the volume that's in our pipeline is not SurePost. We've got commercial volume in our pipeline, additional enterprise volume in our pipeline. So we're going to be our customers where they want to go. But the mix is looking very different as we look ahead than it was in the first quarter. And in terms of pricing, I don't think we're going to talk pricing on this for this call but we always look for opportunities to optimize our pricing.

Brian O. Newman

And the headwind we saw from a mix perspective, Carol alluded to this but back end of the year, we are anniversary-ing a fair amount of SurePost from last peak. And so the overlaps won't drive as big of a headwind.

Operator

We have a question from the line of Scott -- we have a question from the line of Scott Group of Wolfe Research.

Scott H. Group

Brian, the second quarter guide, I guess, implies EBIT down anywhere from 10% to 30%. So any more directional color there? And then on this revenue cost allocation thing with the post office, is there any way to just quantify what the benefit is to the U.S. margin as you're doing this? And is that already sort of captured in the 10% margin comment for Q4? Or does this now take it up versus what you previously thought?

Carol B. Tome

Well, maybe I'll talk about the full year guidance and then you can talk specifically about the second quarter. One of the questions may be, well, why aren't you changing your guidance now that you won this air cargo business and you say it's going to be margin accretive. We were highly confident of the range of guidance that we provided at the end of the year, and we're even more confident now but it's just too early in the year to change the guidance.
So once we get through the second quarter, we'll tell you what we think the back half of the year will be. On Q2 alone, why don't you talk about that?

Brian O. Newman

Sure. Scott, we're maintaining the first half at negative 20% to 30% from a profit perspective. So you can choose the element of the range you want to point towards. I think ADV in domestic, we're expecting Q2 to be slightly positive. RPP should be consistent with what we saw flattish in the first quarter as we move out of the headwinds from a mix perspective. And as Carol said, fuel and the PSS in the back end of the year will help us.
Cost per piece will get better in Q2 -- I'm sorry, in Q3 when we anniversary the cost of the labor contract, but somewhat similar from a Q2 perspective in the U.S. And then from an ADV perspective, internationally, Kate is looking to see that business improve as we sequentially move over the course of the year. So I guess I would steer you towards the 20% to 30%. We've been very consistent on that from a profit standpoint for the first half and you can squeeze it.

Scott H. Group

And then any thoughts on that the postal shift and the margin benefit for Q4?

Carol B. Tome

So this is what I'd like to do, Scott, let's get through the second quarter, and then we'll come back and give you more color. I'd like to get this going. I'd like to get some of it into the network. We've modeled it out. I want to actually see how it performs. So we'll give you more color at the end of the second quarter.

Operator

We have a question from the line of Ravi Shanker of Morgan Stanley.

Ravi Shanker

Carol, in your opening comments, you mentioned that returns were a good business because they were B2B. I'm a little surprised to hear that because I mean, it almost seems like a C2B type business with pretty high fragmentation in the last mile. So if you can just unpack kind of how that works through the supply chain and kind of the profit contribution of that, that would be great.

Carol B. Tome

So we like to return business a lot. You're right, the consumers typically walks into a UPS store to start the return and we consolidate the returns at the UBS store, and they returned to the shipper. And that would be a B2B return. So if you think about -- I'll use our largest customer for an example, we have returns through our UPS stores with our largest customer. We take in thousands of returns for that customer and package it into one consolidated return that goes back to them. So that's a good business for us.
And with Happy Returns, now we were able to offer the same service, which is no box, no label. Same idea, consumer walks in, they make the return, we consolidate it and return it back. That's how we think about it being a B2B business, and the margins are very attractive to us. It's density. That's one reason why the margins are so good because you get density.

Operator

Our next question will come from the line of Brian Ossenbeck of JPMorgan.

Brian Patrick Ossenbeck

Maybe one for Carol, one for Brian. Carol, can you just talk about -- I know you won't talk about too much about pricing, but you're increasing the fuel surcharge about another 50 basis points. I think that's on top of 125 in December. So just wanted to see your thoughts on how the market could absorb that with some excess capacity. And do you still feel as sort of a lever in terms of all-in pricing?
Then for Brian, maybe you can elaborate on the pension contribution strategy. You talked about -- it sounded like maybe the cash contribution was on hold until some other options were considered. So any more thoughts on that would be helpful.

Carol B. Tome

So on the fuel surcharge as we look to the rest of the year, fuel prices are increasing. And this is not atypical for us to adjust our surcharge on the base of rising fuel costs. You also should know that, that doesn't impact all of our customers. Clearly, some are exempted from this. So in terms of the ability to stick, we think it will stick. And just a comment on the capacity at our investor earnings day, we said there was about $12 million ADV excess capacity in the market, and that equilibrium is about 6 million, you need about 6 million.
So really, the excess capacity is around 6 million pieces a day, and we think that will be fully absorbed by 2025. Now you may say why. Well, we're part of that excess. And so we're closing sorts. We're taking capacity out of the market, and our Network of the Future initiative is capacity neutral. Also with our large competitors' consolidation efforts capacity will be leaving the market.
And then another player headquartered in Seattle was the regional, I think the capacity will be taken out of the market. So we think all that capacity will be absorbed and the pricing environment is actually very rational.

Brian O. Newman

And Brian, just on your secondary question around the pension. I had quoted cash -- free cash flow ex pension of $59 million to $67 million. We do have annual service cost in the $1.4 billion range. So from a modeling perspective, you can use that as a placeholder. But the reality is we're taking a look at strategic options on pension, a little too a bit of early days to comment on that, but we'll come back later in the year and share our thinking on some of the actions and activities we're pursuing.

Carol B. Tome

Yes. Our pensions are very well funded. They're over 90% funded. And it gives us an opportunity to step back on that one. You just look at our asset liability strategy, our funding strategy. So we thought we should just pause right now, take a look at it and then when we -- if we make any decisions, we'll share that with you.

Operator

Our next question will come from the line of Conor Cunningham of Melius Research.

Conor T. Cunningham

Just curious on your expectations for -- I mean, sorry, you talked a little bit about volume inflecting soon. And can you just talk about your expectations in terms of volumes as you move from first half to second half. I think previously, you were talking about flat to up 2% in the U.S. domestic market, then you came in a little bit ahead. Just trying to understand how the back half are to look outside of just comps being pretty easy.

Brian O. Newman

So from an ADV perspective in domestic, I think that's where you're headed with a little bit of a slight tick up in positive volume in the second quarter, will likely finish low single-digit decline in the first half, second half we'd expect that to be low single-digit increase.
And you can look at it through various different lenses. We're building momentum ever since August, each month is basically getting sequentially better each quarter from Q3, Q4, Q1 improves. We'd expect to see slight pod volume trends in the second quarter. And then just from a comp standpoint, I mean if I go back from a trend perspective, over the last 10 years, our Q3 is generally about close to 300,000 ADV better than Q1. So even if we assume flat from a Q3 to Q1, that would be 4.5% growth.
So any way you cut it, we see the back end of the year and most important, it's the visibility on the sales pipeline that we're pulling through and the volume levels we're seeing going into Q2.

Operator

Our next question will come from the line of Jonathan Chappell of Evercore ISI.

Jonathan B. Chappell

Brian, you'd mentioned the $1 billion of productivity that you expected to see in the full year '24 guide. Can you just tell us where that stands after the first quarter and how we think about the cadence throughout the rest of the year? Is it front half loaded? Or is it kind of extrapolated evenly by quarter?

Brian O. Newman

Yes. The initiative is progressing slightly ahead of plan. Reductions began in March and will continue through Q2. We'd expect more than 80% of the resource reductions to be complete by Q2. We're on track to that $1 billion that I mentioned. And at a full annual run rate going into next year, we'd expect $1.3 billion. So there'll be some benefit early part of next year.

Operator

Our next question will come from the line of Daniel Imbro of Stephens Inc.

Daniel Robert Imbro

I wanted to follow up on the USPS contract. Carol, the air cargo, I think, should come into your network in the fourth quarter. I think first, any business coming in sooner than that, just to clarify, and then looking at 4Q in the outlook, are there any minimum volume component to the agreement? I mean, obviously, that customer has moved a lot of freight out of the air network as it looks to save costs by using ground. It still looks like ground is cheaper out there. So how do you protect for more of that volume leaving the air cargo market into maybe slower transit time, similar to the rest of your business?

Carol B. Tome

Well, clearly, we want to get all the volume on boarded before peak. That's in their interest and our best interest. We will onboard the volume as we can. Our teams are in Washington, D.C. working with the postal service hand-in-hand as we build our operating plan.

Operator

Our next question will come from the line of Bascome Majors of Susquehanna.

Bascome Majors

As you work on cash flow with the pension strategy stuff you've talked about that we might hear more about late this year, can you talk a little bit about the dividend. If you look at your payout guidance, it implies roughly $13 in earnings at the dividend level that you're paying now. Is there an opportunity to start to raise it more meaningfully before the earnings power of the business gets there? Or do you think we need to wait and get more increases like we saw this year until the business is supporting that more literally?

Carol B. Tome

We have a disciplined approach when it comes to capital allocation. The first use of our cash, as you know, is to invest back into our business and the second is to pay our dividend. We have a targeted dividend payout ratio of 50%. We are higher than that. It's our intent to earn back into a 50% payout ratio over time.
We have no intent to cut the dividend just to make that math work. We're going to earn back into it and the dividend is an important part of the value proposition. So we just raised the dividend and we look to -- of course, subject to board approval, we look to raise the dividend every year. Any color you'd like to add here?

Brian O. Newman

Just, Carol, this year marks the 15th consecutive year we've increased the dividend, and we're committed to a stable and growing dividend. So we will earn back into that, but certainly committed to it.

Carol B. Tome

And I feel to respond to Daniel's question about minimum levels within the USPS contract. I'd like to throw that over to Matt. Matt, could you answer the question?

Matthew Guffey

Yes, absolutely. So thank you, Carol. First off, yes, we do set minimums in the contract. As we built this, we identified a win-win for both the USPS and for us. It's just imperative that, one, we not only have it on the protection for our side and our business on what we're bringing on but also for the USPS because we want to make sure, as Carol mentioned, that we're onboarded before peak season, and we're bringing this on as quickly as possible, and we're working collectively with them.
Nando and the team have done a great job with their operational team. And to Carol's point, we're meeting with them every week in D.C. to continue to onboard that volume to make sure it's a smooth transition.

Operator

Stephanie Moore of Jefferies.

Stephanie Lynn Benjamin Moore

I wanted to touch back on the volume commentary. If you can maybe discuss in your eyes, what drove the improvement as the quarter progressed and your expectations into 2Q. How much of this was from kind of actions within your own control? And then at the same time, maybe areas where the underlying environment is improving some over kind of what we've experienced over the last year. And in that case, where you've seen that improvement in the macro.

Kathleen M. Gutmann

Well, I give a shout out to our sales team. the improving volume trends are in large part due to their hard work and efforts. You may recall at the beginning of the year, we said the growth in the market wasn't going to be very growthy this year. So the fact said, we're able to see sequential improvement in the magnitude that we're seeing is really because of our sales team. We are winning new. We are gaining additional penetration of existing customers. We are meeting customers where they want us to be. And our sales team will continue to do that around the world.
And that's one reason that we're confident in the volume projection of (inaudible) this year.

Operator

Our next question will come from the line of Bruce Chan of Stifel.

Jizong Chan

Carol, just back to your DAP comment from the beginning of the call. I know that's big part of your SMB growth efforts. You said you grew 3% in the first quarter. And I can't help but notice that that's materially (inaudible) said the plan was over $3 billion and then at the Investor Day, you said materially over $3 billion. So I just want to know if there's something happening that's driving a slower growth outlook for DAP.

Carol B. Tome

Yes. Thanks for the question. And I think I got it, you broke up a bit, but it's generally about DAP. So last year, in the first quarter, our DAP revenue grew 51% and our volume grew 61%. So we didn't expect to repeat that kind of growth in the first quarter of this year. And so we were very pleased with how the DAP portfolio performed in the first quarter because it was in line with our expectations.
We had anticipated a slower growth in the first quarter because there were a couple of our partners that we were working on amending the teens and fees. So we expected the growth rate to be slower and then to pick up as we move into the second quarter and the rest of the year. The projections for the DAP around the world, and we're seeing great growth outside the United States, by the way. The projections for the DAP portfolio by the end of the year is in excess of $3 billion.

Operator

Our next question will come from the line of Scott Schneeberger of Oppenheimer.

Scott Andrew Schneeberger

Carol, could you give us an update on your SMB progress. Curious how you're trending towards the long-term target domestically? And then also, how does international compare? You've spoken in the past about making nice progress there. Just curious, how does that compare to domestic right now? And what type of aspiration can you achieve longer term?

Carol B. Tome

Yes. So we're right now at about 29% as of the end of the first quarter. And as we look towards the end of this year, we should be over 30% in the low 30s. So we're trending nicely. And Kate, outside the United States how's SMB performing?

Kathleen M. Gutmann

Yes. Our history outside the U.S. is in SMB. So we have a 62% share of SMB, and this is now where we're implementing debt. So we're only going further. As Carol said, our DAP program and small package around the world is resonating with our SMB shippers as they look for ease and access. So that's excellent. And then I'll just also say in our freight business, we have a DAP like service, which is our forwarding hub, and it's actually well ahead of plan as well. So SMBs are showing that they really need access through the digital platforms, and it's resonating very well.

PJ Guido

It's Stephen, we have time for one more question.

Operator

Our last question will be a follow-up from the line of David Vernon of Bernstein.

David Scott Vernon

I just wanted to ask about -- you mentioned the pricing environment being kind of rational. Could you elaborate on how effective the GRI has been this year? What's the stick rate there? And as you think about the underlying performance in domestic yields ex some of the mix headwinds, could you talk a little bit about the trajectory or the rate of change through the quarter?

Brian O. Newman

Yes, Dave, we had expected about a 50% keep rate. We saw a 240 -- roughly 250 basis points in the first quarter. So generally in line with expectations. We'd expect that base rate to continue over the course of the year. I think Carol hit on a couple of the key points around the other elements of pricing. There's a fuel piece. There's PSS in the back -- in the peak season and then there's the mix component that we've been talking about the focus on commercial on SMB and healthcare.
So all those things combined give us confidence that we'll deliver a low single digit from an RPP second half of the year.

Operator

I will now turn the floor back over to our host, Mr. PJ Guido. Please go ahead, sir.

PJ Guido

Thank you, Stephen. This concludes our call. Thank you for joining, and have a good day.