UNITED PARCEL SERVICE INC. Overview
Highlights of our annual results follow:
Year Ended December 31, $ Change % Change
2019 2018 2019/2018 2019/2018
Revenue (in millions) $ 74,094 $ 71,861 $ 2,233 3.1 %
Operating Expenses (in millions) 66,296 64,837 1,459 2.3 %
Operating Profit (in millions)
774 11.0 % Operating Margin 10.5 % 9.8 % Net Income (in millions)$ 4,440 $ 4,791 $ (351 ) (7.3 )% Basic Earnings Per Share$ 5.14 $ 5.53 $ (0.39 ) (7.1 )% Diluted Earnings Per Share$ 5.11 $ 5.51 $ (0.40 ) (7.3 )% Average Daily Package Volume (in thousands) 21,880 20,677 5.8 % Average Revenue Per Piece$ 10.87 $ 10.98 $ (0.11 ) (1.0 )%
• Consolidated revenue increased 3.1%.
• Average daily package volume increased 5.8% primarily driven by our
Domestic Package segment, which experienced growth from SMBs as well as
several large customers, led by our largest customer, Amazon.
• Average revenue per piece is dependent upon base rates, customer and
product mix, average billable weight per piece, fuel surcharge rates and
currency. Average revenue per piece decreased as a result of changes in
customer and product mix, and lower average billable weight per piece in
our
revenue per piece in our International Package segment.
• Operating profit and operating margin increased with growth and margin
expansion in all segments.
• We reported net income of
$5.11 . Adjusted diluted earnings per share was$7.53 after adjusting for the after-tax impacts of the following: •transformation strategy costs of$196 million ; •legal contingencies and expenses of$91 million ; and •pension mark-to-market losses recognized outside of a 10% corridor of$1.816 billion . 2018 compared to 2017 See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company's Annual Report on Form 10-K for the year endedDecember 31, 2018 filed with theSecurities and Exchange Commission onFebruary 21, 2019 . 22
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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Supplemental Information - Items Affecting Comparability We supplement the reporting of our financial information determined under generally accepted accounting principles inthe United States ("GAAP") with certain non-GAAP financial measures including, as applicable, "adjusted" compensation and benefits, operating expenses, operating profit, operating margin, other income and (expense), income before income taxes, income tax expense, effective tax rate, net income and earnings per share. Adjusted financial measures may exclude the impact of period over period exchange rate changes and hedging activities, amounts related to mark-to-market gains or losses, recognition of contingencies and transformation strategy costs, as described below. We believe that these adjusted financial measures provide meaningful information to assist investors and analysts in understanding our financial results and assessing our prospects for future performance. We believe these adjusted financial measures are important indicators of our recurring results of operations because they exclude items that may not be indicative of, or are unrelated to, our underlying operating results, and provide a useful baseline for analyzing trends in our underlying businesses. Additionally, these adjusted financial measures are used internally by management for the determination of incentive compensation awards, business unit operating performance analysis and business unit resource allocation. Non-GAAP financial measures should be considered in addition to, and not as an alternative for, our reported results prepared in accordance with GAAP. Our non-GAAP financial information does not represent a comprehensive basis of accounting. Therefore, our non-GAAP financial information may not be comparable to similarly titled measures reported by other companies. The year over year comparisons of our financial results are affected by the following items (in millions): Year Ended December 31, Non-GAAP Adjustments 2019 2018 Operating Expenses: Transformation Strategy Costs$ 255 $ 360 Legal Contingencies and Expenses 97 - Total Adjustments to Operating Expenses$ 352
Other Income and (Expense): Defined Benefit Plans Mark-to-Market Charges$ 2,387 $ 1,627 Total Adjustments to Other Income and (Expense)$ 2,387
Total Adjustments to Income Before Income Taxes$ 2,739
Income Tax Benefit from the Mark-to-Market Charges
$ (390 ) Income Tax Benefit from Transformation Strategy Costs (59 ) (87 ) Income Tax Benefit from Legal Contingencies and Expenses (6 ) - Total Adjustments to Income Tax Expense$ (636 )
Total Adjustments to Net Income$ 2,103
These items have been excluded from comparisons of "adjusted" Compensation and benefits, Operating Expenses, Operating Profit, Operating Margin, Other Income and (Expense), Income Tax Expense and effective tax rate in the discussion that follows. The income tax benefit from transformation strategy costs, legal contingencies and expenses and the mark-to-market charges are calculated by multiplying the statutory tax rates applicable in each tax jurisdiction, including theU.S. federal jurisdiction and variousU.S. state and non-U.S. jurisdictions, by the tax deductible adjustments. The blended average of the effective tax rates in 2019 and 2018 were 23.2% and 24.0%, respectively. 23 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Impact of Changes in Foreign Currency Exchange Rates and Hedging Activities
We supplement the reporting of our revenue, revenue per piece and operating profit with non-GAAP measures that exclude the period over period impact of foreign currency exchange rate changes and hedging activities.
Currency-neutral revenue, revenue per piece and operating profit are calculated by dividing current period reportedU.S. dollar revenue, revenue per piece and operating profit by the current period average exchange rates to derive current period local currency revenue, revenue per piece and operating profit. The derived amounts are then multiplied by the average foreign exchange rates used to translate the comparable results for each month in the prior year period (including the period over period impact of foreign currency hedging activities). The difference between the current period reportedU.S. dollar revenue, revenue per piece and operating profit and the derived current periodU.S. dollar revenue, revenue per piece and operating profit is the period over period impact of currency fluctuations.
Transformation Strategy Costs
We supplement the presentation of our operating profit, operating margin, income before income taxes, net income and earnings per share with similar non-GAAP measures that exclude the impact of costs related to restructuring programs, including transformation strategy costs. For information regarding transformation strategy costs, see note 17 to the audited, consolidated financial statements.
Costs Related to Legal Contingencies and Expenses
We supplement the presentation of our operating profit, operating margin, income before income taxes, net income and earnings per share with similar non-GAAP measures that exclude the impact of costs related to certain of our legal contingencies and expenses. For information regarding legal contingencies and expenses, see note 9 to the audited, consolidated financial statements. Defined Benefit Plans Mark-to-Market Charges We recognize changes in the fair value of plan assets and net actuarial gains and losses in excess of a 10% corridor for our pension and postretirement defined benefit plans immediately as part of net periodic benefit cost other than service cost. We supplement the presentation of our income before income taxes, net income and earnings per share with "adjusted" measures that exclude the impact of the portion of net periodic benefit cost other than service cost represented by the gains and losses recognized in excess of the 10% corridor and the related income tax effects. We believe excluding these mark-to-market impacts from our adjusted results provides important supplemental information to remove the volatility caused by short-term changes in market interest rates, equity prices and similar factors. This adjusted net periodic benefit cost ($754 million in 2019 and$615 million in 2018) utilizes the expected return on plan assets (7.68% in 2019 and 2018) and the discount rate used to determine net periodic benefit cost (4.45% in 2019 and 3.81% in 2018). The unadjusted net periodic benefit cost reflects the actual return on plan assets (17.57% in 2019 and -2.38% in 2018) and the discount rate used to measure the projected benefit obligation at theDecember 31 measurement date (3.55% in 2019 and 4.45% in 2018). We recognized pre-tax mark-to-market losses outside of a 10% corridor related to the remeasurement of our pension and postretirement defined benefit plans' assets and liabilities in "Other Income and (Expense)" of$2.387 and$1.627 billion for 2019 and 2018, respectively. InOctober 2019 , we refined the bond matching approach used to determine the discount rate for ourU.S. pension and postretirement plans by implementing advances in technology and modeling techniques. This refinement decreased the projected benefit obligation on our consolidated balance sheet by approximately$900 million as ofDecember 31, 2019 , decreased the pre-tax mark-to-market charge by approximately$810 million and increased net income by$616 million , or$0.71 per share on a basic and diluted basis. This change did not have an impact on adjusted net income or adjusted earnings per share. 24 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The table below indicates the amounts associated with each component of the pre-tax mark-to-market losses, as well as the weighted-average actuarial assumptions used to determine our net periodic benefit cost, for each year:
Year Ended December 31,
Components of mark-to-market gain (loss) (in
millions): 2019 2018
Discount rates $ (5,670 ) $ 845
Return on assets 3,850 (1,057 )
Demographic and other assumption changes (24 ) (22 )
Coordinating benefits attributable to the Central
States Pension Fund (543 ) (1,393 )
Total mark-to-market gain (loss) $ (2,387 ) $ (1,627 )
Year Ended December 31,
Weighted-average actuarial assumptions used to
determine net periodic benefit cost: 2019 2018
Expected rate of return on plan assets 7.68 % 7.68 % Actual rate of return on plan assets 17.57 % (2.38 )% Discount rate used for net periodic benefit cost 4.45 % 3.81 % Discount rate at measurement date 3.55 %
4.45 %
The pre-tax mark-to-market losses for the years ended
rate of return on plan assets was higher than our expected rate of
return, primarily due to strong global equity and U.S. bond markets.
• Coordinating benefits attributable to the
($543 million pre-tax loss): This represents our current best estimate
of the additional potential coordinating benefits that may be required
to be paid related to the Central States Pension Fund .
• Discount Rates (
discount rate for our pension and postretirement medical plans
decreased from 4.45% at December 31, 2018 to 3.55% at December 31,
2019 , primarily due to both a decline in U.S. treasury yields and a
decrease in credit spreads on AA-rated corporate bonds in 2019.
• Demographic and Other Assumption Changes ($24 million pre-tax loss):This represents the difference between actual and estimated participant
data and demographic factors, including items such as healthcare cost
trends, compensation rate increases and rates of termination,
retirement and mortality.
2018 - $1.627 billion pre-tax mark-to-market loss:
• Return on Assets ($1.057 billion pre-tax loss): In 2018, the actual
rate of return on plan assets was lower than our expected rate of
return, primarily due to weak global equity markets.
• Coordinating benefits attributable to the
($1.393 billion pre-tax loss): This represented our then-current best
estimate of potential coordinating benefits that may be required to be
paid related to the Central States Pension Fund .
• Discount Rates (
discount rate for our pension and postretirement medical plans
increased from 3.81% at December 31, 2017 to 4.45% at December 31,
2018 , primarily due to both an increase in U.S. treasury yields and an
increase in credit spreads on AA-rated corporate bonds in 2018.
• Demographic and Other Assumption Changes ($22 million pre-tax loss):This represents the difference between actual and estimated participant
data and demographic factors, including items such as healthcare cost
trends, compensation rate increases and rates of termination,
retirement and mortality.
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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Expense Allocations Certain operating expenses are allocated between our reporting segments using activity-based costing methods. These activity-based costing methods require us to make estimates that impact the amount of each expense category that is attributed to each segment. Changes in these estimates will directly impact the amount of expense allocated to each segment, and therefore the operating profit of each reporting segment. Our allocation methodologies are refined periodically, as necessary, to reflect changes in our businesses. There were no significant changes in our expense allocation methodologies during 2019, 2018 or 2017. 26 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Year Ended December 31 , $ Change % Change
2019 2018 2019/2018 2019/2018
Average Daily Package Volume (in
thousands):
Next Day Air 1,889 1,542 22.5 %
Deferred 1,622 1,432 13.3 %
Ground 15,176 14,498 4.7 %
Total Average Daily Package Volume 18,687 17,472 7.0 %
Average Revenue Per Piece:
Next Day Air $ 17.74 $ 19.53 $ (1.79 ) (9.2 )%
Deferred 12.62 13.12 (0.50 ) (3.8 )%
Ground 8.55 8.51 0.04 0.5 %
Total Average Revenue Per Piece
(0.03 ) (0.3 )% Operating Days in Period 253 253 Revenue (in millions): Next Day Air$ 8,479 $ 7,618 $ 861 11.3 % Deferred 5,180 4,752 428 9.0 % Ground 32,834 31,223 1,611 5.2 % Total Revenue$ 46,493 $ 43,593 $ 2,900 6.7 % Operating Expenses (in millions): Operating Expenses$ 42,329 $ 39,950 $ 2,379 6.0 % Transformation Strategy Costs (108 ) (235 ) 127 (54.0 )% Legal Contingencies and Expenses (97 ) - (97 ) N/M Adjusted Operating Expenses$ 42,124 $ 39,715 $ 2,409 6.1 % Operating Profit (in millions) and Operating Margin: Operating Profit$ 4,164 $ 3,643 $ 521 14.3 % Adjusted Operating Profit$ 4,369 $ 3,878 $ 491 12.7 % Operating Margin 9.0 % 8.4 % Adjusted Operating Margin 9.4 % 8.9 % Revenue
The change in overall revenue was due to the following factors for the year
ended
Rates / Fuel Total Revenue
Volume Product Mix Surcharge Change
Revenue Change Drivers:
2019/2018 7.0 % (0.6 )% 0.3 % 6.7 %
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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Volume 2019 compared to 2018 Our overall volume increased across all products, led by strong growth in ourNext Day Air and Deferred driven by the structural shift to faster delivery in retail and e-commerce, and from additional customer volume. We experienced growth from a number of large customers and SMBs, with volume growth led by our largest customer, Amazon. This growth was enabled by our on-going investment in automated facilities and other transformation initiatives. Business-to-consumer shipments, which represented approximately 54% of the totalU.S. Domestic Package average daily volume, grew 11.3% for the year driven by the growth in e-commerce and retail. Volume grew across all products, with particularly strong growth in our Air products. Business-to-business shipments increased 2.2% for the year with volume increases in both air and ground services. Within our Air products, overall average daily volume increased in bothNext Day Air and Deferred. Strong air volume growth continued primarily in residentialNext Day Air and Second Day package products, as consumers and businesses continue to demand faster delivery options, which we expect will persist. This growth was slightly offset by declines inNext Day Air letter and Second Day letter volume due to shifts in customer preferences. We experienced year over year growth in both residential and commercial ground products. Growth in residential ground volume was driven by changes in customer mix resulting from the continued growth in e-commerce, while growth in commercial ground products was primarily driven by an increase in retail return services. Rates and Product Mix 2019 compared to 2018 Overall revenue per piece decreased due to customer and product mix and fuel surcharge rates, partially offset by changes in base rates. Revenue per piece for ground and air products was positively impacted by a base rate increase onDecember 26, 2018 . UPS Ground andUPS Air services rates increased an average net 4.9%. Revenue per piece for ourNext Day Air and Deferred products decreased primarily due to a shift in customer and product mix and a decrease in average billable weight per piece, which was partially offset by the increase in base rates. Revenue per piece for our ground products increased primarily due to base rate increases and customer and product mix, partially offset by a decrease in average billable weight per piece. Fuel Surcharges We apply a fuel surcharge on our domestic air and ground services. The air fuel surcharge is based on theU.S. Department of Energy's ("DOE")Gulf Coast spot price for a gallon of kerosene-type jet fuel, while the ground fuel surcharge is based on theDOE's On-Highway Diesel Fuel Price. Based on published rates, the average fuel surcharge rates for domestic air and ground products were as follows: Year Ended December 31, % Point Change 2019 2018 2019/2018 Next Day Air / Deferred 7.3 % 7.7 % (0.4 )% Ground 7.2 % 7.0 % 0.2 % EffectiveApril 2, 2018 , we created separate fuel surcharges forDomestic Air shipments andInternational Air export shipments. These surcharges are based on theU.S. Gulf Coast Jet Fuel price and are adjusted weekly. In June andOctober 2018 , ground fuel surcharge rates were raised for all thresholds, and in October andDecember 2018 ,Domestic Air fuel surcharge rates were increased for all thresholds. Ground surcharges continue to be based on the nationalU.S. Average On-Highway Diesel Fuel price and adjusted weekly. While fluctuations in fuel surcharges can be significant from period to period, fuel surcharges represent one of the many individual components of our pricing structure that impact our overall revenue and yield. Additional components include the mix of products sold, the base price and any additional charges or discounts on these services. 28 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Revenue per piece for ground products was positively impacted by fuel surcharge rate increases during 2018, while fuel surcharge rates for air products decreased slightly for the year. Total domestic fuel surcharge revenue increased by$140 million for the year as a result of increases in package volume and shifts in product mix, partially offset by lower fuel surcharge rates on our Air products. Operating Expenses 2019 compared to 2018 Operating expenses, and operating expenses excluding the impact of transformation strategy costs and legal contingencies and expenses, increased largely due to pickup and delivery costs (up$1.385 billion ), costs of operating our domestic integrated air and ground network (up$631 million ), costs of package sorting (up$301 million ) and other indirect operating costs (up$92 million ). In order to manage costs, we continually adjust our air and ground network to better match higher volume levels. In addition, we continue to deploy and utilize technology to increase package sorting and delivery productivity by reducing manual touchpoints. The growth in pickup and delivery and network operational costs was impacted by several factors: • Higher employee compensation and benefit costs largely resulting from: • volume growth, which resulted in an increase in average daily union labor hours of 4.7%;
• union pay rate and benefit increases; and
• growth in the overall size of the workforce due to facility expansions.
We incurred higher employee benefit expenses due to additional headcount, contractual contribution rate increases to union multiemployer plans and changes in benefit eligibility for certain union employees. These increases were slightly offset by lower pension expense for our company-sponsored plans due to higher discount rates used to measure the projected benefit obligations which reduced service costs, and lower premiums due to improved funded status. • We incurred slightly lower fuel expense for the year, driven by declines
in fuel prices and higher alternative fuel tax credits in 2019 due to the
passage of additional legislation. These reductions were partially offset
by increased network volume, which resulted in higher fuel usage. Aircraft
block hours increased 10.3%, daily package delivery stops increased 10.9%
and daily delivery miles increased 7.9%.
• Lower costs for outside contract carriers were the result of retaining
additional volume within our network.
Total cost per piece, which includes transformation strategy costs and legal contingencies and expenses, decreased 0.9% for the year. Excluding the year over year impact of transformation strategy costs and legal contingencies and expenses, adjusted cost per piece decreased 0.8% for the year. Year over year cost per piece decreased due to the incremental impact of our new automated facilities and other transformation initiatives. Operating Profit and Margin 2019 compared to 2018 Operating profit increased$521 million with operating margins increasing 60 basis points to 9.0%. Excluding the year over year impact of transformation strategy costs and legal contingencies and expenses, adjusted operating profit increased$491 million with operating margins increasing 50 basis points to 9.4%. Operating profit increased as a result of the items described above. 29
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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
International Package Operations
Year Ended December 31 , $ Change % Change
2019 2018 2019/2018 2019/2018
Average Daily Package Volume (in
thousands):
Domestic 1,721 1,723 (0.1 )%
Export 1,472 1,482 (0.7 )%
Total Average Daily Package
Volume 3,193 3,205 (0.4 )%
Average Revenue Per Piece:
Domestic $ 6.51 $ 6.59 $ (0.08 ) (1.2 )%
Export 29.10 29.27 (0.17 ) (0.6 )%
Total Average Revenue Per Piece $ 16.93 $ 17.08 $ (0.15 ) (0.9 )%
Operating Days in Period 253 253
Revenue (in millions):
Domestic $ 2,836 $ 2,874 $ (38 ) (1.3 )%
Export 10,837 10,973 (136 ) (1.2 )%
Cargo & Other 547 595 (48 ) (8.1 )%
Total Revenue $ 14,220 $ 14,442 $ (222 ) (1.5 )%
Operating Expenses (in
millions):
Operating Expenses $ 11,563 $ 11,913 $ (350 ) (2.9 )%
Transformation Strategy Costs (122 ) (76 ) (46 ) 60.5 %
Adjusted Operating Expenses $ 11,441 $ 11,837 $ (396 ) (3.3 )%
Operating Profit (in millions)
and Operating Margin:
Operating Profit $ 2,657 $ 2,529 $ 128 5.1 %
Adjusted Operating Profit $ 2,779 $ 2,605 $ 174 6.7 %
Operating Margin 18.7 % 17.5 %
Adjusted Operating Margin 19.5 % 18.0 %
Currency Translation Benefit /
(Cost)-(in millions)*:
Revenue $ (232 )
Operating Expenses 302
Operating Profit $ 70
* Net of currency hedging; amount represents the change compared to the prior year.
Revenue
The change in overall revenue was due to the following factors for the year
ended
Rates / Fuel Total Revenue
Volume Product Mix Surcharge Currency Change
Revenue Change Drivers:
2019/2018 (0.4 )% 0.4 % 0.1 % (1.6 )% (1.5 )%
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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Volume 2019 compared to 2018 Our overall average daily volume decreased slightly due to weak demand from several sectors including high tech, manufacturing, professional services, automotive and government, partially offset by higher demand in healthcare, retail and other sectors. Export volume decreased slightly in 2019. European export volume declined across all trade lanes, while Intra-European volume grew slightly. TotalU.S. export volume decreased, with declines in theEurope andAsia trade lanes partially offset by growth in theU.S. toAmericas andU.S. to ISMEA trade lanes.Asia exports grew in all major trade lanes, with the exception ofthe United States . Export volume for the year was strongest in our non-premium Transborder Standard product, offset by declines in our premium Worldwide and Transborder Express services. Domestic volume also decreased slightly for the year as growth in several domestic markets was more than offset by challenging economic conditions, particularly in theUnited Kingdom and other European countries. Additionally, a postal strike inCanada in 2018 drove additional domestic volume which did not repeat in 2019. Rates and Product Mix 2019 compared to 2018 OnDecember 26, 2018 , we implemented an average 4.9% net increase in base and accessorial rates for international shipments originating inthe United States . Rate changes for shipments originating outside theU.S. are made throughout the year and vary by geographic market. OnAugust 26, 2019 , we implemented a 1.0% increase in International Air-Import fuel surcharge. Total average revenue per piece decreased in 2019 due entirely to a 170 basis point decrease from currency. Excluding the impact of currency, revenue per piece increased 0.8% due to increases in base rates, partially offset by declines in fuel surcharge indices. Domestic revenue per piece decreased 120 basis points, driven entirely by a 390 basis point decrease from currency. Excluding the impact of currency, revenue per piece increased 2.7% due to base rate increases. Export revenue per piece decreased 60 basis points, also driven entirely by a 110 basis point decrease from currency. Excluding the impact of currency, revenue per piece increased 0.5% as the trend toward our lower priced non-premium services was more than offset by base rate increases. Fuel Surcharges We apply fuel surcharges on our international air and ground services. The fuel surcharge for international air products originating inside or outsidethe United States is largely indexed to theDOE's Gulf Coast spot price for a gallon of kerosene-type jet fuel. Fuel surcharges for ground products originating outsidethe United States are indexed to fuel prices in the region or country where the shipments originate. While fluctuations in fuel surcharges can be significant from period to period, fuel surcharges represent one of the many individual components of our pricing structure that impact our overall revenue and yield. Additional components include the mix of products sold, the base price and any additional charges or discounts on these services. Total international fuel surcharge revenue decreased by$33 million in 2019, primarily due to decreases in fuel surcharge indices and decreases in volume. Operating Expenses 2019 compared to 2018 Operating expenses, and operating expenses excluding the year over year impact of transformation strategy costs, decreased for 2019. These decreases are the results of effective management of network capacity and cost in response to lower volumes within our air, ground and local pickup and delivery networks, combined with lower fuel prices and currency exchange rate movements. 31 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In addition to variability in usage and market prices, the manner in which we purchase fuel also influences the net impact of fuel on our results. The majority of our contracts for fuel purchases utilize index-based pricing formulas plus or minus a fixed locational/supplier differential. While many of the indices are aligned, each index may fluctuate at a different pace, driving variability in the prices paid for fuel. Because of this, our operating results may be affected should the market price of fuel suddenly change by a significant amount or change by amounts that do not result in an adjustment in our fuel surcharges, which can affect our earnings either positively or negatively in the short-term. The cost of operating our integrated international air and ground network decreased$130 million for 2019. The decrease in network costs was primarily driven by a 2.1% decrease in aircraft block hours, due in large part to our ability to adjust our global air network to match capacity with demand, and lower package volume for the year, together with lower fuel prices. Pickup and delivery costs decreased$105 million in 2019. The remaining decrease in operating expenses was driven by a$40 million gain from the sale of surplus property inCanada , as well as decreases in the costs of package sorting and other indirect operating costs. Operating Profit and Margin 2019 compared to 2018 Operating profit increased$128 million for the year, with operating margin increasing 120 basis points to 18.7%. Excluding the year over year impact of transformation strategy costs, adjusted operating profit increased, with adjusted operating margin up 150 basis points to 19.5%. Operating profit increased as a result of the items described above. 32 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Supply Chain & Freight Operations
Year Ended December 31, $ Change % Change
2019 2018 2019/2018 2019/2018
Freight LTL Statistics:
Revenue (in millions) $ 2,679 $ 2,706 $ (27 ) (1.0 )%
Revenue Per Hundredweight $ 26.54 $ 25.52 $ 1.02 4.0 %
Shipments (in thousands) 9,281 9,720 (4.5 )%
Shipments Per Day (in thousands) 36.7 38.4 (4.5 )%
Gross Weight Hauled (in millions
of lbs) 10,096 10,605 (4.8 )%
Weight Per Shipment (in lbs) 1,088 1,091 (0.3 )%
Operating Days in Period 253 253
Revenue (in millions):
Forwarding $ 5,867 $ 6,580 $ (713 ) (10.8 )%
Logistics 3,435 3,234 201 6.2 %
Freight 3,265 3,218 47 1.5 %
Other 814 794 20 2.5 %
Total Revenue $ 13,381 $ 13,826 $ (445 ) (3.2 )%
Operating Expenses (in
millions):
Operating Expenses $ 12,404 $ 12,974 $ (570 ) (4.4 )%
Transformation Strategy Costs (25 ) (49 ) 24 (49.0 )%
Adjusted Operating Expenses $ 12,379 $ 12,925 $ (546 ) (4.2 )%
Operating Profit (in millions) and Operating
Margins:
Operating Profit $ 977 $ 852 $ 125 14.7 %
Adjusted Operating Profit $ 1,002 $ 901 $ 101 11.2 %
Operating Margin 7.3 % 6.2 %
Adjusted Operating Margin 7.5 % 6.5 %
Currency Translation Benefit /
(Cost)-(in millions)*:
Revenue $ (75 )
Operating Expenses 67
Operating Profit $ (8 )
* Amount represents the change compared to the prior year.
Year Ended December 31, $ Change % Change
2019 2018 2019/2018 2019/2018
Transformation Strategy Costs
(in millions):
Forwarding $ 12 $ 16 $ (4 ) (25.0 )%
Logistics 13 22 (9 ) (40.9 )%
Freight - 6 (6 ) (100.0 )%
Other - 5 (5 ) (100.0 )%
Total Transformation Strategy
Costs $ 25 $ 49 $ (24 ) (49.0 )%
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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Revenue 2019 compared to 2018 Total revenue for the Supply Chain & Freight segment decreased$445 million in 2019 compared with 2018. Forwarding revenue decreased primarily due to an overall decline in market demand that was impacted by global trade uncertainties. This led to lower volume and declines in market rates in our international air and ocean freight forwarding businesses. In addition, excess capacity in the truckload brokerage market depressed rates, contributing to the year over year decrease in revenue. These decreases were partially offset by yield management initiatives in our air and ocean freight businesses. Logistics revenue increased as we experienced growth in the healthcare, mail services, retail and manufacturing sectors. Overall UPS Freight revenue increased, as declines in LTL tonnage and shipment volume which were largely attributable to market demand and the residual impacts of the fourth quarter 2018 network disruption were more than offset by yield management initiatives and volume growth in our Ground Freight Pricing product. Operating Expenses 2019 compared to 2018 Total operating expenses for the Supply Chain & Freight segment, and operating expenses excluding the year over year impact of transformation strategy costs, decreased in 2019 compared with 2018. Forwarding operating expenses decreased$685 million largely due to reductions in purchased transportation. Purchased transportation expense decreased$655 million primarily due to lower tonnage and declines in market rates in our international air and ocean freight forwarding businesses as well as a decrease in volume and market rates in truckload brokerage. Cost management initiatives in our freight forwarding businesses also contributed to the reduction in operating expenses. Logistics operating expenses increased$172 million , primarily due to increases in purchased transportation driven by increased volume and rates, particularly in our mail services business. Additionally, business investments in healthcare quality assurance and technology increased costs. UPS Freight operating expenses decreased$54 million . Decreases in costs associated with operating our linehaul network ($49 million ) and decreases in pickup and delivery costs ($40 million ) were driven by lower expenses from outside transportation carriers as a result of a decline in tonnage, lower fuel surcharges and the residual impacts of the fourth quarter 2018 network disruption. These decreases were offset by increases in transportation expense for our Ground Freight Pricing product due to higher volume. Cost management initiatives and production improvements largely contributed to the overall reduction in operating expenses. Operating Profit and Margin 2019 compared to 2018 Total operating profit for the Supply Chain & Freight segment increased$125 million in 2019 compared with 2018. Excluding the year over year impact of transformation strategy costs, adjusted operating profit increased$101 million . Operating margin increased 110 basis points to 7.3%, while the adjusted operating margin increased 100 basis points to 7.5%. Operating profit and margin were impacted by the items described above. 34 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Consolidated Operating Expenses
Year Ended December 31, $ Change % Change
2019 2018 2019/2018 2019/2018
Operating Expenses (in
millions):
Compensation and Benefits: $ 38,908 $ 37,235 $ 1,673 4.5 %
Transformation Strategy Costs (166 ) (262 ) 96 (36.6 )%
Adjusted Compensation and
Benefits 38,742 36,973 1,769 4.8 %
Repairs and Maintenance 1,838 1,732 106 6.1 %
Depreciation and Amortization 2,360 2,207 153 6.9 %
Purchased Transportation 12,590 13,409 (819 ) (6.1 )%
Fuel 3,289 3,427 (138 ) (4.0 )%
Other Occupancy 1,392 1,362 30 2.2 %
Other Expenses 5,919 5,465 454 8.3 %
Total Other Expenses 27,388 27,602 (214 ) (0.8 )%
Other Transformation Strategy
Costs (89 ) (98 ) 9 (9.2 )%
Legal Contingencies and Expenses (97 ) - (97 ) N/M
Adjusted Total Other Expenses $ 27,202 $ 27,504 $ (302 ) (1.1 )%
Total Operating Expenses $ 66,296 $ 64,837 $ 1,459 2.3 %
Adjusted Total Operating
Expenses $ 65,944 $ 64,477 $ 1,467 2.3 %
Currency Translation Cost /
(Benefit)* $ (369 )
Year Ended December 31, $ Change % Change
2019 2018 2019/2018 2019/2018
Adjustments to Operating Expenses (in millions):
Transformation Strategy Costs:
Compensation $ 21 $ - $ 21 N/M
Benefits 145 262 (117 ) (44.7 )%
Depreciation and Amortization 3 12 (9 ) (75.0 )%
Other Occupancy 8 - 8 N/M
Other Expenses 78 86 (8 ) (9.3 )%
Total Transformation Strategy
Costs $ 255 $ 360 $ (105 ) (29.2 )%
Legal Contingencies and
Expenses:
Other Expenses $ 97 $ - $ 97 N/M
Total Adjustments to Operating
Expenses $ 352 $ 360 $ (8 ) (2.2 )%
Compensation and Benefits
2019 compared to 2018
Total compensation and benefits, and total compensation and benefits excluding
the year over year impact of transformation strategy costs, increased for 2019.
Total compensation costs increased $1.028 billion or 4.6%. Excluding the year
over year impact of transformation strategy costs, adjusted compensation
increased $1.007 billion largely due to higher U.S. Domestic direct labor costs.
These costs increased as a result of additional headcount, driven by U.S.
Domestic average daily volume growth that resulted in an increase in average
daily union hours of 4.7%. Contractual union wage increases also contributed to
the increase in compensation for hourly employees.
35
--------------------------------------------------------------------------------UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Benefits costs increased$645 million . Excluding the year over year impact of transformation strategy costs, adjusted benefits costs increased$762 million due to the following: • Health and welfare costs increased$570 million , driven by higher
contributions to multiemployer plans due to contractual rate increases, an
overall increase in the size of the workforce and changes in eligibility
for certain union employees.
• Pension and retirement benefits increased $18 million . The impacts ofcontractually-mandated contribution increases to multiemployer plans, as
well as an increase in the size of the overall workforce, were
substantially offset by lower service cost for company-sponsored plans as
a result of higher discount rates.
• Vacation, excused absence, payroll taxes and other expenses increased
million, primarily driven by salary increases and growth in the overall
size of the workforce.
• Workers' compensation expense decreased
favorable actuarial adjustments. We evaluate the total range of actuarial
outcomes when estimating losses that will ultimately occur. See note 1 to
the audited, consolidated financial statements for a further description
of this policy.
Repairs and Maintenance
2019 compared to 2018
The increase in repairs and maintenance expense was driven by maintenance of our
aircraft, routine repairs to buildings and facilities and maintenance of our
other transportation equipment, due to additional investments we have made in
recent periods.
Depreciation and Amortization
2019 compared to 2018
We evaluate the useful lives of all our property, plant and equipment based on
our usage, maintenance and replacement policies, and taking into account
physical and economic factors that may affect the useful lives of the assets.
See note 1 to the audited, consolidated financial statements for a further
description of the policy.
For 2019, depreciation expense increased $365 million , and net income decreased
by $287 million , or $0.33 per share on a basic and diluted basis, as a result of
investments in property, plant and equipment, net of disposals and assets
becoming fully depreciated. Depreciation expense decreased $212 million , and net
income increased $167 million , or $0.19 per share on a basic and diluted basis,
as a result of lengthening our estimated useful lives for various asset
categories in the latter half of 2018. The combined effect of the foregoing was
a net increase in depreciation expense of $153 million and a decrease in net
income of $120 million , or $0.14 per share on a basic and diluted basis, for the
year.
Purchased Transportation
2019 compared to 2018
The decrease in purchased transportation expense charged to us by third-party
air, rail, ocean and truck carriers was primarily driven by the following
factors:
• Expense in our Freight Forwarding and Logistics business decreased $530
million due to decreases in both market rates and volume in our air andocean freight forwarding businesses. Our truckload brokerage business also
experienced declines in rates, primarily driven by market overcapacity.
These decreases were partially offset by increases due to volume growth
and rate increases in our mail services business.
• U.S. Domestic Package expense decreased $186 million primarily due to
lower overall usage of third-party transportation carriers.
• International Package expense decreased $100 million primarily due to
favorable currency exchange rate movements.
• Other purchased transportation expense decreased
in the number of leased and chartered aircraft and lower fuel surcharges
passed on to us by outside carriers.
36--------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Fuel 2019 compared to 2018 The decrease in fuel expense was driven by lower jet fuel, diesel and gasoline prices as well as higher alternative fuel tax credits as a result of legislation passed in 2019. These decreases were partially offset by higher consumption due to additional aircraft block hours and vehicle miles driven by higherU.S. Domestic package volume. Other Occupancy 2019 compared to 2018 The increase in other occupancy expense and other occupancy expense excluding the year over year impact of transformation strategy costs was primarily driven by additional operating facilities coming into service. Other Expenses 2019 compared to 2018 Other expenses, and other expenses excluding the year over year impact of transformation strategy costs and legal contingencies and expenses, increased for 2019. The increase was attributable to various items, including adjustments to reserves for self-insured automobile liability claims, bad debt expense, technology equipment and software licenses, professional service fees and advertising. These increases were partially offset by a$40 million gain on the sale of surplus property inCanada and lower travel and entertainment expenses. Other Income and (Expense) The following table sets forth investment income (expense) and other and interest expense for the years endedDecember 31, 2019 and 2018 (in millions): Year Ended December 31, $ Change % Change 2019 2018 2019/2018 2019/2018 Investment Income (Expense) and Other$ (1,493 ) $ (400 ) $ (1,093 ) 273.3 % Defined Benefit Plans Mark-to-Market Charges 2,387 1,627 760 46.7 % Adjusted Investment Income (Expense) and Other$ 894 $ 1,227 $ (333 ) (27.1 )% Interest Expense (653 ) (605 ) (48 ) 7.9 % Total Other Income and (Expense)$ (2,146 ) $ (1,005 ) $ (1,141 ) 113.5 % Adjusted Other Income and (Expense)$ 241 $ 622 $ (381 ) (61.3 )% Investment Income (Expense) and Other 2019 compared to 2018 Investment income (expense) and other for the period increased$1.093 billion , which included a$760 million increase in mark-to-market pension charges. Excluding the impact of the defined benefit plan mark-to-market charges, adjusted investment income (expense) and other for the period, which includes expected investment returns on pension assets, net of interest cost on projected benefit obligations, prior service cost and investment income, decreased$333 million . Expected returns on plan assets decreased as a result of the lower asset base driven by negative asset returns in 2018, partially offset by the effects of higher discretionary contributions in 2019. Pension interest cost increased with higher year-end discount rates, ongoing plan growth and an increase in the projected benefit obligation as a result of the 2018 year-end measurement of our plans. Investment income increased as a result of higher yields on invested assets, higher overall investment balances and foreign currency exchange rate movements. 37 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Interest Expense 2019 compared to 2018 Interest expense increased primarily due to higher average outstanding debt balances and higher effective interest rates, combined with lower capitalized interest for 2019. Income Tax Expense The following table sets forth income tax expense and our effective tax rate for the years endedDecember 31, 2019 and 2018 (in millions): Year Ended December 31, $ Change % Change 2019 2018 2019/2018 2019/2018 Income Tax Expense:$ 1,212 $ 1,228 $ (16 ) (1.3 )% Income Tax Impact of: Defined Benefit Plans Mark-to-Market Charges 571 390 181 46.4 % Transformation Strategy Costs 59 87 (28 ) (32.2 )% Legal Contingencies and Expenses 6 - 6 N/M Adjusted Income Tax Expense$ 1,848 $ 1,705 $ 143 8.4 % Effective Tax Rate 21.4 % 20.4 % Adjusted Effective Tax Rate 22.0 %
21.3 %
For additional information on income tax expense and our effective tax rate, see note 14 to the audited, consolidated financial statements.
38
--------------------------------------------------------------------------------UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources As ofDecember 31, 2019 , we had$5.741 billion in cash, cash equivalents and marketable securities. We believe that our current cash position, access to commercial paper programs and debt capital markets and cash flow generated from operations should be adequate not only for operating requirements, but also to enable us to complete our capital expenditure programs, transformation strategy and to fund dividend payments, share repurchases, pension contributions and long-term debt payments through the next several years. We regularly evaluate opportunities to optimize our capital structure, including through issuances of debt or equity to refinance existing debt and to fund ongoing cash needs. Cash Flows From Operating Activities The following is a summary of the significant sources (uses) of cash from operating activities (in millions): 2019
2018
Net Income$ 4,440 $
4,791
Non-cash operating activities(1) 6,405
6,048
Pension and postretirement benefit plan contributions (company-sponsored plans)
(2,362 ) (186 )
Hedge margin receivables and payables 171 482
Income tax receivables and payables 599
469
Changes in working capital and other non-current assets and liabilities
(634 ) 1,091
Other operating activities 20
16
Net cash from operating activities$ 8,639 $
12,711
(1) Represents depreciation and amortization, gains and losses on derivative transactions and foreign exchange, deferred income taxes, provisions for uncollectible accounts receivable, amortization on operating lease assets, pension and postretirement benefit expense, stock compensation expense and other non-cash items. Cash from operating activities remained strong throughout 2018 and 2019. Most of the variability in operating cash flows during this period related to funding company-sponsored pension and postretirement benefit plans (and related cash tax deductions). Except for discretionary or accelerated fundings of our plans, contributions to our company-sponsored pension plans have largely varied in accordance with minimum funding requirements. We made discretionary contributions to our three primary, company-sponsoredU.S. pension plans totaling$2.0 billion in 2019. No discretionary contributions were made in 2018. The remaining contributions in 2018 and 2019 were to our international pension plans andU.S. postretirement medical benefit plans. Operating cash flows were impacted by changes in our working capital management whereby certain payments from the fourth quarter of 2018 shifted into the first quarter of 2019. In addition, accelerated growth in the business lifted overall working capital demand. The net hedge margin collateral received from our derivative counterparties was$171 and$482 million during 2019 and 2018, respectively, due to the change in net fair value of the derivative contracts used in our currency and interest rate hedging programs. Cash payments for income taxes were$514 million and$2 million for 2019 and 2018, respectively, primarily due to timing of deductions related to pension contributions. As ofDecember 31, 2019 , our total worldwide holdings of cash, cash equivalents and marketable securities were$5.741 billion , of which approximately$2.564 billion was held by foreign subsidiaries. The amount of cash, cash equivalents and marketable securities held by ourU.S. and foreign subsidiaries fluctuates throughout the year due to a variety of factors, including the timing of cash receipts and disbursements in the normal course of business. Cash provided by operating activities in theU.S. continues to be our primary source of funds to finance domestic operating needs, capital expenditures, share repurchases, pension contributions and dividend payments to shareowners. All cash, cash equivalents and marketable securities held by foreign subsidiaries are generally available for distribution to theU.S. without anyU.S. federal income taxes. Any such distributions may be subject to foreign withholding andU.S. state taxes. When amounts earned by foreign subsidiaries are expected to be indefinitely reinvested, no accrual for taxes is provided. 39 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cash Flows From Investing Activities Our primary sources (uses) of cash for investing activities were as follows (amounts in millions):
2019 2018
Net cash used in investing activities$ (6,061 ) $ (6,330 ) Capital Expenditures: Buildings, facilities and plant equipment$ (2,729 ) $ (3,147 ) Aircraft and parts (1,890 ) (1,496 ) Vehicles (987 ) (931 ) Information technology (774 ) (709 ) Total Capital Expenditures(1):$ (6,380 ) $ (6,283 ) Capital Expenditures as a % of revenue 8.6 % 8.7 % Other Investing Activities: Proceeds from disposals of property, plant and equipment $ 65 $
37
Net change in finance receivables $ 13 $
4
Net (purchases), sales and maturities of marketable securities $ 322 $ (87 ) Cash paid for business acquisitions, net of cash and cash equivalents acquired $ (6 ) $ (2 ) Other investing activities $ (75 ) $ 1 (1) In addition to capital expenditures of$6.380 and$6.283 billion in 2019 and 2018, respectively, there were capital expenditures relating to the principal repayments of finance lease obligations of$140 and$340 million . These are included in cash flows from financing activities. We have commitments for the purchase of aircraft, vehicles, equipment and real estate to provide for the replacement of existing capacity and anticipated future growth. We generally fund our capital expenditures with cash from operations. Future capital spending for anticipated growth and replacement assets will depend on a variety of factors, including economic and industry conditions. In 2017 we began a multi-year investment program in our smart global logistics network which impacts all asset categories, with the largest investments in buildings, facilities and plant equipment. This investment program will continue in 2020, and we anticipate that our capital expenditures will be approximately$6.5 to$7.0 billion . Capital expenditures on buildings, facilities and plant equipment decreased in 2019 compared to 2018 in ourU.S. and international package businesses, as we completed several facility automation and capacity expansion projects in 2018. Capital spending on aircraft increased in 2019 compared 2018 due to a net increase in contract deposits on open aircraft orders and final payments associated with the delivery of aircraft. Capital spending on information technology increased in 2019 compared to 2018 due to continuing development of technology enabled solutions and capitalized software projects. Capital spending on vehicles increased in 2019 relative to 2018, largely due to the timing of vehicle replacements and expansion of the overall fleet to support volume growth. Proceeds from the disposal of property, plant and equipment were largely attributable to the sale of an international property in 2019 and disposal of equipment in 2018. The net change in finance receivables was due to reductions in our finance portfolios in 2019 compared with 2018. Purchases and sales of marketable securities are largely determined by liquidity needs and the periodic rebalancing of investment types, and will fluctuate from period to period. Cash paid for business acquisitions in 2019 and 2018 related to our acquisition of area franchise rights forThe UPS Store , as well as other, small acquisitions in our International Small Package and Logistics business units in 2019. Other investing activities are impacted by changes in our non-current investments and various other items. 40 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cash Flows From Financing Activities Our primary sources (uses) of cash for financing activities were as follows (amounts in millions, except per share data):
2019 2018
Net cash used in financing activities $ (1,727 ) $ (5,692 )
Share Repurchases:
Cash expended for shares repurchased $ (1,004 ) $ (1,011 )
Number of shares repurchased (9.1 ) (8.9 )
Shares outstanding at period end 857 858
Percent increase (decrease) in shares outstanding (0.1 )% (0.1 )% Dividends: Dividends declared per share
$ 3.84 $ 3.64 Cash expended for dividend payments$ (3,194 ) $ (3,011 )
Borrowings:
Net borrowings (repayments) of debt principal
$ (166 ) $ (288 )
Capitalization:
Total debt outstanding at year end$ 25,238 $ 22,736 Total shareowners' equity at year end 3,283 3,037 Total capitalization$ 28,521 $ 25,773 For the years endedDecember 31, 2019 and 2018, we repurchased a total of 9.1 and 8.9 million shares of class A and class B common stock for$1.005 and$1.000 billion , respectively ($1.004 and$1.011 billion in repurchases for 2019 and 2018, respectively, are reported on the cash flow statement due to the timing of settlements). For additional information on our share repurchase activities, see note 11 to the audited, consolidated financial statements. For the years endedDecember 31, 2019 and 2018, dividends reported within shareowners' equity include$147 and$178 million , respectively, of non-cash dividends that were settled in shares of class A common stock. The declaration of dividends is subject to the discretion of the Board of Directors and depends on various factors, including our net income, financial condition, cash requirements, future prospects and other relevant factors. We expect to continue the practice of paying regular cash dividends. InFebruary 2020 , we increased our quarterly dividend payment from$0.96 to$1.01 per share, a 5.2% increase. 41 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Issuances of debt in 2019 consisted of fixed-rate senior notes totaling$3.0 billion and commercial paper. In 2018, issuances of debt consisted primarily of commercial paper. The following is a summary of debt issuances in 2019 (in millions): Principal Amount in USD 2019 Fixed-rate senior notes: 2.200% senior notes $ 400 2.500% senior notes 400 3.400% senior notes (multiple issuances) 1,450 4.250% senior notes 750 Total $ 3,000 Repayments of debt in 2019 and 2018 consisted primarily of our$1.0 billion 5.125% fixed-rate senior notes that matured inApril 2019 and our$750 million 5.50% fixed-rate senior notes that matured inJanuary 2018 . The remaining repayments of debt during the period included paydowns of commercial paper and scheduled principal payments on our finance lease obligations. We consider the overall fixed and floating interest rate mix of our portfolio and the related overall cost of borrowing when planning for future issuances and non-scheduled repayments of debt. The amount of commercial paper outstanding fluctuates throughout the year based on daily liquidity needs. The following is a summary of our commercial paper program (in millions): Functional currency outstanding balance at year Outstanding balance Average balance Average balance end at year end ($) outstanding outstanding ($) Average interest rate
2019
USD $ 2,172 $ 2,172 $ 1,665 $ 1,665 2.24 %
EUR € 949 $ 1,062 € 903 $ 1,011 (0.39 )%
Total $ 3,234
Functional
currency
outstanding
balance at year Outstanding balance Average balance Average balance
end at year end ($) outstanding outstanding ($) Average interest rate
2018
USD $ 1,968 $ 1,968 $ 2,137 $ 2,137 1.81 %
EUR € 606 $ 694 € 360 $ 425 (0.38 )%
Total $ 2,662
The variation in cash received from common stock issuances was primarily due to
the amount of stock option exercises by employees in 2018 and 2019.
Other financing activities includes cash used to repurchase shares from
employees sold to satisfy tax withholding obligations on vested stock awards of
$180 and $259 million in 2019 and 2018, respectively. Net cash inflows from
premium payments and settlements of capped call options for the purchase of UPS
class B shares were $21 and $34 million in 2019 and 2018, respectively.
Sources of Credit
See note 8 to the audited, consolidated financial statements for a discussion of
our available credit and debt covenants.
42
--------------------------------------------------------------------------------UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Guarantees and Other Off-Balance Sheet Arrangements Except as disclosed in note 8 to the audited, consolidated financial statements, we do not have guarantees or other off-balance sheet financing arrangements, including variable interest entities, which we believe could have a material impact on financial condition or liquidity. Contractual Commitments We have contractual obligations and commitments in the form of finance leases, operating leases, debt obligations, purchase commitments and certain other liabilities. We intend to satisfy these obligations primarily through the use of cash flow from operations. The following table summarizes the expected cash outflow to satisfy our contractual obligations and commitments as ofDecember 31, 2019 (in millions): Commitment Type 2020 2021 2022 2023 2024 After 2024 Total Finance Leases$ 199 44 39 37 35 259$ 613 Operating Leases 619 536 451 360 256 1,267 3,489 Debt Principal 4,232 2,551 2,001 2,284 1,474 12,349 24,891 Debt Interest 749 661 601 521 481 6,522 9,535
Purchase Commitments (1) 3,569 1,982 966 323
261 201 7,302 Tax Act Repatriation Liability - - - 13 49 61 123 Pension Funding 1,180 - - - - - 1,180 Total$ 10,548 $ 5,774 $ 4,058 $ 3,538 $ 2,556 $ 20,659 $ 47,133 (1) Purchase commitments includes amounts due under aircraft leases that we entered into in 2019 and ourJanuary 29, 2020 announced commitment to purchase 10,000 electric vehicles. Our finance lease obligations relate primarily to leases on aircraft and real estate. Finance leases and operating leases are discussed further in note 10 to the audited, consolidated financial statements. Purchase commitments, as well as our debt principal obligations, are discussed further in note 8 to the audited, consolidated financial statements. The amount of interest on our debt was calculated as the contractual interest payments due on our fixed-rate debt and variable rate debt based on interest rates as ofDecember 31, 2019 . The calculations of debt interest take into account the effect of interest rate swap agreements. For debt denominated in a foreign currency, theU.S. Dollar equivalent principal amount of the debt at the end of the year was used as the basis to calculate future interest payments. Purchase commitments represent contractual agreements to purchase assets, goods or services that are legally binding, including contracts for aircraft, construction of new or expanded facilities and orders for technology equipment and vehicles. As ofDecember 31, 2019 , we had firm commitments to lease three used and purchase eight new Boeing 767-300 aircraft, to be delivered between 2020 and 2021 and to purchase 13 new Boeing 747-8F aircraft to be delivered between 2020 and 2022. We also had a firm commitment to purchase five Boeing MD-11 aircraft to be delivered between 2020 and 2021. We paid the full purchase price for these MD-11 aircraft inDecember 2019 ; therefore these amounts are not included in the table above. OnDecember 22, 2017 ,the United States enacted into law the Tax Act requiring a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries. Companies may elect to pay the tax over eight years based on an installment schedule outlined in the Tax Act but are required under current Internal Revenue Service guidance to offset certain overpayments of tax against the liability. We made this election and have reflected our remaining transition tax due by year as a contractual obligation. There are no anticipated required minimum cash contributions to our qualifiedU.S. pension plans (these plans are discussed further in note 5 to the audited, consolidated financial statements). The amount of any minimum funding requirement, as applicable, for these plans could change significantly in future periods depending on many factors, including future plan asset returns, discount rates, other actuarial assumptions and changes to pension plan funding regulations. A decline in discount rates or a sustained significant decline in equity or bond returns could result in our domestic pension plans being subject to significantly higher minimum funding requirements. Actual contributions made in future years could materially differ and consequently required minimum contributions beyond 2020 cannot be reasonably estimated. 43 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS As discussed in note 6 to the audited, consolidated financial statements, we are not currently subject to any minimum contributions or surcharges with respect to the multiemployer pension and health and welfare plans in which we participate. Contribution rates to these multiemployer pension and health and welfare plans are established through the collective bargaining process. As we are not subject to any minimum contribution levels, we have not included any amounts in the contractual commitments table with respect to these multiemployer plans. The table above does not include approximately$228 million of liabilities for uncertain tax positions because we are uncertain if or when such amounts will ultimately be settled in cash. Uncertain tax positions are further discussed in note 14 to the audited, consolidated financial statements. As ofDecember 31, 2019 , we had outstanding letters of credit totaling approximately$1.267 billion issued in connection with our self-insurance reserves and other routine business requirements. We also issue surety bonds as an alternative to letters of credit in certain instances, and as ofDecember 31, 2019 , we had$1.327 billion of surety bonds written. As ofDecember 31, 2019 , we had unfunded loan commitments totaling$131 million associated withUPS Capital . We believe that funds from operations and borrowing programs will provide adequate sources of liquidity and capital resources to meet our expected long-term needs for the operation of our business, including anticipated capital expenditures, transformation strategy and pension contributions for the foreseeable future. Contingencies See note 5 to the audited, consolidated financial statements for a discussion of pension related matters and note 9 for a discussion of judicial proceedings and other matters arising from the conduct of our business activities. Collective Bargaining Agreements Status of Collective Bargaining Agreements See note 6 to the audited, consolidated financial statements for a discussion of the status of collective bargaining agreements. Multiemployer Benefit Plans We contribute to a number of multiemployer pension and health and welfare plans under the terms of collective bargaining agreements that cover our union represented employees. Our current collective bargaining agreements set forth the annual contribution increases allotted to the plans that we participate in, and we are in compliance with these contribution rates. These limitations will remain in effect throughout the terms of the existing collective bargaining agreements. New Accounting Pronouncements Recently Adopted Accounting Standards See note 1 to the audited, consolidated financial statements for a discussion of recently adopted accounting standards. Accounting Standards Issued But Not Yet Effective See note 1 to the audited, consolidated financial statements for a discussion of accounting standards issued, but not yet effective. Rate Adjustments EffectiveDecember 29, 2019 , the rates and accessorial charges for UPS Ground,UPS Air and International services increased by an average net 4.9%.UPS Air Freight rates within and between theU.S. ,Canada andPuerto Rico increased an average net 4.2%. Density-based UPS Freight non-contractual LTL rates using Tariff 580 increased an average net 3.9%. These rate changes are customary and occur on an annual basis. Rate changes for shipments originating outside theU.S. are made throughout the year and vary by geographic market. 44
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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Critical Accounting Policies and Estimates This discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which are prepared in accordance with GAAP. As indicated in note 1 to the audited, consolidated financial statements, the amounts of assets, liabilities, revenue and expenses reported in our financial statements are affected by estimates and judgments that are necessary to comply with GAAP. We base our estimates on prior experience and assumptions and third-party input that we consider reasonable to our circumstances. Actual results could differ materially from our estimates, which would affect the related amounts reported in our consolidated financial statements. While estimates and judgments are applied in arriving at many reported amounts, we believe that the following critical accounting policies involve a higher degree of judgment and complexity. Contingencies As discussed in note 9 to the audited, consolidated financial statements, we are involved in various legal proceedings and subject to various contingencies. The events that may impact our contingent liabilities are often unique and generally are not predictable. At the time a contingency is identified, we consider all relevant facts as part of our evaluation. We record a liability for a loss when the loss is probable of occurring and reasonably estimable. Events may arise that were not anticipated and the outcome of a contingency may result in a loss to us that differs from our previously estimated liability. This difference could be material. Income taxes and self-insurance are discussed below. Except as disclosed in note 9 to the audited, consolidated financial statements, other contingent losses that were probable and estimable were not material to our financial position or results of operations as of, or for the year ended,December 31, 2019 . In addition, we have certain contingent liabilities that have not been recognized as of, or for the year ended,December 31, 2019 , because a loss was not reasonably estimable.Goodwill and Intangible Impairment We test goodwill for impairment in each of our reporting units on an annual basis. OurU.S. Domestic Package segment is a reporting unit. In our International Package reporting segment, we have the following reporting units:Europe ,Asia ,Americas and ISMEA. In our Supply Chain & Freight segment we have the following reporting units: Forwarding, Logistics,UPS Mail Innovations ,UPS Freight,The UPS Store ,UPS Capital , Marken and Coyote Logistics. Our annual goodwill impairment testing date isJuly 1st for each reporting unit owned at the testing date. In assessing goodwill for impairment, we initially evaluate qualitative factors to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the qualitative assessment is not conclusive and it is necessary to calculate the fair value of a reporting unit, then we utilize a two-step process to test goodwill for impairment. First, a comparison of the fair value of the applicable reporting unit with the aggregate carrying value, including goodwill, is performed. If the carrying amount of a reporting unit exceeds the reporting unit's fair value, we perform the second step of the goodwill impairment test to determine the amount of impairment loss. The second step includes comparing the implied fair value of the affected reporting unit's goodwill with the carrying value of that goodwill. We primarily determine the fair value of our reporting units using a discounted cash flow ("DCF") model and supplement this with observable valuation multiples for comparable companies, as appropriate. The completion of the DCF model requires that we make a number of significant assumptions to produce an estimate of future cash flows. These assumptions include projections of future revenue, costs, capital expenditures and working capital changes, as well as assumptions about the estimated cost of capital and other relevant variables. The projections that we use in our DCF model are updated annually and will change over time based on the historical performance and changing business conditions for each of our reporting units. The determination of whether goodwill is impaired involves a significant level of judgment in these assumptions, and changes in our business strategy, government regulations, or economic or market conditions could significantly impact these judgments. We routinely monitor market conditions and other factors to determine if interim impairment tests are necessary. If impairment indicators are present in future periods, the resulting impairment charges could have a material impact on our results of operations. None of the reporting units incurred any goodwill impairment charges in 2019 or 2018. Changes in our forecasts could cause carrying values of our reporting units to exceed their fair values in future periods, potentially resulting in a goodwill impairment charge. During the year, management monitored the actual performance of the business relative to the fair value assumptions used during our annual goodwill impairment test. For the periods presented, no triggering events were identified that required an interim impairment test. Based on most recent tests, the fair value of all our reporting units exceed their carrying value. 45
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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS A trade name with a carrying value of$200 million and licenses with a carrying value of$4 million as ofDecember 31, 2019 are considered to be indefinite-lived intangibles, and therefore are not amortized. Impairment tests for indefinite-lived intangibles are performed on an annual basis. We determined that the income approach, specifically the relief from royalty method, is the most appropriate valuation method for the trade name. The estimated fair value of the trade name is compared to the carrying value of the asset. If the carrying value of the trade name exceeds its estimated fair value, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds its fair value. This valuation approach requires that we make a number of assumptions to estimate fair value. These assumptions include projections of future revenues, market royalty rates, tax rates, discount rates and other relevant variables. The projections we use in the model are updated annually and will change over time based on the historical performance and changing business conditions. All of our remaining recorded intangible assets are deemed to be finite-lived intangibles, and are amortized over their estimated useful lives. Impairment tests for these intangible assets are only performed when a triggering event occurs that indicates that the carrying value of the intangible may not be recoverable based on the undiscounted future cash flows of the intangible. If the carrying amount of the intangible is determined not to be recoverable, a write-down to fair value is recorded. Fair values are determined based on a DCF model. If impairment indicators are present in future periods, the resulting impairment charges could have a material impact on our results of operations. Impairments of finite-lived intangible assets were$2 and$12 million in 2019 and 2018, respectively. There were no impairments of indefinite-lived intangible assets in 2019 or 2018. Self-Insurance Accruals We self-insure costs associated with workers' compensation claims, automobile liability, health and welfare and general business liabilities, up to certain limits. Insurance reserves are established for estimates of the loss that we will ultimately incur on reported claims, as well as loss estimates for claims that have been incurred but not yet reported. Recorded balances are based on third-party actuarial estimates, which incorporate historical loss experience and judgments about the present and expected cost per claim. Trends in actual experience are a significant factor in the determination of our reserves. Workers' compensation, automobile liability and general liability insurance claims may take several years to completely settle. Consequently, actuarial estimates are required to project the ultimate cost that will be incurred to fully resolve a claim. A number of factors can affect the actual cost of a claim, including the length of time the claim remains open, trends in healthcare costs, the results of any related litigation and with respect to workers' compensation claims and changes in legislation. Furthermore, claims may emerge in a future year for events that occurred in a prior year at a rate that differs from actuarial projections. All of these factors can result in revisions to actuarial projections and produce a material difference between estimated and actual operating results. Based on our historical experience, during 2019 we changed our self-insurance reserves from the central estimate to the low end of the actuarial range of losses. We believe our estimated reserves for such claims are adequate; actual experience in claim frequency and/or severity could materially differ from our estimates and affect our results of operations. For additional information on our self-insurance reserves, refer to note 1 of the audited, consolidated financial statements. We sponsor a number of health and welfare insurance plans for our employees. Liabilities and expenses related to these plans are based on estimates of, among other things, the number of employees and eligible dependents covered under the plans, anticipated medical usage by participants and overall trends in medical costs and inflation. We believe our estimates are reasonable/appropriate. Actual experience may differ from these estimates and, therefore, produce a material difference between estimated and actual operating results. Pension and Postretirement Medical Benefits Our pension and other postretirement benefit costs are calculated using various actuarial assumptions and methodologies. These assumptions include discount rates, healthcare cost trend rates, inflation, compensation increase rates, expected returns on plan assets, mortality rates and other factors. The assumptions utilized in recording the obligations under our plans represent our best estimates, and we believe that they are reasonable, based on information as to historical experience and performance as well as other factors that might cause future expectations to differ from past trends. 46 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Differences in actual experience or changes in assumptions may affect our pension and other postretirement obligations and future expenses. The primary factors contributing to actuarial gains and losses each year are (1) changes in the discount rate used to value pension and postretirement benefit obligations as of the measurement date, (2) differences between the expected and the actual return on plan assets, (3) changes in demographic assumptions including mortality, (4) participant experience different from demographic assumptions and (5) changes in coordinating benefits with plans not sponsored byUPS . InOctober 2019 , we refined the bond matching approach used to determine the discount rate for ourU.S. pension and postretirement plans by implementing advances in technology and modeling techniques. This refinement decreased the projected benefit obligation on our consolidated balance sheet by approximately$900 million as ofDecember 31, 2019 , decreased the pre-tax mark-to-market charge by approximately$810 million and increased net income by$616 million , or$0.71 per share on a basic and diluted basis. We recognize changes in the fair value of plan assets and net actuarial gains or losses in excess of a corridor (defined as 10% of the greater of the fair value of plan assets or the plans' projected benefit obligations) in pension expense annually atDecember 31st each year. The remaining components of pension expense (herein referred to as "ongoing net periodic benefit cost"), primarily service and interest costs and the expected return on plan assets, are reported on a quarterly basis. The following sensitivity analysis shows the impact of a 25 basis point change in the assumed discount rate and return on assets for our pension and postretirement benefit plans, and the resulting increase/(decrease) on our obligations and expense as of, and for the year ended,December 31, 2019 (in millions). 25 Basis Point 25 Basis Point Pension Plans Increase Decrease Discount Rate: Effect on ongoing net periodic benefit cost $ (37 )
$ 38 Effect on net periodic benefit cost for amounts recognized outside the 10% corridor
(1,390 ) 2,043
Effect on projected benefit obligation (2,156 ) 2,294
Return on Assets:
Effect on ongoing net periodic benefit cost(1) (100 ) 100
Effect on net periodic benefit cost for amounts recognized
outside the 10% corridor(2) (100 ) 100
Postretirement Medical Plans
Discount Rate:
Effect on ongoing net periodic benefit cost 3 (3 )
Effect on net periodic benefit cost for amounts recognized outside the 10% corridor
(37 ) 48
Effect on accumulated postretirement benefit obligation (55 ) 65
Healthcare Cost Trend Rate:
Effect on ongoing net periodic benefit cost 1 (1 )
Effect on net periodic benefit cost for amounts recognized outside the 10% corridor
4 (5 )
Effect on accumulated postretirement benefit obligation 14 (16 )
(1) Amount calculated based on 25 basis point increase / decrease in the
expected return on assets.
(2) Amount calculated based on 25 basis point increase / decrease in the actual
return on assets.
Refer to note 5 to the audited, consolidated financial statements for
information on our potential liability for coordinating benefits related to the
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--------------------------------------------------------------------------------UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Depreciation, Residual Value and Impairment of Fixed Assets As ofDecember 31, 2019 , we had$30.482 billion of net fixed assets, the most significant category of which is aircraft. In accounting for fixed assets, we make estimates of the expected useful lives, the expected residual values and the potential for impairment based on the fair values of the assets and the cash flows which they generate. In estimating the lives and expected residual values of aircraft, we rely upon actual experience with the same or similar aircraft types. Revisions to these estimates could be caused by changes to our maintenance programs, changes in the utilization of the aircraft, governmental regulations on aging aircraft and changing market prices of new and used aircraft of the same or similar types. We periodically evaluate these estimates and assumptions, and adjust them as necessary. Adjustments are accounted for on a prospective basis through depreciation expense. In 2019, we revised our estimates of the useful lives and residual values for certain airframes, engines and related rotable parts. This change increased the useful lives of certain fleet types and reduced the useful lives and residual values of the majority of our used aircraft. The net impact to 2019 depreciation expense was not material. In estimating cash flows, we project future volume levels for our different air products in all geographic regions in which we do business. Adverse changes in these volume forecasts, or a shortfall of our actual volume compared with our projections, could result in our current aircraft capacity exceeding current or projected demand. This situation could lead to an excess of a particular aircraft, resulting in an aircraft impairment charge or a reduction of the expected life of an aircraft (thus resulting in increased depreciation expense). We evaluate the useful lives of our property, plant and equipment based on our usage, maintenance and replacement policies, and taking into account physical and economic factors that may affect the useful lives of the assets. As part of our ongoing investment in transformation in 2018, we revised our estimates of useful lives for building improvements, vehicles and plant equipment based on our current assessment of these factors. In general, these changes in estimate had the effect of lengthening the useful lives of vehicles, building improvements and plant equipment, and were applied prospectively beginning in 2018 through depreciation expense. See "Consolidated Operating Expenses" of this "Management's Discussion and Analysis of Financial Condition and Results of Operations" for the discussion of the impacts to "Depreciation and Amortization." See note 1 to the audited, consolidated financial statements for a discussion of our accounting policies and note 4 for a discussion of the change in estimated useful lives. We review long-lived assets for impairment when circumstances indicate the carrying amount of an asset may not be recoverable based on the undiscounted future cash flows of the asset. If the carrying amount of the asset is determined not to be recoverable, a write-down to fair value is recorded. Fair values are determined based on quoted market values, discounted cash flows or external appraisals, as appropriate. We review long-lived assets for impairment at the individual asset or the asset group level for which the lowest level of independent cash flows can be identified. The circumstances that would indicate potential impairment may include, but are not limited to, a significant change in the extent to which an asset is utilized and operating or cash flow losses associated with the use of the asset. There were no impairment charges on our property, plant and equipment during 2019 or 2018. Fair Value Measurements In the normal course of business, we hold and issue financial instruments that contain elements of market risk, including derivatives, marketable securities, finance receivables, pension assets, other investments and debt. Certain of these financial instruments are required to be recorded at fair value, principally derivatives, marketable securities, pension assets and certain other investments. Fair values are based on listed market prices, when such prices are available. To the extent that listed market prices are not available, fair value is determined based on other relevant factors, including dealer price quotations. If listed market prices or other relevant factors are not available, inputs are developed from unobservable data reflecting our own assumptions and include situations where there is little or no market activity for the asset or liability. Certain financial instruments, including over-the-counter derivative instruments, are valued using pricing models that consider, among other factors, contractual and market prices, correlations, time value, credit spreads and yield curve volatility factors. Changes in the fixed income, foreign exchange and commodity markets will impact our estimates of fair value in the future, potentially affecting our results of operations. A quantitative sensitivity analysis of our exposure to changes in commodity prices, foreign currency exchange rates and interest rates is presented in the "Quantitative and Qualitative Disclosures about Market Risk" section of this report. 48 --------------------------------------------------------------------------------
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain non-financial assets and liabilities are measured at fair value on a nonrecurring basis, including property, plant, and equipment, goodwill and intangible assets. These assets are not measured at fair value on a recurring basis; however, they are subject to fair value adjustments in certain circumstances, such as when there is evidence of an impairment. For acquisitions, we allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired customers, technology and trade names from a market participant perspective, useful lives and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. As a result, actual results may differ from estimates. During the measurement period, which is one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Income Taxes We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of income by legal entity and jurisdiction, tax credits, benefits and deductions, and in the calculation of deferred tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as tax, interest and penalties related to uncertain tax positions. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period. We assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that we will ultimately recover a substantial majority of the deferred tax assets recorded on our consolidated balance sheets. However, should there be a change in our ability to recover our deferred tax assets, our tax provision would increase in the period in which we determined that the recovery was not likely. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. Once it is determined that the position meets the recognition threshold, the second step requires us to estimate and measure the largest amount of tax benefit that is more likely than not to be realized upon ultimate settlement. The difference between the amount of recognizable tax benefit and the total amount of tax benefit from positions filed or to be filed with the tax authorities is recorded as a liability for uncertain tax benefits. It is inherently difficult and subjective to estimate such amounts, as we have to determine the probability of various possible outcomes. We reevaluate uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit and new audit activity. Such a change in recognition or measurement could result in the recognition of a tax benefit or an additional charge to the tax provision. See note 14 to the audited consolidated financial statements for a discussion of impacts of the Tax Act. 49
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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS© Edgar Online, source
