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Securities and Exchange Commission
Washington, D.C. 20549


Form 10-Q

(Mark One)  

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2002,

or

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                              to                             

Commission file number 001-15451


United Parcel Service, Inc.
(Exact name of registrant as specified in its charter)

Delaware
(State or Other Jurisdiction of Incorporation or
Organization)
  58-2480149
(IRS Employer Identification No.)

55 Glenlake Parkway, NE
Atlanta, Georgia

(Address of Principal Executive Offices)

 

30328
(Zip Code)

(404) 828-6000
(Registrant's telephone number, including area code)



Former name, former address and former fiscal year, if changed since last report

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        There were 646,186,115 Class A shares, and 470,398,755 Class B shares, with a par value of $0.01 per share outstanding at November 11, 2002.





PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2002 (unaudited) and December 31, 2001
(In millions, except per share amounts)

 
  September 30,
2002

  December 31,
2001

 
Assets              
Current Assets:              
  Cash & cash equivalents   $ 1,452   $ 858  
  Marketable securities & short-term investments     1,199     758  
  Accounts receivable, net     3,745     4,078  
  Finance receivables, net     1,011     708  
  Other current assets     909     1,195  
   
 
 
    Total Current Assets     8,316     7,597  
Property, Plant & Equipment—at cost, net of accumulated depreciation & amortization of $11,519 and $10,620 in 2002 and 2001     13,612     13,438  
Prepaid Pension Costs     1,936     1,845  
Other Assets     2,086     1,756  
   
 
 
    $ 25,950   $ 24,636  
   
 
 
Liabilities & Shareowners' Equity              
Current Liabilities:              
  Current maturities of long-term debt and commerical paper   $ 1,292   $ 518  
  Accounts payable     1,997     1,899  
  Accrued wages & withholdings     1,816     1,169  
  Other current liabilities     1,058     1,200  
   
 
 
    Total Current Liabilities     6,163     4,786  
Long-Term Debt     3,558     4,648  
Accumulated Postretirement Benefit Obligation, Net     1,234     1,130  
Deferred Taxes, Credits & Other Liabilities     4,038     3,824  
Shareowners' Equity:              
  Preferred stock, no par value, authorized 200 shares, none issued          
  Class A common stock, par value $.01 per share, authorized 4,600 shares, issued 656 and 772 in 2002 and 2001     7     8  
  Class B common stock, par value $.01 per share, authorized 5,600 shares, issued 461 and 349 in 2002 and 2001     4     3  
  Additional paid-in capital     3     414  
  Retained earnings     11,276     10,162  
  Accumulated other comprehensive loss     (333 )   (339 )
  Deferred compensation arrangements     84     47  
   
 
 
      11,041     10,295  
  Less: Treasury stock (1 shares in 2002 and 2001)     (84 )   (47 )
   
 
 
      10,957     10,248  
   
 
 
    $ 25,950   $ 24,636  
   
 
 

See notes to unaudited consolidated financial statements.

2


UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
Three and Nine Months Ended September 30, 2002 and 2001
(In millions, except per share amounts)
(unaudited)

 
  Three Months
Ended
September 30,

  Nine Months
Ended
September 30,

 
 
  2002
  2001
  2002
  2001
 
Revenue   $ 7,754   $ 7,398   $ 23,015   $ 22,324  
   
 
 
 
 
Operating Expenses:                          
  Compensation and benefits     4,520     4,306     13,404     12,826  
  Other     2,284     2,149     6,686     6,570  
   
 
 
 
 
      6,804     6,455     20,090     19,396  
   
 
 
 
 
Operating Profit     950     943     2,925     2,928  
   
 
 
 
 
Other Income and (Expense):                          
  Investment income     20     34     44     126  
  Interest expense     (30 )   (45 )   (121 )   (136 )
   
 
 
 
 
      (10 )   (11 )   (77 )   (10 )
   
 
 
 
 
Income Before Income Taxes And Cumulative Effect of Change In Accounting Principle     940     932     2,848     2,918  
Income Taxes     362     364     1,096     1,138  
   
 
 
 
 
Income Before Cumulative Effect of Change In Accounting Principle     578     568     1,752     1,780  
Cumulative Effect of Change In The Method Of Accounting For Derivatives, Net of Taxes                 (26 )
   
 
 
 
 
Net Income   $ 578   $ 568   $ 1,752   $ 1,754  
   
 
 
 
 
Basic Earnings Per Share Before Cumulative Effect Of Change In Accounting Principle   $ 0.52   $ 0.50   $ 1.57   $ 1.58  
   
 
 
 
 
Basic Earnings Per Share   $ 0.52   $ 0.50   $ 1.57   $ 1.56  
   
 
 
 
 
Diluted Earnings Per Share Before Cumulative Effect Of Change In Accounting Principle   $ 0.51   $ 0.50   $ 1.55   $ 1.55  
   
 
 
 
 
Diluted Earnings Per Share   $ 0.51   $ 0.50   $ 1.55   $ 1.53  
   
 
 
 
 

See notes to unaudited consolidated financial statements.

3


UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREOWNERS' EQUITY
Nine Months Ended September 30, 2002
(In millions, except per share amounts)
(unaudited)

 
  Class A
Common Stock

  Class B
Common Stock

   
   
   
   
   
   
   
 
 
   
   
  Accumulated
Other
Comprehensive
Loss

   
  Treasury Stock
   
 
 
  Additional
Paid-In
Capital

  Retained
Earnings

  Deferred
Compensation
Arrangements

  Total
Shareowners'
Equity

 
 
  Shares
  Amount
  Shares
  Amount
  Shares
  Amount
 
Balance, January 1, 2002   772   $ 8   349   $ 3   $ 414   $ 10,162   $ (339 ) $ 47   (1 ) $ (47 ) $ 10,248  
  Comprehensive income:                                                              
    Net income                     1,752                   1,752  
    Foreign currency adjustments                         2               2  
    Unrealized gain (loss) on marketable securities                         (13 )             (13 )
    Unrealized gain (loss) on cash flow hedges                         17               17  
                                                         
 
  Comprehensive income                                                           1,758  
                                                         
 
    Dividends ($0.57 per share)                     (638 )                 (638 )
    Stock award plans   5               89                       89  
    Common stock purchases   (10 )             (572 )                     (572 )
    Common stock issuances   1               72                       72  
    Common stock held for deferred compensation arrangements                             37       (37 )    
    Conversion of Class A Common stock to Class B Common stock   (112 )   (1 ) 112     1                            
   
 
 
 
 
 
 
 
 
 
 
 
Balance, September 30, 2002   656   $ 7   461   $ 4   $ 3   $ 11,276   $ (333 ) $ 84   (1 ) $ (84 ) $ 10,957  
   
 
 
 
 
 
 
 
 
 
 
 

See notes to unaudited consolidated financial statements.

4


UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2002 and 2001
(In millions)
(unaudited)

 
  Nine Months
Ended
September 30,

 
 
  2002
  2001
 
Cash flows from operating activities:              
  Net income   $ 1,752   $ 1,754  
    Adjustments to reconcile net income to net cash from operating activities:              
      Depreciation and amortization     1,086     1,017  
      Postretirement benefits     104     84  
      Deferred taxes, credits and other     80     178  
      Stock award plans     361     386  
      Changes in assets and liabilities, net of effect of acquisitions:              
        Accounts receivable, net     328     611  
        Finance receivables, net     (581 )   (504 )
        Other current assets     492     352  
        Prepaid pension costs     (91 )   (241 )
        Accounts payable     98     (249 )
        Accrued wages and withholdings     344     319  
        Dividends payable     (212 )   (192 )
        Income taxes payable     (79 )   641  
        Other current liabilities     210     (47 )
   
 
 
    Net cash from operating activities     3,892     4,109  
   
 
 
Cash flows from investing activities:              
  Capital expenditures     (1,246 )   (1,931 )
  Disposals of property, plant and equipment     48     80  
  Purchases of marketable securities and short-term investments     (2,046 )   (2,775 )
  Sales and maturities of marketable securities and short-term investments     1,572     2,666  
  Payments for acquisitions, net of cash acquired     (14 )   (433 )
  Other asset receipts (payments)     (18 )   (73 )
   
 
 
    Net cash used in investing activities     (1,704 )   (2,466 )
   
 
 
Cash flows from financing activities:              
  Proceeds from borrowings     347     1,845  
  Repayments of borrowings     (754 )   (854 )
  Purchases of common stock     (572 )   (1,716 )
  Issuances of common stock pursuant to stock awards and employee stock purchase plans     96     208  
  Dividends     (638 )   (644 )
  Other transactions     (82 )   (69 )
   
 
 
    Net cash used in financing activities     (1,603 )   (1,230 )
   
 
 
Effect of exchange rate changes on cash     9     11  
   
 
 
Net increase in cash and cash equivalents     594     424  
Cash and cash equivalents:              
  Beginning of period     858     879  
   
 
 
  End of period   $ 1,452   $ 1,303  
   
 
 
Cash paid during the period for:              
  Interest (net of amount capitalized)   $ 125   $ 93  
   
 
 
  Income taxes   $ 1,124   $ 264  
   
 
 

See notes to unaudited consolidated financial statements.

5



UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.    For interim consolidated financial statement purposes, we compute our tax provision on the basis of our estimated annual effective income tax rate, and provide for accruals under our various employee benefit plans for each three month period based on one quarter of the estimated annual expense.

2.    In our opinion, the accompanying interim, unaudited, consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly our financial position as of September 30, 2002, our results of operations for the three and nine months ended September 30, 2002 and 2001, and cash flows for the nine months ended September 30, 2002 and 2001. The results reported in these consolidated financial statements should not be regarded as necessarily indicative of results that may be expected for the entire year. The interim financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2001.

        Certain prior period amounts have been reclassified to conform to the current period presentation.

3.    The following table sets forth the computation of basic and diluted earnings per share (in millions except per share amounts):

 
  Three Months Ended
September 30,

  Nine Months Ended
September 30,

 
  2002
  2001
  2002
  2001
Numerator:                        
  Numerator for basic and diluted earnings per share—                        
    Net income   $ 578   $ 568   $ 1,752   $ 1,754
   
 
 
 
Denominator:                        
  Weighted-average shares     1,117     1,125     1,117     1,126
  Deferred compensation arrangements     1     1     1     1
   
 
 
 
Denominator for basic earnings per share     1,118     1,126     1,118     1,127
   
 
 
 
Effect of dilutive securities:                        
  Contingent shares—                        
    Management incentive awards     6     8     5     6
    Stock option plans     10     12     10     13
   
 
 
 
Denominator for diluted earnings per share     1,134     1,146     1,133     1,146
   
 
 
 
Basic Earnings Per Share   $ 0.52   $ 0.50   $ 1.57   $ 1.56
   
 
 
 
Diluted Earnings Per Share   $ 0.51   $ 0.50   $ 1.55   $ 1.53
   
 
 
 

4.    On August 9, 1999, the United States Tax Court held that we were liable for tax on income of Overseas Partners Ltd. ("OPL"), a Bermuda company that had reinsured excess value ("EV") package insurance purchased by our customers beginning in 1984, and that we were liable for additional tax for the 1983 and 1984 tax years. The Court held that for the 1984 tax year we were liable for taxes of $31 million on income reported by OPL, penalties and penalty interest of $93 million, and interest for a total after-tax exposure estimated at approximately $246 million.

        On June 20, 2001, the United States Court of Appeals for the Eleventh Circuit reversed the Tax Court's decision. On September 13, 2001, the Eleventh Circuit denied the IRS's petition to have the appeal reheard en banc. The IRS did not attempt to appeal the case to the U.S. Supreme Court and,

6



consequently, the case has been remanded to the Tax Court to consider alternative arguments raised by the parties. At this time, we do not know what the outcome of the remanded proceedings in the Tax Court will be.

        The IRS has taken similar positions to those advanced in the Tax Court decision for tax years subsequent to 1984. Tax years 1985 through 1990 currently are docketed in the Tax Court, although no trial date has been set pending resolution of the case that covers the 1984 year. Further, the IRS has issued a report asserting similar positions for the 1991 through 1994 tax years, and we expect the IRS to take similar positions for tax years 1995 through 1999. Based on the Tax Court decision, we estimate that our total after-tax exposure for tax years 1984 through 1999 could be as high as $2.353 billion.

        In our second quarter 1999 financial statements, we recorded a tax assessment charge of $1.786 billion, which included an amount for related state tax liabilities. The charge included taxes of $915 million and interest of $871 million. This assessment resulted in a tax benefit of $344 million related to the interest component of the assessment. As a result, our net charge to net income for the tax assessment was $1.442 billion, increasing our total after-tax reserve at that time with respect to these matters to $1.672 billion. The tax benefit of deductible interest was included in income taxes in 1999; however, since none of the income on which this tax assessment is based is our income, we did not classify the tax charge as income taxes.

        We determine the size of our reserve with respect to these matters in accordance with accounting principles generally accepted in the United States of America. In 1999, we estimated our most likely liability based on the initial Tax Court decision. In making this determination, we concluded that, based on the Tax Court decision, it was more likely that we would be required to pay taxes on income reported by OPL and interest, but that it was not probable that we would be required to pay any penalties and penalty interest. In our prior estimation, if penalties and penalty interest ultimately were determined to be payable, we would have had to record an additional charge of up to $681 million. We currently do not know what impact the Eleventh Circuit decision and the remanded proceedings in the Tax Court ultimately will have on our recorded reserve and above estimations for this matter.

        Further, as a result of the unfavorable Tax Court decision, and in order to stop the potential accrual of additional interest that might ultimately be determined to be due to the IRS, on August 31, 1999, we paid $1.349 billion and, on August 8, 2000, we paid an additional $91 million, to the IRS related to these matters for the 1984 through 1994 tax years. We included the profit of the EV insurance program, using the IRS's methodology for calculating these amounts, for both 1998 and 1999 in filings we made with the IRS in 1999. In February 2000, we paid $339 million to the IRS related to these matters for the 1995 through 1997 tax years. These amounts will remain with the IRS pending further proceedings, as discussed below.

        The EV program that was the subject of the Tax Court decision has been changed since September 1999. The revised arrangement should eliminate the issues considered by the Tax Court and the Eleventh Circuit related to OPL.

        In May 2002, we began settlement discussions with the IRS pursuant to mediation conducted by a judge of the Tax Court. Although these settlement discussions are still in process, we and the IRS have reached a tentative basis for settlement of all outstanding tax issues related to EV package insurance. If this tentative basis for settlement becomes final, we expect to receive a refund or credit of some of the amount we previously paid to the IRS.

        Many steps are required before the amount of any refund or credit associated with the EV package insurance issues is determined or before a settlement would become final. These steps will

7



likely take at least several months and could take substantially longer. There can be no assurance that the tentative basis for settlement will not materially change, or that it or any other settlement will be approved and finalized. If we are unable to finalize a settlement, we intend to vigorously defend the remanded proceedings in the Tax Court.

        There are other outstanding tax issues that are unrelated to EV package insurance for tax years covered by the tentative basis for settlement. These issues are described below. The IRS will not issue refunds for a given tax year until all matters for that tax year are resolved. Accordingly, we will not be able to determine the availability, timing or amount of any potential refunds until these unrelated tax issues are concluded.

        Therefore, since contingencies continue to exist and we cannot accurately predict the availability, timing or amount of a possible refund or credit, we are not in a position to reverse any portion of the tax assessment charges that we recorded after the August 1999 Tax Court decision.

        The IRS has proposed adjustments, unrelated to the EV package insurance matters discussed above, regarding the allowance of deductions and certain losses, the characterization of expenses as capital rather than ordinary, the treatment of certain income, and our entitlement to the investment tax credit and the research tax credit in the 1985 through 1990 tax years. The proposed adjustments would result in $37 million of additional income tax expense. Also, the IRS has issued a report taking a similar position with respect to some of these issues for each of the years from 1991 through 1994. This report proposes adjustments that would result in $173 million in additional income tax expense. For the 1985 through 1994 tax years, unpaid interest on these adjustments through September 30, 2002 could aggregate up to approximately $509 million, after the benefit of related tax deductions. We expect that we will prevail on substantially all of these issues. Specifically, we believe that our practice of expensing the items that the IRS alleges should have been capitalized is consistent with the practices of other industry participants. The IRS may take similar positions with respect to some of these issues for each of the years 1995 through 2001. The IRS's proposed adjustments include penalties and penalty interest. We believe that the possibility that such penalties and penalty interest will be sustained is remote. We believe that the eventual resolution of these issues will not have a material adverse effect on our financial condition, results of operations or liquidity.

        We are named as a defendant in twenty-two pending lawsuits that seek to hold us liable for the collection of premiums for EV insurance in connection with package shipments since 1984. Based on state and federal tort, contract and statutory claims, these cases generally claim that we failed to remit collected EV premiums to an independent insurer; we failed to provide promised EV insurance; we acted as an insurer without complying with state insurance laws and regulations; and the price for EV insurance was excessive.

        These actions all were filed after the August 9, 1999 Tax Court decision. As discussed above, on June 20, 2001, the U.S. Court of Appeals for the Eleventh Circuit ruled in our favor and reversed the Tax Court decision.

        These twenty-two cases have been consolidated for pre-trial purposes in a multi-district litigation proceeding ("MDL Proceeding") in federal court in New York. The Court has ruled on the pending motions to dismiss, granting our motion to dismiss with respect to all of the plaintiffs' tort claims and all of their breach of contract claims prior to August 26, 1994. Claims asserted under specific federal statutes, and breach of contract claims commencing on August 26, 1994, may proceed at this time. UPS intends to continue to seek dismissal of these remaining claims.

8



        The defendants in the MDL Proceeding, including UPS, have stipulated to conditional certification of a plaintiff class in most of the lawsuits challenging the EV insurance program for UPS shippers. Class certification is a procedural step that allows claims to be resolved at one time as to all potential claimants; it does not depend on or reflect the merits of the underlying claims. Defendants may move later to set aside or modify the class certification.

        The cases subject to the class certification stipulation will proceed to a single trial before the federal court presiding over the MDL Proceeding, instead of being returned for trial to the numerous federal courts around the country from which they were transferred. In addition, plaintiffs in the five cases with pending motions to remand to state court have withdrawn these motions.

        As previously disclosed, in addition to the cases in which UPS is named as a defendant, there is also an action, Smith v. Mail Boxes Etc., against Mail Boxes Etc. and its franchisees relating to UPS EV insurance purchased through Mail Boxes Etc. centers. This case also has been consolidated into the MDL Proceeding. The plaintiff is seeking to have the case remanded back to state court. Further activity in this case has been stayed until January 2003.

        We believe that the allegations in these cases have no merit and intend to continue to defend them vigorously. The ultimate resolution of these cases cannot presently be determined.

        In addition, we are a defendant in various other lawsuits that arose in the normal course of business. We believe that the eventual resolution of these cases will not have a material adverse effect on our financial condition, results of operations or liquidity.

5.    We report our operations in three segments: U.S. domestic package operations, international package operations and non-package operations. Package operations represent our core business and are divided into regional operations around the world. Regional operations managers are responsible for both domestic and export operations within their geographic region. International package operations include shipments wholly outside the U.S. as well as shipments with either origin or distribution outside the U.S. Non-package operations, which include the UPS Logistics Group and UPS Freight Services, are distinct from package operations and are thus managed and reported separately.

        Segment information for the three and nine months ended September 30 is as follows (in millions):

 
  Three Months Ended
September 30,

  Nine Months Ended
September 30,

 
  2002
  2001
  2002
  2001
Revenue:                        
  U.S. domestic package   $ 5,889   $ 5,806   $ 17,700   $ 17,763
  International package     1,184     1,012     3,382     3,136
  Non-package     681     580     1,933     1,425
   
 
 
 
    Consolidated   $ 7,754   $ 7,398   $ 23,015   $ 22,324
   
 
 
 
Operating profit (loss):                        
  U.S. domestic package   $ 809   $ 895   $ 2,570   $ 2,706
  International package     65     (4 )   157     59
  Non-package     76     52     198     163
   
 
 
 
    Consolidated   $ 950   $ 943   $ 2,925   $ 2,928
   
 
 
 

9


        Two changes were made during the first quarter of 2002, which affect revenue reporting within the non-package segment. Neither of these changes have any effect on current or prior period income. First, effective January 1, 2002, the results of operations of the Transportation Unit of our Logistics Group were moved to our Freight Services Group. Amounts in prior periods have been reclassified for comparison purposes.

        Second, our Logistics Group has historically reported revenue from freight under management on a gross basis, whereas our Freight Services Group, which was formed with the acquisition of Fritz Companies, Inc. in the second quarter of 2001, reports revenue net of freight under management. Beginning with the first quarter of 2002, we are now reporting revenue for both the Logistics Group and Freight Services net of freight under management. Amounts for prior periods have been modified to reflect revenue net of freight under management for comparison purposes. Following is a reconciliation of gross to net revenue for the non-package segment (in millions):

 
  Three Months Ended
September 30,

  Nine Months Ended
September 30,

 
 
  2002
  2001
  2002
  2001
 
UPS Logistics Group gross revenue   $ 328   $ 244   $ 898   $ 675  
  Less freight under management     (62 )   (56 )   (172 )   (172 )
   
 
 
 
 
    Net revenue     266     188     726     503  
   
 
 
 
 
UPS Freight Services gross revenue     613     437     1,590     803  
  Less freight under management     (371 )   (196 )   (891 )   (312 )
   
 
 
 
 
    Net revenue     242     241     699     491  
   
 
 
 
 
Other     173     151     508     431  
   
 
 
 
 
Non-package revenue   $ 681   $ 580   $ 1,933   $ 1,425  
   
 
 
 
 

        Non-package operating profit included $28 and $27 million for the three months ended September 30, 2002 and 2001, respectively, and $84 and $83 million for the nine months ended September 30, 2002 and 2001, respectively, of intersegment profit, with a corresponding amount of operating expense, which reduces operating profit, included in the U.S. domestic package segment.

6.    The major components of other operating expenses for the three and nine months ended September 30 are as follows (in millions):

 
  Three Months Ended
September 30,

  Nine Months Ended
September 30,

 
  2002
  2001
  2002
  2001
Repairs and maintenance   $ 261   $ 258   $ 793   $ 781
Depreciation and amortization     373     361     1,086     1,017
Purchased transportation     394     381     1,092     1,196
Fuel     242     260     675     751
Other occupancy     120     120     379     382
Other expenses     894     769     2,661     2,443
   
 
 
 
  Consolidated   $ 2,284   $ 2,149   $ 6,686   $ 6,570
   
 
 
 

10


7.    Other assets as of September 30, 2002 and December 31, 2001 consist of the following (in millions):

 
  September 30,
2002

  December 31,
2001

Goodwill   $ 1,149   $ 1,112
Intangible assets, net of accumulated amortization     108     107
Non-current finance receivables, net of allowance for credit losses     520     242
Other non-current assets     309     295
   
 
  Consolidated   $ 2,086   $ 1,756
   
 

8.    Effective January 1, 2002, we adopted Financial Accounting Standards Board (FASB) Statement No. 142 "Goodwill and Other Intangible Assets" (FAS 142). Under the provisions of FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized, but rather are subjected to periodic impairment testing. The transitional impairment test required by FAS 142 is a two-step process. The first step involves estimating the fair value of each reporting unit that has goodwill assigned to it and comparing the estimated fair value to the reporting unit's carrying value. A second step is required if the reporting unit's estimated fair value is less than its carrying value. The second step of the impairment test involves estimating the fair value of the goodwill and comparing that estimate to the goodwill's carrying value. A shortfall of the goodwill's fair value below carrying value represents the amount of goodwill impairment.

        We have completed the first step of the impairment testing described above, but we have not completed the second step. Our approach to determining fair value is primarily based on the use of a discounted cash flow methodology. Pursuant to the results of the first step, there is an indication we may have some limited impairment within our non-package segment. The amount of impairment will be determined upon completion of the second step of the impairment test, which will occur by year-end 2002.

        The following table indicates the allocation of goodwill by reportable segment, as of September 30, 2002 and December 31, 2001 (in millions):

 
  September 30,
2002

  December 31,
2001

Goodwill by Segment:            
  U.S. domestic package   $   $
  International package     100     98
  Non-package     1,049     1,014
   
 
    Consolidated   $ 1,149   $ 1,112
   
 

        Goodwill in the international package and non-package segments increased from year-end due to the resolution of purchase price contingencies and other purchase price adjustments to acquisitions closed in 2001.

        Intangible assets of $95 million consisting of franchise rights, non-compete agreements, licenses, and patents continue to be amortized under the provisions of FAS 142 because they have finite lives. The remaining intangible assets, consisting of trade names, of $13 million are considered indefinite-lived intangible assets under FAS 142, and are no longer being amortized.

11



        Goodwill amortization ceased upon the implementation of FAS 142 on January 1, 2002. The following table indicates the impact on net income and earnings per share if the non-amortization provisions of FAS 142 had been applied beginning January 1, 2001 (in millions, except per share amounts).

 
  Three Months Ended
September 30,

  Nine Months Ended
September 30,

 
 
  2002
  2001
  2002
  2001
 
Reported net income   $ 578   $ 568   $ 1,752   $ 1,754  
Adjustments:                          
  Goodwill amortization         21         51  
  Income taxes         (3 )       (10 )
   
 
 
 
 
Adjusted net income     578     586     1,752     1,795  
Cumulative effect of change in accounting principle (FAS 133)                 26  
   
 
 
 
 
Adjusted net income before cumulative effect of change in accounting principle   $ 578   $ 586   $ 1,752   $ 1,821  
   
 
 
 
 
Basic earnings per share:                          
  Reported   $ 0.52   $ 0.50   $ 1.57   $ 1.56  
  Adjusted   $ 0.52   $ 0.52   $ 1.57   $ 1.59  
Diluted earnings per share:                          
  Reported   $ 0.51   $ 0.50   $ 1.55   $ 1.53  
  Adjusted   $ 0.51   $ 0.51   $ 1.55   $ 1.57  
Basic earnings per share before cumulative effect of change in accounting principle:                          
  Reported   $ 0.52   $ 0.50   $ 1.57   $ 1.58  
  Adjusted   $ 0.52   $ 0.52   $ 1.57   $ 1.62  
Diluted earnings per share before cumulative effect of change in accounting principle:                          
  Reported   $ 0.51   $ 0.50   $ 1.55   $ 1.55  
  Adjusted   $ 0.51   $ 0.51   $ 1.55   $ 1.59  

9.    Effective January 1, 2001, we adopted FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133), as amended by Statements No. 137 and No. 138. FAS 133, as amended, requires us to record all financial derivative instruments on our balance sheet at fair value. Derivatives not designated as hedges must be adjusted to fair value through income. If a derivative is designated as a hedge, depending on the nature of the hedge, changes in its fair value that are considered to be effective, as defined, either offset the change in fair value of the hedged assets, liabilities, or firm commitments through income, or are recorded in other comprehensive income (OCI) until the hedged item is recorded in income. Any portion of a change in a derivative's fair value that is considered to be ineffective, or is excluded from the measurement of effectiveness, is recorded immediately in income.

        The nature of our business activities necessitates the management of various financial and market risks, including those related to changes in commodity prices, foreign currency exchange rates, interest rates, and equity prices. As discussed more fully in note 13 "Derivative Instruments and Risk Management" to our consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2001, we use derivative financial instruments to mitigate or eliminate

12



certain of those risks. The January 1, 2001 accounting change described above affected only the pattern and timing of non-cash accounting recognition.

        At January 1, 2001, our financial statements were adjusted to record the cumulative effect of adopting FAS 133, as follows (in millions, except per share amounts):

 
  Income
  OCI
 
Adjustment to fair value of derivatives (a)   $ (42 ) $ 37  
Income tax effects     16     (14 )
   
 
 
Total   $ (26 ) $ 23  
   
 
 
Effect on diluted earnings per share (a)   $ (0.02 )      
   
       

(a)
For income effect, amount shown is net of adjustment to hedged items.

        The cumulative effect on income resulted primarily from marking to market the time value of option contracts used in commodity and foreign currency cash flow hedging. The cumulative effect on OCI resulted primarily from marking to market swap contracts used as cash flow hedges of anticipated foreign currency cash flows and anticipated purchases of energy products.

10.    In response to the September 11, 2001 terrorist attacks, the FAA issued a federal ground stop order prohibiting all flights to, from, and within the United States. Due to this order, all domestic UPS aircraft were grounded, and international flights into the United States were diverted on September 11th and 12th. We were able to transport many of our express shipments through our extensive ground network until the FAA order was lifted and our air operations resumed on the evening of September 13th. Due to the economic disruption caused by these events, we sustained significant declines in our U.S. origin package volume during the weeks following the attacks.

        On September 22, 2001, President Bush signed into law the Air Transportation Safety and System Stabilization Act, a $15 billion emergency economic assistance package to mitigate the dramatic financial losses experienced by the nation's air carriers. We submitted a claim for compensation to the Department of Transportation and recognized a pre-tax amount of $37 million related to this reimbursement as a credit to the other expenses line item of other operating expenses in the third quarter of 2001 under the provisions of EITF 01-10 "Accounting for the Impact of Terrorist Attacks of September 11, 2001."

13



Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Revenue, Volume and Revenue Per Piece

        The following tables set forth information showing the change in revenue, average daily package volume and average revenue per piece, both in dollars or amounts and in percentage terms:

 
  Three Months Ended
September 30,

   
   
 
 
  2002
  2001
  $
  %
 
Revenue (in millions):                        
  U.S. domestic package:                        
    Next Day Air   $ 1,344   $ 1,310   $ 34   2.6 %
    Deferred     672     664     8   1.2  
    Ground     3,873     3,832     41   1.1  
   
 
 
     
  Total U.S. domestic package     5,889     5,806     83   1.4  
  International package:                        
    Domestic     238     213     25   11.7  
    Export     826     696     130   18.7  
    Cargo     120     103     17   16.5  
   
 
 
     
  Total International package     1,184     1,012     172   17.0  
  Non-package:                        
    UPS Logistics Group     266     188     78   41.5  
    UPS Freight Services     242     241     1   0.4  
    Other     173     151     22   14.6  
   
 
 
     
  Total Non-package     681     580     101   17.4  
   
 
 
     
    Consolidated   $ 7,754   $ 7,398   $ 356   4.8 %
   
 
 
     
Average Daily Package Volume (in thousands):                 #      
               
     
  U.S. domestic package:                        
    Next Day Air     1,095     1,074     21   2.0 %
    Deferred     792     822     (30 ) (3.6 )
    Ground     9,766     10,009     (243 ) (2.4 )
   
 
 
     
  Total U.S. domestic package     11,653     11,905     (252 ) (2.1 )
  International package:                        
    Domestic     753     771     (18 ) (2.3 )
    Export     433     394     39   9.9  
   
 
 
     
  Total International package     1,186     1,165     21   1.8  
   
 
 
     
    Consolidated     12,839     13,070     (231 ) (1.8 )%
   
 
 
     
  Operating days in period     64     63            
Average Revenue Per Piece:                     $        
               
     
  U.S. domestic package:                        
    Next Day Air   $ 19.18   $ 19.36   $ (0.18 ) (0.9 )%
    Deferred     13.26     12.82     0.44   3.4  
    Ground     6.20     6.08     0.12   2.0  
  Total U.S. domestic package     7.90     7.74     0.16   2.1  
  International:                        
    Domestic     4.94     4.39     0.55   12.5  
    Export     29.81     28.04     1.77   6.3  
  Total International package     14.02     12.39     1.63   13.2  
    Consolidated   $ 8.46   $ 8.16   $ 0.30   3.7 %
   
 
 
     

14


 
  Nine Months Ended
September 30,

   
   
 
 
  2002
  2001
  $
  %
 
Revenue (in millions):                        
  U.S. domestic package:                        
    Next Day Air   $ 3,993   $ 4,076   $ (83 ) (2.0 )%
    Deferred     2,067     2,091     (24 ) (1.1 )
    Ground     11,640     11,596     44   0.4  
   
 
 
     
  Total U.S. domestic package     17,700     17,763     (63 ) (0.4 )
  International package:                        
    Domestic     689     665     24   3.6  
    Export     2,366     2,173     193   8.9  
    Cargo     327     298     29   9.7  
   
 
 
     
  Total International package     3,382     3,136     246   7.8  
  Non-package:                        
    UPS Logistics Group     726     503     223   44.3  
    UPS Freight Services     699     491     208   42.4  
    Other     508     431     77   17.9  
   
 
 
     
  Total Non-package     1,933     1,425     508   35.6  
   
 
 
     
    Consolidated   $ 23,015   $ 22,324   $ 691   3.1 %
   
 
 
     
Average Daily Package Volume (in thousands):                 #      
               
     
 
U.S. domestic package:

 

 

 

 

 

 

 

 

 

 

 

 
    Next Day Air     1,089     1,097     (8 ) (0.7 )%
    Deferred     838     861     (23 ) (2.7 )
    Ground     9,848     10,067     (219 ) (2.2 )
   
 
 
     
  Total U.S. domestic package     11,775     12,025     (250 ) (2.1 )
  International package:                        
    Domestic     762     783     (21 ) (2.7 )
    Export     431     397     34   8.6  
   
 
 
     
  Total International package     1,193     1,180     13   1.1  
   
 
 
     
    Consolidated     12,968     13,205     (237 ) (1.8 )%
   
 
 
     
  Operating days in period     191     191            
Average Revenue Per Piece:                   $        
               
     
  U.S. domestic package:                        
   
Next Day Air

 

$

19.20

 

$

19.45

 

$

(0.25

)

(1.3

)%
    Deferred     12.91     12.72     0.19   1.5  
    Ground     6.19     6.03     0.16   2.7  
  Total U.S. domestic package     7.87     7.73     0.14   1.8  
  International:                        
    Domestic     4.73     4.45     0.28   6.3  
    Export     28.74     28.66     0.08   0.3  
  Total International package     13.41     12.59     0.82   6.5  
    Consolidated   $ 8.38   $ 8.17   $ 0.21   2.6 %
   
 
 
     

15


Operating Profit

        The following tables set forth information showing the change in operating profit, both in dollars (in millions) and in percentage terms:

 
  Three Months Ended
September 30,

  Change
 
 
  2002
  2001
  $
  %
 
Operating Segment                        
U.S. domestic package   $ 809   $ 895   $ (86 ) (9.6 )%
International package     65     (4 )   69   1,725.0  
Non-package     76     52     24   46.2  
   
 
 
     
  Consolidated Operating Profit   $ 950   $ 943   $ 7   0.7 %
   
 
 
     
 
  Nine Months Ended
September 30,

  Change
 
 
  2002
  2001
  $
  %
 
Operating Segment                        
U.S. domestic package   $ 2,570   $ 2,706   $ (136 ) (5.0 )%
International package     157     59     98   166.1  
Non-package     198     163     35   21.5  
   
 
 
     
  Consolidated Operating Profit   $ 2,925   $ 2,928   $ (3 ) (0.1 )%
   
 
 
     

U.S. Domestic Package Operations

        U.S. domestic package revenue increased $83 million, or 1.4%, for the quarter. This increase was driven by a 2.1% increase in revenue per piece, and partially offset by a 2.1% decline in average daily package volume. The decline in volume was primarily a result of the continued weakness in the U.S. economy, combined with the impact of volume diversion to competitors prior to the agreement reached on a new six-year contract with the International Brotherhood of Teamsters. The decline in volume was most pronounced in the period surrounding the July 31, 2002 expiration date of the existing contract. Next day air volume benefited from a favorable comparison with the prior year, due to the events of September 11, 2001 (See Note 10).

        For the nine months, U.S. domestic package revenue declined $63 million, or 0.4%, driven by a 2.1% decline in volume and partially offset by a 1.8% increase in revenue per piece. The decrease in volume was influenced by the factors noted above.

        On January 7, 2002, we increased rates for standard ground shipments an average of 3.5% for commercial deliveries. The ground residential charge increased $0.05 to $1.10 over the commercial ground rate, and this charge has been applied to express deliveries in 2002. The additional delivery area surcharge, which is added to ground deliveries in certain less accessible areas, remained at $1.50. In addition, in 2002, this charge has been applied to express deliveries to these addresses. Rates for UPS Hundredweight increased 5.9%.

        We also increased rates for UPS Next Day Air, UPS Next Day Air Saver, UPS 2nd Day Air, and 3 Day Select an average of 4.0%. The surcharge for UPS Next Day Air Early A.M. increased from $27.50 to $28.50. Rates for international shipments originating in the United States (Worldwide Express, Worldwide Express Plus, UPS Worldwide Expedited and UPS International Standard service) increased an average of 3.9%. Rate changes for shipments originating outside the U.S. were made throughout the past year and varied by geographic market.

16



        An index-based fuel surcharge, which became effective December 10, 2001, continued and resets on a monthly basis since February 2002. It replaced a fixed fuel surcharge of 1.25%, which was originally implemented prior to 2001. The index-based surcharge is based on the National U.S. Average On-Highway Diesel Fuel Prices as reported by the U.S. Department of Energy. Based on published rates, the average fuel surcharge for the third quarter of 2002 was 0.75% and for the nine months was 0.66%.

        U.S. domestic package operating profit decreased $86 million, or 9.6%, for the quarter ($136 million, or 5.0%, year-to-date) primarily due to the decrease in average daily volume discussed previously and an increase in operating expenses (discussed further below). In the third quarter of 2001, we recorded a credit to expense related to the Air Transportation Safety and System Stabilization Act, which benefited this segment by $14 million (See Note 10).

International Package Operations

        For the third quarter, international package revenue improved $172 million, or 17%, due primarily to volume growth for our export products and strong revenue per piece improvements, a portion of which can be attributed to the impact of currency. This volume growth was driven primarily by the Europe and Asia-Pacific regions, each of which saw export volume increases of 15%. In total, international package average daily volume increased 1.8% and average revenue per piece increased 13.2% (6.9% currency-adjusted).

        For the nine months ended September 30, 2002, revenue was up $246 million, or 7.8%, and was driven by the growth in export volume discussed above. On a year-to-date basis, international package average daily volume increased 1.1% and average revenue per piece increased 6.5% (5.3% currency-adjusted).

        The improvement in operating profit for our international package operations was $69 million for the quarter, $11 million of which was due to currency fluctuations. Year-to-date, operating profit was up $98 million, or 166%, $6 million of which was due to currency fluctuations. In general, the increase in operating profit was primarily due to strong export volume growth and revenue per piece increases. International package operating profit also benefited by $2 million for the quarter, and $9 million year-to-date, from the elimination of goodwill amortization in 2002, as discussed in Note 8. In the third quarter of 2001, we recorded a credit to expense related to the Air Transportation Safety and System Stabilization Act, which benefited this segment by $23 million (see Note 10).

Non-Package Operations

        Non-package revenue increased $101 million, or 17.4%, for the quarter and $508 million, or 35.6%, for the year-to-date period. For the quarter, 6.3% of this revenue growth was due to acquisitions and the remaining 11.1% was due to organic growth of the business. For the year-to-date period, 29.8% of revenue growth was due to acquisitions, while 5.9% was due to organic growth.

        UPS Logistics Group revenue was up 41.5% for the quarter of which approximately half was due to acquisitions, primarily our UNI-DATA subsidiary in Germany, acquired last August. On a year-to-date basis, Logistics Group revenue was up 44.3% of which over half was due to acquisitions. UPS Freight Services revenue growth was flat during the quarter, as the comparison to the prior year was hindered by the exclusion of the FedEx brokerage business that was sold earlier this year. Adjusting for the impact of this event, Freight Services would have reported a mid single digit revenue increase. On a year-to-date basis, Freight Services revenue grew $208 million, or 42.4%, primarily due to having nine full months of revenue from Fritz, which was acquired in May 2001.

        The increase in non-package operating profit for the quarter, and year-to-date, was primarily due to higher operating profits from our Freight Services business combined with a $19 million reduction in

17



goodwill expense ($42 million year-to-date) as a result of the elimination of goodwill amortization in 2002, as discussed in Note 8.

Operating Expenses and Operating Margin

        Consolidated operating expenses increased by $349 million, or 5.4%, for the quarter. Compensation and benefits increased by 5.0% during the quarter, primarily due to increased costs associated with health and retirement benefits. Other operating expenses increased by 6.3% during the quarter, largely due to increased advertising expenses and the $37 million reduction to expense in 2001 for the reimbursement associated with the Air Transportation Safety and System Stabilization Act (See Note 10).

        Operating expenses increased by $694 million, or 3.6%, for the year-to-date period. The non-package segment accounted for the majority of these increases (up $473 million), principally due to acquisitions that we completed during the first nine months of 2001.

        Our operating margin, defined as operating profit as a percentage of revenue, decreased from 12.7% during the third quarter of 2001 to 12.3% during the third quarter of 2002. This decline is primarily due to a 170 basis point decline in the operating margin for our U.S. domestic package segment, which experienced a volume-driven decline in profit.

        For the first nine months of the year, our operating margin decreased from 13.1% in 2001 to 12.7% during 2002. This decline was also affected by the decrease in domestic profitability discussed above.

Investment Income/Interest Expense

        The decrease in investment income of $14 million for the third quarter of 2002 ($82 million year-to-date) is primarily due to a combination of lower interest rates and lower balances available for investment in 2002. The $15 million decline in interest expense for the third quarter and year-to-date is primarily the result of lower interest rates on variable rate debt.

Net Income and Earnings Per Share

        Net income for the third quarter of 2002 was $578 million, an increase of $10 million from $568 million in the third quarter of 2001, resulting in an increase in diluted earnings per share from $0.50 in 2001 to $0.51 in 2002. Adjusting for the effects of goodwill amortization, our net income for the third quarter of 2001 would have been $586 million, or $0.51 per diluted share (see Note 8).

        Net income for the first nine months of 2002 was $1.752 billion, a decrease of $2 million from $1.754 billion in the first nine months of 2001. However, due to a decrease in the weighted average shares outstanding, diluted earnings per share increased from $1.53 in 2001 to $1.55 in 2002. The 2001 results reflect a non-recurring FAS 133 cumulative expense adjustment, net of tax, of $26 million. Excluding the impact of this non-recurring item and adjusting for the effects of goodwill amortization, our net income for the first nine months of 2001 would have been $1.821 billion, or $1.59 per diluted share.

Liquidity and Capital Resources

        Our primary source of liquidity is our cash flow from operations. We maintain significant cash, cash equivalents, marketable securities and short-term investments, amounting to $2.65 billion at September 30, 2002.

        As part of our continuing share repurchase program, $1.0 billion was authorized for share repurchases in February 2002, of which $719 million was still available as of September 30, 2002.

18



        We maintain two commercial paper programs under which we are authorized to borrow up to $7.0 billion. Approximately $1.22 billion was outstanding under these programs as of September 30, 2002. The entire balance outstanding has been classified as a current liability. The average interest rate on the amount outstanding at September 30, 2002 was 1.72%. In addition, we maintain an extendible commercial notes program under which we are authorized to borrow up to $500 million. No amounts were outstanding under this program at September 30, 2002.

        We maintain two credit agreements with a consortium of banks. These agreements provide revolving credit facilities of $1.25 billion each, with one expiring on April 24, 2003 and the other on April 27, 2005. Interest on any amounts we borrow under these facilities would be charged at 90-day LIBOR plus 15 basis points. There were no borrowings under either of these agreements as of September 30, 2002.

        We also maintain a $1.0 billion European medium-term note program. Under this program, we may issue notes from time to time, denominated in a variety of currencies. No amounts were outstanding under this program at September 30, 2002.

        We have a $2.0 billion shelf registration statement under which we may issue debt securities in the United States. There was approximately $1.48 billion issued under this shelf registration statement at September 30, 2002. As of September 30, 2002, $838 million in notes have been issued under the UPS Notes program. These notes have various terms and maturities, all with fixed interest rates. The notes are callable at various stated times after issuance, and $200 million of the notes have been called since the inception of the program. As of September 30, 2002, $638 million in UPS Notes were outstanding.

        On August 9, 1999, the United States Tax Court held that we were liable for tax on income of Overseas Partners Ltd. ("OPL"), a Bermuda company that had reinsured excess value ("EV") package insurance purchased by our customers beginning in 1984, and that we were liable for additional tax for the 1983 and 1984 tax years. The Court held that for the 1984 tax year we were liable for taxes of $31 million on income reported by OPL, penalties and penalty interest of $93 million, and interest for a total after-tax exposure estimated at approximately $246 million.

        On June 20, 2001, the United States Court of Appeals for the Eleventh Circuit reversed the Tax Court's decision. On September 13, 2001, the Eleventh Circuit denied the IRS's petition to have the appeal reheard en banc. The IRS did not appeal the case to the U.S. Supreme Court and, consequently, the case has been remanded to the Tax Court to consider alternative arguments raised by the parties. At this time, we do not know what the outcome of the remanded proceedings in the Tax Court will be.

        The IRS has taken similar positions to those advanced in the Tax Court decision for tax years subsequent to 1984. Tax years 1985 through 1990 currently are docketed in the Tax Court, although no trial date has been set pending resolution of the case that covers the 1984 year. Further, the IRS has issued a report asserting similar positions for the 1991 through 1994 tax years, and we expect the IRS to take similar positions for tax years 1995 through 1999.

        In May 2002, we began settlement discussions with the IRS pursuant to mediation conducted by a judge of the Tax Court. Although these settlement discussions are still in process, we and the IRS have reached a tentative basis for settlement of all outstanding tax issues related to EV package insurance. If this tentative basis for settlement becomes final, we expect to receive a refund or credit of some of the amount we previously paid to the IRS.

        Many steps are required before the amount of any refund or credit associated with the EV package insurance issues is determined or before a settlement would become final. These steps will likely take at least several months and could take substantially longer. There can be no assurance that the tentative basis for settlement will not materially change, or that it or any other settlement will be

19



approved and finalized. If we are unable to finalize a settlement, we intend to vigorously defend the remanded proceedings in the Tax Court.

        There are other outstanding tax issues that are unrelated to EV package insurance for each tax year covered by the tentative basis for settlement. These issues are described below. The IRS will not issue refunds for a given tax year until all matters for that tax year are resolved. Accordingly, we will not be able to determine the availability, timing or amount of any potential refunds until these unrelated tax issues are concluded.

        Therefore, since contingencies continue to exist and we cannot accurately predict the availability, timing or amount of a possible refund or credit, we are not in a position to reverse any portion of the tax assessment charges that we recorded after the August 1999 Tax Court decision.

        The IRS has proposed adjustments, unrelated to the EV package insurance matters discussed above, regarding the allowance of deductions and certain losses, the characterization of expenses as capital rather than ordinary, the treatment of certain income, and our entitlement to the investment tax credit and the research tax credit in the 1985 through 1990 tax years. The proposed adjustments would result in $37 million of additional income tax expense. Also, the IRS has issued a report taking a similar position with respect to some of these issues for each of the years from 1991 through 1994. This report proposes adjustments that would result in $173 million in additional income tax expense. For the 1985 through 1994 tax years, unpaid interest on these adjustments through September 30, 2002 could aggregate up to approximately $509 million, after the benefit of related tax deductions. We expect that we will prevail on substantially all of these issues. Specifically, we believe that our practice of expensing the items that the IRS alleges should have been capitalized is consistent with the practices of other industry participants. The IRS may take similar positions with respect to some of these issues for each of the years 1995 through 2001. The IRS's proposed adjustments include penalties and penalty interest. We believe that the possibility that such penalties and penalty interest will be sustained is remote. We believe that the eventual resolution of these issues will not have a material adverse effect on our financial condition, results of operations or liquidity.

        We are named as a defendant in twenty-two pending lawsuits that seek to hold us liable for the collection of premiums for EV insurance in connection with package shipments since 1984. Based on state and federal tort, contract and statutory claims, these cases generally claim that we failed to remit collected EV premiums to an independent insurer; we failed to provide promised EV insurance; we acted as an insurer without complying with state insurance laws and regulations; and the price for EV insurance was excessive.

        These actions were filed after the August 9, 1999 Tax Court decision. As discussed above, on June 20, 2001, the U.S. Court of Appeals for the Eleventh Circuit ruled in our favor and reversed the Tax Court decision.

        These twenty-two cases have been consolidated for pre-trial purposes in a multi-district litigation proceeding ("MDL Proceeding") in federal court in New York. The Court has ruled on the pending motions to dismiss, granting our motion to dismiss with respect to all of the plaintiffs' tort claims and all of their breach of contract claims prior to August 26, 1994. Claims asserted under specific federal statutes, and breach of contract claims commencing on August 26, 1994, may proceed at this time. UPS intends to continue to seek dismissal of these remaining claims.

        The defendants in the MDL Proceeding, including UPS, have stipulated to conditional certification of a plaintiff class in most of the lawsuits challenging the EV insurance program for UPS shippers. Class certification is a procedural step that allows claims to be resolved at one time as to all potential claimants; it does not depend on or reflect the merits of the underlying claims. Defendants may move later to set aside or modify the class certification.

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        The cases subject to the class certification stipulation will proceed to a single trial before the federal court presiding over the MDL Proceeding, instead of being returned for trial to the numerous federal courts around the country from which they were transferred. In addition, plaintiffs in the five cases with pending motions to remand to state court have withdrawn these motions.

        We believe that the allegations in these cases have no merit and intend to continue to defend them vigorously. The ultimate resolution of these cases cannot presently be determined.

        In addition, we are a defendant in various other lawsuits that arose in the normal course of business. We believe that the eventual resolution of these cases will not have a material adverse effect on our financial condition, results of operations or liquidity.

        Due to the events of September 11, 2001, increased security requirements for air carriers may be forthcoming; however, we do not anticipate that such measures will have a material adverse effect on our financial condition, results of operations or liquidity. In addition, our insurance premiums have risen and we have taken several actions, including self-insuring certain risks, to mitigate the expense increase.

        As of December 31, 2001, we had approximately 232,500 employees (64% of total employees) employed under a national master agreement and various supplemental agreements with local unions affiliated with the International Brotherhood of Teamsters ("Teamsters"). On October 7, 2002, the Teamsters ratified a new master agreement with UPS that runs through July 31, 2008. The new agreement is retroactive to August 1, 2002. The majority of our pilots are employed under a collective bargaining agreement with the Independent Pilots Association, which becomes amendable January 1, 2004. Our airline mechanics are covered by a collective bargaining agreement with Teamsters Local 2727, which becomes amendable on November 1, 2006. In addition, the majority of our ground mechanics who are not employed under agreements with the Teamsters are employed under collective bargaining agreements with the International Association of Machinists and Aerospace Workers. These agreements have various expiration dates between July 31, 2002 and May 31, 2003.

        In November 2002, we announced rate increases, to take effect on January 6, 2003, that are in line with previous rate increases. We increased rates for standard ground shipments an average of 3.9% for commercial deliveries. The ground residential surcharge increased $0.05 to $1.25 over the commercial ground rate. The additional delivery area surcharge added to residential deliveries in certain less accessible areas increased to $0.25 to $1.75. Rates for UPS Hundredweight will increase 5.9%. In addition, we increased rates for UPS Next Day Air an average of 3.4% and increased rates for deferred services by 4.5%. Rates for international shipments originating in the United States (Worldwide Express, Worldwide Express Plus, UPS Worldwide Expedited and UPS International Standard service) increased an average of 3.9%. Rate changes for shipments originating outside the U.S. were made throughout the past year and varied by geographic market. The indexed-based fuel surcharge remains in effect, and is currently at 1.25%.

        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 such as commitments for aircraft purchases, through 2009.

        At September 30, 2002, we had unfunded loan commitments totaling $710 million, consisting of standby letters of credit of $41 million and other unfunded lending commitments of $669 million.

New Accounting Pronouncements

        Effective January 1, 2002, we adopted FASB Statement No. 142 "Goodwill and Other Intangible Assets" (FAS 142). Under the provisions of FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized, but rather are subjected to periodic impairment testing. The transitional impairment test required by FAS 142 is a two-step process. The first step involves estimating the fair

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value of each reporting unit that has goodwill assigned to it and comparing the estimated fair value to the reporting unit's carrying value. A second step is required if the reporting unit's estimated fair value is less than its carrying value. The second step of the impairment test involves estimating the fair value of the goodwill and comparing that estimate to the goodwill's carrying value. A shortfall of the goodwill's fair value below carrying value represents the amount of goodwill impairment.

        We have completed the first step of the impairment testing described above, but we have not completed the second step. Our approach to determining fair value is primarily based on the use of a discounted cash flow methodology. Pursuant to the results of the first step, there is an indication we may have some limited impairment within our Non-Package segment. The amount of impairment will be determined upon completion of the second step of the impairment test, which will occur by year-end 2002.

        Goodwill amortization ceased upon the implementation of FAS 142 on January 1, 2002. See Note 8 to the accompanying consolidated financial statements for a summary of the impact goodwill amortization had on 2001 income and earnings per share.

        In June 2002, the FASB issued Statement No. 146 "Accounting for Costs Associated with Exit or Disposal Activities" (FAS 146). FAS 146 provides guidance on the recognition and measurement of liabilities associated with exit or disposal activities and requires that such liabilities be recognized when incurred. This statement is effective for exit or disposal activities initiated on or after January 1, 2003. We are currently evaluating the potential impact of this statement.

Forward-Looking Statements

        Except for historical information contained herein, "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Liquidity and Capital Resources" and other parts of this report contain "forward-looking" statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements involve certain risks and uncertainties, including statements regarding the intent, belief or current expectations of UPS and its management regarding strategic directions, prospects and future results. Certain factors may cause actual results to differ materially from those contained in the forward-looking statements, including economic and other conditions in the markets in which we operate, governmental regulations, our competitive environment, strikes, work stoppages and slowdowns (or customer behavior in anticipation of such events), increases in aviation and motor fuel prices, cyclical and seasonal fluctuations in our operating results, and other risks discussed in our Form 10-K and other filings with the Securities and Exchange Commission, which discussions are incorporated herein by reference.


Item 3. Quantitative and Qualitative Disclosures About Market Risk

        We are exposed to market risk from changes in foreign currency exchange rates, interest rates, equity prices, and certain commodity prices. All of this market risk arises in the normal course of business, as we do not engage in speculative trading activities. In order to manage the risk arising from these exposures, we utilize a variety of foreign exchange, interest rate, equity and commodity forward contracts, options, and swaps.

        Our market risks, hedging strategies, and financial instrument positions at September 30, 2002 are similar to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2001. During the first nine months of 2002, we issued a total of $346 million of fixed rate notes with various maturities under our UPS Notes program. All of these fixed rate notes were effectively converted to floating interest rates using interest rate swaps. The notes are callable at various stated times after issuance, and $200 million of the notes were called in the first nine months of 2002.

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        The total fair value asset (liability) of our derivative financial instruments, including derivatives added during the first nine months of 2002, is summarized in the following table (in millions):

 
  September 30,
2002

  December 31,
2001

 
Energy Derivatives   $ 31   $ (27 )
Currency Derivatives         4  
Interest Rate Derivatives     (66 )   (74 )
Investment Derivatives     221     214  
   
 
 
    $ 186   $ 117  
   
 
 

        The forward contracts, swaps, and options previously discussed contain an element of risk that the couterparties may be unable to meet the terms of the agreements. However, we minimize such risk exposures for these instruments by limiting the counterparties to large banks and financial institutions that meet established credit guidelines. We do not expect to incur any losses as a result of counterparty default.

        The information concerning market risk under the sub-caption "Market Risk" of the caption "Management's Discussion and Analysis" on pages 29-31 of our consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2001, is hereby incorporated by reference in this Quarterly Report on Form 10-Q.


Item 4. Controls and Procedures

        During the 90-day period prior to the filing date of this report, management, including the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon, and as of the date of, that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required.

        There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date the Company carried out its evaluation. There were no significant deficiencies or material weaknesses identified in the evaluation and therefore, no corrective actions were taken.

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PART II. OTHER INFORMATION


Item 1. Legal Proceedings

        For a discussion of legal proceedings affecting us and our subsidiaries, please see Note 4 to our unaudited consolidated financial statements contained herein.


Item 6. Exhibits and Reports on Form 8-K

(A)  Exhibits:

(B)  Reports on Form 8-K:

        The Company filed a Form 8-K Current Report on July 11, 2002 (Date of Earliest Event Reported: July 10, 2002), providing an update to second quarter operating and financial performance and an update to ongoing labor negotiations.

        The Company filed a Form 8-K Current Report on July 12, 2002 (Date of Earliest Event Reported: July 12, 2002), reporting second quarter financial results and the planned registration of a secondary public offering associated with the inclusion of the Company's Class B common stock in the Standard & Poor's 500 Index.

        The Company filed a Form 8-K Current Report on July 17, 2002 (Date of Earliest Event Reported: July 16, 2002), reporting that the Company had reached a tentative agreement with the International Brotherhood of Teamsters on a new six-year labor contract to replace the agreement expiring on July 31, 2002.

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SIGNATURES

        Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

    UNITED PARCEL SERVICE, INC.
(Registrant)

Date: November 14, 2002

 

By:

 

/s/  
D. SCOTT DAVIS      
D. Scott Davis
Senior Vice President, Treasurer and
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)

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United Parcel Service, Inc. and Subsidiaries

Certifications

        I, Michael L. Eskew, certify that:


Date:  November 14, 2002    
     
     
/s/  MICHAEL L. ESKEW      
Michael L. Eskew
Chairman and Chief Executive Officer
   

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United Parcel Service, Inc. and Subsidiaries

Certifications

        I, D. Scott Davis, certify that:


Date:  November 14, 2002    
     
     
/s/  D. SCOTT DAVIS      
D. Scott Davis
Chief Financial Officer
   

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QuickLinks

PART I. FINANCIAL INFORMATION
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PART II. OTHER INFORMATION
SIGNATURES
United Parcel Service, Inc. and Subsidiaries Certifications
United Parcel Service, Inc. and Subsidiaries Certifications