SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 - -------------------------------------------------------------------------------- FORM 10-Q Quarterly Report Under Section 13 or 15 (d) of the Securities Exchange Act of 1934 - -------------------------------------------------------------------------------- For the Quarter Ended March 31, 2000 Commission file number 0-4714 United Parcel Service, Inc. - -------------------------------------------------------------------------------- (Exact name of registrant specified in its charter) Delaware 58-2480149 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 55 Glenlake Parkway, NE - -------------------------------------------------------------------------------- Atlanta, Georgia 30328 (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code (404) 828-6000 -------------- Not Applicable - -------------------------------------------------------------------------------- Former name, address and 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 and Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. YES X NO -------- Class A and B Common Stock, par value $.01 per share - -------------------------------------------------------------------------------- (Title of Class) 1,037,596,982 Class A shares, 109,400,000 Class B shares - -------------------------------------------------------------------------------- Outstanding as of May 3, 2000 PART I. FINANCIAL INFORMATION Item 1. Financial Statements UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS March 31, 2000 (unaudited) and December 31, 1999 (In millions except share and per share amounts) March 31, December 31, Assets 2000 1999 - ------ ------- ----- Current Assets: Cash and cash equivalents $ 2,471 $ 4,204 Marketable securities and short-term investments 1,707 2,074 Accounts receivable 3,306 3,167 Prepaid employee benefit costs 1,136 1,327 Materials, supplies and other prepaid expenses 460 366 ------ ------ Total Current Assets 9,080 11,138 Property, Plant and Equipment (including aircraft under capitalized lease obligations)- at cost, net of accumulated depreciation and amortization of $9,016 in 2000 and $8,891 in 1999 11,462 11,579 Other Assets 376 326 ------- ------ $20,918 $23,043 ====== ====== Liabilities and Shareowners' Equity Current Liabilities: Commercial paper $ 898 $ - Accounts payable 1,568 1,295 Accrued wages and withholdings 1,337 998 Dividends payable - 361 Tax assessment 146 457 Income taxes payable 430 50 Current maturities of long-term debt 346 512 Other current liabilities 735 525 ------ ----- Total Current Liabilities 5,460 4,198 Long-Term Debt (including capitalized lease obligations) 1,952 1,912 ----- ----- Accumulated Postretirement Benefit Obligation, Net 1,021 990 ----- --- Deferred Taxes, Credits and Other Liabilities 3,501 3,469 ----- ----- Shareowners' Equity: Preferred stock, no par value, authorized 200,000,000 shares, none issued - - Class A common stock, par value $.01 per share, authorized 4,600,000,000 shares, issued 1,033,175,223 and 1,101,295,534 in 2000 and 1999 10 11 Class B common stock, par value $.01 per share, authorized 5,600,000,000 shares, issued 109,400,000 1 1 Additional paid-in capital 1,012 5,096 Retained earnings 8,143 7,536 Accumulated other comprehensive loss (182) (170) ------ ------ 8,984 12,474 ------ ------ $20,918 $23,043 ====== ====== See notes to unaudited consolidated financial statements. UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED INCOME Three Months Ended March 31, 2000 and 1999 (In millions except per share amounts) (unaudited) Three Months Ended March 31, 2000 1999 Revenue $ 7,220 $ 6,331 ------ ------ Operating Expenses: Compensation and benefits 4,075 3,652 Other 2,062 1,813 ------ ------ 6,137 5,465 Operating Profit 1,083 866 ------ ------ Other Income and (Expense): Investment income 333 31 Interest expense (52) (49) Miscellaneous, net (10) (16) ------- ------- 271 (34) ------- ------- Income Before Income Taxes 1,354 832 Income Taxes 541 333 ------ ------ Net Income $ 813 $ 499 ====== ====== Basic Earnings Per Share $ 0.68 $ 0.45 ====== ===== Diluted Earnings Per Share $ 0.67 $ 0.44 ====== ====== See notes to unaudited consolidated financial statements.
UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREOWNERS' EQUITY Three Months Ended March 31, 2000 (In millions except per share amounts) (unaudited) Accumulated Class A Class B Additional Other Total Common Stock Common Stock Paid-In Retained Comprehensive Shareowners' ------------ ------------ Shares Amount Shares Amount Capital Earnings Loss Equity ------ ------ ------ ------ ------- -------- ---- ------ Balance, January 1, 2000 1,101 $11 109 $ 1 $5,096 $7,536 $ (170) $12,474 Comprehensive income: Net income - - - - - 813 - 813 Foreign currency adjustments - - - - - - (16) (16) Unrealized gain on marketable securities - - - - - - 4 4 --- Comprehensive income 801 --- Dividends ($0.17 per share) - - - - - (206) - (206) Stock award plans - - - - 15 - - 15 Common stock purchases: Tender offer (68) (1) - - (4,069) - - (4,070) Other (1) - - - (54) - - (54) Common stock issuances 1 - - - 24 - - 24 ----- --- --- ---- ----- ---- ----- ----- Balance, March 31, 2000 1,033 $10 109 $ 1 $1,012 $8,143 $(182) $8,984 ===== === === === ====== ====== ====== ======
See notes to unaudited consolidated financial statements. UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Three Months Ended March 31, 2000 and 1999 (In millions) (unaudited) Three Months Ended March 31, 2000 1999 ---- ---- Cash flows from operating activities: Net income $ 813 $ 499 Adjustments to reconcile net income to net cash from operating activities: Depreciation and amortization 283 283 Postretirement benefits 31 24 Deferred taxes, credits, and other 79 63 Stock award plans 144 88 Gain on exchange of investments and sale of business (290) - Changes in assets and liabilities: Accounts receivable (139) 36 Prepaid employee benefit costs 191 242 Materials, supplies and other prepaid expenses (94) (37) Accounts payable 273 (175) Accrued wages and withholdings 210 48 Dividends payable (361) (247) Tax assessment (311) - Income taxes payable 380 266 Other current liabilities 151 79 ---- ----- Net cash from operating activities 1,360 1,169 ----- ----- Cash flows from investing activities: Capital expenditures (315) (214) Disposals of property, plant and equipment 193 12 Purchases of marketable securities and short-term investments (766) (487) Sales and maturities of marketable securities and short-term investments 1,385 399 Construction funds in escrow (2) (149) Other asset receipts (payments) (55) 2 ----- ----- Net cash from (used in) investing activities 440 (437) ---- ---- Cash flows from financing activities: Proceeds from borrowings 970 959 Repayments of borrowings (196) (261) Purchases of common stock via tender offer (4,070) - Purchases of common stock (54) (216) Issuances of common stock pursuant to stock awards and employee stock purchase plans 24 333 Dividends (206) - Other transactions - 31 ------ ----- Net cash from (used in) financing activities (3,532) 846 ------ ----- Effect of exchange rate changes on cash (1) (23) ------- ----- Net increase (decrease) in cash and cash equivalents (1,733) 1,555 Cash and cash equivalents: Beginning of period 4,204 1,240 ----- ----- End of period $2,471 $2,795 ===== ===== Cash paid during the period for: Interest (net of amount capitalized) $ 130 $ 35 ===== ===== Income taxes $ 67 $ 26 ===== ===== See notes to unaudited consolidated financial statements. 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 the financial position as of March 31, 2000, the results of operations for the three months ended March 31, 2000 and 1999, and cash flows for the three months ended March 31, 2000 and 1999. 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. 3. The following table sets forth the computation of basic and diluted earnings per share (in millions except per share amounts): Three Months Ended March 31, 2000 1999 Numerator: Numerator for basic and diluted earnings per share - Net Income $ 813 $ 499 ==== ==== Denominator: Weighted-average shares - Denominator for basic earnings per share 1,189 1,113 Effect of dilutive securities: Contingent shares - Management Incentive Awards 4 8 Stock option plans 20 8 ----- ---- Denominator for diluted earnings per share 1,213 1,129 ===== ===== Basic Earnings Per Share $0.68 $0.45 ==== ==== Diluted Earnings Per Share $0.67 $0.44 ==== ==== UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued) 4. On August 9, 1999, the U.S. Tax Court issued an opinion unfavorable to UPS regarding a Notice of Deficiency asserting that we are liable for additional tax for the 1983 and 1984 tax years. The Court held that we are liable for tax on income of Overseas Partners Ltd. ("OPL"), a Bermuda company, which had reinsured excess value package insurance purchased by our customers beginning in 1984. The Court held that for the 1984 tax year we are 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. In February 2000, the U.S. Tax Court entered a decision in accord with its opinion. In addition, during the first quarter of 1999, the IRS issued two Notices of Deficiency asserting that we are liable for additional tax for the 1985 through 1987 tax years, and the 1988 through 1990 tax years. The primary assertions by the IRS relate to the reinsurance of excess value package insurance, the issue raised for the 1984 tax year. The IRS has based its assertions on the same theories included in the 1983-1984 Notice of Deficiency. We anticipate that the IRS will take similar positions for tax years subsequent to 1990. Based on the Tax Court opinion, we currently estimate that our total after-tax exposure for the tax years 1984 through 1999 could be as high as $2.353 billion. We believe that a number of aspects of the Tax Court decision are incorrect, and we intend to appeal the decision to the U.S. Court of Appeals for the Eleventh Circuit. In the 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 is included in income taxes; however, since none of the income on which this tax assessment is based is our income, we have not classified the tax charge as income taxes. We determined the size of our reserve with respect to these matters in accordance with generally accepted accounting principles based on our estimate of our most likely liability. In making this determination, we concluded that 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. If penalties and penalty interest ultimately are determined to be payable, we would have to record an additional charge of up to $681 million. UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued) On August 31, 1999, we deposited $1.349 billion with the IRS related to these matters for the 1984 through 1994 tax years. We included the profit of the excess value package insurance program, using the IRS's methodology for calculating these amounts, for both 1998 and 1999 in filings we made with the IRS in the fourth quarter of 1999. In February 2000, we deposited $339 million with the IRS related to these matters for the 1995 through 1997 tax years. These deposits and filings were made in order to stop the accrual of interest, where applicable, on that amount of the IRS's claim, without conceding the IRS's position or giving up our right to appeal the Tax Court's decision. Effective October 1, 1999, we implemented a new arrangement for providing excess value package insurance for our customers through UPS subsidiaries. This new arrangement results in including in our non-package operating segment the operations of the excess value package insurance program offered to our customers. This revised arrangement should eliminate the issues considered by the Tax Court in the Notices of Deficiency relating to OPL for periods after September 1999. The IRS has proposed adjustments, unrelated to the OPL matters discussed above, regarding the allowance of deductions and certain losses, the characterization of expenses as capital rather than ordinary, and our entitlement to the investment tax credit and the research tax credit in the 1985 through 1990 tax years. These proposed adjustments, if sustained, would result in $82 million in additional income tax expense. We expect that we will prevail on substantially all of these issues. 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. Should the IRS prevail, however, unpaid interest on these adjustments through 1999 could aggregate up to $270 million, after the benefit of related tax deductions. 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. The IRS may take similar positions with respect to some of these issues for each of the years from 1991 through 1999. We believe the eventual resolution of these issues will not result in a material adverse effect upon our financial condition, results of operations or liquidity. We are a defendant in various employment-related lawsuits. In one of these actions, which alleges employment discrimination by UPS, class action status has been granted, and the United States Equal Employment Opportunity Commission has been granted the right to intervene. In our opinion, none of these cases is expected to have a material effect upon our financial condition, results of operations or liquidity. UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued) We have been named as a defendant in 11 lawsuits that seek to hold us (and in two cases, other defendants) liable for the collection of premiums for excess value package insurance in connection with package shipments since 1984. These cases generally claim that we acted as an insurer in violation of our shipping contract and without complying with state insurance laws and regulations, and that the price for excess value package insurance was excessive. Six of these cases have been consolidated for pre-trial purposes in a multi-district litigation proceeding before the United States District Court for the Southern District of New York. We are in the process of removing the remaining cases to federal court and having them consolidated into the multi-district litigation proceeding. These cases are in their initial stages, no discovery has commenced, and no class has been certified. These actions all developed after the August 9, 1999 Tax Court opinion was rendered. We believe the allegations have no merit and intend to defend them vigorously. The ultimate resolution of these matters cannot presently be determined. As part of our 1997-2002 collective bargaining agreement with the Teamsters, we agreed that we would create 2,000 new full-time jobs from existing part-time jobs during each year of the contract. There was a provision, however, which nullified this obligation if there was a reduction in volume that resulted in layoffs. At the end of the first contract year (July 31, 1998), our shipping volume was still below pre-strike levels and employees were laid off. Therefore, we believed that we were not obligated to create the 2,000 jobs for the first year of the contract. The Teamsters filed a grievance concerning this issue, and the case was submitted to an arbitrator. In February 2000, the arbitrator ruled against us and ordered us to create the 2,000 new full-time jobs from existing part-time positions within 90 days of the arbitrator's decision, and to make whole the employees selected for the full-time positions for any lost wages or benefits. We have also agreed to create 2,000 full-time jobs from existing part-time jobs for the second year of the contract and to make the affected employees whole. We have conferred with the Teamsters on this issue and are now in the process of staffing the newly created jobs. In the first quarter of 2000, we recorded a pre-tax charge of $59 million for the retroactive compensation and associated benefits that we expect to pay as a result of this matter. Our package volume surpassed pre-strike levels in 1999, and thus we are in the process of creating the 2,000 full-time jobs called for in the third year of the contract. On November 22, 1999, the U.S. Occupational Safety and Health Administration proposed regulations to mandate an ergonomics standard that would require American industry to make significant changes in the workplace in order to reduce the incidence of musculoskeletal complaints such as low back pain. The exact changes in the workplace that might be required to comply with these standards are not specified in the proposal. If OSHA enforced these regulations by seeking the same ergonomic measures it has advocated in the past under its general authority to remedy "recognized hazards," however, it might demand extensive changes in the physical layout of our distribution centers as well as the hiring of significant numbers of additional full-time and part-time employees. Our competitors, as well as the remainder of American industry, also would incur proportionately comparable costs. UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued) We, our competitors and other affected parties have filed comments with OSHA challenging the medical support and economic and technical feasibility of the proposed regulations. We do not believe that OSHA has complied with the statutory mandate of establishing significant risk of material health impairment or has properly analyzed the costs and benefits of these proposed regulations. We and other affected parties have the right to file additional comments in opposition to the proposed regulations and to appeal any final ergonomics standard to an appropriate federal court of appeals. We anticipate that such a standard would be rejected by the reviewing court. If ergonomic regulations resembling the current proposal were sustained by a reviewing court, we believe that we would prevail in an enforcement proceeding based on substantial defenses including the vagueness of the standards and the technological and economic feasibility of costly abatement measures. OSHA has taken the position that the cost of compliance with the proposed regulations will be only $4.2 billion per year over a ten-year period for all of American industry. We believe that these estimates are unrealistic. We have attempted to estimate the costs of compliance if OSHA adopts the proposed regulations and applies them in the same way as it sought to apply its prior unsuccessful attempts to impose ergonomic measures under its general authority. Based on this experience and assuming that, contrary to our expectations, OSHA were able successfully to obtain court orders applying to all of our facilities that mandated compliance with these regulations, we estimate that the cost of compliance could be approximately $20 billion in initial costs, which would be incurred over a period of years, and approximately $5 billion in incremental annual costs. Such expenditures, if required to be incurred, would materially and adversely affect our results of operations, liquidity and financial condition. In addition, we are a defendant in various other lawsuits that arose in the normal course of business. In our opinion, none of these cases is expected to have a material effect upon 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, are distinct from package operations and are thus managed and reported separately. UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued) Segment information for the three months ended March 31 is as follows (in millions): Three Months Ended March 31, 2000 1999 Revenue: U.S. domestic package $5,841 $5,231 International package 1,023 885 Non-package 356 215 ----- ----- Consolidated $7,220 $6,331 ===== ===== Operating profit: U.S. domestic package $ 893 $ 789 International package 64 52 Non-package 126 25 ----- ---- Consolidated $1,083 $ 866 ====== ==== Non-package operating profit for the three months ended March 31, 2000 and 1999, respectively, included $27 and $29 million of intersegment profit with a corresponding amount of operating expense included in the U.S. domestic package segment. 6. The major components of other operating expenses for the three months ended March 31 are as follows (in millions): Three Months Ended March 31, 2000 1999 ---- ---- Repairs and maintenance $ 239 $ 217 Depreciation and amortization 283 283 Purchased transportation 434 376 Fuel 238 142 Other occupancy 107 101 Other expenses 761 694 ----- ----- Consolidated $2,062 $1,813 ===== ===== 7. Certain prior period amounts have been reclassified to conform to the current period presentation. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Three Months Ended March 31, 2000 and 1999 - ------------------------------------------ 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 March 31, Change ------ 2000 1999 $ % ---- ---- - - Revenue (in millions): U.S. domestic package: Next Day Air $1,381 $1,208 $173 14.3% Deferred 694 611 83 13.6 Ground 3,766 3,412 354 10.4 ----- ----- ---- Total U.S. domestic package 5,841 5,231 610 11.7 International package: Domestic 233 235 (2) (0.9) Export 685 574 111 19.3 Cargo 105 76 29 38.2 ----- ----- --- Total International package 1,023 885 138 15.6 Non-package 356 215 141 65.6 ------ ----- ---- Consolidated $7,220 $6,331 $889 14.0% ===== ===== === Average Daily Package Volume # (in thousands): - U.S. domestic package: Next Day Air 1,071 976 95 9.7% Deferred 856 787 69 8.8 Ground 10,102 9,664 438 4.5 ------ ------ --- Total U.S. domestic package 12,029 11,427 602 5.3 International package: Domestic 754 699 55 7.9 Export 342 279 63 22.6 ------ ------ --- Total International package 1,096 978 118 12.1 ------ ------ --- Consolidated 13,125 12,405 720 5.8% ====== ====== === Operating days in period 65 63 $ Average Revenue Per Piece: - U.S. domestic package: Next Day Air $19.84 $19.65 $.19 1.0% Deferred 12.47 12.32 .15 1.2 Ground 5.74 5.60 .14 2.5 Total U.S. domestic package 7.47 7.27 .20 2.8 International: Domestic 4.75 5.34 (.59) (11.0) Export 30.81 32.66 (1.85) (5.7) Total International package 12.89 13.13 (.24) (1.8) Consolidated $ 7.92 $ 7.73 $.19 2.5% ===== ===== ==== Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) U.S. domestic package revenue increased primarily due to volume gains across all product lines, continuing the trends reported during 1999. This increase was well balanced among our products. Our higher revenue per piece express (Next Day Air and Deferred) products continued to grow faster than our Ground products. However, our Ground products, which contributed over one-half of the revenue growth for this segment, grew at a 4.5% rate, increasing by an average of 438,000 packages per day. Also contributing to the revenue increase were the two extra operating days in the first quarter of 2000 compared to the first quarter of 1999. The average revenue increase for this segment on a per day basis was 8.2%. During the first quarter of 2000, we increased rates for standard ground shipments an average of 3.1% for commercial deliveries. The ground residential charge continued to be $1.00 over the commercial ground rate, with an additional delivery area surcharge of $1.50 added to certain less accessible areas. In addition, we increased rates for UPS Next Day Air, UPS Next Day Air Saver and UPS 2nd Day Air an average of 3.5%. The surcharge for UPS Next Day Air Early A.M. did not change. Rates for international shipments originating in the United States (Worldwide Express, Worldwide Express Plus, UPS Worldwide Expedited and UPS International Standard service) increased by 2.9%. Rate changes for shipments originating outside the U.S. were made throughout the past year and varied by geographic market. The increase in international package revenue was due to volume growth for both our domestic and export products, offset by a decline in the revenue per piece for these products. This decline was primarily due to currency fluctuations, particularly a decline in the value of the Euro relative to the U.S. dollar. Overall average daily package volume increased 12.1% for international operations, with our export products, which have the highest revenue per piece of any of our products, increasing at 22.6%. The average revenue increase for this segment on a per day basis was 12.0%. The increase in non-package revenue resulted primarily from the new arrangement for providing excess value package insurance for our customers as well as continued growth of the UPS Logistics Group. Excluding the excess value business, which was not included in the segment during the same period last year, non-package revenue increased over 20%. Operating expenses increased by $672 million, or 12.3%, which was less than our revenue increase of 14.0%. Compensation and benefits expenses, the largest component of this increase, accounted for $423 million and included a $59 million charge relating to the creation of 4,000 new full-time hourly jobs resulting from the 1997 Teamsters contract. Other operating expenses increased $249 million due to higher fuel costs, claims expense associated with the new arrangement for providing excess value package insurance for our customers, and higher purchased transportation costs. The increase in purchased transportation costs was primarily due to increased business for our international operations, while the $96 million, or 67.6%, increase in fuel costs was due to the increase in fuel prices, the growth in our average daily volume, and the two extra operating days in the quarter, partially offset by the cost reductions generated by our hedging program. International operating expenses were favorably impacted by the decline in the value of the Euro relative to the U.S. dollar. UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued) Our operating margin improved from 13.7 during the first quarter of 1999 to 15.0 during the first quarter of 2000. This improvement continues our recently reported trends and resulted primarily from product mix improvements along with better utilization of existing capacity. The following table sets forth information showing the change in operating profit, both in dollars and in percentage terms: Three Months Ended March 31, Change Operating Segment 2000 1999 $ % ----------------- ---- ---- - - (dollars in millions) U.S. domestic package $ 893 $ 789 $ 104 13.2% International package 64 52 12 23.1 Non-package 126 25 101 404.0 ---- ---- ---- Consolidated operating profit $1,083 $ 866 $ 217 25.1% ===== ==== ==== U.S. domestic package operating profit increased over $100 million due to the volume and revenue improvements discussed previously. The improvement in the operating profit of our international package operations of 23.1% resulted from volume gains and was realized despite significantly higher fuel costs for this segment. Europe continues to be a significant contributor to these results, and we also experienced improvement in our Canadian operations. The increase in non-package operating profit is largely due to the new arrangement for providing excess value package insurance for our customers, which contributed $58 million of additional operating profit for the quarter. Also contributing to the operating profit improvement was the $49 million gain we recognized from the sale of our UPS Truck Leasing subsidiary. These improvements were offset somewhat by start-up costs associated with both Service Parts Logistics and e-commerce initiatives. The increase in investment income of $302 million for the quarter is due to two factors. First, we recognized a $241 million gain on two investments held by our Strategic Enterprise Fund that were acquired by other companies. In addition, we earned income on the $5.3 billion in net IPO proceeds available for investment prior to the tender offer that occurred in early March 2000, and the $1.2 billion in IPO proceeds that were not utilized for the tender offer and were still available for investment during March. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Net income for the first quarter of 2000 increased by $314 million from the first quarter of 1999, resulting in an increase in diluted earnings per share from $0.44 in 1999 to $0.67 in 2000. These results reflect the non-recurring items discussed above, which include the gains on our Strategic Enterprise Fund investments and sale of our Truck Leasing subsidiary, offset partially by the charge for retroactive costs associated with creating new full-time jobs from existing part-time Teamster jobs. Excluding the net after-tax impact of these non-recurring items of $139 million, our net income for the first quarter of 2000 would have been $674 million, with an associated diluted earnings per share of $0.56. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) 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 $4.2 billion at March 31, 2000. Of this amount, approximately $1.2 billion represents the net proceeds remaining from our initial public offering, which was completed in November 1999. We used the majority of the IPO proceeds to fund a cash tender offer to purchase Class A-1 shares from shareowners. The tender offer, which was announced on February 4, 2000 and expired on March 3, 2000, was for up to 100,893,277 shares at a price of $60 per share. The actual number of shares validly tendered and accepted for purchase by us was 67,834,815, which resulted in a cash expenditure of approximately $4.1 billion and reduced our outstanding Class A shares accordingly. The remaining IPO proceeds are available for a share repurchase program that was announced on April 20, 2000. We maintain a commercial paper program under which we are authorized to borrow up to $2.0 billion. Approximately $998 million was outstanding as of March 31, 2000. Since we do not intend to refinance the full commercial paper balance outstanding at March 31, 2000, $898 million has been classified as a current liability in our balance sheet. The average interest rate on the amount outstanding at March 31, 2000 was 6.0%. We maintain two credit agreements with a consortium of banks. These agreements provide revolving credit facilities of $1.25 billion each, with one expiring in April 2001 and the other expiring in April 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 March 31, 2000. We also maintain a European medium-term note program with a borrowing capacity of $1.0 billion. Under this program, we may issue notes from time to time denominated in a variety of currencies. At March 31, 2000, $500 million was available under this program. Of the amount outstanding at March 31, 2000, $200 million bears interest at a stated interest rate of 6.625% and $300 million bears interest at a stated interest rate of 6.25%. In January 1999, we filed a shelf registration statement with the SEC, under which we may issue debt securities in the U.S. marketplace of up to $2.0 billion. The debt may be denominated in a variety of currencies. There was approximately $105 million issued under this shelf registration statement at March 31, 2000. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) On November 22, 1999, the U.S. Occupational Safety and Health Administration proposed regulations to mandate an ergonomics standard that would require American industry to make significant changes in the workplace in order to reduce the incidence of musculoskeletal complaints such as low back pain. The exact changes in the workplace that might be required to comply with these standards are not specified in the proposal. If OSHA enforced these regulations by seeking the same ergonomic measures it has advocated in the past under its general authority to remedy "recognized hazards," however, it might demand extensive changes in the physical layout of our distribution centers as well as the hiring of significant numbers of additional full-time and part-time employees. Our competitors, as well as the remainder of American industry, also would incur proportionately comparable costs. We, our competitors and other affected parties have filed comments with OSHA challenging the medical support and economic and technical feasibility of the proposed regulations. We do not believe that OSHA has complied with the statutory mandate of establishing significant risk of material health impairment or has properly analyzed the costs and benefits of these proposed regulations. We and other affected parties have the right to file additional comments in opposition to the proposed regulations and to appeal any final ergonomics standard to an appropriate federal court of appeals. We anticipate that such a standard would be rejected by the reviewing court. If ergonomic regulations resembling the current proposal were sustained by a reviewing court, we believe that we would prevail in an enforcement proceeding based on substantial defenses including the vagueness of the standards and the technological and economic feasibility of costly abatement measures. OSHA has taken the position that the cost of compliance with the proposed regulations will be only $4.2 billion per year over a ten-year period for all of American industry. We believe that these estimates are unrealistic. We have attempted to estimate the costs of compliance if OSHA adopts the proposed regulations and applies them in the same way as it sought to apply its prior unsuccessful attempts to impose ergonomic measures under its general authority. Based on this experience and assuming that, contrary to our expectations, OSHA were able successfully to obtain court orders applying to all of our facilities that mandated compliance with these regulations, we estimate that the cost of compliance could be approximately $20 billion in initial costs, which would be incurred over a period of years, and approximately $5 billion in incremental annual costs. Such expenditures, if required to be incurred, would materially and adversely affect our results of operations, liquidity and financial condition. Market Risk - ----------- We are exposed to a number of market risks in the ordinary course of business. These risks, which include interest rate risk, foreign currency exchange risk and commodity price risk, arise in the normal course of business rather than from trading. We have examined our exposures to these risks and concluded that none of our exposures in these areas is material to fair values, cash flows or earnings. We have engaged in several strategies to manage these market risks. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Our indebtedness under our various financing arrangements creates interest rate risk. In connection with each debt issuance and as a result of continual monitoring of interest rates, we may enter into interest rate swap agreements for purposes of managing our borrowing costs. For all foreign currency-denominated borrowing and certain lease transactions, we simultaneously entered into currency exchange agreements to lock in the price of the currency needed to pay the obligations and to hedge the foreign currency exchange risk associated with such transactions. We are exposed to other foreign currency exchange risks in the ordinary course of our business operations due to the fact that we provide our services in more than 200 countries and territories and collection of revenue and payment of certain expenses may give rise to currency exposure. We require significant quantities of gasoline, diesel fuel and jet fuel for our aircraft and delivery vehicles. We therefore are exposed to commodity price risk associated with variations in the market price for energy products. We manage this risk with a hedging strategy designed to minimize the impact of sudden, catastrophic increases in the prices of energy products, while allowing us to benefit if fuel prices decline. Our hedging program is designed to moderate the impact of fluctuating crude oil prices and maintain our competitive position relative to our industry peers. Year 2000 Update - ---------------- In 1995, we created a Year 2000 Committee to evaluate the year 2000 issue and to take appropriate action to address its implications for us. Since entering the year 2000, we have not experienced any significant disruptions related to the year 2000 issue, nor are we aware of any significant year 2000-related disruptions impacting our customers and suppliers. While we will continue to monitor our business critical information technology assets, we do not anticipate that we will experience any significant year 2000-related disruptions to our systems, nor to those of our customers and suppliers. Costs incurred to achieve year 2000 readiness, which include both internal and external resources, were charged to expense as incurred. Such costs totaled approximately $104 million, substantially all of which were incurred prior to December 31, 1999. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) "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 about matters that are inherently difficult to predict. These statements include statements regarding our intent, belief and current expectations. We have described some of the important factors that affect these statements as we discussed each subject. Forward-looking statements involve risks and uncertainties that may affect future developments. These risks include, for example, our continued ability to successfully compete, especially with foreign competition, the reliability and availability of rail transportation, the growth rate of e-commerce in relation to our expectations, adverse weather conditions and changing fuel prices. Additional information concerning these risks and uncertainties, and other factors you may wish to consider, are provided in the "Risk Factors" section of our prospectus dated November 9, 1999, as filed with the Securities and Exchange Commission. Item 3. Quantitative and Qualitative Disclosures About Market Risk See Item 2. PART II. OTHER INFORMATION Item 1. Legal Proceedings We have been named as a defendant in 11 lawsuits that seek to hold us (and in two cases, other defendants) liable for the collection of premiums for excess value package insurance in connection with package shipments since 1984. These cases generally claim that we acted as an insurer in violation of our shipping contract and without complying with state insurance laws and regulations, and that the price for excess value package insurance was excessive. Six of these cases have been consolidated for pre-trial purposes in a multi-district litigation proceeding before the United States District Court for the Southern District of New York. We are in the process of removing the remaining cases to federal court and having them consolidated into the multi-district litigation proceeding. These cases are in their initial stages, no discovery has commenced, and no class has been certified. These actions all developed after the August 9, 1999 Tax Court opinion was rendered. We believe the allegations have no merit and intend to defend them vigorously. The ultimate resolution of these matters cannot presently be determined. As part of our 1997-2002 collective bargaining agreement with the Teamsters, we agreed that we would create 2,000 new full-time jobs from existing part-time jobs during each year of the contract. There was a provision, however, which nullified this obligation if there was a reduction in volume that resulted in layoffs. At the end of the first contract year (July 31, 1998), our shipping volume was still below pre-strike levels and employees were laid off. Therefore, we believed that we were not obligated to create the 2,000 jobs for the first year of the contract. The Teamsters filed a grievance concerning this issue, and the case was submitted to an arbitrator. In February 2000, the arbitrator ruled against us and ordered us to create the 2,000 new full-time jobs from existing part-time positions within 90 days of the arbitrator's decision, and to make whole the employees selected for the full-time positions for any lost wages or benefits. We have also agreed to create 2,000 full-time jobs from existing part-time jobs for the second year of the contract and to make the affected employees whole. We have conferred with the Teamsters on this issue and are now in the process of staffing the newly created jobs. In the first quarter of 2000, we recorded a pre-tax charge of $59 million for the retroactive compensation and associated benefits that we expect to pay as a result of this matter. Our package volume surpassed pre-strike levels in 1999, and thus we are in the process of creating the 2,000 full-time jobs called for in the third year of the contract. Item 6. Exhibits and Reports on Form 8-K A) Exhibits: (10) Material Contracts (a) Credit Agreement (364-Day Facility) dated April 27, 2000 among United Parcel Service of America, Inc., the initial lenders named therein, Salomon Smith Barney Inc. as Co-Arranger and Bank of America Securities, LLC, as Co-Arranger and Bank of America N.A. as Documentation Agent and Citibank, N.A. as Administrative and Syndication Agent. (b) Credit Agreement (Five-Year Facility) dated April 27, 2000 among United Parcel Service of America, Inc., the initial lenders named therein, Salomon Smith Barney Inc. as Co-Arranger and Bank of America Securities, LLC, as Co-Arranger and Bank of America N.A. as Documentation Agent and Citibank, N.A. as Administrative and Syndication Agent. (27) Financial Data Schedule (for SEC filing purposes only) (B) Reports on Form 8-K: During the quarter ended March 31, 2000, we filed one Current Report on Form 8-K, dated February 23, 2000. EXHIBIT INDEX (10) Material Contracts (a) Credit Agreement (364-Day Facility) dated April 27, 2000 among United Parcel Service of America, Inc., the initial lenders named therein, Salomon Smith Barney Inc. as Co-Arranger and Bank of America Securities, LLC, as Co-Arranger and Bank of America N.A. as Documentation Agent and Citibank, N.A. as Administrative and Syndication Agent. (b) Credit Agreement (Five-Year Facility) dated April 27, 2000 among United Parcel Service of America, Inc., the initial lenders named therein, Salomon Smith Barney Inc. as Co-Arranger and Bank of America Securities, LLC, as Co-Arranger and Bank of America N.A. as Documentation Agent and Citibank, N.A. as Administrative and Syndication Agent. 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: May 15, 2000 By: /S/ Robert J. Clanin ---------------------- Robert J. Clanin Senior Vice President, Treasurer and Chief Financial Officer