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 September 30, 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) 967,128,260 Class A shares, 164,309,050 Class B shares - -------------------------------------------------------------------------- Outstanding as of November 10, 2000 PART I. FINANCIAL INFORMATION Item 1. Financial Statements
UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS September 30, 2000 (unaudited) and December 31, 1999 (In millions except share and per share amounts) September 30, December 31, Assets 2000 1999 ----------- ----------- Current Assets: Cash & cash equivalents $ 1,670 $4,204 Marketable securities & short-term investments 1,922 2,074 Accounts receivable 3,383 3,167 Prepaid employee benefit costs 1,626 1,327 Materials, supplies & other prepaid expenses 506 366 ----------- ----------- Total Current Assets 9,107 11,138 Property, Plant & Equipment (including aircraft under capitalized lease obligations) - at cost, net of accumulated depreciation & amortization of $9,442 in 2000 and $8,891 in 1999 11,721 11,579 Other Assets 584 326 ----------- ----------- $21,412 $ 23,043 =========== =========== Liabilities & Shareowners' Equity Current Liabilities: Commercial paper $ 955 $ - Accounts payable 1,433 1,295 Accrued wages & withholdings 1,740 998 Dividends payable - 361 Tax assessment 146 457 Income taxes payable 396 50 Current maturities of long-term debt 263 512 Other current liabilities 686 525 ----------- ----------- Total Current Liabilities 5,619 4,198 ----------- ----------- Long-Term Debt (including capitalized lease obligations) 2,052 1,912 ----------- ----------- Accumulated Postretirement Benefit Obligation, Net 1,049 990 ----------- ----------- Deferred Taxes, Credits & Other Liabilities 3,426 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 988,395,928 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 146,553,441 and 109,400,000 in 2000 and 1999 1 1 Additional paid-in capital 345 5,096 Retained earnings 9,152 7,536 Accumulated other comprehensive loss (242) (170) ----------- ----------- 9,266 12,474 ----------- ----------- $21,412 $ 23,043 =========== ===========
See notes to unaudited consolidated financial statements. UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED INCOME Three Months and Nine Months Ended September 30, 2000 and 1999 (In millions except per share amounts) (unaudited) Three Months Ended Nine Months Ended September 30, September 30, ------------------- ----------------------- 2000 1999 2000 1999 --------- --------- ----------- ----------- Revenue $ 7,367 $ 6,715 $ 21,871 $ 19,606 --------- --------- ----------- ----------- Operating Expenses: Compensation and benefits 4,072 3,849 12,189 11,226 Other 2,134 1,876 6,274 5,522 --------- --------- ----------- ----------- 6,206 5,725 18,463 16,748 --------- --------- ----------- ----------- Operating Profit 1,161 990 3,408 2,858 --------- --------- ----------- ----------- Other Income and (Expense): Investment income 71 45 466 115 Interest expense (41) (65) (158) (170) Tax assessment - - - (1,786) Miscellaneous, net (20) (8) (32) (30) --------- --------- ----------- ----------- 10 (28) 276 (1,871) --------- --------- ----------- ----------- Income Before Income Taxes 1,171 962 3,684 987 Income Taxes 469 385 1,474 765 --------- --------- ----------- ----------- Net Income $ 702 $ 577 $2,210 $ 222 ========= ========= =========== =========== Basic Earnings Per Share $0.62 $0.53 $ 1.91 $ 0.20 ========= ========= =========== =========== Diluted Earnings Per Share $0.60 $0.52 $ 1.87 $ 0.20 ========= ========= =========== =========== See notes to unaudited consolidated financial statements.
UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREOWNERS' EQUITY Nine Months Ended September 30, 2000 (In millions except per share amounts) (unaudited) Class A Class B Accumulated Common Stock Common Stock Additional Other Total ---------------- --------------- 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 - - - - - 2,210 - 2,210 Foreign currency adjustments - - - - - - (77) (77) Unrealized gain on marketable securities - - - - - - 5 5 ------------ Comprehensive income 2,138 ------------ Dividends ($0.51 per share) - - - - - (594) - (594) Stock award plans 5 - - - 113 - - 113 Common stock purchases: Tender offer (68) (1) - - (4,069) - - (4,070) Other (9) - (4) - (813) - - (813) Common stock issuances 1 - - - 18 - - 18 Conversion of Class A Common Stock to Class B Common Stock (42) - 42 - - - - - ------- ------ ------ ------ ---------- --------- ------------- ------------ Balance, September 30, 2000 988 $ 10 147 $1 $ 345 $9,152 $ (242) $ 9,266 ======= ====== ====== ====== ========== ========= ============= ============
See notes to unaudited consolidated financial statements.
UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended September 30, 2000 and 1999 (In millions) (unaudited) Nine Months Ended September 30, ------------------- 2000 1999 -------- -------- Cash flows from operating activities: Net income $2,210 $222 Adjustments to reconcile net income to net cash from operating activities: Depreciation and amortization 864 850 Postretirement benefits 59 18 Deferred taxes, credits, and other (9) (79) Stock award plans 415 304 Gain on investments and sale of business (263) - Changes in assets and liabilities: Accounts receivable (216) (132) Prepaid employee benefit costs (299) (294) Materials, supplies and other prepaid expenses (140) (54) Accounts payable 138 (9) Accrued wages and withholdings 371 241 Dividends payable (361) (247) Tax assessment (311) 621 Income taxes payable 481 55 Other current liabilities 98 45 -------- -------- Net cash from operating activities 3,037 1,541 -------- -------- Cash flows from investing activities: Capital expenditures (1,247) (1,080) Disposals of property, plant and equipment 204 155 Purchases of marketable securities and short-term investments (3,423) (2,089) Sales and maturities of marketable securities and short-term investments 3,806 1,785 Construction funds in escrow 59 (138) Other asset receipts (payments) (272) 15 -------- -------- Net cash (used in) investing activities (873) (1,352) -------- -------- Cash flows from financing activities: Proceeds from borrowings 1,643 1,617 Repayments of borrowings (793) (246) Purchases of common stock via tender (4,070) - Other purchases of common stock (813) (1,196) Issuances of common stock pursuant to stock awards and employee stock purchase plans 70 684 Dividends (594) (311) Other transactions (118) (10) -------- -------- Net cash (used in) financing activities (4,675) 538 -------- -------- Effect of exchange rate changes on cash (23) (12) -------- -------- Net increase (decrease) in cash and cash equivalents (2,534) 715 Cash and cash equivalents: Beginning of period 4,204 1,240 -------- -------- End of period $1,670 $1,955 ======== ======== Cash paid during the period for: Interest (net of amount capitalized) $194 $927 ======== ======== Income taxes $905 $660 ======== ========
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 September 30, 2000, the results of operations for the three and nine months ended September 30, 2000 and 1999, and cash flows for the nine months ended September 30, 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 Nine Months Ended September 30, September 30, --------------------- --------------------- 2000 1999 2000 1999 -------- -------- --------- -------- Numerator: Numerator for basic and diluted earnings per share - Net income $ 702 $ 577 $2,210 $ 222 ======== ======== ========= ======== Denominator: Weighted-average shares - Denominator for basic earnings per share 1,140 1,094 1,158 1,107 Effect of dilutive securities: Contingent shares - Management incentive awards 9 15 6 11 Stock option plans 15 9 17 8 -------- -------- --------- -------- Denominator for diluted earnings per share 1,164 1,118 1,181 1,126 ======= ======= ========= ======== Basic Earnings Per Share $0.62 $0.53 $ 1.91 $0.20 ======== ======== ========= ======== Diluted Earnings Per Share $0.60 $0.52 $ 1.87 $0.20 ======== ======== ========= ========
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. The IRS has taken 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 have appealed 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, and on August 8, 2000, we deposited an additional $91 million, 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 September 30, 2000, 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 has taken similar positions with respect to some of these issues for each of the years from 1991 through 1994 and we expect the IRS to take similar positions for the years 1995 through 1999. We believe the eventual resolution of these issues will not result in a material adverse effect on our financial condition, results of operations or liquidity. We are a defendant in various employment-related lawsuits. In our opinion, none of these cases is expected to have a material effect on 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 18 lawsuits that seek to hold us (and in three 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; one case alleges violations of federal antitrust laws. An amended consolidated complaint also alleges a violation of the federal RICO statute. Seventeen 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 having the remaining case 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. 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 would have the right 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. UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued) 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 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 financial condition, results of operations or liquidity. 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 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 delivery 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. Segment information for the three and nine months ended September 30, 2000 and 1999, is as follows (in millions): Three Months Ended Nine Months Ended September 30, September 30, ---------------------- ----------------------- 2000 1999 2000 1999 ---------- ---------- ---------- ----------- Revenue: U.S. domestic package $5,928 $5,574 $17,659 $16,239 International package 1,028 909 3,074 2,702 Non-package 411 232 1,138 665 ---------- ---------- ---------- ----------- Consolidated $7,367 $6,715 $21,871 $19,606 ========== ========== ========== =========== Operating profit: U.S. domestic package $1,043 $916 $ 2,954 $ 2,603 International package 58 47 207 170 Non-package 60 27 247 85 ---------- ---------- ---------- ----------- Consolidated $1,161 $990 $ 3,408 $ 2,858 ========== ========== ========== =========== UNITED PARCEL SERVICE, INC., AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued) Non-package operating profit included $24 and $28 million for the three months ended September 30, 2000 and 1999, respectively, and $77 and $85 million for the nine months ended September 30, 2000 and 1999, 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 months and nine months ended September 30, 2000 and 1999, are as follows (in millions): Three Months Ended Nine Months Ended September 30, September 30, ------------------------ ------------------------ 2000 1999 2000 1999 --------- ---------- --------- ---------- Repairs and maintenance $246 $231 $726 $674 Depreciation and amortization 294 287 864 850 Purchased transportation 478 407 1,378 1,168 Fuel 224 174 672 467 Other occupancy 99 89 297 278 Other expenses 793 688 2,337 2,085 -------- ---------- --------- ---------- Consolidated $2,134 $1,876 $6,274 $5,522 ========= ========== ========= ========== 7. In June 1998, the FASB issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"), as amended by Statement No. 137 and No. 138, which provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. Upon adoption, all derivative instruments will be recognized on the balance sheet at fair value, and changes in the fair values of such instruments must be recognized currently in earnings unless specific hedge accounting criteria are met. FAS 133 will be effective for us on January 1, 2001. Based on an evaluation of our material derivative instruments held at September 30, 2000, the adoption of FAS 133 at that date would not have had a material impact on our financial position or results of operations. 8. 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 September 30, 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 September 30, ------------------- 2000 1999 $ % -------- -------- --------- -------- Revenue (in millions): U.S. domestic package: Next Day Air $1,420 $1,344 $ 76 5.7 % Deferred 690 649 41 6.3 Ground 3,818 3,581 237 6.6 -------- -------- --------- Total U.S. domestic package 5,928 5,574 354 6.4 International package: Domestic 218 221 (3) (1.4) Export 698 605 93 15.4 Cargo 112 83 29 34.9 -------- -------- --------- Total international package 1,028 909 119 13.1 Non-package: UPS Logistics Group 268 197 71 36.0 Other 143 35 108 308.6 -------- -------- --------- Total non-package 411 232 179 77.2 -------- -------- --------- Consolidated $7,367 $6,715 $652 9.7 % ======== ======== ========= Average Daily Package Volume (in thousands): # --------- U.S. domestic package: Next Day Air 1,130 1,046 84 8.0 % Deferred 845 789 56 7.1 Ground 10,345 9,849 496 5.0 -------- -------- --------- Total U.S. domestic package 12,320 11,684 636 5.4 International package: Domestic 770 691 79 11.4 Export 366 298 68 22.8 -------- -------- --------- Total international package 1,136 989 147 14.9 -------- -------- --------- Consolidated 13,456 12,673 783 6.2 % ======== ======== ========= Operating days in period 63 64 Average Revenue Per Piece: U.S. domestic package: $ --------- Next Day Air $19.95 $20.08 $(0.13) (0.6)% Deferred 12.96 12.85 0.11 0.9 Ground 5.86 5.68 0.18 3.2 Total U.S. domestic package 7.64 7.45 0.19 2.6 International: Domestic 4.49 5.00 (0.51) (10.2) Export 30.27 31.72 (1.45) (4.6) Total international package 12.80 13.05 (0.25) (1.9) Consolidated $ 8.07 $ 7.89 $ 0.18 2.3 % ======== ======== ========= Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) U.S. domestic package revenue increased 6.4% primarily due to volume gains across all product lines, continuing the trends reported during the first and second quarters of 2000. Average daily package volume for our Ground products increased 5.0%, or almost one-half million packages per day. This volume increase, combined with a 3.2% increase in revenue per piece for our Ground products, accounted for approximately two-thirds of the overall revenue increase for this segment. The remaining increase in U.S. domestic package revenue was due to continued volume growth for our Next Day Air and Deferred products. The increase in international package revenue of 13.1% 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 a decline in the value of the Euro relative to the U.S. dollar. Excluding the impact of currency fluctuations, overall revenue per piece for our international products would have increased 4.4%. The 22.8% increase in average daily volume for our export products represents our third consecutive quarter with volume increases in excess of 20%. 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. Revenue for the UPS Logistics Group increased by $71 million, or 36.0%, from $197 million to $268 million. Operating expenses increased by $481 million, or 8.4%, to $6.206 billion during the third quarter of 2000. Compensation and benefits expenses increased by $223 million while other operating expenses increased $258 million. The increase in other operating expenses was primarily due to higher purchased transportation costs, higher fuel costs and claims expense associated with the new arrangement for providing excess value package insurance for our customers. The increase in purchased transportation costs were primarily due to increased business for our international and logistics operations, while the $50 million, or 28.7%, increase in fuel costs was due to the increase in fuel prices and the growth in volume, partially offset by the cost reductions generated by our fuel hedging program. International operating expenses were favorably impacted by the decline in the value of the Euro relative to the U.S. dollar. To offset the increasing fuel costs we have experienced over the last several quarters and that we expect to continue into the future, we implemented a temporary 1.25% fuel surcharge effective August 7, 2000. Approximately $50 million in revenue was recorded during the quarter as a result of the surcharge. Our operating margin improved from 14.7% during the third quarter of 1999 to 15.8% during the third quarter of 2000. The 15.8% operating margin represents our fourth consecutive quarter with an operating margin in excess of 15.0%. This improvement continues our recently reported trends and is favorably impacted by continued product mix improvements and our continued successful efforts in obtaining profitable volume growth. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) The following table sets forth information showing the change in operating profit, both in dollars (in millions) and in percentage terms: Three Months Ended September 30, Change ---------------------- ----------------- Operating Segment 2000 1999 $ % --------- --------- -------- ------- U.S. domestic package $1,043 $ 916 $127 13.9 % International package 58 47 11 23.4 Non-package 60 27 33 122.2 --------- --------- ------ Consolidated Operating Profit $1,161 $ 990 $171 17.3 % ========= ========= ====== U.S. domestic package operating profit increased over $100 million due to the volume and revenue improvements discussed previously. International package operating profit increased over 23% due to increased volume and revenue, and was realized despite significantly higher fuel costs. Continuing the trends we have reported in previous quarters, this improvement was well-balanced across our international regions. Excluding the impact of currency fluctuations, this segment would have reported an additional $8 million in operating profit during this period. 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 $60 million of operating profit for the quarter. This improvement was offset in part by start-up costs associated with UPS Service Parts Logistics, UPS Capital Corporation and other initiatives. Our other income and expense improved $38 million, from expense of $28 million in the third quarter of 1999 to income of $10 million in the third quarter of 2000. This improvement was primarily due to higher cash and marketable securities balances that resulted in higher investment income, along with lower debt balances outstanding which resulted in lower interest expense. Net income for the third quarter of 2000 increased by $125 million from the third quarter of 1999. This increase resulted in an improvement in diluted earnings per share from $0.52 in the third quarter of 1999 to $0.60 in the third quarter of 2000. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Nine Months Ended September 30, 2000 and 1999 The following table sets forth information showing the change in revenue, average daily package volume and average revenue per piece, both in dollars and in percentage terms: Nine Months Ended September 30, --------------------- 2000 1999 $ % ---------- --------- --------- ------- Revenue (in millions): U.S. domestic package: Next Day Air $ 4,213 $ 3,834 $379 9.9 % Deferred 2,074 1,897 177 9.3 Ground 11,372 10,508 864 8.2 ---------- --------- --------- Total U.S. domestic package 17,659 16,239 1,420 8.7 International package: Domestic 673 680 (7) (1.0) Export 2,094 1,785 309 17.3 Cargo 307 237 70 29.5 ---------- --------- --------- Total international package 3,074 2,702 372 13.8 Non-package: UPS Logistics Group 696 566 130 23.0 Other 442 99 343 346.5 ---------- --------- --------- Total non-package 1,138 665 473 71.1 ---------- --------- --------- Consolidated $21,871 $19,606 $2,265 11.6 % ========== ========= ========= Average Daily Package Volume (in thousands): # --------- U.S. domestic package: Next Day Air 1,104 1,012 92 9.1 % Deferred 851 790 61 7.7 Ground 10,193 9,709 484 5.0 ---------- --------- ------- Total U.S. domestic package 12,148 11,511 637 5.5 International package: Domestic 758 686 72 10.5 Export 356 290 66 22.8 ---------- --------- --------- Total international package 1,114 976 138 14.1 ---------- --------- --------- Consolidated 13,262 12,487 775 6.2 % ========== ========= ========= Operating days in period 192 191 Average Revenue Per Piece: U.S. domestic package: $ --------- Next Day Air $ 19.88 $ 19.84 $ 0.04 0.2 % Deferred 12.69 12.57 0.12 1.0 Ground 5.81 5.67 0.14 2.5 Total U.S. domestic package 7.57 7.39 0.18 2.4 International: Domestic 4.62 5.19 (0.57) (11.0) Export 30.64 32.23 (1.59) (4.9) Total international package 12.94 13.22 (0.28) (2.1) Consolidated $8.02 $7.84 $ 0.18 2.3 % ========== ========= ========= Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) U.S. domestic package revenue increased 8.7% primarily due to volume gains across all product lines, continuing the trends reported during the first and second quarters of 2000. All products contributed to this increase, with our higher revenue per piece express (Next Day Air and Deferred) products accounting for almost 40% of the overall revenue increase. Our average daily Ground volume grew at a 5.0% rate for the period, increasing by an average of 484,000 packages per day. Also contributing to the revenue increase was one extra operating day in the first nine months of 2000 compared to the first nine months of 1999. 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 a decline in the value of the Euro relative to the U.S. dollar. Overall average daily package volume increased 14.1% for international operations, with our export products, which had an average revenue per piece of $30.64, increasing at 22.8%. 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. Revenue for the UPS Logistics Group increased by $130 million, or 23.0%, from $566 million to $696 million during this period. Operating expenses increased by $1.715 billion, or 10.2%, which was less than our revenue increase of 11.6%. Compensation and benefits expenses, the largest component of this increase, accounted for $963 million and included a $59 million charge recorded in the first quarter of this year relating to the creation of 4,000 new full-time hourly jobs resulting from the 1997 Teamsters contract. Other operating expenses increased $752 million due to higher purchased transportation costs, higher fuel costs and claims expense associated with the new arrangement for providing excess value package insurance for our customers. The increase in purchased transportation costs was primarily due to increased business for our international and logistics operations. The 43.9% increase in fuel costs from $467 million to $672 million was due to the increase in fuel prices and the growth in our average daily volume, partially offset by the cost reductions generated by our fuel hedging program. The increase in other operating expenses was slightly offset by the $49 million gain we recognized in the first quarter of this year from the sale of our UPS Truck Leasing subsidiary. International operating expenses were favorably impacted by the decline in the value of the Euro relative to the U.S. dollar. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) To offset the increasing fuel costs we have experienced over the last several quarters and that we expect to continue into the future, we implemented a temporary 1.25% fuel surcharge effective August 7, 2000. Approximately $50 million in revenue has been recorded year-to-date as a result of the surcharge. Our operating margin improved from 14.6% during the first nine months of 1999 to 15.6% during the same period in 2000. This improvement continues our recently reported trends and is favorably impacted by continued product mix improvements and our continued successful efforts in obtaining profitable volume growth. The following table sets forth information showing the change in operating profit, both in dollars (in millions) and in percentage terms: Nine Months Ended September 30, Change ---------------------- ----------------- Operating Segment 2000 1999 $ % --------- --------- -------- ------- U.S. domestic package $2,954 $2,603 $351 13.5 % International package 207 170 37 21.8 Non-package 247 85 162 190.6 --------- --------- ------ Consolidated Operating Profit $3,408 $2,858 $550 19.2 % ========= ========= ====== U.S. domestic package operating profit increased over $351 million due to the volume and revenue improvements discussed previously. The improvement in the operating profit of our international package operations of 21.8% resulted primarily from increased volume and revenue, and was realized despite significantly higher fuel costs. This improvement occurred throughout our international regions. Excluding the impact of currency fluctuations, this segment would have reported an additional $20 million in operating profit during this period. 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 $175 million of additional operating profit for the nine-month period. Also contributing to the operating profit improvement was the $49 million gain we recognized during the first quarter of 2000 from the sale of our UPS Truck Leasing subsidiary. These improvements were offset somewhat by start-up costs associated with UPS Service Parts Logistics, UPS Capital Corporation and other initiatives. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) The increase in investment income of $351 million for the period is primarily due to two factors. First, in the first quarter of 2000, two companies in which our Strategic Enterprise Fund held investments were acquired by other companies, which caused us to recognize a gain of $241 million. Second, 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. We announced a share repurchase program on April 20, 2000 under which we expect to utilize up to the remaining $1.2 billion not used in the tender offer, of which approximately $500 million remains available for share repurchases as of September 30, 2000, and continues to generate investment income. Net income for the nine months ended September 30, 2000 amounted to $2.210 billion, or $1.87 per diluted share, compared to net income of $222 million, or $0.20 per diluted share, for the same period in the prior year. Our fiscal 2000 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. Our fiscal 1999 results reflect a tax assessment charge resulting from an unfavorable ruling of the U.S. Tax Court. Excluding these non-recurring transactions for each of these periods, net income for the nine months ending September 30, 2000, would have been $2.071 billion, an increase of $407 million over adjusted 1999 net income of $1.664 billion. Adjusted diluted earnings per share increased from $1.48 in 1999 to $1.75 in 2000. 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 $3.592 billion at September 30, 2000. Of this amount, approximately $500 million 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 of approximately $500 million as of September 30, 2000, are available for a share repurchase program that was announced on April 20, 2000. In addition, an additional $750 million has been authorized for share repurchases. We maintain a commercial paper program under which we are authorized to borrow up to $2.0 billion. Approximately $1.055 billion was outstanding under this program as of September 30, 2000. Since we do not intend to refinance the full commercial paper balance outstanding at September 30, 2000, $955 million has been classified as a current liability on our balance sheet. The average interest rate on the amount outstanding at September 30, 2000 was 6.6%. On October 25, 2000, we entered into a second commercial paper program under which we are authorized to borrow up to $5.0 billion. 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 September 30, 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 September 30, 2000, $800 million was available under this program. The $200 million outstanding at September 30, 2000 bears interest at a stated interest rate of 6.625%. 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. In September 2000, we issued $300 million cash-settled convertible senior notes due September 27, 2007 pursuant to our shelf registration statement. The notes were sold at par with a stated interest rate of 1.75% and are callable after three years. The notes are convertible into cash, with the conversion price indexed to the trading price of our Class B common stock. There was approximately $405 million issued under this shelf registration statement at September 30, 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 would have the right 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 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 financial condition, results of operations or liquidity. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) 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. 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 revenues 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. Future Accounting Changes In June 1998, the FASB issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"), as amended by Statement No. 137 and No. 138, which provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. Upon adoption, all derivative instruments will be recognized on the balance sheet at fair value, and changes in the fair values of such instruments must be recognized currently in earnings unless specific hedge accounting criteria are met. FAS 133 will be effective for us on January 1, 2001. We have performed an evaluation of our current material derivative instruments, including those items discussed in the Market Risk section set forth above. Based on our evaluation of the material open derivative contracts we held at September 30, 2000, the adoption of FAS 133 at that date would not have had a material impact on our financial position or results of operations. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) In December 1999, the SEC issued Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. We will adopt SAB 101 as required in the fourth quarter of 2000. This adoption will not have a material impact on our financial position or results of operations. "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 about our strategic direction, prospects and future results. We have described some of the important factors that affect these statements as we discussed each subject. Forward-looking statements involve risks and uncertainties, and certain factors may cause actual results to differ materially from those contained in the forward-looking statements. These factors include, for example, our competitive environment, economic and other conditions in the markets in which we operate, strikes, work stoppages and slowdowns, governmental regulation, increases in aviation and motor fuel prices, and cyclical and seasonal fluctuations in our operating results. 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 18 lawsuits that seek to hold us (and in three 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; one case alleges violations of federal antitrust laws. An amended consolidated complaint also alleges a violation of the federal RICO statute. Seventeen 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 having the remaining case 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. Item 6. - Exhibits and Reports on Form 8-K a) Exhibits: (1) Underwriting Agreement dated September 21, 2000 between United Parcel Service, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated (27) Financial Data Schedule (for SEC filing purposes only) b) Reports on Form 8-K: no reports on Form 8-K were filed during the quarter. EXHIBIT INDEX (1) Underwriting Agreement dated September 21, 2000 between United Parcel Service, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated 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, 2000 By: /S/ Robert J. Clanin Robert J. Clanin Senior Vice President, Treasurer and Chief Financial Officer