Table of Contents

United States
Securities and Exchange Commission
Washington, D.C. 20549
_____________________________________ 
Form 10-Q
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016, or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             
Commission file number 001-15451
_____________________________________ 
g795027a02.jpg
United Parcel Service, Inc.
(Exact name of registrant as specified in its charter)
Delaware
 
58-2480149
(State or Other Jurisdiction of
Incorporation or Organization)
 
(IRS Employer
Identification No.)
 
 
55 Glenlake Parkway, NE Atlanta, Georgia
 
30328
(Address of Principal Executive Offices)
 
(Zip Code)
(404) 828-6000
(Registrant’s telephone number, including area code)
_____________________________________   
Former name, former address and former fiscal year, if changed since last report.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “accelerated filer”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Check one: Large accelerated filer  þ Accelerated filer  ¨ Non-accelerated filer  ¨    (Do not check if a smaller reporting company) Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ
There were 183,295,098 Class A shares, and 689,360,373 Class B shares, with a par value of $0.01 per share, outstanding at October 24, 2016.

Table of Contents

UNITED PARCEL SERVICE, INC.
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2016
TABLE OF CONTENTS
PART I—FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 3.
Item 4.
PART II—OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 6.

Table of Contents

PART I. FINANCIAL INFORMATION

Cautionary Statement About Forward-Looking Statements
This report includes certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Statements in the future tense, and all statements accompanied by terms such as “believe,” “project,” “expect,” “estimate,” “assume,” “intend,” “anticipate,” “target,” “plan,” and variations thereof and similar terms are intended to be forward-looking statements. We intend that all forward-looking statements we make will be subject to safe harbor protection of the federal securities laws pursuant to Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Our disclosure and analysis in this report, in our Annual Report on Form 10-K for the year ended December 31, 2015 and in our other filings with the Securities and Exchange Commission contain forward-looking statements regarding our intent, belief and current expectations about our strategic direction, prospects and future results. From time to time, we also provide forward-looking statements in other materials we release as well as oral forward-looking statements. Such statements give our current expectations or forecasts of future events; they do not relate strictly to historical or current facts. Management believes that these forward-looking statements are reasonable as and when made. However, caution should be taken not to place undue reliance on any such forward-looking statements because such statements speak only as of the date when made.
Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or anticipated results. These risks and uncertainties include, but are not limited to: general economic conditions, both in the U.S. and internationally; significant competition on a local, regional, national, and international basis; changes in our relationships with our significant customers; the existing complex and stringent regulation in the U.S. and internationally, changes to which can impact our business; increased security requirements that may increase our costs of operations and reduce operating efficiencies; legal, regulatory or market responses to global climate change; negotiation and ratification of labor contracts; strikes, work stoppages and slowdowns by our employees; the effects of changing prices of energy, including gasoline, diesel and jet fuel, and interruptions in supplies of these commodities; changes in exchange rates or interest rates; our ability to maintain the image of our brand; breaches in data security; disruptions to the Internet or our technology infrastructure; our ability to accurately forecast our future capital investment needs; exposure to changing economic, political and social developments in international and emerging markets; changes in business strategy, government regulations, or economic or market conditions that may result in substantial impairment of our assets; increases in our expenses or funding obligations relating to employee health, retiree health and/or pension benefits; the potential for various claims and litigation related to labor and employment, personal injury, property damage, business practices, environmental liability and other matters; our ability to realize the anticipated benefits from acquisitions, joint ventures or strategic alliances; our ability to manage insurance and claims expenses; and other risks discussed in our filings with the Securities and Exchange Commission from time to time, including our Annual Report on Form 10-K for the year ended December 31, 2015 or our Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, or described from time to time in our future reports filed with the Securities and Exchange Commission. You should consider the limitations on, and risks associated with, forward-looking statements and not unduly rely on the accuracy of predictions contained in such forward-looking statements. We do not undertake any obligation to update forward-looking statements to reflect events, circumstances, changes in expectations, or the occurrence of unanticipated events after the date of those statements.


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Item 1. Financial Statements
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2016 (unaudited) and December 31, 2015
(In millions)
 
September 30,
2016
 
December 31,
2015
ASSETS
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
3,299

 
$
2,730

Marketable securities
2,059

 
1,996

Accounts receivable, net
6,272

 
7,134

Other current assets
1,223

 
1,348

Total Current Assets
12,853

 
13,208

Property, Plant and Equipment, Net
18,489

 
18,352

Goodwill
3,436

 
3,419

Intangible Assets, Net
1,537

 
1,549

Non-Current Investments and Restricted Cash
485

 
473

Deferred Income Tax Assets
456

 
255

Other Non-Current Assets
1,086

 
1,055

Total Assets
$
38,342

 
$
38,311

LIABILITIES AND SHAREOWNERS’ EQUITY
 
 
 
Current Liabilities:
 
 
 
Current maturities of long-term debt and commercial paper
$
3,820

 
$
3,018

Accounts payable
2,287

 
2,587

Accrued wages and withholdings
2,270

 
2,253

Hedge margin liabilities
487

 
717

Income taxes payable
164

 
147

Self-insurance reserves
655

 
657

Accrued group welfare and retirement plan contributions
591

 
525

Other current liabilities
615

 
792

Total Current Liabilities
10,889

 
10,696

Long-Term Debt
11,506

 
11,316

Pension and Postretirement Benefit Obligations
10,052

 
10,638

Deferred Income Tax Liabilities
72

 
115

Self-Insurance Reserves
1,794

 
1,831

Other Non-Current Liabilities
1,262

 
1,224

Shareowners’ Equity:
 
 
 
Class A common stock (185 and 194 shares issued in 2016 and 2015)
2

 
2

Class B common stock (689 and 693 shares issued in 2016 and 2015)
7

 
7

Additional paid-in capital
—

 
—

Retained earnings
6,385

 
6,001

Accumulated other comprehensive loss
(3,651
)
 
(3,540
)
Deferred compensation obligations
44

 
51

Less: Treasury stock (1 share in 2016 and 2015)
(44
)
 
(51
)
Total Equity for Controlling Interests
2,743

 
2,470

Noncontrolling Interests
24

 
21

Total Shareowners’ Equity
2,767

 
2,491

Total Liabilities and Shareowners’ Equity
$
38,342

 
$
38,311

See notes to unaudited consolidated financial statements.

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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(In millions, except per share amounts)
(unaudited)
 
 
Three Months Ended
September 30,
Nine Months Ended
September 30,
2016
 
2015
2016
 
2015
Revenue
$
14,928

 
$
14,237

$
43,975

 
$
42,309

Operating Expenses:
 
 
 
 
 
 
Compensation and benefits
7,857

 
7,458

23,448

 
22,524

Repairs and maintenance
386

 
362

1,150

 
1,069

Depreciation and amortization
554

 
527

1,661

 
1,543

Purchased transportation
2,212

 
1,926

6,306

 
5,557

Fuel
541

 
617

1,480

 
1,900

Other occupancy
248

 
241

762

 
765

Other expenses
1,096

 
1,122

3,273

 
3,334

Total Operating Expenses
12,894

 
12,253

38,080

 
36,692

Operating Profit
2,034

 
1,984

5,895

 
5,617

Other Income and (Expense):
 
 
 
 
 
 
Investment income and other
13

 
4

38

 
12

Interest expense
(94
)

(83
)
(281
)
 
(256
)
Total Other Income and (Expense)
(81
)
 
(79
)
(243
)
 
(244
)
Income Before Income Taxes
1,953

 
1,905

5,652

 
5,373

Income Tax Expense
683

 
648

1,982

 
1,860

Net Income
$
1,270

 
$
1,257

$
3,670

 
$
3,513

Basic Earnings Per Share
$
1.44

 
$
1.40

$
4.15

 
$
3.90

Diluted Earnings Per Share
$
1.44

 
$
1.39

$
4.13

 
$
3.87


STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(In millions)
(unaudited)
 
 
Three Months Ended
September 30,
Nine Months Ended
September 30,
 
2016
 
2015
2016
 
2015
Net Income
$
1,270

 
$
1,257

$
3,670

 
$
3,513

Change in foreign currency translation adjustment, net of tax
(7
)
 
(141
)
(12
)
 
(344
)
Change in unrealized gain (loss) on marketable securities, net of tax
(1
)
 
—

4

 
1

Change in unrealized gain (loss) on cash flow hedges, net of tax
(64
)
 
(11
)
(183
)
 
6

Change in unrecognized pension and postretirement benefit costs, net of tax
27

 
28

80

 
80

Comprehensive Income
$
1,225

 
$
1,133

$
3,559

 
$
3,256

See notes to unaudited consolidated financial statements.

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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(In millions)
(unaudited)
 
Nine Months Ended
September 30,
 
2016
 
2015
Cash Flows From Operating Activities:
 
 
 
Net income
$
3,670

 
$
3,513

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
Depreciation and amortization
1,661

 
1,543

Pension and postretirement benefit expense
804

 
807

Pension and postretirement benefit contributions
(1,298
)
 
(147
)
Self-insurance provision
(38
)
 
(148
)
Deferred tax (benefit) expense
(150
)
 
(198
)
Stock compensation expense
471

 
452

Other (gains) losses
(165
)
 
(79
)
Changes in assets and liabilities, net of effects of business acquisitions:
 
 
 
Accounts receivable
782

 
738

Other current assets
370

 
521

Accounts payable
(276
)
 
(745
)
Accrued wages and withholdings
46

 
(5
)
Other current liabilities
(491
)
 
214

Other operating activities
(23
)
 
(51
)
Net cash from operating activities
5,363

 
6,415

Cash Flows From Investing Activities:
 
 
 
Capital expenditures
(1,837
)
 
(1,648
)
Proceeds from disposals of property, plant and equipment
76

 
14

Purchases of marketable securities
(4,250
)
 
(6,074
)
Sales and maturities of marketable securities
4,038

 
4,821

Net (increase) decrease in finance receivables
4

 
(11
)
Cash paid for business acquisitions, net of cash and cash equivalents acquired
(3
)
 
(1,925
)
Other investing activities
(55
)
 
(136
)
Net cash used in investing activities
(2,027
)
 
(4,959
)
Cash Flows From Financing Activities:
 
 
 
Net change in short-term debt
(689
)
 
3,546

Proceeds from borrowings
4,018

 
1,927

Repayments of borrowings
(2,323
)
 
(1,699
)
Purchases of common stock
(2,007
)
 
(2,028
)
Issuances of common stock
196

 
194

Dividends
(1,987
)
 
(1,899
)
Other financing activities
11

 
(201
)
Net cash used in financing activities
(2,781
)
 
(160
)
Effect Of Exchange Rate Changes On Cash And Cash Equivalents
14

 
(146
)
Net Increase (Decrease) In Cash And Cash Equivalents
569

 
1,150

Cash And Cash Equivalents:
 
 
 
Beginning of period
2,730

 
2,291

End of period
$
3,299

 
$
3,441

See notes to unaudited consolidated financial statements.

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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
Principles of Consolidation
In our opinion, the accompanying interim, unaudited, consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. These consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly our financial position as of September 30, 2016, our results of operations for the three and nine months ended September 30, 2016 and 2015, and cash flows for the nine months ended September 30, 2016 and 2015. The results reported in these consolidated financial statements should not be regarded as necessarily indicative of results that may be expected for any other period or the entire year. The interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015.
For interim consolidated financial statement purposes, we provide for accruals under our various employee benefit plans and self-insurance reserves for each three month period based on one quarter of the estimated annual expense.
Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications had no material impact on our financial position or results of operations.
Fair Value of Financial Instruments
The carrying amounts of our cash and cash equivalents, accounts receivable, finance receivables and accounts payable approximate fair value as of September 30, 2016. The fair values of our investment securities are disclosed in note 4, recognized multiemployer pension withdrawal liabilities in note 6, our short and long-term debt in note 9 and our derivative instruments in note 14. We utilized Level 1 inputs in the fair value hierarchy of valuation techniques to determine the fair value of our cash and cash equivalents, and Level 2 inputs to determine the fair value of our accounts receivable, finance receivables and accounts payable.
Accounting Estimates
The preparation of the accompanying interim, unaudited, consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best information and actual results could differ materially from those estimates.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
Adoption of New Accounting Standards

In May 2015, the Financial Accounting Standards Board ("FASB") issued an accounting standards update that changes the disclosure requirement for reporting investments at fair value. This update removes the requirement to categorize investments for which fair value is measured using the net asset value (“NAV”) per share practical expedient within the fair value hierarchy. These disclosures are limited to investments for which the entity has elected to measure fair value using the practical expedient. Substantially all of our Level 3 pension and postretirement benefit plan assets were measured using NAV as a practical expedient. This guidance became effective for us in the first quarter of 2016 and did not have a material impact on our consolidated financial position, results of operations or cash flows.
In June 2014, the FASB issued an accounting standards update for companies that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. This guidance became effective for us in the first quarter of 2015 and did not have a material impact on our consolidated financial position, results of operations or cash flows.
Other accounting pronouncements adopted during the periods covered by the consolidated financial statements did not have a material impact on our consolidated financial position, results of operations or cash flows.


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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Accounting Standards Issued But Not Yet Effective

In August 2016, the FASB issued an accounting standards update that addresses the classification and presentation of specific cash flow issues that currently result in diverse practices. The guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. The guidance will generally be applied retrospectively and becomes effective for us in the first quarter of 2018, but early adoption is permitted. We are currently evaluating the impact of this standard on our consolidated cash flows, but do not expect this standard to have a material impact.
 
In March 2016, the FASB issued an accounting standards update that simplifies the income tax accounting and cash flow presentation related to share-based compensation by requiring the recognition of all excess tax benefits and deficiencies directly on the income statement and classification as cash flows from operating activities on the statement of cash flows. This update also makes several changes to the accounting for forfeitures and employee tax withholding on share-based compensation. This new guidance becomes effective for us in the first quarter of 2017, but early adoption is permitted. At this time, we do not expect this accounting standards update to have a material impact on our consolidated financial position, results of operations or cash flows.

In February 2016, the FASB issued an accounting standards update that requires lessees to recognize a right-of-use asset and lease liability on the balance sheet for all leases with terms beyond twelve months. Although the distinction between operating and finance leases will continue to exist under the new standard, the recognition and measurement of expenses and cash flows will not change significantly from the current treatment. This new guidance requires modified retrospective application and becomes effective for us in the first quarter of 2019, but early adoption is permitted. We are currently evaluating this update to determine the full impact of its adoption on our consolidated financial position, results of operations, cash flows and related disclosures. We expect material changes to our consolidated financial position.

In January 2016, the FASB issued an accounting standards update which addresses certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. The amendment will be effective for us beginning the first quarter of 2018. At this time, we do not expect this accounting standards update to have a material impact on our consolidated financial position, results of operations or cash flows.
In May 2014, the FASB issued an accounting standards update that changes the revenue recognition for companies that enter into contracts with customers to transfer goods or services. This amended guidance requires revenue to be recognized in an amount that reflects the consideration to which the company expects to be entitled for those goods and services when the performance obligation has been satisfied. This amended guidance also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenue and related cash flows arising from contracts with customers. In August 2015, the FASB issued an accounting standards update that defers the effective date of the new revenue recognition guidance for one year, to interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted for periods beginning after December 15, 2016. In March 2016, the FASB issued an accounting standards update that further clarifies the May 2014 accounting standards update with respect to principle versus agent considerations in revenue from contracts with customers. In the second quarter of 2016, the FASB issued two accounting standard updates that provide additional guidance when identifying performance obligations and licenses as well as allowing for certain narrow scope improvements and practical expedients. These accounting standard updates have the same effective date as the original standard. The Company is planning to adopt the standard on January 1, 2018. Companies may use either a full retrospective or a modified retrospective approach to adopt this standard. Management is currently evaluating this standard and the related updates, including which transition approach to use, to determine the full impact of adoption.
Other accounting pronouncements issued, but not effective until after September 30, 2016, are not expected to have a material impact on our consolidated financial position, results of operations or cash flows.


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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 3. STOCK-BASED COMPENSATION
We issue employee share-based awards under the UPS Incentive Compensation Plan, which permits the grant of nonqualified and incentive stock options, stock appreciation rights, restricted stock and stock units, and restricted performance shares and performance units, to eligible employees (restricted stock and stock units, restricted performance shares and performance units are herein referred to as "Restricted Units"). Upon vesting, Restricted Units result in the issuance of the equivalent number of UPS class A common shares after required tax withholdings. Dividends accrued on Restricted Units are reinvested in additional Restricted Units at each dividend payable date, and are subject to the same vesting and forfeiture conditions as the underlying Restricted Units upon which they are earned.
The primary compensation programs offered under the UPS Incentive Compensation Plan include the UPS Management Incentive Award program, the UPS Long-Term Incentive Performance Award program and the UPS Stock Option program. We also maintain an employee stock purchase plan which allows eligible employees to purchase shares of UPS class A common stock at a discount. Additionally, our matching contributions to the primary employee defined contribution savings plan are made in shares of UPS class A common stock.
Management Incentive Award Program ("MIP")
During the first quarter of 2016, we granted Restricted Units under MIP to certain eligible management employees. Restricted Units granted under MIP generally vest over a five-year period with approximately 20% of the award vesting on January 15th of each of the years following the grant date (except in the case of death, disability, or retirement, in which case immediate vesting occurs). The entire grant is expensed on a straight-line basis (less estimated forfeitures) ratably over the requisite service period. Based on the date that the eligible management population and performance targets were approved for MIP, we determined the award measurement date to be February 4, 2016 (for U.S.-based employees), March 2, 2016 (for management committee employees) and March 21, 2016 (for international-based employees); therefore, the Restricted Units awarded were valued for stock compensation expense purposes using the closing New York Stock Exchange price of $96.25, $98.77 and $105.15 on those dates, respectively.
Long-Term Incentive Performance Award Program ("LTIP")
We award Restricted Units under LTIP to certain eligible management employees. The performance targets are equally-weighted among adjusted consolidated operating return on invested capital, growth in adjusted consolidated revenue and total shareowner return relative to a peer group of companies.  These Restricted Units generally vest at the end of a three-year period (except in the case of death, disability, or retirement, in which case immediate vesting occurs on a prorated basis). The number of Restricted Units earned will be based on the percentage achievement of the performance targets established on the grant date. 
For the two-thirds of the award related to consolidated operating return on invested capital and growth in consolidated revenue, we recognize the grant-date fair value of these Restricted Units (less estimated forfeitures) as compensation expense ratably over the vesting period, based on the number of awards expected to be earned.  Based on the date that the eligible management population and performance targets were approved for the 2016 LTIP Award, we determined the award measurement date to be March 24, 2016; therefore, the target Restricted Units awarded for this portion of the award were valued for stock compensation expense using the closing New York Stock Exchange price of $105.43 on that date.
The remaining one-third of the award related to total shareowner return relative to a peer group is valued using a Monte Carlo model. The model utilized the following assumptions: expected volatility of 16.45% based on historical stock volatility, a risk-free rate of return of 1.01% and no expected dividend yield because the units earn dividend equivalents.  This portion of the award was valued with a grant date fair value of $135.57 per unit and is recognized as compensation expense (less estimated forfeitures) ratably over the vesting period. 
During the third quarter of 2016, the UPS Compensation Committee approved changes to the compensation arrangements of certain executive officers. These changes include a one-time grant of additional Restricted Units that will vest over the same period as the 2016 LTIP award. Based on the date that the Compensation Committee approved this additional compensation, we determined the award measurement date to be September 16, 2016; therefore, the target Restricted Units awarded for the portion of the award related to consolidated operating return on invested capital and growth in consolidated revenue, were valued for stock compensation expense using the closing New York Stock Exchange price of $106.86 on that date.

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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


The remaining one-third of the award related to total shareowner return relative to a peer group is valued using a Monte Carlo model. The model utilized the following assumptions: expected volatility of 16.61% based on historical stock volatility, a risk-free rate of return of 0.81% and no expected dividend yield because the units earn dividend equivalents.  This portion of the award was valued with a grant date fair value of $147.90 per unit and is recognized as compensation expense (less estimated forfeitures) ratably over the vesting period. 
Nonqualified Stock Options
During the first quarter of 2016, we granted nonqualified stock option awards to a limited group of eligible senior management employees under the UPS Stock Option program. Stock option awards generally vest over a five-year period with approximately 20% of the award vesting at each anniversary date of the grant (except in the case of death, disability, or retirement, in which case immediate vesting occurs). The options granted will expire ten years after the date of the grant. In the first quarter of 2016 and 2015, we granted 0.2 million stock options, respectively, at a grant price of $98.77 and $101.93, respectively. The grant price was based on the closing New York Stock Exchange price of March 2, 2016 and March 2, 2015, respectively.
During the third quarter of 2016, the UPS Compensation Committee approved changes to the compensation arrangements of certain executive officers. These changes include a one-time grant of 0.1 million nonqualified stock options at a grant price of $106.86 pursuant to the terms and conditions of the UPS Stock Option program. The grant price was based on the closing New York Stock Exchange price of September 16, 2016. These stock options will vest ratably over five years with approximately 20% of the award vesting at each anniversary date of the grant (except in the case of death, disability, or retirement, in which case immediate vesting occurs). The options granted will expire ten years after the date of the grant.
The weighted average fair value of our employee stock options granted, as determined by the Black-Scholes valuation model, was $14.09 for the third quarter 2016 award, $17.32 for the first quarter 2016 award and $18.07 for the 2015 award using the following assumptions:
 
Q3 2016
 
Q1 2016
 
2015
Expected life (in years)
7.5

 
7.5

 
7.5

Risk-free interest rate
1.50
%
 
1.66
%
 
2.07
%
Expected volatility
19.10
%
 
23.60
%
 
20.61
%
Expected dividend yield
2.97
%
 
2.94
%
 
2.63
%

Compensation expense for share-based awards recognized in net income for the three months ended September 30, 2016 and 2015 was $125 and $124 million pre-tax, respectively. Compensation expense for share-based awards recognized in net income for the nine months ended September 30, 2016 and 2015 was $471 and $452 million pre-tax, respectively.

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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 4. INVESTMENTS AND RESTRICTED CASH
The following is a summary of marketable securities classified as trading and available-for-sale as of September 30, 2016 and December 31, 2015 (in millions):
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
September 30, 2016:
 
 
 
 
 
 
 
Current trading marketable securities:
 
 
 
 
 
 
 
Corporate debt securities
$
1,156

 
$
—

 
$
—

 
$
1,156

Carbon credit investments (1)
433

 
—

 
(150
)
 
283

Total trading marketable securities
$
1,589

 
$
—

 
$
(150
)
 
$
1,439

 
 
 
 
 
 
 
 
Current available-for-sale securities:
 
 
 
 
 
 
 
U.S. government and agency debt securities
$
321

 
$
2

 
$
—

 
$
323

Mortgage and asset-backed debt securities
86

 
1

 
—

 
87

Corporate debt securities
203

 
2

 
—

 
205

Equity Securities
2

 
—

 
—

 
2

Non-U.S. government debt securities
3

 
—

 
—

 
3

Total available-for-sale marketable securities
$
615

 
$
5

 
$
—

 
$
620

 
 
 
 
 
 
 
 
Total current marketable securities
$
2,204

 
$
5

 
$
(150
)
 
$
2,059

 
 
 
 
 
 
 
 
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
December 31, 2015:
 
 
 
 
 
 
 
Current trading marketable securities:
 
 
 
 
 
 
 
Corporate debt securities
$
715

 
$
—

 
$
—

 
$
715

Non-U.S. government debt securities (1)
363

 
—

 
—

 
363

Carbon credit investments (1)
347

 
9

 
(5
)
 
351

Total trading marketable securities
$
1,425

 
$
9

 
$
(5
)
 
$
1,429

 
 
 
 
 
 
 
 
Current available-for-sale securities:
 
 
 
 
 
 
 
U.S. government and agency debt securities
$
341

 
$
—

 
$
(1
)
 
$
340

Mortgage and asset-backed debt securities
74

 
1

 
(1
)
 
74

Corporate debt securities
147

 
—

 
(1
)
 
146

U.S. state and local municipal debt securities
2

 
—

 
—

 
2

Equity securities
2

 
—

 
—

 
2

Non-U.S. government debt securities
3

 
—

 
—

 
3

Total available-for-sale marketable securities
$
569

 
$
1

 
$
(3
)
 
$
567

 
 
 
 
 
 
 
 
Total current marketable securities
$
1,994

 
$
10

 
$
(8
)
 
$
1,996

(1) These investments are hedged with forward contracts that are not designated in hedging relationships. See Note 14 for offsetting statement of consolidated income impact.



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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Investment Other-Than-Temporary Impairments
We have concluded that no material other-than-temporary impairment losses existed as of September 30, 2016. In making this determination, we considered the financial condition and prospects of the issuers, the magnitude of the losses compared with the investments’ cost, the length of time the investments have been in an unrealized loss position, the probability that we will be unable to collect all amounts due according to the contractual terms of the securities, the credit rating of the securities and our ability and intent to hold these investments until the anticipated recovery in market value occurs.
Maturity Information
The amortized cost and estimated fair value of marketable securities at September 30, 2016, by contractual maturity, are shown below (in millions). Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.
 
Cost
 
Estimated
Fair Value
Due in one year or less
$
1,227

 
$
1,228

Due after one year through three years
453

 
454

Due after three years through five years
17

 
17

Due after five years
72

 
75

 
1,769

 
1,774

Equity and carbon credit investments
435

 
285

 
$
2,204

 
$
2,059

Non-Current Investments and Restricted Cash
We had $444 and $442 million of restricted cash related to our self-insurance requirements as of September 30, 2016 and December 31, 2015 which is reported in non-current investments and restricted cash on the consolidated balance sheets. This restricted cash is primarily invested in money market funds.
At September 30, 2016 and December 31, 2015, we held a $19 million investment in a variable life insurance policy to fund benefits for the UPS Excess Coordinating Benefit Plan. Additionally, we held escrowed cash related to the acquisition and disposition of certain assets of $22 and $12 million as of September 30, 2016 and December 31, 2015, respectively. The amounts described above are classified as non-current investments and restricted cash on the consolidated balance sheets, while the quarterly change in investment fair value is recognized in investment income and other on the statements of consolidated income.
Fair Value Measurements
Marketable securities utilizing Level 1 inputs include active exchange-traded carbon credit investments and certain U.S. Government debt securities, as these securities have quoted prices in active markets. Marketable securities utilizing Level 2 inputs include asset-backed and equity securities and corporate, government, and municipal bonds. These securities are valued using market corroborated pricing, matrix pricing or other models that utilize observable inputs such as yield curves.
We maintain holdings in certain investment partnerships that are measured at fair value utilizing Level 3 inputs (classified as other non-current investments in the tables below and as other non-current assets in the consolidated balance sheets). These partnership holdings do not have quoted prices, nor can they be valued using inputs based on observable market data. These investments are valued internally using a discounted cash flow model with two significant inputs: (1) the after-tax cash flow projections for each partnership and (2) the risk-adjusted discount rate consistent with the duration of the expected cash flows for each partnership. The weighted-average discount rates used to value these investments were 7.49% and 8.22% as of September 30, 2016 and December 31, 2015, respectively. These inputs, and the resulting fair values, are updated on a quarterly basis.

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



The following table presents information about our investments measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value (in millions):
 
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Balance 
September 30, 2016:
 
 
 
 
 
 
 
Marketable Securities:
 
 
 
 
 
 
 
U.S. government and agency debt securities
$
323

 
$
—

 
$
—

 
$
323

Mortgage and asset-backed debt securities
—

 
87

 
—

 
87

Corporate debt securities
—

 
1,361

 
—

 
1,361

Equity securities
—

 
2

 
—

 
2

Non-U.S. government debt securities
—

 
3

 
—

 
3

Carbon credit investments
283

 
—

 
—

 
283

Total marketable securities
606

 
1,453

 
—

 
2,059

Other non-current investments
19

 
—

 
18

 
37

Total
$
625

 
$
1,453

 
$
18

 
$
2,096

December 31, 2015:
 
 
 
 
 
 
 
Marketable Securities:
 
 
 
 
 
 
 
U.S. government and agency debt securities
$
340

 
$
—

 
$
—

 
$
340

Mortgage and asset-backed debt securities
—

 
74

 
—

 
74

Corporate debt securities
—

 
861

 
—

 
861

U.S. state and local municipal debt securities
—

 
2

 
—

 
2

Equity securities
—

 
2

 
—

 
2

Non-U.S. government debt securities
—

 
366

 
—

 
366

Carbon credit investments
351

 
—

 
—

 
351

Total marketable securities
691

 
1,305

 
—

 
1,996

Other non-current investments
19

 
—

 
32

 
51

Total
$
710

 
$
1,305

 
$
32

 
$
2,047



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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


The following table presents the changes in the above Level 3 instruments measured on a recurring basis for the three months ended September 30, 2016 and 2015 (in millions):    
 
Marketable
Securities
 
Other
Non-Current
Investments
 
Total
Balance on July 1, 2016
$
—

 
$
22

 
$
22

Transfers into (out of) Level 3
—

 
—

 
—

Net realized and unrealized gains (losses):
 
 
 
 
 
Included in earnings (in investment income and other)
—

 
(4
)
 
(4
)
Included in accumulated other comprehensive income (pre-tax)
—

 
—

 
—

Purchases
—

 
—

 
—

Sales
—

 
—

 
—

Balance on September 30, 2016
$
—

 
$
18

 
$
18

 
 
 
 
 
 
 
 
 
 
 
 
 
Marketable
Securities
 
Other
Non-Current
Investments
 
Total
Balance on July 1, 2015
$
—

 
$
48

 
$
48

Transfers into (out of) Level 3
—

 
—

 
—

Net realized and unrealized gains (losses):
 
 
 
 
 
Included in earnings (in investment income and other)
—

 
(8
)
 
(8
)
Included in accumulated other comprehensive income (pre-tax)
—

 
—

 
—

Purchases
—

 
—

 
—

Sales
—

 
—

 
—

Balance on September 30, 2015
$
—

 
$
40

 
$
40



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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


The following table presents the changes in the above Level 3 instruments measured on a recurring basis for the nine months ended September 30, 2016 and 2015 (in millions):
 
 
 
 
 
 
 
Marketable
Securities
 
Other
Investments
 
Total
Balance on January 1, 2016
$
—

 
32

 
32

Transfers into (out of) Level 3
—

 
—

 
—

Net realized and unrealized gains (losses):
 
 
 
 
 
Included in earnings (in investment income and other)
—

 
(14
)
 
(14
)
Included in accumulated other comprehensive income (pre-tax)
—

 
—

 
—

Purchases
—

 
—

 
—

Sales
—

 
—

 
—

Balance on September 30, 2016
$
—

 
$
18

 
$
18

 
 
 
 
 
 
 
Marketable
Securities
 
Other
Investments
 
Total
Balance on January 1, 2015
$
—

 
64

 
64

Transfers into (out of) Level 3
—

 
—

 
—

Net realized and unrealized gains (losses):
 
 
 
 
 
Included in earnings (in investment income and other)
—

 
(24
)
 
(24
)
Included in accumulated other comprehensive income (pre-tax)
—

 
—

 
—

Purchases
—

 
—

 
—

Sales
—

 
—

 
—

Balance on September 30, 2015
$
—

 
$
40


$
40

There were no transfers of investments between Level 1 and Level 2 during the three and nine months ended September 30, 2016 and 2015.


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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment as of September 30, 2016 and December 31, 2015 consist of the following (in millions):
 
2016
 
2015
Vehicles
$
8,448

 
$
8,111

Aircraft
15,742

 
15,815

Land
1,392

 
1,263

Buildings
3,432

 
3,280

Building and leasehold improvements
3,559

 
3,450

Plant equipment
8,257

 
8,026

Technology equipment
1,730

 
1,670

Equipment under operating leases
29

 
30

Construction-in-progress
596

 
273

 
43,185

 
41,918

Less: Accumulated depreciation and amortization
(24,696
)
 
(23,566
)
 
$
18,489

 
$
18,352

 
We monitor all property, plant and equipment for any indicators of potential impairment. No impairment charges on property, plant and equipment were recorded during the three and nine months ended September 30, 2016 and 2015.





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NOTE 6. EMPLOYEE BENEFIT PLANS
Company-Sponsored Benefit Plans
Information about net periodic benefit cost for our company-sponsored pension and postretirement benefit plans is as follows for the three and nine months ended September 30, 2016 and 2015 (in millions):
 
U.S. Pension Benefits
 
U.S. Postretirement
Medical Benefits
 
International
Pension Benefits
2016
 
2015
 
2016
 
2015
 
2016
 
2015
Three Months Ended September 30:
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
353

 
$
382

 
$
7

 
$
8

 
$
12

 
$
12

Interest cost
457

 
423

 
32

 
30

 
10

 
11

Expected return on assets
(629
)
 
(622
)
 
(2
)
 
(5
)
 
(15
)
 
(15
)
Amortization of prior service cost
41

 
42

 
1

 
2

 
—

 
—

Net periodic benefit cost
$
222

 
$
225

 
$
38

 
$
35

 
$
7

 
$
8

 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Pension Benefits
 
U.S. Postretirement
Medical Benefits
 
International
Pension Benefits
2016
 
2015
 
2016
 
2015
 
2016
 
2015
Nine Months Ended September 30:
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
1,059

 
$
1,145

 
$
21

 
$
25

 
$
37

 
$
37

Interest cost
1,371

 
1,270

 
92

 
91

 
31

 
33

Expected return on assets
(1,887
)
 
(1,866
)
 
(4
)
 
(13
)
 
(44
)
 
(46
)
Amortization of prior service cost
125

 
126

 
3

 
4

 
—

 
1

Net periodic benefit cost
$
668

 
$
675

 
$
112

 
$
107

 
$
24

 
$
25

During the first nine months of 2016, we contributed $1.227 billion and $71 million to our company-sponsored pension and U.S. postretirement medical benefit plans, respectively. We also expect to contribute $9 and $30 million over the remainder of the year to the pension and U.S. postretirement medical benefit plans, respectively.
The UPS Retirement Plan (a single-employer defined benefit pension plan sponsored by UPS) was closed to new non-union participants effective July 1, 2016. The Company amended the UPS 401(k) Savings Plan so that employees who previously would have been eligible for participation in the UPS Retirement Plan will, in addition to current benefits under the UPS 401(k) Savings Plan, begin receiving a UPS Retirement Contribution. For employees eligible to receive the Retirement Contribution, UPS will contribute 3% to 8% of eligible pay to the UPS 401(k) Savings Plan based on years of vesting service and business unit. Contributions will be made annually in cash to the accounts of participants who are employed on December 31 of each calendar year and become vested after the employee reaches three complete years of service.
Multiemployer Benefit Plans
We contribute to a number of multiemployer defined benefit and health and welfare plans under terms of collective bargaining agreements that cover our union-represented employees. Our current collective bargaining agreements set forth the annual contribution increases allotted to the plans that we participate in, and we are in compliance with these contribution rates. These limitations on annual contribution rates will remain in effect throughout the terms of the existing collective bargaining agreements.
As of September 30, 2016 and December 31, 2015 we had $867 and $872 million, respectively, recognized in "other non-current liabilities" on our consolidated balance sheets associated with our previous withdrawal from a multiemployer pension plan. This liability is payable in equal monthly installments over a remaining term of approximately 46 years. Based on the borrowing rates currently available to the Company for long-term financing of a similar maturity, the fair value of this withdrawal liability as of September 30, 2016 and December 31, 2015 was $941 and $841 million, respectively. We utilized Level 2 inputs in the fair value hierarchy of valuation techniques to determine the fair value of this liability.


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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



UPS was a contributing employer to the Central States Pension Fund (“CSPF”) until 2007 when we withdrew from the plan and fully funded our allocable share of unfunded vested benefits by paying a $6.1 billion withdrawal liability. Under a collective bargaining agreement with the International Brotherhood of Teamsters, UPS agreed to provide coordinating benefits in the UPS/IBT Full Time Employee Pension Plan (“UPS/IBT Plan”) for UPS participants retiring on or after January 1, 2008 in the event that benefits are lawfully reduced by the CSPF in the future.

In December 2014, Congress passed the Multiemployer Pension Reform Act (“MPRA”), which for the first time ever allowed multiemployer pension plans to reduce benefit payments to retirees, subject to specific guidelines in the statute and government oversight. In September 2015, the CSPF submitted a proposed pension benefit reduction plan to the U.S. Department of the Treasury under the MPRA. The CSPF plan proposed to reduce retirement benefits to the CSPF participants, including UPS participants retiring on or after January 1, 2008. We vigorously challenged the proposed benefit reduction plan because we believed that it did not comply with the law and that certain actions by the CSPF were invalid. On May 6, 2016, the U.S. Department of the Treasury rejected the proposed plan submitted by the CSPF, stating that it failed to satisfy a number of requirements set forth in the MPRA.
The CSPF has asserted that it will become insolvent in 2025 which could lead to the reduction of retirement benefits. Although there are numerous factors that could affect the CSPF’s status, if the CSPF were to become insolvent as they have projected , UPS may be required to provide coordinating benefits, thereby increasing the current projected benefit obligation for the UPS/IBT Plan by approximately $4 billion. The CSPF has said that it believes a legislative solution to its funding status is necessary, and we expect that the CSPF will continue to explore options to avoid insolvency.
The potential obligation to pay coordinating benefits from the UPS/IBT Plan is subject to a number of uncertainties, including actions that may be taken by the CSPF, the federal government or others. These actions include whether the CSPF will submit a revised pension benefit reduction plan or otherwise seek federal government assistance, the extent to which benefits are paid by the Pension Benefit Guaranty Corporation, as well as the effect of discount rates and various other actuarial assumptions. The numerous uncertainties that exist regarding the ultimate resolution of the CSPF situation prevent us from making reliable estimates of the timing and amount, if any, of CSPF benefit reductions that could result in additional benefit obligations for the UPS/IBT Plan. Therefore, we have not recognized any liability for additional coordinating benefits of the UPS/IBT Plan, but the current projected benefit obligation could materially increase as these uncertainties are resolved. We will continue to assess the impact of these uncertainties on the projected benefit obligation of the UPS/IBT Plan in accordance with Accounting Standards Codification Topic 715 - Compensation - Retirement Benefits.
Collective Bargaining Agreements
As of December 31, 2015, we had approximately 266,000 employees employed under a national master agreement and various supplemental agreements with local unions affiliated with the Teamsters. In addition, our airline pilots, airline mechanics, ground mechanics and certain other employees are employed under other collective bargaining agreements. In 2014, the Teamsters ratified a new national master agreement (“NMA”) with UPS that will expire on July 31, 2018. The economic provisions in the NMA included wage rate increases, as well as increased contribution rates for healthcare and pension benefits. Most of these economic provisions were retroactive to August 1, 2013, which was the effective date of the NMA. During the first quarter of 2015, we remitted $53 million for these retroactive economic benefits.
We have approximately 2,600 pilots who are employed under a collective bargaining agreement with the Independent Pilots Association ("IPA"), which became amendable at the end of 2011. On June 30, 2016, the IPA and the Company announced a tentative agreement on a new five-year labor contract. On August 31, 2016, the IPA members voted to ratify the agreement. Terms of the agreement became effective September 1, 2016 and run through September 1, 2021. The economic provisions in the agreement included pay increases, a signing bonus and enhanced pension benefits.
Our airline mechanics are covered by a collective bargaining agreement with Teamsters Local 2727, which became amendable November 1, 2013. We are currently in negotiations with Teamsters Local 2727 for a new agreement. In addition, approximately 3,100 of our auto and maintenance mechanics who are not employed under agreements with the Teamsters are employed under collective bargaining agreements with the International Association of Machinists and Aerospace Workers (“IAM”) that will expire on July 31, 2019.

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 7. GOODWILL AND INTANGIBLE ASSETS
The following table indicates the allocation of goodwill by reportable segment as of September 30, 2016 and December 31, 2015 (in millions):
 
U.S. Domestic
Package
 
International
Package
 
Supply Chain &
Freight
 
Consolidated
December 31, 2015:
$
715

 
$
425

 
$
2,279

 
$
3,419

Acquired
—

 
—

 
—

 
—

Currency / Other
$
—

 
$
—

 
$
17

 
$
17

September 30, 2016:
$
715

 
$
425

 
$
2,296

 
$
3,436

The change in goodwill for the Supply Chain & Freight segment was primarily due to the impact of changes in the value of the U.S. Dollar on the translation of non-U.S. Dollar goodwill balances.
The following is a summary of intangible assets as of September 30, 2016 and December 31, 2015 (in millions):
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying
Value
September 30, 2016:
 
 
 
 
 
Capitalized software
$
2,858

 
$
(2,103
)
 
$
755

Licenses
130

 
(63
)
 
67

Franchise rights
128

 
(88
)
 
40

Customer relationships
511

 
(73
)
 
438

Trade name
200

 
—

 
200

Trademarks, patents and other
58

 
(21
)
 
37

Total Intangible Assets, Net
$
3,885


$
(2,348
)
 
$
1,537

December 31, 2015:
 
 
 
 
 
Capitalized software
$
2,739

 
$
(2,026
)
 
$
713

Licenses
189

 
(116
)
 
73

Franchise rights
125

 
(83
)
 
42

Customer relationships
511

 
(35
)
 
476

Trade name
200

 
—

 
200

Trademarks, patents and other
61

 
(16
)
 
45

Total Intangible Assets, Net
$
3,825

 
$
(2,276
)
 
$
1,549


As of September 30, 2016, we had a trade name with a carrying value of $200 million and licenses with a carrying value of $4 million, which are deemed to be indefinite-lived intangible assets and are included in the table above.


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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



NOTE 8. BUSINESS COMBINATIONS
In 2016 and 2015, we acquired several businesses that were not material, individually or in the aggregate, to our consolidated financial position or results of operations. These acquisitions were funded with cash from operations. In March 2015, we acquired Poltraf Sp z.o.o. ("Poltraf"), a Polish-based pharmaceutical logistics company recognized for its temperature-sensitive warehousing and transportation solutions. In May 2015 and June 2015, we acquired Parcel Pro, Inc. ("Parcel Pro") and the Insured Parcel Services division of G4S International Logistics ("IPS"), respectively. These businesses provide services and insurance coverage for the transport of high value luxury goods.
In August 2015, we acquired Coyote Logistics Midco, Inc. ("Coyote"), a U.S.-based truckload freight brokerage company, for $1.829 billion. This acquisition allows us to expand our existing portfolio by adding large scale truckload freight brokerage and transportation management services to our Supply Chain & Freight reporting segment. In addition, we will continue to benefit from synergies in purchased transportation, backhaul utilization, cross-selling to customers, as well as technology systems and industry best practices. The acquisition was funded using cash from operations and issuances of commercial paper. The final purchase price allocation was completed in the third quarter of 2016 and there were no material adjustments recorded.
The financial results of these acquired businesses are included in the Supply Chain & Freight segment from the date of acquisition and were not material to our results of operations.




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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 9. DEBT AND FINANCING ARRANGEMENTS
The carrying value of our outstanding debt as of September 30, 2016 and December 31, 2015 consists of the following (in millions):
 
Principal
Amount
 
 
 
Carrying Value
 
 
Maturity
 
2016
 
2015
Commercial paper
$
3,759

 
2016 -2017
 
$
3,759

 
$
2,965

Fixed-rate senior notes:
 
 
 
 
 
 
 
1.125% senior notes
375

 
2017
 
374

 
372

5.50% senior notes
750

 
2018
 
776

 
787

5.125% senior notes
1,000

 
2019
 
1,060

 
1,064

3.125% senior notes
1,500

 
2021
 
1,634

 
1,613

2.45% senior notes
1,000

 
2022
 
1,031

 
991

6.20% senior notes
1,500

 
2038
 
1,481

 
1,481

4.875% senior notes
500

 
2040
 
489

 
489

3.625% senior notes
375

 
2042
 
367

 
367

8.375% Debentures:
 
 
 
 
 
 
 
8.375% debentures
424

 
2020
 
474

 
474

8.375% debentures
276

 
2030
 
282

 
282

Pound Sterling notes:
 
 
 
 
 
 
 
5.50% notes
86

 
2031
 
80

 
92

5.125% notes
589

 
2050
 
563

 
638

Euro senior notes:
 
 
 
 
 
 
 
1.625% notes
781

 
2025
 
775

 
759

Floating rate senior notes
558

 
2020
 
556

 
544

Floating rate senior notes
833

 
2049-2066
 
824

 
600

Capital lease obligations
453

 
2016-3005
 
453

 
475

Facility notes and bonds
319

 
2016-2045
 
319

 
319

Other debt
29

 
2016-2022
 
29

 
22

Total debt
15,107

 
 
 
15,326

 
14,334

Less: Current maturities
 
 
 
 
(3,820
)
 
(3,018
)
Long-term debt
 
 
 
 
$
11,506

 
$
11,316

Debt Issuances
In March, June and August 2016, we issued floating rate senior notes in principal amounts of $118, $74 and $35 million, respectively. These notes bear interest at three-month LIBOR less 30 basis points and mature in 2066. These notes are callable at various times after 30 years at a stated percentage of par value, and putable by the note holders at various times after one year at a stated percentage of par value.
On October 19, 2016, we issued U.S. and Euro senior rate notes in two separate transactions. These senior notes consist of three separate series, as follows:
•
Two series of notes, each in the principal amount of $500 million, were issued. These notes bear interest at 2.4% and 3.4% fixed rates and are due November 2026 and November 2046, respectively. Interest on these notes is payable semi-annually, in each case beginning May 15, 2017. Each note is callable at our option at a redemption price equal to the greater of 100% of the principal amount, or the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted to the redemption date at a benchmark treasury yield plus 10 and 15 basis points, respectively, and accrued interest.

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•
Notes in the principal amount of €500 million ($549 million) were issued. These notes bear interest at a 1.0% fixed rate and are due November 2028. Interest on these notes is payable annually, beginning November 15, 2017. The notes are callable at our option at a redemption price equal to the greater of 100% of the principal amount, or the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted to the date of redemption at a benchmark comparable German government bond yield plus 15 basis points and accrued interest.
Sources of Credit
We are authorized to borrow up to $10.0 billion under a U.S. commercial paper program and €5.0 billion (in a variety of currencies) under a European commercial paper program. We had the following amounts outstanding under these programs as of September 30, 2016: $2.580 billion with an average interest rate of 0.45% and €1.056 billion ($1.179 billion) with an average interest rate of -0.35%. As of September 30, 2016, we have classified the entire commercial paper balance as a current liability on our consolidated balance sheet.
We maintain two credit agreements with a consortium of banks. One of these agreements provides revolving credit facilities of $1.5 billion, and expires on March 24, 2017. Generally, amounts outstanding under this facility bear interest at a periodic fixed rate equal to LIBOR for the applicable interest period and currency denomination, plus an applicable margin. Alternatively, a fluctuating rate of interest equal to the highest of (1) JPMorgan Chase Bank’s publicly announced prime rate; (2) the Federal Funds effective rate plus 0.50%; and (3) LIBOR for a one month interest period plus 1.00%, plus an applicable margin, may be used at our discretion. In each case, the applicable margin for advances bearing interest based on LIBOR is a percentage determined by quotations from Markit Group Ltd. for our 1-year credit default swap spread, subject to a minimum rate of 0.10% and a maximum rate of 0.75%. The applicable margin for advances bearing interest based on the prime rate is 1.00% below the applicable margin for LIBOR advances (but not lower than 0.00%). We are also able to request advances under this facility based on competitive bids for the applicable interest rate. There were no amounts outstanding under this facility as of September 30, 2016.
The second agreement provides revolving credit facilities of $3.0 billion, and expires on March 25, 2021. Generally, amounts outstanding under this facility bear interest at a periodic fixed rate equal to LIBOR for the applicable interest period and currency denomination, plus an applicable margin. Alternatively, a fluctuating rate of interest equal to the highest of (1) JPMorgan Chase Bank’s publicly announced prime rate; (2) the Federal Funds effective rate plus 0.50%; and (3) LIBOR for a one month interest period plus 1.00%, plus an applicable margin, may be used at our discretion. In each case, the applicable margin for advances bearing interest based on LIBOR is a percentage determined by quotations from Markit Group Ltd. for our 1-year credit default swap spread, interpolated for a period from the date of determination of such credit default swap spread in connection with a new interest period until the latest maturity date of this facility then in effect (but not less than a period of one year). The minimum applicable margin rate is 0.10% and the maximum applicable margin rate is 0.75% per annum. The applicable margin for advances bearing interest based on the prime rate is 1.00% below the applicable margin for LIBOR advances (but not less than 0.00%). We are also able to request advances under this facility based on competitive bids. There were no amounts outstanding under this facility as of September 30, 2016.
Debt Covenants
Our existing debt instruments and credit facilities subject us to certain financial covenants. As of September 30, 2016 and for all prior periods, we have satisfied these financial covenants. These covenants limit the amount of secured indebtedness that we may incur, and limit the amount of attributable debt in sale-leaseback transactions, to 10% of net tangible assets. As of September 30, 2016, 10% of net tangible assets was equivalent to $2.248 billion; however, we have no covered sale-leaseback transactions or secured indebtedness outstanding. We do not expect these covenants to have a material impact on our financial condition or liquidity.
Fair Value of Debt
Based on the borrowing rates currently available to the Company for long-term debt with similar terms and maturities, the fair value of long-term debt, including current maturities, was approximately $17.330 billion and $15.524 billion as of September 30, 2016 and December 31, 2015, respectively. We utilized Level 2 inputs in the fair value hierarchy of valuation techniques to determine the fair value of all of our debt instruments.

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Contractual Commitments
We have contractual obligations and commitments for the purchase of aircraft, vehicles, technology equipment and building and leasehold improvements. On October 27, 2016, we placed an order for 14 Boeing 747-8 freighters to be delivered between 2017 and 2020. The agreement also includes an option to purchase an additional 14 747-8 freighters. In addition, we have new purchase commitments for aircraft engines, equipment and hub automation and expansion projects. These new purchase commitments will provide additional capacity for increased demand for our air and ground shipping services. Including these additional obligations, the expected cash outflow to satisfy our total purchase commitments is as follows (in millions): 2016 (remaining) - $466; 2017 - $1,020; 2018 - $1,010; 2019 - $611; 2020 - $347; and thereafter - $65.


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NOTE 10. LEGAL PROCEEDINGS AND CONTINGENCIES
We are involved in a number of judicial proceedings and other matters arising from the conduct of our business activities.

Although there can be no assurance as to the ultimate outcome, we have generally denied, or believe we have a meritorious defense and will deny, liability in all litigation pending against us, including (except as otherwise noted herein) the matters described below, and we intend to defend vigorously each case. We have accrued for legal claims when, and to the extent that, amounts associated with the claims become probable and can be reasonably estimated. The actual costs of resolving legal claims may be substantially higher or lower than the amounts accrued for those claims.
For those matters as to which we are not able to estimate a possible loss or range of loss, we are not able to determine whether the loss will have a material adverse effect on our business, financial condition or results of operations or liquidity. For matters in this category, we have indicated in the descriptions that follow the reasons that we are unable to estimate the possible loss or range of loss.
Judicial Proceedings
We are a defendant in a number of lawsuits filed in state and federal courts containing various class action allegations under state wage-and-hour laws. At this time, we do not believe that any loss associated with these matters would have a material adverse effect on our financial condition, results of operations or liquidity.
UPS and our subsidiary The UPS Store, Inc., are defendants in Morgate v. The UPS Store, Inc. et al., an action in the Los Angeles Superior Court brought on behalf of a certified class of all franchisees who chose to rebrand their Mail Boxes Etc. franchises to The UPS Store in March 2003. Plaintiff alleges that UPS and The UPS Store, Inc. misrepresented and omitted facts to the class about the market tests that were conducted before offering the class the choice of whether to rebrand to The UPS Store. Trial is scheduled for mid-2017.
There are multiple factors that prevent us from being able to estimate the amount of loss, if any, that may result from the remaining aspects of this case, including: (1) we are vigorously defending ourselves and believe we have a number of meritorious legal defenses; and (2) it remains uncertain what evidence of damages, if any, plaintiffs will be able to present. Accordingly, at this time, we are not able to estimate a possible loss or range of loss that may result from this matter or to determine whether such loss, if any, would have a material adverse effect on our financial condition, results of operations or liquidity.
In AFMS LLC v. UPS and FedEx Corporation, a lawsuit filed in federal court in the Central District of California in August 2010, the plaintiff asserts that UPS and FedEx violated U.S. antitrust law by conspiring to refuse to negotiate with third-party negotiators retained by shippers and by individually imposing policies that prevent shippers from using such negotiators. The Court granted summary judgment motions filed by UPS and FedEx, entered judgment in favor of UPS and FedEx, and dismissed the case. Plaintiff appealed, and briefing is now complete before the Court of Appeals for the Ninth Circuit. The Antitrust Division of the U.S. Department of Justice (“DOJ”) opened a civil investigation of our policies and practices for dealing with third-party negotiators. We have cooperated with this investigation. We deny any liability with respect to these matters and intend to vigorously defend ourselves. There are multiple factors that prevent us from being able to estimate the amount of loss, if any, that may result from these matters including: (1) the DOJ investigation is pending; (2) the Court granted our motion for summary judgment; and (3) the appeal remains pending. Accordingly, at this time, we are not able to estimate a possible loss or range of loss that may result from these matters or to determine whether such loss, if any, would have a material adverse effect on our financial condition, results of operations or liquidity.

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In Canada, four purported class-action cases were filed against us in British Columbia (2006); Ontario (2007) and Québec (2006 and 2013). The cases each allege inadequate disclosure concerning the existence and cost of brokerage services provided by us under applicable provincial consumer protection legislation and infringement of interest restriction provisions under the Criminal Code of Canada. The British Columbia class action was declared inappropriate for certification and dismissed by the trial judge. That decision was upheld by the British Columbia Court of Appeal in March 2010, which ended the case in our favor. The Ontario class action was certified in September 2011. Partial summary judgment was granted to us and the plaintiffs by the Ontario motions court. The complaint under the Criminal Code was dismissed. No appeal is being taken from that decision. The allegations of inadequate disclosure were granted and we are appealing that decision. The motion to authorize the 2006 Québec litigation as a class action was dismissed by the motions judge in October 2012; there was no appeal, which ended that case in our favor. The 2013 Québec litigation also has been dismissed. We deny all liability and are vigorously defending the one outstanding case in Ontario. There are multiple factors that prevent us from being able to estimate the amount of loss, if any, that may result from this matter, including: (1) we are vigorously defending ourselves and believe that we have a number of meritorious legal defenses; and (2) there are unresolved questions of law and fact that could be important to the ultimate resolution of this matter. Accordingly, at this time, we are not able to estimate a possible loss or range of loss that may result from this matter or to determine whether such loss, if any, would have a material adverse effect on our financial condition, results of operations or liquidity.
In February 2015, the State and City of New York filed suit against UPS in the U.S. District Court for the Southern District of New York, arising from alleged shipments of cigarettes to New York State and City residents. The complaint asserts claims under various federal and state laws.  The complaint also includes a claim that UPS violated the Assurance of Discontinuance it entered into with the New York Attorney General in 2005 concerning cigarette deliveries. Trial was held in September, 2016, and closing arguments were held on November 2, 2016. There are multiple factors that prevent us from being able to estimate the amount of loss, if any, that may result from this case, including: (1) we are vigorously defending ourselves and believe we have a number of meritorious factual and legal defenses; and (2) it remains uncertain how the Court will resolve the State and City’s various claims and our defenses. Accordingly, at this time, we are not able to estimate a possible loss or range of loss that may result from this matter or to determine whether such loss, if any, would have a material adverse effect on our financial condition, results of operations or liquidity.
On May 2, 2016, a purported shareowner derivative suit was filed in the Delaware Court of Chancery naming certain of UPS’s current and former officers and directors as defendants, alleging that they breached their fiduciary duties by failing to monitor UPS’s compliance with the Assurance of Discontinuance and other federal and state laws relating to cigarette deliveries. The Company’s and individual defendants’ motion to dismiss was heard in October, 2016.
We are a defendant in various other lawsuits that arose in the normal course of business. We do not believe that the eventual resolution of these other lawsuits (either individually or in the aggregate), including any reasonably possible losses in excess of current accruals, will have a material adverse effect on our financial condition, results of operations or liquidity.
Other Matters
In August 2010, competition authorities in Brazil opened an administrative proceeding to investigate alleged anticompetitive behavior in the freight forwarding industry. Approximately 45 freight forwarding companies and individuals are named in the proceeding, including UPS, UPS SCS Transportes (Brasil) S.A., and a former employee in Brazil. UPS submitted its written defenses to these allegations in April 2014. We are cooperating with this investigation, and intend to continue to vigorously defend ourselves. There are multiple factors that prevent us from being able to estimate the amount of loss, if any, that may result from this matter including: (1) we are vigorously defending the matter and believe that we have a number of meritorious legal defenses; (2) there are unresolved questions of law that could be of importance to the ultimate resolutions of this matter, including the calculation of any potential fine; and (3) there is uncertainty about the time period that is the subject of the investigation. Accordingly, at this time, we are not able to estimate a possible loss or range of loss that may result from this matter or to determine whether such loss, if any, would have a material adverse effect on our financial condition, results of operations or liquidity.


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NOTE 11. SHAREOWNERS' EQUITY
Capital Stock, Additional Paid-In Capital and Retained Earnings
We maintain two classes of common stock, which are distinguished from each other primarily by their respective voting rights. Class A shares are entitled to 10 votes per share, whereas class B shares are entitled to one vote per share. Class A shares are primarily held by UPS employees and retirees, and these shares are fully convertible on a one-to-one basis into class B shares at any time. Class B shares are publicly traded on the New York Stock Exchange under the symbol “UPS”. Class A and B shares both have a $0.01 par value, and as of September 30, 2016, there were 4.6 billion class A shares and 5.6 billion class B shares authorized to be issued. Additionally, there are 200 million preferred shares, with a $0.01 par value, authorized to be issued. As of September 30, 2016, no preferred shares had been issued.
 
The following is a rollforward of our common stock, additional paid-in capital and retained earnings accounts for the nine months ended September 30, 2016 and 2015 (in millions, except per share amounts):
 
2016
 
2015
 
Shares
 
Dollars
 
Shares
 
Dollars
Class A Common Stock
 
 
 
 
 
 
 
Balance at beginning of period
194

 
$
2

 
201

 
$
2

Common stock purchases
(4
)
 
—

 
(3
)
 
—

Stock award plans
5

 
—

 
4

 
—

Common stock issuances
2

 
—

 
2

 
—

Conversions of class A to class B common stock
(12
)
 
—

 
(8
)
 
—

Class A shares issued at end of period
185

 
$
2

 
196

 
$
2

Class B Common Stock
 
 
 
 
 
 
 
Balance at beginning of period
693

 
$
7

 
705

 
$
7

Common stock purchases
(16
)
 
—

 
(17
)
 
—

Conversions of class A to class B common stock
12

 
—

 
8

 
—

Class B shares issued at end of period
689

 
$
7

 
696

 
$
7

Additional Paid-In Capital
 
 
 
 
 
 
 
Balance at beginning of period
 
 
$
—

 
 
 
$
—

Stock award plans
 
 
423

 
 
 
391

Common stock purchases
 
 
(811
)
 
 
 
(567
)
Common stock issuances
 
 
233

 
 
 
245

Option premiums received (paid)
 
 
155

 
 
 
(69
)
Balance at end of period
 
 
$
—

 
 
 
$
—

Retained Earnings
 
 
 
 
 
 
 
Balance at beginning of period
 
 
$
6,001

 
 
 
$
5,726

Net income attributable to common shareowners
 
 
3,670

 
 
 
3,513

Dividends ($2.34 and $2.19 per share)
 
 
(2,093
)
 
 
 
(2,000
)
Common stock purchases
 
 
(1,193
)
 
 
 
(1,468
)
Balance at end of period
 
 
$
6,385

 
 
 
$
5,771

We repurchased 19.3 million shares of class A and class B common stock for $2.004 billion during the nine months ended September 30, 2016, and 20.2 million shares for $2.035 billion during the nine months ended September 30, 2015. During the first quarter of 2016, we also exercised a capped call option that we entered into in 2015 for which we received 0.2 million UPS class B shares. The $25 million premium payment for this capped call option reduced shareowners' equity in 2015. In total, shares repurchased and received in the nine months ended September 30, 2016 were 19.5 million shares for $2.029 billion. In May 2016, the Board of Directors approved a share repurchase authorization of $8.0 billion, which has no expiration date. As of September 30, 2016, we had $6.831 billion of this share repurchase authorization available.

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From time to time, we enter into share repurchase programs with large financial institutions to assist in our buyback of company stock. These programs allow us to repurchase our shares at a price below the weighted average UPS share price for a given period. During the third quarter of 2016, we entered into an accelerated share repurchase program which allowed us to repurchase 2.8 million shares for $300 million. The program was completed in September 2016.
In order to lower the average cost of acquiring shares in our ongoing share repurchase program, we periodically enter into structured repurchase agreements involving the use of capped call options for the purchase of UPS class B shares. We pay a fixed sum of cash upon execution of each agreement in exchange for the right to receive either a pre-determined amount of cash or stock. Upon expiration of each agreement, if the closing market price of our common stock is above the pre-determined price, we will have our initial investment returned with a premium in either cash or shares (at our election). If the closing market price of our common stock is at or below the pre-determined price, we will receive the number of shares specified in the agreement. We received (paid) net premiums of $155 and $(69) million during the first nine months of 2016 and 2015, respectively, related to entering into and settling capped call options for the purchase of class B shares. As of September 30, 2016, we had no capped call options outstanding.
Accumulated Other Comprehensive Income (Loss)
We experience activity in Accumulated other comprehensive income (loss) ("AOCI") for unrealized holding gains and losses on available-for-sale securities, foreign currency translation adjustments, unrealized gains and losses from derivatives that qualify as hedges of cash flows and unrecognized pension and postretirement benefit costs. The activity in AOCI for the nine months ended September 30, 2016 and 2015 is as follows (in millions):
 
2016
 
2015
Foreign currency translation gain (loss):
 
 
 
Balance at beginning of period
$
(897
)
 
$
(457
)
Translation adjustment (net tax of $24 and no tax impact)
(12
)
 
(344
)
Balance at end of period
(909
)
 
(801
)
Unrealized gain (loss) on marketable securities, net of tax:
 
 
 
Balance at beginning of period
(1
)
 
—

Current period changes in fair value (net of tax effect of $3 and $1)
4

 
1

Reclassification to earnings (no tax impact in either period)
—

 
—

Balance at end of period
3

 
1

Unrealized gain (loss) on cash flow hedges, net of tax:
 
 
 
Balance at beginning of period
67

 
61

Current period changes in fair value (net of tax effect of $(15) and $71)
(24
)
 
119

Reclassification to earnings (net of tax effect of $(96) and $(67))
(159
)
 
(113
)
Balance at end of period
(116
)
 
67

Unrecognized pension and postretirement benefit costs, net of tax:
 
 
 
Balance at beginning of period
(2,709
)
 
(3,198
)
Reclassification to earnings (net of tax effect of $48 and $51)
80

 
80

Balance at end of period
(2,629
)
 
(3,118
)
Accumulated other comprehensive income (loss) at end of period
$
(3,651
)
 
$
(3,851
)




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Detail of the gains (losses) reclassified from AOCI to the statements of consolidated income for the three and nine months ended September 30, 2016 and 2015 is as follows (in millions):
Three Months Ended September 30:
 
 
 
 
 
 
Amount Reclassified from AOCI
 
Affected Line Item in the Income Statement
 
2016
 
2015
 
Unrealized gain (loss) on cash flow hedges:
 
 
 
 
 
Interest rate contracts
$
(7
)
 
$
(6
)
 
Interest expense
Foreign exchange contracts
83

 
67

 
Revenue
Income tax (expense) benefit
(29
)
 
(22
)
 
Income tax expense
Impact on net income
47

 
39

 
Net income
Unrecognized pension and postretirement benefit costs:
 
 
 
 
 
Prior service costs
(42
)
 
(44
)
 
Compensation and benefits
Income tax (expense) benefit
15

 
16

 
Income tax expense
Impact on net income
(27
)
 
(28
)
 
Net income
Total amount reclassified for the period
$
20

 
$
11

 
Net income

Nine Months Ended September 30:
 
 
 
 
 
 
Amount Reclassified from AOCI
 
Affected Line Item in the Income Statement
 
2016
 
2015
 
Unrealized gain (loss) on cash flow hedges:
 
 
 
 
 
Interest rate contracts
(19
)
 
(18
)
 
Interest expense
Foreign exchange contracts
—

 
(25
)
 
Interest expense
Foreign exchange contracts
274

 
223

 
Revenue
Income tax (expense) benefit
(96
)
 
(67
)
 
Income tax expense
Impact on net income
159

 
113

 
Net income
Unrecognized pension and postretirement benefit costs:
 
 
 
 
 
Prior service costs
(128
)
 
(131
)
 
Compensation and benefits
Income tax (expense) benefit
48

 
51

 
Income tax expense
Impact on net income
(80
)
 
(80
)
 
Net income
Total amount reclassified for the period
$
79

 
$
33

 
Net income


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Deferred Compensation Obligations and Treasury Stock
Activity in the deferred compensation program for the nine months ended September 30, 2016 and 2015 is as follows (in millions):
 
2016
 
2015
Shares
 
Dollars
 
Shares
 
Dollars
Deferred Compensation Obligations:
 
 
 
 
 
 
 
Balance at beginning of period
 
 
$
51

 
 
 
$
59

Reinvested dividends
 
 
2

 
 
 
3

Benefit payments
 
 
(9
)
 
 
 
(11
)
Balance at end of period
 
 
$
44

 
 
 
$
51

Treasury Stock:
 
 
 
 
 
 
 
Balance at beginning of period
(1
)
 
$
(51
)
 
(1
)
 
$
(59
)
Reinvested dividends
—

 
(2
)
 
—

 
(3
)
Benefit payments
—

 
9

 
—

 
11

Balance at end of period
(1
)
 
$
(44
)
 
(1
)
 
$
(51
)

Noncontrolling Interests:
We have noncontrolling interests in certain consolidated subsidiaries in our International Package and Supply Chain & Freight segments. Noncontrolling interests increased $3 and $2 million for the nine months ended September 30, 2016 and 2015, respectively.


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NOTE 12. SEGMENT INFORMATION
We report our operations in three segments: U.S. Domestic Package operations, International Package operations and Supply Chain & Freight operations. Package operations represent our most significant business and are broken down into regional operations around the world. Regional operations managers are responsible for both domestic and export operations within their geographic area.
U.S. Domestic Package
Domestic Package operations include the time-definite delivery of letters, documents and packages throughout the United States.
International Package
International Package operations include delivery to more than 220 countries and territories worldwide, including shipments wholly outside the United States, as well as U.S. export and U.S. import shipments. Our International Package reporting segment includes the operations of our Europe, Asia, Americas and ISMEA (Indian Subcontinent, Middle East and Africa) operating segments.
Supply Chain & Freight
Supply Chain & Freight includes the operations of our forwarding, logistics, Coyote, UPS Freight and other aggregated business units. Our forwarding, logistics and Coyote units provide services in more than 195 countries and territories worldwide, and include North American and international air and ocean freight forwarding, customs brokerage, truckload freight brokerage, distribution and post-sales services and mail and consulting services. UPS Freight offers a variety of less-than-truckload (“LTL”) and truckload (“TL”) services to customers in North America. Other aggregated business units within this segment include The UPS Store and UPS Capital.
In evaluating financial performance, we focus on operating profit as a segment’s measure of profit or loss. Operating profit is before investment income, interest expense and income taxes. The accounting policies of the reportable segments are the same as those described in the summary of accounting policies included in the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2015, with certain expenses allocated between the segments using activity-based costing methods.
Segment information for the three and nine months ended September 30, 2016 and 2015 is as follows (in millions):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Revenue:
 
 
 
 
 
 
 
U.S. Domestic Package
$
9,289

 
$
8,860

 
$
27,388

 
$
26,482

International Package
3,024

 
2,959

 
9,015

 
8,974

Supply Chain & Freight
2,615

 
2,418

 
7,572

 
6,853

Consolidated
$
14,928

 
$
14,237

 
$
43,975

 
$
42,309

Operating Profit:
 
 
 
 
 
 
 
U.S. Domestic Package
$
1,252

 
$
1,258

 
$
3,587

 
$
3,483

International Package
576

 
507

 
1,763

 
1,557

Supply Chain & Freight
206

 
219

 
545

 
577

Consolidated
$
2,034

 
$
1,984

 
$
5,895

 
$
5,617


 

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NOTE 13. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2016 and 2015 (in millions, except per share amounts):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
2016
 
2015
 
2016
 
2015
Numerator:
 
 
 
 
 
 
 
Net income attributable to common shareowners
$
1,270

 
$
1,257

 
$
3,670

 
$
3,513

Denominator:
 
 
 
 
 
 
 
Weighted average shares
876

 
893

 
880

 
898

Deferred compensation obligations
1

 
1

 
1

 
1

Vested portion of restricted units
3

 
1

 
4

 
2

Denominator for basic earnings per share
880

 
895

 
885

 
901

Effect of dilutive securities:
 
 
 
 
 
 
 
Restricted units
4

 
7

 
3

 
6

Stock options
1

 
1

 
1

 
1

Denominator for diluted earnings per share
885

 
903

 
889

 
908

Basic earnings per share
$
1.44

 
$
1.40

 
$
4.15

 
$
3.90

Diluted earnings per share
$
1.44

 
$
1.39

 
$
4.13

 
$
3.87

Diluted earnings per share for the three months ended September 30, 2016 and 2015 excluded the effect of 0.1 and 0.2 million shares of common stock, respectively (0.2 and 0.2 million for the nine months ended September 30, 2016 and 2015, respectively) that may be issued upon the exercise of employee stock options, because such effect would be antidilutive.

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NOTE 14. DERIVATIVE INSTRUMENTS AND RISK MANAGEMENT
Risk Management Policies
We are exposed to market risk, primarily related to foreign exchange rates, commodity prices and interest rates. These exposures are actively monitored by management. To manage the volatility relating to certain of these exposures, we enter into a variety of derivative financial instruments. Our objective is to reduce, where it is deemed appropriate to do so, fluctuations in earnings and cash flows associated with changes in foreign currency rates, commodity prices and interest rates. It is our policy and practice to use derivative financial instruments only to the extent necessary to manage exposures. As we use price sensitive instruments to hedge a certain portion of our existing and anticipated transactions, we expect that any loss in value for those instruments generally would be offset by increases in the value of those hedged transactions. We do not hold or issue derivative financial instruments for trading or speculative purposes.
Credit Risk Management
The forward contracts, swaps and options discussed below contain an element of risk that the counterparties may be unable to meet the terms of the agreements; however, we minimize such risk exposures for these instruments by limiting the counterparties to banks and financial institutions that meet established credit guidelines, and by monitoring counterparty credit risk to prevent concentrations of credit risk with any single counterparty.
 We have agreements with all of our active counterparties (covering the majority of our derivative positions) containing early termination rights and/or zero threshold bilateral collateral provisions whereby cash is required based on the net fair value of derivatives associated with those counterparties. Events such as a counterparty credit rating downgrade (depending on the ultimate rating level) could also allow us to take additional protective measures such as the early termination of trades. At September 30, 2016 and December 31, 2015, we held cash collateral of $487 and $717 million, respectively, under these agreements; this collateral is included in "cash and cash equivalents" on the consolidated balance sheets and its use by UPS is not restricted.
In connection with the zero threshold bilateral collateral provisions described above, we were not required to post any collateral with our counterparties as of September 30, 2016 and December 31, 2015. As of those dates, there were no instruments in a net liability position that were not covered by the zero threshold bilateral collateral provisions. Additionally, in connection with the agreements described above, we could be required to terminate transactions with certain counterparties in the event of a downgrade of our credit rating.
We have not historically incurred, and do not expect to incur in the future, any losses as a result of counterparty default.
Accounting Policy for Derivative Instruments
We recognize all derivative instruments as assets or liabilities in the consolidated balance sheets at fair value. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the derivative, based upon the exposure being hedged, as a cash flow hedge, a fair value hedge or a hedge of a net investment in a foreign operation.
A cash flow hedge refers to hedging the exposure to variability in expected future cash flows that is attributable to a particular risk. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of AOCI, and reclassified into earnings in the same period during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, or hedge components excluded from the assessment of effectiveness, are recognized in the statements of consolidated income during the current period.
A fair value hedge refers to hedging the exposure to changes in the fair value of an existing asset or liability on the consolidated balance sheets that is attributable to a particular risk. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument is recognized in the statements of consolidated income during the current period, as well as the offsetting gain or loss on the hedged item.
A net investment hedge refers to the use of cross currency swaps, forward contracts or foreign currency denominated debt to hedge portions of our net investments in foreign operations. For hedges that meet the effectiveness requirements, the net gains or losses attributable to changes in spot exchange rates are recorded in the foreign currency translation adjustment within AOCI. The remainder of the change in value of such instruments is recorded in earnings.

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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Types of Hedges
Commodity Risk Management
Currently, the fuel surcharges that we apply to our domestic and international package and LTL services are the primary means of reducing the risk of adverse fuel price changes on our business. We periodically enter into option contracts on energy commodity products to manage the price risk associated with forecasted transactions involving refined fuels, principally jet-A, diesel and unleaded gasoline. The objective of the hedges is to reduce the variability of cash flows, due to changing fuel prices, associated with the forecasted transactions involving those products. We normally designate and account for these contracts as cash flow hedges of the underlying forecasted transactions involving these fuel products and, therefore, the resulting gains and losses from these hedges are recognized as a component of fuel expense or revenue when the underlying transactions occur.
Foreign Currency Risk Management
To protect against the reduction in value of forecasted foreign currency cash flows from our international package business, we maintain a foreign currency cash flow hedging program. Our most significant foreign currency exposures relate to the Euro, British Pound Sterling, Canadian Dollar, Chinese Renminbi and Hong Kong Dollar. We hedge portions of our forecasted revenue denominated in foreign currencies with option and forward contracts. We normally designate and account for these contracts as cash flow hedges of anticipated foreign currency denominated revenue and, therefore, the resulting gains and losses from these hedges are recognized as a component of international package revenue when the underlying sales transactions occur.
We also hedge portions of our anticipated cash settlements of intercompany transactions and interest payments on certain debt subject to foreign currency remeasurement using foreign currency forward contracts. We normally designate and account for these contracts as cash flow hedges of forecasted foreign currency denominated transactions; therefore, the resulting gains and losses from these hedges are recognized as a component of investment income and other when the underlying transactions are subject to currency remeasurement.
We hedge our net investment in certain foreign operations with foreign currency denominated debt instruments. The use of foreign denominated debt as the hedging instrument allows the debt to be remeasured to foreign currency translation adjustment within AOCI to offset the translation risk from those investments. Any ineffective portion of net investment hedging is recognized as a component of investment income and other. Balances in the cumulative translation adjustment accounts remain until the sale or complete liquidation of the foreign entity.
Interest Rate Risk Management
Our indebtedness under our various financing arrangements creates interest rate risk. We use a combination of derivative instruments as part of our program to manage the fixed and floating interest rate mix of our total debt portfolio and related overall cost of borrowing. The notional amount, interest payment date and maturity date of the swaps match the terms of the associated debt being hedged. Interest rate swaps allow us to maintain a target range of floating rate debt within our capital structure.
We have designated and account for the majority of our interest rate swaps that convert fixed rate interest payments into floating rate interest payments as hedges of the fair value of the associated debt instruments. Therefore, the gains and losses resulting from fair value adjustments to the interest rate swaps and fair value adjustments to the associated debt instruments are recorded to interest expense in the period in which the gains and losses occur. We normally designate and account for interest rate swaps that convert floating rate interest payments into fixed rate interest payments as cash flow hedges of the forecasted payment obligations.
We periodically hedge the forecasted fixed-coupon interest payments associated with anticipated debt offerings, using forward starting interest rate swaps, interest rate locks or similar derivatives. These agreements effectively lock a portion of our interest rate exposure between the time the agreement is entered into and the date when the debt offering is completed, thereby mitigating the impact of interest rate changes on future interest expense. These derivatives are settled commensurate with the issuance of the debt, and any gain or loss upon settlement is amortized as an adjustment to the effective interest yield on the debt.

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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Outstanding Positions
As of September 30, 2016 and December 31, 2015, the notional amounts of our outstanding derivative positions were as follows (in millions):
 
September 30, 2016
 
December 31, 2015
Currency hedges:
 
 
 
 
 
British Pound Sterling
GBP
925

 
GBP
1,140

Canadian Dollar
CAD
936

 
CAD
177

Euro
EUR
3,625

 
EUR
3,750

Indian Rupee
INR
206

 
INR
—

Mexican Peso
MXN
1,000

 
MXN
3,863

Japanese Yen
JPY
3,233

 
JPY
20,000

Singapore Dollar
SGD
23

 
SGD
—

 
 
 
 
 
 
Interest rate hedges:
 
 
 
 
 
Fixed to Floating Interest Rate Swaps
$
5,799

 
$
5,799

Floating to Fixed Interest Rate Swaps
$
778

 
$
778

 
 
 
 
 
 
Investment market price hedges:
 
 
 
 
 
Marketable Securities
EUR
390

 
EUR
496

As of September 30, 2016, we had no outstanding commodity hedge positions.
Balance Sheet Recognition and Fair Value Measurements
The following table indicates the location on the consolidated balance sheets in which our derivative assets and liabilities have been recognized, the fair value hierarchy level applicable to each derivative type and the related fair values of those derivatives (in millions). The table is segregated between those derivative instruments that qualify and are designated as hedging instruments and those that are not, as well as by type of contract and whether the derivative is in an asset or liability position.
We have master netting arrangements with substantially all of our counterparties giving us the right of offset for our derivative positions. However, we have not elected to offset the fair value positions of our derivative contracts recorded on our consolidated balance sheets. The columns labeled "Net Amounts if Right of Offset had been Applied" indicate the potential net fair value positions by type of contract and location on the consolidated balance sheets had we elected to apply the right of offset.
 
 
 
Fair Value Hierarchy Level
 
Gross Amounts Presented in
Consolidated Balance Sheets
 
Net Amounts if Right of
Offset had been Applied
Asset Derivatives
Balance Sheet Location
 
 
September 30,
2016
 
December 31,
2015
 
September 30,
2016
 
December 31,
2015
Derivatives designated as hedges:
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Other current assets
 
Level 2
 
$
174

 
$
408

 
$
173

 
$
408

Foreign exchange contracts
Other non-current assets
 
Level 2
 
37

 
92

 
31

 
92

Interest rate contracts
Other non-current assets
 
Level 2
 
254

 
204

 
238

 
185

Derivatives not designated as hedges:
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Other current assets
 
Level 2
 
1

 
2

 
1

 
—

Investment market price contracts
Other current assets
 
Level 2
 
153

 
5

 
153

 
—

Interest rate contracts
Other non-current assets
 
Level 2
 
67

 
57

 
59

 
53

Total Asset Derivatives
 
 
 
 
$
686

 
$
768

 
$
655

 
$
738


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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


 
 
 
Fair Value Hierarchy Level
 
Gross Amounts Presented in
Consolidated Balance Sheets
 
Net Amounts if Right of
Offset had been Applied
Liability Derivatives
Balance Sheet Location
 
 
September 30,
2016
 
December 31,
2015
 
September 30,
2016
 
December 31,
2015
Derivatives designated as hedges:
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Other current liabilities
 
Level 2
 
$
2

 
$
—

 
$
1

 
$
—

Foreign exchange contracts
Other non-current liabilities
 
Level 2
 
19

 
—

 
13

 
—

Interest rate contracts
Other non-current liabilities
 
Level 2
 
16

 
19

 
—

 
—

Derivatives not designated as hedges:
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Other current liabilities
 
Level 2
 
2

 
12

 
2

 
10

Investment market price contracts
Other current liabilities
 
Level 2
 
—

 
9

 
—

 
4

Interest rate contracts
Other non-current liabilities
 
Level 2
 
30

 
13

 
22

 
9

Total Liability Derivatives
 
 
 
 
$
69

 
$
53

 
$
38

 
$
23

Our foreign currency, interest rate and investment market price derivatives are largely comprised of over-the-counter derivatives, which are primarily valued using pricing models that rely on market observable inputs such as yield curves, currency exchange rates and investment forward prices; therefore, these derivatives are classified as Level 2.
Income Statement and AOCI Recognition
The following table indicates the amount of gains and losses that have been recognized in AOCI for the three and nine months ended September 30, 2016 and 2015 for those derivatives designated as cash flow hedges (in millions):
Three Months Ended September 30:
 
 
 
 
Derivative Instruments in Cash Flow Hedging Relationships
 
Amount of Gain (Loss) Recognized in AOCI on Derivative (Effective Portion)
 
2016
 
2015
Interest rate contracts
 
—

 
$
(1
)
Foreign exchange contracts
 
(27
)
 
44

Total
 
$
(27
)
 
$
43

 
 
 
 
 
Nine Months Ended September 30:
 
 
 
 
Derivative Instruments in Cash Flow Hedging Relationships
 
Amount of Gain (Loss) Recognized in AOCI on Derivative (Effective Portion)
 
2016
 
2015
Interest rate contracts
 
$
(3
)
 
$
(1
)
Foreign exchange contracts
 
(36
)
 
191

Total
 
$
(39
)
 
$
190

As of September 30, 2016, $100 million of pre-tax gains related to cash flow hedges that are currently deferred in AOCI are expected to be reclassified to income over the 12 month period ended September 30, 2017. The actual amounts that will be reclassified to income over the next 12 months will vary from this amount as a result of changes in market conditions. The maximum term over which we are hedging exposures to the variability of cash flow is 16 years.
The amount of ineffectiveness recognized in income on derivative instruments designated in cash flow hedging relationships was immaterial for the three and nine months ended September 30, 2016 and 2015.







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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


The following table indicates the amount of gains and losses that have been recognized in AOCI within foreign currency translation adjustment for the three and nine months ended September 30, 2016 and 2015 for those instruments designated as net investment hedges (in millions):
Three Months Ended September 30:
 
 
 
 
Non-derivative Instruments in Net Investment Hedging Relationships
 
Amount of Gain (Loss) Recognized in AOCI on Debt (Effective Portion)
 
2016
 
2015
Foreign denominated debt
 
$
(7
)
 
$
—

Total
 
$
(7
)
 
$
—

 
 
 
 
 
Nine Months Ended September 30:
 
 
 
 
Non-derivative Instruments in Net Investment Hedging Relationships
 
Amount of Gain (Loss) Recognized in AOCI on Debt (Effective Portion)
 
2016
 
2015
Foreign denominated debt
 
$
(30
)
 
—

Total
 
$
(30
)
 
$
—

The amount of ineffectiveness recognized in income on non-derivative instruments designated in net investment hedging relationships was immaterial for the three and nine months ended September 30, 2016 and 2015.
The following table indicates the amount and location in the statements of consolidated income in which derivative gains and losses, as well as the associated gains and losses on the underlying exposure, have been recognized for those derivatives designated as fair value hedges for the three and nine months ended September 30, 2016 and 2015 (in millions):
Derivative Instruments
in Fair Value
Hedging Relationships
Location of Gain (Loss) Recognized in Income
 
Derivative Amount of Gain (Loss) Recognized in Income
 
Hedged Items in
Fair Value
Hedging
Relationships
 
Location of 
Gain (Loss)
Recognized In
 Income
 
Hedged Items Amount of Gain (Loss)
Recognized in Income
 
2016
 
2015
 
 
 
2016
 
2015
Three Months Ended September 30:
 
 
 
 
 
 
 
Interest rate contracts
Interest Expense
 
$
(59
)
 
$
80

 
Fixed-Rate
Debt
 
Interest
Expense
 
$
59

 
$
(80
)
Nine Months Ended September 30:
 
 
 
 
 
 
 
 
 
 
Interest rate contracts
Interest
Expense
 
$
56

 
$
71

 
Fixed-Rate
Debt
 
Interest
Expense
 
$
(56
)
 
$
(71
)

Additionally, we maintain some interest rate swaps, foreign currency forwards and investment market price forward contracts that are not designated as hedges. These interest rate swap contracts are intended to provide an economic hedge of a portfolio of interest bearing receivables. These foreign exchange forward contracts are intended to provide an economic offset to foreign currency remeasurement and settlement risk for certain assets and liabilities on our consolidated balance sheets. These investment market price forward contracts are intended to provide an economic offset to fair value fluctuations of certain investments in marketable securities.
We also periodically terminate interest rate swaps and foreign currency options by entering into offsetting swap and foreign currency positions with different counterparties. As part of this process, we de-designate our original swap and foreign currency contracts. These transactions provide an economic offset that effectively eliminates the effects of changes in market valuation.

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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


The following is a summary of the amounts recorded in the statements of consolidated income related to fair value changes and settlements of these interest rate swaps, foreign currency forward and investment market price forward contracts not designated as hedges for the three and nine months ended September 30, 2016 and 2015 (in millions):
Derivative Instruments Not Designated in
Hedging Relationships
Location of Gain (Loss)
Recognized in Income
 
Amount of Gain (Loss)
Recognized in Income
 
2016
 
2015
Three Months Ended September 30:
 
 
 
 
 
Interest rate contracts
Interest expense
 
$
(2
)
 
$
(2
)
Foreign exchange contracts
Other Operating Expenses
 
—

 
2

Foreign exchange contracts
Investment income and other
 
(11
)
 
14

Foreign exchange contracts
Interest expense
 
—

 
(30
)
Investment market price contracts
Investment income and other
 
(28
)
 
(27
)
 
 
 
$
(41
)
 
$
(43
)
Nine Months Ended September 30:
 
 
 
 
 
Interest rate contracts
Interest expense
 
$
(6
)
 
$
(5
)
Foreign exchange contracts
Other Operating Expenses
 
—

 
18

Foreign exchange contracts
Investment income and other
 
(117
)
 
49

Foreign exchange contracts
Interest expense
 
—

 
6

Investment market price contracts
Investment income and other
 
152

 
(36
)
 
 
 
$
29

 
$
32


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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 15. INCOME TAXES
Our effective tax rate increased to 35.0% in the third quarter of 2016 from 34.0% in the same period of 2015 (35.1% year-to-date in 2016 compared to 34.6% in the same period of 2015), primarily due to the prior year rate including $23 million of net discrete tax benefits related to adjustments of deferred tax balances, the U.S. tax liability accrual associated with a planned distribution of cash from a Canadian subsidiary to its U.S. parent and increases in our reserves for uncertain tax positions.
During the reconciliation of our deferred tax balances in 2015 after filing our annual federal and state tax returns, we identified adjustments to be made in the prior years’ deferred tax balances. These deferred tax balances were adjusted in the quarter ended September 30, 2015, which resulted in a reduction of income tax expense of approximately $66 million. This adjustment was not material to the consolidated balance sheets or statements of consolidated income.
In relation to our acquisition of Coyote (see note 8), we distributed approximately $500 million of cash held by a Canadian subsidiary to its U.S. parent during the fourth quarter of 2015. During the third quarter of 2015, and as a result of the intended distribution, we recorded income tax expense of approximately $21 million.
As discussed in our Annual Report on Form 10-K for the year ended December 31, 2015, we have recognized liabilities for uncertain tax positions. We reevaluate these uncertain tax positions on a quarterly basis. A number of years may elapse before an uncertain tax position is audited and ultimately settled. It is difficult to predict the ultimate outcome or the timing of resolution for uncertain tax positions. It is reasonably possible that the amount of unrecognized tax benefits could significantly increase or decrease within the next twelve months. However, an estimate of the range of reasonably possible outcomes cannot be made. Items that may cause changes to unrecognized tax benefits include various state filing positions, the allocation of income and expense between tax jurisdictions and other transfer pricing matters. These changes could result from the settlement of ongoing litigation, the completion of ongoing examinations, the expiration of the statute of limitations or other unforeseen circumstances.



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

Overview
The U.S. economic environment has continued to be mixed as relatively stable consumer conditions are somewhat offset by continued weakness in industrial production, soft business investment and higher inventory levels.  We continue to see modest GDP growth and U.S. manufacturing has shown some positive signs of growth in recent months, but remains weak overall and continues to hinder the pace of expansion in the overall small package delivery market. Low inflation and low fuel prices continued in the economy, giving consumers more purchasing power. Continued growth in e-commerce and omni-channel retail sales has driven package volume demand for residential products. Given these trends, our products most aligned with business-to-consumer shipments have experienced the strongest growth.
Outside of the U.S., emerging markets have stabilized in recent months and most developed nations have seen modest growth. The impending exit of the United Kingdom from the European Union creates some uncertainty regarding its impact on global GDP. The uneven nature of economic growth worldwide and volatile currency markets have continued shifting trade patterns and weakened demand in certain trade lanes. As a result of these circumstances, we continued to adjust our air capacity and cost structure in our transportation network to better match the prevailing volume levels. Our broad portfolio of product offerings and the flexibilities inherent in our transportation network have helped us adapt to these changing trends.
While the worldwide economic environment has remained challenging in 2016, we have continued to undertake several initiatives in the U.S. and internationally to (1) improve the flexibility and capacity in our transportation network; (2) improve yield management; and (3) increase operational efficiency and contain costs across all segments. Most notably, the continued deployment of technology improvements (including several facility automation projects and the accelerated deployment of our On Road Integrated Optimization and Navigation system - "ORION") should continue to increase our network capacity and improve operational efficiency, flexibility and reliability. Additionally, we have continued to utilize newly expanded operating facilities to improve time-in-transit for shipments in each region.
Our consolidated results are presented in the table below:
 
Three Months Ended
September 30,
 
Change
 
Nine Months Ended
September 30,
 
Change
 
2016
 
2015
 
%
 
2016
 
2015
 
%
Revenue (in millions)
$
14,928

 
$
14,237

 
4.9
%
 
$
43,975

 
$
42,309

 
3.9
 %
Operating Expenses (in millions)
12,894

 
12,253

 
5.2
%
 
38,080

 
36,692

 
3.8
 %
Operating Profit (in millions)
$
2,034

 
$
1,984

 
2.5
%
 
$
5,895

 
$
5,617

 
4.9
 %
Operating Margin
13.6
%
 
13.9
%
 
 
 
13.4
%
 
13.3
%
 
 
Average Daily Package Volume (in thousands)
18,152

 
17,133

 
5.9
%
 
17,891

 
17,269

 
3.6
 %
Average Revenue Per Piece
$
10.49

 
$
10.48

 
0.1
%
 
$
10.48

 
$
10.55

 
(0.7
)%
Net Income (in millions)
$
1,270

 
$
1,257

 
1.0
%
 
$
3,670

 
$
3,513

 
4.5
 %
Basic Earnings Per Share
$
1.44

 
$
1.40

 
2.9
%
 
$
4.15

 
$
3.90

 
6.4
 %
Diluted Earnings Per Share
$
1.44

 
$
1.39

 
3.6
%
 
$
4.13

 
$
3.87

 
6.7
 %


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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS




Results of Operations—Segment Review
The results and discussions that follow are reflective of how our executive management monitors the performance of our reporting segments. From time to time, we supplement the reporting of our financial information determined under generally accepted accounting principles (“GAAP”) with certain non-GAAP financial measures, including, as applicable, "adjusted" operating profit, operating margin, income before income taxes, effective tax rate, net income and earnings per share to exclude the impact of mark-to-market pension accounting adjustments. We believe that these adjusted measures provide meaningful information to assist investors and analysts in understanding our financial results and assessing our prospects for future performance. We believe these adjusted financial measures are important indicators of our recurring operations because they exclude items that may not be indicative of, or are unrelated to, our core operating results, and provide a better baseline for analyzing trends in our underlying businesses.
Certain operating expenses are allocated between our reporting segments based on activity-based costing methods. These activity-based costing methods require us to make estimates that impact the amount of each expense category that is attributed to each segment. Changes in these estimates will directly impact the amount of expense allocated to each segment and therefore the operating profit of each reporting segment. There were no significant changes in our expense allocation methodologies during 2016 or 2015.

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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS




U.S. Domestic Package Operations
 
Three Months Ended
September 30,
 
Change
 
Nine Months Ended
September 30,
 
Change
2016
 
2015
 
%
 
2016
 
2015
 
%
Average Daily Package Volume (in thousands):
 
 
 
 
 
 
 
 
 
 
 
Next Day Air
1,361

 
1,285

 
5.9
 %
 
1,313

 
1,252

 
4.9
 %
Deferred
1,260

 
1,141

 
10.4
 %
 
1,195

 
1,163

 
2.8
 %
Ground
12,743

 
12,114

 
5.2
 %
 
12,652

 
12,208

 
3.6
 %
Total Avg. Daily Package Volume
15,364

 
14,540

 
5.7
 %
 
15,160

 
14,623

 
3.7
 %
Average Revenue Per Piece:
 
 
 
 
 
 
 
 
 
 
 
Next Day Air
$
19.59

 
$
19.90

 
(1.6
)%
 
$
19.51

 
$
20.01

 
(2.5
)%
Deferred
11.99

 
11.91

 
0.7
 %
 
12.12

 
11.90

 
1.8
 %
Ground
8.11

 
8.02

 
1.1
 %
 
8.11

 
8.11

 
—
 %
Total Avg. Revenue Per Piece
$
9.45

 
$
9.37

 
0.9
 %
 
$
9.41

 
$
9.43

 
(0.2
)%
Operating Days in Period
64

 
65

 
 
 
192

 
192

 
 
Revenue (in millions):
 
 
 
 
 
 
 
 
 
 
 
Next Day Air
$
1,706

 
$
1,662

 
2.6
 %
 
$
4,918

 
$
4,810

 
2.2
 %
Deferred
967

 
883

 
9.5
 %
 
2,781

 
2,657

 
4.7
 %
Ground
6,616

 
6,315

 
4.8
 %
 
19,689

 
19,015

 
3.5
 %
Total Revenue
$
9,289

 
$
8,860

 
4.8
 %
 
$
27,388

 
$
26,482

 
3.4
 %
Operating Expenses (in millions)
$
8,037

 
$
7,602

 
5.7
 %
 
$
23,801

 
$
22,999

 
3.5
 %
Operating Profit (in millions)
$
1,252

 
$
1,258

 
(0.5
)%
 
$
3,587

 
$
3,483

 
3.0
 %
Operating Margin
13.5
%
 
14.2
%
 
 
 
13.1
%
 
13.2
%
 
 
Revenue
The change in overall revenue was impacted by the following factors in 2016 compared with the corresponding period of 2015:
 
Volume
 
Rates /
Product Mix
 
Fuel
Surcharge
 
Total Revenue
Change
Net Revenue Change Drivers:
 
 
 
 
 
 
 
Third quarter 2016 vs. 2015
4.0
%
 
1.3
%
 
(0.5
)%
 
4.8
%
Year-to-date 2016 vs. 2015
3.7
%
 
0.6
%
 
(0.9
)%
 
3.4
%
Volume
Our total volume increased in the third quarter and year-to-date periods of 2016 compared with 2015, despite having one less operating day, primarily due to continued growth in the retail, healthcare, automotive and professional services segments. Business-to-consumer shipments, which represent approximately 46% of total U.S. Domestic Package volume, grew more than 9% for the third quarter of 2016 compared with 2015 due to increases in both air and ground shipments led by UPS SurePost. Additionally, business-to-business shipments increased, driven primarily by retail industry return services.
Among our air products, volume increased for Next Day Air services in the third quarter and year-to-date periods of 2016 particularly for those products most aligned with business-to-consumer shipping. We also experienced growth in our deferred air product volume in the third quarter and year-to-date periods of 2016 due to strong growth in e-commerce.
The increase in ground volume in the third quarter and year-to-date periods of 2016 was driven by both business-to-consumer and business-to-business shipping activity. The continued growth was fueled by e-commerce, which resulted in increased use of returns and SurePost services.

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Rates and Product Mix
Overall revenue per piece increased 0.9% for the third quarter of 2016, and remained relatively flat year-to-date compared with the same period of 2015, primarily due to the implementation of several rate and accessorial charge increases (as described below), largely offset by lower fuel surcharge rates and changes in customer and product mix.
Revenue per piece for ground and air products was positively impacted by a base rate increase on December 28, 2015. UPS Ground rates and accessorial charges increased an average net 4.9%, while UPS Air services and accessorial charges increased an average net 5.2%. The surcharge increased for Over Maximum Packages and the index tables for the Ground and Air fuel surcharges were adjusted effective November 2, 2015. A charge for UPS’s Third-Party Billing Service was implemented, effective January 4, 2016. Additionally, the dimensions of ground packages incurring the UPS Additional Handling charge were changed effective June 6, 2016.
Revenue per piece for deferred products increased in the third quarter and for the year-to-date period of 2016, while Next Day Air declined. All products were negatively impacted by lower fuel surcharge rates. Deferred revenue per piece increased primarily due to heavier-weight packages partially offset by product mix. The Next Day Air revenue per piece decline was caused by a shift in customer and product mix. We experienced relatively stronger growth in our lighter-weight business-to-consumer shipments particularly our Next Day Air Saver product, which have lower average yields than our heavier-weight commercial shipments.
Ground revenue per piece increased 1.1% for the third quarter of 2016, but remained flat year-to-date compared with the same period of 2015, primarily due to an increase in volume and rate increases offset by a decrease in average weight per piece and lower fuel surcharge rates. Additionally, customer and product mix changes had a slightly negative impact on revenue per piece as a greater portion of volume in 2016, relative to 2015, came from residential customers and lighter-weight shipments.
Fuel Surcharges
UPS applies a fuel surcharge on our domestic air and ground services. The air fuel surcharge is based on the U.S. Department of Energy’s (“DOE”) Gulf Coast spot price for a gallon of kerosene-type jet fuel, while the ground fuel surcharge is based on the DOE’s On-Highway Diesel Fuel price. Based on published rates, the average fuel surcharges for domestic air and ground products were as follows:
 
Three Months Ended
September 30,
 
Change
 
Nine Months Ended
September 30,
 
Change
 
2016

2015
 
% Point
 
2016
 
2015
 
% Point
Next Day Air / Deferred
4.1
%
 
4.6
%
 
(0.5
)%
 
3.3
%
 
4.8
%
 
(1.5
)%
Ground
5.1
%
 
5.3
%
 
(0.2
)%
 
4.8
%
 
5.6
%
 
(0.8
)%
Total domestic fuel surcharge revenue decreased by $40 million in the third quarter of 2016 ($241 million year-to-date) as a result of lower fuel surcharge rates caused by declining jet and diesel fuel prices; however, the impact of lower fuel prices was partially mitigated by pricing changes to the fuel surcharge indices, as well as the overall increase in package volume.
Operating Expenses
Operating expenses for the segment increased $435 million in the third quarter of 2016 ($802 million year-to-date), primarily due to increases in pick-up and delivery costs ($243 million), the cost of operating our domestic integrated air and ground network ($69 million), the cost of package sorting ($62 million), accessorials and indirect operating costs ($61 million) for the quarter ($515, $53, $114 and $120 million, respectively, year-to-date). For the third quarter, the cost increases were largely due to higher employee compensation expenses, which were impacted by (1) an increase in average daily union labor hours to support volume growth; (2) an increase in wage rates and (3) an increase in health and welfare costs (due to headcount and contractual contribution rate increases to multiemployer plans). For the third quarter of 2016, these costs include an increase in workers' compensation expense due to more favorable actuarial adjustments in 2015 compared with 2016.
Total cost per piece increased 1.6% for the third quarter of 2016 compared with the third quarter of 2015 (down 0.2% year-to-date), due to the cost increases described previously, including higher costs associated with benefits in addition to lower fuel savings realized in 2016 partially offset by productivity gains during the third quarter and year-to-date period. Productivity improvements have continued to be realized through adjusting our air and ground networks to better match volume levels and utilizing technology to increase package sorting and delivery efficiency. The continued deployment of ORION has contained the growth of average daily vehicle miles driven, while the increased redirect of SurePost volume to optimize delivery density on UPS vehicles has reduced the delivery costs for business-to-consumer shipments.

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Operating Profit and Margin
Operating profit decreased $6 million for the third quarter of 2016 compared with 2015, as operating margin decreased 70 basis points to 13.5%. Higher pension and healthcare costs, contractual union wage increases and higher workers' compensation adjustments in 2015 more than offset the volume growth, productivity improvements and net effect of fuel (fuel expense decreased faster than fuel surcharge revenue) discussed previously.
On a year-to-date basis, operating profit increased $104 million in 2016 compared with 2015, as operating margin decreased 10 basis points to 13.1%. Revenue growth from increased volume and enhanced productivity through the continued deployment of ORION technology resulted in higher operating profit, but was partially offset by the net impact of fuel (fuel surcharge revenue decreased faster than fuel expense) and more favorable workers' compensation adjustments in 2015 compared with 2016.

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RESULTS OF OPERATIONS




International Package Operations
 
Three Months Ended
September 30,
 
Change
 
Nine Months Ended
September 30,
 
Change
 
2016
 
2015
 
%
 
2016
 
2015
 
%
Average Daily Package Volume (in thousands):
 
 
 
 
 
 
 
 
 
 
 
Domestic
1,612

 
1,495

 
7.8
 %
 
1,576

 
1,534

 
2.7
 %
Export
1,176

 
1,098

 
7.1
 %
 
1,155

 
1,112

 
3.9
 %
Total Avg. Daily Package Volume
2,788

 
2,593

 
7.5
 %
 
2,731

 
2,646

 
3.2
 %
Average Revenue Per Piece:
 
 
 
 
 
 
 
 
 
 
 
Domestic
$
5.90

 
$
6.11

 
(3.4
)%
 
$
5.96

 
$
6.11

 
(2.5
)%
Export
30.35

 
31.04

 
(2.2
)%
 
30.72

 
31.37

 
(2.1
)%
Total Avg. Revenue Per Piece
$
16.21

 
$
16.67

 
(2.8
)%
 
$
16.43

 
$
16.73

 
(1.8
)%
Operating Days in Period
64

 
65

 
 
 
192

 
192

 
 
Revenue (in millions):
 
 
 
 
 
 
 
 
 
 
 
Domestic
$
609

 
$
594

 
2.5
 %
 
$
1,804

 
$
1,799

 
0.3
 %
Export
2,284

 
2,215

 
3.1
 %
 
6,813

 
6,698

 
1.7
 %
Cargo and Other
131

 
150

 
(12.7
)%
 
398

 
477

 
(16.6
)%
Total Revenue
$
3,024

 
$
2,959

 
2.2
 %
 
$
9,015

 
$
8,974

 
0.5
 %
Operating Expenses (in millions)
$
2,448

 
$
2,452

 
(0.2
)%
 
$
7,252

 
$
7,417

 
(2.2
)%
Operating Profit (in millions)
$
576

 
$
507

 
13.6
 %
 
$
1,763

 
$
1,557

 
13.2
 %
Operating Margin
19.0
%
 
17.1
%
 
 
 
19.6
%
 
17.4
%
 
 
Currency Benefit / (Cost) – (in millions)*:
 
 
 
 
 
 
 
 
 
 
Revenue
 
 
 
 
$
(26
)
 
 
 
 
 
$
(100
)
Operating Expenses
 
 
 
 
19

 
 
 
 
 
93

Operating Profit
 
 
 
 
$
(7
)
 
 
 
 
 
$
(7
)
* Net of currency hedging; amount represents the change in currency translation compared to the prior year.
 
 
 
 
 
 
Revenue
The change in overall revenue was impacted by the following factors in 2016 compared with the corresponding period of 2015:
 
Volume
 
Rates /
Product Mix
 
Fuel
Surcharge
 
Currency
 
Total Revenue
Change
Net Revenue Change Drivers:
 
 
 
 
 
 
 
 
 
Third quarter 2016 vs. 2015
5.9
%
 
(2.1
)%
 
(0.7
)%
 
(0.9
)%
 
2.2
%
Year-to-date 2016 vs. 2015
3.2
%
 
(0.2
)%
 
(1.4
)%
 
(1.1
)%
 
0.5
%
Volume
Our overall average daily volume increased in the third quarter and year-to-date periods of 2016 compared with the corresponding periods of 2015, largely due to strong demand from several economic sectors including retail, healthcare and high tech.
The export volume growth in the third quarter and year-to-date periods of 2016 was mainly driven by our European and Asian operations. Europe and Asia export volume showed significant growth to all regions particularly in the Asia-to-Europe and Asia-to-U.S. trade lanes. Americas export volume increased for the quarter, with solid growth in the Americas-to-Asia and Americas-to-U.S. trade lanes. Export volume into the U.S. grew in all trade lanes. U.S. export volume was flat for the quarter, largely due to the impact of the stronger U.S. Dollar. Export volume growth increased across all products. This growth was led by our premium express products, such as our Worldwide Express services, as we continue to expand these premium services to new markets.

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The increase in domestic volume in the third quarter and year-to-date periods of 2016 was primarily due to growth in Italy, France, Turkey and Canada.
Rates and Product Mix
Total average revenue per piece decreased 2.8% in the third quarter of 2016 (1.8% year-to-date) including the impact of lower fuel surcharge rates and a 90 basis point reduction from the impact of currency (110 basis point reduction year-to-date). These factors were partially offset by an increase in base rates and a continuing shift in product mix as the growth in premium products continues to exceed the growth in our standard products.
On December 28, 2015, we implemented an average 5.2% net increase in base and accessorial rates for international shipments originating in the United States (Worldwide Express, Worldwide Saver, UPS Worldwide Expedited and UPS International Standard service). Rate changes for shipments originating outside the U.S. are made throughout the year and vary by geographic market.
Export revenue per piece decreased 2.2% in the third quarter 2016 (2.1% year-to-date) including the impact of lower fuel surcharge rates and a 30 basis point reduction from the impact of currency (60 basis point reduction year-to-date). These factors were partially offset by an increase in base rates and a continuing shift in product mix as the growth in premium products continues to exceed the growth in our standard products.
Domestic revenue per piece decreased 3.4% in the third quarter of 2016 (2.5% year-to-date) including the impact of lower fuel surcharge rates and a 290 basis point reduction from the impact of currency (350 basis point reduction year-to-date). These factors were partially offset by an increase in base rates.
Fuel Surcharges
We maintain fuel surcharges on our international air and ground services. The fuel surcharges for international air products originating inside or outside the United States are indexed to the DOE's Gulf Coast spot price for a gallon of kerosene-type jet fuel, while the fuel surcharges for ground products originating outside the United States are indexed to fuel prices in the international region or country where the shipment takes place. Total international fuel surcharge revenue decreased by $25 million for the third quarter of 2016 compared with 2015 ($139 million year-to-date), primarily due to lower fuel prices; however, this was partially offset by pricing changes made to the fuel surcharge indices.
Operating Expenses
Overall operating expenses for the segment decreased $4 million in the third quarter of 2016 compared with 2015 ($165 million year-to-date). This decrease was mostly due to lower fuel prices and a $19 million decrease from currency exchange rate movements ($93 million year-to-date).
The decrease in operating expenses was largely driven by the costs of operating our international integrated air and ground network, which decreased $16 million ($124 million year-to-date). The decrease in network costs was largely driven by the impact of currency exchange rate movements, lower fuel expense, and restraining the growth in aircraft block hours (2.5% increase in the third quarter and a 0.4% increase year-to-date), as a result of ongoing modifications to our air network. This was achieved even with a 7.1% increase in third quarter international export volume (3.9% increase year-to-date) and continuing air product service enhancements. These decreases were offset by a $19 million increase in pick-up and delivery costs in the third quarter compared to the corresponding period of 2015, largely due to increased volume. Year-to-date pick-up and delivery costs were down an additional $13 million compared to the corresponding period of 2015, largely due to the impact of currency exchange rate movements and lower fuel expense.
The remaining change in operating expenses in the third quarter and year-to-date periods of 2016 compared with 2015 was largely due to a reduction in the costs of package sorting and decreases in indirect operating costs.
Operating Profit and Margin
Operating profit increased $69 million in the third quarter of 2016 compared with 2015 ($206 million year-to-date), while operating margin increased by 190 basis points to 19.0% (220 basis points to 19.6% year-to-date). Operating profit and margin were positively affected by several factors including revenue management initiatives, the net impact of fuel, effective network management and cost containment initiatives.

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Supply Chain & Freight Operations
 
Three Months Ended
September 30,
 
Change
 
Nine Months Ended
September 30,
 
Change
 
2016

2015
 
%
 
2016
 
2015
 
%
Freight LTL Statistics:
 
 
 
 
 
 
 
 
 
 
 
Revenue (in millions)
$
616

 
$
631

 
(2.4
)%
 
$
1,780

 
$
1,887

 
(5.7
)%
Revenue Per Hundredweight
$
23.63

 
$
22.78

 
3.7
 %
 
$
23.46

 
$
22.78

 
3.0
 %
Shipments (in thousands)
2,551

 
2,692

 
(5.2
)%
 
7,507

 
7,994

 
(6.1
)%
Shipments Per Day (in thousands)
39.9

 
42.1

 
(5.2
)%
 
39.1

 
41.9

 
(6.7
)%
Gross Weight Hauled (in millions of lbs)
2,607

 
2,770

 
(5.9
)%
 
7,589

 
8,282

 
(8.4
)%
Weight Per Shipment (in lbs)
1,022

 
1,029

 
(0.7
)%
 
1,011

 
1,036

 
(2.4
)%
Operating Days in Period
64

 
64

 
 
 
192

 
191

 
 
Revenue (in millions):
 
 
 
 
 
 
 
 
 
 
 
Forwarding and Logistics
$
1,735

 
$
1,500

 
15.7
 %
 
$
4,980

 
$
4,149

 
20.0
 %
Freight
701

 
740

 
(5.3
)%
 
2,050

 
2,202

 
(6.9
)%
Other
179

 
178

 
0.6
 %
 
542

 
502

 
8.0
 %
Total Revenue
$
2,615

 
$
2,418

 
8.1
 %
 
$
7,572

 
$
6,853

 
10.5
 %
Operating Expenses (in millions):
$
2,409

 
$
2,199

 
9.5
 %
 
$
7,027

 
$
6,276

 
12.0
 %
Operating Profit (in millions):
$
206

 
$
219

 
(5.9
)%
 
$
545

 
$
577

 
(5.5
)%
Operating Margin
7.9
%
 
9.1
%
 
 
 
7.2
%
 
8.4
%
 
 
Currency Benefit / (Cost) – (in millions)*:
 
 
 
$ 
 
 
 
 
 
$ 
Revenue
 
 
 
 
$
(8
)
 
 
 
 
 
$
(40
)
Operating Expenses
 
 
 
 
7

 
 
 
 
 
45

Operating Profit
 
 
 
 
$
(1
)
 
 
 
 
 
$
5

* Amount represents the change in currency translation compared to the prior year.
 
 
 
 
 
 
In August 2015, we acquired Coyote Logistics Midco, Inc ("Coyote"), a truckload freight brokerage company. Coyote's financial results are included in the above table within Forwarding and Logistics from the date of acquisition, which has impacted the year-over-year comparability of revenue, operating expenses and operating profit.
Revenue
Total revenue for the Supply Chain & Freight segment increased $197 million in the third quarter of 2016 ($719 million year-to-date) compared with 2015. Forwarding and Logistics revenue increased $235 million in the third quarter of 2016 ($831 million year-to-date) compared with 2015 primarily due to the Coyote acquisition midway through the third quarter of 2015. The increase driven by Coyote was partially offset by a combination of volume and tonnage declines in our international air freight business (impacted by management focus on reducing lower-yielding accounts and softer market conditions), lower rates charged to our customers (largely due to overcapacity in the market), as well as the adverse impact of currency exchange rate movements and lower fuel surcharge rates (due to declining fuel prices). Revenue for our logistics products increased in the third quarter and year-to-date periods of 2016 compared with 2015, as we experienced solid growth in our mail services, healthcare, retail, aerospace and automotive solutions; however, this was partially offset by the adverse impact of currency exchange rate movements and revenue declines among our high tech customers.
Freight revenue decreased $39 million in the third quarter of 2016 ($152 million year-to-date) compared with 2015, primarily due to a 5.9% (8.4% year-to-date) decline in tonnage, a 5.2% (6.1% year-to-date) decrease in shipments and a $15 million decrease ($73 million year-to-date) in fuel surcharge revenue due to lower diesel fuel prices. The decline in shipments and the reduction in weight per shipment were impacted by revenue management initiatives, a decline in market demand and customer mix. LTL Revenue per hundredweight increased, as LTL base rate increases averaging 4.9% took effect on October 26, 2015 and September 19, 2016.

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Revenue for the other businesses within Supply Chain & Freight increased $1 million in the third quarter of 2016 ($40 million year-to-date) compared with 2015 due to revenue growth at The UPS Store, UPS Capital and UPS Customer Solutions.
Operating Expenses
Total operating expenses for the Supply Chain & Freight segment increased $210 million in the third quarter of 2016 ($751 million year-to-date) compared with 2015. Forwarding and Logistics operating expenses increased $236 million for the third quarter of 2016 ($844 million year-to-date) compared with 2015. This increase was largely due to the acquisition of Coyote during the third quarter of 2015, partially offset by the impact of currency exchange rate movements and lower fuel expense. Purchased transportation expense increased by $222 million in the third quarter of 2016 ($734 million year-to-date) compared to 2015 largely due to the acquisition of Coyote, as well as increased volume and rates for mail services. These increases were partially offset by a combination of lower volume and tonnage in our international air freight forwarding business, lower buy rates due to softer market conditions and the impact of foreign currency exchange rate movements.
Although freight operating expenses decreased $28 million in the third quarter of 2016 ($130 million year-to-date) compared with 2015, total cost per LTL shipment increased by 4.5% in the third quarter of 2016 (1.7% year-to-date) compared with 2015. The decrease in operating expenses was largely due to the costs associated with operating our linehaul network (which increased slightly by $4 million over the prior year quarter but decreased $39 million year-to-date as compared to 2015), decreases in pick-up and delivery expenses (which decreased $15 million over the prior year quarter and $39 million year-to-date) and decreases in other expenses (which decreased $18 million over the prior year quarter and $53 million year-to-date). The declines in network costs and pick-up and delivery expenses were driven by a reduction in fuel expense and expense for outside transportation carriers (largely due to lower LTL volume and fuel surcharges passed on to us by outside carriers).
Operating expenses for the other businesses within Supply Chain & Freight increased $2 million in the third quarter of 2016 ($37 million year-to-date) compared with 2015.
Operating Profit and Margin
Total operating profit for the Supply Chain & Freight segment decreased $13 million in the third quarter of 2016 ($32 million year-to-date) compared with 2015.
Operating profit for the Forwarding and Logistics units, which includes Coyote, decreased by $1 million in the third quarter of 2016 ($13 million year-to-date) compared with 2015, primarily due to volume and tonnage declines and revenue management initiatives undertaken in our global freight forwarding operations to improve low-yielding accounts. Operating margins for our global freight forwarding operations decreased slightly in the third quarter of 2016 and improved year-to-date compared with 2015. Operating profit and margins for the logistics unit decreased slightly in the third quarter and year-to-date periods of 2016 compared with 2015. Coyote generated operating profit in the third quarter and year-to-date periods of 2016.
Operating profit for our freight unit decreased $10 million in the third quarter of 2016 ($22 million year-to-date) compared with 2015, as decreases in volume and tonnage more than offset the increased yields and productivity improvements during the quarter. Margins were pressured in the third quarter of 2016 as shipments declined at a faster rate than expenses.
The combined operating profit for all of our other businesses in this segment decreased $2 million in the third quarter of 2016 (a $3 million increase year-to-date) compared with 2015.

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Consolidated Operating Expenses
 
Three Months Ended
September 30,
 
Change
 
Nine Months Ended
September 30,
 
Change
 
2016
 
2015
 
%
 
2016
 
2015
 
%
Operating Expenses (in millions):
 
 
 
 
 
 
 
 
 
 
 
Compensation and Benefits
$
7,857

 
$
7,458

 
5.3
 %
 
$
23,448

 
$
22,524

 
4.1
 %
Repairs and Maintenance
386

 
362

 
6.6
 %
 
1,150

 
1,069

 
7.6
 %
Depreciation and Amortization
554

 
527

 
5.1
 %
 
1,661

 
1,543

 
7.6
 %
Purchased Transportation
2,212

 
1,926

 
14.8
 %
 
6,306

 
5,557

 
13.5
 %
Fuel
541

 
617

 
(12.3
)%
 
1,480

 
1,900

 
(22.1
)%
Other Occupancy
248

 
241

 
2.9
 %
 
762

 
765

 
(0.4
)%
Other Expenses
1,096

 
1,122

 
(2.3
)%
 
3,273

 
3,334

 
(1.8
)%
Total Operating Expenses
$
12,894

 
$
12,253

 
5.2
 %
 
$
38,080

 
$
36,692

 
3.8
 %
 
 
 
 
 
 
 
 
 
 
 
 
Currency (Benefit) / Cost - (in millions)*
 
 
 
 
$
(26
)
 
 
 
 
 
$
(138
)
* Amount represents the change in currency translation compared to the prior year.
 
 
 
 
 
 
Compensation and Benefits
Compensation costs increased $139 million for the third quarter of 2016 ($412 million year-to-date) compared with 2015 largely due to higher U.S. domestic hourly and management compensation costs and the acquisition of Coyote during the third quarter of 2015. Total compensation costs increased 3.0% for the third quarter and year-to-date periods, while consolidated average daily volume growth was 5.9% (3.6% year-to-date). U.S. domestic compensation costs for hourly employees increased largely due to contractual union wage increases and a 5.2% increase in average daily union labor hours (3.0% year-to-date). The increase in average daily labor hours was less than daily volume growth due to productivity gains. Compensation costs for management employees increased primarily due to merit salary increases and slight growth in the overall size of the workforce.
Benefits expense increased $260 million for the third quarter of 2016 compared with 2015 ($512 million year-to-date) primarily due to the following factors:
•
Health and welfare costs increased $76 million for the third quarter ($251 million year-to-date), largely due to increased contributions to multiemployer plans resulting from contractual contribution rate increases and an overall increase in the size of the workforce.
•
Pension expense increased $28 million for the third quarter ($71 million year-to-date), primarily due to additional expense for multiemployer pension plans, which were impacted by contractual contribution rate increases and an overall increase in the size of the workforce.
•
Vacation, holiday and excused absence expense increased $15 million for the third quarter ($54 million year-to-date), due to salary increases and growth in the overall size of the workforce.
•
Workers' compensation expense increased $125 million in the third quarter ($97 million year-to-date). Insurance reserves are established for estimates of the loss that we will ultimately incur on reported workers' compensation claims, as well as estimates of claims that have been incurred but not reported, and take into account a number of factors including our history of claim losses, payroll growth and the impact of safety improvement initiatives. In 2015, we experienced more favorable actuarial adjustments, resulting in increased expense in 2016.

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Repairs and Maintenance
The $24 million increase in repairs and maintenance expense for the third quarter of 2016 compared with 2015 ($81 million year-to-date) was primarily due to aircraft engine maintenance and cost alignments.
Depreciation and Amortization
Depreciation and amortization expense increased $27 million in the third quarter of 2016 ($118 million year-to-date) compared with 2015, primarily due to three factors: (1) depreciation expense on vehicles increased due to the replacement of older, fully-depreciated vehicles, technology upgrades on new vehicles and an overall increase in the size of our vehicle fleet in our U.S. Domestic Package and UPS Freight operations; (2) depreciation expense for buildings and facilities increased due to leasehold improvements and purchases of new equipment and (3) amortization expense increased largely due to new internally developed capitalized software, as well as intangible assets resulting from business acquisitions.
Purchased Transportation
The $286 million increase in purchased transportation expense charged to us by third-party air, rail, ocean and truck carriers for the third quarter of 2016 ($749 million year-to-date) compared with 2015 was primarily driven by the following factors:
•
Expense for our forwarding and logistics business increased $224 million in the third quarter ($739 million year-to-date), due to the acquisition of Coyote and increased volume and rates for mail services; these items were partially offset by a combination of decreased volume and tonnage in our international air freight forwarding business, lower buy rates due to softer market conditions and the impact of foreign currency exchange rates.
•
Expense for our International Package segment increased $33 million in the third quarter ($60 million year-to-date), primarily due to the increased usage of third party carriers; these items were partially offset by the impact of currency exchange rate movements as well as lower fuel surcharges passed to us from outside transportation providers.
•
Expense for our U.S. Domestic Package segment increased $38 million for the third quarter (an increase of $4 million year-to-date), primarily due to increased volume and rates, partially offset by lower fuel surcharges passed to us from rail carriers and outside contract carriers.
•
Expense for our UPS Freight business decreased $6 million in the third quarter ($48 million year-to-date), due to a decrease in LTL shipments and lower fuel surcharges passed to us from outside transportation providers.
Fuel
The $76 million decrease in fuel expense for the third quarter of 2016 ($420 million year-to-date) compared with 2015 was primarily due to lower jet fuel, diesel and unleaded gasoline prices, which decreased fuel expense by $85 million ($455 million year-to-date). These decreases were partially offset by increased fuel consumption, primarily due to increases in total aircraft block hours and Domestic Package delivery stops (due to higher volume) which increased expense by $9 million in the third quarter of 2016 ($35 million year-to-date).
Other Occupancy
Other occupancy expense increased $7 million in the third quarter of 2016 as compared to 2015 primarily due to higher facility rent expense. Year-to-date 2016 expense decreased $3 million as compared to 2015 largely due to a decrease in facility rent expense, natural gas and electric utility costs and snow removal costs at our operating facilities in the first quarter of 2016.
Other Expenses
The $26 million decrease in other expense in the third quarter of 2016 ($61 million year-to-date) compared with 2015 was largely due to reduced auto liability insurance and better cost alignment.



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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS




Other Income and (Expense)
 
Three Months Ended
September 30,
 
Change
 
Nine Months Ended
September 30,
 
Change
 
2016
 
2015
 
%
 
2016
 
2015
 
%
(in millions)
 
 
 
 
 
 
 
 
 
 
 
Investment income and other
$
13

 
$
4

 
N/A

 
$
38

 
$
12

 
N/A

Interest expense
$
(94
)
 
$
(83
)
 
13.3
%
 
$
(281
)
 
$
(256
)
 
9.8
%
Investment Income and Other
The growth in investment income and other for the third quarter and year-to-date of 2016 as compared to 2015 was primarily due to a decrease in losses from fair value adjustments on real estate partnerships, higher interest income and unrealized gains on investments and a benefit from foreign currency exchange rate movements.
Interest Expense
Interest expense increased in the third quarter and year-to-date of 2016 primarily due to an increase in long-term debt and higher effective interest rates on senior notes.
Income Tax Expense
 
Three Months Ended
September 30,
 
Change
 
Nine Months Ended
September 30,
 
Change
 
2016
 
2015
 
%
 
2016
 
2015
 
%
(in millions)
 
 
 
 
 
 
 
 
 
 
 
Income Tax Expense
$
683

 
$
648

 
5.4
%
 
$
1,982

 
$
1,860

 
6.6
%
Effective Tax Rate
35.0
%
 
34.0
%
 
 
 
35.1
%
 
34.6
%
 
 
 Our effective tax rate increased to 35.0% in the third quarter of 2016 from 34.0% in the same period of 2015 (35.1% year-to-date in 2016 compared to 34.6% in the same period of 2015), primarily due to the prior year rate including $23 million of net discrete tax benefits related to adjustments of deferred tax balances, the U.S. tax liability accrual associated with a planned distribution of cash from a Canadian subsidiary to its U.S. parent and increases in our reserves for uncertain tax positions.
During the reconciliation of our deferred tax balances in 2015 after filing our annual federal and state tax returns, we identified adjustments to be made in the prior years’ deferred tax balances. These deferred tax balances were adjusted in the quarter ended September 30, 2015, which resulted in a reduction of income tax expense of approximately $66 million. This adjustment was not material to the consolidated balance sheets or statements of consolidated income.
In relation to our acquisition of Coyote (see note 8), we distributed approximately $500 million of cash held by a Canadian subsidiary to its U.S. parent during the fourth quarter of 2015. During the third quarter of 2015, and as a result of the intended distribution, we recorded income tax expense of approximately $21 million.

 


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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS




Liquidity and Capital Resources
Cash Flows From Operating Activities
The following is a summary of the significant sources (uses) of cash from operating activities (amounts in millions):
 
Nine Months Ended
September 30,
 
2016
 
2015
Net income
$
3,670

 
$
3,513

Non-cash operating activities (a)
2,583

 
2,377

Pension and postretirement benefit contributions (UPS-sponsored plans)
(1,298
)
 
(147
)
Hedge margin receivables and payables
(230
)
 
190

Income tax receivables and payables
100

 
362

Changes in working capital and other non-current assets and liabilities
561

 
171

Other operating activities
(23
)
 
(51
)
Net cash from operating activities
$
5,363

 
$
6,415

___________________ 
(a)
Represents depreciation and amortization, gains and losses on derivative transactions and foreign exchange, deferred income taxes, provisions for uncollectible accounts, pension and postretirement benefit expense, stock compensation expense, and other non-cash items.
Net cash from operating activities decreased $1.052 billion in the third quarter of 2016 compared with 2015, largely due to higher pension and post retirement benefit contributions and reduced receipts of hedge margin collateral from counterparties. These were partially offset by higher net income and improvements in our working capital position. The net hedge margin collateral received from derivative counterparties decreased by $420 million in 2016 relative to 2015, due to a decreased net fair value asset position of the derivative contracts used in our currency and interest rate hedging programs. Net cash payments for income taxes increased in 2016 compared with 2015 and were impacted by the timing of estimated tax payments and receipt of refunds relative to changes in estimates for the underlying tax liabilities. The $390 million improvement in our working capital position in 2016 was primarily driven by decreased average days outstanding on accounts receivable and favorable changes in the timing of cash receipts and payments.
As of September 30, 2016, our worldwide holdings of cash, cash equivalents and marketable securities were $5.358 billion, of which $2.445 billion was held by non-U.S. subsidiaries. The amount of cash, cash equivalents and marketable securities held by our U.S. and non-U.S subsidiaries fluctuates throughout the year due to a variety of factors, including the timing of cash receipts and disbursements in the normal course of business. Cash provided by operating activities in the U.S. continues to be our primary source of funds to finance U.S. operating needs, capital expenditures, share repurchases and dividend payments to shareowners. To the extent that such amounts represent previously untaxed earnings, cash, cash equivalents and marketable securities held by non-U.S. subsidiaries could be subject to tax if such amounts were repatriated in the form of dividends; however, not all non-U.S. cash balances would have to be repatriated in the form of a dividend if returned to the U.S. When amounts earned by non-U.S. subsidiaries are expected to be indefinitely reinvested, no accrual for taxes is provided.

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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS




Cash Flows From Investing Activities
Our primary sources (uses) of cash from investing activities were as follows (amounts in millions):
 
Nine Months Ended
September 30,
 
2016
 
2015
Net cash used in investing activities
$
(2,027
)
 
$
(4,959
)
 
 
 
 
Capital Expenditures:
 
 
 
Buildings and facilities
$
(948
)
 
$
(635
)
Aircraft and parts
(20
)
 
(20
)
Vehicles
(547
)
 
(668
)
Information technology
(322
)
 
(325
)
 
$
(1,837
)
 
$
(1,648
)
 
 
 
 
Capital Expenditures as a % of Revenue
(4.2
)%
 
(3.9
)%
 
 
 
 
Other Investing Activities:
 
 
 
Proceeds from disposals of property, plant and equipment
$
76

 
$
14

Net (increase) decrease in finance receivables
$
4

 
$
(11
)
Net (purchases), sales and maturities of marketable securities
$
(212
)
 
$
(1,253
)
Cash paid for business acquisitions, net of cash and cash equivalents acquired
$
(3
)
 
$
(1,925
)
Other investing activities
$
(55
)
 
$
(136
)
We have commitments for the purchase of aircraft, vehicles, equipment and real estate to provide for the replacement of existing capacity and anticipated future growth. We generally fund our capital expenditures with our cash from operations. Capital spending on buildings and facilities increased in the first nine months of 2016 in our U.S. and international package businesses, largely due to several facility automation and capacity expansion projects. Capital spending on information technology was flat in the first nine months of 2016 compared to the corresponding period of 2015 largely due to the timing of purchases of hardware and capitalized software projects. Capital spending on aircraft in both 2016 and 2015 primarily related to purchases of rotable parts for our existing aircraft fleet. Capital spending on vehicles decreased in the first nine months of 2016 in our U.S. and international package businesses, largely due to the timing of vehicle replacements.
Future capital spending will depend on a variety of factors, including economic and industry conditions. We anticipate that our capital expenditures for 2016 will be approximately $2.8 billion, which includes planned purchase deposits for aircraft on order.
The net changes in finance receivables were primarily due to growth in our cargo finance products and loan principal paydowns in our business credit and leasing portfolios. The purchases and sales of marketable securities are largely determined by liquidity needs and the periodic rebalancing of investment types and will fluctuate from period to period.
The cash paid for business acquisitions in 2016 was related to our acquisition of area franchise rights related to The UPS Store. The cash paid for business acquisitions in the first nine months of 2015 was primarily related to our acquisition of Coyote, Poltraf Sp. z.o.o., Parcel Pro, Inc., and the Insured Parcel Services Division of G4S International Logistics. Other investing activities include minority investments in private ventures, capital contributions into certain investment partnerships and changes in restricted cash balances and various other items.
 


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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS




Cash Flows From Financing Activities
Our primary sources (uses) of cash from financing activities are as follows (amounts in millions, except per share data):
 
Nine Months Ended
September 30,
2016
 
2015
Net cash used in financing activities
$
(2,781
)
 
$
(160
)
Share Repurchases:
 
 
 
Cash expended for shares repurchased
$
(2,007
)
 
$
(2,028
)
Number of shares repurchased
(19.5
)
 
(20.2
)
Shares outstanding at period end
873

 
891

Percent reduction in shares outstanding
(1.5
)%
 
(1.5
)%
Dividends:
 
 
 
Dividends declared per share
$
2.34

 
$
2.19

Cash expended for dividend payments
$
(1,987
)
 
$
(1,899
)
Borrowings:
 
 
 
Net borrowings of debt principal
$
1,006

 
$
3,774

Other Financing Activities:
 
 
 
Cash received for common stock issuances
$
196

 
$
194

Other financing activities
$
11

 
$
(201
)
Capitalization (as of September 30 each year):
 
 
 
Total debt outstanding at period end
$
15,326

 
$
14,601

Total shareowners’ equity at period end
2,767

 
1,948

Total capitalization
$
18,093

 
$
16,549

Debt to Total Capitalization %
84.7
 %
 
88.2
 %
We repurchased a total of 19.3 million shares of class A and class B common stock for $2.004 billion in the first nine months of 2016, and 20.2 million shares for $2.035 billion for the first nine months of 2015 ($2.007 and $2.028 billion in repurchases for 2016 and 2015, respectively, are reported on the statements of consolidated cash flows due to unsettled repurchases). During the first quarter of 2016, we also exercised a capped call option that we entered into in 2015 which allowed us to repurchase 0.2 million class B shares. The $25 million premium payment for this capped call option was classified as an other financing activity in 2015. In total, shares repurchased and received year-to-date in 2016 were 19.5 million shares for $2.029 billion.
In May 2016, the Board of Directors approved a new share repurchase authorization of $8.0 billion, which has no expiration date. As of September 30, 2016, we had $6.831 billion of this share repurchase authorization available.
Share repurchases may take the form of accelerated share repurchases, open market purchases or other such methods as we deem appropriate. The timing of our share repurchases will depend upon market conditions. Unless terminated earlier by the resolution of our Board, the program will expire when we have purchased all shares authorized for repurchase under the program. We anticipate repurchasing a total of approximately $2.7 billion of shares in 2016.
The declaration of dividends is subject to the discretion of the Board of Directors and will depend on various factors, including our net income, financial condition, cash requirements, future prospects and other relevant factors. We increased our quarterly cash dividend payment to $0.78 per share in 2016, compared with the previous $0.73 quarterly dividend rate in 2015. We expect to continue the practice of paying regular cash dividends.
Issuances and repayments of debt in the first nine months of 2016 and 2015 consisted primarily of commercial paper and the issuances of $118, $74 and $35 million of floating rate senior notes in March 2016, June 2016 and August 2016, respectively. We consider the overall fixed and floating interest rate mix of our portfolio and the related overall cost of borrowing when planning for future issuances and non-scheduled repayments of debt.

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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS




As of September 30, 2016, our commercial paper programs had $3.759 billion outstanding in a variety of currencies, which includes $2.580 billion and €1.056 billion ($1.179 billion). The average balance of our U.S. dollar denominated commercial paper was $1.343 billion and the average interest rate paid was 0.44% during the nine months ended September 30, 2016. The average balance of our pound sterling denominated commercial paper was £94 million ($123 million) and the average interest rate paid was 0.52% during the nine months ended September 30, 2016. The average balance of our euro denominated commercial paper was €556 million ($621 million) and the average interest rate received was -0.26% during the nine months ended September 30, 2016. The amount of commercial paper outstanding fluctuates throughout the year based on liquidity needs.
The variation in cash received from common stock issuances to employees was primarily due to the level of stock option exercises during the first nine months of 2016 and 2015.
The cash outflows in other financing activities were impacted by several factors. Cash inflows (outflows) from the premium payments and settlements of capped call options for the purchase of UPS class B shares were $ 155 and ($69) million during the first nine months of 2016 and 2015, respectively. Cash outflows related to the repurchase of shares to satisfy tax withholding obligations on vested employee stock awards was $159 and $176 million during the first nine months of 2016 and 2015, respectively.
Sources of Credit
See note 9 to the unaudited consolidated financial statements for a discussion of our available credit and the financial covenants that we are subject to as part of our credit agreements.
Contractual Commitments
We have contractual obligations and commitments for the purchase of aircraft, vehicles, technology equipment and building and leasehold improvements. On October 27, 2016, we placed an order for 14 Boeing 747-8 freighters to be delivered between 2017 and 2020. The agreement also includes an option to purchase an additional 14 747-8 freighters. In addition, we have new purchase commitments for aircraft engines, equipment and hub automation and expansion projects. These new purchase commitments will provide additional capacity for increased demand for our air and ground shipping services. Including these additional obligations, the expected cash outflow to satisfy our total purchase commitments is as follows (in millions): 2016 (remaining) - $466; 2017 - $1,020; 2018 - $1,010; 2019 - $611; 2020 - $347; and thereafter - $65.

Guarantees and Other Off-Balance Sheet Arrangements
We do not have guarantees or other off-balance sheet financing arrangements, including variable interest entities, which we believe could have a material impact on our financial condition or liquidity.
Contingencies
See note 10 and note 6 to the unaudited consolidated financial statements for a discussion of judicial proceedings and other matters arising from the conduct of our business activities, and note 15 for a discussion of income tax related matters.
Collective Bargaining Agreements
Status of Collective Bargaining Agreements
See note 6 to the unaudited consolidated financial statements for a discussion of the status of our collective bargaining agreements.
Multiemployer Benefit Plans
See note 6 to the unaudited consolidated financial statements for a discussion of our participation in multiemployer benefit plans.

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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS




Recent Accounting Pronouncements
Adoption of New Accounting Standards
See note 2 to the unaudited consolidated financial statements for a discussion of recently adopted accounting standards.
Accounting Standards Issued But Not Yet Effective
See note 2 to the unaudited consolidated financial statements for a discussion of accounting standards issued, but not yet effective.


Rate Adjustments
Effective December 26, 2016, UPS Ground service Daily rates will increase by an average net 4.9 percent. UPS Air and International services, including UPS Air Freight Daily rates within and between the U.S., Canada and Puerto Rico, will increase an average net 4.9 percent.
UPS Freight® general rates increased an average net 4.9 percent, effective September 19, 2016.

Item 3.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk from changes in certain commodity prices, foreign currency exchange rates, interest rates and equity prices. All of these market risks arise in the normal course of business, as we do not engage in speculative trading activities. In order to manage the risk arising from these exposures, we utilize a variety of commodity, foreign exchange and interest rate forward contracts, options and swaps. A discussion of our accounting policies for derivative instruments and further disclosures are provided in note 14 to the unaudited consolidated financial statements.
The total fair value asset (liability) of our derivative financial instruments is summarized in the following table (in millions):
 
September 30,
2016
 
December 31,
2015
Currency Derivatives
$
189

 
$
490

Interest Rate Derivatives
275

 
229

Investment Market Price Derivatives
153

 
(4
)
 
$
617

 
$
715

Our market risks, hedging strategies and financial instrument positions at September 30, 2016 have not materially changed from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2015. In 2016, we entered into several foreign currency forwards on the Euro, British Pound Sterling, Canadian Dollar, Japanese Yen, Mexican Peso, Singapore Dollar and Indian Rupee, as well as terminated forwards that expired during the first nine months of 2016. We entered into several foreign currency options on the Euro, British Pound Sterling and Canadian Dollar, as well as terminated currency option positions that expired during the first nine months of 2016. We entered into new forwards to manage the market value fluctuations of certain investments in marketable securities, as well as terminated forwards that expired during the first nine months of 2016. The remaining fair value changes between December 31, 2015 and September 30, 2016 in the preceding table are primarily due to interest rate, foreign currency exchange rate and market price changes between those dates.
The forward contracts, swaps and options previously discussed contain an element of risk that the counterparties may be unable to meet the terms of the agreements; however, we minimize such risk exposures for these instruments by limiting the counterparties to banks and financial institutions that meet established credit guidelines and by monitoring counterparty credit risk to prevent concentrations of credit risk with any single counterparty.

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We have agreements with all of our active counterparties (covering the majority of our derivative positions) containing early termination rights and/or zero threshold bilateral collateral provisions whereby cash is required based on the net fair value of derivatives associated with those counterparties. Events such as a credit rating downgrade (depending on the ultimate rating level) could also allow us to take additional protective measures such as the early termination of trades. Under these agreements, we held cash collateral of $487 million and were not required to post any collateral with our counterparties as of September 30, 2016.
We have not historically incurred, and do not expect to incur in the future, any losses as a result of counterparty default.
The information concerning market risk in Item 7A under the caption “Quantitative and Qualitative Disclosures about Market Risk” of our Annual Report on Form 10-K for the year ended December 31, 2015, is hereby incorporated by reference in this report.

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Item 4.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures:
As of the end of the period covered by this report, management, including our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (“Exchange Act”)). Based upon that evaluation, our chief executive officer and chief financial officer concluded that the disclosure controls and procedures were effective to ensure that information required to be disclosed in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms; and (2) accumulated and communicated to our management to allow their timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting:
There were no changes in the Company’s internal controls over financial reporting during the quarter ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1.
Legal Proceedings
For a discussion of legal proceedings affecting us and our subsidiaries, please see note 10 to the unaudited consolidated financial statements included in this report.
Item 1A.
Risk Factors
There have been no material changes to the risk factors described in Part 1, Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2015 other than as described below.
Employee health and retiree health and pension benefit costs represent a significant expense to us.

UPS was a contributing employer to the Central States Pension Fund (“CSPF”) until 2007 when we withdrew from the plan and fully funded our allocable share of unfunded vested benefits by paying a $6.1 billion withdrawal liability. Under a collective bargaining agreement with the International Brotherhood of Teamsters, UPS agreed to provide coordinating benefits in the UPS/IBT Full Time Employee Pension Plan (“UPS/IBT Plan”) for UPS participants retiring on or after January 1, 2008 in the event that benefits are lawfully reduced by the CSPF in the future.

In December 2014, Congress passed the Multiemployer Pension Reform Act (“MPRA”), which for the first time ever allowed multiemployer pension plans to reduce benefit payments to retirees, subject to specific guidelines in the statute and government oversight. In September 2015, the CSPF submitted a proposed pension benefit reduction plan to the U.S. Department of the Treasury under the MPRA. The CSPF plan proposed to reduce retirement benefits to the CSPF participants, including UPS participants retiring on or after January 1, 2008. We vigorously challenged the proposed benefit reduction plan because we believed that it did not comply with the law and that certain actions by the CSPF were invalid. On May 6, 2016, the U.S. Department of the Treasury rejected the proposed plan submitted by the CSPF, stating that it failed to satisfy a number of requirements set forth in the MPRA.
The CSPF has asserted that it will become insolvent in 2025 which could lead to the reduction of retirement benefits. Although there are numerous factors that could affect the CSPF’s status, if the CSPF were to become insolvent as they have projected , UPS may be required to provide coordinating benefits, thereby increasing the current projected benefit obligation for the UPS/IBT Plan by approximately $4 billion. The CSPF has said that it believes a legislative solution to its funding status is necessary, and we expect that the CSPF will continue to explore options to avoid insolvency.
The potential obligation to pay coordinating benefits from the UPS/IBT Plan is subject to a number of uncertainties, including actions that may be taken by the CSPF, the federal government or others. These actions include whether the CSPF will submit a revised pension benefit reduction plan or otherwise seek federal government assistance, the extent to which benefits are paid by the Pension Benefit Guaranty Corporation, as well as the effect of discount rates and various other actuarial assumptions. The numerous uncertainties that exist regarding the ultimate resolution of the CSPF situation prevent us from making reliable estimates of the timing and amount , if any, of CSPF benefit reductions that could result in additional benefit obligations for the UPS/IBT Plan. Therefore, we have not recognized any liability for additional coordinating benefits of the UPS/IBT Plan, but the current projected benefit obligation could materially increase as these uncertainties are resolved. We will continue to assess the impact of these uncertainties on the projected benefit obligation of the UPS/IBT Plan in accordance with Accounting Standards Codification Topic 715 - Compensation - Retirement Benefits.


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Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
(c) A summary of our repurchases of our class A and class B common stock during the third quarter of 2016 is as follows (in millions, except per share amounts):
 
Total Number
of Shares
Purchased (1)
 
Average
Price Paid
Per Share
 
Total Number
of Shares Purchased
as Part of Publicly
Announced Program
 
Approximate Dollar
Value of Shares that
May Yet be  Purchased
Under the Program
July 1 – July 31, 2016
1.0

 
$
110.04

 
1.0

 
$
7,403

August 1 – August 31, 2016
3.7

 
109.20

 
3.6

 
7,005

September 1– September 30, 2016
1.6

 
108.79

 
1.6

 
6,831

Total July 1 – September 30, 2016
6.3

 
$
—

 
6.2

 
 
_________________ 
(1) 
Includes shares repurchased through our publicly announced share repurchase programs and shares tendered to pay the exercise price and tax withholding on employee stock options. 
In May 2016, the Board of Directors approved a new share repurchase authorization of $8.0 billion, which has no expiration date.
Share repurchases may take the form of accelerated share repurchases, open market purchases, or other such methods as we deem appropriate. The timing of our share repurchases will depend upon market conditions. Unless terminated earlier by the resolution of our Board, the program will expire when we have purchased all shares authorized for repurchase under the program. We anticipate repurchasing a total of approximately $2.7 billion of shares in 2016.

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Item 6.
Exhibits
These exhibits are either incorporated by reference into this report or filed with this report as indicated below.
Index to Exhibits:
 
 
 
3.1

  
—
  
Form of Restated Certificate of Incorporation of United Parcel Service, Inc. (incorporated by reference to Exhibit 3.2 to Form 8-K filed on May 12, 2010).
 
 
 
3.2

  
—
  
Amended and Restated Bylaws of United Parcel Service, Inc. as of February 14, 2013 (incorporated by reference to Exhibit 3.1 to Form 8-K, filed on February 19, 2013).
 
 
 
 
 
4.1

 
—
 
Form of Note for Floating Rate Senior Notes due March 15, 2066 (incorporated by reference to Exhibit 4.1 to Form 8-K filed on April 1, 2016).
 
 
 
 
 
4.2

 
—
 
Form of Note for Floating Rate Senior Notes due March 15, 2066 (incorporated by reference to Exhibit 4.1 to Form 8-K filed on June 15, 2016).
 
 
 
 
 
4.3

 
—
 
Form of Note for Floating Rate Senior Notes due March 15, 2066 (incorporated by reference to Exhibit 4.1 to Form 8-K filed on August 24, 2016).
 
 
 
 
 
4.4

 
—
 
Form of Note for 2.40% Senior Notes Due November 2026 (incorporated by reference to Exhibit 4.2 to Form 8-K filed on October 24, 2016).
 
 
 
 
 
4.5

 
—
 
Form of Note for 3.40% Senior Notes Due November 2046 (incorporated by reference to Exhibit 4.3 to Form 8-K filed on October 24, 2016).
 
 
 
 
 
4.6

 
—
 
Form of Note for 1.00% Senior Notes Due November 2028 (incorporated by reference to Exhibit 4.1 to Form 8-K filed on October 24, 2016).
 
 
 
 
 
10.1

 
—
 
Amendment No. 1 to UPS Retirement Plan, as Amended and Restated, effective as of June 30, 2016 (incorporated by reference to Exhibit 10.1 to Form 10-Q for the Quarter Ended June 20, 2016).

 
 
 
 
 
†10.2

 
—
 
UPS 401(k) Savings Plan, Amendment and Restatement effective as of July 1, 2016.
 
 
 
 
 
11

  
—
  
Statement regarding Computation of per Share Earnings (incorporated by reference to Note 13 in “Item 1. Financial Statements” of this quarterly report on Form 10-Q).
 
 
 
†12

  
—
  
Computation of Ratio of Earnings to Fixed Charges.
 
 
 
†31.1

  
—
  
Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
†31.2

  
—
  
Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
†32.1

  
—
  
Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
†32.2

  
—
  
Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
†101

  
—
  
The following financial information from the Quarterly Report on Form 10-Q for the quarter ended September 30, 2016, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Statements of Consolidated Income, (iii) the Statements of Consolidated Comprehensive Income, (iv) the Statements of Consolidated Cash Flows, and (v) the Notes to the Consolidated Financial Statements.
___________________
†
Filed herewith.


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
UNITED PARCEL SERVICE, INC.
(Registrant)
 
 
 
Date:
November 3, 2016
By:
  
/S/    RICHARD N. PERETZ        
 
 
 
  
Richard N. Peretz
 
 
 
  
Senior Vice President, Chief Financial Officer and Treasurer
(Duly Authorized Officer and
Principal Accounting Officer)



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