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 June 30, 2004, or

 

 

 

o

 

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

 

For the transition period from         to         

 

Commission file number 001-15451

 

United Parcel Service, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware 

 

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   ý   No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes   ý   No o

 

There were 536,604,719 Class A shares, and 587,773,452 Class B shares, with a par value of $0.01 per share, outstanding at August 2, 2004.

 

 



 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

June 30, 2004 (unaudited) and December 31, 2003

(In millions, except per share amounts)

 

 

 

June 30,
2004

 

December 31,
2003

 

Assets

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash & cash equivalents

 

$

3,312

 

$

2,951

 

Marketable securities & short-term investments

 

1,625

 

1,001

 

Accounts receivable, net

 

3,964

 

4,004

 

Finance receivables, net

 

783

 

840

 

Deferred income taxes

 

297

 

316

 

Other current assets

 

631

 

741

 

Total Current Assets

 

10,612

 

9,853

 

Property, Plant & Equipment - at cost, net of accumulated depreciation & amortization of $13,589 and $13,007 in 2004 and 2003

 

14,072

 

13,908

 

Prepaid Pension Costs

 

2,848

 

2,922

 

Goodwill and Intangible Assets, Net

 

1,314

 

1,273

 

Other Assets

 

1,011

 

953

 

 

 

$

29,857

 

$

28,909

 

Liabilities & Shareowners’ Equity

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Current maturities of long-term debt and commerical paper

 

$

805

 

$

674

 

Accounts payable

 

2,022

 

2,003

 

Accrued wages & withholdings

 

1,678

 

1,166

 

Dividends payable

 

 

282

 

Other current liabilities

 

1,288

 

1,393

 

Total Current Liabilities

 

5,793

 

5,518

 

Long-Term Debt

 

3,182

 

3,149

 

Accumulated Postretirement Benefit Obligation, Net

 

1,436

 

1,335

 

Deferred Taxes, Credits & Other Liabilities

 

4,267

 

4,055

 

Shareowners’ Equity:

 

 

 

 

 

Preferred stock, no par value, authorized 200 shares, none issued

 

 

 

Class A common stock, par value $.01 per share, authorized 4,600 shares, issued 545 and 571 in 2004 and 2003

 

5

 

6

 

Class B common stock, par value $.01 per share, authorized 5,600 shares, issued 583 and 560 in 2004 and 2003

 

6

 

5

 

Additional paid-in capital

 

105

 

662

 

Retained earnings

 

15,301

 

14,356

 

Accumulated other comprehensive loss

 

(238

)

(177

)

Deferred compensation arrangements

 

168

 

136

 

 

 

15,347

 

14,988

 

Less: Treasury stock (3 and 2 shares in 2004 and 2003)

 

(168

)

(136

)

 

 

15,179

 

14,852

 

 

 

$

29,857

 

$

28,909

 

 

See notes to unaudited consolidated financial statements.

 

2



 

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME

Three and Six Months Ended June 30, 2004 and 2003

(In millions, except per share amounts)

(unaudited)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

8,871

 

$

8,226

 

$

17,790

 

$

16,241

 

 

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

5,079

 

4,754

 

10,247

 

9,462

 

Other

 

2,482

 

2,392

 

5,016

 

4,754

 

 

 

7,561

 

7,146

 

15,263

 

14,216

 

Operating Profit

 

1,310

 

1,080

 

2,527

 

2,025

 

 

 

 

 

 

 

 

 

 

 

Other Income and (Expense):

 

 

 

 

 

 

 

 

 

Investment income (loss)

 

14

 

10

 

31

 

(28

)

Interest expense

 

(35

)

(38

)

(74

)

(63

)

 

 

(21

)

(28

)

(43

)

(91

)

 

 

 

 

 

 

 

 

 

 

Income before Income Taxes

 

1,289

 

1,052

 

2,484

 

1,934

 

 

 

 

 

 

 

 

 

 

 

Income Taxes

 

471

 

360

 

907

 

631

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

$

818

 

$

692

 

$

1,577

 

$

1,303

 

 

 

 

 

 

 

 

 

 

 

Basic Earnings Per Share

 

$

0.73

 

$

0.61

 

$

1.40

 

$

1.16

 

 

 

 

 

 

 

 

 

 

 

Diluted Earnings Per Share

 

$

0.72

 

$

0.61

 

$

1.39

 

$

1.15

 

 

See notes to unaudited consolidated financial statements.

 

3



 

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREOWNERS’ EQUITY

Six Months Ended June 30, 2004 and 2003

(In millions, except per share amounts)

(unaudited)

 

 

 

2004

 

2003

 

Shares

 

Dollars

Shares

 

Dollars

Class A Common Stock

 

 

 

 

 

 

 

 

 

Beginning balance

 

571

 

$

6

 

642

 

$

7

 

Common stock purchases

 

(7

)

 

(3

)

 

Stock award plans

 

6

 

 

6

 

 

Common stock issuances

 

1

 

 

1

 

 

Conversions of Class A to Class B common stock

 

(26

)

(1

)

(42

)

(1

)

Ending balance

 

545

 

5

 

604

 

6

 

 

 

 

 

 

 

 

 

 

 

Class B Common Stock

 

 

 

 

 

 

 

 

 

Beginning balance

 

560

 

5

 

482

 

4

 

Common stock purchases

 

(3

)

 

(1

)

 

Conversions of Class A to Class B common stock

 

26

 

1

 

42

 

1

 

Ending balance

 

583

 

6

 

523

 

5

 

 

 

 

 

 

 

 

 

 

 

Additional Paid-In Capital

 

 

 

 

 

 

 

 

 

Beginning balance

 

 

 

662

 

 

 

387

 

Stock award plans

 

 

 

114

 

 

 

61

 

Common stock purchases

 

 

 

(745

)

 

 

(198

)

Common stock issuances

 

 

 

74

 

 

 

80

 

Ending balance

 

 

 

105

 

 

 

330

 

 

 

 

 

 

 

 

 

 

 

Retained Earnings

 

 

 

 

 

 

 

 

 

Beginning balance

 

 

 

14,356

 

 

 

12,495

 

Net income

 

 

 

1,577

 

 

 

1,303

 

Dividends ($0.56 and $0.42 per share)

 

 

 

(632

)

 

 

(472

)

Ending balance

 

 

 

15,301

 

 

 

13,326

 

 

 

 

 

 

 

 

 

 

 

Accumulated Other Comprehensive Income (Loss)

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment:

 

 

 

 

 

 

 

 

 

Beginning balance

 

 

 

(56

)

 

 

(328

)

Aggregate adjustment

 

 

 

(112

)

 

 

70

 

Ending balance

 

 

 

(168

)

 

 

(258

)

 

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on marketable securities:

 

 

 

 

 

 

 

 

 

Beginning balance

 

 

 

14

 

 

 

(34

)

Current period changes in fair value (net of tax effect of $(2) and $4)

 

 

 

(3

)

 

 

7

 

Reclassification to earnings (net of tax effect of $0 and $16)

 

 

 

 

 

 

28

 

Ending balance

 

 

 

11

 

 

 

1

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on cash flow hedges:

 

 

 

 

 

 

 

 

 

Beginning balance

 

 

 

(72

)

 

 

(26

)

Current period changes in fair value (net of tax effect of $22 and $(2))

 

 

 

39

 

 

 

(3

)

Reclassification to earnings (net of tax effect of $8 and $(10))

 

 

 

15

 

 

 

(17

)

Ending balance

 

 

 

(18

)

 

 

(46

)

 

 

 

 

 

 

 

 

 

 

Additional minimum pension liability:

 

 

 

 

 

 

 

 

 

Beginning balance

 

 

 

(63

)

 

 

(50

)

Minimum pension liability adjustment

 

 

 

 

 

 

 

Ending balance

 

 

 

(63

)

 

 

(50

)

 

 

 

 

 

 

 

 

 

 

Ending accumulated other comprehensive income (loss)

 

 

 

(238

)

 

 

(353

)

 

 

 

 

 

 

 

 

 

 

Deferred Compensation Obligations

 

 

 

 

 

 

 

 

 

Beginning balance

 

 

 

136

 

 

 

84

 

Common stock held for deferred compensation arrangements

 

 

 

32

 

 

 

51

 

Ending balance

 

 

 

168

 

 

 

135

 

 

 

 

 

 

 

 

 

 

 

Treasury Stock

 

 

 

 

 

 

 

 

 

Beginning balance

 

(2

)

(136

)

(1

)

(84

)

Common stock held for deferred compensation arrangements

 

(1

)

(32

)

(1

)

(51

)

Ending balance

 

(3

)

(168

)

(2

)

(135

)

 

 

 

 

 

 

 

 

 

 

Ending Total Shareowners’ Equity

 

 

 

$

15,179

 

 

 

$

13,314

 

 

 

 

 

 

 

 

 

 

 

Comprehensive Income

 

 

 

$

1,516

 

 

 

$

1,388

 

 

See notes to unaudited consolidated financial statements.

 

4



 

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Six Months Ended June 30, 2004 and 2003

(In millions)

(unaudited)

 

 

 

Six Months Ended
June 30,

 

 

 

2004

 

2003

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

1,577

 

$

1,303

 

Adjustments to reconcile net income to net cash from operating activities:

 

 

 

 

 

Depreciation and amortization

 

771

 

778

 

Postretirement benefits

 

101

 

86

 

Deferred taxes, credits and other

 

191

 

(78

)

Stock award plans

 

312

 

260

 

Loss on disposal of assets

 

3

 

30

 

Loss on investments

 

2

 

60

 

Provision for losses on finance receivables

 

6

 

9

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

40

 

81

 

Other current assets

 

172

 

(231

)

Prepaid pension costs

 

74

 

73

 

Accounts payable

 

(24

)

21

 

Accrued wages and withholdings

 

266

 

219

 

Dividends payable

 

(282

)

(212

)

Income taxes payable

 

(113

)

140

 

Other current liabilities

 

44

 

40

 

Net cash from operating activities

 

3,140

 

2,579

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(989

)

(1,051

)

Disposals of property, plant and equipment

 

78

 

69

 

Purchases of marketable securities and short-term investments

 

(2,627

)

(3,224

)

Sales and maturities of marketable securities and short-term investments

 

1,997

 

2,850

 

Net (increase) decrease in finance receivables

 

158

 

(22

)

Payments for acquisitions, net of cash acquired

 

(87

)

(2

)

Other asset receipts (payments)

 

(54

)

(83

)

Net cash used in investing activities

 

(1,524

)

(1,463

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from borrowings

 

178

 

207

 

Repayments of borrowings

 

(78

)

(786

)

Purchases of common stock

 

(745

)

(198

)

Issuances of common stock

 

104

 

82

 

Dividends

 

(621

)

(472

)

Other transactions

 

(29

)

(26

)

Net cash used in financing activities

 

(1,191

)

(1,193

)

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(64

)

51

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

361

 

(26

)

Cash and cash equivalents:

 

 

 

 

 

Beginning of period

 

2,951

 

2,211

 

End of period

 

$

3,312

 

$

2,185

 

Cash paid during the period for:

 

 

 

 

 

Interest (net of amount capitalized)

 

$

62

 

$

82

 

Income taxes

 

$

950

 

$

591

 

 

See notes to unaudited consolidated financial statements.

 

5



 

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

 

Note 1.  Basis of Presentation

 

In our opinion, the accompanying interim, unaudited, consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly our financial position as of June 30, 2004, our results of operations for the three and six months ended June 30, 2004 and 2003, and cash flows for the six months ended June 30, 2004 and 2003.  The results reported in these consolidated financial statements should not be regarded as necessarily indicative of results that may be expected for the entire year.  The interim financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2003.

 

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

 

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

 

Note 2.  Stock-Based Compensation

 

Effective January 1, 2003, we adopted the fair value measurement provisions of Financial Accounting Standards Board (“FASB”) Statement No. 123 “Accounting for Stock-Based Compensation” (“FAS 123”).  Under the provisions of FASB Statement No. 148 “Accounting for Stock-Based Compensation – Transition and Disclosure,” we have elected to adopt the measurement provisions of FAS 123 using the prospective method.  Under this approach, all stock-based compensation granted subsequent to January 1, 2003 has been expensed to compensation and benefits over the vesting period based on the fair value at the date the stock-based compensation is granted.  Stock compensation awards include stock options, management incentive awards, restricted performance units, and employer matching contributions (in shares of UPS stock) for a defined contribution benefit plan.

 

The following provides pro forma information as to the impact on net income and earnings per share if we had used the fair value measurement provisions of FAS 123 to account for all stock-based compensation awards granted prior to January 1, 2003 (in millions, except per share amounts).

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Net income

 

$

818

 

$

692

 

$

1,577

 

$

1,303

 

Add:

Stock-based employee compensation expense included in net income, net of tax effects

 

142

 

121

 

276

 

234

 

Less: 

Total pro-forma stock-based employee compensation expense, net of tax effects

 

(154

)

(134

)

(301

)

(260

)

Pro-forma net income

 

$

806

 

$

679

 

$

1,552

 

$

1,277

 

Basic earnings per share

 

 

 

 

 

 

 

 

 

 

As reported

 

$

0.73

 

$

0.61

 

$

1.40

 

$

1.16

 

 

Pro forma

 

$

0.72

 

$

0.60

 

$

1.38

 

$

1.13

 

Diluted earnings per share

 

 

 

 

 

 

 

 

 

 

As reported

 

$

0.72

 

$

0.61

 

$

1.39

 

$

1.15

 

 

Pro forma

 

$

0.71

 

$

0.60

 

$

1.36

 

$

1.12

 

 

6



 

Note 3.  New Accounting Pronouncements

 

In January 2003, the FASB issued Interpretation No. 46 “Consolidation of Variable Interest Entities”, to address perceived weaknesses in accounting for entities commonly known as special purpose or off balance sheet.  In addition to numerous FASB Staff Positions written to clarify and improve the application of FIN 46, the FASB recently announced a deferral for certain entities, and an amendment to FIN 46 entitled FASB Interpretation No. 46 (revised December 2003) “Consolidation of Variable Interest Entities” (“FIN 46”).

 

FIN 46 provides guidance for identifying the party with a controlling financial interest resulting from arrangements or financial instruments rather than voting interests.  FIN 46 defines the term “variable interest entity” and is based on the premise that if a business enterprise absorbs a majority of such an entity’s expected losses and/or receives a majority of its expected residual returns, that enterprise has a controlling financial interest, and would thus require consolidation of the variable interest entity.  As of December 31, 2003, we adopted FIN 46, and the effects of adoption were not material to our results of operations or financial condition.

 

On July 1, 2003, we adopted FASB Statement No. 149 “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“FAS 149”).  FAS 149 amends FAS 133 for certain decisions made by the FASB as part of the Derivatives Implementation Group process.  FAS 149 also amends FAS 133 to incorporate clarifications of the definition of a derivative.  The adoption of FAS 149 was not material to our results of operations or financial condition.

 

On July 1, 2003, we adopted FASB Statement No. 150 “Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity” (“FAS 150”).  FAS 150 establishes how an issuer measures certain freestanding financial instruments with characteristics of both liabilities and equity, and requires that such instruments be classified as liabilities.  The adoption of FAS 150 was not material to our results of operations or financial condition.

 

In December 2003, the FASB revised Statement No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits” (“FAS 132”).  The revised standard requires new disclosures in addition to those required by the original standard about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans.  As revised, FAS 132 is effective for financial statements with fiscal years ending after December 15, 2003.  We have included these disclosures in Note 5 – Employee Benefit Plans.

 

On December 8, 2003, the “Medicare Prescription Drug Improvement and Modernization Act of 2003” (“the Act”) was signed into law.  The provisions of the Act provide for a federal subsidy for plans that provide prescription drug benefits and meet certain qualifications.  In May 2004, the FASB issued FASB Staff Position (FSP) No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”, which provides guidance on the accounting for the effects of the Act.  The impact of the Act and the adoption of this FSP will not be material to our financial condition or results of operations.

 

7



 

Note 4.  Property, Plant and Equipment

 

Property plant and equipment as of June 30, 2004 and December 31, 2003 consists of the following (in millions):

 

 

 

June 30,
2004

 

December 31,
2003

 

Vehicles

 

$

3,526

 

$

3,486

 

Aircraft (including aircraft under capitalized leases)

 

11,240

 

10,897

 

Land

 

724

 

721

 

Buildings

 

2,088

 

2,083

 

Leasehold improvements

 

2,244

 

2,219

 

Plant equipment

 

4,481

 

4,410

 

Technology equipment (including capitalized software)

 

2,524

 

2,366

 

Equipment under operating lease

 

64

 

53

 

Construction-in-progress

 

770

 

680

 

 

 

27,661

 

26,915

 

Less:  Accumulated depreciation and amortization

 

(13,589

)

(13,007

)

 

 

$

14,072

 

$

13,908

 

 

Note 5.  Employee Benefit Plans

 

Information about net periodic benefit cost for the pension and postretirement benefit plans is as follows for the three and six months ended June 30, 2004 and 2003 (in millions):

 

 

 

Three Months Ended June 30,

 

Pension Benefits

 

Postretirement
Medical Benefits

2004

 

2003

 

2004

 

2003

Service cost

 

$

85

 

$

70

 

$

23

 

$

20

 

Interest cost

 

131

 

117

 

41

 

38

 

Expected return on assets

 

(200

)

(168

)

(8

)

(8

)

Amortization of:

 

 

 

 

 

 

 

 

 

Transition obligation

 

2

 

2

 

 

 

Prior service cost

 

10

 

10

 

 

 

Actuarial (gain) loss

 

14

 

7

 

7

 

4

 

Net periodic benefit cost

 

$

42

 

$

38

 

$

63

 

$

54

 

 

 

 

Six Months Ended June 30,

 

 

 

Pension Benefits

 

Postretirement
Medical Benefits

 

 

 

2004

 

2003

 

2004

 

2003

 

Service cost

 

$

170

 

$

141

 

$

46

 

$

40

 

Interest cost

 

263

 

233

 

82

 

74

 

Expected return on assets

 

(400

)

(335

)

(17

)

(15

)

Amortization of:

 

 

 

 

 

 

 

 

 

Transition obligation

 

3

 

4

 

 

 

Prior service cost

 

21

 

19

 

 

 

Actuarial (gain) loss

 

28

 

14

 

15

 

8

 

Net periodic benefit cost

 

$

85

 

$

76

 

$

126

 

$

107

 

 

During the first six months of 2004, we contributed $3 and $31 million to our pension and postretirement medical benefit plans, respectively.  We expect to contribute $287 and $95 million over the remainder of the year to the pension and postretirement medical benefit plans, respectively.

 

8



 

Note 6.  Goodwill, Intangibles, and Other Assets

 

Other assets as of June 30, 2004 and December 31, 2003 consist of the following (in millions):

 

 

 

June 30,
2004

 

December 31,
2003

 

Non-current finance receivables, net of allowance for credit losses

 

$

510

 

$

574

 

Other non-current assets

 

501

 

379

 

 

 

$

1,011

 

$

953

 

 

The following table indicates the allocation of goodwill by reportable segment as of June 30, 2004 and December 31, 2003 (in millions):

 

 

 

December 31,
2003

 

Goodwill
Acquired

 

Currency/
Other

 

June 30,
2004

 

Goodwill by Segment:

 

 

 

 

 

 

 

 

 

U.S. domestic package

 

$

 

$

 

$

 

$

 

International package

 

100

 

44

 

(6

)

138

 

Non-package

 

1,073

 

10

 

(6

)

1,077

 

 

 

$

1,173

 

$

54

 

$

(12

)

$

1,215

 

 

The goodwill added in the International segment resulted from the purchase of the remaining 49% minority interest in UPS Yamato Express Co., which was a joint venture with Yamato Transport Co. in Japan.  UPS Yamato Express Co. provides express package delivery services in Japan.  Upon close of the acquisition, UPS Yamato Express Co. became a wholly-owned subsidiary of UPS.  This acquisition had no material effect on our results of operations or financial condition.

 

The following is a summary of intangible assets as of June 30, 2004 and December 31, 2003 (in millions):

 

 

 

Franchise Rights,
Licenses, Patents,
Trademarks,
and Other

 

Intangible
Pension
Asset

 

Total
Intangible
Assets

 

June 30, 2004:

 

 

 

 

 

 

 

Gross carrying amount

 

$

122

 

$

5

 

$

127

 

Accumulated amortization

 

(28

)

 

(28

)

Net carrying value

 

$

94

 

$

5

 

$

99

 

 

 

 

 

 

 

 

 

December 31, 2003:

 

 

 

 

 

 

 

Gross carrying amount

 

$

118

 

$

5

 

$

123

 

Accumulated amortization

 

(23

)

 

(23

)

Net carrying value

 

$

95

 

$

5

 

$

100

 

 

9



 

Note 7.  Deferred Taxes, Credits and Other Liabilities

 

Deferred taxes, credits and other liabilities as of June 30, 2004 and December 31, 2003 consist of the following (in millions):

 

 

 

June 30,
2004

 

December 31,
2003

 

Deferred federal and state income taxes

 

$

2,543

 

$

2,491

 

Insurance reserves

 

1,054

 

923

 

Other credits and non-current liabilities

 

670

 

641

 

 

 

$

4,267

 

$

4,055

 

 

Note 8.  Legal Proceedings and Contingencies

 

On August 9, 1999 the United States Tax Court held that we were liable for tax on income of Overseas Partners Ltd., a Bermuda company that had reinsured excess value (“EV”) package insurance purchased by our customers beginning in 1984, and that we were liable for additional tax for the 1983 and 1984 tax years.  The IRS took similar positions to those advanced in the Tax Court decision for tax years subsequent to 1984 through 1998.  On June 20, 2001, the U.S. Court of Appeals for the Eleventh Circuit ruled in our favor and reversed the Tax Court decision.  In January 2003, we and the IRS finalized settlement of all outstanding tax issues related to EV package insurance.  Under the terms of settlement, we agreed to adjustments that will result in income tax due of approximately $562 million, additions to tax of $60 million and related interest.  The amount due to the IRS as a result of the settlement is less than amounts we previously had accrued, and less than amounts we had previously paid to the IRS.  As a result, we recorded income, before taxes, of $1.023 billion ($776 million after tax) during the fourth quarter of 2002.  In the first quarter of 2004, we received a refund of $185 million pertaining to the 1983 and 1984 tax years.  The remaining refunds and credits associated with this settlement are expected to be received over the next several years.

 

We are named as a defendant in twenty-three pending lawsuits that seek to hold us liable for the collection of premiums for EV insurance in connection with package shipments since 1984.  Based on state and federal tort, contract and statutory claims, these cases generally claim that we failed to remit collected EV premiums to an independent insurer; we failed to provide promised EV insurance; we acted as an insurer without complying with state insurance laws and regulations; and the price for EV insurance was excessive.  These actions were all filed after the August 9, 1999 U.S. Tax Court decision, discussed above, which the U.S. Court of Appeals for the Eleventh Circuit later reversed.

 

These twenty-three cases have been consolidated for pre-trial purposes in a multi-district litigation proceeding (“MDL Proceeding”) in federal court in New York.  In addition to the cases in which UPS is named as a defendant, there also is an action, Smith v. Mail Boxes Etc., against Mail Boxes Etc. and its franchisees relating to UPS EV insurance and related services purchased through Mail Boxes Etc. centers.  This case also has been consolidated into the MDL Proceeding.

 

In late 2003, the parties reached a global settlement resolving all claims and all cases in the MDL proceeding.  In reaching the settlement, we and the other defendants expressly deny any and all liability.  On July 30, 2004, the court issued an order granting final approval to the substantive terms of the settlement.  The settlement will only become effective after the time for the filing of an appeal has passed, if no appeal is filed, or, if any appeal is filed, if and after it is rejected.

 

If the proposed settlement becomes final, we would provide qualifying settlement class members with vouchers toward the purchase of specified UPS services and would pay a portion of the plaintiffs’ attorneys’ fees, the total amount of which will be determined by the court.  The ultimate cost to us of the proposed settlement will depend on a number of factors, including how many vouchers settlement class members actually request and use.  We do not believe that this proposed settlement will have a material effect on our financial condition, results of operations, or liquidity.

 

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

 

We participate in a number of trustee-managed multi-employer pension and health and welfare plans for employees covered under collective bargaining agreements.  Several factors could result in higher future contributions to these plans, including unfavorable investment performance, changes in demographics, and increased benefits to participants.  At this time, we are unable to determine the amount of additional future contributions, if any, or whether any material adverse effect on our financial condition, results of operations, or cash flows could result from our participation in these plans.

 

10



 

Note 9.  Segment Information

 

We report our operations in three segments: U.S. domestic package operations, international package operations and non-package operations, as follows:

 

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 200 countries and territories worldwide, including shipments wholly outside the U.S. as well as shipments with either origin or distribution outside the U.S.  Our international package reporting segment includes the operations of our Europe, Asia-Pacific, Canada, and Americas operating segments.

 

Non-Package – Non-package operations include UPS Supply Chain Solutions, Mail Boxes Etc. (the franchisor of Mail Boxes Etc. and The UPS Store), UPS Capital Corp., our mail and consulting services, and our excess value package insurance business.  UPS Supply Chain Solutions, which is comprised of our former UPS Freight Services and UPS Logistics Group businesses, provides supply chain design and management, freight forwarding, and customs brokerage services.

 

Segment information for the three and six months ended June 30, 2004 and 2003 is as follows (in millions):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Revenue:

 

 

 

 

 

 

 

 

 

U.S. domestic package

 

$

6,480

 

$

6,124

 

$

13,020

 

$

12,144

 

International package

 

1,613

 

1,371

 

3,232

 

2,673

 

Non-package

 

778

 

731

 

1,538

 

1,424

 

Consolidated

 

$

8,871

 

$

8,226

 

$

17,790

 

$

16,241

 

 

 

 

 

 

 

 

 

 

 

Operating profit:

 

 

 

 

 

 

 

 

 

U.S. domestic package

 

$

892

 

$

832

 

$

1,723

 

$

1,536

 

International package

 

272

 

158

 

541

 

292

 

Non-package

 

146

 

90

 

263

 

197

 

Consolidated

 

$

1,310

 

$

1,080

 

$

2,527

 

$

2,025

 

 

Non-package operating profit included $32 and $26 million for the three months, and $58 and $54 million for the six months ended June 30, 2004 and 2003, respectively, of intersegment profit, with a corresponding amount of operating expense, which reduces operating profit, included in the U.S. domestic package segment.

 

11



 

Note 10.  Other Operating Expenses

 

The major components of other operating expenses for the three and six months ended June 30, 2004 and 2003 are as follows (in millions):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

2004

 

2003

 

2004

 

2003

 

Repairs and maintenance

 

$

253

 

$

246

 

$

504

 

$

475

 

Depreciation and amortization

 

385

 

391

 

771

 

778

 

Purchased transportation

 

474

 

425

 

955

 

850

 

Fuel

 

320

 

249

 

620

 

513

 

Other occupancy

 

170

 

175

 

379

 

372

 

Other expenses

 

880

 

906

 

1,787

 

1,766

 

Consolidated

 

$

2,482

 

$

2,392

 

$

5,016

 

$

4,754

 

 

Note 11.  Earnings Per Share

 

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

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

2004

 

2003

 

2004

 

2003

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income

 

$

818

 

$

692

 

$

1,577

 

$

1,303

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted-average shares

 

1,126

 

1,125

 

1,127

 

1,124

 

Deferred compensation arrangements

 

2

 

2

 

2

 

2

 

Denominator for basic earnings per share

 

1,128

 

1,127

 

1,129

 

1,126

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Contingent shares -

 

 

 

 

 

 

 

 

 

Management incentive awards

 

5

 

5

 

4

 

4

 

Stock option plans

 

4

 

4

 

5

 

6

 

Denominator for diluted earnings per share

 

1,137

 

1,136

 

1,138

 

1,136

 

 

 

 

 

 

 

 

 

 

 

Basic Earnings Per Share

 

$

0.73

 

$

0.61

 

$

1.40

 

$

1.16

 

 

 

 

 

 

 

 

 

 

 

Diluted Earnings Per Share

 

$

0.72

 

$

0.61

 

$

1.39

 

$

1.15

 

 

12



 

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

 

Revenue, Volume and Revenue Per Piece

 

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

 

 

 

Three Months Ended
June 30,

 

Change

 

 

 

2004

 

2003

 

$

 

%

 

Revenue (in millions):

 

 

 

 

 

 

 

 

 

U.S. domestic package:

 

 

 

 

 

 

 

 

 

Next Day Air

 

$

1,492

 

$

1,387

 

$

105

 

7.6

%

Deferred

 

734

 

716

 

18

 

2.5

 

Ground

 

4,254

 

4,021

 

233

 

5.8

 

Total U.S. domestic package

 

6,480

 

6,124

 

356

 

5.8

 

International package:

 

 

 

 

 

 

 

 

 

Domestic

 

318

 

274

 

44

 

16.1

 

Export

 

1,183

 

992

 

191

 

19.3

 

Cargo

 

112

 

105

 

7

 

6.7

 

Total International package

 

1,613

 

1,371

 

242

 

17.7

 

Non-package:

 

 

 

 

 

 

 

 

 

UPS Supply Chain Solutions

 

568

 

530

 

38

 

7.2

 

Other

 

210

 

201

 

9

 

4.5

 

Total Non-package

 

778

 

731

 

47

 

6.4

 

Consolidated

 

$

8,871

 

$

8,226

 

$

645

 

7.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

#

 

 

 

Average Daily Package Volume

 

 

 

 

 

 

 

 

 

(in thousands):

 

 

 

 

 

 

 

 

 

U.S. domestic package:

 

 

 

 

 

 

 

 

 

Next Day Air

 

1,181

 

1,179

 

2

 

0.2

%

Deferred

 

832

 

862

 

(30

)

(3.5

)

Ground

 

10,252

 

9,776

 

476

 

4.9

 

Total U.S. domestic package

 

12,265

 

11,817

 

448

 

3.8

 

International package:

 

 

 

 

 

 

 

 

 

Domestic

 

784

 

742

 

42

 

5.7

 

Export

 

521

 

461

 

60

 

13.0

 

Total International package

 

1,305

 

1,203

 

102

 

8.5

 

Consolidated

 

13,570

 

13,020

 

550

 

4.2

%

 

 

 

 

 

 

 

 

 

 

Operating days in period

 

64

 

64

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

 

 

Average Revenue Per Piece:

 

 

 

 

 

 

 

 

 

U.S. domestic package:

 

 

 

 

 

 

 

 

 

Next Day Air

 

$

19.74

 

$

18.38

 

$

1.36

 

7.4

%

Deferred

 

13.78

 

12.98

 

0.80

 

6.2

 

Ground

 

6.48

 

6.43

 

0.05

 

0.8

 

Total U.S. domestic package

 

8.26

 

8.10

 

0.16

 

2.0

 

International package:

 

 

 

 

 

 

 

 

 

Domestic

 

6.34

 

5.77

 

0.57

 

9.9

 

Export

 

35.48

 

33.62

 

1.86

 

5.5

 

Total International package

 

17.97

 

16.44

 

1.53

 

9.3

 

Consolidated

 

$

9.19

 

$

8.87

 

$

0.32

 

3.6

%

 

13



 

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

 

 

 

Six Months Ended
June 30,

 

Change

 

 

 

2004

 

2003

 

$

 

%

 

Revenue (in millions):

 

 

 

 

 

 

 

 

 

U.S. domestic package:

 

 

 

 

 

 

 

 

 

Next Day Air

 

$

2,962

 

$

2,740

 

$

222

 

8.1

%

Deferred

 

1,498

 

1,414

 

84

 

5.9

 

Ground

 

8,560

 

7,990

 

570

 

7.1

 

Total U.S. domestic package

 

13,020

 

12,144

 

876

 

7.2

 

International package:

 

 

 

 

 

 

 

 

 

Domestic

 

654

 

540

 

114

 

21.1

 

Export

 

2,364

 

1,932

 

432

 

22.4

 

Cargo

 

214

 

201

 

13

 

6.5

 

Total International package

 

3,232

 

2,673

 

559

 

20.9

 

Non-package:

 

 

 

 

 

 

 

 

 

UPS Supply Chain Solutions

 

1,131

 

1,030

 

101

 

9.8

 

Other

 

407

 

394

 

13

 

3.3

 

Total Non-package

 

1,538

 

1,424

 

114

 

8.0

 

Consolidated

 

$

17,790

 

$

16,241

 

$

1,549

 

9.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

#

 

 

 

Average Daily Package Volume

 

 

 

 

 

 

 

 

 

(in thousands):

 

 

 

 

 

 

 

 

 

U.S. domestic package:

 

 

 

 

 

 

 

 

 

Next Day Air

 

1,175

 

1,157

 

18

 

1.6

%

Deferred

 

863

 

853

 

10

 

1.2

 

Ground

 

10,322

 

9,828

 

494

 

5.0

 

Total U.S. domestic package

 

12,360

 

11,838

 

522

 

4.4

 

International package:

 

 

 

 

 

 

 

 

 

Domestic

 

797

 

759

 

38

 

5.0

 

Export

 

519

 

466

 

53

 

11.4

 

Total International package

 

1,316

 

1,225

 

91

 

7.4

 

Consolidated

 

13,676

 

13,063

 

613

 

4.7

%

 

 

 

 

 

 

 

 

 

 

Operating days in period

 

128

 

127

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

 

 

Average Revenue Per Piece:

 

 

 

 

 

 

 

 

 

U.S. domestic package:

 

 

 

 

 

 

 

 

 

Next Day Air

 

$

19.69

 

$

18.65

 

$

1.04

 

5.6

%

Deferred

 

13.56

 

13.05

 

0.51

 

3.9

 

Ground

 

6.48

 

6.40

 

0.08

 

1.3

 

Total U.S. domestic package

 

8.23

 

8.08

 

0.15

 

1.9

 

International package:

 

 

 

 

 

 

 

 

 

Domestic

 

6.41

 

5.60

 

0.81

 

14.5

 

Export

 

35.59

 

32.65

 

2.94

 

9.0

 

Total International package

 

17.92

 

15.89

 

2.03

 

12.8

 

Consolidated

 

$

9.16

 

$

8.81

 

$

0.35

 

4.0

%

 

14



 

Operating Profit

 

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

 

 

 

Three Months Ended
June 30,

 

Change

 

2004

 

2003

 

$

 

%

 

Operating Segment

 

 

 

 

 

 

 

 

 

U.S. domestic package

 

$

892

 

$

832

 

$

60

 

7.2

%

International package

 

272

 

158

 

114

 

72.2

 

Non-package

 

146

 

90

 

56

 

62.2

 

Consolidated Operating Profit

 

$

1,310

 

$

1,080

 

$

230

 

21.3

%

 

 

 

Six Months Ended
June 30,

 

Change

 

2004

 

2003

 

$

 

%

 

Operating Segment

 

 

 

 

 

 

 

 

 

U.S. domestic package

 

$

1,723

 

$

1,536

 

$

187

 

12.2

%

International package

 

541

 

292

 

249

 

85.3

 

Non-package

 

263

 

197

 

66

 

33.5

 

Consolidated Operating Profit

 

$

2,527

 

$

2,025

 

$

502

 

24.8

%

 

U.S. Domestic Package Operations

 

U.S. domestic package revenue increased $356 million, or 5.8%, for the quarter ($876 million, or 7.2%, year-to-date), which was driven by a 3.8% increase in average daily package volume and a 2.0% increase in revenue per piece.  Ground volume increased 4.9% during the quarter, driven in part by the improving U.S. economy.  Next Day Air volume increased 0.2%, due to solid growth in package volume which reflected the improved economy.  However, both Next Day Air and deferred volume were significantly affected by declines in letter volume influenced by the slowdown in mortgage refinancing.

 

Ground revenue per piece increased 0.8% for the quarter primarily due to the impact of a rate increase (described below) that took effect in 2004, but was adversely impacted by the removal of the fuel surcharge on ground products, as discussed below.  The removal of the fuel surcharge on ground products reduced the growth rate of ground revenue per piece by 180 basis points.  Next Day Air revenue per piece increased 7.4%, while deferred revenue per piece increased 6.2%, primarily due to the shift in product mix from letters to packages, the rate increase, and the modified fuel surcharge on domestic air products.

 

On January 5, 2004, a rate increase took effect which was in line with previous years’ rate increases.  We increased rates for standard ground shipments an average of 1.9% for commercial deliveries.  The ground residential surcharge increased $0.25 to $1.40 over the commercial ground rate.  An additional delivery area surcharge of $1.00 was implemented for commercial deliveries in certain ZIP codes.  Rates for UPS Hundredweight increased 5.9%.  In addition, we increased rates for UPS Next Day Air an average of 2.9% and increased rates for deferred services by 2.9%.  Rates for international shipments originating in the United States (Worldwide Express, Worldwide Express Plus, UPS Worldwide Expedited and UPS International Standard service) increased an average of 3.5%.

 

In addition, we discontinued the fuel surcharge on ground products, while we began to apply a new indexed surcharge to domestic air products.  This new fuel surcharge for the domestic air products is based on the U.S. Energy Department’s Gulf Coast spot price for a gallon of kerosene-type jet fuel.  Based on published rates, the average fuel surcharge applied to our air products during the second quarter of 2004 was 5.83% (5.60% year-to-date), compared with the average surcharge of 1.80% applied to both air and ground products in 2003 (1.57% year-to-date), resulting in an increase in domestic fuel surcharge revenue of $19 million during the quarter ($56 million year-to-date).

 

U.S. domestic package operating profit increased $60 million, or 7.2% ($187 million, or 12.2%, year-to-date), primarily due to the increase in volume and revenue growth, combined with an improved operating margin resulting from better utilization of our delivery network.

 

15



 

International Package Operations

 

International package revenue improved $242 million, or 17.7%, for the quarter ($559 million, or 20.9% year-to-date) primarily due to the 13.0% volume growth for our export products and strong revenue per piece improvements, a portion of which can be attributed to the impact of currency fluctuations.  Revenue increased $52 million during the quarter ($153 million year-to-date) due to currency fluctuations.  Revenue growth was also impacted by the change to our fuel surcharge, discussed below, as well as rate changes, which vary by geographical market and occur throughout the year.

 

In January 2004, changes were made to the calculation of our fuel surcharge on international products (including U.S. export products).  The new surcharge is indexed to fuel prices in our different international regions, depending on where the shipment takes place.  The new surcharge is only applied to our international express products, while the previous surcharge was applied to all international products.  These changes, along with higher fuel prices, had the effect of increasing international package revenue by $34 million during the quarter ($73 million year-to-date).

 

We experienced double-digit export volume growth in each region throughout the world, with Asia-Pacific showing 17% export volume growth, and Europe and U.S.-origin export volume growth in excess of 11%.  Domestic volume increased 5.7% for the quarter, representing the third consecutive quarter of strong growth, and primarily reflects improvements in our European domestic delivery business.

 

Export revenue per piece increased 5.5% for the quarter (1.3% currency-adjusted), benefiting from rate increases and the impact of the fuel surcharge, but was negatively impacted by changes in product mix.  In total, international average daily package volume increased 8.5% and average revenue per piece increased 9.3% (4.6% currency-adjusted).

 

The improvement in operating profit for our international package operations was $114 million, or 72.2%, for the quarter ($249 million, or 85.3%, year-to-date), $14 million of which was due to favorable currency fluctuations ($28 million year-to-date).  This increase in operating profit was primarily due to the strong export volume growth and revenue per piece increases described previously, and a strong increase in operating margin through better network utilization.

 

Non-Package Operations

 

Non-package revenue increased $47 million, or 6.4%, for the quarter ($114 million, or 8.0%, year-to-date).  UPS Supply Chain Solutions increased revenue by 7.2% during the quarter (9.8% year-to-date) with the strongest growth coming in our supply chain management and air freight businesses.  Favorable currency fluctuations provided $12 million of the increase in revenue for the quarter ($38 million year-to-date).  The remainder of our non-package operations, which includes Mail Boxes Etc. (the franchisor of Mail Boxes Etc. and The UPS Store), UPS Capital Corporation, our mail and consulting services, and our excess value package insurance business, increased revenue by 4.5% for the quarter (3.3% year-to-date), primarily due to strong double-digit franchise revenue growth at Mail Boxes Etc.

 

Non-package operating profit increased $56 million, or 62.2%, for the quarter ($66 million, or 33.5%, year-to-date).  This increase was affected by a $24 million loss recognized in 2003 on the sale of our former Mail Technologies business.  The remainder of the profit increase was primarily due to higher operating profit from our Supply Chain Solutions unit, our mail services unit, and our excess value insurance business.  Supply Chain Solutions operating profit was driven by the increase in revenue as well as continued operating margin expansion.  Mail Boxes Etc. also contributed strong profit growth, due to the increased franchise revenue noted previously.  Non-package operating profit includes $32 million (compared to $26 million in 2003) of intersegment profit for the quarter, with a corresponding amount of operating expense, which reduces operating profit, in the U.S. domestic package segment.

 

During the second quarter of 2003, we sold our Mail Technologies business unit in a transaction that increased net income by $14 million, or $0.01 per diluted share.  The gain consisted of a pre-tax loss of $24 million recorded in other operating expenses within the non-package segment, and a tax benefit of $38 million recognized in conjunction with the sale.  The tax benefit exceeds the pre-tax loss from this sale primarily because the goodwill impairment charge we previously recorded for the Mail Technologies business unit was not deductible for income tax purposes.  Consequently, our tax basis was greater than our book basis, thus producing the tax benefit described above.  The operating results of our Mail Technologies unit were previously included in our non-package segment, and were not material to non-package operating results in any of the periods presented.

 

Operating Expenses and Operating Margin

 

Consolidated operating expenses increased by $415 million, or 5.8%, for the quarter ($1.047 billion, or 7.4%, year-to-date), $51 million of which was due to currency fluctuations in our international package and non-package segments ($162 million year-to-date).  Compensation and benefits increased by $325 million, or 6.8%, for the quarter ($785 million, or 8.3%, year-to-date), largely due to increased health and welfare benefit costs and higher pension expense.  Stock-based compensation expense increased $21 million, or 17.4%, in the second quarter ($42 million, or 17.9%, year-to-date), primarily as a result of increased

 

16



 

management incentive awards expense and adopting the measurement provisions of FAS 123 beginning with 2003 stock-based compensation awards.

 

Other operating expenses increased by $90 million, or 3.8%, for the quarter ($262 million, or 5.5%, year-to-date), largely due to a 28.5% increase in fuel expense and an 11.5% increase in purchased transportation, but were somewhat offset by declines in depreciation and amortization and other expenses.  The increase in fuel expense was primarily due to higher prices for Jet-A, diesel, and unleaded gasoline.  The increase in purchased transportation expense was influenced by the impact of currency and volume growth in our international package business, as well as growth at our Supply Chain Solutions business.  The decline in depreciation and amortization for the quarter was impacted by lower depreciation expense on aircraft and engines, largely due to the recent retirement of some older aircraft.  The decline in other expenses was primarily due to the $24 million loss on the sale of our former Mail Technologies business in the second quarter of 2003.

 

Our operating margin, defined as operating profit as a percentage of revenue, increased in each segment during the second quarter.  The operating margins for our three business segments were as follows:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

2004

 

2003

 

2004

 

2003

 

Operating Segment

 

 

 

 

 

 

 

 

 

U.S. domestic package

 

13.8

%

13.6

%

13.2

%

12.6

%

International package

 

16.9

%

11.5

%

16.7

%

10.9

%

Non-package

 

18.8

%

12.3

%

17.1

%

13.8

%

Consolidated

 

14.8

%

13.1

%

14.2

%

12.5

%

 

Investment Income/Interest Expense

 

Investment income increased by $4 million during the second quarter, primarily due to higher interest-earning cash balances during 2004 compared to 2003.  The year-to-date increase in investment income of $59 million was primarily due to a $58 million impairment charge recognized during the first quarter of 2003.  We periodically review our investments for indications of other than temporary impairment considering many factors, including the extent and duration to which a security’s fair value has been less than its cost, overall economic and market conditions, and the financial condition and specific prospects for the issuer.  During the first quarter of 2003, after considering the continued decline in the U.S. equity markets, we recognized an impairment charge of $58 million, primarily related to our investment in S&P 500 equity portfolios.

 

 The $3 million decrease in interest expense during the second quarter was primarily due to lower average debt balances outstanding as well as the impact of lower interest rates on certain interest rate swaps.  The year-to-date increase in interest expense of $11 million was affected by imputed interest expense associated with certain investments, currency exchange rates, and a lower amount of capitalized interest during 2004.

 

Net Income and Earnings Per Share

 

Net income for the second quarter of 2004 was $818 million, an 18.2% increase from the $692 million achieved in the second quarter of 2003, resulting in an increase in diluted earnings per share from $0.61 in 2003 to $0.72 in 2004.  Net income in the second quarter of 2003 was favorably impacted by $14 million, or $0.01 per diluted share, due to the sale of our former Mail Technologies business unit.

 

Year-to-date 2004 net income was $1.577 billion, a 21.0% increase from the $1.303 billion in the first six months of 2003, resulting in an increase in diluted earnings per share from $1.15 in 2003 to $1.39 in 2004.  Net income in the first six months of 2003 was favorably impacted by a reduction in income tax expense of $55 million ($0.05 per diluted share) due to the resolution of various tax issues with the Internal Revenue Service, and by $14 million ($0.01 per diluted share) due to the sale of our former Mail Technologies business unit.  Net income in 2003 was adversely impacted by the $58 million ($37 million after-tax, or $0.03 per diluted share) investment impairment charge described previously.

 

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Liquidity and Capital Resources

 

Net Cash From Operating Activities

 

Net cash provided by operating activities increased to $3.140 billion in the first six months of 2004 from $2.579 billion during 2003, largely due to higher net income and the receipt of an income tax refund of $185 million associated with the resolution of the excess value (“EV”) tax case discussed in Note 8 to the unaudited consolidated financial statements.  As discussed in Note 5 to the unaudited consolidated financial statements, we expect to contribute $287 and $95 million over the remainder of the year to our pension and postretirement medical benefit plans, respectively.

 

In November 2003, we announced rate increases, which took effect on January 5, 2004.  The overall impact is in line with previous years’ rate increases.  We increased rates for standard ground shipments an average of 1.9% for commercial deliveries.  The ground residential surcharge increased $0.25 to $1.40 over the commercial ground rate.  An additional delivery area surcharge of $1.00 was implemented for commercial deliveries in certain ZIP codes.  Rates for UPS Hundredweight increased 5.9%.  In addition, we increased rates for UPS Next Day Air an average of 2.9% and increased rates for deferred services by 2.9%.  Rates for international shipments originating in the United States (Worldwide Express, Worldwide Express Plus, UPS Worldwide Expedited and UPS International Standard service) increased an average of 3.5%.  Rate changes for shipments originating outside the U.S. were made throughout the past year and varied by geographic market.

 

In addition, we discontinued the fuel surcharge on ground service, while a new indexed surcharge is being applied to our Next Day Air, deferred products, and international services.  This new fuel surcharge for the domestic air products is based on the U.S. Energy Department’s Gulf Coast spot price for a gallon of kerosene-type jet fuel.  The index for shipments originating in Europe is based on the Rotterdam ARA spot price of kerosene-type jet fuel.

 

Net Cash Used In Investing Activities

 

Net cash used in investing activities increased to $1.524 billion in the first six months of 2004 from $1.463 billion during 2003, primarily due to increased purchases (net of sales and maturities) of marketable securities and short-term investments resulting from our improved free cash flow, but was somewhat offset by loan sales and principal repayments in our finance receivables portfolio and slightly reduced capital expenditures.  We anticipate capital expenditures of approximately $2.2 billion in 2004.  These expenditures will provide for replacement of existing capacity and anticipated future growth and include the projected cost of capitalized software.  We fund our capital expenditures with our cash from operations.

 

Net Cash Used In Financing Activities

 

Net cash used in financing activities decreased to $1.191 billion in the first six months of 2004 from $1.193 billion during 2003, primarily due to lower repayments of debt, which was mostly offset with increased repurchases of stock and higher cash dividends.  Our primary use of cash in financing activities has been to repay long-term debt, repurchase stock, and pay dividends.  During the first half of 2004, we repaid $78 million in debt, primarily consisting of UPS Notes and principal payments on our capitalized lease obligations.  Issuances of debt consisted primarily of UPS Notes and short-term borrowings under our commercial paper program, and totaled $178 million for the six months ended June 30, 2004.  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.

 

In May 2004, a total of $1.0 billion was authorized for share repurchases as part of our continuing share repurchase program.  We repurchased a total of $745 and $198 million of common stock in first half of 2004 and 2003, respectively.  As of June 30, 2004, we had $824 million of this authorization available for future share repurchases.

 

We increased our cash dividend payments to $0.56 per share in the first six months of 2004 from $0.42 per share in the same period of 2003, resulting in an increase in total cash dividends paid to $621 million from $472 million.  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 expect to continue the practice of paying regular cash dividends.

 

Sources of Credit

 

We maintain two commercial paper programs under which we are authorized to borrow up to $7.0 billion.  Approximately $645 million was outstanding under these programs as of June 30, 2004, with an average interest rate of 1.03%.  The entire balance outstanding has been classified as a current liability in our

 

18



 

balance sheet.  In addition, we maintain an extendible commercial notes program under which we are authorized to borrow up to $500 million.  No amounts were outstanding under this program at June 30, 2004.

 

We maintain two credit agreements with a consortium of banks.  These agreements provide revolving credit facilities of $1.0 billion each, with one expiring on April 21, 2005 and the other on April 24, 2008.  Interest on any amounts we borrow under these facilities would be charged at 90-day LIBOR plus 15 basis points.  There were no borrowings under either of these agreements as of June 30, 2004.

 

We also maintain a $1.0 billion European medium-term note program.  Under this program, we may issue notes from time to time, denominated in a variety of currencies.  No amounts were outstanding under this program at June 30, 2004.

 

In August 2003, we filed a $2.0 billion shelf registration statement under which we may issue debt securities in the United States.  There was approximately $126 million issued under this shelf registration statement at June 30, 2004, all of which consists of issuances under our UPS Notes program.

 

Commitments & Contingencies

 

We have contractual obligations and commitments in the form of operating leases, capital leases, debt obligations, and purchase commitments.  We intend to satisfy these obligations through the use of cash flow from operations.

 

We believe that funds from operations and borrowing programs will provide adequate sources of liquidity and capital resources to meet our expected current and long-term needs for the operation of our business, including anticipated capital expenditures such as commitments for aircraft purchases, through 2009.

 

On August 9, 1999 the United States Tax Court held that we were liable for tax on income of Overseas Partners Ltd., a Bermuda company that had reinsured EV insurance purchased by our customers beginning in 1984, and that we were liable for additional tax for the 1983 and 1984 tax years.  The IRS took similar positions to those advanced in the Tax Court decision for tax years subsequent to 1984 through 1998.  On June 20, 2001, the U.S. Court of Appeals for the Eleventh Circuit ruled in our favor and reversed the Tax Court decision.  In January 2003, we and the IRS finalized settlement of all outstanding tax issues related to EV package insurance.  Under the terms of settlement, we agreed to adjustments that will result in income tax due of approximately $562 million, additions to tax of $60 million and related interest.  The amount due to the IRS as a result of the settlement is less than amounts we previously had accrued, and less than amounts we had previously paid to the IRS.  As a result, we recorded income, before taxes, of $1.023 billion ($776 million after tax) during the fourth quarter of 2002.  In the first quarter of 2004, we received a refund of $185 million pertaining to the 1983 and 1984 tax years.  The remaining refunds and credits associated with this settlement are expected to be received over the next several years.

 

We are named as a defendant in twenty-three pending lawsuits that seek to