Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2008, 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

LOGO

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 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 ¨	Smaller reporting company ¨
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ

There were 325,959,379 Class A shares, and 682,203,862 Class B shares, with a par value of $0.01 per share, outstanding at July 31, 2008.

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

June 30, 2008 (unaudited) and December 31, 2007

(In millions)


	June 30, 2008			December 31, 2007
ASSETS
Current Assets:
Cash and cash equivalents	$	1,178		$	2,027
Marketable securities and short-term investments		511			577
Accounts receivable, net		5,946			6,084
Finance receivables, net		524			468
Deferred income tax assets		524			606
Income taxes receivable		252			1,256
Other current assets		989			742

Total Current Assets		9,924			11,760
Property, Plant and Equipment, Net		18,213			17,663
Pension and Postretirement Benefit Assets		4,497			4,421
Goodwill		2,616			2,577
Intangible Assets, Net		604			628
Long-Term Finance Receivables, Net		465			431
Other Non-Current Assets		1,737			1,562

	$	38,056		$	39,042

LIABILITIES AND SHAREOWNERS’ EQUITY
Current Liabilities:
Current maturities of long-term debt and commercial paper	$	3,621		$	3,512
Accounts payable		2,284			1,819
Accrued wages and withholdings		1,670			1,414
Dividends payable		—			440
Self-insurance reserves		713			704
Other current liabilities		1,679			1,951

Total Current Liabilities		9,967			9,840
Long-Term Debt		7,233			7,506
Pension and Postretirement Benefit Obligations		4,730			4,438
Deferred Income Tax Liabilities		2,512			2,620
Self-Insurance Reserves		1,708			1,651
Other Non-Current Liabilities		886			804
Shareowners’ Equity:
Class A common stock (330 and 349 shares issued in 2008 and 2007)		3			3
Class B common stock (681 and 694 shares issued in 2008 and 2007)		7			7
Additional paid-in capital		—			—
Retained earnings		12,841			14,186
Accumulated other comprehensive loss		(1,831	)		(2,013	)
Deferred compensation obligations		119			137

		11,139			12,320
Less: Treasury stock (2 shares in 2008 and 2007)		(119	)		(137	)

Total Shareowners’ Equity		11,020			12,183

Total Liabilities and Shareowners’ Equity	$	38,056		$	39,042

See notes to unaudited consolidated financial statements.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

STATEMENTS OF CONSOLIDATED INCOME

(In millions, except per share amounts)

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008			2007
Revenue	$	13,001		$	12,189		$	25,676		$	24,095
Operating Expenses:
Compensation and benefits		6,522			6,327			13,022			12,668
Repairs and maintenance		303			301			601			607
Depreciation and amortization		452			431			904			867
Purchased transportation		1,679			1,385			3,274			2,715
Fuel		1,167			697			2,117			1,313
Other occupancy		244			215			524			467
Other expenses		1,180			1,068			2,287			2,335

		11,547			10,424			22,729			20,972

Operating Profit		1,454			1,765			2,947			3,123

Other Income and (Expense):
Investment income		14			28			71			42
Interest expense		(104	)		(61	)		(238	)		(110	)

		(90	)		(33	)		(167	)		(68	)

Income Before Income Taxes		1,364			1,732			2,780			3,055
Income Taxes		491			628			1,001			1,108

Net Income	$	873		$	1,104		$	1,779		$	1,947

Basic Earnings Per Share	$	0.86		$	1.04		$	1.73		$	1.83

Diluted Earnings Per Share	$	0.85		$	1.04		$	1.72		$	1.82

STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME

(In millions)

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008			2007
Net income	$	873		$	1,104		$	1,779		$	1,947
Change in foreign currency translation adjustment		5			21			113			52
Change in unrealized gain (loss) on marketable securities, net of tax		(20	)		(11	)		(40	)		(7	)
Change in unrealized gain (loss) on cash flow hedges, net of tax		80			(59	)		30			(98	)
Change in unrecognized pension and postretirement benefit costs, net of tax		33			30			66			60

Comprehensive income	$	971		$	1,085		$	1,948		$	1,954

See notes to unaudited consolidated financial statements.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

STATEMENTS OF CONSOLIDATED CASH FLOWS

(In millions)

(unaudited)


	Six Months Ended June 30,
	2008			2007
Cash Flows From Operating Activities:
Net income	$	1,779		$	1,947
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		904			867
Pension and postretirement benefit expense		361			256
Pension and postretirement benefit contributions		(93	)		(60	)
Self-insurance reserves		66			131
Deferred taxes, credits, and other		(51	)		(199	)
Stock compensation expense		251			213
Other (gains) losses		423			267
Changes in assets and liabilities:
Accounts receivable, net		121			193
Income taxes receivable		1,076			—
Other current assets		(183	)		(44	)
Accounts payable		187			(172	)
Accrued wages and withholdings		246			303
Other current liabilities		(57	)		35
Other operating activities		(2	)		(141	)

Net cash from operating activities		5,028			3,596

Cash Flows From Investing Activities:
Capital expenditures		(1,387	)		(1,206	)
Proceeds from disposals of property, plant and equipment		71			34
Purchases of marketable securities and short-term investments		(1,939	)		(5,630	)
Sales and maturities of marketable securities and short-term investments		1,664			5,554
Net (increase) decrease in finance receivables		(66	)		24
Other investing activities		(282	)		(99	)

Net cash (used in) investing activities		(1,939	)		(1,323	)

Cash Flows From Financing Activities:
Net change in short-term debt		(1,315	)		416
Proceeds from long-term borrowings		5,435			205
Repayments of long-term borrowings		(4,290	)		(123	)
Purchases of common stock		(2,294	)		(1,522	)
Issuances of common stock		98			75
Dividends		(1,337	)		(1,266	)
Other financing activities		(283	)		—

Net cash (used in) financing activities		(3,986	)		(2,215	)

Effect Of Exchange Rate Changes On Cash and Cash Equivalents		48			4

Net Increase (Decrease) In Cash And Cash Equivalents		(849	)		62
Cash And Cash Equivalents:
Beginning of period		2,027			794

End of period	$	1,178		$	856

See notes to unaudited consolidated financial statements.

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 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 June 30, 2008, our results of operations for the three and six months ended June 30, 2008 and 2007, and cash flows for the six months ended June 30, 2008 and 2007. 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 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, 2007.

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

Note 2. Stock-Based Compensation

We issue employee share-based awards under the UPS Incentive Compensation Plan, which permits the grant of nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock, performance shares, performance units, and management incentive awards to eligible employees. The primary compensation programs offered under the UPS Incentive Compensation Plan include the UPS Management Incentive Awards Program, the UPS Long-Term Incentive Program and the UPS Long-Term Incentive Performance Award 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.

During the first quarter of 2008, we granted target restricted stock units (“RSUs”) under the UPS Long-Term Incentive Performance Award program to eligible management. Of the total 2008 target award, 90% of the target award will be divided into three substantially equal tranches, one for each calendar year in the three-year award cycle from 2008 to 2010, using performance criteria targets established each year. For 2008, those targets consist of consolidated operating return on invested capital and growth in consolidated revenue. The remaining 10% of the total 2008 target award will be based upon our achievement of adjusted earnings per share for the three-year award cycle compared to a target established at the beginning of the award cycle.

The number of RSUs earned each year will be the target number adjusted for the percentage achievement of performance criteria targets for the year. The percentage of achievement used to determine the RSUs earned may be a percentage less than or more than 100% of the target RSUs for each tranche. Target RSU award grants range in size from 50% to 250% of annual salary based upon the participant’s responsibility level within UPS. The target RSU grant for the 2008 Long-Term Incentive Performance Awards program was valued using the closing New York Stock Exchange price of $69.61 on March 17, 2008.

During the second quarter of 2008, we granted stock option and restricted performance unit (“RPU”) awards to eligible employees under the UPS Long-Term Incentive Program. Beginning with the awards granted in 2008, stock options are being granted to a more limited group of employees, while a larger proportion of the total award under the UPS Long-Term Incentive Program is being made in the form of RPUs. Additionally, beginning with the 2008 grant, stock option and RPU awards will generally vest over a five year period with approximately 20% of the

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

award vesting at each anniversary date of the grant (except in the case of death, disability, or retirement, whereby immediate vesting occurs). Previously, stock option and RPU grants vested five years after the date of grant (again with the exception of death, disability, or retirement). Consistent with previous awards, the options granted will expire ten years after the date of grant. In the second quarter of 2008, we granted 0.2 million stock options and 1.9 million RPUs at a grant price of $71.58. In the second quarter of 2007, we granted 2.7 million stock options and 1.1 million RPUs at a grant price of $70.90. The fair value of our employee stock options granted, as determined by the Black-Scholes valuation model, was $16.77 and $16.85 for 2008 and 2007, respectively, using the following assumptions:


	2008		2007
Expected life (in years)	7.5		7.5
Risk-free interest rate	3.79	%	4.65	%
Expected volatility	22.24	%	19.15	%
Expected dividend yield	2.39	%	2.28	%

Awards granted under the Management Incentive Awards program are normally granted during the fourth quarter of each year. Compensation expense for share-based awards recognized in net income for the three months ended June 30, 2008 and 2007 was $134 and $118 million pre-tax, respectively. Compensation expense for share-based awards recognized in net income for the six months ended June 30, 2008 and 2007 was $251 and $213 million pre-tax, respectively.

Note 3. Recent Accounting Pronouncements

In September 2006, the FASB issued Statement No. 157 “Fair Value Measurements” (“FAS 157”), which was issued to define fair value, establish a framework for measuring fair value, and expand disclosures about fair value measurements, and is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB deferred the effective date of FAS 157 for one year for certain nonfinancial assets and liabilities, and removed certain leasing transactions from its scope. We adopted FAS 157 on January 1, 2008, and the impact of adoption was not material to our results of operations or financial condition. The disclosures required by FAS 157 are included in Note 12.

In February 2007, the FASB issued Statement No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (“FAS 159”), which gives entities the option to measure eligible financial assets, financial liabilities and firm commitments at fair value (i.e., the fair value option), on an instrument-by-instrument basis, that are otherwise not accounted for at fair value under other accounting standards. The election to use the fair value option is available at specified election dates, such as when an entity first recognizes a financial asset or financial liability or upon entering into a firm commitment. Subsequent changes in fair value must be recorded in earnings. Additionally, FAS 159 allows for a one-time election for existing positions upon adoption, with the transition adjustment recorded to beginning retained earnings. We adopted FAS 159 on January 1, 2008, and elected to apply the fair value option to our investment in certain investment partnerships that were previously accounted for under the equity method. Accordingly, we recorded a $16 million reduction to retained earnings as of January 1, 2008, representing the cumulative effect adjustment of adopting FAS 159.

Through 2007, we utilized the early measurement date option available under FASB Statement No. 87 “Employers’ Accounting for Pensions”, and we measured the funded status of our plans as of September 30 each year. Under the provisions of FASB Statement No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132(R))” (“FAS 158”), we are required to use a December 31 measurement date for all of our pension and postretirement benefit plans beginning in 2008. As a result of this change in measurement date, we recorded a cumulative effect $44 million reduction to retained earnings as of January 1, 2008.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

In June 2007, the EITF reached consensus on Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.” EITF 06-11 requires that the tax benefit related to dividend equivalents paid on restricted stock units, which are expected to vest, be recorded as an increase to additional paid-in capital. EITF 06-11 is applied prospectively for tax benefits on dividends declared in fiscal years beginning after December 15, 2007. We adopted the provisions of EITF 06-11 beginning in the first quarter of 2008. This adoption did not have a material impact on our results of operations or financial condition.

In December 2007, the FASB issued Statement No. 141(R) “Business Combinations” (“FAS 141(R)”). FAS 141(R) requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction (whether a full or partial acquisition); establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; requires expensing of most transaction and restructuring costs; and requires the acquirer to disclose in its financial statements the information needed to evaluate and understand the nature and financial effect of the business combination. FAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009. The impact of FAS No. 141(R) on our consolidated financial statements will depend upon the nature, terms and size of the acquisitions we consummate after the effective date.

In December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51” (“FAS 160”). FAS 160 requires reporting entities to present noncontrolling (minority) interests as equity (as opposed to as a liability or mezzanine equity) and provides guidance on the accounting for transactions between an entity and noncontrolling interests. As of June 30, 2008, we had approximately $7 million in noncontrolling interests classified in other non-current liabilities. FAS 160 applies prospectively as of January 1, 2009, except for the presentation and disclosure requirements which will be applied retrospectively for all periods presented.

In March 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133” (“FAS 161”), which requires additional disclosures about the objectives of the derivative instruments and hedging activities, the method of accounting for such instruments under FAS 133 and its related interpretations, and a tabular disclosure of the effects of such instruments and related hedged items on our financial position, financial performance, and cash flows. FAS 161 is effective for us beginning January 1, 2009. We are currently assessing the potential impact that the adoption of FAS 161 may have on the disclosures within our consolidated financial statements.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 4. Marketable Securities

The following is a summary of marketable securities as of June 30, 2008 and December 31, 2007 (in millions):


	Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
June 30, 2008
Current marketable securities:
U.S. government and agency securities	$	87	$	1	$	1	$	87
Mortgage and asset-backed securities		289		1		3		287
Corporate securities		133		1		1		133
Other debt securities		2		—		—		2

Total debt securities		511		3		5		509
Common equity securities		2		—		—		2

Current marketable securities		513		3		5		511

Non-current marketable securities:
State and local municipal securities		123		—		14		109
Asset-backed securities		150		—		36		114
Common equity securities		25		6		—		31
Preferred equity securities		63		—		5		58

Non-current marketable securities		361		6		55		312

Total marketable securities	$	874	$	9	$	60	$	823


	Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
December 31, 2007
Current marketable securities:
U.S. government and agency securities	$	59	$	2	$	—	$	61
Mortgage and asset-backed securities		251		2		2		251
Corporate securities		152		2		—		154
State and local municipal securities		4		—		—		4
Other debt securities		2		—		—		2

Total debt securities		468		6		2		472
Common equity securities		2		—		—		2
Preferred equity securities		103		—		—		103

Current marketable securities		573		6		2		577

Non-current common equity securities		25		8		—		33

Total marketable securities	$	598	$	14	$	2	$	610

At June 30, 2008, we held $336 million in principal value of investments in auction rate securities. Some of these investments take the form of debt securities, and are structured as direct obligations of local governments or agencies (classified as “State and local municipal securities”). Other auction rate security investments are structured as obligations of asset-backed trusts (classified as “Asset-backed securities”), generally all of which are collateralized by student loans and are guaranteed by the U.S. Government or through private insurance. The remaining auction rate securities take the form of preferred stock, and are collateralized by securities issued directly by large corporations. Substantially all of our investments in auction rate securities maintain ratings of AA / Aa or higher by Standard and Poor’s and Moody’s, respectively.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

During the first quarter of 2008, market auctions, including auctions for substantially all of our auction rate securities portfolio, began to fail due to insufficient buyers. As a result of the persistent failed auctions, and the uncertainty of when these investments could successfully be liquidated at par, we have classified all of our investments in auction rate securities as non-current marketable securities (which are reported in “Other Non-Current Assets” on the consolidated balance sheet), as noted in the table above, as of June 30, 2008. The securities for which auctions have failed will continue to accrue interest and be auctioned at each respective reset date until the auction succeeds, the issuer redeems the securities, or the securities mature.

Historically, the par value of the auction rate securities approximated fair value due to the frequent resetting of the interest rate. While we will continue to earn interest on these investments in failed auction rate securities (often at the maximum contractual interest rate), the estimated fair value of the auction rate securities no longer approximates par value due to the lack of liquidity. We estimated the fair value of these securities after considering several factors, including the credit quality of the securities, the rate of interest received since the failed auctions began, the yields of securities similar to the underlying auction rate securities, and the input of broker-dealers in these securities. As a result, we recorded an after-tax unrealized loss of approximately $35 million on these securities as of June 30, 2008 in other comprehensive income ($55 million pre-tax), reflecting the decline in the estimated fair value of these securities. At the current time, we do not anticipate any losses being realized on these investments.

We have concluded that no other-than-temporary impairment losses on our auction rate securities existed as of June 30, 2008. In making this determination, we considered the financial condition and prospects of the issuer, 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 security, the credit rating of the security, and our ability and intent to hold these investments until the anticipated recovery in market value occurs. Approximately $47 million of these securities were liquidated at par value in the second quarter of 2008.

The amortized cost and estimated fair value of marketable securities and short-term investments at June 30, 2008, 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	$	11	$	11
Due after one year through three years		149		150
Due after three years through five years		27		27
Due after five years		597		544

		784		732
Equity securities		90		91

	$	874	$	823

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 5. Property, Plant and Equipment

Property, plant and equipment as of June 30, 2008 and December 31, 2007 consists of the following (in millions):


	2008			2007
Vehicles	$	5,427		$	5,295
Aircraft (including aircraft under capitalized leases)		14,076			13,541
Land		1,086			1,056
Buildings		2,903			2,837
Leasehold improvements		2,666			2,604
Plant equipment		5,766			5,537
Technology equipment		1,755			1,699
Equipment under operating lease		144			153
Construction-in-progress		1,014			889

		34,837			33,611
Less: Accumulated depreciation and amortization		(16,624	)		(15,948	)

	$	18,213		$	17,663

Note 6. Employee Benefit Plans

Information about net periodic benefit cost for our pension and postretirement benefit plans is as follows for the three and six month period ended June 30, 2008 and 2007 (in millions):


	Three Months Ended June 30,
	U.S. Pension Benefits						U.S. Postretirement Medical Benefits						International Pension Benefits
	2008			2007			2008			2007			2008			2007
Net Periodic Cost:
Service cost	$	177		$	130		$	24		$	26		$	7		$	7
Interest cost		263			208			50			46			8			7
Expected return on assets		(380	)		(326	)		(13	)		(12	)		(9	)		(7	)
Amortization of:
Transition obligation		1			1			—			—			—			—
Prior service cost		47			15			(1	)		(2	)		—			—
Actuarial (gain) loss		2			27			4			5			—			1
Settlements, curtailments, and other		—			—			—			—			—			—

Net periodic benefit cost	$	110		$	55		$	64		$	63		$	6		$	8


	Six Months Ended June 30,
	U.S. Pension Benefits						U.S. Postretirement Medical Benefits						International Pension Benefits
	2008			2007			2008			2007			2008			2007
Net Periodic Cost:
Service cost	$	354		$	260		$	47		$	51		$	14		$	14
Interest cost		526			417			100			91			16			14
Expected return on assets		(759	)		(651	)		(25	)		(23	)		(18	)		(14	)
Amortization of:
Transition obligation		2			2			—			—			—			—
Prior service cost		93			29			(2	)		(4	)		—			—
Actuarial (gain) loss		4			54			9			11			—			2
Settlements, curtailments, and other		—			—			—			3			—			—

Net periodic benefit cost	$	220		$	111		$	129		$	129		$	12		$	16

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

During the first six months of 2008, we contributed $51 and $42 million to our company-sponsored pension and postretirement medical benefit plans, respectively. We expect to contribute $119 and $24 million over the remainder of the year to the pension and postretirement medical benefit plans, respectively.

Note 7. Goodwill and Intangible Assets

The following table indicates the allocation of goodwill by reportable segment as of June 30, 2008 and December 31, 2007 (in millions):


	December 31, 2007		Acquired		Purchase Price Adjustments		Currency/ Other		June 30, 2008
Goodwill by Segment:
U.S. Domestic Package	$	—	$	—	$	—	$	—	$	—
International Package		295		3		—		17		315
Supply Chain & Freight		2,282		—		—		19		2,301

	$	2,577	$	3	$	—	$	36	$	2,616

The following is a summary of intangible assets as of June 30, 2008 and December 31, 2007 (in millions):


	Gross Carrying Amount		Accumulated Amortization			Net Carrying Value
June 30, 2008:
Trademarks, licenses, patents, and other	$	75	$	(62	)	$	13
Customer lists		164		(52	)		112
Franchise rights		110		(38	)		72
Capitalized software		1,693		(1,286	)		407

Total intangible assets, net	$	2,042	$	(1,438	)	$	604


	Gross Carrying Amount		Accumulated Amortization			Net Carrying Value
December 31, 2007:
Trademarks, licenses, patents, and other	$	75	$	(54	)	$	21
Customer lists		162		(40	)		122
Franchise rights		110		(35	)		75
Capitalized software		1,663		(1,253	)		410

Total intangible assets, net	$	2,010	$	(1,382	)	$	628

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 8. Debt and Financing Arrangements

Outstanding debt as of June 30, 2008 and December 31, 2007 consists of the following (in millions):


	2008			2007
8.38% debentures	$	750		$	761
4.50% senior notes		1,738			—
5.50% senior notes		745			—
6.20% senior notes		1,479			—
Floating rate senior notes		438			441
Commercial paper		3,504			7,366
Capital lease obligations		458			479
Facility notes and bonds		434			435
UPS Notes		301			513
Pound Sterling notes		984			989
Other debt		23			34

Total debt		10,854			11,018
Less: current maturities		(3,621	)		(3,512	)

Long-term debt	$	7,233		$	7,506

We are authorized to borrow up to $10.0 billion under the U.S. commercial paper program we maintain. We had $3.504 billion outstanding under this program as of June 30, 2008, with an average interest rate of 2.21%. The entire balance outstanding has been classified as a current liability on our balance sheet as of June 30, 2008. As of December 31, 2007, approximately $4.0 billion of commercial paper was classified as long-term debt in anticipation of the subsequent issuance of fixed rate notes, as discussed further below. We also maintain a European commercial paper program under which we are authorized to borrow up to €1.0 billion in a variety of currencies, however there were no amounts outstanding under this program as of June 30, 2008.

We maintain two credit agreements with a consortium of banks. One of these agreements provides revolving credit facilities of $4.5 billion, and expires on April 18, 2009. The second agreement provides revolving credit facilities of $1.0 billion, and expires on April 19, 2012. Interest on any amounts we borrow under these facilities would be charged at 90-day LIBOR plus 15 basis points. At June 30, 2008, there were no outstanding borrowings under these facilities. Concurrent with entering into the $4.5 billion facility in April 2008, we terminated our previous $1.0 billion credit facility that was scheduled to expire on April 17, 2008, as well as the $7.0 billion credit facility that was scheduled to expire on October 17, 2008.

In January 2008, we completed an offering of $1.750 billion of 4.50% senior notes due January 2013, $750 million of 5.50% senior notes due January 2018, and $1.500 billion of 6.20% senior notes due January 2038. All of the notes pay interest semiannually, and allow for redemption of the notes by UPS at any time by paying the greater of the principal amount or a “make-whole” amount, plus accrued interest. After pricing and underwriting discounts, we received a total of $3.961 billion in cash proceeds from the offering. The proceeds from the offering were used to reduce our outstanding commercial paper balance.

Our existing debt instruments and credit facilities do not have cross-default or ratings triggers, however certain of these debt instruments and credit facilities do subject us to financial covenants. These covenants generally require us to maintain a $3.0 billion minimum net worth and limit the amount of secured indebtedness that may be incurred by the company. These covenants are not considered material to the overall financial condition of the company, and all covenant tests were satisfied as of June 30, 2008.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 9. Legal Proceedings and Contingencies

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. In one of these cases, Marlo v. UPS, which was certified as a class action in a California federal court in June 2004, plaintiffs allege that they improperly were denied overtime, and seek penalties for missed meal and rest periods, and interest and attorneys’ fees. Plaintiffs purport to represent a class of 1,300 full-time supervisors. In August 2005, the court granted summary judgment in favor of UPS on all claims, and plaintiff appealed the ruling. In October 2007, the appeals court reversed the lower court’s ruling. We have denied any liability with respect to these claims and intend to vigorously defend ourselves in this case. In April 2008, the Court decertified the class and vacated the trial scheduled for April 29, 2008. At this time, we have not determined the amount of any liability that may result from this matter or whether such liability, if any, would have a material adverse effect on our financial condition, results of operations, or liquidity.

In another case, Hohider v. UPS, which in July 2007 was certified as a class action in a Pennsylvania federal court, plaintiffs have challenged certain aspects of the Company’s interactive process for assessing requests for reasonable accommodation under the Americans with Disabilities Act. Plaintiffs purport to represent a class of over 35,000 current and former employees, and seek backpay, compensatory and punitive damages, as well as attorneys’ fees. In August 2007, the Third Circuit Court of Appeals granted the Company’s Petition to hear the appeal of the trial court’s recent certification order. The appeal will likely take one year. At this time, we have not determined the amount of any liability that may result from this matter or whether such liability, if any, would have a material adverse effect on our financial condition, results of operations, or liquidity.

UPS and Mail Boxes Etc., Inc. are defendants in various lawsuits brought by franchisees who operate Mail Boxes Etc. centers and The UPS Store locations. These lawsuits relate to the rebranding of Mail Boxes Etc. centers to The UPS Store, The UPS Store business model, the representations made in connection with the rebranding and the sale of The UPS Store franchises, and UPS’s sale of services in the franchisees’ territories. We have denied any liability with respect to these claims and intend to defend ourselves vigorously. At this time, we have not determined the amount of any liability that may result from these matters or whether such liability, if any, would have a material adverse effect on our financial condition, results of operations, or liquidity.

UPS Freight, along with several other companies involved in the LTL freight business, is a defendant in a Multi-District Litigation pending in the United States District Court for the Northern District of Georgia. The lawsuits allege that the defendants conspired to fix fuel surcharge rates, and they seek injunctive relief, treble damages and attorneys’ fees. We intend to defend against these suits vigorously. These cases are at a preliminary stage and at this time, we have not determined the amount of any liability that may result from this matter or whether such liability, if any, would have a material adverse effect on our financial condition, results of operations, or liquidity.

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.

Along with an income tax audit for years 2003 and 2004, the Internal Revenue Service (“IRS”) is currently examining non-income based taxes including excise taxes on transportation of property by air and fuel purchases, which could lead to proposed assessments. The IRS has not presented an official position with regard to excise taxes at this time, and therefore we are not able to determine the technical merit of any potential assessment; however, we do not believe that the resolution of this matter would have a material adverse effect on our financial condition, results of operations, or liquidity.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The Italian Guardia di Finanza, under the authority of the Minister of Economy and Finance, has challenged the inter-company transfer pricing of our Italian subsidiary’s international package business for tax years 2003 through 2007. No final report or assessment has been issued. We have denied any liability with respect to these challenges and intend to defend our position vigorously. We have not accrued any liability for unrecognized tax benefits under FIN 48 for this matter. However, it is possible that the amount of unrecognized tax benefits could change within the next 12 months as we continue to pursue resolution of this matter with the Italian authorities. At this time, we have not determined the amount of liability that may result from this matter or whether such liability, if any, would have a material adverse effect on our financial condition, results of operations, or liquidity.

As of December 31, 2007, we had approximately 246,000 employees employed under a national master agreement and various supplemental agreements with local unions affiliated with the Teamsters. In September 2007, we reached a new national master agreement with the Teamsters, which was ratified in December 2007. The new agreement provides for wage increases as well as contributions to healthcare and pension plans, and most economic provisions of the new five year agreement will take effect on August 1, 2008, with the exception of our withdrawal from the Central States Pension Fund which occurred in 2007. We have approximately 2,900 pilots who are employed under a collective bargaining agreement with the Independent Pilots Association, which becomes amendable at the end of 2011. Our airline mechanics are covered by a collective bargaining agreement with Teamsters Local 2727, which became amendable on November 1, 2006. We began formal negotiations with Teamsters Local 2727 on October 2, 2006. In addition, the majority of our ground mechanics who are not employed under agreements with the Teamsters are employed under collective bargaining agreements with the International Association of Machinists and Aerospace Workers (approximately 2,900). These agreements run through July 31, 2009.

Apart from the Central States Pension Fund, 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 cause us to make significantly 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 liquidity would result from our participation in these plans.

Note 10. 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 into Class B shares at any time. Class B shares are publicly traded on the New York Stock Exchange (NYSE) under the symbol “UPS”. Class A and B shares both have a $0.01 par value, and as of June 30, 2008, 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 no par value, authorized to be issued; as of June 30, 2008, no preferred shares had been issued.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The following is a roll-forward of our common stock, additional paid-in capital, and retained earnings accounts for the six months ended June 30, 2008 and 2007 (in millions, except per share amounts):


	2008					2007
	Shares		Dollars			Shares		Dollars
Class A Common Stock
Balance at beginning of period	349		$	3		401		$	4
Common stock purchases	(7	)		—		(10	)		—
Stock award plans	3			—		1			—
Common stock issuances	1			—		1			—
Conversions of Class A to Class B common stock	(16	)		—		(17	)		—

Class A shares issued at end of period	330		$	3		376		$	4

Class B Common Stock
Balance at beginning of period	694		$	7		672		$	7
Common stock purchases	(29	)		—		(11	)		—
Conversions of Class A to Class B common stock	16			—		17			—

Class B shares issued at end of period	681		$	7		678		$	7

Additional Paid-In Capital
Balance at beginning of period			$	—				$	—
Stock award plans				262					222
Common stock purchases				(349	)				(312	)
Common stock issuances				87					90

Balance at end of period			$	—				$	—

Retained Earnings
Balance at beginning of period			$	14,186				$	17,676
Cumulative adjustment for accounting changes				(60	)				(104	)
Net income				1,779					1,947
Dividends ($0.90 and $0.84 per share)				(927	)				(894	)
Common stock purchases				(2,137	)				(1,194	)

Balance at end of period			$	12,841				$	17,431

On January 1, 2007, we adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109”, which resulted in a reduction to retained earnings of $104 million. On January 1, 2008, we recognized a $44 million reduction to retained earnings as a result of changing our measurement date under FAS 158, which is discussed further in Note 3. Also on January 1, 2008, we recognized a $16 million reduction to retained earnings as a result of adopting FAS 159, which is discussed further in Note 12.

We repurchased a total of 35.7 million shares of Class A and Class B common stock for $2.486 billion during the six months ended June 30, 2008, and 21.0 million shares for $1.506 billion for the six months ended June 30, 2007. In January 2008, we announced a new financial policy regarding our capital structure to enhance shareowner value. We intend to manage our balance sheet to a target debt ratio of approximately 50%-60% funds from operations to total debt. In connection with this policy, the Board of Directors authorized an increase in our share repurchase authorization to $10.0 billion. We intend to complete this level of share repurchases during

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2008 and 2009. Share repurchases may take the form of accelerated share repurchases, open market purchases, or other such methods as we deem appropriate. As of June 30, 2008, we had $7.644 billion of our share repurchase authorization remaining.

Accumulated Other Comprehensive Income (Loss)

We incur activity in 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 six months ended June 30, 2008 and 2007 is as follows (in millions):


	2008			2007
Foreign currency translation adjustment:
Balance at beginning of period	$	81		$	(109	)
Aggregate adjustment for the period		113			52

Balance at end of period		194			(57	)

Unrealized gain (loss) on marketable securities, net of tax:
Balance at beginning of period		9			12
Current period changes in fair value (net of tax effect of $(22) and $0)		(38	)		—
Reclassification to earnings (net of tax effect of $(1) and $(4))		(2	)		(7	)

Balance at end of period		(31	)		5

Unrealized gain (loss) on cash flow hedges, net of tax:
Balance at beginning of period		(250	)		68
Current period changes in fair value (net of tax effect of $(92) and $(40))		(153	)		(67	)
Reclassification to earnings (net of tax effect of $111 and $(19))		183			(31	)

Balance at end of period		(220	)		(30	)

Unrecognized pension and postretirement benefit costs, net of tax:
Balance at beginning of period		(1,853	)		(2,176	)
Unrecognized net actuarial gain (net of tax effect of $8 and $0)		13			—
Reclassification to earnings (net of tax effect of $40 and $34)		66			60

Balance at end of period		(1,774	)		(2,116	)

Accumulated other comprehensive income (loss) at end of period	$	(1,831	)	$	(2,198	)

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Deferred Compensation Obligations and Treasury Stock

Activity in the deferred compensation program for the six months ended June 30, 2008 and 2007 is as follows (in millions):


	2008					2007
	Shares		Dollars			Shares		Dollars
Deferred Compensation Obligations
Balance at beginning of period			$	137				$	147
Reinvested dividends				3					3
Option exercise deferrals				—					—
Benefit payments				(21	)				(14	)

Balance at end of period			$	119				$	136

Treasury Stock
Balance at beginning of period	(2	)	$	(137	)	(3	)	$	(147	)
Reinvested dividends	—			(3	)	—			(3	)
Option exercise deferrals	—			—		—			—
Benefit payments	—			21		1			14

Balance at end of period	(2	)	$	(119	)	(2	)	$	(136	)

Note 11. 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 200 countries and territories worldwide, including shipments wholly outside the United States, as well as shipments with either origin or distribution outside the United States. Our International Package reporting segment includes the operations of our Europe, Asia, and Americas operating segments.

Supply Chain & Freight

Supply Chain & Freight includes our forwarding and logistics operations, UPS Freight, and other aggregated business units. Our forwarding and logistics business provides services in more than 175 countries and territories worldwide, and includes supply chain design and management, freight distribution, customs brokerage, 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 Mail Boxes, Etc. (the franchisor of Mail Boxes, Etc. and The UPS Store) and UPS Capital.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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 financial statements in our Annual Report on Form 10-K for the year ended December 31, 2007, with certain expenses allocated between the segments using activity-based costing methods. Unallocated assets are comprised primarily of cash, marketable securities, short-term investments, and investments in limited partnerships.

Segment information for the three and six months ended June 30, 2008 and 2007 is as follows (in millions):


	Three Months Ended June 30,				Six Months Ended June 30,
	2008		2007		2008		2007
Revenue:
U.S. Domestic Package	$	7,714	$	7,579	$	15,449	$	15,131
International Package		2,948		2,500		5,707		4,885
Supply Chain & Freight		2,339		2,110		4,520		4,079

Consolidated	$	13,001	$	12,189	$	25,676	$	24,095

Operating Profit:
U.S. Domestic Package	$	899	$	1,192	$	1,858	$	2,133
International Package		407		475		828		846
Supply Chain & Freight		148		98		261		144

Consolidated	$	1,454	$	1,765	$	2,947	$	3,123

Note 12. Fair Value Disclosures

Effective January 1, 2008, we adopted FAS 157, which requires disclosures about our assets and liabilities that are measured at fair value. Further information about such assets and liabilities is presented below. We have not applied the provisions of FAS 157 to non-financial assets, such as our property and equipment, goodwill and certain other assets, which are measured at fair value for impairment assessment, nor to any business combinations or asset retirement obligations. We will apply the provisions of FAS 157 to these assets and liabilities, beginning January 1, 2009, in accordance with FASB Staff Position No. 157-2, “Effective Date of FASB Statement No. 157”.

Upon our adoption of FAS 159 on January 1, 2008, we elected to apply the fair value option to our holdings in certain investment partnerships that were previously accounted for under the equity method. Accordingly, we recorded a $16 million reduction to retained earnings as of January 1, 2008, representing the after-tax cumulative effect adjustment of adopting FAS 159.

Our assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with FAS 157. Level 1 inputs utilize quoted prices in active markets for identical assets or liabilities. Level 2 inputs are based on other observable market data, such as quoted prices for similar assets and liabilities, and inputs other than quoted prices that are observable, such as interest rates and yield curves. Level 3 inputs are developed from unobservable data reflecting our own assumptions, and include situations where there is little or no market activity for the asset or liability.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The following is a general description of the valuation methodologies used for financial assets and liabilities measured at fair value, including the general classification of such assets and liabilities pursuant to the valuation hierarchy.

Marketable Securities—Marketable securities utilizing Level 1 inputs include active exchange-traded equity securities and equity index funds, and most U.S. Government debt securities, as these securities all have quoted prices in active markets. Marketable securities utilizing Level 2 inputs include non-auction rate asset-backed securities 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 have classified our auction rate securities portfolio as utilizing Level 3 inputs, as their valuation requires substantial judgment and estimation of factors that are not currently observable in the market due to the lack of trading in the securities. The valuation may be revised in future periods as market conditions evolve. These securities were valued as of June 30, 2008 considering several factors, including the credit quality of the securities, the rate of interest received since the failed auctions began, the yields of securities similar to the underlying auction rate securities, and the input of broker-dealers in these securities.

Derivative Contracts—Our foreign currency, interest rate, and energy 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 commodity forward prices, and therefore are classified as Level 2.

Other Investments—Financial assets and liabilities utilizing Level 3 inputs include our holdings in certain investment partnerships. These partnerships do not have any 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 based on each partnership’s financial statements and cash flow projections.

The following table presents information about our assets and liabilities measured at fair value on a recurring basis as of June 30, 2008, 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 as of June 30, 2008
Assets
Marketable securities	$	114	$	428	$	281	$	823
Derivative contracts		—		24		—		24
Other investments		—		—		351		351

Total	$	114	$	452	$	632	$	1,198

Liabilities
Derivative contracts	$	—	$	237	$	—	$	237

Total	$	—	$	237	$	—	$	237

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the changes in Level 3 instruments measured on a recurring basis for the three months ended June 30, 2008 (in millions).


	Marketable Securities			Other Investments			Total
Balance on April 1, 2008	$	350		$	362		$	712
Transfers into (out of) Level 3		—			—			—
Net realized and unrealized gains (losses):
Included in earnings (in investment income)		—			(11	)		(11	)
Included in accumulated other comprehensive income (pre-tax)		(22	)		—			(22	)
Purchases, issuances, and settlements		(47	)		—			(47	)

Balance on June 30, 2008	$	281		$	351		$	632

The following table presents the changes in Level 3 instruments measured on a recurring basis for the six months ended June 30, 2008 (in millions).


	Marketable Securities			Other Investments			Total
Balance on January 1, 2008	$	10		$	363		$	373
Transfers into (out of) Level 3		373			—			373
Net realized and unrealized gains (losses):
Included in earnings (in investment income)		—			(12	)		(12	)
Included in accumulated other comprehensive income (pre-tax)		(55	)		—			(55	)
Purchases, issuances, and settlements		(47	)		—			(47	)

Balance on June 30, 2008	$	281		$	351		$	632

Note 13. Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share for the three and six months ended June 30, 2008 and 2007 (in millions, except per share amounts):


	Three Months Ended June 30,				Six Months Ended June 30,
	2008		2007		2008		2007
Numerator:
Net income	$	873	$	1,104	$	1,779	$	1,947

Denominator:
Weighted average shares		1,019		1,058		1,027		1,062
Deferred compensation obligations		2		2		2		3

Denominator for basic earnings per share		1,021		1,060		1,029		1,065

Effect of dilutive securities:
Restricted performance units		3		2		3		2
Restricted stock units		4		2		3		1
Stock option plans		1		2		1		2

Denominator for diluted earnings per share		1,029		1,066		1,036		1,070

Basic earnings per share	$	0.86	$	1.04	$	1.73	$	1.83

Diluted earnings per share	$	0.85	$	1.04	$	1.72	$	1.82

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Diluted earnings per share for the three months ended June 30, 2008 and 2007 exclude the effect of 9.8 and 8.8 million shares of common stock (9.8 and 8.1 million for the six months ended June 30, 2008 and 2007), respectively, that may be issued upon the exercise of employee stock options because such effect would be antidilutive.

Note 14. Aircraft Impairment and Obsolescence Charge

In the first quarter of 2007, we initiated a review of our aircraft fleet types as a result of business changes that occurred, including capacity-optimization programs in our domestic and international air freight forwarding business, as well as changes to our aircraft orders and planned delivery dates. The review was completed in March 2007 and, based on the results of our evaluation, we accelerated the planned retirement of certain Boeing 727 and 747 aircraft, and recognized an impairment and obsolescence charge of $221 million for the aircraft and related engines and parts. This charge is included in the caption “Other expenses” in the Statement of Consolidated Income, of which $159 million impacted our U.S. Domestic Package segment and $62 million impacted our International Package segment.

We determined the aircraft impairment in accordance with the provisions of FASB Statement No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“FAS 144”). FAS 144 requires long-lived assets to be reviewed for impairment when circumstances indicate the carrying amount of an asset may not be recoverable based on the undiscounted future cash flows of the asset. If the carrying amount of the asset is determined not to be recoverable, a write-down to fair market value is recorded. For these Boeing 727 and 747 aircraft, the carrying value exceeded the undiscounted future cash flows based upon their anticipated retirement dates. As a result, we recognized an impairment charge representing the difference between the aircraft carrying value and fair market value. The fair market values of the aircraft were generally determined from observable prices in secondary markets for similar aircraft, engines and parts, as well as historical selling prices realized by the Company for the same or similar equipment.

Note 15. UPS Special Voluntary Separation Opportunity Charge

In December 2006, we offered a special voluntary separation opportunity (“SVSO”) to approximately 640 employees who work in non-operating functions. This program was established to improve the efficiency of non-operating processes by eliminating duplication and sharing expertise across the company. The SVSO ended in February 2007, and 195, or 30% of eligible employees, accepted the offer. As a result, we recorded a charge to expense of approximately $68 million in the first quarter of 2007, to reflect the cash payout and the acceleration of stock compensation and certain retiree healthcare benefits under the SVSO program. The cash payout in the first quarter of 2007 totaled $35 million, and we paid $28 million in the first quarter of 2008 related to this program. The $68 million charge is included in the caption “Compensation and benefits” in the Statement of Consolidated Income, of which $53 million impacted our U.S. Domestic Package segment, $8 million impacted our Supply Chain & Freight segment, and $7 million impacted our International Package segment.

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
	2008		2007		$			%
Revenue (in millions):
U.S. Domestic Package:
Next Day Air	$	1,648	$	1,684	$	(36	)	(2.1	)%
Deferred		789		792		(3	)	(0.4	)
Ground		5,277		5,103		174		3.4

Total U.S. Domestic Package		7,714		7,579		135		1.8
International Package:
Domestic		622		517		105		20.3
Export		2,145		1,834		311		17.0
Cargo		181		149		32		21.5

Total International Package		2,948		2,500		448		17.9
Supply Chain & Freight:
Forwarding and Logistics		1,635		1,465		170		11.6
Freight		596		549		47		8.6
Other		108		96		12		12.5

Total Supply Chain & Freight		2,339		2,110		229		10.9

Consolidated	$	13,001	$	12,189	$	812		6.7	%


					#
Average Daily Package Volume (in thousands):
U.S. Domestic Package:
Next Day Air		1,183		1,260		(77	)	(6.1	)%
Deferred		878		899		(21	)	(2.3	)
Ground		10,999		11,071		(72	)	(0.7	)

Total U.S. Domestic Package		13,060		13,230		(170	)	(1.3	)
International Package:
Domestic		1,127		1,077		50		4.6
Export		798		724		74		10.2

Total International Package		1,925		1,801		124		6.9

Consolidated		14,985		15,031		(46	)	(0.3	)%

Operating days in period		64		64

					$
Average Revenue Per Piece:
U.S. Domestic Package:
Next Day Air	$	21.77	$	20.88	$	0.89		4.3	%
Deferred		14.04		13.77		0.27		2.0
Ground		7.50		7.20		0.30		4.2
Total U.S. Domestic Package		9.23		8.95		0.28		3.1
International Package:
Domestic		8.62		7.50		1.12		14.9
Export		42.00		39.58		2.42		6.1
Total International Package		22.46		20.40		2.06		10.1
Consolidated	$	10.93	$	10.32	$	0.61		5.9	%

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS


	Six Months Ended June 30,				Change
	2008		2007		$			%
Revenue (in millions):
U.S. Domestic Package:
Next Day Air	$	3,286	$	3,337	$	(51	)	(1.5	)%
Deferred		1,594		1,594		—		—
Ground		10,569		10,200		369		3.6

Total U.S. Domestic Package		15,449		15,131		318		2.1
International Package:
Domestic		1,205		1,028		177		17.2
Export		4,167		3,581		586		16.4
Cargo		335		276		59		21.4

Total International Package		5,707		4,885		822		16.8
Supply Chain & Freight:
Forwarding and Logistics		3,198		2,851		347		12.2
Freight		1,109		1,037		72		6.9
Other		213		191		22		11.5

Total Supply Chain & Freight		4,520		4,079		441		10.8

Consolidated	$	25,676	$	24,095	$	1,581		6.6	%


					#
Average Daily Package Volume (in thousands):
U.S. Domestic Package:
Next Day Air		1,191		1,253		(62	)	(4.9	)%
Deferred		894		918		(24	)	(2.6	)
Ground		11,069		11,089		(20	)	(0.2	)

Total U.S. Domestic Package		13,154		13,260		(106	)	(0.8	)
International Package:
Domestic		1,114		1,095		19		1.7
Export		788		723		65		9.0

Total International Package		1,902		1,818		84		4.6

Consolidated		15,056		15,078		(22	)	(0.1	)%

Operating days in period		128		128

					$
Average Revenue Per Piece:
U.S. Domestic Package:
Next Day Air	$	21.55	$	20.81	$	0.74		3.6	%
Deferred		13.93		13.57		0.36		2.7
Ground		7.46		7.19		0.27		3.8
Total U.S. Domestic Package		9.18		8.91		0.27		3.0
International Package:
Domestic		8.45		7.33		1.12		15.3
Export		41.31		38.70		2.61		6.7
Total International Package		22.07		19.81		2.26		11.4
Consolidated	$	10.80	$	10.23	$	0.57		5.6	%

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

The following table sets forth information showing the change in UPS Freight’s less-than-truckload revenue, shipments, and weight hauled, both in dollars or amounts and in percentage terms:


	Three Months Ended June 30,				Change
	2008		2007		$ /#			%
LTL revenue (in millions)	$	564	$	526	$	38		7.2	%
LTL revenue per LTL hundredweight	$	19.28	$	17.49	$	1.79		10.2
LTL shipments (in thousands)		2,660		2,724		(64	)	(2.3	)
LTL shipments per day (in thousands)		41.6		42.6		(1.0	)	(2.3	)
LTL gross weight hauled (in millions of pounds)		2,925		3,008		(83	)	(2.8	)
LTL weight per shipment (in pounds)		1,099		1,104		(5	)	(0.5	)
Operating days in period		64		64


	Six Months Ended June 30,				Change
	2008		2007		$ /#			%
LTL revenue (in millions)	$	1,048	$	992	$	56		5.6	%
LTL revenue per LTL hundredweight	$	18.85	$	16.86	$	1.99		11.8
LTL shipments (in thousands)		5,057		5,226		(169	)	(3.2	)
LTL shipments per day (in thousands)		39.5		40.8		(1.3	)	(3.2	)
LTL gross weight hauled (in millions of pounds)		5,559		5,881		(322	)	(5.5	)
LTL weight per shipment (in pounds)		1,099		1,125		(26	)	(2.3	)
Operating days in period		128		128

Operating Profit and Operating Margin

The following tables set forth information showing the change in operating profit, both in dollars (in millions) and in percentage terms, as well as the operating margin for each reporting segment:


	Three Months Ended June 30,				Change
	2008		2007		$			%
Reporting Segment
U.S. Domestic Package	$	899	$	1,192	$	(293	)	(24.6	)%
International Package		407		475		(68	)	(14.3	)
Supply Chain & Freight		148		98		50		51.0

Consolidated Operating Profit	$	1,454	$	1,765	$	(311	)	(17.6	)%


	Three Months Ended June 30,
	2008		2007
Reporting Segment
U.S. Domestic Package	11.7	%	15.7	%
International Package	13.8	%	19.0	%
Supply Chain & Freight	6.3	%	4.6	%
Consolidated Operating Margin	11.2	%	14.5	%

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

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	Six Months Ended June 30,				Change
	2008		2007		$			%
Reporting Segment
U.S. Domestic Package	$	1,858	$	2,133	$	(275	)	(12.9	)%
International Package		828		846		(18	)	(2.1	)
Supply Chain & Freight		261		144		117		81.3

Consolidated Operating Profit	$	2,947	$	3,123	$	(176	)	(5.6	)%


	Six Months Ended June 30,
	2008		2007
Reporting Segment
U.S. Domestic Package	12.0	%	14.1	%
International Package	14.5	%	17.3	%
Supply Chain & Freight	5.8	%	3.5	%
Consolidated Operating Margin	11.5	%	13.0	%

U.S. Domestic Package Operations

U.S. domestic package revenue increased $135 million, or 1.8%, for the quarter ($318 million, or 2.1%, year-to-date), largely due to a 3.1% improvement in revenue per piece, offset by a 1.3% decrease in average daily package volume.

Next Day Air volume, deferred air volume and ground volume declined 6.1%, 2.3%, and 0.7%, respectively during the quarter (4.9%, 2.6%, and 0.2% year-to-date, respectively), primarily as a result of slowing growth in the U.S. economy. Continuing trends of escalating energy costs combined with weak output within the industrial production and retail sales sectors have not been favorable for the small package market, which places additional pressure on our domestic package volume.

The increase in overall revenue per piece of 3.1% (3.0% year-to-date) resulted primarily from a rate increase that took effect during the first quarter and higher fuel surcharge rates, but was partially offset by an unfavorable shift in product mix. Next Day Air and Deferred revenue per piece increased 4.3% and 2.0%, respectively (3.6% and 2.7% year-to-date, respectively), and were positively impacted by the base rate increase and a higher fuel surcharge rate for air products (discussed further below). This increase was adversely impacted by lower average package weights, a mix shift toward lower yielding products, and hedging losses. The adverse impact of these hedges will be substantially reduced in the third and fourth quarters of this year. Ground revenue per piece increased 4.2% (3.8% year-to-date), mainly due to the rate increase, as well as a higher fuel surcharge rate due to increased diesel fuel prices in 2008 compared with the second quarter of 2007.

On November 9, 2007, we announced a rate increase and a change in the fuel surcharge that took effect on December 31, 2007. We increased the base rates 6.9% on UPS Next Day Air, UPS 2nd Day Air, and UPS 3 Day Select, and 4.9% on UPS Ground. Other pricing changes included a $0.10 increase in the residential surcharge, and an increase of $0.10 in the delivery area surcharge on both residential and commercial services to certain ZIP codes.

We also modified the fuel surcharge on domestic air services by reducing the index used to determine the fuel surcharge by 2%. This fuel surcharge continues to be 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 on domestic

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

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air products was 24.39% in the second quarter of 2008, an increase from the 11.49% in the second quarter of 2007 (21.62% year-to-date 2008 compared with 10.48% in the same period of 2007), due to the significant increase in jet fuel prices in 2008, but partially offset by the 2% reduction in the index. The ground fuel surcharge rate continues to fluctuate based on the U.S. Energy Department’s On-Highway Diesel Fuel Price. Based on published rates, the average fuel surcharge on domestic ground products increased to 7.52% in the second quarter of 2008 from 4.00% in the second quarter of 2007 (6.84% year-to-date 2008 compared with 3.83% in the same period of 2007), due to significantly higher diesel fuel prices. Total domestic fuel surcharge revenue, net of the impact of hedging losses, increased by $224 million in the second quarter of 2008 compared with the same period of 2007 (increase of $421 million year-to-date 2008 compared with 2007), primarily due to the higher fuel surcharge rates discussed above, but partially offset by the decline in volume for our air products.

U.S. domestic package operating profit decreased $293 million, or 24.6%, in the second quarter of 2008 compared with the same period in 2007 ($275 million, or 12.9%, year-to-date). Operating profit in 2008 was adversely impacted by the slowing growth in the U.S. economy, lower asset utilization due to the decline in volume, and a shift in product mix away from our premium services. Additionally, operating profit was negatively impacted by the rapid escalation in fuel prices during the quarter and year-to-date periods. There is an approximate two month time lag between fuel price changes and when the adjusted surcharge rates are applied to package shipments. As such, the rapid increase in fuel prices hindered our ability to recapture the resulting increases in fuel expenses through the use of the fuel surcharge.

Operating profit for the first six months of 2007 was adversely affected by the aircraft impairment and SVSO charges (discussed further in the “Operating Expenses” section), which reduced domestic operating profit by $159 million and $53 million, respectively. The absence of these charges in 2008 favorably affected the operating profit comparison between periods.

International Package Operations

International Package revenue improved $448 million, or 17.9%, for the quarter ($822 million, or 16.8%, year-to-date), driven by a 10.2% volume increase for our export products and a 10.1% increase in total revenue per piece (9.0% and 11.4% year-to-date, respectively). The growth in revenue per piece was primarily due to rate increases, the impact of currency exchange rates, and increased fuel surcharge rates.

Total export volume in the second quarter was favorably impacted by the timing of the Easter holiday, which boosted the export volume growth rate by approximately 2%. Export volume increased in each region in the world, with intra-regional volume showing the strongest growth, especially in Europe. Asian export volume continues to benefit from our geographic service expansion, as well as strong economic growth in Asia. Export volume growth was hindered by declines in shipments to the U.S. from each region in the world, due to the slowing U.S. economy. Export volume growth slowed throughout the second quarter.

Non-U.S. domestic volume increased 4.6% for the quarter (1.7% year-to-date), and was impacted by volume growth in our domestic businesses in Europe and the Americas. The second quarter growth in our non-U.S. domestic volume was also positively impacted by the timing of the Easter holiday.

Export revenue per piece increased 6.1% for the quarter (6.7% year-to-date), largely due to base rate increases, higher fuel surcharge rates, and favorable currency exchange rates, but was adversely impacted by relatively higher growth in lower revenue per piece transborder products. Domestic revenue per piece increased 14.9% for the quarter (15.3% year-to-date), and was affected by rate increases and favorable exchange rates.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

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Total average revenue per piece increased 2.4% on a currency-adjusted basis (3.4% year-to-date), and the overall change in segment revenue was positively affected by $177 million during the quarter ($356 million year-to-date) due to currency fluctuations, net of hedging activity.

On December 31, 2007, we increased the base rates 6.9% for international shipments originating in the United States (Worldwide Express, Worldwide Express Plus, UPS Worldwide Expedited and UPS International Standard service). Rate changes for international shipments originating outside the United States vary by geographical market and occur throughout the year.

Additionally, we modified the fuel surcharge on certain U.S.-related international air services by reducing the index used to determine the fuel surcharge by 2%. The fuel surcharge for products originating outside the United States continues to be indexed to fuel prices in our different international regions, depending upon where the shipment takes place. Total international fuel surcharge revenue increased by $164 million in the second quarter ($284 million year-to-date), due to higher fuel surcharge rates caused by increased fuel prices as well as an increase in international air volume.

International Package operating profit decreased $68 million, or 14.3%, in the second quarter of 2008 compared with the same period of 2007 ($18 million, or 2.1%, year-to-date). The decline in operating profit was affected by reduced asset utilization resulting from changes in economic conditions and trade flows. Operating profit was also negatively affected by a shift in product mix away from our premium services, as well as expenses associated with integration activities in our delivery network. Additionally, the decline in operating profit in 2008 was impacted by the rapid escalation in fuel prices during the quarter and year-to-date periods. There is an approximate two month time lag between fuel price changes and when the adjusted surcharge rates are applied to package shipments. As such, the rapid increase in fuel prices hindered our ability to recapture the resulting increases in fuel expenses through the use of the fuel surcharge.

Operating profit for the first six months of 2007 was adversely affected by the aircraft impairment and SVSO charges ($62 million of the aircraft impairment charge and $7 million of the SVSO charge impacted the International Package segment). The absence of these charges in 2008 favorably affected the operating profit comparison between periods. The change in operating profit was also positively affected by $46 million during the quarter ($105 million year-to-date) due to favorable currency exchange rates, net of hedging activity.

Supply Chain & Freight Operations

Supply Chain & Freight revenue increased $229 million, or 10.9%, for the quarter ($441 million, or 10.8%, year-to-date). Forwarding and logistics revenue increased $170 million, or 11.6%, for the quarter ($347 million, or 12.2%, year-to-date), primarily due to growth in international air freight, distribution services and post sales logistics services. Revenue growth in this business was affected by overall market growth and improved customer retention rates. The overall change in forwarding and logistics revenue was positively affected by $97 million during the quarter ($182 million year-to-date) due to favorable currency exchange rates.

UPS Freight increased revenue $47 million, or 8.6%, for the quarter ($72 million, or 6.9%, year-to-date), as a result of improved yields and higher fuel surcharge rates, but partially offset by a decline in average daily LTL shipments. Average LTL shipments per day decreased 2.3% during the quarter (3.2% year-to-date), reflecting the weak LTL market in the United States in 2008 as compared with 2007. However, LTL revenue per hundredweight increased 10.2% for the quarter (11.8% year-to-date), due to an increase in base rates in 2008 and an increase in fuel surcharge revenue as a result of higher diesel prices.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

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In January 2008, UPS Freight announced a general rate increase averaging 5.4% covering non-contractual shipments in the United States and Canada. The increase became effective on February 4, 2008, and applies to minimum charge, LTL and TL rates.

The other businesses within Supply Chain & Freight, which include our retail franchising business and our financial business, increased revenue by 12.5% during the quarter (11.5% year-to-date). This revenue growth was impacted by increased revenue from our contract to provide domestic air transportation services for the U.S. Postal Service.

Operating profit for the Supply Chain & Freight segment increased by $50 million, or 51.0%, for the quarter ($117 million, or 81.3%, year-to-date), primarily due to improved results in the forwarding and logistics business. The improved operating results in this business primarily resulted from revenue management initiatives and a focus on asset utilization. Additionally, margin improvements are being realized by focusing on capacity utilization in the air freight business, through better utilization of space availability on our own aircraft. Operating profit was lower at UPS Freight during the quarter, largely as a result of the slowing LTL market in the United States.

Operating profit for this segment was negatively impacted in the first six months of 2007 by $8 million due to the SVSO charge, as discussed further in the “Operating Expenses” section below. The absence of this charge in 2008 favorably affected the operating profit comparison between periods. The change in operating profit was also positively affected by $4 million in the quarter ($12 million year-to-date) due to favorable currency exchange rates.

Operating Expenses

Consolidated operating expenses increased by $1.123 billion, or 10.8%, for the quarter ($1.757 billion, or 8.4%, year-to-date), of which approximately $224 million ($421 million year-to-date) was due to currency fluctuations in our International Package and Supply Chain & Freight segments.

Compensation and benefits expense increased by $195 million, or 3.1%, for the quarter ($354 million, or 2.8%, year-to-date), and was impacted by several items. The primary increase was related to employee payroll costs due to contractual wage increases for our union employees and normal merit increases for our non-union employees. Other items impacting compensation and benefits expense include increased stock-based compensation, higher expense for employee health and welfare programs, a reduction in pension expense, and slightly lower workers compensation expense. Stock-based compensation expense increased $16 million, or 13.6%, in the second quarter ($38 million, or 17.8%, year-to-date), primarily due to new 2008 awards of stock options and restricted performance units, as well as restricted stock units that are reflected in expense in 2008, but not the first six months of 2007, due to the timing of the award grants.

The total expense for our employee pension programs declined in the second quarter and on a year-to-date basis, and was affected by the 2007 withdrawal from the Central States Pension Fund. Partially offsetting this was higher expense for UPS-sponsored pension plans (See Note 6 to the unaudited consolidated financial statements), which was impacted by expense recognition for the new UPS-IBT pension plan. We also incurred lower workers compensation expense, which continues to trend favorably as a result of decreased injury frequencies and improved oversight and management of claims.

In December 2006, we offered the SVSO to approximately 640 employees who work in non-operating functions. This program was established to improve the efficiency of non-operating processes by eliminating

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

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duplication and sharing expertise across the company. The SVSO ended in February 2007, and 195, or 30% of eligible employees, accepted the offer. As a result, we recorded a charge to expense of approximately $68 million in the first quarter of 2007, to reflect the cash payout and the acceleration of stock compensation and certain retiree healthcare benefits under the SVSO program. The absence of this charge in 2008 favorably affected the compensation and benefits expense comparison between periods.

The 0.7% quarterly increase in repairs and maintenance was largely due to increased aircraft maintenance, while the 1.0% year-to-date decrease was largely due to reduced vehicle maintenance expense. The 4.9% quarterly increase (4.3% year-to-date) in depreciation and amortization was influenced by several factors, including higher depreciation expense on aircraft and vehicles, but partially offset by reduced amortization expense on capitalized software. The 21.2% quarterly increase (20.6% year-to-date) in purchased transportation was driven by a combination of higher volume in our international package and forwarding businesses, the impact of currency exchange rates, and increased fuel surcharge rates charged to us by third-party carriers. The 67.4% quarterly increase (61.2% year-to-date) in fuel expense was impacted by higher prices for jet-A fuel, diesel, and unleaded gasoline as well as lower hedging gains, but partially mitigated by lower fuel usage. The 13.5% quarterly increase (12.2% year-to-date) in other occupancy expense was influenced by higher electricity and natural gas costs, as well as higher rent and property tax expense.

Other expenses increased 10.5% for the quarter, due to a variety of factors, including increased expenses for leased transportation equipment, data processing costs, professional fees, and an increased provision in our allowance for doubtful accounts. On a year-to-date basis, other expenses declined 2.1%, largely due to the absence in 2008 of an aircraft impairment charge recorded in 2007. In the first quarter of 2007, we initiated a review of our aircraft fleet types as a result of business changes that occurred, including capacity-optimization programs in our domestic and international air freight forwarding business, as well as changes to our aircraft orders and planned delivery dates. The review was completed in March 2007, and based on the results of our evaluation, we accelerated the planned retirement of certain Boeing 727 and 747 aircraft, and recognized an impairment and obsolescence charge of $221 million for the aircraft and related engines and parts.

Investment Income and Interest Expense

Investment income decreased $14 million during the second quarter of 2008 compared with the same period in 2007. This decrease was largely due to lower realized gains on sales of investments in the second quarter of 2008 compared with the same period of 2007.

On a year-to-date basis, investment income increased $29 million in 2008 compared with 2007. This increase was primarily due to a higher average balance of interest-earning investments, but partially offset by a lower average yield on our investment portfolio.

The $43 million increase in interest expense during the quarter ($128 million year-to-date) was primarily due to a higher average debt balance. Our debt balance increased at the end of 2007 as a result of commercial paper issuances used to fund our withdrawal from the Central States Pension Fund. In early 2008, we completed the issuance of $4.0 billion in long-term debt, the proceeds of which were used to reduce our commercial paper balance. The impact of increased debt balances was partially mitigated, however, by lower average rates incurred on our variable rate debt and interest rate swap agreements as a result of recent declines in short-term interest rates in the United States.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

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Income Tax Expense

Income tax expense declined by $137 million, or 21.8%, for the quarter ($107 million, or 9.7%, year-to-date), primarily due to lower pre-tax income. Additionally, the effective income tax rate declined to 36.00% in 2008 from 36.25% in 2007. The decrease in the effective tax rate was impacted by a number of factors, including having a relatively larger proportion of our taxable income being earned in international jurisdictions with lower tax rates.

Net Income and Earnings Per Share

Net income for the second quarter of 2008 was $873 million, a 20.9% decrease from the $1.104 billion achieved in the second quarter of 2007, resulting in an 18.3% decrease in diluted earnings per share to $0.85 in 2008 from $1.04 in 2007. On a year-to-date basis, net income was $1.779 billion, an 8.6% decline from the $1.947 billion achieved in 2007. Year-to-date diluted earnings per share declined 5.5% to $1.72 in 2008 compared with $1.82 in 2007. The decline in net income for the quarter and year-to-date periods was primarily affected by the decline in operating profits in both our U.S. Domestic and International package businesses, as previously discussed. Earnings per share was favorably impacted by a reduction in outstanding shares as a result of our ongoing share repurchase program.

Year-to-date 2007 net income and earnings per share were impacted by the aircraft impairment charge and SVSO charge recorded in the first quarter of 2007, the combination of which reduced year-to-date 2007 net income by $184 million and diluted earnings per share by $0.17.

Liquidity and Capital Resources

Net Cash From Operating Activities

Net cash provided by operating activities increased to $5.028 billion in the first six months of 2008 from $3.596 billion during the same period of 2007. The increase in operating cash flow was impacted by approximately $1.035 billion in cash tax benefits received in 2008 (including an $850 million tax refund) resulting from a U.S. Federal tax deduction for the payment made to withdraw from the Central States Pension Fund in 2007. Operating cash flow also increased due to changes in working capital needs, and the timing of certain cash receipts and disbursements. Operating cash flow was negatively impacted in 2007 by several items, including the settlement of the Cornn class action lawsuit and certain payments due under our 2006 collective bargaining agreement with the Independent Pilots Association.

During 2008, the cash outflow for our pension contributions to multiemployer pension plans declined as a result of our withdrawal from the Central States Pension Fund. Our pension contributions to UPS-sponsored plans have increased slightly, primarily due to contributions being made to the new UPS-IBT pension plan. As discussed in Note 6, we expect to contribute $119 million and $24 million over the remainder of the year to our company-sponsored pension and postretirement medical benefit plans, respectively.

Changes in package volume and pricing affect operating cash flow. A base rate increase and a change in the fuel surcharge took effect on December 31, 2007. We increased the base rates 6.9% on UPS Next Day Air, UPS 2nd Day Air, and UPS 3 Day Select, and 4.9% on UPS Ground. We also increased the base rates 6.9% for international shipments originating in the United States (Worldwide Express, Worldwide Express Plus, UPS Worldwide Expedited and UPS International Standard service). Other pricing changes included a $0.10 increase in the residential surcharge, and an increase of $0.10 in the delivery area surcharge on both residential and commercial services to certain ZIP codes. These rate changes are customary, and are consistent with previous

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

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years’ rate increases. Additionally, we modified the fuel surcharge on domestic and U.S.-origin international air services by reducing by 2% the index used to determine the fuel surcharge. The UPS Ground fuel surcharge continues to fluctuate based on the U.S. Energy Department’s On-Highway Diesel Fuel Price. Rate changes for shipments originating outside the U.S. were made throughout the past year and varied by geographic market.

In January 2008, UPS Freight announced a general rate increase averaging 5.4 percent covering non-contractual shipments in the United States and Canada. The increase went into effect on February 4, 2008, and applies to minimum charge, LTL and TL rates.

Net Cash Used In Investing Activities

Net cash used in investing activities increased to $1.939 billion in the first six months of 2008 from $1.323 billion during the same period of 2007. The net purchase of marketable securities and short-term investments increased to $275 million in 2008, compared with $76 million in 2007, as a result of the timing of certain cash receipts and disbursements.

We had capital expenditures of $1.387 billion in the first six months of 2008, an increase from the $1.206 billion in 2007. We fund our capital expenditures with our cash from operations. We have commitments for the purchase of aircraft, vehicles, technology equipment and other fixed assets to provide for the replacement of existing capacity and anticipated future growth. The increased capital expenditures in 2008 were primarily the result of our Worldport hub expansion, as well as the expansion and new construction projects at other facilities in Europe, Canada, and China.

Other investing activities reflected a cash outflow of $282 million in 2008 as compared with a $99 million outflow in 2007, largely due to cash settlements of derivative contracts used in our energy and currency hedging programs, as well as the timing of aircraft purchase contract deposits on our Boeing 767-300 and Boeing 747-400 aircraft orders.

Net Cash Used In Financing Activities

Net cash used in financing activities increased to $3.986 billion in the first six months of 2008 from $2.215 billion during the same period in 2007. Our primary use of cash in financing activities is to repurchase shares, pay dividends, and repay debt obligations. In January 2008, we announced a new financial policy regarding our capital structure to enhance shareowner value. We intend to manage our balance sheet to a target debt ratio of approximately 50%-60% funds from operations to total debt. In connection with this policy, the Board of Directors authorized an increase in our share repurchase authorization to $10.0 billion. We intend to complete this level of share repurchases during 2008 and 2009.

Share repurchases may take the form of accelerated share repurchases, open market purchases, or other such methods as we deem appropriate. During the second quarter of 2008, we entered into an accelerated share repurchase program for $227 million. The program was completed by June 30, 2008, and a total of 3.3 million shares were retired. Additionally, during the second quarter of 2008, we entered into a forward purchase agreement for UPS Class B shares for $220 million, which was completed on July 31, 2008. A total of 3.6 million shares were repurchased under this agreement, approximately 0.8 million of which were in the second quarter of 2008. The cash outflow for the forward purchase agreement that had not been used on share repurchases as of June 30, 2008 was reported in other financing activities on the cash flow statement. Including the repurchases noted above, we repurchased a total of 35.7 million shares of Class A and Class B common stock for $2.486 billion for the six months ended June 30, 2008, and 21.0 million shares for $1.506 billion for the six months ended June 30, 2007 ($2.294 billion and $1.522 billion are reported on the cash flow statement for 2008 and 2007, respectively, due to the timing of settlements). As of June 30, 2008, we had $7.644 billion of our share repurchase authorization remaining.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

We increased our quarterly cash dividend payment to $0.45 per share in 2008 from $0.42 per share in 2007, resulting in an increase in total cash dividends paid for the first six months of 2008 to $1.337 billion from $1.266 billion in 2007. 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.

In January 2008, the Board of Directors approved an earlier payment schedule for the dividend typically declared in November of each year. Beginning in 2008 and going forward, that dividend is expected to be paid in December instead of the following January. As a result, we expect that a total of five dividend payments will be made in 2008.

We repaid debt, net of borrowings, of $170 million in the first six months of 2008, compared with debt issuance, net of repayments, of $498 million in the first six months of 2007. Repayments of debt consisted primarily of paydowns of commercial paper, scheduled principal payments on our capitalized lease obligations and early redemptions of certain tranches of UPS Notes. Our debt balance increased at the end of 2007 as a result of commercial paper issuances used to fund our withdrawal from the Central States Pension Fund. In early 2008, we repaid most of this commercial paper with the use of the proceeds from a senior notes offering (discussed further below), as well as the $850 million U.S. federal tax refund received.

In January 2008, we completed an offering of $1.750 billion of 4.50% senior notes due January 2013, $750 million of 5.50% senior notes due January 2018, and $1.500 billion of 6.20% senior notes due January 2038. All of the notes pay interest semiannually, and allow for redemption of the notes by UPS at any time by paying the greater of the principal amount or a “make-whole” amount, plus accrued interest. After pricing and underwriting discounts, we received a total of $3.961 billion in cash proceeds from the offering. During the first quarter of 2008, we settled certain derivatives that were designated as hedges of this notes offering, resulting in a cash outflow of $84 million (which is reported in other financing activities on the cash flow statement).

Additionally, in the first six months of 2008, we called for the redemption of $239 million of notes issued under our UPS Notes program, and the associated swaps on the notes were terminated. 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.

Sources of Credit

We are authorized to borrow up to $10.0 billion under the U.S. commercial paper program we maintain. We had $3.504 billion outstanding under this program as of June 30, 2008, with an average interest rate of 2.21%. The entire balance outstanding has been classified as a current liability on our balance sheet as of June 30, 2008. As of December 31, 2007, approximately $4.0 billion of commercial paper was classified as long-term debt in anticipation of the subsequent issuance of fixed rate senior notes, as discussed previously. We also maintain a European commercial paper program under which we are authorized to borrow up to €1.0 billion in a variety of currencies, however there were no amounts outstanding under this program as of June 30, 2008.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Except as described in this quarterly report, the nature and amounts of our payment obligations under our debt, capital and operating lease agreements, purchase commitments, and other liabilities as of June 30, 2008 have not materially changed from those at December 31, 2007, as described in our Annual Report on Form 10-K for the year ended December 31, 2007.

Contingencies

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Other Matters

We received grand jury subpoenas from the Antitrust Division of the U.S. Department of Justice (“DOJ”) regarding the DOJ’s investigations into air cargo pricing practices in July 2006 and into freight forwarding pricing practices in December 2007. In October 2007, we received information requests from the European Commission and the New Zealand Commerce Commission relating to investigations of freight forwarding pricing practices. We are cooperating with these investigations.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Recent Accounting Pronouncements

Through 2007, we utilized the early measurement date option available under Statement No. 87 “Employers’ Accounting for Pensions”, and we measured the funded status of our plans as of September 30 each year. Under the provisions of FASB Statement No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132(R))” (“FAS 158”), we are required to use a December 31 measurement date for all of our pension and postretirement benefit plans beginning in 2008. As a result of this change in measurement date, we recorded a cumulative effect $44 million reduction to retained earnings as of January 1, 2008.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Forward-Looking Statements

“Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other parts of this report contain “forward-looking” statements about matters that inherently are difficult to predict. The words “believes,” “expects,” “anticipates,” and similar expressions are intended to identify forward-looking statements. These statements include statements regarding our intent, belief and current expectations about our strategic direction, prospects and future results. We have described some of the important factors that affect these statements as we discussed each subject. Forward-looking statements involve risks and uncertainties, and certain factors may cause actual results to differ materially from those contained in the forward-looking statements. Some of the factors that could cause our actual results to differ materially from the expected results are described in our Annual Report on Form 10-K for the year ended December 31, 2007.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

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

The total fair value asset (liability) of our derivative financial instruments is summarized in the following table (in millions):


	June 30, 2008			December 31, 2007
Energy Derivatives	$	4		$	(179	)
Currency Derivatives		(150	)		(42	)
Interest Rate Derivatives		(67	)		(94	)

	$	(213	)	$	(315	)

Other than noted below, our market risks, hedging strategies, and financial instrument positions at June 30, 2008 have not materially changed from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007. In the first six months of 2008, a number of energy hedging positions expired, and the market risk sensitivity of the positions for the remainder of 2008 is not material. The market risk sensitivities of the currency and interest rate contracts noted above are not materially different from the amounts described in our Annual Report on Form 10-K for the year ended December 31, 2007.

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 large banks and financial institutions that meet established credit guidelines. We do not expect to incur any losses as a result of counterparty default.

The information concerning market risk under the sub-caption “Market Risk” of the caption “Management’s Discussion and Analysis” on pages 37-38 of our consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2007, is hereby incorporated by reference in this Quarterly Report on Form 10-Q.

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 June 30, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

For a discussion of legal proceedings affecting us and our subsidiaries, please see the information under the sub-caption “Contingencies” of the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this report.

Item 1A.

Risk Factors

There have been no material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007.

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 second quarter of 2008 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
April 1 – April 30, 2008	5.6	$	72.47	5.6	$	8,493
May 1 – May 31, 2008	4.1		70.23	4.1		8,204
June 1 – June 30, 2008	8.7		64.84	8.6		7,644

Total April 1 – June 30, 2008	18.4	$	68.36	18.3	$	7,644

(1)	Includes shares repurchased through our publicly announced share repurchase program and shares tendered to pay the exercise price and tax withholding on employee stock options.

In January 2008, we announced a new financial policy regarding our capital structure to enhance shareowner value. We intend to manage our balance sheet to a target debt ratio of approximately 50%-60% funds from operations to total debt. In connection with this policy, the Board of Directors authorized an increase in our share repurchase authorization to $10.0 billion. We intend to complete this level of share repurchases during 2008 and 2009. Share repurchases may take the form of accelerated share repurchases, open market purchases, or other such methods as we deem appropriate. 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.

Item 3.

Defaults Upon Senior Securities

None.

Item 4.

Submission of Matters to a Vote of Security Holders

Our annual meeting of shareowners was held on May 8, 2008.

Proxies for the meeting were solicited pursuant to Regulation 14A under the Securities Exchange Act of 1934. There was no solicitation in opposition to management’s nominees for director as listed in Item No. 1 in the proxy statement, and all of such nominees were elected.

1.	The results of the voting by the shareowners for directors are presented below.


Director		Number of Votes	Percent of Total Voting
F. Duane Ackerman	For Withheld	2,663,318,536 88,266,906	96.79% 3.21%

Michael J. Burns	For Withheld	2,672,106,274 79,479,167	97.11% 2.89%

D. Scott Davis	For Withheld	2,662,111,605 89,473,837	96.75% 3.25%

Stuart E. Eizenstat	For Withheld	2,674,786,028 76,799,414	97.21% 2.79%

Michael L. Eskew	For Withheld	2,648,486,704 103,098,738	96.25% 3.75%

Ann M. Livermore	For Withheld	2,655,458,988 96,126,453	96.51% 3.49%

Rudy Markham	For Withheld	2,675,986,293 75,599,148	97.25% 2.75%

John W. Thompson	For Withheld	2,666,604,258 84,981,184	96.91% 3.09%

Carol B. Tomé	For Withheld	2,665,893,396 85,692,045	96.89% 3.11%

Ben Verwaayan	For Withheld	2,665,929,094 85,656,348	96.89% 3.11%

2.	The proposal and the results of the voting by the shareowners for ratification of our appointment of independent registered public accountants are presented below.

Number of Votes

Percent of

Total Voting

To ratify the appointment of Deloitte & Touche LLP, as the independent registered public accountants for the Company for the year ending December 31, 2008

For

Against

Abstain

2,677,003,526

50,574,777

24,007,135

97.29%

1.84%

0.87%

Item 5.

Other Information

None.

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 10-Q for the Quarter Ended June 30, 2002).

3.2	—	Form of Bylaws of United Parcel Service, Inc. (incorporated by reference to Exhibit 3.2 on Form S-4 (No. 333-83349), filed on July 21, 1999, as amended).

10.1	—	Credit Agreement (364-Day Facility) dated April 17, 2008 among United Parcel Service, Inc., the initial lenders named therein, Citigroup Global Markets Inc. and J.P. Morgan Securities Inc. as joint arrangers and book managers, Barclays Bank PLC and BNP Paribas as co-documentation agents, Citibank, N.A. as administrative agent, and JPMorgan Chase Bank, N.A., as syndication agent (incorporated by reference to Exhibit 10.1 to Form 10-Q for the Quarter Ended March 31, 2008).

10.2	—	Credit Agreement (5-Year Facility) dated April 19, 2007 among United Parcel Service, Inc., the initial lenders named therein, Citigroup Global Markets Inc. and J.P. Morgan Securities Inc. as joint arrangers and book managers, Barclays Bank PLC, BNP Paribas, Mellon Bank N.A., and Wells Fargo Bank, N.A. as co-documentation agents, Citibank, N.A. as administrative agent, and JPMorgan Chase Bank, N.A., as syndication agent (incorporated by reference to Exhibit 10.2 to Form 10-Q for the Quarter Ended March 31, 2007).

10.3	—	Form of Restricted Stock Award Agreement for the 2008 Long-Term Incentive Performance Awards under the Incentive Compensation Plan (incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K, filed on March 20, 2008).

11	—	Statement regarding Computation of per Share Earnings (incorporated by reference to Note 13 to “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.

†	Filed herewith.

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: August 8, 2008	By:	/s/ KURT P. KUEHN
		Kurt P. Kuehn *Senior Vice President,* *Chief Financial Officer and Treasurer* *(Duly Authorized Officer and* *Principal Accounting Officer)*