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 September 30, 2010, 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
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
(Registrants telephone number, including area code)
Former name, former address and former fiscal year, if changed since last report.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of accelerated filer, large accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. Check one: Large accelerated filer þ Accelerated filer ¨ Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
There were 260,027,339 Class A shares, and 728,907,161 Class B shares, with a par value of $0.01 per share, outstanding at October 28, 2010.
UNITED PARCEL SERVICE, INC.
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2010
TABLE OF CONTENTS
PART IFINANCIAL INFORMATION |
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Item 1. |
Financial Statements | 1 | ||||
1 | ||||||
2 | ||||||
2 | ||||||
3 | ||||||
4 | ||||||
4 | ||||||
4 | ||||||
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6 | ||||||
10 | ||||||
11 | ||||||
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13 | ||||||
14 | ||||||
16 | ||||||
19 | ||||||
20 | ||||||
21 | ||||||
26 | ||||||
27 | ||||||
Item 2. |
Managements Discussion and Analysis of Financial Condition and Results of Operations | 28 | ||||
28 | ||||||
29 | ||||||
31 | ||||||
33 | ||||||
35 | ||||||
37 | ||||||
38 | ||||||
39 | ||||||
40 | ||||||
40 | ||||||
41 | ||||||
42 | ||||||
43 | ||||||
44 | ||||||
47 | ||||||
Item 3. |
Quantitative and Qualitative Disclosures About Market Risk | 48 | ||||
Item 4. |
Controls and Procedures | 48 | ||||
PART IIOTHER INFORMATION |
||||||
Item 1. |
Legal Proceedings | 49 | ||||
Item 1A. |
Risk Factors | 49 | ||||
Item 2. |
Unregistered Sales of Equity Securities and Use of Proceeds | 49 | ||||
Item 3. |
Defaults Upon Senior Securities | 49 | ||||
Item 5. |
Other Information | 49 | ||||
Item 6. |
Exhibits | 50 |
PART I. FINANCIAL INFORMATION
Item 1. | Financial Statements |
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
September 30, 2010 (unaudited) and December 31, 2009
(In millions)
September 30, 2010 |
December 31, 2009 |
|||||||
ASSETS | ||||||||
Current Assets: |
||||||||
Cash and cash equivalents |
$ | 3,020 | $ | 1,542 | ||||
Marketable securities |
732 | 558 | ||||||
Accounts receivable, net |
5,250 | 5,369 | ||||||
Finance receivables, net |
259 | 287 | ||||||
Deferred income tax assets |
662 | 585 | ||||||
Income tax receivable |
120 | 266 | ||||||
Other current assets |
713 | 668 | ||||||
Total Current Assets |
10,756 | 9,275 | ||||||
Property, Plant and Equipment, Net |
17,471 | 17,979 | ||||||
Goodwill |
2,085 | 2,089 | ||||||
Intangible Assets, Net |
609 | 596 | ||||||
Non-Current Finance Receivables, Net |
313 | 337 | ||||||
Other Non-Current Assets |
1,673 | 1,607 | ||||||
Total Assets |
$ | 32,907 | $ | 31,883 | ||||
LIABILITIES AND SHAREOWNERS EQUITY | ||||||||
Current Liabilities: |
||||||||
Current maturities of long-term debt and commercial paper |
$ | 994 | $ | 853 | ||||
Accounts payable |
1,840 | 1,766 | ||||||
Accrued wages and withholdings |
1,799 | 1,416 | ||||||
Self-insurance reserves |
783 | 757 | ||||||
Income taxes accrued |
129 | 258 | ||||||
Other current liabilities |
1,256 | 1,189 | ||||||
Total Current Liabilities |
6,801 | 6,239 | ||||||
Long-Term Debt |
8,648 | 8,668 | ||||||
Pension and Postretirement Benefit Obligations |
4,850 | 5,457 | ||||||
Deferred Income Tax Liabilities |
1,497 | 1,293 | ||||||
Self-Insurance Reserves |
1,723 | 1,732 | ||||||
Other Non-Current Liabilities |
862 | 798 | ||||||
Shareowners Equity: |
||||||||
Class A common stock (264 and 285 shares issued in 2010 and 2009) |
3 | 3 | ||||||
Class B common stock (727 and 711 shares issued in 2010 and 2009) |
7 | 7 | ||||||
Additional paid-in capital |
| 2 | ||||||
Retained earnings |
13,603 | 12,745 | ||||||
Accumulated other comprehensive loss |
(5,153 | ) | (5,127 | ) | ||||
Deferred compensation obligations |
101 | 108 | ||||||
Less: Treasury stock (2 shares in 2010 and 2009) |
(101 | ) | (108 | ) | ||||
Total Equity for Controlling Interests |
8,460 | 7,630 | ||||||
Total Equity for Non-Controlling Interests |
66 | 66 | ||||||
Total Shareowners Equity |
8,526 | 7,696 | ||||||
Total Liabilities and Shareowners Equity |
$ | 32,907 | $ | 31,883 | ||||
See notes to unaudited consolidated financial statements.
1
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(In millions, except per share amounts)
(unaudited)
Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Revenue |
$ | 12,192 | $ | 11,153 | $ | 36,124 | $ | 32,920 | ||||||||
Operating Expenses: |
||||||||||||||||
Compensation and benefits |
6,411 | 6,341 | 19,465 | 19,003 | ||||||||||||
Repairs and maintenance |
282 | 265 | 837 | 814 | ||||||||||||
Depreciation and amortization |
448 | 441 | 1,348 | 1,297 | ||||||||||||
Purchased transportation |
1,656 | 1,298 | 4,770 | 3,698 | ||||||||||||
Fuel |
724 | 635 | 2,119 | 1,670 | ||||||||||||
Other occupancy |
222 | 241 | 700 | 738 | ||||||||||||
Other expenses |
833 | 1,003 | 2,825 | 3,158 | ||||||||||||
Total Operating Expenses |
10,576 | 10,224 | 32,064 | 30,378 | ||||||||||||
Operating Profit |
1,616 | 929 | 4,060 | 2,542 | ||||||||||||
Other Income and (Expense): |
||||||||||||||||
Investment income (loss) |
15 | 6 | (7 | ) | (3 | ) | ||||||||||
Interest expense |
(91 | ) | (93 | ) | (260 | ) | (356 | ) | ||||||||
Total Other Income and (Expense) |
(76 | ) | (87 | ) | (267 | ) | (359 | ) | ||||||||
Income Before Income Taxes |
1,540 | 842 | 3,793 | 2,183 | ||||||||||||
Income Tax Expense |
549 | 293 | 1,424 | 788 | ||||||||||||
Net Income |
$ | 991 | $ | 549 | $ | 2,369 | $ | 1,395 | ||||||||
Basic Earnings Per Share |
$ | 1.00 | $ | 0.55 | $ | 2.38 | $ | 1.40 | ||||||||
Diluted Earnings Per Share |
$ | 0.99 | $ | 0.55 | $ | 2.36 | $ | 1.39 | ||||||||
STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(In millions)
(unaudited)
Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Net income |
$ | 991 | $ | 549 | $ | 2,369 | $ | 1,395 | ||||||||
Change in foreign currency translation adjustment |
125 | 163 | (95 | ) | 126 | |||||||||||
Change in unrealized gain (loss) on marketable securities, net of tax |
9 | 12 | 44 | 33 | ||||||||||||
Change in unrealized gain (loss) on cash flow hedges, net of tax |
(113 | ) | (117 | ) | (101 | ) | (166 | ) | ||||||||
Change in unrecognized pension and postretirement benefit costs, net of tax |
43 | 39 | 126 | 118 | ||||||||||||
Comprehensive income |
$ | 1,055 | $ | 646 | $ | 2,343 | $ | 1,506 | ||||||||
See notes to unaudited consolidated financial statements.
2
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(In millions)
(unaudited)
Nine Months Ended September 30, |
||||||||
2010 | 2009 | |||||||
Cash Flows From Operating Activities: |
||||||||
Net income |
$ | 2,369 | $ | 1,395 | ||||
Adjustments to reconcile net income to net cash from operating activities: |
||||||||
Depreciation and amortization |
1,348 | 1,297 | ||||||
Pension and postretirement benefit expense |
672 | 659 | ||||||
Pension and postretirement benefit contributions |
(1,069 | ) | (758 | ) | ||||
Self-insurance reserves |
17 | (31 | ) | |||||
Deferred taxes, credits and other |
(24 | ) | 352 | |||||
Stock compensation expense |
349 | 312 | ||||||
Asset impairment charges |
| 181 | ||||||
Other (gains) losses |
(15 | ) | 65 | |||||
Changes in assets and liabilities, net of effect of acquisitions: |
||||||||
Accounts receivable |
(43 | ) | 550 | |||||
Other current assets |
81 | 161 | ||||||
Accounts payable |
62 | (319 | ) | |||||
Accrued wages and withholdings |
390 | 266 | ||||||
Other current liabilities |
(221 | ) | 33 | |||||
Other operating activities |
7 | 70 | ||||||
Net cash from operating activities |
3,923 | 4,233 | ||||||
Cash Flows From Investing Activities: |
||||||||
Capital expenditures |
(1,011 | ) | (1,185 | ) | ||||
Proceeds from disposals of property, plant and equipment |
294 | 40 | ||||||
Purchases of marketable securities |
(1,751 | ) | (1,866 | ) | ||||
Sales and maturities of marketable securities |
1,718 | 1,854 | ||||||
Net (increase) decrease in finance receivables |
76 | 206 | ||||||
Other investing activities |
181 | 72 | ||||||
Net cash used in investing activities |
(493 | ) | (879 | ) | ||||
Cash Flows From Financing Activities: |
||||||||
Net change in short-term debt |
174 | (1,161 | ) | |||||
Proceeds from long-term borrowings |
113 | 3,140 | ||||||
Repayments of long-term borrowings |
(355 | ) | (1,753 | ) | ||||
Purchases of common stock |
(599 | ) | (395 | ) | ||||
Issuances of common stock |
151 | 104 | ||||||
Dividends |
(1,363 | ) | (1,313 | ) | ||||
Other financing activities |
(60 | ) | (283 | ) | ||||
Net cash used in financing activities |
(1,939 | ) | (1,661 | ) | ||||
Effect Of Exchange Rate Changes On Cash And Cash Equivalents |
(13 | ) | 42 | |||||
Net Increase (Decrease) In Cash And Cash Equivalents |
1,478 | 1,735 | ||||||
Cash And Cash Equivalents: |
||||||||
Beginning of period |
1,542 | 507 | ||||||
End of period |
$ | 3,020 | $ | 2,242 | ||||
See notes to unaudited consolidated financial statements.
3
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Principles of Consolidation
In our opinion, the accompanying interim, unaudited, consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. These consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly our financial position as of September 30, 2010, our results of operations for the three and nine months ended September 30, 2010 and 2009, and our cash flows for the nine months ended September 30, 2010 and 2009. 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, 2009.
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.
Fair Value of Financial Instruments
The carrying amount of our cash and cash equivalents, accounts receivable, finance receivables, and accounts payable approximate fair value as of September 30, 2010. The fair value of our investment securities is disclosed in Note 4, our short and long-term debt in Note 8, and our derivative instruments in Note 13.
Accounting Estimates
The preparation of the accompanying interim, unaudited, consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best information and actual results could differ materially from those estimates.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
Adoption of New Accounting Standards
There were no accounting standards adopted during the nine months ended September 30, 2010 that had a material impact on our consolidated financial statements.
Standards Issued But Not Yet Effective
Other new pronouncements issued but not effective until after September 30, 2010 are not expected to have a significant effect on our consolidated financial position or results of operations.
NOTE 3. 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
4
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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 2010, we granted target restricted stock units (RSUs) under the UPS Long-Term Incentive Performance Award program to eligible management. Of the total 2010 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 2010 to 2012, using performance criteria targets established each year. For 2010, those targets consist of consolidated operating return on invested capital and growth in consolidated revenue. The remaining 10% of the total 2010 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. Based on the date that the eligible management population and performance targets were approved for the 2010 performance tranches, we determined the award measurement date to be March 18, 2010, and therefore the target RSU grant was valued for stock compensation expense purposes using the closing New York Stock Exchange price of $64.42 on that date.
During the second quarter of 2010, we granted stock option and restricted performance unit (RPU) awards to eligible management employees under the UPS Long-Term Incentive Program. Stock options are granted to a limited group of senior management, while all of the eligible management population receives awards in the form of RPUs. Stock option and RPU awards will generally vest over a five year period with approximately 20% of the award vesting at each anniversary date of the grant (except in the case of death, disability, or retirement, whereby immediate vesting occurs). The options granted will expire ten years after the date of grant. In the second quarter of 2010, we granted 0.2 million stock options and 1.8 million RPUs at a grant price of $67.18. In the second quarter of 2009, we granted 0.3 million stock options and 2.2 million RPUs at a grant price of $55.83. The fair value of each stock option granted, as determined by the Black-Scholes valuation model, was $14.83 and $10.86 for 2010 and 2009, respectively, using the following assumptions:
2010 | 2009 | |||||||
Expected life (in years) |
7.5 | 7.5 | ||||||
Risk-free interest rate |
3.30 | % | 3.22 | % | ||||
Expected volatility |
23.59 | % | 23.16 | % | ||||
Expected dividend yield |
2.70 | % | 3.25 | % |
Awards under the Management Incentive 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 September 30, 2010 and 2009 was $111 and $93 million pre-tax, respectively. Compensation expense for share-based awards recognized in net income for the nine months ended September 30, 2010 and 2009 was $349 and $312 million pre-tax, respectively.
5
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of marketable securities classified as available-for-sale as of September 30, 2010 and December 31, 2009 (in millions):
Cost | Unrealized Gains |
Unrealized Losses |
Estimated Fair Value |
|||||||||||||
September 30, 2010 |
||||||||||||||||
Current marketable securities: |
||||||||||||||||
U.S. government and agency debt securities |
$ | 194 | $ | 3 | $ | | $ | 197 | ||||||||
Mortgage and asset-backed debt securities |
189 | 3 | (1 | ) | 191 | |||||||||||
Corporate debt securities |
230 | 9 | | 239 | ||||||||||||
U.S. state and local municipal debt securities |
41 | | | 41 | ||||||||||||
Other debt and equity securities |
58 | 6 | | 64 | ||||||||||||
Current marketable securities |
712 | 21 | (1 | ) | 732 | |||||||||||
Non-current marketable securities: |
||||||||||||||||
Asset-backed debt securities |
84 | 2 | (2 | ) | 84 | |||||||||||
U.S. state and local municipal debt securities |
71 | 3 | (9 | ) | 65 | |||||||||||
Common equity securities |
20 | 12 | | 32 | ||||||||||||
Preferred equity securities |
16 | 2 | (2 | ) | 16 | |||||||||||
Non-current marketable securities |
191 | 19 | (13 | ) | 197 | |||||||||||
Total marketable securities |
$ | 903 | $ | 40 | $ | (14 | ) | $ | 929 | |||||||
Cost | Unrealized Gains |
Unrealized Losses |
Estimated Fair Value |
|||||||||||||
December 31, 2009 |
||||||||||||||||
Current marketable securities: |
||||||||||||||||
U.S. government and agency debt securities |
$ | 126 | $ | | $ | (1 | ) | $ | 125 | |||||||
Mortgage and asset-backed debt securities |
158 | 2 | (1 | ) | 159 | |||||||||||
Corporate debt securities |
213 | 6 | | 219 | ||||||||||||
U.S. state and local municipal debt securities |
22 | | | 22 | ||||||||||||
Other debt and equity securities |
28 | 5 | | 33 | ||||||||||||
Current marketable securities |
547 | 13 | (2 | ) | 558 | |||||||||||
Non-current marketable securities: |
||||||||||||||||
Asset-backed debt securities |
150 | | (38 | ) | 112 | |||||||||||
U.S. state and local municipal debt securities |
115 | | (26 | ) | 89 | |||||||||||
Common equity securities |
21 | 10 | | 31 | ||||||||||||
Preferred equity securities |
16 | | (1 | ) | 15 | |||||||||||
Non-current marketable securities |
302 | 10 | (65 | ) | 247 | |||||||||||
Total marketable securities |
$ | 849 | $ | 23 | $ | (67 | ) | $ | 805 | |||||||
Auction Rate Securities
At September 30, 2010, we held investments in auction rate securities with a cost basis of $171 million. Some of these investments take the form of debt securities, and are structured as direct obligations of local governments or agencies (classified as U.S. state and local municipal debt securities). Other auction rate security investments are structured as obligations of asset-backed trusts (classified as Asset-backed debt securities), generally all of which
6
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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 or money market securities. Substantially all of our investments in auction rate securities maintain investment-grade ratings of BBB / Baa or higher by Standard & Poors Rating Service (Standard & Poors) and Moodys Investors Service (Moodys), respectively.
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 continued to classify 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 September 30, 2010. 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. In the first nine months of 2010, auction rate securities with a par value of $39 million were successfully auctioned, resulting in their liquidation with no realized gain or loss.
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. As a result, we have an after-tax unrealized loss of $4 million on these securities as of September 30, 2010 in accumulated other comprehensive income ($6 million pre-tax), reflecting the decline in the estimated fair value of these securities.
Other-Than-Temporary Impairment Losses
During the second quarter of 2010, we recorded impairment losses on certain asset-backed auction rate securities. The impairment charge resulted from the provisions that allow the issuers of the securities to subordinate our holdings to newly issued debt or to tender for the securities at less than their par value. These securities, which had a cost basis of $128 million, were written down to their fair value of $107 million as of June 30, 2010, as an other-than-temporary impairment. The $21 million total impairment charge during the quarter was recorded in investment income (loss) on the statement of consolidated income.
During the second quarter of 2009, we recorded impairment losses on certain perpetual preferred securities, and an auction rate security collateralized by preferred securities, issued by large financial institutions. The impairment charge resulted from conversion offers from the issuers of these securities at prices well below the stated redemption value of the preferred shares. These securities, which had a cost basis of $42 million, were written down to their fair value of $25 million as of June 30, 2009, as an other-than-temporary impairment. The $17 million total impairment charge during the quarter was recorded in investment income (loss) on the statement of consolidated income.
Other than as previously discussed, we have concluded that no other-than-temporary impairment losses existed as of September 30, 2010. In making this determination, we considered the financial condition and prospects of the issuers, the magnitude of the losses compared with the investments cost, the length of time the investments have been in an unrealized loss position, the probability that we will be unable to collect all amounts due according to the contractual terms of the securities, the credit rating of the securities, and our ability and intent to hold these investments until the anticipated recovery in market value occurs.
7
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Maturity Information
The amortized cost and estimated fair value of marketable securities at September 30, 2010, 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 |
$ | 96 | $ | 96 | ||||
Due after one year through three years |
221 | 225 | ||||||
Due after three years through five years |
65 | 66 | ||||||
Due after five years |
466 | 469 | ||||||
848 | 856 | |||||||
Equity securities |
55 | 73 | ||||||
$ | 903 | $ | 929 | |||||
Restricted Cash
We had $286 million of restricted cash related to our self-insurance requirements, as of September 30, 2010 and December 31, 2009, which is reported in Other Non-Current Assets on the consolidated balance sheets.
Fair Value Measurements
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, corporate bonds, 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 September 30, 2010 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.
We maintain holdings in certain investment partnerships that are measured at fair value utilizing Level 3 inputs (classified as other investments in the tables below, and as Other Non-Current Assets in the consolidated balance sheets). These partnership holdings 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 partnerships financial statements and cash flow projections.
8
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The following table presents information about our investments measured at fair value on a recurring basis as of September 30, 2010 and December 31, 2009, 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 September 30, 2010 |
|||||||||||||
September 30, 2010 |
||||||||||||||||
Marketable Securities: |
||||||||||||||||
U.S. Government and Agency Debt Securities |
$ | 197 | $ | | $ | | $ | 197 | ||||||||
Mortgage and Asset-Backed Debt Securities |
| 191 | 84 | 275 | ||||||||||||
Corporate Debt Securities |
| 239 | | 239 | ||||||||||||
U.S. State and Local Municipal Debt Securities |
| 41 | 65 | 106 | ||||||||||||
Other Debt and Equity Securities |
57 | 39 | 16 | 112 | ||||||||||||
Other investments |
| | 272 | 272 | ||||||||||||
Total |
$ | 254 | $ | 510 | $ | 437 | $ | 1,201 | ||||||||
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
Balance as of December 31, 2009 |
|||||||||||||
December 31, 2009 |
||||||||||||||||
Marketable Securities: |
||||||||||||||||
U.S. Government and Agency Debt Securities |
$ | 125 | $ | | $ | | $ | 125 | ||||||||
Mortgage and Asset-Backed Debt Securities |
| 159 | 112 | 271 | ||||||||||||
Corporate Debt Securities |
| 219 | | 219 | ||||||||||||
U.S. State and Local Municipal Debt Securities |
| 22 | 89 | 111 | ||||||||||||
Other Debt and Equity Securities |
54 | 10 | 15 | 79 | ||||||||||||
Other investments |
| | 301 | 301 | ||||||||||||
Total |
$ | 179 | $ | 410 | $ | 517 | $ | 1,106 | ||||||||
The following table presents the changes in the above Level 3 instruments measured on a recurring basis for the three months ended September 30, 2010 (in millions).
Marketable Securities |
Other Investments |
Total | ||||||||||
Balance on July 1, 2010 |
$ | 184 | $ | 278 | $ | 462 | ||||||
Transfers into (out of) Level 3 |
| | | |||||||||
Net realized and unrealized gains (losses): |
||||||||||||
Included in earnings (in investment income (loss)) |
| (6 | ) | (6 | ) | |||||||
Included in accumulated other comprehensive income (pre-tax) |
10 | | 10 | |||||||||
Purchases, issuances, and settlements |
(29 | ) | | (29 | ) | |||||||
Balance on September 30, 2010 |
$ | 165 | $ | 272 | $ | 437 | ||||||
9
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the changes in the above Level 3 instruments measured on a recurring basis for the nine months ended September 30, 2010 (in millions).
Marketable Securities |
Other Investments |
Total | ||||||||||
Balance on January 1, 2010 |
$ | 216 | $ | 301 | $ | 517 | ||||||
Transfers into (out of) Level 3 |
| | | |||||||||
Net realized and unrealized gains (losses): |
||||||||||||
Included in earnings (in investment income (loss)) |
(28 | ) | (29 | ) | (57 | ) | ||||||
Included in accumulated other comprehensive income (pre-tax) |
58 | | 58 | |||||||||
Purchases, issuances, and settlements |
(81 | ) | | (81 | ) | |||||||
Balance on September 30, 2010 |
$ | 165 | $ | 272 | $ | 437 | ||||||
There were no transfers of investments between Level 1 and Level 2 during the three and nine months ended September 30, 2010 and 2009.
NOTE 5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment as of September 30, 2010 and December 31, 2009 consist of the following (in millions):
2010 | 2009 | |||||||
Vehicles |
$ | 5,410 | $ | 5,480 | ||||
Aircraft (including aircraft under capitalized leases) |
14,051 | 13,777 | ||||||
Land |
1,079 | 1,079 | ||||||
Buildings |
3,101 | 3,076 | ||||||
Building and leasehold improvements |
2,851 | 2,800 | ||||||
Plant equipment |
6,635 | 6,371 | ||||||
Technology equipment |
1,571 | 1,591 | ||||||
Equipment under operating leases |
127 | 145 | ||||||
Construction-in-progress |
215 | 488 | ||||||
35,040 | 34,807 | |||||||
Less: Accumulated depreciation and amortization |
(17,569 | ) | (16,828 | ) | ||||
$ | 17,471 | $ | 17,979 | |||||
We continually monitor our aircraft fleet utilization in light of current and projected volume levels, aircraft fuel prices, and other factors. In 2008, we had announced that we were in negotiations with DHL to provide air transportation services for all of DHLs express, deferred and international package volume within the United States, as well as air transportation services between the United States, Canada and Mexico. In early April 2009, UPS and DHL mutually agreed to terminate further discussions on providing these services. Additionally, our U.S. Domestic Package air delivery volume had declined for several quarters as a result of persistent economic weakness and shifts in product mix from our premium air services to our lower cost ground services. As a result of these factors, the utilization of certain aircraft fleet types had declined and was expected to be lower in the future.
Based on the factors noted above, as well as Federal Aviation Administration aging aircraft directives that would require significant future maintenance expenditures, we determined that a triggering event had occurred that required an impairment assessment of our McDonnell-Douglas DC-8-71 and DC-8-73 aircraft fleets. We conducted an impairment analysis as of March 31, 2009, and determined that the carrying amount of these fleets
10
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
was not recoverable due to the accelerated expected retirement dates of the aircraft. Based on anticipated residual values for the airframes, engines, and parts, we recognized an impairment charge of $181 million in the first quarter of 2009. This charge is included in the caption Other expenses in the Statements of Consolidated Income, and impacted our U.S. Domestic Package segment. The DC-8 fleets were subsequently retired from service. We currently continue to utilize and operate all of our other aircraft fleets.
The impaired airframes, engines, and parts had a net carrying value of $192 million, and were written down to an aggregate fair value of $11 million. The fair values for the impaired airframes, engines, and parts were determined using unobservable inputs (Level 3).
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 nine months ended September 30, 2010 and 2009 (in millions):
U.S. Pension Benefits | U.S. Postretirement Medical Benefits |
International Pension Benefits |
||||||||||||||||||||||
Three Months Ended September 30, | 2010 | 2009 | 2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
Net Periodic Cost: |
||||||||||||||||||||||||
Service cost |
$ | 181 | $ | 172 | $ | 22 | $ | 21 | $ | 6 | $ | 5 | ||||||||||||
Interest cost |
300 | 283 | 53 | 52 | 9 | 8 | ||||||||||||||||||
Expected return on assets |
(400 | ) | (372 | ) | (5 | ) | (6 | ) | (10 | ) | (8 | ) | ||||||||||||
Amortization of: |
||||||||||||||||||||||||
Transition obligation |
| 1 | | | | | ||||||||||||||||||
Prior service cost |
43 | 45 | 1 | 2 | | 1 | ||||||||||||||||||
Actuarial (gain) loss |
19 | 11 | 4 | 3 | 1 | | ||||||||||||||||||
Net periodic benefit cost |
$ | 143 | $ | 140 | $ | 75 | $ | 72 | $ | 6 | $ | 6 | ||||||||||||
U.S. Pension Benefits | U.S. Postretirement Medical Benefits |
International Pension Benefits |
||||||||||||||||||||||
Nine Months Ended September 30, | 2010 | 2009 | 2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
Net Periodic Cost: |
||||||||||||||||||||||||
Service cost |
$ | 542 | $ | 517 | $ | 65 | $ | 64 | $ | 18 | $ | 15 | ||||||||||||
Interest cost |
899 | 848 | 160 | 158 | 26 | 22 | ||||||||||||||||||
Expected return on assets |
(1,199 | ) | (1,116 | ) | (16 | ) | (20 | ) | (27 | ) | (20 | ) | ||||||||||||
Amortization of: |
||||||||||||||||||||||||
Transition obligation |
| 3 | | | | | ||||||||||||||||||
Prior service cost |
129 | 134 | 3 | 5 | | 1 | ||||||||||||||||||
Actuarial (gain) loss |
58 | 34 | 12 | 10 | 2 | 1 | ||||||||||||||||||
Settlements / curtailments |
| 3 | | | | | ||||||||||||||||||
Net periodic benefit cost |
$ | 429 | $ | 423 | $ | 224 | $ | 217 | $ | 19 | $ | 19 | ||||||||||||
During the first nine months of 2010, we contributed $1.001 billion and $68 million to our company-sponsored pension and postretirement medical benefit plans, respectively. We expect to contribute $142 and $23 million over the remainder of the year to the pension and postretirement medical benefit plans, respectively. We are currently evaluating whether to accelerate a portion of our required future contributions for our primary domestic pension plans into the fourth quarter of 2010.
11
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
During October 2010, we announced that we are planning to reinstate matching contributions to our primary 401(k) plan covering most non-union employees based in the United States, effective January 1, 2011. We had previously suspended matching contributions in the first quarter of 2009. The reinstatement of matching contributions is expected to increase expense by approximately $75 million on an annual basis beginning in 2011.
The enactment of the Patient Protection and Affordable Care Act and The Health Care and Education Reconciliation Act of 2010 in 2010 will bring significant changes to the U.S. health care system. The legislation eliminated the tax deductibility of Medicare Part D subsidies for retiree prescription drug coverage; however, this impact has not been material to our financial results. We are evaluating the long-term impacts of this legislation on us. It is difficult to estimate the impact due to the nature of our workforce, the various years in which certain provisions become applicable, and the fact that additional regulatory and rulemaking actions will be occurring. Our current estimate is that we will incur an additional $50 to $65 million of annual expense beginning in 2011, which is primarily due to the multiple coverage provisions of the legislation which require the expansion of dependent coverage to age 26, among other requirements.
NOTE 7. GOODWILL AND INTANGIBLE ASSETS
The following table indicates the allocation of goodwill by reportable segment as of September 30, 2010 and December 31, 2009 (in millions):
U.S. Domestic Package |
International Package |
Supply Chain & Freight |
Consolidated | |||||||||||||
December 31, 2009 balance |
$ | | $ | 374 | $ | 1,715 | $ | 2,089 | ||||||||
Acquired |
| | | | ||||||||||||
Purchase Accounting Adjustments |
| 5 | | 5 | ||||||||||||
Currency / Other |
| (2 | ) | (7 | ) | (9 | ) | |||||||||
September 30, 2010 balance |
$ | | $ | 377 | $ | 1,708 | $ | 2,085 | ||||||||
The increase to goodwill, in the International Package segment, during the third quarter of 2010, was due to adjustments to the purchase price allocation for Unsped Paket Servisi San ve Ticaret A.S. (Unsped), that was acquired in August 2009, after completing our process to identify assumed liabilities. This was offset by the decrease in the International Package and Supply Chain & Freight segments due to the impact of the strengthening U.S. Dollar on the translation of non-U.S. Dollar goodwill balances.
The following is a summary of intangible assets as of September 30, 2010 and December 31, 2009 (in millions):
Gross Carrying Amount |
Accumulated Amortization |
Net Carrying Value |
||||||||||
September 30, 2010 |
||||||||||||
Trademarks, licenses, patents, and other |
$ | 188 | $ | (39 | ) | $ | 149 | |||||
Customer lists |
107 | (63 | ) | 44 | ||||||||
Franchise rights |
109 | (51 | ) | 58 | ||||||||
Capitalized software |
1,905 | (1,547 | ) | 358 | ||||||||
Total Intangible Assets, Net |
$ | 2,309 | $ | (1,700 | ) | $ | 609 | |||||
December 31, 2009 |
||||||||||||
Trademarks, licenses, patents, and other |
$ | 132 | $ | (9 | ) | $ | 123 | |||||
Customer lists |
107 | (52 | ) | 55 | ||||||||
Franchise rights |
109 | (46 | ) | 63 | ||||||||
Capitalized software |
1,812 | (1,457 | ) | 355 | ||||||||
Total Intangible Assets, Net |
$ | 2,160 | $ | (1,564 | ) | $ | 596 | |||||
12
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8. DEBT AND FINANCING ARRANGEMENTS
The carrying value of our outstanding debt as of September 30, 2010 and December 31, 2009 consists of the following (in millions):
Maturity | 2010 | 2009 | ||||||||||
Commercial paper |
2010 | $ | 894 | $ | 672 | |||||||
4.50% senior notes |
2013 | 1,817 | 1,773 | |||||||||
3.875% senior notes |
2014 | 1,084 | 1,023 | |||||||||
5.50% senior notes |
2018 | 812 | 758 | |||||||||
5.125% senior notes |
2019 | 1,059 | 991 | |||||||||
6.20% senior notes |
2038 | 1,480 | 1,480 | |||||||||
8.375% debentures |
2020-2030 | 738 | 739 | |||||||||
Floating rate senior notes |
2049-2053 | 397 | 409 | |||||||||
Facility notes and bonds |
2015-2036 | 320 | 320 | |||||||||
Pound Sterling notes |
2031-2050 | 782 | 791 | |||||||||
Capital lease obligations |
2010-2025 | 254 | 369 | |||||||||
UPS Notes |
| 175 | ||||||||||
Other debt |
2010-2012 | 5 | 21 | |||||||||
Total debt |
9,642 | 9,521 | ||||||||||
Less current maturities |
(994 | ) | (853 | ) | ||||||||
Long-term debt |
$ | 8,648 | $ | 8,668 | ||||||||
Sources of Credit
We are authorized to borrow up to $10.0 billion under the U.S. commercial paper program we maintain. We had $894 million outstanding under this program as of September 30, 2010, with an average interest rate of 0.16%. As of September 30, 2010, we have classified the entire commercial paper balance as a current liability in our consolidated balance sheet. 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 September 30, 2010.
We maintain two credit agreements with a consortium of banks. One of these agreements provides revolving credit facilities of $1.5 billion, and expires on April 14, 2011. Interest on any amounts we borrow under this facility would be charged at 90-day LIBOR plus a percentage determined by quotations from Markit Group Ltd. for our 1-year credit default swap spread, subject to certain minimum rates and maximum rates based on our public debt ratings from Standard & Poors and Moodys. If our public debt ratings are A / A2 or above, the minimum applicable margin is 0.50% and the maximum applicable margin is 1.50%; if our public debt ratings are lower than A / A2, the minimum applicable margin is 1.00% and the maximum applicable margin is 2.50%.
The second agreement provides revolving credit facilities of $1.0 billion, and expires on April 19, 2012. Interest on any amounts we borrow under this facility would be charged at 90-day LIBOR plus 15 basis points. At September 30, 2010, there were no outstanding borrowings under either of these facilities.
In March 2009, we completed an offering of $1.0 billion of 3.875% senior notes due April 2014, and $1.0 billion of 5.125% senior notes due April 2019. These notes pay interest semiannually, and we may redeem the notes at any time by paying the greater of the principal amount or a make-whole amount, plus accrued interest.
13
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
After pricing and underwriting discounts, we received a total of $1.989 billion in cash proceeds from the offering. The proceeds from the offering were used for general corporate purposes, including the reduction of our outstanding commercial paper balance.
Debt Covenants
Our existing debt instruments and credit facilities do not have cross-default or ratings triggers, however these debt instruments and credit facilities do subject us to certain financial covenants. As of September 30, 2010 and for all prior periods, we have satisfied these financial covenants. These covenants limit the amount of secured indebtedness that we may incur, and limit the amount of attributable debt in sale-leaseback transactions, to 10% of net tangible assets. As of September 30, 2010, 10% of net tangible assets is equivalent to $2.341 billion, however we have no covered sale-leaseback transactions or secured indebtedness outstanding. Additionally, we are required to maintain a minimum net worth, as defined, of $5.0 billion on a quarterly basis. As of September 30, 2010, our net worth, as defined, was equivalent to $13.613 billion.
Fair Value of Debt
Based on the borrowing rates currently available to the Company for long-term debt with similar terms and maturities, the fair value of long-term debt, including current maturities, is approximately $10.289 and $10.216 billion as of September 30, 2010 and December 31, 2009, respectively.
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 September 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 plaintiffs appealed the ruling. In October 2007, the appeals court reversed the lower courts ruling. In April 2008, the Court decertified the class and vacated the trial scheduled for that month. After decertification, some plaintiffs filed individual lawsuits raising the same allegations as in the underlying class action. These individual lawsuits are in various stages. We have denied any liability with respect to these claims and intend to vigorously defend ourselves in these cases. 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.
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 Companys 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 back-pay, and compensatory and punitive damages, as well as attorneys fees. In August 2007, the Third Circuit Court of Appeals granted our petition to hear the appeal of the trial courts certification order. In July 2009, the Third Circuit issued its decision decertifying the class and remanding the case to the trial court for further proceedings. In August 2010, we reached a settlement with the plaintiffs and the case was dismissed. The settlement had no material adverse effect on our financial condition, results of operations, or liquidity.
UPS and our subsidiary 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
14
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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 UPSs sale of services in the franchisees territories. In one of the actions, which is pending in California state court, the court certified a class consisting of all Mail Boxes Etc. branded stores that rebranded to The UPS Store in March 2003. 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.
In Barber Auto Sales v. UPS, which a federal court in Alabama certified as a class action in September 2009, the plaintiff asserts a breach of contract claim arising from UPSs assessment of shipping charge corrections when UPS determines that the dimensional weight of packages is greater than reported by the shipper. We have denied any liability with respect to these claims and intend to vigorously defend ourselves in this case. 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.
As of December 31, 2009, we had approximately 254,000 employees employed under a national master agreement and various supplemental agreements with local unions affiliated with the International Brotherhood of Teamsters (Teamsters). These agreements run through July 31, 2013. We have approximately 2,800 pilots who are employed under a collective bargaining agreement with the Independent Pilots Association (IPA), which becomes amendable at the end of 2011. In May 2010, we began the process of furloughing 170 of our airline pilots. Any additional furloughs will be phased in based on prevailing economic conditions. Our airline mechanics are covered by a collective bargaining agreement with Teamsters Local 2727, which became amendable in November 2006. We began formal negotiations with Teamsters Local 2727 in October 2006, and have been under the guidance of the National Mediation Board since January 2008. In addition, the majority (approximately 3,400) 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 (IAM). Our agreement with the IAM runs through July 31, 2014.
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.
In January 2008, a class action complaint was filed in the United States District Court for the Eastern District of New York alleging price-fixing activities relating to the provision of freight forwarding services. UPS was not named in this case. On July 21, 2009, the plaintiffs filed a first amended complaint naming numerous global freight forwarders as defendants. UPS and UPS Supply Chain Solutions are among the 60 defendants named in the amended complaint. We intend to vigorously defend ourselves in this case. 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.
15
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Other Matters
We received a grand jury subpoena from the Antitrust Division of the U.S. Department of Justice (DOJ) regarding the DOJs investigation into certain pricing practices in the freight forwarding industry in December 2007.
In October 2007, June 2008, and February 2009, we received information requests from the European Commission (Commission) relating to its investigation of certain pricing practices in the freight forwarding industry, and subsequently responded to each request. On February 9, 2010, UPS received a Statement of Objections by the Commission. This document contains the Commissions preliminary view with respect to alleged anticompetitive behavior in the freight forwarding industry by 18 freight forwarders, including UPS. Although it alleges anticompetitive behavior, it does not prejudge the Commissions final decision, as to facts or law (which is subject to appeal to the European courts). The options available to the Commission include taking no action or imposing a monetary fine; the range of any potential action by the Commission is not reasonably estimable. Any decision imposing a fine would be subject to appeal. UPS has responded to the Statement of Objections, including at a July 2010 Commission hearing.
In August 2010, competition authorities in Brazil opened an administrative proceeding to investigate alleged anticompetitive behavior in the freight forwarding industry. Approximately 45 freight forwarding companies and individuals are named in the proceeding, including UPS, UPS SCS Transportes (Brasil) S.A., and a former employee in Brazil. UPS will have an opportunity to respond to these allegations.
We also received and responded to related information requests from competition authorities in other jurisdictions.
We are cooperating with each of these investigations, and intend to continue to vigorously defend ourselves. At this time, we are unable to determine the amount of any liability that may result from these matters or whether any such liability would have a material adverse effect on our financial condition, results of operations, or liquidity.
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 September 30, 2010, there were 4.6 billion Class A shares and 5.6 billion Class B shares authorized to be issued. Additionally, there are 200 million preferred shares, with a $0.01 par value, authorized to be issued; as of September 30, 2010, no preferred shares had been issued.
16
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 nine months ended September 30, 2010 and 2009 (in millions, except per share amounts):
2010 | 2009 | |||||||||||||||
Shares | Dollars | Shares | Dollars | |||||||||||||
Class A Common Stock: |
||||||||||||||||
Balance at beginning of period |
285 | $ | 3 | 314 | $ | 3 | ||||||||||
Common stock purchases |
(3 | ) | | (7 | ) | | ||||||||||
Stock award plans |
2 | | 2 | | ||||||||||||
Common stock issuances |
2 | | 3 | | ||||||||||||
Conversions of Class A to Class B common stock |
(22 | ) | | (22 | ) | | ||||||||||
Class A shares issued at end of period |
264 | $ | 3 | 290 | $ | 3 | ||||||||||
Class B Common Stock: |
||||||||||||||||
Balance at beginning of period |
711 | $ | 7 | 684 | $ | 7 | ||||||||||
Common stock purchases |
(6 | ) | | (1 | ) | | ||||||||||
Conversions of Class A to Class B common stock |
22 | | 22 | | ||||||||||||
Class B shares issued at end of period |
727 | $ | 7 | 705 | $ | 7 | ||||||||||
Additional Paid-In Capital: |
||||||||||||||||
Balance at beginning of period |
$ | 2 | $ | | ||||||||||||
Stock award plans |
324 | 311 | ||||||||||||||
Common stock purchases |
(491 | ) | (396 | ) | ||||||||||||
Common stock issuances |
165 | 134 | ||||||||||||||
Balance at end of period |
$ | | $ | 49 | ||||||||||||
Retained Earnings: |
||||||||||||||||
Balance at beginning of period |
$ | 12,745 | $ | 12,412 | ||||||||||||
Net income |
2,369 | 1,395 | ||||||||||||||
Dividends ($1.41 and $1.35 per share) |
(1,413 | ) | (1,354 | ) | ||||||||||||
Common stock purchases |
(98 | ) | | |||||||||||||
Balance at end of period |
$ | 13,603 | $ | 12,453 | ||||||||||||
We repurchased a total of 9.3 million shares of Class A and Class B common stock for $589 million during the nine months ended September 30, 2010, and 7.8 million shares for $396 million during the nine months ended September 30, 2009. As of September 30, 2010, we had $5.414 billion of our share repurchase authorization remaining.
In February 2010, we entered into an accelerated share repurchase program with a large financial institution, which allowed us to repurchase $186 million of shares (3.0 million shares). The program was completed in April 2010.
17
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Accumulated Other Comprehensive Income (Loss)
We experience 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 nine months ended September 30, 2010 and 2009 is as follows (in millions):
2010 | 2009 | |||||||
Foreign currency translation gain (loss): |
||||||||
Balance at beginning of period |
$ | 37 | $ | (38 | ) | |||
Aggregate adjustment for the period |
(95 | ) | 126 | |||||
Balance at end of period |
(58 | ) | 88 | |||||
Unrealized gain (loss) on marketable securities, net of tax: |
||||||||
Balance at beginning of period |
(27 | ) | (60 | ) | ||||
Current period changes in fair value (net of tax effect of $20, and $2) |
34 | 23 | ||||||
Reclassification to earnings (net of tax effect of $6 and $6) |
10 | 10 | ||||||
Balance at end of period |
17 | (27 | ) | |||||
Unrealized gain (loss) on cash flow hedges, net of tax: |
||||||||
Balance at beginning of period |
(200 | ) | (107 | ) | ||||
Current period changes in fair value (net of tax effect of $(34) and $(26)) |
(55 | ) | (43 | ) | ||||
Reclassification to earnings (net of tax effect of $(27) and $(74)) |
(46 | ) | (123 | ) | ||||
Balance at end of period |
(301 | ) | (273 | ) | ||||
Unrecognized pension and postretirement benefit costs, net of tax: |
||||||||
Balance at beginning of period |
(4,937 | ) | (5,437 | ) | ||||
Reclassification to earnings (net of tax effect of $78 and $70) |
126 | 118 | ||||||
Balance at end of period |
(4,811 | ) | (5,319 | ) | ||||
Accumulated other comprehensive income (loss) at end of period |
$ | (5,153 | ) | $ | (5,531 | ) | ||
Deferred Compensation Obligations and Treasury Stock
Activity in the deferred compensation program for the nine months ended September 30, 2010 and 2009 is as follows (in millions):
2010 | 2009 | |||||||||||||||
Shares | Dollars | Shares | Dollars | |||||||||||||
Deferred Compensation Obligations: |
||||||||||||||||
Balance at beginning of period |
$ | 108 | $ | 121 | ||||||||||||
Reinvested dividends |
3 | 3 | ||||||||||||||
Benefit payments |
(10 | ) | (16 | ) | ||||||||||||
Balance at end of period |
$ | 101 | $ | 108 | ||||||||||||
Treasury Stock: |
||||||||||||||||
Balance at beginning of period |
(2 | ) | $ | (108 | ) | (2 | ) | $ | (121 | ) | ||||||
Reinvested dividends |
| (3 | ) | | (3 | ) | ||||||||||
Benefit payments |
| 10 | | 16 | ||||||||||||
Balance at end of period |
(2 | ) | $ | (101 | ) | (2 | ) | $ | (108 | ) | ||||||
18
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Noncontrolling Interests
We have noncontrolling interests in certain consolidated subsidiaries in our International Package and Supply Chain & Freight segments. The noncontrolling interests currently on our balance sheets primarily relate to a joint venture in Dubai that operates in the Middle East, Turkey, and portions of the Central Asia region, which was formed in the third quarter of 2009. The activity related to our noncontrolling interests is presented below for the nine months ended September 30, 2010 and 2009 (in millions):
2010 | 2009 | |||||||
Noncontrolling Interests: |
||||||||
Balance at beginning of period |
$ | 66 | $ | | ||||
Acquired noncontrolling interests |
| 65 | ||||||
Dividends attributable to noncontrolling interests |
| | ||||||
Net income attributable to noncontrolling interests |
| | ||||||
Balance at end of period |
$ | 66 | $ | 65 | ||||
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.
In evaluating financial performance, we focus on operating profit as a segments 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, 2009, with certain expenses allocated between the segments using activity-based costing methods. Unallocated assets are comprised primarily of cash, marketable securities, and investments in limited partnerships.
19
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Segment information for the three and nine months ended September 30, 2010 and 2009 is as follows (in millions):
Three Months
Ended September 30, |
Nine Months
Ended September 30, |
|||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Revenue: |
||||||||||||||||
U.S. Domestic Package |
$ | 7,291 | $ | 6,868 | $ | 21,662 | $ | 20,606 | ||||||||
International Package |
2,676 | 2,422 | 8,086 | 6,908 | ||||||||||||
Supply Chain & Freight |
2,225 | 1,863 | 6,376 | 5,406 | ||||||||||||
Consolidated |
$ | 12,192 | $ | 11,153 | $ | 36,124 | $ | 32,920 | ||||||||
Operating Profit: |
||||||||||||||||
U.S. Domestic Package |
$ | 1,020 | $ | 514 | $ | 2,330 | $ | 1,374 | ||||||||
International Package |
419 | 313 | 1,367 | 900 | ||||||||||||
Supply Chain & Freight |
177 | 102 | 363 | 268 | ||||||||||||
Consolidated |
$ | 1,616 | $ | 929 | $ | 4,060 | $ | 2,542 | ||||||||
As discussed in Note 5, the U.S. Domestic Package segment operating profit was adversely impacted by a $181 million impairment charge in the first quarter of 2009, related to our McDonnell-Douglas DC-8-71 and DC-8-73 airframes, engines, and related parts. As discussed in Note 14, the U.S. Domestic Package segment operating profit was adversely impacted by a $98 million restructuring charge in the first quarter of 2010, while the Supply Chain & Freight segment operating profit was negatively impacted by a $38 million loss on the sale of a specialized transportation business unit in Germany. Additionally, in the third quarter 2010, we recognized a pre-tax gain of $109 million on the sale of real estate used in operations within our U.S. Domestic Package segment.
The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2010 and 2009 (in millions, except per share amounts):
Three Months
Ended September 30, |
Nine Months
Ended September 30, |
|||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Numerator: |
||||||||||||||||
Net income attributable to common shareowners |
$ | 991 | $ | 549 | $ | 2,369 | $ | 1,395 | ||||||||
Denominator: |
||||||||||||||||
Weighted average shares |
990 | 994 | 991 | 995 | ||||||||||||
Deferred compensation obligations |
2 | 2 | 2 | 2 | ||||||||||||
Vested portion of restricted shares |
2 | 1 | 1 | 1 | ||||||||||||
Denominator for basic earnings per share |
994 | 997 | 994 | 998 | ||||||||||||
Effect of dilutive securities: |
||||||||||||||||
Restricted performance units |
3 | 2 | 3 | 2 | ||||||||||||
Restricted stock units |
6 | 5 | 6 | 4 | ||||||||||||
Stock options |
1 | | | | ||||||||||||
Denominator for diluted earnings per share |
1,004 | 1,004 | 1,003 | 1,004 | ||||||||||||
Basic earnings per share |
$ | 1.00 | $ | 0.55 | $ | 2.38 | $ | 1.40 | ||||||||
Diluted earnings per share |
$ | 0.99 | $ | 0.55 | $ | 2.36 | $ | 1.39 | ||||||||
20
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Diluted earnings per share for the three months ended September 30, 2010 and 2009 exclude the effect of 9.8 and 17.3 million shares of common stock (11.5 and 17.5 million for the nine months ended September 30, 2010 and 2009), respectively, that may be issued upon the exercise of employee stock options because such effect would be antidilutive.
NOTE 13. DERIVATIVE INSTRUMENTS AND RISK MANAGEMENT
Risk Management Policies
We are exposed to market risk, primarily related to foreign currency exchange rates, commodity prices, equity prices, and interest rates. These exposures are actively monitored by management. To manage the volatility relating to certain of these exposures, we enter into a variety of derivative financial instruments. Our objective is to reduce, where it is deemed appropriate to do so, fluctuations in earnings and cash flows associated with changes in foreign currency rates, commodity prices, equity prices, and interest rates. It is our policy and practice to use derivative financial instruments only to the extent necessary to manage exposures. As we use price sensitive instruments to hedge a certain portion of our existing and anticipated transactions, we expect that any loss in value for those instruments generally would be offset by increases in the value of those hedged transactions. We do not hold or issue derivative financial instruments for trading or speculative purposes.
Credit Risk Management
The forward contracts, swaps, and options discussed below contain an element of risk that the counterparties may be unable to meet the terms of the agreements. However, we minimize such risk exposures for these instruments by limiting the counterparties to banks and financial institutions that meet established credit guidelines, and monitoring counterparty credit risk to prevent concentrations of credit risk with any single counterparty. Additionally, the majority of our master agreements for derivatives provide for the early termination of any derivative transactions in the event that either the bank counterparty or UPS receives a credit rating below BBB by Standard & Poors or Baa2 by Moodys, or ceases to be rated by either firm. We do not have any credit-risk triggers in our outstanding master agreements that require UPS or the bank counterparties to post collateral.
We have not historically incurred, and do not expect to incur in the future, any losses as a result of counterparty default.
Accounting Policy for Derivative Instruments
We recognize all derivative instruments as assets or liabilities in the balance sheet at fair value. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the derivative, based upon the exposure being hedged, as a cash flow hedge, a fair value hedge, or a hedge of a net investment in a foreign operation.
A cash flow hedge refers to hedging the exposure to variability in expected future cash flows that is attributable to a particular risk. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of AOCI, and reclassified into earnings in the same period during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, or hedge components excluded from the assessment of effectiveness, are recognized in the statement of consolidated income during the current period.
21
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
A fair value hedge refers to hedging the exposure to changes in the fair value of an existing asset or a liability on the balance sheet that is attributable to a particular risk. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument is recognized in the statement of consolidated income during the current period, as well as the offsetting gain or loss on the hedged item.
A net investment hedge refers to the use of cross currency swaps, forward contracts, or foreign currency denominated debt to hedge portions of our net investments in foreign operations. For hedges that meet the effectiveness requirements, the net gains or losses attributable to changes in spot exchange rates are recorded in the cumulative translation adjustment within other AOCI. The remainder of the change in value of such instruments is recorded in earnings.
Types of Hedges
Commodity Risk Management
Currently, the fuel surcharges that we apply to our domestic and international package and LTL services are the primary means of reducing the risk of adverse fuel price changes on our business. We periodically enter into option contracts on energy commodity products to manage the price risk associated with forecasted transactions involving refined fuels, principally jet-A, diesel, and unleaded gasoline. The objective of the hedges is to reduce the variability of cash flows, due to changing fuel prices, associated with the forecasted transactions involving those products. We have designated and account for these contracts as cash flow hedges of the underlying forecasted transactions involving these fuel products and, therefore, the resulting gains and losses from these hedges are recognized as a component of fuel expense or revenue when the underlying transactions occur.
Foreign Currency Risk Management
To protect against the reduction in value of forecasted foreign currency cash flows from our international package business, we maintain a foreign currency cash flow hedging program. Our most significant foreign currency exposures relate to the Euro, the British Pound Sterling, and the Canadian Dollar. We hedge portions of our forecasted revenue denominated in foreign currencies with option contracts. We have designated and account for these contracts as cash flow hedges of anticipated foreign currency denominated revenue and, therefore, the resulting gains and losses from these hedges are recognized as a component of international package revenue when the underlying sales transactions occur.
We have foreign currency denominated debt obligations and capital lease obligations associated with our aircraft. For some of these debt obligations and leases, we hedge the foreign currency denominated contractual payments using cross-currency interest rate swaps, which effectively convert the foreign currency denominated contractual payments into U.S. Dollar denominated payments. We have designated and account for these swaps as cash flow hedges of the forecasted contractual payments and, therefore, the resulting gains and losses from these hedges are recognized in the statement of consolidated income when the currency remeasurement gains and losses on the underlying debt obligations and leases are incurred.
Interest Rate Risk Management
Our indebtedness under our various financing arrangements creates interest rate risk. We use a combination of derivative instruments, including interest rate swaps and cross-currency interest rate swaps, as part of our program to manage the fixed and floating interest rate mix of our total debt portfolio and related overall cost of borrowing. The notional amount, interest payment date, and maturity date of the swaps match the terms of the associated debt being hedged. Interest rate swaps allow us to maintain a target range of floating rate debt within our capital structure.
22
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
We have designated and account for interest rate swaps that convert fixed rate interest payments into floating rate interest payments as hedges of the fair value of the associated debt instruments. Therefore, the gains and losses resulting from fair value adjustments to the interest rate swaps and fair value adjustments to the associated debt instruments are recorded to interest expense in the period in which the gains and losses occur. Upon termination of the hedge relationship, any cumulative fair value adjustments to the debt instruments are amortized or accreted to interest expense on the effective yield method over the remaining term of the debt. We have designated and account for interest rate swaps that convert floating rate interest payments into fixed rate interest payments as cash flow hedges of the forecasted payment obligations. The gains and losses resulting from fair value adjustments to the interest rate swap are recorded to AOCI.
We periodically hedge the forecasted fixed-coupon interest payments associated with anticipated debt offerings, using forward starting interest rate swaps, interest rate locks, or similar derivatives. These agreements effectively lock a portion of our interest rate exposure between the time the agreement is entered into and the date when the debt offering is completed, thereby mitigating the impact of interest rate changes on future interest expense. These derivatives are settled commensurate with the issuance of the debt, and any gain or loss upon settlement is amortized as an adjustment to the effective interest yield on the debt.
Outstanding Positions
As of September 30, 2010 and December 31, 2009, the notional amounts of our outstanding derivative positions were as follows (in millions):
September 30,
2010 Notional Value |
December 31,
2009 Notional Value |
|||||||
Currency Hedges: |
||||||||
Euro |
| 1,676 | | 1,372 | ||||
British Pound Sterling |
£ | 935 | £ | 692 | ||||
Canadian Dollar |
C$ | 273 | C$ | 228 | ||||
Interest Rate Hedges: |
||||||||
Fixed to Floating Interest Rate Swaps |
$ | 3,475 | $ | 3,751 | ||||
Floating to Fixed Interest Rate Swaps |
$ | 28 | $ | 28 |
As of September 30, 2010, we had no outstanding commodity hedge positions. The maximum term over which we are hedging exposures to the variability of cash flow is 40 years.
23
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Balance Sheet Recognition and Fair Value Measurements
The following table indicates the location on the balance sheet in which our derivative assets and liabilities have been recognized, the fair value hierarchy level applicable to each derivative type, and the related fair values of those derivatives (in millions). The table is segregated between those derivative instruments that qualify and are designated as hedging instruments and those that are not, as well as by type of contract and whether the derivative is in an asset or liability position.
Asset Derivatives |
Balance Sheet Location | Fair Value Hierarchy Level |
September 30, 2010 Fair Value |
December 31, 2009 Fair Value |
||||||||||||
Derivatives designated as hedges: |
||||||||||||||||
Foreign exchange contracts |
Other current assets | Level 2 | $ | 24 | $ | 63 | ||||||||||
Foreign exchange contracts |
Other non-current assets | Level 2 | 14 | | ||||||||||||
Interest rate contracts |
Other non-current assets | Level 2 | 251 | 74 | ||||||||||||
Total Asset Derivatives |
$ | 289 | $ | 137 | ||||||||||||
Liability Derivatives |
Balance Sheet Location | Fair Value Hierarchy Level |
September 30, 2010 Fair Value |
December 31, 2009 Fair Value |
||||||||||||
Derivatives designated as hedges: |
||||||||||||||||
Foreign exchange contracts |
Other current liabilities | Level 2 | $ | (21 | ) | $ | | |||||||||
Foreign exchange contracts |
Other non-current liabilities | Level 2 | (153 | ) | (51 | ) | ||||||||||
Interest rate contracts |
Other non-current liabilities | Level 2 | (10 | ) | (13 | ) | ||||||||||
Derivatives not designated as hedges: |
||||||||||||||||
Interest rate contracts |
Other non-current liabilities | Level 2 | (2 | ) | (2 | ) | ||||||||||
Total Liability Derivatives |
$ | (186 | ) | $ | (66 | ) | ||||||||||
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.
24
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Income Statement Recognition:
The following table indicates the amount and location in the statement of consolidated income for the three and nine months ended September 30, 2010 and 2009 in which derivative gains and losses, as well as the related amounts reclassified from AOCI, have been recognized for those derivatives designated as cash flow hedges (in millions).
Three Months Ended September 30,
Derivative Instruments in Cash Flow |
2010 Amount of Gain (Loss) Recognized in OCI on Derivative (Effective Portion) |
2009 Amount of Gain (Loss) Recognized in OCI on Derivative (Effective Portion) |
Location of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) |
2010 Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) |
2009 Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) |
|||||||||||||||
Interest rate contracts |
$ | (2 | ) | $ | (2 | ) | Interest Expense | $ | (4 | ) | $ | (4 | ) | |||||||
Foreign exchange contracts |
11 | (103 | ) | Interest Expense | 42 | 24 | ||||||||||||||
Foreign exchange contracts |
(139 | ) | (65 | ) | Revenue | 12 | 2 | |||||||||||||
Commodity contracts |
| | Revenue | | | |||||||||||||||
Total |
$ | (130 | ) | $ | (170 | ) | $ | 50 | $ | 18 | ||||||||||
Nine Months Ended September 30,
Derivative Instruments in Cash Flow |
2010 Amount of Gain (Loss) Recognized in OCI on Derivative (Effective Portion) |
2009 Amount of Gain (Loss) Recognized in OCI on Derivative (Effective Portion) |
Location of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) |
2010 Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) |
2009 Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) |
|||||||||||||||
Interest rate contracts |
$ | (3 | ) | $ | 125 | Interest Expense | $ | (13 | ) | $ | (10 | ) | ||||||||
Foreign exchange contracts |
(100 | ) | (104 | ) | Interest Expense | (8 | ) | 23 | ||||||||||||
Foreign exchange contracts |
14 | (90 | ) | Revenue | 94 | 102 | ||||||||||||||
Commodity contracts |
| | Revenue | | 82 | |||||||||||||||
Total |
$ | (89 | ) | $ | (69 | ) | $ | 73 | $ | 197 | ||||||||||
As of September 30, 2010, $64 million of pre-tax losses related to cash flow hedges that are currently deferred in AOCI are expected to be reclassified to income over the 12 month period ending September 30, 2011. The actual amounts that will be reclassified to income over the next 12 months will vary from this amount as a result of changes in market conditions.
The amount of ineffectiveness recognized in income on derivative instruments designated in cash flow hedging relationships was immaterial for the three and nine months ended September 30, 2010 and 2009.
25
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The following table indicates the amount and location in the statement of consolidated income in which derivative gains and losses, as well as the associated gains and losses on the underlying exposure, have been recognized for those derivatives designated as fair value hedges for the three and nine months ended September 30, 2010 and 2009 (in millions).
Derivative Instruments in Fair Value Hedging Relationships |
Location of Gain (Loss) Recognized in Income |
2010 Amount of Gain (Loss) Recognized in Income |
2009 Amount of Gain (Loss) Recognized in Income |
Hedged Items in Fair Value Hedging Relationships |
Location of Gain (Loss) Recognized in Income |
2010 Amount of Gain (Loss) Recognized in Income |
2009 Amount of Gain (Loss) Recognized in Income |
|||||||||||||||||||
Three Months Ended September 30, | ||||||||||||||||||||||||||
Interest rate contracts |
Interest Expense | $ | 52 | $ | 69 | Fixed-Rate Debt and Capital Leases |
|
Interest Expense |
|
$ | (52 | ) | $ | (69 | ) | |||||||||||
Nine Months Ended September 30, | ||||||||||||||||||||||||||
Interest rate contracts |
Interest Expense | $ | 224 | $ | 95 | Fixed-Rate Debt and Capital Leases |
|
Interest Expense |
|
$ | (224 | ) | $ | (95 | ) |
Additionally, we maintain some interest rate swap and foreign exchange forward contracts that are not designated as hedges. These interest rate swap contracts are intended to provide an economic hedge of a portfolio of interest bearing receivables, however the income statement impact of these hedges was not material for any period presented. These foreign exchange forward contracts are intended to provide an economic offset to foreign currency remeasurement risks for certain assets and liabilities in our balance sheet. The following is a summary of the amounts recorded in the statement of consolidated income related to fair value changes and settlements of these foreign currency forward contracts not designated as hedges (in millions):
Derivative Instruments Not Designated in Hedging Relationships |
Location of Gain (Loss) Recognized in Income |
2010 Amount of Gain (Loss) Recognized in Income |
2009 Amount of Gain (Loss) Recognized in Income |
|||||||
Three Months Ended September 30, | ||||||||||
Foreign Exchange Contracts |
Other Operating Expenses | $ | (14 | ) | $ | (12 | ) | |||
Nine Months Ended September 30, | ||||||||||
Foreign Exchange Contracts |
Other Operating Expenses | $ | 11 | $ | (21 | ) |
The foreign exchange forward contracts are settled at the end of each month, and therefore no asset or liability was recorded on the balance sheet at September 30, 2010.
NOTE 14. RESTRUCTURING COSTS AND RELATED EXPENSES
In the first quarter of 2010, we incurred restructuring costs associated with the termination of employees, facility consolidations and other costs directly related to restructuring initiatives. These initiatives resulted from the rationalization of acquired companies, as well as restructuring activities associated with cost containment and operational efficiency programs.
Supply Chain & FreightGermany
In February 2010, we completed the sale of a specialized transportation and express freight business in Germany within our Supply Chain & Freight segment. As part of the sale transaction, we incurred certain costs associated with employee severance payments, other employee benefits, transition services, and leases on operating facilities and equipment. Additionally, we provided a guarantee for a period of two years for certain employee benefit payments being assumed by the buyer. We recorded a pre-tax loss of $38 million ($35 million after-tax) for this transaction in the first quarter of 2010, which included the costs associated with the sale transaction and the fair value of the guarantee.
26
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
U.S. Domestic Package Restructuring
In an effort to improve performance in the U.S. Domestic Package segment, we announced a program to streamline our domestic management structure in January 2010. As part of this restructuring, we are reducing the number of domestic districts and regions in our U.S. small package operation, in order to better align our operations geographically and allow more local decision-making and resources to be deployed for our customers. Effective in April 2010, we reduced our U.S. regions from five to three and our U.S. districts from 46 to 20. The restructuring will eliminate approximately 1,800 management and administrative positions in the U.S. To facilitate this goal, approximately 1,100 employees were offered voluntary severance packages. Other impacted employees received severance benefits and access to support programs based on length of service. We recorded a pre-tax charge of $98 million ($64 million after-tax) in the first quarter of 2010 related to the costs of this program, which reflects the value of voluntary retirement benefits, severance benefits and accelerated vesting of stock compensation.
In the first quarter of 2010, we changed the tax status of a German subsidiary that was taxable in the U.S. and its local jurisdiction to one that is taxed solely in its local jurisdiction. This change was made primarily to allow for more flexibility in funding this subsidiarys operations with local liquidity sources, improve the cash flow position in the U.S., and help mitigate future currency re-measurement risk. As a result of this change in tax status, we recorded a non-cash charge of $76 million, which resulted primarily from the write-off of related deferred tax assets which will not be realizable following the change in tax status.
In the third quarter of 2010, we recognized a $40 million tax benefit associated with the release of a valuation allowance against deferred tax assets in our international package operations. However, this item was offset by tax provided for interest earned on refunds and changes in our projected jurisdictional profit mix. The net impact to our third quarter and year-to-date 2010 provision for these items was not material.
We file income tax returns in the U.S. federal jurisdiction, most U.S. state and local jurisdictions, and many non-U.S. jurisdictions. During the third quarter of 2009, we received a refund of $271 million as a result of the resolution of tax years 1999 through 2002 with the Internal Revenue Service (IRS) Appeals Office. During the second quarter of 2010, we resolved all unagreed issues with the IRS Appeals Office for tax years 2003 and 2004 and we received a refund of $139 million for these tax years in October 2010. This amount is included as a current income tax receivable in the accompanying consolidated balance sheets.
We have substantially resolved all U.S. federal income tax matters for tax years prior to 2005. Along with the audit for tax years 2005 through 2007, the IRS is currently examining non-income based taxes, including employment and excise taxes, which could lead to proposed assessments. The IRS has not presented an official position with regard to these taxes at this time, and therefore we are not able to determine the technical merit of any potential assessment. We anticipate receipt of the IRS reports on non-income tax matters by the end of 2010. We have filed all required U.S. state and local returns reporting the result of the resolution of the U.S. federal income tax audit of the tax years 1999 through 2002. We expect to file all required U.S. state and local returns reporting the result of the resolution of the U.S. federal income tax audit of the tax years 2003 and 2004 by the end of 2010. A limited number of U.S. state and local matters are the subject of ongoing audits, administrative appeals or litigation.
27
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
Cautionary Statement About Forward-Looking Statements
This report includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements in the future tense, and all statements accompanied by terms such as believe, project, expect, estimate, assume, intend, anticipate, target, plan, and variations thereof and similar terms are intended to be forward-looking statements. We intend that all forward-looking statements we make will be subject to safe harbor protection of the federal securities laws pursuant to Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Our discussion and analysis in this report, in our Annual Report to Shareholders and in our other filings with the Securities and Exchange filings contain some forward-looking statements regarding our intent, belief and current expectations about our strategic direction, prospects and future results. From time to time, we also provide forward-looking statements in other materials we release as well as oral forward-looking statements. Such statements give our current expectations or forecasts of future events; they do not relate strictly to historical or current facts. Management believes that these forward-looking statements are reasonable as and when made. However, caution should be taken not to place undue reliance on any such forward-looking statements because such statements speak only as of the date when made.
Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or anticipated results. These risks and uncertainties include, but are not limited to, those described in our Annual Report on Form 10-K for the year ended December 31, 2009 and those described from time to time in our reports subsequently filed with the Securities and Exchange Commission. You should consider the limitations on, and risks associated with, forward-looking statements and not unduly rely on the accuracy of predictions contained in such forward-looking statements. We do not undertake any obligation to update forward-looking statements to reflect events, circumstances, changes in expectations, or the occurrence of unanticipated events after the date of those statements.
Our U.S. Domestic Package, International Package, and Supply Chain & Freight segments benefitted from the improving worldwide economic situation in 2010 compared with 2009, leading to improvements in volume, revenue, and operating profit. Significant portions of the world economy are experiencing improved economic growth, international trade, inventory rebuilding, and retail sales. These trends allow us to leverage our transportation network, and provided for stronger operating results in the first nine months of 2010 than in the same period of 2009.
In addition to the improved volume and revenue trends, cost containment initiatives and better network efficiencies achieved over the last several quarters also positively impacted our results. We have continued to invest in our transportation network. During the first half of 2010 we opened the second phase of our Worldport expansion, which will allow the use of larger and more fuel-efficient aircraft and further improve network efficiencies. We opened our new intra-Asia air hub in Shenzhen, China, which will allow us to better serve our customers by reducing time in transit for shipments in the region. We have also streamlined our domestic management structure, sold a non-core supply chain business, and continued to better align our cost structure with current volume levels.
28
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Our consolidated results are presented in the table below:
Three Months
Ended September 30, |
Change | Nine Months
Ended September 30, |
Change | |||||||||||||||||||||
2010 | 2009 | % | 2010 | 2009 | % | |||||||||||||||||||
Revenue (in millions) |
$ | 12,192 | $ | 11,153 | 9.3 | % | $ | 36,124 | $ | 32,920 | 9.7 | % | ||||||||||||
Operating Expenses (in millions) |
10,576 | 10,224 | 3.4 | % | 32,064 | 30,378 | 5.6 | % | ||||||||||||||||
Operating Profit (in millions) |
$ | 1,616 | $ | 929 | 74.0 | % | $ | 4,060 | $ | 2,542 | 59.7 | % | ||||||||||||
Operating Margin |
13.3 | % | 8.3 | % | 11.2 | % | 7.7 | % | ||||||||||||||||
Average Daily Package Volume (in thousands) |
14,969 | 14,261 | 5.0 | % | 14,898 | 14,358 | 3.8 | % | ||||||||||||||||
Average Revenue Per Piece |
$ | 10.27 | $ | 9.90 | 3.7 | % | $ | 10.32 | $ | 9.87 | 4.6 | % | ||||||||||||
Net Income (in millions) |
$ | 991 | $ | 549 | 80.5 | % | $ | 2,369 | $ | 1,395 | 69.8 | % | ||||||||||||
Basic Earnings Per Share |
$ | 1.00 | $ | 0.55 | 81.8 | % | $ | 2.38 | $ | 1.40 | 70.0 | % | ||||||||||||
Diluted Earnings Per Share |
$ | 0.99 | $ | 0.55 | 80.0 | % | $ | 2.36 | $ | 1.39 | 69.8 | % |
The year-over-year comparisons of our financial results are affected by the following items (in millions):
Three Months
Ended September 30, |
Nine Months
Ended September 30, |
|||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Operating Expenses: |
||||||||||||||||
Aircraft Impairment Charge |
$ | | $ | | $ | | $ | 181 | ||||||||
Restructuring Charge |
| | 98 | | ||||||||||||
Loss on Sale of Business |
| | 38 | | ||||||||||||
Gain on Sale of Real Estate |
(109 | ) | | (109 | ) | | ||||||||||
Interest Expense: |
||||||||||||||||
Currency Remeasurement Charge |
| | | 77 | ||||||||||||
Income Tax Expense: |
||||||||||||||||
Income Tax Expense (Benefit) from the Items Above |
48 | | 11 | (94 | ) | |||||||||||
Change in Tax Filing Status for German Subsidiary |
| | 76 | |
Aircraft Impairment Charge
In the first quarter of 2009, we completed an impairment assessment of our McDonnell-Douglas DC-8 aircraft fleet, and recorded a pre-tax impairment charge of $181 million ($116 million after-tax), which affected our U.S. Domestic Package segment.
Restructuring Charge
In the first quarter of 2010, we reorganized the management structure in our U.S. Domestic Package segment, and incurred a restructuring charge associated with this reorganization. This pre-tax charge totaled $98 million ($64 million after-tax), and reflects the value of voluntary retirement benefits, severance benefits and unvested stock compensation.
Loss on Sale of Business
In the first quarter of 2010, we sold a specialized transportation business in Germany within our Supply Chain & Freight segment, and incurred a pre-tax loss on the sale of $38 million ($35 million after-tax).
29
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Gain on Sale of Real Estate
In the third quarter of 2010, we recognized a pre-tax gain of $109 million ($61 million after-tax) on the sale of real estate within our U.S. Domestic Package segment.
Currency Remeasurement Charge
In the second quarter of 2009, we took a $77 million pre-tax charge ($48 million after-tax) for the remeasurement of certain obligations denominated in foreign currencies, in which hedge accounting was not able to be applied.
Change in Tax Filing Status for German Subsidiary
In the first quarter of 2010, we changed the tax status of a German subsidiary that was taxable in the U.S. and its local jurisdiction to one that is solely taxed in its local jurisdiction. As a result of this change in tax status, we recorded a non-cash charge of $76 million to income tax expense, which resulted primarily from the write-off of related deferred tax assets which will not be realizable following the change in tax status.
Results of OperationsSegment Review
The results and discussions that follow are reflective of how our executive management monitors the performance of our reporting segments. We supplement the reporting of our financial information determined under generally accepted accounting principles (GAAP) with certain non-GAAP financial measures, including operating profit, operating margin, pre-tax income, effective tax rate, net income and earnings per share adjusted for the non-comparable items discussed previously. We believe that these adjusted measures provide meaningful information to assist investors and analysts in understanding our financial results and assessing our prospects for future performance. We believe these adjusted financial measures are important indicators of our results of operations because they exclude items that may not be indicative of, or are unrelated to, our core operating results, and provide a better baseline for analyzing trends in our underlying businesses.
30
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
U.S. Domestic Package Operations
Three Months
Ended September 30, |
Change | Nine Months
Ended September 30, |
Change | |||||||||||||||||||||
2010 | 2009 | % | 2010 | 2009 | % | |||||||||||||||||||
Revenue (in millions): |
||||||||||||||||||||||||
Next Day Air |
$ | 1,466 | $ | 1,348 | 8.8 | % | $ | 4,311 | $ | 4,044 | 6.6 | % | ||||||||||||
Deferred |
696 | 664 | 4.8 | % | 2,088 | 2,009 | 3.9 | % | ||||||||||||||||
Ground |
5,129 | 4,856 | 5.6 | % | 15,263 | 14,553 | 4.9 | % | ||||||||||||||||
Total Revenue |
$ | 7,291 | $ | 6,868 | 6.2 | % | $ | 21,662 | $ | 20,606 | 5.1 | % | ||||||||||||
Average Daily Package Volume (in thousands): |
||||||||||||||||||||||||
Next Day Air |
1,181 | 1,144 | 3.2 | % | 1,169 | 1,171 | (0.2 | )% | ||||||||||||||||
Deferred |
856 | 856 | 0.0 | % | 866 | 878 | (1.4 | )% | ||||||||||||||||
Ground |
10,693 | 10,287 | 3.9 | % | 10,656 | 10,424 | 2.2 | % | ||||||||||||||||
Total Avg. Daily Package Volume |
12,730 | 12,287 | 3.6 | % | 12,691 | 12,473 | 1.7 | % | ||||||||||||||||
Average Revenue Per Piece: |
||||||||||||||||||||||||
Next Day Air |
$ | 19.40 | $ | 18.13 | 7.0 | % | $ | 19.31 | $ | 17.99 | 7.3 | % | ||||||||||||
Deferred |
12.70 | 11.93 | 6.5 | % | 12.62 | 11.92 | 5.9 | % | ||||||||||||||||
Ground |
7.49 | 7.26 | 3.2 | % | 7.50 | 7.27 | 3.2 | % | ||||||||||||||||
Total Avg. Revenue Per Piece |
$ | 8.95 | $ | 8.60 | 4.1 | % | $ | 8.94 | $ | 8.60 | 4.0 | % | ||||||||||||
Operating Profit (in millions): |
||||||||||||||||||||||||
Operating Profit |
$ | 1,020 | $ | 514 | 98.4 | % | $ | 2,330 | $ | 1,374 | 69.6 | % | ||||||||||||
Impact of Restructuring Charge |
| | 98 | | ||||||||||||||||||||
Gain on Sale of Real Estate |
(109 | ) | | (109 | ) | | ||||||||||||||||||
Impact of Aircraft Impairment Charge |
| | | 181 | ||||||||||||||||||||
Adjusted Operating Profit |
$ | 911 | $ | 514 | 77.2 | % | $ | 2,319 | $ | 1,555 | 49.1 | % | ||||||||||||
Operating Margin |
14.0 | % | 7.5 | % | 10.8 | % | 6.7 | % | ||||||||||||||||
Adjusted Operating Margin |
12.5 | % | 7.5 | % | 10.7 | % | 7.5 | % | ||||||||||||||||
Operating Days in Period |
64 | 65 | 191 | 192 |
Volume
In the third quarter of 2010, our overall volume increased as improvements in industrial production and retail sales increased overall demand in the U.S. small package market. Among our air products, package volume increased as inventory rebuilding in the manufacturing and retailing sectors contributed to growth. However, our letter volume declined largely due to weakness in the financial and other service industries. The increased volume for our ground products was driven by higher commercial ground volume and growth in our basic product, reflecting the impact of the strengthening economy. The growth in average daily volume was positively impacted by differences in the timing of the July fourth holiday between the third quarter of 2010 and 2009.
Revenue Per Piece
Overall revenue per piece increased for our ground and air products in the third quarter of 2010, due to a combination of base price increases, fuel surcharge rate changes, and a shift in product mix. The revenue per piece for our air products improved due to increased fuel surcharge rates, higher average package weights, and relatively higher growth in our premium products such as Next Day Air Early AM package. The improvement in revenue per piece for our ground products was due to increased fuel surcharge rates, but was partially offset by a mix shift towards lower yielding products.
31
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Revenue per piece for our ground and air products was also impacted by an increase in base rates that took effect on January 4, 2010. 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 an increase in the residential surcharge, and an increase in the delivery area surcharge on both residential and commercial services to certain ZIP codes. These rate changes are customary and occur on an annual basis.
Fuel Surcharges
UPS applies a fuel surcharge on our domestic air and ground services. The air fuel surcharge is based on the U.S. Department of Energys Gulf Coast spot price for a gallon of kerosene-type jet fuel, while the ground fuel surcharge is based on the U.S. Department of Energys On-Highway Diesel Fuel Price. Based on published rates, the average fuel surcharge for domestic air and ground products was as follows:
Three Months
Ended September 30, |
Change | Nine Months
Ended September 30, |
Change | |||||||||||||||||||||
2010 | 2009 | % Point | 2010 | 2009 | % Point | |||||||||||||||||||
Next Day Air / Deferred |
7.5 | % | 4.8 | % | 2.7 | % | 7.7 | % | 2.9 | % | 4.8 | % | ||||||||||||
Ground |
5.7 | % | 3.3 | % | 2.4 | % | 5.5 | % | 3.1 | % | 2.4 | % |
On January 4, 2010, we modified the fuel surcharge on air services by reducing the index used to determine the fuel surcharge by 2%. Additionally, we adjusted the fuel surcharge tables to better align the surcharges between our air and ground products, and to reduce the volatility of air surcharges when fuel prices fluctuate. The increase in the air and ground fuel surcharges in the third quarter of 2010 was due to the significant increase in jet and diesel fuel prices, but was partially offset by the reduction in the index on the air surcharge. Total domestic fuel surcharge revenue, net of the impact of hedging, increased by $149 million in third quarter of 2010 ($459 million year-to-date), primarily due to the higher fuel surcharge rates discussed above, as well as the increase in volume for our ground products.
Operating Profit and Margin
Operating profit in 2010 was positively impacted by the overall economic growth in the U.S., which drove increased volume and yields. Combined with increased network efficiencies and cost containment initiatives, this resulted in strong operating leverage. Network efficiencies have been gained over the last several quarters, as we adjusted our air and ground networks to better match volume levels, and utilized our expanded Worldport facility to utilize larger aircraft as well as increase package sorting efficiency. These changes have resulted in cost savings through fewer aircraft block hours, labor hours in our operations, and vehicle miles driven. The combination of these factors led to an increase in the operating margin in 2010 compared with the corresponding period in 2009.
Operating profit also benefited from the approximate two month time lag between fuel price changes and when the monthly surcharge rates are applied to package shipments. Rapid declines in fuel prices in the first half of 2009 reduced the air fuel surcharge rate significantly for a portion of the third quarter of 2009. Subsequent increases in fuel prices, and the impact on the fuel surcharge, resulted in fuel positively impacting the change in operating profit in 2010 compared with 2009.
32
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
International Package Operations
Three Months
Ended September 30, |
Change | Nine Months
Ended September 30, |
Change | |||||||||||||||||||||
2010 | 2009 | % | 2010 | 2009 | % | |||||||||||||||||||
Revenue (in millions): |
||||||||||||||||||||||||
Domestic |
$ | 569 | $ | 536 | 6.2 | % | $ | 1,714 | $ | 1,478 | 16.0 | % | ||||||||||||
Export |
1,975 | 1,770 | 11.6 | % | 5,992 | 5,133 | 16.7 | % | ||||||||||||||||
Cargo |
132 | 116 | 13.8 | % | 380 | 297 | 27.9 | % | ||||||||||||||||
Total Revenue |
$ | 2,676 | $ | 2,422 | 10.5 | % | $ | 8,086 | $ | 6,908 | 17.1 | % | ||||||||||||
Average Daily Package Volume (in thousands): |
||||||||||||||||||||||||
Domestic |
1,376 | 1,207 | 14.0 | % | 1,359 | 1,128 | 20.5 | % | ||||||||||||||||
Export |
863 | 767 | 12.5 | % | 848 | 757 | 12.0 | % | ||||||||||||||||
Total Avg. Daily Package Volume |
2,239 | 1,974 | 13.4 | % | 2,207 | 1,885 | 17.1 | % | ||||||||||||||||
Average Revenue Per Piece: |
||||||||||||||||||||||||
Domestic |
$ | 6.46 | $ | 6.83 | (5.4 | )% | $ | 6.60 | $ | 6.82 | (3.2 | )% | ||||||||||||
Export |
35.76 | 35.50 | 0.7 | % | 36.99 | 35.32 | 4.7 | % | ||||||||||||||||
Total Avg. Revenue Per Piece |
$ | 17.75 | $ | 17.97 | (1.2 | )% | $ | 18.28 | $ | 18.27 | 0.1 | % | ||||||||||||
Average Revenue Per Piece (Currency-Adjusted)* |
||||||||||||||||||||||||
Domestic |
$ | 6.46 | $ | 6.59 | (2.0 | )% | $ | 6.60 | $ | 6.91 | (4.5 | )% | ||||||||||||
Export |
35.76 | 34.68 | 3.1 | % | 36.99 | 35.34 | 4.7 | % | ||||||||||||||||
Total Avg. Revenue Per Piece |
$ | 17.75 | $ | 17.51 | 1.4 | % | $ | 18.28 | $ | 18.33 | (0.3 | )% | ||||||||||||
*2009 revenue adjusted to 2010 currency exchange rates. |
||||||||||||||||||||||||
Operating Profit (in millions) |
$ | 419 | $ | 313 | 33.9 | % | $ | 1,367 | $ | 900 | 51.9 | % | ||||||||||||
Operating Margin |
15.7 | % | 12.9 | % | 16.9 | % | 13.0 | % | ||||||||||||||||
Operating Days in Period |
64 | 65 | 191 | 192 | ||||||||||||||||||||
Currency Translation Benefit / (Cost)(in millions)*: |
||||||||||||||||||||||||
Revenue |
$ | (62 | ) | $ | 21 | |||||||||||||||||||
Operating Profit |
$ | (3 | ) | $ | 5 |
* | Net of currency hedging; amount represents the change compared to the prior year. |
Volume
Export volume increased for the quarter, primarily due to strong growth in Asia, where volume grew 34%. Europe export also had strong volume growth for the quarter, increasing 13% compared with the prior year, as the worldwide economy and world trade continued to improve. In 2010, we experienced an overall lengthening of trade lanes, as inter-regional trade increased (especially in our Asia-to-Europe and Asia-to-U.S. export lanes), leading to relatively stronger growth for our higher yielding products. Our premium Worldwide Express and Expedited products grew at a relatively faster rate than our standard transborder and trade direct products.
Non-U.S. domestic volume increased 14% for the quarter, due in part to the acquisition of Unsped Paket Servisi San ve Ticaret A.S. (Unsped) in Turkey in the third quarter of 2009. Excluding the acquisition of Unsped, non-U.S. domestic volume growth increased 11%, led by the strength in core European markets, Canada and Mexico.
33
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Revenue Per Piece
Export revenue per piece increased slightly for the third quarter of 2010, largely due to higher fuel surcharge rates and base rate increases, as well as the impact of product mix as higher-yielding products (such as Worldwide Express and Worldwide Expedited) grew at a relatively faster pace. The impact of currency, net of hedging, resulted in a decrease to revenue growth during the quarter. Domestic revenue per piece decreased, primarily due to the impact of lower-yielding domestic packages from the Unsped acquisition. Total average revenue per piece increased 1.4% for the quarter on a currency-adjusted basis.
On January 4, 2010, 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 shipments originating outside the U.S. were made throughout the year and varied by geographic market.
Fuel Surcharges
On January 4, 2010, 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%. Additionally, we adjusted the fuel surcharge tables to reduce the volatility of air surcharges when fuel prices fluctuate. The fuel surcharges for products originating outside the United States continue to be indexed to fuel prices in the international region where the shipment takes place. Total international fuel surcharge revenue increased by $61 million for the third quarter in 2010 ($246 million year-to-date), due to higher fuel surcharge rates caused by increased fuel prices as well as an increase in international air volume.
Operating Profit and Margin
The increase in operating profit for the third quarter of 2010 was primarily driven by volume increases in all major regions and trade lanes worldwide. Additionally, network efficiencies and cost containment initiatives created operating leverage which contributed to the increase in operating profits. During the quarter, our in-country cost per piece declined 2.5%. These factors led to an increase in the operating margin in 2010 compared with the corresponding period in 2009.
34
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Supply Chain & Freight Operations
Three Months
Ended September 30, |
Change | Nine Months
Ended September 30, |
Change | |||||||||||||||||||||
2010 | 2009 | % | 2010 | 2009 | % | |||||||||||||||||||
Revenue (in millions): |
||||||||||||||||||||||||
Forwarding and Logistics |
$ | 1,536 | $ | 1,250 | 22.9 | % | $ | 4,425 | $ | 3,630 | 21.9 | % | ||||||||||||
Freight |
581 | 509 | 14.1 | % | 1,628 | 1,470 | 10.7 | % | ||||||||||||||||
Other |
108 | 104 | 3.8 | % | 323 | 306 | 5.6 | % | ||||||||||||||||
Total Revenue |
$ | 2,225 | $ | 1,863 | 19.4 | % | $ | 6,376 | $ | 5,406 | 17.9 | % | ||||||||||||
Freight LTL Statistics: |
||||||||||||||||||||||||
Revenue (in millions) |
$ | 527 | $ | 474 | 11.2 | % | $ | 1,476 | $ | 1,369 | 7.8 | % | ||||||||||||
Revenue Per Hundredweight |
$ | 18.99 | $ | 17.91 | 6.0 | % | $ | 18.91 | $ | 17.49 | 8.1 | % | ||||||||||||
Shipments (in thousands) |
2,647 | 2,599 | 1.9 | % | 7,447 | 7,553 | (1.4 | )% | ||||||||||||||||
Shipments Per Day (in thousands) |
41.4 | 40.6 | 1.9 | % | 39.0 | 39.5 | (1.4 | )% | ||||||||||||||||
Gross Weight Hauled (in millions of lbs) |
2,776 | 2,647 | 4.9 | % | 7,805 | 7,824 | (0.2 | )% | ||||||||||||||||
Weight Per Shipment (in lbs) |
1,049 | 1,019 | 2.9 | % | 1,048 | 1,036 | 1.2 | % | ||||||||||||||||
Operating Days in Period |
64 | 64 | 191 | 191 | ||||||||||||||||||||
Operating Profit (in millions): |
||||||||||||||||||||||||
Operating Profit |
$ | 177 | $ | 102 | 73.5 | % | $ | 363 | $ | 268 | 35.4 | % | ||||||||||||
Impact of Loss on Sale of Business |
| | 38 | | ||||||||||||||||||||
Adjusted Operating Profit |
$ | 177 | $ | 102 | 73.5 | % | $ | 401 | $ | 268 | 49.6 | % | ||||||||||||
Operating Margin |
8.0 | % | 5.5 | % | 5.7 | % | 5.0 | % | ||||||||||||||||
Adjusted Operating Margin |
8.0 | % | 5.5 | % | 6.3 | % | 5.0 | % | ||||||||||||||||
Currency Translation Benefit / (Cost) (in millions)*: |
||||||||||||||||||||||||
Revenue |
$ | (9 | ) | $ | 139 | |||||||||||||||||||
Operating Profit |
2 | 6 |
* | Net of currency hedging; amount represents the change compared to the prior year. |
Revenue
Forwarding and logistics revenue increased in the third quarter of 2010, primarily due to growth in the demand for forwarding as a result of the continued expansion of the global economy, inventory rebuilding and international trade. Both air freight and ocean freight experienced solid revenue growth, and were impacted by higher volumes, fuel surcharges, and other accessorial charges. Overall tonnage in our international air freight, North American air freight and ocean freight businesses increased 18%, 10% and 8%, respectively, for the third quarter of 2010 compared with the prior year. In our logistics products, we experienced growth in mail services and distribution revenue, with solid increases being achieved in the healthcare and technology sectors.
Freight revenue increased, primarily due to higher fuel surcharge rates and a base rate increase that took effect in January 2010. Average LTL shipments per day, weight per shipment and LTL revenue per hundredweight all increased during the quarter, largely due to our strategy of maintaining our focus on yields and targeting certain customer segments. The increase in LTL revenue per hundredweight was primarily due to an increase in base prices that took effect in January 2010, as UPS Freight increased minimum charge, LTL and TL rates an average of 5.7%, covering non-contractual shipments in the United States, Canada and Mexico. Additionally, LTL revenue per hundredweight increased as a result of higher fuel surcharge rates, as total fuel surcharge revenue increased $22 million for the quarter ($77 million year-to-date) primarily resulting from higher diesel fuel prices.
35
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The other businesses within Supply Chain & Freight experienced an increase in revenue. A primary driver of this increase was our UPS Customer Solutions business, which provides a range of services (e.g. project management, industrial engineering, transportation fleet services, distribution network analysis, package engineering and package visibility).
Operating Profit and Margin
Operating profit in the forwarding unit increased during third quarter of 2010, largely due to a strong increase in tonnage in our air and ocean forwarding businesses. On a year-to-date basis, operating profit increased, but was partially offset by capacity constraints from outside carriers in the first half of 2010. Capacity constraints led to rapidly escalating rates on air freight which could not be passed on to customers in a timely manner, resulting in a negative impact to our operating profit and margin. This situation has improved throughout 2010, as capacity constraints have lessened and we were able to implement revenue management plans which better matched customer pricing with market conditions. Our logistics unit had a solid increase in profitability for the quarter, which was driven primarily by an expansion of operating margins due to operating efficiencies and a focus on higher margin industry sectors.
Operating profit for our UPS Freight unit decreased during the third quarter of 2010 compared with the prior year, due to a prior year reduction in vacation accruals resulting from modifications in vacation policies and changes in the workforce coverage of our individual plans. Excluding the impact of the reduction in vacation accruals, this unit achieved an increase in operating profit largely due to better productivity, increases in base pricing and volume. Productivity metrics increased, including increases in pickup and delivery stops per hour and linehaul utilization.
All of the remaining businesses within this segment had an operating profit during the quarter and year-to-date periods. Third quarter operating profit increased over the third quarter 2009 largely due to improved results in our financial unit. However, year-to-date combined profit for these businesses was lower than the comparable period of 2009, primarily due to the gain on sale of substantially all our international Mail Boxes Etc. operations during the second quarter of 2009.
36
UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Three Months
Ended September 30, |
Change | Nine Months
Ended September 30, |
Change | |||||||||||||||||||||
2010 | 2009 | % | 2010 | 2009 | % | |||||||||||||||||||
Operating Expenses (in millions): |
||||||||||||||||||||||||
Compensation and Benefits |
$ | 6,411 | $ | 6,341 | 1.1 | % | $ | 19,465 | $ | 19,003 | 2.4 | % | ||||||||||||
Impact of Restructuring Charge |
| | (98 | ) | | |||||||||||||||||||
Adjusted Compensation and Benefits |
6,411 | 6,341 | 1.1 | % | 19,367 | 19,003 | 1.9 | % | ||||||||||||||||
Repairs and Maintenance |
282 | 265 | 6.4 | % | 837 | 814 | 2.8 | % | ||||||||||||||||
Depreciation and Amortization |
448 | 441 | 1.6 | % | 1,348 | 1,297 | 3.9 | % | ||||||||||||||||
Purchased Transportation |
1,656 | 1,298 | 27.6 | % | 4,770 | 3,698 | 29.0 | % | ||||||||||||||||
Fuel |
724 | 635 | 14.0 | % | 2,119 | 1,670 | 26.9 | % | ||||||||||||||||
Other Occupancy |
222 | 241 | (7.9 | )% | 700 | 738 | (5.1 | )% | ||||||||||||||||
Other Expenses |
833 | 1,003 | (16.9 | )% | 2,825 | 3,158 | (10.5 | )% | ||||||||||||||||
Impact of Aircraft Impairment Charge |
| | | (181 | ) | |||||||||||||||||||
Impact of Loss on Sale of Business |
| | (38 | ) | | |||||||||||||||||||
Impact of Gain on Sale of Real Estate |
109 | | 109 | | ||||||||||||||||||||
Adjusted Other Expenses |
942 | 1,003 | (6.1 | )% | 2,896 | 2,977 | (2.7 | )% | ||||||||||||||||
Total Operating Expenses |
$ | 10,576 | $ | 10,224 | 3.4 | % | $ | 32,064 | $ | 30,378 | 5.6 | % | ||||||||||||
Adjusted Total Operating Expenses |
10,685 | 10,224 | 4.5 | % | 32,037 | 30,197 | 6.1 | % | ||||||||||||||||
Currency Translation (Benefit) Cost |
$ | (70 | ) | $ | 149 |
Compensation and Benefits
The increases in compensation and benefits expense during the third quarter and year-to-date periods of 2010 compared with 2009 were impacted by several items. Third quarter and year-to-date payroll costs increased, largely due to higher accruals for management incentive compensation plans resulting from improved company financial results. Union payroll costs also increased due to contractual wage increases. These factors were partially offset by a decline in union labor hours, as well as, a reduction in management salary costs resulting from a decrease in the total number of management employees through attrition combined with voluntary and involuntary workforce reductions.
Benefits expense decreased for the third quarter of 2010, largely due to reductions in employee health and welfare costs. The third quarter reduction in health and welfare costs was primarily driven by reductions in the total number of management employees, and union employees covered by UPS-sponsored health and welfare benefit plans. Benefits expense increased in the year-to-date period of 2010, due largely to increases in pension expense, and relocation-related benefit costs for management employees. Pension expense increases resulted primarily from higher union contribution rates for multi-employer pension plans. The relocation benefit costs relate to the restructuring of our domestic package operations that occurred in the first quarter of 2010.
Repairs and Maintenance
Repairs and maintenance expense increased during the third quarter and year-to-date periods of 2010, largely due to higher costs for maintenance on our vehicle fleet.
Depreciation and Amortization
Depreciation and amortization expense increased in the third quarter and year-to-date periods of 2010, primarily as a result of higher depreciation expense on equipment and facilities, as Worldport assets added in the
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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
recent expansion began to be depreciated. Amortization of intangible assets also increased as a result of new intangibles recognized related to the Unsped acquisition in Turkey in the third quarter of 2009, as well as corporate sponsorships entered into in 2010.
Purchased Transportation
The increases in purchased transportation in the third quarter and year-to-date periods of 2010 were driven by higher freight forwarding volume in Asia and Europe, as well as increased fuel surcharge rates charged to us by third-party carriers as a result of higher fuel prices.
Fuel
The increases in fuel expense in the third quarter and year-to-date periods of 2010 were caused primarily by higher prices for jet-A fuel, diesel, and unleaded gasoline, as well as a slight increase in usage of these products in our operations.
Other Occupancy
The decreases in other occupancy expense in the third quarter and year-to-date periods of 2010 were primarily due to decreased labor and overhead expenses and lower rent expense on leased facilities.
Other Expenses
The decreases in other expenses in the third quarter and year-to-date periods of 2010 were largely due to reductions in bad debt expense and foreign currency transaction expense, which reflected gains during 2010 compared to losses in 2009. Additionally, we incurred a loss on the sale of a French repair business in the third quarter of 2009.
Additional expense reductions for the quarter and year-to-date periods were due to cost containment programs, including reductions in telecom costs, office supplies, and outside professional fees. We also incurred lower expenses associated with auto liability insurance and customer claims for lost or damaged packages.
Investment Income (Loss) and Interest Expense
Three Months
Ended September 30, |
Change | Nine Months
Ended September 30, |
Change | |||||||||||||||||||||
2010 | 2009 | % | 2010 | 2009 | % | |||||||||||||||||||
Investment Income (Loss) and Interest Expense (in millions): |
||||||||||||||||||||||||
Investment Income (Loss) |
$ | 15 | $ | 6 | 150.0 | % | $ | (7 | ) | $ | (3 | ) | 133.3 | % | ||||||||||
Interest Expense |
$ | (91 | ) | $ | (93 | ) | (2.2 | )% | $ | (260 | ) | $ | (356 | ) | (27.0 | )% | ||||||||
Impact of Currency Remeasurement Charge |
| | | 77 | ||||||||||||||||||||
Adjusted Interest Expense |
$ | (76 | ) | $ | (87 | ) | (12.6 | )% | $ | (267 | ) | $ | (282 | ) | (5.3 | )% |
Investment Income
The increase in investment income for the third quarter in 2010 was largely due to higher realized gains on sales of investments and a higher average balance of funds invested compared with the prior year.
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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
On a year-to-date basis, the increase in investment losses in 2010 was primarily due to a lower yield earned on our invested assets as a result of declines in short-term interest rates in the United States, as well as higher impairment losses on our holdings of auction rate and preferred securities.
Interest Expense
The decrease in interest expense for the third quarter and year-to-date periods in 2010 was primarily due to lower average debt balances. This was partially offset by lower capitalized interest, due to the recent completion of several large construction projects, including our Worldport expansion.
The following table presents an analysis of income tax expense (in millions) and our effective income tax rate:
Three Months
Ended September 30, |
Change | Nine Months
Ended September 30, |
Change | |||||||||||||||||||||
2010 | 2009 | % | 2010 | 2009 | % | |||||||||||||||||||
Income Tax Expense |
$ | 549 | $ | 293 | 87.4 | % | $ | 1,424 | $ | 788 | 80.7 | % | ||||||||||||
Impact of Change in Tax Filing Status for German Subsidiary |
| | (76 | ) | | |||||||||||||||||||
Impact of Loss on Sale of Business |
| | 3 | | ||||||||||||||||||||
Impact of Restructuring Charge |
| | 34 | | ||||||||||||||||||||
Impact of Gain on Sale of Real Estate |
(48 | ) | | (48 | ) | | ||||||||||||||||||
Impact of Aircraft Impairment Charge |
| | | 65 | ||||||||||||||||||||
Impact Currency Remeasurement Charge |
| | | 29 | ||||||||||||||||||||
Adjusted Income Tax Expense |
$ | 501 | $ | 293 | 71.0 | % | $ | 1,337 | $ | 882 | 51.6 | % | ||||||||||||
Effective Tax Rate |
35.6 | % | 34.8 | % | 37.5 | % | 36.1 | % | ||||||||||||||||
Adjusted Effective Tax Rate |
35.0 | % | 34.8 | % | 35.0 | % | 36.1 | % |
Income tax expense increased primarily due to higher pre-tax income. Our effective tax rate increased in the third quarter of 2010 compared to 2009, primarily due to the tax effect of the gain on the sale of real estate in the third quarter of 2010 occurring at a relatively high marginal tax rate.
On a year-to-date basis, the increase in our effective tax rate in 2010 compared with 2009 was impacted by the higher marginal tax rate applied to the gain on the sale of real estate, as well as, the change in the tax filing status of a German subsidiary that occurred in the first quarter of 2010. Additionally, we are currently unable to recognize the entire potential tax benefit of tax loss carryforwards generated from the sale of a Supply Chain & Freight business in Germany in the first quarter of 2010.
Excluding these items, our adjusted year-to-date effective tax rate decreased in 2010 compared to 2009 primarily due to the effect of having a higher proportion of our taxable income in 2010 being subject to tax outside the United States, where statutory tax rates are generally lower.
In addition to the tax effect of the items described above, we recognized a $40 million tax benefit in the third quarter of 2010 associated with the release of a valuation allowance against deferred tax assets in our International Package business. However, this item was offset by unfavorable return-to-provision adjustments for our 2009 U.S. federal tax return, which was completed during the third quarter, and changes in our projected
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UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
jurisdictional profit mix. The net impact to our consolidated third quarter and year-to-date 2010 provision for these items was not material.
Our year-to-date 2009 income tax provision was increased as a result of providing a valuation allowance of $14 million against certain deferred tax assets in our International Package business.
Liquidity and Capital Resources
Net Cash From Operating Activities
The following is a summary of the significant sources (uses) of cash from operating activities (in millions):
Nine months
ended September 30, |
||||||||
2010 | 2009 | |||||||
Net income |
$ | 2,369 | $ | 1,395 | ||||
Non-cash operating activities (a) |
2,347 | 2,835 | ||||||
Pension and postretirement plan contributions (UPS-sponsored plans) |
(1,069 | ) | (758 | ) | ||||
Changes in working capital and other noncurrent assets and liabilities |
269 | 691 | ||||||
Other operating activities |
7 | 70 | ||||||
Net cash from operating activities |
$ | 3,923 | $ | 4,233 | ||||
(a) | Represents depreciation and amortization, gains and losses on derivative transactions and foreign exchange, deferred income taxes, provisions for uncollectible accounts, pension and postretirement benefit expense, stock compensation expense, impairment charges, and other non-cash items. |
The increase in consolidated net income was more than offset by higher pension contributions and changes in our working capital needs, which resulted in a reduction of operating cash flow in 2010 compared with the same period of 2009. Contributions to our company-sponsored pension plans have varied based primarily on whether any minimum funding requirements are present for individual pension plans. The increase in contributions in 2010 was largely due to minimum funding requirements related to the UPS IBT Pension Plan. As discussed in Note 6 to the unaudited consolidated financial statements, we expect to contribute $165 million to our company-sponsored pension and postretirement medical benefit plans over the remainder of 2010. We are currently evaluating whether to accelerate a portion of our required future contributions for our primary domestic pension plans into the fourth quarter of 2010.
Our working capital needs normally decline after our peak shipping season in the fourth quarter of each year. In 2009, we experienced a historically large reduction of our working capital position as a result of the economic recession. In 2010, our working capital position has declined by a relatively smaller amount, as economic conditions and our overall business have improved.
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