Overview
The U.S. economic expansion has continued at a slow-to-moderate pace through the third quarter of 2012. Continued growth in retail sales, particularly among e-commerce retailers, has provided for expansion in the overall U.S. small package delivery market; however, recent weakness in manufacturing activity, combined with the uneven nature of the overall economic recovery, has negatively impacted the small package delivery market. Given these trends, our products most aligned with business-to-consumer shipments have experienced the strongest growth, while our business-to-business volume continues to be pressured. We expect these trends to continue for the remainder of 2012.
Outside of the U.S., economic growth has slowed considerably due to volatility in world markets and fiscal austerity measures, particularly in Europe. This slower economic growth has created an environment in which customers are more likely to trade-down from premium express products to standard delivery products. Additionally, the uneven nature of economic growth worldwide has led to shifting trade patterns whereby transcontinental trade is being pressured, but intra-regional trade is continuing to grow. These circumstances have led us to adjust our air capacity and cost structure in our transportation network to the prevailing volume mix levels. Our broad portfolio of product offerings and the flexibilities inherent in our transportation network have helped us adapt to these changing trends, which has led to a continued overall solid performance in our International Package business.
While the worldwide economic environment has been challenging in 2012, we have continued to undertake initiatives to improve yield management, increase operational efficiency and contain costs across all segments. Continued deployment of technology improvements should lead to further gains in our operational efficiency, flexibility and reliability, thus restraining cost increases and improving margins. In our International Package segment, we have adjusted our air network and utilized newly constructed or expanded operating facilities to improve time-in-transit for shipments in each region. We have also continued to optimize our aircraft network, to leverage the new route authority we have gained over the last several years and to take full advantage of faster growing trade lanes. Additionally, in the first quarter of 2012, we acquired Kiala S.A., which will expand our service offerings for business-to-consumer deliveries in Europe.
Our consolidated results are presented in the table below:

                                    Three Months Ended                     Nine Months Ended
                                      September 30,          Change          September 30,         Change
                                    2012          2011          %          2012         2011          %
Revenue (in millions)            $  13,071     $ 13,166       (0.7 )%   $ 39,556     $ 38,939        1.6  %
Operating Expenses (in millions)    12,305       11,500        7.0  %     35,431       34,056        4.0  %
Operating Profit (in millions)   $     766     $  1,666      (54.0 )%   $  4,125     $  4,883      (15.5 )%
Operating Margin                       5.9 %       12.7 %                   10.4 %       12.5 %
Average Daily Package Volume (in
thousands)                          15,521       15,079        2.9  %     15,490       14,994        3.3  %
Average Revenue Per Piece        $   10.90     $  11.06       (1.4 )%   $  10.96     $  11.01       (0.5 )%
Net Income (in millions)         $     469     $  1,072      (56.3 )%   $  2,555     $  3,079      (17.0 )%
Basic Earnings Per Share         $    0.49     $   1.10      (55.5 )%   $   2.66     $   3.12      (14.7 )%
Diluted Earnings Per Share       $    0.48     $   1.09      (56.0 )%   $   2.63     $   3.09      (14.9 )%

Items Affecting Comparability
The year-over-year comparisons of our financial results were affected by the
following items (amounts in millions):

                                                 Three Months Ended                Nine Months Ended
                                                   September 30,                     September 30,
                                               2012               2011           2012             2011
Operating Expenses:
Multiemployer Pension Plan Withdrawal
Charge                                    $       896         $        -     $      896       $        -
Gain (Loss) on Real Estate Transactions             -                  -              -              (33 )
Income Tax Expense:
Income Tax Expense (Benefit) from the
Items Above                                      (337 )                -           (337 )             13

Multiemployer Pension Plan Withdrawal Charge In the third quarter of 2012, we recognized an $896 million pre-tax charge ($559 million after-tax) for the establishment of a withdrawal liability related to our withdrawal from a multiemployer pension plan within our U.S. Domestic Package segment. This charge is recorded in compensation and benefits expense in our statements of consolidated income.
Gain (Loss) on Real Estate Transactions
In the second quarter of 2011, we recognized a pre-tax loss from certain real estate transactions within our U.S. Domestic Package segment of $15 million ($11 million after-tax) and a pre-tax gain from certain real estate transactions within our Supply Chain & Freight segment of $48 million ($31 million after-tax). These gains and losses are recorded in other operating expenses in our statements of consolidated income.
Results of Operations-Segment Review
The results and discussions that follow are reflective of how our executive management monitors the performance of our reporting segments. From time to time, we supplement the reporting of our financial information determined under generally accepted accounting principles ("GAAP") with certain non-GAAP financial measures, including operating profit, operating margin, pre-tax income, effective tax rate, net income and earnings per share adjusted for the non-comparable items. 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.
Certain operating expenses are allocated between our reporting segments based on activity-based costing methods. These activity-based costing methods require us to make estimates that impact the amount of each expense category that is attributed to each segment. Changes in these estimates will directly impact the amount of expense allocated to each segment, and therefore the operating profit of each reporting segment. There were no significant changes in our expense allocation methodology during 2012 or 2011.

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


U.S. Domestic Package Operations
                                  Three Months Ended                     Nine Months Ended
                                     September 30,          Change         September 30,         Change
                                   2012          2011         %          2012         2011          %
Average Daily Package Volume
(in thousands):
Next Day Air                       1,264         1,196       5.7  %      1,236        1,174        5.3  %
Deferred                             931           852       9.3  %        947          866        9.4  %
Ground                            11,010        10,688       3.0  %     10,990       10,637        3.3  %
Total Avg. Daily Package
Volume                            13,205        12,736       3.7  %     13,173       12,677        3.9  %
Average Revenue Per Piece:
Next Day Air                   $   19.80      $  20.75      (4.6 )%   $  20.09     $  20.61       (2.5 )%
Deferred                           13.23         13.94      (5.1 )%      13.27        13.69       (3.1 )%
Ground                              7.94          7.92       0.3  %       7.99         7.90        1.1  %
Total Avg. Revenue Per Piece   $    9.45      $   9.53      (0.8 )%   $   9.51     $   9.47        0.4  %
Operating Days in Period              63            64                     191          192
Revenue (in millions):
Next Day Air                   $   1,577      $  1,588      (0.7 )%   $  4,743     $  4,645        2.1  %
Deferred                             776           760       2.1  %      2,400        2,277        5.4  %
Ground                             5,508         5,419       1.6  %     16,780       16,125        4.1  %
Total Revenue                  $   7,861      $  7,767       1.2  %   $ 23,923     $ 23,047        3.8  %
Operating Expenses (in
millions):
Operating Expenses             $   7,732      $  6,721      15.0  %   $ 21,665     $ 20,124        7.7  %
Multiemployer Pension Plan
Withdrawal Charge                   (896 )           -                    (896 )          -
Gain (Loss) on Real Estate
Transactions                           -             -                       -          (15 )
Adjusted Operating Expenses    $   6,836      $  6,721       1.7  %   $ 20,769     $ 20,109        3.3  %
Operating Profit (in millions)
and Margin:
Operating Profit               $     129      $  1,046     (87.7 )%   $  2,258     $  2,923      (22.8 )%
Adjusted Operating Profit      $   1,025      $  1,046      (2.0 )%   $  3,154     $  2,938        7.4  %
Operating Margin                     1.6 %        13.5 %                   9.4 %       12.7 %
Adjusted Operating Margin           13.0 %        13.5 %                  13.2 %       12.7 %

Revenue
The change in overall revenue was impacted by the following factors for the
third quarter and year-to-date periods of 2012 compared with the corresponding
periods of 2011:
                                                                    Total
                                         Rates /         Fuel      Revenue
                            Volume     Product Mix    Surcharge     Change
Net Revenue Change Drivers:
Third quarter 2012 vs. 2011   2.1 %         0.5 %       (1.4 )%       1.2 %
Year-to-date 2012 vs. 2011    3.4 %         0.2 %        0.2  %       3.8 %

Volume
Our overall volume increased in the third quarter and year-to-date periods of 2012 compared with 2011, largely due to continued solid growth in retail e-commerce and strong customer demand for our lightweight products. Business-to-consumer shipments, which represent approximately 40% of total U.S. Domestic Package volume, grew rapidly and drove growth in both air and ground shipments; however, we were negatively impacted by recent economic weakness in the U.S., as business-to-business volume declined about 1% in the third quarter, after experiencing growth earlier in the year.

Among our air products, Next Day Air letter and package volume both experienced solid increases for the third quarter and year-to-date periods of 2012, with particular growth in our Next Day Air Saver products. The higher volume for our deferred air products, which increased over 9% for the third quarter and year-to-date periods, was primarily due to strong demand for our residential package services. The overall solid growth in our air products was driven by business-to-consumer shipments from e-commerce retailers, though U.S. economic weakness restrained the growth in our commercial air volume.
The increase in ground volume for the third quarter and year-to-date periods of 2012 was driven by our lightweight service offerings, including SurePost, which target low-cost, non-urgent residential deliveries. Volume for these lightweight products grew approximately 25%, and accounted for over half of the total increase in ground shipments in the third quarter. Outside of these lightweight service offerings, volume for our traditional ground residential services also experienced a solid increase in the third quarter and year-to-date periods. Overall ground volume growth continues to be driven by strong business-to-consumer shipping activity from e-commerce retailers, as recent weakness in U.S. manufacturing caused a small decline in our commercial ground volume.
Rates and Product Mix
Overall revenue per piece decreased 0.8% for the third quarter of 2012 compared with the same period of 2011 (increased 0.4% year-to-date), and was impacted by changes in base rates, product mix and fuel surcharge rates, as discussed below. Revenue per piece for our Next Day Air and deferred products decreased in the third quarter and year-to-date periods of 2012 compared with 2011, as declines in fuel surcharge rates and product mix changes more than offset the impact of a base rate increase that took effect in early 2012. Changes in product mix negatively impacted revenue per piece for our air products, as letter volume increased at a faster rate than package volume, and our Next Day Air Saver volume continued to grow at a faster rate than our premium Next Day Air services.
Ground revenue per piece increased for the third quarter of year-to-date periods of 2012, compared with the corresponding periods of 2011, primarily due to a base rate increase that took effect in early 2012; however, this was partially offset by product mix changes, as strong volume growth in our lightweight service offerings resulted in these relatively lower-yielding products accounting for a greater portion of our overall volume in the third quarter and year-to-date periods of 2012, compared with the corresponding periods of 2011. Fuel surcharge rate changes, which are discussed further below, adversely impacted revenue per piece growth in the third quarter of 2012 compared with 2011, but positively impacted the year-to-date comparison.
Revenue per piece for our ground and air products was positively impacted by an increase in base rates that took effect on January 2, 2012. We increased the base rates 6.9% on UPS Next Day Air, UPS 2nd Day Air and UPS 3 Day Select, and 5.9% on UPS Ground, while reducing our fuel surcharge indices (discussed further below). Other pricing changes included an increase in the residential surcharge, and an increase in the delivery area surcharge on certain residential and commercial services. 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 Energy's ("DOE") Gulf Coast spot price for a gallon of kerosene-type jet fuel, while the ground fuel surcharge is based on the DOE's On-Highway Diesel Fuel price. Based on published rates, the average fuel surcharge for domestic air and ground products was as follows:

                          Three Months Ended                    Nine Months Ended
                             September 30,         Change         September 30,         Change
                           2012         2011      % Point       2012         2011      % Point
Next Day Air / Deferred    11.1 %        14.7 %    (3.6 )%      12.8 %        13.1 %    (0.3 )%
Ground                      7.3 %         9.0 %    (1.7 )%       7.9 %         7.8 %     0.1  %

On January 2, 2012, in connection with our base rate increase, we modified the fuel surcharge on air and ground services by reducing the index used to determine the fuel surcharge by 2% and 1%, respectively. Total domestic fuel surcharge revenue decreased by $107 million in the third quarter of 2012 compared with the same period of 2011 primarily due to the lower third quarter fuel surcharge rates; however, this was partially offset by the increase in package volume for the quarter. These decreased fuel surcharge rates for the third quarter were due to lower jet and diesel fuel prices, as well as the reduction in the index on the air and ground surcharges.

On a year-to-date basis, total domestic fuel surcharge revenue increased $49 million compared with 2011 primarily due to increased volume. Operating Expenses
Adjusted operating expenses for the segment increased $115 million for the third quarter of 2012 compared with the same period of 2011 ($660 million year-to-date). This increase was primarily due to pick-up and delivery costs, which grew $134 million ($507 million year-to-date), as well as the cost of operating our domestic integrated air and ground network, which increased $54 million for the third quarter ($237 million year-to-date). The growth in pick-up and delivery and network costs was due largely to increased volume and higher employee compensation costs, which were impacted by a union contractual wage increase (package driver wage rates rose 2.0%), an increase in driver hours (up 1.9%) and increased employee health care costs. These increases were partially offset by reductions in indirect operating costs of $75 million for the third quarter ($103 million year-to-date), largely due to reductions in the expense for management incentive awards.
Cost increases have been mitigated as we adjust our air and ground networks to better match higher volume levels and utilize technology to increase package sorting efficiency. Improved delivery densities, particularly for our residential products, have also contained increases in cost. These network efficiency improvements allowed us to process increased volume at a faster rate than the increase in average daily direct labor hours (up 1.6%), aircraft block hours (up 1.2%) and miles driven (up 1.4%) in the third quarter of 2012 compared with the same period of 2011, resulting in a reduction in the total cost per piece of 0.3% (0.1% year-to-date).
Operating Profit and Margin
The 2.0% decline in adjusted operating profit for the third quarter of 2012 was largely due to having one less operating day compared with the same period of 2011. Overall volume growth allowed us to better leverage our transportation network, resulting in productivity improvements and better pick-up and delivery density, which favorably impacted our operating margins; however, these trends were largely offset by the impact of fuel as well as changes in customer and product mix, which combined to pressure our revenue per piece. Because of the increase in fuel prices during the third quarter, operating profit was negatively impacted by approximately $60 million in the third quarter from the two month time lag between the fuel price changes and when the monthly surcharge rates are applied to package shipments. This was a reversal of the fuel impact we had experienced in the second quarter of 2012.
These factors drove a 50 basis point reduction in our adjusted operating margin in the third quarter of 2012, compared with the same period of 2011, resulting in the 2.0% decline in adjusted operating profit. On a year-to-date basis, however, adjusted operating margin increased 50 basis points in 2012 compared with 2011, as the impact of fuel and operating days was lessened. This resulted in a solid 7.4% increase in adjusted operating profit in the year-to-date period of 2012, compared with the corresponding period of 2011.

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


International Package Operations
                                      Three Months Ended                     Nine Months Ended
                                        September 30,          Change          September 30,         Change
                                       2012         2011          %          2012         2011          %
Average Daily Package Volume (in
thousands):
Domestic                               1,386        1,424       (2.7 )%       1,385       1,407       (1.6 )%
Export                                   930          919        1.2  %         932         910        2.4  %
Total Avg. Daily Package Volume        2,316        2,343       (1.2 )%       2,317       2,317          -  %
Average Revenue Per Piece:
Domestic                           $    6.87      $  7.24       (5.1 )%   $    7.01     $  7.26       (3.4 )%
Export                                 37.46        38.27       (2.1 )%       37.31       38.34       (2.7 )%
Total Avg. Revenue Per Piece       $   19.16      $ 19.41       (1.3 )%   $   19.20     $ 19.46       (1.3 )%
Operating Days in Period                  63           64                       191         192
Revenue (in millions):
Domestic                           $     600      $   660       (9.1 )%   $   1,855     $ 1,961       (5.4 )%
Export                                 2,195        2,251       (2.5 )%       6,642       6,698       (0.8 )%
Cargo                                    148          146        1.4  %         426         437       (2.5 )%
Total Revenue                      $   2,943      $ 3,057       (3.7 )%   $   8,923     $ 9,096       (1.9 )%
Operating Expenses (in millions)   $   2,494      $ 2,640       (5.5 )%   $   7,612     $ 7,721       (1.4 )%
Operating Profit (in millions)     $     449      $   417        7.7  %   $   1,311     $ 1,375       (4.7 )%
Operating Margin                        15.3 %       13.6 %                    14.7 %      15.1 %
Currency Translation Benefit /
(Cost)-(in millions)*:                                            $                                     $
Revenue                                                       $  (95 )                              $ (255 )
Operating Expenses                                               104                                   249
Operating Profit                                              $    9                                $   (6 )


___________________

Revenue
The change in overall revenue was impacted by the following factors for the
third quarter and year-to-date periods of 2012 compared with the corresponding
periods of 2011:
                                                                                Total
                                         Rates /         Fuel                  Revenue
                            Volume     Product Mix    Surcharge    Currency     Change
Net Revenue Change Drivers:
Third quarter 2012 vs. 2011 (2.7 )%         3.5 %       (1.4 )%      (3.1 )%    (3.7 )%
Year-to-date 2012 vs. 2011  (0.5 )%         1.3 %        0.1  %      (2.8 )%    (1.9 )%

Volume
Our overall average daily volume declined in the third quarter of 2012 compared with the corresponding period of 2011 (flat year-to-date), as the worldwide economic slowdown impacted the international small package market.

Export volume increased in the third quarter and year-to-date periods of 2012 compared to the corresponding periods of 2011, as more regional sourcing by customers led to solid growth in intra-regional shipments in all areas of the world. This growth in intra-regional shipments was largely offset by declines in volume for several important transcontinental trade lanes in the third quarter and year-to-date periods of 2012. U.S. export volume declined, particularly exports from the U.S. to Europe, as economic weakness within the European Union in the third quarter and year-to-date periods of 2012 negatively impacted our volume; however, Asian export volume increased to all other regions, including the key Asia to U.S. trade lane, and was favorably impacted by new product launches from several customers. Overall export volume continued to shift towards our less premium products, such as Transborder Standard and Worldwide Expedited, as compared with our premium express products, such as Worldwide Express, primarily as a result of economic pressures on our customers internationally.
Domestic volume decreased during the third quarter and year-to-date periods of 2012 compared to the same periods in 2011, and was negatively impacted by economic weakness across Europe; however, this was partially offset by domestic volume growth in the U.K., Mexico and Canada. Rates and Product Mix
Total average revenue per piece increased 2.0% for the third quarter of 2012 (2.0% year-to-date) on a currency-adjusted basis, and was impacted by base rate increases, as well as changes in product mix and fuel surcharge rates, which are discussed below.
Currency-adjusted export revenue per piece decreased 0.2% for the third quarter (0.5% year-to-date), as the shift in product mix from our premium express products to our standard products more than offset the increase in base rates. Additionally, currency-adjusted export revenue per piece was adversely impacted by a shortening of average trade lanes, as we experienced greater volume growth among our lower-yielding Transborder and Trade Direct products relative to our higher-yielding transcontinental volume.
Currency-adjusted domestic revenue per piece increased 3.0% for third quarter (3.7% year-to-date), largely due to base rate increases.
On January 2, 2012, 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), while reducing fuel surcharge indices. Rate changes for shipments originating outside the U.S. are made throughout the year and vary by geographic market. Fuel Surcharges
On January 2, 2012, in connection with our base rate increases, we modified the fuel surcharge on certain U.S.-related international air services by reducing the index used to determine the fuel surcharge by 2%. The fuel surcharges for air products originating outside the United States are indexed to the DOE's Gulf Coast spot price for a gallon of kerosene-type jet fuel, while the fuel surcharges for ground products originating outside the United States are indexed to fuel prices in the international region or country where the shipment takes place. Total international fuel surcharge revenue decreased by $43 million for the third quarter of 2012 when compared with 2011, primarily due to lower package volume and reduced fuel surcharge rates caused by declining fuel prices. . . .