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UPS > SEC Filings for UPS > Form 10-Q on 6-Aug-2014All Recent SEC Filings

Show all filings for UNITED PARCEL SERVICE INC

Form 10-Q for UNITED PARCEL SERVICE INC


6-Aug-2014

Quarterly Report


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

Overview
U.S. economic growth, retail sales and industrial production accelerated in the second quarter of 2014, in comparison to the weather-related declines experienced earlier in the year, which resulted in growth in the small package delivery market. Continued strong growth in e-commerce and omni-channel retail sales has driven package volume increases in both commercial and residential volume. Given these trends, overall volume growth was strong during the second quarter, and products most aligned with business-to-consumer and retail industry shipments experienced the fastest growth.
Economic growth in Europe has continued at a slow, stable pace, as growth in several larger countries (including the U.K. and Germany) has offset slower growth in some of the smaller countries. Economic growth in Asia has continued, though growth in China has moderated. The uneven nature of economic growth worldwide, combined with a trend towards more regional international trade, has led to shifting trade patterns and resulted in overcapacity in certain trade lanes. These factors have created an environment in which customers are more likely to trade-down from premium express products to standard delivery products in both Europe and Asia. As a result of these circumstances, we have adjusted our air capacity and cost structure in our transportation network to better match 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.
While the worldwide economic environment has remained challenging in 2014, we have continued to undertake several initiatives in the U.S. and internationally to (1) improve the flexibility and capacity in our delivery network; (2) improve yield management; and (3) increase operational efficiency and contain costs across all segments. Most notably, the continued deployment of technology improvements (including several facility automation projects and the accelerated deployment of our On Road Integrated Optimization and Navigation system - "ORION") should increase our network capacity, and improve operational efficiency, flexibility and reliability. Additionally, we have continued to adjust our transportation network and utilize newly expanded operating facilities (including the $200 million recently completed expansion of our Cologne air hub) to improve time-in-transit for shipments in each region. Our consolidated results are presented in the table below:

                                    Three Months Ended                     Six Months Ended
                                         June 30,            Change            June 30,            Change
                                    2014          2013          %          2014         2013          %
Revenue (in millions)            $  14,268     $ 13,507        5.6  %   $ 28,047     $ 26,941        4.1  %
Operating Expenses (in millions)    13,521       11,765       14.9  %     25,787       23,619        9.2  %
Operating Profit (in millions)   $     747     $  1,742      (57.1 )%   $  2,260     $  3,322      (32.0 )%
Operating Margin                       5.2 %       12.9 %                    8.1 %       12.3 %
Average Daily Package Volume (in
thousands)                          16,859       15,722        7.2  %     16,929       15,971        6.0  %
Average Revenue Per Piece        $   10.91     $  11.08       (1.5 )%   $  10.81     $  10.97       (1.5 )%
Net Income (in millions)         $     454     $  1,071      (57.6 )%   $  1,365     $  2,108      (35.2 )%
Basic Earnings Per Share         $    0.49     $   1.14      (57.0 )%   $   1.48     $   2.22      (33.3 )%
Diluted Earnings Per Share       $    0.49     $   1.13      (56.6 )%   $   1.47     $   2.21      (33.5 )%

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

                                                        Three Months Ended               Six Months Ended
                                                             June 30,                        June 30,
                                                       2014             2013            2014           2013
Operating Expenses:
Health and Welfare Plan Charges                   $      1,066       $       -     $     1,066      $       -
TNT Termination Fee and Related Expenses                     -               -               -            284
Gain Upon Liquidation of Foreign Subsidiary                  -               -               -           (245 )
Income Tax Expense:
Income Tax Expense (Benefit) from the Items Above         (401 )             -            (401 )          (75 )


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

These items have been excluded from comparisons of "adjusted" operating expenses, operating profit and operating margin in the discussion that follows. Health and Welfare Plan Charges
In connection with the ratification of our national master agreement with the International Brotherhood of Teamsters ("Teamsters") in the second quarter of 2014, we incurred pre-tax charges totaling $1.066 billion ($665 million after-tax) associated with changes in the delivery of healthcare benefits to certain active and retired union employees. These charges are discussed in further detail in the "Collective Bargaining Agreements" section. These charges impacted our U.S. Domestic Package segment ($957 million), International Package segment ($27 million) and Supply Chain & Freight segment ($82 million). TNT Termination Fee and Related Expenses On January 30, 2013, the European Commission issued a formal decision prohibiting our proposed acquisition of TNT Express N.V. ("TNT Express"). As a result of the prohibition by the European Commission, the condition of our offer requiring European Union competition clearance was not fulfilled, and our proposed acquisition of TNT Express could not be completed. Given this outcome, UPS and TNT Express entered a separate agreement to terminate the merger protocol, and we withdrew our formal offer for TNT Express. We paid a termination fee to TNT Express of 200 million ($268 million) under this agreement, and also incurred transaction-related expenses of $16 million during the first quarter of 2013. The combination of these items resulted in a pre-tax charge of $284 million ($177 million after-tax), which impacted our International Package segment.
Gain upon the Liquidation of a Foreign Subsidiary Subsequent to the termination of the merger protocol, we liquidated a foreign subsidiary that would have been used to acquire the outstanding shares of TNT Express in connection with the proposed acquisition. Upon the liquidation of this subsidiary in the first quarter of 2013, we realized a pre-tax foreign currency gain of $245 million ($213 million after-tax), which impacted our International Package segment.

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 discussed above. 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 2014 or 2013.


Table of Contents
                  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                     Six Months Ended
                                        June 30,             Change           June 30,            Change
                                    2014          2013         %          2014         2013         %
Average Daily Package Volume
(in thousands):
Next Day Air                        1,233         1,213       1.6  %      1,242        1,224       1.5  %
Deferred                              988           937       5.4  %      1,036          978       5.9  %
Ground                             12,085        11,176       8.1  %     12,082       11,373       6.2  %
Total Avg. Daily Package Volume    14,306        13,326       7.4  %     14,360       13,575       5.8  %
Average Revenue Per Piece:
Next Day Air                    $   20.73      $  20.52       1.0  %   $  20.45     $  20.32       0.6  %
Deferred                            13.05         13.31      (2.0 )%      12.77        12.96      (1.5 )%
Ground                               8.03          8.18      (1.8 )%       7.98         8.13      (1.8 )%
Total Avg. Revenue Per Piece    $    9.47      $   9.66      (2.0 )%   $   9.41     $   9.58      (1.8 )%
Operating Days in Period               64            64                     127          127
Revenue (in millions):
Next Day Air                    $   1,636      $  1,593       2.7  %   $  3,226     $  3,159       2.1  %
Deferred                              825           798       3.4  %      1,680        1,610       4.3  %
Ground                              6,207         5,850       6.1  %     12,250       11,743       4.3  %
Total Revenue                   $   8,668      $  8,241       5.2  %   $ 17,156     $ 16,512       3.9  %
Operating Expenses (in
millions):
Operating Expenses              $   8,459      $  7,109      19.0  %   $ 16,020     $ 14,295      12.1  %
Health and Welfare Plan Charges      (957 )           -                    (957 )          -
Adjusted Operating Expenses     $   7,502      $  7,109       5.5  %   $ 15,063     $ 14,295       5.4  %
Operating Profit (in millions)
and Margin:
Operating Profit                $     209      $  1,132     (81.5 )%   $  1,136     $  2,217     (48.8 )%
Adjusted Operating Profit       $   1,166      $  1,132       3.0  %   $  2,093     $  2,217      (5.6 )%
Operating Margin                      2.4 %        13.7 %                   6.6 %       13.4 %
Adjusted Operating Margin            13.5 %        13.7 %                  12.2 %       13.4 %

Revenue
The change in overall revenue was impacted by the following factors for the
second quarter and year-to-date periods of 2014 compared with the corresponding
periods of 2013:
                                                                     Total
                                          Rates /         Fuel      Revenue
                             Volume     Product Mix    Surcharge     Change
Net Revenue Change Drivers:
Second quarter 2014 vs. 2013   7.4 %       (2.2 )%          -  %       5.2 %
Year-to-date 2014 vs. 2013     5.8 %       (1.8 )%       (0.1 )%       3.9 %

Volume
Our overall volume increased in the second quarter and year-to-date periods of 2014 compared with 2013, largely due to continued solid growth in e-commerce and overall retail sales. Business-to-consumer shipments, which represent approximately 43% of total U.S. Domestic Package volume, grew 14% for the quarter and drove increases in both air and ground shipments. UPS SurePost volume increased more than 60% in the second quarter, and accounted for approximately half of the overall volume growth for the segment. The growth rate of business-to-business volume also accelerated in the second quarter of 2014, largely due to increased volume from the retail industry, including the use of our solutions for omni-channel (including ship-from-store and ship-to-store models) and returns shipping; additionally, business-to-business volume was positively impacted by growth in shipments from the industrial and manufacturing sectors.


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

Among our air products, volume increased in the second quarter of 2014 compared with 2013 for both our Next Day Air and deferred services. Solid air volume growth continued for those products most aligned with business-to-consumer shipping, including our residential Second Day Air package and residential Next Day Air Saver products. This growth was slightly offset by a decline in Next Day Air letter volume, which was negatively impacted by some competitive losses and slowing growth in the financial services industry. Our business-to-business air volume increased slightly, due to growth in the retail and industrial sectors. The growth in premium and deferred air volume continues to be impacted by economic conditions and changes in our customers' supply chain networks; the combination of these factors influences their sensitivity towards the price and speed of shipments, and therefore the use of our premium air services. The increase in ground volume in the second quarter and year-to-date periods of 2014 was driven by our SurePost service offering, which had a volume increase of 62% for the quarter (56% year-to-date). Additionally, we experienced moderate volume growth in our traditional residential ground services. Demand for SurePost and our traditional residential products continues to be driven by business-to-consumer shipping activity from e-commerce retailers and other large customers; additionally, business-to-consumer ground volume benefited from a large, one-time catalog shipment after a customer upgraded their distribution channel. Business-to-business ground volume also increased, primarily from the growth in omni-channel retail volume and the increased use of our returns service offerings.
Rates and Product Mix
Overall revenue per piece decreased 2.0% for the second quarter of 2014 compared with the same period of 2013 (1.8% year-to-date), and was impacted by changes in base rates, customer and product mix, and fuel surcharge rates.
Revenue per piece for our ground and air products was positively impacted by an increase in base rates that took effect on December 30, 2013. We implemented an average 4.9% net increase in base and accessorial rates on UPS Next Day Air, UPS 2nd Day Air and UPS 3 Day Select, and UPS Ground.
In the second quarter and year-to-date periods of 2014, revenue per piece increased slightly for our Next Day Air products, largely due to the base rate increase, an increase in the average weight per package, and a shift in product mix from lower-yielding letters towards higher-yielding packages. Revenue per piece declined for our deferred products in the second quarter, as customer and product mix changes more than offset the increase in base rates. Product mix adversely impacted deferred revenue per piece, as we experienced relatively stronger growth in our lighter-weight business-to-consumer shipments, which have lower average yields than our heavier-weight commercial shipments. Customer mix also adversely impacted deferred revenue per piece, due to the faster volume growth among our larger customers, which typically have a lower average yield than our smaller and middle-market customers.
Ground revenue per piece decreased in the second quarter and year-to-date periods of 2014, as customer and product mix changes more than offset the impact of the base rate increase. Customer and product mix changes adversely impacted revenue per piece as a greater portion of our overall volume in 2014, relative to 2013, came from lighter-weight shipments (including 62% volume growth in SurePost) and larger customers.
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 were as follows:

                          Three Months Ended                   Six Months Ended
                               June 30,            Change          June 30,           Change
                           2014         2013      % Point      2014         2013     % Point
Next Day Air / Deferred    10.7 %        11.0 %    (0.3 )%     10.6 %       11.0 %    (0.4 )%
Ground                      7.5 %         7.5 %       -  %      7.3 %        7.4 %    (0.1 )%


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

Total domestic fuel surcharge revenue increased by $2 million in the second quarter of 2014, as strong volume increases more than offset the decline in fuel surcharge rates. On a year-to-date basis, fuel surcharge revenue decreased by $17 million, as the lower fuel surcharge rates more than offset the increase in package volume. These decreased fuel surcharge rates for the quarter and year-to-date periods were due to lower jet and diesel fuel prices in the U.S. during 2014.
Operating Expenses
Adjusted operating expenses for the segment increased $393 million for the second quarter of 2014 compared with the same period of 2013 ($768 million year-to-date), and were impacted by several factors. This increase was primarily due to pick-up and delivery costs, which grew $199 million, as well as the cost of operating our domestic integrated air and ground network, which increased $146 million for the second quarter ($374 and $273 million, respectively, year-to-date). The growth in pick-up and delivery and network costs was largely due to increased volume and higher employee compensation costs, which were impacted by an increase in average daily driver hours (up 3.9%) and an increase in employee healthcare expenses. Additionally, we incurred higher costs associated with outside contract carriers, due to volume growth as well as issues associated with service performance of rail carriers. The remaining increase in adjusted operating expenses was mostly attributable to the costs of package sorting, which increased $39 million for the second quarter ($92 million year-to-date), largely due to higher package volume. On a year-to-date basis, poor weather conditions early in 2014 also increased operating expenses through higher overtime hours in our operations, reduced productivity, higher snow removal and utility costs, as well as the additional use of outside contract carriers.
Outside of the adverse weather impact, 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 and delivery efficiency. Improved pick-up and delivery densities, particularly for our residential products, have also contained increases in cost. These network efficiency improvements allowed us to process increased volume (up 7.4%) at a faster rate than the increase in average daily aircraft block hours (no change for the quarter), vehicle miles driven (up 4.0%) and average daily union labor hours (up 6.0%) in the second quarter of 2014 compared with the same period of 2013. The total adjusted cost per piece decreased 1.7% for the second quarter of 2014 compared with the second quarter of 2013 (0.4% year-to-date).
Operating Profit and Margin
Adjusted operating profit increased $34 million for the second quarter of 2014 compared with 2013. Overall volume growth allowed us to better leverage our transportation network, resulting in better pick-up and delivery density; however, these factors were partially offset by changes in customer and product mix, which combined to pressure our revenue per piece. The adjusted operating margin declined by 20 basis points, as we incurred additional operating costs associated with rail service performance and investments made to enhance operational capabilities and expand network capacity.
On a year-to-date basis, adjusted operating profit declined $124 million in 2014 compared with 2013, as adverse weather conditions early in 2014 and lower yields more than offset the volume growth and productivity improvements discussed previously. The unfavorable weather conditions in the U.S. reduced operating profit approximately $200 million in 2014, including the estimated loss in package volume, increased guaranteed service refunds to customers, and higher operating expenses.


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


International Package Operations
                                   Three Months Ended                        Six Months Ended
                                        June 30,              Change             June 30,             Change
                                    2014          2013          %           2014          2013          %
Average Daily Package Volume
(in thousands):
Domestic                            1,496         1,427         4.8  %       1,513        1,422         6.4  %
Export                              1,057           969         9.1  %       1,056          974         8.4  %
Total Avg. Daily Package Volume     2,553         2,396         6.6  %       2,569        2,396         7.2  %
Average Revenue Per Piece:
Domestic                        $    7.23      $   7.06         2.4  %   $    7.18     $   7.12         0.8  %
Export                              35.60         36.51        (2.5 )%       35.10        35.97        (2.4 )%
Total Avg. Revenue Per Piece    $   18.97      $  18.97           -  %   $   18.66     $  18.85        (1.0 )%
Operating Days in Period               64            64                        127          127
Revenue (in millions):
Domestic                        $     692      $    645         7.3  %   $   1,380     $  1,286         7.3  %
Export                              2,408         2,264         6.4  %       4,707        4,450         5.8  %
Cargo                                 152           153        (0.7 )%         292          304        (3.9 )%
Total Revenue                   $   3,252      $  3,062         6.2  %   $   6,379     $  6,040         5.6  %
Operating Expenses (in
millions):
Operating Expenses              $   2,808      $  2,611         7.5  %   $   5,497     $  5,237         5.0  %
Health and Welfare Plan Charges       (27 )           -                        (27 )          -
TNT Termination Fee and Related
Expenses                                -             -                          -         (284 )
Gain Upon Liquidation of
Foreign Subsidiary                      -             -                          -          245
Adjusted Operating Expenses     $   2,781      $  2,611         6.5  %   $   5,470     $  5,198         5.2  %
Operating Profit (in millions) and Operating
Margin:
Operating Profit                $     444      $    451        (1.6 )%   $     882     $    803         9.8  %
Adjusted Operating Profit       $     471      $    451         4.4  %   $     909     $    842         8.0  %
Operating Margin                     13.7 %        14.7 %                     13.8 %       13.3 %
Adjusted Operating Margin            14.5 %        14.7 %                     14.2 %       13.9 %
Currency Translation Benefit / (Cost)-(in
millions)*:                                                     $                                       $
Revenue                                                     $    49                                 $    68
Operating Expenses                                              (26 )                                   (29 )
Operating Profit                                            $    23                                 $    39


___________________


* Net of currency hedging; amount represents the change compared to the prior year.


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


Revenue
The change in overall revenue was impacted by the following factors for the
second quarter and year-to-date periods of 2014 compared with the corresponding
periods of 2013:
                                                                                  Total
                                          Rates /         Fuel                   Revenue
                             Volume     Product Mix     Surcharge    Currency     Change
Net Revenue Change Drivers:
Second quarter 2014 vs. 2013   6.6 %       (2.1 )%         0.1 %        1.6 %       6.2 %
Year-to-date 2014 vs. 2013     7.2 %       (2.7 )%           - %        1.1 %       5.6 %

Volume
Our overall average daily volume increased in the second quarter and year-to-date periods of 2014, largely due to strong demand from several industries (including retail, healthcare, industrial and automotive). The export volume increase in the second quarter and year-to-date periods of 2014 was driven by Europe, which experienced a solid increase in volume to all regions of the world. Volume in the intra-European trade lanes was particularly strong, and increased over 14% for the quarter. We also experienced solid export volume growth in the Americas (largely in the Canada-to-U.S. and Mexico-to-U.S. trade lanes) and in Asia (particularly in the Asia-to-Europe and Asia-to-U.S. trade lanes); however, Asian export growth was restrained by fewer technology product launches and fewer shipments from several key customers. Export volume continued to shift towards our standard products, such as Transborder Standard and Worldwide Standard, as compared with our premium express products, such as Worldwide Express. Our international customers continue to be impacted by economic pressures and changes in their supply chain networks, and the combination of these factors influences their sensitivity towards the price and speed of shipments.
The strong increase in domestic volume in the second quarter and year-to-date periods of 2014 was driven by solid volume growth throughout Europe, as well as . . .

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