UNITED PARCEL SERVICE INC quarterly report, Q3 FY2019

United Parcel Service, Inc. — Form 10-Q Summary

Reporting period: Quarter and nine months ended September 30, 2019. Financial statements are unaudited; comparative balance-sheet amounts are as of December 31, 2018. Unless stated otherwise, amounts are in U.S. dollars.

Business context and financial performance

UPS operates U.S. Domestic Package, International Package, and Supply Chain & Freight businesses. Third-quarter growth was led by U.S. Domestic Package, with higher demand for faster delivery options. All three segments increased operating profit in the quarter.

Metric	Q3 2019	Q3 2018	Change	Nine months 2019	Nine months 2018
Revenue	$18.318B	$17.444B	+5.0%	$53.526B	$52.013B
Operating profit	$2.128B	$1.727B	+23.2%	$5.665B	$5.020B
Operating margin	11.6%	9.9%	+1.7 percentage points	10.6%	9.7%
Net income	$1.750B	$1.508B	+16.0%	$4.546B	$4.338B
Diluted EPS	$2.01	$1.73	+16.2%	$5.23	$4.99

U.S. Domestic Package: Q3 revenue rose 9.8% to $11.455B and operating profit rose 28.1% to $1.216B. Average daily package volume increased 9.2%, while revenue per piece decreased 1.1%.
International Package: Q3 revenue increased 0.5% to $3.494B and operating profit increased 24.4% to $667M. Year-to-date revenue declined 1.5%, partly reflecting currency and softer demand.
Supply Chain & Freight: Q3 revenue declined 4.5% to $3.369B; operating profit increased 1.2% to $245M. Forwarding revenue fell 12.0%, amid lower freight demand and rates.
Q3 consolidated average daily package volume grew 7.7%, while average revenue per piece declined 1.6%.

Cash flow, balance sheet, and liquidity

Nine-month operating cash flow was $5.693B, down from $9.422B. Management cited higher pension contributions, changes in working capital, and lower net cash receipts from income taxes. Pension and postretirement contributions were $2.321B versus $137M in the prior-year period.
Investing cash outflow was $4.027B, including $4.336B of capital expenditures. Financing cash outflow was $1.854B; UPS paid $2.397B in dividends and repurchased $751M of shares.
At September 30, cash and cash equivalents were $4.040B and marketable securities were $498M; together these totaled $4.538B. Current assets were $14.184B and current liabilities were $12.835B.
Total debt carrying value was $23.901B, up from $22.736B at year-end 2018. Long-term debt and finance leases were $21.740B; commercial paper outstanding was $2.054B. The company reported compliance with debt covenants and no borrowings under its $4.5B revolving credit facilities.
Debt to total capitalization was 81.1%, compared with 88.2% at September 30, 2018; shareowners’ equity increased to $5.574B from $3.126B.
Adoption of the lease accounting standard brought operating lease right-of-use assets of $2.504B and operating lease liabilities of $2.563B onto the balance sheet. Comparative periods were not restated.

Material changes, outlook, and management commentary

Management attributed domestic operating improvement primarily to lower unit costs, productivity, higher volumes, and benefits from automated facilities and other transformation initiatives. Q3 total cost per piece decreased 2.7%; management said cost-per-piece growth had slowed as transformation benefits began to emerge.
Transformation strategy costs were $63M in Q3 and $207M year to date, down from $97M and $360M, respectively, in 2018. These are included in reported results; UPS also presents non-GAAP adjusted measures.
Capital expenditures were expected to be approximately $6.5B for 2019. UPS said cash, capital-market access, and operating cash flow should support operations, capital spending, transformation, dividends, share repurchases, and debt payments over the next several years. It anticipated approximately $1.0B of share repurchases in 2019 and expected to continue regular dividends. No specific earnings or revenue guidance was provided in the filing.
A $62M discrete tax benefit was recognized in Q3 after UPS concluded certain foreign deferred tax assets were more likely than not to be realized. The effective tax rate was 20.7% for Q3 and 22.3% year to date, versus 20.2% and 20.8% in 2018.
A $40M gain on the sale of surplus Canadian property benefited International Package operating results. Higher depreciation from investment in property and equipment, net of prior useful-life changes, reduced Q3 net income by a net $49M, or $0.06 per share; the year-to-date reduction was $53M, or $0.06 per share.
The current Teamsters National Master Agreement was ratified in April 2019 and runs through July 31, 2023. Approximately 283,000 employees are covered by the national master and related local agreements.

Risks, contingencies, and unusual items

Multiemployer pension exposure: The Central States Pension Fund has said it could become insolvent in 2025 without a legislative solution. UPS’s coordinating-benefit obligation for the UPS Transfer Group depends on unresolved legal, legislative, and actuarial factors. UPS disclosed that the projected obligation could increase by approximately $2.4B, to approximately $4.0B, if uncertainties are not resolved.
New York cigarette-delivery litigation: A court awarded $9.4M in damages and $237.6M in penalties. UPS accrued $9.4M, estimates potential losses could be up to $247M plus interest, and is appealing; the likely amount within that range could not be estimated.
Other matters include a DOJ investigation concerning USPS international air-contract transportation, and competition investigations in Spain and Turkey. UPS could not estimate potential losses for these matters. The Spanish authority imposed a €19.2M fine; implementation was suspended pending appeal.
Management cited risks including economic weakness and trade uncertainty, competition, fuel and currency movements, labor disruptions and bargaining outcomes, pension and benefit costs, cybersecurity and technology disruption, litigation, and the execution of transformation initiatives. The filing reported no material change to previously disclosed risk factors.
UPS uses derivatives to manage foreign-exchange and interest-rate exposures and stated that it does not use them for speculative trading. No commodity hedge positions were outstanding at September 30.

Important facts for investors to verify

Whether strong domestic package volumes and cost-per-piece improvements continue, and whether lower revenue per piece affects margins.
Progress against the approximately $6.5B 2019 capital-expenditure expectation and the effect of investment spending on future depreciation and cash generation.
Whether operating cash flow recovers after the unusually large pension contributions and working-capital and tax-related cash-flow movements.
Debt maturities, refinancing needs, commercial-paper usage, and continued access to credit facilities.
Developments in the Central States pension matter, including legislation, plan solvency, and any change in UPS’s estimated coordinating-benefit obligation.
Appeal outcomes and potential financial exposure in the New York case, as well as developments in the DOJ and foreign competition investigations.
Whether the Q3 tax benefit and property-sale gain are nonrecurring, and how reported results compare with UPS’s non-GAAP adjusted measures.