United Parcel Service, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; unaudited. Amounts are U.S. dollars unless noted.
Business context and financial performance
UPS operates U.S. Domestic Package, International Package, and Supply Chain & Freight. Management cited strong demand and revenue growth across all three segments, but operating profit declined as labor, fuel, purchased transportation, pension, and network investment costs rose.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $17.444B | $16.173B | $52.013B | $47.610B |
| Operating profit | $1.727B | $1.812B | $5.020B | $5.466B |
| Operating margin | 9.9% | 11.2% | 9.7% | 11.5% |
| Net income | $1.508B | $1.259B | $4.338B | $3.809B |
| Diluted EPS | $1.73 | $1.44 | $4.99 | $4.35 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $9.422B | $4.418B |
| Capital expenditures | Not stated for quarter | Not stated for quarter | $4.490B | $3.708B |
Q3 revenue increased 7.9%, while operating profit fell 4.7%; net income rose 19.8% and diluted EPS rose 20.1%. For the nine-month period, revenue grew 9.2%, operating profit declined 8.2%, net income increased 13.9%, and diluted EPS increased 14.7%. The effective tax rate fell to 20.2% in Q3 and 20.8% year to date, versus 35.0% and 33.9%, respectively, primarily reflecting the Tax Act and other favorable tax items.
Segment performance
| Segment | Q3 revenue | Q3 operating profit | Nine-month revenue | Nine-month operating profit |
|---|---|---|---|---|
| U.S. Domestic Package | $10.437B | $949M | $31.018B | $2.644B |
| International Package | $3.478B | $536M | $10.613B | $1.748B |
| Supply Chain & Freight | $3.529B | $242M | $10.382B | $628M |
Domestic revenue rose 8.1% in Q3, but operating profit fell 6.1%; average daily package volume increased 3.3% and revenue per piece 4.8%. International revenue grew 3.0%, while operating profit fell 11.6%, affected in part by currency and prior-year market conditions in Europe. Supply Chain & Freight revenue rose 12.2% and operating profit 24.1%, supported by forwarding, brokerage, and LTL growth.
Liquidity, debt, and capital allocation
At September 30, 2018, cash and cash equivalents were $4.097B, marketable securities $744M, and cash, cash equivalents, and marketable securities together $4.841B. Total debt was $23.301B, including $3.200B current maturities and commercial paper and $20.101B long-term debt. UPS had no borrowings under its $4.5B and $3.0B revolving credit facilities and was in compliance with debt covenants. Management said cash, capital-market access, and operating cash flow should be adequate for operating needs, planned investment, dividends, repurchases, and debt payments.
Nine-month cash flow from operations was $9.422B, compared with $4.418B in 2017. The increase reflected, among other factors, lower pension contributions ($137M versus $2.585B), favorable timing of tax receipts, hedge-margin movements, and working capital. Investing activities used $4.499B and financing activities used $4.260B. Dividends paid were $2.260B; share repurchases were $770M in cash-flow reporting. Debt-to-total-capitalization was 88.2% at period end.
Material changes, outlook, and notable items
- Costs and margins: Consolidated operating expenses increased 9.4% in Q3 and 11.5% year to date, faster than revenue. Higher fuel prices, compensation and benefits, purchased transportation, facility expansion, and Saturday operations contributed. Fuel expense rose 36.3% in Q3; purchased transportation rose 13.6%.
- Transformation: UPS recorded pre-tax transformation strategy costs of $97M in Q3 and $360M year to date ($73M and $273M after tax). Management described the program as a multi-year effort and said expected U.S. efficiency and growth benefits would not be fully realized until future periods.
- Depreciation estimate: Beginning in Q3, UPS lengthened estimated useful lives for vehicles and building improvements. This reduced depreciation expense by $92M in Q3; the filing does not separately quantify the full-period effect of the estimate change.
- Investment plans: 2018 capital expenditures were expected to be approximately $6.5B–$7.0B. UPS anticipated about $1.0B of 2018 share repurchases and said it expected to continue regular cash dividends. No specific earnings or revenue guidance is provided in this filing.
- Labor: The Teamsters declared the tentative U.S. Domestic Package national agreement ratified on October 5, subject to resolution and ratification of five local and supplemental agreements. The UPS Freight national master agreement was not ratified and remained under negotiation. UPS also remained in negotiations with airline mechanics; the IAM agreements for certain mechanics become amendable in 2019.
- Pension exposure: UPS disclosed a potential approximately $4B increase in the UPS/IBT Plan projected benefit obligation if the Central States Pension Fund becomes insolvent and UPS must provide coordinating benefits. No additional liability was recognized in the latest measurement; the outcome remains uncertain.
- Legal and regulatory matters: UPS appealed a New York cigarette-delivery judgment involving $9.4M damages and $237.6M penalties; it estimated possible losses up to $247M plus interest but could not estimate a likely amount. A €19.2M Spanish competition fine was stayed pending appeal. DOJ and Turkish competition investigations remained unresolved, with losses not estimable.
- Accounting changes: UPS expects the lease accounting standard to materially change its balance sheet upon adoption in 2019. It cited $1.637B of future minimum operating lease commitments as of December 31, 2017.
Important facts for investors to verify
- Whether revenue growth and package volume translate into improved operating profit and margins as transformation initiatives and network investments mature.
- How much of the elevated operating cash flow reflects sustainable operating performance versus pension-contribution, tax-refund, hedge-margin, and working-capital timing.
- Actual transformation costs, realized savings, and the effect of the revised useful-life estimates on future depreciation and earnings.
- Resolution and financial effects of the Central States pension matter, Teamsters agreements, and significant litigation and competition investigations.
- Capital-spending execution, debt and commercial-paper levels, and the balance-sheet impact of lease-standard adoption.