Edgar Filing: UNITED PARCEL SERVICE INC

Form 10-Q

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 June 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

LOGO

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

(Registrant’s 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 265,675,246 Class A shares, and 725,020,296 Class B shares, with a par value of $0.01 per share, outstanding at July 29, 2010.

UNITED PARCEL SERVICE, INC.

QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2010

TABLE OF CONTENTS


PART I—FINANCIAL INFORMATION
Item 1.	Financial Statements	1
	Consolidated Balance Sheets	1
	Statements of Consolidated Income	2
	Statements of Consolidated Comprehensive Income	2
	Statements of Consolidated Cash Flows	3
	Notes to Unaudited Consolidated Financial Statements	4
	Note 1—Basis of Presentation	4
	Note 2—Recent Accounting Pronouncements	4
	Note 3—Stock-Based Compensation	4
	Note 4—Cash and Investments	6
	Note 5—Property, Plant and Equipment	10
	Note 6—Employee Benefit Plans	11
	Note 7—Goodwill and Intangible Assets	12
	Note 8—Debt and Financing Arrangements	13
	Note 9—Legal Proceedings and Contingencies	14
	Note 10—Shareowners’ Equity	16
	Note 11—Segment Information	19
	Note 12—Earnings Per Share	20
	Note 13—Derivative Instruments and Risk Management	21
	Note 14—Restructuring Costs and Related Expenses	26
	Note 15—Income Taxes	26
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
	Overview	28
	Items Affecting Comparability	29
	U.S. Domestic Package Operations	31
	International Package Operations	33
	Supply Chain & Freight Operations	35
	Operating Expenses	36
	Investment Income and Interest Expense	38
	Income Tax Expense	39
	Liquidity and Capital Resources	39
	Net Cash from Operating Activities	39
	Net Cash used in Investing Activities	40
	Net Cash used in Financing Activities	41
	Sources of Credit	42
	Contingencies	43
	Recent Accounting Pronouncements	45
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46
Item 4.	Controls and Procedures	46

PART II—OTHER INFORMATION
Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	47
Item 5.	Other Information	47
Item 6.	Exhibits	48

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

June 30, 2010 (unaudited) and December 31, 2009

(In millions)


	June 30,			December 31,
	2010			2009
ASSETS
Current Assets:
Cash and cash equivalents	$	3,252		$	1,542
Marketable securities		755			558
Accounts receivable, net		5,110			5,369
Finance receivables, net		266			287
Deferred income tax assets		552			585
Income tax receivable		284			266
Other current assets		805			668

Total Current Assets		11,024			9,275
Property, Plant and Equipment, Net		17,615			17,979
Goodwill		2,050			2,089
Intangible Assets, Net		628			596
Non-Current Finance Receivables, Net		312			337
Other Non-Current Assets		1,640			1,607

Total Assets	$	33,269		$	31,883

LIABILITIES AND SHAREOWNERS’ EQUITY
Current Liabilities:
Current maturities of long-term debt and commercial paper	$	1,637		$	853
Accounts payable		1,708			1,766
Accrued wages and withholdings		1,909			1,416
Self-insurance reserves		771			757
Income taxes accrued		291			258
Other current liabilities		1,371			1,189

Total Current Liabilities		7,687			6,239
Long-Term Debt		8,614			8,668
Pension and Postretirement Benefit Obligations		4,947			5,457
Deferred Income Tax Liabilities		1,429			1,293
Self-Insurance Reserves		1,764			1,732
Other Non-Current Liabilities		898			798
Shareowners’ Equity:
Class A common stock (269 and 285 shares issued in 2010 and 2009)		3			3
Class B common stock (724 and 711 shares issued in 2010 and 2009)		7			7
Additional paid-in capital		5			2
Retained earnings		13,067			12,745
Accumulated other comprehensive loss		(5,217	)		(5,127	)
Deferred compensation obligations		101			108
Less: Treasury stock (2 shares in 2010 and 2009)		(101	)		(108	)

Total Equity for Controlling Interests		7,865			7,630
Total Equity for Non-Controlling Interests		65			66

Total Shareowners’ Equity		7,930			7,696

Total Liabilities and Shareowners’ Equity	$	33,269		$	31,883

See notes to unaudited consolidated financial statements.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

STATEMENTS OF CONSOLIDATED INCOME

(In millions, except per share amounts)

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2010			2009			2010			2009
Revenue	$	12,204		$	10,829		$	23,932		$	21,767
Operating Expenses:
Compensation and benefits		6,515			6,330			13,054			12,662
Repairs and maintenance		281			273			555			549
Depreciation and amortization		449			426			900			856
Purchased transportation		1,613			1,188			3,114			2,400
Fuel		717			539			1,395			1,035
Other occupancy		216			225			478			497
Other expenses		1,011			953			1,992			2,155

Total Operating Expenses		10,802			9,934			21,488			20,154

Operating Profit		1,402			895			2,444			1,613

Other Income and (Expense):
Investment income (loss)		(18	)		(22	)		(22	)		(9	)
Interest expense		(84	)		(181	)		(169	)		(263	)

Total Other Income and (Expense)		(102	)		(203	)		(191	)		(272	)

Income Before Income Taxes		1,300			692			2,253			1,341
Income Tax Expense		455			247			875			495

Net Income	$	845		$	445		$	1,378		$	846

Basic Earnings Per Share	$	0.85		$	0.45		$	1.39		$	0.85

Diluted Earnings Per Share	$	0.84		$	0.44		$	1.37		$	0.84

STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME

(In millions)

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2010			2009			2010			2009
Net income	$	845		$	445		$	1,378		$	846
Change in foreign currency translation adjustment		(92	)		38			(220	)		(37	)
Change in unrealized gain (loss) on marketable securities, net of tax		16			24			35			21
Change in unrealized gain (loss) on cash flow hedges, net of tax		(27	)		(91	)		12			(49	)
Change in unrecognized pension and postretirement benefit costs, net of tax		41			40			83			79

Comprehensive income	$	783		$	456		$	1,288		$	860

See notes to unaudited consolidated financial statements.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

STATEMENTS OF CONSOLIDATED CASH FLOWS

(In millions)

(unaudited)


	Six Months Ended June 30,
	2010			2009
Cash Flows From Operating Activities:
Net income	$	1,378		$	846
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		900			856
Pension and postretirement benefit expense		448			441
Pension and postretirement benefit contributions		(812	)		(180	)
Self-insurance reserves		46			(81	)
Deferred taxes, credits and other		35			(39	)
Stock compensation expense		238			219
Asset impairment charges		—			181
Other (gains) losses		128			2
Changes in assets and liabilities, net of effect of acquisitions:
Accounts receivable		42			852
Other current assets		(18	)		101
Accounts payable		(1	)		(293	)
Accrued wages and withholdings		512			274
Other current liabilities		111			(96	)
Other operating activities		5			72

Net cash from operating activities		3,012			3,155

Cash Flows From Investing Activities:
Capital expenditures		(664	)		(671	)
Proceeds from disposals of property, plant and equipment		40			17
Purchases of marketable securities		(1,024	)		(1,428	)
Sales and maturities of marketable securities		898			1,430
Net (increase) decrease in finance receivables		46			155
Other investing activities		96			82

Net cash used in investing activities		(608	)		(415	)

Cash Flows From Financing Activities:
Net change in short-term debt		826			(871	)
Proceeds from long-term borrowings		54			3,134
Repayments of long-term borrowings		(219	)		(1,360	)
Purchases of common stock		(443	)		(247	)
Issuances of common stock		106			68
Dividends		(911	)		(876	)
Other financing activities		(59	)		(283	)

Net cash used in financing activities		(646	)		(435	)

Effect Of Exchange Rate Changes On Cash And Cash Equivalents		(48	)		6

Net Increase (Decrease) In Cash And Cash Equivalents		1,710			2,311
Cash And Cash Equivalents:
Beginning of period		1,542			507

End of period	$	3,252		$	2,818

See notes to unaudited consolidated financial statements.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION

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 June 30, 2010, our results of operations for the three and six months ended June 30, 2010 and 2009, and cash flows for the six months ended June 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 June 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 three months ended June 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 June 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

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 the entire eligible 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 our employee stock options 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 granted under the Management Incentive Awards 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 June 30, 2010 and 2009 was $136 and $113 million pre-tax, respectively. Compensation expense for share-based awards recognized in net income for the six months ended June 30, 2010 and 2009 was $238 and $219 million pre-tax, respectively.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4. CASH AND INVESTMENTS

The following is a summary of marketable securities classified as available-for-sale as of June 30, 2010 and December 31, 2009 (in millions):


	Cost		Unrealized Gains		Unrealized Losses			Estimated Fair Value
June 30, 2010
Current marketable securities:
U.S. government and agency debt securities	$	128	$	4	$	—		$	132
Mortgage and asset-backed debt securities		214		3		—			217
Corporate debt securities		295		7		—			302
U.S. state and local municipal debt securities		42		—		—			42
Other debt and equity securities		58		4		—			62

Current marketable securities		737		18		—			755
Non-current marketable securities:
Asset-backed debt securities		108		—		(4	)		104
U.S. state and local municipal debt securities		76		—		(11	)		65
Common equity securities		20		10		—			30
Preferred equity securities		16		1		(2	)		15

Non-current marketable securities		220		11		(17	)		214

Total marketable securities	$	957	$	29	$	(17	)	$	969


	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 June 30, 2010, we held $200 million in cost basis of investments in auction rate securities. 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 securities”). Other auction rate security investments are structured as obligations of asset-backed trusts (classified as “Asset-backed debt securities”), generally all of

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

which 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 & Poor’s Rating Service (“Standard & Poor’s”) and Moody’s Investors Service (“Moody’s”), 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 June 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 six 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. We estimated the fair value of these securities after 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. As a result, we recorded an after-tax unrealized loss of $10 million on these securities as of June 30, 2010 in other comprehensive income ($16 million pre-tax), reflecting the decline in the estimated fair value of these securities.

Investment Other-Than-Temporary Impairments

During the second quarter of 2010, we recorded impairment losses on certain asset-backed auction rate securities. The impairment charge results 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 income statement.

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 results 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 income statement.

Other than as previously discussed, we have concluded that no other-than-temporary impairment losses existed as of June 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.

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 June 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	$	105	$	105
Due after one year through three years		269		273
Due after three years through five years		47		49
Due after five years		461		454

		882		881
Equity securities		75		88

	$	957	$	969

Restricted Cash

We had $286 million of restricted cash related to our self-insurance requirements, as of June 30, 2010 and December 31, 2009, which is reported in “Other Non-Current Assets” on the consolidated balance sheet.

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 June 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 sheet). 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 partnership’s financial statements and cash flow projections.

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 June 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 June 30, 2010
June 30, 2010
Marketable Securities:
U.S. Government and Agency Debt Securities	$	132	$	—	$	—	$	132
Mortgage and Asset-Backed Debt Securities		—		217		104		321
Corporate Debt Securities		—		302		—		302
U.S. State and Local Municipal Debt Securities		—		42		65		107
Other Debt and Equity Securities		52		40		15		107
Other investments		—		—		278		278

Total	$	184	$	601	$	462	$	1,247


	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 June 30, 2010 (in millions).


	Marketable Securities			Other Investments			Total
Balance on April 1, 2010	$	211		$	290		$	501
Transfers into (out of) Level 3		—			—			—
Net realized and unrealized gains (losses):
Included in earnings (in investment income)		(21	)		(12	)		(33	)
Included in accumulated other comprehensive income (pre-tax)		22			—			22
Purchases, issuances, and settlements		(28	)		—			(28	)

Balance on June 30, 2010	$	184		$	278		$	462

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 six months ended June 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)		(28	)		(23	)		(51	)
Included in accumulated other comprehensive income (pre-tax)		48			—			48
Purchases, issuances, and settlements		(52	)		—			(52	)

Balance on June 30, 2010	$	184		$	278		$	462

There were no transfers of investments between Level 1 and Level 2 during the three and six months ended June 30, 2010 and 2009.

NOTE 5. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment as of June 30, 2010 and December 31, 2009 consist of the following (in millions):


	2010			2009
Vehicles	$	5,426		$	5,480
Aircraft (including aircraft under capitalized leases)		14,069			13,777
Land		1,068			1,079
Buildings		3,075			3,076
Building and leasehold improvements		2,810			2,800
Plant equipment		6,550			6,371
Technology equipment		1,560			1,591
Equipment under operating leases		134			145
Construction-in-progress		189			488

		34,881			34,807
Less: Accumulated depreciation and amortization		(17,266	)		(16,828	)

	$	17,615		$	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 DHL’s 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 FAA 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 was not recoverable due to the accelerated expected retirement dates of the aircraft. Based on anticipated residual values for the airframes,

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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 Statement 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 six month period ended June 30, 2010 and 2009 (in millions):


Three Months Ended June 30,	U.S. Pension Benefits						U.S. Postretirement Medical Benefits						International Pension Benefits
	2010			2009			2010			2009			2010			2009
Net Periodic Cost:
Service cost	$	180		$	173		$	21		$	22		$	6		$	5
Interest cost		299			282			54			53			9			7
Expected return on assets		(399	)		(372	)		(6	)		(7	)		(8	)		(6	)
Amortization of:
Transition obligation		—			1			—			—			—			—
Prior service cost		43			44			1			1			—			—
Actuarial (gain) loss		20			12			4			4			—			1
Settlements / curtailments		—			3			—			—			—			—

Net periodic benefit cost	$	143		$	143		$	74		$	73		$	7		$	7


Six Months Ended June 30,	U.S. Pension Benefits						U.S. Postretirement Medical Benefits						International Pension Benefits
	2010			2009			2010			2009			2010			2009
Net Periodic Cost:
Service cost	$	361		$	345		$	43		$	43		$	12		$	10
Interest cost		599			565			107			106			17			14
Expected return on assets		(799	)		(744	)		(11	)		(14	)		(17	)		(12	)
Amortization of:
Transition obligation		—			2			—			—			—			—
Prior service cost		86			89			2			3			—			—
Actuarial (gain) loss		39			23			8			7			1			1
Settlements / curtailments		—			3			—			—			—			—

Net periodic benefit cost	$	286		$	283		$	149		$	145		$	13		$	13

During the first six months of 2010, we contributed $767 and $45 million to our company-sponsored pension and postretirement medical benefit plans, respectively. We expect to contribute $384 and $44 million over the remainder of the year to the pension and postretirement medical benefit plans, respectively.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

impact was not material to our financial results. We are evaluating the long-term impacts of this legislation to 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 rule setting guidance will be occurring. Our initial 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 June 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		—		—			—			—
Currency / Other		—		(9	)		(30	)		(39	)

June 30, 2010 balance		—	$	365		$	1,685		$	2,050

The decrease in goodwill in the International Package and Supply Chain & Freight segments was 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 June 30, 2010 and December 31, 2009 (in millions):


	Gross Carrying Amount		Accumulated Amortization			Net Carrying Value
June 30, 2010:
Trademarks, licenses, patents, and other	$	185	$	(27	)	$	158
Customer lists		105		(59	)		46
Franchise rights		109		(49	)		60
Capitalized software		1,893		(1,529	)		364

Total Intangible Assets, Net	$	2,292	$	(1,664	)	$	628

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

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 June 30, 2010 and December 31, 2009 consists of the following (in millions):


	Maturity	2010			2009
Commercial paper	2010	$	1,528		$	672
4.50% senior notes	2013		1,813			1,773
3.875% senior notes	2014		1,060			1,023
5.50% senior notes	2018		804			758
5.125% senior notes	2019		1,043			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		741			791
Capital lease obligations	2010-2021		310			369
UPS Notes			—			175
Other debt	2010-2012		17			21

Total debt			10,251			9,521
Less current maturities			(1,637	)		(853	)

Long-term debt		$	8,614		$	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 $1.528 billion outstanding under this program as of June 30, 2010, with an average interest rate of 0.14%. As of June 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 June 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 & Poor’s and Moody’s. 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 June 30, 2010, there were no outstanding borrowings under either of these facilities.

In addition to these credit facilities, we have an automatically effective registration statement on Form S-3 filed with the SEC that is available for registered offerings of short or long-term debt securities.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

notes at any time by paying the greater of the principal amount or a “make-whole” amount, plus accrued interest. 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 June 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 June 30, 2010, 10% of net tangible assets is equivalent to $2.290 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 June 30, 2010, our net worth, as defined, was equivalent to $13.082 billion. We do not expect these covenants to have a material impact on our financial condition or liquidity.

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 $10.727 and $10.216 billion as of June 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 court’s 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 Company’s 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 court’s 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. 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.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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 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 UPS’s 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 UPS’s 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. These talks are currently in recess. 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.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Other Matters

We received grand jury subpoenas from the Antitrust Division of the U.S. Department of Justice (“DOJ”) regarding the DOJ’s investigations into certain pricing practices in the air cargo industry in July 2006, and 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 Commission’s 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 Commission’s 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, and we intend to continue to vigorously defend ourselves in this proceeding.

We also received and responded to related information requests from competition authorities in other jurisdictions.

We are cooperating with each of these inquiries. 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.

NOTE 10. SHAREOWNERS’ EQUITY

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 June 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 June 30, 2010, no preferred shares had been issued.

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 six months ended June 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	)		—		(5	)		—
Stock award plans	2			—		2			—
Common stock issuances	2			—		2			—
Conversions of Class A to Class B common stock	(17	)		—		(17	)		—

Class A shares issued at end of period	269		$	3		296		$	3

Class B Common Stock
Balance at beginning of period	711		$	7		684		$	7
Common stock purchases	(4	)		—		—			—
Conversions of Class A to Class B common stock	17			—		17			—

Class B shares issued at end of period	724		$	7		701		$	7

Additional Paid-In Capital
Balance at beginning of period			$	2				$	—
Stock award plans				206					211
Common stock purchases				(318	)				(248	)
Common stock issuances				115					96

Balance at end of period			$	5				$	59

Retained Earnings
Balance at beginning of period			$	12,745				$	12,412
Net income				1,378					846
Dividends ($0.94 and $0.90 per share)				(947	)				(906	)
Common stock purchases				(109	)				—

Balance at end of period			$	13,067				$	12,352

We currently intend to repurchase shares in 2010 at a rate that will at least offset the dilution from our stock compensation programs. We repurchased a total of 6.9 million shares of Class A and Class B common stock for $427 million during the six months ended June 30, 2010, and 5.1 million shares for $248 million during the six months ended June 30, 2009. As of June 30, 2010, we had $5.576 billion of our share repurchase authorization remaining.

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 six months ended June 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		(220	)		(37	)

Balance at end of period		(183	)		(75	)

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 $12, and $(6))		20			11
Reclassification to earnings (net of tax effect of $9 and $7)		15			10

Balance at end of period		8			(39	)

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 $15 and $38)		26			63
Reclassification to earnings (net of tax effect of $(9) and $(67))		(14	)		(112	)

Balance at end of period		(188	)		(156	)

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 $53 and $46)		83			79

Balance at end of period		(4,854	)		(5,358	)

Accumulated other comprehensive income (loss) at end of period	$	(5,217	)	$	(5,628	)

Deferred Compensation Obligations and Treasury Stock

Activity in the deferred compensation program for the six months ended June 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					2
Benefit payments				(10	)				(16	)

Balance at end of period			$	101				$	107

Treasury Stock
Balance at beginning of period	(2	)	$	(108	)	(2	)	$	(121	)
Reinvested dividends	—			(3	)	—			(2	)
Benefit payments	—			10		—			16

Balance at end of period	(2	)	$	(101	)	(2	)	$	(107	)

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 sheet 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 six months ended June 30, 2010 and 2009 (in millions):


	2010			2009
Noncontrolling Interests
Balance at beginning of period	$	66		$	—
Acquired noncontrolling interests		—			—
Dividends attributable to noncontrolling interests		(1	)		—
Net income attributable to noncontrolling interests		—			—

Balance at end of period	$	65		$	—

NOTE 11. SEGMENT INFORMATION

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 segment’s 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.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Segment information for the three and six months ended June 30, 2010 and 2009 is as follows (in millions):


	Three Months Ended June 30,				Six Months Ended June 30,
	2010		2009		2010		2009
Revenue:
U.S. Domestic Package	$	7,269	$	6,789	$	14,371	$	13,738
International Package		2,771		2,246		5,410		4,486
Supply Chain & Freight		2,164		1,794		4,151		3,543

Consolidated	$	12,204	$	10,829	$	23,932	$	21,767

Operating Profit:
U.S. Domestic Package	$	748	$	476	$	1,310	$	860
International Package		521		293		948		587
Supply Chain & Freight		133		126		186		166

Consolidated	$	1,402	$	895	$	2,444	$	1,613

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.

NOTE 12. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per share for the three and six months ended June 30, 2010 and 2009 (in millions, except per share amounts):


	Three Months Ended June 30,				Six Months Ended June 30,
	2010		2009		2010		2009
Numerator:
Net income attributable to common shareowners	$	845	$	445	$	1,378	$	846

Denominator:
Weighted average shares		991		995		991		995
Deferred compensation obligations		2		2		2		2
Vested portion of restricted shares		1		1		1		1

Denominator for basic earnings per share		994		998		994		998

Effect of dilutive securities:
Restricted performance units		3		2		3		2
Restricted stock units		6		4		6		3
Stock option plans		—		—		—		—

Denominator for diluted earnings per share		1,003		1,004		1,003		1,003

Basic earnings per share	$	0.85	$	0.45	$	1.39	$	0.85

Diluted earnings per share	$	0.84	$	0.44	$	1.37	$	0.84

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Diluted earnings per share for the three months ended June 30, 2010 and 2009 exclude the effect of 9.8 and 17.2 million shares of common stock (12.3 and 17.7 million for the six months ended June 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 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 & Poor’s or Baa2 by Moody’s, 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 income statement during the current period.

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 income statement 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 income statement 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, and maturity dates 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.

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 June 30, 2010 and December 31, 2009, the notional amounts of our outstanding derivative positions were as follows:


	June 30, 2010 Notional Value (in millions)		December 31, 2009 Notional Value (in millions)
Currency Hedges:
Euro	€	1,310	€	1,372
British Pound Sterling	£	757	£	692
Canadian Dollar	C$	182	C$	228

Interest Rate Hedges:
Fixed to Floating Interest Rate Swaps	$	3,675	$	3,751
Floating to Fixed Interest Rate Swaps	$	28	$	28

As of June 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.

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	June 30, 2010 Fair Value			December 31, 2009 Fair Value
Derivatives designated as hedges:
Foreign exchange contracts	Other current assets	Level 2	$	137		$	63
Interest rate contracts	Other non-current assets	Level 2		211			74

Total Asset Derivatives			$	348		$	137


Liability Derivatives	Balance Sheet Location		June 30, 2010 Fair Value			December 31, 2009 Fair Value
Derivatives designated as hedges:
Foreign exchange contracts	Other current liabilities	Level 2	$	—		$	—
Foreign exchange contracts	Other non-current liabilities	Level 2		(162	)		(51	)
Interest rate contracts	Other non-current liabilities	Level 2		(8	)		(13	)
Derivatives not designated as hedges:
Interest rate contracts	Other non-current liabilities	Level 2		(2	)		(2	)

Total Liability Derivatives			$	(172	)	$	(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.

Income Statement Recognition:

The following table indicates the amount and location in the income statement for the three and six months ended June 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 June 30, 2010:
Derivative Instruments in Cash Flow Hedging Relationships	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	)	$	1		Interest Expense	$	(5	)	$	(4	)
Foreign exchange contracts		(86	)		2		Interest Expense		5			2
Foreign exchange contracts		102			(114	)	Revenue		58			37
Commodity contracts		—			—		Revenue		—			—

Total	$	14		$	(111	)		$	58		$	35

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Six Months Ended June 30, 2010:
Derivative Instruments in Cash Flow Hedging Relationships	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	$	(1	)	$	127		Interest Expense	$	(9	)	$	(6	)
Foreign exchange contracts		(111	)		(1	)	Interest Expense		(50	)		(1	)
Foreign exchange contracts		153			(25	)	Revenue		82			104
Commodity contracts		—			—		Revenue		—			82

Total	$	41		$	101			$	23		$	179

As of June 30, 2010, $83 million of pre-tax gains related to cash flow hedges that are currently deferred in AOCI are expected to be reclassified to income over the 12 month period ended June 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 six months ended June 30, 2010 and 2009.

The following table indicates the amount and location in the income statement 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 six months ended June 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 June 30:
Interest rate contracts	Interest Expense	$	131	$	26	Fixed-Rate Debt and Capital Leases	Interest Expense	$	(131	)	$	(26	)
Six Months Ended June 30:
Interest rate contracts	Interest Expense	$	172	$	26	Fixed-Rate Debt and Capital Leases	Interest Expense	$	(172	)	$	(26	)

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 income statement related to fair value changes and settlements of these foreign currency forward contracts not designated as hedges (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
Three Months Ended June 30:
Foreign Exchange Contracts	Other Operating Expenses	$	7	$	(29	)

Six Months Ended June 30:
Foreign Exchange Contracts	Other Operating Expenses	$	25	$	(9	)

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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 June 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 have resulted from the rationalization of acquired companies, as well as restructuring activities associated with cost containment and operational efficiency programs.

Supply Chain & Freight—Germany

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 have 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.

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 unvested stock compensation. Throughout the remainder of 2010, we will incur additional costs related to relocation of employees and other restructuring activities, however we believe those costs will be more than offset by savings from the staffing reductions.

NOTE 15. INCOME TAXES

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 subsidiary’s 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.

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

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2004. 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 the fourth quarter 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 will 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 the third quarter of 2010. A limited number of U.S. state and local matters are the subject of ongoing audits, administrative appeals or litigation.

Item 2.

Management’s 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 disclosure 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.

Overview

Our U.S. Domestic Package, International Package, and Supply Chain & Freight segments were all impacted by the improving worldwide economic situation in the first half of 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 half of 2010 in comparison with the first half of 2009.

In addition to the improved volume and revenue trends, cost containment initiatives and better network efficiencies undertaken 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.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Our consolidated results are presented in the table below:


	Three Months Ended June 30,						Change		Six Months Ended June 30,						Change
	2010			2009			%		2010			2009			%
Revenue (in millions)	$	12,204		$	10,829		12.7	%	$	23,932		$	21,767		9.9	%
Operating Expenses (in millions)		10,802			9,934		8.7	%		21,488			20,154		6.6	%

Operating Profit (in millions)	$	1,402		$	895		56.6	%	$	2,444		$	1,613		51.5	%
Operating Margin		11.5	%		8.3	%				10.2	%		7.4	%
Average Daily Package Volume (in thousands)		14,802			14,284		3.6	%		14,863			14,410		3.1	%
Average Revenue Per Piece	$	10.47		$	9.78		7.1	%	$	10.35		$	9.86		5.0	%
Net Income (in millions)	$	845		$	445		89.9	%	$	1,378		$	846		62.9	%
Basic Earnings Per Share	$	0.85		$	0.45		88.9	%	$	1.39		$	0.85		63.5	%
Diluted Earnings Per Share	$	0.84		$	0.44		90.9	%	$	1.37		$	0.84		63.1	%

Items Affecting Comparability

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


	Three Months Ended June 30,					Six Months Ended June 30,
	2010		2009			2010			2009
Operating Expenses:
Aircraft impairment charge	$	—	$	—		$	—		$	181
Restructuring charge		—		—			98			—
Loss on sale of business		—		—			38			—
Interest Expense:
Currency remeasurement charge		—		77			—			77
Income Tax Expense:
Income Tax Expense (Benefit) from the Items Above		—		(29	)		(37	)		(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 began to reorganize 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).

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

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 Operations—Segment 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.

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 June 30,						Change		Six Months Ended June 30,						Change
	2010			2009			%		2010			2009			%
Revenue (in millions):
Next Day Air	$	1,463		$	1,315		11.3	%	$	2,845		$	2,696		5.5	%
Deferred		698			652		7.1	%		1,392			1,345		3.5	%
Ground		5,108			4,822		5.9	%		10,134			9,697		4.5	%

Total Revenue	$	7,269		$	6,789		7.1	%	$	14,371		$	13,738		4.6	%
Average Daily Package Volume (in thousands):
Next Day Air		1,180			1,180		0.0	%		1,163			1,185		(1.9	)%
Deferred		845			879		(3.9	)%		872			890		(2.0	)%
Ground		10,593			10,406		1.8	%		10,637			10,495		1.4	%

Total Avg. Daily Package Volume		12,618			12,465		1.2	%		12,672			12,570		0.8	%
Average Revenue Per Piece:
Next Day Air	$	19.37		$	17.41		11.3	%	$	19.26		$	17.91		7.5	%
Deferred		12.91			11.59		11.4	%		12.57			11.90		5.6	%
Ground		7.53			7.24		4.0	%		7.50			7.28		3.0	%
Total Avg. Revenue Per Piece	$	9.00		$	8.51		5.8	%	$	8.93		$	8.61		3.7	%
Operating Profit (in millions):
Operating Profit	$	748		$	476		57.1	%	$	1,310		$	860		52.3	%
Impact of Restructuring Charge		—			—					98			—
Impact of Aircraft Impairment Charge		—			—					—			181

Adjusted Operating Profit	$	748		$	476		57.1	%	$	1,408		$	1,041		35.3	%
Operating Margin		10.3	%		7.0	%				9.1	%		6.3	%
Adjusted Operating Margin		10.3	%		7.0	%				9.8	%		7.6	%
Operating Days in Period		64			64					127			127

Volume

In the second 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. Overall average daily package volume increased at the strongest rate since the fourth quarter of 2007. Among our air products, letter volume declined largely due to weakness in the financial and other service industries. However, our air package volume performed relatively better as inventory rebuilding in the manufacturing and retailing sectors impacted growth. 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.

Revenue Per Piece

Overall revenue per piece increased for our ground and air products in the second quarter of 2010 at the strongest rate since the third quarter of 2008, 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. 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.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S 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. Energy Department’s Gulf Coast spot price for a gallon of kerosene-type jet fuel, while the ground fuel surcharge is based on the U.S. Energy Department’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 June 30,				Change		Six Months Ended June 30,				Change
	2010		2009		% Point		2010		2009		% Point
Next Day Air / Deferred	8.5	%	0.3	%	8.2	%	7.8	%	2.0	%	5.8	%
Ground	5.5	%	2.5	%	3.0	%	5.3	%	3.0	%	2.3	%

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 2010 increase in the air and ground fuel surcharges 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 $261 million in second quarter of 2010 ($310 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 reductions in aircraft block hours, labor hours in our operations, and vehicle miles driven, resulting in cost savings. 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 quarter of 2009 reduced the air fuel surcharge rate to zero for much of the second 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.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

International Package Operations


	Three Months Ended June 30,						Change		Six Months Ended June 30,						Change
	2010			2009			%		2010			2009			%
Revenue (in millions):
Domestic	$	561		$	478		17.4	%	$	1,145		$	942		21.5	%
Export		2,085			1,677		24.3	%		4,017			3,363		19.4	%
Cargo		125			91		37.4	%		248			181		37.0	%

Total Revenue	$	2,771		$	2,246		23.4	%	$	5,410		$	4,486		20.6	%
Average Daily Package Volume (in thousands):
Domestic		1,337			1,079		23.9	%		1,350			1,088		24.1	%
Export		847			740		14.5	%		841			752		11.8	%

Total Avg. Daily Package Volume		2,184			1,819		20.1	%		2,191			1,840		19.1	%
Average Revenue Per Piece:
Domestic	$	6.56		$	6.92		(5.2	)%	$	6.68		$	6.82		(2.1	)%
Export		38.46			35.41		8.6	%		37.61			35.21		6.8	%
Total Avg. Revenue Per Piece	$	18.93		$	18.51		2.3	%	$	18.55		$	18.42		0.7	%
Average Revenue Per Piece (Currency-Adjusted)*
Domestic	$	6.56		$	6.84		(4.1	)%	$	6.68		$	7.09		(5.8	)%
Export		38.46			35.66		7.9	%		37.61			35.67		5.4	%
Total Avg. Revenue Per Piece	$	18.93		$	18.56		2.0	%	$	18.55		$	18.77		(1.2	)%
*2009 revenue adjusted to 2010 currency exchange rates.
Operating Profit (in millions)	$	521		$	293		77.8	%	$	948		$	587		61.5	%
Operating Margin		18.8	%		13.0	%				17.5	%		13.1	%
Operating Days in Period		64			64					127			127
Currency Translation Benefit / (Cost)— (in millions)*:
Revenue	$	7							$	83
Operating Profit	$	17							$	8

*	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 growth exceeded 40%. The Europe and U.S. export lanes also had strong volume growth for the quarter, exceeding 10% 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 export lane), leading to relatively stronger growth for our higher yielding products. Our premium product, Worldwide Express, had volume growth exceeding 20% for the quarter.

Non-U.S. domestic volume increased sharply for the quarter, largely due 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, domestic volume growth increased 13%, powered by strength in core European markets and Canada.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Revenue Per Piece

Export revenue per piece increased for the quarter, 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) grew at a relatively faster pace. The impact of currency, net of hedging, resulted in a slight benefit 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 2.0% 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 $120 million for the second quarter in 2010 ($185 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 quarter 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 4%, and aircraft block hours increased at a slower rate than the increase in volume. These factors led to an increase in the operating margin in 2010 compared with the corresponding period in 2009.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Supply Chain & Freight Operations


	Three Months Ended June 30,						Change		Six Months Ended June 30,						Change
	2010			2009			%		2010			2009			%
Revenue (in millions):
Forwarding and Logistics	$	1,498		$	1,183		26.6	%	$	2,889		$	2,380		21.4	%
Freight		555			507		9.5	%		1,047			961		8.9	%
Other		111			104		6.7	%		215			202		6.4	%

Total Revenue	$	2,164		$	1,794		20.6	%	$	4,151		$	3,543		17.2	%
Freight LTL Statistics:
Revenue (in millions)	$	502		$	471		6.6	%	$	949		$	895		6.0	%
Revenue Per Hundredweight	$	18.81		$	17.27		8.9	%	$	18.87		$	17.28		9.2	%
Shipments (in thousands)		2,503			2,611		(4.1	)%		4,800			4,954		(3.1	)%
Shipments Per Day (in thousands)		39.1			40.8		(4.1	)%		37.8			39.0		(3.1	)%
Gross Weight Hauled (in millions of lbs)		2,667			2,728		(2.2	)%		5,029			5,177		(2.9	)%
Weight Per Shipment (in lbs)		1,065			1,045		1.9	%		1,048			1,045		0.3	%
Operating Days in Period		64			64					127			127
Operating Profit (in millions):
Operating Profit	$	133		$	126		5.6	%	$	186		$	166		12.0	%
Impact of Loss on Sale Business		—			—					38			—

Adjusted Operating Profit	$	133		$	126		5.6	%	$	224		$	166		34.9	%
Operating Margin		6.1	%		7.0	%				4.5	%		4.7	%
Adjusted Operating Margin		6.1	%		7.0	%				5.4	%		4.7	%
Currency Translation Benefit / (Cost) – (in millions)*:
Revenue	$	72							$	148
Operating Profit		1								4

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

Revenue

Forwarding and logistics revenue increased in the second 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. International air freight and ocean freight experienced solid revenue growth, and were impacted by higher volumes, fuel surcharges, and other accessorial charges. Overall tonnage growth in our forwarding business exceeded 30% for the second 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 declined, though weight per shipment and LTL revenue per hundredweight increased, 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 a result of the higher fuel surcharge rates, as total fuel surcharge revenue increased $31 million for the quarter ($55 million year-to-date) primarily resulting from higher diesel fuel prices. Additionally, an increase in base prices took effect on January 4, 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.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S 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 contract to provide air transportation services to the U.S. Postal Service.

Operating Profit and Margin

Operating profit in the forwarding unit increased during second quarter of 2010, largely due to a strong increase in tonnage, but was partially offset by continued capacity constraints from outside carriers. During the latter half of 2009, capacity constraints led to rapidly escalating rates on air freight which could not be passed on to customers, resulting in a negative impact to our operating profit and margin. This situation has begun to improve during 2010, as capacity constraints have lessened slightly 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.

Operating profit for our UPS Freight unit improved during the second quarter of 2010 compared with the prior year largely due to better productivity, increases in base pricing, and the impact of fuel. Productivity metrics increased, including increases in pickup and delivery stops per hour and linehaul utilization. The comparison between 2010 and 2009 operating results was positively impacted by the price of fuel, as surcharge revenue increased at a faster pace than the increase in fuel expense.

All of the remaining businesses within this segment had an operating profit during the quarter and year-to-date periods. However, the quarter and year-to-date combined profit for these businesses were lower than the comparable periods of 2009, primarily due to the gain on sale of substantially all our international Mail Boxes Etc. operations during the second quarter of 2009.

Operating Expenses


	Three Months Ended June 30,				Change		Six Months Ended June 30,						Change
	2010		2009		%		2010			2009			%
Operating Expenses (in millions):
Compensation and Benefits	$	6,515	$	6,330	2.9	%	$	13,054		$	12,662		3.1	%
Impact of Restructuring Charge		—		—				(98	)		—

Adjusted Compensation and Benefits		6,515		6,330	2.9	%		12,956			12,662		2.3	%
Repairs and Maintenance		281		273	2.9	%		555			549		1.1	%
Depreciation and Amortization		449		426	5.4	%		900			856		5.1	%
Purchased Transportation		1,613		1,188	35.8	%		3,114			2,400		29.8	%
Fuel		717		539	33.0	%		1,395			1,035		34.8	%
Other Occupancy		216		225	(4.0	)%		478			497		(3.8	)%
Other Expenses		1,011		953	6.1	%		1,992			2,155		(7.6	)%
Impact of Aircraft Impairment Charge		—		—				—			(181	)
Impact of Loss on Sale of Business		—		—				(38	)		—

Adjusted Other Expenses		1,011		953	6.1	%		1,954			1,974		(1.0	)%

Total Operating Expenses	$	10,802	$	9,934	8.7	%	$	21,488		$	20,154		6.6	%
Adjusted Total Operating Expenses		10,802		9,934	8.7	%		21,352			19,973		6.9	%
Currency Translation (Benefit) Cost	$	61					$	219

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Compensation and Benefits

The increase in compensation and benefits expense during the second quarter and year-to-date periods of 2010 compared with 2009 were impacted by several items. A large component of these increases was related to benefits expense, which increased primarily due to higher employee health and welfare costs and pension expense, as well as relocation-related benefit costs for management employees. Employee health and welfare program costs were impacted by higher union contribution rates and lower employee turnover in the union workforce. Pension expense increases resulted primarily from higher union contribution rates for multi-employer pension plans. These increases were partially offset by a reduction in our workers compensation expense.

Overall payroll costs increased, largely due to higher accruals for management incentive compensation plans resulting from improved company financial results. These cost increases were partially offset by reductions in certain employee wage costs, as union labor hours declined, and management salary costs decreased as a result of a reduction in the total number of management employees through attrition combined with voluntary and involuntary workforce reductions.

Repairs and Maintenance

Repairs and maintenance expense increased during the second 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 second quarter and year-to-date periods of 2010, primarily as a result of higher depreciation expense on equipment and facilities, as certain Worldport assets added in the 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 2009, as well as corporate sponsorships entered into in 2010.

Purchased Transportation

The increase in purchased transportation in the second quarter and year-to-date periods of 2010 were driven by a combination of higher volume in our international package and forwarding businesses, currency fluctuations, and increased fuel surcharge rates charged to us by third-party carriers as a result of higher fuel prices.

Fuel

The increase in fuel expense in the second quarter and year-to-date periods of 2010 were impacted 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 decrease in other occupancy expense in the second quarter and year-to-date periods of 2010 were primarily due to decreased labor and overhead expenses, lower rent expense on leased facilities, and lower natural gas costs due to commodity price fluctuations.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Other Expenses

During the second quarter of 2010, the increase in other expenses was largely due to employee relocation costs related to the U.S. domestic package management structure reorganization begun earlier in the year. Additionally, other expenses in the second quarter of 2009 were reduced by a gain on the sale of substantially all of our international franchise operations for Mail Boxes Etc.

Year-to-date, there was a decrease in other expenses due to cost containment programs, including reductions in telecom costs, office supplies, and outside professional fees. We also incurred lower expense associated with customer claims for lost or damaged packages, and lower bad debt expense.

Investment Income and Interest Expense


	Three Months Ended June 30,						Change		Six Months Ended June 30,						Change
	2010			2009			%		2010			2009			%
Investment Income and Interest Expense (in millions):
Investment Income (Loss)	$	(18	)	$	(22	)	(18.2	)%	$	(22	)	$	(9	)	144.4	%
Interest Expense	$	(84	)	$	(181	)	(53.6	)%	$	(169	)	$	(263	)	(35.7	)%
Impact of Currency Remeasurement Charge		—			77					—			77

Adjusted Interest Expense	$	(84	)	$	(104	)	(19.2	)%	$	(169	)	$	(186	)	(9.1	)%

Investment Income

The decrease in investment losses for the second quarter in 2010 was largely due to lower losses related to fair value adjustments on our holdings of certain investment partnerships. Additionally, we realized higher gains on the sale of investments compared to the second quarter of 2009.

On a year-to-date basis, the increase in investment losses 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 second quarter and year-to-date periods was largely due to a lower average debt balance, as well as lower effective interest rates on our variable rate debt and interest rate swaps. This was partially offset by lower capitalized interest, due to the recent completion of several large construction projects, including our Worldport expansion.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Income Tax Expense


	Three Months Ended June 30,						Change		Six Months Ended June 30,						Change
	2010			2009			%		2010			2009			%
Income Tax Expense	$	455		$	247		84.2	%	$	875		$	495		76.8	%
Impact of Change in Tax Filing Status for German Subsidiary		—			—					(76	)		—
Impact of Sale of Business		—			—					3			—
Impact of Restructuring Charge		—			—					34			—
Impact of Aircraft Impairment Charge		—			—					—			65
Impact Currency Remeasurement Charge		—			29					—			29

Adjusted Income Tax Expense	$	455		$	276		64.9	%	$	836		$	589		41.9	%
Effective Tax Rate		35.0	%		35.7	%				38.8	%		36.9	%
Adjusted Effective Tax Rate		35.0	%		35.9	%				35.0	%		36.8	%

Income tax expense increased primarily due to higher pre-tax income. Our effective tax rate decreased in the second quarter of 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 effective tax rates are generally lower.

On a year-to-date basis, the increase in our effective tax rate in 2010 compared with 2009 was primarily due to the change in the tax filing status of a German subsidiary, and because 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. Our first quarter 2009 income tax provision 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 (amounts in millions):


	Six months ended June 30,
	2010			2009
Net income	$	1,378		$	846
Non-cash operating activities(a)		1,795			1,579
Pension and postretirement plan contributions (UPS-sponsored plans)		(812	)		(180	)
Changes in working capital and other noncurrent assets and liabilities		646			838
Other operating activities		5			72

Net cash from operating activities	$	3,012		$	3,155

(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.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

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 $428 million to our company-sponsored pension and postretirement medical benefit plans over the remainder 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.

Net Cash Used In Investing Activities

Our primary sources (uses) of cash for investing activities were as follows (amounts in millions):


	Six months ended June 30,
	2010			2009
Net cash used in investing activities	$	(608	)	$	(415	)

Capital Expenditures:
Buildings and facilities	$	(152	)	$	(337	)
Aircraft and parts		(252	)		(136	)
Vehicles		(125	)		(90	)
Information technology		(135	)		(108	)

	$	(664	)	$	(671	)

Capital Expenditures as a % of Revenue		2.8	%		3.1	%

Other Investing Activities:
Net (increase) decrease in finance receivables	$	46		$	155
Net (purchases) sales of marketable securities	$	(126	)	$	2
Other sources (uses) of cash from investing activities	$	136		$	99

We have commitments for the purchase of aircraft, vehicles, equipment and real estate to provide for the replacement of existing capacity and anticipated future growth. We generally fund our capital expenditures with our cash from operations. In 2010, capital spending on buildings and facilities declined, as a result of the completion of the most recent expansion of our Worldport facility in Louisville, KY and our intra-Asia hub in Shenzhen, China. Future capital spending for anticipated growth and replacement assets will depend on a variety of factors, including economic and industry conditions.

The net change in finance receivables is primarily due to customer paydowns and new loan origination activity, primarily in our commercial lending, asset-based lending and leasing portfolios. The purchases and sales of marketable securities are largely determined by liquidity needs, and will therefore fluctuate from period to period. Other investing activities include the cash settlement of derivative contracts used in our energy and currency hedging programs, the timing of aircraft purchase contract deposits on our Boeing 767-300 and Boeing 747-400 aircraft orders, and changes in restricted cash balances.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Net Cash Used In Financing Activities

Our primary uses of cash flows for financing activities are to repurchase shares, pay cash dividends, and repay debt principal, as follows (amounts in millions, except per share data):


	Six months ended June 30,
	2010			2009
Net cash provided by (used in) financing activities	$	(646	)	$	(435	)

Share Repurchases:
Cash expended for shares repurchased	$	(443	)	$	(247	)
Number of shares repurchased		(6.9	)		(5.1	)
Shares outstanding at period end		991			995
Percent reduction in shares outstanding		(0.3	)%		(0.1	)%

Dividends:
Dividends declared per share	$	0.94		$	0.90
Cash expended for dividend payments	$	(911	)	$	(876	)

Borrowings:
Net borrowings (repayments) of debt principal	$	661		$	903

Other Financing Activities:
Cash received for common stock issuances	$	106		$	68
Other sources (uses) of cash from financing activities	$	(59	)	$	(283	)

Capitalization (as of June 30 each year):
Total debt outstanding at period end	$	10,251		$	10,883
Total shareowners’ equity at period end		7,930			6,793

Total capitalization	$	18,181		$	17,676
Debt to Total Capitalization %		56.4	%		61.6	%

As a result of the uncertain economic environment, we have slowed our share repurchase activity during the 2009 and 2010 periods. We currently intend to repurchase shares in 2010 at a rate that will at least offset the dilution from our stock compensation programs. As of June 30, 2010, we had $5.576 billion of our existing share repurchase authorization remaining.

The declaration of dividends is subject to the discretion of the Board of Directors and will depend on various factors, including our net income, financial condition, cash requirements, future prospects, and other relevant factors. We maintained our quarterly cash dividend payment at $0.47 per share in the second quarter of 2010, compared with the previous $0.45 quarterly dividend rate in 2009. We expect to continue the practice of paying regular cash dividends.

Issuances of debt in 2010 consisted primarily of commercial paper, while in 2009 issuances consisted primarily of commercial paper and an offering of fixed rate senior notes (discussed further below). Repayments of debt consisted primarily of paydowns of commercial paper, scheduled principal payments on our capitalized lease obligations and early redemptions of our retail UPS Notes program. We consider the overall fixed and floating interest rate mix of our portfolio and the related overall cost of borrowing when planning for future issuances and non-scheduled repayments of debt.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

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. 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.

The cash outflows in other financing activities primarily relate to hedging activities. In conjunction with the senior fixed rate debt offering in the first quarter of 2009, we settled several interest rate derivatives that were designated as hedges of these debt offerings, which resulted in a cash outflow of $243 million.

Sources of Credit

We are authorized to borrow up to $10.0 billion under our U.S. commercial paper program. We had $1.528 billion outstanding under this program as of June 30, 2010, with an average interest rate of 0.14%. All of this commercial paper was classified as a current liability as of June 30, 2010. 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 no amounts were outstanding under this program as of June 30, 2010.

Our Moody’s and Standard & Poor’s short-term credit ratings are P-1 and A-1+, respectively. Our Moody’s and Standard & Poor’s long-term credit ratings are Aa3 and AA-, respectively. We have a stable outlook from Moody’s, and a negative outlook from Standard & Poor’s.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Except as described in this quarterly report, the nature and amounts of our payment obligations under our debt, capital and operating lease agreements, purchase commitments, and other liabilities as of June 30, 2010 have not materially changed from those at December 31, 2009, as described in our Annual Report on Form 10-K for the year ended December 31, 2009.

We believe that funds from operations and borrowing programs will provide adequate sources of liquidity and capital resources to meet our expected long-term needs for the operation of our business, including anticipated capital expenditures, such as commitments for aircraft purchases, for the foreseeable future.

Guarantees and Other Off-Balance Sheet Arrangements

We do not have guarantees or other off-balance sheet financing arrangements, including variable interest entities, which we believe could have a material impact on our financial condition or liquidity.

Contingencies

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Other Matters

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

We also received and responded to related information requests from competition authorities in other jurisdictions.

Health Care Legislation

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 was not material to our financial results. We are evaluating the long-term impacts of this legislation to 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 rule setting guidance will be occurring. Our initial 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.

Recent Accounting Pronouncements

Adoption of New Accounting Standards

There were no accounting standards adopted during the six months ended June 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 June 30, 2010 are not expected to have a significant effect on our consolidated financial position or results of operations.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk from changes in foreign currency exchange rates, interest rates, equity prices, and certain commodity prices. This market risk arises in the normal course of business, as we do not engage in speculative trading activities. In order to manage the risk arising from these exposures, we utilize a variety of foreign exchange, interest rate, equity and commodity forward contracts, options, and swaps.

The total fair value asset (liability) of our derivative financial instruments is summarized in the following table (in millions):


	June 30, 2010			December 31, 2009
	June 30, 2010			December 31, 2009
Energy Derivatives	$	—		$	—
Currency Derivatives		(25	)		12
Interest Rate Derivatives		201			59

	$	176		$	71

Our market risks, hedging strategies, and financial instrument positions at June 30, 2010 have not materially changed from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009. The fair value changes between December 31, 2009 and June 30, 2010 in the table above are primarily due to interest rate and foreign currency exchange rate changes between those dates, as well as normal settlements of derivative positions.

The forward contracts, swaps, and options previously discussed 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. We do not expect to incur any losses as a result of counterparty default.

The information concerning market risk under the caption “Quantitative and Qualitative Disclosures about Market Risk” on pages 49-50 of our consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2009, is hereby incorporated by reference in this Quarterly Report on Form 10-Q.

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures:

As of the end of the period covered by this report, management, including our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (“Exchange Act”)). Based upon that evaluation, our chief executive officer and chief financial officer concluded that the disclosure controls and procedures were effective to ensure that information required to be disclosed in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management to allow their timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting:

There were no changes in the Company’s internal controls over financial reporting during the quarter ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

For a discussion of legal proceedings affecting us and our subsidiaries, please see the information under the sub-caption “Contingencies” of the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this report.

Item 1A.

Risk Factors

There have been no material changes to the risk factors described in Part 1, Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2009.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

(c) A summary of our repurchases of our Class A and Class B common stock during the second quarter of 2010 is as follows (in millions, except per share amounts):


	Total Number of Shares Purchased(1)	Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Program	Approximate Dollar Value of Shares that May Yet be Purchased Under the Program
April 1 – April 30, 2010	1.2	$	77.37	1.1	$	5,663
May 1 – May 31, 2010	1.4		64.93	1.1		5,591
June 1 – June 30, 2010	0.2		62.28	0.2		5,576

Total April 1 – June 30, 2010	2.8	$	70.04	2.4

(1)	Includes shares repurchased through our publicly announced share repurchase program and shares tendered to pay the exercise price and tax withholding on employee stock options.

In January 2008, the Board of Directors authorized an increase in our share repurchase authorization to $10.0 billion. Share repurchases may take the form of accelerated share repurchases, open market purchases, or other such methods as we deem appropriate. The timing of our share repurchases will depend upon market conditions. Unless terminated earlier by the resolution of our Board, the program will expire when we have purchased all shares authorized for repurchase under the program.

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. The average price paid per share for the month of April in the table above was higher than the market price of UPS class B shares during that period, due to the net share settlement that occurred under the accelerated share repurchase program. Over the entire term of the accelerated share repurchase program, the average price paid per share repurchased was $62.89, which was below the volume-weighted average price for our class B shares traded on the New York Stock Exchange during the period.

Item 3.

Defaults Upon Senior Securities

None.

Item 5.

Other Information

None.

Item 6.

Exhibits

These exhibits are either incorporated by reference into this report or filed with this report as indicated below.

Index to Exhibits:



3.1	—	Restated Certificate of Incorporation of United Parcel Service, Inc. dated May 6, 2010 (incorporated by reference to Exhibit 3.3 to Form 8-K, filed on May 12, 2010).

3.2	—	Amended and Restated Bylaws of United Parcel Service, Inc. dated May 6, 2010 (incorporated by reference to Exhibit 3.2 to Form 8-K, filed on May 12, 2010).

10.1	—	Credit Agreement (364-Day Facility) dated April 15, 2010 among United Parcel Service, Inc., the initial lenders named therein, Citigroup Global Markets Inc. and J.P. Morgan Securities Inc. as joint lead arrangers and joint bookrunners, Barclays Capital and BNP Paribas Securities Corp. as co-lead arrangers, J.P. Morgan Securities, Inc. as syndication agent, Barclays Capital and BNP Paribas as co-documentation agents, and Citibank, N.A. as administrative agent (incorporated by reference to Exhibit 10.1 on Form 10-Q for the quarter ended March 31, 2010).

10.2	—	Form of Non-Management Director Restricted Stock Award Agreement (incorporated by reference to Exhibit 10.2 on Form 10-Q for the quarter ended March 31, 2010).

10.3	—	Form of Restricted Stock Unit Award Agreement for the 2010 Long-Term Incentive Performance (LTIP) Awards (incorporated by reference to Exhibit 10.1 to Form 8-K, filed on March 3, 2010).

11	—	Statement regarding Computation of per Share Earnings (incorporated by reference to Note 12 to “Item 1. Financial Statements” of this quarterly report on Form 10-Q).

†12	—	Computation of Ratio of Earnings to Fixed Charges.

†31.1	—	Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

†31.2	—	Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

†32.1	—	Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

†32.2	—	Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

††101	—	The following financial information from the Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Cash Flows, and (v) the Notes to the Consolidated Financial Statements.

†	Filed herewith.

††	Furnished electronically herewith

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	UNITED PARCEL SERVICE, INC. (Registrant)

Date: August 9, 2010	By:	/s/ KURT P. KUEHN
		Kurt P. Kuehn
		*Senior Vice President and*
		*Chief Financial Officer*
		*(Duly Authorized Officer and* *Principal Accounting Officer)*