How much of UPS's 1999 earnings decline was caused by the one-time tax charge, and what did underlying earnings look like?

The tax assessment charge reduced 1999 net income by $1.442 billion after tax, cutting diluted EPS from a potential $2.04 to a reported $0.77. Excluding the charge, net income would have been $2.325 billion, up about 34% from $1.741 billion in 1998, and the underlying operating profit rose 29.1%. Investors should note that the charge is non-operating and reflects a dispute over income of a Bermuda reinsurer, not UPS's own business income.

What is the potential future exposure from the Overseas Partners tax dispute?

The Tax Court ruled against UPS for the 1983-1984 tax years, and the IRS has asserted similar positions for 1985-1990. Management estimates total after-tax exposure for 1984-1999 could be as high as $2.353 billion. UPS has reserved $1.672 billion for the matter, has deposited $1.349 billion plus $339 million with the IRS to stop interest accrual, and believes penalties are not probable. Additional penalties and penalty interest of up to $681 million could be recorded if they are ultimately assessed. UPS also said it intends to appeal to the Eleventh Circuit and that the arrangement for excess value insurance was revised effective October 1, 1999 to address the issues for later periods.

What did the IPO mean for UPS's capital structure and shareholders?

The IPO sold 109.4 million Class B shares on the NYSE (ticker UPS) starting November 10, 1999, raising $5.27 billion net. Class A shares carry ten votes each while Class B shares carry one, so Class A holders, mostly employees, retirees and founders' families, retain about 99% of voting power despite owning roughly 90% of shares. The company also used most of the proceeds for a February 2000 tender offer that repurchased 68.3 million Class A-1 shares at $60, a cash outlay of about $4.1 billion. Class B shares have the same economic rights as Class A, so their market price is expected to determine the value of the Class A shares. Dividends were also increased, and UPS announced a shift to quarterly payments in 2000.

What are the main operating trends and growth drivers investors should watch?

Growth came from Next Day Air volume (up 10.8%), Deferred volume (up 8.8%), and rising revenue per piece in U.S. domestic package (up 3.2%). International export volume rose 18.4%, particularly in Asia Pacific and Europe, and the company is pursuing the Challenge Air Cargo acquisition to become the largest air cargo carrier in Latin America. Non-package revenue, driven by UPS Logistics Group and the new excess value insurance arrangement, rose 36.5%. Management plans capital expenditures of about $2.1 billion in 2000 and $2.3 billion in 2001, and it expects its 'Hub 2000' Louisville facility to add over 40% hub capacity. Labor costs remain a risk because of Teamsters contract obligations and a proposed OSHA ergonomics rule that management says could be material.

What legal and regulatory risks could affect UPS beyond the tax matter?

UPS faces nine pending lawsuits, filed after the August 1999 Tax Court decision, that allege it acted as an insurer without complying with state insurance laws and that its excess value coverage prices were excessive. Discovery has not begun and no class has been certified, and management says the claims lack merit. An arbitrator ruled against UPS in February 2000 on a Teamsters grievance, requiring creation of 2,000 full-time jobs per contract year; management says the financial impact should not be material. A proposed OSHA ergonomics standard could require significant warehouse changes and added staffing, and management has said compliance costs could be material. Separately, the IRS has proposed about $82 million in additional tax on unrelated issues, with up to $270 million of interest possible, though management expects to prevail on substantially all of them.

UPS 10-K FY1999 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 30, 2000. Cited figures are marked; the original filing is the authoritative source.

United Parcel Service's first annual report as a public company covers fiscal 1999, a year defined by its November 1999 IPO and a large one-time tax charge.

Revenue rose 9.1% to $27.05 billion^a, driven by U.S. domestic package revenue (+8.1%) and strong export growth (+18.4% average daily export volume). Operating profit grew 29.1% to $3.99 billion, lifting the operating margin to 14.7% from 12.5%, as operating expense growth (6.3%) lagged revenue growth. Compensation and benefits remained the largest cost driver at $15.3 billion.

Reported net income fell 49% to $883 million^b, or $0.77 diluted EPS, because of a $1.786 billion pre-tax tax assessment charge ($1.442 billion after-tax) tied to the Tax Court ruling on Overseas Partners Ltd. Excluding that charge, net income would have been $2.325 billion, or $2.04 diluted EPS, a 30% increase over 1998's $1.57. Management estimates total after-tax exposure for tax years 1984 through 1999 could reach $2.353 billion, with up to $681 million in additional penalties if they are ultimately assessed, and UPS intends to appeal to the Eleventh Circuit. The balance sheet was transformed by the IPO, which raised $5.27 billion net.

Cash, equivalents and marketable securities totaled $6.3 billion^c at year-end, and shareowners' equity rose to $12.5 billion from $7.2 billion. About $4.1 billion of IPO proceeds were then used for a February 2000 tender offer to repurchase 68.3 million Class A-1 shares at $60 each.

Long-term debt was $1.9 billion^d, and UPS holds triple-A ratings from S&P and Moody's. Key risks include the tax dispute, pending excess value coverage lawsuits, a Teamsters arbitration requiring 2,000 new full-time jobs per contract year, and a proposed OSHA ergonomics standard that management says could be material.

02—Key points

Key Highlights

Revenue grew 9.1% to $27.05 billion, with U.S. domestic package revenue up 8.1% to $22.31 billion and average daily package volume up 4.6% to 12.9 million pieces.
Operating profit rose 29.1% to $3.99 billion, and the operating margin expanded to 14.7% from 12.5%, driven by operating expense growth of only 6.3%.
Reported net income declined 49% to $883 million ($0.77 diluted EPS) due to a $1.442 billion after-tax charge for the Overseas Partners tax assessment; excluding it, EPS would have been $2.04, up 30%.
Total after-tax exposure on the tax dispute for 1984-1999 could reach $2.353 billion, with up to $681 million of additional penalties and interest if assessed; UPS plans to appeal.
The November 1999 IPO of 109.4 million Class B shares raised $5.27 billion net; $4.1 billion was then used for a February 2000 tender offer at $60 per share for 68.3 million Class A-1 shares.
Cash and marketable securities of $6.3 billion and shareowners' equity of $12.5 billion, with long-term debt reduced to $1.9 billion and triple-A credit ratings from S&P and Moody's.
Export package volume grew 18.4% and international package operating profit rose to $252 million from $56 million, while non-package revenue grew 36.5% to $1.0 billion, supported by the UPS Logistics Group.

03—Questions

Frequently Asked Questions

How much of UPS's 1999 earnings decline was caused by the one-time tax charge, and what did underlying earnings look like?
The tax assessment charge reduced 1999 net income by $1.442 billion after tax, cutting diluted EPS from a potential $2.04 to a reported $0.77. Excluding the charge, net income would have been $2.325 billion, up about 34% from $1.741 billion in 1998, and the underlying operating profit rose 29.1%. Investors should note that the charge is non-operating and reflects a dispute over income of a Bermuda reinsurer, not UPS's own business income.
What is the potential future exposure from the Overseas Partners tax dispute?
The Tax Court ruled against UPS for the 1983-1984 tax years, and the IRS has asserted similar positions for 1985-1990. Management estimates total after-tax exposure for 1984-1999 could be as high as $2.353 billion. UPS has reserved $1.672 billion for the matter, has deposited $1.349 billion plus $339 million with the IRS to stop interest accrual, and believes penalties are not probable. Additional penalties and penalty interest of up to $681 million could be recorded if they are ultimately assessed. UPS also said it intends to appeal to the Eleventh Circuit and that the arrangement for excess value insurance was revised effective October 1, 1999 to address the issues for later periods.
What did the IPO mean for UPS's capital structure and shareholders?
The IPO sold 109.4 million Class B shares on the NYSE (ticker UPS) starting November 10, 1999, raising $5.27 billion net. Class A shares carry ten votes each while Class B shares carry one, so Class A holders, mostly employees, retirees and founders' families, retain about 99% of voting power despite owning roughly 90% of shares. The company also used most of the proceeds for a February 2000 tender offer that repurchased 68.3 million Class A-1 shares at $60, a cash outlay of about $4.1 billion. Class B shares have the same economic rights as Class A, so their market price is expected to determine the value of the Class A shares. Dividends were also increased, and UPS announced a shift to quarterly payments in 2000.
What are the main operating trends and growth drivers investors should watch?
Growth came from Next Day Air volume (up 10.8%), Deferred volume (up 8.8%), and rising revenue per piece in U.S. domestic package (up 3.2%). International export volume rose 18.4%, particularly in Asia Pacific and Europe, and the company is pursuing the Challenge Air Cargo acquisition to become the largest air cargo carrier in Latin America. Non-package revenue, driven by UPS Logistics Group and the new excess value insurance arrangement, rose 36.5%. Management plans capital expenditures of about $2.1 billion in 2000 and $2.3 billion in 2001, and it expects its 'Hub 2000' Louisville facility to add over 40% hub capacity. Labor costs remain a risk because of Teamsters contract obligations and a proposed OSHA ergonomics rule that management says could be material.
What legal and regulatory risks could affect UPS beyond the tax matter?
UPS faces nine pending lawsuits, filed after the August 1999 Tax Court decision, that allege it acted as an insurer without complying with state insurance laws and that its excess value coverage prices were excessive. Discovery has not begun and no class has been certified, and management says the claims lack merit. An arbitrator ruled against UPS in February 2000 on a Teamsters grievance, requiring creation of 2,000 full-time jobs per contract year; management says the financial impact should not be material. A proposed OSHA ergonomics standard could require significant warehouse changes and added staffing, and management has said compliance costs could be material. Separately, the IRS has proposed about $82 million in additional tax on unrelated issues, with up to $270 million of interest possible, though management expects to prevail on substantially all of them.

04—Continue

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