Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We produced solid growth and operating results in 2017 across all operating segments. In 2017, consolidated revenue increased 8.2% to $65.872 billion, up from $60.906 billion in 2016. Revenue for 2017 increased in all segments and major product categories, due to shipment growth, yield expansion and benefits recognized from our network investments and portfolio initiatives. While operating profits were positively impacted by these growth factors discussed above, they were partially offset by impacts from natural disasters, capacity constraints due to volume surges in the fourth quarter of 2017, operating costs associated with facility construction and the deployment of Saturday operations in our U.S. Domestic Package segment.

Operating profit for 2017 was up 37.7% to $7.529 billion, driven by strong performance in all segments and a $1.851 billion reduction in the pension mark-to-market charges.

Average daily package volume increased 4.9% in 2017. We reported 2017 net income of $4.910 billion and diluted earnings per share of $5.61, compared to 2016 net income of $3.431 billion and diluted earnings per share of $3.87.

Our consolidated results are presented in the table below:

	Year Ended December 31,												% Change
	2017				2016				2015				2017/ 2016			2016/ 2015
Revenue (in millions)	$	65,872			$	60,906			$	58,363			8.2	%		4.4	%
Operating Expenses (in millions)	58,343				55,439				50,695				5.2	%		9.4	%
Operating Profit (in millions)	$	7,529			$	5,467			$	7,668			37.7	%		(28.7	)%
Operating Margin	11.4		%		9.0		%		13.1		%
Average Daily Package Volume (in thousands)	20,030				19,090				18,324				4.9	%		4.2	%
Average Revenue Per Piece	$	10.53			$	10.30			$	10.37			2.2	%		(0.7	)%
Net Income (in millions)	$	4,910			$	3,431			$	4,844			43.1	%		(29.2	)%
Basic Earnings Per Share	$	5.64			$	3.89			$	5.38			45.0	%		(27.7	)%
Diluted Earnings Per Share	$	5.61			$	3.87			$	5.35			45.0	%		(27.7	)%

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Items Affecting Comparability

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 "adjusted" compensation and benefits, operating expenses, operating profit, operating margin, income tax expense and effective tax rate. These adjustments reflect the non-comparable items discussed below. 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 recurring results of operations because they exclude items that may not be indicative of, or are unrelated to, our underlying results of operations and provide a useful baseline for analyzing trends in our underlying businesses. Additionally, these adjusted financial measures are used internally by management for the determination of incentive compensation awards, business unit operating performance analysis and business unit resource allocation.

Non-GAAP financial measures should be considered in addition to, and not as an alternative for, our reported results prepared in accordance with GAAP. Our non-GAAP financial information does not represent a comprehensive basis of accounting. Therefore, our non-GAAP financial information may not be comparable to similarly titled measures reported by other companies.

We supplement the reporting of our revenue, revenue per piece and operating profit with similar non-GAAP measures that exclude the period-over-period impact of foreign currency exchange rate changes and hedging activities. We believe currency-neutral revenue, revenue per piece and operating profit information allows users of our financial statements to understand growth trends in our products and results. We evaluate the performance of our International Package and Supply Chain & Freight businesses on a currency-neutral basis.

Currency-neutral revenue, revenue per piece and operating profit are calculated by dividing current period reported U.S. dollar revenue, revenue per piece and operating profit by the current period average exchange rates to derive current period local currency revenue, revenue per piece and operating profit. The derived current period local currency revenue, revenue per piece and operating profit are then multiplied by the average foreign exchange rates used to translate the comparable results for each month in the prior year period (including the period over period impact of foreign currency revenue hedging activities). The difference between the current period reported U.S. dollar revenue, revenue per piece and operating profit and the derived current period U.S. dollar revenue, revenue per piece and operating profit is the period over period impact of currency fluctuations.

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

	Year Ended December 31,
Non-GAAP Adjustments	2017				2016				2015
Operating Expenses:
Defined Benefit Plans Mark-to-Market Charges	$	800			$	2,651			$	118
Total Adjustments to Operating Expenses	800				2,651				118
Income Tax Benefit from the Mark-to-Market Charges	(193		)		(978		)		(39		)
Income Tax Benefit from the Tax Cuts and Jobs Act and Other Non-U.S. Tax Law Changes	(258		)		—				—
Total Adjustments to Net Income	$	349			$	1,673			$	79

These items have been excluded from comparisons of "adjusted" compensation and benefits, operating expenses, operating profit, operating margin, income tax expense and effective tax rate in the discussion that follows. The income tax effects of the mark-to-market charges are calculated by multiplying the statutory tax rates applicable in each tax jurisdiction, including the U.S. federal jurisdiction and various U.S. state and non-U.S. jurisdictions, by the adjustments. The blended average of the applicable statutory tax rates in 2017, 2016 and 2015 were 24.1%, 36.9% and 33.1%, respectively.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Defined Benefit Plans Mark-to-Market Charges

We recognize changes in the fair value of plan assets and net actuarial gains and losses in excess of a 10% corridor for our pension and postretirement defined benefit plans immediately as part of net periodic benefit cost. We supplement the presentation of our operating profit and operating margin with "adjusted" measures that exclude the impact of the portion of net periodic benefit cost represented by the gains and losses recognized in excess of the 10% corridor and the related income tax effects.

The adjustments made to exclude these mark-to-market adjustments utilize the expected return on plan assets ($2.956, $2.580 and $2.567 billion for 2017, 2016 and 2015, respectively) and the discount rates used for determining net periodic benefit cost. The non-adjusted net periodic benefit cost reflects the actual return on plan assets ($4.811 billion, $1.846 billion and $110 million for 2017, 2016 and 2015, respectively) and the discount rates used for measuring the projected benefit obligation as summarized in the table below. We believe excluding these mark-to-market charges from our adjusted results provides important supplemental information that reflects the anticipated long-term cost of our defined benefit plans and provides a benchmark for historical defined benefit cost trends that may provide a useful comparison of year-to-year financial performance without considering the short-term impact of changes in market interest rates, equity prices and similar factors.

In 2017, we recognized pre-tax mark-to-market losses in compensation and benefits expense of $800 million on our pension and postretirement defined benefit plans related to the remeasurement of plan assets and liabilities recognized outside of a 10% corridor. These charges impacted our U.S. Domestic Package segment ($637 million), International Package segment ($35 million) and Supply Chain & Freight segment ($128 million).

In 2016, we recognized pre-tax mark-to-market losses in compensation and benefits expense of $2.651 billion on our pension and postretirement defined benefit plans related to the remeasurement of plan assets and liabilities recognized outside of a 10% corridor. These charges impacted our U.S. Domestic Package segment ($1.908 billion), International Package segment ($425 million) and Supply Chain & Freight segment ($318 million).

In 2015, we recognized pre-tax mark-to-market losses in compensation and benefits expense of $118 million on our pension and postretirement defined benefit plans related to the remeasurement of plan assets and liabilities recognized outside of a 10% corridor. These charges impacted our U.S. Domestic Package segment ($62 million), International Package segment ($44 million) and Supply Chain & Freight segment ($12 million).

The table below indicates the amounts associated with each component of the pre-tax mark-to-market losses, as well as the weighted-average actuarial assumptions used to determine our net periodic benefit costs, for each year:

		Year Ended December 31,
Components of mark-to-market gain (loss) (in millions):		2017				2016				2015
Discount rates		$	(2,288	)		$	(1,953	)		$	1,624
Return on assets		1,525				(732		)		(1,550		)
Demographic and assumption changes		(37		)		34				(133		)
Reclassification of prior year unrecognized benefit cost		—				—				(59		)
Total mark-to-market gain (loss)		$	(800	)		$	(2,651	)		$	(118	)
		Year Ended December 31,
Weighted-average actuarial assumptions used to determine net periodic benefit cost:		2017				2016				2015
Expected rate of return on plan assets		8.65		%		8.65		%		8.66		%
Actual rate of return on plan assets		14.25		%		6.06		%		0.37		%
Discount rate used for net periodic benefit cost		4.34		%		4.81		%		4.36		%
Discount rate at measurement date		3.81		%		4.34		%		4.81		%

The $800 million, $2.651 billion and $118 million pre-tax mark-to-market losses for the years ended December 31, 2017, 2016 and 2015, respectively, were comprised of the following components:

2017 - $800 million pre-tax mark-to-market loss:

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

•	Discount Rates ($2.288 billion pre-tax loss): The weighted-average discount rate for our pension and postretirement medical plans decreased from 4.34% at December 31, 2016 to 3.81% at December 31, 2017, primarily due to both a decline in U.S. treasury yields and a decrease in credit spreads on AA-rated corporate bonds in 2017.

•	Return on Assets ($1.525 billion pre-tax gain): In 2017, the actual 14.25% rate of return on plan assets exceeded our expected rate of return of 8.65%, primarily due to strong global equity and U.S. bond markets.

•	Demographic and Assumption Changes ($37 million pre-tax loss): This represents the difference between actual and estimated participant data and demographic factors, including items such as healthcare cost trends, compensation rate increases and rates of termination, retirement and mortality.

2016 - $2.651 billion pre-tax mark-to-market loss:

•	Discount Rates ($1.953 billion pre-tax loss): The weighted-average discount rate for our pension and postretirement medical plans decreased from 4.81% at December 31, 2015 to 4.34% at December 31, 2016, primarily due to a decrease in credit spreads on AA-rated corporate bonds in 2016.

•	Return on Assets ($732 million pre-tax loss): In 2016, the actual 6.06% rate of return on plan assets fell short of our expected rate of return of 8.65%, primarily due to weak bond markets.

•	Demographic and Assumption Changes ($34 million pre-tax gain): This represents the difference between actual and estimated participant data and demographic factors, including items such as healthcare cost trends, compensation rate increases and rates of termination, retirement and mortality.

2015 - $118 million pre-tax mark-to-market loss:

•	Discount Rates ($1.624 billion pre-tax gain): The weighted-average discount rate for our pension and postretirement medical plans increased from 4.36% at December 31, 2014 to 4.81% at December 31, 2015, primarily due to an increase in U.S. treasury yields and credit spreads on AA-rated corporate bonds in 2015.

•	Return on Assets ($1.550 billion pre-tax loss): In 2015, the actual 0.37% rate of return on plan assets fell short of our expected rate of return of 8.66%, primarily due to weak global equity markets.

•	Demographic and Assumption Changes ($133 million pre-tax loss): This represents the difference between actual and estimated participant data and demographic factors, including items such as healthcare cost trends, compensation rate increases and rates of termination, retirement and mortality.

•

Reclassification of Prior Year Unrecognized Benefit Cost ($59 million pre-tax loss): Our mark-to-market accounting policy requires recognition of gains and losses in excess of a corridor equal to 10% of the plans' projected benefit obligations (or fair value of the plans' assets, if greater). The decrease in certain plans' projected benefit obligations resulted in a lower corridor, which required recognition of prior year unrecognized benefit costs for some of our plans.

Income Tax Benefit from the Tax Cuts and Jobs Act

We supplement the presentation of our income tax expense and effective tax rate with "adjusted" measures that exclude the impact of the income tax benefit from the Tax Cuts and Jobs Act (the "Tax Act") described in the "Income Tax Expense" section of Management's Discussion and Analysis and note 13 to the audited consolidated financial statements. We believe income tax expense and the effective tax rate excluding the tax benefit is useful in evaluating our ongoing operating performance for the current period to that of other periods presented. The estimates are based on our initial analysis and interpretations of the Tax Act.

Expense Allocations

Certain operating expenses are allocated between our reporting segments using activity-based costing methods. These activity-based costing methods require us to make estimates that impact the amount of each expense category that is attributed to each segment. Changes in these estimates will directly impact the amount of expense allocated to each segment, and therefore the operating profit of each reporting segment. Our allocation methodologies are refined periodically, as necessary, to reflect changes in our businesses. There were no significant changes in our expense allocation methodologies during 2017, 2016 or 2015.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

U.S. Domestic Package Operations

	Year Ended December 31,												% Change
	2017				2016				2015				2017/ 2016			2016/ 2015
Average Daily Package Volume (in thousands):
Next Day Air	1,460				1,379				1,316				5.9	%		4.8	%
Deferred	1,400				1,351				1,313				3.6	%		2.9	%
Ground	14,061				13,515				12,969				4.0	%		4.2	%
Total Avg. Daily Package Volume	16,921				16,245				15,598				4.2	%		4.1	%
Average Revenue Per Piece:
Next Day Air	$	19.11			$	19.20			$	19.66			(0.5	)%		(2.3	)%
Deferred	12.43				11.85				11.70				4.9	%		1.3	%
Ground	8.19				7.97				7.98				2.8	%		(0.1	)%
Total Avg. Revenue Per Piece	$	9.48			$	9.25			$	9.28			2.5	%		(0.3	)%
Operating Days in Period	254				255				254
Revenue (in millions):
Next Day Air	$	7,088			$	6,752			$	6,570			5.0	%		2.8	%
Deferred	4,421				4,082				3,903				8.3	%		4.6	%
Ground	29,255				27,467				26,274				6.5	%		4.5	%
Total Revenue	$	40,764			$	38,301			$	36,747			6.4	%		4.2	%
Operating Expenses (in millions):
Operating Expenses	$	36,484			$	35,284			$	31,980			3.4	%		10.3	%
Defined Benefit Plans Mark-to-Market Charges	(637		)		(1,908		)		(62		)
Adjusted Operating Expenses	$	35,847			$	33,376			$	31,918			7.4	%		4.6	%
Operating Profit (in millions) and Operating Margin:
Operating Profit	$	4,280			$	3,017			$	4,767			41.9	%		(36.7	)%
Adjusted Operating Profit	$	4,917			$	4,925			$	4,829			(0.2	)%		2.0	%
Operating Margin	10.5		%		7.9		%		13.0		%
Adjusted Operating Margin	12.1		%		12.9		%		13.1		%

Revenue

The change in overall revenue was impacted by the following factors for the years ended December 31, 2017 and 2016, compared with the corresponding prior year periods:

	Volume			Rates / Product Mix			Fuel Surcharge			Total Revenue Change
Revenue Change Drivers:
2017/ 2016	3.8	%		1.7	%		0.9	%		6.4	%
2016/ 2015	4.6	%		0.2	%		(0.6	)%		4.2	%

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Volume

2017 compared to 2016

Our overall volume increased across all products in 2017, largely due to continued growth in overall retail sales, of which e-commerce continues to represent a larger percentage of the total growth. Business-to-consumer shipments, which represented more than 50% of total U.S. Domestic Package volume, grew 9.3% for the year, which drove increases in both air and ground shipments. Business-to-business shipments decreased slightly in 2017 compared to 2016 largely due to declines in volume in professional services, as a result of increased digitization, and high tech industries.

Among our air products, volume increased in 2017 for our Next Day Air and Deferred services. Solid air volume growth continued for those products most aligned with business-to-consumer shipping, including our residential Next Day Air, Next Day Air Saver and Three Day Select package products, as consumers continue to demand faster options. This growth was slightly offset by a decline in Next Day Air letter volume, largely due to declines in the professional services industry as a result of continued growth in digitization.

The increase in ground volume in 2017 was driven by growth in residential ground and SurePost volume, which benefited from continued e-commerce demand. Business-to-business shipments decreased slightly due to adverse weather conditions in third quarter 2017 however this decrease was partially offset by an increase in our return shipping services.

2016 compared to 2015

Our total volume increased across all products in 2016, largely due to continued growth in e-commerce and overall retail sales and the impact of one additional operating day. Business-to-consumer shipments, which represented more than 48% of total U.S. Domestic Package volume, grew nearly 9% for the year and 11.5% in the fourth quarter, which drove increases in both air and ground shipments. Business-to-business volume remained flat in 2016 due to revenue management initiatives and the overall slowing of the industrial manufacturing sector, offset by increased volume from the retail industry, including the use of our solutions for omni-channel (including ship-from-store and ship-to-store models) and returns shipping.

Next Day Air volume increased 5.2% in 2016, due to strong growth in e-commerce. We also experienced increased volume for our deferred air services in 2016, particularly for those products most aligned with business-to-consumer shipping, such as our residential Second Day Air Package and Three Day Select products partially offset by decreases in our business-to-business deferred air volume.

The increase in ground volume in 2016 was driven by growth in residential ground and SurePost volume while business-to-business shipments remained flat. Accelerating growth in e-commerce drove demand for our SurePost service, with volume increasing 19% in 2016.

Rates and Product Mix

2017 compared to 2016

Overall revenue per piece increased 2.5% in 2017, and was impacted by changes in base rates, customer and product mix and fuel surcharge rates.

Revenue per piece for ground and air products was positively impacted by a base rate increase on December 26, 2016. UPS Ground rates and UPS Air services rates increased an average net 4.9%. Effective January 8, 2017, we changed the dimensional weight calculation for packages subject to UPS daily rates. On June 19, 2017, we announced a new peak charge applicable during selected weeks in November and December 2017 for U.S. Residential, Large Packages and packages Over Maximum Limits. The new charge is designed to enable UPS to continue to offset some of the additional expenses incurred during significant volume surges. Additionally on October 25, 2017, we announced an average 4.9% base rate increase effective December 24, 2017 for UPS Ground and UPS Air services.

In the first quarter of 2017, we began our expanded Saturday ground operations to several metropolitan areas in the U.S. As of December 2017, Saturday service is available in approximately 4,700 cities and towns in the U.S. covering approximately 50% of the population. A Saturday pickup stop charge went into effect on May 1, 2017 and varies depending on the pickup service selected.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Revenue per piece for our Next Day Air services decreased in 2017 compared with 2016. The decrease in Next Day Air revenue per piece was primarily driven by a shift in product mix, as our lower yielding products experienced much larger volume growth than our higher yielding products. This shift was offset slightly by an increase in the average billable weight per piece. Revenue per piece of our deferred air services increased in 2017 compared with 2016. Deferred revenue per piece increased primarily due to an increase in average billable weight per piece, but was partially offset by an unfavorable shift in product mix. All products were positively impacted by higher fuel surcharge rates for 2017.

Ground revenue per piece increased in 2017, primarily due to base rate increases, higher fuel surcharge rates and an increase in average billable weight per piece. These factors were partially offset by changes in product mix, as we experienced faster volume growth in our SurePost product.

2016 compared to 2015

Overall revenue per piece decreased 0.3% in 2016, and was impacted by changes in base rates, customer and product mix and fuel surcharge rates.

Ground revenue per piece decreased in 2016, primarily due to customer and product mix changes, which adversely impacted revenue per piece as a greater portion of volume in 2016, relative to 2015, came from residential customers and lighter-weight shipments as SurePost volume surged. Additionally, lower fuel surcharge rates contributed to the decline. These drivers more than offset the rate actions taken since the fourth quarter of 2015.

Revenue per piece for Next Day Air products declined in 2016, while our deferred air products increased. All products were negatively impacted by lower fuel surcharge rates. The Next Day Air revenue per piece decline was caused by a shift in customer and product mix as well as an increase in lighter-weight packages. We experienced relatively stronger growth in our lighter-weight business-to-consumer shipments, particularly our Next Day Air Saver product, which have lower average yields than our heavier-weight commercial shipments. Customer mix also adversely impacted Next Day Air revenue per piece, due to faster volume growth among our larger customers, which have a lower average yield than our small and middle-market customers. Deferred revenue per piece increased primarily due to heavier-weight packages partially offset by product mix.

Revenue per piece for ground and air products was positively impacted by a base rate increase on December 28, 2015. UPS Ground rates and accessorial charges increased an average net 4.9%, while UPS Air services and accessorial charges increased an average net 5.2%. The surcharge increased for Over Maximum Packages and the index tables for the Ground and Air fuel surcharges were adjusted effective November 2, 2015. A charge for UPS’s Third-Party Billing Service was implemented, effective January 4, 2016. Additionally, the dimensions of ground packages incurring the UPS Additional Handling charge were changed effective June 6, 2016.

Fuel Surcharges

UPS applies a fuel surcharge on our domestic air and ground services. The air fuel surcharge is based on the U.S. Department of Energy’s (“DOE”) Gulf Coast spot price for a gallon of kerosene-type jet fuel, while the ground fuel surcharge is based on the DOE’s On-Highway Diesel Fuel Price. Based on published rates, the average fuel surcharge rates for domestic air and ground products were as follows:

	Year Ended December 31,									% Point Change
	2017			2016			2015			2017/ 2016			2016/ 2015
Next Day Air / Deferred	5.2	%		3.6	%		4.8	%		1.6	%		(1.2	)%
Ground	5.6	%		4.9	%		5.5	%		0.7	%		(0.6	)%

Effective February 6, 2017, the U.S. fuel surcharge rates are reset weekly instead of monthly. In addition, the price indices have moved from a two month to a two week lag.

Total domestic fuel surcharge revenue increased by $347 million in 2017 as a result of higher fuel surcharge rates caused by an increase in jet and diesel fuel prices, as well as an overall increase in package volume. In addition to the factors above, fuel surcharge revenue was positively impacted by changes to the fuel surcharge calculation, as rates and price indices are updated more frequently to better align with prevailing market rates. In 2016, total fuel surcharge revenue decreased by $219 million as a result of lower fuel surcharge rates caused by declining jet and diesel fuel prices, partially offset by the overall increase in package volume for the period.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Operating Expenses

2017 compared to 2016

Operating expenses for the period increased $1.2 billion, which included a $1.3 billion decrease in mark-to-market pension charges. Excluding the impact of the defined benefit plan mark-to-market charges, adjusted operating expenses for the segment increased $2.5 billion in 2017, primarily due to pickup and delivery costs (up $1.0 billion), the cost of operating our domestic integrated air and ground network (up $922 million), the costs of package sorting (up $246 million) and accessorials and indirect operating costs (up $279 million). These increases were driven primarily by overall volume growth in 2017. Adjusted operating expenses were impacted by several factors:

•	We incurred higher employee compensation, largely resulting from volume growth, an increase in average daily union labor hours (up 6.5%), growth in the overall size of the workforce and an increase in wage rates.

•	Employee benefit costs increased, largely due to increased employee healthcare, partially offset by a decrease in pension expense and workers' compensation expense.

•	We incurred higher fuel expense in 2017 primarily due to higher fuel prices and increased volume which resulted in higher fuel usage (increase in aircraft block hours of 7.0% and package delivery miles driven of 4.1%).

•	We incurred higher costs associated with outside contract carriers, primarily due to volume growth (including SurePost), higher fuel surcharges passed to us by carriers and general rate increases.

Total cost per piece decreased 0.3% in 2017 compared to 2016 and was primarily impacted by a 380 basis point decrease due to the defined benefit plan mark-to-market charge offset by the cost increases described previously. The increased expenses in 2017 were also driven by: capacity constraints due to volume surges in the fourth quarter of 2017, start-up costs of several investments underway to further expand and modernize our air and ground networks, and the costs of implementing Saturday operations. Costs were further impacted by rising fuel prices. In order to contain costs, we continually adjust our air and ground networks to better match higher volume levels. In addition, we continue to deploy and utilize technology to increase package sorting and delivery productivity.

2016 compared to 2015

Operating expenses for the period increased $3.3 billion, which included a $1.8 billion increase in mark-to-market pension charges. Excluding the impact of the defined benefit plan mark-to-market charges, adjusted operating expenses for the segment increased $1.5 billion in 2016, primarily due to pickup and delivery costs (up $814 million), the cost of operating our domestic integrated air and ground transportation network (up $282 million), the costs of package sorting (up $181 million) and accessorials and indirect operating costs (up $180 million). Adjusted operating expenses were impacted by several factors:

•	We incurred higher employee compensation, largely resulting from an increase in average daily union labor hours (up 4.2%) and growth in the overall size of the workforce partially offset by lower wage rates.

•	Employee benefit costs increased, largely due to increased employee healthcare, pension expense and workers' compensation expense.

•	We incurred lower fuel expense in 2016 primarily due to lower fuel prices and an increase in average miles per gallon. This was partially offset by higher fuel usage (due to an increase in aircraft block hours and vehicle miles driven.)

•	We incurred higher expenses for purchased transportation due to higher volume, partially offset by lower fuel surcharge rates passed to us from third-party carriers.

Total cost per piece increased 5.5% in 2016 compared to 2015 and was primarily impacted by a 540 basis point increase due to the defined benefit plan mark-to-market charge and the cost increases described previously. These increases were partially offset by the continued deployment of ORION, which has contained the growth of average daily vehicle miles driven, and the increased redirect of SurePost volume to optimize delivery density on UPS vehicles, which has reduced the delivery costs for business-to-consumer shipments.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Operating Profit and Margin

2017 compared to 2016

Operating profit increased $1.3 billion in 2017 compared with 2016, primarily due to a $1.3 billion decrease in mark-to-market pension charges to operating expense. Operating margin increased 260 basis points to 10.5%. Adjusted operating profit decreased $8 million in 2017 compared with 2016, while the adjusted operating margin decreased 80 basis points to 12.1%. Operating profit was negatively impacted by an increase in continued investments in new buildings and new strategic investments including deployment of Saturday operations. There was an adverse impact from higher purchased transportation costs due to volume surges in the fourth quarter 2017 and from fuel as expense increased at a faster pace than fuel surcharge revenue.

2016 compared to 2015

Operating profit decreased $1.8 billion in 2016 compared with 2015, primarily due to a $1.8 billion increase in mark-to-market pension charges to operating expense. Operating margin decreased 510 basis points to 7.9%. Adjusted operating profit increased $96 million in 2016 compared with 2015, while the adjusted operating margin decreased 20 basis points to 12.9%. Revenue growth from increased volume and enhanced productivity through the continued deployment of ORION technology resulted in higher operating profit, but was offset by an unfavorable shift in customer and product mix, especially in the fourth quarter. The net impact of fuel also negatively impacted operating profit as fuel surcharge revenue decreased faster than fuel expense.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

International Package Operations

	Year Ended December 31,												% Change
	2017				2016				2015				2017/ 2016				2016/ 2015
Average Daily Package Volume (in thousands):
Domestic	1,714				1,635				1,575				4.8		%		3.8		%
Export	1,395				1,210				1,151				15.3		%		5.1		%
Total Avg. Daily Package Volume	3,109				2,845				2,726				9.3		%		4.4		%
Average Revenue Per Piece:
Domestic	$	6.08			$	5.85			$	6.06			3.9		%		(3.5		)%
Export	28.69				30.38				31.10				(5.6		)%		(2.3		)%
Total Avg. Revenue Per Piece	$	16.22			$	16.29			$	16.63			(0.4		)%		(2.0		)%
Operating Days in Period	254				255				254
Revenue (in millions):
Domestic	$	2,645			$	2,441			$	2,425			8.4		%		0.7		%
Export	10,167				9,374				9,092				8.5		%		3.1		%
Cargo & Other	526				535				632				(1.7		)%		(15.3		)%
Total Revenue	$	13,338			$	12,350			$	12,149			8.0		%		1.7		%
Operating Expenses (in millions):
Operating Expenses	$	10,874			$	10,306			$	10,012			5.5		%		2.9		%
Defined Benefit Plan Mark-to-Market Charges	(35		)		(425		)		(44		)
Adjusted Operating Expenses	$	10,839			$	9,881			$	9,968			9.7		%		(0.9		)%
Operating Profit (in millions) and Operating Margin:
Operating Profit	$	2,464			$	2,044			$	2,137			20.5		%		(4.4		)%
Adjusted Operating Profit	$	2,499			$	2,469			$	2,181			1.2		%		13.2		%
Operating Margin	18.5		%		16.6		%		17.6		%
Adjusted Operating Margin	18.7		%		20.0		%		18.0		%
Currency Translation Benefit / (Cost)—(in millions)*:
Revenue													$	(325	)		$	(138	)
Operating Expenses													(50		)		146
Operating Profit													$	(375	)		$	8

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

Revenue

The change in overall revenue was impacted by the following factors for the years ended December 31, 2017 and 2016, compared with the corresponding prior year periods:

	Volume			Rates / Product Mix			Fuel Surcharge			Currency			Total Revenue Change
Revenue Change Drivers:
2017/ 2016	8.9	%		(0.9	)%		2.6	%		(2.6	)%		8.0	%
2016/ 2015	4.8	%		(1.2	)%		(0.8	)%		(1.1	)%		1.7	%

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Volume

2017 compared to 2016

Our overall average daily volume increased in 2017, largely due to continued strength in business-to-consumer volume, as well as strong demand from several sectors including retail, industrial manufacturing, high-tech and healthcare.

We continued to experience export volume growth in 2017. The growth was mainly driven by our European, Asian and U.S. operations, which experienced increases in volume to major trade lanes of the world. European export volume increased in 2017, with growth in all trade lanes. Asia export volume also increased in 2017, with particular strength in Asia-to-U.S., Asia-to-Americas and intra-Asia trade lanes. Export volume into the U.S. grew in all trade lanes, led by Europe and the Americas. Export volume growth was strong across all major products, with a continued shift towards our premium express products, such as Worldwide Express and Transborder Express services.

The increase in domestic growth in 2017 was primarily due to growth in Turkey, Germany, France, Italy and U.K.

2016 compared to 2015

Our overall average daily volume increased in 2016, largely due to continued strength in business-to-consumer volume, as well as strong demand from several sectors including retail, industrial manufacturing, high-tech and healthcare.

We continued to experience export volume growth in 2016. The growth was mainly driven by our European and Asian operations, which experienced increases in volume to all regions of the world. European export volume increased in 2016, with particular strength in the Europe-to-U.S. and intra-Europe trade lanes. Asia export volume also increased in 2016, with growth in all trade lanes. However, U.S. export volume declined largely due to the impact of the stronger U.S. Dollar. Export volume growth was distributed across all products led by our Worldwide Express product.

The increase in domestic volume in 2016 was primarily due to growth in Italy, France, Turkey and Mexico.

Rates and Product Mix

2017 compared to 2016

Total average revenue per piece decreased 0.4% in 2017, impacted by a 250 basis point reduction from currency and a shift in product mix. These factors were partially offset by an increase in fuel surcharge rates as well as an increase in base rates.

On December 26, 2016, we implemented an average 4.9% net increase in base and accessorial rates for international shipments originating in the United States. Rate changes for shipments originating outside the U.S. are made throughout the year and vary by geographic markets. Effective September 17, 2017, a peak surcharge was applied to any shipment originating from China or Hong Kong to the United States for certain service levels during the peak period. The surcharge was applied as a rate per pound based upon the billable weight of the shipment. Additionally, on October 25, 2017, we announced an average 4.9% net increase in base and accessorial rates for international shipping originating in the United States; changes became effective on December 24, 2017.

Export revenue per piece decreased 5.6% in 2017, impacted by a 320 basis point reduction from currency and product mix. This was partially offset by an increase in fuel surcharges, an increase in base rates and strong volume growth in premium products.

Domestic revenue per piece increased 3.9% in 2017, impacted by a 50 basis point increase from currency, increase in base rates and higher fuel surcharges.

2016 compared to 2015

Total average revenue per piece decreased 2.0% in 2016, impacted by a 110 basis point reduction from currency as well as lower fuel surcharge rates. These factors were partially offset by an increase in base rates, lower discounts and a shift in product mix as the growth in premium products continued to exceed the growth in our standard products.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

On December 28, 2015, we implemented an average 5.2% net increase in base and accessorial rates for international shipments originating in the United States (Worldwide Express, Worldwide Saver, UPS Worldwide Expedited and UPS International Standard service). On November 2, 2015, the surcharge increased for Over Maximum Packages and the tables for Ground, Air and International fuel surcharges were adjusted. Rate changes for shipments originating outside the U.S. are made throughout the year and vary by geographic market.

Export revenue per piece decreased 2.3% in 2016, impacted by a 50 basis point reduction from currency as well as lower fuel surcharge rates. These factors were partially offset by an increase in base rates, lower discounts and favorable package weight and characteristics.

Domestic revenue per piece decreased 3.5% in 2016, impacted by a 380 basis point reduction from currency as well as lower fuel surcharge rates. These factors were partially offset by an increase in base rates.

Fuel Surcharges

We maintain fuel surcharges on our international air and ground services. The fuel surcharges for international air products originating inside or outside the United States are indexed to the DOE's Gulf Coast spot price for a gallon of kerosene-type jet fuel, while the fuel surcharges for ground products originating outside the United States are indexed to fuel prices in the international region or country where the shipment takes place.

Total international fuel surcharge revenue increased by $325 million in 2017, primarily due to volume increases, higher fuel prices and pricing changes made to base freight rates and to the fuel surcharge indices from a two month lag to a two week lag. Total international fuel surcharge revenue decreased by $119 million in 2016, primarily due to price reductions in the fuel surcharge indices; however, this was partially offset by an increase in volume and changes in mix.

Operating Expenses

2017 compared to 2016

Overall operating expenses increased by $568 million, which included a $390 million decrease in mark-to-market pension charges. Excluding the impact of the defined benefit plan mark-to-market charges, adjusted operating expenses for the segment increased $958 million in 2017 primarily due to increased volumes, higher fuel usage and currency fluctuations.

Operating expenses were impacted by changes in the cost of operating our international integrated air and ground network, which increased $418 million, as well as pickup and delivery costs, which increased $280 million. The increase in network costs was largely driven by volume growth in our Express products, which drove a 3.0% increase in aircraft block hours and higher fuel usage. Additionally, the increase in pickup and delivery costs is due to increased volume. Operating expenses were also impacted in 2017 by a $260 million increase in indirect overhead and package sorting costs and other costs.

2016 compared to 2015

Overall operating expenses increased by $294 million, which included a $381 million increase in mark-to-market pension charges. Excluding the impact of the defined benefit plan mark-to-market charges, adjusted operating expenses for the segment decreased $87 million in 2016 primarily due to currency exchange rate movements and lower fuel expense.

Operating expenses were impacted by changes in the cost of operating our international integrated air and ground network, which decreased $40 million, as well as pickup and delivery costs, which decreased $143 million. The decreases in network and pickup and delivery costs were largely due to the impact of currency exchange rate movements and lower fuel expense. Network cost reductions were somewhat offset by an increase in aircraft block hours (up 1.2% in 2016), driven by a 5.1% increase in international export volume and continuing air product service enhancements.

Operating expenses were also impacted in 2016 by a $96 million increase in indirect overhead, package sorting costs and other gains and losses. The total cost per piece for the segment decreased 1.8% in 2016.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Operating Profit and Margin

2017 compared to 2016

Operating profit increased $420 million in 2017 compared with 2016, which included a $390 million decrease in operating expenses due to mark-to-market pension adjustments. Operating margin increased 190 basis points to 18.5%. Adjusted operating profit increased by $30 million in 2017, while the adjusted operating margin decreased 130 basis points to 18.7%. Operating margin was affected by negative currency exchange movements due to volatility of both hedged and unhedged currencies. Included in adjusted operating profit is a $375 million decrease due to currency.

2016 compared to 2015

Operating profit decreased $93 million in 2016 compared with 2015, which included a $381 million increase in operating expenses due to mark-to-market pension adjustments. Operating margin decreased 100 basis points to 16.6%. Adjusted operating profit increased by $288 million in 2016, while the adjusted operating margin increased 200 basis points to 20.0%. Operating profit and margin were positively affected by several factors including base rate increases, modifications to the fuel surcharge indices and currency exchange rate movements (including currency hedging gains).

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Supply Chain & Freight Operations

	Year Ended December 31,												% Change
	2017				2016				2015				2017/ 2016				2016/ 2015
Freight LTL Statistics:
Revenue (in millions)	$	2,596			$	2,384			$	2,479			8.9		%		(3.8		)%
Revenue Per Hundredweight	$	24.08			$	23.44			$	22.94			2.7		%		2.2		%
Shipments (in thousands)	10,203				9,954				10,433				2.5		%		(4.6		)%
Shipments Per Day (in thousands)	40.5				39.3				41.2				3.1		%		(4.6		)%
Gross Weight Hauled (in millions of lbs)	10,782				10,167				10,808				6.0		%		(5.9		)%
Weight Per Shipment (in lbs)	1,057				1,021				1,036				3.5		%		(1.4		)%
Operating Days in Period	252				253				253
Revenue (in millions):
Forwarding and Logistics	$	7,981			$	6,793			$	5,900			17.5		%		15.1		%
Freight	2,998				2,736				2,881				9.6		%		(5.0		)%
Other	791				726				686				9.0		%		5.8		%
Total Revenue	$	11,770			$	10,255			$	9,467			14.8		%		8.3		%
Operating Expenses (in millions):
Operating Expenses	$	10,985			$	9,849			$	8,703			11.5		%		13.2		%
Defined Benefit Plans Mark-to-Market Charges	(128		)		(318		)		(12		)
Adjusted Operating Expenses	$	10,857			$	9,531			$	8,691			13.9		%		9.7		%
Operating Profit (in millions) and Operating Margins:
Operating Profit	$	785			$	406			$	764			93.3		%		(46.9		)%
Adjusted Operating Profit	$	913			$	724			$	776			26.1		%		(6.7		)%
Operating Margin	6.7		%		4.0		%		8.1		%
Adjusted Operating Margin	7.8		%		7.1		%		8.2		%
Currency Translation Benefit / (Cost)—(in millions)*:
Revenue													$	10			$	(56	)
Operating Expenses													(12		)		59
Operating Profit													$	(2	)		$	3

*	Amount represents the change compared to the prior year.

In December 2016, we acquired Marken, a global provider of supply chain solutions to the life sciences industry and leader in clinical trials, material storage and distribution. Marken's financial results are included in the above table within Forwarding and Logistics from the date of the acquisition and have impacted the year-over-year comparability of revenue, operating expenses and operating profit for the years ended December 31, 2017 and 2016.

In August 2015, we acquired Coyote, a truckload freight brokerage company. Coyote's financial results are included in the above table within Forwarding and Logistics from the date of the acquisition, which has impacted the year-over-year comparability of revenue, operating expenses and operating profit for the years ended December 31, 2016 and 2015.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Revenue

2017 compared to 2016

Total revenue for the Supply Chain & Freight segment increased $1.515 billion in 2017 compared to 2016.

Forwarding and Logistics revenue increased $1.188 billion in 2017 compared with 2016, primarily due to increased truckload brokerage freight volume movement and tonnage increases in our international air freight and North American air freight forwarding businesses. The volume and tonnage increases were driven by improving overall market demand. Revenue for our logistics products increased in 2017 due to growth in mail services, healthcare, retail and aerospace solutions, offset by declines among our high tech customers. Additionally, the Marken acquisition on December 21, 2016 contributed to the increase in revenue. Revenue was positively impacted by currency exchange rate movements.

UPS Freight revenue increased $262 million in 2017 compared to 2016, driven by increases in shipments and weight per shipment. These increases were impacted by an overall improvement in market demand and customer mix. LTL revenue per hundredweight increased slightly as LTL base rate increases, averaging 4.9%, took effect September 19, 2016. Additionally, effective June 26, 2017, LTL base rates increased by an additional 4.9% for certain shipments in the U.S., Canada and Mexico. Fuel surcharge revenue also increased $70 million due to changes in overall LTL shipment volume and diesel fuel prices.

Revenue for the other businesses within Supply Chain & Freight increased $65 million in 2017 due to revenue growth at UPS Capital Corporation and UPS Customer Solutions, as well as service contracts with the U.S. Postal Service.

2016 compared to 2015

Total revenue for the Supply Chain & Freight segment increased $788 million in 2016 compared to 2015.

Forwarding and Logistics revenue increased $893 million in 2016 compared with 2015, primarily due to the Coyote acquisition midway through the third quarter of 2015, offset by a combination of volume and tonnage declines in our North American air freight and international air freight businesses (impacted by management focus to reduce lower-yielding accounts and softer market conditions). Additionally, revenue was adversely impacted by currency exchange rate movements and lower fuel surcharge rates (due to declining fuel prices). Revenue for our logistics products increased in 2016 as there was growth in our mail services and retail, aerospace, healthcare and automotive solutions.

UPS Freight revenue decreased $145 million in 2016 compared with 2015, driven by lower tonnage (down 5.9% from 2015) and a $73 million decrease in fuel surcharge revenue due to lower diesel fuel prices. The decline in shipments and the reduction in the weight per shipment were impacted by revenue management initiatives, an overall decline in market demand and customer mix. LTL revenue per hundredweight increased as LTL base rate increases averaging 4.9% took effect on October 26, 2015 and September 19, 2016.

Revenue for the other businesses within Supply Chain & Freight increased $40 million in 2016 due to revenue growth at UPS Capital Corporation, UPS Customer Solutions and The UPS Store.

Operating Expenses

2017 compared to 2016

Supply Chain & Freight operating expenses for the period increased $1.136 billion, which includes a $190 million decrease in mark-to-market pension charges.

Forwarding and Logistics operating expenses increased $927 million, largely due to increased purchased transportation expenses and the acquisition of Marken in 2016. This was offset by operating efficiencies, a decrease in the mark-to-market pension charges in 2017 compared to 2016 and the receipt of a $20 million favorable legal settlement in the second quarter of 2017. Purchased transportation expense increased by $949 million compared to 2016 due to increased truckload brokerage freight movement, the acquisition of Marken in 2016, and the resulting increased fuel surcharges passed to us from outside transportation providers. Increased tonnage and third-party air carrier procurement rates in our North American and international air freight forwarding businesses, and increased volume and rates for mail services, also contributed to increased purchased transportation expenses.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

UPS Freight operating expenses increased $196 million in 2017 compared with 2016. The increase in operating expense was largely due to costs associated with operating our linehaul network ($120 million) and increases in pickup and delivery costs ($79 million). The network costs and pickup and delivery expenses were driven by higher fuel cost and higher expense for outside transportation carriers (largely due to LTL volume growth and fuel surcharges passed to us by outside carriers). Total cost per LTL shipment increased 4.7% in 2017 compared to 2016. Operating expenses related to our casualty self-insurance reserves also increased in 2017 compared with 2016.

Other expenses for the other businesses within Supply Chain & Freight increased $13 million in 2017 compared with 2016 primarily due to UPS Capital, UPS Customer Solutions and service contracts with the U.S. Postal Service, slightly offset by decreases in The UPS Store.

2016 compared to 2015

Supply Chain & Freight operating expenses for the period increased $1.146 billion, which included a $306 million increase in mark-to-market pension charges. Forwarding and Logistics operating expenses increased $910 million, largely due to the acquisition of Coyote during the third quarter of 2015 and the increase in mark-to-market pension adjustment, partially offset by the impact of currency exchange rate movements and lower fuel expense. Purchased transportation expense increased by $862 million compared to 2015 largely due to the acquisition of Coyote. These increases were partially offset by a combination of lower volume and tonnage in our North American air freight and international air freight forwarding businesses, lower buy rates due to softer market conditions and the impact of currency exchange rates.

UPS Freight operating expenses decreased $103 million in 2016 compared with 2015, primarily as a result of decreases in our network costs ($58 million) and pickup and delivery costs ($34 million), offset in part by the increased mark-to-market pension charges. The declines in network costs and pickup and delivery expenses were driven by a reduction in fuel expense and expense for outside transportation carriers (due to lower LTL volume and fuel surcharges passed to us by outside carriers). Total cost per LTL shipment increased by 2.7% compared with 2015 due to operating expenses declining at a faster rate than the reduction in tonnage and shipments.

Other expenses for the other businesses within Supply Chain & Freight increased $33 million in 2016 compared with 2015 primarily due to UPS Capital, UPS Customer Solutions and The UPS Store.

Operating Profit and Margin

2017 compared to 2016

Supply Chain & Freight operating profit increased $379 million in 2017 compared with 2016, which includes a $190 million decrease in the mark-to-market pension charges. Operating margin increased 270 basis points to 6.7%, while the adjusted operating margin increased 70 basis points to 7.8%.

Operating profit for Forwarding and Logistics increased $261 million in 2017 compared with 2016. Operating profit and margins for the North American air freight business increased in 2017 due to an increase in volume, slightly offset by higher transportation expenses. Operating profit and margins in our international air freight forwarding business increased due to volume increases and higher revenue per kilo, slightly offset by higher rates at which we procure capacity from third-party air carriers. Operating profit for the logistics units improved from 2017 compared to 2016, due to strong performance in the U.S. as well as within our mail services. Additionally, the Marken acquisition in 2016 contributed to the increase in operating profit.

UPS Freight operating profit increased $66 million in 2017 compared with 2016, as increased volume and prices were partially offset by increased purchased transportation costs.

The combined operating profit for all of our other businesses in this segment increased $52 million in 2017, primarily due to higher operating profit at UPS Capital, UPS Customer Solutions and The UPS Store, as well as service contracts with the U.S. Postal Service.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

2016 compared to 2015

Supply Chain & Freight operating profit decreased $358 million in 2016 compared with 2015, which includes a $306 million increase in the mark-to-market pension adjustments. Operating margin decreased 410 basis points to 4.0%, while the adjusted operating margin decreased 110 basis points to 7.1%.

Operating profit for Forwarding and Logistics, which includes Coyote, decreased $17 million in 2016 compared with 2015. Operating results for the North American air freight and international air freight forwarding businesses declined, as buy and sell spreads for capacity decreased. Profitability in ocean freight slightly declined due to margin compression from soft market conditions. Operating profit for the logistics unit increased slightly in 2016 compared to 2015.

Operating profit for the freight unit decreased $42 million in 2016 compared with 2015, as a decline in tonnage and increase in pension costs more than offset the increased LTL revenue per hundredweight realized during the year.

The combined operating profit for all of our other businesses in this segment increased $7 million in 2016, primarily due to higher operating profit at UPS Capital, UPS Customer Solutions and The UPS Store.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Operating Expenses

	Year Ended December 31,												% Change
	2017				2016				2015				2017/ 2016				2016/ 2015
Operating Expenses (in millions):
Compensation and Benefits:	$	34,588			$	34,770			$	31,028			(0.5		)%		12.1		%
Defined Benefit Plans Mark-to-Market Charges	(800		)		(2,651		)		(118		)
Adjusted Compensation and Benefits	33,788				32,119				30,910				5.2		%		3.9		%
Repairs and Maintenance	1,600				1,538				1,400				4.0		%		9.9		%
Depreciation and Amortization	2,282				2,224				2,084				2.6		%		6.7		%
Purchased Transportation	10,989				9,129				8,043				20.4		%		13.5		%
Fuel	2,690				2,118				2,482				27.0		%		(14.7		)%
Other Occupancy	1,155				1,037				1,022				11.4		%		1.5		%
Other Expenses	5,039				4,623				4,636				9.0		%		(0.3		)%
Total Operating Expenses	$	58,343			$	55,439			$	50,695			5.2		%		9.4		%
Adjusted Total Operating Expenses	$	57,543			$	52,788			$	50,577			9.0		%		4.4		%
Currency Translation Cost / (Benefit)*													$	62			$	(205	)

*	Amount represents the change compared to the prior year.

Compensation and Benefits

2017 compared to 2016

Total compensation and benefits decreased $182 million in 2017 compared to 2016. Excluding the impact of the defined benefit plans mark-to-market charges, adjusted compensation and benefits expense increased $1.669 billion in 2017.

Employee payroll costs increased $1.295 billion in 2017 compared with 2016, largely due to higher U.S. domestic hourly and management compensation costs. Total compensation costs increased 6.5%, while consolidated average daily volume growth was 4.9%. U.S. domestic compensation costs for hourly employees increased largely due to fourth quarter 2017 seasonal staffing increases resulting from a 5.4% volume growth, contractual union wage increases, headcount increases, wage rate adjustments for part time workers and a 6.5% increase in average daily union labor hours. Compensation costs for management employees increased primarily due to merit salary increases and growth in the overall size of the workforce.

Benefits expense decreased $1.477 billion in 2017 compared to 2016, primarily due to the following factors:

•

Pension costs decreased $1.869 billion in 2017 compared to 2016, primarily due to a $1.851 billion decrease in defined benefit plans mark-to-market charges. Additionally, expenses decreased due to higher asset returns in company sponsored plans as a result of discretionary contributions. This decrease was offset by additional expense for multiemployer pension plans, which were impacted by contractual contribution rate increases and an overall increase in size of workforce.

•	Health and welfare costs increased $229 million in 2017, largely due to increased contributions to multiemployer plans resulting from contractual contribution rate increases and an overall increase in the size of the workforce.

•	Vacation, holiday, excused absence, payroll tax and other expenses increased $226 million in 2017 due to salary increases and growth in the overall size of the workforce.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

•

Workers' compensation expense decreased $63 million in 2017 as we experienced more favorable actuarial adjustments. This decrease was partially offset by increases in work hours, medical trends and wage increases. Insurance reserves are established for estimates of the loss that we will ultimately incur on reported workers' compensation claims, as well as estimates of claims that have been incurred but not reported, and take into account a number of factors, including our history of claim losses, payroll growth and the impact of safety improvement initiatives.

2016 compared to 2015

Total compensation and benefits increased $3.742 billion in 2016 compared to 2015. Excluding the impact of the defined benefit plans mark-to-market charges, adjusted compensation and benefits expense increased $1.209 billion in 2016.

Employee payroll costs increased $609 million in 2016 compared with 2015, largely due to higher U.S. domestic hourly and management compensation costs and the acquisition of Coyote during the third quarter of 2015. Total compensation costs increased 3.2%, while consolidated average daily volume growth was 4.2%. U.S. domestic compensation costs for hourly employees increased largely due to increased headcount, contractual union wage increases and a 4.2% increase in average daily union labor hours. Compensation costs for management employees increased primarily due to merit salary increases and growth in the overall size of the workforce, partially offset by lower incentive compensation.

Benefits expense increased $3.133 billion in 2016 compared to 2015, primarily due to increased pension costs, health and welfare costs, workers' compensation expenses, vacation, holiday and excused absence expenses and payroll taxes. These factors are discussed further as follows:

•	Pension costs increased $2.634 billion in 2016 compared to 2015, primarily due to $2.533 billion in defined benefit plans mark-to-market charges. Additionally, expenses increased for multiemployer pension plans due to increased contribution rates and headcount.

•	Health and welfare costs increased $277 million in 2016, largely due to increased contributions to multiemployer plans resulting from contractual contribution rate increases and an overall increase in the size of the workforce.

•	Vacation, holiday, excused absence and payroll tax expense increased $125 million in 2016, due to salary increases and growth in the overall size of the workforce.

•

Workers' compensation expense increased $96 million in 2016. Insurance reserves are established for estimates of the loss that we will ultimately incur on reported workers' compensation claims, as well as estimates of claims that have been incurred but not reported, and take into account a number of factors, including our history of claim losses, payroll growth and the impact of safety improvement initiatives. In 2015, we experienced more favorable actuarial adjustments, resulting in increased expense in 2016.

Repairs and Maintenance

2017 compared to 2016

The $62 million increase in repairs and maintenance expense in 2017 was primarily due to repairs and maintenance of our transportation equipment resulting from growth in the size of our vehicle fleet and routine repairs to buildings and facilities.

2016 compared to 2015

The $138 million increase in repairs and maintenance expense in 2016 was primarily due to an increase in airframe and aircraft engine maintenance resulting from increased air volume and increased vehicle maintenance costs in our global package and freight operations, primarily due to the growth in the size of our vehicle fleet.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Depreciation and Amortization

2017 compared to 2016

Depreciation and amortization expense increased $58 million in 2017 compared with 2016, primarily due to the following factors: (1) depreciation expense on vehicles increased due to an overall increase in the size of our vehicle fleet in our U.S. Domestic Package and UPS Freight operations, (2) depreciation expense for buildings and facilities increased due to the opening of new facilities and facility automation and capacity expansion projects and (3) amortization expense of intangible assets increased in conjunction with the Marken acquisition. These factors were largely offset by a decrease in amortization expense related to longer lived internally developed capitalized software.

2016 compared to 2015

Depreciation and amortization expense increased $140 million in 2016 compared with 2015, primarily due to the following factors: (1) depreciation expense for buildings and facilities increased due to leasehold improvements and purchases of new equipment; (2) increase in amortization expense largely due to new internally developed capitalized software, as well as intangible assets resulting from business acquisitions and (3) depreciation expense on vehicles increased due to the replacement of older, fully-depreciated vehicles, technology upgrades on new vehicles and an overall increase in the size of our vehicle fleet in our U.S. Domestic Package and UPS Freight operations.

Purchased Transportation

2017 compared to 2016

The $1.860 billion increase in purchased transportation expense charged to us by third-party air, rail, ocean and truck carriers in 2017 was primarily driven by the following factors:

•

Expense for our forwarding and logistics business increased $949 million in 2017, primarily due to increased truckload brokerage freight loads per day and the resulting increased fuel surcharges passed to us from outside transportation providers; increased volume and rates for mail services and increased tonnage in our North American and international air freight forwarding businesses. Additionally, purchased transportation expense increased due to the acquisition of Marken in December 2016.

•	U.S. Domestic Package expense increased $421 million in 2017, primarily due to increased volume (including SurePost), higher rates and higher fuel surcharges passed to us from outside contract carriers.

•	International Package expense increased $270 million in 2017, primarily due to the increased usage of third-party carriers (due to higher volume); higher fuel surcharges passed to us from outside transportation providers and an unfavorable impact of currency exchange rate movements.

•	UPS Freight expense increased $163 million in 2017, due to an increase in LTL shipments and higher fuel surcharges passed to us from outside transportation providers.

2016 compared to 2015

The $1.086 billion increase in purchased transportation expense charged to us by third-party air, ocean and truck carriers in 2016 was driven by several factors:

•

Expense for our forwarding and logistics business increased $840 million in 2016, primarily due to the acquisition of Coyote and increased volume and rates for mail services; these items were partially offset by a combination of decreased volume and tonnage in our North American air freight and international air freight forwarding business, lower buy rates in international air freight due to softer market conditions and the impact of foreign currency exchange rates.

•	U.S. Domestic Package expense increased $130 million in 2016, primarily due to increased volume and rates, partially offset by lower fuel surcharges passed to us from rail carriers and outside contract carriers.

•	International Package expense increased $112 million in 2016, primarily due to increased usage of third-party carriers; this was partially offset by the impact of currency exchange rate movements as well as lower fuel surcharges passed to us from outside transportation providers.

•	UPS Freight expense decreased $18 million in 2016, largely due to decreased LTL shipments and the resulting decreased use of, and lower fuel surcharges passed to us from, outside transportation carriers.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Fuel

2017 compared to 2016

The $572 million increase in fuel expense in 2017 was primarily due to higher jet fuel, diesel and unleaded gasoline prices, which increased fuel expense by $419 million. Additionally, increased alternative fuel costs and fuel consumption increased expense by $170 million primarily due to volume increases, which resulted in higher total aircraft block hours and Domestic Package delivery miles driven. These increases were partially offset by increased fuel efficiency.

2016 compared to 2015

The $364 million decrease in fuel expense in 2016 was primarily due to lower jet fuel, diesel and unleaded gasoline prices, which decreased fuel expense by $461 million. The lower fuel prices were partially offset by increased fuel consumption, primarily due to increases in total aircraft block hours and Domestic Package delivery stops (due to higher volume), which increased expense by $97 million and lower alternative fuel and tax credits.

Other Occupancy

2017 compared to 2016

The $118 million increase in other occupancy expense in 2017 was largely due to higher facility rent expense driven by new facilities, higher utilities and property taxes at our operating facilities.

2016 compared to 2015

The $15 million increase in other occupancy expense in 2016 was largely due to higher facility rent expense, partially offset by lower utilities and snow removal costs at our operating facilities.

Other Expenses

2017 compared to 2016

The $416 million increase in other expenses in 2017 was caused by a number of factors:

•	Auto liability insurance expense increased $75 million due to increased miles driven, medical trend rates and severity experience trends.

•	Transportation equipment rental increased $60 million driven by growth in package volume.

The remaining $280 million increase is comprised of increases in several other expense categories, including outside professional services, merchandise protection, computer and plant supplies and air cargo handling, partially offset by a decrease in advertising expense.

2016 compared to 2015

The $13 million decrease in other expenses in 2016 was largely due to a decrease in overall auto liability insurance, offset by an increase in outside professional services.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Investment Income and Interest Expense

The following table sets forth investment income and interest expense for the years ended December 31, 2017, 2016 and 2015 (in millions):

	Year Ended December 31,												% Change
	2017				2016				2015				2017/ 2016			2016/ 2015
Investment Income and Other	$	72			$	50			$	15			44.0	%		NA
Interest Expense	$	(453	)		$	(381	)		$	(341	)		18.9	%		11.7	%

Investment Income and Other

2017 compared to 2016

The growth in investment income and other in 2017 as compared to 2016 was primarily due to higher interest income from invested assets and the continued decrease in losses from fair value adjustments on real estate partnerships partially offset by foreign currency exchange rate movements.

2016 compared to 2015

The growth in investment income and other in 2016 as compared to 2015 was primarily due to a decrease in losses from fair value adjustments on real estate partnerships, higher interest income and unrealized gains on investments and a benefit from foreign currency exchange rate movements.

Interest Expense

2017 compared to 2016

Interest expense increased in 2017 as compared to 2016 primarily due to the issuance of long-term CAD Senior Notes, Euro Senior Notes and USD Senior Notes and higher effective interest rates on senior notes.

2016 compared to 2015

Interest expense increased in 2016 as compared to 2015 primarily due to an increase in average outstanding commercial paper balances, an increase in long-term debt and higher effective interest rates on senior notes.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Income Tax Expense

The following table sets forth income tax expense and our effective tax rate for the years ended December 31, 2017, 2016 and 2015 (in millions):

	Year Ended December 31,												% Change
	2017				2016				2015				2017/ 2016			2016/ 2015
Income Tax Expense:	$	2,238			$	1,705			$	2,498			31.3	%		(31.7	)%
Income Tax Impact of:
Defined Benefit Plans Mark-to-Market Charge	193				978				39
Income Tax Benefit from the Tax Cuts and Jobs Act and Other Non-U.S. Tax Law Changes	258				—				—
Adjusted Income Tax Expense	$	2,689			$	2,683			$	2,537			0.2	%		5.8	%
Effective Tax Rate	31.3		%		33.2		%		34.0		%
Adjusted Effective Tax Rate	33.8		%		34.5		%		34.0		%

Our effective tax rate is affected by recurring factors, such as statutory tax rates in the jurisdictions we operate in and the relative amounts of taxable income we earn in those jurisdictions. It is also affected by discrete items that may occur in any given year but may not be consistent from year to year.

Our effective tax rate decreased to 31.3% in 2017, compared with 33.2% in 2016 and 34.0% in 2015, primarily due to the effects of the following discrete tax items and recurring factors:

Tax Cuts and Jobs Act

On December 22, 2017, the United States enacted into law the Tax Act. The Tax Act makes broad and complex changes to the U.S. tax code, including a permanent corporate rate reduction to 21% and a transition to a territorial international system effective in 2018. Going forward, we expect a lower future effective tax rate than we have reported in recent years. Applying the lower corporate tax rate will lower our overall income tax expense, which will impact net income and cash flows. Benefits from the lower tax rate will allow us to fund strategic initiatives for our customers, employees and shareowners. The Tax Act also includes provisions that affect 2017, including: (1) requiring a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries (“Transition Tax”) that is payable over eight years; (2) requiring a remeasurement of all U.S. deferred tax assets and liabilities to the newly enacted corporate tax rate of 21% and (3) providing for additional first-year depreciation that allows full expensing of qualified property placed into service after September 27, 2017.

In late December 2017, the SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the related accounting under U.S. GAAP. If a company’s accounting for certain income tax effects of the Tax Act is incomplete, but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. Accordingly, we have recorded provisional estimates related to our Transition Tax liability, our change in indefinite reinvestment assertion for certain foreign subsidiaries and the remeasurement of our U.S. net deferred tax liabilities.

To calculate the amount of the Transition Tax, we must determine, in addition to other factors, the amount of post-1986 earnings and profits (“E&P”) of the foreign subsidiaries as well as the amount of non-U.S. income taxes paid on such earnings. We are able to make a reasonable estimate of the Transition Tax and recorded a provisional liability of $310 million; however, there are certain factors that could impact our provisional estimate.

First, several of our foreign subsidiaries have a fiscal year-end, and E&P for these subsidiaries cannot be precisely calculated until their fiscal years conclude during 2018. Second, we continue to gather additional information needed to precisely estimate the impact of the Transition Tax on our U.S. state and local tax liabilities given the complexity of the relevant state laws. Finally, we expect additional regulatory guidance and technical clarifications from the U.S. Department of the Treasury and Internal Revenue Service within the next 12 months that could change our provisional estimate of the Transition Tax.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

As the U.S. has moved to a territorial system, we have also changed our indefinite reinvestment assertion with respect to the earnings of certain foreign subsidiaries. As a result, we have recorded a provisional deferred tax liability and corresponding increase to deferred tax expense of $24 million. There are certain factors, discussed above with regard to the Transition Tax, which could also impact our provisional estimate for the change in indefinite reinvestment assertion. For all other foreign subsidiaries, we continue to assert that these earnings are indefinitely reinvested. We will continue to evaluate our indefinite reinvestment assertion for all foreign subsidiaries in light of the Tax Act, and our provisional estimate is subject to change.

For our net U.S. deferred tax liabilities, we have recorded a provisional decrease of $606 million with a corresponding reduction to deferred tax expense of $606 million for the year ended December 31, 2017. While we are able to make a reasonable estimate of the impact of the reduction in the corporate rate, it may be affected by other analyses related to the Tax Act, including, but not limited to, completing the analysis of our 2017 capital expenditures that qualify for full expensing and the state tax effect of adjustments made to federal temporary differences.

Other 2017 Discrete Items

In the fourth quarter of 2017, we recognized an income tax benefit of $193 million related to pre-tax mark-to-market losses of $800 million on our pension and postretirement defined benefit plans. This income tax benefit was generated at a lower average statutory tax rate than the 2017 U.S. federal statutory tax rate due to future tax rate changes enacted by the Tax Act and differences between U.S. and foreign statutory rates, which was partially offset by the effect of U.S. state and local taxes.

In the fourth quarter of 2017, tax law changes were enacted in certain non-U.S. jurisdictions in which we operate. As a result, we have recorded a decrease to our foreign net deferred tax assets of $14 million with a corresponding net increase to deferred tax expense of $14 million for the year ended December 31, 2017.

In the first quarter of 2017, we adopted a new accounting standard that requires the recognition of excess tax benefits related to share-based compensation in income tax expense, which resulted in tax benefits for the year ended December 31, 2017 of $71 million and reduced our effective tax rate by 1.0%.

2016 Discrete Items

In the fourth quarter of 2016, we recognized an income tax benefit of $978 million related to pre-tax mark-to-market losses of $2,651,000,000.000 billion on our pension and postretirement defined benefit plans. This income tax benefit was generated at a higher average statutory tax rate than the U.S. federal statutory tax rate because it included the effect of U.S. state and local taxes.

2015 Discrete Items

During the third quarter of 2015 and after the filing of our annual federal tax returns, we reconciled our deferred tax balances and identified adjustments to be made with respect to prior years’ deferred tax balances. The adjustments resulted in a reduction of income tax expense of $66 million.

In connection with our acquisition of Coyote Logistics in 2015, we distributed $500 million of cash held by a Canadian subsidiary to its U.S. parent during the fourth quarter of 2015. As a result of the distribution, we recorded additional net income tax expense of $28 million.

In the fourth quarter of 2015, we recognized an income tax benefit of $39 million related to pre-tax mark-to-market losses of $118 million on our pension and postretirement defined benefit plans. This income tax benefit was generated at a lower average statutory tax rate than our U.S. federal statutory tax rate because it was due, in part, to non-U.S. benefit plans.

Other favorable rate impacting items in 2015 include: resolution of several U.S. state and local tax matters; the extension of favorable U.S. federal tax provisions associated with the Protecting Americans from Tax Hikes Act of 2015 related to research and development tax credits and work opportunity tax credits; and the execution of two bilateral advance pricing agreements. These agreements established intercompany transfer pricing arrangements between the U.S. and certain non-U.S. jurisdictions related to our small package operations for tax years 2010 through 2019.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

As described in the Items Affecting Comparability section, certain items have been excluded from comparisons of "adjusted" income taxes in the discussion that follows.

Our adjusted effective tax rate decreased to 33.8% in 2017 from 34.5% in 2016 primarily due to favorable discrete tax adjustments related to recognition of excess tax benefits related to share-based compensation in income tax expense.

Our adjusted effective tax rate increased to 34.5% in 2016 from 34.0% in 2015 primarily due to a decrease in favorable discrete tax adjustments relative to 2015 partially offset by favorable changes in the proportion of our taxable income in certain U.S. and non-U.S. jurisdictions relative to total pre-tax income.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Liquidity and Capital Resources

As of December 31, 2017, we had $4.069 billion in cash, cash equivalents and marketable securities. We believe that our current cash position, access to the long-term debt capital markets and cash flow generated from operations should be adequate not only for operating requirements but also to enable us to complete our capital expenditure programs and to fund dividend payments, share repurchases and long-term debt payments through the next several years. In addition, we have funds available from our commercial paper program and the ability to obtain alternative sources of financing. We regularly evaluate opportunities to optimize our capital structure, including through issuances of debt to refinance existing debt and to fund ongoing cash needs.

Cash Flows From Operating Activities

The following is a summary of the significant sources (uses) of cash from operating activities (amounts in millions):

	2017				2016				2015
Net Income	$	4,910			$	3,431			$	4,844
Non-cash operating activities(1)	5,776				6,444				4,122
Pension and postretirement plan contributions (UPS-sponsored plans)	(7,794		)		(2,668		)		(1,229		)
Hedge margin receivables and payables	(732		)		(142		)		170
Income tax receivables and payables	(550		)		(505		)		(6		)
Changes in working capital and other non-current assets and liabilities	(178		)		(62		)		(418		)
Other operating activities	47				(25		)		(53		)
Net cash from operating activities	$	1,479			$	6,473			$	7,430

(1)	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 and other non-cash items.

Cash from operating activities remained strong throughout 2015 to 2017. Most of the variability in operating cash flows during the 2015 to 2017 time period relates to the funding of our company-sponsored pension and postretirement benefit plans (and related cash tax deductions). Except for discretionary or accelerated fundings of our plans, contributions to our company-sponsored pension plans have largely varied based on whether any minimum funding requirements are present for individual pension plans.

•	We made discretionary contributions to our three primary company-sponsored U.S. pension plans totaling $7.291, $2.461 and $1.030 billion in 2017, 2016 and 2015, respectively.

•	The remaining contributions from 2015 to 2017 were largely due to contributions to our international pension plans and U.S. postretirement medical benefit plans.

Apart from the transactions described above, operating cash flow was impacted by changes in our working capital position, payments for income taxes and changes in hedge margin payables and receivables. Cash payments for income taxes were $1.559, $2.064 and $1.913 billion for 2017, 2016 and 2015, respectively, and were primarily impacted by the timing of current tax deductions. The net hedge margin collateral (paid)/received from derivative counterparties was $(732), $(142) and $170 million during 2017, 2016 and 2015, respectively, due to settlements and changes in the fair value of the derivative contracts used in our currency and interest rate hedging programs.

As of December 31, 2017, the total of our worldwide holdings of cash, cash equivalents and marketable securities were $4.069 billion, of which approximately $1.800 billion was held by foreign subsidiaries. The amount of cash, cash equivalents and marketable securities held by our U.S. and foreign subsidiaries fluctuates throughout the year due to a variety of factors, including the timing of cash receipts and disbursements in the normal course of business. Cash provided by operating activities in the U.S. continues to be our primary source of funds to finance domestic operating needs, capital expenditures, share repurchases and dividend payments to shareowners. As a result of the Tax Act, all cash, cash equivalents and marketable securities held by foreign subsidiaries are generally available for distribution to the U.S. without any U.S. federal income taxes. Any such distributions may be subject to foreign withholding and U.S. state taxes. When amounts earned by foreign subsidiaries are expected to be indefinitely reinvested, no accrual for taxes is provided.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Cash Flows From Investing Activities

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

	2017				2016				2015
Net cash used in investing activities	$	(4,975	)		$	(2,566	)		$	(5,309	)
Capital Expenditures:
Buildings, facilities and plant equipment	$	(2,954	)		$	(1,316	)		$	(996	)
Aircraft and parts	(789		)		(350		)		(27		)
Vehicles	(924		)		(864		)		(936		)
Information technology	(560		)		(435		)		(420		)
Total Capital Expenditures:	$	(5,227	)		$	(2,965	)		$	(2,379	)
Capital Expenditures as a % of Revenue	7.9		%		4.9		%		4.1		%
Other Investing Activities:
Proceeds from disposals of property, plant and equipment	$	24			$	88			$	26
Net decrease in finance receivables	$	5			$	9			$	5
Net (purchases), sales of marketable securities	$	356			$	908			$	(1,027	)
Cash paid for business acquisitions	$	(134	)		$	(547	)		$	(1,904	)
Other investing activities	$	1			$	(59	)		$	(30	)

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. Future capital spending for anticipated growth and replacement assets will depend on a variety of factors, including economic and industry conditions. We anticipate that our capital expenditures for 2018 will be approximately $6.5 to $7.0 billion.

Capital expenditures on buildings, facilities and plant equipment increased in 2017 compared to the 2015 to 2016 periods in our U.S. and international package businesses, largely due to several facility automation and capacity expansion projects. Capital spending on aircraft increased in 2017 compared to the 2015 to 2016 periods due to contract deposits on open aircraft orders and final payments for new Boeing 747-8F cargo aircraft and previously owned Boeing 767-300 cargo aircraft. Capital spending on vehicles increased in 2017 in our U.S. and international package businesses, largely due to growth in our business and the timing of vehicle replacements. Capital spending on information technology increased in 2017 compared to the 2015 to 2016 periods due to further development of our smart logistics network, technology enhancements and capitalized software projects.

The proceeds from the disposal of property, plant and equipment in the 2015 to 2017 periods were largely due to vehicle retirements in 2017, insurance recoveries in 2016 and real estate sales in 2015. The net decline in finance receivables in 2017 was primarily due to growth in our cargo finance products, partially offset by loan principal paydowns in our business credit portfolio. The net change in finance receivables in the 2016 and 2015 periods was primarily due to customer paydowns and loan sales 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 the periodic rebalancing of investment types and will fluctuate from period to period.

Cash paid for business acquisitions in the 2015 to 2017 periods was primarily related to the acquisitions of Poltraf Sp. z.o.o., Parcel Pro, Inc. and Coyote in 2015; Marken in 2016 and Freightex, Nightline and STTAS in 2017.

Other investing activities are impacted by changes in our non-current investments and restricted cash balances, capital contributions into certain investment partnerships and various other items. In 2017, 2016 and 2015, we increased the non-current investments and restricted cash balance associated with our self-insurance requirements by $4, $3 and $0 million, respectively.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Cash Flows From Financing Activities

Our primary sources (uses) of cash for financing activities were as follows (amounts in millions, except per share data):

	2017				2016				2015
Net cash used in financing activities	$	3,287			$	(3,140	)		$	(1,565	)
Share Repurchases:
Cash expended for shares repurchased	$	(1,813	)		$	(2,678	)		$	(2,702	)
Number of shares repurchased	(16.1		)		(25.4		)		(26.8		)
Shares outstanding at year-end	859				868				886
Percent reduction in shares outstanding	(1.0		)%		(2.0		)%		(2.1		)%
Dividends:
Dividends declared per share	$	3.32			$	3.12			$	2.92
Cash expended for dividend payments	$	(2,771	)		$	(2,643	)		$	(2,525	)
Borrowings:
Net borrowings (repayments) of debt principal	$	7,827			$	2,034			$	3,588
Other Financing Activities:
Cash received for common stock issuances	$	247			$	245			$	249
Other financing activities	$	(203	)		$	(98	)		$	(175	)
Capitalization:
Total debt outstanding at year-end	$	24,289			$	16,075			$	14,334
Total shareowners’ equity at year-end	1,030				429				2,491
Total capitalization	$	25,319			$	16,504			$	16,825

For the years ended December 31, 2017, 2016 and 2015, we repurchased a total of 16.1, 25.2 and 26.8 million shares of class A and class B common stock for $1.816, $2.680 and $2.711 billion, respectively ($1.813, $2.678 and $2.702 billion in repurchases for 2017, 2016 and 2015, respectively, are reported on the cash flow statement due to the timing of settlements). During the first quarter of 2016, we also exercised a capped call option that we entered in 2015 for which we received 0.2 million UPS class B shares. The $25 million premium payment for this capped call option reduced shareowners' equity in 2015.

In May 2016, the Board of Directors approved a share repurchase authorization of $8.0 billion, which replaced an authorization previously announced in 2013. The share repurchase authorization has no expiration date. As of December 31, 2017, we had $4.339 billion of this share repurchase authorization remaining.

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. We anticipate repurchasing approximately $1.0 billion of shares in 2018.

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 expect to continue the practice of paying regular cash dividends. In February 2018, we increased our quarterly dividend payment from $0.83 to $0.91 per share, a 10% increase.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

The following is a summary of debt issuances as of December 31, 2017, 2016 and 2015 (in millions):

	Principal Amount in USD
2017
Fixed-rate senior notes:
2.050% senior notes	$	700
2.350% senior notes	600
2.500% senior notes	1,000
2.800% senior notes	500
3.050% senior notes	1,000
3.750% senior notes	1,150
Floating-rate senior notes (multiple issuances)	1,461
Euro senior notes:
0.375% senior notes (€700)	815
1.500% senior notes (€500)	582
Canadian senior notes:
2.125% senior notes (C$750)	547
Total	$	8,355

	Principal Amount in USD
2016
Fixed-rate senior notes:
2.400% senior notes	$	500
3.400% senior notes	500
Floating-rate senior notes (multiple issuances)	226
Euro senior notes:
1.000% senior notes (€500)	549
Total	$	1,775

	Principal Amount in USD
2015
Facility notes and bonds	$	100
Floating-rate senior notes (multiple issuances)	144
Euro senior notes:
1.625% senior notes (€700)	765
Floating-rate senior notes (€500)	547
Total	$	1,556

The remaining debt issuances for the 2015 to 2017 periods consisted primarily of commercial paper.

Repayment of debt in 2017 consisted primarily of the maturity of our $375 million fixed-rate senior notes that matured on October 1, 2017. In 2016, there were no repayments of fixed-rate senior notes or floating-rate senior notes. Repayments of debt in 2015 consisted primarily of the maturity of our $100 million facility bonds associated with our Philadelphia, Pennsylvania airport facilities. The remaining repayments of debt during the 2015 through 2017 time period included paydowns of commercial paper and scheduled principal payments on our capitalized lease obligations. 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

The amount of commercial paper outstanding fluctuates throughout the year based on daily liquidity needs. The following is a summary of our commercial paper program (amount in millions):

	Functional currency outstanding balance at year-end				Outstanding balance at year-end ($)				Average balance outstanding				Average balance outstanding ($)				Average interest rate
2017
USD	$	2,458			$	2,458			$	2,163			$	2,163			0.88	%
EUR	€	622			$	745			€	941			$	1,062			(0.39	)%
Total					$	3,203

	Functional currency outstanding balance at year-end				Outstanding balance at year-end ($)				Average balance outstanding				Average balance outstanding ($)				Average interest rate
2016
USD	$	2,406			$	2,406			$	1,838			$	1,838			0.44	%
EUR	€	801			$	844			€	776			$	817			(0.28	)%
GBP	£	—			$	—			£	94			$	116			0.50	%
Total					$	3,250

	Functional currency outstanding balance at year-end				Outstanding balance at year-end ($)				Average balance outstanding				Average balance outstanding ($)				Average interest rate
2015
USD	$	2,279			$	2,279			$	2,159			$	2,159			0.13	%
EUR	€	310			$	339			€	10			$	11			(0.09	)%
GBP	£	234			$	347			£	241			$	368			0.50	%
Total					$	2,965

The variation in cash received from common stock issuances was primarily due to the level of stock option exercises by employees in the 2015 through 2017 period.

The cash outflows in other financing activities were impacted by several factors, primarily the repurchase of shares to satisfy tax withholding obligations on vested employee stock awards of $247, $167 and $217 million for 2017, 2016 and 2015, respectively. Net cash inflows (outflows) from the premium payments and settlements of capped call options for the purchase of UPS class B shares were $54 million in both 2017 and 2016, and $(17) million for 2015.

Sources of Credit

See note 8 to the audited consolidated financial statements for a discussion of our available credit and debt covenants.

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 financial condition or liquidity.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Contractual Commitments

We have contractual obligations and commitments in the form of capital leases, operating leases, debt obligations, purchase commitments and certain other liabilities. We intend to satisfy these obligations through the use of cash flow from operations. The following table summarizes the expected cash outflow to satisfy our contractual obligations and commitments as of December 31, 2017 (in millions):

Commitment Type	2018				2019				2020				2021				2022				After 2022				Total
Capital Leases	$	81			$	79			$	69			$	49			$	45			$	500			$	823
Operating Leases	398				305				239				186				138				371				1,637
Debt Principal	3,960				1,009				1,024				2,551				2,000				13,342				23,886
Debt Interest	578				544				510				475				433				5,604				8,144
Purchase Commitments (1)	3,789				2,462				2,428				1,926				323				13				10,941
Tax Act Repatriation Liability	23				25				25				25				25				187				310
Pension Funding	—				—				—				—				—				—				—
Other Liabilities	5				—				—				—				—				—				5
Total	$	8,834			$	4,424			$	4,295			$	5,212			$	2,964			$	20,017			$	45,746

(1) Purchase commitments include our announcement on February 1, 2018 for 14 new Boeing 747-8 freighters and four new Boeing 767 aircraft.

Our capital lease obligations relate primarily to leases on aircraft. Capital leases, operating leases and purchase commitments, as well as our debt principal obligations, are discussed further in note 8 to our consolidated financial statements. The amount of interest on our debt was calculated as the contractual interest payments due on our fixed-rate debt, in addition to interest on variable rate debt that was calculated based on interest rates as of December 31, 2017. The calculations of debt interest take into account the effect of interest rate swap agreements. For debt denominated in a foreign currency, the U.S. Dollar equivalent principal amount of the debt at the end of the year was used as the basis to calculate future interest payments.

Purchase commitments represent contractual agreements to purchase assets, goods or services that are legally binding, including contracts for aircraft, construction of new or expanded facilities and orders for technology equipment and vehicles. As of December 31, 2017, we had firm commitments to purchase 14 new Boeing 747-8F cargo aircraft. The 14 aircraft are to be delivered between 2017 and 2020. On February 1, 2018, we announced an order for 14 additional Boeing 747-8 freighters previously under option and four new Boeing 767 aircraft to be delivered between 2019 and 2022.

On December 22, 2017, the United States enacted into law the Tax Act requiring a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries. Companies may elect to pay the tax over eight years based on an installment schedule outlined in the Tax Act. We intend to make this election and have reflected our estimated transition tax due by year as a contractual obligation.

There are no anticipated required minimum cash contributions to our qualified U.S. pension plans (these plans are discussed further in note 4 to the audited consolidated financial statements). The amount of any minimum funding requirement, as applicable, for these plans could change significantly in future periods, depending on many factors, including future plan asset returns, discount rates and changes to pension plan funding regulations. A decline in discount rates or a sustained significant decline in the world equity or bond markets could result in our domestic pension plans being subject to significantly higher minimum funding requirements. Actual contributions made in future years could materially differ and consequently required minimum contributions beyond 2020 cannot be reasonably estimated.

As discussed in note 5 to the audited consolidated financial statements, we are not currently subject to any minimum contributions or surcharges with respect to the multiemployer pension and health and welfare plans in which we participate. Contribution rates to these multiemployer pension and health and welfare plans are established through the collective bargaining process. As we are not subject to any minimum contribution levels, we have not included any amounts in the contractual commitments table with respect to these multiemployer plans.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

The contractual payments due for “other liabilities” primarily include commitment payments related to our investment in certain partnerships.

The table above does not include approximately $212 million of liabilities for uncertain tax positions because we are uncertain if or when such amounts will ultimately be settled in cash. Uncertain tax positions are further discussed in note 13 to the consolidated financial statements.

As of December 31, 2017, we had outstanding letters of credit totaling approximately $1.084 billion issued in connection with our self-insurance reserves and other routine business requirements. We also issue surety bonds as an alternative to letters of credit in certain instances, and as of December 31, 2017, we had $932 million of surety bonds written. As of December 31, 2017, we had unfunded loan commitments totaling $137 million associated with UPS Capital.

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, for the foreseeable future.

Contingencies

See note 4 to the audited consolidated financial statements for a discussion of pension related matters and note 9 for a discussion of judicial proceedings and other matters arising from the conduct of our business activities.

Collective Bargaining Agreements

Status of Collective Bargaining Agreements

As of December 31, 2017, we had approximately 280,000 employees employed under a national master agreement and various supplemental agreements with local unions affiliated with the Teamsters. These agreements run through July 31, 2018.

We have approximately 2,700 pilots who are employed under a collective bargaining agreement with the Independent Pilots Association ("IPA"), which runs through September 1, 2021.

Our airline mechanics are covered by a collective bargaining agreement with Teamsters Local 2727, which became amendable November 1, 2013. We are currently in negotiations with Teamsters Local 2727. In addition, approximately 3,100 of our auto and maintenance 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”) that will expire on July 31, 2019.

Multiemployer Benefit Plans

We contribute to a number of multiemployer defined benefit and health and welfare plans under terms of collective bargaining agreements that cover our union represented employees. Our current collective bargaining agreements set forth the annual contribution increases allotted to the plans that we participate in, and we are in compliance with these contribution rates. These limitations will remain in effect throughout the terms of the existing collective bargaining agreements.

New Accounting Pronouncements

Recently Adopted Accounting Standards

See note 1 to the audited consolidated financial statements for a discussion of recently adopted accounting standards.

Accounting Standards Issued But Not Yet Effective

See note 1 to the audited consolidated financial statements for a discussion of accounting standards issued, but not yet effective.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America. As indicated in note 1 to our consolidated financial statements, the amounts of assets, liabilities, revenue and expenses reported in our financial statements are affected by estimates and judgments that are necessary to comply with generally accepted accounting principles. We base our estimates on prior experience and other assumptions that we consider reasonable to our circumstances. Actual results could differ from our estimates, which would affect the related amounts reported in our consolidated financial statements. While estimates and judgments are applied in arriving at many reported amounts, we believe that the following matters may involve a higher degree of judgment and complexity.

Contingencies

As discussed in note 9 to our consolidated financial statements, we are involved in various legal proceedings and contingencies. The events that may impact our contingent liabilities are often unique and generally are not predictable. At the time a contingency is identified, we consider all relevant facts as part of our evaluation. We record a liability for a loss when the loss is probable of occurring and reasonably estimable. Events may arise that were not anticipated and the outcome of a contingency may result in a loss to us that differs from our previously estimated liability. These factors could result in a material difference between estimated and actual operating results. Contingent losses that are probable and estimable, excluding those related to income taxes and self-insurance which are discussed further below, were not material to our financial position or results of operations as of, and for the year ended, December 31, 2017. In addition, we have certain contingent liabilities that have not been recognized as of December 31, 2017, because a loss is not reasonably estimable.

Goodwill and Intangible Impairment

We perform impairment testing of goodwill for each of our reporting units on an annual basis. In our U.S. Domestic Package and International Package reporting segments, we have the following reporting units: Europe, Asia, Americas and ISMEA (Indian Subcontinent, Middle East and Africa). In our Supply Chain & Freight segment we have the following reporting units: Forwarding, Logistics, UPS Mail Innovations, UPS Freight, The UPS Store, UPS Capital, Marken and Coyote Logistics. During the third quarter of 2017, we changed the measurement date of our annual goodwill impairment testing from October 1st to July 1st. This change better aligns the timing of the goodwill impairment test with our long-term business planning process. The change was not material to our consolidated financial statements as it did not result in the delay, acceleration or avoidance of an impairment charge. Our annual goodwill impairment testing date is July 1st for each reporting unit owned at the testing date. In assessing goodwill for impairment, we initially evaluate qualitative factors to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the qualitative assessment is not conclusive and it is necessary to calculate the fair value of a reporting unit, then we utilize a two-step process to test goodwill for impairment. First, a comparison of the fair value of the applicable reporting unit with the aggregate carrying value, including goodwill, is performed. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, we perform the second step of the goodwill impairment test to determine the amount of impairment loss. The second step includes comparing the implied fair value of the affected reporting unit’s goodwill with the carrying value of that goodwill.

We primarily determine the fair value of our reporting units using a discounted cash flow model (“DCF model”) and supplement this with observable valuation multiples for comparable companies, as appropriate. The completion of the DCF model requires that we make a number of significant assumptions to produce an estimate of future cash flows. These assumptions include projections of future revenue, costs, capital expenditures and working capital changes. In addition, we make assumptions about the estimated cost of capital and other relevant variables, as required, in estimating the fair value of our reporting units. The projections that we use in our DCF model are updated annually and will change over time based on the historical performance and changing business conditions for each of our reporting units. The determination of whether goodwill is impaired involves a significant level of judgment in these assumptions, and changes in our business strategy, government regulations, or economic or market conditions could significantly impact these judgments. We routinely monitor market conditions and other factors to determine if interim impairment tests are necessary. If impairment indicators are present in future periods, the resulting impairment charges could have a material impact on our results of operations.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

None of the reporting units incurred any goodwill impairment charges in 2017, 2016 or 2015. Changes in our forecasts could cause carrying values of our reporting units to exceed their fair values in future periods, potentially resulting in a goodwill impairment charge. During the year, management monitored the actual performance of the business relative to the fair value assumptions used during our annual goodwill impairment test. For the periods presented, no triggering events were identified that required an interim impairment test. Based on most recent tests, the fair value of all our reporting units substantially exceed their carrying value.

A trade name with a carrying value of $200 million and licenses with a carrying value of $5 million as of December 31, 2017 are considered to be indefinite-lived intangibles, and therefore are not amortized. Impairment tests for indefinite-lived intangibles are performed on an annual basis. We determined that the income approach, specifically the relief from royalty method, is the most appropriate valuation method for the trade name. The estimated fair value of the trade name is compared to the carrying value of the asset. If the carrying value of the trade name exceeds its estimated fair value, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds its fair value. This valuation approach requires that we make a number of assumptions to estimate fair value. These assumptions include projections of future revenues, market royalty rates, tax rates, discount rates and other relevant variables. The projections we use in the model are updated annually and will change over time based on the historical performance and changing business conditions.

All of our remaining recorded intangible assets are deemed to be finite-lived intangibles, and are thus amortized over their estimated useful lives. Impairment tests for these intangible assets are only performed when a triggering event occurs that indicates that the carrying value of the intangible may not be recoverable based on the undiscounted future cash flows of the intangible. If the carrying amount of the intangible is determined not to be recoverable, a write-down to fair value is recorded. Fair values are determined based on a DCF model. If impairment indicators are present in future periods, the resulting impairment charges could have a material impact on our results of operations. There were no impairments of any indefinite-lived or finite-lived intangible assets in 2017, 2016 or 2015.

Self-Insurance Accruals

We self-insure costs associated with workers’ compensation claims, automotive liability, health and welfare and general business liabilities, up to certain limits. Insurance reserves are established for estimates of the loss that we will ultimately incur on reported claims, as well as estimates of claims that have been incurred but not yet reported. Recorded balances are based on reserve levels, which incorporate historical loss experience and judgments about the present and expected levels of cost per claim. Trends in actual experience are a significant factor in the determination of such reserves. We believe our estimated reserves for such claims are adequate, but actual experience in claim frequency and/or severity could materially differ from our estimates and affect our results of operations.

Workers’ compensation, automobile liability and general liability insurance claims may take several years to completely settle. Consequently, actuarial estimates are required to project the ultimate cost that will be incurred to fully resolve the claims. A number of factors can affect the actual cost of a claim, including the length of time the claim remains open, trends in healthcare costs and the results of related litigation. Furthermore, claims may emerge in future years for events that occurred in a prior year at a rate that differs from previous actuarial projections. Changes in state legislation with respect to workers' compensation can affect the adequacy of our self-insurance accruals. All of these factors can result in revisions to prior actuarial projections and produce a material difference between estimated and actual operating results. Prior to 2017, outside actuarial studies were performed semi-annually and we used the studies to estimate the liability in intervening quarters. Beginning in 2017, outside actuarial studies are now performed quarterly as we believe this provides us with better quarterly estimates of our outstanding workers' compensation liability.

We sponsor a number of health and welfare insurance plans for our employees. These liabilities and related expenses are based on estimates of the number of employees and eligible dependents covered under the plans, anticipated medical usage by participants and overall trends in medical costs and inflation. Actual experience may differ from these estimates and, therefore, produce a material difference between estimated and actual operating results.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Pension and Postretirement Medical Benefits

Our pension and other postretirement benefit costs are calculated using various actuarial assumptions and methodologies. These assumptions include discount rates, healthcare cost trend rates, inflation, compensation increase rates, expected returns on plan assets, mortality rates and other factors. The assumptions utilized in recording the obligations under our plans represent our best estimates, and we believe that they are reasonable, based on information as to historical experience and performance as well as other factors that might cause future expectations to differ from past trends.

Differences in actual experience or changes in assumptions may affect our pension and other postretirement obligations and future expense. The primary factors contributing to actuarial gains and losses each year are (1) changes in the discount rate used to value pension and postretirement benefit obligations as of the measurement date, (2) differences between the expected and the actual return on plan assets, (3) changes in demographic assumptions including mortality, (4) participant experience different from demographic assumptions and (5) changes in coordinating benefits with plans not sponsored by UPS.

We recognize changes in the fair value of plan assets and net actuarial gains or losses in excess of a corridor (defined as 10% of the greater of the fair value of plan assets or the plans' projected benefit obligations) in pension expense annually at December 31st each year. The remaining components of pension expense (herein referred to as "ongoing net periodic benefit cost"), primarily service and interest costs and the expected return on plan assets, are reported on a quarterly basis.

The following sensitivity analysis shows the impact of a 25 basis point change in the assumed discount rate, return on assets, and healthcare cost trend rate for our pension and postretirement benefit plans, and the resulting increase (decrease) on our obligations and expense as of, and for the year ended, December 31, 2017 (in millions).

Pension Plans	25 Basis Point Increase				25 Basis Point Decrease
Discount Rate:
Effect on ongoing net periodic benefit cost	$	(49	)		$	50
Effect on net periodic benefit cost for amounts recognized outside the 10% corridor	(616		)		1,492
Effect on projected benefit obligation	(1,883		)		2,007
Return on Assets:
Effect on ongoing net periodic benefit cost(1)	(84		)		84
Effect on net periodic benefit cost for amounts recognized outside the 10% corridor(2)	(37		)		37
Postretirement Medical Plans
Discount Rate:
Effect on ongoing net periodic benefit cost	3				(3		)
Effect on net periodic benefit cost for amounts recognized outside the 10% corridor	(11		)		13
Effect on accumulated postretirement benefit obligation	(62		)		73
Healthcare Cost Trend Rate:
Effect on ongoing net periodic benefit cost	1				(1		)
Effect on net periodic benefit cost for amounts recognized outside the 10% corridor	10				(10		)
Effect on accumulated postretirement benefit obligation	16				(17		)

(1)	Amount calculated based on 25 basis point increase / decrease in the expected return on assets.

(2)	Amount calculated based on 25 basis point increase / decrease in the actual return on assets.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Pension Backstop

UPS was a contributing employer to the Central States Pension Fund ("CSPF") until 2007 when we withdrew from the plan and fully funded our allocable share of unfunded vested benefits by paying a $6.1 billion withdrawal liability. Under a collective bargaining agreement with the International Brotherhood of Teamsters ("IBT"), UPS agreed to provide coordinating benefits in the UPS/IBT Full Time Employee Pension Plan ("UPS/IBT Plan") for UPS participants whose last employer was UPS and who had not retired as of January 1, 2008 ("the UPS Transfer Group") in the event that benefits are lawfully reduced by the CSPF in the future consistent with the terms of our withdrawal agreement with the CSPF.

In December 2014, Congress passed the Multiemployer Pension Reform Act ("MPRA") which for the first time ever allowed multiemployer pension plans to reduce benefit payments to retirees, subject to specific guidelines in the statute and government approval. In September 2015, the CSPF submitted a proposed pension benefit reduction plan to the U.S. Department of the Treasury under the MPRA. The CSPF plan proposed to reduce retirement benefits to the CSPF participants, including the UPS Transfer Group. We vigorously challenged the proposed benefit reduction plan because we believed that it did not comply with the law and the CSPF failed to comply with its contractual obligation to obtain our consent to reduce benefits to the UPS Transfer Group under the terms of the withdrawal agreement with the CSPF. On May 6, 2016, the U.S. Department of the Treasury rejected the proposed plan submitted by the CSPF, stating that it failed to satisfy a number of requirements set forth in the MPRA.

The CSPF has asserted that it will become insolvent in 2025, which could lead to the reduction of retirement benefits. Although there are numerous factors that could affect the CSPF's funding status, if the CSPF were to become insolvent as they have projected, UPS may be required to provide coordinating benefits, thereby increasing the current projected benefit obligation for the UPS/IBT Plan by approximately $4 billion. The CSPF has said that it believes a legislative solution to its funding status is necessary, and we expect that the CSPF will continue to explore options to avoid insolvency.

The potential obligation to pay coordinating benefits from the UPS/IBT Plan is subject to a number of significant uncertainties, including actions that may be taken by the CSPF, the federal government or others. These actions include whether the CSPF will submit a revised pension benefit reduction plan or otherwise seek federal government assistance, the extent to which benefits are paid by the Pension Benefit Guaranty Corporation, our ability to successfully defend our legal positions as well as the effect of discount rates, CSPF asset returns and various other actuarial assumptions.

We account for this potential obligation under Accounting Standards Codification Topic 715- Compensation- Retirement Benefits (“ASC 715”). Under ASC 715 we are required to provide a best estimate of various actuarial assumptions, including the eventual outcome of this matter, in measuring our pension benefit obligation at the December 31st measurement date. While we currently believe the most likely solution to this matter and the broader systemic problems facing multiemployer pension plans is intervention by the federal government, ASC 715 does not permit anticipation of changes in law in making a best estimate of pension liabilities. Our best estimate as of the measurement date of December 31, 2017, does not incorporate this solution. However, if a future change in law resulted in an obligation to provide coordinating benefits under the UPS/IBT Plan, it may be a significant event, and may require us to remeasure the plan assets and projected benefit obligation of the UPS/IBT Plan at the date the law is enacted.

Our best estimate of the next most likely outcome to resolve the CSPF’s solvency concerns is that the CSPF will submit another benefit suspension application under the MPRA to forestall insolvency without reducing benefits to the UPS Transfer Group. If the CSPF attempts to reduce benefits for the UPS Transfer Group under a MPRA filing, we would be in a strong legal position to prevent that from occurring given that these benefits cannot be reduced without our consent and such a reduction, without first exhausting reductions to other groups in the CSPF, would be contrary to the statute. Accordingly, our best estimate as of the measurement date of December 31, 2017, is that there is no liability to be recognized for additional coordinating benefits of the UPS/IBT Plan. However, the projected benefit obligation could materially increase as the uncertainties are resolved. We will continue to assess the impact of these uncertainties on the projected benefit obligation of the UPS/IBT Plan in accordance with ASC 715.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Depreciation, Residual Value and Impairment of Fixed Assets

As of December 31, 2017, we had $22.118 billion of net fixed assets, the most significant category of which is aircraft. In accounting for fixed assets, we make estimates about the expected useful lives and the expected residual values of the assets, and the potential for impairment based on the fair values of the assets and the cash flows generated by these assets.

In estimating the lives and expected residual values of aircraft, we have relied upon actual experience with the same or similar aircraft types. Subsequent revisions to these estimates could be caused by changes to our maintenance program, changes in the utilization of the aircraft, governmental regulations on aging aircraft and changing market prices of new and used aircraft of the same or similar types. We periodically evaluate these estimates and assumptions, and adjust the estimates and assumptions as necessary. Adjustments to the expected lives and residual values are accounted for on a prospective basis through depreciation expense. In estimating cash flows, we project future volume levels for our different air express products in all geographic regions in which we do business. Adverse changes in these volume forecasts, or a shortfall of our actual volume compared with our projections, could result in our current aircraft capacity exceeding current or projected demand. This situation could lead to an excess of a particular aircraft, resulting in an aircraft impairment charge or a reduction of the expected life of an aircraft (thus resulting in increased depreciation expense).

We review long-lived assets for impairment when circumstances indicate the carrying amount of an asset may not be recoverable based on the undiscounted future cash flows of the asset. If the carrying amount of the asset is determined not to be recoverable, a write-down to fair value is recorded. Fair values are determined based on quoted market values, discounted cash flows or external appraisals, as appropriate. We review long-lived assets for impairment at the individual asset or the asset group level for which the lowest level of independent cash flows can be identified. The circumstances that would indicate potential impairment may include, but are not limited to, a significant change in the extent to which an asset is utilized and operating or cash flow losses associated with the use of the asset.

There were no impairment charges on our property, plant and equipment during 2017, 2016 and 2015.

Fair Value Measurements

In the normal course of business, we hold and issue financial instruments that contain elements of market risk, including derivatives, marketable securities, finance receivables, pension assets, other investments and debt. Certain of these financial instruments are required to be recorded at fair value, principally derivatives, marketable securities, pension assets and certain other investments. Fair values are based on listed market prices, when such prices are available. To the extent that listed market prices are not available, fair value is determined based on other relevant factors, including dealer price quotations. Certain financial instruments, including over-the-counter derivative instruments, are valued using pricing models that consider, among other factors, contractual and market prices, correlations, time value, credit spreads and yield curve volatility factors. Changes in the fixed income, foreign exchange and commodity markets will impact our estimates of fair value in the future, potentially affecting our results of operations. A quantitative sensitivity analysis of our exposure to changes in commodity prices, foreign currency exchange rates and interest rates is presented in the “Quantitative and Qualitative Disclosures about Market Risk” section of this report.

We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired customers, technology and trade names from a market participant perspective, useful lives and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Income Taxes

We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of income by legal entity and jurisdiction, tax credits, benefits, and deductions, and in the calculation of deferred tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as tax, interest and penalties related to uncertain tax positions. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period.

We assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that we will ultimately recover a substantial majority of the deferred tax assets recorded on our consolidated balance sheets. However, should there be a change in our ability to recover our deferred tax assets, our tax provision would increase in the period in which we determined that the recovery was not likely.

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. Once it is determined that the position meets the recognition threshold, the second step requires us to estimate and measure the largest amount of tax benefit that is more likely than not to be realized upon ultimate settlement. The difference between the amount of recognizable tax benefit and the total amount of tax benefit from positions filed or to be filed with the tax authorities is recorded as a liability for uncertain tax benefits. It is inherently difficult and subjective to estimate such amounts, as we have to determine the probability of various possible outcomes. We reevaluate uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement could result in the recognition of a tax benefit or an additional charge to the tax provision.

See note 13 to the audited consolidated financial statements for a discussion of impacts of the Tax Act.

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS