UNITED PARCEL SERVICE INC 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview We are on a journey to execute our Customer First, People Led, Innovation Driven strategy within our Better not Bigger framework. We are focused on improving revenue quality, reducing our cost to serve, growing operating profit and allocating capital in a disciplined fashion. The Customer First component of our strategy focuses on, among other things, enhancing the capabilities that we believe our customers value the most: speed and ease of access to our services. The People Led component of our strategy aims to enhance the employee value proposition. Our Innovation Driven strategic approach utilizes technology and automation to deliver sustainable improvements to our network and to enhance the customer experience. We have two reportable segments: U.S. Domestic Package and International Package, which are together referred to as our global small package operations. Our remaining businesses are reported as Supply Chain Solutions. For the year, we increased average daily volume, revenue per piece and operating margin within global small package operations, with growth led by small- and medium-sized businesses ("SMBs") as we executed on our strategy. The COVID-19 pandemic continued to have, and is expected to continue to have, an impact on our business. We experienced a year-over-year increase in commercial volume as business returned to pre-pandemic levels, while business-to-consumer volume declined, partly due to the surge in e-commerce at the onset of the pandemic. In the second half of the year, COVID-19 resulted in a reduction in the number of flights we operated in Asia relative to our expectations, which contributed to an overall decline in international volume in the fourth quarter. Within Supply Chain Solutions, operating margin increased with demand for our services particularly strong in Forwarding and healthcare logistics, including COVID-19 relief efforts. The overall economic environment continues to be challenging. Global supply chain disruption continues, and resulted in capacity constraints that drove higher transportation costs, particularly in our Supply Chain Solutions businesses. Rising inflation and labor market challenges continue to cause wage pressures in certain markets. We continue to monitor the impacts of these external conditions on our business; however, we anticipate that demand for our services will remain strong. During the first quarter of 2021, following enactment of the American Rescue Plan Act ("ARPA"), we remeasured the UPS/IBT Full Time Employee Pension Plan. This resulted in a $3.3 billion pre-tax mark-to-market gain in the first quarter. We completed the divestiture of UPS Freight on April 30, 2021, and used the cash proceeds of $848 million to reduce outstanding indebtedness. We recognized a pre-tax gain of $46 million for the year in respect of this transaction. The divestiture triggered a remeasurement of certain of our U.S. defined benefit pension and postretirement benefit plans, which had only an immaterial impact on results of operations for the year. For additional information on this divestiture, see note 4 to the audited, consolidated financial statements. Following the divestiture, we renamed our Supply Chain & Freight businesses Supply Chain Solutions. In October 2021, we completed the acquisition of Roadie, a technology platform focused on same-day delivery services, for $586 million. The results of Roadie are reported within Supply Chain Solutions. The acquisition did not have a material impact on our results of operations for the year. See note 9 to the audited, consolidated financial statements for additional information on this transaction. 21 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Highlights of our results for the years ended December 31, 2021 and 2020, which are discussed in more detail in the sections that follow, include: Year Ended December 31, Change 2021 2020 $ % Revenue (in millions) $ 97,287 $ 84,628 $ 12,659 15.0 % Operating Expenses (in millions) 84,477 76,944 7,533 9.8 % Operating Profit (in millions) $ 12,810 $ 7,684 $ 5,126 66.7 % Operating Margin 13.2 % 9.1 % Net Income (in millions) $ 12,890 $ 1,343 $ 11,547 859.8 % Basic Earnings Per Share $ 14.75 $ 1.55 $ 13.20 851.6 % Diluted Earnings Per Share $ 14.68 $ 1.54 $ 13.14 853.2 % Operating Days 254 255 Average Daily Package Volume (in thousands) 25,250 24,676 2.3 % Average Revenue Per Piece $ 12.32 $ 10.94 $ 1.38 12.6 % • Revenue increased in all segments, with double digit revenue per piece growth in both U.S. Domestic Package and International Package. • Average daily package volume increases were driven by growth in SMB and business-to-business volume. • Operating expenses increased, primarily driven by fuel and third-party transportation costs. • Operating profit and operating margin increased in global small package and Supply Chain Solutions. • We reported net income of $12.9 billion and diluted earnings per share of $14.68. Adjusted diluted earnings per share was $12.13 after adjusting for the after-tax impacts of: ◦ a gain on the divestiture of UPS Freight of $35 million or $0.04 per diluted share; ◦ transformation strategy costs of $285 million or $0.32 per diluted share; and ◦ a pension mark-to-market gain recognized outside of a 10% corridor of $2.5 billion or $2.83 per share. In the U.S. Domestic Package segment, volume increases were driven by strong growth from SMBs. Revenue and revenue per piece increased through execution of our revenue quality initiatives, with favorable shifts in customer and product mix and base rate increases, as well as increases in fuel and demand-related surcharges. Expenses increased primarily due to higher fuel prices and increases in employee compensation and benefit costs, which were slightly offset by productivity improvements. The International Package segment also experienced volume growth for the year, driven by business-to-business volume. Revenue and revenue per piece increased due to fuel and demand-related surcharges, base rate increases, shifts in customer and product mix and favorable currency movements. Expense increases were primarily due to higher network costs, driven by higher fuel prices, and volume growth, which resulted in additional third-party pickup and delivery expense. In Supply Chain Solutions, the impact of divesting UPS Freight was more than offset by revenue growth from the remaining businesses, primarily Forwarding and Logistics. Forwarding growth was driven by higher volumes in our air and ocean freight businesses and market rate and base pricing increases. Within Logistics, we experienced strong growth in our healthcare operations. Expense increases in Supply Chain Solutions were primarily due to higher third-party transportation costs. 2020 compared to 2019 See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company's Annual Report on Form 10-K for the year ended December 31, 2020 filed with the Securities and Exchange Commission on February 22, 2021. 22 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Supplemental Information - Items Affecting Comparability We supplement the reporting of our financial information determined under generally accepted accounting principles in the United States ("GAAP") with certain non-GAAP financial measures. These include: "adjusted" compensation and benefits; operating expenses; operating profit; operating margin; other income and (expense); income before income taxes; income tax expense; effective tax rate; net income; and earnings per share. Adjusted financial measures may exclude the impact of period over period exchange rate changes and hedging activities, amounts related to mark-to-market gains or losses, transformation and other charges, goodwill and asset impairment charges and divestitures, as described below. We believe that these non-GAAP measures provide additional meaningful information to assist users of our financial statements in more fully understanding our financial results and assessing our ongoing performance, because they exclude items that may not be indicative of, or are unrelated to, our underlying operations, and may provide a useful baseline for analyzing trends in our underlying businesses. These non-GAAP measures are used internally by management for business unit operating performance analysis, business unit resource allocation and in connection with incentive compensation award determinations. Adjusted financial measures should be considered in addition to, and not as an alternative for, our reported results prepared in accordance with GAAP. Our adjusted financial measures do not represent a comprehensive basis of accounting. Therefore, our adjusted financial measures may not be comparable to similarly titled measures reported by other companies. Adjusted amounts reflect the following (in millions): Year Ended December 31, Non-GAAP Adjustments 2021 2020 Operating Expenses: Transformation Strategy Costs $ 380 $ 348 Goodwill and Asset Impairment Charges, and Divestitures (46) 686 Total Adjustments to Operating Expenses $ 334 $ 1,034 Other Income and (Expense): Defined Benefit Plans Mark-to-Market (Gain) Loss $ (3,272) $ 6,484 Total Adjustments to Other Income and (Expense) $ (3,272) $ 6,484 Total Adjustments to Income Before Income Taxes $ (2,938) $ 7,518 Income Tax (Benefit) Expense from Defined Benefit Plans Mark-to-Market $ 784 $ (1,555) Income Tax Benefit from Transformation Strategy Costs (95) (83) Income Tax (Benefit) Expense from Goodwill and Asset Impairment Charges, and Divestitures 11 (57) Total Adjustments to Income Tax Expense $ 700 $ (1,695) Total Adjustments to Net Income $ (2,238) $ 5,823 These items have been excluded from comparisons of "adjusted" compensation and benefits, operating expenses, operating profit, operating margin, other income and (expense), income tax expense and effective tax rate in the discussion that follows. The income tax impacts from transformation and other charges; mark-to-market gains and losses; goodwill and asset impairment charges, and divestitures 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 tax-deductible adjustments. The blended average effective tax rates in 2021 and 2020 were 23.8% and 22.5%, respectively. 23 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Transformation and Other Charges, Goodwill and Asset Impairment Charges, and Divestitures We supplement the presentation of our operating profit, operating margin, income before income taxes, net income and earnings per share with non-GAAP measures that exclude the impact of charges related to transformation activities, goodwill and asset impairment charges and divestitures. For more information regarding transformation activities, see note 19 to the audited, consolidated financial statements. For more information regarding goodwill and asset impairment charges and divestitures, see note 4 to the audited, consolidated financial statements. Changes in Foreign Currency Exchange Rates and Hedging Activities We also supplement the reporting of revenue, revenue per piece and operating profit with adjusted 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 International Package and Supply Chain Solutions on this 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 amounts are then multiplied by the average foreign currency 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 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. Defined Benefit Plans Mark-to-Market Impacts 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 Investment income (expense) and other within Other Income and (Expense) . We supplement the presentation of our income before income taxes, net income and earnings per share with non-GAAP measures that exclude the impact of these gains and losses and the related income tax effects. We believe excluding these mark-to-market impacts provides important supplemental information by removing the volatility associated with short-term changes in market interest rates, equity values and similar factors. Investment income (expense) and other reflects the actual return on plan assets (9.11% in 2021 and 12.54% in 2020) and the discount rate used to measure the projected benefit obligation at the December 31st measurement date (3.11% in 2021 and 2.87% in 2020). Adjusted Investment income (expense) and other utilizes the expected return on plan assets (6.40% in 2021 and 7.70% in 2020) and the discount rate used to determine net periodic benefit cost (2.87% in 2021 and 3.55% in 2020). The remeasurement of our pension and postretirement defined benefit plans' assets and liabilities resulted in a $3.3 billion mark-to-market gain in 2021 and $6.5 billion loss in 2020. 24 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The table below shows the amounts associated with each component of the pre-tax mark-to-market gain (loss), as well as the weighted-average actuarial assumptions used to determine our net periodic benefit cost, for each year: Year Ended December 31, Components of mark-to-market gain (loss) (in millions): 2021 2020 Discount rates $ 1,871 $ (6,540) Return on assets (269) 2,390 Demographic and other assumption changes (97) (381) Coordinating benefits attributable to the Central States Pension Fund 1,767 (1,953) Total mark-to-market gain (loss) $ 3,272 $ (6,484) Year Ended December 31, Weighted-average actuarial assumptions: 2021 2020 Expected rate of return on plan assets 6.40 % 7.70 % Actual rate of return on plan assets 9.11 % 12.54 % Discount rate used for net periodic benefit cost 2.87 % 3.55 % Discount rate at measurement date 3.11 % 2.87 % The pre-tax mark-to-market gains and losses for the years ended December 31, 2021 and 2020 consisted of the following: 2021 - $3.3 billion pre-tax mark-to-market gain: • Discount Rates ($1.9 billion pre-tax gain): This gain was driven by the interim remeasurement of the UPS/IBT Plan in the first quarter of 2021. The weighted-average discount rate for our UPS/IBT Plan increased from 2.98% as of December 31, 2020 to 3.70% as of March 31, 2021, primarily due to an increase in U.S. treasury yields. • Return on Assets ($0.3 billion pre-tax loss): This loss was primarily driven by the interim remeasurement of the UPS/IBT Plan in the first quarter of 2021. As of March 2021, the actual rate of return on the plan assets was approximately 220 basis points lower than our expected rate of return, primarily due to weak global equity and U.S. bond market performance. • Demographic and Other Assumption Changes ($0.1 billion 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. • Coordinating benefits attributable to the Central States Pension Fund ($1.8 billion pre-tax gain): This represents the reduction of the liability for potential coordinating benefits that may be required to be paid related to the Central States Pension Fund. 2020 - $6.5 billion pre-tax mark-to-market loss: • Discount Rates ($6.5 billion pre-tax loss): The weighted-average discount rate for our pension and postretirement medical plans decreased from 3.55% as of December 31, 2019 to 2.87% as of December 31, 2020, primarily due to a decline in U.S. treasury yields that was slightly offset by an increase in credit spreads on AA-rated corporate bonds. • Return on Assets ($2.4 billion pre-tax gain): In 2020, the actual rate of return on plan assets was higher than our expected rate of return, primarily due to strong global equity and U.S. bond market performance. • Demographic and Other Assumption Changes ($0.4 billion 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. • Coordinating benefits attributable to the Central States Pension Fund ($2.0 billion pre-tax loss): This represents our current best estimate of additional potential coordinating benefits that may be required to be paid related to the Central States Pension Fund. 25 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Expense Allocations Certain operating expenses are allocated between our operating 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 would 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. In the first quarter of 2021, we updated our cost allocation methodology for aircraft engine maintenance expense to better align with aircraft utilization by segment. This change resulted in a reallocation of expense from our U.S. Domestic Package segment to our International Package segment of approximately $73 million for the year. Upon the divestiture of UPS Freight, revenue and costs associated with the Ground with Freight Pricing ("GFP") product began to be reported in U.S. Domestic Package. 26 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS U.S. Domestic Package Year Ended December 31, Change 2021 2020 $ % Average Daily Package Volume (in thousands): Next Day Air 2,093 1,987 5.3 % Deferred 1,723 1,783 (3.4) % Ground 17,646 17,371 1.6 % Total Average Daily Package Volume 21,462 21,141 1.5 % Average Revenue Per Piece: Next Day Air $ 18.83 $ 16.82 $ 2.01 12.0 % Deferred 13.36 12.46 0.90 7.2 % Ground 9.92 8.87 1.05 11.8 % Total Average Revenue Per Piece $ 11.06 $ 9.92 $ 1.14 11.5 % Operating Days in Period 254 255 Revenue (in millions): Next Day Air $ 10,009 $ 8,522 $ 1,487 17.4 % Deferred 5,846 5,665 181 3.2 % Ground 44,462 39,312 5,150 13.1 % Total Revenue $ 60,317 $ 53,499 $ 6,818 12.7 % Operating Expenses (in millions): Operating Expenses $ 53,881 $ 49,608 $ 4,273 8.6 % Transformation and Other Charges (281) (237) (44) 18.6 % Adjusted Operating Expenses $ 53,600 $ 49,371 $ 4,229 8.6 % Operating Profit (in millions) and Operating Margin: Operating Profit $ 6,436 $ 3,891 $ 2,545 65.4 % Adjusted Operating Profit $ 6,717 $ 4,128 $ 2,589 62.7 % Operating Margin 10.7 % 7.3 % Adjusted Operating Margin 11.1 % 7.7 % Revenue The change in revenue was due to the following factors: Revenue Change Drivers: Volume Rates / Product Mix Fuel Surcharge Total Revenue Change 2021 vs. 2020 1.1 % 9.2 % 2.4 % 12.7 % Volume Average daily volume increased slightly, driven by SMB customer volume growth of 18% as a result of the continued execution of the Customer First component of our strategy, which was partially offset by a decline in Ground residential volume from our large customers. We anticipate this decline will moderate in 2022 and be offset by growth in Ground residential volume from our SMB customers. We expect overall volume growth levels in 2022 will remain consistent with 2021. 27 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Business-to-consumer shipments represented approximately 60.7% of average daily volume compared to 63.6% in 2020. The decrease in 2021 was attributable to elevated e-commerce spending and a reduction in business-to-business activity in 2020 as a result of the COVID-19 pandemic. Business-to-business shipments increased 9.4%, primarily in our Ground commercial product, as business activity largely recovered from the impacts of the COVID-19 pandemic. Average daily volume in our Next Day Air product increased as a result of the increase in business-to-business activity from SMBs and large customers. Higher residential demand also contributed to the growth in Next Day Air. Deferred volume decreased but remained slightly above pre-pandemic levels, with shifts in customer mix impacting product demand. SurePost average daily volume decreased 10.7%, driven by declines in volume from large customers. Ground commercial volume increased 7.0%, with growth in all customer segments. Rates and Product Mix Overall revenue per piece increased in all customer segments, driven by increases in base rates and the increase in commercial volume discussed above. Revenue per piece was favorably impacted by the growth in SMB volume resulting from continued execution of our strategy, and from demand-related and fuel surcharges. Rates for ground and air services increased an average of 4.9% in December 2020, and our SurePost rates also increased at that time. We anticipate demand-related surcharges will remain largely unchanged in 2022. Revenue per piece for our Next Day Air and Deferred products increased as a result of the factors described above. The increase was slightly offset by the impact of a reduction in average billable weight per piece. Revenue per piece for our Ground product increased due to an increase in average billable weight per piece in addition to the factors described above. We are focused on continuing to grow revenue per piece through execution of our strategy. Fuel Surcharges We apply a fuel surcharge on our domestic air and ground services that is adjusted weekly. 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 2021 2020 2021 vs. 2020 Next Day Air / Deferred 8.1 % 3.9 % 4.2 % Ground 8.6 % 6.6 % 2.0 % While fluctuations in fuel surcharges can be significant from period to period, fuel surcharges are only one of the many individual components of our market pricing strategy that impact our overall revenue and yield. Additional components include the mix of services sold, the base price and additional charges for these services and the pricing discounts offered. Total domestic fuel surcharge revenue increased by $1.3 billion, driven by a significant increase in fuel surcharge indices. We expect the impact of these increases will continue in 2022. Operating Expenses Operating expenses, and operating expenses excluding the year-over-year impact of transformation and other charges, increased, driven by a $1.7 billion increase in the cost of operating our integrated air and ground network and a $1.7 billion increase in pickup and delivery costs. In addition, the cost of package sorting increased $514 million and other indirect operating costs increased by $245 million. The increase in expense was driven by: • Higher fuel costs, primarily attributable to increases in the price of jet fuel, diesel and gasoline, which we expect to persist. • Higher employee benefit expense for our union workforce due to contractual contribution rate increases to multiemployer plans and additional headcount becoming eligible for health, welfare and retirement benefits. 28 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS • Additional compensation expense due to contractual rate increases for our union workforce. Cost of living and wage-rate adjustments driven by inflation and other market factors also drove higher compensation costs. Volume growth also contributed to the increase. These increases were partially offset by productivity improvements. Management payroll increased, primarily due to incentive compensation and commission payments. • Higher third-party transportation costs as a result of our investments to improve time-in-transit within our ground network partially offset by lower third-party carrier costs for SurePost and rail due to lower volumes. • The reallocation of expense for the GFP product following the divestiture of UPS Freight resulted in an increase of $281 million in segment operating expenses. Total cost per piece, and adjusted cost per piece excluding the year-over-year impact of transformation and other charges, increased 7.4%. We anticipate that overall costs and cost per piece may continue to increase during 2022 as a result of contractual cost increases and market factors, including inflation and the availability and cost of labor. We expect this expense growth to moderate in 2022 due to additional operational improvements. Operating Profit and Margin As a result of the factors described above, operating profit increased $2.5 billion, with operating margin increasing 340 basis points to 10.7%. Excluding the year-over-year impact of transformation and other charges, adjusted operating profit increased $2.6 billion, with adjusting operating margin increasing 340 basis points to 11.1%. 29 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS International Package Year Ended December 31, Change 2021 2020 $ % Average Daily Package Volume (in thousands): Domestic 1,988 1,863 6.7 % Export 1,800 1,672 7.7 % Total Average Daily Package Volume 3,788 3,535 7.2 % Average Revenue Per Piece: Domestic $ 7.31 $ 6.65 $ 0.66 9.9 % Export 32.83 28.52 4.31 15.1 % Total Average Revenue Per Piece $ 19.44 $ 16.99 $ 2.45 14.4 % Operating Days in Period 254 255 Revenue (in millions): Domestic $ 3,690 $ 3,160 $ 530 16.8 % Export 15,012 12,159 2,853 23.5 % Cargo & Other 839 626 213 34.0 % Total Revenue $ 19,541 $ 15,945 $ 3,596 22.6 % Operating Expenses (in millions): Operating Expenses $ 14,895 $ 12,509 $ 2,386 19.1 % Transformation and Other Charges (74) (96) 22 (22.9) % Adjusted Operating Expenses $ 14,821 $ 12,413 $ 2,408 19.4 % Operating Profit (in millions) and Operating Margin: Operating Profit $ 4,646 $ 3,436 $ 1,210 35.2 % Adjusted Operating Profit $ 4,720 $ 3,532 $ 1,188 33.6 % Operating Margin 23.8 % 21.5 % Adjusted Operating Margin 24.2 % 22.2 % Currency Translation Benefit / (Cost)—(in millions)*: Revenue $ 402 Operating Expenses (300) Operating Profit $ 102 * Net of currency hedging; amount represents the change compared to the prior year. Revenue The change in revenue was due to the following: Revenue Change Drivers: Volume Rates / Product Mix Fuel Surcharges Currency Total Revenue Change 2021 vs. 2020 6.7 % 8.1 % 5.2 % 2.6 % 22.6 % 30 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Volume Average daily volume increased for both domestic and export products, with growth primarily in the first half of the year. Volume declined in the fourth quarter, largely due to the year-over-year impacts of COVID-19 on consumer behavior. For the year, we experienced growth from both SMBs and large customers, primarily in the retail, manufacturing and technology sectors. Business-to-business volume increased 10.8% as commercial activity largely returned to pre-pandemic levels. Business-to-consumer volume increased 5.1%, with growth primarily in the first quarter when COVID-19 driven volume was not present in the comparative period. We expect overall volume growth to accelerate in 2022. Export volume increased for the year, led by Europe and the Americas, while Asia volume was largely unchanged. Volume growth was strongest on intra-Europe trade lanes, as well as from Europe and the Americas to the United States. Trade between Europe and the United Kingdom declined throughout the year as a result of Brexit, which became effective on January 1, 2021. Asia export volume grew significantly in the first quarter, but was then impacted in the second quarter by a reduction in shipments of personal protective equipment relative to 2020. Additionally, COVID-19 impacts within the region reduced the number of flights operated in the second half of the year. Premium products saw volume growth of 14.9%, driven by Worldwide Express and Transborder Express products. Volume for non-premium products increased 6.9%, driven by growth in our Transborder Standard product. Worldwide Standard volume increased primarily as a result of Brexit, with shipments between the United Kingdom and the European Union that are now subject to duties and taxes shifting from Transborder to Worldwide products. Domestic volume increased for the year in many markets, with the strongest growth in the United Kingdom and Western Europe, largely due to the impact of COVID-19 on business-to-consumer demand. During the fourth quarter, domestic volume declined, driven by a reduction in e-commerce resulting in fewer residential deliveries, that was slightly offset by growth in commercial volume. Rates and Product Mix In December 2020, 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 market. In response to capacity constraints resulting from the COVID-19 pandemic, we began to apply demand-related surcharges on certain lanes in the second quarter of 2020. These surcharges are expected to remain elevated in 2022. Total revenue per piece increased 14.4%, driven by changes in base pricing, fuel and demand-related surcharges and favorable shifts in customer and product mix. Currency movements contributed to the increase in revenue per piece for the year, but had a negative impact in the fourth quarter. Excluding the impact of currency, revenue per piece increased 12.0% for the year. Export revenue per piece increased 15.1% as a result of the factors described above. Excluding the impact of currency movements, export revenue per piece increased 13.2%. Domestic revenue per piece increased 9.9% due to changes in base pricing, fuel surcharges and customer and product mix. Although currency movements negatively impacted revenue per piece in the fourth quarter, they contributed to the increase in revenue per piece for the year. Excluding the impact of currency movements, revenue per piece increased 5.6%. We expect revenue per piece growth to moderate in 2022. Fuel Surcharges The fuel surcharge for international air services originating inside or outside the U.S. is largely indexed to the DOE's Gulf Coast spot price for a gallon of kerosene-type jet fuel. The fuel surcharges for ground services originating outside the U.S. are indexed to fuel prices in the region or country where the shipment originates. While fluctuations can be significant from period to period, fuel surcharges represent one of the many individual components of our market pricing strategy that impact our overall revenue and yield. Additional components include the mix of services sold, the base price and extra service charges and any pricing discounts offered. Total international fuel surcharge revenue increased by $866 million, primarily due to increases in fuel surcharge indices, as well as overall volume growth and changes in customer and product mix. 31 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Operating Expenses Operating expenses, and operating expenses excluding the year-over-year impact of transformation and other charges, increased. The costs of operating our integrated international air and ground network increased $1.2 billion driven by the impact of higher fuel prices and volume growth. We expect these trends to continue in 2022. In addition to variability in usage and market prices, the manner in which we purchase fuel also influences the net impact of costs on our results. The majority of our contracts for fuel purchases utilize index-based pricing formulas plus or minus a fixed locational/supplier differential. While many of the indices are aligned, each index may fluctuate at a different pace, driving variability in the prices paid for fuel. Because of this, our operating results may be affected should the market price of fuel suddenly change by a significant amount or change by amounts that do not result in an adjustment in our fuel surcharges, which can significantly affect our earnings either positively or negatively in the short-term. Pickup and delivery costs increased $718 million, primarily due to volume growth that drove additional third-party transportation expense. Package sorting costs increased $198 million, also as a result of overall volume growth. We anticipate that these operating expenses may continue to increase due to volume growth and external market factors, such as fuel prices and inflation. The remaining increase in operating expenses was due to increases in other indirect operating costs. Operating Profit and Margin As a result of the factors described above, operating profit increased $1.2 billion, with operating margin increasing 230 basis points to 23.8%. Excluding the year-over-year impact of transformation and other charges, adjusted operating profit also increased $1.2 billion, with operating margin increasing 200 basis points to 24.2%. 32 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Supply Chain Solutions Year Ended December 31, Change 2021 2020 $ % Freight Less-Than-Truckload Statistics: Revenue (in millions) $ 881 $ 2,566 $ (1,685) (65.7) % Revenue Per Hundredweight $ 29.93 $ 27.46 $ 2.47 9.0 % Shipments (in thousands) 2,829 8,847 (68.0) % Shipments Per Day (in thousands) 33.3 34.8 (4.3) % Gross Weight Hauled (in millions of lbs) 2,944 9,343 (68.5) % Weight Per Shipment (in lbs) 1,041 1,056 (1.4) % Operating Days in Period 85 254 Revenue (in millions): Forwarding $ 9,872 $ 6,975 $ 2,897 41.5 % Logistics 4,767 4,073 694 17.0 % Freight 1,064 3,149 (2,085) (66.2) % Other 1,726 987 739 74.9 % Total Revenue $ 17,429 $ 15,184 $ 2,245 14.8 % Operating Expenses (in millions): Operating Expenses $ 15,701 $ 14,827 $ 874 5.9 % Transformation Strategy Costs (25) (15) (10) 66.7 % Goodwill, Asset Impairment Charges and Divestitures 46 (686) 732 N/M Adjusted Operating Expenses $ 15,722 $ 14,126 $ 1,596 11.3 % Operating Profit (in millions) and Operating Margins: Operating Profit $ 1,728 $ 357 $ 1,371 384.0 % Adjusted Operating Profit $ 1,707 $ 1,058 $ 649 61.3 % Operating Margin 9.9 % 2.4 % Adjusted Operating Margin 9.8 % 7.0 % Currency Translation Benefit / (Cost)—(in millions)*: Revenue $ 96 Operating Expenses (132) Operating Profit $ (36) * Amount represents the change compared to the prior year. Year Ended December 31, Change 2021 2020 $ % Transformation Strategy Costs (in millions): Forwarding $ 8 $ 8 $ — — % Logistics 5 6 (1) (16.7) % Freight 1 1 — — % Other 11 — 11 N/A Total Transformation Strategy Costs $ 25 $ 15 $ 10 66.7 % On April 30, 2021, we completed the divestiture of UPS Freight. For the year ended December 31, 2021, we recognized a pre-tax gain of $46 million related to this divestiture. See note 4 to the audited, consolidated financial statements for additional information. 33 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Revenue Total revenue for Supply Chain Solutions increased $2.2 billion. Forwarding revenue increased for the year. In our international air freight business, revenue growth was driven by higher volume as a result of strong outbound demand globally. Demand-related surcharges and rate increases also contributed to revenue growth as demand continued to exceed capacity in the market. We expect the elevated level of demand to persist. Ocean freight forwarding revenue increased, driven by Asia-export volume and higher market rates throughout the year. We expect surcharges for ocean freight forwarding to be lower in 2022 relative to 2021 as supply and demand within the market begins to normalize. Revenue in our truckload brokerage business increased due to market rate increases and the continued execution of our strategy, slightly offset by a reduction in volume. Within Logistics, our healthcare operations experienced strong revenue growth across a broad range of customers, including COVID-19 relief efforts. Revenue in our mail services business increased as a result of rate increases and a favorable shift in product characteristics, partially offset by lower volumes. Our other distribution operations experienced year-over-year revenue increases, driven by new business growth. As a result of the divestiture, UPS Freight revenue decreased $2.1 billion for the year. Revenue from the other businesses within Supply Chain Solutions increased, driven by services provided to the acquirer of UPS Freight under certain transition services agreements and by growth in our logistics consulting services, UPS Capital and additional volume from service contracts with the U.S. Postal Service. Operating Expenses Total operating expenses for Supply Chain Solutions, and operating expenses excluding the year-over-year impact of transformation and other charges, increased in 2021. Forwarding operating expenses increased $2.6 billion, driven by an increase in purchased transportation of $2.5 billion. This increase was primarily due to higher market rates across all of our forwarding businesses that were driven by supply constraints and demand-related surcharges, as well as volume growth in our international air freight and ocean freight forwarding businesses. Capacity constraints are expected to persist, resulting in purchased transportation cost remaining elevated. Logistics operating expenses increased $538 million, due to higher purchased transportation expense and operational expense growth in our healthcare operations as a result of COVID-19 relief efforts and strong demand for our healthcare logistics services. Carrier rate increases drove higher expense within mail services and business growth in our other distribution operations also resulted in additional purchased transportation expense. UPS Freight operating expenses decreased $2.8 billion as a result of the divestiture. Expense for the other businesses within Supply Chain Solutions increased, primarily due to higher third-party transportation expense in logistics consulting and transportation and other costs incurred under transition services agreements with the acquirer of UPS Freight. Operating Profit and Margin As a result of the factors described above, total operating profit increased $1.4 billion, with operating margin increasing 750 basis points to 9.9%. Excluding the year-over-year impact of transformation and other charges and other gains, adjusted operating profit increased $649 million, with adjusted operating margin increasing 280 basis points to 9.8%. 34 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Consolidated Operating Expenses Year Ended December 31, Change 2021 2020 $ % Operating Expenses (in millions): Compensation and benefits $ 46,707 $ 44,529 $ 2,178 4.9 % Transformation and Other Charges (206) (211) 5 (2.4) % Adjusted Compensation and benefits 46,501 44,318 2,183 4.9 % Repairs and maintenance 2,443 2,365 78 3.3 % Depreciation and amortization 2,953 2,698 255 9.5 % Purchased transportation 19,058 15,631 3,427 21.9 % Fuel 3,847 2,582 1,265 49.0 % Other occupancy 1,698 1,539 159 10.3 % Other expenses 7,771 7,600 171 2.3 % Total Other expenses 37,770 32,415 5,355 16.5 % Transformation and Other Charges (174) (137) (37) 27.0 % Goodwill, asset impairment charges and divestitures 46 (686) 732 N/M Adjusted Total Other expenses $ 37,642 $ 31,592 $ 6,050 19.2 % Total Operating Expenses $ 84,477 $ 76,944 $ 7,533 9.8 % Adjusted Total Operating Expenses $ 84,143 $ 75,910 $ 8,233 10.8 % Currency (Benefit) / Cost - (in millions)* $ 432 *Amount represents the change in currency translation compared to the prior year. Year Ended December 31, Change 2021 2020 $ % Adjustments to Operating Expenses (in millions): Transformation Strategy Costs: Compensation $ 30 $ 34 $ (4) (11.8) % Benefits 176 177 (1) (0.6) % Other occupancy 3 8 (5) (62.5) % Other expenses 171 129 42 32.6 % Total Transformation Strategy Costs $ 380 $ 348 $ 32 9.2 % Goodwill and asset impairment charges, and divestitures: Other expenses $ (46) $ 686 $ (732) N/M Total Adjustments to Operating Expenses $ 334 $ 1,034 $ (700) (67.7) % 35 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Compensation and Benefits Total compensation and benefits, and total compensation and benefits excluding the year-over-year impact of transformation and other charges, increased in 2021. Total compensation costs, and total compensation costs excluding the year-over-year impact of transformation and other charges, increased $1.0 billion or 3.8%, primarily as a result of: • U.S. Domestic compensation increased $704 million as a result of higher direct labor costs due to contractual rate increases for our union workforce, as well as wage-rate and cost of living adjustments driven by inflation and other market factors. Volume growth drove additional headcount and an increase in average daily union hours, which was partially offset by productivity improvements. • International cost increased $380 million, primarily due to volume growth, as well as the impacts of operational disruption last year that resulted from COVID-19 restrictions. • Management compensation increased $416 million due to salary increases, higher incentive compensation and sales commissions and workforce growth that was primarily from additional part-time positions. • These increases were partially offset by the impact of divesting UPS Freight, which decreased cost by $583 million. Benefits costs increased $1.3 billion. Excluding the year-over-year impact of transformation and other charges, adjusted benefits increased $1.2 billion as a result of: • Health and welfare costs increased $530 million, driven by increased contributions to multiemployer plans resulting from growth in the eligible workforce and contractual rate increases. • Pension and postretirement benefits increased $374 million due to an increase in the overall size of the workforce, increased contributions to multiemployer plans as a result of contractually-mandated rate increases and higher service costs for company-sponsored plans. • Vacation, excused absence, payroll taxes and other expenses increased $212 million, primarily driven by salary increases, increases in the overall size of the workforce and additional discretionary payments to certain employees. • Workers' compensation expense increased $51 million due to an increase in total hours worked and higher claim counts, partially offset by improved claims trends relative to the previous year and lower activity resulting from the divestiture of UPS Freight. Repairs and Maintenance The increase in repairs and maintenance expense was driven by additional aircraft engine maintenance cost, primarily due to the increase in operating activity. Routine repairs and maintenance for buildings and facilities, and maintenance costs for our other transportation equipment, increased slightly. Depreciation and Amortization Depreciation and amortization expense increased as a result of additional operating facilities coming into service and investments in internally developed software, as well as growth in the size of our vehicle and aircraft fleets. Purchased Transportation The increase in purchased transportation expense charged to us by third-party air, ocean and truck carriers was primarily driven by: • Supply Chain Solutions expense increased $2.2 billion, primarily due to market rate and volume increases in our international air freight and ocean freight businesses and rate increases in our truckload brokerage business. These increases were partially offset by the impact of the divestiture of UPS Freight, which reduced third-party transportation costs by $596 million. • International Package expense increased $617 million, primarily due to additional volume being handled by third-party pickup and delivery services in Asia and Europe. Currency movements also negatively impacted expense, primarily in Europe. 36 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS • U.S. Domestic Package expense increased $310 million due to ongoing investments to improve time-in-transit in our U.S. ground network and overall increases in per-shipment costs. These impacts were partially offset by decreases in rail and SurePost volumes for the year. Fuel Higher fuel prices increased expense $1.2 billion. Increases in usage from additional aircraft block hours and miles driven were partly offset by the impact of the divestiture of UPS Freight. Other Occupancy The increase in other occupancy expense, and other occupancy expense excluding the year-over-year impact of transformation and other charges, was due to higher utilities costs, rent and property tax increases and ongoing facility maintenance. Other Expenses Other expenses, and other expenses excluding the year-over-year impact of transformation strategy costs and goodwill, asset impairment charges and divestitures, increased as a result of: • Other operational expenses, including vehicle and equipment rentals, increased $214 million, primarily driven by business growth. • The cost of business services that support our operating segments increased $129 million, driven by business growth and the expansion of services provided. • Customer claims increased $108 million, driven by changes to our claims policy, which resulted in higher claims for lost packages. • Other increases included the cost of goods provided under transitional service agreements to the acquirer of UPS Freight, information technology expenses, payment processing fees and the write down of certain construction in progress activities. These increases were partially offset by reductions in self-insured automobile liability claims due to improvements in claims experience, a reduction in our allowance for credit losses and a reduction in purchases of COVID-related safety and cleaning supplies. 37 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Other Income and (Expense) The following table sets forth investment income (expense) and other and interest expense for the years ended December 31, 2021 and 2020 (in millions): Year Ended December 31, Change 2021 2020 $ % Investment Income (Expense) and Other $ 4,479 $ (5,139) $ 9,618 N/M Defined Benefit Plans Mark-to-Market (Gain) Loss (3,272) 6,484 (9,756) N/M Adjusted Investment Income (Expense) and Other $ 1,207 $ 1,345 $ (138) (10.3) % Interest Expense (694) (701) 7 (1.0) % Total Other Income and (Expense) $ 3,785 $ (5,840) $ 9,625 N/M Adjusted Other Income and (Expense) $ 513 $ 644 $ (131) (20.3) % Investment Income (Expense) and Other Investment and other income increased $9.6 billion, primarily due to a net $3.3 billion mark-to-market gain from remeasurements of our defined benefit plans in 2021 compared to a $6.5 billion loss in 2020. Excluding the impact of these mark-to-market gains and losses, adjusted investment and other income decreased $138 million, driven by a decrease in other pension income which includes expected returns on pension assets, net of interest cost on projected benefit obligations and prior service costs. • Expected returns on pension assets decreased due to a reduction in our expected rate of return assumption. This was partially offset by a higher asset base due to discretionary contributions and positive asset returns in 2020. • Pension interest cost decreased, driven by a reduction in projected benefit obligations following interim plan remeasurements. The interim plan remeasurements were triggered by the signing into law of the ARPA in March 2021 and by the divestiture of UPS Freight in April 2021. We also experienced a reduction in prior service cost. The remaining items in other income decreased due to foreign currency losses, partially offset by net gains from certain non-current investments. Interest Expense Interest expense for the year decreased due to lower average outstanding debt balances and lower effective interest rates on floating rate debt and commercial paper, partially offset by a reduction in capitalization of interest. 38 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, 2021 and 2020 (in millions): Year Ended December 31, Change 2021 2020 $ % Income Tax Expense: $ 3,705 $ 501 $ 3,204 639.5 % Income Tax Impact of: Defined Benefit Plans Mark-to-Market (784) 1,555 (2,339) N/M Transformation Strategy Costs 95 83 12 14.5 % Goodwill, Asset Impairment Charges and Divestitures (11) 57 (68) N/M Adjusted Income Tax Expense $ 3,005 $ 2,196 $ 809 36.8 % Effective Tax Rate 22.3 % 27.2 % Adjusted Effective Tax Rate 22.0 % 23.5 % For additional information on income tax expense and our effective tax rate, see note 16 to the audited, consolidated financial statements. 39 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, 2021, we had $10.6 billion in cash, cash equivalents and marketable securities. We believe that these positions, expected cash from operations, access to commercial paper programs and capital markets and other available liquidity options will be adequate to fund our material short- and long-term cash requirements, including our business operations, planned capital expenditures and pension contributions, transformation strategy costs, debt obligations and planned shareowner returns. We regularly evaluate opportunities to optimize our capital structure, including through issuances of debt to refinance existing debt and to fund operations. We deploy a disciplined and balanced approach to capital allocation, including returns to shareowners through dividends and share repurchases. Cash Flows From Operating Activities The following is a summary of the significant sources (uses) of cash from operating activities (in millions): 2021 2020 Net income $ 12,890 $ 1,343 Non-cash operating activities (a) 3,335 11,181 Pension and postretirement benefit plan contributions (company-sponsored plans) (576) (3,125) Hedge margin receivables and payables 272 (507) Income tax receivables and payables 170 205 Changes in working capital and other non-current assets and liabilities (1,106) 1,383 Other operating activities 22 (21) Net cash from operating activities $ 15,007 $ 10,459 (a) Represents depreciation and amortization, gains and losses on derivative transactions and foreign currency exchange, deferred income taxes, allowances for expected credit losses, amortization of operating lease assets, pension and postretirement benefit plan (income) expense, stock compensation expense, changes in casualty self-insurance reserves, goodwill and other asset impairment charges and other non-cash items. Net cash from operating activities increased $4.5 billion year to date, primarily due to improved performance. Additional impacts included: • Contributions to our company-sponsored pension and U.S. postretirement medical benefit plans totaled $576 million and $3.1 billion in 2021 and 2020, respectively. This included discretionary contributions of $200 million and $2.8 billion, respectively. • Our net hedge margin collateral position increased by $779 million due to changes in the fair value of derivative contracts used in our currency and interest rate hedging programs. • Cash payments for income taxes were $1.9 billion and $1.1 billion for 2021 and 2020, respectively, with changes primarily driven by an increase in income. • During 2020, our working capital benefited from a one-time deferral of employer payroll taxes of approximately $1.1 billion under the CARES Act. During the fourth quarter of 2021, we paid $577 million of these deferred employer payroll taxes. Other changes in working capital were driven by business growth and the timing of duty and tax settlements. As part of our ongoing efforts to improve our working capital efficiency, certain financial institutions offer a Supply Chain Finance ("SCF") program to certain of our suppliers. We agree to commercial terms with our suppliers, including prices, quantities and payment terms, regardless of whether the supplier elects to participate in the SCF program. Suppliers issue invoices to us based on the agreed-upon contractual terms. If they participate in the SCF program, our suppliers, at their sole discretion, determine which invoices, if any, to sell to the financial institutions. Our suppliers’ voluntary inclusion of invoices in the SCF program has no bearing on our payment terms. No guarantees are provided by us under the SCF program. We have no economic interest in a supplier’s decision to participate, and we have no direct financial relationship with the financial institutions, as it relates to the SCF program. 40 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Amounts due to our suppliers that participate in the SCF program are included in Accounts payable in our consolidated balance sheets. We have been informed by the participating financial institutions that as of December 31, 2021 and 2020, suppliers sold them $545 and $639 million, respectively, of our outstanding payment obligations. Amounts due to suppliers that participate in the SCF program may be reflected in cash flows from operating activities or cash flows from investing activities in our consolidated statements of cash flows. The amounts settled through the SCF program were approximately $1.7 and $1.8 billion for the years ended December 31, 2021 and 2020, respectively. As of December 31, 2021, approximately $3.1 billion of our total worldwide holdings of cash, cash equivalents and marketable securities were 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, pension contributions and dividend payments to shareowners. 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. 41 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 from investing activities for the years ended December 31, 2021 and 2020 were as follows (in millions): 2021 2020 Net cash used in investing activities $ (3,818) $ (5,283) Capital Expenditures: Buildings, facilities and plant equipment $ (1,635) $ (2,460) Aircraft and parts (1,185) (1,145) Vehicles (807) (1,002) Information technology (567) (805) Total Capital Expenditures (1) : $ (4,194) $ (5,412) Capital Expenditures as a % of revenue 4.3 % 6.4 % Other Investing Activities: Proceeds from disposals of businesses, property, plant and equipment $ 872 $ 40 Net change in finance receivables $ 34 $ 44 Net (purchases), sales and maturities of marketable securities $ 54 $ 106 Cash paid for business acquisitions, net of cash and cash equivalents acquired $ (602) $ (20) Other investing activities $ 18 $ (41) (1) In addition to capital expenditures of $4.2 and $5.4 billion in 2021 and 2020, respectively, there were capital expenditures relating to principal repayments of finance lease obligations of $208 and $192 million, respectively. These are included in cash flows from financing activities. 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. Future capital spending for anticipated growth and replacement assets will depend on a variety of factors, including economic and industry conditions. Our current investment program anticipates investments in technology initiatives and enhanced network capabilities, including over $1 billion of projects to support our environmental sustainability goals. It also provides for maintenance of buildings, facilities and plant equipment and replacement of certain aircraft within our fleet. We currently expect that our capital expenditures will be approximately $5.5 billion in 2022, of which approximately 60 percent will be allocated to expansion projects. In 2021, capital expenditures on buildings, facilities and operating equipment decreased in our global small package business, as we reduced spending on facility expansion projects. Capital spending on aircraft increased slightly as final payments associated with the delivery of aircraft were largely offset by reductions in contract deposits on open aircraft orders. Capital expenditures on information technology decreased due to the timing of projects. Proceeds from the disposal of businesses, property, plant and equipment increased as we completed the divestiture of UPS Freight for cash proceeds of $848 million in the second quarter. The proceeds were used to reduce outstanding indebtedness. The net change in finance receivables was primarily due to reductions in outstanding balances within our finance portfolios. 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 2021 was primarily attributable to the acquisition of Roadie and the purchase of development areas for The UPS Store. Cash paid for business acquisitions in 2020 related to the purchase of development areas for The UPS Store. Other investing activities were impacted by changes in our non-current investments, purchase contract deposits and various other items. 42 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): 2021 2020 Net cash used in financing activities $ (6,823) $ (4,517) Share Repurchases: Cash paid to repurchase shares $ (500) $ (224) Number of shares repurchased (2.6) (2.1) Shares outstanding at period end 870 865 Percent increase (decrease) in shares outstanding 0.6 % 0.9 % Dividends: Dividends declared per share $ 4.08 $ 4.04 Cash paid for dividends $ (3,437) $ (3,374) Borrowings: Net borrowings (repayments) of debt principal $ (2,773) $ (851) Other Financing Activities: Cash received for common stock issuances $ 251 $ 285 Other financing activities $ (364) $ (353) Capitalization: Total debt outstanding at year end $ 21,915 $ 24,654 Total shareowners’ equity at year end 14,269 669 Total capitalization $ 36,184 $ 25,323 We repurchased 2.6 million shares of class B common stock for $500 million under our stock repurchase program in 2021. We repurchased 2.1 million shares of class A and class B common stock for $217 million in 2020 ($224 million in repurchases is reported on the statement of cash flows for 2020 due to the timing of settlements). For additional information on our share repurchase activities, see note 13 to the audited, consolidated financial statements. For the years ended December 31, 2021 and 2020, dividends reported within shareowners' equity include $167 and $178 million, respectively, of non-cash dividends that were settled in shares of class A common stock. The declaration of dividends is subject to the discretion of the Board and depends on various factors, including our net income, financial condition, cash requirements, future prospects and other relevant factors. In the first quarter of 2022, we increased our quarterly dividend from $1.02 to $1.52 per share. 43 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Issuances of debt in 2021 consisted of short-term borrowings under our commercial paper program, of which none remained outstanding as of December 31, 2021. Issuances of debt in 2020 consisted of borrowings under our commercial paper program and issuances of fixed-rate senior notes as follows (in millions): Principal Amount in USD 2020 Fixed-rate senior notes: 3.900% senior notes $ 1,000 4.450% senior notes 750 5.200% senior notes 500 5.300% senior notes 1,250 Total $ 3,500 Repayments of debt in 2021 included our $1.5 billion 3.125% senior notes, our $700 million 2.050% senior notes and our $350 million floating rate senior notes. We also reduced our commercial paper balances and made scheduled principal payments on our finance lease obligations. Repayments of debt in 2020 included our $424 million 8.375% debentures and our €500 million floating rate senior notes. We also paid down commercial paper balances and made scheduled principal payments on our finance lease obligations. We have $2.0 billion of fixed and floating rate notes that mature in 2022. We may repay these amounts when due with cash generated from operations or other borrowings, depending on various factors. We consider the overall fixed and floating interest rate mix of our portfolio and the related overall cost of borrowing when planning for future issuances and non-scheduled repayments of debt. The amount of commercial paper outstanding fluctuates throughout the year based on daily liquidity needs. The following is a summary of our commercial paper program (in millions): Functional currency outstanding balance at year end Outstanding balance at year end ($) Average balance outstanding Average balance outstanding ($) Average interest rate 2021 USD $ — $ — $ 151 $ 151 0.05 % Total $ — Functional currency outstanding balance at year end Outstanding balance at year end ($) Average balance outstanding Average balance outstanding ($) Average interest rate 2020 USD $ 15 $ 15 $ 1,426 $ 1,426 0.78 % EUR € — $ — € 432 $ 493 (0.39) % Total $ 15 As of December 31, 2021, we had no outstanding balances under our U.S. and European commercial paper program. Except as disclosed in note 10 to the audited, consolidated financial statements, we do not have guarantees or other off-balance sheet financing arrangements, including variable interest entities, which we believe could have a material impact on our financial condition or liquidity. The variation in cash received from common stock issuances was driven by the number of stock options exercised by employees and movements in other employee-related plans in 2021 and 2020. Other financing activities includes cash used to repurchase shares to satisfy tax withholding obligations on vested stock awards of $358 and $340 million in 2021 and 2020, respectively. The increase in cash used was driven by changes in payment levels for certain of our awards. 44 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Sources of Credit See note 10 to the audited, consolidated financial statements for a discussion of our available credit and debt covenants. Contractual Commitments We have material cash requirements for known contractual obligations and commitments in the form of finance leases, operating leases, debt obligations, purchase commitments and certain other liabilities that are disclosed in the notes to the audited, consolidated financial statements and discussed below. We expect to fund these obligations and other discretionary payments, including expected returns to shareowners, primarily through cash from operations. We anticipate making discretionary contributions to our company-sponsored U.S. pension and postretirement benefit plans of approximately $1.9 billion in 2022, which are included within Expected employer contributions to plan trusts shown in note 6 to the audited, consolidated financial statements. There are currently no anticipated required minimum cash contributions to our qualified U.S. pension plans. The amount of any minimum funding requirement, as applicable, for these plans could change significantly in future periods depending on many factors, including plan asset returns, discount rates, other actuarial assumptions, changes to pension plan funding regulations and the discretionary contributions that we make. Actual contributions made in future years could materially differ and consequently required minimum contributions beyond 2022 cannot be reasonably estimated. As discussed in note 7 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. We have outstanding letters of credit and surety bonds that are discussed in note 10 to the audited, consolidated financial statements. Additionally, we have $2.0 billion of fixed- and floating-rate senior notes that mature in 2022. We may repay these amounts when due with cash generated from operations or other borrowings, depending on various factors. Annual principal payments on our long-term debt, estimated debt interest obligations and purchase commitments are also set out in note 10. Included within purchase commitments as disclosed in note 10, we have firm commitments to purchase two new Boeing 747-8F aircraft to be delivered in 2022 and 19 new Boeing 767-300 aircraft to be delivered between 2023 and 2025. We have an option to purchase an additional 8 new Boeing 767-300 aircraft for delivery in 2025 and 2026 which are not reflected in our purchase commitments. Our finance lease obligations, including purchase options that are reasonably certain to be exercised, relate primarily to leases on aircraft and real estate. These obligations, together with our obligations under operating leases are set out in note 12 to the audited, consolidated financial statements. Under provisions of the Tax Cuts and Jobs Act (the "Tax Act"), we elected to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries over eight years through 2025. Additionally, we have uncertain tax positions that are further discussed in note 16 to the audited, consolidated financial statements. In 2022, we will pay $558 million of employer payroll taxes that we deferred under the CARES Act. Contingencies See note 6 to the audited, consolidated financial statements for a discussion of pension related matters and note 11 to the audited, consolidated financial statements for a discussion of judicial proceedings and other matters arising from the conduct of our business activities. 45 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Collective Bargaining Agreements Status of Collective Bargaining Agreements See note 7 to the audited, consolidated financial statements for a discussion of the status of collective bargaining agreements. Multiemployer Benefit Plans We contribute to a number of multiemployer pension and health and welfare plans under the terms of collective bargaining agreements that cover our union represented employees. These agreements set forth the annual contribution rate increases for the plans that we participate in. 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. Rate Adjustments From time to time we adjust published rates applicable to our services. These rates, when published, are made available on our website at www.ups.com . We provide the address to our internet site solely for information. We do not intend for this address to be an active link or to otherwise incorporate the contents of any website into this or any other report we file with the Securities and Exchange Commission. 46 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Critical Accounting Estimates 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 GAAP. We base our estimates on prior experience, current trends, various other assumptions and third-party input that we consider reasonable to our circumstances. Actual results could differ materially 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 critical accounting estimates involve a higher degree of judgment and complexity. Contingencies From time to time, we are involved in various legal proceedings and have exposure to various other contingent obligations. 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 apply judgment when establishing a range of reasonably possible losses for our contingencies. Our judgment is influenced by our understanding of information currently available for legal actions and potential outcomes of these actions, including the advice from our internal counsel, external counsel and senior management . We record a liability for a loss when the loss is probable of occurring and reasonably estimable. For such accruals, we record the amount we consider to be the best estimate within a range of potential losses; however, when there appears to be a range of equally possible losses, our accrual is based on the low-end of this range. The likelihood of a loss with respect to a particular contingency is often difficult to predict and determining a reasonable estimate of the loss or a range of loss may not be practicable based on the information available. Additionally, events may arise that were not anticipated and, as a result, the outcome of a contingency may result in a loss that differs materially from our previously estimated liability. Except as disclosed in note 11 to the audited, consolidated financial statements, contingent losses that were probable and estimable were not material to our financial position or results of operations as of, or for the year ended, December 31, 2021. In addition, we have certain contingent liabilities that have not been recognized as of, or for the year ended, December 31, 2021, because a loss was not reasonably estimable. Obligations relating to income taxes and self-insurance are discussed below. Goodwill and Intangible Asset Impairments We assess goodwill for impairment at the reporting unit level. The determination of reporting units requires judgment, and if we changed the definition of our reporting units, it is possible that we would have reached different conclusions when performing our impairment tests. 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, we quantitatively assess the fair value of a reporting unit to test goodwill for impairment. This assessment uses a combination of income and market approaches: • The income approach uses a discounted cash flow (“DCF”) model, which requires us to make a number of significant assumptions to produce an estimate of future cash flows. These assumptions include projections of future revenue, costs, capital expenditures, working capital and the cost of capital. We are also required to make assumptions relating to our overall business and operating strategy, and the regulatory and market environment. Changes in any of these assumptions could significantly impact the fair value of any one 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 market approach uses observable market data of comparable public companies to estimate fair value utilizing financial metrics (such as enterprise value to net sales). We apply judgment to select appropriate comparison companies based on the business operations, size and operating results of our reporting units. Changes to our selection of comparable companies may result in changes to the estimates of fair value of our reporting units. For reporting units tested using a quantitative model during 2021, we concluded the fair value of each reporting unit exceeded its carrying value by more than 10 percent. Our truckload brokerage reporting unit was most sensitive to changes in valuation assumptions. The ratio of excess fair value of this reporting unit to its carrying value would decrease by approximately one percentage point if the cost of capital increased by ten basis points. 47 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Goodwill impairment charges could have a material impact on our results of operations. None of our reporting units incurred any goodwill impairment charges in 2021. During 2020, we recognized a goodwill impairment charge of $494 million in our UPS Freight reporting unit in conjunction with our evaluation of assets held for sale, which is discussed in note 4 to the audited, consolidated financial statements. We evaluate the indefinite-lived trade name associated with our truckload brokerage business for impairment using the relief from royalty method. This valuation approach requires that we make a number of assumptions to estimate fair value, including 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. If the carrying value of the trade name exceeds its estimated fair value, an impairment charge would be recognized for the excess amount. Our annual impairment test for the current year indicated that the fair value of the indefinite-lived trade name remained greater than its carrying value, although this excess was less than 10 percent. Our valuation estimate was most sensitive to changes in royalty rates and the cost of capital. The ratio of excess fair value to carrying value would decrease by approximately one percentage point if the royalty rate decreased by five basis points or the cost of capital increased by ten basis points. Our truckload brokerage business has been negatively impacted by increases in the market rates at which it purchases transportation, which has in turn negatively impacted its operating margins. Business performance below current forecasts or unfavorable changes in valuation assumptions, such as a lower royalty rate or higher cost of capital, could result in an impairment of the trade name in the future. Our finite-lived intangible assets are amortized over their estimated useful lives. Impairment tests for these assets are only performed when a triggering event occurs that indicates that the carrying value of the intangible may not be recoverable based on its undiscounted future cash flows. If the carrying amount of the intangible is determined not to be recoverable, a write-down to fair value is recorded. Fair values are estimated using a DCF model. If impairment indicators are present, the resulting impairment charges could have a material impact on our results of operations. See note 8 to the audited, consolidated financial statements for details of finite-lived intangible asset impairments. Self-Insurance Accruals We base self-insurance reserves on actuarial estimates, which are determined, with the assistance of third-party actuaries, through a complex process that includes the application of various actuarial methods and assumptions. The process incorporates actual loss experience and judgments about expected future development based on historical experience, recent and projected trends in claim frequency and severity, and changes in claims handling practices, among other factors. Workers’ compensation, automobile liability and general liability insurance claims may take several years to resolve. Consequently, actuarial estimates are required to project the ultimate cost that will be incurred to resolve a claim. Several factors can affect the actual cost, or severity, of a claim, including the length of time the claim remains open, trends in healthcare costs, the results of any related litigation and changes in legislation. Furthermore, claims may emerge in a future year for events that occurred in a prior policy period at a rate that differs from actuarial projections. All these factors can result in revisions to actuarial projections and produce a material difference between estimated and actual operating results. We increased our total reserves related to prior year claims by $34 million and $169 million in 2021 and 2020, respectively. Due to the complexity and inherent uncertainty associated with the estimation of our workers’ compensation, automobile and general liability claims, the third-party actuary develops a range of expected losses. We believe our estimated reserves for such claims are adequate; however, actual experience in claim frequency and/or severity of a claim could materially differ from our estimates and affect our results of operations. We also sponsor several health and welfare insurance plans for our employees. Liabilities and expenses related to these plans are based on estimates of the number of employees and eligible dependents covered under the plans, global health events, anticipated utilization by participants and overall trends in medical costs and inflation. We believe our estimates are reasonable and appropriate. Actual experience may differ materially from these estimates and, therefore, produce a material difference between estimated and actual operating results. 48 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Self-insurance reserves as of December 31, 2021 and 2020 were as follows (in millions): 2021 2020 Current self-insurance reserves $ 1,048 $ 1,085 Non-current self-insurance reserves (1) 1,855 1,619 Total self-insurance reserves $ 2,903 $ 2,704 (1) Included within Other Non-Current Liabilities in the consolidated balance sheets. A five percent reduction or improvement in the assumed claim severity and claim frequency rates used to estimate our self-insurance reserves would result in an increase or decrease of approximately $290 million, respectively, in our reserves and expenses as of, and for the year ended, December 31, 2021. Pension and Other Postretirement Medical Benefits Our pension and other postretirement medical benefit costs are calculated using various actuarial assumptions and methodologies. These assumptions include discount rates, healthcare cost trend rates, inflation, compensation increases, expected returns on plan assets, mortality rates, regulatory requirements 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 expenses. The primary factors contributing to actuarial gains and losses each year are: • Changes in the discount rate used to value pension and postretirement benefit obligations as of the measurement date; • Differences between expected and the actual return on plan assets; • Changes in demographic assumptions including mortality; • Differences in participant experience from demographic assumptions; and • 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 upon remeasurement of a plan. The remaining components of pension expense (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. 49 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following sensitivity analysis shows the impact of a 25 basis point change in the assumed discount rate and return on assets for our pension and postretirement benefit plans, and the resulting increase (decrease) in our obligations and expense as of, and for the year ended, December 31, 2021 (in millions): Pension Plans 25 Basis Point Increase 25 Basis Point Decrease Discount Rate: Effect on ongoing net periodic benefit cost $ (41) $ 41 Effect on net periodic benefit cost for amounts recognized outside the 10% corridor (210) 447 Effect on projected benefit obligation (2,498) 2,662 Return on Assets: Effect on ongoing net periodic benefit cost (1) (134) 134 Effect on net periodic benefit cost for amounts recognized outside the 10% corridor (2) $ — $ — Postretirement Medical Plans Discount Rate: Effect on ongoing net periodic benefit cost $ 4 $ (4) Effect on net periodic benefit cost for amounts recognized outside the 10% corridor (32) 58 Effect on accumulated postretirement benefit obligation (54) 64 Healthcare Cost Trend Rate: Effect on ongoing net periodic benefit cost — — Effect on net periodic benefit cost for amounts recognized outside the 10% corridor 11 (12) Effect on accumulated postretirement benefit obligation $ 12 $ (14) (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. Refer to note 6 to the audited, consolidated financial statements for information on our potential liability for coordinating benefits related to the Central States Pension Fund. Depreciation, Residual Value and Impairment of Fixed Assets As of December 31, 2021, we had $33.5 billion of net fixed assets, the most significant category of which was aircraft. In accounting for fixed assets, we make estimates of the expected useful lives and residual values. We evaluate the useful lives of our property, plant and equipment based on our usage, maintenance and replacement policies, and taking into account physical and economic factors that may affect the useful lives of the assets. Our accounting policy for long-lived assets is set out in note 1 to the audited, consolidated financial statements. In estimating the useful lives and expected residual values of aircraft, we consider actual experience with the same or similar aircraft types and future volume projections for our air products. Adverse changes in volume forecasts, or a shortfall in 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 impairment charge or a reduction of the expected useful life of an aircraft that may result in increased depreciation expense. Revisions to estimates of useful lives and residual values could also be caused by changes to our maintenance programs, 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 them as necessary. Adjustments are accounted for on a prospective basis through depreciation expense. We monitor our long-lived assets for indicators of impairment which 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. If circumstances are present that indicate the carrying value of our long-lived assets may not be recoverable, we then perform impairment testing at the asset group level. 50 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Asset groups represent the lowest level at which independent cash flows can be identified. Determining the asset group requires judgment and changes in the way asset groups are defined could have material impact to the results of impairment testing. We perform recoverability testing by comparing the undiscounted cash flows of the asset group to the carrying value of the asset group. 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. Details of long-lived asset impairments are included in note 5 to the audited, consolidated financial statements. 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. These financial instruments are measured and reported at fair value on a recurring basis based upon a fair value hierarchy (Levels 1, 2 and 3). Fair values are based on listed market prices (Level 1), 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 (Level 2). If listed market prices or other relevant factors are not available, inputs are developed from unobservable data reflecting our own assumptions and include situations where there is little or no market activity for the asset or liability (Level 3). 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 currency exchange and commodity markets will impact our estimates of fair value in the future, potentially affecting our results of operations. Further information on our accounting polices relating to fair value measurements can be found in note 1 to the audited, consolidated financial statements. As of December 31, 2021, the majority of our financial instruments were categorized as either Level 1 or Level 2. Refer to notes 3, 10 and 18 to the audited, consolidated financial statements for further information on these instruments. 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. Within our pension assets, we hold investments in hedge, risk parity, private debt, private equity and real estate funds which are primarily measured using net asset value ("NAV") as a practical expedient for fair value, as appropriate. These investments were valued at $9.6 billion as of December 31, 2021. In order to estimate NAV, we evaluate audited and unaudited financial reports from fund managers and make adjustments for investment activity between the date of the financial reports and December 31st. These investments are not actively traded, and their values can only be estimated using these assumptions. If our estimates of activity changed, this could have a material impact on the reported value of these investments and on the return on assets that we report. Refer to note 6 to the audited, consolidated financial statements for further information on our pension assets. Certain non-financial assets and liabilities are measured at fair value on a nonrecurring basis, including property, plant, and equipment, goodwill and intangible assets. These assets are subject to fair value adjustments in certain circumstances, such as when there is evidence of an impairment or when an asset or disposal group is classified as held for sale. In accounting for business acquisitions, we allocate the fair value of purchase consideration to the assets acquired and liabilities assumed based on their estimated fair values. Estimating the fair value of assets acquired and liabilities assumed requires judgment, especially with respect to identified intangible assets as there may be limited or no observable transactions within the market, requiring us to develop internal models to estimate fair value. For example, estimating the fair value of identified intangible assets may require us to develop valuation assumptions, including but not limited to, future expected cash flows from identified intangible assets, synergies and the cost of capital. Certain inputs require us to determine assumptions that are reflective of a market participant view of fair value. Changes in any of these assumptions may materially impact the amount we recognize for identifiable assets and liabilities, in addition to the residual amount allocated to goodwill. 51 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. 52 UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS