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UNP > SEC Filings for UNP > Form 10-K on 7-Feb-2014All Recent SEC Filings

Show all filings for UNION PACIFIC CORP

Form 10-K for UNION PACIFIC CORP


7-Feb-2014

Annual Report


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

The following discussion should be read in conjunction with the Consolidated Financial Statements and applicable notes to the Financial Statements and Supplementary Data, Item 8, and other information in this report, including Risk Factors set forth in Item 1A and Critical Accounting Policies and Cautionary Information at the end of this Item 7.

The Railroad, along with its subsidiaries and rail affiliates, is our one reportable business segment. Although revenue is analyzed by commodity, we analyze the net financial results of the Railroad as one segment due to the integrated nature of the rail network.

EXECUTIVE SUMMARY

2013 Results

Safety - During 2013, we continued focusing on safety to reduce risk and eliminate incidents for our employees, our customers and the public. Our sustained efforts to improve crossing warning systems and, where possible, close at-grade crossings reduced grade crossing incidents per million train miles by 7% during the year. We closed 212 grade crossings in 2013 to reduce our exposure to incidents and continued using video cameras on our locomotives to analyze safety incidents. Although reportable personal injury incidents per 200,000 employee hours increased 4% from last year's record low, it is our second lowest year and a 9% decline from 2011. Our reportable derailment incidents per million train miles increased slightly, less than 1%, from 2012. These results demonstrate our continued development and expansion of our safety programs and initiatives, including Courage to Care, Total Safety Culture, and Standard Work.

Financial Performance - In 2013, we generated operating income of $7.4 billion, a 10% increase over 2012. Core pricing gains of 3.6% along with our ongoing focus on safety, service, network efficiency and productivity drove record financial results for the year. Our operating ratio for 2013 of 66.1% was an all-time best, improving from last year's operating ratio of 67.8%. Net income of $4.4 billion surpassed our previous milestone set in 2012, translating into earnings of $9.42 per diluted share for 2013.

Freight Revenues - Our freight revenues grew 5% year-over-year to $20.7 billion. Freight revenues for five of the six commodity groups increased despite flat volume. Volume growth in shale-related products (crude oil and frac sand), automotive and domestic intermodal offset declines in coal, international intermodal and agricultural products. Core pricing gains, an automotive logistics management arrangement and shifts in business mix all resulted in higher average revenue per car (ARC), which drove the growth in freight revenue in 2013 compared to 2012. Our fuel surcharge was essentially flat versus 2012, as lower fuel price offset improved fuel recovery provisions and the lag effect of our programs (surcharges trail fluctuations in fuel price by approximately two months).

Network Operations - In 2013, despite challenging weather and significant shifts in our business mix, our operations remained efficient and fluid. As reported to the Association of American Railroads (AAR), average train speed declined 2% in 2013 compared to 2012, reflecting severe weather conditions and shifts of traffic to sections of our network with higher utilization. Average terminal dwell time increased 3% primarily due to continuing growth of manifest traffic, which requires more time in terminals for switching cars and building trains.

Fuel Prices - In 2013, the average price per barrel of crude oil increased from 2012. However, the average price per gallon of diesel fuel that we paid in 2013 decreased 2% from the average price in 2012, as lower crude oil to diesel conversion spreads in 2013 more than offset the higher price for crude oil. The lower price decreased operating expenses by $75 million (excluding any impact from year-over-year volume). A 1% decline in gross-ton miles also drove lower fuel expense. Our fuel consumption rate, computed as gallons of fuel consumed divided by gross ton-miles, increased 2% compared to 2012 partially offsetting the decreases. Declines in heavier, more fuel-efficient coal shipments drove the gross-ton-mile and fuel consumption rate variances.

Free Cash Flow - Cash generated by operating activities totaled $6.8 billion, yielding record free cash flow of $2.1 billion after reductions of $3.4 billion for cash used in investing activities and a 16%


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increase in dividends paid. Free cash flow is defined as cash provided by operating activities less cash used in investing activities and dividends paid.

Free cash flow is not considered a financial measure under accounting principles generally accepted in the U.S. (GAAP) by SEC Regulation G and Item 10 of SEC Regulation S-K and may not be defined and calculated by other companies in the same manner. We believe free cash flow is important to management and investors in evaluating our financial performance and measures our ability to generate cash without additional external financings. Free cash flow should be considered in addition to, rather than as a substitute for, cash provided by operating activities. The following table reconciles cash provided by operating activities (GAAP measure) to free cash flow (non-GAAP measure):

     Millions                                     2013           2012           2011
     Cash provided by operating activities   $   6,823      $   6,161      $   5,873
     Cash used in investing activities         (3,405)        (3,633)        (3,119)
     Dividends paid                            (1,333)        (1,146)          (837)

     Free cash flow                          $   2,085      $   1,382      $   1,917

2014 Outlook

Safety - Operating a safe railroad benefits our employees, our customers, our shareholders, and the communities we serve. We will continue using a multi-faceted approach to safety, utilizing technology, risk assessment, quality control, training and employee engagement, and targeted capital investments. We will continue using and expanding the deployment of Total Safety Culture and Courage to Care throughout our operations, which allows us to identify and implement best practices for employee and operational safety. Derailment prevention and the reduction of grade crossing incidents are also critical aspects of our safety programs. We will continue our efforts to increase detection of rail defects; improve or close crossings; and educate the public and law enforcement agencies about crossing safety through a combination of our own programs (including risk assessment strategies), various industry programs and local community activities across our network.

Network Operations - We believe the Railroad is capable of handling growing volumes while providing high levels of customer service. Our track structure is in excellent condition, and certain sections of our network have surplus line and terminal capacity. We are in a solid resource position, with sufficient supplies of locomotives, freight cars and crews to support growth.

Fuel Prices - Uncertainty about the economy makes projections of fuel prices difficult. We again could see volatile fuel prices during the year, as they are sensitive to global and U.S. domestic demand, refining capacity, geopolitical events, weather conditions and other factors. To reduce the impact of fuel price on earnings, we will continue seeking cost recovery from our customers through our fuel surcharge programs and expanding our fuel conservation efforts.

Capital Plan - In 2014, we plan to make total capital investments of approximately $3.9 billion, including expenditures for Positive Train Control (PTC), which may be revised if business conditions warrant or if new laws or regulations affect our ability to generate sufficient returns on these investments. (See further discussion in this Item 7 under Liquidity and Capital Resources - Capital Plan.)

Positive Train Control - In response to a legislative mandate to implement PTC by the end of 2015, we have invested $1.2 billion in capital expenditures and plan to spend an additional $450 million during 2014 on developing and deploying PTC. We currently estimate that PTC, in accordance with implementing rules issued by the Federal Rail Administration (FRA), will cost us approximately $2 billion by the end of the project. This includes costs for installing the new system along our tracks, upgrading locomotives to work with the new system, and adding digital data communication equipment to integrate the various components of the system and achieve interoperability for the industry. Although it is unlikely that the rail industry will meet the current mandatory 2015 deadline (as the FRA indicated in its 2012 report to Congress), we are making a good faith effort to do so and we are working closely with regulators as we implement this new technology.


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Financial Expectations - We are cautious about the economic environment, but, assuming that industrial production grows approximately 3% as projected, volume should exceed 2013 levels. Even with no volume growth, we expect earnings to exceed 2013 earnings, generated by core pricing gains, on-going network improvements and productivity initiatives. We expect that free cash flow for 2014 will be lower than 2013 as higher cash from operations will be more than offset by additional cash of approximately $400 million that will be used to pay income taxes that were previously deferred through bonus depreciation, increased capital spend and higher dividend payments.

RESULTS OF OPERATIONS

Operating Revenues



                                                                                                % Change           % Change
Millions                                          2013            2012            2011       2013 v 2012        2012 v 2011
Freight revenues                            $   20,684      $   19,686      $   18,508                5%                 6%
Other revenues                                   1,279           1,240           1,049                3                 18

Total                                       $   21,963      $   20,926      $   19,557                5%                 7%

We generate freight revenues by transporting freight or other materials from our six commodity groups. Freight revenues vary with volume (carloads) and ARC. Changes in price, traffic mix and fuel surcharges drive ARC. We provide some of our customers with contractual incentives for meeting or exceeding specified cumulative volumes or shipping to and from specific locations, which we record as reductions to freight revenues based on the actual or projected future shipments. We recognize freight revenues as shipments move from origin to destination. We allocate freight revenues between reporting periods based on the relative transit time in each reporting period and recognize expenses as we incur them.

Other revenues include revenues earned by our subsidiaries, revenues from our commuter rail operations, and accessorial revenues, which we earn when customers retain equipment owned or controlled by us or when we perform additional services such as switching or storage. We recognize other revenues as we perform services or meet contractual obligations.

Freight revenues from five of our six commodity groups increased during 2013 compared to 2012. Revenue from agricultural products was down slightly compared to 2012. ARC increased 5%, driven by core pricing gains, shifts in business mix and an automotive logistics management arrangement. Volume was essentially flat year over year as growth in automotives, frac sand, crude oil and domestic intermodal offset declines in coal, international intermodal and grain shipments.

Freight revenues from four of our six commodity groups increased during 2012 compared to 2011. Revenues from coal and agricultural products declined during the year. Our franchise diversity allowed us to take advantage of growth from shale-related markets (crude oil, frac sand and pipe) and strong automotive manufacturing, which offset volume declines from coal and agricultural products. ARC increased 7%, driven by core pricing gains and higher fuel cost recoveries. Improved fuel recovery provisions and higher fuel prices, including the lag effect of our programs (surcharges trail fluctuations in fuel price by approximately two months), combined to increase revenues from fuel surcharges.

Our fuel surcharge programs generated freight revenues of $2.6 billion, $2.6 billion, and $2.2 billion in 2013, 2012, and 2011, respectively. Fuel surcharge in 2013 was essentially flat versus 2012 as lower fuel price offset improved fuel recovery provisions and the lag effect of our programs (surcharges trail fluctuations in fuel price by approximately two months). Rising fuel prices and more shipments subject to fuel surcharges drove the increase from 2011 to 2012.

In 2013, other revenue increased from 2012 due primarily to miscellaneous contract revenue and higher revenues at our subsidiaries that broker intermodal and automotive services.

In 2012, other revenues increased from 2011 due primarily to higher revenues at our subsidiaries that broker intermodal and automotive services. Assessorial revenues also increased in 2012 due to container revenue related to an increase in intermodal shipments.


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The following tables summarize the year-over-year changes in freight revenues, revenue carloads, and ARC by commodity type:

Freight Revenues                                                                                % Change           % Change
Millions                                          2013            2012            2011       2013 v 2012        2012 v 2011
Agricultural                                $    3,276      $    3,280      $    3,324                -%               (1)%
Automotive                                       2,077           1,807           1,510               15                20
Chemicals                                        3,501           3,238           2,815                8                15
Coal                                             3,978           3,912           4,084                2                (4)
Industrial Products                              3,822           3,494           3,166                9                10
Intermodal                                       4,030           3,955           3,609                2                10

Total                                       $   20,684      $   19,686      $   18,508                5%                6 %



Revenue Carloads                                                                                % Change            % Change
Thousands                                         2013            2012            2011       2013 v 2012         2012 v 2011
Agricultural                                       874             900             934              (3)%               (4)%
Automotive                                         781             738             653               6                 13
Chemicals                                        1,103           1,042             921               6                 13
Coal                                             1,703           1,871           2,164              (9)               (14)
Industrial Products                              1,236           1,185           1,146               4                  3
Intermodal [a]                                   3,325           3,312           3,254               -                  2

Total                                            9,022           9,048           9,072               - %                - %



                                                                                                % Change           % Change
Average Revenue per Car                           2013            2012            2011       2013 v 2012        2012 v 2011
Agricultural                                $    3,746      $    3,644      $    3,561                3%                 2%
Automotive                                       2,659           2,448           2,311                9                  6
Chemicals                                        3,176           3,107           3,055                2                  2
Coal                                             2,336           2,092           1,888               12                 11
Industrial Products                              3,093           2,947           2,762                5                  7
Intermodal [a]                                   1,212           1,194           1,109                2                  8

Average                                     $    2,293      $    2,176      $    2,040                5%                 7%

[a] Each intermodal container or trailer equals one carload.

Agricultural Products - Lower volume                     2013 Agricultural Carloads
offset price improvements as freight
revenue declined slightly versus 2012. In                 [[Image Removed: LOGO]]
the fourth quarter grain shipments
increased 41% due to a robust fall
harvest. Despite the fourth quarter
growth, grain shipments still decreased 4%
for the full year when compared to 2012,
reflecting the impact of the severe
drought in 2012 that affected territory
served by us during the first three
quarters of 2013. Export wheat shipped to
the Gulf and Pacific Northwest increased
in the second half of 2013, partially
offsetting the declines in grain.

Lower  volume  more  than  offset  pricing
gains

and increased fuel surcharges as agricultural freight revenue decreased in 2012 versus 2011. Weak export demand for U.S. wheat drove a 19% decrease in wheat shipments year over year, as the foreign wheat market improved significantly from the weather affected crop in 2011. In addition, corn shipments declined 11% for the year, with more significant declines in the fourth quarter, reflecting the impact of the severe drought across the U.S. Lower gasoline demand, reduced exports and higher corn prices decreased ethanol shipments during the second half of the year. Growth in imported beer from Mexico and a strong domestic harvest of fresh potatoes partially offset these declines.


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 Automotive - Higher ARC due to               2013 Automotive Carloads
 price increases and the
 logistics management arrangement                [[Image Removed: LOGO]]
 that covers fees and container
 costs, coupled with increased
 shipments of automotive parts
 and finished vehicles, improved
 automotive revenue in 2013
 compared to 2012. Higher
 production and sales levels
 during 2013 drove the volume
 growth.

 In 2012, stronger shipments of
 finished vehicles and automotive
 parts along with pricing gains
 and higher fuel surcharges
 improved automotive freight
 revenue from 2011 levels. Higher
 production and sales levels
 drove the volume growth. In
 addition, 2012 shipments
 compared favorably to 2011 due
 to lower shipments of
 international vehicles in 2011
 following the disaster in Japan.




Chemicals - Volume gains and price improvement                    2013 Chemicals Carloads
increased freight revenue from chemicals in 2013
versus 2012. Shipments of crude oil from the Bakken,              [[Image Removed: LOGO]]
Permian, Niobrara and Eagle Ford shale formations
primarily to the Gulf area drove the growth in
shipments of chemicals. In addition, shipments of
industrial chemicals increased as manufacturing,
housing and automotive markets improved.

Higher volume, price improvements and fuel
surcharges increased freight revenue from chemicals
in 2012. Shipments of crude oil primarily from the
Bakken, Permian and Eagle Ford Shale formations to
the Gulf area increased over  three  fold,  driving
 the

improvement in chemicals shipments. In addition, plastics and industrial chemicals shipments increased as low natural gas prices have made U.S. chemicals more cost competitive globally. Declines in potash due to temporary shutdowns and reduced production at several mines partially offset the increases in chemical shipments during the year.

 Coal - ARC gains driven by price                2013 Coal Carloads
 increases and positive business
 mix partially offset by volume                [[Image Removed: LOGO]]
 declines increased freight
 revenue from coal shipments in
 2013 versus 2012. Southern
 Powder River Basin (SPRB)
 shipments declined 10% from 2012
 due to the loss of a customer
 contract at the beginning of the
 year, relatively mild summer
 weather, and tighter coal
 inventory management by
 utilities. Shipments from
 Colorado and Utah mines
 decreased 13% compared to 2012,
 driven by soft domestic demand
 and mine production issues,
 partially offset by second half
 growth in international
 shipments. Severe flooding and
 washouts in Colorado also
 reduced volumes from certain
 producers in the third quarter.

Lower volume, partially offset by pricing gains and fuel surcharge recoveries reduced freight revenue from coal shipments in 2012 compared to 2011. Shipments of coal from the Southern Powder River Basin (SPRB) mines decreased 15% from 2011. Above average coal stockpiles due to an unseasonably warm winter and low natural gas prices, which caused some displacement of coal in electricity production, led to


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the volume declines. In addition, the loss of two contracts to a competitor contributed to lower volumes from the SPRB. Coal shipments from the Colorado and Utah mines increased 2% versus 2011. Increased export shipments of Colorado and Utah coal in 2012 offset the domestic declines due to higher stockpiles and low natural gas prices.

 Industrial Products - Freight            2013 Industrial Products Carloads
 revenue from industrial products
 increased in 2013 versus 2012                 [[Image Removed: LOGO]]
 driven by volume growth and
 higher ARC due to pricing gains
 and favorable business mix.
 Shipments of non-metallic
 minerals (primarily frac sand)
 grew as a result of drilling
 activity for energy products.
 Additionally, growth in new
 housing construction and home
 improvements drove an increase
 in lumber shipments. Declines in
 ferrous scrap and government
 shipments partially offset these
 higher volumes.

 Pricing improvement, higher
 volume and additional fuel
 surcharges increased freight
 revenue from industrial products
  in  2012  versus

2011. Shipments of non-metallic minerals (primarily frac sand), grew in response to increased horizontal drilling activity for energy products. More construction activity during a relatively mild winter led to higher demand for shipments of lumber, cement and stone compared to 2011. The growth in housing starts throughout 2012 also increased lumber shipments, up 12% from 2011. Steel shipments finished slightly down from 2011 levels as lower demand for export scrap and mine production issues in the second half of the year offset increases in the first half due to higher demand for steel coils and plate for pipe and auto production.

 Intermodal - Pricing                         2013 Intermodal Carloads
 improvements and slight volume
 growth drove increased freight                [[Image Removed: LOGO]]
 revenue from intermodal
 shipments in 2013 compared to
 2012. Domestic traffic increased
 3% due to conversions from truck
 transportation to rail.
 International traffic declined
 2% versus 2012, reflecting
 market share shifts within the
 ocean carrier industry and an
 increase in transloading in the
 second half of the year.
 Transloading involves the
 transfer of goods from
 international to domestic
 containers at distribution
 centers near West coast ports,
 which reduces demand for rail
 transportation to these centers.

 Higher fuel surcharges,
 including improved fuel

recovery provisions, core pricing gains and volume growth increased freight revenue from intermodal shipments in 2012. Volume levels from international traffic remained flat year-over-year as the loss of a customer contract in the first half of the year offset modest West Coast import growth. Domestic traffic increased 3% versus 2011 due to better market conditions and continued conversion of traffic from truck to rail.

Mexico Business - Each of our commodity groups includes revenue from shipments to and from Mexico. Revenue from Mexico business increased 9% to $2.1 billion in 2013 versus 2012. Shipments were up 3% versus 2012, all commodity groups grew with the exception of agricultural products. The largest growth came from automotive and industrial products shipments.

Revenue from Mexico business increased 8% to $1.9 billion in 2012 versus 2011. Volume levels for four of the six commodity groups (industrial products and agricultural products declined), were up 5% in aggregate versus 2011, with particularly strong growth in automotive and intermodal shipments.


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Operating Expenses



                                                                                                % Change          % Change
Millions                                          2013            2012            2011       2013 v 2012       2012 v 2011
Compensation and benefits                   $    4,807      $    4,685      $    4,681               3 %                -%
Fuel                                             3,534           3,608           3,581              (2)                 1
Purchased services and materials                 2,315           2,143           2,005               8                  7
Depreciation                                     1,777           1,760           1,617               1                  9
Equipment and other rents                        1,235           1,197           1,167               3                  3
Other                                              849             788             782               8                  1

Total                                       $   14,517      $   14,181      $   13,833               2 %                3%

Operating expenses increased $336 million in                   2013 Operating Expenses
2013 versus 2012. Wage and benefit inflation,
new logistics management fees and container                    [[Image Removed: LOGO]]
costs for our automotive business, locomotive
overhauls, property taxes and repairs on jointly
owned property contributed to higher expenses
during the year. Lower fuel prices partially
offset the cost increases.

Operating expenses increased $348 million in
2012 versus 2011. Depreciation, wage and benefit
inflation, higher fuel prices and volume-related
trucking services purchased by our logistics
subsidiaries, contributed to higher expenses
 during  the  year.  Efficiency  gains,

volume related fuel savings (2% fewer gallons of fuel consumed) and $38 million of weather related expenses in 2011, which favorably affects the comparison, partially offset the cost increase.

Compensation and Benefits - Compensation and benefits include wages, payroll . . .

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