UNION PACIFIC CORP quarterly report, Q3 FY2011

Business context and reporting period

Union Pacific Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2011, compared with the same 2010 periods. The company operates one reportable segment: its integrated railroad network.

Financial results and key metrics

Amounts are in millions except per-share data, percentages, and operating statistics.

Metric	Q3 2011	Q3 2010	Nine months 2011	Nine months 2010
Operating revenue	$5,101	$4,408	$14,449	$12,555
Operating income	$1,578	$1,401	$4,107	$3,668
Net income	$904	$778	$2,328	$2,005
Diluted EPS	$1.85	$1.56	$4.74	$3.98
Operating ratio	69.1%	68.2%	71.6%	70.8%

• Q3 revenue rose 16%, operating income 13%, and net income 16% year over year. Nine-month revenue increased 15% and net income 16%.
• Freight revenue increased 16% in Q3 and 15% year to date. Average revenue per car rose 14% and 12%, respectively, while carloads increased 1% and 3%.
• Operating expenses grew 17% in Q3 and 16% year to date, faster than revenue. Fuel expense increased 51% and 47%, respectively; higher fuel prices accounted for $260 million and $723 million of the increases.
• Cash provided by operations was $4,334 for nine months, versus $2,720 in 2010. Capital investment was $2,218, dividends paid were $607, and reported free cash flow was $1,486 versus $1,009. The filing adjusts the 2010 operating cash flow comparison for a $400 million receivables-securitization accounting change.
• At September 30, cash was $1,647 and current assets were $4,214, compared with current liabilities of $3,724. Debt was $9,407, including $642 due within one year; shareholders’ equity was $18,565. The reported debt-to-capital ratio was 33.6%, and adjusted debt-to-capital was 41.4%.
• The company had $1.8 billion available under its revolving credit facility, no commercial paper outstanding, and was in compliance with its debt covenant. The facility expires in May 2015.

Material changes versus prior periods

• Higher fuel surcharge revenue, core pricing gains, and volume growth lifted revenue. All six freight commodity groups reported higher revenue in Q3, although intermodal carloads fell 6% and agricultural carloads fell 3%.
• Fuel prices, wage and benefit inflation, volume-related costs, depreciation, and weather-related costs pressured expenses. Flood-related costs were $20 million year to date; heat and drought added $18 million in Q3.
• The operating ratio worsened by 0.9 percentage points in Q3 and 0.8 points year to date, despite higher operating income.
• Cash from operations increased, aided by higher earnings, lower cash income-tax payments, and comparison effects from the 2010 securitization accounting change. Cash capital investment rose to $2,218 from $1,686.
• Cash dividends paid rose to $607 from $438. The company repurchased 10.9 million shares for $1,036 during the first nine months and had authorization to repurchase 31.7 million additional shares at quarter-end.

Outlook, commentary, risks, and unusual items

• Management reported record Q3 diluted EPS and attributed improved results to pricing and volume gains, partly offset by inflation and weather. It said the adverse effects of Southern heat and drought were expected to carry into Q4; no specific earnings or revenue guidance is provided in the filing text.
• Weather and higher traffic affected service: Q3 average train speed fell 4% to 24.6 mph, and terminal dwell time rose 5% to 26.2 hours. Management said Southern conditions were improving and the network maintained reliable operations.
• Rail labor negotiations remained unresolved for unions representing most unsettled employees. A Presidential Emergency Board process began in October 2011, extending the process through an investigation and cooling-off period.
• The company reported $4.6 billion of future operating lease commitments and $2.6 billion of capital lease obligations. It also had $4.6 billion of purchase obligations and $4.0 billion of minimum lease payments associated with unconsolidated variable-interest entities.
• Contingencies include environmental, personal-injury, asbestos, tax, and other claims. Management did not expect known claims, after recorded liabilities and insurance recoveries, to materially adversely affect results, financial condition, or liquidity. A favorable pipeline-easement rent decision could materially affect results when recovered, but no gain was recorded because amount and timing were uncertain.
• In July 2011, the company agreed to provide $50 million for a border and rail supply-chain security initiative; CBP agreed to reduce pre-June 2011 drug-related fines to zero as the company makes the expenditures. A separate approximately $38 million fine dispute remained in litigation. The Omaha Lead Site settlement required a $25 million payment.
• The IRS and company reached an agreement in principle covering tax years 1999–2004, subject to formalization and interest calculations. The company paid $45 million and reported $119 million of uncertain tax positions at quarter-end. Management anticipated an immaterial reduction in tax expense upon formal resolution.
• The company issued $500 million of 4.75% notes due 2041 and exchanged $857 million of existing notes for $750 million of 4.163% notes due 2022 plus cash consideration; no gain or loss was recognized on the exchange.

Important facts for investors to verify

• Whether fuel prices, inflation, and weather-related costs continue to outpace pricing and productivity gains, and the effect on the operating ratio.
• Whether service metrics recover from lower train speeds and higher terminal dwell time, especially as weather impacts carry into Q4.
• Actual volume and pricing trends by commodity, particularly intermodal, agricultural, energy, and industrial products.
• Cash generation after capital investment, dividends, and share repurchases; confirm the company’s capacity and intended pace for buybacks.
• Debt maturities, lease commitments, covenant headroom, and continued access to the revolving and receivables-securitization facilities.
• Resolution and financial consequences of labor negotiations, IRS and CBP matters, environmental claims, and the pipeline-rent proceeding.