Union Pacific Corporation — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2010. Dollar amounts are in millions unless stated otherwise. Comparisons are with 2009; prior-period figures reflect the retrospective rail-grinding accounting change.
Business context
Union Pacific operates one reportable segment: its integrated railroad network. Freight revenue comes from agricultural, automotive, chemicals, energy, industrial products, and intermodal shipments.
Financial performance
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Operating revenue | $4,182 | $3,303 | $8,147 | $6,718 |
| Operating income | $1,279 | $748 | $2,267 | $1,419 |
| Operating ratio | 69.4% | 77.4% | 72.2% | 78.9% |
| Net income | $711 | $465 | $1,227 | $827 |
| Diluted EPS | $1.40 | $0.92 | $2.42 | $1.64 |
| Cash from operations | Not separately presented for quarter | $1,695 | $1,508 |
- Q2 revenue grew 27%, freight revenue 27%, and net income 53%. Six-month revenue grew 21% and net income 48%.
- Q2 freight revenue excluding fuel surcharges increased $610, driven by 18% carload growth and core pricing. Average revenue per car rose 8%; fuel-surcharge programs generated $309 versus $84 in Q2 2009.
- All six commodity groups grew in Q2. Intermodal revenue rose 35%, industrial products 30%, and automotive revenue more than doubled; automotive carloads increased 71%.
- Operating expenses rose 14% in Q2 and 11% year to date. Higher fuel prices accounted for $186 of the Q2 increase and $357 year to date; volume-related costs and inflation also contributed. Productivity, resource utilization, and workforce reductions partially offset these increases.
- Operating margin, calculated as operating income divided by revenue, was approximately 30.6% in Q2 2010 versus 22.6% in Q2 2009, and 27.8% versus 21.1% for the six-month periods.
Cash flow, debt, and liquidity
- Six-month capital investments were $1,056; cash used in investing was $1,068. Reported free cash flow, defined by the company as operating cash flow less investing cash flow and dividends paid, was $755, compared with $281. The company’s comparable calculation adds back receivables-securitization cash flows: $400 in 2010 and $184 in 2009.
- Cash and equivalents were $1,317 at June 30, down from $1,850 at year-end 2009. Current assets were $3,702 and current liabilities $3,035.
- Balance-sheet debt was $9,365, including $248 due within one year; debt-to-capital was 35.1%, down from 37.0% at year-end. Adjusted debt-to-capital, including operating leases and unfunded pension and OPEB, was 43.5%, down from 46.1%.
- The company had $1.9 billion available under its revolving credit facility, no commercial paper outstanding, and was in compliance with its debt covenant. The receivables-securitization facility had $600 capacity and $100 outstanding at June 30.
- Financing cash use included $885 of debt repayments, $422 of share repurchases, and $272 of dividends paid. The company repurchased 6.5 million shares in Q2 for approximately $466; it reported a further 3.3 million shares repurchased for approximately $231 after quarter-end through the filing date.
Material changes and unusual items
- Effective January 1, 2010, rail-grinding costs changed from capitalization and depreciation to expense as incurred. Prior periods were restated; the change reduced six-month 2010 net income by $4 and June 30, 2010 net properties by $232 relative to the former method.
- New accounting guidance caused receivables transfers to be treated as secured borrowings rather than sales, shifting related cash flows from operating to financing activities. This affects reported operating cash flow and debt comparisons.
- Q2 2009 other income included a $116 pretax gain from a land sale to Colorado’s Regional Transportation District. Q2 2010 other income was $19 versus $135 a year earlier. Six-month 2010 results also included a $16 early-debt-extinguishment charge and a $45 one-time CSX Intermodal-related payment in operating expenses.
- On July 14, 2010, after quarter-end, $375.9 of 7.875% notes due 2019 were exchanged for 5.78% notes due 2040, with cash consideration of approximately $95.8 plus accrued interest.
Management commentary, outlook, and risks
- Management attributed the recovery in traffic to improving economic conditions, especially in automotive, intermodal, and industrial products. It said efficiency initiatives helped handle higher volumes and improve the operating ratio.
- Service measures were mixed: Q2 train speed declined 4% from a record year-earlier quarter, with Midwest flooding and track work cited; terminal dwell rose 1%. Average rail-car inventory fell 2%, while customer satisfaction improved to 89 from 87.
- No specific revenue, earnings, or operating-ratio guidance is provided in the supplied filing text. Management expected to remain within its credit covenant under current capital plans, while noting future compliance could be affected by factors beyond its control.
- Management did not expect known claims, environmental matters, commitments, guarantees, or contingencies to materially adversely affect results, financial condition, or liquidity, but estimates and outcomes remain uncertain. The company identified 294 potentially liable environmental sites and reported $219 of environmental liabilities.
- Notable legal exposures include the Omaha Lead Site matter, where an EPA interim remedy was estimated at $50 and the company disputes liability; fuel-surcharge antitrust litigation, which the company says it will vigorously defend; and customs penalties relating to drugs found on trains from Mexico. On July 19, 2010, CBP notified the railroad of additional penalties of about $101, bringing the stated outstanding amount to about $162.5, with further unspecified penalties possible.
- Other risks include personal-injury and asbestos claims, environmental remediation uncertainty, and $386 of contingent guarantees. The company reported no material changes to its previously disclosed risk factors.
Important facts for investors to verify
- Whether traffic growth, pricing, and productivity gains persist as comparisons normalize, and whether fuel-cost recovery keeps pace with fuel prices.
- The cash-flow and leverage effects of the receivables-accounting change; distinguish reported operating cash flow from the company’s adjusted free-cash-flow presentation.
- Whether service performance recovers from flooding and infrastructure work without constraining capacity or customer satisfaction.
- Developments, potential financial exposure, and insurance recoveries in the Omaha Lead Site, fuel-surcharge litigation, and CBP penalty matters.
- The subsequent debt exchange, post-quarter share repurchases, and their effects on interest expense, liquidity, and capital allocation.