Union Pacific Corporation — Q3 2010 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2010. Union Pacific operates one reportable segment: its integrated railroad business. Financial comparisons to 2009 reflect the retrospective accounting change for rail-grinding costs.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Operating revenue | $4.408bn | $3.671bn | $12.555bn | $10.389bn |
| Operating income | $1.401bn | $961m | $3.668bn | $2.380bn |
| Net income | $778m | $514m | $2.005bn | $1.341bn |
| Diluted EPS | $1.56 | $1.01 | $3.98 | $2.66 |
| Operating ratio | 68.2% | 73.8% | 70.8% | 77.1% |
- Q3 revenue grew 20% and operating income 46%; nine-month revenue grew 21% and operating income 54%. Management attributed stronger results principally to higher freight volume and core pricing.
- Q3 carloads increased 14%; average revenue per car increased 6%. Freight revenue rose across all six commodity groups, with particularly strong automotive, industrial-products, and intermodal growth.
- Operating cash flow for the first nine months was $2.720bn, versus $2.199bn. Capital investment was $1.686bn; dividends paid were $438m. Company-defined free cash flow was $1.009bn, including an adjustment for receivables securitization accounting.
- Cash was $1.358bn at September 30, 2010. Current assets were $3.910bn and current liabilities $3.185bn. Debt reported on the balance sheet totaled $9.719bn; debt-to-capital was 35.8%, and adjusted debt-to-capital was 44.0%.
- The company had $1.9bn available under its revolving credit facility and no commercial paper outstanding. It reported compliance with its debt covenant. The facility expires in April 2012.
Material changes versus the prior comparable period
- Growth and pricing gains improved the operating ratio by 5.6 percentage points in Q3 and 6.3 points year to date. Higher fuel expense partly offset operating leverage: fuel expense increased 30% in Q3 and 47% year to date, with fuel prices and higher traffic contributing.
- Q3 freight volume gains were accompanied by higher operating expenses, including compensation, purchased services, and volume-related costs. Management cited productivity, efficient asset use, and lower personal-injury expense as offsets.
- Cash used in financing rose to $1.539bn from $295m, primarily reflecting $1.019bn of cash share repurchases and net debt repayment. The company repurchased 14.1m shares through September 30.
- Other income for the first nine months fell to $45m from $172m, largely because 2009 included a $116m pre-tax gain on a real-estate sale. 2010 included a $16m early debt-extinguishment charge.
- Effective January 1, 2010, rail-grinding costs began to be expensed as incurred rather than capitalized and depreciated. The change was applied retrospectively; it reduced reported nine-month 2010 net income by $7m and adjusted opening 2010 retained earnings by $140m.
Outlook, commentary, risks, and unusual items
- The filing provides no quantified earnings or revenue guidance. Management said current capital plans were expected to maintain covenant compliance and intended to replace the revolving credit agreement by its April 2012 expiration.
- Management said demand had improved from the weak 2009 environment and described the network as operating efficiently. Hurricane Alex and subsequent flooding in Mexico disrupted the Laredo and Brownsville gateways for much of July; Q3 train speed fell 6% year over year and terminal dwell increased 2%.
- The company reported a $45m one-time operating expense in Q1 related to a transaction with CSX Intermodal. The 2009 comparison includes the $116m real-estate gain; these items affect period comparisons.
- Material legal and regulatory matters include an EPA remediation dispute concerning the Omaha Lead Site and U.S. Customs penalties related to alleged drug discoveries in railcars crossing from Mexico. Outstanding CBP penalties were approximately $357m at September 30, 2010; the Railroad disputes liability and is contesting the matters.
- At September 30, the company recorded $214m of environmental liabilities, $166m of asbestos liabilities, and $460m of personal-injury liabilities. Management stated it did not expect known claims and contingencies, after recorded liabilities and insurance recoveries, to materially adversely affect results, financial condition, or liquidity; estimates and outcomes remain uncertain.
- Additional exposures include $4.2bn of future minimum lease payments associated with unconsolidated variable-interest-entity leases and $382m of contingent guarantees. Management reported no known event of default requiring payment under those guarantees.
Important facts for investors to verify
- Whether freight-volume growth, pricing, and operating-ratio improvement persist, particularly as fuel, labor, and other operating costs change.
- Cash conversion and capital needs, including the effect of receivables-securitization accounting on operating cash flow and the company-defined free-cash-flow measure.
- Debt maturities, refinancing plans, revolving-facility renewal, and the effects of share repurchases and dividends on liquidity and leverage.
- Developments in the Omaha environmental matter and CBP penalties, including potential liability, timing, and insurance or other recoveries.
- Comparability of reported periods after the retrospective rail-grinding accounting change and the impact of the unusual 2009 real-estate gain and 2010 CSXI payment.