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Oct. 17, 2019, 4:31 p.m. EDT

10-Q: UNION PACIFIC CORP

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(EDGAR Online via COMTEX) -- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

UNION PACIFIC CORPORATION AND SUBSIDIARY COMPANIES

RESULTS OF OPERATIONS

Three and Nine Months Ended September 30, 2019, Compared to

Three and Nine Months Ended September 30, 2018

For purposes of this report, unless the context otherwise requires, all references herein to "UPC", "Corporation", "Company", "we", "us", and "our" shall mean Union Pacific Corporation and its subsidiaries, including Union Pacific Railroad Company, which we separately refer to as "UPRR" or the "Railroad".

The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and applicable notes to the Condensed Consolidated Financial Statements, Item 1, and other information included in this report. Our Condensed Consolidated Financial Statements are unaudited and reflect all adjustments (consisting only of normal and recurring adjustments) that are, in the opinion of management, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America (GAAP).

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

Available Information

Our Internet website is www.up.com . We make available free of charge on our website (under the "Investors" caption link) our Annual Reports on Form 10-K; our Quarterly Reports on Form 10-Q; our current reports on Form 8-K; our proxy statements; Forms 3, 4, and 5, filed on behalf of directors and executive officers; and amendments to any such reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (the Exchange Act), as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (SEC). We also make available on our website previously filed SEC reports and exhibits via a link to EDGAR on the SEC's Internet site at www.sec.gov . We provide these previously filed reports as a convenience and their contents reflect only information that was true and correct as of the date of the report. We assume no obligation to update this historical information. Additionally, our corporate governance materials, including By-Laws, Board Committee charters, governance guidelines and policies, and codes of conduct and ethics for directors, officers, and employees are available on our website. From time to time, the corporate governance materials on our website may be updated as necessary to comply with rules issued by the SEC and the New York Stock Exchange or as desirable to promote the effective and efficient governance of our company. Any security holder wishing to receive, without charge, a copy of any of our SEC filings or corporate governance materials should send a written request to: Corporate Secretary, Union Pacific Corporation, 1400 Douglas Street, Omaha, NE 68179.

References to our website address in this report, including references in Management's Discussion and Analysis of Financial Condition and Results of Operations, Item 2, are provided as a convenience and do not constitute, and should not be deemed, an incorporation by reference of the information contained on, or available through, the website. Therefore, such information should not be considered part of this report.

Critical Accounting Policies and Estimates

We base our discussion and analysis of our financial condition and results of operations upon our Condensed Consolidated Financial Statements. The preparation of these financial statements requires estimation and judgment that affect the reported amounts of revenues, expenses, assets, and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. If these estimates differ materially from actual results, the impact on the Condensed Consolidated Financial Statements may be material. Our critical accounting policies are available in Item 7 of our 2018 Annual Report on Form 10-K. Changes to our accounting policies as a result of adopting ASU 2016-02 are discussed within Note 16 of the Condensed Consolidated Financial Statements.

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RESULTS OF OPERATIONS

Quarterly Summary

We reported earnings of $2.22 per diluted share on net income of $1.6 billion in the third quarter of 2019 compared to earnings of $2.15 per diluted share on net income of $1.6 billion for the third quarter of 2018. Freight revenues decreased 7% in the third quarter compared to the same period in 2018 driven by an 8% decline in carloads due to weak demand in several market sectors, particularly intermodal, coal and frac sand. The declines were partially offset by growth in construction, petroleum products, and plastics markets. Average revenue per car (ARC) increased 1% due to core pricing gains partially offset by lower fuel surcharge revenue and negative mix of traffic.

We continued our implementation of Unified Plan 2020, the Company's plan for operating a safe and efficient railroad by increasing the reliability of our service product, reducing variability in network operations, and improving resource utilization costs. Year-over-year we saw 18% improvement in locomotive productivity, 10% improvement in freight car velocity and 4% improvement in work force productivity. These actions were the primary driver of the 2.2 point improvement in the operating ratio.

Volume declines and productivity initiatives drove operating expenses down 10% from 2018. These factors coupled with improved pricing and lower fuel prices partially offset the impact of the revenue decline as operating income decreased 2% in the third quarter compared to the same period in 2018.







        Operating Revenues
                                           Three Months Ended             Nine Months Ended
                                              September 30,                 September 30,
                Millions                         2019      2018  Change        2019      2018  Change
                Freight revenues           $   5,146   $ 5,558    (7) %   $ 15,392  $ 15,997    (4) %
                Other subsidiary revenues        223       228    (2)          665       656     1
                Accessorial revenues             132       126     5           388       373     4
                Other                             15        16    (6)           51        49     4
                Total                      $   5,516   $ 5,928    (7) %   $ 16,496  $ 17,075    (3) %
        


We generate freight revenues by transporting freight or other materials from our four commodity groups. Freight revenues vary with volume (carloads) and ARC. Changes in price, traffic mix and fuel surcharges drive ARC. Customer incentives, which are primarily provided for shipping to/from specific locations or based on cumulative volumes, are recorded as a reduction to operating revenues. Customer incentives that include variable consideration based on cumulative volumes are estimated using the expected value method, which is based on available historical, current, and forecasted volumes, and recognized as the related performance obligation is satisfied. We recognize freight revenues over time as shipments move from origin to destination. The allocation of revenue between reporting periods is based on the relative transit time in each reporting period with expenses recognized as incurred.

Other revenues consist primarily of revenues earned by our other subsidiaries (primarily logistics and commuter rail operations) and accessorial revenues. Other subsidiary revenues are generally recognized over time as shipments move from origin to destination. The allocation of revenue between reporting periods is based on the relative transit time in each reporting period with expenses recognized as incurred. Accessorial revenues are recognized at a point in time as performance obligations are satisfied.

Freight revenues decreased 7% during the third quarter of 2019 compared to 2018, resulting from an 8% volume decline, lower fuel surcharge revenue and negative mix of traffic, partially offset by core pricing gains. Fewer shipments of intermodal, coal, and frac sand partially offset by growth in construction, petroleum products, and plastics drove the volume declines.

Each of our commodity groups includes revenue from fuel surcharges. Freight revenues from fuel surcharge programs were $393 million and $1.2 billion in the third quarter and year-to-date periods of 2019 compared to $482 million and $1.25 billion in the same period of 2018. Lower fuel surcharge revenue resulted from volume declines and lower year-over-year prices.

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Other revenues were flat in the third quarter of 2019 compared to third quarter of 2018 due to volume declines offset by higher accessorial charges focused on incentivizing customers' efficient use of Company assets. Year-to-date, other revenues increased driven by accessorial charges and higher revenue at our subsidiaries partially offset by volume declines compared to the same period in 2018.

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







                               Three Months Ended             Nine Months Ended
        Freight Revenues          September 30,                 September 30,
        Millions                     2019      2018  Change        2019      2018  Change
        Agricultural Products  $   1,123   $ 1,133    (1) %   $  3,345  $  3,345      - %
        Energy                       975     1,214   (20)        2,923     3,498   (16)
        Industrial                 1,485     1,497    (1)        4,389     4,274     3
        Premium                    1,563     1,714    (9)        4,735     4,880    (3)
        Total                  $   5,146   $ 5,558    (7) %   $ 15,392  $ 15,997    (4) %
                              Three Months Ended            Nine Months Ended
        Revenue Carloads         September 30,                September 30,
        Thousands,                 2019      2018  Change       2019      2018  Change
        Agricultural Products      278       285    (2) %       821       849    (3) %
        Energy                     374       440   (15)       1,083     1,246   (13)
        Industrial                 467       458     2        1,356     1,321     3
        Premium [a]              1,010     1,133   (11)       3,093     3,250    (5)
        Total                    2,129     2,316    (8) %     6,353     6,666    (5) %
                                 Three Months Ended             Nine Months Ended
                                    September 30,                 September 30,
        Average Revenue per Car        2019      2018  Change         2019     2018  Change
        Agricultural Products    $   4,042   $ 3,973     2  %   $   4,073  $ 3,939     3  %
        Energy                       2,613     2,757    (5)         2,700    2,807    (4)
        Industrial                   3,178     3,269    (3)         3,236    3,236      -
        Premium                      1,546     1,513     2          1,531    1,501     2
        Average                  $   2,417   $ 2,399     1  %   $   2,423  $ 2,400     1  %
        


[a] For intermodal shipments each container or trailer equals one carload.

Agricultural Products - Freight revenue from agricultural products shipments decreased in the third quarter 2019 compared to 2018 due to volume declines and lower fuel surcharge partially offset by core pricing gains. Third quarter volume levels were down 2% as declines in export grain and grain products were partially offset by biofuels, import beer and wheat shipments compared to 2018. Freight revenues were flat in the year-to-date period compared to 2018 as volume declines were offset by core pricing gains and positive mix of traffic. Year-to-date volume declines were impacted by weather-related challenges experienced in the first half of 2019.

Energy - Freight revenue from energy shipments decreased 20% and 16% in the third quarter and year-to-date periods, respectively, of 2019 compared to 2018 due to declines in volume and negative mix of traffic, partially offset by core pricing gains. Third quarter results were impacted by lower fuel surcharge revenue. Frac sand shipments declined 45% in the third quarter compared to last year as regional sand supplies displaced select shipments originating from the upper Midwest. In addition, coal and coke shipments declined 17% due to lower natural gas prices, decreased exports and losses of commercial contracts. Year-to-date, frac sand shipments and coal and coke shipments declined 47% and 13%, respectively, compared to 2018. Volume declines, for the year-to-date periods, were impacted by weather-related challenges experienced in the first half of 2019. Growth in petroleum shipments (both crude and refined) due to strong drilling activity partially offset the sand and coal volume declines in both periods.

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Industrial - Freight revenue from industrial shipments decreased in the third quarter of 2019 compared to 2018 due to negative mix of traffic and lower fuel surcharge revenue partially offset by core pricing gains and volume growth. Year-to-date, freight revenue increased due to core pricing gains and volume growth partially offset by negative mix of traffic. Volume increased 2% and 3% in the third quarter and year-to-date periods, respectively, compared to 2018 driven by strong market demand in construction products and plastics, while forest products shipments decreased due to softness in the lumber and paper markets. Year-to-date volume levels were impacted by weather-related challenges experienced in the first half of 2019.

Premium - Freight revenue from premium shipments decreased in the third quarter and year-to-date periods of 2019 compared to 2018 due to volume declines, partially offset by core pricing gains. Third quarter results were impacted by lower fuel surcharge revenue. Volume decreased 11% and 5% in the third quarter and year-to-date periods, respectively, compared to 2018 driven by declines in domestic intermodal shipments, including containerized automotive parts, due to increased truck competition. Weak market conditions reflecting trade uncertainty and escalating tariffs contributed to the declines as international shipments were 12% lower in the third quarter. These third quarter declines have mostly offset the increase in the first half of the year due to a surge in January shipments and newly secured business. Year-to-date volume declines were impacted by weather-related challenges experienced in the first half of 2019.

Mexico Business - Each of our commodity groups includes revenue from shipments to and from Mexico. Revenue from Mexico business decreased 5% to $602 million in the third quarter of 2019 compared to $636 million in 2018 driven by a 6% decline in volume. The decrease in volume was driven by fewer shipments of grain, coal, and automotive parts, partially offset by growth in petroleum products and industrial chemicals shipments. Year-to-date, freight revenue decreased 4% to $1.8 billion as a result of fewer shipments of automotive parts, grain and coal partially offset by growth in petroleum products and industrial chemical shipments and core pricing gains.







        Operating Expenses
                                          Three Months Ended             Nine Months Ended
                                             September 30,                 September 30,
        Millions                                2019      2018  Change        2019      2018  Change
        Compensation and benefits         $   1,134   $ 1,262   (10) %   $  3,484  $  3,776    (8) %
        Purchased services and materials        574       632    (9)        1,723     1,861    (7)
        Depreciation                            557       547     2         1,657     1,636     1
        Fuel                                    504       659   (24)        1,595     1,891   (16)
        Equipment and other rents               236       272   (13)          754       803    (6)
        Other                                   277       287    (3)          829       801     3
        Total                             $   3,282   $ 3,659   (10) %   $ 10,042  $ 10,768    (7) %
        


Operating expenses decreased $377 million and $726 million in the third quarter and year-to-date periods, respectively, compared to 2018 driven by cost savings from lower volume, productivity improvements, and lower fuel price. Increased costs due to inflation, more destroyed equipment, and depreciation partially offset these decreases compared to 2018. Year-to-date 2019 expenses were impacted positively due to the employment tax refund (see Note 17 of the Condensed Consolidated Financial Statements) and negatively due to the first half weather-related challenges.

Compensation and Benefits - Compensation and benefits include wages, payroll taxes, health and welfare costs, pension costs, other postretirement benefits, and incentive costs. For the third quarter and year-to-date periods, expenses decreased 10% and 8% compared to 2018 due to lower wage and benefit costs driven by reduced workforce levels, lower volume, and the employment tax refund. Wage inflation partially offset the decreases. Increased expense associated with the workforce reduction and weather-related challenges partially offset the decrease in the year-to-date period.

Purchased Services and Materials - Expense for purchased services and materials includes the costs of services purchased from outside contractors and other service providers (including equipment maintenance and contract expenses incurred by our subsidiaries for external transportation services); materials used to maintain the Railroad's lines, structures, and equipment; costs of operating facilities jointly used by UPRR and other railroads; transportation and lodging for train crew employees; trucking and contracting costs for

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intermodal containers; leased automobile maintenance expenses; and tools and supplies. Purchased services and materials decreased 9% and 7% in the third quarter and year-to-date periods, respectively, compared to 2018. Lower locomotive repair expense due to a smaller active fleet in service, volume-related costs for intermodal and transload services and lower costs for services purchased from outside contractors primarily drove the decreases in both periods. Conversely, higher costs associated with derailments partially offset these decreases in both period versus 2018. Weather-related challenges unfavorably impacted the year-to-date period.

Depreciation - The majority of depreciation relates to road property, including rail, ties, ballast, and other track material. A higher depreciable asset base, reflecting recent years' higher capital spending, increased depreciation expense in the third quarter and year-to-date periods of 2019 compared to 2018.

Fuel - Fuel includes locomotive fuel and fuel for highway and non-highway vehicles and heavy equipment. Lower locomotive diesel fuel prices, which averaged $2.09 per gallon (including taxes and transportation costs) in the third quarter of 2019 compared to $2.38 per gallon in the same period in 2018, a 10% decline in gross ton-miles and a 3% improvement in fuel consumption rate, computed as gallons of fuel consumed divided by gross ton-miles in thousands, drove the decrease in the third quarter compared to the same period in 2018. For the nine-month period, locomotive diesel fuel prices averaged $2.13 per gallon in 2019 compared to $2.27 in 2018, decreasing expenses by 6%. In addition, gross ton-miles decreased 7% and fuel consumption rate improved 3% during the year-to-date period, driving lower fuel expense compared to 2018.

Equipment and Other Rents - Equipment and other rents expense primarily includes rental expense that the Railroad pays for freight cars owned by other railroads or private companies; freight car, intermodal, and locomotive leases; and office and other rentals. Equipment and other rents expense decreased 13% and 6% in the third quarter and year-to-date periods, respectively, compared to 2018, driven by decreased car rent expense due to volume declines, improved cycle time, and lower locomotive and freight car lease expenses. Year-to-date expenses were unfavorably impacted by weather-related cost challenges.

Other - Other expenses include state and local taxes; freight, equipment and property damage; utilities, insurance, personal injury, environmental, employee travel, telephone and cellular, computer software, bad debt and other general expenses. Other costs decreased 3% in the third quarter compared to 2018 driven primarily by lower costs associated with environmental expenses related to our operating properties, employee travel, and utilities expense partially offset by increased costs as a result of more destroyed equipment and freight loss and damage costs. Conversely, other expenses increased 3% in the year-to-date period compared to 2018 due to increased costs as a result of more destroyed equipment and freight loss and damage costs partially offset by lower costs associated with employee travel and environmental expenses related to our operating properties.







        Non-Operating Items
                           Three Months Ended              Nine Months Ended
                              September 30,                  September 30,
        Millions                2019        2018  Change        2019      2018  Change
        Other income      $      53   $      48    10  %   $    187  $     48      F %
        Interest expense       (266)       (241)   10          (772)     (630)   23
        Income taxes           (466)       (483)   (4)       (1,353)   (1,313)    3
        


Other Income - Other income increased in the third quarter of 2019 compared to 2018 as a result of lower costs associated with our benefit plans and higher rental income partially offset by higher environmental costs associated with non-operating properties. For the nine-month period, other income increased due to $31 million in interest income associated with the employment tax refund in 2019, a decrease of $85 million in expense associated with early-extinguishment of outstanding debentures and mortgage bonds recognized in the first quarter of 2018, and lower costs associated with our benefit plans.

Interest Expense - Interest expense increased in the third quarter of 2019 compared to 2018 due to an increase in the weighted-average debt level of $25.4 billion in 2019 compared to $22.6 billion in 2018. The effective interest rate was 4.3% for both periods. Year-to-date, interest expense increased due to an increased weighted-average debt level of $24.6 billion in 2019 from $19.4 billion in 2018. The year-to-date effective interest rate was 4.3% in 2019 compared to 4.4% in 2018.

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Income Taxes - Income taxes were lower in the third quarter of 2019 compared to 2018, driven by lower income. Our effective tax rates for the third quarter of 2019 and 2018 were 23.1% and 23.3%, respectively. Reductions to unrecognized tax benefits for statute expirations in the third quarter of both 2019 and 2018 lowered the effective tax rate. For the nine-month periods of 2019 and 2018, our effective tax rates were 23.1% and 22.9%, respectively. In the second quarter of 2018, Iowa and Missouri enacted laws to reduce their corporate tax rate, which lowered our 2018 effective tax rate. In 2019, Arkansas enacted a law to reduce its corporate tax rate. This reduced our 2019 effective tax rate. The Arkansas reduction was less than the Iowa and Missouri reductions resulting in a higher effective tax rate for 2019 compared to 2018.

OTHER OPERATING/PERFORMANCE AND FINANCIAL STATISTICS

We report a number of key performance measures weekly to the Surface Transportation Board (STB). We provide this data on our website at www.up.com/investor/aar-stb_reports/index.htm .







        Operating/Performance Statistics
        Railroad performance measures are included in the table below:
                                             Three Months Ended             Nine Months Ended
                                                September 30,                 September 30,
                                                 2019      2018   Change       2019      2018   Change
        Gross ton-miles (GTMs) (billions)       215.5     240.2   (10)   %    645.8     698.1    (7)   %
        Revenue ton-miles (billions)            108.1     123.3   (12)        323.5     358.3   (10)
        Freight car velocity (daily miles         213       193    10           201       189     6
        per car)
        Average train speed (miles per hour)     23.7      24.0    (1)         23.4      24.5    (4)
        [a]
        Average terminal dwell time (hours)      23.4      29.3   (20)         25.1      30.6   (18)
        [a]
        Locomotive productivity (GTMs per         124       105    18           118       104    13
        horsepower day)
        Workforce productivity (car miles         883       852     4           853       838     2
        per employee)
        Employees (average)                    36,659    42,323   (13)       38,456    42,057    (9)
        


[a] As reported to the STB.

Gross and Revenue Ton-Miles - Gross ton-miles are calculated by multiplying the weight of loaded and empty freight cars by the number of miles hauled. Revenue ton-miles are calculated by multiplying the weight of freight by the number of tariff miles. Gross ton-miles and revenue ton-miles decreased 10% and 12%, respectively, during the third quarter of 2019 compared to 2018, driven by an 8% decline in carloadings. Changes in commodity mix drove the variance in year-over-year decreases between gross ton-miles, revenue ton-miles and carloads. Year-to-date, gross ton-miles and revenue ton-miles decreased 7% and 10%, respectively, compared to 2018, driven by a 5% decrease in carloadings.

Freight Car Velocity - Freight car velocity measures the average daily miles per car on our network. The two key drivers of this metric are the speed of the train between terminals (average train speed) and the time a rail car spends at the terminals (average terminal dwell time). Implementation of Unified Plan 2020 drove the 10% and 6% improvement for the third quarter and nine-month periods of 2019, respectively. Average terminal dwell time decreased 20% and 18% during the third quarter and year-to-date periods, respectively, compared to the same period in 2018 largely due to improved terminal processes, transportation plan changes to eliminate switches, and a decrease in freight car inventory levels. Conversely, average train speed declined 1% and 4% for the third quarter and year-to-date periods, respectively, compared to 2018, largely due to an increase in work events, however the overall movement of freight cars is faster.

Locomotive Productivity - Locomotive productivity is gross ton-miles per average daily locomotive horsepower. Locomotive productivity increased 18% year-over-year as we reduced our active locomotive fleet by 23% since the third quarter of 2018. Year-to-date, locomotive productivity improved 13% driven by the reduced fleet size.

Workforce Productivity - Workforce productivity is average daily car miles per employee. Workforce productivity improved 4% as average daily car miles . . .

Oct 17, 2019

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