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July 22, 2021, 3:21 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 Six Months Ended June 30, 2021, Compared to

Three and Six Months Ended June 30, 2020

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.

Cautionary Information

Statements in this Form 10-Q/filing, including forward-looking statements, speak only as of and are based on information we have learned as of July 22, 2021. We assume no obligation to update any such information to reflect subsequent developments, changes in assumptions, or changes in other factors affecting forward-looking information. If we do update one or more of these statements, no inference should be drawn that we will make additional updates with respect thereto or with respect to other statements.

Certain statements in this report, and statements in other reports or information filed or to be filed with the SEC (as well as information included in oral statements or other written statements made or to be made by us), are forward-looking statements within the meaning of Section 27A Securities Act of 1933 and the Section 21E of the Exchange Act. These forward-looking statements and information include, without limitation, the statements and information set forth under the caption "Effects from COVID-19" in Item 2 regarding the impact of the coronavirus (COVID-19) pandemic on our business and operations; "Liquidity and Capital Resources" in Item 2 regarding our capital plan, contractual obligations, and commercial commitment; and statements under the caption "Other Matters." Forward-looking statements and information also include any other statements or information in this report regarding: potential impacts of the COVID-19 pandemic on our business operations, financial results, liquidity, and financial position, and on the world economy (including our customers and supply chains), including as a result of decreased volume and carloadings; closing of customer manufacturing, distribution or production facilities; expectations as to operational or service improvements; expectations regarding the effectiveness of steps taken or to be taken to improve operations, service, infrastructure improvements, and transportation plan modifications; expectations as to cost savings, revenue growth, and earnings; the time by which goals, targets, or objectives will be achieved; projections, predictions, expectations, estimates, or forecasts as to our business, financial, and operational results, future economic performance, and general economic conditions; proposed new products and services; estimates of costs relating to environmental remediation and restoration; estimates and expectations regarding tax matters, expectations that claims, litigation, environmental costs, commitments, contingent liabilities, labor negotiations or agreements, or other matters will not have a material adverse effect on our consolidated results of operations, financial condition, or liquidity and any other similar expressions concerning matters that are not historical facts.

Forward-looking statements and information reflect the good faith consideration by management of currently available information, and may be based on underlying assumptions believed to be reasonable under the circumstances. However, such information and assumptions (and, therefore, such forward-looking statements and information) are or may be subject to risks and uncertainties over which management has little or no influence or control, and many of these risks and uncertainties are currently amplified by and may continue to be amplified by, or in the future may be amplified by, the COVID-19

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pandemic. The Risk Factors in Item 1A of our 2020 Annual Report on Form 10-K, filed February 5, 2021, could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in the forward-looking statements, and this report, including this Item 2, should be read in conjunction with these Risk Factors. Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times that, or by which, such performance or results will be achieved. Forward-looking information is subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in the statements.

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 2020 Annual Report on Form 10-K. There have not been any significant changes with respect to these policies during the first six months of 2021.

RESULTS OF OPERATIONS

Quarterly Summary

The Company reported earnings of $2.72 per diluted share on net income of $1.8 billion and an operating ratio of 55.1% in the second quarter of 2021 compared to earnings of $1.67 per diluted share on net income of $1.1 billion and an operating ratio of 61.0% for the second quarter of 2020. After freight revenues declined 24% year-over-year in the second quarter of 2020 driven by the economic impact of COVID-19 and the economic shutdown that reduced volumes by 20%, our second quarter of 2021 freight revenues increased 29% compared to the same period in 2020 driven by a 6% higher average revenue per car (ARC) and a 22% volume increase. The ARC increase was due to higher fuel surcharge revenue and core pricing gains. Operating expenses increased 17% driven by higher fuel prices, volume related costs, and higher casualty costs, partially offset by productivity. After operating income decreased 27% year-over-year in the second quarter of 2020, our second quarter of 2021 operating income increased 50% compared to the same period in 2020.

Effects from COVID-19

The economy continues to improve as pandemic restrictions ease and society reopens. However, supply chain disruptions continue. Most notably, the semiconductor chip shortage continues to impact the automotive industry, while strong international intermodal demand is contributing to network congestion. The impact of the semiconductor chip shortage is masked in our year-over-year comparison as the second quarter of 2020 saw a temporary suspension of automotive production due to the pandemic. The pandemic also has upended the intermodal supply chain as demand for consumer goods remains high. This high demand has strained the ports, railroad equipment and chassis availability, truck driver supply, and warehouse receiving capacity. These disruptions limit our revenue growth by slowing asset turns and increasing costs through lower freight car velocity and multiple handlings, which will continue to impact our third quarter and potentially the remainder of the year. Demand in most other markets positively impacted the second quarter of 2021 as they recover from the dramatic slowdown caused by the spread of COVID-19 in the second quarter of 2020.

The safety of our employees, our customers, and the communities we serve remains a high priority. In an effort to mitigate the spread of COVID-19, we are promoting and encouraging all of our employees through financial incentives to get vaccinated.

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        Operating Revenues
                                            Three Months Ended             Six Months Ended
                                                 June 30,                      June 30,
                 Millions                         2021      2020  Change        2021     2020  Change
                 Freight revenues           $   5,132   $ 3,972    29  %   $  9,781  $ 8,852    10  %
                 Other subsidiary revenues        180       150    20           357      364    (2)
                 Accessorial revenues             176       103    71           337      220    53
                 Other                             16        19   (16)           30       37   (19)
                 Total                      $   5,504   $ 4,244    30  %   $ 10,505  $ 9,473    11  %
        


We generate freight revenues by transporting freight or other materials from our three 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 revenue increased 29% during the second quarter of 2021 compared to 2020, resulting from a 22% volume increase, higher fuel surcharge revenue, and core pricing gains. Volume increases were primarily driven by recovery from the dramatic slowdown caused by the spread of COVID-19 in the second quarter of 2020.

Each of our commodity groups includes revenue from fuel surcharges. Freight revenues from fuel surcharge programs were $414 million in the second quarter of 2021 compared to $206 million in the same period of 2020. The increase was driven by higher fuel price and increased volume, partially offset by the lag impact on fuel surcharge recovery (it can generally take up to two months for changing fuel prices to affect fuel surcharge recoveries).

Accessorial revenue increased in the second quarter and the year-to-date period compared to 2020 driven by increased intermodal shipments. Other subsidiary revenues increased in the second quarter compared to 2020 driven primarily by the U.S. automotive plant shut downs in the second quarter of 2020 impacting our subsidiary that brokers intermodal and transload logistics services. Year-to-date, subsidiary revenues are down compared to the same period in 2020 as the semi-conductor shortage impacting 2021 automobile production outweighs the recovery from COVID-19 declines in 2020.

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







                                         Three Months Ended             Six Months Ended
        Freight Revenues                      June 30,                      June 30,
        Millions                               2021      2020  Change        2021     2020  Change
        Grain & grain products           $     795   $   644    23  %   $  1,561  $ 1,333    17  %
        Fertilizer                             179       168     7           349      342     2
        Food & refrigerated                    251       205    22           486      455     7
        Coal & renewables                      423       369    15           764      790    (3)
        Bulk                                 1,648     1,386    19         3,160    2,920     8
        Industrial chemicals & plastics        498       435    14           933      930      -
        Metals & minerals                      467       368    27           842      837     1
        Forest products                        348       266    31           664      569    17
        Energy & specialized markets           546       431    27         1,076    1,058     2
        Industrial                           1,859     1,500    24         3,515    3,394     4
        Automotive                             428       189      F          875      713    23
        Intermodal                           1,197       897    33         2,231    1,825    22
        Premium                              1,625     1,086    50         3,106    2,538    22
        Total                            $   5,132   $ 3,972    29  %   $  9,781  $ 8,852    10  %
                                        Three Months Ended           Six Months Ended
        Revenue Carloads                     June 30,                    June 30,
        Thousands,                           2021      2020  Change      2021     2020  Change
        Grain & grain products               204       167    22  %      407      342    19  %
        Fertilizer                            54        53     2          98       99    (1)
        Food & refrigerated                   48        41    17          93       89     4
        Coal & renewables                    198       186     6         372      394    (6)
        Bulk                                 504       447    13         970      924     5
        Industrial chemicals & plastics      156       141    11         296      295      -
        Metals & minerals                    182       162    12         328      336    (2)
        Forest products                       64        50    28         124      106    17
        Energy & specialized markets         138       115    20         277      277      -
        Industrial                           540       468    15       1,025    1,014     1
        Automotive                           173        79      F        353      287    23
        Intermodal [a]                       878       724    21       1,674    1,433    17
        Premium                            1,051       803    31       2,027    1,720    18
        Total                              2,095     1,718    22  %    4,022    3,658    10  %
                                         Three Months Ended             Six Months Ended
                                              June 30,                      June 30,
        Average Revenue per Car                2021      2020  Change        2021     2020  Change
        Grain & grain products           $   3,894   $ 3,861     1  %   $  3,838  $ 3,901    (2) %
        Fertilizer                           3,304     3,181     4         3,550    3,456     3
        Food & refrigerated                  5,226     4,986     5         5,230    5,142     2
        Coal & renewables                    2,134     1,979     8         2,051    2,001     2
        Bulk                                 3,266     3,099     5         3,256    3,161     3
        Industrial chemicals & plastics      3,189     3,086     3         3,153    3,148      -
        Metals & minerals                    2,569     2,276    13         2,567    2,494     3
        Forest products                      5,463     5,256     4         5,357    5,361      -
        Energy & specialized markets         3,944     3,739     5         3,886    3,813     2
        Industrial                           3,442     3,201     8         3,430    3,345     3
        Automotive                           2,479     2,388     4         2,482    2,487      -
        Intermodal [a]                       1,363     1,241    10         1,332    1,274     5
        Premium                              1,547     1,354    14         1,532    1,476     4
        Average                          $   2,449   $ 2,312     6  %   $  2,432  $ 2,420      - %
        


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

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Bulk - Bulk includes shipments of grain and grain products, fertilizer, food and refrigerated goods, and coal and renewables. Freight revenue from bulk shipments increased in the second quarter of 2021 compared to 2020 due to a 13% volume increase, core pricing gains, and higher fuel surcharge revenue. Strong demand for export grain and increased ethanol demand from the COVID-19 recovery drove a 22% increase in shipments of grain and grain products. Market conditions for coal were favorable in the second quarter as worldwide electricity demand recovered from the pandemic and natural gas prices rose, driving a 9% increase in volume compared to the second quarter of 2020, despite a contract loss. Year-to-date, freight revenue from bulk shipments increased compared to the same period in 2020, driven by 5% higher volume, core pricing gains, and positive mix of traffic. Strong demand for export grain drove a 19% increase in shipments of grain and grain products year-to-date, which partially offset lower volume from coal and renewables shipments in the first quarter.

Industrial - Industrial includes shipments of industrial chemicals and plastics, metals and minerals, forest products, and energy and specialized markets. Freight revenue from industrial shipments increased in the second quarter compared to the same period in 2020 due to higher volume, positive mix of traffic, core pricing gains, and higher fuel surcharge revenue. Volume increases in the second quarter of 2021 were primarily driven by the recovery from the pandemic slowdown that impacted production across a wide array of industries in the second quarter of 2020. Year-to-date, freight revenue from industrial shipments increased compared to the same period in 2020, driven by core pricing gains, positive mix of traffic, and a 1% volume increase. The pandemic recovery in the second quarter offset a majority of the losses in the first quarter caused by weather interruptions in the Gulf Coast impacting industrial chemicals and plastics and metals and mineral industries, and unfavorable regional crude oil pricing spreads impacting petroleum shipments. Forest product shipments increased due to high demand for cardboard boxes and lumber.

Premium - Premium includes shipments of finished automobiles, automotive parts, and merchandise in intermodal containers, both domestic and international. Premium freight revenue increased in the second quarter and year-to-date periods compared to same periods in 2020 due to volume increases, higher fuel surcharge revenue, positive mix of traffic, and core pricing gains. Automotive shipments in the second quarter of 2021 were more than double the shipments in the same period last year, as North American manufacturing plants temporarily suspended production due to the pandemic. This recovery is masking the impact to automotive shipments in the second quarter of 2021 due to the shortage of semiconductors. Despite the supply chain disruptions, intermodal shipments increased 21% in the second quarter of 2021 due to improving economic conditions, inventory restocking, contract wins, and continued strength of e-commerce and parcel shipments. The year-to-date period also was negatively impacted by weather disruptions in the first quarter of 2021.

Mexico Business - Each of our commodity groups includes revenue from shipments to and from Mexico. Revenue from Mexico business increased 59% to $618 million in the second quarter of 2021 compared to 2020 driven by a 53% volume increase, higher fuel surcharge revenue, and core pricing gains. Volume increases in the second quarter of 2021 were driven by the recovery from the pandemic slowdown in the second quarter of 2021, including shipments of auto parts, finished vehicles, petroleum products, brewers and beverage, and grain. Year-to-date, freight revenue increased 22% to $1,183 million as a result of increased volume, higher fuel surcharges, and core pricing gains.







        Operating Expenses
                                          Three Months Ended             Six Months Ended
                                               June 30,                      June 30,
        Millions                                2021      2020  Change        2021     2020  Change
        Compensation and benefits         $   1,022   $   905    13  %   $  2,048  $ 1,964     4  %
        Depreciation                            550       551      -        1,099    1,098      -
        Purchased services and materials        478       441     8           968      962     1
        Fuel                                    497       247      U          908      681    33
        Equipment and other rents               200       211    (5)          412      438    (6)
        Other                                   284       235    21           604      533    13
        Total                             $   3,031   $ 2,590    17  %   $  6,039  $ 5,676     6  %
        


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Operating expenses increased $441 million and $363 million in the second quarter and year-to-date periods, respectively, compared to 2020 driven by higher fuel prices, volume-related costs, inflation, 2020 management actions responding to the sharp decline in volume (temporary unpaid leave, salary reductions, and shop closures), incentive compensation, higher casualty costs, an insurance reimbursement recognized in 2020, and higher state and local taxes. Partially offsetting these increases compared to 2020 are productivity initiatives. In addition, the year-to-date period comparison was impacted negatively by weather-related expenses.

Compensation and Benefits - Compensation and benefits include wages, payroll taxes, health and welfare costs, pension costs, other postretirement benefits, and incentive costs. For the second quarter and year-to-date periods, expenses increased 13% and 4%, respectively, compared to 2020 due to increases in carload volumes, wage inflation, 2020 management actions responding to the sharp decline in volume (temporary unpaid leave, salary reductions, and shop closures), and incentive compensation. Partially offsetting these increases are productivity initiatives resulting in employee levels that were flat and down 6% in the second quarter and year-to-date periods, respectively, compared to 2020 despite volume increases. In addition, the year-to-date period comparison was impacted negatively by weather-related expenses.

Depreciation - The majority of depreciation relates to road property, including rail, ties, ballast, and other track material. Depreciation expense was essentially flat for the second quarter and six-month periods of 2021 compared to 2020.

Purchased Services and Materials - Expense for purchased services and materials includes the costs of services purchased (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 intermodal containers; leased automobile maintenance expenses; and tools and supplies. Purchased services and materials increased 8% and 1% in the second quarter and year-to-date periods, respectively, compared to 2020 primarily due to higher volume-related costs for transload services incurred by one of our subsidiaries and other volume-related costs such as transportation and lodging for train crews. In addition, the year-to-date period was negatively impacted by weather-related expense and positively impacted by lower locomotive and freight car maintenance expenses due to a smaller active fleet in the first quarter.

Fuel - Fuel includes locomotive fuel and fuel for highway and non-highway vehicles and heavy equipment. Fuel expense increased in the second quarter of 2021 compared to the same period in 2020 driven by a 71% increase in locomotive diesel fuel prices, which averaged $2.16 and $1.26 per gallon (including taxes and transportation costs) in the second quarter of 2021 and 2020, respectively, and a 22% increase in gross ton-miles. The fuel consumption rate, computed as gallons of fuel consumed divided by gross ton-mile in thousands, improved 3% versus the second quarter in 2020 offsetting some of the increased costs due to the higher price and increased volume. For the six-month period, locomotive diesel fuel prices averaged $2.01 per gallon in 2021 compared to $1.59 in 2020, driving the increase in expenses by 33%. In addition, gross ton-miles increased 8% during the year-to-date period, also driving higher fuel expense compared to 2020. The higher costs were partially offset by fuel consumption rate improvement of 2%.

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 5% in the second quarter and 6% in the year-to-date period compared to 2020 driven by lower rent on stored equipment and higher equity income from our investment in TTX Company, partially offset by increased freight car rent expense due to volume increases.

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 increased 21% and 13% in the second quarter and year-to-date periods, respectively, compared to 2020 driven by casualty expenses including personal injury, environmental, destroyed equipment, and damaged freight, an insurance reimbursement recognized in 2020, and higher state and local taxes.

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        Non-Operating Items
                            Three Months Ended              Six Months Ended
                                 June 30,                       June 30,
        Millions                 2021        2020  Change        2021     2020  Change
        . . .
        


Jul 22, 2021

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