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UNION PACIFIC CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) UNION PACIFIC CORPORATION AND SUBSIDIARY COMPANIES RESULTS OF OPERATIONS Three and Nine Months Ended September 30, 2014, Compared to Three and Nine Months Ended September 30, 2013 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; eXtensible Business Reporting Language (XBRL) documents; 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: 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 2013 Annual 23-------------------------------------------------------------------------------- Table of Contents Report on Form 10-K. There have not been any significant changes with respect to these policies during the first nine months of 2014. RESULTS OF OPERATIONS Quarterly Summary We reported earnings of $1.53 per diluted share on net income of $1.4 billion in the third quarter of 2014 compared to earnings of $1.24 per diluted share on net income of $1.2 billion for the third quarter of 2013. Year-to-date, net income was $3.7 billion versus $3.2 billion for the same period in 2013. Freight revenues increased 11%, or $569 million, in the third quarter compared to the same period in 2013 driven by 7% volume growth and pricing gains. Volume growth from grain, frac sand, rock, and intermodal (domestic and international) shipments offset declines in crude oil and coal shipments. The third quarter of 2014 generated best-ever quarterly financial results, reflecting our ability to leverage the additional volumes and improve core pricing. In the third quarter of 2014, our average train speed and average terminal dwell, as reported to the Association of American Railroads (AAR), were essentially flat with the second quarter despite higher volumes, which increased 3%. In the third quarter, we purchased additional locomotives and increased active Train, Engine and Yard (TE&Y) employees in an effort to improve network performance and handle growing demand. We will continue adding resources in the fourth quarter and in 2015 as we focus on improving service and velocity. Operating Revenues Three Months Ended Nine Months Ended September 30, % September 30, % Millions 2014 2013 Change 2014 2013 Change Freight revenues $ 5,819 $ 5,250 11% $ 16,766 $ 15,387 9% Other revenues 363 323 12 1,069 946 13 Total $ 6,182 $ 5,573 11% $ 17,835 $ 16,333 9% We generate freight revenues by transporting freight or other materials from our six commodity groups. Freight revenues vary with volume (carloads) and Average Revenue per Car (ARC). Changes in price, traffic mix and fuel surcharges drive ARC. We provide some of our customers with contractual incentives for meeting or exceeding specified cumulative volumes or shipping to and from specific locations, which we record as reductions to freight revenues based on the actual or projected future shipments. We recognize freight revenues as shipments move from origin to destination. We allocate freight revenues between reporting periods based on the relative transit time in each reporting period and recognize expenses as we incur them. Other revenues include revenues earned by our subsidiaries, revenues from commuter rail operations that we manage, accessorial revenues, which we earn when customers retain equipment owned or controlled by us or when we perform additional services such as switching or storage, and miscellaneous contract revenue. We recognize other revenues as we perform services or meet contractual obligations. Freight revenues for all six commodity groups increased during the third quarter of 2014 and the year-to-date period of 2014 compared to 2013, as a result of economic improvements in certain market sectors, along with the improved 2013 harvest. Volume levels increased for five of the six commodity groups, with particularly strong growth in agricultural products, industrial products and intermodal. ARC increased 3% and 2% during the third quarter and year-to-date periods of 2014 versus 2013, respectively, driven by pricing gains. In addition, business mix was a slight positive in the third quarter compared to 2013 and a slight negative year to date. Each of our commodity groups includes revenue from fuel surcharges. Freight revenues from fuel surcharge programs were $721 million and $2.1 billion in the third quarter and year-to-date periods of 2014, compared to $633 million and $1.9 billion in the same periods of 2013. Higher fuel surcharge recoveries were driven by increased volume and the lag impact of our fuel surcharge programs (it can 24 -------------------------------------------------------------------------------- Table of Contents generally take up to two months for changing fuel prices to affect fuel surcharge recoveries) partially offset by the lower fuel prices. In the third quarter and year-to-date periods of 2014, other revenues increased from 2013 due to higher revenues at our subsidiaries, primarily those that broker intermodal and automotive services, accessorial revenue driven by increased volume and per diem revenue for container usage (previously included in automotive freight revenue). 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 2014 2013 Change 2014 2013 Change Agricultural $ 915 $ 771 19% $ 2,759 $ 2,339 18% Automotive 527 512 3 1,560 1,533 2 Chemicals 936 883 6 2,742 2,646 4 Coal 1,099 1,082 2 3,049 2,993 2 Industrial Products 1,161 975 19 3,302 2,868 15 Intermodal 1,181 1,027 15 3,354 3,008 12 Total $ 5,819 $ 5,250 11% $ 16,766 $ 15,387 9% Three Months Ended Nine Months Ended Revenue Carloads September 30, % September 30, % Thousands 2014 2013 Change 2014 2013 Change Agricultural 239 210 14% 721 631 14% Automotive 204 195 5 600 576 4 Chemicals 288 282 2 841 840 - Coal 466 468 - 1,313 1,284 2 Industrial Products 363 325 12 1,033 931 11 Intermodal [a] 936 848 10 2,693 2,480 9 Total 2,496 2,328 7% 7,201 6,742 7% Three Months Ended Nine Months Ended September 30, % September 30, % Average Revenue per Car 2014 2013 Change 2014 2013 Change Agricultural $ 3,836 $ 3,679 4% $ 3,828 $ 3,707 3% Automotive 2,590 2,620 (1) 2,600 2,661 (2) Chemicals 3,249 3,134 4 3,261 3,151 3 Coal 2,362 2,312 2 2,323 2,331 - Industrial Products 3,195 2,998 7 3,195 3,080 4 Intermodal [a] 1,260 1,211 4 1,245 1,213 3 Average $ 2,331 $ 2,255 3% $ 2,328 $ 2,282 2% [a] Each intermodal container or trailer equals one carload. Agricultural Products - Higher volume and pricing gains drove the increase in freight revenue from agricultural shipments in the third quarter and year-to-date periods of 2014 versus 2013. Grain shipments increased 34% in the third quarter 2014 versus 2013, due to strength in the domestic feed grain market and strong corn exports, partially offset by lower export wheat due to a larger world crop. Grain shipments year-to-date increased 39%, reflecting the strong overall harvest in 2013 and the impact of the severe drought in 2012 that affected territory served by us and significantly reduced volumes during the first three quarters of 2013. Automotive - Freight revenue from automotive shipments increased compared to the third quarter and year-to-date periods of 2013. Growth in automotive parts and finished vehicle shipments and core price improvements drove the higher revenue. Finished vehicle shipments increased in the second and third 25-------------------------------------------------------------------------------- Table of Contents quarters with improved sales and production, which offset declines in the first quarter due to winter weather. Volume for automotive parts increased during the third quarter and year-to-date periods of 2014 driven by continued strength in production and market penetration. Mix shifts and a change in how we are compensated for container usage, which is now included as a per diem charge in other revenue, negatively impacted ARC in the third quarter and year-to-date periods. Chemicals - Core price improvements increased freight revenue from chemicals in the third quarter and year-to-date periods of 2014 versus 2013. Higher volume and ARC driven by positive business mix also contributed to the increased freight revenue in the third quarter of 2014 versus 2013. Shipments of industrial chemicals grew as a result of continued strong demand in the drilling market in the third quarter and year-to-date periods of 2014. Shipments of crude oil from the Bakken and Eagle Ford shale formations to the Gulf area declined in both periods, as market factors, primarily regional pricing differences for various types of crude oil, have displaced some of the former gulf coast shipments to the East and West Coasts. Coal - Higher fuel surcharges and core pricing gains, partially offset by modest volume declines, increased freight revenue from coal shipments in the third quarter of 2014 compared to 2013. Year-to-date, higher volume offset the lower ARC driven by negative business mix, resulting in a net increase to freight revenue in 2014. Despite strong demand due to inventory replenishment following the cold winter, network performance and contract losses limited second and third quarter volume growth. Southern Powder River Basin shipments declined 2% for the third quarter and 1% year-to-date. The second and third quarter declines offset volume increases during the first quarter from severe winter weather conditions, low inventories at utilities and higher natural gas prices. Shipments from Colorado and Utah mines increased 11%, from both the third quarter and year-to-date periods of 2013, driven by higher natural gas prices and strong exports through the West Coast. Industrial Products - Volume growth, core pricing gains and positive business mix increased freight revenue from industrial products in the third quarter and year-to-date periods of 2014 versus 2013. Shipments of non-metallic minerals (primarily frac sand, up 39%) grew as a result of drilling activity for energy products, partly reflecting evolving drilling practices, which can increase the amount of frac sand used at certain wells. Additionally, both rock and lumber increased in the third quarter, driven by new housing and commercial construction. Intermodal - Increased shipments and core pricing improvement drove higher freight revenue from intermodal shipments in the third quarter and year-to-date periods of 2014 compared to the same periods in 2013. International shipments increased 8% in the third quarter driven primarily by new business and improving economic conditions. We believe that some of the increased volumes of international intermodal during the second quarter may be attributed to an acceleration of shipments in anticipation of a possible impasse during renegotiations of labor contracts at West Coast ports. These gains in the second and third quarters offset the declines in the first quarter due to severe weather that negatively impacted consumer demand. Domestic traffic for the quarter and year-to-date periods increased 13% and 11%, respectively, driven by continued conversions from trucks and new premium services. Mexico Business - Each of our commodity groups includes revenue from shipments to and from Mexico. Revenue from Mexico business increased 10% to $579 million in the third quarter of 2014 versus the same period in 2013. Volume levels increased 9% from the third quarter of 2013, driven by strong growth in four of our six commodity groups. Year-to-date, revenue grew 11% versus 2013 to $1.7 billion. Volume levels increased 11% from 2013, as increases in agricultural products, chemicals, intermodal, industrial products and automotive offset lower export coal shipments. 26 -------------------------------------------------------------------------------- Table of Contents Operating Expenses Three Months Ended Nine Months Ended September 30, % September 30, % Millions 2014 2013 Change 2014 2013 Change Compensation and benefits $ 1,287 $ 1,196 8% $ 3,787 $ 3,597 5% Fuel 882 866 2 2,726 2,629 4 Purchased services and materials 650 588 11 1,893 1,730 9 Depreciation 481 447 8 1,415 1,319 7 Equipment and other rents 310 309 - 938 924 2 Other 242 205 18 696 661 5 $ 3,852 $ 3,611 7% $ 11,455 $ 10,860 5% Total Operating expenses increased $241 million and $595 million in the third quarter and nine-month periods of 2014, respectively, versus 2013. Volume related expenses, incremental costs associated with operating a slower network, depreciation, wage and benefit inflation, and locomotive and freight car materials contributed to the higher costs during the periods. Lower fuel price partially offset these increases. In addition, the first nine months of 2014 includes first quarter weather related costs of approximately $35 million. Compensation and Benefits - Compensation and benefits include wages, payroll taxes, health and welfare costs, pension costs, other postretirement benefits, and incentive costs. Volume-related expenses, including training, and a slower network increased our train and engine work force, which, along with general wage and benefit inflation, drove the increases in the third quarter of 2014 versus 2013. Weather related costs in the first quarter of 2014 also increased costs for the year-to-date period. Fuel - Fuel includes locomotive fuel and gasoline for highway and non-highway vehicles and heavy equipment. Fuel costs were higher as gross-ton miles increased 8% in the third quarter. The fuel consumption rate, computed as gallons of fuel consumed divided by gross ton-miles in thousands, improved 1% compared to the third quarter of 2013 due to productivity. Locomotive diesel fuel prices, which averaged $3.01 per gallon (including taxes and transportation costs) in the third quarter of 2014, improved 5% from the same period in 2013. For the nine month period, lower locomotive diesel fuel prices that averaged $3.08 per gallon versus $3.17 per gallon in 2013 reduced expenses by $73 million, which partially offset the increased fuel expense associated with the 7% increase in carloadings. 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 intermodal containers; leased automobile maintenance expenses; and tools and supplies. Purchased services increased 11% and 8% in the third quarter and year-to-date periods of 2014 when compared to the same periods in 2013, primarily due to volume-related expense incurred by our logistics subsidiaries for external transportation and increased crew transportation and lodging due to volume and a slower network. The year-to-date comparison was also impacted by snow removal in the first quarter of 2014. Locomotive and freight car material expenses increased in the third quarter of 2014 compared to the third quarter of 2013 due to additional volumes, including the impact of activating stored equipment to address operational issues caused by demand and a slower network. Depreciation - The majority of depreciation relates to road property, including rail, ties, ballast, and other track material. A higher depreciable asset base, reflecting higher ongoing capital spending, increased depreciation expense in the third quarter and year-to-date periods of 2014 compared to 2013. 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. Higher intermodal volumes increased short-term freight car rental expense in the third quarter and year-to-date periods of 2014 compared to 2013. Conversely, lower container and freight car lease expense partially offset the higher freight car rental expense, as we exercised purchase options on some of our leased equipment. 27 -------------------------------------------------------------------------------- Table of Contents 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 in the third quarter increased from 2013 driven by higher property taxes, damaged freight and equipment costs and personal injury expense. Year-to-date, lower damaged freight and equipment costs and environmental expense offset higher property taxes, utilities costs and personal injury expense compared to the same period in 2013. Non-Operating Items Three Months Ended Nine Months Ended September 30, % September 30, % Millions 2014 2013 Change 2014 2013 Change Other income $ 20 $ 28 (29)% $ 80 $ 91 (12)% Interest expense (144) (138) 4 (415) (399) 4 Income taxes (836) (701) 19 (2,296) (1,951) 18 Other Income - Other income decreased in the third quarter of 2014 versus 2013 due to lower gains from real estate sales. Year-to-date, other income decreased as the $17 million received from a settlement of land lease arrangement in 2013 and lower gains from real estate sales more than offset an increase due to the sale of a permanent easement in 2014. Interest Expense - Interest expense increased in the third quarter of 2014 versus 2013 due to an increased weighted-average debt level of $11.2 billion in 2014 versus $9.6 billion in 2013. Year-to-date, the increase in the weighted-average debt level to $10.6 billion in 2014 from $9.5 billion in 2013 more than offset a lower effective interest rate of 5.4% versus 5.7%, increasing interest expense for 2014 compared to the same period of 2013. Income Taxes - Higher pre-tax income increased income tax expense in the third quarter and year-to-date periods of 2014 compared to 2013. Our effective tax rate for the third quarter of 2014 and 2013 was 37.9%. Our 2014 year-to-date effective tax rate was 38.0% compared to 37.8% in 2013. OTHER OPERATING/PERFORMANCE AND FINANCIAL STATISTICS We report a number of key performance measures weekly to the Association of American Railroads (AAR). We provide this data on our website at www.up.com/investors/reports/index.shtml. Operating/Performance Statistics Railroad performance measures are included in the table below: Three Months Ended Nine Months Ended September 30, % September 30, % 2014 2013 Change 2014 2013 ChangeAverage train speed (miles per hour) 23.8 26.3 (10) % 24.1 26.1 (8) % Average terminal dwell time (hours) 29.7 26.3 13 % 30.1 26.8 12 % Gross ton-miles (billions) 260.0 241.4 8 % 752.6 704.4 7 % Revenue ton-miles (billions) 140.6 131.3 7 % 407.9 382.7 7 % Operating ratio 62.3 64.8 (2.5) pts 64.2 66.5 (2.3) pts Employees (average) 47,550 46,605 2 % 46,922 46,610 1 % Average Train Speed - Average train speed is calculated by dividing train miles by hours operated on our main lines between terminals. Average train speed, as reported to the Association of American Railroads (AAR), decreased 10% and 8%, respectively, in the third quarter and year-to-date periods of 2014 versus 2013. A 7% volume increase, a major infrastructure project in Fort Worth, Texas, and inclement weather drove the decline in the third quarter. Flooding in the Midwest in the second quarter and severe weather conditions in the first quarter that impacted all major U.S. and Canadian railroads reduced year-to-date train speed. 28 -------------------------------------------------------------------------------- Table of Contents Average Terminal Dwell Time - Average terminal dwell time is the average time that a rail car spends at our terminals. Lower average terminal dwell time improves asset utilization and service. Average terminal dwell time increased 13% and 12%, respectively, in the third quarter and year-to-date periods of 2014 compared to 2013, reflecting the impacts of higher volumes and inclement weather. 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 both increased 7% during the first nine months of 2014 compared to the same period in 2013 driven by a 7% increase in carloadings. Operating Ratio - Operating ratio is our operating expenses reflected as a percentage of operating revenue. Our operating ratio improved 2.5 points to a record low 62.3% in the third quarter of 2014 versus the same period of 2013 and 2.3 points to 64.2% in the nine-month period of 2014 versus 2013. Core pricing gains, business demand and productivity more than offset the incremental operating costs associated with a slower network, weather and inflation. Employees - Employee levels increased 2% in the third quarter of 2014 and increased 1% for the nine-month period of 2014 compared to the same periods in 2013. A decrease in our capital workforce due to improved productivity and project mix offset the larger train and engine work force required for higher volume levels and a slower network. We successfully managed the growth of our full-time-equivalent train and engine force levels at a rate less than our volume growth in the third quarter and year-to-date periods of 2014 compared to the same periods in 2013. Debt to Capital / Adjusted Debt to Capital Sep. 30, Dec. 31, Millions, Except Percentages 2014 2013 Debt (a) $ 11,505 $ 9,577 Equity 21,553 21,225 Capital (b) $ 33,058 $ 30,802 34.8% 31.1% Debt to capital (a/b) Sep. 30, Dec. 31, Millions, Except Percentages 2014 2013 Debt $ 11,505 $ 9,577 Net present value of operating leases 2,866 3,057 Unfunded pension and OPEB 146 170 Adjusted debt (a) 14,517 12,804 Equity 21,553 21,225 Adjusted capital (b) $ 36,070 $ 34,029 Adjusted debt to capital (a/b) 40.2% 37.6% Adjusted debt to capital is a non-GAAP financial measure under SEC Regulation G and Item 10 of SEC Regulation S-K, and may not be defined and calculated by other companies in the same manner. We believe this measure is important to management and investors in evaluating the total amount of leverage in our capital structure, including off-balance sheet lease obligations, which we generally incur in connection with financing the acquisition of locomotives and freight cars and certain facilities. Operating leases were discounted using 5.4% at September 30, 2014, and 5.7% at December 31, 2013. The discount rate reflects our effective interest rate. We monitor the ratio of adjusted debt to capital as we manage our capital structure to balance cost-effective and efficient access to the capital markets with the Corporation's overall cost of capital. Adjusted debt to capital should be considered in addition to, rather than as a substitute for, debt to capital. The tables above provide reconciliations from debt to capital to adjusted debt to capital. 29-------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES Financial Condition Cash Flows Millions, for the Nine Months Ended September 30, 2014 2013 Cash provided by operating activities $ 5,358 $ 4,881 Cash used in investing activities (3,325) (2,596) Cash used in financing activities (1,578) (1,982) Net change in cash and cash equivalents $ 455 $ 303 Operating Activities Higher net income in the nine months of 2014 increased cash provided by operating activities compared to the same period of 2013. Higher net income was partially offset by the impact of higher cash payments for income taxes resulting from the expiration of bonus depreciation. Investing Activities Higher capital investments in the nine months of 2014, including the early buyout of the long-term operating lease of our headquarters building for approximately $261 million, drove the increase in cash used in investing activities compared to the same period in 2013. The table below details cash capital investments: Millions, for the Nine Months Ended September 30, 2014 2013 Rail and other track material $ 566 $ 591 Ties 323 361 Ballast 153 176 Other [a] 213 207 Total road infrastructure replacements 1,255 1,335 Line expansion and other capacity projects 348 324 Commercial facilities 121 86 Total capacity and commercial facilities 469 410 Locomotives and freight cars 797 484 Positive train control 277 308 Technology and other [b] 428 98 Total cash capital investments $ 3,226 $ 2,635 [a] Other includes bridges and tunnels, signals, other road assets, and road work equipment. [b] Technology and other includes the early buyout of our headquarters building operating lease. Financing Activities Cash used in financing activities decreased in the first nine months of 2014 versus the same period of 2013. Higher dividend payments in 2014 of $1.2 billion compared to $968 million in 2013, an increase of $173 million in debt repaid, and an increase of $880 million for the repurchase of shares under our common stock repurchase program all partially offset an increase of $1.6 billion from debt issued during the period. Free Cash Flow - Free cash flow is defined as cash provided by operating activities less cash used in investing activities and dividends paid. Higher capital spending and dividends decreased free cash flow in 2014. 30-------------------------------------------------------------------------------- Table of Contents Free cash flow is not considered a financial measure under accounting principles generally accepted in the U.S. (GAAP) by SEC Regulation G and Item 10 of SEC Regulation S-K and may not be defined and calculated by other companies in the same manner. We believe free cash flow is important to management and investors in evaluating our financial performance and measures our ability to generate cash without additional external financings. Free cash flow should be considered in addition to, rather than as a substitute for, cash provided by operating activities. The following table reconciles cash provided by operating activities (GAAP measure) to free cash flow (non-GAAP measure): Millions, for the Nine Months Ended September 30, 2014 2013 Cash provided by operating activities $ 5,358 $ 4,881 Cash used in investing activities (3,325) (2,596) Dividends paid (1,186) (968) Free cash flow $ 847 $ 1,317 Credit Facilities - During the second quarter of 2014, we replaced our $1.8 billion revolving credit facility, which was scheduled to expire in May 2015, with a new $1.7 billion facility that expires in May 2019 (the facility). The facility is based on substantially similar terms as those in the previous credit facility. At September 30, 2014, we had $1.7 billion of credit available under the facility, which is designated for general corporate purposes and supports the issuance of commercial paper. We did not draw on either facility at any time during the nine months ended September 30, 2014. Commitment fees and interest rates payable under the facility are similar to fees and rates available to comparably rated, investment-grade borrowers. The facility allows for borrowings at floating rates based on London Interbank Offered Rates, plus a spread, depending upon credit ratings for our senior unsecured debt. The facility matures in 2019 under a five-year term. The facility requires that the Corporation maintain a debt-to-net-worth coverage ratio as a condition to making a borrowing. At September 30, 2014, and December 31, 2013 (and at all times during the year), we were in compliance with this covenant. The definition of debt used for purposes of calculating the debt-to-net-worth coverage ratio includes, among other things, certain credit arrangements, capital leases, guarantees and unfunded and vested pension benefits under Title IV of ERISA. At September 30, 2014, the debt-to-net-worth coverage ratio allowed us to carry up to $43 billion of debt (as defined in the facility), and we had $11.6 billion of debt (as defined in the facility) outstanding at that date. Under our current capital plans, we expect to continue to satisfy the debt-to-net-worth coverage ratio; however, many factors beyond our reasonable control could affect our ability to comply with this provision in the future. The facility does not include any other financial restrictions, credit rating triggers (other than rating-dependent pricing), or any other provision that could require us to post collateral. The facility also includes a $125 million cross-default provision and a change-of-control provision. During the three and nine months ended September 30, 2014, we did not issue or repay any commercial paper, and at September 30, 2014, we had no commercial paper outstanding. Our revolving credit facility supports our outstanding commercial paper balances, and, unless we change the terms of our commercial paper program, our aggregate issuance of commercial paper will not exceed the amount of borrowings available under the facility. Shelf Registration Statement and Significant New Borrowings - Under our current shelf registration, we may issue, from time to time, any combination of debt securities, preferred stock, common stock, or warrants for debt securities or preferred stock in one or more offerings. We have no immediate plans to issue equity securities; however, we will continue to explore opportunities to replace existing debt or access capital through issuances of debt securities under our shelf registration, and, therefore, we may issue additional debt securities at any time. 31 -------------------------------------------------------------------------------- Table of Contents During the nine months ended September 30, 2014, we issued the following unsecured, fixed-rate debt securities under our current shelf registration: Date Description of Securities January 10, 2014 $300 million of 2.25% Notes due February 15, 2019 $400 million of 3.75% Notes due March 15, 2024 $300 million of 4.85% Notes due June 15, 2044 August 12, 2014 $350 million of 3.25% Notes due January 15, 2025 $350 million of 4.15% Notes due January 15, 2045 We used the net proceeds from this offering for general corporate purposes, including the repurchase of common stock pursuant to our share repurchase program. These debt securities include change-of-control provisions. At September 30, 2014, we had remaining authority to issue up to $1.15 billion of debt securities under our shelf registration. Equipment Trust - On May 20, 2014, UPRR consummated a pass-through (P/T) financing, whereby a P/T trust was created, which issued $500 million of P/T trust certificates with a stated interest rate of 3.227%. The P/T trust certificates will mature on May 14, 2026. The proceeds from the issuance of the P/T trust certificates were used to purchase equipment trust certificates to be issued by UPRR to finance the acquisition of 245 locomotives. The equipment trust certificates are secured by a lien on the locomotives. During the three months ended June 30, 2014, UPRR received $402 million in proceeds (net of $3 million in transaction fees) to fund the purchase of the initial 199 locomotives delivered by the closing of the financing. The remaining proceeds of $95 million were held in an escrow account. As of September 30, 2014, the $95 million of restricted cash held in the escrow account was included in other assets on the Condensed Consolidated Statements of Financial Position. On October 2, 2014, UPRR received the remaining proceeds of $95 million to fund the purchase of the remaining 46 locomotives. UPRR evaluated whether the P/T trust is a variable interest entity (VIE). As UPRR has control over the escrow account based on the P/T trust agreement, it was determined that UPRR has a variable interest in the trust and must consolidate the trust in accordance with ASC 810. As such, the Company recorded the debt obligation and restricted cash held in escrow upon the initial issuance of the P/T trust certificates. Debt Redemption - On May 14, 2013, we redeemed all $40 million of our outstanding 5.65% Port of Corpus Christi Authority Revenue Refunding Bonds due December 1, 2022. The redemption resulted in an early extinguishment charge of $1 million during the three months ended June 30, 2013. Receivables Securitization Facility - On July 29, 2014 we completed the renewal of our receivables securitization facility. The new $650 million, 3-year facility replaces the prior $600 million, 364-day facility. Under the facility, the Railroad sells most of its eligible third-party receivables to Union Pacific Receivables, Inc. (UPRI), a wholly-owned, bankruptcy-remote subsidiary that may subsequently transfer, without recourse, an undivided interest in accounts receivable to investors. The investors have no recourse to the Railroad's other assets except for customary warranty and indemnity claims. Creditors of the Railroad do not have recourse to the assets of UPRI. The amount outstanding under the facility was $400 million and $0 at September 30, 2014, and December 31, 2013, respectively. The amount outstanding under the facility was supported by $1.3 billion and $1.1 billion of accounts receivable as collateral at September 30, 2014, and December 31, 2013, respectively, which, as a retained interest, is included in accounts receivable, net in our Condensed Consolidated Statements of Financial Position. The outstanding amount the Railroad is allowed to maintain under the facility, with a maximum of $650 million, may fluctuate based on the availability of eligible receivables and is directly affected by business volumes and credit risks, including receivables payment quality measures such as default and dilution ratios. If default or dilution ratios increase one percent, the allowable outstanding amount under the facility would not materially change. 32 -------------------------------------------------------------------------------- Table of Contents The costs of the receivables securitization facility include interest, which will vary based on prevailing benchmark and commercial paper rates, program fees paid to participating banks, commercial paper issuing costs, and fees of participating banks for unused commitment availability. The costs of the receivables securitization facility are included in interest expense and were $1 million for the three months ended September 30, 2014, and 2013, and $3 million for the nine months ended September 30, 2014, and 2013. Share Repurchase Program Effective January 1, 2014, our Board of Directors authorized the repurchase of up to 120 million shares of our common stock by December 31, 2017, replacing our previous repurchase program. As of September 30, 2014, we repurchased a total of $11.7 billion of our common stock since the commencement of our repurchase programs in 2007. The table below represents shares repurchased in the first three quarters of 2013 under our previous repurchase program, and shares repurchased in the first three quarters of 2014 under the new program. All references to common shares and per share amounts have been retroactively adjusted to reflect the June 2014 stock split for all periods presented. Number of Shares Purchased Average Price Paid 2014 2013 2014 2013 First quarter 7,640,000 5,762,800 $ 89.43 $ 68.29 Second quarter 8,320,000 6,122,940 96.84 75.71 Third quarter 8,347,000 7,333,788 102.54 78.39 Total 24,307,000 19,219,528 $ 96.47 $ 74.51 Remaining number of shares that may be repurchased under current authority 95,693,000 Management's assessments of market conditions and other pertinent factors guide the timing and volume of all repurchases. We expect to fund any share repurchases under this program through cash generated from operations, the sale or lease of various operating and non-operating properties, debt issuances, and cash on hand. Repurchased shares are recorded in treasury stock at cost, which includes any applicable commissions and fees. From October 1, 2014, through October 22, 2014, we repurchased 2.2 million shares at an aggregate cost of approximately $230 million. Off-Balance Sheet Arrangements, Contractual Obligations, and Commercial Commitments As described in the notes to the Condensed Consolidated Financial Statements and as referenced in the tables below, we have contractual obligations and commercial commitments that may affect our financial condition. However, based on our assessment of the underlying provisions and circumstances of our contractual obligations and commercial commitments, including material sources of off-balance sheet and structured finance arrangements, there is no known trend, demand, commitment, event, or uncertainty that is reasonably likely to occur that would have a material adverse effect on our consolidated results of operations, financial condition, or liquidity. In addition, our commercial obligations, financings, and commitments are customary transactions that are similar to those of other comparable corporations, particularly within the transportation industry. 33 -------------------------------------------------------------------------------- Table of Contents The following tables identify material obligations and commitments as of September 30, 2014: Oct. 1 Contractual Obligations through Payments Due by Dec. 31, Dec. 31, After Millions Total 2014 2015 2016 2017 2018 2018 Other Debt [a] $ 17,999 $ 99 $ 829 $ 954 $ 1,373 $ 869 $ 13,875 $ - Operating leases [b] 3,711 69 491 468 416 344 1,923 - Capital lease obligations [c] 1,958 30 249 249 247 225 958 - Purchase obligations [d] 6,075 1,064 2,532 1,223 312 256 656 32 Other postretirement benefits [e] 406 10 43 43 44 45 221 - Income tax contingencies [f] 55 27 - - - - - 28 Total contractual obligations $ 30,204 $ 1,299 $ 4,144 $ 2,937 $ 2,392 $ 1,739 $ 17,633 $ 60 [a] Excludes capital lease obligations of $1,537 million and unamortized discount of ($598) million. Includes an interest component of $7,433 million. [b] Includes leases for locomotives, freight cars, other equipment, and real estate. [c] Represents total obligations, including interest component of $421 million. [d] Purchase obligations include locomotive maintenance contracts; purchase commitments for fuel purchases, locomotives, ties, ballast, rail, and aircraft; and agreements to purchase other goods and services. For amounts where we cannot reasonably estimate the year of settlement, they are reflected in the Other column. [e] Includes estimated other postretirement, medical, and life insurance payments and payments made under the unfunded pension plan for the next ten years. [f] Future cash flows for income tax contingencies reflect the recorded liabilities and assets for unrecognized tax benefits, including interest and penalties, as of September 30, 2014. For amounts where the year of settlement is uncertain, they are reflected in the Other column. Oct. 1 Other Commercial Commitments through Amount of Commitment Expiration by Dec. 31, Dec. 31, After Millions Total 2014 2015 2016 2017 2018 2018 Credit facilities [a] $ 1,700 $ - $ - $ - $ - $ - $ 1,700 Receivables securitization facility [b] 650 - - - 650 - - Guarantees [c] 88 3 12 30 10 11 22 Standby letters of credit [d] 28 7 21 - - - - $ 2,466 $ 10 $ 33 $ 30 $ 660 $ 11 $ 1,722 Total commercial commitments [a] None of the credit facility was used as of September 30, 2014. [b] $400 million of the receivables securitization facility was utilized at September 30, 2014, which is accounted for as debt. The full program matures in July 2017. [c] Includes guaranteed obligations related to equipment financings and affiliated operations. [d] None of the letters of credit were drawn upon as of September 30, 2014. OTHER MATTERS Asserted and Unasserted Claims - Various claims and lawsuits are pending against us and certain of our subsidiaries. We cannot fully determine the effect of all asserted and unasserted claims on our consolidated results of operations, financial condition, or liquidity; however, to the extent possible, where asserted and unasserted claims are considered probable and where such claims can be reasonably estimated, we have recorded a liability. We do not expect that any known lawsuits, claims, environmental costs, commitments, contingent liabilities, or guarantees will have a material adverse effect on our consolidated results of operations, financial condition, or liquidity after taking into account liabilities and insurance recoveries previously recorded for these matters. Indemnities - Our maximum potential exposure under indemnification arrangements, including certain tax indemnifications, can range from a specified dollar amount to an unlimited amount, depending on the nature of the transactions and the agreements. Due to uncertainty as to whether claims will be made or how they will be resolved, we cannot reasonably determine the probability of an adverse claim or reasonably estimate any adverse liability or the total maximum exposure under these indemnification 34 -------------------------------------------------------------------------------- Table of Contents arrangements. We do not have any reason to believe that we will be required to make any material payments under these indemnity provisions. CAUTIONARY INFORMATION 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, or will be, forward-looking statements as defined by the Securities Act of 1933 and the Securities Exchange Act of 1934. These forward-looking statements and information include, without limitation, the statements and information in this Item 2 regarding our resources, operations, capital plan and statements under the captions "Quarterly Summary" and "Off-Balance Sheet Arrangements, Contractual Obligations, and Commercial Commitments". Forward-looking statements and information also include any other statements or information in this report regarding: 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 variables or unknown or unforeseeable events or circumstances over which management has little or no influence or control. The Risk Factors in Item 1A of our 2013 Annual Report on Form 10-K, filed February 7, 2014, 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. To the extent circumstances require or we deem it otherwise necessary, we will update or amend these risk factors in a Form 10-Q or Form 8-K. Information regarding new risk factors or material changes to our risk factors, if any, is set forth in Item 1A of Part II of this report. 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. Forward-looking statements speak only as of the date the statement was made. We assume no obligation to update forward-looking information to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information. If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect thereto or with respect to other forward-looking statements. |