Union Pacific Earnings 2018-12-31



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

[X]     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2018

OR

[  ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to ____________

Commission File Number 1-6075

UNION PACIFIC CORPORATION

(Exact name of registrant as specified in its charter)

1400 DOUGLAS STREET, OMAHA, NEBRASKA

(Address of principal executive offices)

68179

(Zip Code)

(402) 544-5000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:



☑ Yes   ☐ No

☐ Yes   ☑ No

☑ Yes   ☐ No

☑ Yes   ☐ No

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☐ Yes   ☑ No

      ☐





The number of shares outstanding of the registrant’s Common Stock as of February 1, 2019 was 722,877,817.



 

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Documents Incorporated by Reference – Portions of the registrant’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held on May 16, 2019, are incorporated by reference into Part III of this report. The registrant’s Proxy Statement will be filed with the Securities and Exchange Commission pursuant to Regulation 14A.



UNION PACIFIC CORPORATION

TABLE OF CONTENTS



 

 

 

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February 8, 2019



Fellow Shareholders:



I am pleased to report that Union Pacific produced record 2018 financial results and finished the year with significant improvements in service reliability and efficiency, after overcoming network congestion and excess operating costs.  The year was also one of change, as we embarked on a fundamental shift in our operating philosophy by adopting precision scheduled railroading (PSR) principles with the launch of Unified Plan 2020.  An increase in customer shipments of 4 percent in 2018, coupled with core pricing and productivity gains, generated earnings of $7.91 per share.  This represents a 37 percent improvement compared to 2017 adjusted results of $5.79 per share*.  Our operating ratio was 62.7 percent, 0.1 point better than last year’s adjusted 62.8 percent*.



Premium carloadings were up 6 percent, driven primarily by increases in international and domestic intermodal shipments.  Our Industrial business unit also experienced a 6 percent increase in shipments across a number of segments due to strong industrial production, while Agricultural Products carloadings were down 1 percent reflecting lower export grain movements.  Energy volume declined 2 percent due to lower coal and frac sand carloadings, partially offset by an increase in petroleum products shipments.



As we entered 2018, the railroad was experiencing unusual network congestion on key routes and in terminals that negatively impacted our operational performance.  These inefficiencies also drove excess costs and impacted our ability to reliably serve our customers.  In response, we initiated Unified Plan 2020 and began implementing PSR October 1.  Fundamentally, PSR is an operating principle that emphasizes on-time service performance for every rail car, execution accountability, and lean resource utilization, while at the same time improving total safety performance.



Unified Plan 2020 implementation is progressing ahead of our original schedule, with the initial roll out expected to be complete by mid-2019.  Results are encouraging as railroad operations improved steadily throughout the fourth quarter, driving out excess costs.  We removed over 1,200 locomotives and approximately 30,000 freight cars from our network since August 1, which increases operational fluidity and provides a source of future growth capacity. 



Despite our best efforts, we lost a little ground with our safety results in 2018.  Our 0.82 reportable personal injury rate increased 4 percent compared to 2017, although preliminary results show this was the best safety performance for all Class 1 railroads for the fourth year in a row.  Our reportable derailment incident rate and crossing incidents rate increased 12 and 5 percent, respectively, compared to 2017.  The entire Union Pacific team is not satisfied with these results and will not be satisfied until every employee returns home safely every day and we eliminate all derailments.  We are committed to making progress toward these goals in 2019. 



As part of our robust capital program, we invested about $3.2 billion in 2018 including $1.8 billion in replacement capital to harden our infrastructure, replace older assets, and to improve the safety and resiliency of our network.  We also invested $520 million toward new rail capacity and commercial facilities projects to support future growth and productivity initiatives.



Total shareholder return, including price appreciation and dividends, increased 5.3 percent in 2018, compared to a negative 4.4 percent for the S&P 500.  Our return on invested capital* of 15.1 percent increased 1.4 points over 2017’s adjusted 13.7 percent.  We raised our quarterly dividend with two 10 percent increases, resulting in dividends paid in 2018 totaling $2.3 billion.  In addition, we repurchased 57.2 million Union Pacific shares, decreasing our total share count by 6 percent.  Combining dividends and share repurchases, Union Pacific returned $10.5 billion to our shareholders in 2018.



Looking to 2019, we are optimistic that continued economic growth, our improving service performance, increasingly-efficient use of our assets, and the strength of our diverse franchise will drive positive volume and top-line revenue growth.  We expect to generate significant productivity benefits and enhance customer experience through our G55 + 0 initiatives and the continued roll out of Unified Plan 2020.  Every Union Pacific employee is committed to achieving industry-leading safety, service reliability, and financial performance in the coming year.



Chairman, President and Chief Executive Officer

*See Item 7 of this report for reconciliations to U.S. GAAP.

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DIRECTORS AND SENIOR MANAGEMENT





SENIOR MANAGEMENT*

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PART I



Item 1. Business



GENERAL



Union Pacific Railroad Company is the principal operating company of Union Pacific Corporation. One of America's most recognized companies, Union Pacific Railroad Company links 23 states in the western two-thirds of the country by rail, providing a critical link in the global supply chain.  The Railroad’s diversified business mix includes Agricultural Products, Energy, Industrial and Premium. Union Pacific serves many of the fastest-growing U.S. population centers, operates from all major West Coast and Gulf Coast ports to eastern gateways, connects with Canada's rail systems and is the only railroad serving all six major Mexico gateways. Union Pacific provides value to its roughly 10,000 customers by delivering products in a safe, reliable, fuel-efficient and environmentally responsible manner.



Union Pacific Corporation was incorporated in Utah in 1969 and maintains its principal executive offices at 1400 Douglas Street, Omaha, NE 68179. The telephone number at that address is (402) 544-5000. The common stock of Union Pacific Corporation is listed on the New York Stock Exchange (NYSE) under the symbol “UNP”.



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”.



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 our directors and certain executive officers; and amendments to such reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (the Exchange Act). We provide these reports and statements 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. 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 NYSE 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.



We have included the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) certifications regarding our public disclosure required by Section 302 of the Sarbanes-Oxley Act of 2002 as Exhibits 31(a) and (b) to this report.



References to our website address in this report, including references in Management’s Discussion and Analysis of Financial Condition and Results of Operations, Item 7, 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.



OPERATIONS



The Railroad, along with its subsidiaries and rail affiliates, is our one reportable operating segment. Although we provide revenue by commodity group, we analyze the net financial results of the Railroad as one segment due to the integrated nature of our rail network. Additional information regarding our business and operations, including revenue and financial information and data and other information regarding environmental matters, is presented in Risk Factors, Item 1A; Legal Proceedings, Item 3; Selected Financial Data, Item 6; Management’s Discussion and Analysis of Financial Condition and Results of Operations, Item 7; and the Financial Statements and Supplementary Data, Item 8 (which include information regarding revenues, statements of income, and total assets). 

manifest, and premium business. Bulk traffic primarily consists of coal, grain, soda ash, ethanol, rock and crude oil shipped in unit trains – trains transporting a single commodity from one origin to one destination. Manifest traffic includes individual carload or less than train-load business involving commodities such as lumber, steel, paper, food and chemicals. The transportation of finished vehicles, auto parts, intermodal containers and truck trailers are included as part of our premium business. In 2018, we generated freight revenues totaling $21.4 billion from the following four commodity groups:



Agricultural Products – Transportation of grains, commodities produced from these grains, fertilizer, and food and beverage products generated 21% of the Railroad’s 2018 freight revenue. We access most major grain markets, linking the Midwest and Western U.S. producing areas to export terminals in the Pacific Northwest and Gulf Coast ports, as well as Mexico. We also serve significant domestic markets, including grain processors, animal feeders and ethanol producers in the Midwest, West, South and Rocky Mountain states. Fertilizer movements originate in the Gulf Coast region, the western U.S. and Canada (through interline access) for delivery to major agricultural users in the Midwest, western U.S., as well as abroad.



Energy – The Company’s Energy shipments are grouped into the following three categories: (i) coal, (ii)  sand and (iii) petroleum, liquid petroleum gases (LPG) and renewables. In 2018, this group generated 21% of our freight revenue. The Railroad’s network supports the transportation of coal shipments to independent and regulated power companies and industrial facilities throughout the U.S. Through interchange gateways and ports, UPRR’s reach extends to eastern U.S. utilities, as well as to Mexico and other international destinations. Coal traffic originating in the Powder River Basin (PRB) area of Wyoming is the largest segment of the Railroad’s coal business. Demand for hydraulic fracturing sand, or frac-sand, is generated by oil and gas drilling, whereas, the Company’s petroleum and LPG shipments are primarily impacted by refinery utilization rates, regional crude pricing differentials, pipeline capacity, and the use of asphalt for road programs. Renewable shipments consist primarily of biomass exports and wind turbine components.



Industrial – Our extensive network facilitates the movement of numerous commodities between thousands of origin and destination points throughout North America. The Industrial group consists of several categories, including construction, industrial chemicals, plastics, forest products, specialized products (primarily waste, lime, salt and government), metals and ores, and soda ash. Transportation of these products accounted for 27% of our freight revenue in 2018. Commercial, residential and governmental infrastructure investments drive shipments of steel, aggregates (cement components), cement and wood products. Industrial and light manufacturing plants receive steel, nonferrous materials, minerals and other raw materials.



The industrial chemicals market consists of a vast number of chemical compounds that support the manufacturing of more complex chemicals. Plastics shipments support automotive, housing, and the durable and disposable consumer goods markets. Paper and packaging commodities, as well as appliances, move to major metropolitan areas for consumers. Forest product shipments originate primarily in the Pacific Northwest or western Canada and move throughout the U.S. for use in new home construction and repair and remodeling. Oil and gas drilling generates demand for raw steel, finished pipe, stone and drilling fluid commodities. Soda ash originates in southwestern Wyoming and California, destined for chemical and glass producing markets in North America and abroad.

 

Premium – In 2018, the Premium franchise generated 31% of Union Pacific’s total freight revenue. Our Premium franchise includes three segments: international intermodal, domestic intermodal, and finished vehicles. International business consists of import and export traffic moving in 20 or 40-foot shipping

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containers, that mainly passes through West Coast ports served by UP’s extensive terminal network. Domestic business includes container and trailer traffic picked up and delivered within North America for intermodal marketing companies (primarily shipper agents and logistics companies), as well as truckload carriers.



We are the largest automotive carrier west of the Mississippi River and operate or access 38 vehicle distribution centers. The Railroad’s extensive franchise serves five vehicle assembly plants and connects to West Coast ports, all six major Mexico gateways, and the Port of Houston to accommodate both import and export shipments. In addition to transporting finished vehicles, UPRR provides expedited handling of automotive parts in both boxcars and intermodal containers destined for Mexico, the U.S. and Canada.



Seasonality – Some of the commodities we carry have peak shipping seasons, reflecting either or both the nature of the commodity and the demand cycle for the commodity (such as certain agricultural and food products that have specific growing and harvesting seasons). The peak shipping seasons for these commodities can vary considerably each year depending upon various factors, including the strength of domestic and international economies and currencies and the strength of harvests and market prices for agricultural products.



Working Capital – At December 31, 2018, we had a working capital deficit. At December 31, 2017, we had a working capital surplus. The deficit at 2018 year-end was primarily due to an increase in upcoming debt maturities. As past years indicate, it is not unusual for us to have a working capital deficit; however, we believe it is not an indication of a lack of liquidity.  We also maintain adequate resources, including our credit facility, and when necessary, access to capital markets to meet any foreseeable cash requirements.



Competition – We are subject to competition from other railroads, motor carriers, ship and barge operators, and pipelines. Our main railroad competitor is Burlington Northern Santa Fe LLC. Its primary subsidiary, BNSF Railway Company (BNSF), operates parallel routes in many of our main traffic corridors. In addition, we operate in corridors served by other railroads and motor carriers. Motor carrier competition exists for all four of our commodity groups (excluding most coal shipments). Because of the proximity of our routes to major inland and Gulf Coast waterways, barges can be particularly competitive, especially for grain and bulk commodities in certain areas where we operate. In addition to price competition, we face competition with respect to transit times, quality and reliability of service from motor carriers and other railroads. Motor carriers in particular can have an advantage over railroads with respect to transit times and timeliness of service.  However, railroads are much more fuel-efficient than trucks, which reduces the impact of transporting goods on the environment and public infrastructure, and we have been making efforts to convert certain truck traffic to rail.  Additionally, we must build or acquire and maintain our rail system; trucks and barges are able to use public rights-of-way maintained by public entities. Any of the following could also affect the competitiveness of our transportation services for some or all of our commodities: (i) improvements or expenditures materially increasing the quality or reducing the costs of these alternative modes of transportation, (ii) legislation that eliminates or significantly increases the size or weight limitations applied to motor carriers, or (iii) legislation or regulatory changes that impose operating restrictions on railroads or that adversely affect the profitability of some or all railroad traffic. Finally, many movements face product or geographic competition where our customers can use different products (e.g. natural gas instead of coal, sorghum instead of corn) or commodities from different locations (e.g. grain from states or countries that we do not serve, crude oil from different regions). Sourcing different commodities or different locations allows shippers to substitute different carriers and such competition may reduce our volume or constrain prices. For more information regarding risks we face from competition, see the Risk Factors in Item 1A of this report.



Key Suppliers – We depend on two key domestic suppliers of high horsepower locomotives. Due to the capital intensive nature of the locomotive manufacturing business and sophistication of this equipment, potential new suppliers face high barriers of entry into this industry. Therefore, if one of these domestic suppliers discontinues manufacturing locomotives, supplying parts or providing maintenance for any reason, including insolvency or bankruptcy, we could experience a significant cost increase and risk reduced availability of the locomotives that are necessary to our operations. Additionally, for a high percentage of our rail purchases, we utilize two steel producers (one domestic and one international) that meet our specifications. Rail is critical for maintenance, replacement, improvement, and expansion of our network and facilities. Rail manufacturing also has high barriers of entry, and, if one of those suppliers discontinues operations for any reason, including insolvency or bankruptcy, we could experience cost increases and difficulty obtaining rail.

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Employees –  Approximately 85% of our full-time employees are represented by 14 major rail unions.  Pursuant to the Railway Labor Act (RLA), our collective bargaining agreements are subject to modification every five years.  The most recent round of negotiations started on January 1, 2015, and throughout 2017 and 2018, we concluded new agreements with all 14 major rail unions. Existing agreements remain in effect until new agreements are ratified or until the RLA procedures are exhausted.  The RLA procedures include mediation, potential arbitration, cooling-off periods, and the possibility of Presidential Emergency Boards and Congressional intervention.  The next round of negotiations begins with the service of RLA Section 6 notices on or about November 1, 2019 related to years 2019-2023.  Contract negotiations historically continue for an extended period of time, and work stoppages during negotiations are rare.



Railroad Security – Our security efforts consist of a wide variety of measures including employee training, engagement with our customers, training of emergency responders, and partnerships with numerous federal, state, and local government agencies.  While federal law requires us to protect the confidentiality of our security plans designed to safeguard against terrorism and other security incidents, the following provides a general overview of our security initiatives. 



UPRR Security Measures – We maintain a comprehensive security plan designed to both deter and respond to any potential or actual threats as they arise.  The plan includes four levels of alert status, each with its own set of countermeasures.  We employ our own police force, consisting of commissioned and highly-trained officers. Our employees also undergo recurrent security and preparedness training, as well as federally-mandated hazardous materials and security training. We regularly review the sufficiency of our employee training programs. We maintain the capability to move critical operations to back-up facilities in different locations.



We operate an emergency response management center 24 hours a day.  The center receives reports of emergencies, dangerous or potentially dangerous conditions, and other safety and security issues from our employees, the public, law enforcement and other government officials.  In cooperation with government officials, we monitor both threats and public events, and, as necessary, we may alter rail traffic flow at times of concern to minimize risk to communities and our operations.  We comply with the hazardous materials routing rules and other requirements imposed by federal law.  We also design our operating plan to expedite the movement of hazardous material shipments to minimize the time rail cars remain idle at yards and terminals located in or near major population centers.  Additionally, in compliance with Transportation Security Agency regulations, we deployed information systems and instructed employees in tracking and documenting the handoff of Rail Security Sensitive Materials with customers and interchange partners.



We also have established a number of our own innovative safety and security-oriented initiatives ranging from various investments in technology to The Officer on Train program, which provides local law enforcement officers with the opportunity to ride with train crews to enhance their understanding of railroad operations and risks. Our staff of information security professionals continually assesses cyber security risks and implements mitigation programs that evolve with the changing technology threat environment. To date, we have not experienced any material disruption of our operations due to a cyber threat or attack directed at us.



Cooperation with Federal, State, and Local Government Agencies – We work closely on physical and cyber security initiatives with government agencies, including the U.S. Department of Transportation (DOT) and the Department of Homeland Security (DHS) as well as local police departments, fire departments, and other first responders.  In conjunction with the Association of American Railroads (AAR), we sponsor Ask Rail, a mobile application which provides first responders with secure links to electronic information, including commodity and emergency response information required by emergency personnel to respond to accidents and other situations.  We also participate in the National Joint Terrorism Task Force, a multi-agency effort established by the U.S. Department of Justice and the Federal Bureau of Investigation to combat and prevent terrorism. 



We work with the Coast Guard, U.S. Customs and Border Protection (CBP), and the Military Transport Management Command, which monitor shipments entering the UPRR rail network at U.S. border crossings and ports.  We were the first railroad in the U.S. to be named a partner in CBP’s Customs-Trade Partnership Against Terrorism, a partnership designed to develop, enhance, and maintain effective security processes throughout the global supply chain.



Cooperation with Customers and Trade Associations – Through TransCAER (Transportation Community Awareness and Emergency Response) we work with the AAR, the American Chemistry Council, the American Petroleum Institute, and other chemical trade groups to provide communities with preparedness

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tools, including the training of emergency responders.  In cooperation with the Federal Railroad Administration (FRA) and other interested groups, we are also working to develop additional improvements to tank car design that will further limit the risk of releases of hazardous materials.



GOVERNMENTAL AND ENVIRONMENTAL REGULATION



Governmental Regulation – Our operations are subject to a variety of federal, state, and local regulations, generally applicable to all businesses.  (See also the discussion of certain regulatory proceedings in Legal Proceedings, Item 3.)



The operations of the Railroad are also subject to the regulatory jurisdiction of the Surface Transportation Board (STB).  The STB has jurisdiction over rates charged on certain regulated rail traffic; common carrier service of regulated traffic; freight car compensation; transfer, extension, or abandonment of rail lines; and acquisition of control of rail common carriers. The STB continues its efforts to explore expanding rail regulation and is reviewing proposed rulemaking in various areas, including reciprocal switching, commodity exemptions, and expanding and easing procedures for smaller rate complaints. The STB also continues to develop a methodology for determining railroad revenue adequacy and the possible use of a revenue adequacy constraint in regulating railroad rates.  The STB posts quarterly reports on rate reasonableness cases and maintains a database on service complaints, and has the authority to initiate investigations, among other things.



The operations of the Railroad also are subject to the regulations of the FRA and other federal and state agencies. In 2010, the FRA issued initial rules governing installation of Positive Train Control (PTC). PTC is a collision avoidance technology intended to override engineer controlled locomotives and stop train-to-train and overspeed accidents, misaligned switch derailments, and unauthorized entry to work zones. The Surface Transportation Extension Act of 2015 amended the Rail Safety Improvement Act to require implementation of PTC by the end of 2018, which deadline may be extended to December 31, 2020, provided certain other criteria are satisfied.  On December 10, 2018, we received FRA approval for an alternative schedule to implement, test and refine our PTC during 2019-2020.    Through 2018, we have invested approximately $2.8 billion in the ongoing development of PTC. Final implementation of PTC will require us to adapt and integrate our system with other railroads whose implementation plan may be different than ours. 



DOT, the Occupational Safety and Health Administration, the Pipeline and Hazardous Materials Safety Administration, and DHS, along with other federal agencies, have jurisdiction over certain aspects of safety, movement of hazardous materials and hazardous waste, emissions requirements, and equipment standards. Additionally, various state and local agencies have jurisdiction over disposal of hazardous waste and seek to regulate movement of hazardous materials in ways not preempted by federal law.



Environmental Regulation – We are subject to extensive federal and state environmental statutes and regulations pertaining to public health and the environment. The statutes and regulations are administered and monitored by the Environmental Protection Agency (EPA) and by various state environmental agencies. The primary laws affecting our operations are the Resource Conservation and Recovery Act, regulating the management and disposal of solid and hazardous wastes; the Comprehensive Environmental Response, Compensation, and Liability Act, regulating the cleanup of contaminated properties; the Clean Air Act, regulating air emissions; and the Clean Water Act, regulating waste water discharges.



Information concerning environmental claims and contingencies and estimated remediation costs is set forth in Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies – Environmental, Item 7 and Note 18 to the Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data.

 

Item 1A. Risk Factors



The information set forth in this Item 1A should be read in conjunction with the rest of the information included in this report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, Item 7, and Financial Statements and Supplementary Data, Item 8.



We Must Manage Fluctuating Demand for Our Services and Network Capacity – If there are significant reductions in demand for rail services with respect to one or more commodities or changes in consumer preferences that affect the businesses of our customers, we may experience increased costs associated

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with resizing our operations, including higher unit operating costs and costs for the storage of locomotives, rail cars, and other equipment; work-force adjustments; and other related activities, which could have a material adverse effect on our results of operations, financial condition, and liquidity. If there is significant demand for our services that exceeds the designed capacity of our network, we may experience network difficulties, including congestion and reduced velocity, that could compromise the level of service we provide to our customers. This level of demand may also compound the impact of weather and weather-related events on our operations and velocity. Although we continue to improve our transportation plan, add capacity, improve operations at our yards and other facilities, and improve our ability to address surges in demand for any reason with adequate resources, we cannot be sure that these measures will fully or adequately address any service shortcomings resulting from demand exceeding our planned capacity.  We may experience other operational or service difficulties related to network capacity, dramatic and unplanned fluctuations in our customers’ demand for rail service with respect to one or more commodities or operating regions, or other events that could negatively impact our operational efficiency, any of which could have a material adverse effect on our results of operations, financial condition, and liquidity. 



We Transport Hazardous Materials – We transport certain hazardous materials and other materials, including crude oil, ethanol, and toxic inhalation hazard (TIH) materials, such as chlorine, that pose certain risks in the event of a release or combustion. Additionally, U.S. laws impose common carrier obligations on railroads that require us to transport certain hazardous materials regardless of risk or potential exposure to loss. A rail accident or other incident or accident on our network, at our facilities, or at the facilities of our customers involving the release or combustion of hazardous materials could involve significant costs and claims for personal injury, property damage, and environmental penalties and remediation in excess of our insurance coverage for these risks, which could have a material adverse effect on our results of operations, financial condition, and liquidity.



We Are Subject to Significant Governmental Regulation – We are subject to governmental regulation by a significant number of federal, state, and local authorities covering a variety of health, safety, labor, environmental, economic (as discussed below), and other matters.  Many laws and regulations require us to obtain and maintain various licenses, permits, and other authorizations, and we cannot guarantee that we will continue to be able to do so. Our failure to comply with applicable laws and regulations could have a material adverse effect on us. Governments or regulators may change the legislative or regulatory frameworks within which we operate without providing us any recourse to address any adverse effects on our business, including, without limitation, regulatory determinations or rules regarding dispute resolution, increasing the amount of our traffic subject to common carrier regulation, business relationships with other railroads, calculation of our cost of capital or other inputs relevant to computing our revenue adequacy, the prices we charge, and costs and expenses. Significant legislative activity in Congress or regulatory activity by the STB could expand regulation of railroad operations and prices for rail services, which could reduce capital spending on our rail network, facilities and equipment and have a material adverse effect on our results of operations, financial condition, and liquidity. As part of the Rail Safety Improvement Act of 2008, rail carriers were to implement PTC by the end of 2015 (the Rail Safety Improvement Act).  The Surface Transportation Extension Act of 2015 amended the Rail Safety Improvement Act to require implementation of PTC by the end of 2018, which deadline may be extended to December 31, 2020, provided certain other criteria are satisfied.  On December 10, 2018, we received approval from the FRA for an alternative schedule to implement, test and refine our PTC during 2019-2020.  Final implementation of PTC will require us to adapt and integrate our system with other railroads whose implementation plan may be different than ours.  This implementation could have a material adverse effect on our results of operations and financial condition. Additionally, one or more consolidations of Class I railroads could also lead to increased regulation of the rail industry.



We May Be Affected by General Economic Conditions – Prolonged severe adverse domestic and global economic conditions or disruptions of financial and credit markets may affect the producers and consumers of the commodities we carry and may have a material adverse effect on our access to liquidity and our results of operations and financial condition.



We Face Competition from Other Railroads and Other Transportation Providers – We face competition from other railroads, motor carriers, ships, barges, and pipelines. In addition to price competition, we face competition with respect to transit times and quality and reliability of service. We must build or acquire and maintain our rail system, while trucks, barges and maritime operators are able to use public rights-of-way maintained by public entities. Any future improvements or expenditures materially increasing the quality or reducing the cost of alternative modes of transportation, or legislation that eliminates or significantly increases the size or weight limitations currently applicable to motor carriers, could have a material adverse

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effect on our results of operations, financial condition, and liquidity. Additionally, any future consolidation of the rail industry could materially affect the competitive environment in which we operate.



We Rely on Technology and Technology Improvements in Our Business Operations – We rely on information technology in all aspects of our business. If we do not have sufficient capital to acquire new technology or if we are unable to develop or implement new technology such as PTC or the latest version of our transportation control systems, we may suffer a competitive disadvantage within the rail industry and with companies providing other modes of transportation service, which could have a material adverse effect on our results of operations, financial condition, and liquidity. Additionally, if a cyber attack or other event causes significant disruption or failure of one or more of our information technology systems, including computer hardware, software, and communications equipment, we could suffer a significant service interruption, safety failure, security breach, or other operational difficulties, which could have a material adverse impact on our results of operations, financial condition, and liquidity.



We May Be Subject to Various Claims and Lawsuits That Could Result in Significant Expenditures – As a railroad with operations in densely populated urban areas and other cities and a vast rail network, we are exposed to the potential for various claims and litigation related to labor and employment, personal injury, property damage, environmental liability, and other matters. Any material changes to litigation trends or a catastrophic rail accident or series of accidents involving any or all of property damage, personal injury, and environmental liability that exceed our insurance coverage for such risks could have a material adverse effect on our results of operations, financial condition, and liquidity.



We Are Subject to Significant Environmental Laws and Regulations – Due to the nature of the railroad business, our operations are subject to extensive federal, state, and local environmental laws and regulations concerning, among other things, emissions to the air; discharges to waters; handling, storage, transportation, disposal of waste and other materials; and hazardous material or petroleum releases. We generate and transport hazardous and non-hazardous waste in our operations, and we did so in our former operations. Environmental liability can extend to previously owned or operated properties, leased properties, and properties owned by third parties, as well as to properties we currently own. Environmental liabilities have arisen and may also arise from claims asserted by adjacent landowners or other third parties in toxic tort litigation. We have been and may be subject to allegations or findings that we have violated, or are strictly liable under, these laws or regulations. We currently have certain obligations at existing sites for investigation, remediation and monitoring, and we likely will have obligations at other sites in the future.  Liabilities for these obligations affect our estimate based on our experience and, as necessary, the advice and assistance of our consultants.  However, actual costs may vary from our estimates due to any or all of several factors, including changes to environmental laws or interpretations of such laws, technological changes affecting investigations and remediation, the participation and financial viability of other parties responsible for any such liability and the corrective action or change to corrective actions required to remediate any existing or future sites. We could incur significant costs as a result of any of the foregoing, and we may be required to incur significant expenses to investigate and remediate known, unknown, or future environmental contamination, which could have a material adverse effect on our results of operations, financial condition, and liquidity.



We May Be Affected by Climate Change and Market or Regulatory Responses to Climate Change – Climate change, including the impact of global warming, could have a material adverse effect on our results of operations, financial condition, and liquidity.  Restrictions, caps, taxes, or other controls on emissions of greenhouse gasses, including diesel exhaust, could significantly increase our operating costs.  Restrictions on emissions could also affect our customers that (a) use commodities that we carry to produce energy, (b) use significant amounts of energy in producing or delivering the commodities we carry, or (c) manufacture or produce goods that consume significant amounts of energy or burn fossil fuels, including chemical producers, farmers and food producers, and automakers and other manufacturers.  Significant cost increases, government regulation, or changes of consumer preferences for goods or services relating to alternative sources of energy or emissions reductions could materially affect the markets for the commodities we carry, which in turn could have a material adverse effect on our results of operations, financial condition, and liquidity.  Government incentives encouraging the use of alternative sources of energy could also affect certain of our customers and the markets for certain of the commodities we carry in an unpredictable manner that could alter our traffic patterns, including, for example, increasing royalties charged to producers of PRB coal by the U.S. Department of Interior and the impacts of ethanol incentives on farming and ethanol producers. Finally, we could face increased costs related to defending and resolving legal claims and other litigation related to climate change and the alleged impact of our operations on climate change.  Any of these factors, individually or in operation with one or more of the other factors, or

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other unforeseen impacts of climate change could reduce the amount of traffic we handle and have a material adverse effect on our results of operations, financial condition, and liquidity.



Severe Weather Could Result in Significant Business Interruptions and Expenditures – As a railroad with a vast network, we are exposed to severe weather conditions and other natural phenomena, including earthquakes, hurricanes, fires, floods, mudslides or landslides, extreme temperatures, and significant precipitation. Line outages and other interruptions caused by these conditions can adversely affect our entire rail network and can adversely affect revenue, costs, and liabilities, which could have a material adverse effect on our results of operations, financial condition, and liquidity.



Strikes or Work Stoppages Could Adversely Affect Our Operations – The U.S. Class I railroads are party to collective bargaining agreements with various labor unions. The majority of our employees belong to labor unions and are subject to these agreements. Disputes with regard to the terms of these agreements or our potential inability to negotiate acceptable contracts with these unions could result in, among other things, strikes, work stoppages, slowdowns, or lockouts, which could cause a significant disruption of our operations and have a material adverse effect on our results of operations, financial condition, and liquidity. Additionally, future national labor agreements, or renegotiation of labor agreements or provisions of labor agreements, could compromise our service reliability or significantly increase our costs for health care, wages, and other benefits, which could have a material adverse impact on our results of operations, financial condition, and liquidity.  Labor disputes, work stoppages, slowdowns or lockouts at loading/unloading facilities, ports or other transport access points could compromise our service reliability and have a material adverse impact on our results of operations, financial condition, and liquidity.  Labor disputes, work stoppages, slowdowns or lockouts by employees of our customers or our suppliers could compromise our service reliability and have a material adverse impact on our results of operations, financial condition, and liquidity.



The Availability of Qualified Personnel Could Adversely Affect Our Operations – Changes in demographics, training requirements, and the availability of qualified personnel could negatively affect our ability to meet demand for rail service. Unpredictable increases in demand for rail services and a lack of network fluidity may exacerbate such risks, which could have a negative impact on our operational efficiency and otherwise have a material adverse effect on our results of operations, financial condition, and liquidity.



We May Be Affected By Fluctuating Fuel Prices – Fuel costs constitute a significant portion of our transportation expenses. Diesel fuel prices can be subject to dramatic fluctuations, and significant price increases could have a material adverse effect on our operating results. Although we currently are able to recover a significant amount of our fuel expenses from our customers through revenue from fuel surcharges, we cannot be certain that we will always be able to mitigate rising or elevated fuel costs through our fuel surcharges. Additionally, future market conditions or legislative or regulatory activities could adversely affect our ability to apply fuel surcharges or adequately recover increased fuel costs through fuel surcharges. As fuel prices fluctuate, our fuel surcharge programs trail such fluctuations in fuel price by approximately two months, and may be a significant source of quarter-over-quarter and year-over-year volatility, particularly in periods of rapidly changing prices. International, political, and economic factors, events and conditions affect the volatility of fuel prices and supplies. Weather can also affect fuel supplies and limit domestic refining capacity. A severe shortage of, or disruption to, domestic fuel supplies could have a material adverse effect on our results of operations, financial condition, and liquidity.  Alternatively, lower fuel prices could have a positive impact on the economy by increasing consumer discretionary spending that potentially could increase demand for various consumer products we transport. However, lower fuel prices could have a negative impact on other commodities we transport, such as coal and domestic drilling-related shipments, which could have a material adverse effect on our results of operations, financial condition, and liquidity.



We Utilize Capital Markets – Due to the significant capital expenditures required to operate and maintain a safe and efficient railroad, we rely on the capital markets to provide some of our capital requirements.  We utilize long-term debt instruments, bank financing and commercial paper from time-to-time, and we pledge certain of our receivables.  Significant instability or disruptions of the capital markets, including the credit markets, or deterioration of our financial condition due to internal or external factors could restrict or prohibit our access to, and significantly increase the cost of, commercial paper and other financing sources, including bank credit facilities and the issuance of long-term debt, including corporate bonds. A significant deterioration of our financial condition could result in a reduction of our credit rating to below investment grade, which could restrict, or at certain credit levels below investment grade may prohibit us, from utilizing our current receivables securitization facility. This may also limit our access to external sources of capital and significantly increase the costs of short and long-term debt financing.

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A Significant Portion of Our Revenue Involves Transportation of Commodities to and from International Markets – Although revenues from our operations are attributable to transportation services provided in the U.S., a significant portion of our revenues involves the transportation of commodities to and from international markets, including Mexico and Southeast Asia, by various carriers and, at times, various modes of transportation. Significant and sustained interruptions of trade with Mexico or countries in Southeast Asia, including China, could adversely affect customers and other entities that, directly or indirectly, purchase or rely on rail transportation services in the U.S. as part of their operations, and any such interruptions could have a material adverse effect on our results of operations, financial condition and liquidity. Any one or more of the following could cause a significant and sustained interruption of trade with Mexico or countries in Southeast Asia: (a) a deterioration of security for international trade and businesses; (b) the adverse impact of new laws, rules and regulations or the interpretation of laws, rules and regulations by government entities, courts or regulatory bodies, including modifications to the North American Free Trade Agreement (NAFTA) or its proposed successor called the U.S.-Mexico-Canada Agreement (USMCA) and actions of taxing authorities that affect our customers doing business in foreign countries; (c) any significant adverse economic developments, such as extended periods of high inflation, material disruptions in the banking sector or in the capital markets of these foreign countries, and significant changes in the valuation of the currencies of these foreign countries that could materially affect the cost or value of imports or exports; (d) shifts in patterns of international trade that adversely affect import and export markets; and (e) a material reduction in foreign direct investment in these countries.



We Are Subject to Legislative, Regulatory, and Legal Developments Involving Taxes – Taxes are a significant part of our expenses.  We are subject to U.S. federal, state, and foreign income, payroll, property, sales and use, fuel, and other types of taxes. Changes in tax rates, such as those included in the U.S. Tax Cuts and Jobs Act, enactment of new tax laws, revisions of tax regulations, and claims or litigation with taxing authorities could result in a material effect to our results of operations, financial condition, and liquidity.  Higher tax rates could have a material adverse effect on our results of operations, financial condition, and liquidity.



We Are Dependent on Certain Key Suppliers of Locomotives and Rail – Due to the capital intensive nature and sophistication of locomotive equipment, parts and maintenance, potential new suppliers face high barriers to entry.  Therefore, if one of the domestic suppliers of high horsepower locomotives discontinues manufacturing locomotives, supplying parts or providing maintenance for any reason, including bankruptcy or insolvency, we could experience significant cost increases and reduced availability of the locomotives that are necessary for our operations.  Additionally, for a high percentage of our rail purchases, we utilize two steel producers (one domestic and one international) that meet our specifications.  Rail is critical to our operations for rail replacement programs, maintenance, and for adding additional network capacity, new rail and storage yards, and expansions of existing facilities.  This industry similarly has high barriers to entry, and if one of these suppliers discontinues operations for any reason, including bankruptcy or insolvency, we could experience both significant cost increases for rail purchases and difficulty obtaining sufficient rail for maintenance and other projects.



We May Be Affected by Acts of Terrorism, War, or Risk of War – Our rail lines, facilities, and equipment, including rail cars carrying hazardous materials, could be direct targets or indirect casualties of terrorist attacks. Terrorist attacks, or other similar events, any government response thereto, and war or risk of war may adversely affect our results of operations, financial condition, and liquidity. In addition, insurance premiums for some or all of our current coverages could increase dramatically, or certain coverages may not be available to us in the future.

 

Item 1B. Unresolved Staff Comments



None.



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Item 2. Properties



We employ a variety of assets in the management and operation of our rail business. Our rail network covers 23 states in the western two-thirds of the U.S.





TRACK



Our rail network includes 32,236 route miles.  We own 26,039 miles and operate on the remainder pursuant to trackage rights or leases. The following table describes track miles at December 31, 2018, and 2017:







HEADQUARTERS BUILDING



We own our headquarters building in Omaha, Nebraska. The facility has 1.2 million square feet of space that can accommodate approximately 4,000 employees.



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HARRIMAN DISPATCHING CENTER



The Harriman Dispatching Center (HDC), located in Omaha, Nebraska, is our primary dispatching facility. It is linked to regional dispatching and locomotive management facilities at various locations along our network. HDC employees coordinate moves of locomotives and trains, manage traffic and train crews on our network, and coordinate interchanges with other railroads. Approximately 900 employees currently work on-site in the facility. In the event of a disruption of operations at HDC due to a cyber attack, flooding or severe weather or other event, we maintain the capability to conduct critical operations at back-up facilities in different locations.



RAIL FACILITIES



In addition to our track structure, we operate numerous facilities, including terminals for intermodal and other freight; rail yards for building trains (classification yards), switching, storage-in-transit (the temporary storage of customer goods in rail cars prior to shipment) and other activities; offices to administer and manage our operations; dispatching centers to direct traffic on our rail network; crew quarters to house train crews along our network; and shops and other facilities for fueling, maintenance, and repair of locomotives and repair and maintenance of rail cars and other equipment.  The following table includes the major yards and terminals on our system:







RAIL EQUIPMENT



Our equipment includes owned and leased locomotives and rail cars; heavy maintenance equipment and machinery; other equipment and tools in our shops, offices, and facilities; and vehicles for maintenance, transportation of crews, and other activities. As of December 31, 2018, we owned or leased the following units of equipment:













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CAPITAL EXPENDITURES



Our rail network requires significant annual capital investments for replacement, improvement, and expansion. These investments enhance safety, support the transportation needs of our customers, and improve our operational efficiency. Additionally, we add new locomotives and freight cars to our fleet to replace older, less efficient equipment, to support growth and customer demand, and to reduce our impact on the environment through the acquisition of more fuel-efficient and low-emission locomotives.



2018 Capital Program – During 2018, our capital program totaled approximately $3.2 billion. (See the cash capital investments table in Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources, Item 7.)



2019 Capital Plan – In 2019, we expect our capital plan to be approximately $3.2 billion, flat compared to 2018.  The plan includes expenditures to renew and improve our existing infrastructure as well as new capacity investments designed to support future business growth and operational efficiency.  In addition, expenditures will be made for locomotive modernization and freight cars.  The capital plan may be revised if business conditions warrant or if new laws or regulations affect our ability to generate sufficient returns on these investments.  (See further discussion of our 2019 capital plan in Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources, Item 7.)



OTHER



Equipment Encumbrances – Equipment with a carrying value of approximately $1.8 billion and $2.0 billion at December 31, 2018, and 2017, respectively served as collateral for capital leases and other types of equipment obligations in accordance with the secured financing arrangements utilized to acquire or refinance such railroad equipment.



Environmental Matters – Certain of our properties are subject to federal, state, and local laws and regulations governing the protection of the environment.  (See discussion of environmental issues in Business – Governmental and Environmental Regulation, Item 1, Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies – Environmental, Item 7, and Note 18 of the Consolidated Financial Statements.)

 

Item 3. Legal Proceedings



From time to time, we are involved in legal proceedings, claims, and litigation that occur in connection with our business. We routinely assess our liabilities and contingencies in connection with these matters based upon the latest available information and, when necessary, we seek input from our third-party advisors when making these assessments. Consistent with SEC rules and requirements, we describe below material pending legal proceedings (other than ordinary routine litigation incidental to our business), material proceedings known to be contemplated by governmental authorities, other proceedings arising under federal, state, or local environmental laws and regulations (including governmental proceedings involving potential fines, penalties, or other monetary sanctions in excess of $100,000), and such other pending matters that we may determine to be appropriate.



ENVIRONMENTAL MATTERS



District Attorneys from Placer, San Joaquin, San Bernardino and Nevada counties in California have asserted claims against Union Pacific in connection with more than 150 alleged violations of environmental laws that occurred in their counties, largely between 2011 and 2014.  The alleged violations consist of violation of (1) various hazardous waste requirements, (2) Hazardous Materials Business Plan requirements, (3) above ground petroleum storage requirements, and (4) various spill requirements.   The Company has entered into a Stipulation for Entry of Final Judgment with the District Attorneys to resolve their claims in connection with these matters for payment of a $2 million civil penalty, $313,000 in attorneys’

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fees and investigative costs, and a 3 year environmental compliance monitoring and reporting program performed under the supervision of an agreed upon outside consultant.  The Stipulation, together with the District Attorneys Complaint and a Final Judgment (reflecting the terms of the Stipulation) were lodged with the Court in December 2018.  The Judgment was signed on December 19, 2018.



The United States Department of Justice has asserted claims against Union Pacific in connection with a September 12, 2014 release of diesel from a locomotive fuel tank arising out of a derailment that occurred in Salem, OR.  Some portion of that fuel entered Pringle Creek, which the United States asserts is a Water of the United States.  The Company has agreed to resolve those claims through a Stipulation of Settlement and Judgment, pursuant to which the Company will pay $47,500 to the United States and $47,500 to the State of Oregon.



We receive notices from the EPA and state environmental agencies alleging that we are or may be liable under federal or state environmental laws for remediation costs at various sites throughout the U.S., including sites on the Superfund National Priorities List or state superfund lists. We cannot predict the ultimate impact of these proceedings and suits because of the number of potentially responsible parties involved, the degree of contamination by various wastes, the scarcity and quality of volumetric data related to many of the sites, and the speculative nature of remediation costs.



Information concerning environmental claims and contingencies and estimated remediation costs is set forth in Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies – Environmental, Item 7.  See also Note 18 of the Consolidated Financial Statements.



OTHER MATTERS



Antitrust Litigation – As we reported in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2007, 20 rail shippers (many of whom are represented by the same law firms) filed virtually identical antitrust lawsuits in various federal district courts against us and four other Class I railroads in the U.S. Currently, UPRR and three other Class I railroads are the named defendants in the lawsuit. The original plaintiff filed the first of these claims in the U.S. District Court in New Jersey on May 14, 2007. The number of complaints reached a total of 30. These suits allege that the named railroads engaged in price-fixing by establishing common fuel surcharges for certain rail traffic.

   

On June 21, 2012, Judge Friedman issued a decision that certified a class of plaintiffs with eight named plaintiff representatives. The decision included in the class all shippers that paid a rate-based fuel surcharge to any one of the defendant railroads for rate-unregulated rail transportation from July 1, 2003, through December 31, 2008. On July 5, 2012, the defendant railroads filed a petition with the U.S. Court of Appeals for the District of Columbia requesting that the court review the class certification ruling. On August 9, 2013, the Circuit Court vacated the class certification decision and remanded the case to the district court to reconsider the class certification decision in light of a recent Supreme Court case and incomplete consideration of errors in the expert report of the plaintiffs. After reviewing an intervening case, supplemental expert materials and related briefing from the parties, Judge Friedman scheduled and completed a new class certification hearing during the week of September 26, 2016.  On October 10, 2017, the parties received a ruling from Judge Friedman denying class certification. Plaintiffs have sought appellate review of that ruling and on December 20, 2017, were granted the right of an interlocutory appeal by the U.S. Court of Appeals for the District of Columbia Circuit.  A hearing of the appeal was conducted on September 28, 2018.  We are awaiting a decision on that hearing.



As we reported in our Current Report on Form 8-K, filed on June 10, 2011, the Railroad received a complaint filed in the U.S. District Court for the District of Columbia on June 7, 2011, by Oxbow Carbon & Minerals LLC and related entities (Oxbow).  The parties are currently conducting discovery in this matter.  For additional information on Oxbow, please refer to Item 3. Legal Proceedings, under Other Matters, Antitrust Litigation in our Annual Report on Form 10-K for the year ended December 31, 2016. 



We continue to deny the allegations that our fuel surcharge programs violate the antitrust laws or any other laws. We believe that these lawsuits are without merit, and we will vigorously defend our actions. Therefore, we currently believe that these matters will not have a material adverse effect on any of our results of operations, financial condition, and liquidity.









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In 2016, a lawsuit was filed in U.S. District Court for the Western District of Washington alleging violations of the Americans with Disabilities Act (ADA) and Genetic Information Nondiscrimination Act relating to Fitness for Duty requirements for safety sensitive positions.



On August 8, 2016, the U.S. District Court for the Western District of Washington granted plaintiffs' motion to transfer their claim to the U.S. District Court of Nebraska. On February 5, 2019, the U.S. District Court of Nebraska granted plaintiffs’ motion to certify the ADA allegations as a class action. We intend to appeal this class certification to the U.S. Court of Appeals for the 8th Circuit. We continue to deny these allegations, believe this lawsuit is without merit and will defend our actions.  We believe this lawsuit will not have a material adverse effect on any of our results of operations, financial condition, and liquidity.



Item 4. Mine Safety Disclosures



Not applicable. 

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Executive Officers of the Registrant and Principal Executive Officers of Subsidiaries



The Board of Directors typically elects and designates our executive officers on an annual basis at the board meeting held in conjunction with the Annual Meeting of Shareholders, and they hold office until their successors are elected. Executive officers also may be elected and designated throughout the year, as the Board of Directors considers appropriate. There are no family relationships among the officers, nor is there any arrangement or understanding between any officer and any other person pursuant to which the officer was selected. The following table sets forth certain information current as of February 8, 2019, relating to the executive officers.





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PART II



Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities



Our common stock is traded on the New York Stock Exchange (NYSE) under the symbol “UNP”.



At February 1, 2019, there were 722,877,817 shares of common stock outstanding and 30,902 common shareholders of record. On that date, the closing price of the common stock on the NYSE was $159.67. We paid dividends to our common shareholders during each of the past 119 years. 



Comparison Over One- and Three-Year Periods – The following table presents the cumulative total shareholder returns, assuming reinvestment of dividends, over one- and three-year periods for the Corporation (UNP), a peer group index (comprised of CSX Corporation and Norfolk Southern Corporation), the Dow Jones Transportation Index (DJ Trans), and the Standard & Poor’s 500 Stock Index (S&P 500).







Five-Year Performance Comparison – The following graph provides an indicator of cumulative total shareholder returns for the Corporation as compared to the peer group index (described above), the DJ Trans, and the S&P 500. The graph assumes that $100 was invested in the common stock of Union Pacific Corporation and each index on December 31, 2013 and that all dividends were reinvested. The information below is historical in nature and is not necessarily indicative of future performance.





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Purchases of Equity Securities – During 2018, we repurchased 57,669,746 shares of our common stock at an average price of $143.70. The following table presents common stock repurchases during each month for the fourth quarter of 2018:







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Item 6. Selected Financial Data



The following table presents as of, and for the years ended, December 31, our selected financial data for each of the last five years. The selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations, Item 7, and with the Financial Statements and Supplementary Data, Item 8. The information below is historical in nature and is not necessarily indicative of future financial condition or results of operations.







 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations



The following discussion should be read in conjunction with the Consolidated Financial Statements and applicable notes to the Financial Statements and Supplementary Data, Item 8, and other information in this report, including Risk Factors set forth in Item 1A and Critical Accounting Policies and Cautionary Information at the end of this Item 7.



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



EXECUTIVE SUMMARY



2018 Results

As a result, network operations improved significantly as we progressed throughout the fourth quarter.  We reduced our active locomotive fleet by 625 locomotives and reduced operating car inventory by more than 10% compared to September 30, 2018, while handling relatively similar volume levels.    As reference, average terminal dwell, as reported to the AAR improved 14%  to 26.7 hours in the fourth quarter compared to the first half of 2018.  On a full year basis, average terminal dwell improved 2% while average train speed decreased 4% compared to 2017.  Additional details on our Unified Plan 2020 goals and implementation schedule are included in the “2019 Outlook” section of Item 7.

[1] For comparability purposes, the following table reconciles our full year 2017 reported results under accounting principles generally accepted in the U.S. (GAAP) to our 2017 adjusted results (non-GAAP) for tax related items recognized in 2017.  We believe the adjusted results provide relevant information to our investors as they more accurately reflect on-going financial performance.  In addition, these measures should be considered in addition to, and not a substitute for operating income, income taxes, net income, diluted EPS, operating ratio, and effective tax rate.

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*Adjusted for the retrospective adoption of ASU 2017-07 which was effective January 1, 2018.







Free cash flow is not considered a financial measure under 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):







2019 Outlook







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In addition, we are working through a terminal rationalization process to more fully optimize our train operations and crew resources.  These potential changes, combined with other G55+0 initiatives, are designed to better align our management structure and decision making processes in conjunction with our Unified Plan 2020 operating model.





Lower fuel prices could have a positive impact on the economy by increasing consumer discretionary spending that potentially could increase demand for various consumer products that we transport. Alternatively, lower fuel prices could likely have a negative impact on other commodities such as coal and domestic drilling-related shipments.







RESULTS OF OPERATIONS



Operating Revenues







We generate freight revenues by transporting freight or other materials from our four 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 increased 8% year-over-year to $21.4 billion driven by 4% volume growth, higher fuel surcharge revenue, and core pricing gains, partially offset by negative mix of traffic. Growth in international

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and domestic intermodal, petroleum products, metals, rock, plastics, and industrial chemical shipments more than offset declines in coal, grain, and frac sand shipments.



Freight revenues increased 7% in 2017 to $19.8 billion driven by volume growth of 2%, higher fuel surcharge revenue, and core pricing gains. Growth in frac sand, coal, and intermodal shipments more than offset declines in grain, crude oil, finished vehicles, and rock shipments.



Our fuel surcharge programs generated freight revenues of $1.7 billion, $966 million, and $560 million in 2018, 2017, and 2016, respectively. Fuel surcharge revenue in 2018 increased $769 million as a result of a 27% increase in fuel price and 4% growth in carloadings.  Fuel surcharge revenue in 2017 increased $406 million as a result of a 22% increase in fuel price, a 2% growth in carloadings, and the lag impact on fuel surcharge (it can generally take up to two months for changing fuel prices to affect fuel surcharge recoveries). 



In 2018, other revenues increased from 2017 driven by higher accessorial revenues associated with carload and container volume growth.



In 2017, other revenues increased from 2016 due to higher revenues at our subsidiaries, primarily those that broker intermodal, transload, and refrigerated warehousing logistics services.



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

















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Freight revenue from agricultural products increased in 2017 compared to 2016 driven by core pricing gains and higher fuel surcharge revenue, partially offset by a 1% decrease in volume.  Grain and grain product shipments decreased 3% in 2017 compared to 2016.  Strong export demand for wheat drove volume growth in the first half of the year, which was more than offset by declines of grain shipments in the second half of the year due to an abundance of global supply reducing U.S. grain competitiveness. Conversely, fertilizer shipments increased 7% as a result of continued strength in potash exports.



Volume growth of 11% and higher fuel surcharge revenue drove an increase in freight revenue from energy shipments in 2017 compared to 2016. Shipments out of the Powder River Basin (PRB) grew 5% driven by strong growth in the first half of the year due to higher year-over-year natural gas prices and lower inventory levels at utilities. Shipments out of Colorado and Utah increased 7% compared to 2016 due to the same drivers, combined with stronger export demand. In addition, increased shale drilling activity and proppant intensity per drilling well drove substantial volume growth in frac sand shipments versus 2016.



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Volumes were flat as growth in shipments of metals, waste, and government shipments were offset by declines in construction materials due to inclement weather in the West in the first half of the year, combined with decreased construction activity in Texas and lower industrial chemical shipments. 



Higher fuel surcharge revenue and core pricing gains drove an increase in freight revenue from premium shipments in 2017 compared to 2016. Volumes were flat as a 1% growth in international shipments was muted by flat domestic shipments (including containerized automotive parts) due to available truck capacity during most of 2017, which offset a strong holiday shipping season in the fourth quarter. In addition, shipments of finished vehicles fell 7% in 2017 resulting from lower domestic sales and reduced production for certain manufactures. 

 

Mexico Business – Each of our commodity groups includes revenue from shipments to and from Mexico. Freight revenue from Mexico business was $2.5 billion in 2018, up 10% compared to 2017, driven by 1% volume growth, fuel surcharge revenue, and core pricing gains. The increase in volume was driven by higher shipments of corn and feed grains, coal, and finished vehicles, partially offset by declines in automotive parts and intermodal shipments.



Freight revenue from Mexico business was $2.3 billion in 2017, up 2% compared to 2016.  Core pricing gains and higher fuel surcharge revenue more than offset the 1% volume decline. The decrease in volume was driven by lower shipments of automotive parts, partially offset by growth in coal and refined petroleum products shipments.



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Operating Expenses







to the third quarter workforce reduction plan, depreciation, contract services, and volume-related costs.  Partially offsetting these increases was a $212 million reduction to operating expense related to income tax adjustments at certain equity-method affiliates, continued productivity gains, lower locomotive and freight car lease expense, and lower environmental, personal injury, and joint facility costs. 



Compensation and Benefits – Compensation and benefits include wages, payroll taxes, health and welfare costs, pension costs, other postretirement benefits, and incentive costs. In 2018, expenses increased 2% compared to 2017, due to volume-related costs,  excess network costs, higher training expenses for trainmen, and wage inflation.  Lower management and administrative wage and benefit costs partially offset these increases.



In 2017, expenses increased 3% compared to 2016, driven by general wage and benefit inflation, $86 million of expenses associated with the workforce reduction plan, volume-related costs, and higher training expenses for trainmen, which were partially offset by resource productivity gains.



Fuel – Fuel includes locomotive fuel and gasoline for highway and non-highway vehicles and heavy equipment. Locomotive diesel fuel prices, which averaged $2.29 per gallon (including taxes and transportation costs) in 2018, compared to $1.81 per gallon in 2017, increased expenses $507 million. In addition, gross-ton miles and the fuel consumption rate (c-rate) both increased 3% in 2018, also driving higher fuel expense compared to 2017. The c-rate is computed as gallons of fuel consumed divided by gross ton-miles in thousands.



Locomotive diesel fuel prices, which averaged $1.81 per gallon (including taxes and transportation costs) in 2017, compared to $1.48 per gallon in 2016, increased expenses $334 million. In addition, fuel costs were higher as gross-ton miles increased 5% compared to 2016.  The c-rate improved 2% compared to 2016.



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 increased  3% in 2018 compared to 2017 primarily due to volume-related costs, inflationary cost pressures on transportation-related contract services incurred at our subsidiaries that broker intermodal and transload services, and higher locomotive repair costs due to the larger active fleet in service.  Lower joint facility expenses partially offset these increases.



Purchased services and materials increased 5% in 2017 compared to 2016 primarily due to volume-related costs (including higher subsidiary contract services) and Hurricane Harvey-related contract service costs, which were partially offset by lower joint facility expenses.



Depreciation – The majority of depreciation relates to road property, including rail, ties, ballast, and other track material.  A higher depreciable asset base increased depreciation expense in 2018 compared to 2017.



A higher depreciable asset base increased depreciation expense in 2017 compared to 2016. This increase was partially offset by our recent depreciation studies that resulted in lower depreciation rates for some asset classes.  



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 rent expenses. Equity income from certain equity method investments is also included.  Equipment and other rents expense increased $184 million compared to 2017 largely driven by a $212 million reduction to 2017 rent expense related to income tax adjustments at certain equity-method affiliates as a result of the lower federal tax rate implemented January 1, 2018.  Increased car rent expense due to volume growth and slower network velocity also contributed to the increase.  Lower locomotive and freight car lease expenses in 2018 partially offset these increases. 



Equipment and other rents expense decreased $249 million compared to 2016.  $212 million of the reduction was due to income tax adjustments at certain equity-method affiliates. Lower locomotive and freight car lease expense also contributed to the year-over-year decrease.  Conversely, increased car rent expense due to volume growth in certain markets partially offset these decreases.



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 expenses increased 8% in 2018 compared to 2017 as a result of higher state and local taxes and environmental expenses related to our operating properties.  Lower personal injury expense, an insurance reimbursement for lost revenue and expenses incurred during Hurricane Harvey in 2017, and reduced costs for destroyed equipment owned by third parties and lower freight damage expense partially offset these increases.

 

Other expenses decreased 5% in 2017 compared to 2016 as a result of lower environmental and personal injury expenses, and higher bad debt expense in 2016 resulting from a customer bankruptcy.  Conversely, increased costs associated with destroyed equipment owned by third parties, and higher property and damaged freight costs partially offset these decreases. 



Non-Operating Items







Other Income – Other income decreased in 2018 compared to 2017 largely as a result of a $65 million gain on a litigation settlement for back rent and a $57 million real estate gain, both recognized in the third quarter of 2017.  In addition, an $85 million expense associated with early-extinguishment of outstanding debentures and mortgage bonds recognized in the first quarter of 2018 also contributed to the decrease.  Higher interest income earned in 2018 partially offset these decreases.



Other income increased in 2017 compared to 2016 primarily as a result of a $65 million gain on a litigation settlement for back rent and a $57 million real estate sale gain, both recognized in the third quarter of 2017.  Rental income also increased in 2017 compared to 2016.

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Interest Expense – Interest expense increased in 2018 compared to 2017 due to an increased weighted-average debt level of $20.1 billion in 2018 from $15.9 billion in 2017, partially offset by the impact of a lower effective interest rate of 4.4% in 2018 compared to 4.6 % in 2017.



Interest expense increased in 2017 compared to 2016 due to an increased weighted-average debt level of $15.9 billion in 2017 from $15.0 billion in 2016, partially offset by the impact of a lower effective interest rate of 4.6% in 2017 compared to 4.7% in 2016.



Income Taxes – Income tax expense was $1.8 billion in 2018 compared to a benefit of $3.1 billion in 2017.  The Tax Cuts and Jobs Act was enacted on December 22, 2017 and reduced the federal income tax rate from 35% to 21% effective January 1, 2018.  Consequently, we remeasured our deferred tax assets and liabilities, resulting in a $5.9 billion non-cash reduction in our income tax expense in 2017. 



Our effective tax rate for 2018 was 22.9% compared to (40.4)% in 2017.  The 2018 effective tax rate declined due to decreases in the corporate state income tax rates in Iowa and Missouri.  The 2017 rate was substantially reduced by the impact of the Tax Act, which resulted in a $5.9 billion non-cash reduction in our 2017 tax expense.

  

OTHER OPERATING/PERFORMANCE AND FINANCIAL STATISTICS



We report a number of key performance measures weekly to the AAR.  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:







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 AAR, declined 4% in 2018 compared to 2017 largely driven by network congestion on key routes and terminals combined with high freight car inventory levels during the first half of the year, somewhat offset by implementation of the first phase of our Unified Plan 2020 in late third quarter 2018.  Continued implementation and testing of PTC across a larger portion of our network also negatively impacted overall average train speed throughout the year.    



Average train speed declined 5% in 2017 compared to 2016 as disruptions across our network, including the impact of Hurricane Harvey, negatively impacted network fluidity.  Continued implementation and testing of Positive Train Control across a growing number of routes in our network combined with operational challenges also negatively impacted overall average train speed.



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 decreased 2% in 2018 compared to 2017 driven by an 18% improvement in the fourth quarter compared to the same period in 2017.  Implementation of the first phase of our Unified Plan 2020 in late-third quarter 2018 drove the improvement, more than offsetting the impact of network congestion and high inventory levels experienced in the first half of the year.



Average terminal dwell time increased 8% in 2017 compared to 2016 resulting from network disruptions and operational challenges which negatively impacted network fluidity.



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 increased 3% and

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2%, respectively in 2018 compared to 2017, resulting from a 4% increase in carloads. Changes in commodity mix drove the variances in year-over-year increases between gross ton-miles, revenue ton-miles, and carloads.



Gross ton-miles and revenue ton-miles increased 5% and 6%, respectively in 2017 compared to 2016, resulting from a 2% increase in carloads. Changes in commodity mix drove the variances in year-over-year increases between gross ton-miles, revenue ton-miles, and carloads.



Operating Ratio – Operating ratio is our operating expenses reflected as a percentage of operating revenue.  Our operating ratio increased 0.9 points to 62.7% in 2018 compared to 2017.  Income tax adjustments recognized in 2017 at our equity-method affiliates resulted in one point of the increase.  Core pricing gains and volume growth, mostly offset by excess network costs, higher fuel prices, and inflation, drove 0.1 point of operating ratio improvement.



Our operating ratio improved 1.9 points to 61.8% in 2017 compared to 2016.  Income tax adjustments recognized in 2017 at our equity-method affiliates drove one point of the improvement.  Core pricing gains, volume growth, and productivity savings more than offset higher inflation, higher fuel prices, and other expenses to drive 0.9 points of operating ratio improvement.



Employees – Employee levels were flat in 2018 compared to 2017 as a smaller capital workforce and fewer management and administrative personnel offset the impact of 4% volume growth, which contributed to an increase in TE&Y employees.



Employee levels decreased 2% in 2017 compared to 2016, driven by productivity gains, a smaller capital workforce, and fewer management and administrative personnel, which more than offset the impact of 2% volume growth.



Return on Average Common Shareholders’ Equity







Return on Invested Capital as Adjusted (ROIC)