Annual Reports

  • 10-K (Feb 3, 2017)
  • 10-K (Feb 5, 2016)
  • 10-K (Feb 6, 2015)
  • 10-K (Feb 7, 2014)
  • 10-K (Feb 8, 2013)
  • 10-K (Feb 3, 2012)

 
Quarterly Reports

 
8-K

 
Other

Union Pacific 10-K 2013
Form 10-K
Table of Contents

 

 

 

 

 

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, 2012

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)

 

UTAH     13-2626465

(State or other jurisdiction of

incorporation or organization)

   

(I.R.S. Employer

Identification No.)

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:

 

Title of each Class

  

Name of each exchange on which registered

Common Stock (Par Value $2.50 per share)    New York Stock Exchange, Inc.

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

þ  Yes             ¨  No            

 

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

¨  Yes            þ  No            

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

þ  Yes             ¨  No            

 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

þ  Yes            ¨  No            

 

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer   þ        Accelerated filer  ¨        Non-accelerated filer  ¨        Smaller reporting company  ¨

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

¨  Yes             þ  No            

As of June 29, 2012, the aggregate market value of the registrant’s Common Stock held by non-affiliates (using the New York Stock Exchange closing price) was $56.2 billion.

The number of shares outstanding of the registrant’s Common Stock as of February 1, 2013 was 469,298,732.

 

 

 

 

 

 


Table of Contents

Documents Incorporated by Reference – Portions of the registrant’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held on May 16, 2013, 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

 

 

CEO’s Letter

     3   
 

Directors and Senior Management

     4   
PART I   

Item 1.

 

Business

     5   

Item 1A.

 

Risk Factors

     10   

Item 1B.

 

Unresolved Staff Comments

     13   

Item 2.

 

Properties

     13   

Item 3.

 

Legal Proceedings

     16   

Item 4.

 

Mine Safety Disclosures

     18   
 

Executive Officers of the Registrant and Principal Executive Officers of Subsidiaries

     18   
PART II   

Item 5.

 

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

     19   

Item 6.

 

Selected Financial Data

     21   

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     22   
 

Critical Accounting Policies

     42   
 

Cautionary Information

     47   

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

     48   

Item 8.

 

Financial Statements and Supplementary Data

     49   
 

Report of Independent Registered Public Accounting Firm

     50   

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     83   

Item 9A.

 

Controls and Procedures

     83   
 

Management’s Annual Report on Internal Control Over Financial Reporting

     84   
 

Report of Independent Registered Public Accounting Firm

     85   

Item 9B.

 

Other Information

     86   
PART III   

Item 10.

 

Directors, Executive Officers, and Corporate Governance

     86   

Item 11.

 

Executive Compensation

     86   

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     87   

Item 13.

 

Certain Relationships and Related Transactions and Director Independence

     87   

Item 14.

 

Principal Accountant Fees and Services

     87   
PART IV   

Item 15.

 

Exhibits, Financial Statement Schedules

     88   
 

Signatures

     89   
 

Certifications

     99   

 

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Table of Contents

February 8, 2013

Fellow Shareholders:

Last year was a historic milestone for Union Pacific, marking 150 years of building America. It was our most profitable year on record, leading the U.S. rail industry in overall financial performance. Our 2012 results are a testament to the strength and diversity of our franchise and the dedication and commitment of our employees. For the first time, we achieved a sub-70 operating ratio of 67.8 percent, contributing to record earnings per share of $8.27, and a best-ever return on invested capital of 14.0 percent. Shareholders were rewarded with increased financial returns, including a 29 percent increase in dividends declared per share compared to 2011 and $1.5 billion in share repurchases. UP’s stock price reached new highs in 2012, increasing 19 percent and outpaced the S&P 500 by 5 points.

Despite a challenging economic environment and a significantly weaker coal market, our diverse portfolio of business, including shale-related crude oil and frac sand moves, automotive shipments, chemicals, and domestic intermodal traffic, offset the 14 percent decline in coal volumes. Operationally, we successfully managed the shifts in business mix, improved network efficiency and fluidity, and operated a safer railroad.

We achieved these record results by following a very straightforward strategy – an unrelenting focus on creating value for our customers by providing safe, efficient, and reliable service. In turn, customers rewarded us with record satisfaction ratings, clearly valuing our service offerings and the efficiencies we provide as part of their total supply chain. In addition, with our Total Safety Culture and The UP Way infused throughout the Company, employee injuries hit a record low in 2012, capping more than a decade of significant improvement.

Our capital investments play a critical role in meeting the long-term demand for freight transportation in the U.S. In 2012, we invested a record $3.7 billion across our network, supported by our best-ever financial returns. Over half was spent on replacing and hardening our infrastructure to further enhance safety and reliability. The balance was invested to increase customer value, support business growth, and advance efforts on Positive Train Control (PTC) implementation, a federally mandated program. Through 2012, we have invested nearly $750 million dollars of our estimated $2 billion spend on PTC.

A significant portion of our growth capital investment in 2012 was targeted to the southern region of our network to meet growing demand for new business, particularly in the shale-related energy arena. The increasing development of oil production in various domestic shale formations is providing an emerging market opportunity for rail with shipments of inbound frac sand and pipe, and outbound crude oil. In 2012, the impact was substantial – our crude oil shipments grew more than three fold compared to 2011. Going forward, we anticipate continued opportunities for growth in this market driven by our proven ability to provide an efficient and flexible transportation solution for growing demand.

In an evolving marketplace, our franchise diversity remains an absolute core strength of Union Pacific. An increasing U.S. population base will stimulate long-term growth for many of the goods we carry. To meet this growing demand, we anticipate continued opportunities to convert freight from the highway, supported by our integrated network, competitive service offerings, and environmental advantages. We also play a vital role in the global supply chain, with international trade currently representing more than 30 percent of our revenue base. In particular, as the only railroad to serve all six major gateways to Mexico, we are in an excellent position to benefit from economic growth in that country.

The men and women of Union Pacific are proud of the Company’s 150-year history, but we’re squarely focused on the opportunities the future presents, as well as its challenges. The results achieved in 2012 demonstrate the power and potential of our franchise as we continue to run an even safer railroad, help our country grow, create value for our customers, and increase financial returns for our shareholders. Our future is bright as we see even greater prospects in the years to come.

 

LOGO

President & Chief Executive Officer

 

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Table of Contents

DIRECTORS AND SENIOR MANAGEMENT

 

BOARD OF DIRECTORS      

Andrew H. Card, Jr.

Acting Dean

The Bush School of

Government & Public Service,

Texas A&M University

Board Committees: Audit, Finance

 

Erroll B. Davis, Jr.

Superintendent

Atlanta Public Schools

Board Committees: Compensation

and Benefits (Chair), Corporate

Governance and Nominating

 

Thomas J. Donohue

President and

Chief Executive Officer

U.S. Chamber of Commerce

Board Committees: Compensation

and Benefits, Corporate Governance

and Nominating

 

Archie W. Dunham

Retired Chairman

ConocoPhillips

Board Committees: Corporate

Governance and Nominating,

Finance

  

Judith Richards Hope

Distinguished Visitor from Practice

and Professor of Law

Georgetown University Law Center

Board Committees: Audit (Chair),

Finance

 

John J. Koraleski

President and

Chief Executive Officer

Union Pacific Corporation and

Union Pacific Railroad Company

 

Charles C. Krulak

General, USMC, Ret.

President

Birmingham – Southern College

Board Committees: Audit, Finance

 

Michael R. McCarthy

Chairman

McCarthy Group, LLC

Board Committees: Audit, Finance

 

Michael W. McConnell

General Partner

Brown Brothers Harriman & Co.

Board Committees: Audit,

Finance (Chair)

  

Thomas F. McLarty III

President

McLarty Associates

Board Committees: Compensation

and Benefits, Corporate

Governance and Nominating

 

Steven R. Rogel

Retired Chairman

Weyerhaeuser Company

Lead Independent Director

Board Committees: Compensation

and Benefits, Corporate Governance and Nominating (Chair)

 

Jose H. Villarreal

Advisor

Akin, Gump, Strauss, Hauer & Feld, LLP

Board Committees: Compensation

and Benefits, Corporate

Governance and Nominating

 

James R. Young

Chairman

Union Pacific Corporation and

Union Pacific Railroad Company

 

SENIOR MANAGEMENT      

James R. Young

Chairman

Union Pacific Corporation and

Union Pacific Railroad Company

 

John J. Koraleski

President and

Chief Executive Officer

Union Pacific Corporation and

Union Pacific Railroad Company

 

Eric L. Butler

Executive Vice President-

Marketing and Sales

Union Pacific Railroad Company

 

Diane K. Duren

Executive Vice President

Union Pacific Corporation

 

Charles R. Eisele

Senior Vice President–Strategic

Planning

Union Pacific Corporation

 

Lance M. Fritz

Executive Vice President–

Operations

Union Pacific Railroad Company

  

Mary Sanders Jones

Vice President and Treasurer

Union Pacific Corporation

 

D. Lynn Kelley

Vice President–Continuous

Improvement

Union Pacific Railroad Company

 

Robert M. Knight, Jr.

Executive Vice President–Finance

and Chief Financial Officer

Union Pacific Corporation

 

Joseph E. O’Connor, Jr.

Vice President–Purchasing

Union Pacific Railroad Company

 

Patrick J. O’Malley

Vice President–Taxes and General
Tax Counsel

Union Pacific Corporation

 

Michael A. Rock

Vice President–External Relations

Union Pacific Corporation

  

Barbara W. Schaefer

Senior Vice President–Human Resources and Secretary

Union Pacific Corporation

 

Lynden L. Tennison

Senior Vice President and

Chief Information Officer

Union Pacific Corporation

 

Gayla L. Thal

Senior Vice President–Law

and General Counsel

Union Pacific Corporation

 

Jeffrey P. Totusek

Vice President and Controller

Union Pacific Corporation

 

Robert W. Turner

Senior Vice President–

Corporate Relations

Union Pacific Corporation

 

William R. Turner

Vice President–Labor Relations

Union Pacific Railroad Company

 

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Table of Contents

PART I

Item 1. Business

GENERAL

Union Pacific Railroad is the principal operating company of Union Pacific Corporation. One of America’s most recognized companies, Union Pacific Railroad 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, Automotive, Chemicals, Coal, Industrial Products and Intermodal. 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”, “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 directors and executive officers; and amendments to 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. 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).

 

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Table of Contents

Operations – UPRR is a Class I railroad operating in the U.S. We have 31,868 route miles, linking Pacific Coast and Gulf Coast ports with the Midwest and eastern U.S. gateways and providing several corridors to key Mexican gateways. We serve the western two-thirds of the country and maintain coordinated schedules with other rail carriers to move freight to and from the Atlantic Coast, the Pacific Coast, the Southeast, the Southwest, Canada, and Mexico. Export and import traffic moves through Gulf Coast and Pacific Coast ports and across the Mexican and Canadian borders. Our freight traffic consists of bulk, manifest, and premium business. Bulk traffic is primarily coal, grain, rock, or soda ash in unit trains – trains transporting a single commodity from one source to one destination. Manifest traffic is individual carload or less than train-load business and includes  commodities  such  as  lumber,  steel,  paper,

  

2012 Freight Revenue

 

LOGO

 

food and chemicals. The transportation of finished vehicles, intermodal containers and truck trailers is part of our premium business. In 2012, we generated freight revenues totaling $19.7 billion from the following six commodity groups:

Agricultural – Transportation of grains, commodities produced from these grains, and food and beverage products generated 17% of the Railroad’s 2012 freight revenue. The Company accesses most major grain markets, linking the Midwest and western 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. Unit trains, which transport a single commodity between producers and export terminals or domestic markets, represent approximately 35% of agricultural shipments.

Automotive – We are the largest automotive carrier west of the Mississippi River and operate or access over 40 vehicle distribution centers. The Railroad’s extensive franchise serves vehicle assembly plants and connects to West Coast ports and the Port of Houston to accommodate both import and export shipments. In addition to transporting finished vehicles, UP provides expedited handling of automotive parts in both boxcars and intermodal containers destined for Mexico, the U.S. and Canada. The automotive group generated 9% of Union Pacific’s freight revenue in 2012.

Chemicals – Transporting chemicals generated 16% of our freight revenue in 2012. The Railroad’s unique franchise serves the chemical producing areas along the Gulf Coast, where roughly two-thirds of the Company’s chemical business originates, terminates or travels. Our chemical franchise also accesses chemical producers in the Rocky Mountains and on the West Coast. The Company’s chemical shipments include three broad categories: Petrochemicals, Fertilizer and Soda Ash. Petrochemicals include industrial chemicals, plastics and petroleum products, including crude oil and liquid petroleum gases. The petroleum products primarily originate from the Bakken shale formation in North Dakota and the Permian and Eagle Ford shale formations in Texas, which we also deliver to the Gulf Coast area. Fertilizer movements originate in the Gulf Coast region, the western part of the U.S. and Canada for delivery to major agricultural users in the Midwest, western U.S. and abroad. Soda ash originates in southwestern Wyoming and California, destined for chemical and glass producing markets in North America and abroad.

Coal – Shipments of coal and petroleum coke accounted for 20% of our freight revenue in 2012. The Railroad’s network supports the transportation of coal and petroleum coke to utilities and industrial facilities throughout the U.S. Through interchange gateways and ports, UP’s reach extends to eastern U.S. utilities, Mexico, Europe and Asia. Water terminals allow the Railroad to move western U.S. coal east via the Mississippi and Ohio Rivers, as well as the Great Lakes. Export coal moves through West Coast ports to Asia and through Mississippi River and Gulf Coast terminals to Europe. Coal traffic originating in the Southern Powder River Basin (SPRB) area of Wyoming is the largest segment of UP’s coal business.

Industrial Products – Our extensive network facilitates the movement of numerous commodities between thousands of origin and destination points throughout North America. The Industrial Products commodity group consists of several categories, including construction products, metals, minerals, paper, consumer

 

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goods, lumber and other miscellaneous products. In 2012, this group generated 18% of Union Pacific’s total freight revenue. Commercial and highway construction drives shipments of steel and construction products, consisting of rock, cement and roofing materials. Oil and gas drilling generates demand for raw steel, finished pipe, frac sand and drilling fluid products. Industrial manufacturing plants receive nonferrous metals and industrial minerals. Paper and consumer goods, including furniture and appliances, move to major metropolitan areas for consumers. Lumber shipments originate primarily in the Pacific Northwest and Canada and move throughout the U.S. for use in new home construction and repair and remodeling.

Intermodal – Our Intermodal business includes two shipment categories: international and domestic. International business consists of imported and exported container traffic 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. Less-than-truckload and package carriers with time-sensitive business requirements are also an important part of these domestic shipments. Together, international and domestic business generated 20% of UP’s 2012 freight revenue.

Seasonality – Some of the commodities we carry have peak shipping seasons, reflecting either or both the nature of the commodity, such as certain agricultural and food products that have specific growing and harvesting seasons, and the demand cycle for the commodity, such as intermodal traffic, which generally has a peak shipping season during the third quarter to meet holiday-related demand for consumer goods during the fourth quarter. The peak shipping seasons for these commodities can vary considerably from year to 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. In response to an annual request delivered by the Surface Transportation Board (STB) of the U.S. Department of Transportation (DOT) to all of the Class I railroads operating in the U.S., we issue a publicly available letter during the third quarter detailing our plans for handling traffic during the third and fourth quarters and providing other information requested by the STB.

Working Capital – At December 31, 2012 and 2011, we had a working capital surplus. This reflects a strong cash position, which provides enhanced liquidity in an uncertain economic environment. In addition, we believe we have adequate access to capital markets to meet any foreseeable cash requirements, and we have sufficient financial capacity to satisfy our current liabilities.

Competition – We are subject to competition from other railroads, motor carriers, ship and barge operators, and pipelines. Our main rail competitor is Burlington Northern Santa Fe LLC. Its rail 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 five of our six commodity groups (excluding coal). 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 addition to price competition, we face competition with respect to transit times and quality and reliability of service. While 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 future improvements or expenditures materially increasing the quality or reducing the costs of these alternative modes of transportation, or legislation releasing motor carriers from their size or weight limitations, could have a material adverse effect on our business.

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 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 suppliers (one domestic and one international) that meet our specifications. Rail is critical for both maintenance of our network and replacement and improvement or 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.

Employees – Approximately 86% of our 45,928 full-time-equivalent employees are represented by 14 major rail unions. During the year, we concluded the most recent round of negotiations, which began in

 

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2010, with the ratification of new agreements by several unions that continued negotiating into 2012. All of the unions executed similar multi-year agreements that provide for higher employee cost sharing of employee health and welfare benefits and higher wages. The current agreements will remain in effect until renegotiated under provisions of the Railway Labor Act. The next round of negotiations will begin in early 2015.

Railroad Security – Our security efforts rely upon a wide variety of measures including employee training, cooperation 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 to 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 more than 200 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 have an emergency response management center, which operates 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, and 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 Material 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 the 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.

Cooperation with Federal, State, and Local Government Agencies – We work closely on physical and cyber security initiatives with government agencies that include the DOT and the Department of Homeland Security (DHS), as well as local police departments, fire departments, and other first responders. In conjunction with DOT, DHS, and other railroads, we sponsor Operation Respond, which provides first responders with secure links to electronic railroad resources, including mapping systems, shipment records, and other essential 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 – Along with other railroads, we work with the American Chemistry Council to train approximately 200,000 emergency responders annually. We work with many of our chemical shippers to establish plant security plans, and we continue to take steps to more closely monitor and track hazardous materials shipments. 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.

 

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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 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. In 2012, the STB continued its efforts to explore whether to expand rail regulation. The STB has requested parties to submit studies that describe and quantify the potential impact of expanded reciprocal switching or trackage rights arrangements on railroads. Although several bills involving railroad regulation expired during the last session of Congress, we continually monitor any legislative activity involving rail and transportation regulation.

The operations of the Railroad also are subject to the regulations of the FRA and other federal and state agencies. On January 12, 2010, the FRA issued initial rules governing installation of Positive Train Control (PTC) by the end of 2015. The final regulation is still forthcoming. Although still under development, PTC is a collision avoidance technology intended to override locomotive controls and stop a train before an accident. Following the issuance of the initial rules, the FRA acknowledged that projected costs will exceed projected benefits by a ratio of at least 22 to one, and we estimate that our costs will be higher than those assumed by the FRA. In August 2012, the FRA provided Congress with a status report regarding implementation of PTC. This report indicated that the rail industry will likely achieve only partial deployment of PTC by the current deadline due to significant technical and other issues. Through 2012, we have invested nearly $750 million in the development of PTC.

DOT, the Occupational Safety and Health 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. The Rail Safety Improvement Act of 2008, among other things, revised hours of service rules for train and certain other railroad employees, mandated implementation of PTC, imposed passenger service requirements, addressed safety at rail crossings, increased the number of safety related employees of the FRA, and increased fines that may be levied against railroads for safety violations. 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 17 to the Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data.

 

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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 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 increases or decreases of demand for rail service with respect to one or more of our commodity groups or operating regions, or other events that could have a negative impact on our operational efficiency, any of which could have a material adverse effect on our results of operations, financial condition, and liquidity. In the event that we experience significant reductions of demand for rail services with respect to one or more of our commodity groups, we may experience increased costs associated 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.

We May Be Affected by General Economic Conditions – Prolonged severe adverse domestic and global economic conditions or disruptions of financial and credit markets, including the availability of short- and long-term debt financing, 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 Are Required to Transport Hazardous Materials – Federal laws require railroads, including us, to transport certain hazardous materials regardless of risk or potential exposure to loss. Any rail accident or other incident or accident on our network, at our facilities, or at the facilities of our customers involving the release of hazardous materials, including toxic inhalation hazard (or TIH) materials such as chlorine, could involve significant costs and claims for personal injury, property damage, and environmental penalties and remediation, which could have a material adverse effect on our results of operations, financial condition, and liquidity.

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. While 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 future improvements or expenditures materially increasing the quality or reducing the cost of alternative modes of transportation, or legislation releasing motor carriers from their size or weight limitations, could have a material adverse 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 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, 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

 

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of the Rail Safety Improvement Act of 2008, rail carriers must currently implement PTC by the end of 2015, which could have a material adverse effect on our ability to make other capital investments. Rail carriers may not meet the mandatory deadline for PTC implementation. One or more consolidations of Class I railroads could also lead to increased regulation of the rail industry.

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.

Strikes or Work Stoppages Could Adversely Affect Our Operations as the Majority of Our Employees Belong to Labor Unions and Labor Agreements – The U.S. Class I railroads are party to collective bargaining agreements with various labor unions. 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.

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 that may cause business interruptions, including line outages on our rail network, that can adversely affect our entire rail network and result in increased costs, increased liabilities, and decreased revenue, which could have a material adverse effect 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 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, and 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 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

 

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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, 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 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.

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.

Rising or Elevated Fuel Costs and Whether We Are Able to Mitigate These Costs with Fuel Surcharges Could Materially and Adversely Affect Our Business – Fuel costs constitute a significant portion of our transportation expenses. Diesel fuel prices are 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 increased fuel expenses through revenue from fuel surcharges, we cannot be certain that we will always be able to mitigate rising or elevated fuel costs through surcharges. 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. International, political, and economic circumstances affect fuel prices and supplies. Weather can also affect fuel supplies and limit domestic refining capacity. If a fuel supply shortage were to arise, higher fuel prices could, despite our fuel surcharge programs, 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 deterioration of our financial condition could result in a reduction of our credit rating to below investment grade, which could prohibit or restrict us from utilizing our current receivables securitization facility or accessing external sources of short- and long-term debt financing and significantly increase the costs associated with utilizing the receivables securitization facility and issuing both commercial paper and long-term debt.

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, enactment of new tax laws, revisions of tax regulations, and claims or litigation with taxing authorities could result in substantially higher taxes and, therefore, 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, potential new suppliers face high barriers to entry. Therefore, if one of the domestic suppliers of high horsepower locomotives discontinues manufacturing locomotives for any reason, including bankruptcy or insolvency, we could experience significant cost

 

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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 suppliers (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.

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.

 

LOGO

 

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TRACK

Our rail network includes 31,868 route miles. We own 26,020 miles and operate on the remainder pursuant to trackage rights or leases. The following table describes track miles at December 31, 2012 and 2011.

 

      2012      2011  

Route

     31,868         31,898   

Other main line

     6,715         6,644   

Passing lines and turnouts

     3,124         3,112   

Switching and classification yard lines

     9,046         8,999   

 

Total miles

     50,753         50,653   
                   

HEADQUARTERS BUILDING

We maintain our headquarters in Omaha, Nebraska. The facility has 1.2 million square feet of space for approximately 4,000 employees and is subject to a financing arrangement.

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. Over 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 train-building (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 tables include the major yards and terminals on our system:

 

Top 10 Classification Yards

   2012     

Avg. Daily

Car Volume

2011

 

North Platte, Nebraska

     2,300         2,200   

North Little Rock, Arkansas

     1,600         1,600   

Englewood (Houston), Texas

     1,500         1,400   

Fort Worth, Texas

     1,400         1,300   

Proviso (Chicago), Illinois

     1,300         1,400   

Livonia, Louisiana

     1,300         1,300   

Pine Bluff, Arkansas

     1,200         1,200   

Roseville, California

     1,200         1,200   

West Colton, California

     1,100         1,100   

Neff (Kansas City), Missouri

     1,000         1,000   

 

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Top 10 Intermodal Terminals

   2012      Annual Lifts
2011
 

ICTF (Los Angeles), California

     448,000         432,000   

East Los Angeles, California

     427,000         428,000   

Global 4 (Joliet), Illinois

     347,000         298,000   

Dallas, Texas

     310,000         261,000   

Global I (Chicago), Illinois

     306,000         295,000   

Yard Center (Chicago), Illinois

     273,000         277,000   

Marion (Memphis), Tennessee

     271,000         283,000   

Global II (Chicago), Illinois

     253,000         273,000   

Mesquite, Texas

     236,000         232,000   

LATC (Los Angeles), California

     230,000         226,000   

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, 2012, we owned or leased the following units of equipment:

 

Locomotives

   Owned      Leased      Total     

Average

Age (yrs.)

 

Multiple purpose

     5,468         2,365         7,833         17.3   

Switching

     400         24         424         32.9   

Other

     77         57         134         32.8   

 

Total locomotives

     5,945         2,446         8,391         N/A   
                                     
           

Freight cars

   Owned      Leased      Total     

Average

Age (yrs.)

 

Covered hoppers

     13,008         17,946         30,954         19.6   

Open hoppers

     9,484         3,998         13,482         27.8   

Gondolas

     6,341         5,168         11,509         23.0   

Boxcars

     4,621         1,603         6,224         27.5   

Refrigerated cars

     2,438         4,263         6,701         25.1   

Flat cars

     2,742         684         3,426         30.6   

Other

     104         375         479         N/A   

 

Total freight cars

     38,738         34,037         72,775         N/A   
                                     
           

Highway revenue equipment

   Owned      Leased      Total     

Average

Age (yrs.)

 

Containers

     17,207         36,714         53,921         6.6   

Chassis

     9,245         27,748         36,993         7.6   

 

Total highway revenue equipment

     26,452         64,462         90,914         N/A   
                                     

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.

2012 Capital Expenditures – During 2012, we made capital investments totaling $3.7 billion. (See the capital expenditures table in Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Financial Condition, Item 7.)

 

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2013 Capital Expenditures – In 2013, we expect to make capital investments of approximately $3.6 billion, including expenditures for PTC of approximately $450 million. We may revise our 2013 capital plan if business conditions warrant or if new laws or regulations affect our ability to generate sufficient returns on these investments. (See discussion of our 2013 capital plan in Management’s Discussion and Analysis of Financial Condition and Results of Operations – 2013 Outlook, Item 7.)

OTHER

Equipment Encumbrances – Equipment with a carrying value of approximately $2.9 billion at both December 31, 2012 and 2011 served as collateral for capital leases and other types of equipment obligations in accordance with the secured financing arrangements utilized to acquire such railroad equipment.

As a result of the merger of Missouri Pacific Railroad Company (MPRR) with and into UPRR on January 1, 1997, and pursuant to the underlying indentures for the MPRR mortgage bonds, UPRR must maintain the same value of assets after the merger in order to comply with the security requirements of the mortgage bonds. As of the merger date, the value of the MPRR assets that secured the mortgage bonds was approximately $6.0 billion. In accordance with the terms of the indentures, this collateral value must be maintained during the entire term of the mortgage bonds irrespective of the outstanding balance of such bonds.

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, and Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies – Environmental, Item 7.)

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

On January 14, 2013, the Illinois Attorney General’s Office notified UPRR that it will seek a penalty against the Railroad for environmental conditions caused by its predecessor at a former locomotive fueling facility in South Pekin, Illinois. This former CNW facility discontinued fueling operations in the early 1980s. Subsequent environmental investigation revealed evidence of fuel releases to soil and groundwater. In January 2007, the State rejected UPRR’s proposed compliance commitment agreement and responded with a notice of intent to pursue legal action. UPRR continued to perform remedial investigations under the supervision of the Illinois EPA. In June 2012, the Illinois EPA approved UPRR’s proposed remedial action plan for the contaminated groundwater. Although no further action is required for the contamination, the State is now seeking to recover a penalty. The State has offered to settle the matter prior to litigation for payment of a $240,000 penalty. If we are unable to reach an agreement, the state will pursue legal action for a penalty, which we expect will exceed $100,000.

We received 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.

 

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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.

OTHER MATTERS

Antitrust Litigation – As we reported in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2007, 20 small 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. (one railroad was eventually dropped from the lawsuit). The original plaintiff filed the first of these claims in the U.S. District Court in New Jersey on May 14, 2007, and the additional plaintiffs filed claims in district courts in various states, including Florida, Illinois, Alabama, Pennsylvania, and the District of Columbia. These suits allege that the named railroads engaged in price-fixing by establishing common fuel surcharges for certain rail traffic.

We received additional complaints following the initial claim, increasing the total number of complaints to 30. In addition to suits filed by direct purchasers of rail transportation, a few of the suits involved plaintiffs alleging that they are or were indirect purchasers of rail transportation and seeking to represent a purported class of indirect purchasers of rail transportation that paid fuel surcharges. These complaints added allegations under state antitrust and consumer protection laws. On November 6, 2007, the Judicial Panel on Multidistrict Litigation ordered that all of the rail fuel surcharge cases be transferred to Judge Paul Friedman of the U.S. District Court in the District of Columbia for coordinated or consolidated pretrial proceedings. Subsequently, the direct purchaser plaintiffs and the indirect purchaser plaintiffs filed Consolidated Amended Class Action Complaints against UPRR and three other Class I railroads.

One additional shipper filed a separate antitrust suit during 2008. Subsequently, the shipper voluntarily dismissed the action without prejudice.

On October 10, 2008, Judge Friedman heard oral arguments with respect to the defendant railroads’ motions to dismiss. In a ruling on November 7, 2008, Judge Friedman denied the motion with respect to the direct purchasers’ complaint, and pretrial proceedings are underway in that case, the status of which is described below. On December 31, 2008, Judge Friedman dismissed the complaints of the indirect purchasers based upon state antitrust, consumer protection, and unjust enrichment laws. He also ruled, however, that these plaintiffs could proceed with their claim for injunctive relief under the federal antitrust laws, which is identical to a claim by the direct purchaser plaintiffs. The indirect purchasers appealed Judge Friedman’s ruling to the U.S. Court of Appeals for the District of Columbia. On April 16, 2010, the U.S. Court of Appeals for the District of Columbia affirmed Judge Friedman’s ruling dismissing the indirect purchasers’ claims based on various state laws.

With respect to the direct purchasers’ complaint, Judge Friedman conducted a two-day hearing on October 6 and 7, 2010, on the class certification issue and the railroad defendants’ motion to exclude evidence of interline communications. On April 7, 2011, Judge Friedman issued an order deferring any decision on class certification until the Supreme Court issued its decision in the Wal-Mart employment discrimination case.

On June 21, 2012, Judge Friedman issued his decision certifying a class of plaintiffs to be represented by the eight named plaintiffs. The class includes 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 1, 2008. This is a procedural ruling, which does not affirm any of the claims asserted by the plaintiffs and does not affect the ability of the railroad defendants to disprove the allegations made by the plaintiffs. 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 28, 2012, a panel of the Circuit Court of the District of Columbia referred the petition to a merits panel of the court to address the issues in the petition and to address whether the district court properly granted class certification.

We 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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Item 4. Mine Safety Disclosures

Not applicable.

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 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, 2013, relating to the executive officers.

 

Name

  

Position

  

Age

  

Business
Experience During
Past Five Years

James R. Young

  

Chairman of UPC and the Railroad

   60    [1]

John J. Koraleski

  

President and Chief Executive Officer of UPC and the Railroad

   62    [2]

Robert M. Knight, Jr.

  

Executive Vice President – Finance and Chief Financial Officer of UPC and the Railroad

   55    Current Position

Diane K. Duren

  

Executive Vice President of UPC and the Railroad

   53    [3]

Barbara W. Schaefer

  

Senior Vice President – Human Resources and Secretary of UPC and the Railroad

   59    [4]

Gayla L. Thal

  

Senior Vice President – Law and General Counsel of UPC and the Railroad

   56    [5]

Jeffrey P. Totusek

  

Vice President and Controller of UPC and Chief Accounting Officer and Controller of the Railroad

   54    Current Position

Lance M. Fritz

  

Executive Vice President – Operations of the Railroad

   50    [6]

Eric L. Butler

  

Executive Vice President – Marketing and Sales of the Railroad

   52    [7]

 

[1]

On March 2, 2012, Mr. Young stepped down from his duties as President and Chief Executive Officer of UPC and the Railroad due to a health condition. He remains Chairman of the Board.

 

[2]

Mr. Koraleski was elected Chief Executive Officer and President of UPC and the Railroad effective March 2, 2012. He previously was Executive Vice President – Marketing and Sales of the Railroad effective March 1, 1999.

 

[3]

Ms. Duren was elected to her current position effective October 1, 2012. She previously was Vice President and General Manager – Chemicals effective August 1, 2006. In addition, Ms. Duren was elected Corporate Secretary, which will become effective March 1, 2013, upon Ms. Schaefer’s retirement.

 

[4]

Ms. Schaefer is retiring from UPC and the Railroad effective March 1, 2013.

 

[5]

Ms. Thal was elected to her current position effective March 15, 2012. She previously was Vice President – Law and Chief Compliance Officer effective December 1, 2005.

 

[6]

Mr. Fritz was elected to his current position effective September 1, 2010. He previously was Vice President – Operations of the Railroad, effective January 1, 2010. Mr. Fritz previously served as Vice President – Labor Relations effective March 1, 2008.

 

[7]

Mr. Butler was elected to his current position effective March 15, 2012. He previously was Vice President and General Manager – Industrial Products effective April 14, 2005.

 

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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”. The following table presents the dividends declared and the high and low prices of our common stock for each of the indicated quarters.

 

2012 - Dollars Per Share

   Q1      Q2      Q3      Q4  

Dividends

   $ 0.60       $ 0.60       $ 0.60       $ 0.69   

Common stock price:

           

High

     117.40         119.82         129.27         128.38   

Low

     104.77         104.08         115.38         116.06   
           

2011 - Dollars Per Share

   Q1      Q2      Q3      Q4  

Dividends

   $ 0.38       $ 0.475       $ 0.475       $ 0.60   

Common stock price:

           

High

     99.50         105.60         107.89         106.60   

Low

     90.66         92.80         79.58         77.73   

At February 1, 2013, there were 469,298,732 shares of common stock outstanding and 32,519 common shareholders of record. On that date, the closing price of the common stock on the NYSE was $133.96. We have paid dividends to our common shareholders during each of the past 113 years. We declared dividends totaling $1,180 million in 2012 and $938 million in 2011. On November 15, 2012, we increased the quarterly dividend to $0.69 per share, payable beginning on January 2, 2013, to shareholders of record on November 30, 2012. We are subject to certain restrictions regarding retained earnings with respect to the payment of cash dividends to our shareholders. The amount of retained earnings available for dividends increased to $15.1 billion at December 31, 2012, from $13.8 billion at December 31, 2011. (See discussion of this restriction in Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources, Item 7.) We do not believe the restriction on retained earnings will affect our ability to pay dividends, and we currently expect to pay dividends in 2013.

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).

 

Period

   UNP      Peer
Group
     DJ
Trans
     S&P
500
 

1 Year (2012)

     21.2%         (8.6)%         7.5%         16.0%   

3 Year (2010-2012)

     108.6           28.7            36.3           36.3     

 

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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, 2007 and that all dividends were reinvested.

 

LOGO

Purchases of Equity Securities – During 2012, we repurchased 13,804,709 shares of our common stock at an average price of $115.33. The following table presents common stock repurchases during each month for the fourth quarter of 2012:

 

Period

   Total Number of
Shares
Purchased [a]
     Average
Price Paid
Per Share
    

Total Number of Shares

Purchased as Part of a

Publicly Announced Plan

or Program [b]

    

Maximum Number of

Shares That May Yet

Be Purchased Under the Plan

or Program [b]

 

Oct. 1 through Oct. 31

     1,068,414         121.70         1,028,300         16,041,399   

Nov. 1 through Nov. 30

     659,631         120.84         655,000         15,386,399   

Dec. 1 through Dec. 31

     411,683         124.58         350,450         15,035,949   

 

Total

     2,139,728       $ 121.99         2,033,750         N/A   
                                     

 

[a]

Total number of shares purchased during the quarter includes approximately 105,978 shares delivered or attested to UPC by employees to pay stock option exercise prices, satisfy excess tax withholding obligations for stock option exercises or vesting of retention units, and pay withholding obligations for vesting of retention shares.

 

[b]

On April 1, 2011, our Board of Directors authorized the repurchase of up to 40 million shares of our common stock by March 31, 2014. These repurchases may be made on the open market or through other transactions. Our management has sole discretion with respect to determining the timing and amount of these transactions.

 

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Table of Contents

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 not necessarily indicative of future financial condition or results of operations.

 

Millions, Except per Share Amounts,

Carloads, Employee Statistics, and Ratios

   2012      2011      2010      2009      2008  

For the Year Ended December 31

              

Operating revenues [a]

   $     20,926       $     19,557       $     16,965       $     14,143       $     17,970   

Operating income

     6,745         5,724         4,981         3,379         4,070   

Net income

     3,943         3,292         2,780         1,890         2,335   

Earnings per share - basic

     8.33         6.78         5.58         3.76         4.57   

Earnings per share - diluted

     8.27         6.72         5.53         3.74         4.53   

Dividends declared per share

     2.49         1.93         1.31         1.08         0.98   

Cash provided by operating activities

     6,161         5,873         4,105         3,204         4,044   

Cash used in investing activities

     (3,633)         (3,119)         (2,488)         (2,145)         (2,738)   

Cash used in financing activities

     (2,682)         (2,623)         (2,381)         (458)         (935)   

Cash used for common share repurchases

     (1,474)         (1,418)         (1,249)                 (1,609)   

At December 31

              

Total assets

   $ 47,153       $ 45,096       $ 43,088       $ 42,184       $ 39,509   

Long-term obligations

     24,157         23,201         22,373         22,701         21,314   

Debt due after one year

     8,801         8,697         9,003         9,636         8,607   

Common shareholders’ equity

     19,877         18,578         17,763         16,801         15,315   

Additional Data

              

Freight revenues [a]

   $ 19,686       $ 18,508       $ 16,069       $ 13,373       $ 17,118   

Revenue carloads (units) (000)

     9,048         9,072         8,815         7,786         9,261   

Operating ratio (%) [b]

     67.8         70.7         70.6         76.1         77.4   

Average employees (000)

     45.9         44.9         42.9         43.5         48.2   

Financial Ratios (%)

              

Debt to capital [c]

     31.2         32.4         34.2         37.0         36.8   

Return on average common
shareholders’ equity [d]

     20.5         18.1         16.1         11.8         15.2   

 

[a]

Includes fuel surcharge revenue of $2.6 billion, $2.2 billion, $1.2 billion, $0.6 billion, and $2.3 billion for 2012, 2011, 2010, 2009, and 2008, respectively, which partially offsets increased operating expenses for fuel. Fuel surcharge revenue is not comparable from year to year due to implementation of new mileage-based fuel surcharge programs in each respective year. (See further discussion in Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Operating Revenues, Item 7.)

 

[b]

Operating ratio is defined as operating expenses divided by operating revenues.

 

[c]

Debt to capital is determined as follows: total debt divided by total debt plus common shareholders’ equity.

 

[d]

Return on average common shareholders’ equity is determined as follows: Net income divided by average common shareholders’ equity.

 

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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

2012 Results

 

   

Safety – Our employee safety results continued to improve in 2012. The employee injury incident rate per 200,000 employee hours declined 9% from 2011, to a new record low. These results reflect employee training, the move to standard work, and extensive efforts to identify and eliminate risk. Our use of technologies such as laser, ultrasound, and acoustic vibration monitoring, which help identify potential rail, wheel and axle failures before they occur contributed to the reduction of our equipment incident rate to 9.38 per million train miles, another best ever result. With respect to public safety, we closed 237 grade crossings in 2012 to reduce our exposure to incidents and continued use of video cameras on our locomotives to analyze public safety incidents. We now have camera-equipped locomotives in the lead position on over 97% of our through-freight trains. Despite our efforts during 2012, the rate of grade crossing incidents per million train miles increased 13% from 2011. Overall, our 2012 safety results reflect our structured approach to reduce risk and eliminate incidents for our employees, our customers and the public.

 

   

Financial Performance – We produced another record-setting year in 2012, generating operating income of $6.7 billion, an 18% increase over 2011. Despite flat volume, core pricing gains of 4.5% and higher fuel surcharge recoveries more than offset inflation and higher depreciation expense to drive the increase. Our operating ratio for 2012 of 67.8% was an all-time best, improving from last year’s operating ratio of 70.7%. Net income of $3.9 billion surpassed our previous milestone set in 2011, translating into earnings of $8.27 per diluted share for 2012.

 

   

Freight Revenues – Our freight revenues grew 6% year-over-year to $19.7 billion. Freight revenues for four of the six commodity groups increased despite flat volume. Volume declines in Coal and Agricultural Products offset double digit volume increases in Automotive and Chemicals. Core pricing gains and higher fuel surcharges drove the growth in freight revenue in 2012 compared to 2011. Fuel surcharges increased due to higher fuel prices, the lag effect of our programs (surcharges trail fluctuations in fuel price by approximately two months) and new fuel surcharge provisions in renegotiated contracts.

 

   

Network Operations – In 2012, our business mix changed significantly both geographically and by commodity. Nevertheless, by adjusting resources to match market and network requirements, we continued operating an efficient and fluid network. As reported to the Association of American Railroads (AAR), average train speed increased 4% in 2012 compared to 2011, reflecting more efficient operations and relatively mild weather conditions compared to 2011, which included severe winter weather, flooding, and extreme heat and drought that affected various parts of our network during the year. Average terminal dwell time remained flat despite a shift in business mix to more manifest traffic, which requires more switching, resulting in more terminal dwell time. Average rail car inventory decreased slightly, reflecting productivity improvements and ongoing initiatives designed to reduce the number of cars in our fleet. These operational improvements resulted in a record customer satisfaction index in 2012.

 

   

Fuel Prices – Despite consistent average crude oil barrel prices in 2011 and 2012, our price per gallon of diesel fuel consumed increased 3% due to higher crude oil to diesel conversion spreads. The higher spreads increased operating expenses by $105 million (excluding any impact from year-over-year volume). A 2% decline in gross-ton miles partially offset the higher expenses. Our fuel consumption rate did not change in 2012 from the rate in 2011.

 

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Free Cash Flow – Cash generated by operating activities totaled $6.2 billion, reduced by $3.6 billion for cash used in investing activities and a 37% increase in dividends paid, yielding free cash flow of $1.4 billion. Free cash flow is defined as cash provided by operating activities (adjusted for the reclassification of our receivables securitization facility), less cash used in investing activities and dividends paid.

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

   2012      2011      2010  

Cash provided by operating activities

   $     6,161       $     5,873       $     4,105   

Receivables securitization facility [a]

                   400   

Cash provided by operating activities
adjusted for the receivables securitization facility

     6,161         5,873         4,505   

Cash used in investing activities

     (3,633)         (3,119)         (2,488)   

Dividends paid

     (1,146)         (837)         (602)   

 

Free cash flow

   $ 1,382       $ 1,917       $ 1,415   
                            

 

[a]

Effective January 1, 2010, a new accounting standard required us to account for receivables transferred under our receivables securitization facility as secured borrowings in our Consolidated Statements of Financial Position and as financing activities in our Consolidated Statements of Cash Flows. The receivables securitization facility is included in our free cash flow calculation to adjust cash provided by operating activities as though our receivables securitization facility had been accounted for under the new accounting standard for all periods presented.

2013 Outlook

 

   

Safety – Operating a safe railroad benefits our employees, our customers, our shareholders, and the communities we serve. We will continue using a multi-faceted approach to safety, utilizing technology, risk assessment, quality control, training and employee engagement, and targeted capital investments. We will continue using and expanding the deployment of Total Safety Culture throughout our operations, which allows us to identify and implement best practices for employee and operational safety. Derailment prevention and the reduction of grade crossing incidents are critical aspects of our safety programs. We will continue our efforts to increase rail defect detection; improve or close crossings; and educate the public and law enforcement agencies about crossing safety through a combination of our own programs (including risk assessment strategies), various industry programs and local community activities across our network.

 

   

Network Operations – We will continue focusing on our six critical initiatives to improve safety, service and productivity during 2013. We are seeing solid contributions from reducing variability, continuous improvements, and standard work. Resource agility allows us to respond quickly to changing market conditions and network disruptions from weather or other events. The Railroad continues to benefit from capital investments that allow us to build capacity for growth and harden our infrastructure to reduce failure.

 

   

Fuel Prices – Uncertainty about the economy makes projections of fuel prices difficult. We again could see volatile fuel prices during the year, as they are sensitive to global and U.S. domestic demand, refining capacity, geopolitical events, weather conditions and other factors. To reduce the impact of fuel price on earnings, we will continue seeking cost recovery from our customers through our fuel surcharge programs and expanding our fuel conservation efforts.

 

   

Capital Plan – In 2013, we plan to make total capital investments of approximately $3.6 billion, including expenditures for Positive Train Control (PTC), which 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 in this Item 7 under Liquidity and Capital Resources – Capital Plan.)

 

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Positive Train Control – In response to a legislative mandate to implement PTC, we expect to spend approximately $450 million during 2013 on developing and deploying PTC. We currently estimate that PTC, in accordance with implementing rules issued by the Federal Rail Administration (FRA), will cost us approximately $2 billion by the end of the project. This includes costs for installing the new system along our tracks, upgrading locomotives to work with the new system, and adding digital data communication equipment to integrate the components of the system.

 

   

Financial Expectations – We are cautious about the economic environment but if industrial production grows approximately 2% as projected, volume should exceed 2012 levels. Even with no volume growth, we expect earnings to exceed 2012 earnings, generated by real core pricing gains, on-going network improvements and operational productivity initiatives. We also expect that a new bonus depreciation program under federal tax laws will positively impact cash flows in 2013.

RESULTS OF OPERATIONS

Operating Revenues

 

Millions

   2012      2011      2010      % Change
2012 v 2011
     % Change
2011 v 2010
 

Freight revenues

   $     19,686       $     18,508       $   16,069         6%         15%   

Other revenues

     1,240         1,049         896         18           17     

 

Total

   $ 20,926       $ 19,557       $ 16,965         7%         15%   
                                              

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 our commuter rail operations, and 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. We recognize other revenues as we perform services or meet contractual obligations.

Freight revenues from four of our six commodity groups increased during 2012 compared to 2011. Revenues from coal and agricultural products declined during the year. Our franchise diversity allowed us to take advantage of growth from shale-related markets (crude oil, frac sand and pipe) and strong automotive manufacturing, which offset volume declines from coal and agricultural products. ARC increased 7%, driven by core pricing gains and higher fuel cost recoveries. Improved fuel recovery provisions and higher fuel prices, including the lag effect of our programs (surcharges trail fluctuations in fuel price by approximately two months), combined to increase revenues from fuel surcharges.

Freight revenues for all six commodity groups increased during 2011 compared to 2010, while volume increased in all commodity groups except intermodal. Increased demand in many market sectors, with particularly strong growth in chemicals, industrial products, and automotive shipments for the year, generated the increases. ARC increased 12%, driven by higher fuel cost recoveries and core pricing gains. Fuel cost recoveries include fuel surcharge revenue and the impact of resetting the base fuel price for certain traffic. Higher fuel prices, volume growth, and new fuel surcharge provisions in renegotiated contracts all combined to increase revenues from fuel surcharges.

Our fuel surcharge programs (excluding index-based contract escalators that contain some provision for fuel) generated freight revenues of $2.6 billion, $2.2 billion, and $1.2 billion in 2012, 2011, and 2010, respectively. Ongoing rising fuel prices and increased fuel surcharge coverage drove the increases. Additionally, fuel surcharge revenue is not entirely comparable to prior periods as we continue to convert portions of our non-regulated traffic to mileage-based fuel surcharge programs.

 

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In 2012, other revenues increased from 2011 due primarily to higher revenues at our subsidiaries that broker intermodal and automotive services. Assessorial revenues also increased in 2012 due to container revenue related to an increase in intermodal shipments.

In 2011, other revenues increased from 2010 due primarily to higher revenues at our subsidiaries that broker intermodal and automotive services.

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

 

Freight Revenues

Millions

   2012      2011      2010      % Change
2012 v 2011
     % Change
2011 v 2010
 

Agricultural

   $ 3,280       $ 3,324       $ 3,018         (1)%         10%   

Automotive

     1,807         1,510         1,271         20            19     

Chemicals

     3,238         2,815         2,425         15            16     

Coal

     3,912         4,084         3,489         (4)           17     

Industrial Products

     3,494         3,166         2,639         10            20     

Intermodal

     3,955         3,609         3,227         10            12     

 

Total

   $     19,686       $     18,508       $   16,069         6%          15%   
                                              
              

Revenue Carloads

Thousands

   2012      2011      2010      % Change
2012 v 2011
     % Change
2011 v 2010
 

Agricultural

     900         934         918         (4)%         2%   

Automotive

     738         653         611         13            7     

Chemicals

     1,042         921         844         13            9     

Coal

     1,871         2,164         2,056         (14)           5     

Industrial Products

     1,185         1,146         1,073         3            7     

Intermodal [a]

     3,312         3,254         3,313         2            (2)    

 

Total

     9,048         9,072         8,815         -%          3%   
                                              
              

Average Revenue per Car

   2012      2011      2010      % Change
2012 v 2011
     % Change
2011 v 2010
 

Agricultural

   $ 3,644       $ 3,561       $ 3,286         2%          8%   

Automotive

     2,448         2,311         2,082         6            11     

Chemicals

     3,107         3,055         2,874         2            6     

Coal

     2,092         1,888         1,697         11            11     

Industrial Products

     2,947         2,762         2,461         7            12     

Intermodal [a]

     1,194         1,109         974         8            14     

 

Average

   $ 2,176       $ 2,040       $ 1,823         7%          12%   
                                              

 

[a]

Each intermodal container or trailer equals one carload.

 

 

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Agricultural Products – Lower volume more than offset core pricing gains and increased fuel surcharges as agricultural freight revenue decreased in 2012 versus 2011. Weak export demand for U.S. wheat drove a 19% decrease in wheat shipments year over year, as the foreign wheat market improved significantly from the weather affected crop in 2011. In addition, corn shipments declined 11% for the year, with more significant declines in the fourth quarter, reflecting the impact of the severe drought across the U.S. Lower gasoline demand, reduced exports and higher corn prices decreased ethanol shipments during the second half of the year. Growth in imported beer from Mexico and a strong domestic harvest of fresh potatoes partially offset these declines.

  

2012 Agricultural Carloads

 

LOGO

Fuel surcharges, price improvements and modest volume growth increased agricultural freight revenue  in 2011 versus 2010. The federal mandate for higher levels of ethanol in the nation’s fuel supply and new business increased shipments of ethanol by 10% in 2011 versus 2010. Strong export demand for U.S. wheat via Gulf ports in the first half of 2011 was the primary driver of a 6% increase in wheat and food grains shipments for 2011 compared to 2010, despite a 19% decrease in shipments in the second half of 2011 when U.S. grain exports declined. Poor wheat production in some foreign markets drove the export demand during the first six months of the year.

 

Automotive – Increased shipments of finished vehicles and automotive parts along with core pricing gains and higher fuel surcharges improved automotive freight revenue from 2011 levels. Higher production and sales levels drove the volume growth. In addition, 2012 shipments compared favorably to 2011 due to lower shipments of international vehicles in 2011 following the disaster in Japan.

 

Higher volume, core pricing gains and fuel surcharges improved automotive freight revenue in 2011, from 2010 levels. Although higher production and sales levels during 2011 contributed to volume growth, the disaster in Japan partially offset the increase in shipments. The disruption caused by this event reduced parts shipments in the second quarter and shipments of international vehicles in the second and third quarters.  Finished  autos  shipments  were up 7% in 2011 from 2010, aided by a 14% increase in the fourth quarter as the U.S. light-vehicle sales rate was the highest since the second quarter of 2008.

  

2012 Automotive Carloads

 

LOGO

 

Chemicals – Higher volume, core price improvements and fuel surcharges increased freight revenue from chemicals in 2012. Shipments of crude oil primarily from the Bakken, Permian and Eagle Ford Shale formations to the Gulf area increased over three fold, driving the improvement in chemicals shipments. In addition, plastics and industrial chemicals shipments increased as low natural gas prices have made U.S. chemicals more cost competitive globally. Declines in potash due to temporary shutdowns and reduced production at several mines partially offset the increases in chemical shipments during the year.

  

2012 Chemicals Carloads

 

LOGO

 

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Volume gains, fuel surcharges and price improvements increased freight revenue from chemicals in 2011 versus 2010. In mid-2010, we began moving crude oil shipments from the Bakken formation in North Dakota to facilities in Louisiana. This new business, along with shipments from the Eagle Ford shale formation in south Texas, contributed to a 37% increase in shipments of petroleum products during 2011. Strong domestic demand and robust spring planting increased fertilizer shipments by 9% versus 2010. Additionally, improving market conditions increased demand for industrial chemicals during 2011, driving volume levels up versus 2010.

 

Coal – Lower volume, partially offset by core pricing gains and fuel surcharge recoveries reduced freight revenue from coal shipments in 2012 compared to 2011. Shipments of coal from the Southern Powder River Basin (SPRB) mines decreased 15% from 2011. Above average coal stockpiles due to an unseasonably warm winter and low natural gas prices, which caused some displacement of coal in electricity production, led to the volume declines. In addition, the loss of two contracts to a competitor contributed to lower volumes from the SPRB. Coal shipments from the Colorado and Utah mines increased 2% versus 2011. Increased export shipments of Colorado and Utah coal in 2012 offset the domestic declines due to higher stockpiles and low natural gas prices.

  

2012 Coal Carloads

 

LOGO

Core pricing gains, higher fuel surcharges, and increased volume grew coal freight revenue in 2011 versus 2010 levels. Shipments of coal from the SPRB were up 5% in 2011 compared to 2010, reflecting new business to Wisconsin facilities and the start-up of a new power plant near Waco, Texas. Completion of a year-long equipment relocation process at one of the mines in the third quarter of 2011 and minimal production problems elsewhere improved shipments from Colorado and Utah by 3% in 2011 versus 2010. These gains, along with increased exports to Europe and Asia, offset first half production problems and weak demand from eastern coal utilities.

 

Industrial Products – Core pricing improvement, higher volume and additional fuel surcharges increased freight revenue from industrial products in 2012 versus 2011. Shipments of non-metallic minerals (primarily frac sand), grew in response to increased horizontal drilling activity for energy products. More construction activity during a relatively mild winter led to higher demand for shipments of lumber, cement and stone compared to 2011. The growth in housing starts throughout 2012 also increased lumber shipments, up 12% from 2011. Steel shipments finished slightly down from 2011 levels as lower demand for export scrap and mine production issues in the second half of the year offset increases in the first half due to higher demand for steel coils and plate for pipe and auto production.

  

2012 Industrial Products Carloads

 

LOGO

Increased volume, fuel surcharges, and core pricing improvement increased freight revenue from industrial products  in  2011 versus  2010.  Shipments  of  non-metallic minerals (primarily frac sand) grew in response to a dramatic rise in horizontal drilling activity for natural gas and oil, while steel shipments increased due to higher demand for steel coils and plate for automotive and pipe production. In addition, an increase in iron ore export business to China also drove volume growth. Conversely, lower commercial construction activity reduced stone, sand and gravel shipments in 2011 compared to 2010.

 

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Intermodal – Higher fuel surcharges, including improved fuel recovery provisions, core pricing gains and volume growth increased freight revenue from intermodal shipments in 2012. Volume levels from international traffic remained flat year-over-year as the loss of a customer contract in the first half of the year offset modest West Coast import growth. Domestic traffic increased 3% versus 2011 due to better market conditions and continued conversion of traffic from truck to rail.

 

Fuel surcharge gains, including better contract provisions for fuel cost recovery, and pricing improvements, partially offset by lower volume, increased freight revenue from intermodal shipments in 2011 compared to 2010. Volume from international   traffic  decreased  5%  in  2011  versus  2010,

  

2012 Intermodal Carloads

 

LOGO

driven by softer economic conditions, reflected in a muted international peak shipping season, which usually starts in the third quarter, and the loss of a customer contract. Conversely, conversions from truck to rail and recovering consumer demand offset competition for domestic shipments, resulting in a 2% volume increase in domestic shipments during 2011.

Mexico Business – Each of our commodity groups includes revenue from shipments to and from Mexico. Revenue from Mexico business increased 8% to $1.9 billion in 2012 versus 2011. Volume levels for four of the six commodity groups (industrial products and agricultural products declined), were up 5% in aggregate versus 2011, with particularly strong growth in automotive and intermodal shipments.

Revenue from Mexico business increased 16% to $1.8 billion in 2011 versus 2010. Volume levels increased 9% in aggregate versus 2010, with particularly strong growth in automotive and industrial products. Coal was the one commodity group that declined as one of our customers conducted a supplier contract renewal during the year, shifting transportation modes from rail to truck during the process.

 

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Operating Expenses

 

Millions

   2012      2011      2010      % Change
2012 v 2011
     % Change
2011 v 2010
 

Compensation and benefits

   $ 4,685       $ 4,681       $ 4,314         -%         9%   

Fuel

     3,608         3,581         2,486         1           44     

Purchased services and materials

     2,143         2,005         1,836         7           9     

Depreciation

     1,760         1,617         1,487         9           9     

Equipment and other rents

     1,197         1,167         1,142         3           2     

Other

     788         782         719         1           9     

 

Total

   $     14,181       $     13,833       $   11,984         3%         15%   
                                              

 

Operating expenses increased $348 million in 2012 versus 2011. Depreciation, wage and benefit inflation, higher fuel prices and volume-related trucking services purchased by our logistics subsidiaries, contributed to higher expenses during the year. Efficiency gains, volume related fuel savings (2% fewer gallons of fuel consumed) and $38 million of weather related expenses in 2011, which favorably affects the comparison, partially offset the cost increase.

 

Operating expenses increased $1.8 billion in 2011 versus 2010. Our fuel price per gallon rose 36% during 2011, accounting for $922 million of the increase. Wage and benefit inflation, volume-related costs, depreciation, and property taxes also contributed to higher expenses. Expenses increased $20 million for costs related to the flooding in the Midwest and $18 million due to the impact of severe heat and

  

2012 Operating Expenses

 

LOGO

drought in the South, primarily Texas. Cost savings from productivity improvements and better resource utilization partially offset these increases. A $45 million one-time payment relating to a transaction with CSX Intermodal, Inc (CSXI) increased operating expenses during the first quarter of 2010, which favorably affects the comparison of operating expenses in 2011 to those in 2010.

Compensation and Benefits – Compensation and benefits include wages, payroll taxes, health and welfare costs, pension costs, other postretirement benefits, and incentive costs. Expenses in 2012 were essentially flat versus 2011 as operational improvements and cost reductions offset general wage and benefit inflation and higher pension and other postretirement benefits. In addition, weather related costs increased these expenses in 2011.

A combination of general wage and benefit inflation, volume-related expenses, higher training costs associated with new hires, additional crew costs due to speed restrictions caused by the Midwest flooding and heat and drought in the South, and higher pension expense drove the increase during 2011 compared to 2010.

Fuel – Fuel includes locomotive fuel and gasoline for highway and non-highway vehicles and heavy equipment. Higher locomotive diesel fuel prices, which averaged $3.22 per gallon (including taxes and transportation costs) in 2012, compared to $3.12 in 2011, increased expenses by $105 million. Volume, as measured by gross ton-miles, decreased 2% in 2012 versus 2011, driving expense down. The fuel consumption rate was flat year-over-year.

Higher locomotive diesel fuel prices, which averaged $3.12 (including taxes and transportation costs) in 2011, compared to $2.29 per gallon in 2010, increased expenses by $922 million. In addition, higher gasoline prices for highway and non-highway vehicles also increased year-over-year. Volume, as measured by gross ton-miles, increased 5% in 2011 versus 2010, driving expense up by $122 million.

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

 

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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. Expenses for contract services increased $103 million in 2012 versus 2011, primarily due to increased demand for transportation services purchased by our logistics subsidiaries for their customers and additional costs for repair and maintenance of locomotives and freight cars.

Expenses for contract services increased $106 million in 2011 versus 2010, driven by volume-related external transportation services incurred by our subsidiaries, and various other types of contractual services, including flood-related repairs, mitigation and improvements. Volume-related crew transportation and lodging costs, as well as expenses associated with jointly owned operating facilities, also increased costs compared to 2010. In addition, an increase in locomotive maintenance materials used to prepare a portion of our locomotive fleet for return to active service due to increased volume and additional capacity for weather related issues and warranty expirations increased expenses in 2011.

Depreciation – The majority of depreciation relates to road property, including rail, ties, ballast, and other track material. A higher depreciable asset base, reflecting ongoing capital spending, increased depreciation expense in 2012 compared to 2011.

A higher depreciable asset base, reflecting ongoing capital spending, increased depreciation expense in 2011 compared to 2010. Higher depreciation rates for rail and other track material also contributed to the increase. The higher rates, which became effective January 1, 2011, resulted primarily from increased track usage (based on higher gross ton-miles in 2010).

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. Increased automotive and intermodal shipments, partially offset by improved car-cycle times, drove an increase in our short-term freight car rental expense in 2012. Conversely, lower locomotive lease expense partially offset the higher freight car rental expense.

Costs increased in 2011 versus 2010 as higher short-term freight car rental expense and container lease expense offset lower freight car and locomotive lease expense.

Other – Other expenses include personal injury, freight and property damage, destruction of equipment, insurance, environmental, bad debt, state and local taxes, utilities, telephone and cellular, employee travel, computer software, and other general expenses. Other costs in 2012 were slightly higher than 2011 primarily due to higher property taxes. Despite continual improvement in our safety experience and lower estimated annual costs, personal injury expense increased in 2012 compared to 2011, as the liability reduction resulting from historical claim experience was less than the reduction in 2011.

Higher property taxes, casualty costs associated with destroyed equipment, damaged freight and property and environmental costs increased other costs in 2011 compared to 2010. A one-time payment of $45 million in the first quarter of 2010 related to a transaction with CSXI and continued improvement in our safety performance and lower estimated liability for personal injury, which reduced our personal injury expense year-over-year, partially offset increases in other costs.

Non-Operating Items

 

Millions

   2012      2011      2010      % Change
2012 v 2011
     % Change
2011 v 2010
 

Other income

   $ 108       $ 112       $ 54         (4)%         107%   

Interest expense

     (535)         (572)         (602)         (6)            (5)     

Income taxes

         (2,375)             (1,972)             (1,653)         20%          19%   
                                              

Other Income – Other income decreased in 2012 versus 2011 due to lower gains from real estate sales and higher environmental costs associated with non-operating properties, partially offset by an interest payment from a tax refund.

 

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Other income increased in 2011 versus 2010 due to higher gains from real estate sales, lower environmental costs associated with non-operating properties and the comparative impact of premiums paid for early redemption of long-term debt in the first quarter of 2010.

Interest Expense – Interest expense decreased in 2012 versus 2011 reflecting a lower effective interest rate in 2012 of 6.0% versus 6.2% in 2011 as the debt level did not materially change in 2012.

Interest expense decreased in 2011 versus 2010 due to a lower weighted-average debt level of $9.2 billion versus $9.7 billion. The effective interest rate was 6.2% in both 2011 and 2010.

Income Taxes – Higher pre-tax income increased income taxes in 2012 compared to 2011. Our effective tax rate for 2012 was relatively flat at 37.6% compared to 37.5% in 2011.

Income taxes were higher in 2011 compared to 2010, primarily driven by higher pre-tax income. Our effective tax rate remained relatively flat at 37.5% in 2011 compared to 37.3% in 2010.

OTHER OPERATING/PERFORMANCE AND FINANCIAL STATISTICS

We report key performance measures weekly to the Association of American Railroads (AAR), including carloads, average daily inventory of freight cars on our system, average train speed, and average terminal dwell time. We provide this data on our website at www.up.com/investors/reports/index.shtml.

Operating/Performance Statistics

Railroad performance measures reported to the AAR, as well as other performance measures, are included in the table below:

 

      2012      2011      2010      % Change
2012 v 2011
     % Change
2011 v 2010
 

Average train speed (miles per hour)

     26.5         25.6         26.2         4 %           (2)%     

Average terminal dwell time (hours)

     26.2         26.2         25.4         - %           3 %     

Average rail car inventory (thousands)

     269.1         272.9         274.4         (1)%           (1)%     

Gross ton-miles (billions)

     959.3         978.2         931.4         (2)%           5 %     

Revenue ton-miles (billions)

     521.1         544.4         520.4         (4)%           5 %     

Operating ratio

     67.8         70.7         70.6         (2.9)pts         0.1 pts   

Employees (average)

     45,928         44,861         42,884         2 %           5 %     

Customer satisfaction index

     93         92         89         1 pt           3 pts   
                                              

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), increased 4% in 2012 versus 2011. Efficient operations and relatively mild weather conditions during the year compared favorably to 2011, during which severe winter weather, flooding, and extreme heat and drought affected various parts of our network. We continued operating a fluid and efficient network while handling essentially the same volume and adjusting operations to accommodate increased capital project work on our network compared to 2011. The extreme weather challenges in addition to increased carloadings and traffic mix changes, led to a 2% decrease in average train speed in 2011 compared to 2010.

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 remained flat in 2012 compared to 2011, despite a shift in traffic mix to more manifest shipments, which require more switching at terminals. Average terminal dwell time increased 3% in 2011 compared to 2010. Additional volume, weather challenges, track replacement programs, and a shift of traffic mix to more manifest shipments, which require additional terminal processing, all contributed to the increase.

Average Rail Car Inventory – Average rail car inventory is the daily average number of rail cars on our lines, including rail cars in storage. Lower average rail car inventory reduces congestion in our yards and sidings, which increases train speed, reduces average terminal dwell time, and improves rail car utilization. Despite a shift in traffic mix from coal to shale-related and automotive shipments with longer

 

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cycle times, productivity improvements reduced average rail car inventory by 1% in 2012 compared to 2011. Average rail car inventory decreased slightly in 2011 compared to 2010, as we continued to adjust the size of our freight car fleet.

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 declined 2% in 2012 compared to 2011, while revenue ton-miles decreased 4% and carloads remained relatively flat. Changes in commodity mix drove the year-over-year variances between gross ton-miles, revenue ton-miles and carloads. Gross and revenue-ton-miles increased 5% in 2011 compared to 2010, driven by a 3% increase in carloads and mix changes to heavier commodity groups, notably a 5% increase in coal shipments.

Operating Ratio – Operating ratio is our operating expenses reflected as a percentage of operating revenue. Our operating ratio improved 2.9 points to a record low of 67.8% in 2012 versus 2011. Core pricing gains, improved fuel recovery provisions, efficient operations and cost reductions more than offset the impact of inflationary pressures. Our operating ratio increased 0.1 points to 70.7% in 2011 versus 2010. Higher fuel prices, inflation and weather related costs, partially offset by core pricing gains and productivity initiatives, drove the increase.

Employees – Employee levels increased 2% in 2012 versus 2011. Work related to the increase in capital investment, including positive train control, accounted for over half of the increase. Additionally, the shift in our traffic mix required more resources in the Southern region to support the growth in shale-related shipments. Employee levels were up 5% in 2011 versus 2010, driven by a 3% increase in volume levels, a higher number of trainmen, engineers, and yard employees receiving training during the year, and increased work on capital projects.

Customer Satisfaction Index – Our customer satisfaction survey asks customers to rate how satisfied they are with our performance over the last 12 months on a variety of attributes. A higher score indicates higher customer satisfaction. We believe that improvement in survey results in 2012 generally reflects customer recognition of our service quality supported by our capital investment program.

Return on Average Common Shareholders’ Equity

 

Millions, Except Percentages

   2012      2011      2010  

Net income

   $ 3,943       $ 3,292       $ 2,780   

Average equity

   $     19,228       $     18,171       $     17,282   

 

Return on average common shareholders’ equity

     20.5%          18.1%          16.1%    
                            

Return on Invested Capital as Adjusted (ROIC)

 

Millions, Except Percentages

   2012      2011      2010  

Net income

   $ 3,943       $ 3,292       $ 2,780   

Add: Interest expense

     535         572         602   

Add: Interest on present value of operating leases

     190         208         222   

Less: Taxes on interest

     (273)         (293)         (307)   

 

Net operating profit after taxes as adjusted (a)

   $ 4,395       $ 3,779       $ 3,297   
                            

Average equity

   $ 19,228       $ 18,171       $ 17,282   

Add: Average debt

     8,952         9,074         9,545   

Add: Average value of sold receivables

                   200   

Add: Average present value of operating leases

     3,160         3,350         3,574   

 

Average invested capital as adjusted (b)

   $     31,340       $     30,595       $     30,601   
                            

 

Return on invested capital as adjusted (a/b)

     14.0%          12.4%          10.8%    
                            

ROIC is considered a non-GAAP financial measure 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 this measure is important in evaluating the efficiency and effectiveness of our long-term capital investments. In addition, we currently use ROIC as a performance criteria in determining certain elements of equity compensation for our executives. ROIC should be considered in addition to, rather than as a substitute

 

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for, other information provided in accordance with GAAP. The most comparable GAAP measure is Return on Average Common Shareholders’ Equity. The tables on the previous page provide reconciliations from return on average common shareholders’ equity to ROIC. Our 2012 ROIC improved 1.6 points compared to 2011, primarily as a result of higher earnings.

Debt to Capital / Adjusted Debt to Capital

 

Millions, Except Percentages

   2012      2011  

Debt (a)

   $ 8,997       $ 8,906   

Equity

     19,877         18,578   

Capital (b)

   $ 28,874       $ 27,484   

 

Debt to capital (a/b)

     31.2%          32.4%    
                   
     

Millions, Except Percentages

   2012      2011  

Debt

   $ 8,997       $ 8,906   

Net present value of operating leases

     3,096         3,224   

Unfunded pension and OPEB

     679         623   

Adjusted debt (a)

   $ 12,772       $ 12,753   

Equity

     19,877         18,578   

Adjusted capital (b)

   $     32,649       $     31,331   

 

Adjusted debt to capital (a/b)

     39.1%          40.7%    
                   

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 6.0% and 6.2% at December 31, 2012 and 2011, respectively. 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 our 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. Our December 31, 2012 debt to capital ratios decreased as a result of a $1.3 billion increase in equity from December 31, 2011, driven by higher earnings.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2012, our principal sources of liquidity included cash, cash equivalents, our receivables securitization facility, and our revolving credit facility, as well as the availability of commercial paper and other sources of financing through the capital markets. We had $1.8 billion of committed credit available under our credit facility, with no borrowings outstanding as of December 31, 2012. We did not make any borrowings under this facility during 2012. The value of the outstanding undivided interest held by investors under the $600 million capacity receivables securitization facility was $100 million as of December 31, 2012, and is included in our Consolidated Statements of Financial Position as debt due after one year. The receivables securitization facility obligates us to maintain an investment grade bond rating. If our bond rating were to deteriorate, it could have an adverse impact on our liquidity. Access to commercial paper as well as other capital market financings is dependent on market conditions. Deterioration of our operating results or financial condition due to internal or external factors could negatively impact our ability to access capital markets as a source of liquidity. Access to liquidity through the capital markets is also dependent on our financial stability. We expect that we will continue to have access to liquidity through any or all of the following sources or activities: (i) increasing the utilization of our receivables securitization, (ii) issuing commercial paper, (iii) entering into bank loans, outside of our revolving credit facility, or (iv) issuing bonds or other debt securities to public or private investors based on our assessment of the current condition of the credit markets. The Company’s $1.8 billion revolving credit facility is intended to back Union Pacific’s ability to issue commercial paper and is an emergency back-up source of liquidity. The Company has no current intentions of borrowing under this facility.

 

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At December 31, 2012 and 2011, we had a working capital surplus. This reflects a strong cash position, which provides enhanced liquidity in an uncertain economic environment. In addition, we believe we have adequate access to capital markets to meet any foreseeable cash requirements, and we have sufficient financial capacity to satisfy our current liabilities.

 

Cash Flows

Millions

   2012      2011      2010  

Cash provided by operating activities

   $ 6,161       $ 5,873       $ 4,105   

Cash used in investing activities

         (3,633)             (3,119)             (2,488)   

Cash used in financing activities

     (2,682)         (2,623)         (2,381)   

 

Net change in cash and cash equivalents

   $ (154)       $ 131       $ (764)   
                            

Operating Activities

Higher net income in 2012 increased cash provided by operating activities compared to 2011, partially offset by lower tax benefits from bonus depreciation (as explained below) and payments for past wages based on national labor negotiations settled earlier this year.

Higher net income and lower cash income tax payments in 2011 increased cash provided by operating activities compared to 2010. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 provided for 100% bonus depreciation for qualified investments made during 2011, and 50% bonus depreciation for qualified investments made during 2012. As a result of the Act, the Company deferred a substantial portion of its 2011 income tax expense. This deferral decreased 2011 income tax payments, thereby contributing to the positive operating cash flow. In future years, however, additional cash will be used to pay income taxes that were previously deferred. In addition, the adoption of a new accounting standard in January of 2010 changed the accounting treatment for our receivables securitization facility from a sale of undivided interests (recorded as an operating activity) to a secured borrowing (recorded as a financing activity), which decreased cash provided by operating activities by $400 million in 2010.

Investing Activities

Higher capital investments in 2012 drove the increase in cash used in investing activities compared to 2011. Included in capital investments in 2012 was $75 million for the early buyout of 165 locomotives under long-term operating and capital leases during the first quarter of 2012, which we exercised due to favorable economic terms and market conditions.

Higher capital investments partially offset by higher proceeds from asset sales in 2011 drove the increase in cash used in investing activities compared to 2010.

 

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The tables below detail cash capital investments and track statistics for the years ended December 31, 2012, 2011, and 2010:

 

Millions

   2012      2011      2010  

Rail and other track material

   $ 759       $ 697       $ 626   

Ties

     434         403         444   

Ballast

     203         220         190   

Other [a]

     312         382         365   

 

Total road infrastructure replacements

     1,708         1,702         1,625   
                            

Line expansion and other capacity projects

     489         311         122   

Commercial facilities

     169         111         227   

 

Total capacity and commercial facilities

     658         422         349   
                            

Locomotives and freight cars

     875         675         330   

Positive train control

     349         229         84   

Technology and other

     148         148         94   

 

Total cash capital investments

   $     3,738       $     3,176       $     2,482   
                            

 

[a]    Other includes bridges and tunnels, signals, other road assets, and road work equipment.

 

       

  
      2012      2011      2010  

Track miles of rail replaced

     1,051         895         795   

Track miles of rail capacity expansion

     139         69         46   

New ties installed (thousands)

     4,436         3,785         4,334   

Miles of track surfaced

     11,049           11,284             10,883   

Capital Plan – In 2013, we expect our total capital investments to be approximately $3.6 billion, which may be revised if business conditions warrant or if new laws or regulations affect our ability to generate sufficient returns on these investments. We expect to use over 60% of our 2013 capital investments to replace and improve existing capital assets. Among our major investment categories are replacing and improving track infrastructure; upgrading our locomotive and freight car fleet, including acquisition of 100 locomotives and 900 freight cars, primarily large covered hoppers, gondolas, auto racks and refrigerated box cars; improving technology, including investing in PTC; and other capital projects. Additionally, we will continue increasing our network and terminal capacity; for example, to balance terminal capacity with more mainline capacity from our track expansion in the Southern region, we are constructing a rail facility at Santa Teresa, New Mexico, that initially will include a run-through and fueling facility and an intermodal ramp.

We expect to fund our 2013 cash capital investments by using some or all of the following: cash generated from operations, proceeds from the sale or lease of various operating and non-operating properties, proceeds from the issuance of long-term debt, and cash on hand. Our annual capital plan is a critical component of our long-term strategic plan, which we expect will enhance the long-term value of the Corporation for our shareholders by providing sufficient resources to (i) replace and improve our existing track infrastructure to provide safe and fluid operations, (ii) increase network efficiency by adding or improving facilities and track, and (iii) make investments that meet customer demand and take advantage of opportunities for long-term growth.

Financing Activities

Cash used in financing activities increased in 2012 versus 2011. Dividend payments increased by $309 million, reflecting our higher dividend rate, and common stock repurchases increased by $56 million. Our debt levels did not materially change from last year after a decline in debt levels from 2010. Therefore, less cash was used in 2012 for debt activity than in 2011.

Cash used in financing activities increased in 2011 versus 2010. Higher dividend payments in 2011 of $837 million compared to $602 million in 2010, reflecting our increased dividend rate and the repurchase of $1.4 billion of our common stock, a $169 million increase from 2010 repurchases, drove the increase. We used less cash to reduce outstanding debt in 2011, which partially offset this increase.

 

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Credit Facilities – On December 31, 2012, we had $1.8 billion of credit available under our revolving credit facility (the facility), which is designated for general corporate purposes and supports the issuance of commercial paper. We did not draw on the facility during 2012. 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 our senior unsecured debt ratings. The facility matures in 2015 under a four year term and requires the Corporation to maintain a debt-to-net-worth coverage ratio as a condition to making a borrowing. At December 31, 2012, and December 31, 2011 (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 December 31, 2012, the debt-to-net-worth coverage ratio allowed us to carry up to $39.8 billion of debt (as defined in the facility), and we had $9.6 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 $75 million cross-default provision and a change-of-control provision.

During 2012, we issued and repaid commercial paper of $50 million. At December 31, 2012 and 2011, 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.

At December 31, 2012 and 2011, we reclassified as long-term debt $100 million of debt due within one year that we intend to refinance. This reclassification reflected our ability and intent to refinance any short-term borrowings and certain current maturities of long-term debt on a long-term basis.

Ratio of Earnings to Fixed Charges

For each of the years ended December 31, 2012, 2011, and 2010, our ratio of earnings to fixed charges was 10.4, 8.4, and 6.9, respectively. The ratio of earnings to fixed charges was computed on a consolidated basis. Earnings represent income from continuing operations, less equity earnings net of distributions, plus fixed charges and income taxes. Fixed charges represent interest charges, amortization of debt discount, and the estimated amount representing the interest portion of rental charges. (See Exhibit 12 to this report for the calculation of the ratio of earnings to fixed charges.)

Common Shareholders’ Equity

Dividend Restrictions – Our revolving credit facility includes a debt-to-net worth covenant (discussed in the Credit Facilities section above) that, under certain circumstances, restricts the payment of cash dividends to our shareholders. The amount of retained earnings available for dividends was $15.1 billion and $13.8 billion at December 31, 2012 and 2011, respectively.

 

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Share Repurchase Program

Effective April 1, 2011, our Board of Directors authorized the repurchase of 40 million shares of our common stock by March 31, 2014, replacing our previous repurchase program. As of December 31, 2012, we repurchased a total of $7.1 billion of our common stock since the commencement of our repurchase programs. The table below represents shares repurchased under the new repurchase program, except for the first quarter of 2011 which represent shares repurchased under the previous program.

 

      Number of Shares Purchased            Average Price Paid  
      2012      2011            2012      2011  

First quarter

     3,917,369          2,636,178           $ 110.64        $ 94.10    

Second quarter

     3,770,528         3,576,399             110.02         100.75   

Third quarter

     3,098,812         4,681,535             122.13         91.45   

Fourth quarter

     2,033,750         3,885,658               121.81         98.16   

Total

     12,820,459         14,779,770           $     115.01       $ 95.94    
                                          

 

Remaining number of shares that may be repurchased under current authority

        15,035,949   
                                          

Management’s assessments of market conditions and other pertinent facts 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.

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.

During 2012, we issued the following unsecured, fixed-rate debt securities under our current shelf registration:

 

Date

   Description of Securities

June 11, 2012

  

$300 million of 2.95% Notes due January 15, 2023

$300 million of 4.30% Notes due June 15, 2042

We used the net proceeds from the 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 December 31, 2012, we had remaining authority to issue up to $1.4 billion of debt securities under our shelf registration.

On May 22, 2012, we borrowed $100 million under a 4-year-term loan (the loan). The loan has a floating rate based on London Interbank Offered Rates, plus a spread, and is prepayable in whole or in part without a premium prior to maturity. The agreement documenting the loan has provisions similar to our revolving credit facility, including identical debt-to-net-worth covenant and change of control provisions and similar customary default provisions. The agreement does not include any other financial restrictions, credit rating triggers, or any other provision that would require us to post collateral.

During the third and fourth quarters of 2012, we acquired 343 locomotives by exercising early buy-out rights in certain operating and capital lease agreements. Following the acquisition of the locomotives, we sold them to financing parties and entered into capital lease financing agreements with these parties. We did not recognize any gains or losses as a result of these transactions. Capital lease obligations totaling $286 million are reported in our Consolidated Statements of Financial Position as debt at December 31, 2012.

 

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Debt Exchange – On June 23, 2011, we exchanged $857 million of various outstanding notes and debentures due between 2013 and 2019 (Existing Notes) for $750 million of 4.163% notes (New Notes) due July 15, 2022, plus cash consideration of approximately $267 million and $17 million for accrued and unpaid interest on the Existing Notes. In accordance with the Accounting Standards Codification (ASC) 470-50-40, Debt-Modifications and Extinguishments-Derecognition, this transaction was accounted for as a debt exchange, as the exchanged debt instruments are not considered to be substantially different. The cash consideration was recorded as an adjustment to the carrying value of debt, and the balance of the unamortized discount and issue costs from the Existing Notes is being amortized as an adjustment of interest expense over the term of the New Notes. No gain or loss was recognized as a result of the exchange. Costs related to the debt exchange that were payable to parties other than the debt holders totaled approximately $6 million and were included in interest expense during the three months ended June 30, 2011.

The following table lists the outstanding notes and debentures that were exchanged:

 

Millions

  

Principal amount

exchanged

 

7.875% Notes due 2019

   $ 196   

5.450% Notes due 2013

     50   

5.125% Notes due 2014

     45   

5.375% Notes due 2014

     55   

5.700% Notes due 2018

     277   

5.750% Notes due 2017

     178   

7.000% Debentures due 2016

     38   

5.650% Notes due 2017

     18   

 

Total

   $ 857   
          

Debt Redemptions – On November 30, 2012, we redeemed all $450 million of our outstanding 5.45% notes due January 31, 2013. The redemption resulted in an early extinguishment charge of $4 million.

On April 28, 2012, we redeemed all $100 million of our outstanding 5.70% Tooele County, Utah Hazardous Waste Treatment Revenue Bonds due November 1, 2026. The redemption resulted in an early extinguishment charge of $2 million in the second quarter of 2012.

On December 19, 2011, we redeemed the remaining $175 million of our 6.5% notes due April 15, 2012, and all $300 million of our outstanding 6.125% notes due January 15, 2012. The redemptions resulted in an early extinguishment charge of $5 million.

On March 22, 2010, we redeemed $175 million of our 6.5% notes due April 15, 2012. The redemption resulted in an early extinguishment charge of $16 million in the first quarter of 2010.

On November 1, 2010, we redeemed all $400 million of our outstanding 6.65% notes due January 15, 2011. The redemption resulted in a $5 million early extinguishment charge.

Receivables Securitization Facility – Under the receivables securitization facility, the Railroad sells most of its accounts receivable to Union Pacific Receivables, Inc. (UPRI), a wholly-owned, bankruptcy-remote subsidiary. UPRI may subsequently transfer, without recourse on a 364-day revolving basis, an undivided interest in eligible accounts receivable to investors. The total capacity to transfer undivided interests to investors under the facility was $600 million at December 31, 2012 and 2011, respectively. The value of the outstanding undivided interest held by investors under the facility was $100 million at both December 31, 2012 and 2011. The value of the undivided interest held by investors was supported by $1.1 billion of accounts receivable at both December 31, 2012 and 2011. At both December 31, 2012 and 2011, the value of the interest retained by UPRI was $1.1 billion. This retained interest is included in accounts receivable, net in our Consolidated Statements of Financial Position.

The value of the outstanding undivided interest held by investors could fluctuate based upon the availability of eligible receivables and is directly affected by changing business volumes and credit risks, including default and dilution. If default or dilution ratios increase one percent, the value of the outstanding undivided interest held by investors would not change as of December 31, 2012. Should our

 

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credit rating fall below investment grade, the value of the outstanding undivided interest held by investors would be reduced, and, in certain cases, the investors would have the right to discontinue the facility.

The Railroad collected approximately $20.1 billion and $18.8 billion of receivables during the years ended December 31, 2012 and 2011, respectively. UPRI used certain of these proceeds to purchase new receivables under the facility.

The costs of the receivables securitization facility include interest, which will vary based on prevailing commercial paper rates, program fees paid to banks, commercial paper issuing costs, and fees for unused commitment availability. The costs of the receivables securitization facility are included in interest expense and were $3 million, $4 million and $6 million for 2012, 2011 and 2010, respectively.

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.

In July 2012, the receivables securitization facility was renewed for an additional 364-day period at comparable terms and conditions.

Subsequent Event – On January 2, 2013, we transferred an additional $300 million in undivided interest to investors under the receivables securitization facility, increasing the value of the outstanding undivided interest held by investors from $100 million to $400 million.

Contractual Obligations and Commercial Commitments

As described in the notes to the Consolidated Financial Statements and as referenced in the tables below, we have contractual obligations and commercial commitments that may affect our financial condition. 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, other than the risks that we and other similarly situated companies face with respect to the condition of the capital markets (as described in Item 1A of Part II of this report), 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.

The following tables identify material obligations and commitments as of December 31, 2012:

 

              Payments Due by December 31,  

Contractual Obligations

Millions

   Total      2013      2014      2015      2016      2017     

After

2017

     Other  

Debt [a]

   $ 12,637       $ 507       $ 904       $ 632       $ 769       $ 900       $ 8,925       $  

Operating leases [b]

     4,241         525         466         410         375         339         2,126          

Capital lease obligations [c]

     2,441         282         265         253         232         243         1,166          

Purchase obligations [d]

     5,877         3,004         1,238         372         334         213         684         32   

Other post retirement benefits [e]

     452         43         44         45         45         46         229          

Income tax contingencies [f]

     115                                                   115   

 

Total contractual obligations

   $   25,763       $   4,361       $   2,917       $   1,712       $   1,755       $   1,741       $   13,130       $   147   
                                                                         

 

[a]

Excludes capital lease obligations of $1,848 million and unamortized discount of $(365) million. Includes an interest component of $5,123 million.

 

[b]

Includes leases for locomotives, freight cars, other equipment, and real estate.

 

[c]

Represents total obligations, including interest component of $593 million.

 

[d]

Purchase obligations include locomotive maintenance contracts; purchase commitments for fuel purchases, locomotives, ties, ballast, and rail; 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 post retirement, medical, and life insurance payments, 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 December 31, 2012. For amounts where the year of settlement is uncertain, they are reflected in the Other column.

 

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              Amount of Commitment Expiration per Period  

Other Commercial Commitments

Millions

   Total      2013      2014      2015      2016      2017      After
2017
 

Credit facilities [a]

   $ 1,800       $      $      $ 1,800       $      $      $  

Receivables securitization facility [b]

     600         600                                      

Guarantees [c]

     307                214         12         30         10         33   

Standby letters of credit [d]

     25         24                                      

 

Total commercial commitments

   $     2,732       $     632       $     215       $     1,812       $     30       $     10       $     33   
                                                                

 

[a]

None of the credit facility was used as of December 31, 2012.

 

[b]

$100 million of the receivables securitization facility was utilized at December 31, 2012, which is accounted for as debt. The full program matures in July 2013.

 

[c]

Includes guaranteed obligations related to our headquarters building, equipment financings, and affiliated operations.

 

[d]

None of the letters of credit were drawn upon as of December 31, 2012.

Off-Balance Sheet Arrangements

Guarantees – At December 31, 2012, we were contingently liable for $307 million in guarantees. We have recorded a liability of $2 million for the fair value of these obligations as of December 31, 2012 and 2011. We entered into these contingent guarantees in the normal course of business, and they include guaranteed obligations related to our headquarters building, equipment financings, and affiliated operations. The final guarantee expires in 2022. We are not aware of any existing event of default that would require us to satisfy these guarantees. We do not expect that these guarantees will have a material adverse effect on our consolidated financial condition, results of operations, or liquidity.

OTHER MATTERS

Labor Agreements – Approximately 86% of our 45,928 full-time-equivalent employees are represented by 14 major rail unions. During the year, we concluded the most recent round of negotiations, which began in 2010, with the ratification of new agreements by several unions that continued negotiating into 2012. All of the unions executed similar multi-year agreements that provide for higher employee cost sharing of employee health and welfare benefits and higher wages. The current agreements will remain in effect until renegotiated under provisions of the Railway Labor Act. The next round of negotiations will begin in early 2015.

Inflation – Long periods of inflation significantly increase asset replacement costs for capital-intensive companies. As a result, assuming that we replace all operating assets at current price levels, depreciation charges (on an inflation-adjusted basis) would be substantially greater than historically reported amounts.

Derivative Financial Instruments – We may use derivative financial instruments in limited instances to assist in managing our overall exposure to fluctuations in interest rates and fuel prices. We are not a party to leveraged derivatives and, by policy, do not use derivative financial instruments for speculative purposes. Derivative financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness between the hedging instrument and the item being hedged, both at inception and throughout the hedged period. We formally document the nature and relationships between the hedging instruments and hedged items at inception, as well as our risk-management objectives, strategies for undertaking the various hedge transactions, and method of assessing hedge effectiveness. Changes in the fair market value of derivative financial instruments that do not qualify for hedge accounting are charged to earnings. We may use swaps, collars, futures, and/or forward contracts to mitigate the risk of adverse movements in interest rates and fuel prices; however, the use of these derivative financial instruments may limit future benefits from favorable price movements.

Market and Credit Risk – We address market risk related to derivative financial instruments by selecting instruments with value fluctuations that highly correlate with the underlying hedged item. We manage credit risk related to derivative financial instruments, which is minimal, by requiring high credit standards for counterparties and periodic settlements. At December 31, 2012 and 2011, we were not required to provide collateral, nor had we received collateral, relating to our hedging activities.

 

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Determination of Fair Value – We determine the fair values of our derivative financial instrument positions based upon current fair values as quoted by recognized dealers or the present value of expected future cash flows.

Sensitivity Analyses – The sensitivity analyses that follow illustrate the economic effect that hypothetical changes in interest rates could have on our results of operations and financial condition. These hypothetical changes do not consider other factors that could impact actual results.

At December 31, 2012, we had variable-rate debt representing approximately 3.4% of our total debt. If variable interest rates average one percentage point higher in 2013 than our December 31, 2012 variable rate, which was approximately 1.1%, our interest expense would increase by approximately $3 million. This amount was determined by considering the impact of the hypothetical interest rate on the balances of our variable-rate debt at December 31, 2012.

Market risk for fixed-rate debt is estimated as the potential increase in fair value resulting from a hypothetical one percentage point decrease in interest rates as of December 31, 2012, and amounts to an increase of approximately $1 billion to the fair value of our debt at December 31, 2012. We estimated the fair values of our fixed-rate debt by considering the impact of the hypothetical interest rates on quoted market prices and current borrowing rates.

Interest Rate Fair Value Hedges – We manage our overall exposure to fluctuations in interest rates by adjusting the proportion of fixed and floating rate debt instruments within our debt portfolio over a given period. We generally manage the mix of fixed and floating rate debt through the issuance of targeted amounts of each as debt matures or as we require incremental borrowings. We employ derivatives, primarily swaps, as one of the tools to obtain the targeted mix. In addition, we also obtain flexibility in managing interest costs and the interest rate mix within our debt portfolio by evaluating the issuance of and managing outstanding callable fixed-rate debt securities.

Swaps allow us to convert debt from fixed rates to variable rates and thereby hedge the risk of changes in the debt’s fair value attributable to the changes in interest rates. We account for swaps as fair value hedges using the short-cut method as allowed by the Derivatives and Hedging Topic of the Financial Accounting Standards Board (FASB) ASC; therefore, we do not record any ineffectiveness within our Consolidated Financial Statements. As of December 31, 2012 and 2011, we had no interest rate fair value hedges outstanding.

Interest Rate Cash Flow Hedges – We report changes in the fair value of cash flow hedges in accumulated other comprehensive loss until the hedged item affects earnings. At December 31, 2012 and 2011, we had reductions of $1 million and $2 million, respectively, recorded as an accumulated other comprehensive loss that is being amortized on a straight-line basis through September 30, 2014. As of December 31, 2012 and 2011, we had no interest rate cash flow hedges outstanding.

Accounting Pronouncements – On January 1, 2012, we adopted 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (ASU 2011-05) which requires presentation of the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements and eliminates the option to present components of other comprehensive income as part of the statement of changes in shareholders’ equity. The standard does not change the items that must be reported in other comprehensive income, how such items are measured or when they must be reclassified to net income. Also, in December of 2011, the FASB issued Accounting Standards Update No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassification of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 (ASU 2011-12). On February 5, 2013, the FASB issued Accounting Standards Update 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which adds additional disclosure requirements for items reclassified out of accumulated other comprehensive income. This ASU will be effective for the first interim reporting period in 2013.

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

 

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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 arrangements. We do not have any reason to believe that we will be required to make any material payments under these indemnity provisions.

Climate Change – Although climate change could have an adverse impact on our operations and financial performance in the future (see Risk Factors under Item 1A of this report), we are currently unable to predict the manner or severity of such impact. However, we continue to take steps and explore opportunities to reduce the impact of our operations on the environment, including investments in new technologies, using training programs to reduce fuel consumption, and changing our operations to increase fuel efficiency.

CRITICAL ACCOUNTING POLICIES

Our Consolidated Financial Statements have been prepared in accordance with GAAP. 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 we believe are 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. The following critical accounting policies are a subset of our significant accounting policies described in Note 2 to the Financial Statements and Supplementary Data, Item 8. These critical accounting policies affect significant areas of our financial statements and involve judgment and estimates. If these estimates differ significantly from actual results, the impact on our Consolidated Financial Statements may be material.

Personal Injury – The cost of personal injuries to employees and others related to our activities is charged to expense based on estimates of the ultimate cost and number of incidents each year. We use an actuarial analysis to measure the expense and liability, including unasserted claims. The Federal Employers’ Liability Act (FELA) governs compensation for work-related accidents. Under FELA, damages are assessed based on a finding of fault through litigation or out-of-court settlements. We offer a comprehensive variety of services and rehabilitation programs for employees who are injured at work.

Our personal injury liability is not discounted to present value. Approximately 90% of the recorded liability is related to asserted claims, and approximately 10% is related to unasserted claims at December 31, 2012. Because of the uncertainty surrounding the ultimate outcome of personal injury claims, it is reasonably possible that future costs to settle these claims may range from approximately $334 million to $368 million. We record an accrual at the low end of the range as no amount of loss within the range is more probable than any other. Estimates can vary over time due to evolving trends in litigation.

Our personal injury liability activity was as follows:

 

Millions

   2012      2011      2010  

Beginning balance

   $ 368       $ 426       $ 545   

Current year accruals

     121         118         155   

Changes in estimates for prior years

     (58)         (71)         (101)   

Payments

     (97)         (105)         (173)   

 

Ending balance at December 31

   $     334       $     368       $     426   

 

Current portion, ending balance at December 31

   $ 95       $ 103       $ 140   
                            

 

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Our personal injury claims activity was as follows:

 

      2012      2011      2010  

Open claims, beginning balance

     2,869         3,151         3,500   

New claims

     2,719         2,781         2,843   

Settled or dismissed claims

     (2,796)         (3,063)         (3,192)   

 

Open claims, ending balance at December 31

     2,792         2,869         3,151   
                            

Asbestos – We are a defendant in a number of lawsuits in which current and former employees and other parties allege exposure to asbestos. We assess our potential liability using a statistical analysis of resolution costs for asbestos-related claims. This liability is updated annually and excludes future defense and processing costs. The liability for resolving both asserted and unasserted claims was based on the following assumptions:

 

   

The ratio of future claims by alleged disease would be consistent with historical averages adjusted for inflation.

   

The number of claims filed against us will decline each year.

   

The average settlement values for asserted and unasserted claims will be equivalent to historical averages.

   

The percentage of claims dismissed in the future will be equivalent to historical averages.

Our liability for asbestos-related claims is not discounted to present value due to the uncertainty surrounding the timing of future payments. Approximately 22% of the recorded liability related to asserted claims and approximately 78% related to unasserted claims at December 31, 2012. Because of the uncertainty surrounding the ultimate outcome of asbestos-related claims, it is reasonably possible that future costs to settle these claims may range from approximately $139 million to $149 million. We record an accrual at the low end of the range as no amount of loss within the range is more probable than any other.

Our asbestos-related liability activity was as follows:

 

Millions

   2012      2011      2010  

Beginning balance

   $     147       $     162       $     174   

Credits

     (2)         (5)         (1)   

Payments

     (6)         (10)         (11)   

 

Ending balance at December 31

   $ 139       $ 147       $ 162   

 

Current portion, ending balance at December 31

   $      $      $ 12   
                            

 

Our asbestos-related claims activity was as follows:

 

  

      2012      2011      2010  

Open claims, beginning balance

     1,291         1,437         1,670   

New claims

     233         235         216   

Settled or dismissed claims

     (266)         (381)         (449)   

 

Open claims, ending balance at December 31

     1,258         1,291         1,437   
                            

In conjunction with the liability update performed in 2012, we also reassessed estimated insurance recoveries. We have recognized an asset for estimated insurance recoveries at December 31, 2012 and 2011. The amounts recorded for asbestos-related liabilities and related insurance recoveries were based on currently known facts. However, future events, such as the number of new claims filed each year, average settlement costs, and insurance coverage issues, could cause the actual costs and insurance recoveries to be higher or lower than the projected amounts. Estimates also may vary in the future if strategies, activities, and outcomes of asbestos litigation materially change; federal and state laws governing asbestos litigation increase or decrease the probability or amount of compensation of claimants; and there are material changes with respect to payments made to claimants by other defendants.

 

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Environmental Costs – We are subject to federal, state, and local environmental laws and regulations. We have identified 284 sites at which we are or may be liable for remediation costs associated with alleged contamination or for violations of environmental requirements. This includes 32 sites that are the subject of actions taken by the U.S. government, 17 of which are currently on the Superfund National Priorities List. Certain federal legislation imposes joint and several liability for the remediation of identified sites; consequently, our ultimate environmental liability may include costs relating to activities of other parties, in addition to costs relating to our own activities at each site.

When we identify an environmental issue with respect to property owned, leased, or otherwise used in our business, we perform, with assistance of our consultants, environmental assessments on the property. We expense the cost of the assessments as incurred. We accrue the cost of remediation where our obligation is probable and such costs can be reasonably estimated. We do not discount our environmental liabilities when the timing of the anticipated cash payments is not fixed or readily determinable. At December 31, 2012, none of our environmental liability was discounted, while less than 1% of our environmental liability was discounted at 2.0% at December 31, 2011.

Our environmental liability activity was as follows:

 

Millions

   2012      2011 [a]      2010  

Beginning balance

   $     172       $     213       $     217   

Accruals

     48         29         57   

Payments

     (50)         (70)         (61)   

 

Ending balance at December 31

   $ 170       $ 172       $ 213   
                            

 

Current portion, ending balance at December 31

   $ 50       $ 50       $ 74   
                            

 

[a]    Payments include $25 million to resolve the Omaha Lead Site liability.

 

Our environmental site activity was as follows:

 

       

  

  
      2012      2011      2010  

Open sites, beginning balance

     285         294         307   

New sites

     56         51         44   

Closed sites

     (57)         (60)         (57)   

 

Open sites, ending balance at December 31

     284         285         294   
                            

The environmental liability includes future costs for remediation and restoration of sites, as well as ongoing monitoring costs, but excludes any anticipated recoveries from third parties. Cost estimates are based on information available for each site, financial viability of other potentially responsible parties, and existing technology, laws, and regulations. The ultimate liability for remediation is difficult to determine because of the number of potentially responsible parties, site-specific cost sharing arrangements with other potentially responsible parties, 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. Estimates of liability may vary over time due to changes in federal, state, and local laws governing environmental remediation. Current obligations are not expected to have a material adverse effect on our consolidated results of operations, financial condition, or liquidity.

Property and Depreciation – Our railroad operations are highly capital intensive, and our large base of homogeneous, network-type assets turns over on a continuous basis. Each year we develop a capital program for the replacement of assets and for the acquisition or construction of assets that enable us to enhance our operations or provide new service offerings to customers. Assets purchased or constructed throughout the year are capitalized if they meet applicable minimum units of property criteria. Properties and equipment are carried at cost and are depreciated on a straight-line basis over their estimated service lives, which are measured in years, except for rail in high-density traffic corridors (i.e., all rail lines except for those subject to abandonment, yard and switching tracks, and electronic yards) for which lives are measured in millions of gross tons per mile of track. We use the group method of depreciation in which all items with similar characteristics, use, and expected lives are grouped together in asset classes, and are depreciated using composite depreciation rates. The group method of depreciation treats each asset class as a pool of resources, not as singular items. We currently have more than 60 depreciable

 

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asset classes, and we may increase or decrease the number of asset classes due to changes in technology, asset strategies, or other factors.

We determine the estimated service lives of depreciable railroad property by means of depreciation studies. We perform depreciation studies at least every three years for equipment and every six years for track assets (i.e., rail and other track material, ties, and ballast) and other road property. Our depreciation studies take into account the following factors:

 

   

Statistical analysis of historical patterns of use and retirements of each of our asset classes;

   

Evaluation of any expected changes in current operations and the outlook for continued use of the assets;

   

Evaluation of technological advances and changes to maintenance practices; and

   

Expected salvage to be received upon retirement.

For rail in high-density traffic corridors, we measure estimated service lives in millions of gross tons per mile of track. It has been our experience that the lives of rail in high-density traffic corridors are closely correlated to usage (i.e., the amount of weight carried over the rail). The service lives also vary based on rail weight, rail condition (e.g., new or secondhand), and rail type (e.g., straight or curve). Our depreciation studies for rail in high density traffic corridors consider each of these factors in determining the estimated service lives. For rail in high-density traffic corridors, we calculate depreciation rates annually by dividing the number of gross ton-miles carried over the rail (i.e., the weight of loaded and empty freight cars, locomotives and maintenance of way equipment transported over the rail) by the estimated service lives of the rail measured in millions of gross tons per mile. Rail in high-density traffic corridors accounts for approximately 70 percent of the historical cost of rail and other track material. Based on the number of gross ton-miles carried over our rail in high density traffic corridors during 2012, the estimated service lives of the majority of this rail ranged from approximately 15 years to approximately 30 years. For all other depreciable assets, we compute depreciation based on the estimated service lives of our assets as determined from the analysis of our depreciation studies. Changes in the estimated service lives of our assets and their related depreciation rates are implemented prospectively.

Estimated service lives of depreciable railroad property may vary over time due to changes in physical use, technology, asset strategies, and other factors that will have an impact on the retirement profiles of our assets. We are not aware of any specific factors that are reasonably likely to significantly change the estimated service lives of our assets. Actual use and retirement of our assets may vary from our current estimates, which would impact the amount of depreciation expense recognized in future periods.

Changes in estimated useful lives of our assets due to the results of our depreciation studies could significantly impact future periods’ depreciation expense and have a material impact on our Consolidated Financial Statements. If the estimated useful lives of all depreciable assets were increased by one year, annual depreciation expense would decrease by approximately $58 million. If the estimated useful lives of all depreciable assets were decreased by one year, annual depreciation expense would increase by approximately $62 million. Our recent depreciation studies have resulted in changes in depreciation rates for some asset classes. Based on these changes, depreciation expense will increase approximately 3% to 4% in 2013 versus 2012.

Under group depreciation, the historical cost (net of salvage) of depreciable property that is retired or replaced in the ordinary course of business is charged to accumulated depreciation and no gain or loss is recognized. The historical cost of certain track assets is estimated using (i) inflation indices published by the Bureau of Labor Statistics and (ii) the estimated useful lives of the assets as determined by our depreciation studies. The indices were selected because they closely correlate with the major costs of the properties comprising the applicable track asset classes. Because of the number of estimates inherent in the depreciation and retirement processes and because it is impossible to precisely estimate each of these variables until a group of property is completely retired, we continually monitor the estimated service lives of our assets and the accumulated depreciation associated with each asset class to ensure our depreciation rates are appropriate. In addition, we determine if the recorded amount of accumulated depreciation is deficient (or in excess) of the amount indicated by our depreciation studies. Any deficiency (or excess) is amortized as a component of depreciation expense over the remaining service lives of the applicable classes of assets.

For retirements of depreciable railroad properties that do not occur in the normal course of business, a gain or loss may be recognized if the retirement meets each of the following three conditions: (i) is

 

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unusual, (ii) is material in amount, and (iii) varies significantly from the retirement profile identified through our depreciation studies. During the last three fiscal years, no gains or losses were recognized due to the retirement of depreciable railroad properties. A gain or loss is recognized in other income when we sell land or dispose of assets that are not part of our railroad operations.

Income Taxes – We account for income taxes by recording taxes payable or refundable for the current year and deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. These expected future tax consequences are measured based on current tax law; the effects of future tax legislation are not anticipated. Future tax legislation, such as a change in the corporate tax rate, could have a material impact on our financial condition, results of operations, or liquidity. For example, a 1% increase in future income tax rates would increase our deferred tax liability by approximately $340 million.