UNION PACIFIC CORP (UNP) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
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 Estimates and Cautionary Information at the end of this Item 7. The following section generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7, of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020.
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
2021 Results
| Column 1 | Column 2 |
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| ● | Coronavirus Pandemic – Our results during 2021 continued to be impacted by the effects of COVID. Most notably were supply chain issues in the automotive industry due to semiconductor chip shortages and congestion in several parts of the intermodal supply chain. The impact of the semiconductor chip shortage is masked in our year-over-year financial comparison for 2021 and 2020 as the second quarter of 2020 saw a temporary suspension of automotive production due to the pandemic. Excluding the second quarter, automotive shipments were down 14% year-over-year. The pandemic also upended the intermodal supply chain as demand for consumer goods remained high. The elevated demand adversely affected the ports, chassis availability, truck driver supply, and warehouse receiving capacity. These disruptions limited our revenue growth by slowing asset turns and increasing costs through lower freight car velocity and multiple container handlings that impeded our operating efficiency. Rail carloadings also were impacted as adjustments made to compensate for constrained inland drayage and warehouse capacity shifted traffic patterns, driving declines in international intermodal shipments. Demand in other markets increased as the economy recovered. On October 11, 2021, the Company announced that it is complying with the Presidential Executive Order 14042 (EO) that mandates employees of federal contractors and subcontractors be fully vaccinated against COVID, unless employees are legally entitled to an accommodation. A federal district court issued a nationwide injunction against the vaccine mandate in the EO. The company is complying with the injunction while continuing to encourage employees to get their vaccinations. Full implementation and enforcement of the COVID vaccine mandate may affect workforce availability ranging from, among other things, absences to obtain vaccination, recovery from any side-effects, resignations from unwillingness to comply with the mandate, and/or organized work stoppages from any of our organized union labor workforce. After receiving communications from three of our unions objecting to the vaccination requirement, we filed lawsuits on October 15, 2021, to prevent any disruption to the national rail network. We seek to resolve any vaccination dispute through the various dispute resolution procedures outlined in the Railway Labor Act. These lawsuits have been stayed pending a final disposition of the enforceability of the EO by the court. |
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| ● | Safety – The health and wellbeing of our employees was a focal point in 2021 as we navigated the continuously changing environment due to COVID. We have and are continuing to adapt to protect the safety of our employees, our customers, and the communities we serve. Safety procedures and policies continue to be refined based on Centers for Disease Control and Prevention (CDC) guidelines. In this ever-changing environment, we remain intently focused on reducing risk and eliminating incidents for our employees, our customers, and the public. We continued to use Total Safety Culture, Courage to Care, COMMIT (Coaching, Observing, Mentoring, and Motivating with Integrity and Trust), and Peer to Peer throughout our operations to enhance employee safety and engagement. Throughout the year, we worked to implement a physics engine and proprietary software to evaluate train and route characteristics to enable proactive intervention to prevent derailments. Despite these efforts, our safety results deteriorated year-over-year. Our reportable personal injury incidents rate per 200,000 employee-hours of 0.98 increased 9% from 2020 and our reportable equipment incident rate per million train miles increased 7%. In the second half of 2021, we engaged a third-party expert to evaluate the effectiveness of our safety programs and received recommendations for improvement, which we will implement in 2022. |
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| ● | Network Operations – We faced many operational challenges throughout 2021, including Winter Storm Uri, global supply chain disruptions, wildfires, bridge outages, mudslides, and hurricanes. These challenges required adjustments to our transportation plans and impacted overall fluidity of the network. As a result, many of our operating metrics deteriorated year-over-year. Freight car velocity decreased due to increased terminal dwell and higher operating car inventory levels, which drove lower trip plan compliance. To assist with improving network fluidity we are maintaining higher crew and locomotive resources in the short-term. Once the network is balanced and service is restored, we will adjust our resources to the current volume levels. Additional details on these metrics are discussed in Other Operating/Performance and Financial Statistics of this Item 7. |
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| ● | Freight Revenues – Our freight revenues increased 11% year-over-year to $20.2 billion driven by a 4% increase in volume, higher fuel surcharge revenue, core pricing gains, and positive mix of traffic (for example, a relative increase in industrial shipments, which have a higher average revenue per car (ARC)). Volume increased in every key market segment compared to 2020 due to the recovery from the depressed economy brought on by the COVID pandemic in 2020. While the markets rebounded from 2020, our 2021 volume levels were 4% below 2019 pre-pandemic levels. |
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| ● | Financial Results – In 2021, we generated operating income of $9.3 billion, 19% above 2020, as we recovered from the impacts of COVID. In addition, 2020 included a non-cash impairment charge of $278 million related to our Brazos yard investment. Higher fuel prices, increased volume-related costs, inflation, and costs associated with Winter Storm Uri and the wildfires in California drove operating expenses up 7% from 2020. Revenue from the additional volume and traffic mix, higher fuel surcharge revenue, improved pricing, productivity initiatives, and intermodal accessorial charges more than offset the increased expenses, producing an all-time record 57.2% operating ratio, improving 2.7 points from 2020. Net income of $6.5 billion translated into earnings of $9.95 per diluted share, up 26% from 2020. |
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| ● | Fuel Prices – Our average price of diesel fuel in 2021 was $2.23 per gallon, an increase of 49% from 2020. The higher price resulted in higher operating expenses of $668 million (excluding any impact from year-over-year volume increases). Gross ton-miles increased 6% driving higher fuel expense. Partially offsetting this increase was a 1% improvement to a record low fuel consumption rate, computed as gallons of fuel consumed divided by gross ton-miles. |
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| ● | Liquidity – We are continually evaluating our financial condition and liquidity. On December 31, 2021, we had $960 million of cash and cash equivalents. Despite the challenging year, we generated $9.0 billion of cash from operating activities, yielding free cash flow of $3.5 billion after reductions of $2.7 billion for cash used in investing activities and $2.8 billion in dividends. We repurchased $7.3 billion of our shares. We have been, and we expect to continue to be, in compliance with our debt covenants. We have $2.0 billion of credit available under our revolving credit facility and up to $500 million undrawn on our Receivables Facility. As of December 31, 2021, none of the revolving credit facility was drawn. Additional details are discussed in Liquidity and Capital Resources of this Item 7. |
Free cash flow is defined as cash provided by operating activities less cash used in investing activities and dividends paid. Free cash flow is not considered a financial measure under GAAP by SEC Regulation G and Item 10 of SEC Regulation S-K and may not be defined and calculated by other companies in the same manner. We believe free cash flow is important to management and investors in evaluating our financial performance and measures our ability to generate cash without additional external financing. 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 | 2021 | 2020 | 2019 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Cash provided by operating activities | $ | 9,032 | $ | 8,540 | $ | 8,609 | ||||||
| Cash used in investing activities | (2,709 | ) | (2,676 | ) | (3,435 | ) | ||||||
| Dividends paid | (2,800 | ) | (2,626 | ) | (2,598 | ) | ||||||
| Free cash flow | $ | 3,523 | $ | 3,238 | $ | 2,576 |
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2022 Outlook
| Column 1 | Column 2 |
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| ● | Safety – Operating a safe railroad benefits all our constituents: our employees, customers, shareholders, and the communities we serve. We will continue using a multi-faceted approach to safety utilizing technology, risk assessments, training, employee engagement, quality control, and targeted capital investments. As mentioned previously, our initiatives will be informed by recommendations identified in the third-party assessment of the effectiveness of our safety program. Consistent with these recommendations, we will continually evaluate and adjust deployment of Total Safety Culture, Courage to Care, COMMIT, and Peer to Peer throughout our operations, which allows us to identify and implement best practices for employee and operational safety. In addition, our Operating Practices Command Center will continue the implementation of our predictive technology and reduce variability by identifying causes of mainline service interruptions and develop solutions, in addition to, assisting employees with understanding policies, procedures, and best practices for handling trains. We will continue our efforts to utilize data to identify and mitigate risk, detect rail defects, 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), industry programs, and local community activities across the network. We also are dedicated to maintaining a healthy workplace and continue monitoring the COVID case levels, modifying our policies as needed to protect employees and minimize the risk of workplace transmission. |
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| ● | Network Operations – In 2022, we will continue transforming our railroad to increase reliability of our service product, reduce variability in network operations, and improve resource utilization. Further train length initiatives allow us to efficiently add incremental volume growth to our existing train network. We will continue to make capital investments to improve operational performance and efficiency. A more efficient network requires fewer locomotives, freight cars, and other resources. |
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| ● | Financial Expectations – We expect volume to outpace industrial production in 2022 as the results of our business development efforts are bringing new customers to our railroad. In the current environment, we expect continued margin improvement driven by pricing in excess of inflation and ongoing efficiency initiatives, better leveraging our resources and improving our service product. We expect to generate strong cash flow from operating activities allowing us to continue our industry leading dividend payout ratio and strong share repurchase programs. Economic uncertainties remain in 2022 as COVID impacts linger and could have a material impact on our 2022 financial and operating results. Regardless of external factors, we will focus on efficiently managing operations; seeking new business opportunities; protecting our employees, customers, and communities; and providing excellent service to our customers. |
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| ● | Market Conditions – While current forecasts for industrial production indicate continued economic growth, we expect uncertainties with COVID and the economy to continue in 2022. How governments and consumers react to the resurgence, mutation of the virus, and vaccine mandates could result in or contribute to customer disruptions, an elongated recovery period, constrained workforce availability, or a general economic downturn from current levels. Disruptions in our customers’ supply chains caused by the pandemic or other factors may continue to impact our shipments. In addition, other factors such as changes in monetary policy may affect economic activity and demand for rail transportation; natural gas prices, weather conditions, and demand for other energy sources may impact the coal market; crude oil price spreads may drive demand for petroleum products and drilling materials; available truck capacity could impact our intermodal business; and international trade agreements could promote or hinder trade. |
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| ● | Fuel Prices – Projections for crude oil and natural gas continue to fluctuate in the current environment. 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. As prices fluctuate, there will be a timing impact on earnings, as our fuel surcharge programs trail increases or decreases in fuel price by approximately two months. Significant changes in fuel prices could have an impact on consumer discretionary spending, impacting demand for various consumer products we transport. Alternatively, those changes could have an inverse impact on commodities such as coal, petroleum products, and domestic drilling-related shipments. |
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| ● | Capital Plan – In 2022, we expect our capital plan to be approximately $3.3 billion, up 10% from 2021 as we make investments to support our growth strategy. We will continue to harden our infrastructure, replace older assets, and improve the safety and resilience of the network. In addition, the plan includes targeted freight car acquisitions, investments in growth-related projects to drive more carloads to the network, certain ramps to efficiently handle volumes from new and existing intermodal customers, continuous modernization of our locomotive fleet, and projects intended to improve operational efficiency. The capital plan may be revised if business conditions warrant or if new laws or regulations affect our ability to generate sufficient returns on these investments. (See further discussion in this Item 7 under Liquidity and Capital Resources – Capital Plan.) |
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RESULTS OF OPERATIONS
Operating Revenues
| % Change | % Change | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Millions | 2021 | 2020 | 2019 | 2021 v 2020 | 2020 v 2019 | |||||||||||||||
| Freight revenues | $ | 20,244 | $ | 18,251 | $ | 20,243 | 11 | % | (10 | )% | ||||||||||
| Other subsidiary revenues | 741 | 743 | 880 | - | (16 | ) | ||||||||||||||
| Accessorial revenues | 752 | 473 | 514 | 59 | (8 | ) | ||||||||||||||
| Other | 67 | 66 | 71 | 2 | (7 | ) | ||||||||||||||
| Total | $ | 21,804 | $ | 19,533 | $ | 21,708 | 12 | % | (10 | )% |
We generate freight revenues by transporting freight or other materials from our three commodity groups. Freight revenues vary with volume (carloads) and ARC. Changes in price, traffic mix, and fuel surcharges drive ARC. Customer incentives, which are primarily provided for shipping to/from specific locations or based on cumulative volumes, are recorded as a reduction to operating revenues. Customer incentives that include variable consideration based on cumulative volumes are estimated using the expected value method, which is based on available historical, current, and forecasted volumes, and recognized as the related performance obligation is satisfied. We recognize freight revenues over time as shipments move from origin to destination. The allocation of revenue between reporting periods is based on the relative transit time in each reporting period with expenses recognized as incurred.
Other subsidiary revenues (primarily logistics and commuter rail operations) are generally recognized over time as shipments move from origin to destination. The allocation of revenue between reporting periods is based on the relative transit time in each reporting period with expenses recognized as incurred. Accessorial revenues are recognized at a point in time as performance obligations are satisfied.
Our freight revenues increased 11% year-over-year to $20.2 billion driven by a 4% increase in volume, higher fuel surcharge revenue, core pricing gains, and positive mix of traffic (for example, a relative increase in industrial shipments, which have a higher ARC). Volume increased in every key market segment compared to 2020 due to the recovery from the depressed economy brought on by the COVID pandemic in 2020. While the markets have rebounded from 2020, our 2021 volume levels are 4% below 2019 pre-pandemic levels.
Our fuel surcharge programs generated freight revenues of $1.7 billion and $1.0 billion in 2021 and 2020, respectively. Fuel surcharge revenue in 2021 increased $0.7 billion as a result of a 49% increase in fuel price and a 4% increase in carloadings, partially offset by the lag impact on fuel surcharge (it can generally take up to two months for changing fuel prices to affect fuel surcharges recoveries).
In 2021, other subsidiary revenues were flat with 2020 as the semiconductor shortage negatively impacting 2021 automotive production offset the recovery from other COVID related declines in 2020. Accessorial revenue increased in 2021 compared to 2020 driven by increased intermodal accessorial charges tied to global supply chain disruptions. Other revenue was essentially flat year-over-year.
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The following tables summarize the year-over-year changes in freight revenues, revenue carloads, and ARC by commodity type:
| Freight Revenues | % Change | % Change | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Millions | 2021 | 2020 | 2019 | 2021 v 2020 | 2020 v 2019 | |||||||||||||||
| Grain & grain products | $ | 3,181 | $ | 2,829 | $ | 2,776 | 12 | % | 2 | % | ||||||||||
| Fertilizer | 697 | 660 | 653 | 6 | 1 | |||||||||||||||
| Food & refrigerated | 998 | 937 | 1,008 | 7 | (7 | ) | ||||||||||||||
| Coal & renewables | 1,780 | 1,534 | 2,092 | 16 | (27 | ) | ||||||||||||||
| Bulk | 6,656 | 5,960 | 6,529 | 12 | (9 | ) | ||||||||||||||
| Industrial chemicals & plastics | 1,943 | 1,845 | 1,885 | 5 | (2 | ) | ||||||||||||||
| Metals & minerals | 1,811 | 1,580 | 2,042 | 15 | (23 | ) | ||||||||||||||
| Forest products | 1,357 | 1,160 | 1,160 | 17 | - | |||||||||||||||
| Energy & specialized markets | 2,212 | 2,037 | 2,385 | 9 | (15 | ) | ||||||||||||||
| Industrial | 7,323 | 6,622 | 7,472 | 11 | (11 | ) | ||||||||||||||
| Automotive | 1,761 | 1,680 | 2,123 | 5 | (21 | ) | ||||||||||||||
| Intermodal | 4,504 | 3,989 | 4,119 | 13 | (3 | ) | ||||||||||||||
| Premium | 6,265 | 5,669 | 6,242 | 11 | (9 | ) | ||||||||||||||
| Total | $ | 20,244 | $ | 18,251 | $ | 20,243 | 11 | % | (10 | )% |
| Revenue Carloads | % Change | % Change | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Thousands | 2021 | 2020 | 2019 | 2021 v 2020 | 2020 v 2019 | |||||||||||||||
| Grain & grain products | 805 | 745 | 708 | 8 | % | 5 | % | |||||||||||||
| Fertilizer | 201 | 193 | 190 | 4 | 2 | |||||||||||||||
| Food & refrigerated | 189 | 185 | 192 | 2 | (4 | ) | ||||||||||||||
| Coal & renewables | 819 | 797 | 997 | 3 | (20 | ) | ||||||||||||||
| Bulk | 2,014 | 1,920 | 2,087 | 5 | (8 | ) | ||||||||||||||
| Industrial chemicals & plastics | 606 | 587 | 611 | 3 | (4 | ) | ||||||||||||||
| Metals & minerals | 697 | 646 | 744 | 8 | (13 | ) | ||||||||||||||
| Forest products | 250 | 220 | 220 | 14 | - | |||||||||||||||
| Energy & specialized markets | 559 | 539 | 624 | 4 | (14 | ) | ||||||||||||||
| Industrial | 2,112 | 1,992 | 2,199 | 6 | (9 | ) | ||||||||||||||
| Automotive | 701 | 692 | 858 | 1 | (19 | ) | ||||||||||||||
| Intermodal [a] | 3,211 | 3,149 | 3,202 | 2 | (2 | ) | ||||||||||||||
| Premium | 3,912 | 3,841 | 4,060 | 2 | (5 | ) | ||||||||||||||
| Total | 8,038 | 7,753 | 8,346 | 4 | % | (7 | )% |
| % Change | % Change | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Average Revenue per Car | 2021 | 2020 | 2019 | 2021 v 2020 | 2020 v 2019 | |||||||||||||||
| Grain & grain products | $ | 3,953 | $ | 3,797 | $ | 3,919 | 4 | % | (3 | )% | ||||||||||
| Fertilizer | 3,470 | 3,427 | 3,448 | 1 | (1 | ) | ||||||||||||||
| Food & refrigerated | 5,279 | 5,047 | 5,241 | 5 | (4 | ) | ||||||||||||||
| Coal & renewables | 2,173 | 1,926 | 2,098 | 13 | (8 | ) | ||||||||||||||
| Bulk | 3,305 | 3,104 | 3,128 | 6 | (1 | ) | ||||||||||||||
| Industrial chemicals & plastics | 3,207 | 3,144 | 3,087 | 2 | 2 | |||||||||||||||
| Metals & minerals | 2,598 | 2,445 | 2,745 | 6 | (11 | ) | ||||||||||||||
| Forest products | 5,424 | 5,269 | 5,264 | 3 | - | |||||||||||||||
| Energy & specialized markets | 3,956 | 3,780 | 3,821 | 5 | (1 | ) | ||||||||||||||
| Industrial | 3,467 | 3,324 | 3,398 | 4 | (2 | ) | ||||||||||||||
| Automotive | 2,511 | 2,427 | 2,474 | 3 | (2 | ) | ||||||||||||||
| Intermodal [a] | 1,403 | 1,267 | 1,286 | 11 | (1 | ) | ||||||||||||||
| Premium | 1,601 | 1,476 | 1,538 | 8 | (4 | ) | ||||||||||||||
| Average | $ | 2,519 | $ | 2,354 | $ | 2,425 | 7 | % | (3 | )% |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| [a] | For intermodal shipments, each container or trailer equals one carload. |
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| Column 1 | Column 2 |
|---|---|
| Bulk – Bulk includes shipments of grain and grain products, fertilizer, food and refrigerated goods, and coal and renewables. Freight revenues from bulk shipments increased in 2021 compared to 2020 due to a 5% volume increase, core pricing gains, higher fuel surcharge revenue, and positive business mix. Despite weather disruptions in the first quarter of 2021, volume increased with strong demand for grain in the first half of the year and coal in the second half, due to higher natural gas prices. In addition, strength in the export potash market and recovery from the COVID pandemic that negatively impacted production of imported beer, food products, and the demand for ethanol and related products in 2020 contributed to additional increases in volume. | 2021 Bulk Carloads |
| Industrial – Industrial includes shipments of industrial chemicals and plastics, metals and minerals, forest products, and energy and specialized markets. Freight revenues from industrial shipments increased in 2021 versus 2020 due a 6% increase in volume, core pricing gains, higher fuel surcharge, and positive mix of traffic. Strength from the pandemic recovery overcame the first quarter 2021 losses caused by Winter Storm Uri disruptions in the Gulf Coast, which impacted the industrial chemicals and plastics and metals and minerals industries. Additionally, forest product shipments increased due to higher demand for cardboard boxes and lumber. | 2021 Industrial Carloads |
|---|---|
| Premium – Premium includes shipments of finished automobiles, automotive parts, and merchandise in intermodal containers, both domestic and international. Freight revenues from premium shipments increased 11% in 2021 compared to 2020, despite the weather disruptions in the first quarter of 2021, driven by higher fuel surcharges, core pricing gains, and a 2% volume increase. Automotive shipments of 173 thousand carloads in the second quarter of 2021 were more than double the 79 thousand carloads in the same period in 2020 as North American manufacturing plants suspended production due to the pandemic in that year. This recovery masked the impact to automotive shipments in 2021 due to the on-going shortage of semiconductors. Excluding the second quarter, automotive shipments are down 14% year-over-year. The pandemic also upended the intermodal supply chain as demand for consumer goods remained high. This high demand strained port capacity, chassis availability, truck driver supply, and warehouse receiving capacity. Despite the global supply chain disruptions, intermodal shipments increased 2% in 2021 due to improving economic conditions, inventory restocking, contract wins, and continued strength of e-commerce and parcel shipments. | 2021 Premium Carloads |
Mexico Business – Each of our commodity groups includes revenue from shipments to and from Mexico. Revenue from Mexico business was $2.4 billion in 2021, up 13% compared to 2020, driven by a 3% increase in volume and higher fuel surcharge revenue, core pricing gains, and positive mix of traffic. The volume increase was driven by the recovery from the 2020 pandemic and an increase in petroleum and grain shipments, partially offset by the impact of the global supply chain disruptions on intermodal shipments and the semiconductor shortage in the automotive industry.
Operating Expenses
| % Change | % Change | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Millions | 2021 | 2020 | 2019 | 2021 v 2020 | 2020 v 2019 | |||||||||||||||
| Compensation and benefits | $ | 4,158 | $ | 3,993 | $ | 4,533 | 4 | % | (12 | )% | ||||||||||
| Depreciation | 2,208 | 2,210 | 2,216 | - | - | |||||||||||||||
| Fuel | 2,049 | 1,314 | 2,107 | 56 | (38 | ) | ||||||||||||||
| Purchased services and materials | 2,016 | 1,962 | 2,254 | 3 | (13 | ) | ||||||||||||||
| Equipment and other rents | 859 | 875 | 984 | (2 | ) | (11 | ) | |||||||||||||
| Other | 1,176 | 1,345 | 1,060 | (13 | ) | 27 | ||||||||||||||
| Total | $ | 12,466 | $ | 11,699 | $ | 13,154 | 7 | % | (11 | )% |
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| Column 1 | Column 2 |
|---|---|
| Operating expenses increased $767 million in 2021 compared to 2020 driven by higher fuel prices, volume-related costs, inflation, higher casualty costs, 2020 management actions, weather and wildfire-related expenses, incentive compensation, and higher state and local taxes. Partially offsetting these increases compared to 2020 include a $278 million impairment charge in 2020, productivity initiatives, a one-time bonus payment for agreement employees in 2020, and lower severance costs. Full year results of 2021 and 2020 both include a reduction of expense for weather and wildfire-related insurance reimbursements, $6 million and $25 million, respectively. | 2021 Operating Expenses |
Compensation and Benefits – Compensation and benefits include wages, payroll taxes, health and welfare costs, pension costs, and incentive costs. In 2021, expenses increased 4% compared to 2020, due to volume related costs, inflation, 2020 management actions responding to the sharp decline in volume (temporary unpaid leave, salary reductions, and shop closures), incentive compensation, and higher costs due to weather and wildfire-related events. Partially offsetting these increases were productivity initiatives resulting in employee levels that declined 3% compared to 2020 despite a 4% volume increase, a 2020 one-time bonus payment for agreement employees who worked during the pandemic, and lower severance costs.
Depreciation – The majority of depreciation relates to road property, including rail, ties, ballast, and other track material. Depreciation expense was flat in 2021 compared to 2020.
Fuel – Fuel includes locomotive fuel and gasoline for highway and non-highway vehicles and heavy equipment. Locomotive diesel fuel prices, which averaged $2.23 per gallon (including taxes and transportation costs) in 2021, compared to $1.50 per gallon in 2020, increased expenses $668 million (excluding any impact from increased volume year-over-year). Gross ton-miles increased 6% driving higher fuel expense. Partially offsetting this increase was a 1% improvement to a record low fuel consumption rate, computed as gallons of fuel consumed divided by gross ton-miles.
Purchased Services and Materials – Expense for purchased services and materials includes the costs of services purchased from outside contractors and other service providers (including equipment maintenance and contract expenses incurred by our subsidiaries for external transportation services); materials used to maintain the Railroad’s lines, structures, and equipment; costs of operating facilities jointly used by UPRR and other railroads; transportation and lodging for train crew employees; trucking and contracting costs for intermodal containers; leased automobile maintenance expenses; and tools and supplies. Purchased services and materials increased 3% in 2021 compared to 2020 driven by inflation, higher professional services expense, volume-related costs associated with our intermodal business, higher costs due to weather and wildfire-related events, increased locomotive and freight car maintenance expense as we added resources to the network, and higher costs for transportation of train crews.
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, offset by equity income from certain equity method investments. Equipment and other rents expense decreased 2% compared to 2020 driven by lower rent on equipment in storage and higher equity income from our investment in TTX Company, partially offset by increased freight car rent expense due to volume increases and slower freight car velocity.
Other – Other expenses include state and local taxes, freight, equipment and property damage, utilities, insurance, personal injury, environmental, employee travel, telephone and cellular, computer software, bad debt, and other general expenses. Other expenses decreased 13% in 2021 compared to 2020 as a result of a $278 million non-cash impairment charge related to our Brazos yard investment in 2020, lower write-offs of cancelled in-progress capital projects, 2020 lease impairments, and higher equity income. Partially offsetting these decreases were increased casualty expenses, including personal injury, damaged freight, and environmental, and higher state and local taxes. Both periods in 2021 and 2020 included a reduction of expense for weather and wildfire-related insurance reimbursements, $6 million and $25 million, respectively.
Non-Operating Items
| % Change | % Change | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Millions | 2021 | 2020 | 2019 | 2021 v 2020 | 2020 v 2019 | |||||||||||||||
| Other income, net | $ | 297 | $ | 287 | $ | 243 | 3 | % | 18 | % | ||||||||||
| Interest expense | (1,157 | ) | (1,141 | ) | (1,050 | ) | 1 | 9 | ||||||||||||
| Income tax expense | (1,955 | ) | (1,631 | ) | (1,828 | ) | 20 | (11 | ) |
Other Income, net – Other income increased in 2021 compared to 2020 due to a $36 million gain from the sale of an investment in a technology company, partially offset by lower real estate sale gains. Real estate sales in 2021 included a $50 million gain from a property sale to the Colorado Department of Transportation, while 2020 included a $69 million gain from a land and permanent easement sale to the Illinois State Toll Highway Authority.
Interest Expense – Interest expense increased in 2021 compared to 2020 due to an increased weighted-average debt level of $28.3 billion in 2021 from $27.9 billion in 2020. The effective interest rate was 4.1% for both periods.
Income Taxes – Income tax expense increased in 2021 compared to 2020 due to higher pre-tax income. Our effective tax rates for 2021 and 2020 were 23.1% and 23.4%, respectively.
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OTHER OPERATING/PERFORMANCE AND FINANCIAL STATISTICS
We report a number of key performance measures weekly to the STB. We provide this data on our website at www.up.com/investor/aar-stb_reports/index.htm.
Operating/Performance Statistics
Management continuously measures these key operating metrics to evaluate our operational efficiency and asset utilization in striving to provide a consistent, reliable service product to our customers.
Railroad performance measures are included in the table below:
| % Change | % Change | |||||||
|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | 2021 v 2020 | 2020 v 2019 | ||||
| Gross ton-miles (GTMs) (billions) | 817.9 | 771.8 | 846.6 | 6 | % | (9) | % | |
| Revenue ton-miles (billions) | 411.3 | 385.0 | 423.4 | 7 | (9) | |||
| Freight car velocity (daily miles per car) [a] | 203 | 221 | 209 | (8) | 6 | |||
| Average train speed (miles per hour) [b] | 24.6 | 25.9 | 25.1 | (5) | 3 | |||
| Average terminal dwell time (hours) [b] | 23.7 | 22.7 | 24.8 | 4 | (8) | |||
| Locomotive productivity (GTMs per horsepower day) | 133 | 137 | 120 | (3) | 14 | |||
| Train length (feet) | 9,334 | 8,798 | 7,747 | 6 | 14 | |||
| Intermodal car trip plan compliance (%) | 73 | 81 | 75 | (8) | pts | 6 | pts | |
| Manifest/Automotive car trip plan compliance (%) | 63 | 71 | 65 | (8) | pts | 6 | pts | |
| Workforce productivity (car miles per employee) | 1,038 | 947 | 857 | 10 | 11 | |||
| Total employees (average) | 29,905 | 30,960 | 37,483 | (3) | (17) | |||
| Operating ratio | 57.2 | 59.9 | 60.6 | (2.7) | pts | (0.7) | pts |
| [a] | 2019 has been recast to conform to the current year presentation which reflects minor refinements. |
|---|---|
| [b] | As reported to the STB. |
Gross and Revenue Ton-Miles – Gross ton-miles are calculated by multiplying the weight of loaded and empty freight cars by the number of miles hauled. Revenue ton-miles are calculated by multiplying the weight of freight by the number of tariff miles. In 2021, gross ton-miles and revenue ton-miles increased 6% and 7%, respectively, compared to 2020, driven by a 4% increase in carloadings. Changes in commodity mix drove the variance in year-over-year increases between gross ton-miles, revenue ton-miles, and carloads (smaller increases in our intermodal and automotive shipments, which are generally lighter, coupled with higher increases in grain and industrial shipments, which are generally heavier).
Freight Car Velocity – Freight car velocity measures the average daily miles per car on our network. The two key drivers of this metric are the speed of the train between terminals (average train speed) and the time a rail car spends at the terminals (average terminal dwell time). Train speed slowed and terminal dwell increased in 2021 compared to the same periods in 2020 as the network handled additional volume and was impacted by weather and wildfire-related challenges, bridge outages caused by the California wildfires, other incidents causing delays on the network, and global supply chain disruptions. Continued implementation of our operating plan helped to partially offset these impacts.
Locomotive Productivity – Locomotive productivity is gross ton-miles per average daily locomotive horsepower. Locomotive productivity decreased 3% in 2021 compared to 2020 driven by the increased active fleet needed to handle the 4% volume increase as well as manage network disruptions, partially offset by transportation plan changes.
Train Length – Train length is the average maximum train length on a route measured in feet. Our train length increased 6% compared to 2020 as a result of blending service products and transportation plan changes designed to improve overall operational efficiency. However, in the second half of the year, train length declined slightly from the first half of 2021 due to California wildfire bridge outage reroutes in the third quarter and operational challenges in the fourth quarter.
Car Trip Plan Compliance – Car trip plan compliance is the percentage of cars delivered on time in accordance with our original trip plan. Our network trip plan compliance is broken into the intermodal and manifest/automotive products. Intermodal trip plan compliance deteriorated in 2021 compared to 2020 primarily due to global supply chain disruptions. Manifest/automotive trip plan compliance deteriorated in 2021 compared to 2020 as our network slowed because of the outages and incidents described above that required increased resource allocation and rebalancing.
Workforce Productivity – Workforce productivity is average daily car miles per employee. Workforce productivity improved 10%, reaching an all-time record as employee counts were down 3% compared to 2020, while average daily car miles increased 6%. Productivity initiatives and a smaller capital workforce offset higher train and engine employee levels due to weather and wildfire-related challenges, network disruptions, and reduced crew utilization keeping total employee levels lower than 2020.
Operating Ratio – Operating ratio is our operating expenses reflected as a percentage of operating revenue. Our operating ratio of 57.2% was an all-time record and improved 2.7 points compared to 2020 mainly driven by a 2020 one-time impairment, core pricing gains, productivity initiatives, and positive mix of traffic, which were partially offset by higher fuel prices, inflation, and other cost increases.
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Return on Average Common Shareholders’ Equity
| Millions, Except Percentages | 2021 | 2020 | 2019 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net income | $ | 6,523 | $ | 5,349 | $ | 5,919 | ||||||
| Average equity | $ | 15,560 | $ | 17,543 | $ | 19,276 | ||||||
| Return on average common shareholders' equity | 41.9 | % | 30.5 | % | 30.7 | % |
Return on Invested Capital as Adjusted (ROIC)
| Millions, Except Percentages | 2021 | 2020 | 2019 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net income | $ | 6,523 | $ | 5,349 | $ | 5,919 | ||||||
| Interest expense | 1,157 | 1,141 | 1,050 | |||||||||
| Interest on average operating lease liabilities | 54 | 64 | 76 | |||||||||
| Taxes on interest | (280 | ) | (282 | ) | (266 | ) | ||||||
| Net operating profit after taxes as adjusted | $ | 7,454 | $ | 6,272 | $ | 6,779 | ||||||
| Average equity | $ | 15,560 | $ | 17,543 | $ | 19,276 | ||||||
| Average debt | 28,229 | 25,965 | 23,796 | |||||||||
| Average operating lease liabilities | 1,682 | 1,719 | 2,052 | |||||||||
| Average invested capital as adjusted | $ | 45,471 | $ | 45,227 | $ | 45,124 | ||||||
| Return on Invested Capital as Adjusted | 16.4 | % | 13.9 | % | 15.0 | % |
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 to management and investors in evaluating the efficiency and effectiveness of our long-term capital investments. In addition, we currently use ROIC as a performance criterion in determining certain elements of equity compensation for our executives. ROIC should be considered in addition to, rather than as a substitute for, other information provided in accordance with GAAP. The most comparable GAAP measure is return on average common shareholders’ equity. The tables above provide reconciliations from return on average common shareholders’ equity to ROIC. At December 31, 2021, 2020, and 2019, the incremental borrowing rate on operating leases was 3.2%, 3.7%, and 3.7%, respectively.
Adjusted Debt / Adjusted EBITDA
| Millions, Except Ratios | Dec. 31, | Dec. 31, | Dec. 31, | |||
|---|---|---|---|---|---|---|
| for the Twelve Months Ended | 2021 | 2020 | 2019 | |||
| Net income | $ | 6,523 | $ | 5,349 | $ | 5,919 |
| Add: | ||||||
| Income tax expense/(benefit) | 1,955 | 1,631 | 1,828 | |||
| Depreciation | 2,208 | 2,210 | 2,216 | |||
| Interest expense | 1,157 | 1,141 | 1,050 | |||
| EBITDA | $ | 11,843 | $ | 10,331 | $ | 11,013 |
| Adjustments: | ||||||
| Other income, net | (297) | (287) | (243) | |||
| Interest on operating lease liabilities | 56 | 59 | 68 | |||
| Adjusted EBITDA | $ | 11,602 | $ | 10,103 | $ | 10,838 |
| Debt | $ | 29,729 | $ | 26,729 | $ | 25,200 |
| Operating lease liabilities | 1,759 | 1,604 | 1,833 | |||
| Unfunded/(funded) pension and other postretirement benefits, | ||||||
| net of tax cost/(benefit) of ($21), $195, and $124 | (72) | 637 | 400 | |||
| Adjusted debt | $ | 31,416 | $ | 28,970 | $ | 27,433 |
| Adjusted debt / Adjusted EBITDA | 2.7 | 2.9 | 2.5 |
Adjusted debt to adjusted EBITDA (earnings before interest, taxes, depreciation, amortization, and adjustments for other income and interest on present value of operating leases) 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 to management and investors in evaluating the Company’s ability to sustain given debt levels (including leases) with the cash generated from operations. In addition, a comparable measure is used by rating agencies when reviewing the Company’s credit rating. Adjusted debt to adjusted EBITDA should be considered in addition to, rather than as a substitute for, net income. The table above provides reconciliations from net income to adjusted debt to adjusted EBITDA. At December 31, 2021, 2020, and 2019, the incremental borrowing rate on operating leases was 3.2%, 3.7% and 3.7%, respectively.
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LIQUIDITY AND CAPITAL RESOURCES
We are continually evaluating our financial condition and liquidity. We analyze a wide range of economic scenarios and the impact on our ability to generate cash. These analyses inform our liquidity plans and activities outlined below and indicate we have sufficient borrowing capacity to sustain an extended period of lower volumes.
At December 31, 2021, we had a working capital deficit due to upcoming debt maturities. At December 31, 2020, we had a surplus due to an increased cash balance held due to the uncertainty related to COVID. It is not unusual for us to have a working capital deficit, and we believe it is not an indication of a lack of liquidity. We also maintain adequate resources, including our credit facility and, when necessary, access the capital markets to meet any foreseeable cash requirements.
During the year, we generated $9.0 billion of cash from operating activities, completed a $1.7 billion debt exchange, and issued $3.5 billion of long-term debt. We have been, and we expect to continue to be, in compliance with our debt covenants. We increased the dividend twice during 2021 paying out $2.8 billion and repurchased shares totaling $7.3 billion, including the completion of our $2 billion accelerated share repurchase programs entered into on May 25, 2021.
Our principal sources of liquidity include cash, cash equivalents, our Receivables Facility, our revolving credit facility, as well as the availability of commercial paper and other sources of financing through the capital markets. On December 31, 2021, we had $960 million of cash and cash equivalents, $2.0 billion of committed credit available under our revolving credit facility, and up to $500 million undrawn on the Receivables Facility. As of December 31, 2021, none of the revolving credit facility was drawn, and we did not draw on our revolving credit facility at any time during 2021. At December 31, 2021, we had $300 million of the Receivables Facility drawn, $400 million of commercial paper, and a $100 million term loan outstanding. Our access to the Receivables Facility may be reduced or restricted if our bond ratings fall to certain levels below investment grade. 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 financing 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 the following sources or activities: (i) increasing the utilization of our Receivables Facility, (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 $2.0 billion revolving credit facility is intended to support the issuance of commercial paper by UPC and also serves as an additional source of liquidity to fund short-term needs. The Company currently does not intend to make any borrowings under this facility.
As described in the notes to the Consolidated Financial Statements and as referenced in the table below, we have contractual obligations that may affect our financial condition. Based on our assessment of the underlying provisions and circumstances of our contractual obligations, 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 like those of other comparable corporations, particularly within the transportation industry.
The following table identifies material obligations as of December 31, 2021:
| Payments Due by December 31, | |||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Contractual Obligations | After | ||||||||||||||||||||||||||
| Millions | Total | 2022 | 2023 | 2024 | 2025 | 2026 | 2026 | ||||||||||||||||||||
| Debt [a] | $ | 53,942 | $ | 3,172 | $ | 2,337 | $ | 2,356 | $ | 2,336 | $ | 1,875 | $ | 41,866 | |||||||||||||
| Purchase obligations [b] | 2,555 | 753 | 446 | 368 | 335 | 256 | 397 | ||||||||||||||||||||
| Operating leases [c] | 1,966 | 333 | 293 | 285 | 285 | 215 | 555 | ||||||||||||||||||||
| Other post retirement benefits [d] | 400 | 45 | 44 | 40 | 39 | 39 | 193 | ||||||||||||||||||||
| Finance lease obligations [e] | 378 | 107 | 81 | 68 | 45 | 36 | 41 | ||||||||||||||||||||
| Total contractual obligations | $ | 59,241 | $ | 4,410 | $ | 3,201 | $ | 3,117 | $ | 3,040 | $ | 2,421 | $ | 43,052 |
| [a] | Excludes finance lease obligations of $336 million as well as unamortized discount and deferred issuance costs of ($1,763) million. Includes an interest component of $22,786 million. |
|---|---|
| [b] | Purchase obligations include locomotive maintenance contracts; purchase commitments for fuel purchases, ties, ballast, and rail; and agreements to purchase other goods and services. |
| [c] | Includes leases for locomotives, freight cars, other equipment, and real estate. Includes an interest component of $207 million. |
| [d] | Includes estimated other post retirement, medical, and life insurance payments, and payments made under the unfunded pension plan for the next ten years. |
| [e] | Represents total obligations, including interest component of $42 million. |
LIBOR Transition – See Note 14 to the Financial Statements and Supplementary Data, Item 8. The use of an alternative rate or benchmark may negatively impact the terms of our facilities, including in the form of an adverse effect on interest rates and higher borrowing costs and interest expense.
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| Cash Flows | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Millions | 2021 | 2020 | 2019 | |||||||||
| Cash provided by operating activities | $ | 9,032 | $ | 8,540 | $ | 8,609 | ||||||
| Cash used in investing activities | (2,709 | ) | (2,676 | ) | (3,435 | ) | ||||||
| Cash used in financing activities | (7,158 | ) | (4,902 | ) | (5,646 | ) | ||||||
| Net change in cash, cash equivalents, and restricted cash | $ | (835 | ) | $ | 962 | $ | (472 | ) |
Operating Activities
Cash provided by operating activities increased in 2021 compared to 2020 due primarily to an increase in net income, partially offset by higher receivables and the partial payment of the deferred 2020 employment tax that was allowed by a provision in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).
Cash Flow Conversion – Cash flow conversion is defined as cash provided by operating activities less cash used in capital investments as a ratio of net income.
Cash flow conversion rate is not considered a financial measure under GAAP by SEC Regulation G and Item 10 of SEC Regulation S-K and may not be defined and calculated by other companies in the same manner. We believe cash flow conversion rate is important to management and investors in evaluating our financial performance and measures our ability to generate cash without additional external financing. Cash flow conversion rate 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 cash flow conversion rate (non-GAAP measure):
| Millions, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For the Year Ended December 31, | 2021 | 2020 | 2019 | |||||||||
| Cash provided by operating activities | $ | 9,032 | $ | 8,540 | $ | 8,609 | ||||||
| Cash used in capital investments | (2,936 | ) | (2,927 | ) | (3,453 | ) | ||||||
| Total (a) | 6,096 | 5,613 | 5,156 | |||||||||
| Net income (b) | 6,523 | 5,349 | 5,919 | |||||||||
| Cash flow conversion rate (a/b) | 93 | % | 105 | % | 87 | % |
Investing Activities
Cash used in investing activities in 2021 increased compared to 2020 primarily driven by increased capital investment in road infrastructure replacements.
The following tables detail cash capital investments and track statistics for the years ended December 31:
| Millions | 2021 | 2020 | 2019 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Ties | $ | 443 | $ | 507 | $ | 427 | |||||
| Rail and other track material | 507 | 471 | 561 | ||||||||
| Ballast | 215 | 225 | 271 | ||||||||
| Other [a] | 700 | 584 | 694 | ||||||||
| Total road infrastructure replacements [b] | 1,865 | 1,787 | 1,953 | ||||||||
| Line expansion and other capacity projects | 284 | 332 | 357 | ||||||||
| Commercial facilities | 243 | 171 | 183 | ||||||||
| Total capacity and commercial facilities | 527 | 503 | 540 | ||||||||
| Locomotives and freight cars [c] | 322 | 269 | 610 | ||||||||
| Positive train control | 84 | 79 | 95 | ||||||||
| Technology and other | 138 | 289 | 255 | ||||||||
| Total cash capital investments | $ | 2,936 | $ | 2,927 | $ | 3,453 |
| [a] | Other includes bridges and tunnels, signals, other road assets, and road work equipment. |
|---|---|
| [b] | Includes weather and wildfire-related damages to our property of $60 million, $40 million, and $113 million in 2021, 2020, and 2019, respectively. |
| [c] | Locomotives and freight cars include early lease buyouts of $34 million, $38 million, and $290 million in 2021, 2020, and 2019, respectively. |
| 2021 | 2020 | 2019 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Track miles of rail replaced | 502 | 468 | 534 | ||||||||
| Track miles of rail capacity expansion | 70 | 83 | 55 | ||||||||
| New ties installed (thousands) | 4,058 | 4,671 | 3,475 | ||||||||
| Miles of track surfaced | 10,441 | 10,414 | 7,741 |
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Capital Plan – In 2022, we expect our capital plan to be approximately $3.3 billion, up 10% compared to 2021. We will continue to harden our infrastructure, replace older assets, and improve the safety and resiliency of the network. In addition, the plan includes targeted freight car acquisitions, investments in growth-related projects to drive more carloads to the network, certain ramps to efficiently handle volumes from new and existing intermodal customers, continuous modernization of our locomotive fleet, and projects intended to improve operational efficiency. The capital plan may be revised if business conditions warrant or if new laws or regulations affect our ability to generate sufficient returns on these investments.
Financing Activities
Cash used in financing activities increased in 2021 compared to 2020 driven by increased share repurchases.
See Note 14 to the Financial Statements and Supplementary Data, Item 8, for a description of all our outstanding financing arrangements and significant new borrowings, and Note 18 to the Financial Statements and Supplementary Data, Item 8, for a description of our share repurchase programs.
OTHER MATTERS
Inflation – For capital-intensive companies, inflation significantly increases asset replacement costs for long-lived assets. 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.
Sensitivity Analyses – The sensitivity analyses that follow illustrate the economic effect that hypothetical changes in interest and tax rates could have on our results of operations and financial condition. These hypothetical changes do not consider other factors that could impact actual results.
Interest Rates – At December 31, 2021, we had variable-rate debt representing approximately 2.7% of our total debt. If variable interest rates average one percentage point higher in 2022 than our December 31, 2021, variable rate, which was approximately 0.7%, our interest expense would increase by approximately $8.0 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, 2021.
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, 2021, and amounts to an increase of approximately $4.9 billion to the fair value of our debt at December 31, 2021. 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.
Tax Rates – Our deferred tax assets and liabilities are measured based on current tax law. 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 permanent 1% increase in future income tax rates would increase our deferred tax liability by approximately $500 million. Similarly, a permanent 1% decrease in future income tax rates would decrease our deferred tax liability by approximately $500 million.
Accounting Pronouncements – See Note 3 to the Financial Statements and Supplementary Data, Item 8.
Asserted and Unasserted Claims – See Note 17 to the Financial Statements and Supplementary Data, Item 8.
Indemnities – See Note 17 to the Financial Statements and Supplementary Data, Item 8.
Climate Change – Although climate change could have an adverse impact on our operations and financial performance (see Risk Factors under Item 1A of this report), we are currently unable to predict the manner or severity of such impact. In December 2021, we released our initial Climate Action Plan, which outlines the steps we are taking to reduce our environmental impact. This plan aligns with our corporate strategy: Serve (improve operational efficiency and minimize fuel consumption), Grow (offer sustainable supply chain solutions), Win (decarbonize our footprint and the environment), Together (engage our stakeholders and align interests). We continue to take steps and explore opportunities to reduce our operational impact on the environment, including increased usage of renewable fuels, investments in new technologies, using training programs and technology to reduce fuel consumption, and changing our operations to increase fuel efficiency (see "Sustainable Future" in the Operations section in Item 1 of this report).
CRITICAL ACCOUNTING ESTIMATES
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 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 estimates are a subset of our significant accounting policies described in Note 2 to the Financial Statements and Supplementary Data, Item 8. These critical accounting estimates 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.
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Personal Injury – See Note 17 to the Financial Statements and Supplementary Data, Item 8, and "We May Be Subject to Various Claims and Lawsuits That Could Result in Significant Expenditures" in the Risk Factors, Item 1A.
Our personal injury liability is subject to uncertainty due to unasserted claims, timing and outcome of claims, and evolving trends in litigation. There were no material changes to the assumptions used in the latest actuarial analysis.
Our personal injury liability balance and claims activity was as follows:
| 2021 | 2020 | 2019 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Ending liability balance at December 31 (millions) | $ | 325 | $ | 270 | $ | 265 | ||||||
| Open claims, beginning balance | 1,897 | 1,985 | 2,025 | |||||||||
| New claims | 2,719 | 2,577 | 3,025 | |||||||||
| Settled or dismissed claims | (2,589 | ) | (2,665 | ) | (3,065 | ) | ||||||
| Open claims, ending balance at December 31 | 2,027 | 1,897 | 1,985 |
Environmental Costs – See Note 17 to the Financial Statements and Supplementary Data, Item 8, "We Are Subject to Significant Environmental Laws and Regulations" in the Risk Factors, Item 1A, and Environmental Matters in the Legal Proceedings, Item 3.
Our environmental liability is subject to several factors such as type of remediation, nature and volume of contaminate, and number and financial viability of other potentially responsible parties, as well as uncertainty due to unknown alleged contamination, evolving trends in remediation techniques and final remedies, and changes in laws and regulations.
Our environmental liability balance and site activity was as follows:
| 2021 | 2020 | 2019 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Ending liability balance at December 31 (millions) | $ | 243 | $ | 233 | $ | 227 | ||||||
| Open sites, beginning balance | 373 | 360 | 334 | |||||||||
| New sites | 105 | 96 | 114 | |||||||||
| Closed sites | (102 | ) | (83 | ) | (88 | ) | ||||||
| Open sites, ending balance at December 31 | 376 | 373 | 360 |
Property and Depreciation – See Note 11 to the Financial Statements and Supplementary Data, Item 8.
Assets purchased or constructed throughout the year are capitalized if they meet applicable minimum units of property.
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 $69 million. If the estimated useful lives of all depreciable assets were decreased by one year, annual depreciation expense would increase by approximately $73 million. We are projecting an increase in our depreciation expense by approximately 2% in 2022 versus 2021. This is driven by an increase in our projected depreciable asset base.
During the last three fiscal years, no gains or losses were recognized due to the retirement of depreciable railroad properties.
Pension Plans – See Note 5 to the Financial Statements and Supplementary Data, Item 8.
The critical assumptions used to measure pension obligations and expenses are the discount rates and expected rate of return on pension assets.
We evaluate our critical assumptions at least annually, and selected assumptions are based on the following factors:
| ● | We measure the service cost and interest cost components of our net periodic pension cost by using individual spot rates matched with separate cash flows for each future year. Discount rates are based on a Mercer yield curve of high-quality corporate bonds (rated AA by a recognized rating agency). |
|---|---|
| ● | Expected return on plan assets is based on our asset allocation mix and our historical return, taking into consideration current and expected market conditions. |
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The following tables present the key assumptions used to measure net periodic pension cost/benefit for 2022 and the estimated impact on 2022 net periodic pension cost/benefit relative to a change in those assumptions:
| Assumptions | ||||
|---|---|---|---|---|
| Discount rate for benefit obligations | 2.80 | % | ||
| Discount rate for interest on benefit obligations | 2.41 | % | ||
| Discount rate for service cost | 2.91 | % | ||
| Discount rate for interest on service cost | 2.86 | % | ||
| Expected return on plan assets | 6.25 | % |
| Sensitivities | Increase in Expense | ||
|---|---|---|---|
| Millions | Pension | ||
| 0.25% decrease in discount rates | $ | 16 | |
| 0.25% decrease in expected return on plan assets | $ | 11 |
The following table presents the net periodic pension cost for the years ended December 31:
| Est. | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Millions | 2022 | 2021 | 2020 | 2019 | |||||||||||
| Net periodic pension cost | $ | 23 | $ | 85 | $ | 50 | $ | 34 |
CAUTIONARY INFORMATION
Certain statements in this report, and statements in other reports or information filed or to be filed with the SEC (as well as information included in oral statements or other written statements made or to be made by us), are, or will be, forward-looking statements as defined by the Securities Act of 1933 and the Securities Exchange Act of 1934. These forward-looking statements and information include, without limitation, statements in the Chairman’s letter preceding Part I; statements regarding planned capital expenditures under the caption “2022 Capital Plan” in Item 2 of Part I; and statements and information set forth under the captions “2022 Outlook”; “Liquidity and Capital Resources” in Item 7 of Part II regarding our capital plan, share repurchase programs, contractual obligations, "Pension Benefits", and "Other Matters" in this Item 7 of Part II. Forward-looking statements and information also include any other statements or information in this report (including information incorporated herein by reference) regarding: potential impacts of the COVID pandemic on our business operations, financial results, liquidity, and financial position, and on the world economy (including our customers and supply chains), including as a result of fluctuations in volume and carloadings; closing of customer manufacturing, distribution or production facilities; expectations as to operational or service improvements; expectations regarding the effectiveness of steps taken or to be taken to improve operations, service, infrastructure improvements, and transportation plan modifications (including those discussed in our Climate Change Plan); expectations as to cost savings, revenue growth, and earnings; the time by which goals, targets, or objectives will be achieved; projections, predictions, expectations, estimates, or forecasts as to our business, financial, and operational results, future economic performance, and general economic conditions; proposed new products and services; estimates and expectations regarding tax matters; expectations that claims, litigation, environmental costs, commitments, contingent liabilities, labor negotiations or agreements, cyber-attacks or other matters will not have a material adverse effect on our consolidated results of operations, financial condition, or liquidity and any other similar expressions concerning matters that are not historical facts. Forward-looking statements may be identified by their use of forward-looking terminology, such as “believes,” “expects,” “may,” “should,” “would,” “will,” “intends,” “plans,” “estimates,” “anticipates,” “projects” and similar words, phrases, or expressions.
Forward-looking statements should not be read as a guarantee of future performance, results or outcomes, and will not necessarily be accurate indications of the times that, or by which, such performance, results or outcomes will be achieved. Forward-looking statements and information are subject to risks and uncertainties, including the impact of the COVID pandemic and responses by governments, businesses, and individuals, that could cause actual performance or results to differ materially from those expressed in the statements and information. Forward-looking statements and information reflect the good faith consideration by management of currently available information, and may be based on underlying assumptions believed to be reasonable under the circumstances. However, such information and assumptions (and, therefore, such forward-looking statements and information) are or may be subject to variables or unknown or unforeseeable events or circumstances that management has little or no influence or control, and many of these risks and uncertainties are currently amplified by and may continue to be amplified by, or in the future may be amplified by, the COVID pandemic. The Risk Factors in Item 1A of this report could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in any forward-looking statements or information. To the extent circumstances require or we deem it otherwise necessary, we will update or amend these risk factors in a Form 10-Q, Form 8-K, or subsequent Form 10-K. All forward-looking statements are qualified by, and should be read in conjunction with, these Risk Factors.
Forward-looking statements speak only as of the date the statement was made. We assume no obligation to update forward-looking information to reflect actual results, changes in assumptions, or changes in other factors affecting forward-looking information. If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect thereto or with respect to other forward-looking statements.