What changed in this filing

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Item 2. Management’s Discussion and Analysis

2022-07-27 compared with 2022-04-27 · 112 added, 92 removed, 122 unchanged (63% of the section changed)

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We are also a principal carrier of coal, automobiles, and automotive parts.

Revenue grew 10% in the first quarter as a result of stronger average revenue per unit.

Volumes declined compared to the prior year, partly attributable to lower network velocity, and we are progressing with initiatives to improve network fluidity and resiliency for our customers.

We experienced an increase in fuel commodity prices, which led to higher fuel surcharge revenues and fuel expense.

The overall increase in revenue drove improvements in income from railway operations, net income and diluted earnings per share.

However, the net impact of fuel prices on revenues and expenses contributed to the degradation of the operating ratio.

Strong revenue growth drove operating income improvement in the second quarter.

Although lower network velocity contributed to volume declines compared to prior year, higher fuel surcharge revenues and pricing gains led to revenue per unit growth that more than offset the impact of lower volume.

The increase in fuel commodity prices also led to higher fuel expense.

The net impact of fuel prices on revenues and expenses, coupled with lower current-year gains on operating property sales, contributed to the degradation of the railway operating ratio (a measure of the amount of operating revenues consumed by operating expenses).

While network fluidity remained challenged, we are taking the steps necessary for service restoration.

These efforts include recruiting, training, and retaining our transportation crews as well as evolving our operating plan, with the goal of improving service for our customers.

The COVID-19 pandemic continues to impact the U.S.

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SUMMARIZED RESULTS OF OPERATIONS

First Quarter

2022 2021 % change

Second Quarter First Six Months

2022 2021 % change 2022 2021 % change

($ in millions, except per share amounts)

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Railway operating ratio (percent) 60.9 58.3 4% 61.8 59.9 3%

Income from railway operations increased due to higher railway operating revenues.

Revenue growth was driven by higher fuel surcharge revenues and pricing gains, which exceeded the impact of a 5% volume decline.

The rise in revenues was offset in part by increased railway operating expenses, driven by higher fuel prices, other inflationary pressures, and service-related costs.

Our share repurchase activity resulted in the increase in diluted earnings per share that exceeded the increase in net income.

Income from railway operations increased in both periods due to higher railway operating revenues.

Revenue growth was driven by higher fuel surcharge revenues and pricing gains, which exceeded the impact of a 3% and 4% volume decline in the second quarter and first six months, respectively.

The rise in revenues was offset in part by increased railway operating expenses, driven by higher fuel prices, other inflationary pressures, service-related costs, lower gains on the sale of operating properties, and higher claims-related expenses.

Offsetting the growth in income from railway operations were lower net returns on corporate-owned life insurance (COLI) and higher income taxes.

Our share repurchase activity resulted in the percentage increase in diluted earnings per share that exceeded that of net income.

DETAILED RESULTS OF OPERATIONS

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The following tables present a comparison of revenues ($ in millions), units (in thousands), and average revenue per unit ($ per unit) by commodity group.

First Quarter

Revenues 2022 2021 % change

Second Quarter First Six Months

Revenues 2022 2021 % change 2022 2021 % change

Agriculture, forest and consumer products $ 624 $ 578 8% $ 1,197 $ 1,117 7%

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Total 1,851 1,542 20% 1,806 1,531 18%

Railway operating revenues increased $276 million compared with the same period last year.

Railway operating revenues increased $451 million in the second quarter and $727 million for the first six months compared with the same periods last year.

The table below reflects the components of the revenue change by major commodity group ($ in millions).

First Quarter

Merchandise Intermodal Coal

Second Quarter First Six Months

Merchandise Intermodal Coal Merchandise Intermodal Coal

Increase (Decrease)

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Approximately 95% of our revenue base is covered by contracts that include negotiated fuel surcharges.

Revenues associated with these surcharges totaled $244 million and $97 million in 2022 and 2021, respectively.

Revenues associated with these surcharges totaled $421 million and $148 million in the second quarters of 2022 and 2021, respectively, and $665 million and $245 million for the first six months of 2022 and 2021, respectively.

The increase in fuel surcharge revenues is driven by higher fuel commodity prices.

Should the current fuel price environment persist for the remainder of 2022, we expect fuel surcharge revenue to be higher than 2021.

Merchandise revenues increased due to higher average revenue per unit driven by higher fuel surcharge revenue and increased pricing partially offset by decreased volume.

Volumes fell as declines in automotive and metals and construction shipments more than offset higher chemical shipments.

Agriculture, forest and consumer products volume decreased, as declines in corn, soybeans, and fertilizers more than offset increases in ethanol and feed.

Decreased corn and fertilizer shipments were due to decreased customer demand.

Soybean volumes were lower due to slower equipment cycle times.

Ethanol and feed shipments were higher due to increased demand in those markets.

Chemicals volume rose as growth in shipments of solid waste and natural gas liquids more than offset declines in petroleum.

Volume gains for solid waste and natural gas liquids were driven by increased growth with existing customers.

Petroleum volume declined as a result of reduced demand.

Metals and construction volume fell, largely the result of decreased shipments of coil steel, iron and steel driven by commodity pricing and slower equipment cycle times.

These declines were partially offset by higher aggregates traffic due to strong demand and rebuilding inventories.

Automotive volume declined due to plant shutdowns, as a result of the global microchip shortage, and slower equipment cycle times.

Should the current fuel price environment persist for the remainder of 2022, we expect fuel surcharge revenue to continue to be higher than 2021.

Merchandise revenues increased in both periods due to higher average revenue per unit, driven by higher fuel surcharge revenue and increased pricing, partially offset by decreased volume.

Volumes fell in both periods as declines in metals and construction and agriculture, forest, and consumer products shipments more than offset higher chemical shipments.

Agriculture, forest and consumer products volume decreased in both periods, as declines in corn, fertilizers, and pulp more than offset increases in soybeans and feed.

Decreased corn and pulp shipments were due to service disruptions.

Lower fertilizer shipments were due to high fertilizer prices causing customers to draw down on existing inventories or delay purchases.

Soybean volumes were higher due to increased opportunity for exports and feed shipments were up because of increased customer demand.

Chemicals volume rose in both periods due to growth in shipments of sand and solid waste, driven by growth with existing customers.

Metals and construction volume fell in both periods, largely the result of decreased shipments of coil steel, iron and steel, aggregates, scrap metal, and cement driven by commodity pricing, service disruptions and slower equipment cycle times.

Automotive volume increased in the second quarter but decreased for the first six months.

Higher shipments in the second quarter were primarily due to production shutdowns in the prior year caused by parts supply issues.

Volumes for the first six months were impacted by plant shutdowns, as a result of the global microchip shortage, and slower equipment cycle times.

Merchandise revenues for the remainder of the year are expected to be higher due to increased average revenue per unit, driven by higher fuel surcharge revenue and pricing gains, and volume growth.

Intermodal revenues increased, driven by higher average revenue per unit, a result of higher fuel surcharge revenues, pricing gains and storage service charges, partially offset by lower volume.

Intermodal revenues increased in both periods, driven by higher average revenue per unit, a result of higher fuel surcharge revenues, pricing gains and storage service charges, partially offset by lower volume.

Intermodal units (in thousands) by market were as follows:

First Quarter

2022 2021 % change

Second Quarter First Six Months

2022 2021 % change 2022 2021 % change

Domestic 670.4 661.9 1% 1,323.8 1,300.9 2%

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Total 1,016.5 1,062.6 (4%) 1,973.0 2,079.0 (5%)

Domestic volume rose due to strong demand, partially offset by labor and capacity constraints, overall supply chain congestion, and limited chassis availability.

International volume decreased as supply chain constraints with warehousing, drayage, terminals, ports, labor, and equipment more than offset strong consumer demand.

Intermodal revenues for the remainder of the year are expected to rise, driven by increased fuel surcharge revenue, pricing gains, and volume growth, partially offset by lower storage service revenues.

Coal revenues increased due to higher average revenue per unit, driven by pricing gains and higher fuel surcharge revenue.

Domestic volume rose slightly due to strong demand, partially offset by service disruptions and limited chassis availability.

International volume decreased as supply chain constraints with terminals, ports, labor, and chassis availability, as well as excess inventory in the warehousing retail sector more than offset strong consumer demand.

Intermodal revenues for the remainder of the year are expected to rise, driven by increased fuel surcharge revenue, volume growth, and pricing gains, partially offset by lower storage service revenues.

Coal revenues increased in both periods due to higher average revenue per unit, driven by pricing gains and higher fuel surcharge revenue, partially offset by lower volume.

Coal tonnage (in thousands) by market was as follows:

First Quarter

2022 2021 % change

Second Quarter First Six Months

2022 2021 % change 2022 2021 % change

Utility 8,267 8,563 (3%) 17,228 17,109 1%

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Total 18,646 19,339 (4%) 37,254 37,964 (2%)

Coal tonnage was flat due to increased utility volume, offset by reduced export, domestic metallurgical, and industrial tonnage.

Utility tonnage increased due to strengthened market conditions driven by increased natural gas prices and the need to replenish depleted inventories.

Coal tonnage declined in both periods primarily due to decreased domestic metallurgical tonnage.

While utility tonnage increased slightly for the first six months, it experienced a decrease in the second quarter due to service disruptions and tight coal supply.

Export tonnage decreased due to service disruptions and tight coal supply.

Domestic metallurgical coal tonnage fell due to reduced coke shipments related to customer sourcing changes.

Industrial coal tonnage decreased due to sourcing challenges with coal supply.

Coal revenues for the remainder of the year are expected to rise due to increased revenue per unit, driven by increased fuel surcharge revenue and pricing gains.

Volumes are expected to remain flat.

Industrial coal tonnage increased in both periods due to increased demand.

Coal revenues for the remainder of the year are expected to rise due to increased volumes.

Railway Operating Expenses

Railway operating expenses summarized by major classifications follow ($ in millions):

First Quarter

2022 2021 % change

Second Quarter First Six Months

2022 2021 % change 2022 2021 % change

Compensation and benefits $ 614 $ 624 (2%) $ 1,233 $ 1,235 —%

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Total $ 1,979 $ 1,632 21% $ 3,809 $ 3,256 17%

Compensation and benefits expense increased as follows:

• increased pay rates (up $10 million),

• overtime (up $9 million),

• stock-based and incentive compensation (up $8 million),

• employee activity levels (down $17 million), and

• other (down $2 million).

Average rail headcount for the quarter was down by over 500 compared with the first quarter of 2021, but up over 200 compared to the fourth quarter of 2021.

Purchased services and rents increased as follows ($ in millions):

First Quarter

2022 2021 % change

Compensation and benefits expense decreased in both periods as follows:

• incentive and stock-based compensation (down $32 million for the quarter and $24 million for the first six months),

• employee activity levels (up $2 million for the quarter but down $15 million for the first six months),

• overtime (up $4 million for the quarter and $13 million for the first six months),

• increased pay rates (up $11 million for the quarter and $21 million for the first six months), and

• other (up $5 million for the quarter and $3 million for the first six months).

Average rail headcount for the quarter was up by over 100 compared with the second quarter of 2021, and up over 600 compared with the fourth quarter of 2021.

Purchased services and rents increased in both periods as follows ($ in millions):

Second Quarter First Six Months

2022 2021 % change 2022 2021 % change

Purchased services $ 387 $ 352 10% $ 736 $ 670 10%

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Total $ 481 $ 429 12% $ 918 $ 822 12%

Purchased services increased due to higher intermodal-related expenses, technology costs, as well as, increased operational and transportation expenses.

Equipment rents increased due to lower equity in TTX earnings, increased automotive equipment expenses and greater time-and-mileage expense, partially offset by decreased intermodal equipment expenses.

Fuel expense, which includes the cost of locomotive fuel as well as other fuel used in railway operations, increased due to higher locomotive fuel prices (up 77%), partially offset by decreased consumption (down 2%).

Should the current fuel price environment persist for the remainder of 2022, we expect higher fuel expenses compared to 2021.

Materials and other expenses increased as follows ($ in millions):

First Quarter

2022 2021 % change

Purchased services increased in both periods due to inflationary pressures which resulted in higher intermodal-related expenses, increased operational and transportation expenses, as well as, higher technology-related costs.

Equipment rents increased in both periods as lower network fluidity led to greater time-and-mileage expenses and increased automotive equipment expenses.

Additionally, both periods had lower equity in TTX earnings.

Fuel expense, which includes the cost of locomotive fuel as well as other fuel used in railway operations, increased in both periods due to higher locomotive fuel prices (up 124% in the second quarter and 102% in the first six months), partially offset by decreased consumption (down 3% in both the second quarter and first six months).

Should the current fuel price environment persist for the remainder of 2022, we expect fuel expenses to continue to be higher compared to 2021.

Materials and other expenses increased in both periods as follows ($ in millions):

Second Quarter First Six Months

2022 2021 % change 2022 2021 % change

Materials $ 70 $ 61 15% $ 132 $ 122 8%

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Total $ 172 $ 97 77% $ 343 $ 248 38%

Materials expense remained relatively flat.

Claims expense increased as a result of higher costs associated with personal injuries.

Other expense increased due to higher sales and use taxes and travel expenses.

Gains from operating property sales, included in Other, totaled $6 million and $4 million in 2022 and 2021, respectively.

Materials expense increased in both periods due to increased track and freight car materials costs.

Locomotive maintenance costs were also higher in the second quarter.

Claims expense increased in both periods as a result of higher costs associated with personal injuries, environmental remediation matters, and derailments.

Other expense increased in both periods due to lower gains from operating property sales and litigation-related expenses.

Gains from operating property sales totaled $28 million and $67 million for the second quarters of 2022 and 2021, respectively, and $34 million and $71 million in the first six months of 2022 and 2021, respectively.

Other income (expense) – net

Other income (expense) – net decreased $12 million due to lower net returns on corporate-owned life insurance (COLI) partially offset by a higher net pension benefit.

The first-quarter effective tax rate was 22.9% compared with 22.3% in the same period last year.

The effective rate for 2022 reflects lower tax benefits on stock-based compensation and returns on COLI.

Other income (expense) – net decreased $49 million in the second quarter and $61 million for the first six months.

Both periods experienced lower net returns on COLI partially offset by a higher net pension benefit.

The second-quarter and six month effective tax rates for 2022 were 24.7% and 23.9%, compared with 21.3% and 21.8%, respectively, for the same periods last year.

The increases in the effective rates for 2022 reflect lower returns on COLI and lower tax benefits on stock-based compensation.

Additionally, in 2021, we recognized a $23 million reduction in deferred taxes associated with a state tax law change.

On July 8, 2022, House Bill 1342 was signed into law in the Commonwealth of Pennsylvania, making significant changes to its corporate income tax rate.

The bill reduces its corporate income tax rate from 9.99% to 4.99%, with reductions occurring in phases beginning each tax year from January 1, 2023 through January 1, 2031.

GAAP requires companies to recognize the effect of tax law changes in the period of enactment.

As a result, it is expected that there will be a decrease in “Deferred income taxes” on the Consolidated Balance Sheet and a corresponding decrease in “Income taxes” on the Income Statement in the third quarter of 2022.

We currently estimate that the impact will be approximately $135 million.

FINANCIAL CONDITION AND LIQUIDITY

Cash provided by operating activities, our principal source of liquidity, was $1.0 billion for both the first three months of 2022 and 2021.

We had negative working capital of $132 million and $354 million at March 31, 2022 and December 31, 2021, respectively.

Cash and cash equivalents totaled $1.6 billion at March 31, 2022.

Cash used in investing activities was $335 million for the first three months of 2022, compared with $202 million for the same period last year.

Cash provided by operating activities, our principal source of liquidity, was $2.0 billion for the first six months of 2022, compared with $2.1 billion for the same period of 2021.

We had working capital of $248 million and negative working capital of $354 million at June 30, 2022 and December 31, 2021, respectively.

Cash and cash equivalents totaled $1.3 billion at June 30, 2022.

Cash used in investing activities was $714 million for the first six months of 2022, compared with $529 million for the same period last year.

The increase was primarily driven by higher property additions.

Cash provided by financing activities was $73 million for the first three months of 2022, while $930 million was used in financing activities for the same period last year, reflecting increased proceeds from borrowing and lower debt repayments, partially offset by higher dividends.

We repurchased $600 million of Common Stock in the first three months of 2022 compared to $591 million in the same period last year.

On March 29, 2022, our Board of Directors authorized a new program for the repurchase of up to an additional $10.0 billion of Common Stock beginning April 1, 2022.

Cash used in financing activities was $877 million for the first six months of 2022, while $1.0 billion was used in financing activities for the same period last year, reflecting increased proceeds from borrowing partially offset by higher debt repayments and dividends.

We repurchased $1.5 billion of Common Stock in the first six months of both 2022 and 2021.

On March 29, 2022, our Board of Directors authorized a new program for the repurchase of

up to an additional $10.0 billion of Common Stock beginning April 1, 2022.

Our previous share repurchase program terminated on March 31, 2022.

The timing and volume of future share repurchases will be guided by our assessment of market conditions and other pertinent factors.

Repurchases may be executed in the open market, through derivatives, accelerated repurchase and other negotiated transactions and through plans designed to comply with Rule 10b5-1(c) under the Securities and Exchange Act of 1934 .

Any near-term purchases under the program are expected to be made with internally-generated cash, cash on hand, or proceeds from borrowings.

In February 2022, we issued $600 million of 3.00% senior notes due 2032 and $400 million of 3.70% senior notes due 2053.

Our debt-to-total capitalization ratio was 52.4% at March 31, 2022, and 50.4% at December 31, 2021.

We have in place and available an $800 million credit agreement expiring in March 2025, which provides for borrowings at

prevailing rates and includes covenants.

We had no amounts outstanding under this facility at March 31, 2022 or December 31, 2021.

We also have in place an accounts receivable securitization program with a maximum borrowing capacity of $400 million.

Our debt-to-total capitalization ratio was 53.4% at June 30, 2022, and 50.4% at December 31, 2021.

In June 2022, we issued $750 million of 4.55% senior notes due 2053.

In May 2022, we renewed our accounts receivable securitization program with a maximum borrowing capacity of $400 million.

The term expires in May 2023.

We had no amounts outstanding under this program and our available borrowing capacity was $400 million at both March 31, 2022, and December 31, 2021.

In addition, we have investments in general purpose corporate-owned life insurance policies and had the ability to borrow against these policies up to $675 million and $715 million at March 31, 2022 and December 31, 2021, respectively.

We had no amounts outstanding under this program and our available borrowing capacity was $400 million at both June 30, 2022, and December 31, 2021.

In February 2022, we issued $600 million of 3.00% senior notes due 2032 and $400 million of 3.70% senior notes due 2053.

We also have in place and available an $800 million credit agreement expiring in March 2025, which provides for borrowings at prevailing rates and includes covenants.

We had no amounts outstanding under this facility at June 30, 2022 or December 31, 2021.

In addition, we have investments in general purpose corporate-owned life insurance policies and had the ability to borrow against these policies up to $630 million and $715 million at June 30, 2022 and December 31, 2021, respectively.

We expect cash on hand combined with cash provided by operating activities will be sufficient to meet our ongoing obligations.

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Nonetheless, we are monitoring the ongoing impacts of the COVID-19 pandemic, which could lead to a decline of cash inflows from operations.

There have been no material changes to the information on future contractual obligations, including those that may have material cash requirements, contained in our Form 10-K for the year ended December 31, 2021, with the exception of additional senior notes (see Note 7) and $1.0 billion of additional unconditional purchase obligations, which extend through 2025.

There have been no material changes to the information on future contractual obligations, including those that may have material cash requirements, contained in our Form 10-K for the year ended December 31, 2021, with the exception of additional senior notes (see Note 7) and approximately $1.0 billion of additional unconditional purchase obligations, which extend through 2025.

CRITICAL ACCOUNTING ESTIMATES

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Pursuant to the Railway Labor Act, these agreements remain in effect until new agreements are reached, or until the bargaining procedures mandated by the Railway Labor Act are completed.

We largely bargain nationally in concert with other major railroads, represented by the National Carriers’ Conference Committee.

Moratorium provisions in the labor agreements govern when the railroads and unions may propose changes to the agreements.

The current round of bargaining commenced on November 1, 2019, with both management and the unions serving their formal proposals for changes to the collective bargaining agreements, and negotiations are ongoing with the assistance of mediators assigned by the National Mediation Board.

We largely bargain nationally in concert with other major railroads, represented by the National Carriers’ Conference Committee.

After management and the unions served their formal proposals in November 2019 for changes to the collective bargaining agreements, negotiations began in 2020 following the expiration of the last moratorium.

On June 17, 2022, the National Mediation Board notified the parties that all practical methods of ending the dispute had been exhausted without effecting a settlement and that its mediation services had been terminated.

Although negotiations between the parties continue, this release allowed either party to engage in self-help (strike or lockout) after a 30-day cooling off period.

However, because the dispute threatens to interrupt commerce and deprive certain segments of the domestic economy of essential transportation service, President Biden created Presidential Emergency Board (PEB) No.

250, effective July 18, 2022, to investigate the facts of the dispute and make recommendations.

The creation of the PEB delays any potential self-help for 60 days while the PEB makes recommendations (expected 30 days from the date the PEB was created) and the parties engage in further negotiations (for a period of 30 days).

The outcome of the negotiations cannot be determined at this time;

however, if the dispute is not resolved during this final period of negotiations and either party rejects the recommendations of the PEB, self-help could occur in mid-September.

As has occurred during prior labor agreement negotiations, the parties could potentially reach an agreement during post-PEB negotiations, or Congress could take legislative action to preempt self-help and avert a service disruption.

A service disruption, depending on the duration, could have a material adverse effect on our financial position, results of operations, or liquidity.

In addition, changes in our labor agreements could significantly increase our costs for health care, wages, and other benefits.

New Accounting Pronouncements

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In preparing financial statements, GAAP requires the use of historical cost that disregards the effects of inflation on the replacement cost of property.

As a capital-intensive company, we have most of our capital invested in long-

lived assets.

As a capital-intensive company, we have most of our capital invested in long-lived assets.

The replacement cost of these assets, as well as the related depreciation expense, would be substantially greater than the amounts reported on the basis of historical cost.

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While we believe these expectations, assumptions, estimates, beliefs, and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks and uncertainties, many of which involve factors or circumstances that are beyond our control.

These and other important factors, including those discussed under “Risk Factors” in our latest Form 10-K, as well as our subsequent filings with the Securities and Exchange Commission, may cause actual results, performance, or achievements to differ materially from those expressed or implied by these forward-looking statements.

expressed or implied by these forward-looking statements.

The forward-looking statements herein are made only as of the date they were first issued, and unless otherwise required by applicable securities laws, we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis