<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________ to____________________
Commission file number 32-62756
SOUTHERN PACIFIC RAIL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 84-1092482
---------------------------- -----------------------
(State or other jurisdiction (I.R.S. employer
of organization) identification no.)
Southern Pacific Building
One Market Plaza
San Francisco, CA 94105
Telephone Number (415) 541-1000
Indicate by checkmark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Outstanding
Class at July 31, 1996
- --------------------------------------- -------------------
Common stock, $.001 par value per share 156,154,639 shares
<PAGE>
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SOUTHERN PACIFIC RAIL CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
1996 1995
-------- ------------
(in millions)
<S> <C> <C>
ASSETS
------
CURRENT ASSETS
Cash and cash equivalents.......................... $ 129.7 $ 105.8
Accounts receivable, net of allowance for
doubtful accounts................................ 102.8 104.1
Accounts receivable sales proceeds receivable...... 157.3 205.5
Materials and supplies, at cost.................... 79.6 76.0
Notes receivable................................... 7.3 7.7
Other current assets............................... 53.6 58.7
-------- --------
Total current assets............................. 530.3 557.8
-------- --------
REAL ESTATE HELD FOR SALE............................ 344.0 341.9
-------- --------
PROPERTY, AT COST
Roadway and structures............................. 2,719.0 2,584.2
Railroad equipment................................. 1,556.3 1,557.3
Other property..................................... 311.4 320.7
-------- --------
Total property................................... 4,586.7 4,462.2
Less accumulated depreciation and amortization..... 827.3 773.2
-------- --------
Property, net.................................... 3,759.4 3,689.0
-------- --------
OTHER ASSETS AND DEFERRED CHARGES
Note receivable and other investments.............. 84.6 85.6
Other.............................................. 79.0 75.1
-------- --------
Total other assets............................... 163.6 160.7
-------- --------
Total assets................................... $4,797.3 $4,749.4
======== ========
</TABLE>
(Continued)
See accompanying notes to consolidated condensed financial statements.
2
<PAGE>
SOUTHERN PACIFIC RAIL CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
1996 1995
-------- ------------
(in millions)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES
Accounts and wages payable......................... $ 186.2 $ 145.9
Accrued payables................................... 165.5 181.2
Current portion of long term debt.................. 57.4 58.9
Redeemable preference shares of a subsidiary....... 2.0 2.0
Other current liabilities.......................... 575.8 632.6
-------- --------
Total current liabilities........................ 986.9 1,020.6
-------- --------
LONG-TERM DEBT....................................... 1,776.7 1,699.3
-------- --------
DEFERRED INCOME TAXES................................ 237.4 218.6
-------- --------
OTHER LIABILITIES.................................... 691.1 729.9
-------- --------
REDEEMABLE PREFERENCE SHARES OF A
SUBSIDIARY......................................... 19.9 20.1
-------- --------
STOCKHOLDERS' EQUITY
Common stock....................................... 0.2 0.2
Additional paid-in capital......................... 1,122.2 1,121.8
Accumulated deficit................................ (37.1) (61.1)
-------- --------
Total stockholders' equity...................... 1,085.3 1,060.9
-------- --------
Total liabilities and stockholders' equity...... $4,797.3 $4,749.4
======== ========
</TABLE>
See accompanying notes to consolidated condensed financial statements.
3
<PAGE>
SOUTHERN PACIFIC RAIL CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
---------------- ----------------
1996 1995 1996 1995
---- ---- ---- ----
(in millions, except per share amounts)
<S> <C> <C> <C> <C>
OPERATING REVENUES
Railroad.......................................... $803.7 $782.8 $1,567.2 $1,527.0
Other............................................. 24.4 21.7 46.4 44.3
------ ------ -------- --------
Total........................................... 828.1 804.5 1,613.6 1,571.3
------ ------ -------- --------
OPERATING EXPENSES
Railroad.......................................... 747.3 723.2 1,458.7 1,411.6
Special charge (Note 5)........................... - 64.6 - 64.6
Other............................................. 25.1 21.6 46.0 43.3
------ ------ -------- --------
Total........................................... 772.4 809.4 1,504.7 1,519.5
------ ------ -------- --------
OPERATING INCOME (LOSS)............................. 55.7 (4.9) 108.9 51.8
------ ------ -------- --------
OTHER INCOME (EXPENSE)
Gains from sales of property and real estate...... 27.0 1.0 42.1 14.8
Real estate and other rentals, net................ 5.5 3.9 10.1 7.8
Interest.......................................... 2.3 2.8 4.8 6.5
Other expense, net................................ (17.7) (11.2) (38.6) (28.9)
------ ------ -------- --------
Total........................................... 17.1 (3.5) 18.4 0.2
------ ------ -------- --------
INTEREST EXPENSE.................................... 43.5 31.4 87.9 64.3
------ ------ -------- --------
INCOME (LOSS) BEFORE INCOME TAXES................... 29.3 (39.8) (39.4) (12.3)
------ ------ -------- --------
INCOME TAX (BENEFIT)
Current........................................... - (0.4) - (0.1)
Deferred.......................................... 11.4 (15.4) 15.4 (4.7)
------ ------ -------- --------
Total........................................... 11.4 (15.8) 15.4 (4.8)
------ ------ -------- --------
NET INCOME (LOSS)................................... $ 17.9 $(24.0) $ 24.0 $ (7.5)
====== ====== ======== ========
INCOME (LOSS) APPLICABLE TO
COMMON STOCKHOLDERS................................ $ 17.9 $(24.0) $ 24.0 $ (7.5)
====== ====== ======== ========
EARNING (LOSS) PER SHARE............................ $ 0.11 $(0.15) $ 0.15 $ (0.05)
====== ====== ======== ========
</TABLE>
See accompanying notes to consolidated condensed financial statements.
4
<PAGE>
SOUTHERN PACIFIC RAIL CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 1996
(Unaudited)
<TABLE>
<CAPTION>
Common Stock
----------------- Additional
Number of Paid-in Accumulated
Shares Amount Capital Deficit Total
------ ------ ---------- ----------- -----
(in millions)
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1995.............. 156 $0.2 $1,121.8 $(61.1) $1,060.9
Net income................................. - - - 24.0 24.0
Issuance of Common Stock................... - - 0.4 - 0.4
--- ---- -------- ------ --------
Balances at June 30, 1996.................. 156 $0.2 $1,122.2 $(37.1) $1,085.3
=== ==== ======== ====== ========
</TABLE>
See accompanying notes to consolidated condensed financial statements.
5
<PAGE>
SOUTHERN PACIFIC RAIL CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
----------------
1996 1995
---- ----
(in millions)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)............................................ $ 24.0 $ (7.5)
------- -------
Adjustments to net income (loss):
Gains from sales of property and real estate................ (42.1) (14.8)
Depreciation and amortization............................... 87.4 73.5
Deferred income taxes....................................... 15.4 (4.7)
Special charge.............................................. - 64.6
Other adjustments........................................... (16.5) (118.7)
------- -------
Total adjustments.......................................... 44.2 (0.1)
------- -------
Net cash provided by (used for) operating activities........ 68.2 (7.6)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Property sold and retired.................................... 52.9 16.7
Capital expenditures......................................... (154.7) (174.8)
Decrease in short-term investments........................... - 95.0
Change in notes receivable and other investments, net........ (2.4) (5.8)
------- -------
Net cash used for investing activities...................... (104.2) (68.9)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of debt, net of costs................. 100.0 25.0
Debt and revolver repayment.................................. (39.2) (71.4)
Redeemable preference shares repayment....................... (0.9) (0.8)
------- -------
Net cash provided by (used for) financing activities........ 59.9 (47.2)
------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS....................... 23.9 (123.7)
CASH AND CASH EQUIVALENTS-BEGINNING OF THE PERIOD............. 105.8 145.6
------- -------
CASH AND CASH EQUIVALENTS-END OF THE PERIOD................... $ 129.7 $ 21.9
======= =======
</TABLE>
See accompanying notes to consolidated condensed financial statements.
6
<PAGE>
SOUTHERN PACIFIC RAIL CORPORATION AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
JUNE 30, 1996
(UNAUDITED)
(1) OWNERSHIP AND PRINCIPLES OF CONSOLIDATION
-----------------------------------------
Southern Pacific Rail Corporation ("SPRC") is the parent company of
Southern Pacific Transportation Company ("SPT"), which includes St. Louis
Southwestern Railway Company ("SSW"), SPCSL Corp. ("SPCSL") and The Denver and
Rio Grande Western Railroad Company ("D&RGW"). SPRC together with its
subsidiaries is referred to as the Company. The consolidated financial
statements are prepared on the purchase accounting basis and include the
accounts of the Company and its subsidiaries on a consolidated basis. The
railroad subsidiaries report their financial position and results of operations
on the historical cost basis. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
These consolidated condensed financial statements should be read in
conjunction with the consolidated financial statements and notes thereto for the
year ended December 31, 1995. In the opinion of management, all adjustments
(consisting of normal, recurring accruals) necessary for a fair presentation of
interim period results have been included. However, these results are not
necessarily indicative of results for a full year.
(2) RECLASSIFICATIONS
-----------------
Certain of the prior period amounts have been reclassified to conform to
the June 30, 1996 consolidated condensed financial statement presentation.
(3) MERGER WITH UNION PACIFIC
-------------------------
On August 3, 1995, the Board of Directors of SPRC approved an agreement
providing for the merger of SPRC and the Union Pacific Railroad Company
("UPRR"), a wholly-owned subsidiary of Union Pacific Corporation ("UP"). Under
the terms of the agreement, a subsidiary of UP acquired 25% of the common stock
of SPRC at a price of $25.00 per share pursuant to a tender offer. The merger
was approved in an oral voting conference by the Surface Transportation Board
("STB") of the Department of Transportation (successor to the Interstate
Commerce Commission ("ICC")) on July 3, 1996. At that time, the STB announced
the following decision: to approve the merger subject to a number of conditions,
principally (a) a settlement agreement between UP/SP and BNSF (as defined
herein) under which BNSF will receive trackage rights over more than 4,000 miles
of UP/SP track and will purchase over 300 miles of UP/SP lines, augmented in a
number of ways to expand BNSF's ability to gain access to traffic (e.g., through
transloading facilities (facilities where goods are transferred between trucks
and railcars) and build-ins of rail lines to exclusively-served customers,
through serving new shipper facilities on the lines over which it will have
trackage rights, and through opening to BNSF 50% of all traffic now committed
under contracts to UP or SP by shippers served by UP and SP and no other
railroad), (b) a settlement agreement between UP/SP and the Chemical
Manufacturers Association which provides certain additional protections to
shippers, (c) a settlement agreement between UP/SP and Utah Railway Company
("Utah Railway") under which Utah Railway will receive access to certain coal
mines and loading facilities in Utah and trackage rights over SP from Utah
Railway's line in Utah to Grand Junction, Colorado, (d) the grant of trackage
rights to the Texas Mexican Railway ("Tex Mex") over UP/SP lines between Corpus
7
<PAGE>
Christi/Robstown, Texas, and Beaumont, Texas, via Houston, Texas, restricted to
traffic moving on Tex Mex's Laredo-Corpus Christi/Robstown line, including
terminal-area trackage rights in Houston, (e) environmental mitigation
conditions, including a condition restricting increases in train volumes through
Reno, Nevada, and Wichita, Kansas, for 18 months following the merger while a
consultant conducts a study of possible measures to reduce the potential adverse
impact of increased rail traffic through those communities and the STB decides
upon such measures, (f) standard labor protective conditions and (g) a 5-year
oversight process, pursuant to which the STB will review whether the conditions
imposed on the merger have effectively addressed competitive issues.
Consummation of the merger remains subject to issuance of a final written order
by the STB, which is expected by August 12, 1996. Upon issuance of that order,
the two companies would be permitted to close the transaction 30 days later. If,
as expected, the written order does not contain terms materially different from
those voted upon by the STB on July 3, 1996, UP has indicated that it expects to
proceed with the transaction in accordance with and subject to the terms and
conditions of the Amended Merger Agreement.
A Special Meeting of the stockholders of SPRC will be held on August 16,
1996 for the purpose of voting on the approval and adoption of an Amended and
Restated Agreement and Plan of Merger, dated as of July 12, 1996 (the "Amended
Merger Agreement"), by and among SPRC, UP, UPRR, UP Holding Company, Inc., a
wholly owned subsidiary of UP ("Holding") and Union Pacific Merger Co., a wholly
owned subsidiary of UP ("Mergerco"). The Amended Merger Agreement amends and
restates the Agreement and Plan of Merger, dated as of August 3, 1995, as
amended (the "Original Merger Agreement"), by and among SPRC, UP, UPRR and UP
Acquisition Corporation, a former indirect wholly owned subsidiary of UP, that
was approved and adopted by the SPRC stockholders at a special meeting of SPRC
stockholders on January 17, 1996, pursuant to which SPRC would be merged into
UPRR. Pursuant to the Amended Merger Agreement, among other things, (i) SPRC
will be merged with and into UPRR, with UPRR as the surviving corporation, as
provided in the Original Merger Agreement, or, in the alternative, SPRC will be
merged with and into either Holding or Mergerco, with Holding or Mergerco as the
surviving corporation (such alternative mergers hereinafter referred to as the
"Merger"), and (ii) as also provided in the Original Merger Agreement, each
share of SPRC common stock, par value $.001 per share, will be converted into
the right to receive, in accordance with the election to be filed by each
stockholder, (a) $25.00 per Share in cash, without interest thereon, (b) .4065
shares of Union Pacific common stock, par value $2.50 per share, or (c) a
combination thereof, all as more fully set forth in the Amended Merger
Agreement. Of the shares of SPRC common stock outstanding immediately prior to
the merger (other than the shares previously acquired by UP in the tender
offer), 20% would be acquired for cash and 80% would be acquired in exchange for
shares of UP common stock.
The reason for the alternative structure is to maximize UP's flexibility
after the merger in achieving additional service improvements and operating
efficiencies, while maintaining the same tax consequences to SPRC stockholders.
The amendment to the Merger Agreement will have no substantive impact on SPRC
stockholders. Except for the UP subsidiary with which SPRC could be merged, all
aspects of the Merger, including the UP common stock and cash to be received by
SPRC stockholders, remain unchanged.
The merger agreement provides that prior to completion of the merger, or
termination of the merger agreement if that occurs before the merger is
completed, the business of the Company and its subsidiaries generally will be
conducted in the ordinary course of business consistent with past practice, or
pursuant to "customary actions". Customary actions are defined as actions in the
ordinary course of a person's business where the action is generally recognized
as being customary and prudent for other major enterprises in the person's line
of business. The merger agreement may be terminated by the Board of Directors of
either the Company or UP if the merger has not occurred on or prior to March 31,
1997. The agreement restricts the Company, with certain exceptions, from
amending its articles or bylaws, paying dividends, issuing stock, redeeming or
repurchasing shares of its stock, making compensation changes, making loans,
advances, capital contributions or investments (except for railroad and real
estate joint ventures and certain other transactions) and engaging in
transactions with affiliates. In addition, among other things, the agreement
restricts the Company from incurring debt other than pursuant to arrangements
existing on the date of the merger
8
<PAGE>
agreement (the Company's $450 million of bank credit facilities and replacements
therefor and refinancings thereof, and capital leases to finance the rebuilding
of freight cars and purchase of equipment under existing commitments), plus
borrowings not to exceed $25 million in the fiscal year ending December 31,
1996, and $12.5 million in the fiscal quarter ending March 31, 1997.
The Company has incurred expenses of $18.7 million in 1995 and 1996
associated with the proposed merger and, if the merger is completed, has
committed to continuity, enhanced severance for certain employees and
transaction expenses of up to an additional $40 million. The accompanying
financial statements do not include accruals for merger expenses or adjustments
relating to decisions regarding the Company's operations and assets that might
result from the merger.
(4) SUPPLEMENTAL CASH FLOW INFORMATION
----------------------------------
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------
1996 1995
---- ----
(in millions)
<S> <C> <C>
Cash payments:
Interest......................................... $92.6 $ 46.6
Income taxes..................................... (4.2) 1.2
Non-cash transactions:
Capital lease obligations for rail equipment..... 13.6 359.3
Issuance of common stock......................... 0.4 5.8
</TABLE>
(5) SPECIAL CHARGE
--------------
In June 1995, the Board of Directors approved plans aimed at reducing
future operating costs and increasing productivity which resulted in a $64.6
million pretax charge. Approximately $41 million of the charge is related to
severance payments to be made for approximately 582 employees (both management
and labor), approximately $4 million of the charge is related to costs
associated with terminating certain leased facilities, and approximately $20
million is for the expected loss associated with the sale, lease or abandonment
of 600 miles of light density rail lines. Through the first six months of 1996,
severance payments totaling $4.3 million for 83 employees whose positions have
been terminated have been charged to the severance reserve. As a result of the
July 3, 1996 decision approving the merger, the Company has suspended its plans
for the severance and relocation of a substantial portion of these employees.
The Company continues to review these plans pending receipt and review of a
written merger decision on August 12, 1996 and closing of the merger.
(6) LONG TERM DEBT
--------------
Certain of the Company's debt agreements contain quarterly financial
covenants and restrictions based on minimum tangible net worth, a maximum funded
debt to net worth ratio and a minimum fixed charge coverage ratio. As a result
of not achieving certain ratios and covenants in its $375 million Senior Notes
at December 31, 1995, the Company is restricted in incurring additional
indebtedness, except for certain limited categories of debt, including $200
million available under its revolving bank credit facility. Because continued
compliance with the financial terms and covenants under its bank credit
facilities would require more gains than was contemplated from the sales of
properties in the first and second quarters of 1996, the Company and its banks
amended those covenants through the second quarter of 1996 to eliminate the
fixed charge coverage test for these periods. Effective as of the end of the
third quarter, the fixed charge coverage test must be satisfied. If the merger
were not consummated in the third quarter of 1996 and the Company's earnings did
not meet the reinstated fixed charge coverage test as of the end of that
quarter, the Company would
9
<PAGE>
be in default on both its revolver and term loan unless it were able to obtain
waivers or amendments to its loan agreements. Management of the Company
currently does not believe the Company will meet its revised financial covenants
in 1996, unless property sales significantly exceed current expectations. If
these covenants were not satisfied, there is no assurance that necessary waivers
and amendments could be obtained. If the Company were unable to meet these
covenants, or obtain waivers or amendments, substantially all of the Company's
outstanding indebtedness could be declared in default and payment thereon
accelerated, creating a serious liquidity problem.
(7) COMMITMENTS AND CONTINGENCIES
-----------------------------
The Company is subject to Federal, state and local environmental laws and
regulations and is currently participating in the investigation and remediation
of numerous sites. Where the remediation costs can be reasonably determined, and
where such remediation is probable, the Company has recorded a liability. It is
possible that additional losses will be incurred, but such amounts cannot be
reasonably estimated. The Company does not believe that disposition of
environmental matters known to the Company will have a material adverse effect
on the Company's financial condition or liquidity; however, there can be no
assurance that the impact of these matters on its results of operations for any
given reporting period will not be material.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
- ---------------------
Three Months Ended June 30, 1996 Compared to Three Months Ended June 30,
------------------------------------------------------------------------
1995
- ----
The Company had net income of $17.9 million ($.11 per share) for the second
quarter of 1996 compared to a net loss of $24.0 million ($.15 per share) for the
second quarter of 1995. The 1995 amount included a $64.6 million pre-tax special
charge. The Company had operating income of $55.7 million for the second quarter
of 1996 compared to an operating loss of $4.9 million for the 1995 quarter (an
operating income of $59.7 million for the 1995 quarter excluding the special
charge). For the second quarter of 1996, railroad operating revenues increased
2.7% and railroad operating expenses decreased 5.1% compared to the 1995 period
(including the 1995 special charge). Excluding the 1995 special charge, 1996
railroad operating expenses for the second quarter increased by 3.3% compared to
the second quarter of 1995.
Operating Revenues. In the second quarter of 1996, railroad operating revenues
- ------------------
increased $20.9 million, or 2.7%, compared to the second quarter of 1995.
Railroad freight operating revenues increased $26.1 million, or 3.4%, due to
stable or increased shipments of all commodities with the exception of coal
shipments which declined 7.5% due primarily to a mine closure and temporary
downtime at other mines. The improvement in railroad freight operating revenues
in the 1996 quarter is in part due to comparison to a weak performance in the
1995 quarter as a result of bad weather in the spring of 1995. Other railroad
revenues (primarily demurrage and incidental) decreased $5.2 million during the
second quarter of 1996 compared to the 1995 quarter. For the second quarter of
1996, carloads increased 2.3% and revenue ton-miles increased 7.4% compared to
the same period in 1995. The average net freight revenue per ton-mile for the
second quarter of 1996 declined by 3.7% compared to the second quarter of 1995
due principally to an increase in traffic volume for commodities that generate
lower revenue per ton-mile (e.g., iron ore and aggregates traffic).
The following table compares traffic volume (in carloads), gross freight
revenues (before contract allowances and adjustments) and gross freight revenue
per carload by commodity group for the three months ended June 30, 1996 and
1995.
10
<PAGE>
CARLOAD AND GROSS FREIGHT REVENUE COMPARISON
THREE MONTHS ENDED JUNE 30, 1996 AND 1995
<TABLE>
<CAPTION>
Gross Freight
Carloads Gross Freight Revenues Revenue Per Carload
------------------------- ------------------------- --------------------------
Commodity Group 1996 1995 % Change 1996 1995 % Change 1996 1995 % Change
--------------- ---- ---- -------- ---- ---- -------- ---- ---- --------
(in thousands) (dollars in millions, except revenue per carload)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Intermodal................... 183.0 178.2 2.7 % $220.9 $209.0 5.7 % $1,207 $1,172 3.0 %
Chemical and petroleum
products.................... 90.1 82.8 8.8 155.7 148.6 4.8 1,728 1,795 (3.7)
Coal......................... 87.5 94.6 (7.5) 87.9 92.5 (5.0) 1,005 978 2.7
Food and agricultural
products.................... 59.7 59.8 (0.2) 103.7 103.9 (0.2) 1,737 1,739 (0.1)
Forest products.............. 55.0 53.6 2.6 106.0 101.0 5.0 1,927 1,885 2.2
Metals and ores.............. 53.1 52.4 1.3 80.0 77.7 3.0 1,507 1,483 1.6
Construction materials and
minerals.................... 54.5 50.4 8.1 51.7 47.4 9.1 949 940 0.9
Automotive................... 22.9 20.2 13.4 50.2 46.2 8.7 2,190 2,294 (4.5)
----- ----- ------ ------
Total.............. 605.8 592.0 2.3 % $856.1 $826.3 3.6 % $1,413 $1,396 1.2 %
===== ===== ====== ======
</TABLE>
. Intermodal carloads and revenue increased for the second quarter of
1996 compared to the same period in 1995 due to increases in container-
on-flatcar ("COFC") traffic from both international and domestic
sources as well as trailer-on-flatcar ("TOFC") traffic which is
recovering from a depressed level during the second quarter of 1995.
Revenue per carload increased due to changes in commodity mix and
increased length of haul for TOFC traffic.
. Chemical and petroleum products carloads and revenue increased during
the second quarter of 1996 compared to the same period in 1995 due to
increased traffic in environmental wastes, crude oil, plastics, soda
ash, chlorine and fertilizers. The second quarter of 1995 was affected
by California and Texas flooding as well as changing customer shipping
patterns for crude oil. Revenue per carload decreased for the 1996
quarter from the 1995 quarter due primarily to changes in the commodity
and customer mix.
. Coal carloads and revenue decreased for the 1996 period due to a mine
closure and temporary mine downtime during 1996 as well as to changes
in customer mix. Revenue per carload increased for 1996 due to changes
in length of haul and customer mix.
. Food and agricultural products carloads and revenue declined slightly
for the 1996 quarter compared to the 1995 quarter due to declines in
grain and grain products that resulted from reduced crop harvests and
shifting demand patterns during 1996. These declines were partially
offset by increased shipments of canned goods, temperature control
products, sugar beets and alcoholic beverages.
. Forest products carloads and revenue increased during the second
quarter of 1996 due to strong demand for lumber stock and
particleboard, commodities that were depressed by a soft construction
market and severe weather impacts in the second quarter of 1995. These
increases in 1996 were partially offset by decreased shipments of
newsprint, printing papers, wood pulp, scrap paper and woodchips. The
revenue per carload increase was due largely to an increased share of
the higher revenue per car lumber traffic in the commodity mix as well
as increased length of haul for plywood and paperboard.
11
<PAGE>
. Carloads and revenue for metals and ores traffic increased in the
second quarter of 1996 compared to the second quarter of 1995 due to
growth in mini-mill traffic associated with strong construction demand
in California, increased iron ore and scrap traffic and strong sulfuric
acid volumes.
. Construction materials and minerals carloads and revenues increased
for the 1996 period due to increased shipments of aggregates, minerals,
and miscellaneous building materials.
. Automotive carloads and revenue increased during the 1996 period due
to strength in the Mexico market as well as to the addition of selected
new traffic. Revenue per carload declined during the second quarter of
1996 due to customer and market mix changes as well as to competitive
rate pressure.
Operating Expenses. Railroad operating expenses for the second quarter of 1996
- -------------------
decreased $40.5 million, or 5.1%, compared to the second quarter of 1995.
Excluding the 1995 special charge, 1996 railroad operating expenses for the
second quarter increased by 3.3% compared to the second quarter of 1995. The
following table sets forth a comparison of the Company's railroad operating
expenses during the three months ended June 30, 1996 and 1995.
RAILROAD OPERATING EXPENSE COMPARISON
THREE MONTHS ENDED JUNE 30, 1996 AND 1995
<TABLE>
<CAPTION>
1996 1995 % Change
---- ---- --------
(in millions)
<S> <C> <C> <C>
Compensation and benefits....... $282.8 $280.8 0.7 %
Fuel............................ 80.8 65.2 23.9
Materials and supplies.......... 37.5 47.9 (21.7)
Equipment rental................ 86.4 80.3 7.6
Depreciation and amortization... 43.9 38.9 12.9
Other........................... 215.9 210.1 2.8
Special charge.................. - 64.6 (100.0)
------ ------
Total...................... $747.3 $787.8 (5.1) %
====== ======
</TABLE>
. Compensation and benefit costs increased $2.0 million, or 0.7%, for
the second quarter of 1996 compared to the second quarter of 1995. The
increased costs were due primarily to increased transportation labor as
revenue ton-miles increased 7.4% , gross ton-miles increased 6.6% and
carloads increased 2.3% in the 1996 quarter compared to the second
quarter of 1995. Train crew starts increased 2.4% for the second
quarter of 1996 compared to the 1995 quarter. The Company decreased
employment by 1.0% to a total of 18,840 as of the end of June 1996
compared to 19,028 at the end of June 1995. Expressed as a percentage
of operating revenues, compensation and benefit expenses were 34.2% for
the second quarter of 1996 compared to 34.9% for the second quarter of
1995.
. Fuel expenses increased $15.6 million, or 23.9%, for the second
quarter of 1996 compared to the same period in 1995. The increase was a
result of a 22.4% increase in the average price per gallon of fuel from
$.58 during the 1995 quarter to $.70 during the 1996 quarter, coupled
with a 1.3% increase in gallons consumed for the 1996 quarter compared
to the 1995 quarter. Effective April 1, 1996, the Company had no fuel
hedging agreements in place. Fuel expense for the 1995 quarter includes
not only amounts paid to the Company's suppliers, but also $0.2 million
paid under fuel hedging contracts. While total fuel expense
12
<PAGE>
increased for the 1996 quarter, fuel efficiency also increased by 5.9%
as measured by gallons consumed per gross ton-mile.
. Materials and supplies expenses decreased $10.4 million, or 21.7%,
for the second quarter of 1996 compared to the second quarter of 1995
due primarily to reduced locomotive material expenses and running
repairs and increased use of the power-by-the-mile maintenance program.
Locomotive overhauls charged to expense decreased from 37 locomotives
during the 1995 quarter to 12 locomotives during the 1996 quarter. In
addition, maintenance of way material expenses for signal and bridge
repairs decreased during the 1996 quarter compared to the 1995 quarter.
The Company is planning on overhauling fewer locomotive units during
1996 compared to prior years due to budgetary constraints, the
acquisition of locomotives in 1995 and the fact that fewer older units
remain to be overhauled.
. Equipment rental costs increased $6.1 million, or 7.6%, for the
second quarter of 1996 compared to the second quarter of 1995. The
increase was primarily attributable to an $11.7 million increase in car
hire associated with increases in traffic volume and cycle times,
partially offset by a $5.6 million reduction in locomotive lease
expenses during the 1996 quarter.
. Depreciation and amortization expense increased $5.0 million, or
12.9%, for the second quarter of 1996 due to an increase in the
depreciable property base principally from significant equipment
acquisitions during the latter part of 1995.
. Other expenses increased $5.8 million, or 2.8%, for the second
quarter of 1996 compared to the second quarter of 1995. This category
of expense includes outside repairs and services, joint facility rent
and maintenance costs, casualty costs and property and other taxes. The
second quarter 1996 increase is primarily due to a $5.2 million
increase in locomotive power-by-the-mile costs resulting from an
increase in the number of locomotive units subject to that maintenance
program and a $5.2 million increase in purchased maintenance of way
services, partially offset by a $2.8 million reduction in information
system outsourcing costs as well as reduced intermodal facility rent
and repair costs.
. In June 1995, the Company's Board of Directors approved plans aimed
at reducing future operating costs and increasing productivity, which
resulted in a $64.6 million pretax special charge. Approximately $41
million of the charge is related to severance payments to be made for
582 employees (both management and labor), approximately $4 million of
the charge is related to costs associated with terminating certain
leased facilities, and approximately $20 million is for the expected
loss on the sale, lease or abandonment of 600 miles of light density
rail lines. See "Liquidity and Capital Resources - Other".
Other Income (Expense) and Interest Expense. Other income (expense) was a net
- --------------------------------------------
income of $17.1 million for the second quarter of 1996 compared to a net expense
of $3.5 million for the same period in 1995. The increased net income was due
primarily to a $26.0 million increase in gains on sales of property, partially
offset by $5.3 million in expense during 1996 associated with the UPRR/SPRC
merger. Interest expense was $43.5 million for the second quarter of 1996
compared to $31.4 million for the second quarter of 1995, an increase of $12.1
million. The increase is due to the higher level of capitalized lease
obligations for new locomotives and freight cars outstanding during the second
quarter of 1996 combined with interest expense associated with the $150 million
term loan borrowed in September 1995.
13
<PAGE>
Six Months Ended June 30, 1996 Compared to Six Months Ended June 30, 1995
-------------------------------------------------------------------------
The Company had net income of $24.0 million ($.15 per share) for the firs
six months of 1996 compared to a net loss of $7.5 million ($.05 per share) for
the first six months of 1995. The 1995 amount included a $64.6 million pre-tax
special charge. The Company had operating income of $108.9 million for the first
half of 1996 compared to $51.8 million for the 1995 period (an operating income
of $116.4 million for the 1995 period excluding the special charge). For the
first six months of 1996, railroad operating revenues increased 2.6% and
railroad operating expenses decreased 1.2% compared to the 1995 period
(including the 1995 special charge). Excluding the 1995 special charge, railroad
operating expenses for the first six months of 1996 increased by 3.3% compared
to the first six months of 1995.
Operating Revenues. In the first six months of 1996, railroad operating
- ------------------
revenues increased $40.2 million, or 2.6%, compared to the first six months of
1995. Railroad freight operating revenues increased $52.4 million, or 3.6%, due
to stable or increased shipments of all commodities with the exception of coal
shipments which decreased 5.3% due primarily to a mine closure and temporary
downtime at other mines. The improvement in railroad freight operating revenues
in 1996 is in part due to comparison to a weak performance in 1995 as a result
of bad weather in the first half of 1995. Other railroad revenues (primarily
demurrage and incidental) decreased $12.2 million during the first half of 1996
compared to the 1995 period. For the first six months of 1996, carloads
increased 3.4% and revenue ton-miles increased 8.0% compared to the same period
in 1995. The average net freight revenue per ton-mile for the first half of 1996
declined by 4.1% compared to the first half of 1995 due principally to an
increase in traffic volume for commodities that generate lower revenue per ton-
mile (e.g., iron ore and aggregates traffic).
The following table compares traffic volume (in carloads), gross freight
revenues (before contract allowances and adjustments) and gross freight revenue
per carload by commodity group for the six months ended June 30, 1996 and 1995.
CARLOAD AND GROSS FREIGHT REVENUE COMPARISON
SIX MONTHS ENDED JUNE 30, 1996 AND 1995
<TABLE>
<CAPTION>
Gross Freight
Carloads Gross Freight Revenues Revenue Per Carload
-------------------------- -------------------------- ---------------------------
Commodity Group 1996 1995 % Change 1996 1995 % Change 1996 1995 % Change
--------------- ---- ---- -------- ---- ---- -------- ---- ---- --------
(in thousands) (dollars in millions, except revenue per carload)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Intermodal............................ 360.1 351.1 2.6 % $ 429.6 $ 414.0 3.8 % $1,193 $1,179 1.2 %
Chemical and petroleum products....... 174.7 160.1 9.1 304.0 290.9 4.5 1,740 1,817 (4.2)
Coal.................................. 171.9 181.6 (5.3) 169.0 175.5 (3.7) 983 966 1.7
Food and agricultural products........ 116.9 116.8 0.1 206.4 200.8 2.8 1,766 1,719 2.7
Forest products....................... 109.2 105.5 3.5 209.1 202.1 3.5 1,915 1,916 -
Metals and ores....................... 102.6 101.5 1.1 153.2 149.4 2.5 1,493 1,472 1.4
Construction materials and minerals... 104.1 91.3 14.0 98.0 87.7 11.7 941 960 (1.9)
Automotive............................ 46.0 39.0 17.9 103.0 90.6 13.7 2,241 2,324 (3.6)
------- ------- ------- -------
Total............................ 1,185.5 1,146.9 3.4 % $1,672.3 $1,611.0 3.8 % $1,411 $1,405 0.4 %
======= ======= ======== ========
</TABLE>
. Intermodal carloads and revenue increased for the first six months of
1996 compared to the same period for 1995 due to increased COFC traffic
from both international and domestic sources. TOFC revenue increased
due to a longer length of haul during the 1996 period.
. Chemical and petroleum products carloads and revenue increased during
the first six months of 1996 compared to the same period in 1995 due to
increased traffic in environmental wastes, crude oil, plastics, soda
ash, petroleum products
14
<PAGE>
and chlorine. The 1995 period was affected by flooding in California
and Texas as well as by the impact of extended plant maintenance and
shifting customer patterns for crude oil. Revenue per carload decreased
for the 1996 period due to changes in the commodity and customer mix.
. Coal carloads and revenue decreased for the 1996 period due to a mine
closure and temporary mine downtime as well as to changes in customer
demand patterns. Revenue per carload increased due to increases in the
average length of haul and changes in commodity mix.
. Food and agricultural products carloads remained stable for the first
six months of 1996 compared to the same 1995 period, while revenue and
revenue per carload increased due primarily to increased length of haul
for grain and grain products as well as growth in higher revenue per
car canned food shipments.
. Forest products carloads and revenue increased during the first six
months of 1996 due to increased shipments of paperboard, lumber stock,
particleboard and scrap paper. Shipments in the first half of 1995 were
depressed by a slow construction market affecting lumber, severe
weather and flooding in California and a millworkers strike that ended
in March 1995 that affected shipments of paper.
. Carloads and revenue for metals and ores traffic increased in the
first six months of 1996 compared to the first six months of 1995 due
primarily to increased shipments of mini-mill products driven by strong
construction demand in California as well as to increases in iron ore,
scrap, zinc products, integrated steel and pipe shipments.
. Construction materials and minerals carloads and revenue increased
for the 1996 period due principally to increased shipments of
aggregates, minerals and miscellaneous building materials.
. Automotive carloads and revenue increased during the first six months
of 1996 compared to the first six months of 1995 due to strength in the
Mexico market as well as to the addition of selected new traffic.
Revenue per carload declined due to customer and market mix changes as
well as to competitive rate pressure.
Operating Expenses. Railroad operating expenses for the first six months of
- -------------------
1996 decreased $17.5 million, or 1.2%, compared to the first six months of 1995.
Excluding the 1995 special charge, railroad operating expenses for the first six
months of 1996 increased by 3.3% compared to the first six months of 1995. The
following table sets forth a comparison of the Company's railroad operating
expenses during the six months ended June 30, 1996 and 1995.
15
<PAGE>
RAILROAD OPERATING EXPENSE COMPARISON
SIX MONTHS ENDED JUNE 30, 1996 AND 1995
<TABLE>
<CAPTION>
1996 1995 % Change
---- ---- --------
(in millions)
<S> <C> <C> <C>
Compensation and benefits........... $ 563.7 $ 550.5 2.4 %
Fuel................................ 145.6 127.2 14.5
Materials and supplies.............. 66.9 95.3 (29.8)
Equipment rental.................... 165.9 156.7 5.9
Depreciation and amortization....... 87.4 73.5 18.9
Other............................... 429.2 408.4 5.1
Special charge...................... - 64.6 (100.0)
-------- --------
Total.......................... $1,458.7 $1,476.2 (1.2) %
======== ========
</TABLE>
. Compensation and benefit costs increased $13.2 million, or 2.4%, for
the first six months of 1996 compared to the first six months of 1995.
The increased costs were due primarily to increased transportation
labor as revenue ton-miles increased 8.0% , gross ton-miles increased
7.2% and carloads increased 3.4% in the first half of 1996 compared to
the first half of 1995. Train crew starts increased by 2.9% for the
1996 period compared to the 1995 period. In addition, the increase
included an adjustment in the first quarter of 1995 to reflect reduced
costs associated with non-agreement fringe benefits. Company employment
decreased by 1.0% to a total of 18,840 as of the end of June 1996
compared to 19,028 at the end of June 1995. Expressed as a percentage
of operating revenues, labor and fringe benefit expenses were 34.9% for
the first six months of 1996 compared to 35.0% for the first six months
of 1995.
. Fuel expenses increased $18.4 million, or 14.5%, for the first six
months of 1996 compared to the same period in 1995. The increase was a
result of a 12.7% increase in the average price per gallon of fuel from
$.57 during the 1995 period to $.64 during the 1996 period, coupled
with a 1.6% increase in gallons consumed for the 1996 period compared
to the 1995 period. Fuel expense includes amounts paid to the Company's
suppliers and amounts paid under fuel hedging contracts. Effective
April 1, 1996, the Company had no fuel hedging agreements in place.
Included in the six month 1996 fuel expense was $2.6 million received
under fuel hedging contracts compared to $2.7 million paid during the
1995 period. While total fuel expense increased for the 1996 period,
fuel efficiency also increased by approximately 5% as measured by
gallons consumed per gross ton-mile.
. Materials and supplies expenses decreased $28.4 million, or 29.8%,
for the first half of 1996 compared to the first half of 1995 due
primarily to reduced locomotive material expenses and running repairs
and increased use of the power-by-the-mile maintenance program.
Locomotive overhauls charged to expense decreased from 62 locomotives
during the 1995 period to 18 locomotives during the 1996 period. In
addition, maintenance of way material expenses for signal and bridge
repairs decreased during the 1996 period compared to the 1995 period.
The Company is planning on overhauling fewer locomotive units during
1996 compared to prior years due to budgetary constraints, the
acquisition of locomotives in 1995 and the fact that fewer older units
remain to be overhauled.
. Equipment rental costs increased $9.2 million, or 5.9%, for the first
half of 1996 compared to the first half of 1995. The increase was
primarily attributable to a $17.9 million increase in car hire
associated with increases in traffic volume and
16
<PAGE>
cycle times, partially offset by an $8.7 million reduction in
locomotive lease expenses during the 1996 period.
. Depreciation and amortization expense increased $13.9 million, or
18.9%, for the first six months of 1996 due to an increase in the
depreciable property base principally from significant equipment
acquisitions during the latter part of 1995.
. Other expenses increased $20.8 million, or 5.1%, for the first six
months of 1996 compared to the first six months of 1995. This category
of expense includes outside repairs and services, joint facility rent
and maintenance costs, casualty costs and property and other taxes. The
increase is primarily due to an $11.2 million increase in locomotive
power-by-the-mile costs resulting from an increase in the number of
locomotive units subject to that maintenance program, a $7.5 million
increase in purchased maintenance of way services, $5.0 million in
insurance recoveries received during the 1995 period as partial
settlement of claims relating to the 1993 midwest flooding and a $2.8
million increase in joint facility costs associated with the increase
in traffic volume and the new Burlington Northern Santa Fe Corporation
("BNSF") trackage rights agreements. Partially offsetting these
increased expenses are a $4.0 million reduction in information system
outsourcing costs during 1996 and a $4.4 million reduction in
intermodal facility rent and equipment repair costs.
. In June 1995, the Board of Directors approved plans aimed at reducing
future operating costs and increasing productivity which resulted in a
$64.6 million pretax special charge. Approximately $41 million of the
charge was related to severance payments to be made during the next
year for 582 employees (both management and labor), approximately $4
million of the charge was related to costs associated with terminating
certain leased facilities, and approximately $20 million was for the
expected loss associated with the sale, lease or abandonment of 600
miles of light density rail lines. See "Liquidity and Capital
Resources - Other".
Other Income (Expense) and Interest Expense. Other income (expense) was a net
- --------------------------------------------
income of $18.4 million for the first six months of 1996 compared to a net
income of $0.2 million for the same period in 1995. The increased net income was
due primarily to a $27.3 million increase in gains on sales of property and a
$2.3 million charge during the 1995 period associated with the repayment of the
Company's $290 million Senior Secured Notes, partially offset by $11.0 million
in expense during 1996 associated with the UPRR/SPRC merger. Interest expense
was $87.9 million for the first six months of 1996 compared to $64.3 million for
the first six months of 1995, an increase of $23.6 million. The increase is due
to the higher level of capitalized lease obligations for new locomotives and
freight cars outstanding during the first half of 1996 combined with interest
expense associated with the $150 million term loan borrowed in September 1995.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Company's business is capital intensive and requires on-going
substantial expenditures for, among other things, maintenance of the rail
system, improvements to roadway, structures and technology and acquisitions and
repair of equipment. During the first half of 1996, and for more than a decade
before that, the Company's railroad operations did not produce sufficient cash
flows to meet its capital expenditure, debt service and other cash needs. As a
result, the Company has relied and continues to rely on proceeds from transit
corridor, real estate and other asset sales, borrowings and other financing for
these purposes. As a result of drawing $100 million on its revolving credit
facility in June 1996 in order to pay debt, interest and capital lease payments
due in early July, at June 30, 1996, the Company had cash and cash equivalents
of $129.7 million and had $200 million available under its revolving credit
facility.
17
<PAGE>
At this time, the Company faces extraordinary capital investment
requirements in order to meet the challenges of its major competitors,
particularly as a result of the recent merger of Burlington Northern Railroad
Company ("BN") and The Atchison, Topeka & Santa Fe Railway Company ("ATSF") in
1995. The increasing service competition that has developed and will be
accelerating will require substantial additional capital expenditures for
equipment, track improvements and other new facilities and technology. The
Company estimates that it needs to expend approximately $500 million in capital
per year simply to maintain its existing plant and equipment and its current
service levels. In addition, the Company has identified capital expenditures of
more than $1 billion that it believes should be made in excess of normal capital
expenditures to maintain its current competitive position. Without these
expenditures, the Company will continue to fall farther behind its competitors.
The Company's two major competitors have substantially stronger cash flow and
financial capabilities and their facilities and technology is more advanced than
those of the Company. The completion of the BN/ATSF merger and the integration
of that system occurred more quickly than the Company initially anticipated. The
combined BN/ATSF is a substantially stronger competitor than either railroad was
separately. The stronger financial condition and resources of the Company's
major competitors will allow them to make more investments designed to enhance
service, attract new customers, gain market share and achieve even more
efficient operations. For example, BNSF has announced that it will spend in
excess of $2 billion in capital for 1996.
The Company anticipates that, if the proposed merger with UPRR were not
completed or were delayed, cash flows generated by rail operations would
continue to be insufficient to meet all its cash needs including acquisition of
equipment and other necessary capital expenditures. Although the final written
order of the STB is expected by August 12, 1996, there is no assurance that STB
approval will be obtained by such date or that the STB's final written order
will not contain terms materially different from those voted upon by the STB on
July 3, 1996, as a result of which UP might elect under the terms of the merger
agreement not to complete the merger. In addition, any appeals from the STB
final order might not be resolved for a substantial period of time after the
entry of the final written order by the STB.
Certain of the Company's debt agreements contain quarterly financial
covenants and restrictions based on minimum tangible net worth, a maximum funded
debt to net worth ratio and a minimum fixed charge coverage ratio. As a result
of not achieving certain ratios and covenants in its $375 million Senior Notes
at December 31, 1995, the Company is restricted in incurring additional
indebtedness, except for certain limited categories of debt, including $200
million available under its revolving bank credit facility. Because continued
compliance with the financial terms and covenants under its bank credit
facilities would require more gains than was contemplated from the sales of
properties in the first and second quarters of 1996, the Company and its banks
amended those covenants through the second quarter of 1996 to eliminate the
fixed charge coverage test for these periods. Effective as of the end of the
third quarter, the fixed charge coverage test must be satisfied. If the merger
were not consummated in the third quarter of 1996 and the Company's earnings did
not meet the reinstated fixed charge coverage test as of the end of that
quarter, the Company would be in default on both its revolver and term loan
unless it were able to obtain waivers or amendments to its loan agreements.
Management of the Company currently does not believe it will meet its revised
financial covenants in 1996, unless property sales significantly exceed current
expectations. If this were to occur, there is no assurance that necessary
waivers and amendments could be obtained. If the Company were unable to meet
these covenants, or obtain waivers or amendments, substantially all of the
Company's outstanding indebtedness could be declared in default and payment
thereon accelerated.
In order to satisfy its future cash flow requirements, as well as the
financial covenants in its bank credit facilities, the Company must improve its
operating results while maintaining its bank credit facilities for use as
required. Management of the Company does not believe that the Company should
plan to continue to rely on real estate sales to fund its operations. The timing
of such sales is difficult to predict. The supply of real estate that can be
sold (especially readily salable real estate) is being depleted. Public funding
for transit corridor sales is more difficult to obtain. Proceeds from sales of
real estate and other properties totaled $52.9 million in the first six months
of 1996 and no
18
<PAGE>
large real estate sales are anticipated during the remainder of the year.
Management believes that under current circumstances the Company cannot expect
to obtain capital in the amounts required to fund the capital expenditures
described above that would be necessary for the Company to compete effectively
in all its present markets with its present services. Therefore, if the merger
with UPRR were not completed or were delayed, management believes it would be
necessary for the Company to develop and implement a plan for a major reduction
in its services and investments. See "Certain Effects of Competition" below.
Operating Activities
--------------------
As shown in the Consolidated Condensed Statements of Cash Flows, cash
provided by operating activities (before capital expenditures for maintenance of
its rail system and other items) was $68.2 million for the first half of 1996
compared to a use of cash of $7.6 million for the first half of 1995. The change
between periods was due primarily to the net effect of changes in income offset
by changes in accounts receivable and payable between periods based on the
timing of receipts and payments. The Company expects to fund its operations
(including scheduled interest payments, capital lease payments and severance
payments attributable to items provided for in the special charge) over the next
twelve months with cash from operations, cash on hand, property sales, capital
leases and borrowings under its bank credit facilities, if available.
The Company had working capital deficits of $456.5 million and $481.6
million at June 30, 1996 and 1995, respectively. The reduced deficit was due
primarily to increased cash and cash equivalents on hand at June 30, 1996
attributable to the drawdown from the Company's revolving credit facility of
$100 million in June 1996 partially offset by an increase in current liabilities
at June 30, 1996. The increased liability included higher reserves and a higher
interest payable balance due primarily to accrued interest associated with the
increased capital lease obligations outstanding at June 30, 1996 compared to
June 30, 1995.
Investing Activities
--------------------
Capital expenditures (exclusive of capital leases) for the first half of
1996 were $154.7 million compared to $174.8 million for the same period in 1995.
The 1996 amount included approximately $144.5 million for roadway and structures
and $4.0 million for rebuilt locomotives. The 1995 amount included approximately
$135.9 million for roadway and structures, $16.9 million for rebuilt locomotives
and $9.5 million for improvements to a corporate office building in Denver,
Colorado. During the first six months of 1996, the Company rebuilt 12
locomotives compared to 39 locomotives during the 1995 period. The Company
expects 1996 capital expenditures for railroad operations to be approximately
$337 million (exclusive of capital leases). The Company expects to fund 1996
capital expenditures with cash from operations, cash on hand, property sales,
capital leases and borrowing under its bank credit facilities.
The Company has been engaged in a program to expand and upgrade its
locomotive and freight car fleets principally through capitalized lease
financing. The Company acquired a significant number of locomotives in 1995 and
has no commitments to purchase additional locomotives. During the first six
months of 1996, the Company received 493 reconditioned freight cars and incurred
$13.6 million in capitalized lease obligations. All of the remaining 54
reconditioned freight cars to be financed under capital leases are expected to
be received by year end with a total capitalized lease obligation for the year
of approximately $14.3 million. The Company will have to acquire additional road
locomotives and rebuild or replace a substantial portion of the switch
locomotive fleet in the near future.
The Company received cash proceeds from sales and retirements of real
estate and other property totaling $52.9 million and $16.7 million for the first
six months of 1996 and 1995, respectively.
The Company plans on acquiring through operating leases, approximately
3,300 new and remanufactured freight cars during 1996 at an estimated annual
operating lease expense of $8.9
19
<PAGE>
million in 1996 and approximately $17.1 million annually thereafter. The Company
has received 2,177 of these freight cars as of June 30, 1996.
Financing Activities
--------------------
On June 27, 1996, the Company drew $100 million on its revolving credit
facility for debt, interest and capital lease payments. The outstanding balance
accrues interest based upon short-term money market rates payable quarterly. The
Company repaid $39.2 million of equipment obligation debt during the first six
months of 1996.
Certain Effects of Competition
------------------------------
The Company faces extraordinary capital investment requirements in order to
meet the challenges of its major competitors, particularly as a result of the
BN/ATSF merger in 1995. The increasing service competition that has developed
and will be accelerating will require substantial additional capital
expenditures for equipment, track improvements and other new facilities and
technology. The Company estimates that it needs to expend approximately $500
million in capital per year simply to maintain its existing plant and equipment
and its current service levels. In addition, the Company has identified capital
expenditures of more than $1 billion that it believes should be made in excess
of normal capital expenditures to maintain its current competitive position.
Without these expenditures, the Company will continue to fall farther behind its
competitors. The Company's two major competitors have substantially stronger
cash flow and financial capabilities and their facilities and technology are
more advanced than those of the Company. The completion of the BN/ATSF merger
and the integration of that system occurred more quickly than the Company
initially anticipated. The combined BN/ATSF is a substantially stronger
competitor than either railroad was separately. The stronger financial condition
and resources of the Company's major competitors will allow them to make more
investments designed to enhance service, attract new customers, gain market
share and achieve even more efficient operations. For example, BNSF has
announced that it will spend in excess of $2 billion in capital in 1996. The
Company faces substantially increased service competition from the Company's
major competitors relating to transit time and consistency, areas in which the
Company has historically lagged its principal competitors. This intense service
competition, including new single line service provided by the merged BN/ATSF,
is expected to continue as the BN/ATSF merger has created a much stronger
competitor. BN/ATSF's ability to offer expanded single line service that the
Company cannot offer to its customers will also negatively impact the Company.
Pressure on the Company to improve service and price more aggressively is
expected to continue and is expected to have an adverse impact on operating
results because the Company does not expect to be able to reduce costs as
rapidly as it would have without the increased service competition from the
BN/ATSF or to expend capital equivalent to its competitors and compete with
equal service. After several years of extraordinary capital expenditures to
rebuild its locomotive fleet, the Company will not be able to match the
financial resources of BN/ATSF or UP going forward to provide the facilities and
other service enhancing investments necessary to be fully competitive on a
stand-alone basis. Although no specific plan has as yet been prepared,
management believes, if the proposed merger with UPRR were not implemented or
were delayed, it would be necessary for the Company to develop and implement a
plan for a major reduction in its services and a reduction in capital
expenditures to a level sustainable out of cash flow from rail operations.
Management would expect to focus the Company's operations, pricing initiatives
and capital investments on markets and shippers where it has existing
competitive advantages and de-emphasize those markets where it faces rigorous
competition. Management expects that, over time, a significant portion of its
services would be eliminated or reduced and the number of employees would be
reduced. Examples of service reductions that would be considered are reductions
in midwestern and Texas intermodal operations, some transcontinental and west
coast intermodal business lines, closure of several smaller intermodal
terminals, a de-emphasis on operations across the Central Corridor and
rationalization of parallel main lines across east Texas.
20
<PAGE>
Other
-----
On April 3, 1996, the Company paid UPRR $31.8 million as the final payment
under the settlement agreement previously entered into pertaining to the
compensation SSW would pay for trackage rights over UPRR lines between Kansas
City and St. Louis.
In June 1995, the Board of Directors approved plans aimed at reducing
future operating costs and increasing productivity which resulted in a $64.6
million pretax charge. Approximately $41 million of the charge is related to
severance payments to be made for approximately 582 employees (both management
and labor), approximately $4 million of the charge is related to costs
associated with terminating certain leased facilities, and approximately $20
million is for the expected loss associated with the sale, lease or abandonment
of 600 miles of light density rail lines. Through the first six months of 1996,
severance payments totaling $4.3 million for 83 employees whose positions have
been terminated have been charged to the severance reserve. As a result of the
July 3, 1996 decision approving the merger, the Company has suspended its plans
for the severance and relocation of a substantial portion of these employees.
The Company continues to review these plans pending receipt and review of a
written merger decision on August 12, 1996 and closing of the merger.
In 1995, the Financial Accounting Standards Board issued Statement No. 121,
"Impairment of Long-Lived Assets", which was adopted by the Company effective
January 1, 1996 and had no financial statement impact. Future business decisions
could impact the financial statement results under this accounting standard.
The Company is subject to Federal, state and local environmental laws and
regulations and is currently participating in the investigation and remediation
of numerous sites. Where the remediation costs can be reasonably determined, and
where such remediation is probable, the Company has recorded a liability. It is
possible that additional losses will be incurred, but such amounts cannot be
reasonably estimated. The Company does not believe that disposition of
environmental matters known to the Company will have a material adverse effect
on the Company's financial condition or liquidity; however, there can be no
assurance that the impact of these matters on its results of operations for any
given reporting period will not be material.
The Company had entered into fuel hedging agreements covering 46% of its
first quarter 1996 fuel needs at an average purchase price of $.485 per gallon
(excluding handling costs). Effective April 1, 1996, the Company has no hedging
agreements in place and accordingly will incur all the effects of current fuel
prices. Further fuel hedging activity may occur during 1996.
The Company has incurred expenses of $18.7 million in 1995 and 1996
associated with the proposed merger and, if the merger is completed, has
committed to continuity, enhanced severance for certain employees and
transaction expenses of up to an additional $40 million. The accompanying
financial statements do not include accruals for merger expenses or adjustments
relating to decisions regarding the Company's operations and assets that might
result from the merger.
Cautionary Statement
--------------------
This report contains "forward looking statements" within the meaning of the
federal securities laws, including management's expectation that a final written
STB order regarding the proposed UP merger containing terms that are not
materially different from those voted upon by the STB on July 3, 1996 will be
served by August 12, 1996, management's belief that known environmental matters
and other types of claims and litigation will not have a material adverse effect
on the Company's financial condition or liquidity, the Company's expected 1996
capital expenditures and funding therefor, the Company's expectations as to
funding its operations over the next twelve months, and other statements of
expectations, beliefs, plans, and similar expressions concerning matters that
are not historical facts. These statements are subject to risks and
uncertainties that could cause actual results to differ materially from those
expressed in the statements. Important factors that could
21
<PAGE>
cause such differences include but are not limited to the fact that the STB's
July 3, 1996 action was not final, the increasingly intense competition within
the Company's service territory (see "Certain Effects of Competition" above),
the Company's insufficient cash flow from operations and resulting dependence on
real estate sales, and other constraints on the Company's liquidity and capital
resources, as well as its substantial capital requirements to improve its
service and facilities (see "Liquidity and Capital Resources" above), existing
restrictions on the Company's borrowing capacity, the Company's continuing
exposure to environmental liabilities and other types of claims and litigation,
the impact of federal, state and local regulation of the Company's business and
the possibility for adverse changes in such governmental regulation, natural
events such as flooding and earthquakes and the effects of adverse general
economic conditions. These and other risks and uncertainties affecting the
Company are discussed in greater detail in other filings by the Company with the
Securities and Exchange Commission, including but not limited to the Company's
registration statement on Form S-1 initially filed on June 4, 1994 (File No.
33-79950) and the joint proxy statement/prospectus dated December 12, 1995.
22
<PAGE>
PART II - OTHER INFORMATION
---------------------------
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its annual meeting of stockholders on May 1, 1996.
At the meeting, the stockholders' were asked to vote on two proposals.
A brief description of each proposal and the results of the votes cast is
provided.
<TABLE>
<CAPTION>
Description Vote Recap
- ----------------------------------------------------------- -----------------------------
For Withheld
------------ --------------
<S> <C> <C>
(I) Proposal No. 1 The election of six directors whose
terms of office will expire at the
Annual Meeting of Stockholders in
1997 as follows:
P.F. Anschutz 141,093,241 89,822
J.R. Davis 141,087,441 95,622
J.L. Haines 141,095,231 87,832
D.L. Polson 141,093,777 89,286
F.V. Sica 140,928,072 254,991
R.F. Starzel 141,096,536 86,527
(II) Proposal No. 2 The ratification of the selection of For: 141,132,551
KPMG Peat Marwick LLP as the Against: 31,711
independent auditors of the Company Abstain: 18,801
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) During the quarter ended June 30, 1996, no reports on Form 8-K
were filed by the Company.
23
<PAGE>
SIGNATURE
---------
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SOUTHERN PACIFIC RAIL CORPORATION
Date: August 9, 1996 By: /s/ B.C. Kane
-------------- ------------------------------
Controller
(Principal Accounting Officer)
24
<PAGE>
SOUTHERN PACIFIC RAIL CORPORATION
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
11 Computation of Earnings Per Share
27 Financial Data Schedule
</TABLE>
25
<PAGE>
EXHIBIT 11
SOUTHERN PACIFIC RAIL CORPORATION AND SUBSIDIARY COMPANIES
COMPUTATION OF EARNINGS PER SHARE
---------------------------------
(In Thousands, Except Per Share Amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
1996 1995 (1) 1996 1995 (1)
---- -------- ---- --------
<S> <C> <C> <C> <C>
Average number of shares outstanding.. 156,155 156,141 156,155 156,129
======== ======== ======== ========
Net income (loss)..................... $ 17,895 $(24,014) $ 24,007 $ (7,501)
======== ======== ======== ========
Earnings (loss) per share............. $ 0.11 $ (0.15) $ 0.15 $ (0.05)
======== ======== ======== ========
</TABLE>
- --------------------
(1) The 1995 net loss amounts include a $64,628 pretax, $39,552 estimated
after-tax special charge.
26
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SOUTHERN
PACIFIC RAIL CORPORATION'S FORM 10-Q FOR THE SECOND QUARTER OF 1996 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 130
<SECURITIES> 0
<RECEIVABLES> 269
<ALLOWANCES> (9)
<INVENTORY> 80
<CURRENT-ASSETS> 530
<PP&E> 4,587
<DEPRECIATION> 827
<TOTAL-ASSETS> 4,797
<CURRENT-LIABILITIES> 987
<BONDS> 1,777
20
0
<COMMON> 0
<OTHER-SE> 1,085
<TOTAL-LIABILITY-AND-EQUITY> 4,797
<SALES> 0
<TOTAL-REVENUES> 1,614
<CGS> 0
<TOTAL-COSTS> 1,505
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 88
<INCOME-PRETAX> 39
<INCOME-TAX> 15
<INCOME-CONTINUING> 24
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 24
<EPS-PRIMARY> 0.15
<EPS-DILUTED> 0.15
</TABLE>
