<COVER PAGE>
FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549-1004
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from___________________ to _____________________
Commission file number 1-6146
UNION PACIFIC RAILROAD COMPANY
(Exact name of Registrant as specified in its charter)
DELAWARE 94-6001323
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1416 DODGE STREET, OMAHA, NEBRASKA
(Address of principal executive offices)
68179
(Zip Code)
(402) 271-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
YES X NO
_______ ________
As of June 30, 1998, the Registrant had outstanding 7,130 shares of
Common Stock, $10 par value, and 620 shares of Class A Stock, $10 par
value.
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL
INSTRUCTIONS H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS
FORM WITH THE REDUCED DISCLOSURE FORMAT.
<INDEX PAGE>
UNION PACIFIC RAILROAD COMPANY
INDEX
PART I. FINANCIAL INFORMATION
------------------------------
Page Number
-----------
ITEM 1: CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
CONDENSED STATEMENT OF CONSOLIDATED INCOME
AND RETAINED EARNINGS - For the Three Months
and Six Months Ended June 30, 1998 and 1997. . . . . . . . 1
CONDENSED STATEMENT OF CONSOLIDATED FINANCIAL
POSITION - At June 30, 1998 and
December 31, 1997. . . . . . . . . . . . . . . . . . . . 2
CONDENSED STATEMENT OF CONSOLIDATED CASH FLOWS
For the Six Months Ended
June 30, 1998 and 1997 . . . . . . . . . . . . . . . . . 4
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . 5
ITEM 2: MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS
OF OPERATIONS. . . . . . . . . . . . . . . . . . . . . . 10
PART II. OTHER INFORMATION
----------------------------
ITEM 1: LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . 18
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . 22
SIGNATURE . . . . . . . . . . . . . . . . . . . . . . . . . . 23
<PAGE> 1
PART I - FINANCIAL INFORMATION
- ------------------------------
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNION PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY
COMPANIES
CONDENSED STATEMENT OF CONSOLIDATED INCOME AND RETAINED
EARNINGS
For The Three and Six Months Ended June 30, 1998 and 1997
----------------------------------------------------------
(Millions of Dollars, Except Ratio)
(Unaudited)
Three Months Six Months
Ended June 30, Ended June 30,
1998 1997 1998 1997
------ ------ ------ ------
Operating Revenues . . . . . . . . . . $2,317 $2,611 $4,601 $5,174
------ ------ ------ ------
Operating Expenses:
Salaries, wages and employee
benefits. . . . . . . . . . . . . . 889 857 1,773 1,712
Equipment and other rents . . . . . . 344 310 700 624
Fuel and utilities (Note 3). . . . . 201 252 409 533
Depreciation and amortization . . . . 248 243 494 483
Materials and supplies. . . . . . . . 134 122 266 270
Purchased services. . . . . . . . . . 154 145 295 304
Other costs (Note 5). . . . . . . . . 464 183 728 396
------ ------ ------ ------
Total . . . . . . . . . . . . . . . 2,434 2,112 4,665 4,322
Operating Income (Loss). . . . . . . . (117) 499 (64) 852
Other Income - Net . . . . . . . . . . 50 17 69 53
Interest Expense (Note 3). . . . . . . (147) (119) (282) (241)
------ ------ ------ ------
Income (Loss) Before Income Taxes. . . (214) 397 (277) 664
Income Tax Expense (Benefit) . . . . . (92) 147 (123) 244
------ ------ ------ ------
Net Income (Loss) . . . . . . . . . $ (122) $ 250 $ (154) $ 420
====== ====== ====== ======
Retained Earnings:
Beginning of period . . . . . . . . . $3,968 $4,000 $4,110 $3,939
Net income (loss) . . . . . . . . . . (122) 250 (154) 420
Dividends to parent . . . . . . . . . (110) (105) (220) (214)
------ ------ ------ ------
End of Period. . . . . . . . . . $3,736 $4,145 $3,736 $4,145
====== ====== ====== ======
Ratio of Earnings to Fixed
Charges (Note 4). . . . . . . . . . - 3.4 - 3.0
=== === === ===
The accompanying accounting policies and notes to condensed financial
statements are an integral part of these statements.
<PAGE> 2
UNION PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY
COMPANIES
CONDENSED STATEMENT OF CONSOLIDATED FINANCIAL POSITION
------------------------------------------------------
(Millions of Dollars)
(Unaudited)
June 30, December 31,
ASSETS 1998 1997
------ ----------- ------------
Current Assets:
Cash and temporary investments . . . . . $ 29 $ 50
Accounts receivable - net (Note 3) . . . 358 456
Materials and supplies . . . . . . . . . 316 288
Other current assets . . . . . . . . . . 194 251
------- -------
Total Current Assets . . . . . . . . . 897 1,045
------- -------
Investments:
Investments in and advances to
affiliated companies . . . . . . . . . . 655 595
Other investments . . . . . . . . . . . . 6 29
------- -------
Total Investments . . . . . . . . . . . 661 624
------- -------
Properties, at cost:
Road and other . . . . . . . . . . . . . 24,251 23,610
Equipment . . . . . . . . . . . . . . . . 7,521 7,084
------- -------
Total Properties . . . . . . . . . . . 31,772 30,694
Less accumulated depreciation and
amortization . . . . . . . . . . . . . 5,553 5,208
------- -------
Properties - Net . . . . . . . . . . . 26,219 25,486
------- --------
Other Assets . . . . . . . . . . . . . . . 139 92
------- -------
Total Assets . . . . . . . . . . . . . $27,916 $27,247
======= =======
The accompanying accounting policies and notes to condensed financial
statements are an integral part of these statements.
<PAGE> 3
UNION PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY COMPANIES
CONDENSED STATEMENT OF CONSOLIDATED FINANCIAL POSITION
------------------------------------------------------
(Millions of Dollars, Except Per Share Amounts)
(Unaudited)
June 30, December 31,
LIABILITIES AND STOCKHOLDER'S EQUITY 1998 1997
------------------------------------ --------- ------------
Current Liabilities:
Accounts payable . . . . . . . . . . . . . . . $ 517 $ 660
Accrued wages and vacation . . . . . . . . . . 440 382
Income and other taxes. . . . . . . . . . . . . 255 263
Accrued casualty costs . . . . . . . . . . . . 319 318
Debt due within one year . . . . . . . . . . . 162 229
Other current liabilities (Notes 2 and 5) . . . 896 915
------- -------
Total Current Liabilities . . . . . . . . . . 2,589 2,767
------- -------
Debt Due After One Year . . . . . . . . . . . . 2,621 2,361
Deferred Income Taxes . . . . . . . . . . . . . 6,573 6,698
Accrued Casualty Costs . . . . . . . . . . . . . 661 671
Retiree Benefit Obligations . . . . . . . . . . 760 749
Due to UPC Long-Term . . . . . . . . . . . . . . 5,166 3,993
Other Liabilities (Note 2) . . . . . . . . . . . 1,000 1,087
Redeemable Preference Shares . . . . . . . . . . 28 29
Series A, $10,000 par value; 4,829 shares outstanding
Series B, $10,000 par value; 436 shares outstanding
Stockholder's Equity (Note 2):
Common stock - $10.00 par value; 9,200
shares authorized and 4,465 outstanding . . . . - -
Class A stock - $10.00 par value; 800
shares authorized and 388 outstanding . . . . - -
Capital surplus . . . . . . . . . . . . . . . . 4,782 4,782
Retained earnings . . . . . . . . . . . . . . . 3,736 4,110
------- -------
Total Stockholder's Equity . . . . . . . . . 8,518 8,892
------- -------
Total Liabilities and Stockholder's
Equity . . . . . . . . . . . . . . . . . $27,916 $27,247
======= =======
The accompanying accounting policies and notes to condensed financial
statements are an integral part of these statements.
<PAGE> 4
UNION PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY COMPANIES
CONDENSED STATEMENT OF CONSOLIDATED CASH FLOWS
For the Six Months Ended June 30, 1998 and 1997
--------------------------------------------------
(Millions of Dollars)
(Unaudited)
1998 1997
----------- -----------
Cash from Operations:
Net Income (Loss) . . . . . . . . . . . . $ (154) $ 420
Non-Cash Charges to Income:
Depreciation and amortization . . . . . 494 483
Deferred income taxes . . . . . . . . . (124) 105
Other - net . . . . . . . . . . . . . . (149) (185)
Changes in current assets and
liabilities . . . . . . . . . . . . . . (51) (145)
------- -------
Cash Provided by Operations . . . . . . . . . 16 678
------- -------
Investing Activities:
Capital investments . . . . . . . . . . . . . . (1,231) (924)
Other - net . . . . . . . . . . . . . . . . . . 41 (101)
------- -------
Cash Used in Investing Activities . . . . . . (1,190) (1,025)
------- -------
Equity and Financing Activities:
Debt repaid . . . . . . . . . . . . . . . . . . (180) (170)
Financings . . . . . . . . . . . . . . . . . . 380 153
Dividends paid to parent. . . . . . . . . . . . (220) (214)
Advances from affiliated
companies - net. . . . . .. . . . . . . . . . 1,173 596
------- -------
Cash Provided by Equity and
Financing Activities . . . . . . . . . . . 1,153 365
------- -------
Net Change in Cash and Temporary
Investments . . . . . . . . . . . . . . . $ (21) $ 18
======= =======
The accompanying accounting policies and notes to condensed financial
statements are an integral part of these statements.
<PAGE> 5
UNION PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------------------
(Unaudited)
1. RESPONSIBILITIES FOR FINANCIAL STATEMENTS: The condensed consolidated
financial statements of Union Pacific Railroad Company (the Company or
the Railroad) are unaudited and reflect all adjustments (consisting
only of normal and recurring adjustments) that are, in the opinion of
management, necessary for a fair presentation of the financial position
and operating results for the interim periods. The condensed
consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto contained in
the Company's Annual Report on Form 10-K for the year ended
December 31, 1997. The results of operations for the three months and
six months ended June 30, 1998 are not necessarily indicative of the
results for the year ending December 31, 1998. The financial
statements present the results of operations and financial position of
the Company combined with Southern Pacific Rail Corporation (Southern
Pacific or SP), a holding company wholly owned by Union Pacific
Corporation (UPC or Corporation), which owns 2,665 shares of common
stock, $10 par value, of Union Pacific Railroad Company and 232 shares
of Class A stock, $10 par value of Union Pacific Railroad Company.
Certain 1997 amounts have been reclassified to conform to the 1998
financial statement presentation.
2. ACQUISITION OF SOUTHERN PACIFIC RAIL CORPORATION: UPC consummated the
acquisition of Southern Pacific in September 1996. The acquisition of
Southern Pacific has been accounted for using the purchase method.
On February 1, 1998, Union Pacific Railroad Company, a Utah corporation
(UPRR-Utah), was merged with and into Southern Pacific Transportation
Company, a Delaware corporation (SPT), the principal SP rail affiliate
(the SPT Merger), with SPT continuing as the surviving corporation and
changing its name to "Union Pacific Railroad Company," immediately
following the SPT Merger. Immediately prior to the SPT Merger, SPT was
a wholly-owned, indirect subsidiary of UPC, and UPRR-Utah was a
subsidiary of UPC, with all of the issued and outstanding shares of
voting stock of UPRR-Utah being owned, directly or indirectly, by UPC.
UPRR-Utah and SPT operated as a unified system before and after the SPT
Merger.
The SPT Merger has been accounted for in a manner similar to a
pooling-of-interest combination of entities under common control since
both entities involved in the merger were indirect wholly-owned
subsidiaries of UPC at the date of the SPT Merger and with the surviving
entity continuing as such.
In connection with the continuing integration of the rail operations of
UPRR-Utah and Southern Pacific, the Company is continuing to eliminate
duplicate positions, (primarily positions other than train crews),
<PAGE> 6
relocate positions, merge or dispose of redundant facilities, dispose
of certain rail lines and cancel uneconomical and duplicative SP
contracts. The Company has also repaid certain of Southern Pacific's
debt obligations. The Company recognized a $958 million liability in
the Southern Pacific purchase price allocation for costs associated
with SP's portion of these activities.
Through June 30, 1998, approximately $357 million in merger-related
costs were paid by the Company and charged against these reserves,
principally consisting of approximately $172 million and $73 million,
respectively, for severance and relocation payments made to
approximately 4,000 Southern Pacific employees and approximately $84
million for labor protection payments. The Company expects the
remaining merger payments will be made over the course of the next five
years as the rail operations of the UPRR-Utah and SP are integrated and
labor negotiations are completed and implemented.
In addition, the Company expects to incur approximately $184 million in
acquisition-related costs through 1999 for severing or relocating
Railroad employees, disposing of certain Railroad facilities, training
and equipment upgrading. These costs will be charged to expense as
incurred over the next two years. Results for the three and six months
ended June 30, 1998 include $11 million and $29 million (after tax),
respectively, in acquisition-related operating costs.
3. FINANCIAL INSTRUMENTS:
Risk Management: The Company uses derivative financial instruments in
limited instances for other than trading purposes to manage risk as it
relates to fuel prices and interest rates. Where the Company has fixed
interest rates or fuel prices through the use of swaps, futures or
forward contracts, the Company has mitigated the downside risk of
adverse price and rate movements; however, it has also limited future
gains from favorable movements.
The Company addresses market risk related to these instruments by
selecting instruments whose value fluctuations highly correlate with
the underlying item being hedged. Credit risk related to derivative
financial instruments, which is minimal, is managed by requiring
minimum credit standards for counterparties and monthly settlements.
The total credit risk associated with the Company's counterparties was
$0 at June 30, 1998. The Company has not been required to provide, nor
has it received, any collateral relating to its hedging activity.
The fair market value of the Company's derivative financial instrument
positions at June 30, 1998 were determined based upon current fair
market values as quoted by recognized dealers, or developed based on
the present value of expected future cash flows discounted at the
applicable zero coupon U.S. treasury rate and swap spread.
Fuel: Over the past three years, fuel costs approximated 10% of the
Company's total operating expenses. As a result of the significance of
the fuel costs and the historical volatility of fuel prices, the
<PAGE> 7
Company periodically uses swaps, futures and forward contracts to
mitigate the impact of fuel price volatility. The intent of this
program is to protect the Company's operating margins and overall
profitability from adverse fuel price changes.
At June 30, 1998, the Company had hedged 50% of its estimated remaining
1998 fuel consumption at $0.51 per gallon on a Gulf Coast basis and had
outstanding swap agreements covering its fuel purchases of $164 million,
with gross and net liability positions of $34 million. Fuel hedging
increased the Company's second quarter 1998 and 1997 fuel costs
by $20 million and approximately $1 million, respectively. Fuel hedging
increased the Railroad's six months 1998 and 1997 fuel costs by
$34 million and $1 million, respectively.
Interest Rates: The Company controls its overall risk relating to
fluctuations in interest rates by managing the proportion of fixed and
floating rate debt instruments within its debt portfolio over a given
period. Derivatives are used in limited circumstances as one of the
tools to obtain the targeted mix. The mix of fixed and floating rate
debt is largely managed through the issuance of targeted amounts of
such debt as debt maturities occur or as incremental borrowings are
required. The Company also obtains additional flexibility in managing
interest cost and the interest rate mix within its debt portfolio by
issuing callable fixed rate debt securities.
At June 30, 1998, the Company had outstanding interest rate swaps on
$106 million of notional principal amount of debt (4% of the total debt
portfolio, excluding obligations to the Corporation) with gross and net
liability positions of $8 million. These contracts mature over the next
one to eight years. Interest rate hedging activity increased interest
expense in the first six months of 1998 and 1997 by less than $1
million and $2 million, respectively.
Sale of Receivables: The Company has sold, on a revolving basis, an
undivided percentage ownership interest in a designated pool of
accounts receivable. At December 31, 1997 and June 30, 1998, accounts
receivable are presented net of the $650 million and $602 million,
respectively, of the receivables sold.
4. RATIO OF EARNINGS TO FIXED CHARGES: The ratio of earnings to fixed
charges has been computed on a total enterprise basis. Earnings
represent income from continuing operations less equity in
undistributed earnings of unconsolidated affiliates, plus income taxes
and fixed charges. Fixed charges represent interest, amortization of
debt discount and expense, and the estimated interest portion of rental
charges. For the three and six months ended June 30, 1998, fixed
charges exceeded earnings by approximately $228 million and $301
million, respectively.
5. COMMITMENTS AND CONTINGENCIES: There are various claims and lawsuits
pending against the Company. Certain customers have submitted claims
for damages related to the delay of shipments by the Railroad as a
result of congestion problems, and certain customers have filed
<PAGE> 8
lawsuits seeking relief related to such delays. The nature of the
damages sought by claimants includes, but is not limited to,
contractual liquidated damages, freight loss or damage, alternative
transportation charges, additional production costs, lost business and
lost profits. In addition, some customers have asserted that they have
the right to cancel contracts as a result of alleged material breaches
of such contracts by the Company. In the second quarter of 1998, the
Company took a $155 million after-tax charge for the resolution of
customer claims. The Company will continue to evaluate the adequacy of
Its reserves for claims and may add to such reserves if appropriate.
The Company is also party to certain regulatory proceedings before the
Surface Transportation Board of the U.S. Department of Transportation
(STB). One proceeding pertains to rail service problems in the western
United States. As an outgrowth of this proceeding, the STB issued an
emergency service order imposing certain temporary measures on the
Railroad designed, among other things, to reduce congestion on the
Railroad's lines in the Houston, Texas area. On July 31, 1998, the
STB terminated the emergency service order. The STB kept in place the
requirement that the Railroad report certain service data, which the
Railroad had acknowledged the STB had the authority to impose under a
provision of the Interstate Commerce Act separate from the emergency
service provision. The STB also prescribed, under another statutory
provision separate from the emergency service provision, a 45-day
"wind-down" period during which certain rights that Texas Mexican
Railway Company and The Burlington Northern and Santa Fe Railway
Company (BNSF) had received under the emergency service order to handle
UP traffic in Houston would be continued. A second proceeding,
initiated under the STB's continuing oversight jurisdiction with
respect to the Corporation's acquisition of Southern Pacific and
consolidation of Southern Pacific with UPRR-Utah (and separate from the
STB's regularly scheduled annual proceeding to review the
implementation of the merger and the effectiveness of the conditions
that the STB imposed on it), is for the purpose of considering the
justification for and advisability of any proposals for new remedial
conditions to the merger as they pertain to service in the Houston,
Texas/Gulf Coast area. Various parties have filed applications in this
proceeding seeking the imposition of additional conditions to the
merger including, among other things, the granting of overhead trackage
rights on certain of the Company's lines in Texas, "neutral switching
supervision" on certain of the Company's branch lines, the opening to
other railroads and switching by a "neutral switching company" of
numerous industries now exclusively served by the Company in the
Houston area, and the compulsory sale or lease to other carriers of
certain of the Company's lines and facilities. The Company believes
that the applications are without merit and intends to contest them
vigorously. In addition, the STB has initiated various inquiries and
formal rulemaking proceedings regarding certain elements of rail
regulation following two days of hearings by the STB at the request of
two members of Congress and in response to shippers' expressions of
concern regarding railroad service quality, railroad rates and
allegedly inadequate regulatory remedies. There can be no assurance
that the proposals advanced by parties in the remedial conditions
<PAGE> 9
proceeding or the proceedings initiated in response to the rail
regulation hearings will not be approved in some form. Should the STB
or Congress take aggressive action in the rail regulation proceedings
(e.g., by making purportedly competition-enhancing changes in rate and
route regulation and "access" provisions), the adverse effect on the
Railroad and other rail carriers could be material.
The Railroad is also 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. In addition, the
Company periodically enters into financial and other commitments and
has retained certain contingent liabilities upon the disposition of
formerly-owned operations.
In addition, UPC and certain of its officers and directors are
currently defendants in two purported class action securities lawsuits.
The class action suits allege, among other things, that management
failed to properly disclose the Railroad's service and safety problems
and thereby issued materially false and misleading statements
concerning the merger with SP and the safe, efficient operation of its
rail network. Because both the size of the class and the damages are
uncertain, UPC and the Railroad are unable at this time to determine
the potential liability, if any, which might arise from these lawsuits.
UPC management believes that these claims are without merit and intends
to defend them vigorously.
It is not possible at this time for the Company to fully determine the
effect of all unasserted claims on its consolidated financial
condition, results of operations or liquidity; however, to the extent
possible, where unasserted claims can be estimated and where such
claims are considered probable, the Company has recorded a liability.
The Company does not expect that any known lawsuits, claims,
environmental costs, commitments or guarantees will have a material
adverse effect on its consolidated financial condition.
6. ACCOUNTING PRONOUNCEMENTS: In June 1997, the Financial Accounting
Standards Board (FASB) issued Statement No. 130, "Reporting
Comprehensive Income" (FAS 130) that is effective for all periods in
1998, including interim periods. The Railroad has adopted the
provisions of FAS 130 effective January 1, 1998. The components of
comprehensive income include, among other things, changes in the market
value of futures contracts which qualify for hedge accounting and a net
loss recognized as an additional pension liability but not yet
recognized as net periodic pension cost. There is no impact from
adopting FAS 130 for the six months ended June 30, 1998.
Also in June 1997, the FASB issued Statement No. 131, "Disclosures
about Segments of an Enterprise and Related Information" that is
effective in 1998. The Company curre ntly complies with the
provisions of this Statement.
<PAGE> 10
In February 1998, the FASB issued Statement No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" that is
effective in 1998 (FAS 132). FAS 132 revises and standardizes
disclosures required by FAS 87, 88, and 106. Restatement of the
retirement plans footnote will be required for all earlier
periods presented in comparative financial statements at December 31,
1998.
In June 1998, the FASB issued Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (FAS 133) that will be
effective in 2000. Management has not yet determined the effect, if
any, FAS 133 will have on the Company's financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
UNION PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY COMPANIES
MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS
Six Months Ended June 30, 1998 Compared to June 30, 1997
------------------------------------------------------------
Mergers
--------
On February 1, 1998, Union Pacific Railroad Company, a Utah Corporation
(UPRR-Utah), was merged with and into Southern Pacific Transportation
Company, a Delaware Corporation (SPT), the principal Southern Pacific Rail
Corporation (Southern Pacific or SP) rail affiliate (the SPT Merger), with
SPT continuing as the surviving corporation and changing its name to
"Union Pacific Railroad Company" (the Company or the Railroad),
immediately following the SPT Merger. Immediately prior to the SPT Merger,
SPT was a wholly-owned, indirect subsidiary of Union Pacific Corporation
(UPC or the Corporation), and UPRR-Utah was also a subsidiary of UPC, with
all of the issued and outstanding shares of voting stock of UPRR-Utah
being owned, directly or indirectly, by UPC. UPRR-Utah and SPT operated as
a unified system before and after the SPT Merger.
The SPT Merger has been accounted for in a manner similar to a pooling-of-
interest combination of entities under common control since both entities
involved in the merger were indirect wholly-owned subsidiaries of UPC at
the date of the SPT Merger and with the surviving entity continuing as
such.
In September 1996, UPC completed its acquisition of Southern Pacific and,
throughout 1997 and 1998, continued the process of integrating the
operations of SP's rail subsidiaries into UPRR-Utah's operations. The
Corporation expects to complete the full integration of the operations of
UPRR-Utah and the Southern Pacific rail subsidiaries during 1999. The
Corporation believes that the full implementation of the merger will
<PAGE> 11
result in shorter routes, faster transit times, better on-time
performance, expanded single-line service and more efficient traffic flow.
As a result of the SP acquisition, the Company now operates the largest
rail system in the United States, with 35,000 route miles linking Pacific
Coast and Gulf Coast ports to the Midwest and eastern U.S. gateways.
Congestion and Service Issues
-----------------------------
As previously reported, congestion in and around Houston and the coastal
areas of Texas and Louisiana (the Gulf Coast region) began to have a
material adverse effect on the Company's operations and earnings in the
third quarter of 1997. System congestion started in the Gulf Coast region
and spread throughout the system as the Company shifted resources to help
mitigate the problem in the Gulf Coast region. The congestion was brought
on by, among other things, crew shortages and restricted track access
caused by necessary track maintenance on former Southern Pacific lines,
increased demand, washouts due to severe weather, derailments and
congestion at Texas/Mexico gateways. Traffic slowed further as rail yards
in the Gulf Coast region filled, slowing access into and out of the yards
and forcing trains to be held on sidings. Slower average train velocity
led to a greater need for locomotives in the region. As traffic in the
region backed up and the Railroad redeployed locomotives to the Gulf Coast
region to help alleviate local congestion, congestion problems spread to
other parts of the Railroad's system during the third and fourth quarters
of 1997.
The Company has adopted certain measures to alleviate the congestion
problems, including the implementation of a Service Recovery Plan (the
Plan) on October 1, 1997. The Plan focuses on reducing the number of cars
on the system and restoring system velocity, which, in turn, results in
more reliable service to customers. In addition to implementation of the
Plan, the Company has taken other measures to address the service and
congestion problems, including (i) a concentrated effort to hire more
train and engine employees, (ii) the implementation of directional
running, which provides for the movement of trains primarily in opposing
directions on parallel lines and results in the avoidance of numerous
daily train "meets" on those lines, on parallel tracks between Houston and
St. Louis, and (iii) the establishment of a coordinated dispatching center
in Houston, which is designed to provide close coordination of operations
of the Railroad and The Burlington Northern and Santa Fe Railway Company
(BNSF) in the Houston area and ensure the best possible handling of all
rail traffic there. Implementation of the Plan and other service recovery
measures described above have significantly alleviated congestion in the
Gulf Coast region. Recently, service in the Railroad's Central Corridor
between Chicago and Utah has been slowed by track maintenance and capacity
expansion work which is expected to be completed by year-end. In
addition, the Railroad has recently experienced congestion on its lines in
the Los Angeles basin and on the Sunset Route west of El Paso, Texas,
caused in part by two derailments, tight crew supply and limited track
capacity in that region, and the learning curve associated with the
<PAGE> 12
integration of the computer system of Southern Pacific in the region into
the Railroad's computer system, which commenced July 1, 1998. The Company
has been working to reduce this congestion by rerouting trains from this
region to other portions of its system.
Financial Impact of Congestion - The Company has estimated that the cost
of the congestion-related problems for the six months ended June 30, 1998
was approximately $694 million, after tax, which reflected the combined
effects of lost business, higher costs associated with system congestion,
and costs associated with service recovery efforts, alternate
transportation and customer claims. Congestion-related costs for the
quarter include a $155 million after-tax charge for the resolution of
customer claims. Although progress has been made in improving service, the
Company expects these problems to continue to have an adverse impact on
1998 results. In addition, as a result of operating losses incurred by
the Company and in order to fund its capital programs, the Corporation has
incurred substantial incremental debt since December 31, 1997, most of
which has been repaid with the proceeds of the issuance on April 1, 1998
of $1.5 billion of 6-1/4% preferred securities of Union Pacific Capital
Trust, a statutory business trust sponsored by the Corporation, which
securities are convertible into common stock of the Corporation at an
initial conversion price of $68.90. The timing of the Company's return to
profitability will be determined by how rapidly it is able to eliminate
congestion, and return to normal operations throughout its systems.
Results of Operations
----------------------
The Company reported a loss of $154 million for the first six months of
1998, compared to $420 million of reported net income in 1997. This
decline in earnings is the result of the continuing effects of congestion
on the Company's operations, which was estimated to cost the Company
approximately $694 million after-tax in the first six months of 1998.
Both periods included the impact of one-time SP merger-related costs for
severance, relocation and training of the Railroad employees ($29 million
reduction in net income in 1998 and $36 million reduction in net income in
1997).
The operating ratio for the first six months of 1998 was 101.4, which
included approximately 21.2 points estimated to be attributable to
congestion costs (both lost business and incremental operating costs).
This compares to an operating ratio of 83.5 for the same period in 1997.
Operating revenues fell $573 million (11%) to $4.6 billion in 1998. This
decrease reflects continuing congestion, the impact of the ongoing Asian
financial crisis on export grain and intermodal markets and weak grain
demand as farmers delay shipments due to the current grain price
environment. Average commodity revenue per car (ARC) fell 2% to $1,138
per car, while total carloadings fell 9% to 4 million. Commodity revenue
in 1998 fell 11% over the same period in 1997 as shown in the table below:
<PAGE> 13
Commodity Revenue
Six Months Ended 6/30/98
----------------------------
Versus 1997
(Revenue Commodity ------------------
in Thousands) Cars ARC Revenue Change %
Agricultural 396,964 $1,531 $ 607,636 $(156,751) (21)
Automotive 324,650 1,458 473,500 (15,091) (3)
Chemicals 449,508 1,720 773,179 (114,268) (13)
Energy 869,149 1,133 985,179 (22,134) (2)
Industrial 666,856 1,354 903,089 (105,336) (10)
Intermodal 1,226,556 599 734,215 (137,841) (16)
--------- ------ ---------- --------- --
Total Commodity 3,933,683 $1,138 $4,476,798 $(551,421) (11)
========= ====== ========== ========= ==
Agricultural Products: Commodity revenue fell 21% to $608 million.
Carloadings declined 16% to approximately 397,000 cars, primarily the
result of a 24% decrease in corn volumes due to soft export demand caused
by strong foreign harvests (primarily in China), as well as the
continuation of system velocity issues. Other agricultural products
suffered from slow train cycles and related equipment shortages as well.
Average commodity revenue per car declined 5%, primarily the result of
weak exports, which reduced the average length of haul by approximately
10% as business movements shifted from the Pacific Northwest to the Gulf
Coast region.
Automotive: Commodity revenue fell 3% to $474 million, while carloadings
were flat at approximately 325,000 cars. Lower parts volumes (down 6%)
led the decline in traffic, primarily the result of slow cycle times and
diverted business due to service issues. This was partially offset by a
4% increase in finished vehicles, the result of strong Ford and Chrysler
gains. Finished vehicle results were also affected by strike-related
declines at GM, which reduced revenues by approximately $9 million and
carloadings by approximately 7,000. Average commodity revenue per car
declined 3%, resulting from the addition of new shorter haul Ford business
and less long-haul Mexico parts business.
Chemicals: Carloadings declined 9% to approximately 450,000 cars and
commodity revenue decreased 13% to $773 million. The decline in volume
resulted principally from congestion-related diversions to other modes of
transportation as well as to other rails. Rain in certain parts of the
country lowered the demand for petroleum products, fertilizer and potash.
In addition, the Asian crisis reduced demand for exports of soda ash while
warm weather in some areas hurt demand for LP gas. Average commodity
revenue per car declined 4% due to generally shorter hauls (storage-in-
transit moves for plastic and growth in short-haul potash moves) and
unfavorable product mix.
Energy (Primarily Coal): Commodity revenue fell 2% to approximately $985
million in 1998, driven by a 3% decrease in carloadings. Continued slow
system speeds, diversions of business to competing railroads and weak
export markets led the decline, despite strong domestic demand. Average
commodity revenue per car rose slightly to $1,133 as generally shorter
hauls were offset by favorable product mix. Powder River Basin (PRB) train
<PAGE> 14
cycles rose slightly and longer trains boosted carloads by nearly 13,000
units over 1997. Most other mine locations posted declines, largely due
to related train cycle issues.
Industrial Products: Carloadings decreased 11%, while commodity revenue
declined 10% to $903 million. Volume declines resulted primarily from
equipment shortages and service issues, including diversions of traffic to
other modes of transportation and to other rails. Other contributing
factors were strong competition, the Mexican embargo (affecting appliances
and consumer products) and capacity constraints (affecting cement
production). Average commodity revenue rose slightly to $1,354.
Intermodal: Commodity revenue declined 16% to $734 million while
carloadings fell 13% to 1,227,000 loads, the result of lower system speeds
and related diversions of traffic to BNSF and other rails, as well as weak
exports. Average commodity revenue per car fell 4% due to unfavorable mix
and a large volume of low ARC equipment repositioning moves due to
equipment imbalances caused by the Asian crisis.
Operating expenses were $4,665 million, $343 million (8%) higher than the
first half of 1997 operating costs of $4,322 million. Higher operating
costs reflect approximately $375 million of estimated congestion-related
costs. The impact of congestion was slightly offset by lower fuel costs,
merger and cost reduction benefits and volume-related cost savings, as
carloads were off 9% and gross-ton miles were down 9%.
Salaries, wages and employee benefits were $61 million (4%) higher than
1997, as net congestion-related costs and wage inflation (generated by the
National Labor Agreement) were partially offset by merger consolidation
benefits. Year-over-year, the work force levels were up slightly, as
hiring exceeded merger-related reductions, attrition, and the effect of
lower volumes.
Depreciation expense grew $11 million to $494 million due to the Company's
continued reinvestment in new equipment and rail infrastructure. The
Railroad spent over $2 billion on capital projects in 1997 and anticipates
spending $2.2 billion in 1998 of which $400 million will be merger-related.
Materials & Supplies costs for the six months were down $4 million (1%)
from six months 1997, as congestion and volume savings were partially
offset by higher material freight charges and freight car and roadway
machine material.
Fuel & Utilities expenses were down $124 million or 23% from 1997,
reflecting lower fuel prices and congestion-related volume declines. A
reduction in gross-ton miles (down 9%) generated volume-related fuel
savings of $42 million versus 1997. Prices were down 8.4 cents per gallon
to 62.6 cents, saving $57 million. The fuel consumption rate of 1.418
gallons per thousand gross-ton miles improved 1% from last year's 1.429,
lowering the Railroad's fuel costs by $9 million.
<PAGE> 15
Rent Expense was up $76 million (12%) versus 1997, as system congestion
(which hindered car cycle times) combined with unfavorable rates (strong
market demand for equipment) to drive up equipment rent costs.
Congestion-related increases in car cycle times increased costs by $85
million, which was partially offset by volume-related savings of $49
million.
Other Costs (including purchased services) increased $323 million (46%)
from 1997, reflecting approximately $300 million for resolution of
customer claims, and service recovery initiatives (focused on combating
system congestion). Congestion-related cost increases were partially
offset by merger consolidation benefits (trackage rights reimbursements
and contract pricing savings) and cost savings from company-wide cost
control efforts.
Operating income fell $916 million (108%) to a loss of $64 million in
1998, due to the factors mentioned above. Other income increased $16
million, primarily reflecting increased real estate sales and a recovery
of funds from insurers related to first quarter 1997 flood damage.
Interest expense increased $41 million, the result of higher debt levels
and higher interest rates resulting from a recent credit rating downgrade.
Income taxes decreased $367 million to a benefit $123 million, primarily
reflecting a loss before income taxes.
Other Matters
--------------
Accounting Pronouncements - In June 1997, the Financial Accounting
Standards Board (FASB) issued Statement No. 130, "Reporting Comprehensive
Income" (FAS 130) that is effective for all periods in 1998, including
interim periods. The Company has adopted the provisions of FAS 130
effective January 1, 1998. The components of comprehensive income
include, among other things, changes in the market value of futures
contracts which qualify for hedge accounting and a net loss recognized as
an additional pension liability but not yet recognized as net periodic
pension cost. There is no impact from adopting FAS 130 for the six months
ended June 30, 1998.
Also in June 1997, the FASB issued Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information" that is effective in
1998. The Company currently complies with the provisions of this
Statement.
In February 1998, the FASB issued Statement No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" (FAS 132)
that is effective in 1998. FAS 132 revises and standardizes disclosures
required by FAS 87, 88, and 106. Restatement of the retirement plans
footnote will be required for all earlier periods presented in comparative
financial statements at December 31, 1998.
In June 1998, the FASB issued Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (FAS 133) that will be
<PAGE> 16
effective in 2000. Management has not yet determined the effect, if any,
FAS 133 will have on the Railroad's financial statements.
Commitments and Contingencies - There are various claims and lawsuits
pending against the Company. Certain customers have submitted claims for
damages related to the delay of shipments by the Railroad as a result of
congestion problems, and certain customers have filed lawsuits seeking
relief related to such delays. The nature of the damages sought by
claimants includes, but is not limited to, contractual liquidated damages,
freight loss or damage, alternative transportation charges, additional
production costs, lost business and lost profits. In addition, some
customers have asserted that they have the right to cancel contracts as a
result of alleged material breaches of such contracts by the Railroad. In
the second quarter of 1998, the Company took a $155 million after-tax
charge for the resolution of customer claims. The Company will continue
to evaluate the adequacy of its reserves for claims and may add to such
reserves if appropriate.
The Company is also party to certain regulatory proceedings before the
Surface Transportation Board of the U.S. Department of Transportation
(STB). One proceeding pertains to rail service problems in the western
United States. As an outgrowth of this proceeding, the STB issued an
emergency service order imposing certain temporary measures on the
Railroad designed, among other things, to reduce congestion on the
Railroad's lines in the Houston, Texas area. On July 31, 1998, the STB
terminated the emergency service order. The STB kept in place the
requirement that the Railroad report certain service data, which the
Railroad had acknowledged the STB had the authority to impose under a
provision of the Interstate Commerce Act separate from the emergency
service provision. The STB also prescribed, under another statutory
provision separate from the emergency service provision, a 45-day "wind-
down" period during which certain rights that Texas Mexican Railway
Company (Tex Mex) and BNSF had received under the emergency service order
to handle UP traffic in Houston would be continued. A second proceeding,
initiated under the STB's continuing oversight jurisdiction with respect
to the Corporation's acquisition of Southern Pacific and consolidation of
Southern Pacific with UPRR-Utah (and separate from the STB's regularly
scheduled annual proceeding to review the implementation of the merger and
the effectiveness of the conditions that the STB imposed on it), is for
the purpose of considering the justification for and advisability of any
proposals for new remedial conditions to the merger as they pertain to
service in the Houston, Texas/Gulf Coast area. Various parties have filed
applications in this proceeding seeking the imposition of additional
conditions to the merger including, among other things, the granting of
overhead trackage rights on certain of the Railroad's lines in Texas,
"neutral switching supervision" on certain of the Railroad's branch lines,
the opening to other railroads and switching by a "neutral switching
company" of numerous industries now exclusively served by the Railroad in
the Houston area, and the compulsory sale or lease to other carriers of
certain of the Railroad's lines and facilities. The Railroad believes
that the applications are without merit and intends to contest them
vigorously. In addition, the STB has initiated various inquiries and
formal rulemaking proceedings regarding certain elements of rail
<PAGE> 17
regulation following two days of hearings by the STB at the request of two
members of Congress and in response to shippers' expressions of concern
regarding railroad service quality, railroad rates and allegedly
inadequate regulatory remedies. There can be no assurance that the
proposals advanced by parties in the remedial conditions proceeding or the
proceedings initiated in response to the rail regulation hearings will not
be approved in some form. Should the STB or Congress take aggressive
action in the rail regulation proceedings (e.g., by making purportedly
competition-enhancing changes in rate and route regulation and "access"
provisions), the adverse effect on the Railroad and other rail carriers
could be material.
The Company is also 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. In addition, the Company periodically enters
into financial and other commitments and has retained certain contingent
liabilities upon the disposition of formerly-owned operations.
In addition, UPC and certain of its officers and directors are currently
defendants in two purported class action securities lawsuits. The class
action suits allege, among other things, that management failed to
properly disclose the Railroad's service and safety problems and thereby
issued materially false and misleading statements concerning the merger
with SP and the safe, efficient operation of its rail network. Because
both the size of the class and the damages are uncertain, UPC and the
Railroad are unable at this time to determine the potential liability, if
any, which might arise from these lawsuits. UPC management believes that
these claims are without merit and intends to defend them vigorously.
It is not possible at this time for the Company to fully determine the
effect of all unasserted claims on its consolidated financial condition,
results of operations or liquidity; however, to the extent possible, where
unasserted claims can be estimated and where such claims are considered
probable, the Company has recorded a liability. The Company does not
expect that any known lawsuits, claims, environmental costs, commitments
or guarantees will have a material adverse effect on its consolidated
financial condition.
Year 2000 - In 1995, the Company began modifying its computer systems to
process transactions involving the year 2000 and beyond. Costs to convert
these systems, estimated to total $46 million, are expensed as incurred.
At June 30, 1998, approximately 70% of the Company's systems had been
modified, and the majority of the remaining systems are expected to be
modified by year-end 1998. During 1999, systems will be tested to assure
compliance with year 2000 requirements.
The Company is in the process of contacting entities with whom it
exchanges data to determine the status of their year 2000 modification
efforts. In addition, the Company is working with vendors who supply
equipment and/or software that could experience year 2000 problems.
<PAGE> 18
The Company believes its systems will be successfully and timely modified.
However, failure to do so or failure on the part of third parties with
whom the Company does business could materially impact operations and
financial results in the year 2000.
Cautionary Information
----------------------
Certain information included in this report contains, and other materials
filed or to be filed by the Railroad with the Securities and Exchange
Commission (as well as information included in oral statements or other
written statements made or to be made by the Railroad) contain or will
contain, forward-looking statements within the meaning of the Securities
Act of 1933, as amended, and the Securities Exchange Act of 1934, as
amended. Such forward-looking information may include, without
limitation, statements that the Company does not expect that lawsuits,
environmental costs, commitments, contingent liabilities, labor
negotiations or other matters will have a material adverse effect on its
financial condition, results of operations or liquidity and other similar
expressions concerning matters that are not historical facts, and
projections as to the Company's financial results. Such forward-looking
information is or will be based on information available at that time, and
is or will be subject to risks and uncertainties that could cause actual
results to differ materially from those expressed in the statements.
Important factors that could cause such differences include, but are not
limited to whether the Railroad is fully successful in overcoming its
congestion-related problems and implementing its service recovery plans
and other financial and operational initiatives, industry competition and
regulatory developments, natural events such as floods and earthquakes,
the effects of adverse general economic conditions, changes in fuel
prices, labor strikes, the impact of year 2000 systems problems and the
ultimate outcome of shipper claims related to congestion, environmental
investigations or proceedings and other types of claims and litigation.
PART II. OTHER INFORMATION
---------------------------
Item 1. LEGAL PROCEEDINGS
SOUTHERN PACIFIC ACQUISITION: As previously reported, various appeals have
been filed with respect to the STB's August 12, 1996 decision (the
Decision) approving the acquisition of control of Southern Pacific by the
Corporation. All of the appeals have been consolidated in the U.S. Court
of Appeals for the District of Columbia Circuit. Oral argument in the case
is scheduled for September 11, 1998. Various appellants have withdrawn
their appeals, leaving only BNSF, the Western Coal Traffic League (WCTL),
and the City of Reno, Nevada with appeals pending. On April 10, 1998,
WCTL filed a motion to vacate and remand the Decision in light of a
proceeding the STB commenced on March 31, 1998, under its continuing
oversight jurisdiction over the merger, to consider whether any additional
conditions are justified and should be imposed to deal with service
problems in the Houston/Gulf Coast area. That motion was denied by the
court on May 22, 1998. The Company believes that it is unlikely that the
<PAGE> 19
disposition of the remaining appeals will have a material adverse impact
on its consolidated financial condition or its results of operations.
SHIPPER CLAIMS: Certain customers have submitted claims for damages
related to the delay of shipments by the Company as a result of congestion
problems, and certain customers have filed lawsuits seeking relief related
to such delays. The nature of the damages sought by claimants includes,
but is not limited to, contractual liquidated damages, freight loss or
damage, alternative transportation charges, additional production costs,
lost business and lost profits. In addition, some customers have asserted
that they have the right to cancel contracts as a result of alleged
material breaches of such contracts by the Company. While the Company
does not believe that such claims will have a material adverse effect on
its financial condition, it is not possible to determine fully the
effects of all asserted and unasserted claims. In the second quarter of
1998, the Company took a $155 million after-tax charge for the resolution
of customer claims. The Railroad will continue to evaluate the adequacy
of its reserves for claims and may add to such reserves if appropriate.
RAIL SERVICE PROCEEDINGS AND RELATED MATTERS: As previously reported, the
Company was subject to an emergency service order issued by the STB on
October 31, 1997, as an outgrowth of a proceeding initiated by the STB on
October 2, 1997 to investigate rail service problems in the western United
States. On July 31, 1998, the STB terminated the emergency service order.
The STB kept in place the requirement that the Railroad report certain
service data, which the Railroad had acknowledged the STB had the
authority to impose under a provision of the Interstate Commerce Act
separate from the emergency service provision. The STB also prescribed,
under another statutory provision separate from the emergency service
provision, a 45-day "wind-down" period during which certain rights that
Tex Mex and BNSF had received under the emergency service order to handle
UP traffic in Houston would be continued.
Also as previously reported on March 31, 1998, the STB initiated a
proceeding under its continuing oversight jurisdiction with respect to the
merger of the Corporation and Southern Pacific to consider proposals for
new remedial conditions to the merger as they pertain to service in the
Houston, Texas/Gulf Coast area. This proceeding, which is separate from
the STB's regularly scheduled annual proceeding to review the
implementation of the merger and the effectiveness of the conditions that
the STB imposed on it, was initiated in response to submissions by Tex
Mex, Kansas City Southern Railway Company (KCS) and the Greater Houston
Partnership (GHP), proposing that the Railroad be directed to transfer
certain lines and facilities in the Gulf Coast region to other rail
carriers, that a "neutral" switching operation be established in the
greater Houston area and that provisions in the STB's emergency service
order that expanded Tex Mex's right to handle traffic to and from Houston
be adopted permanently. The STB's decision announcing the proceeding
established a procedural schedule for the submission of evidence, replies
and rebuttal. Separately from this proceeding, a shortline railroad, the
Arkansas, Louisiana and Mississippi Railroad ("AL&M"), has filed a request
that an additional condition be imposed on the merger allowing AL&M to
interchange with BNSF.
<PAGE> 20
On July 8, 1998, various parties filed applications for conditions in the
remedial conditions proceeding. For example, BNSF sought trackage rights
over the Railroad's line between San Antonio and Laredo, Texas, trackage
rights on the Railroad's line between Taylor and Milano, Texas, "neutral
switching supervision" on certain branches in the Houston and Beaumont
areas, and a variety of other conditions. KCS and Tex Mex, in a joint
filing with the Railroad Commission of Texas, the Chemical Manufacturers
Association, the Society of the Plastics Industry and several other
parties, sought a number of conditions, including the opening to other
railroads and switching by a "neutral switching company" of numerous
industries now exclusively served by the Railroad in the Houston area, the
compulsory sale or lease to Tex Mex of a Railroad yard in Houston, the
compulsory sale to Tex Mex of a former SP line between Rosenberg and
Victoria, Texas, the compulsory transfer to KCS and Tex Mex of the
Railroad's Beaumont Subdivision between Houston and Beaumont in exchange
for a track that KCS and Tex Mex propose to construct on the right-of-way
of the SP line between those cities, and the adoption on a permanent basis
of the provision of the emergency service order allowing Tex Mex to handle
traffic moving between Houston and points other than Tex Mex's own lines,
and of certain other provisions of that order. A number of shippers,
including Dow Chemical Company, Formosa Plastics Corporation and E.I.
DuPont de Nemours and Company, also individually sought various
conditions. The Railroad's response in opposition to the condition
requests is due on September 18, 1998. The Railroad believes that the
applications are without merit and intends to contest them vigorously.
There can be no assurance that the proposals advanced by BNSF, Tex Mex,
KCS, GHP or other parties in the remedial conditions proceeding or other
condition requests such as the request of AL&M will not be approved in
some form.
RAIL ACCESS AND COMPETITION: As previously reported, the STB, acting
pursuant to requests from two members of Congress and responding to
shippers' concerns about railroad service quality, railroad rates and
allegedly inadequate regulatory remedies, issued a decision on April 17,
1998, following two days of hearings, which opened inquiries into certain
elements of rail regulation. The STB noted that no parties to the hearings
had shown how aggressive remedies designed to produce lower rates and
enhance competition would permit the industry to cover system costs and
support reinvestment. Nevertheless, it (i) directed a panel of
disinterested economic experts to recommend appropriate standards to
measure railroad revenue adequacy, which is used to determine whether
rates are lawful (this portion of the decision was subsequently modified
to permit, as an alternative, discussions of this issue between railroad
and shipper representatives); (ii) initiated a rulemaking proceeding to
consider revisions to "competitive access" regulations in order to address
quality of service issues; (iii) ordered interested parties to identify
modifications to regulations governing access on non-service-related
grounds; (iv) began a rulemaking proceeding to consider eliminating
product and geographic competition as factors to be considered in deciding
whether a railroad has market dominance over rail traffic; (v) ordered
large and small railroads to negotiate arrangements that would increase
the role of short-line rail carriers; and (vi) directed the railroads to
<PAGE> 21
establish "formalized dialogue" immediately with large and small shippers
and rail labor. The rulemakings described in clauses (ii) and (iv) of the
preceding sentence are pending. Meetings between railroad and shipper
representatives under the supervision of an administrative law judge on
the topics described in clauses (i) and (iii) of the foregoing sentence
have failed to produce agreement, as have discussions between
representatives of the large railroads and smaller railroads on the topics
described in clause (v). The dialogues described in clause (vi) of the
foregoing sentence are ongoing. Should the STB or Congress take
aggressive action, (e.g., by making purportedly competition-enhancing
changes in rate and route regulation and "access" provisions), the adverse
effect on the Railroad and other railroads could be material.
DERIVATIVE LITIGATION: As previously reported in the Company's 1997 Annual
Report on Form 10-K, certain current and former directors of the
Corporation had been named as defendants in a purported derivative action
filed on behalf of the Corporation in the Federal District Court for the
Northern District of Texas in late 1997. The derivative action alleged,
among other things, that the named current and former directors breached
their fiduciary duties to the Corporation by approving the mergers of
Southern Pacific and Chicago and North Western Transportation Company into
the Corporation without ensuring that the Corporation or the Railroad had
adequate systems in place to integrate effectively those companies into
the operations of the Corporation and the Railroad. The derivative action
was voluntarily dismissed by the plaintiffs, without prejudice, on May 26,
1998.
ENVIRONMENTAL MATTERS: The Company has received approximately 20 Notices
of Violation (NOVs) from the South Coast Air Quality Management District
(the District) relating to fumes emitted from idling diesel locomotives at
Slover siding near the Railroad's yard in West Colton, California. Trains
awaiting crews or room to enter the West Colton yard have been parked at
Slover siding with their engines running for various amounts of time,
causing exhaust fumes to enter the backyards and homes of residents living
along the siding. The District has cited the Railroad for creating a
public nuisance pursuant to the California Health and Safety Code and the
District's regulations. Each violation carries a maximum civil penalty of
$25,000 per day, which may be increased in some circumstances to $50,000
per day. The Railroad has modified its operating procedures for trains
entering the West Colton yard to reduce the problem and may enter into a
stipulation with the District. The Railroad expects to settle the NOVs
for an amount that is less than the maximum permitted by law, but the
exact amount cannot be determined at this time.
<PAGE> 22
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits
--------
12 - Ratio of Earnings to Fixed Charges
27 - Financial Data Schedule.
(b) Reports on Form 8-K
-------------------
On April 23, 1998, the Company filed a Current Report on
Form 8-K announcing first quarter 1998 results.
On May 29, 1998, the Company filed a Current Report on Form
8-K announcing the Company's expectation of a loss from
continuing operations in the second quarter of 1998.
[SIGNATURE]
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on this 14th day of August, 1998.
UNION PACIFIC RAILROAD COMPANY
By /s/ John J. Koraleski
-------------------------------
John J. Koraleski
Executive Vice President-Finance
and Chief Financial Officer
(chief accounting officer and
duly authorized officer)
<EXHIBIT INDEX> INDEX
UNION PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY
COMPANIES
EXHIBIT INDEX
Exhibit No. Description
----------- -----------------------------------------
12 Computation of Ratio of Earnings to
Fixed Charges
27 Financial Data Schedule
UNION PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY COMPANIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
-------------------------------------------------
(In Millions of Dollars, Except Ratios)
(Unaudited)
Six Months
Ended June 30,
---------------
1998 1997
----- ----
Earnings:
Net income (loss) . . . . . . . . . . . . . $(154) $420
Undistributed equity earnings. . . . . . . . (24) 16
----- ----
Total. . . . . . . . . . . . . . . . . . . . (178) 404
----- ----
Income Taxes . . . . . . . . . . . . . . . . . (123) 244
----- ----
Fixed Charges:
Interest expense including amortization
of debt discount. . . . . . . . . . . . . 282 241
Portion of rentals representing an interest
factor. . . . . . . . . . . . . . . . . . 87 88
----- ----
Total . . . . . . . . . . . . . . . . . . 369 329
----- ----
Earnings available for fixed charges . . . . . 68 977
===== ====
Fixed Charges -- as above. . . . . . . . . . . 369 329
Ratio of earnings to fixed charges (Note 4). . 0.2 3.0
==== ====
<TABLE> <S> <C>
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This is a legend.
</LEGEND>
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0
28
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