<COVER>
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 September 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 1-6075
UNION PACIFIC CORPORATION
(Exact name of registrant as specified in its charter)
UTAH 13-2626465
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1717 Main Street, Suite 5900, Dallas, Texas
(Address of principal executive offices)
75201
(Zip Code)
(214) 743-5600
(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 October 31, 1998, there were 247,375,588 shares of the
Registrant's Common Stock outstanding.
<INDEX>
UNION PACIFIC CORPORATION
INDEX
PART I. FINANCIAL INFORMATION
Page Number
Item 1: Condensed Consolidated Financial Statements:
CONDENSED STATEMENT OF CONSOLIDATED INCOME -
For the Three Months and Nine Months Ended
September 30, 1998 and 1997.................. 1
CONDENSED STATEMENT OF CONSOLIDATED FINANCIAL
POSITION - At September 30, 1998 and
December 31, 1997............................. 2
CONDENSED STATEMENT OF CONSOLIDATED CASH FLOWS
- For the Nine Months Ended September 30, 1998
and 1997...................................... 4
CONDENSED STATEMENT OF CONSOLIDATED RETAINED
EARNINGS - For the Nine Months Ended September
30, 1998 and 1997............................. 4
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS.................................... 5
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations............ 11
Item 3: Quantitative and Qualitative Disclosures About
Market Risk.................................... 20
PART II. OTHER INFORMATION
Item 1: Legal Proceedings................................. 21
Item 6: Exhibits and Reports on Form 8-K.................. 22
Signature.................................................. 23
1
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
UNION PACIFIC CORPORATION AND SUBSIDIARY COMPANIES
CONDENSED STATEMENT OF CONSOLIDATED INCOME
For the Three Months and Nine Months Ended September 30, 1998 and 1997
(Amounts in Millions, Except Ratio and Per Share Amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
----------------------------------
Operating Revenues ....................... $2,404 $2,575 $7,094 $7,817
Operating Expenses (Note 2):
Salaries, wages and employee benefits... 926 891 2,779 2,674
Equipment and other rents............... 329 336 1,038 969
Depreciation and amortization........... 253 244 751 732
Fuel and utilities (Note 4)............. 193 229 604 766
Purchased services...................... 164 171 504 500
Materials and supplies.................. 131 119 399 391
Other costs............................. 205 170 937 579
Total................................ 2,201 2,160 7,012 6,611
------ ------ ------ ------
Operating Income.......................... 203 415 82 1,206
Other Income - Net........................ 37 102 113 159
Interest Expense (Note 4)................. (189) (156) (526) (451)
------ ------ ------ ------
Income (Loss) before Income Taxes......... 51 361 (331) 914
Income Taxes (Benefit) Expense............ 19 124 (140) 329
Income (Loss) from Continuing Operations.. 32 237 (191) 585
------ ------ ------ ------
Discontinued Operations (Note 3):
Income (Loss) from Operations of
Discontinued Operations............ - 3 4 (1)
Estimated Loss on Disposal of
Discontinued Operations (net of
income taxes of $1 million and
$199 million, respectively)........ 6 - (256) -
------ ------ ------ -----
Income (Loss) from Discontinued Operations. 6 3 (252) (1)
------ ------ ------ ------
Net Income (Loss)......................... $ 38 $ 240 $ (443) $ 584
====== ====== ====== ======
Earnings Per Share (Note 9):
Basic:
Income(Loss)from Continuing Operations.. $ 0.13 $ 0.96 $(0.78) $ 2.38
Income(Loss)from Discontinued Operations 0.02 0.01 (1.02) -
------ ------ ------ ------
Net Income (Loss)....................... $ 0.15 $ 0.97 $(1.80) $ 2.38
====== ====== ====== ======
Diluted:
Income(Loss)from Continuing Operations.. $ 0.13 $ 0.95 $(0.78) $ 2.36
Income(Loss)from Discontinued Operations 0.02 0.01 (1.02) (0.01)
------ ------ ------ ------
Net Income (Loss)....................... $ 0.15 $ 0.96 $(1.80) $ 2.35
====== ====== ====== ======
Weighted Average Number of Shares (Basic).. 246.1 245.9 246.0 245.7
Weighted Average Number of Shares (Diluted) 246.7 248.6 246.0 248.0
Cash Dividends Per Share.................. $ 0.20 $ 0.43 $ 0.60 $ 1.29
Ratio of Earnings to Fixed Charges (Note 5) -- -- 0.4 2.5
The accompanying accounting policies and notes to condensed consolidated
financial statements are an integral part of these statements.
2
UNION PACIFIC CORPORATION AND SUBSIDIARY COMPANIES
CONDENSED STATEMENT OF CONSOLIDATED FINANCIAL POSITION
(Millions of Dollars)
(Unaudited)
September 30, December 31,
ASSETS 1998 1997
------------ -----------
Current Assets:
Cash and temporary investments . . . . . . . . $ 554 $ 89
Accounts receivable - net (Note 4) . . . . . . 401 505
Materials and supplies . . . . . . . . . . . . 308 288
Other current assets . . . . . . . . . . . . . 234 357
Investment in Discontinued Operations (Note 3). 518 955
------- --------
Total Current Assets. . . . . . . . . . . . 2,015 2,194
------- --------
Investments:
Investments in and advances to affiliated
companies . . . . . . . . . . . . . . . . . . 508 443
Other investments. . . . . . . . . . . . . . . . 156 181
------- --------
Total Investments . . . . . . . . . . . . . 664 624
------- --------
Properties:
Railroad:
Road and other . . . . . . . . . . . . . . . . 24,624 23,610
Equipment. . . . . . . . . . . . . . . . . . . 7,497 7,084
------- -------
Total Railroad. . . . . . . . . . . . . . . 32,121 30,694
Other. . . . . . . . . . . . . . . . . . . . . . 77 70
------- -------
Total Properties. . . . . . . . . . . . . . 32,198 30,764
Accumulated depreciation . . . . . . . . . . . . (5,670) (5,240)
------- -------
Properties - Net . . . . . . . . . . . . . . . 26,528 25,524
------- -------
Other Assets . . . . . . . . . . . . . . . . . . . 222 185
------- -------
Total Assets. . . . . . . . . . . . . . . .$ 29,429 $ 28,527
======== ========
The accompanying accounting policies and notes to condensed consolidated
financial statements are an integral part of these statements.
3
UNION PACIFIC CORPORATION AND SUBSIDIARY COMPANIES
CONDENSED STATEMENT OF CONSOLIDATED FINANCIAL POSITION
(Amounts in Millions, Except Share and Per Share Amounts)
(Unaudited)
September 30, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997
------------- ------------
Current Liabilities:
Accounts payable................................ $ 531 $ 711
Accrued wages and vacation...................... 407 388
Accrued casualty costs.......................... 319 318
Dividends and interest.......................... 244 293
Income and other taxes.......................... 281 263
Debt due within one year........................ 178 229
Other current liabilities (Notes 2 and 7)....... 820 881
-------- --------
Total Current Liabilities.................... 2,780 3,083
-------- --------
Debt Due After One Year........................... 9,029 8,280
Deferred Income Taxes............................. 5,978 6,284
Accrued Casualty Costs............................ 675 678
Retiree Benefits Obligation....................... 782 752
Other Long-Term Liabilities (Notes 2 and 7)....... 1,056 1,225
Company-Obligated Mandatorily Redeemable
Convertible Preferred Securities (Note 6)....... 1,500 -
Stockholders' Equity:
Common stock, $2.50 par value, authorized
500,000,000 shares, 276,244,491 shares issued
in 1998, 276,047,556 shares issued in 1997.... 691 690
Paid-in surplus................................. 4,049 4,066
Retained earnings............................... 4,680 5,271
Treasury stock, at cost, 28,867,358 shares in
1998, 29,045,938 shares in 1997............... (1,791) (1,802)
-------- --------
Total Stockholders' Equity.................... 7,629 8,225
-------- --------
Total Liabilities and Stockholders' Equity.... $ 29,429 $ 28,527
======== ========
The accompanying accounting policies and notes to condensed consolidated
financial statements are an integral part of these statements.
4
UNION PACIFIC CORPORATION AND SUBSIDIARY COMPANIES
CONDENSED STATEMENT OF CONSOLIDATED CASH FLOWS
For the Nine Months Ended September 30, 1998 and 1997
(Millions of Dollars)
(Unaudited)
1998 1997
------- --------
Cash from continuing operations:
Income (loss)from continuing operations ........... $ (191) $ 585
Non-cash charges to income:
Depreciation and amortization................... 751 732
Deferred income taxes........................... (122) 228
Other - net..................................... (182) (444)
Changes in current assets and liabilities.......... (96) 17
------- --------
Cash from continuing operations................. 160 1,118
------- --------
Cash flows from investing activities:
Cash provided by discontinued operations .......... 18 44
Capital investments................................ (1,760) (1,407)
Other - net........................................ 92 201
------- --------
Cash used in investing activities............... (1,650) (1,162)
------- --------
Cash flows from equity and financing activities:
Dividends paid..................................... (205) (317)
Debt repaid........................................ (1,751) (248)
Financings......................................... 3,956 645
Other - net........................................ (45) (25)
------- -------
Cash provided by equity and financing activities 1,955 55
------- -------
Net increase in cash and temporary investments.. $ 465 $ 11
======= ========
CONDENSED STATEMENT OF CONSOLIDATED RETAINED EARNINGS
For the Nine Months Ended September 30, 1998 and 1997
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)
1998 1997
------- -------
Balance at Beginning of Year........................ $ 5,271 $ 5,262
Net Income (Loss)................................... (443) 584
------- -------
Total........................................... 4,828 5,846
Dividends Declared ($0.60 per share in 1998 and
$1.29 per share in 1997)........................ (148) (318)
------- -------
Balance at End of Period....................... $ 4,680 $ 5,528
======= =======
The accompanying accounting policies and notes to condensed consolidated
financial statements are an integral part of these statements.
5
UNION PACIFIC CORPORATION AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Responsibilities for Financial Statements - The condensed consolidated
financial statements 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 Statement of Consolidated Financial Position at December 31,
1997 is derived from audited financial statements. The condensed
consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto contained in
the Union Pacific Corporation (the Corporation or UPC) Annual Report
to Shareholders incorporated by reference in the Corporation's Annual
Report on Form 10-K for the year ended December 31, 1997. The results
of operations for the three and nine months ended September 30, 1998
are not necessarily indicative of the results for the entire year
ending December 31, 1998. Certain 1997 amounts have been reclassified
to conform to the 1998 financial statement presentation.
2. Acquisition of Southern Pacific Rail Corporation (Southern Pacific or
SP) - In connection with the continuing integration of Union Pacific
Railroad Company (UPRR or the Railroad) and its predecessors with
Southern Pacific's rail operations, UPC is continuing to eliminate
duplicate positions (primarily positions other than train crews),
relocate positions, merge or dispose of redundant facilities, dispose
of certain rail lines and cancel uneconomical and duplicative SP
contracts. The Corporation has also repaid certain of Southern
Pacific's debt obligations. UPC recognized a $958 million liability in
the Southern Pacific purchase price allocation for costs associated
with SP's portion of these activities.
Through September 30, 1998, approximately $460 million in merger-
related costs were charged against these reserves, principally
consisting of approximately $246 million and $76 million,
respectively, for severance and relocation payments made to
approximately 4,400 Southern Pacific employees and approximately $96
million for labor protection payments. The Corporation expects the
remaining merger payments will be made over the course of the next
three years as the rail operations of UPRR and SP are integrated and
labor negotiations are completed and implemented.
In addition, the Railroad expects to incur approximately $165 million
in acquisition-related costs for severing or relocating UPRR
employees, disposing of certain UPRR facilities, training and
equipment upgrading. These costs will be charged to expense as
incurred over the next three years. Results for the three and nine
months ended September 30, 1998 include $7 million and $36 million,
after tax, respectively, in acquisition-related operating costs.
3. Divestitures - Overnite: In May 1998, the Corporation's Board of
Directors approved a formal plan to divest UPC's investment in
Overnite Transportation Company (Overnite or OTC). As a result, UPC
recorded a $256 million after-tax loss (net of taxes of $199 million)
from the planned disposition of OTC, including results for the third
quarter of 1998 which are adjusted for certain intercompany items.
Although a planned initial public offering of the Corporation's entire
interest in Overnite (the IPO) was postponed in the third quarter,
management is continuing to monitor market conditions and will proceed
with the IPO when conditions warrant. Management is also considering
alternate means of disposing of its investment in OTC.
6
OTC's results have been reported as a discontinued operation in the
accompanying consolidated financial statements for all periods
presented. Prior periods' financial statements have been restated to
conform with the current year's presentation. Operating revenues for
OTC were $257 million and $776 million, respectively, for the three
and nine months ended September 30, 1998 and $946 million and $961
million for the years ended December 31, 1997 and 1996, respectively.
OTC's capital expenditures were $11 million and $37 million,
respectively, for the three and nine months ended September 30, 1998
and $40 million and $10 million for the years ended December 31, 1997
and 1996, respectively. OTC's net income was $6 million and $13
million, respectively, for the three and nine months ended September
30, 1998, adjusted for certain intercompany items. OTC reported net
income of $4 million for the year ended December 31, 1997 and a net
loss of $43 million for the year ended December 31, 1996 (including
goodwill amortization of $20 million in both periods).
UPC intends to use the cash proceeds from the disposition of OTC for
general corporate purposes, including repayment of borrowings, working
capital requirements and capital expenditures.
Skyway: On November 4, 1998, the Corporation completed the sale of
Skyway Freight Systems, Inc. (Skyway), a wholly owned subsidiary.
Skyway provides contract logistics and supply chain management
services. The proceeds will be used to repay outstanding debt.
4. Financial Instruments - The Corporation 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 Corporation has fixed interest rates or fuel prices through the
use of swaps, futures or forward contracts, the Corporation has
mitigated the downside risk of adverse price and rate movements;
however, it has also limited future gains from favorable movements.
The total credit risk associated with the Corporation's counterparties
was $23 million at September 30, 1998. The Corporation has not been
required to provide, nor has it received, any collateral relating to
its hedging activities.
The fair market value of the Corporation's derivative financial
instrument positions at September 30, 1998 was determined based upon
current fair market values as quoted by recognized dealers or
developed based upon the present value of future cash flows discounted
at the applicable zero coupon U.S. Treasury rate and swap spread.
Interest Rates - At September 30, 1998, the Corporation had
outstanding interest rate swaps on $152 million of notional principal
amount of debt (2% of the total debt portfolio) with a gross fair
market value asset position of $22 million and a gross fair market
value liability position of $20 million. These contracts mature over
the next two years. Interest rate hedging activity had no significant
effect on interest expense in the third quarter of 1998 and increased
interest expense by $3 million in the third quarter of 1997.
Fuel - At September 30, 1998, the Railroad had hedged approximately
49% of its estimated remaining 1998 diesel fuel consumption at $0.51
per gallon, on a Gulf Coast basis and approximately 37% of its
estimated 1999 diesel fuel consumption at $0.42 per gallon, on a Gulf
Coast basis. At September 30, 1998, the Railroad had outstanding swap
agreements covering its fuel purchases of $291 million, with gross and
net asset positions of less than $1 million. Fuel hedging increased
third quarter 1998 fuel expense by $25 million and third quarter 1997
fuel expense by approximately $1 million. For the nine months ended
September 30, fuel hedging increased 1998 fuel expense by $59 million
and 1997 fuel expense by approximately $1 million.
7
Sale of Receivables - The Railroad has sold, on a revolving basis, an
undivided percentage ownership interest in a designated pool of
accounts receivable. The amount of receivables sold fluctuates based
upon the availability of the designated pool of receivables and is
directly affected by changing business volumes and credit risks. At
December 31, 1997 and September 30, 1998, accounts receivable are
presented net of the $650 million and $580 million, respectively, of
receivables sold.
5. 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 nine months ended September 30, 1998, fixed
charges exceeded earnings by approximately $365 million.
6. Convertible Preferred Securities - On April 1, 1998, the Corporation
completed a private placement of $1.5 billion of 6-1/4% preferred
securities (the Convertible Preferred Securities) of Union Pacific
Capital Trust (the Trust), a statutory business trust sponsored by the
Corporation. Each of the Convertible Preferred Securities has a
stated liquidation amount of $50 and is convertible, at the option of
the holder thereof, into shares of UPC's common stock, par value $2.50
per share (the UPC Common Stock), at the rate of 0.7257 shares of UPC
Common Stock for each of the Convertible Preferred Securities,
equivalent to a conversion price of $68.90 per share of UPC Common
Stock, subject to adjustment under certain circumstances. The
Corporation owns all of the common securities of the Trust. Proceeds
from the sale of the Convertible Preferred Securities were used for
repayment of borrowings.
7. Commitments and Contingencies - There are various claims and lawsuits
pending against the Corporation and certain of its subsidiaries.
Certain customers have submitted claims for damages related to
shipments delayed 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. UPC
continues to evaluate the adequacy of its reserves for customer
claims.
The Railroad 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
7
certain rights that Texas Mexican Railway Company (Tex Mex) and The
Burlington Northern and Santa Fe Railway Company (BNSF) had received
under the emergency service order to handle the Railroad's traffic in
Houston would be continued. The 45-day "wind-down" period expired
September 17, 1998. A second proceeding, initiated under the STB's
continuing oversight jurisdiction with respect to the merger of the
Corporation and Southern Pacific (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 area and
surrounding coastal areas of Texas and Louisiana. 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's response in opposition to the condition
requests was filed on September 18, 1998, and rebuttal in support of
the condition applications was filed on October 16, 1998. The
Railroad believes that the applications are without merit and
vigorously opposed them in its September 18 submission. 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 traffic with BNSF. The Railroad has also opposed this
request. 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 in April 1998 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 Corporation 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 Corporation has recorded a liability. In
addition, the Corporation 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 actions, which have been
consolidated into one proceeding. The consolidated complaint alleges,
among other things, that the Corporation violated the federal
securities laws by failing to disclose material facts and making
materially false and misleading statements concerning the service,
congestion and safety problems encountered following the Corporation's
acquisition of Southern Pacific in 1996. These lawsuits were filed in
late 1997 in the United States District Court for the Northern
District of Texas and seek to recover unspecified amounts of damages.
9
Management believes that the plaintiffs' claims are without merit and
intends to defend them vigorously. The defendants have moved to
dismiss this action, and the motion has been fully briefed.
In addition to the class action litigation, certain current and former
directors of the Corporation and the Railroad were named as defendants
in a purported derivative action filed on behalf of the Corporation
and the Railroad in the United States 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 and the Railroad by
approving the acquisition of Southern Pacific. The defendants moved
to dismiss the derivative action. In response, the plaintiffs sought
to voluntarily dismiss their claims, and the derivative action was
dismissed, without prejudice, by order of the court dated May 26,
1998.
On September 14, 1998, a different shareholder plaintiff filed a new
purported derivative action on behalf of the Corporation and the
Railroad in the District Court of Tarrant County, Texas, naming as
defendants the Corporation, the Railroad, and the current and certain
former directors of the Corporation and the Railroad. This new
derivative action alleges, among other things, that the named current
and former directors breached their fiduciary duties to the
Corporation and the Railroad by approving and implementing the
Southern Pacific merger without informing themselves of its impact or
ensuring that adequate controls were put in place and by causing UPC
and the Railroad to make misrepresentations about the Railroad's
service problems to the financial markets and regulatory authorities.
The defendants believe that these claims are without merit and intend
to defend them vigorously.
It is not possible at this time for the Corporation 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 Corporation has recorded a
liability. The Corporation does not expect that any known lawsuits,
claims, environmental costs, commitments or guarantees will have a
material adverse effect on its consolidated financial condition.
8. 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. UPC 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
derivative instruments which qualify for hedge accounting under
Statement No. 133, when adopted, and net loss recognized as an
additional pension liability but not yet recognized as net periodic
pension cost. The impact of adopting FAS 130 for the nine months ended
September 30, 1998 was approximately a $2 million after-tax reduction
of net income.
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 Corporation currently complies with the
provisions of this Statement.
10
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. This Statement will only
affect footnote disclosure and will not otherwise have an effect on
the consolidated financial statements of the Corporation.
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 is just beginning the process of
determining the effect, if any, FAS 133 will have on the Corporation's
financial statements.
9. Earnings Per Share - The following table provides a reconciliation
between basic and diluted earnings per share, in accordance with FAS
128, "Earnings Per Share":
(Dollars in Millions, Except Per Three Months Ended Nine Months Ended
Share Amounts) September 30 September 30
------------------ -----------------
1998 1997 1998 1997
Income Statement Data: ----- ----- ----- -----
Income(Loss)from Continuing
Operations $ 32 $ 237 $(191) $ 585
Interest associated with Convertible
Preferred Securities .............. 15 - 29 -
Income (Loss) Available to Common
Stockholders from Continuing
Operations ........................ 47 237 (162) 585
Income (Loss) from Discontinued
Operations ....................... 6 3 (252) (1)
Net Income (Loss) Available to Common
Stockholders ...................... 38 240 (443) 584
Weighted Average Number of Shares
Outstanding:
Basic ............................... 246.1 245.9 246.0 245.7
Dilutive effect of common stock
equivalents ....................... 22.4 2.7 16.0 2.3
----- ----- ----- -----
Diluted ............................. 268.5 248.6 262.0 248.0
===== ===== ===== =====
Earnings Per Share:
Basic:
Income (Loss) from Continued
Operations................... $0.13 $0.96 $(0.78) $2.38
Income (Loss) from Discontinued
Operations................... 0.02 0.01 (1.02) -
----- ----- ------ -----
Net Income (Loss)............... $0.15 $0.97 $(1.80) $2.38
===== ===== ====== =====
Diluted:
Income (Loss) from Continued
Operations................... $0.13 (a) $0.95 $(0.78)(a) $2.36
Income (Loss) from Discontinued
Operations .................. 0.02 0.01 (1.02) (0.01)
----- ----- ------ -----
Net Income (Loss)............... $0.15 (b) $0.96 $(1.80)(b) $2.35
===== ===== ====== =====
(a) Excludes the interest associated with the Convertible
Preferred Securities, which are anti-dilutive.
(b) Excludes the effect of anti-dilutive common stock
equivalents, which are 21.8 million and 16.0 million,
respectively, for the three and nine months ended September
30, 1998.
11
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
UNION PACIFIC CORPORATION AND SUBSIDIARY COMPANIES
RESULTS OF OPERATIONS
Overview - During the second quarter of 1998, Union Pacific Corporation
(the Corporation or UPC) restated all periods to reflect Overnite
Transportation Company (Overnite or OTC) as a discontinued operation due
to its planned sale. Since Union Pacific Railroad Company (UPRR or the
Railroad) is the remaining significant operating company of the
Corporation, corporate expenses, previously considered non-operating
expenses, are now included in Other Costs for all periods presented.
Previously, such expenses were presented below operating income. The
impact of reclassifying such expenses as operating expenses was to reduce
operating income by $18 million and $69 million, respectively, for the
three and nine months ended September 30, 1998 and $42 million and $96
million, respectively, for the three and nine months ended September 30,
1997.
Southern Pacific Rail Corporation (Southern Pacific or SP) Acquisition -
In September 1996, the Corporation completed its acquisition of Southern
Pacific and, throughout 1997 and 1998, continued the process of
integrating the operations of SP's rail subsidiaries into the operations
of the Railroad and its predecessors. The Corporation expects to complete
the full integration of the operations of UPRR and the Southern Pacific
rail subsidiaries over the next three years. The Corporation believes
that the full implementation of the merger will 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, UPC 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.
Overnite Divestiture - In May 1998, the Corporation's Board of Directors
approved a formal plan to divest UPC's investment in Overnite. See Note
3 to the condensed consolidated financial statements, which is
incorporated herein by reference, for a complete discussion of the effects
of the planned sale of OTC.
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 Corporation's
operations and earnings in the third quarter of 1997. System congestion
started in the Gulf Coast region and spread throughout the system during
the third and fourth quarters of 1997, and continued to adversely affect
the Railroad's operations and financial results during the first nine
months of 1998. The Railroad has adopted certain measures to alleviate
the congestion problems, and implementation of these service recovery
measures has significantly relieved congestion in the Gulf Coast region.
During the third quarter of 1998, service in the Railroad's Central
Corridor between Chicago and Utah was slowed by track maintenance and
capacity expansion work which is expected to be completed during 1999.
UPRR also experienced congestion on its lines in Northern California, in
the Los Angeles Basin and on the Sunset Route west of El Paso, Texas,
caused in part by two derailments on July 8 and July 9, 1998, tight crew
supply and limited track capacity in that region, and the learning curve
associated with the integration of the computer system of Southern Pacific
in the region with the Railroad's computer system, which commenced July
1, 1998. The Railroad has eliminated this congestion by various
12
measures, including rerouting trains from this region to other portions
of its system. During the late third quarter and early fourth quarter of
1998, the Railroad's operations were also adversely affected by severe
weather in the southern portion of its system, including Hurricane
Georges, which disrupted operations in New Orleans and other parts of
Louisiana during the last three days of September, heavy rains that moved
from northern Texas through Oklahoma and into the Kansas City area on
October 3 and 4, heavy rains that resulted in severe flooding in central
and southern Texas later in the month of October, and heavy rains and
flooding across parts of Oklahoma and Kansas in early November. Despite
these weather problems, the Railroad has been able to respond quickly to
reroute traffic, repair damages caused by washouts and restore service
without severe or lengthy disruptions to the Railroad's operations,
reflecting the Railroad's overall progress in addressing the service and
congestion problems. Although progress has been made in improving
service, the Corporation expects these problems to continue to have an
adverse impact on 1998 results.
During the third quarter of 1998, the Corporation announced a new long-term
strategy to improve the effectiveness of the organization. This
effort will be focused on culture change, business process improvement and
decentralization, each of which is designed to improve customer
satisfaction, increase employee engagement, and improve financial results.
Quarter Ended September 30, 1998 Compared to September 30, 1997
The Corporation returned to profitability in the third quarter of 1998
after three consecutive quarterly losses by posting earnings of $38
million, down from $240 million in the third quarter of 1997. Despite
service improvements during the quarter, year-over-year results were
affected by service problems in the western part of the Railroad's system,
which were resolved during the quarter, traffic slow-downs related to
major track maintenance and capacity expansion efforts along the
Railroad's Central Corridor (scheduled to be completed during 1999),
severe weather in the southern portion of the Railroad's system and the
cost of continued service recovery. Operating income of $203 million for
the third quarter of 1998 compares to $415 million in last year's third
quarter, reflecting a year-over-year increase in pre-tax service-related
costs and lost revenues, as service issues began late in the third quarter
of 1997. The operating ratio for the third quarter of 1998 was 91.6%, up
7.7 points from 1997's 83.9%. Lost revenue and costs related to service
performance were the key drivers of the change.
REVENUE SUMMARY - Operating revenues were down $171 million (7%) at $2,404
million. Carloadings for the third quarter of 1998 of 2,021,969 were down
149,127 units, or 7%, from year-ago loads of 2,171,096. Declines were led
by continuing service issues, weakening demand for whole grain exports
(due to strong worldwide crop yields) and a soft export market (caused by
the Asian currency crisis impact). Average revenue per car (ARC) was
slightly off versus last year for the quarter at $1,126 per car from last
year's $1,131. The decline in ARC was driven by large volumes of very
low-ARC empty repositioning moves for intermodal traffic, higher low-ARC
stone moves, shortfalls of high-ARC steel traffic, and large volumes of
very low-ARC storage-in-transit (SIT) moves in the chemical business. The
following table summarizes the quarter-over-quarter change in rail
commodity revenue (CR) and ARC by commodity type (carloads in thousands
and commodity revenues in millions):
13
Change % Change
----------------- --------------
Cars ARC CR Cars ARC CR Cars ARC CR
---- --- -- ---- --- -- ---- --- --
Automotive 141 $1,447 $ 204 (8) $(14) $ (14) (6) (1) (6)
Agriculture 213 1,566 334 (11) 38 (9) (5) 2 (3)
Intermodal 633 604 382 (106) (34) (89) (14) (5) (19)
Chemicals 232 1,657 385 (18) (71) (47) (7) (4) (11)
Energy 449 1,148 516 10 51 33 2 5 7
Industrial 354 1,289 456 (16) (88) (53) (4) (6) (10)
----- ------ ------ --- ---- ----- --- --- ----
Total 2,022 $1,126 $2,277 (149) $ (5) $(179) (7) -- (7)
===== ====== ====== === ==== ===== === === ====
Agricultural Products revenues fell 3% for the quarter, as loads finished
down 5% and ARC improved 2%. Key drivers included diversions of wet corn
milling products from the Railroad to trucks and other rails; congestion,
which limited canned and packaged, wheat, frozen and food grains
categories of agricultural products business; inexpensive corn replacing
feed-additives which lowered livestock/feed moves; and depressed corn
prices and very soft export demand which hurt corn traffic. Quarter-over-quarter
ARC was up 2% primarily due to price increases and improvements
in haul length for wheat moves.
Automotive revenues were down 6%, reflecting a 6% decline in volume and
a 1% decrease in ARC. Finished vehicles volumes were down 1% primarily due
to the impact of the General Motors (GM) strike, which cost the Railroad
approximately $21 million for the quarter. International business, down
22% in loadings, experienced lower Asian imports in addition to service-related
diversions. These declines were partially offset by Ford's new
Mixing Center business and strong Chrysler volumes (up 18%). Parts
volumes lost 10% year-over-year as Ford's volumes fell from the Railroad's
equipment shortages and GM switched from intermodal containers to boxcars,
which switch lowered parts carloadings as more parts fit in each boxcar.
ARC fell 1% as a result of large shortfalls of higher-ARC finished
vehicles due to the GM strike.
Chemicals shipments fell 7%, while ARC dropped 4% when compared to 1997
results. Congestion-related diversions to truck, barge and other
railroads plagued most business lines (especially liquid and dry
chemicals). In addition, the Asian crisis significantly reduced the
demand for export soda ash, as carloads were down nearly 11%, while
unplanned mine shutdown not only reduced traffic for phosphate rock, but
reduced the overall demand for phosphorus. The 4% decline in ARC was
largely due to lower high-ARC liquid and dry and soda ash moves, strong
movements of low-ARC plastics (softness in international market and
weakening prices hurt higher-ARC volumes) and the loss of long-haul
business due to slow train speeds.
Energy movements were up 2% versus 1997, while ARC was up 5%. Maintenance
and capacity-driven congestion in the Central Corridor continued to hamper
Powder River Basin (PRB) trains. However, PRB trains per day showed gains
year-over-year (25.2 in 1998 from 24.3 a year ago), and longer trains
(119.7 cars/train in the third quarter of 1998 vs. 117.3 in 1997) helped
boost quarter-over-quarter volumes. Colorado and Utah volumes were also
up for the quarter due to better service performance than 1997 levels.
The 5% increase in ARC was primarily a result of more high-ARC PRB
traffic.
Industrial Products posted a 4% volume decline and a 6% decline in ARC,
resulting in a 10% drop in revenues. Volumes continued to be plagued by
instances of equipment shortages and service issues (caused by slowed
local switching and congestion). A large portion of industrial products
moves occur in the South where congestion hit hardest, although service
14
levels have continued to improve. Construction materials, metallic
minerals, cement, ferrous scrap, and consumer/machinery moves were all
affected by Southern congestion. In addition, several of the same
commodities have also been affected by Central Corridor congestion (due
to maintenance and capacity expansion) and congestion in the Western
portion of the Railroad's system, as the final portion of the Railroad's
operating system was brought on-line in July 1998. ARC fell 6% due to
product mix issues, largely strong low-ARC stone moves and shortfalls of
high-ARC steel traffic.
Intermodal revenue showed a 19% year-over-year decline, as volumes fell
14% and ARC fell 5%. Congestion issues and related diversions severely
affected several intermodal segments, especially Intermodal Marketing
Company (IMC)/truckload and less-than-truckload (LTL)/premium. Volumes
also suffered from weak exports (Asian currency crisis). A partial offset
was the impact of new APL business and the high demand for containers.
ARC fell as traffic mix shortfalls (relatively fewer high-ARC
IMC/truckload and LTL/premium loads) were exacerbated by increased volumes
of low-ARC empty repositioning moves--as equipment imbalances precipitated
by strong imports and weak exports caused customers to significantly
increase empty container repositioning.
EXPENSE SUMMARY - Operating expenses were $2,201 million for the third
quarter of 1998, $41 million (2%) worse than the third quarter 1997
operating expenses of $2,160 million. However, third quarter 1998
operations did improve significantly from the second quarter of 1998. The
following statistical table reflects the improvements in the Railroad's
operating performance:
1997 1998
---------------- -----------------
2nd 3rd 4th 1st 2nd 3rd
(Average Units Except Ratios) Qtr Qtr Qtr Qtr Qtr Qtr
- ----------------------------- --- --- --- --- --- ---
Seven-Day Carloadings (000's) 170.7 165.9 153.6 152.5 154.9 155.3
Train Speed (MPH) 18.4 15.0 13.2 13.8 14.0 14.4
Car Cycle Times (Days) 12.7 15.2 16.8 17.6 16.4 15.9
Operating Ratio 80.9 82.0 102.5 97.7 105.1 90.5
Labor Expense was $35 million (4%) higher than 1997. Slower train speeds
(which increased the number of train crews required), inflation and other
service-related cost overruns contributed to higher costs. These higher
costs were partially offset by lower volumes (gross-ton miles were down
3%) and the elimination of duplicative positions as part of merger
implementation.
Depreciation expense grew $9 million, or 4%, to $253 million, driven by
the Railroad's extensive capital programs in 1997 and 1998. The Railroad
spent over $2 billion on capital projects in 1997 and expects to spend
$2.2 billion in 1998, of which $400 million is merger-related.
Materials and Supplies costs for the quarter were up $12 million to $131
million, or 10%, from third quarter 1997. The increase reflects increased
maintenance of locomotives, freight cars and roadway machines. Material
costs for signal and communications equipment were also higher year-over-year.
Fuel and Utilities expenses were down $36 million, or 16%, from 1997. A
reduction in gross-ton miles year-over-year (down 3%) generated volume-related
fuel savings of $6 million versus 1997. Prices were down 7 cents
per gallon to 60 cents, saving $20 million. The fuel consumption rate of
1.36 gallons per thousand gross-ton miles improved 3% from last year's
1.40, lowering the Railroad's fuel costs by $6 million. Hedges of 58% of
third quarter fuel volumes increased fuel costs by $25 million, or 9 cents
per gallon (included in the cost per gallon information above). These
hedges have increased fuel expense by $59 million year-to-date.
15
Rent Expense was down $7 million, or 2%, versus 1997. Cycle times were
above normal at 15.9 days. However, cycles were only 0.7 days higher than
year-ago levels, resulting in increased year-over-year service-related
costs of $5 million. Locomotives leased for service recovery resulted in
an additional $4 million. However, these increases were more than offset
by lower volumes due to service shortfalls.
Purchased Services and Other Costs increased $28 million, or 8%, from
1997, reflecting continued customer relations and service recovery costs.
Service recovery increased other costs by $43 million, driven by higher
liquidated damages on coal contracts, while crew transportation costs were
higher by $4 million. These cost increases were offset by BNSF's
increased use of trackage rights and merger-related cost savings on
computer costs and contract pricing.
NON-OPERATING COSTS - Other income, net fell $65 million, or 64%, from
1997, primarily reflecting reduced asset sales. Interest expense rose $33
million, reflecting higher debt levels and higher interest rates resulting
from a credit rating downgrade which occurred earlier in 1998. Income
taxes fell $105 million from 1997, primarily the result of lower pre-tax
income.
Nine Months Ended September 30, 1998 Compared to September 30, 1997
The Corporation posted a loss of $443 million for the first nine months
of 1998, compared to earnings of $584 million in 1997. 1998 results were
affected by slow train speeds and service issues that have been lessening
as the year has progressed. Operating income of $82 million for the
period compares to $1,206 million last year, reflecting a year-over-year
increase in pre-tax service-related costs and lost revenues, as service
issues began late in the third quarter of 1997. The year-to-date
operating ratio for 1998 was 98.8%, up 14.2 points from 1997's 84.6%.
REVENUE SUMMARY - Operating revenues were down $723 million (9%) at $7,094
million. Carloadings for the period were down 549,061 units, or 8%, from
year-ago loads of 6,504,713. Declines were led by continuing service
issues, weakening demand for whole grain exports (due to strong worldwide
crop yields), the GM strike and a soft export market (caused by the Asian
currency crisis impact). Average revenue per car was off 1% versus last
year at $1,134 per car from last year's $1,151. The decline in ARC was
driven by large volumes of very low-ARC empty repositioning moves for
intermodal traffic; higher low-ARC stone moves and shortfalls of high-ARC
steel traffic; large volumes of very low-ARC storage-in-transit moves in
the chemical business; the absence of long-haul Pacific Northwest grain
moves (due to the Asian currency crisis); and the new shorter-distance
Ford traffic. The following table summarizes the year-over-year change
in rail commodity revenue and ARC by commodity type (carloads in thousands
and commodity revenues in millions):
Change % Change
----------------- --------------
Cars ARC CR Cars ARC CR Cars ARC CR
---- --- ---- ---- --- --- ---- --- ---
Automotive 466 $1,455 $ 677 (8) $(38) $ (29) (2) (3) (4)
Agriculture 610 1,543 942 (88) (43) (166) (13) (3) (15)
Intermodal 1,859 601 1,116 (282) (26) (227) (13) (4) (17)
Chemicals 681 1,699 1,158 (63) (72) (161) (8) (4) (12)
Energy 1,319 1,138 1,501 (14) 20 11 (1) 2 1
Industrial 1,021 1,332 1,359 (94) (29) (159) (8) (2) (10)
----- ------ ------ ----- ----- ------ --- --- ----
Total 5,956 $1,134 $6,753 (549) $(17) $(731) (8) (1) (10)
===== ====== ====== ===== ===== ====== === === ====
16
EXPENSE SUMMARY - Operating expenses were $7,012 million for the nine
months ended September 30, 1998, $401 million (6%) higher than 1997
operating costs of $6,611 million. Labor costs were $105 million (4%)
higher than 1997. Slower train speeds caused the need for increased train
crew levels, while inflation and other service-related cost overruns
contributed to higher costs. These higher costs were partially offset
by lower volumes (carloads down 8%) and the elimination of duplicative
positions as part of merger implementation. Depreciation expense grew $19
million, or 3%, to $751 million, driven by the Railroad's extensive
capital programs in 1997 and 1998. Materials and supplies costs were up
$8 million to $399 million, or 2%, from 1997, reflecting increased
maintenance of locomotives and freight cars, and higher material costs.
Fuel and utilities expenses were down $162 million, or 21%, from 1997.
A reduction in gross-ton miles year-over-year (down 7%) generated volume-related
fuel savings, while prices fell 9 cents per gallon (13%) to 62
cents. Rent expense was up $69 million, or 7%, versus 1997. Slower train
speeds caused car cycle times to run 3.1 days above 1997 levels.
Locomotives leased for service recovery also increased rent costs
year-over-year. These higher costs were offset by lower volumes due to service
shortfalls. Other costs, including purchased services, increased $362
million, or 34%, from 1997, largely reflecting costs associated with the
resolution of customer claims, as well as higher property taxes, contract
services and legal costs.
NON-OPERATING COSTS - Other income, net declined $46 million reflecting
the absence of the 1997 signboard business sale and various line sales.
Interest costs increased $75 million to $526 million, reflecting higher
interest costs for borrowings to fund capital spending which could not be
funded from operating cash flow at the Railroad due to the effects of
service recovery. Income taxes changed by $469 million to a benefit of
$140 million, primarily the result of lower pre-tax income.
CHANGES IN FINANCIAL CONDITION AND OTHER DEVELOPMENTS
FINANCIAL CONDITION - For the nine months ended September 30, 1998, cash
from continuing operations was $160 million, compared to $1,118 million
in 1997. This $958 million decrease primarily reflects lower earnings and
timing of working capital requirements due to service issues, as well as
merger consolidation spending.
Cash used in investing activities was $1,650 million in the first nine
months of 1998 compared to $1,162 million in 1997. This 42% increase
primarily reflects higher capital spending for equipment, track renewal,
capacity and merger integration.
Cash provided by equity and financing activities was $1,955 million in the
first nine months of 1998 compared to $55 million in 1997. This change
in cash provided by equity and financing activities principally reflects
the need for UPC to borrow funds to support capital spending levels and
to replace operating cash shortfalls caused by service issues. The ratio
of debt to debt plus equity decreased to 50.2% at September 30, 1998,
compared to 50.8% at December 31, 1997 and 49.7% at September 30, 1997.
This change resulted from the private placement of the Convertible
Preferred Securities described below, which are considered as equity in
the calculation of the ratio of debt to debt plus equity, somewhat offset
by increased debt levels.
FINANCING ACTIVITIES - On April 1, 1998, the Corporation completed a
private placement of $1.5 billion of 6-1/4% preferred securities of Union
Pacific Capital Trust, a statutory business trust sponsored by the
Corporation (the Trust), which securities are convertible into common
stock of the Corporation at an initial conversion price of $68.90 (the
Convertible Preferred Securities).
17
The Convertible Preferred Securities are presented as a separate line item
in the consolidated balance sheet as of September 30, 1998 between
liabilities and equity and appropriate disclosures are included in the
notes to the financial statements (see Note 6 to the condensed
consolidated financial statements). For financial reporting purposes, the
Corporation has recorded distributions payable on the Convertible
Preferred Securities as an interest charge to earnings in the statement
of consolidated income.
In July, 1998 the Corporation entered into a new credit facility which
increased its total lines of credit to $4 billion. In late September
1998, the Railroad successfully completed a leveraged lease financing of
72 locomotives via the issuance of Pass Through Certificates in the
principal amount of $101.5 million with a total equipment cost of $142.9
million. The related leases are being accounted for as operating leases.
In mid-October 1998, the Corporation issued $225 million in senior
unsecured notes which mature in 2001. Also in October, the Corporation
designated the balance of its shelf registration statement ($1.225
billion) as potentially available for a medium-term note program. By
November 12, 1998, the Corporation had issued $418 million under the
medium-term note program and intends to continue to issue debt from time
to time either pursuant to the medium-term program or in underwritten
transactions, with the proceeds of such issuances to be used for general
corporate purposes, including repayment of maturing debt or commercial
paper borrowings.
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. UPC 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 derivative instruments which
qualify for hedge accounting under Statement No. 133, when adopted, and
net loss recognized as an additional pension liability but not yet
recognized as net periodic pension cost. The impact of adopting FAS 130
for the nine months ended September 30, 1998 was approximately a $2
million after-tax reduction of net income.
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 Corporation 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. This Statement will only affect footnote
disclosure and will not otherwise have an effect on the consolidated
financial statements of the Corporation.
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 is just beginning the process of
determining the effect, if any, FAS 133 will have on the Corporation's
financial statements.
Commitments and Contingencies - There are various claims and lawsuits
pending against the Corporation and certain of its subsidiaries. In
addition, the Corporation and its subsidiaries are subject to various
Federal, state and local environmental laws and are currently
18
participating in the investigation and remediation of various sites. A
discussion of certain claims, lawsuits and contingencies is set forth in
Note 7 to the condensed consolidated financial statements, which is
incorporated herein by reference.
Year 2000 - The Year 2000 (Y2K) compliance project at UPC includes
software (internally developed and purchased), hardware and embedded chips
inside equipment and machinery, primarily at the Railroad. The
Corporation's enterprise-wide project encompasses computer systems and
equipment in multiple data centers and a telecommunications network spread
over 23 states. Equipment containing embedded computer chips includes
locomotives, automated train switching systems, computer aided train
dispatching systems, signaling systems, computerized fueling stations,
weigh-in-motion scales, crane, lifts, PBX systems, elevators, and
computerized monitoring systems throughout UPC. The Corporation began
work early on its Y2K project, beginning research in 1994 and completing
an impact analysis of its mainframe COBOL systems in 1995. The Y2K
project has been a high priority since then.
UPC's Y2K Project is divided into five major initiatives, as follows:
The Mainframe Systems - consists of the Railroad's enterprise-wide
mainframe systems. Modifications of these systems are ahead of
schedule, and the Corporation estimates that approximately 90% of
these systems have been converted, tested and certified as Y2K
compliant as of September 30, 1998. The remainder are expected to be
completed by December 31, 1998. Periodic audits are planned during
1999 to ensure that certified programs remain Y2K complaint.
The Client Server Systems - consists of the Corporation's enterprise-wide
client server systems. Modifications of these systems are on
schedule, and the Corporation estimates that approximately 50% of all
critical client server systems have been converted, tested, and
certified as Y2K compliant as of September 30, 1998. The remainder
are expected to be completed by December 31, 1998. The non-critical
client server systems are scheduled to be certified as Y2K compliant
by mid-1999.
The User Department Developed Systems - consists of both mainframe and
PC-based systems developed by internal user departments.
Modifications of these systems are on schedule, and the Corporation
estimates that approximately 84% of these systems have been converted,
tested, and certified as Y2K compliant as of September 30, 1998.
Ninety-eight percent of the systems will be completed by December 31,
1998, and the remaining 2% are non-critical systems and will be
completed in the first quarter of 1999.
The Vendor Supplied and Embedded Systems - consists of vendor-supplied
software, desktop, mainframe and server hardware, databases and
operating systems, as well as, equipment and machinery with embedded
systems. Work on these components and systems is on schedule, and the
Corporation estimates that approximately 90% of the suppliers of these
systems have indicated that they have a solid plan in place to be Y2K
compliant in a timely manner. The review of the remaining 10% will
be completed in 1998, which will result in either solid plans or a
contingency direction. To assure safety and Y2K compliance, UPC is
testing selected critical software, hardware and embedded systems,
even if the vendor has already certified the product. UPC is working
with other railroads via involvement in various Association of
American Railroad (AAR) committees and is sharing information on the
compliance and testing of safety critical components common to the
industry. In addition, UPC has helped fund the development of a
shared web site for this purpose, and access to this information is
now available to participating railroads.
19
The Electronic Commerce Systems - consists of all electronic exchanges
of information with customers, vendors, other railroads, and financial
institutions. The railroad industry has agreed on a standard 4-digit
year for all electronic interchanges. The Railroad expects to be able
to transmit and receive the new EDI standard which involves a 4-digit
year by January 1999. In addition, by December 1998, the Railroad
will be in position to continue to handle EDI transactions in existing
formats with proper interpretation of the century date. UPC is
working with the AAR in testing the new standard with other railroads
and with its trading partners.
For each of these initiatives, seven major categories of events have been
identified for which contingency plans are being developed. These
categories are 1) key data - integrity/loss, 2) critical software, 3)
critical hardware, 4) communications, 5) critical supplies and suppliers,
6) facilities, and 7) key personnel. The contingency plans also include
a Y2K command center which will be staffed 24 hours a day in the fourth
quarter of 1999 and continuing into early 2000 for any problems that might
occur due to Y2K. The staff will be composed of technical experts to fix
or advise what to fix if systems fail, and knowledgeable representatives
from each business unit. Preliminary contingency plans are on schedule
to be completed by year-end 1998 and will be adjusted as needed in 1999.
As of September 30, 1998, approximately 85% of the Corporation's systems
(excluding Overnite) have been certified as Y2K compliant, and the
majority of the remaining systems are expected to be modified by year-end
1998. Modification to Overnite's systems comprises approximately 10% of
UPC's total Y2K workload, and is estimated to be 70% complete. The
remaining modification to Overnite's systems is expected to be completed
in the first quarter of 1999. Costs to convert UPC's systems are expensed
as incurred. As of September 30, 1998, more than half of the costs of the
Y2K project, estimated to be $61 million in total, have been expensed.
Although the Corporation believes its systems will be successfully
modified, failure to modify its systems and purchased equipment, or
failure on the part of other entities with whom UPC exchanges or on whom
UPC relies for data, to successfully modify their systems, 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 Corporation 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 Corporation) 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 Corporation does not expect that claims,
lawsuits, environmental costs, commitments, contingent liabilities, labor
negotiations or other matters will have a material adverse effect on its
consolidated financial condition, results of operations or liquidity and
other similar expressions concerning matters that are not historical
facts, and projections or predictions as to the Corporation's financial
or operational 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
Corporation 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 severe weather, floods and
20
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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Corporation 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 Corporation has fixed interest rates
or fuel prices through the use of swaps, futures or forward contracts, the
Corporation has mitigated the downside risk of adverse price and rate
movements; however, it has also limited future gains from favorable
movements.
The Corporation addresses market risk related to these instruments by
selecting instruments whose value fluctuations correlate highly 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 periodic settlements. The total credit
risk associated with the Corporation's counterparties was $23 million at
September 30, 1998. The Corporation has not been required to provide, nor
has it received, any collateral relating to its hedging activities.
The fair market value of the Corporation's derivative financial instrument
positions at September 30, 1998 was determined based upon current fair
market values as quoted by recognized dealers or developed based upon the
present value of future cash flows discounted at the applicable zero
coupon U.S. Treasury rate and swap spread.
Interest Rates - The Corporation 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
Corporation 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 September 30, 1998, the Corporation had outstanding interest rate swaps
on $152 million of notional principal amount of debt (2% of the total
debt portfolio) with a gross fair market value asset position of $22
million and a gross fair market value liability position of $20 million.
These contracts mature over the next two years. Interest rate hedging
activity had no significant effect on interest expense in the third
quarter of 1998 and increased interest expense by $3 million in the third
quarter of 1997.
Fuel - Over the past three years, fuel costs approximated 10% of the
Corporation's total operating expenses. As a result of the significance
of the fuel costs and the historical volatility of fuel prices, the
Railroad periodically use swaps, futures and forward contracts to mitigate
the impact of fuel price volatility. The intent of this program is to
protect the Corporation's operating margins and overall profitability from
adverse fuel price changes.
At September 30, 1998, the Railroad had hedged approximately 49% of its
estimated remaining 1998 diesel fuel consumption at $0.51 per gallon, on
a Gulf Coast basis and approximately 37% of its estimated 1999 diesel fuel
21
consumption at $0.42 per gallon, on a Gulf Coast basis. At September 30,
1998, the Railroad had outstanding swap agreements covering fuel purchases
of $291 million, with gross and net asset positions of less than $1
million. Fuel hedging increased third quarter 1998 fuel expense by $25
million and third quarter 1997 fuel expense by approximately $1 million.
For the nine months ended September 30, fuel hedging increased 1998 fuel
expense by $59 million and 1997 fuel expense by approximately $1 million.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The discussion of certain legal proceedings affecting the Corporation
and/or certain of its subsidiaries set forth in Note 7 to the condensed
consolidated financial statements included in Item 1 of Part I of this
Report is incorporated herein by reference. In addition to those matters,
the following proceedings, or developments in proceedings presently
pending, arose or occurred during the third quarter of 1998.
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
was held on September 11, 1998, and the case is awaiting decision. The
Corporation believes that it is unlikely that the disposition of the
remaining appeals will have a material adverse impact on its consolidated
financial condition or its results of operations.
ENVIRONMENTAL MATTERS: As previously reported, the Railroad 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. Although the Railroad modified
its operating procedures for trains entering the West Colton yard to
reduce the problem, the District entered an order with respect to the
situation which the Railroad believes is an impermissible burden on
interstate commerce and is preempted by applicable federal law. The
Railroad has filed an action in Federal district court seeking to overturn
the District's order on those grounds, but the court has not yet ruled on
this matter. The Railroad and the District have not entered into
discussions concerning settlement of the outstanding NOVs pending
resolution of this lawsuit. Accordingly, the exact amount of any payment
to the District in connection with the NOVs cannot be determined at this
time.
The Railroad has received notification that the District Attorney for San
Bernardino County, California has opened an investigation into the
Railroad's handling of several hazardous material spills in Barstow and
West Colton, California. The incident in Barstow involved a rear-end
collision between two trains near Barstow in August 1997 that resulted in
a spillage of locomotive diesel fuel and leakage from two tank cars
containing toxic chemicals. Three incidents in the West Colton yard in
1998 involved leaking tank cars and spills of diesel fuel from a derailed
locomotive. The District Attorney's office is investigating allegations
that cleanup procedures were not undertaken promptly and required notices
were not given in connection with these incidents. An initial indication
of fines exceeding $250,000 with respect to these incidents has been
22
communicated by the District Attorney's office. While the Railroad
expects to enter into settlement negotiations with the District Attorney's
office, the exact amount of any fines or penalties that may be required
to be paid as a part of any settlement cannot be determined at this time.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Letter Agreement, dated September 8, 1998, between UPC
and Mr. Ivor J. Evans
10.2 1993 Stock Option and Retention Stock Plan of Union
Pacific Corporation, as amended as of September 24, 1998
10.3 1988 Stock Option and Restricted Stock Plan of Union
Pacific Corporation, as amended as of September 24, 1998
12 Computation of Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
(b) Reports on Form 8-K
On July 23, 1998, UPC filed a Current Report on Form 8-K
announcing second quarter 1998 results, which Report was refiled
on July 24, 1998 for the purpose of changing EDGAR data
concerning address information for UPC.
23
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
Dated: November 12, 1998
UNION PACIFIC CORPORATION
(Registrant)
/s/ John J. Koraleski
---------------------
John J. Koraleski
Controller
(chief accounting officer and
duly authorized officer)
EXHIBIT INDEX
UNION PACIFIC CORPORATION
EXHIBIT INDEX
Exhibit No. Description
10.1 Letter Agreement, dated September 8, 1998, between UPC
and Mr. Ivor J. Evans
10.2 1993 Stock Option and Retention Stock Plan of Union
Pacific Corporation, as amended as of September 24, 1998
10.3 1988 Stock Option and Restricted Stock Plan of Union
Pacific Corporation, as amended as of September 24,
1998
12 Computation of Ratio of Earnings to Fixed Charges
27 Financial Data Schedule