UNP

Union Pacific Corp. 10-Q Summary: Period Ended September 30, 2003

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2003, and the nine-month period ended on the same date. Union Pacific Corporation (UPC) operates primarily in rail transportation through its subsidiary, Union Pacific Railroad Company (UPRR). The filing also includes results for discontinued trucking operations (Overnite Transportation Company and Motor Cargo Industries), which were reclassified as discontinued operations in anticipation of their sale via an initial public offering completed in November 2003.

Key Financial Metrics

Note: Net income for the nine months ended September 30, 2003, includes a $274 million cumulative effect of an accounting change (FAS 143) and $37 million from discontinued operations.

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased 4% in the third quarter and 3% year-to-date, driven by a 3% increase in average revenue per car due to pricing gains, fuel surcharges, and positive commodity mix. Revenue carloads remained essentially flat.
• Expense Pressures: Operating expenses rose 6% in the quarter and 6% year-to-date. The primary drivers were higher fuel prices (averaging 90 cents/gallon in Q3 vs. 75 cents in 2002), wage and benefit inflation, and volume-related costs.
• Profitability Decline: Operating income decreased 4% in the quarter and 9% year-to-date. Higher fuel and labor costs offset revenue gains and productivity improvements.
• Accounting Change: The adoption of FAS 143 (Asset Retirement Obligations) resulted in a one-time net income benefit of $274 million for the nine-month period, as the company ceased accruing track removal costs in advance.
• Debt Reduction: The company redeemed $1.0 billion of Convertible Preferred Securities (CPS) during the first nine months, reducing interest expense. Average debt levels decreased to $9.1 billion year-to-date from $9.6 billion in 2002.

Guidance, Outlook, and Risks

• Operational Outlook: Management noted that network performance was adversely impacted by record volumes, summer maintenance, and a shortage of trainmen and engineers. Remediation programs, including hiring and acquiring locomotives, are expected to resolve issues by early 2004.
• Discontinued Operations: The sale of the Overnite trucking subsidiary was completed in November 2003. The company expects to record a gain of approximately $200 million in the fourth quarter of 2003.
• Debt Strategy: The remaining $500 million of CPS is scheduled for redemption in December 2003 using proceeds from the Overnite sale. This is expected to provide a net earnings benefit of approximately $0.26 per diluted share in 2004.
• Risks and Contingencies:
  • Fuel Prices: Continued volatility in fuel prices remains a significant risk to operating margins.
  • Environmental: The company has identified 417 sites for potential remediation, with a current liability accrual of $195 million. Ultimate costs are difficult to estimate due to joint and several liability provisions.
  • Legal: Various claims and lawsuits are pending, including shareholder litigation regarding the Overnite anti-union campaign (dismissed on appeal) and a settled contract dispute with Western Resources, Inc.

Investor Verification Checklist

• Fuel Hedging Effectiveness: Verify the extent of fuel hedging (approx. 7% of consumption) and its impact on mitigating the 19% increase in fuel expenses.
• Network Recovery: Monitor subsequent reports for evidence of improved network performance and resolution of crew shortages.
• Overnite Sale Proceeds: Confirm the final gain recognized from the Overnite sale in the Q4 2003 filing and the successful redemption of the remaining CPS.
• Environmental Accruals: Review updates on the $195 million environmental liability and any new site assessments.
• Capital Expenditures: Track the $1.3 billion capital investment plan, specifically the shift toward new, fuel-efficient locomotives to offset rising fuel costs.