UNP

Union Pacific Corp. 10-Q Summary: Period Ended September 30, 2004

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for Union Pacific Corporation (UPC) and its subsidiaries, including Union Pacific Railroad Company (UPRR). The report covers the three and nine months ended September 30, 2004. UPC operates as a single reportable segment: the Railroad. The company completed the sale of its trucking operations (Overnite Transportation) in November 2003, which are now reported as discontinued operations.

Key Financial Metrics

Note: 2003 Net Income includes $274 million from the cumulative effect of an accounting change and $37 million from discontinued operations. 2004 Net Income excludes discontinued operations.

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased 4% in the third quarter and 5% year-to-date, driven by a 2% increase in revenue carloads and a 2% increase in Average Revenue per Car (ARC). Fuel surcharges contributed significantly to ARC growth.
• Profitability Decline: Operating income decreased 29% in both the quarter and year-to-date periods. This was primarily due to a 39% increase in fuel costs (prices rose from $0.90 to $1.25 per gallon), wage inflation, and higher operational costs associated with network congestion.
• Expense Increases: Total operating expenses rose 12% year-to-date. Fuel and utilities expenses increased $278 million. Salaries and wages increased $223 million due to hiring and training new crews to address labor shortages.
• Cash Flow: Cash provided by operating activities decreased slightly ($56 million) year-to-date, while capital expenditures increased to $1.348 billion, primarily for track infrastructure ($1.035 billion).

Outlook, Risks, and Management Commentary

• Operational Challenges: Management cites record volumes and resource shortages (specifically locomotive engineers) as causes for slower network velocity and higher costs. Average train speed improved to 22.3 mph in September but dipped to 21.3 mph in October. Significant improvement is not expected until the end of the peak season (late November).
• Capital Allocation: The company is aggressively hiring (over 5,000 new conductors expected by year-end) and acquiring locomotives (216 new units and 350 leased units in the first nine months) to improve service.
• Legal and Contingencies:
  • Asbestos: A charge for unasserted asbestos claims is expected to be recorded in the fourth quarter of 2004.
  • Environmental: The company faces potential liability at 384 sites, with $185 million accrued. A qui tam lawsuit regarding the Terminal Island oil field seeks $2.4 billion in damages, though UPC disputes the claims and has an indemnification agreement with Anadarko Petroleum.
  • Tax Dispute: The IRS has issued a preliminary notice of deficiency regarding property donation deductions from 1995-1998; UPC intends to litigate.
• Liquidity: The company maintains $2.0 billion in available revolving credit facilities (undrawn). Retained earnings available for dividends were reduced to $5.2 billion due to revised net worth covenants in credit facilities.

Investor Verification Checklist

• Network Velocity Trends: Monitor weekly updates on average train speed and freight cars on line to assess if operational improvements are materializing post-peak season.
• Fuel Price Sensitivity: Verify the impact of current fuel prices on operating margins, as fuel costs are a significant variable expense.
• Q4 Asbestos Charge: Confirm the magnitude of the expected asbestos liability charge in the fourth quarter earnings release.
• Capital Expenditure Execution: Track the deployment of new locomotives and track improvements to ensure they translate into reduced congestion and lower unit costs.
• Legal Exposure: Review updates on the Terminal Island qui tam lawsuit and the IRS tax dispute for any material developments.