UNION PACIFIC RAILROAD CO/DE - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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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)

Securities registered pursuant to Section 12(b) of the Act:

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THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(a) AND
(b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE
FORMAT.

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
--- ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ].

None of the Registrant's voting stock is held by non-affiliates. The Registrant
is a wholly owned subsidiary of Union Pacific Corporation.

As of February 28, 2002, the Registrant had outstanding 7,130 shares of Common
Stock, $10 par value, and 620 shares of Class A Stock, $10 par value.

DOCUMENTS INCORPORATED BY REFERENCE: None

2

TABLE OF CONTENTS
UNION PACIFIC RAILROAD COMPANY

PART I

Item 1. Business................................................................................ 4

Item 2. Properties.............................................................................. 6

Item 3. Legal Proceedings....................................................................... 7

Item 4. Submission of Matters to a Vote of Security Holders..................................... 8

PART II

Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters............... 9

Item 6. Selected Financial Data................................................................. 9

Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations......................................................................... 9

Management's Narrative Analysis of the Results of Operations............................ 9

Cautionary Information.................................................................. 17

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.............................. 18

Item 8. Financial Statements and Supplementary Data............................................. 19

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure......................................................................... 39

PART III

Item 10. Directors and Executive Officers of the Registrant...................................... 40

Item 11. Executive Compensation.................................................................. 40

Item 12. Security Ownership of Certain Beneficial Owners and Management.......................... 40

Item 13. Certain Relationships and Related Transactions.......................................... 40

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................... 41

Signatures.............................................................................. 42

3

PART I

ITEM 1. BUSINESS

COMPANY - Union Pacific Railroad Company (the Registrant), a Class I Railroad
incorporated in Delaware and an indirect wholly owned subsidiary of Union
Pacific Corporation (the Corporation or UPC), together with a number of wholly
owned and majority-owned subsidiaries, certain affiliates and various
minority-owned companies (collectively, the Company, UPRR or the Railroad),
operates various railroad and railroad-related businesses. The Railroad has over
33,000 route miles linking Pacific Coast and Gulf Coast ports to the Midwest and
eastern United States gateways and providing several north/south corridors to
key Mexican gateways. The Railroad serves the western two-thirds of the country
and maintains coordinated schedules with other carriers for the handling of
freight to and from the Atlantic Coast, the Pacific Coast, the Southeast, the
Southwest, Canada and Mexico. Export and import traffic is moved through Gulf
Coast and Pacific Coast ports and across the Mexican and Canadian borders.
Railroad freight is comprised of six commodity lines: agricultural, automotive,
chemicals, energy, industrial products and intermodal. The Railroad continues to
focus on utilization of its capital asset base to meet current operating needs
and to introduce innovative rail services across every commodity line.

ACQUISITIONS

SOUTHERN PACIFIC - During 2001, UPC completed its integration of Southern
Pacific's rail operations (see notes 1 and 2 to the Consolidated Financial
Statements, Item 8). UPC consummated the acquisition of Southern Pacific in
September 1996 for $4.1 billion. Sixty percent of the outstanding Southern
Pacific common shares was converted into UPC common stock and the remaining 40%
of the outstanding shares was acquired for cash. UPC initially funded the cash
portion of the acquisition with credit facility borrowings, all of which have
been subsequently refinanced with other borrowings. The acquisition of Southern
Pacific has been accounted for using the purchase method of accounting and was
fully consolidated into UPC results beginning October 1996.

MEXICAN RAILWAY CONCESSION - During 1997, the Railroad and a consortium of
partners were granted a 50-year concession to operate the Pacific-North and
Chihuahua Pacific lines in Mexico and a 25% stake in the Mexico City Terminal
Company at a price of $525 million. The consortium assumed operational control
of both lines in 1998. In March 1999, the Railroad purchased an additional 13%
ownership interest for $87 million from one of its partners. The Railroad
currently holds a 26% ownership share in the consortium. This investment is
accounted for using the equity method of accounting.

COMPETITION - The Railroad is subject to price and service competition from
other railroads, motor carriers and barge operators. The Railroad's main
competitor is Burlington Northern Santa Fe Corporation. Its rail subsidiary, The
Burlington Northern and Santa Fe Railway Company (BNSF), operates parallel
routes in many of the Railroad's main traffic corridors. In addition, the
Railroad's operations are conducted in corridors served by other competing
railroads and by motor carriers. Motor carrier competition is particularly
strong for intermodal traffic. Because of the proximity of the Railroad's routes
to major inland and Gulf Coast waterways, barge competition can be particularly
pronounced, especially for grain and bulk commodities.

EMPLOYEES - Approximately 87% of the Railroad's nearly 48,000 employees are
represented by 14 major rail unions. National negotiations under the Railway
Labor Act to revise the national labor agreements for all crafts began in late
1999. In May 2001, the Brotherhood of Maintenance of Way Employees (BMWE)
ratified a five-year agreement, which included provisions for an annual wage
increase (based on the consumer price index) and progressive health and welfare
cost sharing. The health and welfare cost sharing was a milestone as the BMWE is
the first union to make significant cost contributions to their health and
welfare plan. Contract discussions with the remaining unions are either in
negotiation or mediation. Also during 2001, much of the operating craft unions'
focus was on a proposed merger between the United Transportation Union and the
Brotherhood of Locomotive Engineers (BLE). In a December 2001 re-vote, the BLE
resoundingly rejected the merger. Both operating craft unions have indicated a
desire to complete national negotiations. The Company anticipates significant
progress in 2002.

4

GOVERNMENTAL REGULATION - The Company's operations are currently subject to a
variety of federal, state and local regulations (see also the discussion of
certain regulatory proceedings in Legal Proceedings, Item 3).

The Railroad is subject to the regulatory jurisdiction of the Surface
Transportation Board (STB) of the United States Department of Transportation
(DOT) and other federal and state agencies. The operations of the Railroad are
also subject to the regulations of the Federal Railroad Administration of the
DOT. The STB has jurisdiction over rates charged on certain regulated rail
traffic; freight car compensation; transfer, extension or abandonment of rail
lines; and acquisition of control of rail common carriers. In March 2000, the
STB imposed a 15-month moratorium on railroad merger applications between Class
I railroads. The moratorium directed large railroads to avoid merger activities
for 15 months until the STB adopted new rules governing merger proceedings. The
rulemaking proceeding was completed June 11, 2001. On that date, the moratorium
ended, and the STB issued new rules to be applied in merger proceedings
involving Class I carriers which impose greater protective conditions on future
transactions to enhance competition.

The DOT and the Occupational Safety and Health Administration, along with
other federal agencies have jurisdiction over certain aspects of safety,
movement of hazardous materials, movement and disposal of hazardous waste and
equipment standards. Various state and local agencies have jurisdiction over
disposal of hazardous waste and seek to regulate movement of hazardous materials
in areas not otherwise preempted by federal law.

ENVIRONMENTAL REGULATION - The Railroad is subject to various environmental
statutes and regulations, including the Resource Conservation and Recovery Act
(RCRA), the Comprehensive Environmental Response, Compensation and Liability Act
of 1980 (CERCLA) and the Clean Air Act (CAA).

RCRA applies to hazardous waste generators and transporters, as well as to
persons engaged in treatment and disposal of hazardous waste, and specifies
standards for storage areas, treatment units and land disposal units. All
generators of hazardous waste are required to label shipments in accordance with
detailed regulations and to prepare a detailed manifest identifying the material
and stating its destination before waste can be released for offsite transport.
The transporter must deliver the hazardous waste in accordance with the manifest
and only to a treatment, storage or disposal facility qualified for RCRA interim
status or having a final RCRA permit.

The Environmental Protection Agency (EPA) regulations under RCRA have
established a comprehensive system for the management of hazardous waste. These
regulations identify a wide range of industrial by-products and residues as
hazardous waste, and specify requirements for management of such waste from the
time of generation through the time of disposal and beyond. States that have
adopted hazardous waste management programs with standards at least as stringent
as those promulgated by the EPA may be authorized by the EPA to administer all
or part of RCRA on behalf of the EPA.

CERCLA was designed to establish a strategy for cleaning up facilities at
which hazardous waste or other hazardous substances have created actual or
potential environmental hazards. The EPA has designated certain facilities as
requiring cleanup or further assessment. Among other things, CERCLA authorizes
the federal government either to clean up such facilities itself or to order
persons responsible for the situation to do so. The act created a multi-billion
dollar fund to be used by the federal government to pay for such cleanup
efforts. In the event the federal government pays for such cleanup, it will seek
reimbursement from private parties upon which CERCLA imposes liability.

CERCLA imposes strict liability on the owners and operators of facilities
in which hazardous waste and other hazardous substances are deposited or from
which they are released or are likely to be released into the environment. It
also imposes strict liability on the generators of such waste and the
transporters of the waste who select the disposal or treatment sites. Liability
may include cleanup costs incurred by third persons and damage to publicly owned
natural resources. The Company is subject to potential liability under CERCLA as
an owner or operator of facilities at which hazardous substances have been
disposed of or as a generator or a transporter of hazardous substances disposed
of at other locations. Some states have enacted, and other states are
considering enacting, legislation similar to CERCLA. Certain provisions of these
acts are more stringent than CERCLA. States that have passed such legislation
are currently active in designating more facilities as requiring cleanup and
further assessment.

5

The operations of the Company are subject to the requirements of the CAA.
The 1990 amendments to the CAA include a provision under Title V requiring that
certain facilities obtain operating permits. EPA regulations require all states
to develop federally-approvable permit programs. Affected facilities must submit
air operating permit applications to the respective states within one year of
the EPA's approval of the state programs. Certain of the Company's facilities
may be required to obtain such permits. In addition, in December 1997, the EPA
issued final regulations which require that certain purchased and remanufactured
locomotives meet stringent emissions criteria. While the cost of meeting these
requirements may be significant, expenditures are not expected to materially
affect the Company's financial condition or results of operations.

The operations of the Company are also subject to other laws protecting the
environment, including permit requirements for wastewater discharges pursuant to
the National Pollutant Discharge Elimination System and storm-water runoff
regulations under the Federal Water Pollution Control Act.

Information concerning environmental claims and contingencies and estimated
remediation costs is set forth in Management's Narrative Analysis of the Results
of Operations - Other Matters - Environmental Costs, Item 7, and in note 11 to
the Consolidated Financial Statements, Item 8.

ITEM 2. PROPERTIES

The Company's primary real estate, equipment and other property (properties) are
owned or leased to support its operations. The Company believes that its
properties are in good condition and adequate for current operations. The
Railroad operates facilities and equipment designated for both the maintenance
and repair of the property, including locomotives, rail cars, and other
equipment, and for monitoring such maintenance and repair work. The facilities
include rail yards, intermodal ramps and maintenance shops throughout the rail
system. Additionally, the Company had approximately $1.7 billion in capital
expenditures during 2001 for, among other things, building and maintaining
track, structures and infrastructure and upgrading and augmenting equipment.

Certain of the Company's properties are subject to federal, state and local
provisions involving the protection of the environment. See discussion of
environmental issues in Management's Narrative Analysis of the Results of
Operations - Other Matters - Environmental Costs, Item 7, and in note 11 to the
Consolidated Financial Statements, Item 8. See also notes 1, 6 and 7 to the
Consolidated Financial Statements, Item 8, for additional information regarding
the Company's properties.

TRACK - The Company's rail operations utilize over 33,000 main line and branch
line route miles in 23 states in the western two-thirds of the United States.
The Company owns 27,500 route miles with the remainder of route miles operated
under trackage rights or leases. As of and for the years ending December 31,
2001, 2000 and 1999, route miles operated and track miles installed and replaced
are as follows:

6

EQUIPMENT - The Company's primary rail equipment as of and for the years ending
December 31, 2001, 2000 and 1999, consisted of the following:

ITEM 3. LEGAL PROCEEDINGS

SOUTHERN PACIFIC ACQUISITION

On August 12, 1996, the STB served a decision (the Decision) approving the
acquisition of control of Southern Pacific by UPC, subject to various
conditions. The acquisition was consummated on September 11, 1996. Various
appeals were filed with respect to the Decision, and all such appeals were
ultimately consolidated in the U.S. Court of Appeals for the District of
Columbia Circuit, and all of the appeals have since been withdrawn or denied.

Among the conditions to the STB's approval of the Southern Pacific
acquisition was the requirement that the STB retain oversight jurisdiction for
five years to examine whether the conditions imposed under the Decision remain
effective to address the competitive harms caused by the merger. On July 2,
2001, the Railroad filed its fifth comprehensive summary with the STB.
Interested parties were required to file comments concerning the fifth annual
oversight proceeding by August 21, 2001, and replies were due on September 4,
2001. On December 20, 2001, the STB issued a decision concluding the fifth and
final oversight proceeding and announcing the end to the formal oversight
process. The STB will continue to have authority to enforce the conditions it
imposed on the merger to ensure they are implemented in a manner that
effectively preserves pre-merger competition.

ENVIRONMENTAL MATTERS

On January 30, 2002, the Louisiana Department of Environmental Quality (LDEQ)
issued to the Railroad a notice of a proposed penalty assessment in the amount
of $195,700 in connection with the release of water potentially impacted by the
derailment of a train near Eunice, Louisiana on May 27, 2000. The Railroad
previously met with the LDEQ regarding this matter to present documentation
indicating that no penalty should be assessed and intends to vigorously defend
this matter.

The State of Illinois filed a complaint against the Railroad with the
Illinois Pollution Board on May 14, 2001, seeking penalties for an alleged
violation of state air pollution laws arising out of a release of styrene from a
tank car near Cora, Illinois, which occurred on August 29, 1997. The car
contained styrene monomer, a hazardous substance, stabilized by an inhibitor by
the origin shipper. The car was delayed in transit for a number of different
reasons including rerouting and reconsignment by the shipper. The Railroad was
not notified that such delays could jeopardize the shipment. Eventually the
effect of the inhibitor wore off and the styrene went into a reactive state
resulting in pressure and venting near Cora, Illinois. A sparsely-populated area
was evacuated for a few hours. The situation was controlled and remediated
promptly. Styrene has since been put on the Railroad's list of time sensitive
shipments for special monitoring.

7

The State of Illinois seeks to assess a penalty in excess of $100,000. The
Railroad believes the penalty should be significantly less than $100,000 and is
vigorously defending the case. A hearing of the complaint is scheduled for March
22, 2002.

The Corporation and its affiliates have received notices from the EPA and
state environmental agencies alleging that they are or may be liable under
certain federal or state environmental laws for remediation costs at various
sites throughout the United States, including sites which are on the Superfund
National Priorities List or state superfund lists. Although specific claims have
been made by the EPA and state regulators with respect to some of these sites,
the ultimate impact of these proceedings and suits by third parties cannot be
predicted at this time because of the number of potentially responsible parties
involved, the degree of contamination by various wastes, the scarcity and
quality of volumetric data related to many of the sites, and/or the speculative
nature of remediation costs. Nevertheless, at many of the superfund sites, the
Company believes it will have little or no exposure because no liability should
be imposed under applicable law, one or more other financially able parties
generated all or most of the contamination, or a settlement of the Company's
exposure has been reached although regulatory proceedings at the sites involved
have not been formally terminated.

Information concerning environmental claims and contingencies and estimated
remediation costs is set forth in Management's Narrative Analysis of the Results
of Operations - Other Matters - Environmental Costs, Item 7, and in note 11 to
the Consolidated Financial Statements, Item 8.

OTHER MATTERS

As previously reported in the Company's Annual Report on Form 10-K for 2000,
Western Resources (Western) filed a complaint on January 24, 2000, in the U.S.
District Court for the District of Kansas alleging that UPRR and BNSF materially
breached their service obligations under the transportation contract to deliver
coal in a timely manner to Western's Jeffrey Energy Center. The original
complaint sought recovery of consequential damages and termination of the
contract, excusing Western from further performance. In an amended complaint
filed September 1, 2000, Western claimed the right to retroactive termination
and added a claim for restitution. On October 23, 2001, Western moved for leave
to file a second amendment to its complaint to add counts for innocent
misrepresentation and negligent misrepresentation and to request rescission of
the contract. The railroads are vigorously defending this lawsuit and oppose
amendment of the complaint. The suit currently is scheduled for trial in May
2002. If, however, Western is permitted to file the second amended complaint,
the trial date likely will be postponed. UPRR and BNSF have filed two motions
seeking dismissal of the termination and restitution claims, both of which are
still pending. The railroads believe they have substantial defenses in the case
and intend to continue to defend it aggressively.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Omitted in accordance with General Instruction I of Form 10-K.

8

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS

As of the date of filing this Report, the Registrant had the following amounts
of capital stock issued and outstanding: 7,130 shares of Common Stock, par value
$10.00 per share (the Company Common Stock), 620 shares of Class A Stock, par
value $10.00 per share (the Company Class A Stock), 4,829 Redeemable Preference
Shares (Series A), initial par value $10,000 per share, and 436 Redeemable
Preference Shares (Series B), initial par value $10,000 per share (collectively,
the Preference Shares). All of the Company Common Stock and the Company Class A
Stock, which constitutes all of the voting capital stock of the Registrant, is
owned by the Corporation or a wholly owned subsidiary of the Corporation, and
all of the Preference Shares, which are non-voting stock, are owned by the
Federal Railroad Administration. Accordingly, there is no market for the
Registrant's capital stock.

Dividends on the Company Common Stock, which are paid on a quarterly basis,
totaled $146 million and $143 million in 2001 and 2000, respectively. Dividends
paid on the Company Class A Stock were $54 million and $57 million in 2001 and
2000, respectively. Information concerning restrictions on the Registrant's
ability to pay dividends on the Company Common Stock and the Company Class A
Stock is set forth in note 9 to the Consolidated Financial Statements, Item 8.
All such information is incorporated herein by reference.

ITEM 6. SELECTED FINANCIAL DATA

Omitted in accordance with General Instruction I of Form 10-K.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Omitted in accordance with General Instruction I of Form 10-K. In lieu thereof,
a narrative analysis is presented.

MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

2001 COMPARED TO 2000 RESULTS OF OPERATIONS

NET INCOME - The Railroad reported record net income of $1.1 billion in 2001
compared to net income of $926 million in 2000, up 14%. Excluding the work force
reduction charge in 2000, net income was $998 million. The increase in earnings
resulted from higher commodity revenue and real estate sales combined with lower
fuel expense, interest expense and materials and supplies expense. These
improvements were partially offset by inflation, lower other revenue and higher
equipment rent and depreciation expenses.

OPERATING REVENUES - Operating revenues increased $69 million (1%) over 2000 to
a record $10.8 billion. Revenue carloads were flat with an increase in the
energy and agricultural commodity groups offset by decreases in the other four
commodity groups. The decrease in other revenue was the result of lower
switching, subsidiary and accessorial revenues. The Company recognizes
transportation revenues on a percentage-of-completion basis as freight moves
from origin to destination. Other revenue is recognized as service is performed
or contractual obligations are met.

9

The following tables summarize the year-over-year changes in rail commodity
revenue, revenue carloads and average revenue per car by commodity type:

Agricultural - Revenue increased 4%, due primarily to a 3% increase in average
revenue per car. Carloads were flat, as higher corn shipments and meals and oils
exports were offset by a decrease in demand for domestic and export wheat
shipments and a poor sugar-beet harvest. Revenue gains were also achieved
through increased beer imports from Mexico, wine shipments from California to
eastern markets, express service of fresh and frozen products and increased
demand for cottonseed. Average revenue per car increased due to a longer average
length of haul, resulting from fewer short-haul wheat and sweetener shipments
combined with increased long-haul domestic and Mexico corn shipments.

Automotive - Revenue declined 5% as a result of a 6% decrease in carloads and a
1% increase in average revenue per car. Materials volumes declined 16%, as the
soft economy and a decline in vehicle sales led to high inventories, low
industry production and auto plant shutdowns. Total finished vehicle shipments
declined only 1%, as industry weakness was mitigated by market share gains.
Consumer incentives in the fourth quarter stimulated vehicle sales and helped
offset weakness early in the year. Average revenue per car increased due to a
shift in mix of materials shipped, resulting from fewer shipments of materials
with lower average revenue per car. Additionally, more materials were shipped in
boxcars rather than containers, which yield higher average revenue per car than
containers.

Chemicals - Revenue declined 6%, due to a 6% decrease in carloads. Volume
declines were the result of the soft economy, as reduced demand for consumer
durables led to high manufacturer inventories and weak demand for plastics.
Reduced industrial manufacturing also depressed demand for liquid and dry
chemicals. Fertilizer and phosphate rock revenues decreased as high energy costs
early in the year reduced the market for these commodities. Average revenue per
car was flat, as the positive impact of fewer low average revenue per car
phosphate rock shipments was offset by a decrease in average revenue per car for
soda ash shipments.

Energy - Energy commodity revenue increased 11% compared to 2000, due to a 12%
increase in carloads. Records were set in 2001 for total carloads, revenue and
coal trains loaded per day in the Southern Powder River Basin in Wyoming

10

and in the coal mining regions of Colorado and Utah. These increases were driven
by strong utility demand caused by severe winter weather in late 2000 and the
first quarter of 2001. In the first half of the year, demand for coal also
increased due to the high cost of alternative fuels, such as natural gas, fuel
oil and higher-priced eastern-sourced coal. Carloads also increased due to gains
in market share.

Industrial Products - Revenue decreased 1%, as a 2% decline in carloads was
partially offset by a 1% increase in average revenue per car. The decline was
mainly the result of the economic slowdown, which had a negative effect on many
economically sensitive commodities including steel and paper markets. Steel
producers were additionally impacted by high levels of low-cost imported steel,
which forced plant shutdowns and bankruptcies. Newsprint and fiber revenue
declined due to lack of demand for printed advertising. Partially offsetting
these declines were increases in construction-related commodities, led by stone
and cement, as strong building and road construction activity continued in the
South and Southwestern regions of the country. Lumber volumes increased due to
strong housing construction and uncertainty surrounding restrictions on Canadian
lumber imports. Average revenue per car increased due to price increases and a
greater mix of longer average length of haul business. These gains were
partially offset by the impact of increased shipments of stone, which generates
lower average revenue per car.

Intermodal - Revenue was flat, as a 3% decline in carloads was offset by a 3%
increase in average revenue per car. The volume decrease was primarily the
result of soft economic demand for domestic shipments. In addition, the
voluntary action of shedding low-margin trailer business in favor of
higher-margin containers contributed to the decline. Partially offsetting the
domestic declines were increases in international shipments, the result of
higher import demand. The increase in average revenue per car was primarily the
result of price increases.

OPERATING EXPENSES - Operating expenses decreased $109 million (1%) to $8.7
billion in 2001. Excluding the $115 million work force reduction charge in 2000,
operating expenses were essentially flat. Higher expenses as a result of
inflation, higher equipment rents expense and depreciation were offset by
savings from lower force levels, productivity gains and cost control efforts and
lower fuel prices.

Salaries, Wages and Employee Benefits - Salaries, wages and employee benefits
decreased $83 million (2%) in 2001 to $3.5 billion. Excluding the $115 million
work force reduction charge in 2000, salaries, wages and employee benefits
expense increased $32 million (1%). The primary driver of the increase was wage
and employee benefits inflation. A 3% gross ton mile increase also added volume
costs. A 4% reduction in employee force levels as a result of the work force
reduction plan offset a significant portion of these higher costs.

Equipment and Other Rents - Expenses increased $32 million (3%) compared to 2000
due primarily to higher locomotive leases and longer car cycle times. The higher
locomotive lease expense is due to the Railroad's increased leasing of new, more
reliable and fuel efficient locomotives. These new locomotives replaced older,
non-leased models in the fleet, which helped reduce expenses for depreciation,
labor, materials and fuel during the year. The increase in car cycle times is
partially attributable to a decline in automotive shipments earlier in the year,
which resulted in excess freight cars being stored at assembly plants and
unloading facilities. Partially offsetting the increases in expenses were lower
volume costs, lower car leases and lower prices for equipment. The decrease in
volume costs was attributable to a decline in carloads in business segments such
as industrial products and intermodal that utilize a high percentage of rented
freight cars.

Depreciation - Depreciation expense increased $31 million (3%) over 2000,
resulting from capital spending in recent years. Capital spending totaled $1.7
billion in 2001 and in 2000 and $1.8 billion in 1999.

Fuel and Utilities - Expenses decreased $30 million (2%). The decrease was
driven by lower fuel prices and a record low fuel consumption rate, as measured
by gallons consumed per thousand gross ton miles. Fuel prices averaged 88 cents
per gallon in 2001 compared to 90 cents per gallon in 2000, including taxes,
transportation costs and regional pricing spreads of 17 cents and 13 cents in
2001 and 2000, respectively. The Railroad hedged approximately 32% of its fuel
consumption for the year, which increased fuel costs by $20 million. As of
December 31, 2001, expected fuel consumption for 2002 is 44% hedged at 56 cents
per gallon excluding taxes, transportation costs and regional pricing spreads
and for 2003 is 5% hedged at 56 cents per gallon excluding taxes, transportation
costs and regional pricing spreads (see note 4 to the Consolidated Financial
Statements, Item 8).

11

Materials and Supplies - Expenses decreased $71 million (13%), reflecting
locomotive overhaul reductions and productivity improvements and cost control
measures. Locomotive overhauls decreased due to acquisition of new,
more-reliable locomotives during the year and the sale of older units, which
required higher maintenance. Materials and supplies expenses related to car
maintenance also declined due to lower business levels in the industrial
products and automotive commodity groups. The cars utilized in these commodity
groups normally require more maintenance than the cars utilized within the other
commodity groups.

Casualty Costs - Costs increased $9 million (3%) compared to 2000, as higher
insurance, bad debt and environmental expenses were partially offset by lower
personal injury costs and lower costs for damaged freight cars.

Other Costs - Expenses increased $3 million (flat) compared to 2000 primarily
due to higher state and local taxes.

OPERATING INCOME - Operating income increased $178 million (9%) to $2.1 billion.
Excluding the $115 million work force reduction charge in 2000, operating income
increased $63 million (3%) in 2001. The operating ratio for 2001 was 80.7%,
compared to 82.3% in 2000. Excluding the work force reduction charge, the
operating ratio for 2000 was 81.2%.

NON-OPERATING ITEMS - Non-operating expense decreased $56 million (12%) compared
to 2000. Real estate sales and net other income increased $48 million (38%).
Interest expense decreased $8 million (1%) as a result of lower weighted-average
debt levels and weighted-average interest rates in 2001. Income taxes increased
$102 million (20%) in 2001 compared to 2000. Excluding the work force reduction
charge in 2000, income tax expense increased $59 million (11%). The increase was
a result of higher pre-tax income levels in 2001 and an increase in the
effective tax rate from 35.6% in 2000 to 36.7% in 2001.

LIQUIDITY AND CAPITAL RESOURCES

FINANCIAL CONDITION

Cash from operations was $2.0 billion and $2.1 billion 2001 and 2000,
respectively. The decrease from 2000 to 2001 is primarily due to the timing of
large cash payments, including the payments for the work force reduction plan.

Cash used in investing activities was $1.5 billion in 2001 and $1.6 billion
in 2000. The decrease from 2000 to 2001 is due to reduced capital spending and
higher asset sales in 2001, partially offset by the receipt of cash dividends in
2000.

Cash used in financing activities was $522 million and $497 million in 2001
and 2000, respectively. The increase from 2000 to 2001 reflects higher debt
repayments (including $145 million of accelerated debt repayments), partially
offset by increased debt financings.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

As described in the notes to the Consolidated Financial Statements, Item 8, as
referenced in the tables below, the Company has contractual obligations and
commercial commitments that may affect the financial condition of the Company.
However, based on management's assessment of the underlying provisions and
circumstances of the material contractual obligations and commercial commitments
of the Company, including material sources of off-balance sheet and structured
finance arrangements, there is no known trend, demand, commitment, event or
uncertainty that is reasonably likely to occur which would have a material
effect on the Company's financial condition or results of operations. In
addition, the commercial obligations, financings and commitments made by the
Company are customary transactions which are similar to those of other
comparable industrial companies, particularly within the transportation
industry.

12

The following tables identify material obligations and commitments as of
December 31, 2001:

[a] Excludes intercompany borrowings of $5,003 million and capital leases
of $1,439 million.

[b] Unconditional purchase obligations represent multi-year contractual
commitments to purchase assets at fixed prices and fixed volumes. These
commitments are made in order to take advantage of pricing
opportunities and to insure availability of assets to meet quality and
operational requirements. Excluded are annual contracts made in the
normal course of business for performance of routine services, as well
as commitments where contract provisions allow for cancellation.

[c] Includes guaranteed obligations of affiliated operations.

FINANCING ACTIVITIES

During July 2001, UPRR entered into capital leases covering new locomotives.
The related capital lease obligations totaled approximately $124 million and are
included in the Statements of Consolidated Financial Position as debt (see note
6 to the Consolidated Financial Statements, Item 8). During October 2001, the
Company made an early repayment of approximately $145 million of callable
equipment obligations.

In December 2001, the Railroad entered into a synthetic operating lease
arrangement to finance a new headquarters building which will be constructed in
Omaha, Nebraska. The expected completion date of the building is 2004. It will
total approximately 1.1 million square feet with approximately 3,800 office
workspaces. The cost to construct the new headquarters, including capitalized
interest, is approximately $260 million. The Corporation has guaranteed the
Railroad's obligation under this lease.

UPRR will be the construction agent for the lessor. Total building related
costs incurred and drawn from the lease funding commitments as of December 31,
2001, were approximately $10 million. After construction is complete, the lease
has an initial term of five years and provisions for renewal for an extended
period subject to agreement between the Railroad and lessor. At any time during
the lease, the Railroad may, at its option, purchase the building at
approximately the amount expended by the lessor to construct the building. If
the Railroad elects not to renew the lease or purchase the building, the
Railroad has guaranteed a residual value of approximately $220 million. At
December 31, 2001, the Railroad has guaranteed, under certain circumstances, a
residual value of less than $10 million.

On February 8, 2002, the Company announced that it will redeem the
Missouri-Kansas-Texas Railroad Company (MKT) 5 1/2% Subordinated Income
Debentures due January 1, 2033 and the MKT Registered Certificates. The MKT
Debentures and the MKT Certificates will be redeemed on March 15, 2002 for an
estimated $20 million, including accrued interest on the MKT Debentures.

13

OTHER MATTERS

PERSONAL INJURY - The cost of injuries to employees and others on Railroad
property is charged to expense based on actuarial estimates of the ultimate cost
and number of incidents each year. In 2001, the Railroad's work-related injuries
that resulted in lost job time declined 7% compared to 2000. In addition,
accidents at grade crossings decreased 6% compared to 2000. Annual expenses for
the Railroad's personal injury-related events were $204 million in 2001,
reflecting lower than anticipated settlement costs and $207 million in 2000.
Compensation for work-related accidents is governed by the Federal Employers'
Liability Act (FELA). Under FELA, damages are assessed based on a finding of
fault through litigation or out-of-court settlements. The Railroad offers a
comprehensive variety of services and rehabilitation programs for employees who
are injured at work.

ENVIRONMENTAL COSTS - The Company generates and transports hazardous and
nonhazardous waste in its current and former operations, and is subject to
federal, state and local environmental laws and regulations. The Company has
identified approximately 370 active sites at which it is or may be liable for
remediation costs associated with alleged contamination or for violations of
environmental requirements. This includes 48 sites that are the subject of
actions taken by the U.S. government, 28 of which are currently on the Superfund
National Priorities List. Certain federal legislation imposes joint and several
liability for the remediation of identified sites; consequently, the Company's
ultimate environmental liability may include costs relating to other parties, in
addition to costs relating to its own activities at each site.

When environmental issues have been identified with respect to the property
owned, leased or otherwise used in the conduct of the Company's business, the
Company and its consultants perform environmental assessments on such property.
The Company expenses the cost of the assessments as incurred. The Company
accrues the cost of remediation where its obligation is probable and such costs
can be reasonably estimated.

As of December 31, 2001, the Company has a liability of $171 million accrued
for future environmental costs. The liability includes future costs for
remediation and restoration of sites, as well as for ongoing monitoring costs,
but excludes any anticipated recoveries from third parties. Cost estimates are
based on information available for each site, financial viability of other
potentially responsible parties, and existing technology, laws and regulations.
The Company believes that it has adequately accrued for its ultimate share of
costs at sites subject to joint and several liability. However, the ultimate
liability for remediation is difficult to determine because of the number of
potentially responsible parties involved, site-specific cost sharing
arrangements with other potentially responsible parties, the degree of
contamination by various wastes, the scarcity and quality of volumetric data
related to many of the sites, and/or the speculative nature of remediation
costs. The Company expects to pay out the majority of the December 31, 2001,
environmental liability over the next five years, funded by cash generated from
operations.

Remediation of identified sites previously used in operations, used by
tenants or contaminated by former owners required cash spending of $63 million
in 2001 and $62 million in 2000. The Company is also engaged in reducing
emissions, spills and migration of hazardous materials, and spent cash of $5
million and $8 million in 2001 and 2000, respectively, for control and
prevention. In 2002, the Company anticipates spending $60 million for
remediation and $5 million for control and prevention. The impact of current
obligations is not expected to have a material adverse effect on the results of
operations or financial condition of the Company.

LABOR MATTERS -Approximately 87% of the Railroad's nearly 48,000 employees are
represented by 14 major rail unions. National negotiations under the Railway
Labor Act to revise the national labor agreements for all crafts began in late
1999. In May 2001, the Brotherhood of Maintenance of Way Employees (BMWE)
ratified a five-year agreement, which included provisions for an annual wage
increase (based on the consumer price index) and progressive health and welfare
cost sharing. The health and welfare cost sharing was a milestone as the BMWE is
the first union to make significant cost contributions to their health and
welfare plan. Contract discussions with the remaining unions are either in
negotiation or mediation. Also during 2001, much of the operating craft unions'
focus was on the proposed merger between the United Transportation Union and the
Brotherhood of Locomotive Engineers (BLE). In a December 2001 re-vote, the BLE
resoundingly rejected the merger. Both operating craft unions have indicated a
desire to complete national negotiations. The Company anticipates significant
progress in 2002.

14

INFLATION - The cumulative effect of long periods of inflation has significantly
increased asset replacement costs for capital-intensive companies such as the
Railroad. As a result, depreciation charges on an inflation-adjusted basis,
assuming that all operating assets are replaced at current price levels, would
be substantially greater than historically reported amounts.

DERIVATIVE FINANCIAL INSTRUMENTS - The Railroad uses derivative financial
instruments, which are subject to market risk, in limited instances for other
than trading purposes to manage risk related to changes in fuel prices. The
Company also may, from time to time, use derivative financial instruments to
achieve the Company's interest rate objectives. The purpose of these programs is
to protect the Company's operating margins and overall profitability from
adverse fuel price changes or interest rate fluctuations.

The Corporation may also use fuel swaptions to secure more favorable swap
prices. Swaptions are swaps that are extendable past their base period at the
option of the counterparty. Swaptions do not qualify for hedge accounting
treatment and are marked-to-market through the Consolidated Statements of
Income.

The sensitivity analyses that follow illustrate the economic effect that
hypothetical changes in interest rates or fuel prices could have on the
Company's financial instruments. These hypothetical changes do not consider
other factors that could impact actual results.

Interest Rates -At December 31, 2001 and 2000, the Company had variable-rate
debt representing less than 1% of its total debt. If variable interest rates
average 10% higher in 2002 than the Company's December 31, 2001 variable rate,
the Company's interest expense would increase by less than $1 million after tax.
If variable interest rates had averaged 10% higher in 2001 than the Company's
December 31, 2000 variable rate, the Company's interest expense would have
increased by less than $1 million after tax. These amounts were determined by
considering the impact of the hypothetical interest rates on the balances of the
Company's variable-rate debt at December 31, 2001 and 2000, respectively. In
addition, the Company obtains flexibility in managing interest costs and the
interest rate mix within its debt portfolio by issuing callable fixed-rate debt
securities.

Market risk for fixed-rate debt is estimated as the potential increase in
fair value resulting from a hypothetical 10% decrease in interest rates as of
December 31, 2001, and amounts to approximately $84 million at December 31,
2001. Market risk resulting from a hypothetical 10% decrease in interest rates
as of December 31, 2000, amounted to approximately $122 million at December 31,
2000. The fair values of the Company's fixed-rate debt were estimated by
considering the impact of the hypothetical interest rates on quoted market
prices and current borrowing rates.

Fuel - Fuel costs are a significant portion of the Company's total operating
expenses. As a result of the significance of fuel costs and the historical
volatility of fuel prices, the Company periodically use swaps, futures and/or
forward contracts to mitigate the impact of adverse fuel price changes. The
Company at times may use swaptions to secure more favorable swap prices.

As of December 31, 2001, expected rail fuel consumption for 2002 is 44%
hedged (or swaptions are in place) at 56 cents per gallon excluding taxes,
transportation costs and regional pricing spreads. As of December 31, 2001,
expected rail fuel consumption for 2003 is 5% hedged (or swaptions are in place)
at 56 cents per gallon excluding taxes, transportation costs and regional
pricing spreads. For the Company's fuel hedges, if rail fuel prices decrease 10%
from the December 31, 2001 level, the corresponding increase in fuel expense
would be approximately $20 million after tax. For the Company's swaptions, if
rail fuel prices decrease 10% from the December 31, 2001 level, the
corresponding increase in expense would be approximately $4 million after tax.

As of December 31, 2000, the Company had hedged approximately 8% of its
forecasted 2001 fuel consumption at 68 cents per gallon, excluding taxes,
transportation costs and regional pricing spreads. If rail fuel prices had
decreased 10% from the December 31, 2000 level, the corresponding increase in
fuel expense would have been approximately $5 million after tax.

15

ACCOUNTING PRONOUNCEMENTS - Effective January 1, 2001, the Company adopted
Financial Accounting Standards Board Statement (FASB) No. 133, "Accounting for
Derivative Instruments and Hedging Activities (FAS 133) and FASB No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities"
(FAS 138). FAS 133 and FAS 138 require that the changes in fair value of all
derivative financial instruments the Company uses for fuel or interest rate
hedging purposes be recorded in the Company's Consolidated Statements of
Financial Position. In addition, to the extent fuel hedges are ineffective due
to pricing differentials resulting from the geographic dispersion of the
Company's operations, income statement recognition of the ineffective portion of
the hedge position may be required. Also, derivative instruments that do not
qualify for hedge accounting treatment per FAS 133 and FAS 138 may require
income statement recognition. The adoption of FAS 133 and FAS 138 resulted in
the recognition of a $2 million asset on January 1, 2001 (see note 4 to the
Consolidated Financial Statements, Item 8).

In September 2000, the FASB issued Statement No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
(FAS 140), replacing FASB No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" (FAS 125). FAS 140 revises
criteria for accounting for securitizations, other financial asset transfers and
collateral and introduces new disclosures. FAS 140 was effective for fiscal 2000
with respect to the new disclosure requirements and amendments of the collateral
provisions originally presented in FAS 125. All other provisions were effective
for transfers of financial assets and extinguishments of liabilities occurring
after March 31, 2001. The provisions are to be applied prospectively with
certain exceptions. The adoption of FAS 140 did not have a significant impact on
the Company's Consolidated Financial Statements.

In July 2001, the FASB issued Statement No. 141, "Business Combinations"
(FAS 141). FAS 141 revises the method of accounting for business combinations
and eliminates the pooling method of accounting. FAS 141 was effective for all
business combinations that were initiated or completed after June 30, 2001.
Management believes that FAS 141 will not have a significant impact on the
Company's Consolidated Financial Statements.

Also in July 2001, the FASB issued Statement No. 142, "Goodwill and Other
Intangible Assets" (FAS 142). FAS 142 revises the method of accounting for
goodwill and other intangible assets. FAS 142 eliminates the amortization of
goodwill, but requires goodwill to be tested for impairment at least annually at
a reporting unit level. FAS 142 is effective for the Company's fiscal year
beginning January 1, 2002. Management believes that FAS 142 will not have a
material impact on the Company's Consolidated Financial Statements. In
accordance with FAS 142, the Company will eliminate annual goodwill amortization
of $2 million. At December 31, 2001, the Company had $50 million of goodwill
remaining.

In August 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations" (FAS 143). FAS 143 is effective for the Company's fiscal
year beginning January 1, 2003, and requires the Company to record the fair
value of a liability for an asset retirement obligation in the period in which
it is incurred. Management is in the process of evaluating the impact this
standard will have on the Company's Consolidated Financial Statements.

In addition, in October 2001, the FASB issued Statement No. 144, "Accounting
for the Impairment of Disposal of Long-Lived Assets" (FAS 144). FAS 144 replaces
FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed of" (FAS 121). FAS 144 develops one
accounting model, based on the framework established in FAS 121, for long-lived
assets to be disposed of by sale. The accounting model applies to all long-lived
assets, including discontinued operations, and it replaces the provisions of APB
Opinion No. 30, "Reporting Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for disposal of segments of a business. FAS
144 requires that long-lived assets be measured at the lower of carrying amount
or fair value less cost to sell, whether reported in continuing operations or in
discontinued operations. FAS 144 also broadens the definition of discontinued
operations. FAS 144 is effective for the Company's fiscal year beginning January
1, 2002. Management believes that FAS 144 will not have a significant impact on
the Company's Consolidated Financial Statements.

COMMITMENTS AND CONTINGENCIES - There are various claims and lawsuits pending
against the Company and certain of its subsidiaries. The Company is also subject
to various federal, state and local environmental laws and regulations, pursuant
to which it is currently participating in the investigation and remediation of
various sites. A discussion of

16

certain claims, lawsuits, contingent liabilities and guarantees is set forth in
note 11 to the Consolidated Financial Statements, Item 8.

A LOOK FORWARD

2002 BUSINESS OUTLOOK

The Railroad expects to build on the positive momentum generated in the past
several years and continue to grow revenue, earnings and free cash flow. Free
cash flow is defined as cash provided by operating activities less cash used in
investing activities and dividends paid. The impact in 2001 of economic
recession and declining industrial production is expected to subside in the
latter half of 2002. Year-over-year revenue growth is projected in the
economically sensitive intermodal, chemical and industrial products commodity
segments. Agricultural products, notably wheat, is also expected to improve.
Energy revenue is expected to decline slightly from the record setting pace of
2001. Automotive revenue is also expected to decrease; however, new contracts in
the automotive sector are expected to help mitigate this decline, and,
therefore, the automotive sector should continue to be a strong revenue
provider. The Railroad will continue to focus on improving service performance
and developing new, innovative rail service offerings to meet the changing needs
of its customers. Cost control and continuing improvements in productivity
should help drive the operating ratio lower. Fuel prices are expected to be
substantially below the levels of the past two years, but will still be
susceptible to volatile price swings. To help reduce the impact of fuel price
volatility on earnings, the Railroad will continue to look for opportunities to
use hedge contracts.

On December 21, 2001, The Railroad Retirement and Survivors' Improvement Act
of 2001 (the Act) was signed into law. The Act was a result of historic
cooperation between rail management and labor, and provides improved railroad
retirement benefits for employees and reduced payroll taxes for employers.
Although the exact impact is not yet known, the Railroad anticipates that the
phased-in tax reductions will have a beneficial impact on its financial results
in the future.

2002 CAPITAL INVESTMENTS

The Company's 2002 capital expenditures and debt service requirements are
expected to be funded through cash generated from operations, additional debt
financings, including financing from the Corporation, and the sale or lease of
various operating and non-operating properties. The Company expects that these
sources will continue to provide sufficient funds to meet cash requirements in
the foreseeable future. In 2002, the Railroad expects to spend approximately
$1.7 billion on capital expenditures. These capital expenditures will be used to
maintain track and structures, continue capacity expansions on its main lines,
upgrade and augment equipment to better meet customer needs and build
infrastructure.

CAUTIONARY INFORMATION

Certain statements in this report are, and statements in other material filed or
to be filed 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 Company or the Corporation) are, or will be, forward looking within the
meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934.
These forward-looking statements include, without limitation, statements
regarding: expectations as to operational improvements; expectations as to cost
savings, revenue growth and earnings; the time by which certain objectives will
be achieved; estimates of costs relating to environmental remediation and
restoration; proposed new products and services; expectations that claims,
lawsuits, environmental costs, commitments, contingent liabilities, labor
negotiations or agreements, or other matters will not have a material adverse
effect on its consolidated financial position, results of operations or
liquidity; and statements concerning projections, predictions, expectations,
estimates or forecasts as to the Company's and its subsidiaries' business,
financial and operational results, and future economic performance, statements
of management's goals and objectives and other similar expressions concerning
matters that are not historical facts.

Forward-looking statements should not be read as a guarantee of future
performance or results, and will not necessarily be accurate indications of the
times at, or by which, such performance or results will be achieved.
Forward-

17

looking information is based on information available at the time and/or
management's good faith belief with respect to future events, and is subject to
risks and uncertainties that could cause actual performance or 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 Company and
its subsidiaries are fully successful in implementing their financial and
operational initiatives; industry competition, conditions, performance and
consolidation; legislative and/or regulatory developments, including possible
enactment of initiatives to re-regulate the rail business; natural events such
as severe weather, floods and earthquakes; the effects of adverse general
economic conditions, both within the United States and globally; any adverse
economic or operational repercussions from recent terrorist activities, any
government response thereto and any future terrorist activities; changes in fuel
prices; changes in labor costs; labor stoppages; and the outcome of claims and
litigation.

Forward-looking statements speak only as of the date the statement was made.
The Company assumes no obligation to update forward-looking information to
reflect actual results, changes in assumptions or changes in other factors
affecting forward-looking information. If the Company does update one or more
forward-looking statements, no inference should be drawn that the Company will
make additional updates with respect thereto or with respect to other
forward-looking statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Information concerning market risk sensitive instruments is set forth under
Management's Narrative Analysis of the Results of Operations - Other Matters,
Item 7, and note 4 to the Consolidated Financial Statements, Item 8.

****************************************

18

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

19

INDEPENDENT AUDITORS' REPORT

To the Board of Directors
Union Pacific Railroad Company
Omaha, Nebraska

We have audited the accompanying consolidated statements of financial position
of Union Pacific Railroad Company (an indirect wholly owned subsidiary of Union
Pacific Corporation) and Consolidated Subsidiary and Affiliate Companies (the
"Company") as of December 31, 2001 and 2000, and the related consolidated
statements of income, changes in common shareholders' equity and cash flows for
each of the three years in the period ended December 31, 2001. Our audits also
included the consolidated financial statement schedule listed in the Table of
Contents at Part IV, Item 14. These consolidated financial statements and
consolidated financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and consolidated financial statement schedule
based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Union Pacific Railroad Company
and Consolidated Subsidiary and Affiliate Companies at December 31, 2001 and
2000, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, such consolidated financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.

/s/ DELOITTE & TOUCHE LLP

Omaha, Nebraska
January 24, 2002

20

CONSOLIDATED STATEMENTS OF INCOME
Union Pacific Railroad Company and Consolidated Subsidiary and Affiliate
Companies

The accompanying notes are an integral part of these Consolidated Financial
Statements.

21

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
Union Pacific Railroad Company and Consolidated Subsidiary and Affiliate
Companies

The accompanying notes are an integral part of these Consolidated Financial
Statements.

22

CONSOLIDATED STATEMENTS OF CASH FLOWS
Union Pacific Railroad Company and Consolidated Subsidiary and Affiliate
Companies

The accompanying notes are an integral part of these Consolidated Financial
Statements.

23

CONSOLIDATED STATEMENTS OF CHANGES IN COMMON SHAREHOLDERS' EQUITY
Union Pacific Railroad Company and Consolidated Subsidiary and Affiliate
Companies

[a] Common stock $10.00 par value: 9,200 shares authorized; 4,465
outstanding.

[b] Class A stock, $10.00 par value: 800 shares authorized, 388
outstanding.

The accompanying notes are an integral part of these Consolidated Financial
Statements.

24

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Union Pacific Railroad Company and Consolidated Subsidiary and Affiliate
Companies

SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION - The Consolidated Financial Statements include the
accounts of Union Pacific Railroad Company, a Delaware corporation (the
Registrant), and all of its subsidiaries and certain affiliates (collectively,
the Company, UPRR or the Railroad). The Registrant is an indirect wholly owned
subsidiary of Union Pacific Corporation, a Utah corporation (the Corporation or
UPC). Investments in affiliated companies (20% to 50% owned) are accounted for
using the equity method of accounting. All material intercompany transactions
are eliminated.

CASH AND TEMPORARY INVESTMENTS - Temporary investments are stated at cost which
approximates fair value and consist of investments with original maturities of
three months or less.

INVENTORIES - Inventories consist of materials and supplies carried at the lower
of average cost or market.

PROPERTY AND DEPRECIATION - Properties are carried at cost. Provisions for
depreciation are computed principally on the straight-line method based on
estimated service lives of depreciable property. The cost (net of salvage) of
depreciable rail property retired or replaced in the ordinary course of business
is charged to accumulated depreciation. A gain or loss is recognized in other
income for all other property upon disposition. The cost of internally developed
software is capitalized and amortized over a five-year period. An obsolescence
review of capitalized software is performed on a periodic basis.

IMPAIRMENT OF LONG-LIVED ASSETS - The Company reviews long-lived assets,
including identifiable intangibles, for impairment when events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If impairment indicators are present and the estimated future
undiscounted cash flows are less than the carrying value of the long-lived
assets, the carrying value is reduced to the estimated fair value as measured by
the discounted cash flows.

REVENUE RECOGNITION - Transportation revenues are recognized on a
percentage-of-completion basis as freight moves from origin to destination.
Other revenue is recognized as service is performed or contractual obligations
are met.

TRANSLATION OF FOREIGN CURRENCY - The Company translates its portion of the
assets and liabilities related to foreign investments into U.S. dollars at the
exchange rates in effect at the balance sheet date. Revenues and expenses are
translated at the average rates of exchange prevailing during the year. The
resulting translation adjustments are reflected within shareholders' equity as
accumulated other comprehensive income or loss. Transaction gains and losses
related to intercompany accounts are not material.

FINANCIAL INSTRUMENTS - The carrying value of the Company's non-derivative
financial instruments approximates fair value, except for differences with
respect to long-term, fixed-rate debt and certain differences relating to cost
method investments and other financial instruments that are not significant. The
fair value of financial instruments is generally determined by reference to
market values as quoted by recognized dealers or developed based upon the
present value of expected future cash flows discounted at the applicable U.S.
Treasury rate, London Interbank Offered Rates (LIBOR) or swap spread.

The Company periodically uses derivative financial instruments to manage
risk related to changes in fuel prices and interest rates.

USE OF ESTIMATES - The Consolidated Financial Statements of the Company include
estimates and assumptions regarding certain assets, liabilities, revenues and
expenses and the disclosure of certain contingent assets and liabilities. Actual
future results may differ from such estimates.

PERSONAL INJURY - The cost of injuries to employees and others on UPRR property
is charged to expense based on actuarial estimates of the ultimate cost and
number of incidents each year.

25

ENVIRONMENTAL - When environmental issues have been identified with respect to
the property owned, leased or otherwise used in the conduct of the Company's
business, the Company and its consultants perform environmental assessments on
such property. The Company expenses the cost of the assessments as incurred. The
Company accrues the cost of remediation where its obligation is probable and
such costs can be reasonably estimated.

CHANGE IN PRESENTATION - Certain prior year amounts have been reclassified to
conform to the 2001 Consolidated Financial Statement presentation. These
reclassifications had no effect on previously reported operating income or net
income.

1. OPERATIONS

The Railroad is a Class I railroad that operates in the United States. As of
October 1, 1996, the Railroad included Southern Pacific Rail Corporation
(Southern Pacific or SP). In addition, during 1997, the Railroad and a
consortium of partners were granted a 50-year concession to operate the
Pacific-North and Chihuahua Pacific lines in Mexico. The Railroad made an
additional investment in the consortium in 1999. During 2001, UPC completed its
integration of Southern Pacific's rail operations.

The Railroad has over 33,000 route miles linking Pacific Coast and Gulf
Coast ports to the Midwest and eastern United States gateways and providing
several north/south corridors to key Mexican gateways. The Railroad serves the
western two-thirds of the country and maintains coordinated schedules with other
carriers for the handling of freight to and from the Atlantic Coast, the Pacific
Coast, the Southeast, the Southwest, Canada and Mexico. Export and import
traffic is moved through Gulf Coast and Pacific Coast ports and across the
Mexican and Canadian borders. Railroad freight is comprised of six commodity
lines: agricultural, automotive, chemicals, energy, industrial products and
intermodal. The Railroad continues to focus on utilization of its capital asset
base to meet current operating needs and to introduce innovative rail services
across every commodity line.

The Railroad is subject to price and service competition from other
railroads, motor carriers and barge operators. The Railroad's main competitor is
Burlington Northern Santa Fe Corporation. Its rail subsidiary, The Burlington
Northern and Santa Fe Railway Company, operates parallel routes in many of the
Railroad's main traffic corridors. In addition, the Railroad's operations are
conducted in corridors served by other competing railroads and by motor
carriers. Motor carrier competition is particularly strong for intermodal
traffic. Because of the proximity of the Railroad's routes to major inland and
Gulf Coast waterways, barge competition can be particularly pronounced,
especially for grain and bulk commodities.

EMPLOYEES - Approximately 87% of the Railroad's nearly 48,000 employees are
represented by 14 major rail unions. National negotiations under the Railway
Labor Act to revise the national labor agreements for all crafts began in late
1999. In May 2001, the Brotherhood of Maintenance of Way Employees (BMWE)
ratified a five-year agreement, which included provisions for an annual wage
increase (based on the consumer price index) and progressive health and welfare
cost sharing. The health and welfare cost sharing was a milestone as the BMWE is
the first union to make significant cost contributions to their health and
welfare plan. Contract discussions with the remaining unions are either in
negotiation or mediation. Also during 2001, much of the operating craft unions'
focus was on a proposed merger between the United Transportation Union and the
Brotherhood of Locomotive Engineers (BLE). In a December 2001 re-vote, the BLE
resoundingly rejected the merger. Both operating craft unions have indicated a
desire to complete national negotiations. The Company anticipates significant
progress in 2002.

2. ACQUISITIONS

SOUTHERN PACIFIC - During 2001, UPC completed its integration of Southern
Pacific's rail operations. UPC consummated the acquisition of Southern Pacific
in September 1996 for $4.1 billion. Sixty percent of the outstanding Southern
Pacific common shares was converted into UPC common stock, and the remaining 40%
of the outstanding shares was acquired for cash. UPC's investment in Southern
Pacific was subsequently pushed down to the Railroad. The acquisition of

26

Southern Pacific has been accounted for using the purchase method of accounting
and was fully consolidated into the Company's results beginning October 1996.

Merger Consolidation Activities - In connection with the acquisition and
integration of UPRR and Southern Pacific's rail operations, UPC completed the
elimination of 5,200 duplicate positions in 2001 in accordance with the original
merger plan. UPC also completed the relocation of 4,700 positions, merging or
disposing of redundant facilities and disposing of certain rail lines. In
addition, the Company canceled and settled the remaining uneconomical and
duplicative SP contracts, including payroll-related contractual obligations in
accordance with the original merger plan.

Merger Liabilities - In 1996, UPC recognized a $958 million pre-tax liability in
the SP purchase price allocation for costs associated with SP's portion of these
activities. Merger liability activity reflected cash payments for merger
consolidation activities and reclassification of contractual obligations from
merger liabilities to contractual liabilities. The fair value allocation of SP's
purchase price to fixed assets was reduced by $50 million as costs for certain
merger activities were less than anticipated in the original plan. Where merger
related costs were greater than what was anticipated in the plan, those costs
were charged to expense in the period incurred. Where the merger implementation
caused the Company to incur more costs than were envisioned in the original
merger plan, such costs were charged to expense in the period incurred. Merger
liability activity was $89 million, $10 million and $45 million in 2001, 2000
and 1999, respectively.

The components of the merger liability as of December 31, 2001 were as
follows:

3. TRANSACTIONS WITH AFFILIATES

Amounts due to and from affiliates, including advances to and borrowings from
the Corporation, bear interest at an annually determined rate, which considers
the Corporation's cost of debt. Net intercompany interest expense charged to the
Railroad on such amounts was $398 million, $405 million and $420 million in
2001, 2000 and 1999, respectively.

4. FINANCIAL INSTRUMENTS

ADOPTION OF STANDARD - Effective January 1, 2001, the Company adopted Financial
Accounting Standards Board Statement (FASB) No. 133, "Accounting for Derivative
Instruments and Hedging Activities (FAS 133) and FASB No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities" (FAS 138). FAS
133 and FAS 138 require that the changes in fair value of all derivative
financial instruments the Company uses for fuel or interest rate hedging
purposes be recorded in the Company's Consolidated Statements of Financial
Position. In addition, to the extent fuel hedges are ineffective due to pricing
differentials resulting from the geographic dispersion of the Company's
operations, income statement recognition of the ineffective portion of the hedge
position may be required. Also, derivative instruments that do not qualify for
hedge accounting treatment per FAS 133 and FAS 138 may require income statement
recognition. The adoption of FAS 133 and FAS 138 resulted in the recognition of
a $2 million asset on January 1, 2001.

STRATEGY AND RISK - The Company and its subsidiaries use derivative financial
instruments, which are subject to market risk, in limited instances for other
than trading purposes to manage risk related to changes in fuel prices. The
Company uses swaps, futures and/or forward contracts to mitigate adverse price
and rate movements and exposure to variable cash flows. The use of these
instruments also limits future gains from favorable movements. The purpose of
these programs is to protect the Company's operating margins and overall
profitability from adverse fuel price changes.

27

The Company may also use fuel swaptions to secure more favorable swap
prices. Swaptions are swaps that are extendable past their base period at the
option of the counterparty. Swaptions do not qualify for hedge accounting
treatment and are marked-to-market through the Consolidated Statements of
Income.

MARKET AND CREDIT RISK - The Company addresses market risk related to derivative
financial 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 high
credit standards for counterparties and periodic settlements. The Company has
not been required to provide collateral; however, the Company may receive
collateral relating to its hedging activity where the concentration of credit
risk was substantial.

In addition, the Company enters into secured financings in which the debtor
has pledged collateral. The collateral is based upon the nature of the financing
and the credit risk of the debtor. The Company generally is not permitted to
sell or repledge the collateral unless the debtor defaults.

DETERMINATION OF FAIR VALUE - The fair values of the Company's derivative
financial instrument positions at December 31, 2001 and 2000, were determined
based upon current fair values as quoted by recognized dealers or developed
based upon the present value of expected future cash flows discounted at the
applicable U.S. Treasury rate, London Interbank Offered Rates (LIBOR) or swap
spread.

FUEL STRATEGY - As a result of the significance of the Company's fuel costs and
the historical volatility of fuel prices, the Company periodically use swaps,
futures and/or forward contracts to mitigate adverse fuel price changes. In
addition, the Company at times may use fuel swaptions to secure more favorable
swap prices. The following is a summary of the Company's derivative financial
instruments at December 31, 2001 and 2000:

[a] Fuel hedges which were in effect during 2001. Fuel hedges include the
swap portion of a swaption with a base term within 2001, and they
exclude the option portion of the swaption to extend the swap past
2001.

[b] Excluded taxes, transportation costs and regional pricing spreads.

[c] Fuel hedges which are in effect during 2002. These hedges expire
December 31, 2002. Fuel hedges include the swap portions of the
swaptions with base terms within 2002, and they exclude the option
portions of the swaptions to extend the swaps past 2002.

[d] Fuel hedges which are in effect during 2003. These hedges expire
December 31, 2003.

The fair value asset and liability positions of the Company's outstanding
derivative financial instruments at December 31, 2001 and 2000 were as follows:

As of December 31, 2001, fuel hedging positions of $11 million will be
reclassified from accumulated other comprehensive income to fuel expense over
the life of the hedge as fuel is consumed. Fuel swaption positions will be

28

reflected in the Consolidated Statements of Income as fuel expense over the life
of the swap and as other income as the fair value of the outstanding option
fluctuates.

The Company's use of derivative financial instruments had the following
impact on pre-tax income for the years ended December 31, 2001, 2000 and 1999:

FAIR VALUE OF DEBT INSTRUMENTS - The fair value of the Company's long- and
short-term debt has been estimated using quoted market prices or current
borrowing rates. At December 31, 2001 and 2000, the fair value of total debt
exceeded the carrying value by approximately $93 million and $29 million,
respectively. At December 31, 2001 and December 31, 2000, approximately $273
million and $435 million, respectively, of fixed-rate debt securities contain
call provisions that allow the Company to retire the debt instruments prior to
final maturity subject, in certain cases, to the payment of premiums.

SALE OF RECEIVABLES - The Railroad has sold, on a revolving basis, an undivided
percentage ownership interest in a designated pool of accounts receivable to
third parties through a bankruptcy-remote subsidiary. Receivables are sold at
carrying value, which approximates fair value. The third parties have designated
the Railroad to service the sold receivables. 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, 2001 and 2000, accounts receivable are presented net of $600 million of
receivables sold.

5. INCOME TAXES

The Company is included in the consolidated income tax return of the
Corporation. The consolidated income tax liability of the Corporation is
allocated among the parent and its subsidiaries on the basis of the separate
contributions to the consolidated income tax liability, with full benefit of tax
losses and credits made available through consolidation by allocation to the
individual companies generating such losses and credits.

Components of income tax expense were as follows for the years ended
December 31, 2001, 2000 and 1999:

29

Deferred income tax liabilities (assets) were comprised of the following at
December 31, 2001 and 2000:

At December 31, 2001, the Company has a deferred income tax asset reflecting
the benefits of $230 million in net operating loss carryforwards, which expire
between 2009 and 2018. The Internal Revenue Code limits a corporation's ability
to utilize net operating loss carryforwards. The Company does not expect these
limits to impact its ability to utilize its carryforwards. The Company has
analyzed its deferred income tax assets and believes a valuation allowance is
not necessary.

For the years ending December 31, 2001, 2000 and 1999, a reconciliation
between statutory and effective tax rates of continuing operations is as
follows:

The Internal Revenue Service is currently examining the Company's tax
returns for 1986 through 1998. All years prior to 1986 are closed. The Company
believes it has adequately provided for federal and state income taxes.

6. DEBT

Total debt as of December 31, 2001 and 2000, is summarized below:

30

DEBT MATURITIES - Aggregate debt maturities, excluding intercompany borrowings,
as of December 31, 2001, are as follows:

MORTGAGED PROPERTIES - At December 31, 2001 and 2000, approximately $9.4 billion
and $9.6 billion, respectively, of Railroad properties secure outstanding
equipment obligations and mortgage bonds.

INCOME-BASED SECURITIES - The Company has certain debt instruments which contain
provisions that limit the payment of interest, require sinking fund installments
and impose certain restrictions in the event all interest is not paid based upon
available income levels. Other debt instruments contain provisions that may
impose restrictions on the Company's ability to declare dividends on certain
classes of capital stock (note 9).

SIGNIFICANT NEW FINANCINGS - During July 2001, UPRR entered into capital leases
covering new locomotives. The related capital lease obligations totaled
approximately $124 million and are included in the Statements of Consolidated
Financial Position as debt.

7. LEASES

The Company leases certain locomotives, freight cars, trailers and other
property. Future minimum lease payments for operating and capital leases with
initial or remaining non-cancelable lease terms in excess of one year as of
December 31, 2001 were as follows:

Rent expense for operating leases with terms exceeding one month was $571
million in 2001, $550 million in 2000 and $609 million in 1999. Contingent
rentals and sub-rentals are not significant.

8. RETIREMENT PLANS

BENEFIT SUMMARY - The Company provides defined benefit retirement income to
eligible non-union employees through qualified and non-qualified (supplemental)
pension plans. In addition, the Company provides a defined contribution plan
(thrift plan) to eligible non-union employees. All non-union and certain of the
Company's union employees participate in defined contribution medical and life
insurance programs for retirees. All Railroad employees are covered by the
Railroad Retirement System (the System).

31

FUNDING AND BENEFIT PAYMENTS - Qualified and non-qualified pension benefits are
based on years of service and the highest compensation during the latest years
of employment. The qualified plans are funded based on the Projected Unit Credit
actuarial funding method and are funded at not less than the minimum funding
standards set forth in the Employee Retirement Income Security Act of 1974, as
amended. The Company has settled a portion of the non-qualified unfunded
supplemental plan's accumulated benefit obligation by purchasing annuities.
Company contributions into the thrift plan are based on 50% of the participant's
contribution, limited to 3% of the participant's base salary. Company thrift
plan contributions were $11 million for each of the three years ended December
31, 2001, 2000, and 1999. The Company also provides medical and life insurance
benefits on a cost sharing basis for qualifying employees. These costs are
funded as incurred. In addition, contributions made to the System are expensed
as incurred and amounted to approximately $429 million in 2001, $430 million in
2000, and $426 million in 1999.

Changes in the Company's projected benefit obligation are as follows, for
the years ended December 31, 2001 and 2000:

As part of the work force reduction plan, discussed in note 14, the Company
reclassified $59 million and $1 million in 2001 for pension and other
postretirement benefits, respectively, from other current liabilities to retiree
benefits obligation.

Changes in the Company's benefit plan assets are as follows for the years
ended December 31, 2001 and 2000:

The components of funded status of the benefit plans for the years ended
December 31, 2001 and 2000 were as follows:

At December 31, 2001 and 2000, $29 million and $25 million, respectively of
the total pension and other post-retirement liability were classified as a
current liability.

32

Amounts recognized for the benefit plan liabilities in the Consolidated
Statements of Financial Position for December 31, 2001 and 2000 consisted of:

The components of the Company's net periodic pension costs (income) for the
years ended December 31, 2001, 2000 and 1999 were as follows:

At December 31, 2001 and 2000, approximately 32% of the funded plans' assets
each year were held in fixed-income and short-term securities, with the
remainder in equity securities.

The weighted-average actuarial assumptions for the years ended December 31,
2001, 2000 and 1999 were as follows:

Assumed health care cost trend rates have a significant effect on the amount
reported for health care plans. A one-percentage point change in the assumed
health care cost trend rates would have the following effects on other
postretirement benefits:

33

9. CAPITAL STOCK AND DIVIDEND RESTRICTIONS - The Board of Directors of the
Registrant has restricted the availability of retained earnings for payment of
dividends by $131 million. This represents (a) the amount by which the estimated
fair value of the Registrant's investment in its non-transportation
subsidiaries, as determined by the Board of Directors of the Registrant,
exceeded the net book value of such investment, which was transferred to the
Corporation by means of a dividend in June 1971 ($110 million) and (b) the
amount by which the fair market value exceeded the book value of certain
investment securities which were transferred to the Corporation by means of a
dividend in November 1972 ($21 million).

The Company's capital structure consists of Class A Stock and Common Stock.
The Class A Stock is entitled to a cash dividend whenever a dividend is declared
on the Common Stock, in an amount which equals 8 percent of the sum of the
dividends on both the Class A Stock and the Common Stock.

The number of shares shown in the Statements of Changes in Common
Shareholders' Equity in the Consolidated Financial Statements, Item 8, excludes
2,665 shares of Common Stock and 232 shares of Class A Stock owned by Southern
Pacific Rail Corporation, whose results are included in the Consolidated
Financial Statements.

The Company is subject to certain restrictions related to the payment of
dividends. The amount of retained earnings available for dividends under the
most restrictive test was $4.8 billion and $4.0 billion at December 31, 2001 and
2000, respectively.

10. STOCK OPTIONS AND OTHER STOCK PLANS

STOCK OPTIONS - The Railroad participates in the Corporation's stock incentive
programs. The Corporation applies Accounting Principles Board Opinion No. 25 and
related interpretations in accounting for its stock plans. Pursuant to the
Corporation's stock incentive plans for officers, key employees and non-employee
directors, 12,461,025; 6,089,561; and 4,809,408 common shares were available for
grant at December 31, 2001, 2000 and 1999, respectively. Options are granted at
fair value on the grant date and are outstanding for a period of 10 years from
the grant date. Options generally become exercisable no earlier than one year
after grant.

DETERMINATION OF FAIR VALUE OF OPTIONS - The fair value of each stock option
granted is estimated for the determination of pro forma expense using a
Black-Scholes option-pricing model. The following table details the number of
options granted, weighted-average exercise price of the options granted,
weighted-average assumptions utilized in determining the pro forma expense and
the weighted-average fair value of options for the years ended December 31,
2001, 2000 and 1999:

The expense impact of the option grant is determined as of the date of the
grant and is reflected in pro forma results over the options' vesting period.
Pro forma net income for 2001, 2000 and 1999, including compensation expense for
options that vested in each year, was $1,039 million, $897 million, and $805
million, respectively.

During 1998, the Corporation implemented a broad-based option program that
granted each active employee the option to purchase 200 shares of UPC common
stock at $55.00 per share. This program resulted in 11,124,000 new options in
1998 and generated an after-tax pro forma compensation expense of $7 million in
2001 and $28 million in both 2000 and 1999. The conversion of these options will
be effected with treasury shares as the options were not issued under the stock
option plan for officers and key employees.

34

Changes in common stock options outstanding were as follows:

Stock options outstanding at December 31, 2001 were as follows:

Stock options exercisable at December 31, 2001 were as follows:

OTHER INCENTIVE PLANS - The Corporation's plans provide for awarding retention
shares of common stock or stock units (the right to receive shares of common
stock) to eligible employees. These awards are subject to forfeiture if
employment terminates during the prescribed retention period, generally three
years, or, in some cases, if a certain prescribed stock price or other financial
criteria are not met. During the year ended December 31, 2001, 223,502 retention
shares and stock units were issued at a weighted-average fair value of $49.95.
During 2000, 171,309 retention shares and stock units were issued at a
weighted-average fair value of $41.22. During 1999, 18,700 retention shares and
stock units were issued at a weighted-average fair value of $53.03. A portion of
the retention awards issued in 1999 were subject to stock price or performance
targets. The cost of retention awards is amortized to expense over the retention
period.

In November 2000, the Corporation approved the 2001 Long Term Plan (LTP).
The LTP includes certain performance criteria and a retention requirement.
During the year ended December 31, 2001, 766,900 performance retention shares
and stock units were issued at a weighted-average fair value of $50.11. The cost
of the LTP is expensed over the performance period which ends January 31, 2004.

35

The Corporation adopted the Executive Stock Purchase Incentive Plan (ESPIP)
effective October 1, 1999, in order to encourage and facilitate ownership of
common stock by officers and other key executives of the Corporation and its
subsidiaries. Under the ESPIP, the participants purchased a total of 542,000
shares of the Corporation's common stock with the proceeds of 6.02%
interest-bearing, full recourse loans from the Corporation. Loans totaled $25
million. Deferred cash payments will be awarded to the participants to repay
interest and the loan principal if certain performance and retention criteria
are met within a 40-month period ending January 31, 2003. Dividends paid on the
purchased shares were originally assigned to the Corporation to offset the
accrued interest on the loan until certain performance criteria are met. The
first performance criterion was satisfied in March 2001 and, accordingly
thereafter, the dividends on the purchased shares are now paid directly to the
participants, and a deferred cash payment equal to the net accrued interest will
be paid to the participants at the expiration of the 40-month period. The cost
of the ESPIP is amortized to expense over the 40-month period.

During the year ended December 31, 2001, the Railroad expensed $8 million
related to the other incentive plans described above. During the years ended
December 31, 2001, 2000 and 1999, UPC expensed $4 million, $11 million and $3
million, respectively, attributable to the Railroad participants in the other
incentive plans described above.

11. COMMITMENTS AND CONTINGENCIES

UNASSERTED CLAIMS - There are various claims and lawsuits pending against the
Company and certain of its subsidiaries. It is not possible at this time for the
Company to determine fully 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, contingent liabilities or guarantees will have a material adverse
effect on its consolidated financial condition, results of operations or
liquidity.

ENVIRONMENTAL -The Company generates and transports hazardous and nonhazardous
waste in its current and former operations, and is subject to federal, state and
local environmental laws and regulations. The Company has identified
approximately 370 active sites at which it is or may be liable for remediation
costs associated with alleged contamination or for violations of environmental
requirements. This includes 48 sites that are the subject of actions taken by
the U.S. government, 28 of which are currently on the Superfund National
Priorities List. Certain federal legislation imposes joint and several liability
for the remediation of identified sites; consequently, the Company's ultimate
environmental liability may include costs relating to other parties, in addition
to costs relating to its own activities at each site.

When environmental issues have been identified with respect to the property
owned, leased or otherwise used in the conduct of the Company's business, the
Company and its consultants perform environmental assessments on such property.
The Company expenses the cost of the assessments as incurred. The Company
accrues the cost of remediation where its obligation is probable and such costs
can be reasonably estimated.

As of December 31, 2001, the Company has a liability of $171 million accrued
for future environmental costs. The liability includes future costs for
remediation and restoration of sites, as well as for ongoing monitoring costs,
but excludes any anticipated recoveries from third parties. Cost estimates are
based on information available for each site, financial viability of other
potentially responsible parties, and existing technology, laws and regulations.
The Company believes that it has adequately accrued for its ultimate share of
costs at sites subject to joint and several liability. However, the ultimate
liability for remediation is difficult to determine because of the number of
potentially responsible parties involved, site-specific cost sharing
arrangements with other potentially responsible parties, the degree of
contamination by various wastes, the scarcity and quality of volumetric data
related to many of the sites, and/or the speculative nature of remediation
costs. The Company expects to pay out the majority of the December 31, 2001,
environmental liability over the next five years, funded by cash generated from
operations. The impact of current obligations is not expected to have a material
adverse effect on the results of operations or financial condition of the
Company.

PURCHASE OBLIGATIONS AND GUARANTEES - The Company and its subsidiaries
periodically enter into financial and other commitments in connection with their
businesses. At December 31, 2001, the Company had unconditional purchase
obligations of $547 million for the purchase of locomotives as part of the
Company's multi-year capital asset acquisition

36

plan. In addition, the Company was contingently liable for $205 million in
guarantees and $7 million in letters of credit at December 31, 2001. These
contingent guarantees were entered into in the normal course of business and
include guaranteed obligations of affiliated operations. The Company is not
aware of any existing event of default which would require it to satisfy these
guarantees.

OTHER - In December 2001, the Railroad entered into a synthetic operating lease
arrangement to finance a new headquarters building which will be constructed in
Omaha, Nebraska. The expected completion date of the building is 2004. It will
total approximately 1.1 million square feet with approximately 3,800 office
workspaces. The cost to construct the new headquarters, including capitalized
interest, is approximately $260 million. Union Pacific Corporation has
guaranteed the Railroad's obligation under this lease.

UPRR will be the construction agent for the lessor. Total building related
costs incurred and drawn from the lease funding commitments as of December 31,
2001, were approximately $10 million. After construction is complete, the lease
has an initial term of five years and provisions for renewal for an extended
period subject to agreement between the Railroad and lessor. At any time during
the lease, the Railroad may, at its option, purchase the building at
approximately the amount expended by the lessor to construct the building. If
the Railroad elects not to renew the lease or purchase the building, the
Railroad has guaranteed a residual value of approximately $220 million. At
December 31, 2001, the Railroad has guaranteed, under certain circumstances, a
residual value of less than $10 million.

RISK FACTORS - The Company's future results may be affected by changes in the
economic environment, fluctuations in fuel prices, operational repercussions
from any terrorist activities or government response thereto and external
factors such as weather. Several of the commodities transported by the Company
come from industries with cyclical business operations. As a result, prolonged
negative changes in the U.S. and global economic conditions can have an adverse
effect on the Company's operating results. In addition, to the extent that
diesel fuel costs are not recovered through increased revenue, improved fuel
conservation or mitigated by hedging activity, operating results for the Company
can also be adversely affected.

12. OTHER INCOME

Other income included the following:

13. ACCOUNTING PRONOUNCEMENTS

In September 2000, the FASB issued Statement No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities" (FAS 140),
replacing FASB No. 125, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities" (FAS 125). FAS 140 revises criteria
for accounting for securitizations, other financial asset transfers and
collateral and introduces new disclosures. FAS 140 was effective for fiscal 2000
with respect to the new disclosure requirements and amendments of the collateral
provisions originally presented in FAS 125. All other provisions were effective
for transfers of financial assets and extinguishments of liabilities occurring
after March 31, 2001. The provisions are to be applied prospectively with
certain exceptions. The adoption of FAS 140 did not have a significant impact on
the Company's Consolidated Financial Statements.

In July 2001, the FASB issued Statement No. 141, "Business Combinations" (FAS
141). FAS 141 revises the method of accounting for business combinations and
eliminates the pooling method of accounting. FAS 141 was effective for all
business combinations that were initiated or completed after June 30, 2001.
Management believes that FAS 141 will not have a significant impact on the
Company's Consolidated Financial Statements.

37

Also in July 2001, the FASB issued Statement No. 142, "Goodwill and Other
Intangible Assets" (FAS 142). FAS 142 revises the method of accounting for
goodwill and other intangible assets. FAS 142 eliminates the amortization of
goodwill, but requires goodwill to be tested for impairment at least annually at
a reporting unit level. FAS 142 is effective for the Company's fiscal year
beginning January 1, 2002. Management believes that FAS 142 will not have a
material impact on the Company's Consolidated Financial Statements. In
accordance with FAS 142, the Company will eliminate annual goodwill amortization
of $2 million. At December 31, 2001, the Company had $50 million of goodwill
remaining.

In August 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations" (FAS 143). FAS 143 is effective for the Company's fiscal
year beginning January 1, 2003, and requires the Company to record the fair
value of a liability for an asset retirement obligation in the period in which
it is incurred. Management is in the process of evaluating the impact this
standard will have on the Company's Consolidated Financial Statements.

In addition, in October 2001, the FASB issued Statement No. 144, "Accounting
for the Impairment of Disposal of Long-Lived Assets" (FAS 144). FAS 144 replaces
FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed of" (FAS 121). FAS 144 develops one
accounting model, based on the framework established in FAS 121, for long-lived
assets to be disposed of by sale. The accounting model applies to all long-lived
assets, including discontinued operations, and it replaces the provisions of APB
Opinion No. 30, "Reporting Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for disposal of segments of a business. FAS
144 requires that long-lived assets be measured at the lower of carrying amount
or fair value less cost to sell, whether reported in continuing operations or in
discontinued operations. FAS 144 also broadens the definition of discontinued
operations. FAS 144 is effective for the Company's fiscal year beginning January
1, 2002. Management believes that FAS 144 will not have a significant impact on
the Company's Consolidated Financial Statements.

14. WORK FORCE REDUCTION PLAN

Prompted by signs of an economic slowdown, the Company's Board of Directors
approved a work force reduction plan (the Plan) in the fourth quarter of 2000.
The Plan called for the elimination of approximately 2,000 Railroad positions
during 2001. In December 2001, the Plan was completed with positions eliminated
through a combination of subsidized early retirements, involuntary layoffs and
attrition. The Plan affected both agreement and non-agreement employees across
the entire 23-state Railroad system. As of December 31, 2001, 2,021 positions
had been eliminated in accordance with the Plan. Of those eliminations, 1,051
were made through subsidized early retirements and involuntary layoffs with the
remaining coming through attrition.

The Company accrued $115 million pre-tax or $72 million after-tax in the
fourth quarter of 2000 for costs related to the Plan. The expense was charged to
salaries, wages and employee benefits in the Company's 2000 Consolidated
Statements of Income. Plan liability activity in 2001 includes $49 million paid
in cash or reclassified to contractual liabilities for severance benefits to 571
employees; $60 million of subsidized early retirement benefits covering 480
employees; with the remaining $6 million charged back against salaries, wages
and employee benefits in the Company's Consolidated Statements of Income.

38

15. SELECTED QUARTERLY DATA (UNAUDITED)

Selected unaudited quarterly data are as follows:

[a] Included $115 million pre-tax ($72 million after-tax) work force
reduction charge (see note 14).

****************************************

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

39

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Omitted in accordance with General Instruction I of Form 10-K.

ITEM 11. EXECUTIVE COMPENSATION

Omitted in accordance with General Instruction I of Form 10-K.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Omitted in accordance with General Instruction I of Form 10-K.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Omitted in accordance with General Instruction I of Form 10-K.

40

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) Financial Statements, Financial Statement Schedules and Exhibits:

(1) Financial Statements

The financial statements filed as part of this filing are
listed on the index to Consolidated Financial Statements, Item
8, on page 19.

(2) Financial Statement Schedules

Schedule II - Valuation and Qualifying Accounts

Schedules not listed above have been omitted because they are
not applicable or not required or the information required to
be set forth therein is included in the Consolidated Financial
Statements, Item 8, or notes thereto.

(3) Exhibits

Exhibits are listed in the exhibit index on page 44.

(b) Reports on Form 8-K

On October 18, 2001, the Registrant filed a Current Report on Form 8-K
announcing UPC's financial results for the third quarter of 2001.

On January 24, 2002, the Registrant filed a Current Report on Form 8-K
announcing UPC's financial results for the fourth quarter of 2001.

41

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, on this 4th day of March,
2002.

UNION PACIFIC RAILROAD COMPANY

By /s/ Richard K. Davidson
------------------------------------
Richard K. Davidson, Chairman,
Chief Executive Officer and Director

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below, on this 4th day of March, 2002, by the following persons
on behalf of the registrant and in the capacities indicated.

PRINCIPAL EXECUTIVE OFFICER
AND DIRECTOR:

/s/ Richard K. Davidson
---------------------------------------
Richard K. Davidson, Chairman,
Chief Executive Officer and Director

PRINCIPAL FINANCIAL OFFICER:

/s/ James R. Young
---------------------------------------
James R. Young,
Chief Financial Officer

PRINCIPAL ACCOUNTING OFFICER:

/s/ Richard J. Putz
---------------------------------------
Richard J. Putz,
Chief Accounting Officer and Controller

* By /s/ Thomas E. Whitaker
------------------------------------
Thomas E. Whitaker, Attorney-in-fact

42

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Union Pacific Railroad Company and Consolidated Subsidiary and Affiliate
Companies

43

UNION PACIFIC RAILROAD COMPANY
EXHIBIT INDEX

Exhibit No. Description

Filed with this Statement

12 Ratio of Earnings to Fixed Charges.

24 Powers of Attorney Executed by the Directors of UPRR.

Incorporated by Reference

2 Agreement and Plan of Merger, dated as of January 29,
1998, between UPRR and Southern Pacific
Transportation Company (SPT) is incorporated herein
by reference to Exhibit 2 to the Registrants' Current
Report on Form 8-K dated February 13, 1998.

3(a) Amended Certificate of Incorporation of the
Registrant, effective as of February 1, 1998, is
incorporated herein by reference to Exhibit 3(a) to
the Company's Annual Report on Form 10-K for the year
ended December 31, 1998.

3(b) By-laws of the Registrant, as amended effective as of
November 19, 1998, are incorporated herein by
reference to Exhibit 3(b) to the Company's Annual
Report on Form 10-K for the year ended December 31,
1998.

4 Pursuant to various indentures and other agreements,
the Registrant has issued long-term debt. No such
agreement has securities or obligations covered
thereby which exceed 10% of the Registrant's total
consolidated assets. The Registrant agrees to furnish
the Commission with a copy of any such indenture or
agreement upon request by the Commission.

10(a) Amended and Restated Anschutz Shareholders Agreement,
dated as of July 12, 1996, among UPC, UPRR, The
Anschutz Corporation (TAC), Anschutz Foundation (the
Foundation) and Mr. Philip F. Anschutz, is
incorporated herein by reference to Annex D to the
Joint Proxy Statement/Prospectus included in
Post-Effective Amendment No. 2 to UPC's Registration
Statement on Form S-4 (No. 33-64707).

10(b) Amended and Restated Registration Rights Agreement,
dated as of July 12, 1996, among UPC, TAC and the
Foundation is incorporated herein by reference to
Annex H to the Joint Proxy Statement/Prospectus
included in Post-Effective Amendment No. 2 to UPC's
Registration Statement on Form S-4 (No. 33-64707).

10(c) Amended and Restated Registration Rights Agreement,
dated as of July 12, 1996, among UPC, UP Holding
Company, Inc., Union Pacific Merger Co. and Southern
Pacific Rail Corporation (SP) is incorporated herein
by reference to Annex J to the Joint Proxy
Statement/Prospectus included in Post-Effective
Amendment No. 2 to UPC's Registration Statement on
Form S-4 (No. 33-64707).

44

10(d) Agreement, dated September 25, 1995, among UPC, UPRR,
Missouri Pacific Railroad Company (MPRR), SP, SPT,
The Denver & Rio Grande Western Railroad Company
(D&RGW), St. Louis Southwestern Railway Company
(SLSRC) and SPCSL Corp. (SPCSL), on the one hand, and
Burlington Northern Railroad Company (BN) and The
Atchison, Topeka and Santa Fe Railway Company (Santa
Fe), on the other hand, is incorporated by reference
to Exhibit 10.11 to UPC's Registration Statement on
Form S-4 (No. 33-64707).

10(e) Supplemental Agreement, dated November 18, 1995,
between UPC, UPRR, MPRR, SP, SPT, D&RGW, SLSRC and
SPCSL, on the one hand, and BN and Santa Fe, on the
other hand, is incorporated herein by reference to
Exhibit 10.12 to UPC's Registration Statement on Form
S-4 (No. 33-64707).

45