UNION PACIFIC RAILROAD CO/DE - 10-Q Quarterly Report

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FORM 10-Q

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

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the quarterly period ended June 30, 2002

- OR -

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the transition period from ___________________ to ________________

Commission file number 1-6075

UNION PACIFIC RAILROAD COMPANY
(Exact name of registrant as specified in its charter)

UTAH 94-6001323
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

1416 DODGE STREET, OMAHA, NEBRASKA
(Address of principal executive offices)

68179
(Zip Code)

(402) 271-5000
(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

YES X NO
--- ---

As of July 31, 2002, the Registrant had outstanding 7,130 shares of Common
Stock, $10 par value, and 620 shares of Class A Stock, $10 par value.

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

UNION PACIFIC RAILROAD COMPANY
INDEX

2

PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

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

3

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

4

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

5

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

6

[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.

7

UNION PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY
AND AFFILIATE COMPANIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. RESPONSIBILITIES FOR FINANCIAL STATEMENTS - 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 or
Railroad), operates various railroad and railroad-related businesses. The
Consolidated Financial Statements of the Company are unaudited and reflect all
adjustments (consisting only of normal and recurring adjustments) that are, in
the opinion of management, necessary for a fair presentation of the financial
position and operating results for the interim periods presented. The Statement
of Consolidated Financial Position at December 31, 2001 is derived from audited
financial statements. The Consolidated Financial Statements should be read in
conjunction with the Consolidated Financial Statements and notes thereto
contained in the Company's Annual Report on Form 10-K for the year ended
December 31, 2001. The results of operations for the three and six months ended
June 30, 2002 are not necessarily indicative of the results for the year ending
December 31, 2002. Certain prior year amounts have been reclassified to conform
to the 2002 financial statement presentation.

2. FINANCIAL INSTRUMENTS

STRATEGY AND RISK - The Company and its subsidiaries use derivative financial
instruments 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 the downside risk of adverse price movements and
hedge the 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.

The Company may also use swaptions to secure near-term 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.

MARKET AND CREDIT RISK - The Company addresses market risk related to derivative
financial instruments by selecting instruments with value fluctuations that
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. At June 30, 2002,
the Company has not been required to provide collateral, nor has the Company
received collateral relating to its hedging activity.

DETERMINATION OF FAIR VALUE - The fair values of the Company's derivative
financial instrument positions at June 30, 2002 and December 31, 2001, detailed
below, 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 - 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 uses swaps, futures and/or
forward contracts to mitigate the impact of adverse fuel price changes. In
addition, the Company at times may use swaptions to secure near-term swap
prices.

8

The following is a summary of the Company's derivative financial instruments
at June 30, 2002 and December 31, 2001:

[a] Fuel hedges expired December 31, 2001. Fuel hedges included the swap portion
of a swaption with a base term expiring December 31, 2001, and they excluded
the option portion of the swaption to extend the swap through December 31,
2002.

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

[c] Fuel hedges expire December 31, 2002. Fuel hedges include the swap portions
of the swaptions with base terms expiring December 31, 2002, and they
exclude the option portions of the swaptions to extend the swaps through
December 31, 2003.

[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 June 30, 2002 and December 31, 2001 were as
follows:

Fuel hedging positions will be reclassified from accumulated other
comprehensive income to fuel expense over the life of the hedge as fuel is
consumed. Rail fuel swaption positions will be 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 three months and six months ended June 30, 2002
and 2001:

Through June 30, 2002, the Company had recorded less than $1 million for
fuel hedging ineffectiveness.

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 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 June 30,
2002 and December 31, 2001, accounts receivable are presented net of
approximately $600 million receivables sold. In May 2002, the sale of
receivables program

9

was renewed for one year without any significant term changes.

3. CAPITAL STOCK - The number of shares shown in the Common Stock section of the
Consolidated Statement of Changes in Common Shareholders' Equity excludes 2,665
shares of Common Stock and 232 shares of Class A Stock owned by Southern
Pacific, an affiliate of the Registrant, whose results are included in the
Company's Consolidated Financial Statements.

4. DEBT - During June 2002, the Company entered into a capital lease covering
new locomotives. The related capital lease obligation totaled approximately $126
million and is included in the Consolidated Statements of Financial Position as
debt.

5. OTHER INCOME - Other income included the following for the three months and
six months ended June 30, 2002 and 2001:

6. COMMITMENTS AND CONTINGENCIES

CLAIMS AND LITIGATION - There are various claims and lawsuits pending against
the Company and certain of its subsidiaries, in addition to unasserted claims.
It is not possible at this time for the Company to determine fully the effect of
all such 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 or
claims, including unasserted claims, will have a material adverse effect on its
consolidated financial condition, results of operations or liquidity.

Western Resources (Western) filed a complaint on January 24, 2000 in the
U.S. District Court for the District of Kansas alleging that the Company and The
Burlington Northern Santa Fe Railway Company (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. During
the period covered by this report, the judge affirmed the magistrate's earlier
decision to reject Western's motion for leave to amend the complaint to include
claims for negligent and innocent misrepresentation and rescission on grounds
that the motion was not timely. Two motions filed by the railroads to remove the
restitution and termination claims were denied on June 19, 2002 and June 26,
2002. The trial date for this action has been rescheduled from August 6, 2002 to
August 19, 2002 to allow for the disposition of several procedural motions. The
railroads believe they have substantial defenses in the case and continue to
defend it aggressively.

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 52 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.

10

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 external 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 June 30, 2002, the Company has a liability of $169 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 June 30, 2002, 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,
financial condition or liquidity of the Company.

OTHER MATTERS - The Company periodically enters into financial and other
commitments in connection with its businesses. 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.

7. ACCOUNTING PRONOUNCEMENTS - In August 2001, the Financial Accounting
Standards Board (FASB) issued FAS 143, "Accounting for Asset Retirement
Obligations" (FAS 143). FAS 143 requires the Company to record the fair value of
a liability for an asset retirement obligation in the period in which it is
incurred and is effective for the Company's fiscal year beginning January 1,
2003. Management is in the process of evaluating the impact this standard will
have on the Company's Consolidated Financial Statements.

In April 2002, the FASB issued Statement No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" (FAS 145). FAS 145 concludes that debt extinguishments used as part
of a company's risk management strategy should not be classified as an
extraordinary item. FAS 145 also requires sale-leaseback accounting for certain
lease modifications that have economic effects that are similar to
sale-leaseback transactions. Management believes that FAS 145 will not have a
significant impact on the Company's Consolidated Financial Statements.

In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (FAS 146). FAS 146 requires that a
liability for a cost associated with an exit or disposal activity is recognized
at fair value when the liability is incurred and is effective for exit or
disposal activities that are initiated after December 31, 2002. Management is
evaluating the impact this standard may have on the Corporation's Consolidated
Financial Statements.

11

ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

UNION PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY
AND AFFILIATE COMPANIES
RESULTS OF OPERATIONS

THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO
THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2001

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 or Railroad), operates various railroad and
railroad-related businesses.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management's Narrative Analysis of the Results of Operations addresses Union
Pacific Railroad Company's Consolidated Financial Statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and assumptions. Management bases its estimates on historical
experience and on various other factors that are believed to be reasonable under
the circumstances. Actual results may vary under different assumptions or
conditions.

Management believes the following accounting policies are among the most
critical in the preparation of the Consolidated Financial Statements, in that
they depend upon the application of judgements and the extensive use of
estimates.

Revenue recognition - 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.

Environmental costs - 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 for the assessments
as incurred. The Company accrues the cost of remediation where its obligation is
probable and such costs can be reasonably estimated.

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.

NET INCOME - Rail operations reported net income in the second quarter of 2002
of $316 million, compared to net income of $262 million in 2001, an increase of
$54 million (21%). Year-to-date, net income increased $88 million (19%) to $559
million, compared to 2001 net income of $471 million. The increase in earnings
in both periods resulted primarily from lower fuel prices and higher operating
revenue combined with productivity gains and cost control efforts. These
improvements were partially offset by inflation, lower real estate sales and
higher volume-related costs.

OPERATING REVENUES - Operating revenue is comprised of Commodity Revenue and
other revenues. Other revenues primarily include subsidiary revenue from various
companies that are wholly owned or majority owned by the Railroad, revenue from
the Chicago commuter rail operations and accessorial revenue earned due to
customer detainment of railroad owned or controlled equipment. Second quarter
rail operating revenues increased $108 million (4%) to $2.8 billion compared to
2001. Year-to-date, rail revenues increased $102 million (2%) compared to 2001.
Second quarter revenue carloads increased 5% and year-to-date carloads increased
3% compared to a year ago, with the greatest growth in both periods in the
intermodal and automotive commodity groups. Other revenues increased 4% in the
second quarter due to higher subsidiary and switching revenue. Year-to-date,
other revenue was flat compared to 2001.

12

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 3% in the second quarter and 1% for the
year-to-date period of 2002 over the comparable periods in 2001, despite flat
carloads in both periods. Meals and oils led the increase, due to increased
demand for soybean meal shipments into Mexico and soybean oil exports. Demand
for cottonseed shipments used for feed also increased. Weak domestic demand for
wheat partially offset these increases. Average revenue per car increased due to
the positive mix impact of more carloads with a longer average length of haul.

Automotive - Revenue increased 8% for the second quarter and 5% for the
year-to-date period of 2002 over the comparable periods in 2001, due to
increases in carloads. The carload increase was due primarily to market share
gains for finished vehicle shipments. Average revenue per car declined due to a
combination of competitive pressures and increased shipments of shorter average
length.

Chemicals - Revenue increased 4% for the second quarter and 1% for the
year-to-date period of 2002 over the comparable periods in 2001, due to
increases in carloads. While general economic conditions and decreased
industrial production resulted in a revenue decline in the first quarter,
increased levels of industrial production boosted second quarter carloads 5%
higher than 2001. Plastics carloads increased due to greater activity in the
automotive industry and strong housing starts, while increased demand among
commodity liquid producers drove shipments of liquid and dry chemicals higher.
Average revenue per car declined due to a 26% increase in phosphate rock
carloads that have low average revenue per car and rate pressures.

13

Energy - Revenue decreased 1% for the second quarter and 2% for the year-to-date
period of 2002 over the comparable periods in 2001, as a 1% increase in carloads
in both periods was more than offset by a decline in average revenue per car.
The second quarter carload increase was driven mainly by the absence of an
annual track maintenance program that reduced energy carloads in June of 2001
and in prior years. The track maintenance program is now performed without an
annual shutdown. The second quarter and year-to-date carload increases were also
driven by more efficient train performance and favorable operating weather
conditions. Partially offsetting the increase was softer demand caused by mild
winter weather. Average revenue per car declined primarily due to the impact of
contract price negotiations on expiring long-term contracts with certain major
customers.

Industrial Products - Revenue increased 2% for the second quarter and 1% for the
year-to-date periods of 2002 over the comparable periods in 2001, as declining
carloads in both periods were more than offset by higher average revenue per
car. The volume decline was mainly the result of the soft economy, which had a
negative effect on many economically-sensitive commodities including steel and
paper products. Steel producers were adversely impacted by high levels of
low-cost imported steel, which forced plant shutdowns and bankruptcies in prior
periods. Metallic minerals shipments were also negatively impacted by the weak
steel market. Offsetting these declines were volume increases in
construction-related commodities, led by stone and cement, as strong building
and road construction activity continued in the Southern and Southwestern
regions of the country. Lumber volumes increased due to strong housing
construction and other general demand for lumber products. Average revenue per
car increased due to price increases and a greater mix of longer average length
of haul business, mainly lumber.

Intermodal - Revenue increased 11% for the second quarter and 6% for the
year-to-date periods of 2002 over the comparable periods in 2001. Consecutive
first and second quarter records were set for revenue, which was driven by
increased international shipments due to high import demand and increased market
share. Partially offsetting this increase were declines in domestic shipments,
due to soft economic demand and the voluntary action of reducing low-margin
domestic truckload trailer business in favor of higher-margin containers.
Average revenue per car declined 1% in the second quarter and was flat for the
six month period compared to 2001, due to a higher mix of international
shipments, which have a lower average revenue per car compared to domestic
shipments. The effect of this mix more than offset price increases.

OPERATING EXPENSES - Second quarter operating expenses were flat at $2.2 billion
in 2002 and 2001. Year-to-date operating expenses decreased $64 million (1%).
Expenses in both periods were reduced by significantly lower fuel prices and
savings from lower employee force levels and productivity improvements. These
decreases more than offset inflation, second-quarter volume costs, and increased
casualty, lease and depreciation expense.

Salaries, Wages and Employee Benefits - Salaries, wages and employee benefits
increased $19 million (2%) in the second quarter of 2002, compared to 2001.
Year-to-date, wage and benefit expenses rose $16 million (1%). Increases were
driven by inflation and volume related costs as the result of 3% growth in gross
ton miles in the first quarter and a 5% increase in the second quarter. A 3%
reduction in employee force levels in both periods and improvements in worker
productivity partially offset wage and employee benefits inflation and volume
costs.

Equipment and Other Rents - Equipment and other rents primarily includes rental
expense the Company pays for freight cars owned by other railroads or private
companies; freight car, intermodal, and locomotive leases; other specialty
equipped vehicle leases; and office and other rentals. Expenses increased $2
million (1%) in the second quarter and $8 million (1%) year-to-date, compared to
2001. The increases were due primarily to higher expenses for locomotive leases
and office and miscellaneous rentals in both periods and higher volume-related
costs in the second quarter. Partially offsetting the increases was a decrease
in car cycle times (the average number of accumulated days that loaded and empty
cars from other railroads spend on the Railroad's system during a month) and
lower rental prices for freight cars. 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 decrease in car cycle times is partially attributable to
improved train speed and better car utilization. The increase in volume costs
was attributable to an increase in carloads in certain commodity types such as
intermodal, automotive, and chemicals that utilize a high percentage of rented
freight cars.

Depreciation - The majority of depreciation relates to road property.
Depreciation expense increased $4 million (1%) in the second quarter and $7
million (1%) year-to-date, over 2001, resulting from capital spending in recent
years. Capital spending totaled $946 million in the first six months of 2002
compared to

14

$780 million in the first six months of 2001. Capital spending for the year
totaled $1.7 billion in both 2001 and 2000 and $1.8 billion in 1999.

Fuel and Utilities - Fuel and utilities is comprised of locomotive fuel,
utilities other than telephone, and gasoline and other fuels. Expenses decreased
$52 million (16%) in the second quarter and $161 million (25%) in the
year-to-date period of 2002 compared to a year ago. The decrease was driven by
significantly lower fuel prices and a lower fuel consumption rate, as measured
by gallons consumed per thousand gross ton miles. Fuel prices averaged 72 cents
per gallon in the second quarter of 2002 compared to 92 cents per gallon in the
second quarter of 2001, including taxes and transportation costs. Year-to-date,
fuel prices averaged 67 cents per gallon compared to 92 cents per gallon in the
year-to-date period a year ago. Lower fuel prices in 2002 resulted in a $65
million reduction in fuel expense in the second quarter and a $165 million
reduction in the first six months, compared to 2001. The lower consumption rate
decreased fuel expense by $1 million in the second quarter and $12 million
year-to-date. A 5% increase in gross ton miles increased fuel expense by $16
million in the second quarter and a 4% increase in gross ton miles year-to-date
increased fuel expense by $25 million compared to a year ago. The Railroad
hedged or had fuel swaptions in place which equaled approximately 42% of its
fuel consumption for the second quarter and 43% of its fuel consumption year to
date, which decreased fuel costs by $9 million in the second quarter and $13
million in the first six months of 2002. As of June 30, 2002, expected fuel
consumption for the remainder of 2002 is 40% hedged at 68 cents per gallon
(including estimated taxes and transportation costs and regional pricing
spreads) and is 5% hedged at 70 cents per gallon (including estimated taxes,
transportation costs and regional pricing spreads) for 2003. Utilities,
gasoline, and propane expenses decreased $3 million in the second quarter and
decreased $9 million year-to-date primarily due to lower rates and fuel prices.

Materials and Supplies - Materials used for the maintenance of the Railroad's
lines, structures, and equipment is the principal component of materials and
supplies expense. Office, small tools, and other supplies and the costs of
freight services purchased to ship company materials are also included. Expenses
decreased $8 million (6%) in the second quarter and decreased $13 million (5%)
year-to-date, primarily reflecting locomotive overhaul reductions. Locomotive
overhauls decreased due to acquisition of new, more-reliable locomotives during
the past year and the sale of older units, which required higher maintenance and
outsourcing some locomotive maintenance which is included in purchased services
and other.

Casualty Costs - The largest component of casualty costs is expenses associated
with personal injury. Freight and property damage; and bad debt, insurance, and
environmental matters are also included in casualty costs. Costs increased $21
million (28%) in the second quarter compared to 2001 and increased $20 million
(12%) year-to-date. The increase in expenses in both periods is due to higher
personal injury costs, higher expenses for environmental matters and an increase
in bad debt expense. The quarterly year-over-year increase in casualty costs is
expected to continue for the remainder of 2002 and first quarter of 2003 due to
higher personal injury and insurance expenses.

Purchased Services and Other Costs - Purchased services and other costs includes
the costs of services purchased from outside contractors, state and local taxes,
net costs of operating facilities jointly used by UPRR and other railroads,
transportation and lodging for train crew employees, trucking and contracting
costs for intermodal containers, leased automobile maintenance expenses,
telephone and cellular expense, employee travel expense, and computer and other
general expenses partially offset by credits for overhead expenses charged to
capital projects. Expenses increased $15 million (7%) in the second quarter and
increased $59 million (14%) year-to-date, compared to last year. The increase in
both periods is primarily due to increased spending for contract services,
higher expenses for jointly operated facilities, higher volume-related
intermodal transportation costs in the second quarter, and higher general
expenses.

OPERATING INCOME - Operating income increased $107 million (22%) in the second
quarter to $598 million. Operating income for the first six months of 2002 grew
$166 million (18%) to $1.1 billion. The operating ratio for the second quarter
was 78.7%, compared to 81.8% in 2001. The year-to-date operating ratio was 79.7%
compared to 82.4% a year ago.

NON-OPERATING ITEMS - Interest expense decreased $9 million (6%) in the second
quarter and $17 million (6%) year-to-date, primarily as a result of lower
average debt levels and lower weighted-average interest rates in 2002. Income
taxes increased $25 million (16%) in the second quarter and $48 million (17%)
year to date, compared to 2001, which was primarily the result of higher pre-tax
income in both periods in 2002.

15

During the last six months of 2002 the Railroad expects to sell
approximately 175 miles of a rail corridor to the Utah Transit Authority. When
this transaction is complete, the Railroad anticipates that it will result in a
pre-tax gain of approximately $140 million and will be recorded in other income.

FINANCING ACTIVITIES - During June 2002, the Company entered into a capital
lease covering new locomotives. The related capital lease obligation totaled
approximately $126 million and is included in the Consolidated Statements of
Financial Position as debt.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS - There have been no material
changes in Contractual Obligations and Commercial Commitments from the
information provided in Item 7. Management's Narrative Analysis of the Results
of Operations of the Company's Annual Report on Form 10-K for the year ended
December 31, 2001.

OTHER MATTERS

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 certain claims, lawsuits, contingent liabilities
and guarantees is set forth in note 6 to the Consolidated Financial Statements,
which is incorporated herein by reference.

ACCOUNTING PRONOUNCEMENTS - In August 2001, the Financial Accounting Standards
Board (FASB) issued FAS 143, "Accounting for Asset Retirement Obligations" (FAS
143). FAS 143 requires the Company to record the fair value of a liability for
an asset retirement obligation in the period in which it is incurred and is
effective for the Company's fiscal year beginning January 1, 2003. Management is
in the process of evaluating the impact this standard will have on the Company's
Consolidated Financial Statements.

In April 2002, the FASB issued Statement No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" (FAS 145). FAS 145 concludes that debt extinguishments used as part
of a company's risk management strategy should not be classified as an
extraordinary item. FAS 145 also requires sale-leaseback accounting for certain
lease modifications that have economic effects that are similar to
sale-leaseback transactions. Management believes that FAS 145 will not have a
significant impact on the Company's Consolidated Financial Statements.

In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (FAS 146). FAS 146 requires that a
liability for a cost associated with an exit or disposal activity is recognized
at fair value when the liability is incurred and is effective for exit or
disposal activities that are initiated after December 31, 2002. Management is
evaluating the impact this standard may have on the Corporation's Consolidated
Financial Statements.

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) are, or will be, forward-looking statements as defined by 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 our 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-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.

16

Important factors that could affect the Company's and its subsidiaries'
future results and could cause those results or other outcomes to differ
materially from those expressed or implied in the forward-looking statements
include, but are not limited to:

o whether the Company and its subsidiaries are fully successful
in implementing their financial and operational initiatives;

o industry competition, conditions, performance and
consolidation;

o legislative and regulatory developments, including possible
enactment of initiatives to re-regulate the rail business;

o natural events such as severe weather, floods and earthquakes;

o the effects of adverse general economic conditions, both
within the United States and globally;

o changes in fuel prices;

o changes in labor costs;

o domestic and global economic repercussions from terrorist
activities and any governmental response thereto;

o labor stoppages; and

o 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in market risk from the information provided
in Item 7A. Quantitative and Qualitative Disclosures About Market Risk of the
Company's Annual Report on Form 10-K for the year ended December 31, 2001.
Disclosure concerning market risk-sensitive instruments is set forth in note 2
to the Consolidated Financial Statements included in Item 1 of Part I of this
Report and is incorporated herein by reference.

17

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

ENVIRONMENTAL MATTERS

As previously reported by the Company in its Annual Report on Form 10-K for 2001
and Form 10-Q for the quarter ended March 31, 2002, 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 the origin shipper with an inhibitor. 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 stability of 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
subject to special monitoring. The Railroad has agreed in principle with the
State of Illinois to settle the matter and will pay a penalty of $50,000.

As previously reported by the Company in its report on Form 10-Q for the
quarter ended March 31, 2002, The District Attorneys of Merced, Madera,
Stanislaus, San Joaquin and Sacramento counties in the state of California have
threatened to file criminal charges against the Railroad in connection with
various releases of calcium oxide (lime), cement and fly ash between December
27, 2001 and March 16, 2002. They contend that criminal violations occurred by
virtue of the alleged failure by the Railroad to timely report one or more of
the releases, its alleged disposal of hazardous waste and the alleged release of
material into the waters of the State of California. The Company disputes both
the factual and legal bases for these claims and intends to vigorously defend
any action that might be filed.

OTHER MATTERS

As previously reported by the Company in its Annual Report on Form 10-K for 2001
and Form 10-Q for the quarter ended March 31, 2002, Western Resources (Western)
filed a complaint on January 24, 2000 in the U.S. District Court for the
District of Kansas alleging that the Company and The Burlington Northern Santa
Fe Railway Company (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. During the period
covered by this report, Western's motion for leave to amend the complaint was
denied by the magistrate on grounds that the motion was not timely and the
magistrate's denial of leave to amend has been affirmed by the judge. Two
motions filed by the railroads to remove the restitution and termination claims
were denied on June 19, 2002 and June 26, 2002. The trial date for this action
has been rescheduled from August 6, 2002 to August 19, 2002 to allow for the
disposition of several procedural motions. The railroads believe they have
substantial defenses in the case and continue to defend it aggressively.

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS

Exhibits are listed in the exhibit index on page 21.

(b) REPORTS ON FORM 8-K

On April 25, 2002, the Registrant filed a Current Report on Form 8-K
announcing UPC's financial results for the first quarter of 2002.

On July 18, 2002, the Registrant filed a Current Report on Form 8-K
announcing UPC's financial results for the second quarter of 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

Dated: August 8, 2002

UNION PACIFIC RAILROAD COMPANY
(Registrant)

By /s/ James R. Young
---------------------------------------
James R. Young,
Chief Financial Officer
(Principal Financial Officer)

By /s/ Richard J. Putz
---------------------------------------
Richard J. Putz
Chief Accounting Officer and Controller
(Chief Accounting Officer and Duly
Authorized Officer)

20

UNION PACIFIC RAILROAD COMPANY
EXHIBIT INDEX