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FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Commission file number 1-6146

UNION PACIFIC RAILROAD COMPANY

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 o

     Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

YES o NO x

     As of October 31, 2003, 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.

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UNION PACIFIC RAILROAD COMPANY

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PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Consolidated Statements of Income (Unaudited)
Union Pacific Railroad Company and Consolidated Subsidiary and Affiliate Companies

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

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Consolidated Statements of Income (Unaudited)
Union Pacific Railroad Company and Consolidated Subsidiary and Affiliate Companies

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

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Consolidated Statements of Financial Position (Unaudited)
Union Pacific Railroad Company and Consolidated Subsidiary and Affiliate Companies

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

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Consolidated Statements of Cash Flows (Unaudited)
Union Pacific Railroad Company and Consolidated Subsidiary and Affiliate Companies

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

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Consolidated Statement of Changes in Common Shareholders’ Equity (Unaudited)
Union Pacific Railroad Company and Consolidated Subsidiary and Affiliate Companies

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

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

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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, UPRR, the Company or the 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 Consolidated Statement of Financial Position at December 31, 2002 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, 2002. The results of operations for the three months and nine months ended September 30, 2003 are not necessarily indicative of the results for the entire year ending December 31, 2003. Certain prior year amounts have been reclassified to conform to the 2003 financial statement presentation.

2. Stock-Based Compensation – The Company participates in the Corporation’s stock incentive plans. At September 30, 2003, the Corporation had several stock-based employee compensation plans. The Railroad accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees", and related Interpretations. No stock option expense is reflected in net income as all options granted under those plans had an exercise price equal to the market value of the Union Pacific Corporation common stock on the date of grant. Stock-based employee compensation expense related to restricted stock and other incentive plans is reflected in net income. The following table illustrates the effect on net income if the Company had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation", to stock-based employee compensation.

     The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model. The following were the weighted-average assumptions for options granted during both the three months and nine months ended September 30, 2003: risk-free interest rate of 2.9%; dividend yield of 1.5%; expected lives of 5 years; and volatility of 28.4%. Assumptions for both the three months and nine months ended September 30, 2002 were: risk-free interest rate of 4.4%; dividend yield of 1.3%; expected lives of 5 years; and volatility of 28.8%.

3. Intercompany Relationship with UPC — At September 30, 2003 and December 31, 2002, the Railroad had $961 million and $904 million working capital deficit balances, respectively, relating to UPC’s management of its cash position. As part of UPC’s cash management activities, the Railroad advances excess cash (cash available after satisfying all of the Railroad’s obligations and paying dividends to UPC) to UPC. Dividends declared and paid to UPC by the Railroad typically approximate the dividends that UPC declares to its shareholders; however, there is no formal requirement to do so. The dividend declaration between the Railroad and UPC is determined solely by the Railroad’s Board of Directors. To the extent the Railroad requires additional cash for use in its operations, UPC makes such funds available for borrowing by the Railroad. Transactions between UPC and UPRR are treated as net intercompany borrowings in the Consolidated Statements of Financial Position.

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     The majority of the Railroad’s intercompany borrowings from UPC relate to the acquisitions of the Chicago and North Western Transportation Company and Southern Pacific Rail Corporation which were funded by UPC on behalf of the Railroad. These acquisition costs were assumed by the Railroad in the form of intercompany borrowings from UPC. The intercompany borrowings accrue interest at an annual rate of 7.5%, which may be adjusted from time to time, and are payable on demand. There are no restrictions on the amount the Railroad is able to borrow from UPC. Intercompany borrowings are unsecured and rank equally with all of the Railroad’s other unsecured indebtedness.

     UPC provides the Company with various services, including strategic planning, legal, treasury, accounting, auditing, insurance, human resources and corporate affairs. In 2003, pursuant to a services agreement, UPC will continue to provide services to the Company, and the Company will pay UPC its share of the costs as determined by an independent review. Billings for these services were $13 million and $40 million for the three months and nine months ended September 30, 2003.

4. 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, collars, 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 benefits from favorable movements. The purpose of these programs is to protect the Company’s operating margins and overall profitability from adverse fuel price changes.

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 September 30, 2003, 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 September 30, 2003 and December 31, 2002, 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 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, collars, futures and/or forward contracts to mitigate the impact of adverse fuel price changes.

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     The following is a summary of the Company’s derivative financial instruments at September 30, 2003 and December 31, 2002:

		[a] Fuel hedges expired December 31, 2002. Fuel hedges included the swap portion of a swaption with a base term expiring December 31, 2002.
		[b] Excluding taxes, transportation costs and regional pricing spreads.
		[c] Fuel hedges which are in effect during 2003. These hedges expire December 31, 2003.

     The fair value asset positions of the Company’s outstanding derivative financial instruments at September 30, 2003 and December 31, 2002 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.

     The Company’s use of derivative financial instruments had the following impact on pre-tax income for the three months and nine months ended September 30, 2003 and 2002:

     Through September 30, 2003, the Company had recorded less than $1 million for fuel hedging ineffectiveness.

Sale of Receivables - The Railroad has sold, on a 364-day 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. Payments

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collected from sold receivables can be reinvested in new receivables on behalf of the buyers. Should the Corporation’s credit rating fall below investment grade, the amount of receivables sold would be reduced, and in certain cases, the buyers have the right to discontinue this reinvestment, thus requiring the Railroad to fund the receivables. At September 30, 2003 and December 31, 2002, accounts receivable are presented net of $590 million and $600 million of receivables sold, respectively. On August 7, 2003, the sale of receivables program was renewed for one year without any significant term changes.

5. 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.

6. Other Income - Other income included the following for the three months and nine months ended September 30, 2003 and 2002:

7. Commitments and Contingencies

Unasserted Claims - 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 reasonably 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.

Personal Injury and Occupational Illness - The cost of injuries to employees and others related to Railroad activities is charged to expense based on actuarial estimates of the ultimate cost and number of incidents each year. The three month and nine month expenses for the Company’s personal injury-related events were $66 million and $187 million in 2003 and $58 million and $174 million in 2002, respectively. As of September 30, 2003, the Company had a liability of $630 million accrued for personal injury costs, of which $272 million was recorded as a current liability. The Railroad has additional amounts accrued for claims related to certain occupational illnesses. Compensation for Railroad 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 - The Company generates and transports hazardous and nonhazardous waste in its current operations and has done so in its former operations, and it is subject to federal, state and local environmental laws and regulations. The Company has identified approximately 417 sites at which it is or may be liable for remediation costs associated with alleged contamination or for violations of environmental requirements. This includes 57 sites that are the subject of actions taken by the U.S. government, 32 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 an environmental issue has 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.

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     As of September 30, 2003, the Company had a liability of $195 million accrued for future environmental costs, of which $59 million was recorded in current liabilities as accrued casualty 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 September 30, 2003 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 reasonably 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.

     At September 30, 2003, the Company had unconditional purchase obligations of $180 million for the acquisition of locomotives as part of the Company’s multi-year capital asset acquisition plan. In addition, the Company was contingently liable for $343 million in guarantees and $28 million in letters of credit at September 30, 2003. 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.

     As described in note 10 to the Consolidated Financial Statements, Item 8, in the Annual Report on Form 10-K, the Railroad has a synthetic operating lease arrangement to finance a new headquarters building. The Railroad has guaranteed a residual value equal to 85% of the total construction related costs upon completion of the building. During construction, the Railroad guarantees 89.9% of the construction costs incurred. At September 30, 2003, the Railroad’s guarantee related to the building was $92 million. The guarantee will be approximately $220 million upon completion of the building. At September 30, 2003, the Railroad had a liability recorded of approximately $7 million related to the fair value of this guarantee.

     During May 2003, UPRR entered into a capital lease covering new locomotives. The related capital lease obligation totaled approximately $188 million and is included in the Consolidated Statements of Financial Position as debt.

8. Accounting Pronouncements - In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46). FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. FIN 46 also requires disclosures about variable interest entities that a company is not required to consolidate but in which it has a significant variable interest. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. As described in note 10 to the Consolidated Financial Statements, Item 8, in the Annual Report on Form 10-K, the Railroad has a synthetic operating lease arrangement to finance a new headquarters building, which falls within the guidance of FIN 46. In June 2003, the Railroad restructured the synthetic lease resulting in no effect to the Consolidated Financial Statements due to the adoption of FIN 46.

     In October 2003, the FASB issued FASB Staff Position Number FIN 46-6 (FSP 46-6) which provides public entities an opportunity to delay implementation of FIN 46, for agreements entered into prior to February 1, 2003, until periods ending after December 15, 2003. FSP 46-6 does not impact the Company, as the Company has already adopted FIN 46.

9. Cumulative Effect of Accounting Change — Surface Transportation Board (STB) accounting rules require that railroads accrue the cost of removing track structure over the expected useful life of these assets. Railroads historically used this prescribed accounting for reports filed with both the STB and SEC. In August 2001, the FASB issued Statement No. 143, “Accounting for Asset Retirement Obligations” (FAS 143). This statement was effective

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for the Company beginning January 1, 2003, and prohibits the accrual of removal costs unless there is a legal obligation to remove the track structure at the end of its life. The Company concluded that it did not have a legal obligation to remove the track structure, and therefore, under generally accepted accounting principles, the Company could not accrue the cost of removal in advance. Reports filed with the SEC will reflect the expense of removing these assets in the period in which they are removed. For STB reporting requirements only, the Company will continue to follow the historical method of accruing in advance, as prescribed by the STB. FAS 143 also requires the Company to record a liability for legally obligated asset retirement costs associated with tangible long-lived assets. In the first quarter of 2003, the Company recorded income from a cumulative effect of accounting change, related to the adoption of FAS 143, of $274 million, net of tax of $167 million. The accounting change had no effect on the Company’s liquidity. Had the change been retroactively applied, the change would have had an immaterial impact on net income.

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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 Nine Months Ended September 30, 2003 Compared to
Three Months and Nine Months Ended September 30, 2002

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

     A copy of this Quarterly Report on Form 10-Q, as well as certain other filings made by the Company, including the Company’s 2002 Annual Report on Form 10-K, current reports on Form 8-K and any amendments to such reports are available free of charge on the Internet at Union Pacific Corporation’s website at www.up.com/investors. Additionally, the Corporation’s corporate governance materials, including Board Committee charters, governance guidelines and policies and codes of conduct and ethics for directors, officers and employees may also be found on the Internet at the Corporation’s website at www.up.com/investors.

Critical Accounting Policies and Estimates

The Company’s discussion and analysis of its financial condition and results of operations are based upon its Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires estimation and judgment that affect the reported amounts of revenues, expenses, assets and liabilities. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. If these estimates differ materially from actual results, the impact on the Consolidated Financial Statements may be material. The Company’s critical accounting policies are available in the Company’s 2002 Annual Report on Form 10-K, Item 7.

Net Income – The Company reported net income of $317 million in the third quarter of 2003 compared to net income of $414 million in 2002, a decrease of $97 million (23%). Year-to-date net income was $1.1 billion. Year-to-date income before the cumulative effect of accounting change decreased $194 million (20%) to $779 million, compared to 2002 net income of $973 million. The decrease in both periods resulted primarily from higher fuel prices, inflation, volume-related expenses and lower gains from real estate sales. The third quarter decrease in net income was partially offset by 4% operating revenue growth, lower depreciation expense, lower interest expense and cost control efforts. The decrease year-to-date was partially offset by 3% operating revenue growth, lower depreciation expense, lower interest expense and cost control efforts.

Operating Revenues – Operating revenue is comprised of rail 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. Operating revenues increased $108 million (4%) to $2.9 billion in the third quarter and $257 million (3%) to $8.6 billion in the nine-month period compared to 2002. Commodity revenue increased $101 million (4%) in the third quarter to $2.8 billion, led by growth in the Agricultural Products, Energy and Industrial Products commodity groups. Third quarter revenue carloads were essentially flat compared to a year ago. Average revenue per car for the period increased 3% to $1,195 driven by positive mix, fuel surcharges, pricing gains and index-based contract escalators. Year-to-date rail commodity revenue grew 3% to $8.2 billion compared to 2002. Revenue carloads were flat and average revenue per car showed a 3% increase to $1,192 when compared to a year ago. Other revenues increased $7 million (6%) to $119 million in the third quarter compared to a year ago and increased $31 million (10%) year-to-date when compared to 2002 as a result of higher subsidiary revenue and accessorial revenue.

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