Union Pacific

Trains Magazine General Discussion
1

I really enjoy reading anything that Fred Frailey writes. He is a very talented writer. Any article that he pens is in depth and very informative. I must take exception with the article Rising Phoenix on a winged shield in this month’s Trains. Not so much for the content, but for one line. BTW, I have not finished reading the article, but should tonight.

Frailey states “In the end, you are left to wonder how a company run by so many smart, savvy, experienced people could screw up so thoroughly.”

Mr. Frailey…this is the THIRD TIME in less than 10 years that the “smart, savvy, experience people” dropped the ball.

How could he have included that line in that article about that company?

Other than that, this excellent article is his usual good stuff.

I am appalled by the accounting hocus pocus, razzle dazzle which went on during fiscal 2002 which enabled the company to “forgive and knock off the books a collective $31 million of the $47 million loaned” the excecutives for purchasing stock in the company. Further, the $5.05 mark was only reached by a 75 cent per share “extraordinary adjustments” that was made.

This story points out that there appears to be something very rotten in Omaha, and other points in the winged empire.

For management to completely disregard the future for current results is something we have learned to live with. But, when that total disregard is laced with 31 million personal reasons to do so, it borders on if not criminal, then at least a lack of fidicuary responsibilty to the shareholders.

Will someone please explain to me how *** Davidson has survived? Is the board of directors so weak to allow him to remain? Is the corporate culture so inbred that there is no one to stand up and disagree? Is his power in the company so concentrated that he is insulated?

Most telling, do the financial markets have such a low opinion of the railroad industry that they allow

2

Ed

With regard to Frailey’s sentence that you quoted, it seems to me that you WERE left to wonder.

Forgiving the loans made to senior managers to purchase UP stock was not accounting hocus pocus. There was nothing illegal or shady about that action. It had to have Director approval and as the article noted it was reported in the company prospectus. This is just another type of bonus and the kind of thing that is often offered to senior corporate managers as an incentive to meet specified goals.

That is not to say that it was necessarily a wise move on the part of the directors or top management. Clearly the railroad got screwed up pretty badly and service went in the tank. I think there was a forum topic or topics about UP’s problems earlier this year. My own view was that no excuse for the labor shortage could have any merit, and had I been the Board of Directors, I may have been using Donald Trump’s favorite phrase. Of course, I am not the Union Pacific Corporation Board of Directors and I don’t have any direct ownership of UP stock, so I don’t think I have any rights in that area.

So why didn’t the UP Directors make some management changes. Here is my guess. The deal was set up. Bring in EPS at $5.00 or more and as a bonus we will forgive $31,000,000 worth of the loans. PERIOD. I am willing to bet that there were no provisions of the deal that said any service standards had to be met, or that there couldn’t be a meltdown, or that only X number of customer complaints would be acceptable. Davidson went out and did what he committed to do. What then would be the basis for the board to fire him? You did what we asked you to do, but we just don’t like how you did it, so we are going to fire you anyway?

In spite of all the problems the UP had the numbers haven’t come out so bad. Here are the earnings per share from 1999 to 2003. $3.22, 3.34, 3.77, 5.07 (2002, the bonus year) and $5.02 for 2003. The unaudited results for 2004 through

3

Jay:

I admit I shot first and then looked. I have not investigated the finances of UP. I will today.

But, the “extraordinary” stuff in accounting is always very questionable. I have to get my son on the bus and go to work, but will respond later.

Fred’s article was very well written. My basic point of this article and the UP situation is why do they keep falling down? Three times in 10 years seems a bit excessive.

SP I can understand, but in looking back, they did not do a good job. The CNW should have been simple, but it wasnt.

Let me ask this…how has UP’s main competitor held up during this last period? What are operations like on the BNSF?

ed

4

Ed & Jay,

That was exactly what I was thinking. Of course, I have tempered my enthusiasm with my maxim of: For every complex problem, there is a simple cause and solution to the problem that a true outsider will see that is ALWAYS WRONG.

I am an outsider, and I will not definitively say “I am right.” But . . .

(1) How many times can someone drop the ball and get away with it?

(2) I think the reason UP execs have been allowed to get away with it is because of rail consolidation. As noted above, UP’s bottom line hasn’t been that bad. Highways are already overcrowded and there doesn’t seem to be enough capacity competition to make UP management pay for their mistakes.

This scares me. I am not a capitalist or a socialist—but I do believe in being ideologically consistent. One of the very bed rocks of a free market economy is competition regulates the market and is the “invisible hand” that provides for the public good. I have to wonder if we are not seeing the “invisible finger?”

Like I said, I am an outsider, and there are at least five people on this forum alone who would only have to say, no Gabe, you are mistaken for me to shelve my belief. But, to quote a football great, “what the [heck] is going on out there?”

Gabe

5

Ed

First of all, I am not trying to say that you are off base. The questions you raise are certainly valid and to be real, I can’t say that my answers are any more than the opinion of a person with somewhat limited expertise on the subject. I am certainly not going to defend the UP to my last breath. Their screw ups, and I think that is an appropriate term, probably caused some economic damage to the shareholders, and most certainly caused economic damage to many of their shippers.

I think the cause of the problem stems from the somewhat nebulous thing called corporate culture. During my 2 years in the Army, I often heard that there is a right way, a wrong way, and the Army way. Almost any succesful business tends to adopt an attitude that (staying within the law) we can’t do any wrong.

Again, I am not an absolute authority on this, but it seems to me that the UP has had a long history of success. Some of that success resulted in being at the right place at the right time, but the people running the place generally didn’t loose the opportunity to reap the rewards. A history like that tends to build the mind set that we’ve got it right and if it ain’t broke, don’t fix it. As you say, you would think that after a couple of big screw ups, that attitude would change, but the culture gets very entrenched and becomes extremely difficult to change. No doubt there were some among the UP’s management team that had second thoughts about a plan of action, but if a view runs counter to the company’s convential wisdom, a person needs to take some care in pursueing an issue. That can be bad for one’s career.

If you want to make comparisons, I think it is clear that the BNSF did a better job of dealing with the business growth. They certainly didn’t completely ignore their own forecasts for operating employment needs.

By the way, all this only reinforces my own pleasure that I no onger have to find gainful employment with a company of large size. My "r

6

I found Mr. Fraileys article very well written and even handed. I too have wondered how on earth has Davidson&Co. not been canned years ago??? This is the exact same team of senior managers that brought you the C&NW total screw-up, followed by Meltdown1(1997-99) and now Meltdown2 . And to add substantial insult to injury Davidson and his associates had the gall to engineer(pun intended) a phony spike in earnings so that they could be rewarded with HUGE cash bonuses and other rewards on the eve of the latest operating disaster.
The fascinating question is where have the “independant” members of the Board of Directors been?? In a coma??? Where have the institutional investors been???
The most illustrative example of how bad these guys have performed is to compare the UP’s vital stats(dwell times,train speeds etc. etc.) to the BNSF’s. The differences are HUGE and clearly show the tremendous difference competent management can make.
Seems to me that how Davidson&Co. have gotten away with this so far is worthy of an in depth article by Dan Malchalba of the WSJ??
There’s got to be something here not apparent to us outsiders!

7

May I reiterate a couple of my points.

Unless a person is very skilled at corporate finance and accounting, and have thoroughly reviewed all of the public documents, any arguement that the financial statements do not fairly reflect corporate condition is nothing more than a speculative bias. You have to remember that the annual report has been subject to review by the Board"s audit committee and by outside auditors and the annual report has been signed off by the CFO and by the Board by the CEO. People can go to jail for telling a lie about these things.

You can compare “vital” statistics and all you get is a comparison of “vital” statistics. From the viewpoint of the shareholders and their elected representitives on the board, the "vital’ statistics can go in the tank and if the EPS, the dividend and the share price doesn’t follow into the same tank, there is not going to be any dramatic action. Since we are not flies on the wall, we don’t know what board members may have said to Davidson, but one thing is clear. They have decided that his mistakes didn’t rise to the level that demands dismissal. I think it is reasonable to keep in mind that the guy you know may be better suited to resolve problems than the guy you might think you want to have. I have seen first hand the result of a top management change in a large corporation. It wasn’t pretty for the customers, the employers or the shareholders. The last group wound up with zip, zero, nada.

Should Davidson be free from blame for the employee screw up? Of course not, and he has gotten it pretty good. I still think that Frailey gave an accurate account of what happened, why it happened and what is being done to fix the problem. Unless a retired director writes a “tell all” book at some time in the future, don’t expect to get further factual insight as to what went on.

Jay

8

A friend of mine is the president of a large trucking company (1,000 + trucks). He made the comment to me, that thanks to the service problems at UP, he literally has more business than he can handle. And once that trucking company gets the business away from UP, they are going to bend over backwards to keep it.

Regards,
Burlington John

9

Gabe

If I may throw my two cents at your comment. If I get it, you are wondering if Davidson and his top people said we have 31 mill in personal income at stake so screw the rest of the stakeholders in this operation. Obviously, I couldn’t know for sure, but I think not. My view is that everybody there got trapped by the culture of rigid adherance to the budget. As Frailey notes, that was a disipline imposed by Drew Lewis some 20 years earlier.

I think you will agree that large corporations tend not to be very pragmatic. Over time the very large group of individuals may be going in lock step, but to get everybody to turn on a dime is almost imposible. That says something to the idea that society would be better off with a larger number of smaller companies, who could be more nimble in their response to changing conditions. That idea is probably part of the reason that short lines can do fairly well with a lot less. However, as we should realize, our relatively free enterprise system encourages growth from smaller to bigger.

Anyway, I guess we both could be right on this one.

Jay

10

BurlingtonJohn

I certainly find no fault with your friend’s postion. I would do exactly the same thing, with the same pleasure.

Jay

11

The UP will always get the Lion
s share of the business because of the location of the central corridor and its supplementary routes through El Paso. Sure it can loose something here and there to trucking companies and to the BNSF, but in the long run it will always have all the business it can handle. This kind of “franchise” allows a company to get away with making huge mistakes. But it also means smart management can really do wonders if given the opportunity. I think the UP will have smart management and will bring back customers they lost and be a credit to the railroad industry. I give them five years before people comment on the great improvement.

12

Jay,

I am not really saying there was any malicious/criminal intent on the part of top. I am merely dumbfounded that someone could drop the ball 3 times in a big way and still maintain leadership.

Gabe

13

It is corporate culture at UP that brought it down with the SP merger and could be on the brink of doing it again. UPs attitude at the time of the SP merger was we bought yuou and you do not know anything. We know it all and you cannot tell us anything. The know it alls did not listen to the SP operating people in Houston and closed some small yards. The rest is history-bad history.

UP has a corporate history of financial shenagans. Looking back over the years we had the Credit Mobilier (sp?), the eye doctor (Durant), Harriman, a few others that I cannot remember, and now Davidson. True, today’s UP does not represent the actions of those of 100+ years ago, but one can only wonder.

I also have not finished Frailey’s article, but plan to do it tonight… I am not a financial analyst, so I cannot speak with authority on the workings of the “earnings” plateau reached that triggered the forgiving of the loans. It appears that all was perfectly legal, however, to an outsider it has a certain stench. Anytime you use “extradornary items” to reach a stated goal the question is raised as to ethics.

Only time will tell…

14

I have good reason to believe that the WSJ will be persuing this. If they end up doing a story I’m sure it will prove to be very interesting reading. Believe me, I’ve been around this game a long time and there’s something very interesting missing here. By ANY normal corporate standards Davidson&CO. would have been gone after the C&NW foul-up and most definitly as a result of Meltdown1. To still be around(with huge undeserved rewards to boot!!!) as Meltdown2 unfolds-defies common sense and begs disclosure.
Good luck- WSJ!!!

15

I am surprised no one has run with—or against—my suggestion that there is something fundamentally wrong here—not just with UP but with the western rail market in general. I am not saying I am right or that my position is all that, but I am really dumbfounded.

Capitalism needs competition to regulate itself—or an army of regulators if the government allows companies to kill competition. I am fine either method. But are no alarm bells sounding that a company feels so secure in its lack of competition that it can survive with someone who drops the ball more than Oklahoma did against USC last night?

Without the threat of lost business to competition, capitalism does not work—in my opinion. I think this is a bad omen.

Gabe

16

Several points here, not necessarily in any order of importance:

  1. I still have not reviewed UP’s financials and after I do, will probably not know enough to comment. I know just enough to get around a balance sheet, income statement, and cash flow statement to get by, but I am not an accountant.

  2. Still…75 cents of “extraordinary” income and just getting over the $5/share earnings threshold is very suspect.

  3. The agreement should have been based on “operating income”. Who is to know that UP did not sell off family jewels in order to reach that $5 figure? I would really like to know where that 75 cents came from. Part of the “extraordinary adjustments” included “tax credits”.

  4. How in the world would “tax credits” be a logical method for determining compensation (which is what the loan forgiveness really was)? Tax credits often come from tax loss carry forwards, which is the use of losses from companies purchased (SP?).

  5. Regarding their corporate culture…I really have no comment on that since I am not a member of the company, but railroad industry seems extremely rigid in their methods. I am not saying that is bad, but it does not appear the local managers have the ability to make decisions to affect the service levels.

  6. Isnt it amazing that Ike Evans had to approve all supervisory appointments in 2002? Here we have the President of the company, having to OK an Assistant Trainmaster or Yardmaster, or whatever they are called? What are Division Managers there for?

Hopefully we have a CPA in our midst that can add some financial assistance.

ed

17

Sorry Gabe, I did misunderstand. On recent threads, several have suggested that railroads have monopoly positions in certain areas. I think more accurately, those situations could be described as market dominance and that is a condition that exists in many business areas. Does that result in management taking a screw the other stakeholders attitude. Maybe so.

The both the leaders and the general public in the European Union take that view. They are demanding much greater corrective action of Microsoft than our country did. Incidently making our friend The Anti Gates happier. And they also blocked the merger of GE and Honeywell. Those are just illustrations of their attitude on the subject, but it happens because the EU citizens are much more receptive to socialistic regulations than we are.

A little off topic here, but you might want to look at a recently published book by TR Reid “The United States of Europe”. Perhaps some insight on what it might take to correct the kind of problem you have posed.

Jay

18

I am hoping to find resumes or something that will tell about how much experience the executives and board of directors have with railroads, so far this is all I have found.

http://www.uprr.com/aboutup/exec/index.shtml
http://www.up.com/investors/direct_officers.shtml
http://www.up.com/investors/governance/index.shtml

19

Calls that the senior management of a company should be fired after a significant event has happened are common. However, those calls are often made without consideration of who would replace them and how do you execute a smooth transistion without further screwing up the company. An orderly, planned transistion of senior management is difficult enough to do while keeping the business operating smoothly. Adding the emotional content of “you’re fired” does not make the transistion any easier.

Bottom line - a senior management change is underway at UP and in 2 or 3 years we should know if it is an improvement.

dd

20

dldance,

You raise a good point; but, how many times does one have to drop the ball before the process is “sped up a bit?”

Also, though your point can’t be seriously disputed, might it be argued that this phenomenon is a bad thing in that it gives the people at the top that much more job security and lack of accountability? For my job, I know if I make certain mistakes, I will no longer have my job–and probably have a considerably more difficult time finding another in my chosen field. Accordingly, I endeavor to not make such mistakes.

Do you think, perhaps, it would benefit corporate America as a whole if corporations would try to overcome this obstacle to firing?

I am not arguing with your theory—as I think you are correct, I am just curious as to what you think as to my evaluation of the consequences of your theory.

Gabe