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He's been working on the railroad: the challenge and opportunity of the just-deregulated railroad drew Rob Knight's interest fresh out of college nearly three decades ago. The industry's changes and new developments--from fuel-efficiency to intermodal--continue to keep him motivated.

Throughout American history, much has been written about the lure of railroads. Drama surrounded their 19th century beginnings with visions of linking the nation via a transcontinental route that would reduce the time to cross the continent, promote settlement, develop the nation's interior and encourage trade.

In 1862, President Abraham Lincoln signed The Pacific Railroad Act, allowing for construction of the transcontinental. Two companies were chosen to complete the tasks: the Central Pacific Railroad of California and the Union Pacific Co.

Fast forward to the 21st century, when President Barack Obama gave the rails a nod by reviving Lincoln's tradition of traveling by train to Washington, D.C., for his inauguration. Another modern-day person was lured by the railroad, nearly 30 years ago: Rob Knight, the chief financial officer of Union Pacific Corp., signed on with UP fresh out of Kansas State University.

In 1980--with a business degree and concentration in accounting--Knight started his career as an internal auditor, and he's still chugging along, so to speak, with the now $18 billion, 48,000-employee UP.


Railroads as a career choice weren't on the front-burner of everybody's mind back then," says Knight, recalling that energy and other areas of commerce were hot.

But he saw excitement, challenge and opportunity. It was in 1980 that the Staggers Rail Act (signed by President Jimmy Carter) was enacted and the industry was deregulated--a step that "changed the game," Knight notes.

Railroads are critical to commerce in our society, he says. With deregulation, the business was evolving: "the railroad would now have to change and operate like a business and rapidly change the way it would perform and function and think."

The excitement for Knight has continued, as the industry has evolved. "We've had challenges and setbacks along the way," he says, but the environment has continued to provide personal motivation and job satisfaction.

During his 29-year career, Knight has touched a variety of the areas in the business, which he says has given him good perspective: he's run the quality group and the energy business unit; been vice president and general manger of automotive; then moved back to finance and ultimately into the CFO position five years ago.

Thus, he's had general manager responsibilities for two of the firm's six business units, which include agricultural products, automotive, chemicals, energy, industrial products and intermodal (the transport of truck trailers and containers). In those roles, he has dealt with customers, negotiated contracts and was involved in other business decisions.

As CFO, Knight's role goes beyond the finance function of adding up the numbers and making sure there are internal controls. He oversees a 545-member staff that has responsibility for real estate, tax, audit, finance, treasury, investor relations, accounting and planning and analysis, among others. Senior-level finance directors from each of the six business units also report to him.


These finance executives, he explains, work cooperatively throughout the organization with the objective of--from an analytical perspective--"making sure we're focused on generating returns and at the same time, recognizing that the way we're going to generate returns is by providing a quality underlying service to our customers that they value, that they're willing to pay fair rates for and that we're making the right investments in the business."

Rail, he notes, is a very capital intensive industry; last year alone, UP spent more than $3 billion. Thus, "it's our responsibility to make sure that every dollar we spend has the anticipated returns we expect, and to make sure that is linked with service, safety, growth and returns."

Competitive Advantages: 'How Green It Is'

The U.S. rail system is divided into four major rails, with two each in the East and West. UP crosses into or touches 23 states (and must, therefore, deal with separate tax obligations for each one).


It's a huge transportation player, primarily in the Western U.S., serving major ports--such as Los Angeles and Long Beach, Calif.--as well as six prime rail gateway crossings into Mexico. It also connects to the two large Eastern railroads and two large Canadian railroads.

"I can't think of anything--whether it's a computer, a car, a house or a building or energy--that doesn't have rail as an underlying transportation source," says Knight, on the value of rail to business and consumer alike.

UP moves coal from the Wyoming Powder River Basin mines to electric utilities. Knight explains that UP serves the Powder River Basin mines, which consist of the lower-sulfur--the so-called "cleaner coal." Some little-known facts about coal: about 55 percent of U.S. electricity comes from it, and there's an estimated 300 years of supply of this "cleaner" coal in the U.S.--primarily in Wyoming.

Among the other large-volume items shipped on UP are automobiles and parts, chemicals, large construction and housing-related items, ethanol and more recently--windmills, which are beginning to provide a growth opportunity. "Those blades are so big that they require special handling services," notes Knight.

UP's competitors come in several shapes and sizes, he says. There's the other large Western railroad, Burlington Northern Santa Fe, and trucks are often part of the equation, as are barge operators. Each of these gives customers choices and multiple alternatives.

UP's active marketing and sales organization works directly with current and prospective customers to design specific strategies. For example, a manufacturing or retail customer can have goods shipped directly to its facility or distribution center.

People who are rail customers generally understand the benefits, says Knight. Customers are fairly large, sophisticated transportation experts in firms with transportation departments, and it's their job to understand alternatives.

With last year's staggering fuel prices, the advantages of shipping by rail became clear to many who may not have been so familiar with rail. As Knight says, using a single gallon of diesel fuel, his railroad can move a ton roughly 800 miles--which makes it about three times more fuel-efficient than trucks.

Indeed, the railroad freight system hauls enormous amounts of tonnage, quite efficiently. For example, the fuel rail uses to move its tonnage leaves 60 percent less of a carbon footprint than other modes of transportation.

To illustrate this point, Knight says moving an intermodal train, say from Los Angeles to Chicago--a common large move--is equivalent to taking 300 trucks off the highway. Thus, besides providing an economic advantage, rail offers an environmental advantage--something more and more customers are beginning to value.

Climate Drives Uncertainty

The dim economic outlook for the global economy is also having its impact on UP. The good news is that its earnings were up overall for 2008--31 percent compared with 2007 (if measured in EPS; 26 percent if measured in net income). However, the entire year showed a 5 percent volume fall-off, with the fourth-quarter alone logging a 12 percent drop.

In the railroad business, volume is a key indicator, says Knight. And, as a major servicer of industrial customers, he characterizes the fall-off as "significant." Obviously, he notes, the decrease is due to the current economic conditions. As such, he adds, due to the uncertainty and "lack of visibility," the firm has not given financial guidance for this year.

With the soft economy, he says, there might be less electricity usage, since plants are running fewer shifts. But, he quickly adds, coal shipments should be relatively steady. Consumers still turn their lights on and still need to eat; municipalities still need the chlorine that goes into water purification, etc. So, one of the bright spots for rails, he notes, is they'll continue moving the fundamentals.

Rail, he continues is so critical and tends to be somewhat of a leading indicator of an economic recovery, because it moves the large industrial goods. Thus, Knight believes that as the economy starts to rebuild, "you will see it in rail volumes."

Thus, even as the global economy remains in its current weakened state, Knight is optimistic about the railroads, and UP specifically. "Long term, I can't think of a business that's better than the rail industry." The company is well-positioned, he indicates. "We will withstand this economic downturn and come out of it very strong."

Indeed, he says his goal is for the firm to become even stronger "than when we went into it."

The challenge he's most concerned about, however, is two-fold: First, the general economy and when it will turn around. The second pertains to the economic impact on UP's customers. "Will they be able to withstand this downturn--and 'hang in there' so when the economy comes back, they will, too?"

Part of that, he notes, is his customers' ability to get credit. "The longer this goes on and the tighter it is, the more potentially negative it is on our customer base," he says.

'Project Operating Ratio'

Even prior to the economic downturn--in fact, over the last few years--Knight and his Finance group have led an effort to "smartly" tighten all costs and expenditures. "We know the worst thing we could do would be to overcut and not be prepared when volumes and the economy return," he says.

Under "Project Operating Ratio," all 48,000 UP employees are focused on what they can do and how they can help improve safety and service and do things more efficiently. All these efforts serve to improve the firm's operating ratio, which, as Knight explains "in the rail world" is the opposite of operating margin.

"You want to reduce your operating ratio, which is effectively increasing your operating margin."

Examples include: improving service and thus increasing the value of rail to our customers; operations improving cost efficiency by running more productive trains; or administrative areas using technology to do things more efficiently.

To launch the program (following assistance from an outside consultant), Knight asked employees to send him notes with ideas; he proudly reports he's received more than 3,000 suggestions. This, he says, indicates "it's working and creating a lot of momentum and enthusiasm in the culture of our company."

A concrete way he knows it's working is that the firm's operating ratio has improved by 9.5 points in the last three years--and each point in "his world" represents about $180 million in 2008 operating income.

Separately, in other areas, Knight says the company is tightening everywhere it can. From a tactical standpoint, it froze executive salaries and cut back on travel as well as various discretionary spending.

More broadly, Knight is watching the firm's cash and liquidity. He's pleased, having just completed 2008 with more than $1.2 billion in cash, which represents a "larger number than you would have seen in previous years," and which, he notes, was "by design."

Knight says UP continues to have a strong balance sheet, which affords it a solid debt rating and continued access to credit markets. It's important to UP to maintain its BBB/Baa2 credit rating with Standard & Poor's and Moody's, respectively.

Looking back over the past nearly 30 years since railroad deregulation, Knight observes the progress made could not have happened under government regulation. The industry made significant productivity and service changes, which continue, as it runs an increasingly efficient product for customers, and at lower cost.

Deregulation, he adds, made it possible for railroads to redefine the industry as "transportation companies" rather than "railroads."

Much of its future growth is expected from containerized traffic--the intermodal business--which requires UP to work very closely with its customers in defining transportation solutions that frequently involve a rail piece, a truck and sometimes working with a logistics provider that the customer has hired.

To sustain the growth, Knight says, railroads need to remain competitive and responsible to shareholders. Railroad companies must make their own capital investments (track structure, development, maintenance, replacement, etc.), unlike other transportation modes such as the government-financed national highway system.

"This only works if we have the ability to earn an adequate return on those capital investments," he says.
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Title Annotation:chief financial officer Rob Knight
Author:Heffes, Ellen M.
Publication:Financial Executive
Article Type:Interview
Date:Mar 1, 2009
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