聯合太平洋集團 (UNP) 2002 Q2 法說會逐字稿

Good morning and welcome to the Union Pacific second quarter earnings release teleconference.

At this time, all participants are in a listen-only mode and the floor will be open for questions and comments following the presentation. If at any point you wish to register your question, please press one, four, on your touch-tone phone.

At this time, it is my pleasure to turn the floor over to your host, Mr. Dick Davidson.

Good morning and thank you for joining us on our second quarter earnings conference call.

With me here this morning are Jim Young, our CFO, and

Evans, the president o four railroad. Jim will go over the details of our financial performance, and then

will give you an update on our railroad business. Then I'll come back and wrap up the program with a few final points before we take your question.

Now before Jim and I get into the nuts and bolts, I have the present task of beginning our call, reporting the results of our record second quarter.

Earnings per share rose 21 percent to $1.15 per share from 95 cents per share in 2001. Railroad revenue increased four percent, and our rail operating ratio improved to 79.3 percent. This is the first time since the merger that we have achieved a second quarter operating ratio below 80 percent. We're starting to see the increased business levels that we need to really leverage this franchise.

Another plus for the quarter is our continued streak of productivity gains. Productivity improved at a record pace of over nine percentage points in the second quarter, as we continued to move our

more reliably and efficiently. Throughout 2002, we've all been trying to gauge the state of the economy, and our business trends have been one way of gaining some insight on that.

If you look at the bars on the left side of the slide, you can see that volumes have improved since the beginning of the year. In the first quarter, car loadings were just about flat. But since April, there's been a positive up-tick.

Now April was skewed a little bit, since Easter fell in March this year, versus April in 2001. But May was a solid month, and then June came on strong despite tough comparisons. Now remember that June started and ended on a weekend this year, so it was a pretty difficult month.

The right-hand side of this slide highlights the positive results of our diverse commodity mix and comparative product offerings. We've spoken with you in the past about our yield strategy and the introduction of new products into the marketplace. And our quarterly results demonstrate the implementation of those strategies and the potential that exists as we leverage this terrific franchise.

A year ago, energy was the really good news story. But today, it's

, autos and chemicals leading the way.

will talk in more detail about the

in each of the commodity groups. But let me say, it's heartening to see five of the six groups on the positive side of the ledger . And it's especially encouraging to see chemicals on the plus side for the first time in almost two years.

Now looking back at the quarter, we capitalized on business volumes that were stronger than we anticipated going in. We reported records for operating revenue, operating income, net income, and earnings per share. We continued to leverage increased revenue, employee productivity gains, and lower fuel prices due to an improved operating ratio. And overnight was again a strong contributor, posting increased volume and income.

Together, these achievements generated the free cash flow necessary to strengthen our balance sheet and move us closer to the goal of earning our cost of capital. In fact, our financial improvement was recognized this May by Standard & Poor's with an improved credit rating, and in addition, a positive outlook on top of that for our company - a real accomplishment in this time of market uncertainty.

Now I'm going to turn it over to Jim to discuss the financials, and then I'll return after

with some comments on the remainder of the year. Jim?

Thanks, Dick, and good morning, everyone.

We'll start with the income statement here for the corporation. For the second quarter, total operating income came in at $602 million. That's an increase of 22 percent compared to a year ago. I'll cover the details of the operating income when I talk about the railroad and overnight here in a minute.

Other income totaled $35 million. That's down $40 million - over 50 percent - to the prior year. Big piece of that, as you'll know, as I indicated in our first quarter earnings release, was real estate reductions. Looking forward to third quarter, we're also seeing a very - the trend will continue in terms of real estate. We look, excluding

, to be down about $20 million on real estate for third quarter. Now, this excludes the impact of

. As you recall with

, as I mentioned in first quarter, we'll be up about -

sales should come in around $140 million pre-tax for the quarter.

That brings us down to interest expense, which is reduced by about 11 percent or $19 million. That's a function of reduced debt levels and lower interest rates.

Let's take a look here at commodity revenue for the railroad. If you step back and look at revenue for the quarters Dick indicated, we had a very good quarter. Our revenues were up in five of six commodities. In fact, in three of those six, the auto industrial products and intermodal, we set all-time records.

will cover the details on that here in a minute.

On average revenue per car, the overall total

was down about one percent. It reflects some soft pricing here for the quarter. The

was down for the first half of the year about one-and-a-half points. If you step back and look at the individual commodities, you'll see that industrial had a good trend

continued here - up almost three percent. Seven of our nine groups in the industrial commodities area was up in terms of pricing. We also had some favorable mix with very strong lumber moves.

On the ag products area - up about two percent. Good pricing in terms of our beverages, frozen foods areas, our refrigerated products areas again reflects our new products we're introducing into the market.

If you take a look at intermodal, that's probably where we have the biggest swing year-over-year. This category's been running up about two to three percent. This quarter we're down around six percent - or six tenths of a percent. There's three main drivers there. One, we had a substantial increase in international container business. In fact, it was up about 35 percent. That carries over to average revenue - lower average revenue per unit. The second item in that category was the RCF. Pricing in this category - about half of that business is impacted by RCF.

And the last is our strategy of converting trailer business to containers. We've had a strategy ongoing here for several years. The containers tend to carry a little bit lower average revenue per car. But what's important here is the economics and double-stack are very good and that carries a much higher profitability of margin.

Chemicals is primarily a function of a substantial increase in phosphate rock moves. Mix is a prime driver there. And we've talked about automotive and energy before those reflect the GM contract in our legacy business. All in all, down about one percent. We still see, for the rest of the year as our - the economy strengthens, that we should be able to achieve an all end price increase of about one percent.

Take a look at the operating income for the railroad. Total revenue up about four percent. As I've mentioned earlier, commodity revenue is up around four. Our other revenue had a very strong quarter, up almost eight percent. This revenue includes things like our new insight business, our logistics UPDS group. We've seen good strong revenue there. A big piece of that also

business moving in other areas like your autos, industrial products, et cetera.

Salary and benefits up around three percent or $25 million. Two-thirds of that is volume. The rest is smaller items. The single largest item in there is we did have a $5 million charge for targeted severance programs in the quarter. Rent expense is flat year over year. Volume was offset by a five-percent increase in equipment utilization. The biggest change when you look at the income statement here is fuel and utilities, down about $50 million, 17 percent. It's entirely a function of reduced fuel price per gallon as you'll note down at the bottom of the table there, down about 22 percent. I'll talk about that in a minute. Materials and supplies, again, continuing with the trend we've seen about a year-and-a-half now, reflects the more modern locomotive fleet we have. Overall locomotive maintenance costs are down about $12 million for the quarter. Purchase services is where we saw the largest increase, up 13 percent, almost $40 million.

There's really three drivers in there. About a third of that is higher volume - primarily Intermodal.

is where we have contract

- TOC, COC operations, lost and damage. Another third would fall in the category of maintenance. If you will recall here, I mentioned in the first quarter release that the prior year, the comparisons we had really stopped a lot of spending with the recession starting here a year ago. What this reflects, again, is a more normalized level of spending. Plus we are shifting some programs to contract maintenance.

The biggest single other driver in that group would be environmental cost, which were up about $5 million. You put it together, the costs were flat, revenue up four percent, drove 22 percent increase in operating income. If you look at the operating ration for the quarter - great results, as Dick said. All time record - 79.3, compared to 82.3 a year ago. That's down three points. Now, what I've done here is separated out fuel to give you a perspective on our operating ratio without fuel and you'll see, even taking fuel out of the equation, we had a very nice reduction improvement in our operating ratio.

Employee counts, this chart shows here at 3.5 by

trend by quarter. So I think quarter is showing in the orange bar. It's been a great trend when you look year over year. Overall employee counts, compared to a year ago, are down about three percent, almost 1,700 jobs, on top of

.

If you step back and look at this timeline here, this reflects about a 25 percent increase in productivity for the same quarter, compared back to 1999. Fuel costs, our chart here shows here our quarter,

quarters and the first two quarters this year, 72 cents for this quarter, compared to 92 cents last year. As you know, we have about 40 percent of our fuel hedged at 70 cents.

You'll note that this spread is going to start to shrink here as we go forward for the year. In fact, we're seeing fuel up in the $27, $28 bill range right now. Even with the hedge, it looks like our July fuel costs

will come in around 75 cents. So fuel could be real challenge going forward for the rest of the year.

Take a quick look at overnight. Really had a very good quarter. Still a tough environment, but we are seeing improvement in volume. Overall revenue is up around two percent on four percent volume. The average revenue per

rate was down a couple of percentage points.

It's entirely a function of reduction

fuel surcharge. And you can see that on the financials here, where the fuel prices were down about 17 percent.

and benefits up around six percent. Half of that is volume. The balance is higher wage and a benefit cost.

expense shows the largest increase up around 12 percent. I think part of that is the shift of business to rail, plus a greater

in terms of contract haulage in certain corridors that allows overnight to - did not have as good an opportunity here to balance our drivers and

target contract haulage in these

.

The biggest other driver shows fuel about 17 percent. You can see the fuel price is down 20 percent for the year. The rest of their cost categories reflect a good cost control.

So for overnight, operating

$18.3 million, that's up about two percent. Their operating ratio was flat year over year. I'm confident you'll see overnight, when it's all said and done, will again be at the top of the industry

.

Cash flow, again, this shows our first half cash flow. Good strong results, as we saw in the first quarter. Cash from operations up around 31 percent here. Almost $260 million reflects the nice improvement in income plus improved working capital. All in, our free cash flow was positive to the tune of $88 million, compared to use of cash last year of $159 million. So we've had a very nice improvement in our free cash flow.

That completes the financial review. I'll turn it over to

.

Thanks, Jim, and good morning.

By now you know why we're so enthused with our second quarter performance. Records were set for 28 key financial and operational measures for the second quarter, and 17 of those records were for any quarter in our history. Our results clearly demonstrate that the fundamentals of profitable revenue growth and running a highly efficient railroad are solidly in place.

revenue of almost $2.7 billion for the quarter was up $104 million, or four percent from a year ago. Once again, the diversity of our business mix paid off.

and automotive led the way, as five of our six commodities showed gains. Chemicals improved for the first time in seven quarters, which we believe is a positive indicator for the overall economy.

Energy declined slightly, even though volume rose to a second quarter record.

As Jim explained, average revenue per car was down in the second quarter. Nevertheless, we are committed to achieving a one percent price increase this year. Our price program is on course. You can see that clearly in our industrial products and our ag businesses. Let me assure you that we are fully committed to achieving a point of price in 2002. In fact on August 1, we're taking up to a ten percent price increase on our domestic intermodal business. In addition, last Friday we started our Internet auction of

boxes to take advantage of the domestic

market. That's a month earlier than in the past. Based on last year, we can expect a 15 to 25 percent average premium for our

containers.

Looking at the highlights from each of the businesses, it was our best quarter ever for intermodal. Revenues rose 11 percent to more than a half a billion dollars. Driving the increase was continued strength in the international sector with revenues up 36 percent over a year ago. We also saw domestic gains which we expect to get even better during the second half of the year. Yield improvement continued with a combination of price increases in certain lanes and an emphasis on operational efficiencies, especially asset utilization. As I mentioned earlier, with our August 1 price increase and the

box auction up and running, the positive trend in both of these areas should continue during the second half.

We're keeping a close eye on negotiations between the West coast ports and the longshoremen. In the case of a strike or a slowdown, we might see a little less volume, but we don't really believe that the business would be lost - just delayed.

As we look ahead to steadily increasing international container traffic, I'm pleased to report we're making good progress on the construction of our new intermodal facility at

. Initial operations to get underway this fall and be fully completed next summer. The new yard will help us to efficiently handle the expected intermodal growth in Chicago and the rest of the upper Midwest. The state of the art yard will be one of the biggest and most efficient intermodal facilities in the world, handling 350,000 trailers and containers annually with a capacity to grow in the future.

Automotive revenues also set a quarterly record, increasing by some eight percent. A strong market and our new GM contract were the major drivers. We continue to realize operational efficiencies from our GM partnership as we leverage our auto network for increased revenue and yield.

Looking at the rest of the year, the reintroduction of financing incentives by the

is expected to provide a continued boost to sales. The consensus forecast for 2002 production remains at about 16.5 million units, which is below last year but far above forecasts made earlier in the year.

I'm pleased to report that chemical revenues rose four percent - the first increase in our chemical business since the second quarter of 2000. Normally chemicals are a lagging indicator for the economy, meaning that they're usually the last to recover from an economic downturn. Looking ahead to the second half of the year, we're projecting a strengthening demand for plastics and domestic soda ash.

Revenue from ag products was up three percent, even though volume was flat from a year ago. Average revenue per car set a second quarter record, primarily due to price increases for fresh and frozen products. Wheat demand remained weak, and corn - both volume and revenue - was virtually unchanged from a year ago.

Our frozen business was a bright spot, primarily due to gains

moving our

premium refrigerated service to major markets in the East and Southeast. June was the best month for express lane volume in revenue since we inaugurated the service in April of 2000. We expect the express lane revenues to be up by more than 15 percent for the full year. Once again, this is railroad volume gains coming right off the highways.

For the remainder of the year, the big question mark surrounding our ag business will be the impact of the midwestern drought. As this time, USDA estimates that 90 percent of the corn and soybean crops are in fair to excellent conditions in the markets that we serve. With continued irrigation and a little rain, we still hope to see a fairly good harvest.

Despite the major loss of business from Geneva Steel, revenue for industrial product of 533 million was the highest ever for our quarter. Industrial product is one commodity group that we use most often to gauge the general direction of the economy. Construction materials such as lumber, cement and stone registered big gains during the quarter. The housing market appears to be holding up and our lumber revenues rose by 10 percent. Our rock network helped us to increase stone revenues by eight percent. A big factor was strong demand for road paving materials in Texas, Arkansas and Kansas. On the downside, steel, metallic minerals and hazardous waste shipments were off.

Looking ahead, we expect a strong performance for most segments of the industrial products group, with materials used in highway and housing construction leading the way. Ground paper also appears to be on the upswing as the overall economy strengthens. Our I-5 corridor remains one of our strongest growth engines, especially lumber and paper from the Pacific Northwest and in California, Arizona and Nevada. We expect our I-5

product to earn close to $230 million in revenue this year, which would be about 30 million or 15 percent above last year, again, the major of which comes right off the highway.

Coal was our only declining commodity group. Despite a difficult comparison with last year, revenues were off by only one percent. Revenues from Colorado and Utah mines were up by 10 percent, despite export weakness through Los Angeles ports and into Mexico. For the rest of the year, we expect to average about 33 trains per day out of the Powder River Basin. A hot summer in the Midwest and Southwest with strings of 90 and 100 degree-days is wielding down utility stockpiles.

We continue to make improvements in operating efficiency during the quarter, driving more of our revenue gains to the bottom line. Productivity was up nine percent, compared with a year ago, continuing a trend that began almost two decades ago, as you can see on the right side of the slide.

We've talked before about our emphasis on reducing failure costs, which we define as the cost of not doing things right the first time. We measure failure costs or what we call cost of quality as a percent of revenue. Halfway through the year, our cost of quality is down to 11.4 of revenue, meaning for every dollar of revenue, it costs us 11.4 cents to correct mistakes in such areas as safety, derailment prevention, car utilization and recrew rates. I want to emphasis how big an opportunity we consider cost of quality to be, particularly for continuing our string of productivity improvement.

Our cost of quality focus helped to drive the sixth consecutive

customer satisfaction to the highest level since the FP merger. Customer satisfaction is now improved in 14 of the past 15 quarters. We've been able to improve customer satisfaction because of our focus on meeting customer commitment, by reducing failure costs and improving our ease of doing business. As I said before, satisfied customers vote with their business. And they did so again in the second quarter.

On July 1st, we celebrated the 140th anniversary of Union Pacific railroad. Since the 1860s, we provided the ties that bind a nation. But what really excites us is that there are no limits on how far we can go from here. We just have had our best quarter ever. Reliable service, along with the power of this franchise and new product offerings and alliances are keeping us on course to hit our full-year targets and to achieve the best year in our 140-year history - thank you, Dick.

Are you excited,

?

I absolutely am.

As

mentioned, the third quarter started in a terrific way for us, as we celebrated our 140th anniversary on July 1. Many of you know we had the honor of ringing the

bell at the New York Stock Exchange to mark that occasion. And it was an exciting time for us, as we commemorated our heritage and were able to pay tribute to our employees, from the past and present day.

It was also an opportunity to remind folks that even though UP has been around since the days of Abraham Lincoln, 140 years, the tremendous franchise that we operate today is really a brand new network with only about four years of operating history. As we look forward into the third quarter and our 141st year of business, we're becoming slightly more optimistic about our business.

Recent economic news looks positive, as we get into the busy season in the second half of the year. Based on the trends that we've been seeing, we believe the third quarter year-over-year revenue growth should match and perhaps exceed the second quarter increases. Once again, fuel price will be the wildcard for the quarter. The price of crude has inched back up recently to over $27 a barrel, which translates into a diesel price in the 78 to 80 cents per gallon range.

We have some protection here, as you know, since over 40 percent of our fuel is hedged at about 70 cents a gallon. Even so, fuel is likely to be a tougher year-over-year comparison in the third quarter than it was in the second.

When you put it all together, we've got the potential for another solid quarter in front of us. We have seen continued year-over-year improvement in our operating ratio and low double-digit growth in operating income. As we cautioned at the second quarter earnings release, the magnitude of our net income will depend upon the timing of the Utah Transit Authority, or UTA real estate sale.

If it occurs in the third quarter, it would clearly be a nice edition. Though we expect healthy earnings growth even without this transaction.

For the full year 2002, our outlook remains essentially unchanged from where we were at the beginning of the year. And with over half of the year now in the rearview mirror, we're even more comfortable that the targets that we've projected then can be obtained.

We started out projecting revenue growth of one to three percent, and if recent trends continue, we should be at the high end of that. Assuming fuel prices stay around 75 cents a gallon, including our hedge, we should achieve a full year operating ratio below 80 percent and double-digit earnings per share growth for the year. We would also expect to generate free cash flow of between $350 and $450 million. In fact, we would like to be at the high end of that range if this Utah real estate sale goes through.

Taken together, these performance targets would move us close to the goal of

across the capital, which is critical to achieving shareholder value.

Let me close by reiterating Union Pacific's commitment to our shareholders, our customers, and our employees. If you have our slides in front of you, you'll see that Union Pacific's vision statement is displayed. This is the vision - the vision we set for ourselves following the

merger. We made the commitment to be a company where customers want to do business, employees are proud to work, and shareholder value is created. In today's marketing environment of accounting issues, corporate abuses, and investor distrust, I think it's totally appropriate to reemphasize this commitment.

Our customers, employees, and shareholders were the ones who sustained the Union Pacific in our efforts throughout the past 140 years, and it's the same constituents who should enjoy the benefit of this wonderful new franchise. We're really just beginning to hit our stride, so it's truly an exciting time to be a part of the Union Pacific team as we begin to realize our goals of becoming a premier railroad and a truly great company.

Thanks for joining us today, and now we would be happy to take the questions.

Thank you. The floor is now open for questions.

You may register your question by pressing one, four on your touch-tone telephone at this time. If at any point your question has been answered, you may remove yourself from queue by pressing the pound key. We do ask all participants to please utilize the handset for optimum sound quality.

Once again, that is one, followed by four on your touch-tone phone to register your question.

Thank you. Our first question is coming from

of Credit Suisse First Boston. Please go ahead with your question.

Hi, folks. How are you?

We're doing find,

. Thank you.

I just had a couple that I'd like to go through. First, on the capital investment number of a billion - nine, is that any change from where you've been?

Well, not really. As you may remember,

, we started out with a range of one - seven to one - nine and said we were going to kind of wait until we could see the whites of their eyes and how our business developed for the year. And we've kind of skewed that towards the higher end of the one - seven to one - nine. We'll probably be a little under one - nine, the way it looks right now.

The additional money went into - basically into additional track expenditures.

OK. Could you, Dick and/or Jim, you talk to that in the context of earning your cost of capital? How do you think about where cap ex could go, vis-à-vis

you earn your cost of capital? How do - how do you think about those?

It really hasn't changed,

, that, you know, we've always said for planning purposes, you should just figure us at about $2 billion a year, although for the last three years, we've been under that. But, you know, that's kind of the target I think is appropriate for you to use in your planning.

, if I could turn it over to you for a question.

mentioned one percent. Do you mean real pricing or do you mean yield? Can you clarify that?

,

is not the perfect proxy for price. But I'm talking net price

one percent.

Thank you.

Thank you. Our next question is coming from

of Bear Stearns. Please go ahead with your question.

Good morning, everybody.

Morning,

.

Let's see, I've got two questions for you - one on the revenue side and one on the expense side.

First, on the revenue side, you know, very, very strong quarter - impressive, and the outlook that you're providing seems to be pretty good, as well. Have you seen any signs that two - second quarter was maybe a little bit of a blip for an inventory rebuild and while third quarter looks good, it may be a bit less than second quarter?

It seems like the stock market is certainly assuming the worst for the economy and also a lot of questions with respect to is the economy going to have a double dip. That type of thing. So, can you give me any sense for whether you're seeing any - have any concerns about that?

Well, this is Davidson. I'll answer it and then everybody else can straighten me out. I don't think a day goes by that we don't have concern,

. I mean, we always worry about what the future is going to hold and if the economy is going to stay with us. But, having said that, everybody

wisdom that the reason that our consumer products business and intermodal business was so strong in the second quarter was because the Asian countries were pre-shipping. But I can tell you that for the first couple weeks of July, our intermodal business is priced strong. On a volume basis, we're up 14 percent, year over year through mid-July. So, you know, we've got our fingers crossed. But we are looking for at least a stronger growth in the third quarter as we saw in the second and hopefully a little bit stronger.

, do you ...

No, the only thing I would add to that, Dick, is that autos are at, you know, around 60 days of sales and that's fairly normal. So we don't really see inventory build - the inventories building,

.

OK. And then, I guess, one further on the revenue side, you commented on the 5

and express lane being very, you know, very - or expressway being very favorable. You also have a lot of leverage to cross border with Mexico. Can you give us a sense of whether Mexico looks like it's really come back? Kind of what the growth was in the quarter in your cross border with Mexico. And also, if that really starts to come back further, is that, you know, does that give you upside to the forecast you put out there?

Dick, let me take a pass at that one. If you take the impact of autos out, which are - which are down because of their shutdown and some decisions that the automakers have made of where they're going to manufacture products, we're seeing Mexican revenues up in the four percent range now. It's not in the double-digit range that we would like, but it's comparable with U.S. - domestic.

OK. OK. And then, one quick question on the cost side. The very good improvement in terms of year over year reduction on headcount. And I'm just wondering if you expect that to

fourth quarter and also whether the, you know, a little bit of the resistance for

on the

initiative has any effect.

I'm not - let me repeat your question back and see if we've got it right. You were kind of cutting out. I think you asked will we see a lower headcount at the end of this year than we had last year and is the (BLE) position on

having an impact on our implementation plans. Is that it?

Yeah. That's right.

, do you want to ...

... Well, the headcount in the fourth quarter will be down over the prior fourth quarter. And, yes, the

- we are - and we have a difference of opinion about the implementation of

with

and there's a process that we're going through to resolve that. But at this point in time,

is moving along and has not been a hindrance in the implications so far.

We're moving along on implementation,

. We're - we are at the third terminal for installation of

now and we had really had only planned, I think, what - five for the full year. And we are on schedule, so it's a nice technological advance in our business.

OK. Great. Thanks for the time.

Thank you. Our next question is coming from

of Deutsche Bank. Please go ahead with your question.

Hey, good morning, gentlemen.

Hi,

.

First of all, can you speak to whether the recent flooding down in Texas had any material disruption to your system, and should we expect any material impact to your profitability as you get the quarter started?

Well, the question probably would be answered different ways by different people in our company. Our operating vice president would say, yes, I've had a material impact, because we did have some wash outs on our line between Houston and El Paso, and also our line to Laredo. But they responded well and restored the railroad in a timely fashion.

I mean -- those -- I've been out there and faced those kinds of situations myself, it's tough

, and when you're in the heat of the fire, it's a challenging thing, and our people did respond to the challenge quite well. But we kept the railroad running through detours. Some traffic was delayed, and at the end of the day, I think from your point of view, it will not have a material impact, although it was painful at the time.

OK. You also talked a little bit last quarter about you had changed your philosophy on how you do your maintenance to the track coming in and out of the

River Basin. I'm curious -- you know, what did you see by changing this philosophy a little bit? You know, did it meet -- I guess did the new philosophy kind of meet your expectations, and -- or should we see any kind of reversion back to the old means of actually taking a couple of weeks to go through a thorough track maintenance program.

We won't, but I'll let

answer that in more detail.

No, it was -- we've got to the point where we don't have to take the maintenance shutdown, and that's the good news for ourselves and our customers. We're actually more efficient without taking the shutdown, and we're still a basically double track all the way through -- to Kansas City from the -- Chicago through our

River Basin, and we don't have to go ahead and take a shutdown to do it.

So, we've got a little bit to go yet, we've got maybe 30 or 40 more miles to finish, and we're working on that, but no -- it was a --

, very much of a positive for us.

OK, last question and then I'll let somebody have at it. In talking about the headcount for the year, have you been able to quantify yet the total number of employees that are looking to take the retirement under the new rules, and have you been able to quantify any further training cost as you begin to replace some of those employees?

You want that?

The answer is, yes, we have, and John, we are in a process at this point in time, through normal attrition, retirement to

, factoring in

, we're in a process -- an anticipated growth. We're out trying to hire six to 700 people right now. And we've been actually in a hiring mode since February, as we've looked at our volume roll out in front of us. So net net, we've got -- we have done that analysis, and we're in the market, and we should start to see the impact of the new hires coming in later part of this month.

That's a real key point, what

just said. With -- with the accelerated retirements, what we will see by year end -- we had a few pockets of excess employees that fell out because of our merger, and those excess employees should pretty well be minimized by the end of this year. So it's a great change, here, that we're seeing with the business growth and the accelerated retirement. Net net, it's going to have a positive impact for us.

, let me add one more thing to it. At the end of the year, we will still be down, net employees, despite the hiring of six or 700 people as we leverage, you know, that volume to the bottom line.

All right, and no problems in finding those employees as you

?

No, we've - actually, we've been very pleased with the pool - the candidate pool. It's - there's really good people. Of course, these are good paying jobs. Our only - I guess if I had a magic wand is that - is our training period takes a while and it's - there's a little bit of a train - and those costs are reflected in our numbers.

Thanks

.

Thank you. Our next question is coming from

of Morgan Stanley. Please go ahead with your question.

Hey, guys. Great quarter. I just wanted to ask you first a little about pricing. Jim - and I know you guys have already said you want to hit this goal of one percent - and I just - the thing I'm trying to understand is, Jim, you made some mention about pricing being soft, and I wasn't sure if you were just referring to the

which obviously is beyond your control or if there's something that you versus the

or anything else out there would be causing pricing to be going down on any specific commodities.

No,

, I was really looking at, you know,

. About a third of our business is impacted by

, and as I think I had said, if you look at

first half of the year, it's down about one-and-a-half percent to a year ago. Now, what that also implies is costs are down quite a bit ...

Exactly.

...

.

OK, good. I just wanted to make sure it wasn't - it wasn't a market share issue somewhere.

Can maybe someone just talk briefly about the philosophy of public pricing? I know you guys have started working in that direction. One of your competitors is - seems to be really embracing it. And just where are we at now?

You want to take that,

?

Yes, we are making great progress particularly in our industrial products group and our ag businesses, moving more and more of that business to public pricing. And we're going to be probably in the industrial products about the 40 percent range of that business,

, will be public pricing, where a couple years ago, it was a very small percentage.

How about intermodal?

The majority of ag is already public pricing.

How about intermodal?

Intermodal is - depending - if you look at it from the

- the container business, a lot of that is already public pricing.

is put our containers on an auction, and ...

Right.

... so that's certainly public and everybody can see that. As you know, the international business - the bulk of that is under contract.

Right. And the last thing, I guess circling back to Jim - Jim, the only cost area that I thought was - or issue I guess I would want to make sure I fully understand going forward is the fact that the math works out your cost per employee in the quarter went up about six-and-a-half percent if I'm doing the math right. Obviously you're getting big productivity enhancements that are offsetting a lot of that, but I'm trying to understand how much of that increase was maybe one-time in nature for some because of the way the contract plays out and you're accruing for it versus we need to look for that on an ongoing basis.

Now if you're looking at salaries and benefits on a per-employee basis, you know, you do - you need to take out the severance charge. There's $5 million in there.

You also get mix, you know. Where we're hiring, if you think about it, is in

, which tends to carry the higher average comp per employee. And in the other areas, you know, a lot of our job reductions and efficiencies come in kind of the back office areas

, and those tend to carry a lower average comp per employee. So you do get - you know, I hate to use the term, but in fact you get a little bit of mix that'll drive that up.

OK, great. Thanks, guys.

Thank you,

.

Thank you. Our next question is coming from

of Salomon Smith Barney. Please go ahead with your question.

Yes, good morning, all.

Morning,

.

Yes, just a few questions - one, obviously you've gotten your debt upgrade and obviously the positive outlook. What is the outlook and how are you evaluating the process of using that free cash flow toward dividends

stock buyback? And what kind of timeframe of evaluation should we sort of keep in mind?

Well, I don't think it's changed,

, from the last time we talked about it. At least throughout this year, we're going to continue to improve our debt ratio. We just half of the rating agencies on the right here. We've still got the other half to go. With, I think, by the end of the year it should be an overwhelming position. So, it looks like next year, with a little good luck, we could be in a position to start evaluating what we might do. But this year, I think, we're right on course to continue paying down debt.

OK. And then a couple other quick questions. Could you give us some insight on how your service delivery index has been performing? Obviously, that is something that, episodically, you put in your slides during the quarterly releases. And I'm just curious, how did that perform during the quarter and how do evaluate that?

, that is in lock step, really, with customer satisfaction and was at an all time high, as well.

Did it sequentially improve

?

Yes.

OK. And then just a couple other quick ones. And you may have mentioned this. But on chemicals, could you give me some sense of why the revenue per car declined? Was that mix? Was it yield? Was it pricing? Help me a little bit understanding what happened in the chemical area.

Jim?

Yeah. This is Jim. There's two or three things in there, but we had a very large movement of phosphate rock. That carries an average arc about $250 per car. So you do get some mix in there. You also have - RCF also will impact that category. About 35, 40 percent of that business is linked into the RCF. So that does put a little bit of pressure on that business.

OK. And then just one last one. And it's really more a formality. But in this heightened environment of sensitivity, do I take it that you all have no concerns about the attestation that you all will have to make about your financials come in August to the SEC? I'm really asking it more as a formality than I expect that you all think that there's anything that might change materially.

You can - this is Davidson. I'll answer for me, anyway. You can put it in the bank that we'll be proud to sign.

You bet.

OK. No, I mean, it's more a formality. In this environment of sensitivity, any small change gets people jittery. And I guess, just last one.

, you mentioned the new product area. I guess, two things about that. Can you give us some sense, when you aggregate the new products, what your bogie still might be, relative to yearly contribution from the plethora of different products that you've added?

And then, secondly, have you looked at the issue of erosion relative to not to new products, but just in general, some of your areas of based business. And I guess the reason I'm asking the question is how many and how much do you have to have new products help you relative to what might be some sunset areas of your business that are, through no fault of your own, seeing less volumes?

I think that's a - that's a - that's really a great question. And I think it's very - it's very difficult to understand what churn that you have to - and what new products you have to refresh or replace that churn. We are - we're working diligently to understand that. And when we do our business planning, and it's different for each of the business commodities. Obviously, you have, potentially, more churn in industrial products - maybe ag, you know, and intermodal than you might have in the others. So, I can't answer that specifically because it varies. But I can tell you that we're looking at it. Right now, I can - I can tell you two things. One, we think the revenue from new products this year will be about a couple hundred million dollars plus, and then in every single case, the new products are more profitable than the ones that they replaced.

OK, great. Well thank you, we'll let someone else have it.

Hey,

, I wanted to answer your question about the August 15th sign up. I should have answered that a little more fully, actually. A few months ago, we filed a shelf registration for $1.5 billion. As a result of that, the SEC reviewed our 2001 financial statements, 10-K and annual report in the first quarter of 2002, and we got a good review from them, just in the last couple of days. So they found our numbers quite acceptable.

Great, thank you.

Thank you. Our next question is coming from

of JP Morgan. Please go ahead with your question.

Thanks guys, I just wanted to drill down a little bit more on the revenue items, maybe for

, and give you some of the push back that we're hearing. I want to focus just quickly on chemicals

on the paper. But on the chemical side, you being such a big carrier of it, we're hearing from investors that the chemical companies are not being very optimistic about the second half of the year, and the concern is that we did have an inventory replenishment.

, you said you're looking for plastic and soda

to pick up in the second half of the year. What are your customers telling you that convinces you we're going to have a pick up in the second half of the year?

, that is the feedback that we're getting. It'd be interesting that you're hearing something different. Right now, I can tell you -- I mean, I don't know what to say other than the fact through the first 17 days of July, chemical business is up already -- is up 9 percent over prior year, and it's primarily been driven by plastics and soda

.

And you feel it's behind just for the maybe auto or ...

Well, auto, we're encouraged from a standpoint with the fact that the big three have come in and are going to do their financing incentives, and the fact that where their inventories are. I mean, if their inventories were, you know, higher than the norm, which is in that 60-day range, then there would be a concern. But so we don't see an inventory buildup up there, either. It'll be very interesting, if you're getting different input, you know, and feedback from our customers than we are there, that's a concern. But we're -- obviously, we are cautiously optimistic about all this, and, you know, we're -- there's a lot of things going on in the world that could influence how things turn out. But at this point in time, that's the best information that we have.

I'd make one further point, too.

, our service in chemicals is improving dramatically with this new pipeline service you've heard us talk about. We're starting to get questions about taking business off the waterways, taking business off trucks. So, you know, it could -- we could conjure up a scenario where even if the business was a bit soft, we'd still see good growth because our business -- our performance has improved so vastly with this pipeline service that you're going to see quite a change I think in the use of rail versus other modes of transportation.

That's a good point,

, I should have picked up on -- I should have answered

that way in that the pipeline services -- our order of magnitude in transit time and asset utilization for our customers.

Well, that makes total sense ...

It's huge and it takes the variability out of the service, so we've got wonderful feedback from our customers on it.

No, that's good to hear. And

, you can imagine, I think most of the cyclical companies are just being cautious about the second half. Like, for example, International Paper was being cautious about paper in the second half of the year. So I think they don't want to obviously raise investor expectations. So it's good to get your kind of feedback on that independently.

And then similar on that note would be ...

for the other company.

Well, it's good to share that information.

And similar point on intermodal, we hear, you know, there's just boxes piling up around the warehouses in the L.A. area. You know, in your sense

intermodal, I mean do you feel that even if there was a moderate amount of pre-shipping, you know, is most of that kind of in the L.A. area and getting ready to ship or is most of it kind of shipped in the normal patterns that you've seen?

I think that our - the retail customers are too sophisticated with their logistic supply chains to be

excess inventory. I just don't think they would do it,

. And we're absolutely currrent. Yes, we're current, and the other good news on that is that the boat's coming. The forecast that we're

are at 90 percent capacity.

So you're ...

So we see it as demand.

You see it as demand.

Maybe a little - maybe a little inventory refreshment and possibly a little hedge. You know, it's hard to sort all that out.

But the containers are coming in and you're carrying them into the U.S. obviously?

That's right. When they hit the ground, we load them and go with them.

OK. Now, that's good to hear. We get a lot of questions about those two areas. And then ...

The

launch of that - doing that a month earlier than what we'd done last year is all - is all demand.

The auction

...

The auction - yes, the

auction - that's because the demand - you know, you don't do that unless there's demand.

Well, that's very good to hear. We get those two questions a lot.

And then just quickly a couple of just modeling questions - on the purchase services expense, Jim, is that something that we're going to kind of see at higher levels going forward for the rest of the year?

Right,

. I think we'll see in the 320 - 325 range here over the

, although, again, with intermodal, if it stays strong, you do - you could see a little bit higher number in terms of the volume cost that's associated with contracts.

OK, that's helpful. And then lastly, Jim, I got a little confused on the interest - no, other income explanation. You said real estate sales would be down 20 million year-over-year, but kind of what base are you looking for? We've got kind of a 31 million in other income for the third quarter last year. Are you saying 20 million off the 31 million? I would imagine that 31's a mix of other numbers.

Right. Third quarter - yes, now take

out of the equation. The third quarter will be down in the $20 - $25 million to the prior year excluding

.

So it could be down in the 11 - it was 31 last year.

Yes.

You're talking 11. I mean a pretty low number in that other income.

,

, but that's - it's in the same ballpark probably.

OK. No, I mean that's a pretty low number historically, so I just wanted to make sure that we had that right.

Right.

OK. No, thank you very much.

The

don't overlook. If it happens - if it happens and it's - if it does, it'll be towards the end of the third quarter - right, Jim? It's $140 million ...

Free cash.

... cash infusion.

That would be nice. We hope that comes through.

Thank you very much guys. Great quarter.

Thank you,

.

Thank you. Our next question is coming

of Merrill Lynch. Please go ahead with your question.

Thanks. Good morning. Just a couple of follow-up questions - the employee productivity increases that you talked about - can you talk about more specifics about what that was or was that solely due to the headcount reductions?

Oh, no. It's a jillion and one things. It literally is. You could look at

cost element in the - on the sheet and, you know, find improvements, but I'll let

get into the specifics of it.

No, you said it, Dick. It's a jillion things. It's - of course, the headcount is a -

, is a piece of it. But it's looking at every cost, every failure cost, everything we don't do right, and creating an expectation that we will do better. And I mean we're excited about ...

We have about - what? - 200 accounts in our cost of quality system that every one of them contributes to improved productivity as you take the failure out. And then you leverage that with increased volume and, god, it just makes a beautiful scenario.

And I might add that Dick and I sit through and review those with our people about our plans to - what we're going to do to take costs out and how we're going to address it and whether the capability is there and whether we've got the resources - the right resources in place, et cetera, et cetera, et cetera.

Great. And just a follow-up,

, on the chemicals. I just wanted to stick on this one for a second because you said you were surprised that it's kind of the upswing after seven quarters. And usually this was the economic lag. Do you think that means what you've seen is already well into the turnaround? Or are you surprised that this could be an early indicator as to opposed to a lagging?

I think it's an early indicator. It's an early indicator that the business is starting to see some positives of which, you know, the last two years have been very, very difficult for our customers and for us in this business.

OK.

And it isn't exactly easy yet.

Yeah.

Yeah.

Although we're ...

And Dick made a good point that with what we're doing - and I should have - with

question I should have answered the same way. Our service levels with our chemical customers is - are, at this point in time, is very, very good. And with the pipeline services that we're offering, we have the opportunity to outperform the market here a little bit. Regardless if it's soft, we'll still do OK.

And if I could just - two numerical questions. Just how many lanes are you up to with express lane now? And then does the overnight numbers, especially the operation ratio, include motor cargo into them?

As far as the pipeline services, we're at five now. We have five lanes in place that we're working with our customers with.

And the motor cargo number, as you know, is a pro forma, so - or the overnight numbers is a pro forma, so it includes motor cargo in the numbers a year ago.

Great. Thanks.

Thank you. Our next question is coming from

of Goldman Sachs. Please go ahead with your question.

Yes. Hi. Good morning.

Good morning.

Just a couple of quick questions. One - although export agriculture, I guess, has been weak, can you maybe see some improvement in that, especially if the U.S. dollar weakens or - further. And then, secondly, perhaps assess the - I think I have a pretty good idea, but assess the probability of the UTA gain happening in the third quarter and what may or not change the timing of that. Thanks.

Well, let me answer the ...

I'll do the ag one. We don't anticipate a strong export market to make our forecast. We're not planning on one. And to your question, if the dollar does weaken, then there's the probability of some potential upside, potentially, there.

Except for Mexico.

Mexico has been good. Yeah. That's true.

But the Asian export market is very, very, very soft.

I - you want to answer on the UTA, Jim?

UTA is moving along. I would give it 95 percent plus in terms of closing the end of the third quarter. So we're feeling good about it. We'll announce it when it closes. It's such a big deal.

That's about like a lawyer saying better than 50 percent.

Just a reminder, though, again, when you think of UTA in terms of the overall real estate line, there's two pieces. Because, obviously, UTA's a big deal -- $140 million. But our overall base real estate sales, when you take out UTA will be down in the neighborhood of about 40 to $50 million this year. So, again, when you look at your projections, you need to net that negative against the positive on UTA.

Great. Thanks very much.

Thank you. Our next question is coming from

of

Trust. Please go ahead with your question.

Yeah. Hi, Dick. Congratulations on a wonderful quarter.

Good morning. Thank you.

I had a couple of questions to ask. The first question is regarding the heritage of the railroad industry, of which the Union Pacific is very dominant, and the cash flows that you're generating, tying that in with the problems of confidence and credibility that seem to surround it now. I'm just wondering if anybody at the corporation is giving any serious consideration to the possibility of raising the dividends, in that some of the signs that we see when we ride our Harleys around in some of the caves we end up in, it says, "In God We Trust, All Others Send Cash." And I'm just wondering if that is anything that's being considered to a greater degree than it has been in in the past because of the possible need for the positive message that that would send to investors in your company?

, I don't know that we heard everything you said, we're kind of getting a little feedback here. I think it was the situation if we continue to generate significant free cash, what we might do with it. And

could answer this with more precision than me, but we will continue to pay debt down the rest of this year, and when we get our ratings back from the other agency, then we'll be in a position to decide where we should go. And we'll probably ask a lot of you folks about your opinions, too, when that time comes.

Jim, do you want to ...

No, that's right. We are seeing more interest from investors on dividends. I know it's contrary to good -- good efficient tax theory, but that yield is on everybody's mind these days. And, you know, our goal is to put ourselves in a position, we're generating the cash so that we can make some of those decisions.

If I understood him right, I think he said he wanted to buy a new Harley with increased dividends, but is that what you said,

?

Well, there you go. The second question that I wanted to touch on was the purchase services. I didn't quite understand why -- you know, there has to be possibly some tradeoff here relative to some of the other operating expenses. And I don't quite understand where it's coming from.

There is a little bit. We've got some contracting in there that's higher year over year that we've done some outsourcing in terms of some programs. But again, the big -- one of the big drivers in there was the substantial increase in

, that's where a lot of the external contract work, operations of our terminals,

cost, loss in damage for all of our business, come through.

I needed to hit one follow up question I wanted to ask

. And that's, Union Pacific is blessed with a lot of duplicity of

, and when you're in a growth phase, which hopefully you're in, that that's going to become very important. And I'm just wondering if you could differentiate how you intend to use the Golden State versus the route that goes from Ogden down to Las Vegas, to the southwest.

Yes, we've -- you know, that was laid out in our merger plans and we really haven't changed from that. Our thought was to put our premium business --

and automotive, primarily, not exclusively, but primarily over the Golden State route, and then the rest of our business over the central corridor. As you know, though,

. I know you're aware of this, because you just wrote me a letter congratulating us for upgrading and adding capacity on the Golden State. We still have quite a lot of work to do there as far as adding capacity, although we've made huge progress in strengthening the route with rail and ties.

It's a strong railroad now, and we will -- and we have the luxury here, have been able to add capacity as is needed, and the long term, that's our goal, is to run the premium business over the Golden State and the rest of it over the central corridor. Now that's -- that's not 100 percent precise because there'll still be a bit of a mix on both sides, but that's the overall game plan.

Well, I think that's just wonderful, because over the last 30 years, the railroads got out of the passenger business almost entirely, and that was a big operating headache, and now they're trying to run high speed priority trains with slower speed non-priority trains ...

Right.

... headache, you do have the ability to work around that once you get everything place. I think that's -- that it's really a super deal.

One of the terrific things about merger, it's allowed us to differentiate our

on what, and take advantage of directional running. It's just been a huge improvement for us.

Well, we'll be waiting to see continued projects and results.

Good, thank you.

Thank you. We're showing time for one last question. Our last question is coming from

of Salomon Smith Barney. Please go ahead with your question.

Yes, I just had several quick follow ups. One,

, I don't know whether you mentioned this, and if you did, I apologize. But could you explain why the tax rate was slightly better than perhaps what the planning assumptions we might have been using was. It was like 36.4, and we'd been sort of running 37, 37.5? And should we continue to expect that going forward?

, there are a couple smaller items this quarter, a few donations in terms of properties. There's a couple of small, one-time tax settlements. If you look at this quarter, we're down compared to the prior quarter about 1.4 points. First half of the year, though, the overall tax rate has run around 37.6 versus 37 a year ago. I would plan in terms of around that 37-plus range for the balance of the year.

OK, and then just a couple other quick follow ups. On coal, I'm just wondering, I know that obviously coal for the second quarter was flat-ish, but obviously you had the benefit of not having the shutdown. So that effectively, just simplistically, adds about 7 to 8 percent volume for that period, and therefore helped you have the quarter you did. When you look on a third quarter basis without having the benefit of that shutdown to help the comparisons, how do you see the stockpiles versus burn, and what your run rate on coal movements might be in the third quarter, understanding obviously we do watch the Weather Channel and it is blazingly hot in a lot of your territory.

, we basically see the third quarter flat, but weather is -- you know, is the big swing factor here. If it continues to be hot, we can be optimistic. If it cools, you know, it's a little tougher. But we look at it in third quarter being flat, and you're right about the second quarter. We did benefit from not being down for our week shutdown.

Last question and I'll let you all go is, I know that you've talked a lot about

and that's got some history to it, but obviously, and just one of questions I've got is -- is -- why might not you transition or try to transition more just to a fuel-based surcharge rather than having this rather

indicator that takes into account a basket of costs as opposed to just taking out the fuel part of the equation. Particularly relative to looking at unit yields. Obviously, that is an item that, you know, we talk about in terms of effecting what we see in the face of the financials. but would you consider or would you -- or are you trying relative to just going to a straight fuel type of oriented surcharge mechanism without involving all the other basket of costs that are in

.

Jim, or ...

I'll take a pass on a couple. One, it's a good question. We are where we are, and a lot of our contracts already have a provision for

,

. Two, in a lot of cases, you remember in the past, rather than use a fuel surcharge, we've tried to take price and make it permanent as opposed to going up and down. So there's pluses and minuses in that regard.

Actually, you know, the point is that fuel is down and we haven't lowered prices. And I think that's the probably the overall takeaway that you ought to take away from this.

But I think we are decoupling more and more as we enter into contracts, too,

. The percentage of contracts that are tied to

is substantially lower than it was just a few years ago.

Hey,

, one other thing in

, I didn't mention it. You know, it's a little bit out of synch with what's going on, you know, the labor side. The way

works, you do not get any labor cost increases in until there's actually a settlement, even though we're accruing for settlements under cost. So I think you need to keep that in mind. It's down now because of fuel, but over time, there will be core inflation in your numbers, excluding productivity. And when you have a long-term contract, you want to have some protection in it.

In many our new contracts, the threshold,

, is lower.

Got it.

Well, thank you all very much. We'll look forward to seeing you next quarter, or not seeing you, but talking with you.

Thank you, this does conclude today's teleconference, you may disconnect your lines at this time and have a wonderful day.