聯合太平洋集團 (UNP) 2002 Q3 法說會逐字稿

Forward-looking statements include projections and estimates of earnings, revenues, cost savings, expenses or other financial items. Statements of management's plans for future operation and management's expectations as to future performance and operations and the time by which it will be achieved, statements concerning proposed new products and services and economic industry or market conditions and statements.

Forward-looking statements are subject to risk and could differ materially from that anticipated by the forward-looking statement. Important factors that could cause differences could include the company's success in implementing the financial and operational initiatives, impact on industry competition, conditions, performance and consolidation, legislative and/or regulatory developments, including initiatives to regulate the rail business, severe weather, floods and earth quakes, adverse general economic conditions, both within the United States and globally, any adverse economic or operational repercussions from terrorist activities and any government response there to. Change us in fuel prices, labor costs, labor stoppages and the outcome of claims and litigation.

Forward-looking statements speak only as of the date the statement was made and the company assumes no obligation to update information to reflect actual results.

Changes in assumptions or other factors of forward-looking information, no inference should be drawn that the company will make updates regard to that statement or any other forward-looking statements.

Good morning, and welcome to the Union Pacific's third quarter earnings release teleconference. At this time all participants are on a listen-only mode, and the floor will be opened for questions and comments following the presentation.

If at any point you wish to register your question, please press one followed by four.

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

Thank you, Melissa.

Good morning, and thank you for joining us on our third quarter earnings conference call. With me this morning are Jim Young, our CFO; and Ike Evans, the president of the railroad.

Jim will discuss the details of our third quarter financial performance and then Ike will provide an update on our railroad operations. I'll then come back and wrap up the program with a few remarks about our fourth quarter outlook. And then we'll take your questions.

In recent weeks, the market has been keenly focused on the impact of the west coast port disruption. We'll talk about that this morning as well, but first, I'm very pleased to report another record quarter of earnings growth for the Union Pacific.

We're reporting 2002 third quarter earnings per share of $1.63, versus $1.04 per share in 2001.

Now, this includes 32 cents for the Utah Transit Authority transaction, and 12 cents for a favorable tax settlement. But even without these, we had over 14 percent growth in our core earnings per share.

This baseline growth in earnings is the ultimate proof statement that the Union Pacific franchise is delivering consistent results, despite the negative forces of the economy, mother nature, or the west coast port situation.

We achieved these report results by sticking to the basics of running an efficient railroad. Our intense focus on the quality processes continues to show success in the form of margin expansion.

Quarter over quarter, we've improved our rail operating margin by almost 7 percent, moving us closer to our year-end goal of a 20 percent-plus rail operating margin and for the old-timers in the audience, this translates to an operating ratio of 78.3 percent, a great quarterly achievement.

Other highlights for the third quarter were all-time quarterly bests for total car loading, operating revenue, operating income, and net income. And while we're always pleased when we top the records of previous quarters, this success is even more gratifying given the difficult economic headwind.

Our string of efficiency gains continued as railroad employee productivity grew 6 percentage points.

Overnite also made an impressive contribution to the quarter, recording its best quarterly performance since 1994 with improvements in operating revenues and operating margin.

The bankruptcy of Consolidated Freightway in September opened the door for Overnite to win new business and win better margins. As I mentioned earlier, we finalized the land sale with UTA on September 20. As anticipated, this transaction added a little over $140 million to our pre-tax income for the quarter - a great win for Union Pacific and also for the state of Utah.

Combining record third quarter volumes with our margin and productivity improvements, Union Pacific produced a terrific quarterly results - a heart-warming achievement for the employees, customers and shareholders.

I'll turn it over to Jim and Ike for the details. Jim?

Thanks, Dick, and good morning, everyone.

We'll start with the third quarter income for the corporation. Total operating income hit $644 million. That's up 12 percent from the third quarter last year. This growth is driven by strong operating income at both the railroad, which was up 11 percent, and Overnite which was up 20 percent.

Other income at $161 million, increased $130 million, reflecting the property sale to the Utah Transit Authority, which closed on September 20. As Dick said, the UTA sale contributed $141 million to pre-tax income or 32 cents per share of earnings.

Interest expense also declined $18 million or 10 percent. That's a trend we've seen all year here. Half of this decline is attributed to a $550 million reduction in our net debt outstanding, and the balance to lower interest rates.

The tax rate for the quarter hit 33 percent, compared to 38 percent last year. That reduced rate reflects a tax settlement at Overnite, which totaled $33 million or 12 cents a share.

Total corporate net income of $437 million for the third quarter increased 64 percent.

Now, excluding the property sale and the tax settlement, total corporate net income hit $316 million. That's an increase of 18 percent to a year ago. And again, as Dick mentioned, EPS at 163 was up 57 percent. And if you take out the property and tax items, EPS hit 119 a share, up 14 percent.

Moving on in the next slide, we'll take a look at railroad revenue results.

This slide shows revenue by the six businesses of the (railroad), and the percentage change from third quarter last year. Also included are the percent change in car loads and average (load) per car year over year.

Total revenue grew 4 percent compared to last year, with five of our six business groups showing increases. It really shows the strength and the diversity of our business. Ike will cover more detail of our revenue here in a few minutes.

Average revenue per car was flat compared to last year. A couple of big drivers here. Automotive ARC was up 3 percent. It's entirely mixed. We had a very strong increased - 15 percent in finished vehicles. They tend to carry higher average revenue per car. While the parts business was down about 4 percent.

[inaudible] mobile ARC was flat, reflects a 23 percent increase in international container volume, while our premium in truckload volume fell about 3 percent.

(Paid) products ARC up about 4 percent. That group reflects improved pricing on improved food products division for business, but also an increased lengfth of haul. Industrial products up 1 percent, reflects both a good pricing.

In fact, 7 out of our 11 business segments in the industrial products area had increases in arc.

This also was impacted by [inaudible] mix as our lumber loadings, which tend to carry the highest revenue per unit in that category, were up 4 percent.

Overall, ARC was flat overall.

From a yield perspective, we've talked about how we view yield, that includes not only price and mix, but productivity. If you look at - while average revenue per car was flat, our operating income per car load was up 7 percent, I think really reflects what we're doing here on improving our overall yields.

Let's take a look at third quarter operating income at the railroad. Total operating revenue increased 4 percent. I just talked about our commodity revenue in the six groups, which was up 4 percent.

But also, our other revenue, which includes our logistics businesses, UP Distribution Services and Insight, grew 17 million or 16 percent. So we had a strong showing in the other revenue lines.

On the operating expense side, labor costs were up 4 percent. That reflects volume as gross ton miles increased 4 percent, plus higher wage and benefit inflation which was around 4 percent. Now this is partially offset by improved productivity.

You'll note our overall employee count for the quarter was down 2 percent, so we handled 4 percent higher volume with 2 percent fewer employees. So good productivity improvement.

Rent expense, up $9 million or 3 percent. Two-thirds of that are the increased locomotive lease costs reflecting the continued acquisition of (SD70) locomotives.

Our car cycle times for the quarter were down, improved 4 percent from a year ago.

Fuel costs had the biggest decline, 8 percent or 24 million. Average fuel price was 75 cents, compared to 86 cents a year ago. As a reminder, we had 41 percent of our fuel hedged in the third quarter at 67 cents.

I'll talk about our outlook for fuel here in a minute.

Materials and supplies. It's continued a trend we've seen all year, reduced locomotive maintenance costs. And purchase services up about 10 percent. About a third of that increase is driven by volume, which includes Intermodal (dredge), loading and unloading costs at terminals, crew hauling and lodging.

The balance of the increase falls into higher contract maintenance and other costs.

In summary, operating costs were up 2 percent, while revenue was up 4, drove 11 percent increase in our operating income to an all-time record.

A couple of other key stats here. We mentioned the operating margin and operating ratio were also all-time bests for the quarter.

This chart shows our third quarter operating ratio compared to the last three years. I've also shown fuel price in the bottom so you can get a feel what - how fuel came out for the quarter.

At 783, that's an all-time best for the operating ratio for the railroad. Clearly fuel did help. But even if you take it out of the equation, fuel accounts for 1.1 points of the 1.4 point drop. So even without fuel we had a good reduction in our - or improvement in our operating ratio.

Take a minute to talk about fuel prices.

The chart shows our average price per gallon that the railroad paid here in each quarter last year in orange. You'll note you started high and finished low. This year, it's been the other way around. We started low at 61 cents. And right now, for third quarter, we're at 75 cents.

Fuel is obviously very volatile today. I show you our current spot at 88 cents. That is the price we're paying, excluding our hedge. Last week, that was in the low 90s, so it has been moving down.

We do have 41 percent of our fuel hedged in the fourth quarter at 67 cents. My outlook for fuel right now is we'll be close to where we were in fourth quarter of a year ago - about 81 cents - but it is moving the right way for us.

Take a minute here to look at Overnite's operating performance for the third quarter.

It was record quarter for Overnite. Revenue growth up 7 percent drove a 19 percent increase in Overnite's operating income. On the expense side, sellers and benefits, up 8 percent. That reflects both increased volume, as well as higher wage and benefit costs, which were partially offset by increased productivity.

You'll note Overnite's tonage increased 8 percent for the quarter, while their average employee count was down 3 percent. So they had a great, great quarter for productivity.

Rent expense up 15 percent. That reflects increased contract miles due to higher volume. And Overnite's operating ratio at 92.7 was the lowest since third quarter of '94. So a very good record quarter for Overnite.

Dick mentioned Consolidated Freight and the opportunities there. Clearly, it's a great opportunity for Overnite. We've got a three-part strategy.

One, we want to be selective in terms of the incremental business we take on. Overnite has set some minimal profitability - minimum profitability requirements in terms of looking at the business. We won't handle it all, because it won't meet these requirements.

Two, we're looking at some key terminals to further complement both the motor cargo Overnite network.

And third we're going to leverage price in the markets with where CF was the low price leader.

So it's really a very good opportunity for Overnite.

Take a minute to look at our free cash flow. Year to date, free cash flow after dividends total $474 million. That's up substantially from a year ago.

Cash from operations increased 35 percent or $481 million. And just as a reminder, cash from operations excludes the proceeds from real estate sales. Those are reported down in the line cash used for capital and others. So our core operating cash performance was very good so far this year.

Cash capital, right now, is just under $1.5 billion. That's up about $100 million to a year ago. That was more than offset by cash real estate proceeds of $225 million, which is up about $140 million from a year ago.

Obviously, we are exceeding our free cash flow targets we set earlier in the year, that we had targeted $350, $450 million.

Right now, I see us at the end of the year in the 550-plus range, so great performance on the cash side.

Balance sheet, again, great story. Continuing to show good improvement. On the left side, I show our debt to cap ratios with and without leases. You'll see we've had nice improvement in both of them. They now both are under 50 percent. And the right does show our key coverage ratios in terms of interest coverage and cash flow to debt. Again, very good performance.

That completes the financial review.

We'll turn it over to Ike.

Thanks, Jim, and good morning.

In total, we set 23 third quarter records for financial and operational performance. And 14 of those were records for any quarter.

Quite simply, the third quarter of 2002 was the best in our history.

Commodity revenues of more than 2.7 billion, were up over 100 million, or 4 percent, from a year ago. We saw a continuation of our second quarter business trends. Five of our six business groups gained, led by automotive, which was up 13 percent on the strength of finished vehicle sales.

Intermodal was up 9 percent, and was driven primarily by import traffic and would have been stronger without the port slowdown and the eventual lockout that occurred at the end of the quarter.

Ag products increased 4 percent, despite a 5 percent falloff in wheat. Fruits and vegetables more than picked up the slack, increasing 17 percent as we made share gains through our express lane service to eastern markets.

Industrial products had another record quarter, up 4 percent. Lumber and stone were both up, while steel shipments rose for the first time this year.

Chemicals improved for the second straight quarter after two years of decline. Revenue was up 2 percent, primarily on the strength of liquid petroleum gas.

Coal was the only commodity that was off in the quarter, down 3 percent. The decline was due to legacy contracts, mine performance. And down time at some utilities was longer than expected.

Still, our outlook for the remainder of the year is positive. Utility stockpiles are at normal levels and our productivity in the Powder River Basin is improving.

As an example, we loaded 1,000 Powder River basin (trains) in September, the most ever in a 30 day period.

This graph shows the strength of our traffic volumes compared with the last two years. During the third quarter, we saw seven-day car loadings top the 190,000 mark twice, our highest levels ever.

When the ports shut down on September 27, car loadings dropped from best-ever levels to a low of over 150,000 on October 8, the day before the ports reopened. Today, our seven-day car loadings have almost returned to pre-shutdown levels.

The majority of the port related shortfall was Intermodal traffic. We did experience some impact in other business segments ranging from import autos to export grains and soda ash.

Through the first three weeks of October, the port impact can still clearly be seen with total car loads down 6 percent.

Encouragingly, automotive and industrial products were each up 7 percent. However, as we look to the Rhea remainder of the fourth quarter, the key will be to see how much of the shortfall can be regained. It's too soon to determine exactly how much of business will be affected by lost shipping cycles.

When the ports reopened two weeks ago, there were 23,000 eastbound containers on ships that were scheduled to move on Union Pacific. We also had 8,700 westbound containers on the docks, at inland terminals, and in (sitings).

We took several steps under a recovery plan.

First, we upgraded our locomotive fleet that serves the ports. We brought in our newest units, swapping out older models. The day before the ports reopened was we had 100 new units ready to go in the L.A. Basin.

We've worked closely with our customers and the ports to develop realistic plans to handle the expected surge in volume, and to establish metering systems for both inbound and outbound freight, so that we can maintain a rational flow of traffic.

Another step that has really paid off is the setting up of a tactical operations center, you might call a war room. Its sole purpose is to make quick decisions to move freight in the most efficient manner.

Overall, we're confident that we can keep the pipeline flowing both eastbound and westbound. There's no doubt that we're making great progress, though we still have several weeks of hard work ahead of us.

Our recovery plan is working, because our operating network was already in great shape prior to the port shutdown. Train plan compliance is our version of an on-time measure. It has improved steadily for the past year to its current level of 95 percent.

To and from industry, coming in at 85 percent for the quarter, is another key measure. It measures how well we handle the critical first and last stages of each freight movement.

Both of these indicators were at best-ever levels at the end of the third quarter. And best of all, we accomplished this improvement while handling steadily increasing traffic volumes.

Improvements in operating efficiency allowed us to handle more business with fewer resources.

Measured in gross ton miles per employee, we had another record quarter for productivity. It rose 6 percent as our volumes increased by 4 percent and average employees declined by 2 percent.

Longer cars, aluminum cars, distributed power and other initiatives have translated into more cost effective use of the equipment. And as a result, equipment utilization has improved by 3 percent in each of the last three years.

Customer service continues to improve even as we move more gross ton miles than at any time in our history. Our service delivery index, an internal benchmark, measures oure performance against customer commitments.

The fact that we've improved our service level during periods of record growth is a clear indication that our operations are fluid and we are meeting our customer requirements.

We measure more than 130 categories across the railroad, where if we do things right the first time we have the opportunity to reduce our costs. Derailments, lost locomotive productivity, less than efficient asset utilization are all examples of quality process failures. Our cost of quality management process reduces failure costs by avoiding mistakes or by doing it right the first time.

There's still tremendous opportunity for improvement. But providing quality service to our customers is costing less and less every year. It's down to 11.6 percent of revenue through September.

Our customers are noticing that progress is being made. And we're seeing the results reflected in our customer satisfaction survey. The survey is an index - is at an all-time high, year to date of 78 percent. Ultimately, that translates into revenue growth, as we know that our customers vote with their transportation dollars.

Our quality program is deeply rooted in the culture of this company. This year, we have again been selected to as a Malcolm Baldridge (ph) national quality award finalist. A team of examiners will spend next week with us looking closely at every aspect of our business.

This review is an excellent way to audit our quality processes, by benchmarking us against the very best, Union Pacific will become an even better company.

Thank you. I'll turn it back to Dick.

Let me echo some of Ike's comments about the (Baldridge) site visit.

As someone who's a firm believer in the quality program, it's a great honor for Union Pacific to be named as a finalist for the Malcolm Baldridge (ph) quality award. The Baldridge (ph) name is synonymous with quality and quality companies achieve quality results.

When we meet our customers' expectations and do so consistently, customers are rewarded with superior service and, in turn, we're rewarded with their business.

The true test of a quality company - or one of the true tests, is how you recover from business interruptions. So our focus on quality will be in full force as we tackle the challenges and opportunities of the fourth quarter.

As Ike mentioned already, the west coast labor dispute has had a significant impact on our fourth quarter performance.

Between lost revenue and the disruption to our operations, we're currently estimating an earnings impact, between a nickel and 10 cents a share.

As we ramp up our eastbound service and monitor the port's progress, the estimate could change. So it really just depends on how quickly the ports can catch up. And that's a fairly fluid estimate that I've given you.

The good news is that our strong rail franchise gives us the revenue diversity and the network flexibility to restart operations fairly quickly. We're committed to moving out the backlog and serving our customers' needs as quickly as possible.

Quite frankly, we view the port situation as a rare event that doesn't change the underlying strength of the Union Pacific or our terrific franchise.

The economy wildcard here continues to be in play. Prior to the west coast part shutdown, it seemed like the economy was firming somewhat as certain core businesses, like autos and Intermodal were showing quarterly growth. Now, it may be a few months before the port effect clears completely and we can get a better view of what the future looks like.

One thing that is clear, however, is the negative impact that uncertainties in the Middle East have had on the price of oil. With crude prices staying around $29 a barrel since early September, 40 percent of our fourth quarter consumption is protected at our hedge price of just under 70 cents, as Jim mentioned. So our overall price exposure should be moderated. But a spot price near 90 cents a gallon pressures our margins and prevents us from increasing our 2003 hedge at this time.

On the plus side, our trucking company has had an opportunity to build on its third quarter successes and continue to grow its market share. Overnite's September revenues were almost $108 million, an all-time best for the company.

Now it's too soon to tell if one month creates a trend, but Overnite's pursuit of former CF business should certainly be a long-term win for an already very strong Overnite franchise.

Now, moving beyond the external factors, we'll continue to direct our efforts at those areas we can control and follow our strategy to grow revenue and contain cost.

First on the list of controllable items is productivity. You've heard me say this many times before, that productivity is a focus area for the Union Pacific. And the fourth quarter is no exception to that. We're still on track to achieve the targeted year over year headcount reduction of 2 percentage points by the end of year.

While the environment remains uncertain, we still expect to see year over year revenue growth in the 1 to 3 percent range for the quarter. When combined with continued productivity improvement, this should help us sustain our trend of continued margin growth.

As a result, despite the challenges we've discussed, we still expect both operating income and earnings to meet or slightly exceed last year's fourth quarter numbers, which you may remember were 565 million of operating income and $1.06 per share. And Union Pacific's focus on improving our return on total capital is firmly in place. We have talked about making progress on the goal all year. And by year end, we should have made another strong step forward.

Now, before I close and before we get to your questions, I'd like to bring you up to date on one additional item.

You'll recall that back in the third quarter of 1999, we announced a stock purchase incentive program. Under that program, 64 members of the management team purchased just over a million shares of Union Pacific stock at its fair market value, using proceeds of full recourse company loans to purchase those shares. The program grew out of our sincere belief that Union Pacific stock was undervalued. And we wanted our executive team to increase their skin in the game. Each participant is personally on the hook for those loans, including myself.

On January 31, 2003, the first payment becomes due.

All of our executives have significant stock ownership targets ranging up to seven times salary for myself - although I can tell you that my ownership currently exceeds 25 times my salary - so much of our net worth is tied to the value of the Union Pacific stock. And it is very, very rare that you will ever see one of our officers sell stock. However, because of this program, we anticipate that a number of officers will need to sell shares to meet their financial obligations.

Now, I guess that's a long-winded way of telling you that if you see some UP officers selling U.P. stock, it's to repay the amount owed to the company and nothing more. It's just that simple.

In fact, our belief in the future of the company is as strong or stronger than ever. As a management team, we remain focused on setting Union Pacific apart as a premiere railroad in North America.

With our great network, solid customer base, dedicated workforce, and 140 years of history, this company is really just beginning to hit its stride. We're committed to achieving the vision that we work hard toward every day - to be a place where our customers want to do business, employees are proud to work, and shareholder value is created.

So thanks for joining us today and now we'd be happy to take your questions.

Melissa?

Thank you. The floor is now open for questions. You may register your question by pressing one, followed by four on your touch tone telephone at this time. If, at any point, your question has been answered, you may remove yourself from the queue by pressing the pound key.

We do ask all participants to please utilize the handset for optimum sound quality. Our first question is coming from James Valentine. Please state your affiliation.

Morgan Stanley.

A great quarter, guys. Two questions.

First, maybe someone could just address the productivity issue - that it was good - it was very good in the third quarter. And just want to try to understand, it's better than most other railroads are seeing out there. I'm trying to understand the sustainability of this magnitude of labor productivity improvement going forward.

Can this go out - play in this level into '03 and '04? Or has most of the low hanging fruit been picked?

Jim, let me - this is Davidson.

If you would look at our history, it's interesting, because I just was at a conference yesterday of the American Enterprise Institute talking about this very thing.

Going back to the mid '80s up until today, we've improved our productivity at a compound growth rate of 6.5 percent a year. The people around this table and the remainder of our senior staff are all firmly convinced we can continue strong productivity growth as far into the future as the eye can see.

And you know, we regard it as a real opportunity for us, rather than a challenge, because the way we look at our quality efforts and the cost of quality, and reducing failure cost, and taking advantage of all of the technology that's out there, we're looking for strong productivity growth as far into the future as the eye can see.

Great, great.

And the second question is, I'll leave it for Jim or Ike, but the RCAF (ph). Some of the work we've done - we know the rail cost adjustment factor has gone up more in the month of October than I think any time in the last four or five years on a sequential basis. And the work we've done shows that, I think, you have the most exposure to this benefit of anybody out there.

I was wondering if you might be able to quantify it in terms of fourth quarter impact and if it continues at this rate, maybe a 2003 impact.

Jim, do you want to take that one?

I'll take it. Jim, you know, the forecasts in fourth quarter, RCAF (ph), is to be about - just up a little more, I think, than 4 percent from the prior quarter.

Yes. That's great.

Which is the strike (ph) - in fact it's been negative or declined the first three quarters of the year. We clearly, our look at it is it affects about a third of our business, but you have to factor in caps in some of these. Some of the contracts that include in RCAF will limit the percent increase, which is mainly timing. You will still pick it up if RCAF continues to move up. So we see it as an opportunity. The numbers you had were a little strong for the immediate quarter, but it clearly is up side for us.

And this level of magnitude should continue into next year, given that we have - the labor contract's been signed now at least with the UTU and you're going to have four quarters of the benefit?

That's right.

Great. Thanks so much.

Thank you. Your next question is coming from Gary Yablon. State your affiliation.

Gary Yablon, First Boston: First Boston. Hi, folks, how are you?

Hi, Gary.

Gary Yablon, First Boston: A clarifying item, Dick. What you stated at the end of your presentation on having up operating income and up earnings does that include the impact on the ports that you mentioned, the five to ten cents?

Yes it does, Gary.

OK. Thank you. Other rail expense category, I guess, maybe for Jim, was much improved from the second quarter and I think it was better than what your guidance was on the second quarter conference call. Could you help us out with that a bit?

Well, I'm not quite certain. I did tell you that it was going to be a little bit higher as we've gone forward here.

You know, contracts play a part of this thing, volume plays a part. When I provide estimates on the other cost categories, we're probably a little more conservative. Again, next year I think you need to stick - when you look at this category, we probably need to stick around the 300-plus, 310 kind of range for this category.

OK. In terms of just a couple of brief ones more. Consolidated Freightways, would you have an incremental revenue guess, kind of an annual run rate of what you think Overnite would retain (ph)?

At this point, it would be purely Kentucky windage, we would hope north of 5 percent gain there, not just from revenue we'd pick up from them, but there should be a little bit stronger pricing opportunity there now too.

OK. So 5 percent more revenue and not all of it's volume? Some of it is price?

That's what he'd hope for, somebody with a little luck, a little north of 5 percent, but it's better to be conservative here on your calculations.

OK. Just finally, in terms of coal pricing, maybe for Dick or Ike, could you give us an update on what you're seeing on a go for ward? Not so much on the legacy business, but go forward?

We don't have any major contracts that come up next year so obviously, we're looking for opportunities to really - we're really focusing on the productivity side. A lot of the productivity that I talked about was driven by the distributed power, longer trains and aluminum cars. We're working with the mines and our customers to find ways to be more efficient in that regard. But Gary, as far as pricing the markets, that's pricing, you know, in that regard so I can't - I don't know how to respond any differently than that.

You're part of the market, so - but maybe if we go out a couple of years when do the next set of good-sized contract comes up, Ike?

Our next large contract is not for a couple of years. 2005, Gary.

OK. Thanks.

Gary, one thing I'd point out the pricing environment is tough. You know, it's very competitive, but we're continuing to improve yield on the coal business.

Right. OK. Thank you.

Thank you. Your next question is coming from Scott Flower. Please state your affiliation.

Salomon Smith Barney. Solid quarter, guys. Just wanted to ask a couple of questions. One was in looking at that customer satisfaction chart, and obviously you've steadily improved and that tends to be a leading indicator relative to some of the opportunities in the market, is there any kind of an asymptote (ph), I noticed the rate of change is starting to slow relative to the yearly improvements. I'm just wondering, obviously, the theoretical maximum is probably, you know, 100 or such. But what do you chink the pragmatic maximum is? The slope of the curve is that you were looking toward an asymptote (ph). I'm just wondering what are your thoughts? How much can you improve? What's the optimum? Et cetera.

I think it is somewhat (inaudile). I don't think we'll hit the 100 percent level, but we'll keep moving towards it, but, of course, the line will turn up and never quite reach the theoretical maximum. Now, Ike, you want to take it?

Scott, we do a couple of surveys, this is just one, where we go out monthly, ask our customers, you know, with what they think of our service. But we also go out with an annual survey, where we measure ourselves against other rails and against truck. And truck is in the 80 to 85 percent range so I don't think 100 is a game. I think, you know, 80, 85 is the game as we go about our yield strategy of - and our revenue opportunities of taking business off the highway, trying to provide truck-like services, not just in time, but it's just truck-like service and we think we can do that. As you start to approach 80 and get in that range, you're doing pretty good.

Then just a couple of other questions. Dick and I don't know whether Ike has a comment on this. The STB announced some new processes relative to shipper rate cases and my sense is some of that was related to being responsive to Senator Broe (ph) and some of his committee hearings about the arguousness (ph) of rate cases. Do you see any substantive effect to the changes that were announced over the last month or two?

I'm not aware of anything that would have any serious impact. You know, we are involved in trying to gather some clarification about how some of these rate cases should be progressed in some of the stand alone cost methodology addressed. I think it's an issue that's somewhat fluid, but I don't think that we see anything that's caused us any undue concern up to this point.

Scott Flower OK. And then just a couple of quick financial questions for Jim. Could you refresh us on what your - I know it may change, but what your 2003 hedge position is and, secondly, CSX paid some reclaim costs relative to car hire back a couple years ago. I don't know, 10 or 15 million. Did you receive that relative to a Contra expense this quarter? If you could help me with those two items.

On the fuel hedge piece, we're hedged five percent next year at right at 70 cents.

OK.

You know, when the numbers start to get a seven in front of them again we'll take a look at it. It has been moving down. In terms of the CSX car hire settlement. I have $800 million a year of car hire that comes through the accounts. In the settlement, there was 10 to 12 brought through over time. It was not visible to us as we looked in the whole scheme of things.

But, I mean, their argument on this quarter for them, and it's not respective to you is they paid 10 million to you. From a P&L perspective, you saw that over time as to when they necessarily paid it to you.

In fact, the net claims with CSX, you have both pluses and minuses when you looked at what's $2 million in the third quarter.

OK.

Again that's giving you a feel that it's really immaterial.

OK. Great. Thank you.

OK.

Unidentified; Thank you.

Appreciate your comments, by the way.

Thank you. Your next question is coming from John Barnes. Please state your affiliation.

John Barnes, Deutsche Banc Securities: Deutsche Banc Securities. Good morning, guys.

Hi, John.

Going back to the fuel hedge question, briefly, can you give us an idea of maybe your coverage, your hedge coverage on a quarterly basis into '03? Are you more covered in the first half or is it pretty evenly spread?

John, it's evenly spread.

)) OK. With the west coast port issues, some of the trucking companies and even some of your rail competitors have said that they've seen some other revenue opportunities as they've tried to be creative to help their customers. Are you seeing any of those opportunities that may offset some of the, maybe, lost revenue opportunities associated with just congestion and that type of thing?

Ivor Evans John, this is Ike, and the answer is we have not at this point in time.

OK.

What kind of other opportunities are they seeing? Maybe I'm missing an opportunity.

Just, you know, customers approaching them about, you know doing something a little bit unusual to make sure that their particular freight gets moved or maybe takes priority and be willing to pay up for it.

Now that you mention it, that kind of tickles the memory here. We are seeing improved opportunities. Ike, do you want to talk about it?

We went through that, John. We put together a program where we worked specifically with each customer. As a matter of fact, we meet every morning at 7:00 to go through where we are with the port, what the customer's particular demands and requirements are, who met them, who didn't and what we can do to keep things fluid and who we can help in special situations so we're very proactive and dynamic and looking at it daily.

One of the clearer results here, I mean, that we can point to that we've seen a number of solid train loads of vehicles move that are unloading in northern California that normally - that's wrong. It's Portland, Oregon, that normally the ship would dock in northern California. We're running train loads of automobiles from southern California to Portland, that normally would go directly to southern California by ship. So there are a few situations showing up like that.

But it all - it's just helping to mitigate, I would say, what the revenue loss was with the, about, two weeks of interruption that we went through. Having said that, you know, as I said, it's a very fluid situation. We don't know where we're going to end up exactly at the end of the year on playing catch-up here. However, as Ike said, as far as this month, our business that kind of fell off a Cliff early in the month and is rebounded very strongly since. We're running at almost a 191,000 run weight for the last seven-day period. So business has bounced back quite nicely.

OK. One of the aspect of the Intermodal business that has been weak all year has been 0 on the trailer side with the Consolidated Freightways failure have you seen a surge in the trailer or flat bed activity?

No. We're marketing trailer business. I thought we'd kind of gone through that with everybody. We're trying to discourage the trailer business, actually, and convert everything over to double stack, because it's so much more efficient and profitable than the trailer business.

John Barnes OK. And lastly, can you give us an idea of the ongoing tax rate? Should we expect it to get back to normal after the tax settlement?

I would use a 37 and a half kind of a rate, right between 37 and 38.

OK. Thanks so much.

Pretty tight range, Jim, for a finance guy.

Thank you. Your next question is coming from Jordan Alleger. State your affiliation.

Jordan Alleger, Goldman Sachs: Goldman Sachs. Just a question on the agriculture side. You showed some good offsets from a volume standpoint this past quarter. Just wondering, do you have an update on sort of the view there? My guess it may be a little - tougher, given the harvest. Curious if you can give perspective.

Our express lane service, which is an alliance with CSX, continues to be run lights out and be dynamite and we continue to take share. By the way, that is all incremental revenue, all off the highway, and gains continue to acceptance monthly as we pick up new customers. So that's what the offset of that is, and the reliability of that service, by the way, is in the high 90 percent. So we're tickled pink with it and it continues to work well.

The Green side of our business, Jordan, you know, as everybody's well aware, there's a drought out here in the Midwest, and while yields clearly, in some of our service areas, like Nebraska and Kansas, is going to be down substantially, it looks like Iowa will have a lights out harvest and Minnesota will have a very good harvest so there's pluses and minuses. I'd would just remind you we're not as dependent on export grain, perhaps, as you might be thinking. The majority, two-thirds or more of our grain is consumed in the domestic market. So while there's some headwinds clearly, as Ike said, there's some very nice offsets too and don't forget our business to and from Mexico has been a strong point for us.

We made a decision a few years ago to build our ag business around the domestic markets and just if we have an export market, it's up side, but our business case is built around the domestic market.

Great. Just one other question. Continue to do a good job on the materials side. Do you continue to see good momentum on that front, looking forward?

My answer is yes, as we continue to work with our supply base and find ways to be more productive with our suppliers and remove costs, we don't see material being - we basically see a flat going into next year.

Also, the modernization of our locomotive fleet has a lot to do with that too. We've had an interesting situation. Before we went into the mergers in the mid-'90s, Union Pacific had the best locomotive fleet in the world and after the mergers we had the worst and we've recovered again to where we're the best and our strong locomotive fleet is really helping offset some of those material expenses for us.

Thank you.

And healthy fuel expense too, I might say.

Thank you. Your next question is coming from Dan hemmy. State your affiliation.

Dan Hemme, Prudential Securities (ph): Prudential securities. Can you talk a little bit about what your expectations are for headcount in 2003 and what you're using for economic inputs really, with car load expectation?

It's too early to get into 2003. We're in the midst of the budget process right now. I will tell you this, that regard - are regardless of what happens to headcount, our unit costs will continue to get more favorable, our cost per unit of work performed. At some point - we're always going to be alert to operating more efficiently and where we can take advantage of technology or process improvement to operate leaner.

On the other hand, you're rewarded for good performance with business growth, which, in some cases, is directly related to how many employees you have to have to run the train, as an example. So you're not always going to be able to take head count down forever, but we'll be able to take unit costs down forever. That's what you should focus on.

Dan Hemme (ph): OK. Also, can you talk a little bit more detail or color about what is in the five to ten cent estimate? Is this pure revenue lost, or is there cost? What makes up that range of estimates?

It's essentially pure revenue. Although it's mostly Intermodal, we were impacted a bit on the automotive side, the chemical side, and the grain side. But Intermodal is the vast majority of that.

Dan Hemme (ph): OK. That's it. Thanks very much.

Thank you. As a reminder, if you do have a question, you may press 1, followed by 4 on your touch tone telephone at this time. Our next question is coming from Ken Hexter, please state your affiliation.

Ken Hexter (ph), Merrill Lynch: Hi, it's Ken Hexter with Merrill Lynch. Good morning and some great numbers out today. Just if you can talk a little bit about, I think, Jim mentioned some of the modal conversion on the truck side was down. Can you talk about what you're looking for as far as continued modal conversion from trucks? An update, also, on the pension adjustments. I think that was done last quarter down to 9 percent. Is there any kind of impact that was built into the numbers for this quarter? And can you kind of just do a little bit of detail on the tax benefit at Overnite to help us understand exactly where that came from? Thanks.

I'll let Ike talk about the modal conversion and Jim can talk about the pension and taxes.

Our focus, particularly with our car load business, is solely at taking business off the highway. And many of our new products and services, we've introduced some 34 of them, some of them are in conjunction with DNS and CSX and the CP and CN as well and some are entirely within the Union Pacific network, all aimed at taking business off the highway. Our objective is to expand our served market into a much bigger market than what we look at today. So that's going to continue, and with that focus we have to do that. I mean, the bulk business is there is more bulk business, but the opportunity for growth above industrial production is clearly going to be revenue that we get off the highway.

James Young (?): On the pension side, as you mentioned, we lowered our return rate from 10 to 9 earlier in the year. Let me give you a feel for what that means cost-wise. Every point is about $22 million of higher costs, which 16 is at railroad, 6 is at Overnite. We're sitting at 9 percent and the way things are going, we may move it down next year. So it's not a huge number for us. We factor that into one of the things we have to offset going forward. The tax side relates to the IRS has agreed to allows low us to deduct for tax purposes a small portion of the acquisition costs for Overnite. As you know, we wrote them off, we wrote the goodwill off in 1986 or 1998, I'm sorry. From the acquisition. But that still, the majority of it is not deductible until you have a disposition of the assets. So it's a small portion of the Overnite goodwill.

Dan Hemme (ph): Thanks, Jim. One quick follow-up, if I may. I want to understand, I think you said during the conversation that truck load was down three percent on the Intermodal? I just want to clarify that I got that right.

Our LTL premium truck load business is down. And that tends to carry the high - very high rate per car load or per unit. Part of that is shift into containers, as Dick said and part of it, the economy, if you kind of look at the core economy out here, third quarter, it's not been probably as strong as what we wanted.

Dan Hemme (ph): OK. That's great. What is your view on the afternoon market going forward? Should we see car loads, at least for this quarter, maintaining the same pace?

We see the fourth quarter from an automotive standpoint so far, as long as the manufacturers continue with the financing, to be fairly strong. The inventories are at relatively normal levels and I think that we'll see a decent run in the fourth quarter here.

Dan Hemme (ph): Great. Thanks, guys.

Thank you. Your next question is coming from Tom Wadowitz. Please state your affiliation.

It's Tom Wadowitz, Bear Stearns. Two questions for you. On the agriculture side, you showed the strong yield growth and wanted to see if you could tell me if you expect that continue. And further on the ag side, has the Mexico business come back - in my understanding was that there were some constraints on the ag business to Mexico, just because Mexico itself had a strong crop year this year. I'm wondering if that kind of kicks back in in fourth quarter and you get a bump up in volume.

Ike, do you want to talk about the yield?

We expect the yield in ag products to continue. Because in part of that is driven by, you know, express lane service, which is - brings in, comes in at higher margins than the core business. Mexico has picked up. I should have responded to Ken's question that Mexico is a huge opportunity for us in modal conversion as well and we're working diligently to convert from truck to rail and we're making great progress. As far as Mexico, we see normalized - we don't see any restraints at this particular time.

Our automotive business, to and from Mexico, as you may know has slowed somewhat, as the production facilities in Mexico have been curtailed so much to support production facilities in the U.S., but that's been largely mitigated by growth in other commodity areas coming in and out of Mexico.

OK. Another question for you, on the headcount side, I know you talked about this a little bit already, but on the second quarter, I believe, Ike, you'd indicated you were planning to hire 600 to 700 train workers in the second half of the year. I'm wondering if you've done that. And going forward, if it's fair so too assume that the headcount reduction in total would kind of slow down.

The - we have hired those 600-plus people. But you have to also keep in mind, we had over 400 attrition at the same time, with $6030. So - and that number, though, is we still will be down 2 percent at the end of the year.

The way you got to look at this is when Ike said attrition of 400, actually, by the end of this year, it's going to be a heck of a lot more than that. We will have attritted (ph) out 12 or 1500 people and only hired back two-thirds. So net, we're going to be way down due to the 60/30. 30 years service, retirement at age 60, it accelerated attrition which is exactly what we'd hoped for. And we don't have to replace everybody. So, you know, it's a great scenario, we're going to end up at the end of the year, with two percent less people than we had last year. You shouldn't be overly concerned about the fact - you ought to be concerned if we don't have to hire anybody, because that means business isn't growing. You really ought to not get hung up in the numbers, the net, net, we're going to be down 2 percent, year end.

OK. Great. And then just one last question. We've heard different things from the other railroads so far this week in terms of overall caution about the economy, but still seeing strength in certain segments. And I was wondering if you can give us a sense of that as well, if there are any particular segments that look strong? Does chemical still look strong and are there any areas that rolled over and got weaker?

I think most of our business, you know, it's hard to characterize it as strong except for some segments. The automobile business, finished automobile business just gang busters right now. Our lumber business, every quarter, has been a record that we're handling. Steel has finally turned up a little bit. Our construction materials, our aggregates and that sort of thing have been setting records every month. Our chemical business has weakened a bit from the second and third quarter. In the third quarter, we thought the reason might have been that we had one tropical storm and two hurricanes back-to-back that time came in on the chemical coast and clearly had an impact.

Thus far in October, we haven't seen the strength that we'd like to see. So there clearly are pluses and minuses. We do believe that the economy is off the bottom. If not where it was a year ago, it's somewhat better. But if anybody's looking for a V-shaped upturn, they're going to look a long time, because it's not there. It's very gradual, at best. The way we're trying to approach things is to get better and better service so we can convert more truck load business to the railroad and increase our market share that way and not just depend on the economy. We're trying to improve our penetration and trying to improve our pricing as well. So what we're trying to business position ourselves so that we're going to improve regardless.

OK. Thanks for the time.

Thank you.

Thank you. Your next question is coming from Jason Sidell (ph). State your affiliation.

Jason Sidell (ph): Independent. Nice quarter. Dick, you gave pretty good color on the west coast ports in terps of possible impact for the fourth quarter. Can we delve deeper and look to what percent of normal capacity are the operating at now and what percent does the five to ten current range aassume that they get back to or don't get back to?

I think you've already exhausted my knowledge. I think I'll lateral that ball to Ike.

We are running at normal, on a normalized basis. Our concern would be is that we did lose ten days, and to the degree we're cutting into the backlog. That's the question that remains and the wildcard out there. We don't know what the productivity capabilities are because we don't know how many people the ocean carriers, the steamboat guys have asked for. We don't get that, but we do know we're running at about normal train load levels, but we are concerned that whether we're cutting in the backlog. So if you don't cut into backlog you have a potential risk and that ten-day outage, how much of that you get back. And that's the $64,000 question, because potentially, the demand could show slow, or you lose ship rotation and those are things we don't know.

Jason Sidell (ph): OK. Thank you. And real quick, I know, Dick, you said you're not going to look out too much to 2003. I was wondering if you can give us maybe a range of cap ex?

We've said forever, put your model together, the easiest thing to do is use $2 billion. We haven't spent twit $2 billion for the past two years, but for planning purposes, that's a good number for you.

Jason Sidell (ph) Thanks, guys.

Thank you. Your next question is from scout Scott Flower.

Salomon again, still. Just a couple questions as follow-up. Dick, could you help us with where is the process on health and welfare relative to the UTU? I know there's a fact finding panel and agreement to talk through the issues and then there's some formalized end to that at which it goes to arbitration. Where are we in that process, and when does the timeline end? If you could refresh our memory on that?

Yeah, well, we're not into the arbitration phase yet, Scott. In fact, I don't quite know when it will start. You May remember that the TCU now has an arbitration provision as well. And I'm hopeful that bite end of the year, both of them will be nearing resolution. Because it is quite an important issue, as we all know. But there isn't a definite time frame nailed down yet, Scott.

OK. And then just one very quick follow-up, relative to Ike. I know as you talked about the customer satisfaction survey that you mentioned truck. Where does the rest of the rail industry stack up relative to that metric? I know that on the slide, it showed where you set up. Where does the rest of the rail industry show up relative to where you set up?

I don't think that would be appropriate.

I'm talking generically, not specific carriers.

I think what's more important is how we're doing in relationship to - because that that's our objective to provide truck-like service. We should focus.

OK. Maybe just directionally, or do you stand apart from the rest of the rail industry, without giving a number?

We're making great progress in getting to providing truck-like service.

All right. Thank you.

We're not there yet, though.

Thank you. Your next question is coming from James Valentine. Please restate your affiliation.

Morgan Stanley. Just a clarification on the pension, because obviously, no surprise. You're getting a lot of questions here. Obviously, the railroads don't have nearly the impact of many other industrial industries so I'm fully on board there. Some of the work we did a few months ago, I want to quantify, Jim, if planned assets in total were down at five percent at the end of the year and granted that is probably optimistic now, but that was a number we were using a few months ago, we assumed on a year over year basis you have $20 million of incremental costs. Because you changed the assumption rate, I'm not sure if it's flog through now or next year. If it's next year, it's a another 20 million. I want to get my hands around those numbers and see if they're realistic.

Our change in assumption rate is flowing through now.

Incrementally, it will be whatever the plan asset changes at December 31 impact on next year?

And if you lower your assumption again in '03. You know, you're at 9 percent now. If you go to 8 percent, you'll have to factor in some higher costs then.

Is it realistic if you were to do that, you'd do it on January 1, or would you wait until the year progresses?

We're going to take a look at doing it first quarter.

Sounds like you're pretty convinced it's going to happen so we should probably put it in our numbers.

Where do you think the market's going?

I'm with you. We have other companies out there at 10 percent or higher. I'm using that at the high end.

Yeah.

The other question was belt pack (ph). Nobody brought that up. I wanted to - I know it was in part of your implicit answer, you'll have productivity gains into perpetuity. We're looking at 50, 60 million of savings, it might be done by '04. I don't know if that's optimistic in terms of the number or timing.

Jim, we'd probably get it done by the end of '04, but your number probably is low in total. Be very disappointed if it's 60 or 50 million.

I'm using it as a net number. The gross number could be higher, 70, 80. Given that the Union employees are getting a shift differential. I thought it would be 50, 60 million.

I would hope the number would be higher than that.

Good, great. Thanks.

Thank you. Your final question is coming from Gary Yablon. Please restate your affiliation.

First Boston. Jim, just want to stay on the pension topic for a second. I apologize for that. Funding - funded status and percentage of funded as relates to the ARISA guidelines, are you well above the 80 percent threshold or floor, I guess?

James Young (?): Well, Jim, in '1 - the way the ARISA guidelines work today, neither the railroad or Overnite have to make a cash infusion this year or looks like even next year. We - my cash outlook I gave you here includes a cash put at Overnite for the pension. We'll gor to do one voluntary and we're looking at doing something voluntary at the railroad. Today, again, when you look at the recurrent ARISA requirements nothing is mandatory.

OK. So that meaning you're above the 80 percent?

Yes.

Now, my understanding is you can be below 80 percent if the prior two years were above and still not have to do anything. Is that correct?

You know, I'm not going - it varies here. And what you want to do, obviously, 90 percent, I think, if you're below 90 in two out of three years, you have to make a contribution, if you fall under 80 in one year, you have to a do a catch up. There's a penalty. The key is what the current guidelines follow. You have some relief from the tax payer relief act which year, which are really, again, dictate that no cash fundings required. We do want to get a head start on it.

OK. Understood. Thank you.

Gentlemen, we are showing no further questions in queue at this time.

We thank everybody for the positive comments here. It's nice to have a quarter like this. We'll see you again in 90 days.

Thank you for your participation. This concludes this morning's teleconference. You may disconnect your lines at this time.