聯合太平洋集團 (UNP) 2003 Q1 法說會逐字稿

Good morning and welcome to the Union Pacific's first quarter earnings release teleconference.

At this time, all participants are in a listen-only mode, and the floor will be opened for questions and comments following the presentation.

If at any point you want to register your question, please press 1 and then 4 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.

Thank you for joining us with in our first earnings quarter conference call.

With me is Jim Young, CFO and Ike Evans, President and COO.

I'll start with a few words about the first quarter followed by Jim for financial details and Ike for highlights.

Before we get started, the 2002 fact book is now available available at our website, www.up.com.

It has been in prior years, the fact book is only available on the web.

As we mentioned in our March conference call, the first quarter of 2003 was a challenge for us.

Our first quarter earnings totalled 60 cents per share versus 86 cents earned in the first quarter of 2002.

In March we explained that fuel prices was the main driver behind our short fall in earnings.

In the first quarter of 2002 our average price was 61 cents a gallon.

This year it was a $1.

The 39 cent increase translated into nearly $125 million of additional expense costing us about 30 cents a share.

We also incurred a one time expense for severance payment that added another $14 million to expense or another 3 cents a share.

In late March, a couple of saw severe winter storms hammered us in Colorado and Wyoming which impacted our coal operations and reduced our revenue for the quarter as well.

Our total earnings of $1.67 include the cumulative effect of an accounting change to adopt FAS 143.

Jim will walk you through the details, but this change did provide a one time addition of $1.07 per share to our share to our quarterly earnings.

In a business like ours, there will always be external factors that are beyond our control.

Accepting that, we've always focused on managing those things that are within our power to control.

Such as productivity, quality, and customer service.

Once again, our productivity improved this quarter to a new first quarter best of 5.2 million gross ton miles per an employee.

A 3% increase over last year's level, and extends our more than five year streak of productivity gain.

I'm particularly pleased that we saw this improvement given the first quarter operating obstacles and minimum growth and gross ton miles.

Our dedication to process improvements, technology, and quality has enabled us to sustain our progress in this area.

Our cost to quality measure also showed great improvement in the quarter.

With over a 1 point drop from 2002 level we continue to shrink our failure cost and we're making great progress towards our long-term goal of being in low single digits.

The obvious connection here is with our improved customer satisfaction.

Our first quarter customer satisfaction index had a new record level in the quarter and is further proof our quality processes and mind set are delivering positive results for the company and our customers.

Looking back at the quarter we can point to several positives.

In a difficult business environment, we grew our rail revenue almost 3%, achieved carload growth in four of our six business groups, and revenue growth in five of six.

Keep in mind, that growth came despite revenue loss due to coal inventory adjustments in several severe storms.

Our industrial products: automotive, the inter-motor business teams, each had record first quarter revenues.

Industrial products saw continued growth in steel, paper and lumber while auto showed growth in both finished vehicles and parts.

In addition, inter-motor overcame the effects of softer domestic demand and some lost business to achieve a record performance.

Overnight had strong growth in quarterly operating income with a 20% increase.

Leo Suggs and his Overnight team are doing a terrific job of revenue and capitalizing on opportunities created by the closure of a major competitor and improving productivity.

The combination of their quality commitment with consistent on-time performance is translating into improved bottom-line results.

On the other hand, the railroad was impacted by high fuel prices.

In fact, our quarterly average of more than $1 per gallon had been surpassed once before in our history, and we saw spot prices reach all-time highs.

So it truly is an exceptional occurrence and one that hopefully will -- won't repeat itself anytime soon.

In any case, we do recognize the need to match changes in rates to changes in fuel prices on a more timely pool.

And we have our best minds working on the solution to this.

Ike is going to talk to you more about the winter storms.

Let me say, the February storms in the east and the March storms in Wyoming and Colorado really added an extra challenge that hindered our performance for the quarter.

We do have winter every quarter, so I hate to lean on that too much, but when it comes in large batches like it this, it is difficult to overcome.

Finally, we did see the economy become softer as the quarter progressed.

In total, the first quarter of 2003 was not what we anticipated or wanted it to be, but at the end of the day difficult conditions like this will make us a better and stronger company and will set the table for the period in front of us.

With that, let me turn it over to Jim to take you through the financial performance.

Jim?

Thanks, Dick.

Good morning, everyone.

We'll start with the corporation's consolidated income, total operating income of $381 million was down 24% compared to the same period a year ago.

I'll cover the individual results here in a minute with Overnight and the railroad.

Other income of 13 million declined almost 40% here year over year.

As we indicated last year when we were looking forward to this year that, you know, the run rate in this line item will be 10-15 million a quarter as a result of lower real estate sales.

We don't have any large sales on the table at this point.

I'll give you an outlook for a second quarter here in a minute.

Interest expense down 12 million or 7% and reflects continuing progress of reducing our debt.

In fact, our average debt levels were down $500 million compared to a year ago.

Tax rate for the quarter at 36.4 compares to 37.8 last year.

Property donations plus foreign tax credits associated with our Ferrilmax investment drove that rate lower.

You should still plan on around 37% for the year.

Net income before the accounting change at 155 million, its down 30%.

FAS 143.

I'll talk about it in a minute, but it does reflect adoption of an accounting standard for retirement obligations.

And then our diluted earnings per share of 60 cents before the accounting change.

Now, that does not include the dilutive effect of Tides, 21.8 million shares.

That's not in the 60 cents or the $1.67.

Take a look at other income.

The chart shows you our first quarter results year over year, and that provides your outlook for the second quarter.

Right now if you look a year ago we reported $35 million pretax in other income.

We add large property sale in Vegas that was worth 25 million.

Our outlook for second quarter of this year shows that other income actually will be a negative $5 million.

And you can see the components there that we will have real estate sales in there around 10.

But that's also where we will record the $15 million cost for the redemption of Tides.

We still expect third and fourth quarter to be around 15 million each going forward.

I'll take a minute here and talk about the accounting change as we talked about it here about a month ago on our announcement, relates to retirement obligations here on removal costs.

There is a one-time impact here.

The income statement impact is $1.07 a share.

That will be 99 cents when the year is out because of the -- we did not include the convert in the dilution first quarter.

Balance sheet impact which you will see is the -- increase in our assets, properties will be written up and then also an increase in shareholders' equity..

There is no cash flow statement impact.

The ongoing impact you will see a depreciation costs down, material supply costs down, and there will be offset by increases in salary and benefits and other costs.

Overall, it is about a wash in terms of the ongoing impact.

It was a slight benefit in first quarter.

About $5 million pretax, but will likely fluctuate depending on the track work and the seasonality of the work.

Second and third quarters are peak times for track works, so we'll see greater effects of labor and material costs in those quarters.

Take a look at the railroad's revenue results for the quarter.

Ike will provide more detail here in a minute.

Overall commodityrevenue up 2% with five of the six business groups showing growth.

In fact, three groups set all-time records.

If you look at industrial and automotive, and inter-motor.

Average revenue per car up 2%, with five of our six business groups showing increases.

The increase reflect both price and favorable mix.

About 2/3 of the increase in arc is associated with price, the rest mix.

Fuel surcharge revenue for the quarter totaled about $15 million.

You also note if you look on revenue-per-revenue-ton-mile basis we even showed strong results there.

It was up about 3%.

Take a look here at operating results at the railroad.

Total operating revenue increased 3% for the quarter.

We had about a 12%, 13% increase in other revenue primarily in our UP logistics group, they had nice growth this quarter.

Salary and benefit costs were up $52 million or 6%.

Even though as you'll note on the chart, our overall employee counts decreased 2% or a thousand positions.

Take a minute here and I'll help you understand the increase in labor.

The chart shows on the right our employee count trends for each quarter.

Again we had the reduction we committed to.

It should hold for the rest of the year.

On the left it shows you our labor costs.

If you start with a year ago at $913 million, we had inflation, about $19 million, that's 2%, our productivity, reduced costs, $28 million.

Productivity is about 3%.

So those together before you get into some of the more unusual items which show our labor costs down 1% year over year, FAS 143, added $28 million in costs.

Again. that will be offset by reduced depreciation.

Protection pay jumped $18 million for the quarter.

As you recall we talked about this here last year that we will see our overall protection -- labor protection costs increase about $60 million this year.

And if you'll remember, our reserve we established when we put the SPUP together and ran out here last year, and we are taking the costs to operating expense.

The good news here is while we have the increase, you will see this fall off very quickly over the next three years.

It will fall off in thirds.

And then severance added $14 million to our costs in labor.

You recall we had given an outlook of about $45 million of costs.

What happened here, really it is a good news story, we were able to get the positions reduced at a much lower costs.

We had greater attrition, plus the average cost on the buyouts were were a little bit lower.

We should see, potentially, another penny or two in terms of severance in the second and third quarter.

Let's go back to the operation side of the railroad.

If you look at rent expense, it is down 2%.

Primarily reduced lower lease rates and improve cycle times.

Depreciation costs, down around 3%.

Other's two drivers: the accounting adjustment FAS 143 reduced depreciation $23 million.

That was partially offset by increased depreciation by $14 million as a result of our capital programs.

Fuel is a big driver, up 56%.

Take a minute and talk about fuel.

The chart provides the first quarter fuel price comparisons showing the 61 cents a year ago to the dollar.

It is $125 million increase in fuel costs.

Our outlook for the second quarter is volatile.

A year ago we paid an average 72 cents for the quarter, and so far in April we have averaged anywhere from 85 to 90 cents.

In fact, in the last about week it has fluctuated almost 6, 7 cents.

Yesterday, costs were down at the lower end.

But right now we are planning for our fuel prices to be on the high side in this range.

If they hold at the 90-cent level for the quarter that would add another $60 million to our costs in second quarter.

Full year outlook is still pretty tough.

Futures markets today are indicating around a 25, 26-dollar barrel crude.

But again, very volatile.

We'll see what OPEC does today.

Back to the operations side for the railroad, if you look at materials and supplies down, 15%.

About 2/3 of that reduction is associated with the accounting change.

The balance is overall reduced spending in terms of spending in terms of materials.

Purchase services and others where we had the largest increase, up just under $50 million.

There are four or five items that drive that.

We had increased locomotive costs on contacts, about 10 million, inner mobile drage cost is up about 11.

Part of that is related to higher fuel cost.

Our insurance cost were up around 10, state local taxes up 7, and then the FAS accounting adjustment added $3 million.

Put it altogether and revenue up 3, cost up 9, total operating income debt around 25%.

Our operating margin deteriorated about 4.9 points.

If you look at fuel and severance alone, that cost us 5 points on the margin.

Take a quick look at Overnight.

As Dick said it had a great quarter.

Total revenue up 10% on 5% volume.

Now, their fuel surcharge accounted for about 2 points of that growth.

So taking the fuel charge out, Overnight did a good job of getting their yields up for the quarter.

Salaries and benefits up 8%.

About half that is volume.

Half of that wage and benefit costs.

Rents had the largest increase, 20%.

Again, what they are doing there is using more contract -- outside contract work in terms of handling the CF business.

You will note fuel up almost 50%.

That was offset by their fuel surcharge.

In total, Overnight revenue up 10, cost up 10, operating income up 20%.

You also note, they add tough quarter with weather, and if you live back in the east I know we battled through a tough first quarter.

Very good results.

They in fact were able to keep their service levels still high at 97%.

And also were able to improve the margin by.30 of a point.

Cash flow, cash from operations down around $10 million the same time a year ago.

This includes -- we put $70 million into our pensions here in the first quarter.

So without the pension we add good increase in our cash flow from operations.

Cash use for capital and other was down slightly around 12 million.

It does include a $96 million dividend from Ferrilmax.

It is our final installment.

As you may recall we pretty much declared a dividend last year, and we finally got that cash.

A great new story.

With that dividend and we now recovered 90% of our original cash investment in Ferrilmax.

Dividends paid up 8 million.

It reflects the increase in the dividend that our board approved. 15% last year.

So free cash flow is a use. 196 million, about the same as a year ago.

We still are a target for our goal here of 4 to 600 million dollars of free cash flow for the year after dividends.

A quick comment on the converts.

As you -- hopefully you have seen that we are going to call a portion of our converts.

I want to remind you, we have $1.5 billion of a converts on our books.

That has the impact of diluting -- dilution around 22 million shares or 8%, annual interest costs around $94 million.

We will redeem a third or $500 million here on May 16th.

It will save us $31 million in interest, and we'll increase our EPS by about 3%.

One-time costs, 3 cents in the second quarter.

The remainder of 2003, with the redemption should be a 4 cent per share benefit.

Then next year the full benefit is 12 cents.

That completes my review and I turn it over to Ike.

Thanks, Jim.

Good morning.

Although our first quarter was a difficult one for us, we did rise to the challenge and delivered solid results.

First quarter revenues for our six business teams grew 2% or nearly 60 million.

Five of the six groups had year-over- year gains and in total it was our best quarter performance.

On the surface, 2% commodity revenue growth was disappointing, but when you consider it came after offset ago softer than expected economy, the continued affect of some lost inner mobile business, and more than $20 million short fall in energy revenues over last year, the strength of our franchise and our revenue diversity really remains evident.

As Dick mentioned earlier, a couple of winter storms had a significant impact on our first quarter revenues and operations.

In mid-February, our eastern partners were hit with a storm that affected their operations and their ability to interchange traffic with us.

During the first quarter, received about 2500 cars and containers from the CSX and NX every day.

However, during the two weeks following the storm we saw our on-line cart inventory drop by 6,000 cars as equipment was held by the eastern roads.

Our March carloadings were turning up and it surpassed 2002 levels.

Then on March 18th, a major winter storm hit the southern basin as well as our Colorado coal operations.

And that storm was followed by a smaller storm about a week later.

Together the two storms took about 70 coal trains out of our first quarter revenues or about $10 million.

There were also additional costs associate to the storms such as extra cruise fuel and lodging expenses.

The good news though is winter is behind us.

And the moisture provided by some of the storms could actually benefit us at harvest time.

Looking at each business team, industrial products revenue was up 8%, a 5% increase in carloadings.

This business team continues to do a great job raising prices and increasing yield.

Steel, paper and lumber had strong quarterly gains, but we also had good growth in scrap and non-metallic metals, and not surprisingly, government shipments nearly tripled in the quarter.

Looking at the rest of the year, we would look for overall growth in this area.

Consumer goods such as appliances will likely be slow in the second quarter as consumer spending has tightened.

We would, however look for a significant pick up in our stone and cement business as road construction and similar infrastructure projects pick up.

At least in the near term we expect continued growth in government shipments.

Our automotive growth recorded another great quarter with revenues up 7% on a 7% increase in carloads.

Although in total, our average revenue per car arc was flat in the quarter, separately, both finished vehicles and parts had good arc improvement.

But given the nearly 19% growth in parts revenue, the positive pricing we saw in both areas is not reflected in arc, it was offset because of mix.

Our efforts to gain market share from trucks continue to gain momentum.

Working with our alliance partners we are moving parts that were once moved by truck out of Mexico and Detroit.

Additionally, our service on finished vehicles continued to be recognized as we are again named the supplier of the year by General Motors and received the president's logistic award from Toyota for the fourth straight year.

The outlook for rest of the year is mixed.

The big three continued to stimulate sales with other growing incentive programs, but auto production will likely be down year after year as auto inventories grow.

These production cutbacks will make it difficult for to us match last year's finished vehicle volume.

But we expect to see strong year over gains in auto parts.

We continue to leverage our auto network, taking share from truck with parts and finished vehicles.

Parts alone could account for 40 to 50,000 additional truck conversions this year.

Inner mobile revenues were up 2% on a 2% increase in car loadings.

Although international revenues were down slightly year over year, our domestic business had solid growth.

On the international side, we had lost business, but lost the business to offset and one of our customers lost a contract late in the year that impacted first quarter volumes.

Domestically volumes improved as we took trucks off the highway, but demand was flat as consumer confidence weakened throughout the quarter.

We would expect to see inner mobile strength during the year as the international market grows and we identify new domestic business opportunities.

As shown by our 7% domestic growth in the first quarter we are attracting new customers despite an uncertain economy and we expect the trend to continue.

Chemical revenues were up 2% on a 1% increase in carloadings.

Growth in this sector came primarily from fertilizer and soda ash.

Offsetting this growth were OPG's which were down significantly, as scarce gas supplies were used for heating versus chemical production.

And plastics were also down year over year as plant production slowed.

The outlook is very dependant on the economy and fuel prices.

Natural gas and crude prices have subsided from earlier highs, but the chemical industry remains under stress from increased export competition, surplus capacity and fee stock prices above the norm.

Despite, this we continue to look for barge and truck conversion opportunities.

For example, we have recently begun teaming with Transflow's internal network with the economics and safety of UP rail service to reach new customers.

And we'll continue to expand our pipeline service, improving asset utilization for our customers and ourselves.

Agriculture product revenues were up 1% on a 1% decline in volumes.

A very good news story from a pricing perspective.

Key areas of growth in the quarter of ethanol as well as canned and packaged foods.

Shipments of fresh fruits and vegetables from California were up nearly 120% from last year and wine carloads were improved by 60%.

Weak demand for fresh potatoes and frozen freedom fries held back our cargo of growth somewhat and last year's poor wheat crop continues to be a factor in our grain carloads.

Additionally, grain volumes to Mexico were impacted by delay in issuing new QPO's and a change in the QPO expiration dates.

Looking at the rest of the year, express lane growth should continue, but the soft fry demand we experienced in the first quarter will likely remain.

Our grain volume should also pick up.

QPO's have been issued for the remainder of the year.

Domestic feed grain business remains strong, and we currently expect a good wheat crop this summer.

Energy revenues were down 4% on a 4% decline in carloadings.

We knew January would be a tough month since last January was our best month ever in terms of trains per day out of the basin and total carloadings.

February volumes improved and the first few weeks of March were over a year ago.

But then the winter storms impacted our volumes.

Carloads were also impacted by utilities adjusting their coal inventory levels.

Demand is good, coal stockpiles are low, and in some cases too low, and the national weather service is predicting above normal spring and summer temperatures over much of the states.

Dick talked to you earlier about our continued productivity success.

A key contributor to some of our gains has been the implementation remote control or RCL.

To date we implemented RCL in 13 locations.

This year we will introduce RCL to 26 new locations using 6 training teams and a schedule that will allow to us fully implement in early 2004.

In addition, there is a new RCL supplier in the market place enabling us to optimize the capital dollars allocated to this project.

With each implementation, we are working smarter and benefiting quicker.

We've also made great improvement in three major safety areas shown on the slide.

Compared to the first quarter of 2002, reported injuries have declined 24%.

Derailment costs are down 20%.

Grade costing accidents are also down 20%.

These improvements can be traced to the efforts of Dennis Duffy and his team.

They used six key questions in their daily operations.

The first question is, Do we have a safety plan?

And the last question is, Did we do it safely?

This mindset is at the forefront for every employee, and even one accident is too many.

Operationally we continue to improve.

We know that customers require consistent, reliable performance, and that means running the train on schedule, putting the right cars on the right train, and switching cars into and out of industry yards as committed.

It also means maintaining the fluid system as illustrated by our recrews rate.

Three of the four measures reached best ever levels in the quarter.

Recrews being the only exception, but the 4.4% recrew rate was a first quarter best, so we are doing better on every front.

We recognize that one of the keys to getting additional business off the highway is service reliability.

In addition to the operating measures shown in the previous slide, our service delivery index finished at an all time best in the quarter.

But what really counts is how customers view our performance.

And our customer satisfaction index also reached a best ever level in the quarter.

March's rating of 83 was the best ever single month score.

As customers gain confidence in our ability to meet their performance expectations, they are more willing to ship premium products at a premium price.

Shipments that are time sensitive such as auto parts are finding rail service more attractive, and we continue to expand our product offerings reach to a growing customer base.

In February, we announced the expansion of our blue streak service with Norfolk Southern connecting northern California and Nevada with destinations on the east coast.

We also announced the expansion of our passport service into Mexico, a joint rail and truck move with CSI.

Offering these products in the market place is dependant upon our ability to deliver them.

And we're proving that we can.

Looking forward, our first quarter successes position us to help drive further performance gains.

Our franchise strength and revenue diversity helps us grow in a difficult environment.

The introduction and expansion of new products will allow to us keep growing and keep reaching new customers.

Our commitment to our customers is evidenced by increased levels of satisfaction and service.

As we continue to improve the reliability of our operations, customers are becoming more comfortable riding rail versus riding the road.

And our focus on productivity and quality remains unrelenting.

Taking it together, that's what sets us apart, and that's what will help us succeed.

With that, I turn it back to you, Dick

Thanks, Ike.

I'd just echo what I said about the overall state of the railroad.

It is in great condition.

Ike gave you an idea of some of the opportunities ahead in 2003 for our business teams.

We feel that we are extremely well positioned to leverage our operations with increased business as the economy gets well.

The real wild cards continue to be the timing of that recovery and where fuel prices are going.

Many of the recent economic indicators continue to paint a flat to weakening economic picture.

Given that backdrop we would expect to see second quarter growth in our rail revenue of about 3% with some upside if the economy would pick up steam.

This growth will come most likely from a mix of results within our business teams.

On the minus side, auto production forecasts have been cut and the chemical industry continues to be impacted by slow demand and high feed stock prices.

On the positive side, we would look for both the industrial products and energy to be at the higher end of our growth potential.

We would also look for continued growth from Overnight trucking.

Despite growing revenues, we will likely see a decline in our second quarter operating income as fuel prices remain significantly above last year's quarterly price of 72 cents a gallon.

As Jim mentioned, we also expect roughly 3 cents of one-time costs associated with the partial redemption of our convertible preferred security.

With you will all these factors added together, it is unlikely we will be able to match our 2002 earnings of $1.15 a share in the second quarter.

But assuming fuel prices remain at present levels, we do expect to be able to report earnings that are somewhat north of the $1 share.

Looking beyond the second quarter of 2003, the outlook becomes even more uncertain.

High fuel prices and economic weakness in the first half of the year make it unlikely that we will be able to attain our original 2003 goal of 5 to 10% growth over 2002 core earnings of $4.30 a diluted share.

However, it is really too soon to know how fuel and the economy will play out in the second half of the year.

We're hopeful that consumer confidence will be restored and fuel prices will return to normal levels, but we really need to wait and see how things progress.

So stay tuned.

We'll try to give you a more complete picture at our midyear report.

We remain confident, however, that despite some of these challenges we will reach our free cashflow after dividend target of 4 to 600 million.

In the months ahead we will continue to focus on the things we can control to make Union Pacific a stronger company.

Our yield strategy, quality programs, productivity improvements and better service to our customers.

Our cost of quality, customer satisfaction ratings and many of our operating metrics are our best ever levels.

However, there are still huge room for improvement going forward.

And with these strong fundamentals we are well positioned to take advantage of the opportunities ahead of us as we strive to be a customer where our customers are proud to do business, our employees want to work and shareholder value is created.

Before we take questions, I'd be remiss if I didn't pay tribute to the men and women of Union Pacific that have been called back to the armed services to serve in Iraq to help protect our freedoms.

Union Pacific currently has over a hundred employees called to active duty.

We're committed to making sure those individuals don't suffer financially as a result of their service to the country.

In fact, Forbes magazine recently recognized UP as one of the 10th best employers in the nation for reservists.

More importantly, we're hopeful they will all return home safely and soon.

With that, we would be happy to take the questions.

Emma?

Thank you.

The floor is now open for questions.

If you do have a question, please press the numbers 1 followed by 4 on your touch tone phone at this time.

If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key.

Once again that, is 1 followed by 4 to register your question at this time.

Our first question today is coming from Scott Flower of Solomon Smith Barney.

Please go ahead with your question.

Good morning, gentlemen.

Just a couple questions, one is, I'm trying to get a sense, if you look at inner mobile and understanding you have puts and takes in the international side due to contracts, is there any sense that some of what's going on in baseline demand is being pulled forward due to the fairly substantial May 1st pricing increases being announced by the container shipping companies?

Scott, that's a good question.

We have tried to sort that out and really haven't been able to come up with a definitive answer.

Clearly there is probably a little bit of that, but I'm not sure how much, and we still think though that with what we're doing as far as the business opportunity that's we're pursuing, taking business off the highway that we still feel bullish on what we could do inner mobile for the rest of the year.

I know you laid out data, but I think they were in trucks off the highway.

How much of an offset truly can some of the auto parts conversion be relative to the -- to some of the softening on the aggregate production on the set up autos?

I don't know if you use a 3 for 1 conversion or what ratio you use.

When you look at automotive is there a potential to being flat relative to production on setup of autos by virtue of the auto parts conversion or because they are lower rated per unit that you are not going to be able to quite offset the declines in set up auto production?

Scott, I think that depends on, you know, what the finished vehicle numbers end up.

We're still thinking that the industry will be in the 16 million range, and with that, with the opportunities that we're pursuing on parts coming off the highway, we'll more than offset where we were last year.

Okay.

And just --

Let me add to that on the auto parts, you know, we're up 20% on parts, but that is a modest beginning compared to what the potential market is out there.

It is a huge market, and I think as we prove our service levels and attractiveness to the consumers and producers, I think for years to come that can be a great driver for us.

Don't you think?

Yeah, we had a real mindset to overcome when we first started with parts, just in time, in line sequencing, lean manufacturing all meant truck.

And we have clearly proven with the reliability of our service that we can provide truck-like service and the parts manufacture -- not just the OEM's but the parts manufacturers are recognizing real economics and we are very bullish and have very aggressive growth targets on the automotive parts side.

The leverage of this automotive network we have.

Two other quick questions, one, are we primarily done relative to the head count reductions you are going to take on the G&A side in first quarter?

I guess the target was to get a lot of those, as much as you could into one Q. And the other quick question is, if I missed this, forgive me, could Jim give us an update on where you are on hedged position?

Has that changed at all?

I think last I recall it was in the 7% range.

I didn't know if there has been opportunity to bump that up.

Why don't you just take it all, Jim.

Scott, we'll see more in the head count reductions.

There is maybe another penny or two in severance cost.

But we're still year over year looking to be down 2%.

We have not added to our hedge position.

We are 7% hedged at 72 cents.

We are looking really here 405 right now, and we're going to start to get close and take some positions.

Have you done anything for '04 yet or no?

No.

Okay.

Great.

Thanks very much.

Thank you.

Our next question is coming from James Valentine of Morgan Stanley.

Go ahead with your question.

Good morning, guys.

Good morning, Jim.

I had a few questions here.

First, Jim, I guess there was only one number in the expense item that's came out a little higher than we were thinking.

In fact, quite a bit and it was the other expense.

Did you a good job of breaking it down, as 40 million of these break out expenses that you can identify.

I'm trying to understand if at 364 million in purchase services and others is for some reason a new runway rate or basically how much of this 40 million of inflation you talk about is not going to continue to recur in the following quarters?

Jim, that runway will be around 360 or so.

We had actually said that in fourth quarter numbers.

You know, a couple of those items in there, when you look at insurance or you look at state and local taxes, that was up about 7 or 8 million dollars.

Those can vary quarter to quarter.

But for the run rate, the 360 is the right number.

Okay.

The second question was on relationship with TFM.

If KNC Southern gets control of TFM, it has made no secret over the years it would like to see a greater number of the carloads coming north at Laredo, run further north on its line as opposed to Union Pacific.

I can wondering if you could walk us through whether it is the way the customers can operate in terms of making decisions, their authority or any kind of legal issue or anything else that basically you you can use to your advantage to make sure that there is not a natural migration over to their system once the business comes north of the border.

Jim, this is Davidson and I'll answer that.

As you well know from a route standpoint, when you look north of the border, Union Pacific's route, pick any point you want to, Chicago or Kansas City as origin or destination, we have a 40 or 50% natural route advantage in terms of mileage, curvature, rise and fall and the other physical characteristic and a lot better railroad.

We have a high speed railroad where we can provide excellent service.

Furthermore, the majority of the traffic is locked up under contract.

So you take into account the service capabilities, the fact that much of the traffic is locked up under long-term contract or intermediate long-term contract and plus TFN has got to have a strong traffic flow to and from Union Pacific to make money.

We are the 80% market share participant there.

But they have traffic going let's say to Chicago and onto Detroit or somewhere for the auto industry.

Is it feasible they would say after the transaction is approved, we're going migrate this business to our line to get it up to the midwest, Chicago and beyond?

To the extent it is server sensitive, I don't see how that could possibly happen since we have seen that it wasn't service sensitive and have to have the price low enough to.

If you had low bulk commodity that was not service sensitive perhaps they could price low enough to attract it, but you know, we worried about that quite honestly in 1996 when TFM was conveyed to TMM and KCS and it turned out to be something not to worry about.

We became quite good business partners down there and I would anticipate that would continue.

Okay.

Great.

Great.

If I can just ask one last question on coal.

There was a meeting among the railroads, coal -- coal mines and utilities recently regarding the expectations for full year for coal growth, and my understanding is they had went from having a 1% growth expectation up to 2.5 to 5.5% growth expectations.

And since the first quarter was down 4 1/2 that implies a very strong rest of the year.

Burlington Northern made a comment earlier this week they just don't see the high end of the range.

They think this is closer to the 2 1/2.

Do you have any kind of view on where that number my shake out eventually after a full year?

We agree with the Burlington Northern.

We think it is at the lower end as well, Jim.

So it is in the 2.5 3% range probably.

Great.

Thanks, guys.

Thank you, Jim.

Thank you.

Our next question is coming from Tom Wadewitz from Bear Stearns.

Please go ahead with your question.

Hi.

Good morning.

I have a couple questions on revenue side.

You talked about some of the concerns in a chemical's area.

I wonder if you could give a few further thoughts on that and just give as you sense of what your customers are telling you if gas prices stay in the $5 to $6 per million BTU, do you think things get worse over time and there is risk that some of that capacity gets shuttered?

And also have you seen any evidence that imports have increased to, you know, potentially also as a result of the feed stock issue?

Hopefully, Tom, it won't get any worse.

I mean, our chemical customers have been under some severe cost pressures because of the high feed stocks.

But, actually, their inventory levels are at all time lows.

Our sit capacity is lower than it has ever been, so with any kind of pull at all, it will flow.

There is not inventory sitting out there.

I think our chemical customers have done a great job on working on their cost structures and they are lean and they are ready.

Hopefully it won't get any worse than it is.

As far as capacity, I think they have gone through the bulk of the capacity rationalization, at least short term wise, that we're going to see in the next year or so.

There are one or two bright spots if you look close enough.

Such as soda ash.

Our soda ash shipments has been relatively strong.

And some of our liquid products have been fairly strong.

Plastics has been the real notable weak spot.

That's right.

And then a question for you on the auto side.

I know you have got the additional GM business and it flows a certain way and you had been talking about potential for back haul business, is there over the next year do you have any optimism on opportunities to increase that back haul business, or is that something we really shouldn't be looking for?

No, I wouldn't say over the next years.

I would say this year.

We continue to work with the auto manufacturers looking for opportunity and we have identified some.

And that's why we are still bullish on our auto business that we think we have not only just some part side but back haul opportunity that's we are not in a position to really discuss at this point.

Also, rental returns.

Really, having a huge auto network like we have is presenting us with unforeseen opportunities that we've got a great opportunity for back haul and for leveraging our network and I think over time you will see solid results.

We have changed the relationship with our auto customers.

With the long-term agreements we were actually involved to more of a partnership and they are looking for ways to leverage our auto network because they know the advantages they get from that as well.

We turned it into a real win-win game both for ourselves and for our customers.

I mean, is it fair to say you are more focused on existing relationships as opposed to new contracts and just kind of leveraging existing relationships?

Well, --

I would say it is a degree of affection.

We love them all.

We have -- Tom, as you know we have the bulk, the majority of the business.

So to a certain degree, yes, it is.

But each one of those customers, there are opportunities and we are pursuing those.

Okay.

Last question for you, on the yield side, pretty strong yields.

Can you give us any sense of how much of that is mix and how much is price and also whether you think that's a type of yield growth that is sustainable throughout the year?

I know you all forget the boost RCAP in second quarter, so that should help out.

But just a sense of how stainable the yields are throughout the year.

Well, as Jim mentioned, the 2% arc, about 2/3 of that was price.

And the rest of it was -- 1/3 was mix.

We are committed to getting a point of price.

We don't see anything at this point in time -- and I'm talking -- you know, that will change that.

A point of price, net of fuel and fuel surcharges and RCF.

Okay.

Great.

Thanks for the time.

Thank you.

Our next question is coming from John Barnes of Deutsche Banc Securities.

Please go ahead with your questions.

Good morning.

Hi, John.

Can you elaborate first, a clean up question, Overnight, revenue was up about 10%.

I don't think we have rolled over on the acquisition yet.

How much of that was organic and how much -- do you have a feel for that?

John, we have rolled over.

We acquired motor cargo in November or December of '01.

So we have lasped the cycle now.

My apologies for that then.

So it is all organic.

Obviously there is a CF pick up there, but you know their performance was absolutely golden when you factor in how severe the eastern United States suffered due to this tough winter condition.

So it is all organic growth and their performance just gets better and better.

Thanks.

Sorry about that.

Can you elaborate a little bit -- I know you made comments about trying to further penetrate your commodity mix with fuel surcharges, you know, on the commodities that are not covered under RCAF.

Can you give us a picture on where you stand in terms of how much of your business outside the RCAF business is under a fuel surcharge?

We think 45% of our business that we have the opportunity for -- to recover with fuel costs, higher fuel costs with fewer surcharges about 45%.

Okay.

Lastly, can you talk a little, Dick, on there have been some comments that a couple shipper groups, three shipper groups have all come together to support a shipper, Friendly Legislation up in DC.

I was curious as to your take on anything on the legislative front, especially as it, you know, surrounding pricing.

It is an interesting question.

You know, several years ago, the same group was out there.

Maybe not all operating under one banner, perhaps as they are today.

But the scenario years ago was bad service was creating the need for additional rail-to-rail competition.

Of course that Trojan horse died because we're giving excellent service today and essentially I think the whole railroad industry is.

So they are no longer talking about bad service creating the need for more railroad competition.

It is price.

So they frame the question somewhat differently.

So I guess what they will go into congress and say, "congress, you need to vote shareholders of these huge companies additional income at the expense of the railroads".

At the end of the day, I don't think it holds water.

I don't think any rational person will say we need to disadvantage the railroads to the advantage of these huge, huge companies that are coming in here asking for relief.

So, you know, it is something we always have to stay alert to because there are a few people, and you shouldn't, John, in any way think that all the shippers under the definition of one commodity group favor this.

It is just a few customers in each group that are pushing this issue and it is probably the same one that's have been pushing it for the last 10 or 15 years.

It is something we stay alert torques but at the end of the day, the argument doesn't go well.

Anything else on the legislative front?

Yeah, absolutely.

We are in great hopes that maybe we will have some success with the fuel tax repeal.

As you probably know, the senate and house have both progressed a proposal as part of the energy bill, and we have our fingers crossed it may get through this year.

There is no guarantee of it, but we are focused on it.

It would be 55 or 60 million a year to our company.

Okay.

Thanks, guys, I appreciate it.

Thank you.

Thank you.

Our next question is coming from Ken Hoexter of Merrill Lynch.

Go ahead with your question.

Hi.

Good morning.

Just wanted to ask a quick question on your salaries and benefits expense on a per employee basis.

It was up about almost 8% and that's the second quarter in a row we have seen it in 8%.

Can you talk about your experience there with increased pension cost, increased workers' comp, and what you expect the trend there, going forward?

Because it historically they have been closer to the 5 to 6% range.

Thanks.

Ken, I think really what you need to do is take out some of those unusual items.

If you look at the chart I provided in the salary and benefits, you can take out FAS 143, protection pay, the severance cost.

You would actually see that cost per employee down -- I think it would be maybe just slightly up year over year.

So there are, as you can see on that page, about $60 million of -- you know, nonrecurring is probably not the right term, but unusual when you compare them to a year ago.

And eventually some of the protection pay and the severance obviously will go away.

Okay.

Great.

And just a follow on to that, any update on the status of the employee negotiations?

And then on a different subject on coal, I know a bunch of questions were asked earlier, but just kind of, what is your view on where the utilities are?

I think Dick mention briefly in his summation with respect to inventory levels as far as seeing companies start to restock or buy faster on spot demand?

Thanks.

Ike mentioned that the wooly worms indicated we would have a hot summer, I think.

So, Ike, do you want to develop that concept more?

We are keeping our fingers crossed that the wooly worms are right.

Right now inventory levels are at all time lows.

And we expect demand particularly in the near term will be very, very, very good.

And our services, better than ever.

So it should flow flew.

We think that's one reason inventories decreased a little bit.

Customers know they can absolutely depend on our service now.

You asked about labor negotiations too.

Unless Ike knows something more currently, we are still negotiating, but have not made a lot of progress with anybody at this point.

TCU, as you know has, concluded and the engineering employees, maintenance way workers are concluded and they are sharing, and health care benefits to the tune of -- by the end of the contract, 12 or 13%.

If we go one more year we can negotiate a 10-year agreement instead of a 5-year agreement.

It will be the end of the fifth year at the end of '04.

Okay.

Great, thanks, Dick.

Thank you.

Our next question is coming from Gary Yablon of Credit Suisse First Boston.

Please go ahead with your question.

Hi, guys.

How are you?

Hi, Gary.

Jim, can I ask you a question about fuel surcharge?

When you look at where prices are today, let's assume they stay here fort rest of the quarter and you think about whatever surcharge you can collect that you have earned, but collect in 2Q and RCAF, is it possible it comes out to be a net plus for you in the second quarter?

No.

You look at second quarter here, fuel as I said, we are looking at potentially $60-million increase compared to the a year ago.

We had a $125 million increase in the first quarter.

You know, there are lead lags in these.

There is timing in terms of when fuel falls off on some of these contracts.

But, you know, at best, if you look out for the full year, we may -- we may get 15, 20% offset against fuel prices at best.

Okay. 15, 20%, okay.

Just sticking with you for a second, on protection pay, Jim, I just want to make sure I understand.

You have talked to us today and in the past about the 18 million in the quarter and it looks like for the full year is that $60 million, that is right?

Yeah, net increase.

Now in total, Gary, we work here in some protection.

The UP portion protection had always gone to OE.

This protection is only for the former SP employees.

In total, we are paying out $100 million a year on protection.

And, again, we will start to see that fall off.

Many of these protection deals have a time horizon that is 6 or 7 years.

And you will start to see it fall off about a third, a third and a third over the next three years.

So, '04 is a third lower than roughly $100 million?

Yes.

And take it annually down until it is done?

Is that right?

Yeah, you should see of the hundred million dollars we have coming through OE, it will fall off a third.

Okay.

Gary, let me elaborate a little on that because it is not nearly as negative as it sounds either.

It is actually quite positive.

When we went through the merger with the Southern Pacific, in purchase accounting, we accrued for the labor protection that we knew we would incur over the next five years -- Now, Jim, you correct me if I misstate some accounting principal here.

That was based on the fact that we thought we would reduce about 5200 people as a result of the merger.

Well, the truth is, if you look back to 1996 when we merged, we had 56,000 employees.

Today we have about 46,000.

Right.

So we have introduced more people to the protection roles than we had anticipated by a huge margin.

And whether it is all attributable to the merger or not really is kind of irrelevant at this point.

But we ended up with more protection costs than we anticipated and didn't recover.

Of course, the merger reserve expires after so many years and that's gone.

So I always think the glass is about 2/3 full than half empty.

That means our efficiencies are improving more quickly.

Understood.

Understood.

Ike, if I can throw one at you.

I should know this better, but in terms of the coal business, there is a contract that's coming up over the cost of the next year.

I'm trying to understand between yourselves and Burlington when we start to see better disciplining pricing on the coal front, so when we can test those waters.

Do we not have a contract coming up over the course of the next year or several months?

We only have one contract, Gary, that expires this year and it is late in the year.

And keep in mind, markets, you know, markets set pricing.

That's what they told me.

And you feel no different, Ike, about the pricing environment?

I know that's been your stance.

Do you feel better, worse, same?

Obviously we all would like for pricing and the coal market to be better, but keep in mind that this is still great business.

And markets do set pricing.

Okay.

All right.

Thank you.

There is one positive though and that's that most of the old legacy contracts are gone.

Are done.

You don't have much of that left.

No.

You will see a vast difference in the fluctuations in contracts.

There is the other side to it.

I should have mentioned this, we are improving our yield.

As we really, really focus on DPU, longer trains, aluminum cars, and being more efficient as what we do.

Heavier loads.

Heavier loads.

We're reviewing the whole thing, so yield is actually up.

Can you do 3 to 4% volume, let's say for two years, whenever the two-year period is without having to add much in the way of power?

Our plan is to retire about 400 locomotives a year.

And we probably will purchase a hundred to a couple hundred depending on demand.

If you look at our power, Gary, it is essentially flat.

Right.

As Dick would remind me when I tell him that it doesn't take into account the horsepower advantages that we have gotten with that, but the number of units is actually slashed from 1999.

Understood.

It is down slightly.

Yeah.

Okay.

Thank you very much.

Thank you.

Thank you.

Our next question is coming from Jennifer Ritter of Lehman Brothers.

Please go ahead with your question.

Good morning.

Two questions, the first is what prompted you to take the convertibles out of your share count this quarter?

And the second is, can you quantify the extent of the fuel surcharge in your revenues this quarter?

I'll let Jim answer the accounting question.

Okay.

The fuel surcharge, Jennifer, numbers about $15 million.

Great.

Thanks.

Jennifer, you know, looking at our cash position, we finished the year, if you in fact it shows in the cash flow we had about $360 million.

You know, I was thinking about the dilution for the share count -- not why you are calling a portion of the converts, but why it is not in your share count this quarter, even the portion that is still going to be outstanding.

Well, if you look and convert is dilutive or not, you do the calculation both ways.

If the current levels of income, it is not diluted.

So you exclude it from the count.

What will happen though, it is break point is about 67 cents in terms of where it becomes dilutive.

And I said that earlier, you will see the convert be dilutive in second quarter.

We will put it back in the share count for Q2?

Yes.

Thanks for your help on that.

Thank you.

Our next question is coming from Jeff Kaufman from Fulcrum.

Please go ahead with your question.

Thanks, the good ones have been asked already here.

Jim, just follow-up on Jennifer's question.

So, in terms of thinking about full year shares outstanding are you thinking somewhere around the $270 million range?

That's right.

When you take the convert out of the equation, we're going to retire a little more than 7 million shares.

That's about the right number.

Okay.

And if I take a step back, I thank you for breaking out kind of the odd costs such as the protection cost and the weather cost.

If I take a step back and try to sum all these up because they were located in a lot of different places, and take a look out say next year and think about cost we're incurring now because of weather, because of these accruals, because of some accounting changes, how much expense are we burdened with now that we won't be burdened with 12 months out?

Weather is impossible to predict.

Right.

It is an outdoor sport.

I understand that.

The biggest wild card, again, the one that is probably most predictable now is your labor protection, as we said.

We know it will fall off a third next year.

The other is a wild card on fuel prices.

It is tough to say, although I will tell you the future's market today says fuel next year is in the high 70s next year or so.

So we should have nice improvement..

There we set a minimum goal when we look out in the years of 5% productivity.

We have done better than that in every year you look at the past 10 years.

But there should be some offset to inflation here as we go forward.

Okay.

But those are the two I should focus on.

Okay, thank you very much.

Thank you.

Our next question is coming from Bob Dunn of SAM Investments.

Please go ahead with your question.

Thank you.

What factors lead you to call just 1/3 of the convertibles and could what conditions might be necessary for to you call the rest of it?

Cash.

Cash?

Cash.

We do need do need to improve our balance sheet a little more, and we will see how our cash position goes for the rest of the year.

But really what we chose here, we called all the early debt we could in terms of, we had very expensive debt that we called earlier and paid for and we are just managing our cash to put us in that kind of position that we can make some nice decisions like that.

Just like we raised the dividend last November.

We are looking for the best use of our cash, improving our balance sheet and rewarding our shareholders.

So it depends on cash flow going forward?

That's it.

Thank you.

Well, two more questions.

Okay.

Thank you.

Our next question is coming from Jay Metia of Forrest Investments.

Please go ahead with your question.

Hi.

I'm just wondering if you could give just a sensitivity of dollar change in oil price to the EPS going forward?

Well, every penny, think of it this way, 1 cent change in fuel is around $13 million pretax.

So you can do the math in terms of the impact.

You know, first quarter, as Dick mentioned, our fuel costs were up almost $125 million.

It costs around 30 cents a share.

But we consume about 1.35 billion gallons a year.

Okay.

And the energy bill, the legislation you were talking about earlier, could you just explain again how -- kind of quantify how that -- how much that my impact you going forward?

Well, it would be the tax deficit reduction tax that's imposed on our fuel consumption.

It is around 55 million annually to us, I think.

In reduced taxes.

4.3 cents a gallon.

4.3 cents.

Okay.

Thanks very much.

Thank you.

Our next question is coming from Reno Bianchi of Citigroup.

Go ahead with your question.

Thank you.

Good morning.

A couple questions, I don't want to be the convert issue to death.

One thing I am a little bit puzzled.

You closed the quarter with $311 million.

The first stock is $500 million, where is the cash coming from?

We will -- again, most will come from cash in the books.

The balance will come out of commercial paper which will -- and then probably by the end of the second quarter or so we should be positive again.

So you will do a little short-term financing with commercial paper.

If I were to do the analysis of the actual saving on a net basis, you know, what would be the right number to use for the interest income you will generate because you're going to redeem the preferred stock?

And incremental debt that you will incur to pay down the stuff, the redeemable --

You know that is going to be variable in terms of any commercial paper cost can be very low.

We said I think $31 million is what the convert would save us for the -- on interest.

Right.

It is very minor terms for any offset for the commercial paper.

Okay.

The second question that I have is in view of the progress then that you made recently with respect to Overnight.

Can you just restate a little bit what your long-term strategic thinking is vis-a-vis, Overnight.

Our long-term strategic objective has been, as long as we owned Overnight to continue to make it a better company, to improve the management, to grow the revenue, to grow the bottom line profit and produce more free cash for the Union Pacific corporation, and that's exactly what's been happening over the last number of years.

It has been a very, very nice improvement in that company.

It is doing great and we are proud of it.

Now, having said all that, it is not a core holding for us.

There little synergy between Overnight trucking and Union Pacific railroad company.

But, recognizing it is a great business in its own right it covers all its own cash requirements and spends a lot of free cash to Omaha, so we've enjoyed owning it.

At some point, if somebody wants to own it more we could be talked out of it probably.

Let me ask you a follow-up question, do you think that Overnight right now has enough of a critical mass to be a potentially palatable candidate to somebody else, or do you think you need to pursue more ad hoc acquisitions to make it more palatable to external and potential suiters.

Time will tell, I guess.

It is a pretty good sized company in its own right as you know.

Right.

It is been 1.3, 1.4 billion of revenue a year.

So it is worth by the railroad, as a stand alone company though it could be a pretty good sized company.

Fair enough.

Thank you very much.

Well, thank you very much for all the excellent questions we had this morning.

We appreciate your interest in our company and we look forward to visiting with you three months from now.

Thank you.

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