聯合太平洋集團 (UNP) 2005 Q2 法說會逐字稿

These statements are, or will be, forward-looking statements and include without limitation expectation as to increased returns, cost savings, and earnings, estimates or forecasts relating to the Corporation's business operations or performance or increasing demand for rail transportation in excessive supply.

Expectations regarding operational improvements, including management initiatives that have been, or will be, implemented.

Expectations regarding field price and the time by which certain objectives will be achieved.

Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the time that, or by which, such performance or results will be achieved.

Forward-looking information is subject to risks and uncertainties that could cause actual performance or results to differ material from those expressed in the statements.

For detailed information regarding forward-looking information and such risks and uncertainties is contained in the materials accompanied by this presentation and the filings made by the Corporation with the Securities and Exchange Commission which are available on the Corporation's website.

The Corporation assumes no need to update any statements or information provided in this presentation or the accompanying materials.

Greetings, ladies and gentlemen, and welcome to the Union Pacific second quarter earnings release conference call.

At this time all participants are in a listen-only mode.

A brief question-and-answer session will follow the formal presentation.

If anyone should require Operator assistance during the conference please press star, zero on your telephone keypad.

As a reminder this conference is being recorded.

It is now my pleasure to introduce your host Mr. Dick Davidson, Chairman and CEO of Union Pacific.

Thank you, Mr. Davidson, you may begin.

Thank you, Dan.

Good morning.

I'd like to welcome everyone to our second quarter earnings conference call.

Here with me this morning are Jim Young, our President and Rob Knight, our CFO.

Rob will walk you through our financial performance and Jim will discuss our network operations, including an update on the implementation of our Unified Plan, as well as a review of the performance of our major business segments.

I'll then return after their comments to give you the outlook for the rest of the year and then we'll open it up for your questions.

Before turning it over to Rob, let me start out by providing our second quarter results.

I'm pleased to report that our second quarter earnings rose 47% to $0.88 per share, compared to earnings of $0.60 per share last year.

Demand for our services continues to be strong and we're just beginning to see improvements in our ability to take some of it to the bottom line.

As a result, our operating income, the best measure of our core performance rose 30% in the quarter to $468 million.

This is our first year-over-year growth in six quarters and we look forward to this positive trend continuing.

We are encouraged by the operational and financial turnaround we are experiencing, but in fact, the second quarter should have been much better.

Our network operations, although improved, continue to impact our profitability in the form of high failure cost and restrained volumes.

The significant and ongoing disruption on the Southern Powder River Basin joint line, which Jim's going to discuss in more detail, severely impacted our coal loadings.

We estimate, since the middle of May, we missed the opportunity to load over 300 trains decreasing earnings by roughly $0.09 per share in the quarter.

We've talked about the maintenance issues on the joint line which are being addressed.

What's equally disappointing is that we also lost loads because of issues than some of the mines themselves.

The good news is that revenue growth in the other segments of our business was somewhat stronger than we anticipated.

As a result, despite some challenges we reported operating revenue growth of 10% in the second quarter to a record 3.3 billion, our highest quarterly revenue ever.

The drivers of this growth were our continued focus on yield improvement, fuel surcharges, and modest volume growth.

Based upon our experience in the second quarter the economy remains strong.

Total volume growth was only 1%, but that figure includes the impact of lower Southern Powder River Basin coal loadings.

Excluding coal, our volumes were up by about 2% with intermodal and industrial products growing nearly 5% and 3% respectively.

As we're gradually increasing our operating efficiency we're able to make more of this growing volume -- take more of this growing revenue base to the bottom line.

Our quarterly operating ratio improved by two points year-over-year.

It's a step in the right direction but still far from satisfactory.

We paid an average of $1.67 per gallon for diesel fuel in the quarter.

This was on the high side of our expectations and represented a 44% increase over the $1.16 we paid a year ago.

Although, high diesel prices and fuel price volatility remain a challenge we continue to work diligently to take the impact of fuel price out of the equation.

Clearly, the second quarter results are a positive step for our Company.

We still have a great deal of work ahead, but we believe we're starting to see the benefits of the various network management initiatives undertaken in recent months and we look forward to leveraging those efforts going forward.

So with that let me turn it over to Rob to take a closer look at our financials.

Rob?

Thanks, Dick.

And good morning.

I'll start off today with a look at our income statement.

Operating revenue grew by 10% in the second quarter or $315 million.

Driving this growth was a 10% increase in commodity revenue to $3.2 billion, our best ever quarterly performance.

We achieved this growth with only a 1% volume increase.

The second quarter started off strong with April volumes up 3%, but the unexpected decline in coal shipments associated with the Southern Powder River Basin joint line issues curtailed growth in May and June.

Prior to the May incidents we were on pace to move an additional 40,000 carloads or $50 million in coal revenue for the quarter.

However, other business groups experienced stronger revenue growth which helped offset the coal shortfall and kept commodity revenue growth within our guidance range.

Our mix of business was actually negative in the quarter due to a decrease in higher priced automotive and chemical carloads combined with a 5% increase in lower price intermodal business. [Indiscernible] to the first quarter fuel surcharges contributed about half of the growth or $158 million.

You'll recall that there's about a two month lag in our recovery process, so in this environment of rising high -- fuel prices we're continually chasing the recoverage curve.

Yield initiatives added more than four points to our revenue growth.

This was another strong quarterly improvement and reflects the great demand we're seeing in the marketplace.

Turning now to our Operating Expenses, which were up 8% in the quarter to just under $2.9 billion.

This slide shows the year-over-year change in each of our six expense categories.

I'll quickly walk through the first three listed here and then talk a little bit more detail on the last three.

Equipment and other rents was down $22 million in the quarter or 6%, which was better than expected.

There were several puts and takes in this line item, but our improved car cycle times accounted for about half of the decrease.

Lease expense for new freight cars and locomotives was less than expected in the quarter due to delivery delays which will now take place in the third quarter.

Offsetting some of the good news items were cost increases due to higher business volumes, as well as the mix of business.

And total locomotive lease payments were higher in the quarter reflecting last year's long-term acquisitions.

Looking ahead to the third quarter, we're looking for flat to possibly 1% growth year-over-year here.

Long-term locomotive leases should be higher in the quarter and volume costs could also increase during the peak season.

We would, however, expect to offset most of the increase to better cycle times and fewer short-term power leases.

Depreciation expense was up 15 million in the quarter or 5%.

This is consistent with our full-year outlook and reflects our ongoing capital programs.

Materials and supplies expense increased 12% in the quarter or $14 million consistent with our guidance.

Inflation is the primary cost driver in this category with higher material cost for both locomotive and freight cars.

Given the increased prices for steel and scrap, we would anticipate another double-digit increase in this category during the third quarter.

Let's turn now to Purchase Services and Other, up $10 million in the quarter or 2%, in-line with our expectations.

You may recall that this category had a $30 million increase last year from the San Antonio derailment and our headquarter consolidation.

That year-over-year reduction was more than offset in 2005 by roughly $40 million of higher costs, primarily, contract maintenance, state and local taxes, increased joint facility costs, as well as general price inflation.

In the third quarter, we're starting out behind the eightball due to a couple of items from a year ago which totaled roughly $25 million; a favorable actuarial study and an insurance reimbursement.

We would, however, expect better cost performance as we gain operational efficiency.

Including the $25 million challenge we're likely to see a year-over-year increase of around 10%.

If you look at our salary and benefit expense, this is another area where we're starting to see margin improvement.

Both our headcounts and our costs were up 3% in the quarter, so we've basically were able to offset inflation.

We saw improvement in crude utilization and this category also had a year-over-year reduction of about 6 million related to last year's headquarter consolidation.

Training expenses were roughly flat year-over-year at $24 million driven by our continued hiring and increased engineer training.

For the third quarter we would again expect to offset some of the increased inflation costs with productivity and efficiency gains, but continued pressure from high crude costs and a larger employee base will likely result in a quarterly increase similar to what we saw in the second quarter.

Looking out to the end of the year, our current expectation is that we will average on a full-year basis, about 2% more employees than we did in 2004.

In part, increased work force levels are attributable to the second half hiring done in order to prepare for 2006.

Turning now to fuel expense, which was up $162 million in the quarter, or a 44% increase in diesel fuel prices.

As Dick mentioned, we paid $1.67 per gallon for diesel versus $1.16 per gallon a year ago.

As I stated earlier, we recovered roughly $158 million from our fuel surcharge recovery programs.

Our fuel consumption rate was also a good news story in the quarter improving 3% from last year and saving us roughly $13 million.

A portion of the improvement can be attributable to better service performance, fuel conservation initiatives, and a more efficient locomotive fleet.

Looking ahead to the third quarter there doesn't appear to be much relief in sight in terms of high fuel costs.

The combination of crude oil prices fluctuating around $60 a barrel and above-average refining spreads are producing a spot price today of around $1.70 or so per gallon.

For the full quarter, we have a wide range in terms of our estimates, $1.65 to $1.80 per gallon which translates to 57 to $63 per barrel of crude oil price reflecting the uncertainty regarding both crude prices and spread.

Through the first half of the year, we've paid an average of $1.56 per gallon, so on a full-year basis we are raising our outlook to the range of $1.60 to $1.65 per gallon to reflect current market conditions.

So to wrap-up our discussion of operating expenses let's take a look at our second quarter operating ratio.

If you look at the bars on the left of the chart, we are reporting more than a two-point improvement in our operating ratio compared to last year's second quarter.

There are really two drivers, higher yields and better operating efficiency.

When comparing the two years there are some ins and outs on both sides.

Last year, as I mentioned, we had the San Antonio incident and the headquarter relocation, but this year we had the joint line issues.

To better gauge whether or not we're seeing real improvement you need to take out the impact of fuel.

The bars on the right have been adjusted to reflect a $0.75 per gallon fuel price subtracting both the additional costs, as well as the fuel surcharge revenue.

So the net/net, we actually saw close to three points of improvement in our operating ratio.

As Dick said, this is not where we want to be but we are moving in the right direction.

Turning back to the full income statement, other income was up $21 million in the quarter to $29 million.

This increase is attributable to a couple of real estate transactions that closed earlier than anticipated in the quarter.

On a full-year basis, we would now estimate total other income to be at the high side of our 75 to $100 million guidance range.

Through the first half, we've recorded 49 million in other income and would expect to see a similar amount in the second half of the year assuming real estate sales stay strong.

Interest expense was down $2 million in the quarter reflecting a slightly lower-average debt level in the second quarter of 7.9 billion versus 8.1 billion a year ago.

Income tax expense was considerably higher in the quarter, up $57 million at an effective tax rate of nearly 37%.

This was in-line with our expectations and reflects both the effect of our higher income, as well as last year's lower tax rate associated with our headquarter's consolidation.

We have recently reached final settlement with the IRS related to the resolution of tax liabilities for tax years 1986 to 1994.

Now that these tax years have been resolved we are analyzing these settlements to determine the impact this may have on previously recorded estimates of deferred tax assets and liabilities.

Although the review is still in progress, we currently anticipate recording a one-time reduction in both our deferred tax liability and income tax expense in the third quarter.

This change would not impact our cash flows.

Given the number of years involved, as well as the complexity and interrelationships of issues required to complete this review we don't yet have a reasonable estimate of the amount of the adjustment.

We'll continue to update you as to the exact timing and the amount.

The final results of the second quarter were a 47% increase in both our net income and our earnings per share.

Now, this came out above our expectations, especially following the joint line issues, but we had some good news from real estate sales, a couple of favorable expense items, and stronger revenue growth in groups other than coal.

That helped us to push our earnings up to the $0.88 for the quarter.

The second quarter was an encouraging quarter for us and we will look for further improvements in the second half of the year.

Looking at our cash flow through the first six months, although on the surface it appears we are tracking behind last year's pace, it's really a timing issue related to our locomotive leases.

Importantly, our guidance for full-year free cash flow after dividends of 250 to 350 million is unchanged.

What jumps out at you here is the 555 million year-over-year change in cash used in capital investments/other.

This reflects in part higher capital spending of $221 million.

In addition, the timing of our locomotive financing results in a temporary "other" classification on the statement of cash flows.

In the third quarter, once the financing is complete, the impact of the new locomotives will move to cash from operations as rent expense.

If you look at our debt-to-capital ratios, we've seen improvement in both the unadjusted and lease adjusted measures over the last few years and during the first six months of '05.

At year-end, we would still expect to see a year-over-year improvement in both measures.

But the lease adjusted measure which should increase slightly from today's level, as I mentioned in the discussion of equipment rents and cash flows, this is really a timing function in terms of our locomotive financing.

In summary, we had a solid performance in the second quarter.

The continued focus by our marketing team on improving yields is driving record topline performance.

At the same time we're doing a better job of mitigating the earnings volatility caused by fluctuating fuel prices.

Our stated goal is to zero out the impact of rising fuel prices.

We are not there yet, but we are making real improvements.

Finally, we saw gains in our operational efficiency which translated into better cost control.

We realize that we are just scratching the surface here, but we believe we're turning the corner and expect continuing margin improvement in the second half of the year.

With that I'll turn it over to Jim.

Thanks, Rob.

And good morning, everybody.

I'd like to start out today with the slide that we used in January at our fourth quarter earnings release.

As you can see, we've become much more bullish about our revenue growth from where we were six months ago, which I'll talk more about in a minute.

Operationally, we are seeing some improvement and continue to move forward with our network management initiatives.

We've completed the network analysis and implemented major pieces of the Unified Plan.

We've significantly improved the strength of our crew resources by graduating nearly 1,000 locomotive engineers in the first half of 2005.

We've completed our acquisition of locomotives during the first half adding around 315 to the fleet and we've achieved greater than 4% yield improvement in the first half.

Now, we're a long way from where we want to be, but we are making progress and are well-positioned to execute in our second half objectives of leveraging the Unified Plan, and improving our productivity.

Let me walk you through some of the specifics.

This slide illustrates the three key metrics we report weekly to the AAR, as well as our carload volume.

Despite being impacted by the disruptions in our coal network, we did see a second quarter improvement in both car inventory and terminal dwell, while velocity was flat to a year-ago.

On the positive side, we did reduce freight car inventories and our second quarter terminal dwell was 11% better than 2004.

In particular, if you look at some of the terminals that we have -- that have benefited from the Unified Plan, places like Hinkle, Kansas City, Livonia, North Platte, dwell times have decreased substantially.

As shown by the graph in the bottom right-hand corner, at the same time we were working to make operational improvements we continued to move record volumes across our network.

On an individual basis April and June both set all-time records for 7-day carloadings and May started out at a record pace prior to the joint line incidents.

In the first quarter I talked to you about productivity improvement as one of the keys to converting our strong revenue growth into bottom line results.

Looking at asset utilization, as measured by car cycle time, we improved year-over-year, we were better sequentially versus the first quarter, and achieved faster car cycle times than in 2003.

From an employee productivity standpoint, we had expected to build on our first quarter progress and report flat to slightly positive productivity in the second quarter.

As you can see by the bottom chart, we were on track in April but the loss of coal volumes in May and June were a setback.

It's difficult for us on a short-term basis to absorb or redeploy assets when there's a sudden volume decline like what we experienced demand the joint line.

Although, coal volume growth will be constrained in the second half of the year we still expect to achieve productivity improvements.

Turning to the Unified Plan let me give you a quick implementation update.

As we discussed at the May analyst meeting we are on target to complete our initial network modifications by mid August.

As of today we have implemented changes to our automotive, manifest, and Mexico operations.

The thing to remember here is, you don't just flip a switch when changing railroad operations.

The implementation requires refinement over a period of weeks, as the changes work through the system and issues are resolved.

Over the second half of the year, as we adapt and refine the new operational plans, we should start to see the full impact of the Unified Plan.

Schedule for implementation during the first two weeks of August is the new intermodal plan.

This plan simplifies operations by dedicating specific domestic and international terminals, establishes more point-to-point intermodal trains, and significantly reduces work events in the Chicago and Los Angeles area.

Two of the biggest challenges on the railway today are in L.A. and Houston.

In addition to the intermodal changes L.A. should also benefit from the efforts we have under way in the basin to reduce manifest work events.

We are working in Houston to streamline operations.

We are making further improvements in the Sunset corridor by establishing more single destination trains.

You've heard us mention several times today that the second quarter impact was the Southern Powder River Basin joint line issues, let me give you our outlook for the rest of the year.

As you've likely seen in our customer updates Burlington Northern has begun its aggressive maintenance program, which will likely continue through November.

The cost of this work is capitalized and we estimate that UP's share will be around 10 to $12 million for 2005.

It is possible that the maintenance work could carry over to 2006 but we'll update that as the work progresses.

The chart at the bottom of the slide shows the difference between what we had originally planned to run in terms of trains per day out of the basin versus today's outlook.

While the maintenance work is being completed we estimate that our train loads will average between 31 and 32 trains per day.

This compares to our average of nearly 36 trains per day in the first quarter of 2005.

So far in July we're running ahead of that rate, but still below total demand levels.

The entire coal logistics chain is struggling right now.

The pie charts on the left side of the slide illustrate the actual train loads, as well as the estimated missed loads in the first half of the year.

We handled roughly 95% of the demand in the first quarter with some missed opportunities due to both rail and mine issues.

Unfortunately, we handled only 84% of the second quarter loads.

In addition to the joint line issues, mine production problems increased in the second quarter and are continuing today.

Let's take a look at revenue.

We broke several revenue records in the second quarter and we're pleased that all groups, including automotive had revenue growth in the quarter.

Our yields are improving across the board and we continue to make good progress in our efforts to add fuel surcharge provisions to every piece of business we handle.

Looking at it by commodity, AG products had it's third consecutive quarter of double-digit revenue growth and its best ever second quarter.

Our yield focus, coupled with strong demand for ethanol, soybean meal, and Mexican beer drove this great performance.

Looking out to the second half of the year we expect continued growth, but against some tougher comparisons, especially in the fourth quarter.

Automotive managed a 1% increase in revenue and 3% fewer carloads.

Finished vehicle movements were down 6% but auto part movements increased 3%.

Our expectation is for continued softness in this area, but still positive revenue growth on a full-year basis.

On 1% fewer carloads our chemical group posted a 7% increase in revenue, its best ever quarterly revenue.

Fertilizer and soda ash movements were the primary drivers, in addition to our yield initiatives.

Similar AG products we have some tougher comps in the second half of the year.

Despite setting a second quarter record for revenue energy was really our one disappointment in the quarter.

I just walked you through the second half operating plan, but it's important to note that we do anticipate both carload and revenue growth in our energy business over the balance of the year.

Industrial products, had a best ever revenue quarter and its third consecutive quarter of double-digit revenue growth.

Yield initiatives and strong demand for lumber, rock, and waste combined for a 19% quarterly revenue increase.

This business segment continues to outpace our original expectations and we see the potential for solid growth against tougher comparisons over the last six months of the year.

Finally, our intermodal revenue was up 10% on a 5% increase in volumes.

As with the first quarter international volume growth was a key factor of 10% in the quarter.

With the beginning of peak season under way we anticipate a strong finish to the year.

Overall, our full-year revenue outlook for 9 plus percent is up significantly from our original forecast.

A portion of the growth is due to increased fuel surcharge recovery associated with higher diesel prices.

But if you strip that out, we are seeing the positive impact of higher core yields and continued volume strength.

The diversity of our revenue base and the underlying strength of the economy have enabled us to overcome the issues of the January storm and the coal network disruption.

Unfortunately, those events took away the upside potential we had at the start of the year.

Let's take a look at the balance of the year.

Over the next six months you will see steady improvement in the operations of this railroad.

With the implementation of the initial Unified Plan, changes nearly complete, we will focus our efforts on running the plan.

We would expect to improve our productivity through faster cycle times and reduce terminal dwell, increase network velocity by running more point-to-point trains, and enhance the overall efficiency of the network.

In addition to the Unified Plan, L.A. and Houston should also benefit from our lean management initiatives.

At our analyst meeting we shared with you the results of our work on the Sunset corridor and in Phoenix -- and in the Phoenix terminal to increase velocity and reduce dwell times.

We've begun similar efforts in these two locations with the goal as it was in Phoenix to maximize throughput by better aligning supply and demand.

Our challenge over the next several months will be to realize the benefits of our network management initiatives while handling record peak season volumes.

We are better prepared than we were a year ago in terms of resources and network operations, but our network will be challenged to handle the record volume.

Dick will walk you through the specifics of how these expectations will translate into financial performance.

And with that I'll turn it back over to Dick.

Thanks, Jim.

Despite a few setbacks, we are on track with our plans for '05.

There's no silver bullet in this business, but as we finish our initial cut of the Unified Plan implementation and gain discipline in executing that plan we expect to see continued improvement.

Before I get into the specifics of the third quarter I'd like to take a minute to show you how the revenue guidelines that Jim laid out differ from our May outlook.

Given the challenges of the joint line, we have modified our revenue growth estimates for energy down to the 9% range, which is less than previous projections, but still very strong.

The good news, however, is that demand in all areas especially industrial products, AG products, and chemicals is coming in stronger than we had previously expected and making up some of the difference.

Another factor impacting revenue growth in the third and fourth quarters is obviously high fuel prices.

With today's crude prices fluctuating near $60 a barrel, our fuel surcharge recovery estimates have increased and are included in these updated revenue projections.

So although the total projections, a little above our prior estimates, part of that growth is an offset for higher fuel expense.

In terms of our guidance for the remainder of 2005, we would expect to see continued improvement in our overall performance both operationally and financially.

For the third quarter, in particular, we estimate that revenue growth should be slightly above our second quarter revenue growth rate and come in, in the 11 to 12% range.

Fuel prices are quite volatile and could be at or above the second quarter level in the $1.65 to $1.80 per gallon range.

This compares to $1.25 that we paid in the third quarter of '04.

While we would look to offset an increasing percentage of this added expense, we still haven't got to the 100% coverage that we would like.

So fuel will likely be a headwind for us in the quarter, as well as for the rest of the year.

Despite that challenge our operating ratio should again improve in the third quarter as our operational initiatives gain traction.

Taken together, these key financial drivers should produce third quarter earnings of $0.88 to $0.98 per share or a year-over-year growth of about 14 to 27%.

Within this guiding range we have tried to capture both the pluses and the minuses that could happen in the quarter.

At the lower end of our range is the potential for further issues in Southern Powder River Basin, as well as continued pressures from operational inefficiencies and escalating fuel prices.

If we could see some release from these high fuel costs and we saw some upside from the projected 31 to 32 trains per day out of the basin we could push things towards the higher end of the range.

Now, turning to the full year, we now expect higher revenue growth as just outlined on the previous slide.

We've also increased our fuel price expectations for the year, so on balance even with these changes, our full-year earnings outlook remains unchanged at 3.25 to 3.50 per share.

This reflects the potential challenges ahead, as well as the opportunities provided by our diverse franchise over the remainder of the year.

We're confident that Union Pacific is taking the right steps to once again be a company that produces steady, improving financial results.

We're looking forward to a strong peak season but acknowledge that it could present some challenges for us.

Our Company has more business demand than we're able to accommodate; a situation that is truly unprecedented during my 45-year career in the business.

We're encouraged by the changes we see in our day-to-day operations and firmly believe that the long-term future of this great Company has never been better.

So with that we'd be happy to take your questions.

Thank you.

Ladies and gentlemen, we will now be conducting a question-and-answer session. [OPERATOR INSTRUCTIONS].

Our first question is coming from Jordan Alliger of Deutsche Bank.

Please proceed with your question.

Good morning.

Good morning, Jordan.

Yes, just a quick question.

Given the one plan and the progress you've made in the implementations that you're working on, and you're expecting velocity improvements, should we start thinking about velocity being up versus a year ago or is the expectation of sort of the peak volumes may limit some of that potential improvement at least for the time being?

Well, Jordan, I expect improvement year-over-year.

But I will tell you, we will be challenged here in terms of volume on the intermodal side, but we, as I said earlier, we're healthier than we were in terms of power and locomotive engineers.

And we are seeing benefits in terms of -- and you look at the terminal dwell times which is key.

It gives you an idea of what we've been able to accomplish in the terminals.

It will be a challenge, but my expectations are for improvement year-over-year.

Okay.

And then just a quick follow-up question, in terms of the expectations for yields, I think of 8% plus or the revenues 11 to 12%, we know what the mix was for the second quarter.

Does the proportions generally hold and sort of roughly half coming from fuel or does that creep up a little bit, basically, sort of mix versus price versus fuel?

Rob or Jim?

Yes, I'll take this, Jim.

When you look at the revenue growth and what we've ramped up here, you know, a little less than half will be fuel recovery in terms of that growth.

And I think when you look at the yield and the volume it will be pretty similar to what you saw then in the second quarter.

Thank you.

Our next question is coming from Ed Wolfe of Bear Stearns.

Please proceed with your question.

Good morning.

Just a little more feedback on -- or guidance if you could on the Powder River Basin, I think you said $0.09 was the impact in the quarter.

What -- within your guidance, what's your expectations for the impact in the third and fourth quarter?

And can you also give us a sense how many trains on average you were running last third quarter and fourth quarter out of the PRB joint line?

Well, let us kind of jointly answer this.

I'm going to have -- let Rob look up what last year's performance was.

But we think the myth in the third quarter could be similar to what we saw in the second quarter as far as the cost per share.

Although, I will say, that for the first few weeks of July, our coal loadings have been slightly stronger than we had projected.

We -- we've been running a little over 33 trains per day, so that's a little bit better than what our expectations had been.

But we're reluctant to say that's going to be a permanent state or we'll get better because there's lots of things that can go happening.

In fact, as you know, the -- as Jim said and I mentioned the mines have had quite a bit of trouble themselves producing the call in the second and third quarter.

We averaged 32 trains last year in the third quarter.

Is that not --?

It's like 30 -- for the full third quarter we averaged about 30 -- just over 33.

Over 33.

Yes, and demand we would expect to be in that 35, 36 kind of level that we saw in the second quarter as well.

We see that kind of level of demand for the third quarter as well.

Now, going into the fourth quarter, depending on when the track structure freezes up, which will stop the maintenance effort, we could see improved coal loadings.

But it still -- it's hard to make a really accurate prediction because of all the uncertainties that are going on there.

But I will say that July is, at least at this point, has been somewhat better than we had anticipated.

For the quarter last year what was the average, was it 33 in the third quarter?

Yes, the third quarter last year was 33.

Just a hair over 33.

And the fourth quarter last year, I'm trying to get?

Just under 32.

Switching gears on the labor side, your average employee comp was down.

Can you talk to what was going on there and what we should expect going forward?

Yes, I'll tell you.

This is Jim.

You know, you did see some more efficiency in terms of operations here compared to what we had a year ago.

We did -- you had inflation there as Rob talked about it.

There's some mix with T&Y which drives that number up a little bit.

But you know overall I think it just reflects just kind of some general -- general efficiency moves.

So going forward should we expect that number stays flat to down or is that going to move back up pretty quickly?

Well, you're still going to be battling inflation going forward here in mix, but I tell you, we've got significant failure costs out here that we've got great opportunity.

I'm not going to predict how that's going to come out here, but we've got a lot of our velocity issues and the [indiscernible] costs hit the labor category here.

So we've got great opportunity.

Okay, I think you said the headcount you expect to be up about 2% in the second half, do you have any thoughts for '06 with the headcount directionally might be doing?

It's a little early to be predicting that.

Well, I think though we should see a slight moderation because our hiring will -- we're moderated hiring somewhat this year compared to last year and I suspect we'll moderate it a bit more next year because we're having a great year getting our locomotive engineers trained.

We're going to have nearly 2,000 of them up and going.

So we probably could tighten it just a little bit in '06.

But, of course, volume we'll have a lot to do with it as well.

We haven't locked in a budget yet, so it's really too early to call.

Ed, this the Rob Knight.

The 2% reference on headcount was a full year, not just a second half.

It was for the full year we would expect to be up about 2%.

And that's helpful.

And just one last question.

What were the total gains on sales from real estate in the quarter?

It's was about 20 -- around 29.

And what was it a year ago?

Yes, it's -- yes, 8 -- the total on the other income line, Ed?

Yes.

8 was a year ago and 29 on the income line the bulk of that is in real estate.

And there are some other items that go into that account as well.

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

Please proceed with your question.

I just want to kind of go over your fuel surcharges a second.

It looks like fuel was up about 162 million but -- and you increased, I think you said, 158 million by your surcharge.

You said you're not near 100%.

That seems pretty close.

So what -- I guess obviously it's the rolling in of additional customers as well.

How do you view your coverage right now and where do you look for it to go to?

That comparison you just made was year-over-year.

The way we look at, as you know, is a comparison versus the benchmark $0.75 per gallon.

And how are we doing on recovering fuel above $0.75?

It is running just a hair over -- for the quarter, it was just a hair over 70%.

So we're still not where we need to be in terms of taking that off the table.

We continue to make progress in the marketplace, but the recovery rate as we measure it based on that 75% threshold would be in a 72% kind of range.

Okay.

So -- I guess in the back half of the year does this start to get a lot tougher since you really started getting aggressive with the surcharges at the end of last year?

I mean as far as looking at the year-over-year increase.

It depends on what fuel prices will do.

I mean because, again, there's a two month lag.

So --.

There, let's assume they moderate at these levels.

If they moderate then it should start to creep up a little bit.

Again, we're not going to take it off the table completely.

We're going to have to continue to be aggressive in our efforts to recover that, but it should creep up a little bit.

Ken, as you know, the thing that kind of is the controlling factor there, is that contracts renew and we convert more business to tariff and that sort of thing.

We'll recover more and more and more, and we're not going to rest until we get close to that 100%.

That's great.

I like to hear that.

On the CapEx, I think it was Rob who mentioned it earlier as far as additional leases.

It looks like CapEx was about 600 million for the quarter.

Did I get that number right?

And, obviously, a big spike.

Was that all due to additional locomotives in the quarter?

Yes, there was about 220 million more capital -- CapEx spending in the quarter versus last year.

And the total capital spending in that line item -- yes, for the full year, the $2.1 billion cash capital spend?

Yes, has that changed or is that still the same?

That's still the same.

Okay.

That's what I was getting at.

Because it was about 80 million over my target.

I just wanted to see if that changed at all.

And then last question, I know you said it's a bit early to discuss the charge on the changes of the deferred tax liabilities.

Are we going to see an adjustment to your ongoing effective tax rate going forward?

No, shouldn't.

That shouldn't impact the ongoing rate.

And it's not really a charge.

It's an adjustment that we're evaluating the impact it will be, but it won't -- it's not necessarily -- it's not a charge.

We would anticipate being a slight positive here.

I mean we haven't figured out the number yet, but we anticipate it being a positive number in the third quarter.

It would actually convert into a reduced income tax rate; would it not, Rob?

For the third quarter, yes.

For reduced income -- it would show up as a reduced income tax for the third quarter, but it does not effect the ongoing rate.

And no impact on cash?

Right.

Great.

Thanks.

Nice job on the yields.

Our next question is coming from Thomas Wadewitz of JPMorgan.

Please proceed with your question.

Good morning.

I've got -- I guess two different questions here.

You've mentioned [indiscernible] on fuel surcharge and I understand that kind of -- it's pretty good coverage at 70%, but you've got to get -- do some more work there.

Can you give me a sense of how much of your business is really under a long-term contract that's difficult to get to?

I mean, I'm thinking of utility contracts, you have some maybe 10-, 15-year contracts.

I'm not sure where you're at with the Pacer business and so forth.

But can you give me any sense of how much of that business that's difficult to access, in say the next 6 to 12 months?

Hey, Tom.

You know, we -- it's about 40% plus is what I would call long-term contract.

We get a shot at that over the next -- about maybe 20% of that number, 15, 20% of that number comes up over a five -- when you look out the next five years.

So when you look at this here it says that in a given year, our total revenue base, about half is in contract -- it's one -- a year less -- letter quotes, tariffs.

So, again, in any given year here we can probably touch about 60% of the total revenue base.

Okay.

So it --?

Now we have other contracts that are longer than that.

You have contracts that go out here still another six, seven years beyond where we are today.

So if you look at the longer term contracts and factor that in, I mean can you get to a 90% coverage by the end of this year or --?

No.

Is that by end of '06 you get to 90%?

I'm just trying to think of some time frame for really making that further step up.

I think it's going to -- you're still five years out plus before you're going to start touching up towards that kind of 95 -- 90, 95% range.

We're going to make steady progress every year.

I hope fuel comes down, when you look at it here, but we've made great progress.

We really are -- I meant that.

We're just going to -- we'll be focused from now until all our contracts renew until we -- we just don't want fuel to be the variable on the table.

Right.

Okay.

Fair enough.

One other question for you.

Looking at the demand side and as you go into peak season, wonder if you can offer any thoughts on how you will manage what is an increase in volume pressure?

Last year you seemed to be making some progress on the network operation and then towards the end of the year you really saw things fall off fairly -- fairly sharply.

And I'm wondering what the expectation is for demand in the peak season and what you're going to do a bit differently this year to avoid giving back some of the progress that hopefully you'll make over the next few months?

There's a lot of answers to that.

One, implementation, the Unified Plan, which is going quite well.

Resources -- we've bought a lot of locomotives.

We've hired a lot of people.

We've trained a lot of locomotive engineers.

Process improvement through the industrial engineering efforts.

We've got that Sunset route running so much better.

Capital spending we will add 68 miles of double track to the Sunset route this year and make other debottlenecking capital investments.

We're going to open a brand new intermodal terminal in the third quarter in Dallas, which will be a state-of-the-art facility.

This -- the implementation of the Unified Plan as it pertains to intermodal should have a substantial impact.

I mean, there are an awful lot of good things coming down the road here.

Now, that doesn't mean that we won't have some bumps here and there because I'm sure we will.

We always do when you don't have a roof on your factory.

But we've got a lot of good things that are going on here.

Is there a need to hold down volume growth a bit from the -- say the intermodal side in the peak season or do you think you're positioned to handle pretty strong -- if they have a good season where it's 10% increase -- you're positioned to handle that?

Well, it's not going to be easy, but we think we will be able to handle it a little better than a year ago.

Now, as I understand it, the boats are nearly full today that are on the water.

So how much growth -- what peak is really going to be may not be a lot greater than what we're seeing today.

We're seeing good volumes, as you know, in our international business today.

So I don't think we're going to see a sharp spike.

At least that's not what our intermodal experts are looking for.

Right.

Okay.

Great.

Thank you for the time.

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

Please proceed with your question.

Great.

Thanks.

I guess the first one is going back to your analyst meeting you mentioned that this year there was a portion of management incentive comp that was tied to achieving network velocity goals.

I was wondering if you're currently running it at that goal?

No, unfortunately we're not.

Okay.

And if you didn't have the PRB problems do you think you would be near there or exceeding it?

Would not.

But it would clearly be better than it is today.

Okay.

Second is, I think you mentioned -- somebody mentioned that pricing was up about 4.5% excluding fuel surcharge.

Should we expect the year-over-year growth of this to decelerate a little bit because you're going to lap some tough comparisons?

As I recall, you know that UP acknowledged that maybe they were a little bit slower to pull the pricing lever because of service issues last year and then ultimately the second half of the year you came through with some good pricing.

I just want to know if that 4.4% is sustainable?

Jim, I think it's sustainable.

We are starting to cycle again where we were getting pretty aggressive on price from a year ago.

But right now the demand is still very strong, and we still -- to improve the returns in this business look at the capital requirements we have going forward.

Prices have to be much higher than they are today.

Okay.

Great.

A question on the PRB in that I wish, unfortunately, BN was reporting before you, so that I could ask them this first.

But just in preparation for what they are going to talk about on their call, I was wondering if you could discuss your view on how much maintenance is going to need to be done next summer?

Because I know both you and they sit down annually and decide how much maintenance is going to be done.

And I guess the question is, if they're going to do, I think about 90 of the 270 miles this year are going to be undercut, are we talking about the same level next year?

And if so, or even if not, are we talking about a similar kind of 33-trains-a-day sealing for next year?

Jim, we can't predict this with 100% accuracy because we don't know how much we'll get done this year.

It's going to kind of depend on mother nature and a whole variety of other things, but this will be the toughest year clearly.

Of the 270 miles or whatever it is, total track miles up there --.

Right.

-- only something slightly over 100 miles, if I recollect right, has to be undercut.

Now, the ballast is fouled so much that it has to be cleaned.

So I think the majority of the ballast cleaning should get done this year.

And it would be at my hope and anticipation that while some work could flop over into '06, and I think it clearly will, it would be a far lesser magnitude.

Okay, good.

And the last question is, it may be unfair, it's kind of open ended here.

But it has to do with Houston, in that, we're coming up on the 10-year anniversary of Southern Pacific and it just seems its problem doesn't go away.

And I guess I'm wondering in the back of my mind is, is this going to require a lot of capital?

I mean ultimately five years from now we look back and we say, "What did it take to fix Houston?"

Are we talking hundreds and hundreds of millions of dollars of capital potentially putting in new rail yards, building new facilities or -- I just don't understand why here we are 10 years later and we're still struggling with congestion and philosophy in Houston.

Jim, I hope business grows to the point where we have those kinds of challenges that with the current volumes.

No, we do need some additional capital spending, some additional bottlenecking -- debottlenecking.

But not to the magnitude that you're talking about.

We have a joint effort going on right now between KCS, UP, and Burlington Northern, the three parties that run through Houston to kind of look at it on a holistic basis and I think primarily through process improvement and implementation of the Unified Plan there, we should see real substantial progress.

In fact, as of this morning, you know we had two big yards in Houston;

Settegast and Englewood.

Settegast dwell time was 24 hours this morning and had almost no cars at two-days old.

Now, Englewood is a little slower, but our Unified Plan changes are going to focus on that until we get Englewood in the box as well.

We've got huge resources.

You know the merger with the Southern Pacific presented us some challenges, but it has also presented us with some opportunities; parallel routes, directional running, that sort of thing.

We've made some management changes there.

We've got people down there the lean team and the Unified Plan team working it through and I think, I'm absolutely optimistic we are going to see real progress here in the short to intermediate term.

Okay.

Great.

Thanks so much.

And a great improvement in the quarter.

Thanks, Jim.

Our next question is coming from Scott Flower of Smith Barney Citigroup.

Please proceed with your question.

Yes, good morning, all.

Hey, I wanted to follow-up on the PRB issue because I think it's important.

And I think I've gotten a lot of color, but I just wanted to maybe get a little additional sense.

Is it your view that obviously -- I mean, I applaud you for trying to fix the problem versus doing triage given all that's going on with the network.

But is it your sense that '06 is primarily the tag end stuff that may or may not get done due to freeze in the winter?

And that for all intents and purposes the vast preponderance of the significant undercutting and maintenance work gets done this year?

And if you get a little good luck with weather that maybe you get substantially completed and there's a little bit of cleanup or is there -- do we have several months of fairly major work that we'll see in spring next year?

Quite honestly you'd be better off asking Matt that when you talk to him.

But my take on it is the critical stuff is going to get done this year, I believe, and some of the critical things are like switch replacement, ballast cleaning.

I think that the majority of the work will be behind us, and that's my hope certainly, and next year will be a lesser impact.

Okay.

And then I guess on the intermodal, I guess a couple of things.

Is it your sense that the shipping lines are trying to flatten peak out just because of the issues and the ports of L.A/Long beach?

And then secondly, is part of the flatness, some of the increasing notice or commentary you get from the shipping lines that they are finding the Suez much more attractive?

Is it just that -- you're still going to have secular growth on the West, you almost can't not.

But that some of that growth gets flattened by some of the old water services to the East Coast, in addition to perhaps some flattening in moving it of peak from fourth quarter?

Scott, I think there clearly is some flattening, some advance shipping.

You know, you look out today in the -- the international bonds are very, very strong.

You could argue peak is here, and at least on the intermodal side.

It's hard to tell that -- what's going around Suez canal.

You can't change that necessarily quickly and while there is some, I don't -- our outlook still has some very strong growth going forward.

Okay.

And then, just curious on the AG side, obviously, that has been strong for you.

Has there been any change in ocean spreads?

Are you still seeing good demands through the PNW for some of the AG exports or is that waning a little bit?

It -- I don't quite know -- I think it's probably a little bit softer, but I don't want to guess at it here, Scott.

Okay.

And then I guess two last quick ones.

One, I don't think there's any update.

But, Dick, has there ever been any change in labor negotiations or is it pretty much status quo?

Is there anything that's going on relative to labor negotiations that we should be aware of?

No, I don't think there's anything startling, Scott.

Okay.

And then just the last question.

My sense is not much, but I'll ask it anyway is, did Emily have any significant impact on your operations?

Obviously, you've done some things in the Unified Plan relative to Mexico and I would imagine that would have had some impact.

But is it in the scope of things a pretty minor event?

Pretty minor event.

Great.

Now, it's not over with yet.

I mean it's still raining like all get out down in Mexico and there could be some ancillary fallout, but at this point there's no problem.

Okay.

Terrific.

Thank you.

Our next question is coming from Randy Cousins of BMO Nesbitt Burns.

Please proceed with your question.

Good morning.

Coming back to the coal issue, just with reference to 2006 in terms of picking up volumes, you did 574,000 carloads in Q1 in the energies segment dropped down to 522.

It's -- for modeling purposes for 2006, should we just assume that you guys can bounce back to that 574?

What is the opportunity in 2006 once you get all this sort of maintenance issue behind you?

Well, I guess in the first quarter this year we've averaged 36 trains a day or so and there is no reason to expect that we can't do that or slightly better, I think, in the next year.

Okay.

And I think the demand clearly ought to be there because coal stock piles are going to be stressed, I believe.

Okay.

And in terms of the surcharge, one of the things I wanted to ask about was all surcharges are not created equal; that is, AR cap you've got various surcharges embedded in your contracts and there seems to be a bit of a lag between sort of when the surcharge shows up in terms of your cash flows -- [audio difficulty] leveling off in pricing.

How is this going to affect this sort of [audio difficulty] -- or how should we model this in terms of the revenue aspect?

John, this is Rob.

As we've said there's -- on average with -- Randy, excuse me.

Randy.

There's about a two-month lag in our surcharges on average and you're right, not all surcharges are created equal.

But that's a pretty good number to use from a modeling perspective.

So if it leveled off, yes, you would see some catch up in a [audio difficulty] environment.

Rob, that's on the highway piece, right?

About 30% fuel surcharge.

Yes.

But in general from a modeling standpoint.

But you have contracts that have RCF?

We have got a range that adjusts once a year, so you will -- again, the two months that is not applied -- the whole spread --?

Right.

-- on fuel surcharge.

There's -- not all are created equal.

Jim's right, I mean some are renewed annually.

Some are renewed quarterly.

But when fuel levels off it's clearly a good news thing for us?

Yes, but from a modeling standpoint a couple of months.

So when we think about '06, if fuel levels off at current levels, you guys should get a pop in terms of sort of fuel recovery 2006 then, right?

Absolutely.

And we'll build in more market based contracts as well with more adequate fuel recovery mechanisms in them as time goes along.

That's something that goes on all the time.

My final question comes back to -- I guess it was Jim's chart on the revised guidance.

And I may have just missed it, but Jim, did you say how much of that sort of change in the Delta in the revised guidance that you're giving here is due to higher fuel charges?

I did.

I said that Delta was about -- it's less than half goes with fuel if you look at the increase.

And the balance is again stronger core price -- primarily stronger core price.

So it will balance the year.

So there hasn't been really any change in your -- setting aside the Powder River Basin there hasn't been a whole lot of real changes in terms of your volume expectation because you've got 1% volume growth here.

So it seems to me that you guys are seeing more and more pricing power.

Is that a fair comment?

We have.

And as I said really what we lost -- we've been able to overcome the storms in the first quarter and Powder River here balance through the year we've really just lost our upside here on the balance of the year.

And in terms of sort of your ability to sort of continue to sort of get value for the product that you deliver, looking to 2006, what kind of sort of pricing opportunity do you see in terms of sort of real pricing excluding fuel?

It's probably a little early to be talking about that.

We haven't got our budgeting work done yet.

But I think our marketing people would tell you that with the huge demand we're seeing exceeding our ability to accept all the business levels, the buyout should clearly be pretty strong.

Our next question is coming from Peter Jacobs of Ragen.

Please proceed with your question.

Yes.

Thank you.

First of all, could you please comment on the outlook in general for your ability to increase volumes in 2006?

I think if you stayed in the 1 to 3% range you'd be pretty safe.

Okay.

Thank you.

And secondly, perhaps for Rob, when I'm looking at the fuel surcharge calculation and recovery, could you just help me out on this a little bit because it's based on a $0.75 nominal level, but when I go through the calculation for this year, you spent about -- or for this quarter, about 559 million in fuel.

And if it had been at the $0.75 level it would have been about 250 and so that's a little bit over a $300 million increase, but you've recovered about 158 million in revenue and now that would calculate out to be about a 50% recovery.

So is there something I'm missing there?

Yes.

What you're missing is the amount recovered, the 158 is year-over-year difference.

In total, we recovered more than the 158 against that $0.75 threshold.

So of the Delta that we spent you're about right it's a little over 300 million more than $0.75.

We recovered in total about 72% of that for the quarter.

Okay, thanks for the explanation and that completes my questions.

Our next question comes from John Barnes of BB&T Capital Markets.

Please proceed with your question.

Hi, good morning, guys.

On the headcount side real quick, do you think that as we get into '06 and '07 that begins to stabilize a little bit maybe even begin to trend down some?

Or has headcount really become just a step function with volume, that if you're handling more volume in the system you're going to continually need more employees?

It won't be 100% direct relationship because we'll always be creating efficiencies in other parts of the organization.

But it will be more closely wired to volume than it has been in the past, clearly.

We've always said that.

And John, remember we still have -- we've got about 1500 people in training that -- that will not be the run rate.

You know, once -- we're not 100% healthy in training, particularly, engineers, but by the end of the third quarter we should be in good shape.

We'll have fewer people in training, so --.

And the [indiscernible] run rate will be less than a 1,000 I guess. [multiple speakers].

Right.

7, 800 --.

We probably have about 1,000 people right now extra in training that we won't see next year.

Okay.

All right.

In terms of -- let's see.

In terms of the Powder River Basin, assuming that you get your issues corrected, you did indicate that there were still mine disruptions there.

Are you still going to be held back some even if you get all of the issues on the joint track corrected?

You're still going to be under some pressure as the mines take their time in getting their disruptions cleared up?

You know, you'd have to have some mines to comment on what their situation is, but at the end of the day there's three parties involved here, there's the mines, the railroads, and the consumers, utilities, that all has to be functioning here as a team.

My guess is the mines have been impacted somewhat with the same issues as the railroad has with excessive moisture there in huge demand.

But it's our objective to work together as a team here and deliver the amount of coal that people want to consume.

So it would be presumption for us, I think to say what the situation would be with the mines next year.

You should address them probably directly.

Okay.

And then lastly, I have heard from a couple of people in the industry that there are a couple of railroads, yours included, that -- not doing quite a good as job as hoped going returning foreign cars of your system in a more timely fashion.

And I recognize that you're full of volume right now and the volume turns are pretty good.

But are you having a problem getting empties off your -- and especially foreign cars out of your system and if you'll address that, could that help on the velocity side?

Will it help on the velocity side?

Well, John, that's been a clear focus of ours and it should be evident because the inventory levels are down, our terminal dwell is improving, and our car higher payments are moderating.

So we are moving cars faster and getting them offline.

Not to a level we want it yet or maybe as some of our partners out there would like it to be, but it is improving and we'll continue to improve as the Unified Plan kicks in.

Okay, so you think that there is further improvement to be done on that metric?

Absolutely.

Okay.

All right.

That's what I was getting at.

Guys, thanks for your time.

Okay, John.

Our next question is coming from Jason Seidl of Credit Suisse First Boston.

Please proceed with your question.

Good morning, gentlemen.

Two quick questions.

One, as we look in the next year for coal demand -- I imagine right now utility stock piles are probably pretty low.

Once you get past any of your remaining issues out of the joint line, I imagine there's going to be a pretty big spike in demand.

Is there anything you need to do to prepare for such demand?

Yes, there is.

We -- as you know, during the first quarter there were many days that we would load 37 trains a day there and some days even more.

And I think most of our operating people would tell you that the place that's kind of seemed to experience the most challenge with those sorts of loadings were our processing, the inspecting, and certifying the trains under FRA rules.

And that's primarily in places like North Platte, Nebraska.

In that vein, we have applied our lean strategy to the servicing tracks there and think that we have a way to substantially improve throughput and there are some capital involved which we're going to put in the ground this year or at least get started this year.

So yes, there -- we'll always be debottlenecking, but I will tell you the Powder River Basin infrastructure, you know, we've got a solid railroad.

We've got a double track main line.

Mostly with concrete ties and premium rail, all the way from North Platte up into the joint mines and into the joint line and the joint line is adding a third main track in a number of places.

And we will have some challenges on the root end of St. Louis and Chicago, but we are addressing them and you know, it's part of our ongoing capital program that you shouldn't see any big spike trying to get ready for it, but there will be money spent to continue to grow.

Okay.

Fair enough.

Second question is more of an economic question.

I mean this morning we saw that China severed its peg to the dollar for the currency and they're going to let it float.

What sort of impact do you foresee that having on some of your international intermodal car volumes?

I'll have to let our money man answer that I don't know.

Well, my take on that would be not much.

I mean demand is outpacing today what our capability is to handle it and I don't think that's going to have much of an impact on the demand.

Okay.

Thanks for the time, gentlemen.

Our next question is coming from John Larkin of Legg Mason.

Please proceed with your question.

Yes, good morning, gentlemen.

Just wanted to bore in a little more deeply into the two business segments that had such spectacular average revenue per car growth.

Agricultural and industrial were both up 16% in terms of revenue per car, and I was wondering if there was something going on with respect to mix and/or length of haul change?

And whether those mix or length of haul changes were sustainable over the long-term?

This is Jim.

What we're seeing there to me really reflects the strength and the potential and the manifest network in a lot of those areas, particularly in industrial products.

Quite honestly, we surprised ourself where we're looking for that price elasticity point in the demand and I've got to control that volume on the network.

We've been aggressive on pricing, but I tell you, we also have -- we've a lot of demands where you could put some capital to increase volume.

So I don't think there is anything in particular in terms of mix.

It's really testing the market in a lot of those areas.

Again, primarily a manifest to terms of how high pricing can go.

Maybe it reflects how underpriced the product really was when you look back over the years.

But we're going to continue to be aggressive there and you know, most of the customers I'm in front of and I'm in front of a lot of them.

When we look at this thing no customer wants to have a price increase but they all want to ship more business to the railroads and they also want to make certain we're there for growth in the next two or three years.

So we've been very happy with what we've been able to do on the yields, but they still have to move up.

I said it earlier that while we've had good pricing, for us to look at getting this business at or above cost of capital we've still got a long way to go.

I think what Jim said is critical about the customer still wanting to shift business to the railroad.

And the reason for that is are these cost of trucking probably is escalating a lot faster than rail pricing even because of the high energy cost and in order to hire drivers, you know, with the quality of life issues you've got to pay them a lot more money.

So you know, it -- this situation we're in really plays to the strength of the railroads.

Thank you Jim and Dick.

Just one final question on the intermodal side, your growth for the quarter in terms of carloads was at 5%, but it seems to me the last month or so it's been better than that.

Is all of that growth coming through international or are you also seeing growth with LTL, UPS, truckload partners, and intermodal marketing companies?

It's primarily been international.

Internationals really have double-digit growth when you look at it.

Our domestic business is right now flat to down a little bit.

Again, you're running into peak.

Peak is starting and we should see that continue to grow some.

Thank you, Jim.

Our next question is coming from Chris Laychak of Perkins Wolf.

Please proceed with your question.

Good morning, gentlemen.

I don't want to beat a dead horse here, but I just wanted to zero in on next year's '06's PRB coal volumes.

Because it looks like the utility is going to be coming out of '05 at least 30 million tons short, if not more.

PBuddy on their conference call the other day agreed that we could see 430, 440 million tons coming out of the basin which would be anywhere from 5 to 10% increase.

Granted, I guess it's not a fair question because as you said it's the mine, it's the customers, it's the two railroads involved and I guess it would be a good question for Matt in the next couple of days.

But as far as it relates to your system, your track, do you guys have the capacity in '06 to do a 5 to 8% type coal volume increase?

Against what's going to happen this year?

Correct.

Absolutely.

You know, we're -- right now we're down 10% to 15% in loadings because of what's happened up there.

So if the joint line gets back in shape we can certainly accommodate that.

You really ought to look at what we moved in the first quarter and use that as a benchmark I think.

That was a great quarter for us and I think we can improve on that a little bit.

So you feel like there will be additional capacity coming out of this maintenance project period here over the next six months?

Well, yes, absolutely.

And don't forget that we added 14 miles of third main track this summer on the south end of the Powder River Basin.

And we've got a capital project, which I'm going to ask the Board to approve next week building additional inspection and throughput capacity in North Platte, Nebraska.

So, you know, we've got a lot of good things happening and we're resourced.

We now have manpower, locomotives, I'm not saying that we're eager to take on any comers here.

We're going to still be selective about our business we grow with.

But yes, we can handle more coal.

Thank you.

Thank you.

There are no further questions at this time.

I'd like to turn the floor back over to management for closing comments.

Well, we appreciate your level of interest.

That was a great question session here and I think it shows the interest and concern that you all have and it's fun for us to talk about these issues, particularly as things are improving here.

So we'll look forward to getting together with you again in three months and hopefully we'll have even better news to report.

Ladies and gentlemen, this does conclude today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.