聯合太平洋集團 (UNP) 2005 Q3 法說會逐字稿

Thank you for your patience.

Good morning ladies and gentlemen.

Welcome to the Union Pacific third quarter earnings conference call.

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

A brief question and answer session will follow the formal presentation. [Operator Instructions] 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 and welcome to our third quarter earnings conference call.

Here this morning are Jim Young, our President and Rob Knight, our Chief Financial Officer.

Rob is here to discuss our financial performance and Jim will provide an update on our network operations as well as review our major business segments.

After their remarks I will wrap up the program with our fourth quarter outlook and then take your questions.

Looking back at the third quarter of 2005, we certainly faced some challenges from extremely high fuel prices and hurricanes to constrained loadings off southern Powder River Basin joint line.

Fortunately, we also had opportunities in the quarter to move more freight, improve our yields and reduce some of our failure costs.

For the quarter we're reporting earnings per share of $1.38.

The $1.38 includes $0.44 per share for the tax reduction that we announced a few weeks ago.

Excluding that amount, our earnings would have increased 22% to $0.94 versus $0.77 per share that we reported last year.

That's a solid increase even in the face of the quarter's many challenges.

The primary driver of our quarterly earnings growth was record third quarter revenue at $3.5 billion.

Demand for rail service remains very strong, creating an environment for solid yield improvement.

In addition, fuel surcharges and volume growth which, as I mentioned, was con trained by the hurricanes contributed to the 13% quarterly revenue increase.

We converted this double digit revenue growth into a 15% increase in operating income to $481 million.

Growth in operating income can be directly correlated to improvements in operating efficiency.

We are seeing gains although other factors combine to offset some of that progress.

Record diesel fuel prices were a rising head wind during the quarter.

Costing us an average of $1.88 per gallon fortunately that's a 50% increase over last year's quarterly price of $1.25 per gallon and $0.08 a gallon above the high-end of our expected third quarter fuel price range.

Fuel surcharge programs have clearly reduced the earnings impact associated with the spike in fuel prices.

Even with the surcharges, our net fuel expense exceeded our benchmark costs by more than $110 million.

With high diesel fuel prices continue to go impact our earnings, we have an absolute mandate with our fuel surcharge program to take that higher cost out of the equation as existing contracts are renewed.

Quarterly earnings gains were also limited by the two hurricanes that hammered the Gulf Coast region in August and September.

Thankfully, our rail system escaped the Brunt of Hurricane Katrina's furry which added only $3 million to our quarterly operating costs.

Hurricane Rita, though, had a much bigger role in our quarterly results reducing operating income by roughly $28 million primarily in the form of lost or hopefully deferred revenue.

On a more personal note, many of our employees in the region lost their homes and personal belongings.

We've been working closely with these folks to help them get back to their feet and return to work as quickly as they're able.

Although Rita's landfall occurred further east than originally predicted, several days of car loadings in and around the Houston area were lost due to shut downs and embargoes.

About two days before the landfall we, and more than 150 of our customers, began shutting down operations over roughly a 2500-mile territory in anticipation of the storm.

Our rail system was again spared significant structural damage but the hurricane wiped out commercial electrical power across large parts of southeast Texas and western Louisiana.

After clearing more than 5,000 trees from our tracks and installing hundreds of portable generators, we were able to restore operations across the entire region within four days.

We were left with little opportunity, however, to make up lost business at the end of the quarter.

Particularly since many of our customer facilities remain closed.

Even today a number of our customers in the region are still not operational and several have just recently restarted production.

Now, Jim will provide for details on this in a moment.

Clearly Hurricane Rita left her mark on the quarter.

Let me say, however, that I am pleased by the way our employees rose to the challenge of getting ready in advance of the storm and then restarting our railroad following the hurricanes as well as the other adverse weather conditions that we faced this year.

With each attack by mother nature, we quickly restored service to our customers and continued the vital work of moving this nation's freight.

With that let me turn it over to Rob to take you through the third quarter financials.

Rob.

Thanks, Dick, and good morning.

I'll start off today by looking at some detail behind our reported earnings per share.

On the left side of the slide, we show last year's third quarter earnings of $0.77 per share.

The net impact of our business growth added $0.32 per share, but as Dick mentioned, fuel prices also came in above our original estimate costing us about $0.08 per share.

Two hurricanes, primarily Rita, subtracted another $0.07 per share from our earnings.

If you add these numbers across from left to right, they total the $0.94 per share.

Our reported GAAP earnings were $1.38 per share, which as Dick mentioned, includes the one time income tax reduction of $0.44.

Let's look more closely at the key drivers behind the results.

Or commodity revenue grew 12% in the quarter to a record $3.3 billion with only 1% volume growth in the quarter, the driver was the 11% increase in average revenue per car.

The components of the increase were pretty evenly split between yield improvement and fuel recovery.

Average revenue per car increased solidly across all six of our commodity groups ranging from 6% at the low end to 19% at the high-end.

The third quarter was our best ever quarterly average revenue per car at $1,357 per car.

Jim will give more details on individual business segments, but the quarterly yield gains were a real positive story for us.

Turning to operating expense we had a 12% increase to just under $3 billion for the quarter.

As you can see, salary and benefits is clearly the largest piece of our expense pie at 37%.

Fuel and utility expense is the fastest growing up 47% in the quarter.

A few years ago before fuel prices climbed to today's record levels, fuel and utilities made up only about 12% of our total operating expense compared to the 22% today.

Let's take a few minutes to look at the did I tail in a couple of these expense categories.

Starting out with salary and benefits, expenses were up 3% in the quarter on a 1% increase in work force levels consistent with our quarterly guidance.

Wage inflation, volume increases, and higher work force levels were the main drivers of the increased expense.

As you might recall, last year we paid $7 million for severance costs related to our headquarters consolidation.

Better crew utilization and lower training costs in the quarter also helped offset some of the cost pressures in this category.

We would expect fourth quarter salaries and benefit expense to roughly equal third quarter levels as productivity gains should offset inflation in higher crew costs.

Consistent with previous guidance, we would expect our full year work force levels to average about 2% higher than 2004 levels.

The larger work force is due in part, to second half hiring in advance of anticipated 2006 volumes and attrition.

Turning now to the equipment and other rent line this category was basically flat year-over-year increasing just $2 million in the third quarter.

We offset higher long-term locomotive lease payments with better car cycle productivity.

This expense category also benefited from fewer short-term locomotive leases and lower rental expense associated with the consolidation of office space into our new headquarters.

For the fourth quarter we would expect expenses to be roughly in line with third quarter levels in the 350 to $360 million range.

Long-term locomotive leases and volume costs associated with the intermodal peak season are expected to be higher year-over-year.

We should however be able to offset some of these increases through better car cycle times and fewer short-term locomotive leases.

Turning now to fuel, we continue to see a steady climb in quarterly diesel fuel prices.

As this chart illustrates, throughout last year we experienced more than 40% increase in diesel fuel prices.

Unfortunately this trend is repeating itself as we are seeing another 40% plus price increase in 2005.

Year-over-year high fuel prices added $210 million to our third quarter costs.

Even factoring in greater fuel surcharge recovery, these prices reduced our quarterly earnings by $0.08 per share.

Although we did improve our fuel recovery in the quarter, we only recovered 70% of the costs above our benchmark rate.

Said another way, if surcharges had recovered 100% of the higher costs above our benchmark, our operating income would have been $110 million higher than it was.

As we said before, our fuel surcharge programs have roughly a two month lag.

When fuel prices spike as they did following Hurricane Katrina, we can experience a disproportionate quarterly earnings impact.

In addition to the lag, our cost recovery is also impacted by higher refining spreads which are at unprecedented levels today.

Currently, however, only about half of our surcharge programs cover the rising spreads.

Looking at the bars on chart we see crude oil prices in orange.

Refining spreads in blue and regional spreads and taxes in green.

Between July and October, crude prices have been relatively constant averaging a little more than $60 per barrel and back in July before the hurricanes and refining outages, we were paying $1.75 per gallon for diesel.

But if you fast forward to October, refining spreads are now at historic high levels and a delivered price of diesel fuel has risen to nearly $2.30 per gallon.

As Dick mentioned, high diesel fuel prices continue to negatively impact earnings.

Our objective is to continue to put fuel surcharges on all of our business allowing us to recovery 100% of our costs above the benchmark rate.

For purchase services and other, we had a $36 million increase to $424 million.

As I mentioned in July, we had a $25 million headwind in this category due to a couple of favorable items last year.

This year on top of the headwind, we also had cost increases due to higher volume and the effect of the hurricanes.

The good news is we were able to offset some of these higher expenses through failure cost reductions, lower joint facility costs, and fewer relocation payments.

Looking ahead to the fourth quarter, you'll remember that last year we recorded a $247 million non-cash asbestos charge.

On a year-over-year basis a more comparable starting point is $440 million.

From that base, we expect a 1 to 2% cost increase due primarily to higher contract maintenance.

Looking at a summarized income statement for the quarter, total operating income was up 15% to $481 million.

While we are clearly not satisfied with this level of earnings, we are pleased to report revenues growing at a faster rate than expenses.

Along with the growth in operating income, we had a slight improvement in our third quarter operating ratio, clearly this is a higher ratio than where we want to be but we're moving in the right direction.

In fact, this slide takes our reported operating ratio shown on the left in 2004 and 2005, and adjusts it for fuel shown on the right.

You can see that since the first quarter we started to achieve real improvement in our core operations, roughly two percentage points better year-over-year in the third quarter.

This analysis does not make any adjustments for the hurricanes or other quarterly ins and outs.

It simply neutralizes the impact of fuel by adjusting diesel fuel prices to our benchmark price and eliminating fuel surcharge revenue altogether.

Looking ahead to the fourth quarter you'll remember last your our reporting operating ratio was affected by the asbestos charge I just mentioned.

Excluding that charge last year's operating ratio was 86%.

For 2005 we expect an operating ratio around that same level.

In the fourth quarter we would expect on a fuel adjusted basis to again see real improvement in our core operating ratio.

Let's wrap up our third quarter discussion with a look at the full income statement.

Other income increased by $12 million in the quarter to $42 million.

This brings year-to-date other income up to $91 million and tracking above our full year guidance of 100 million.

The real estate market has stayed strong in 2005 and we would now expect full year other income to be closer to $140 million.

Interest expense was down $8 million in the quarter to $124 million.

This decline was driven by lower debt levels averaging 7.6 billion in the third quarter of '05 versus 8.2 billion a year ago.

Income tax expense was only $30 million in the quarter versus $114 million a year ago.

Although our earnings were higher, the one time income tax reduction we announced a few weeks ago resulted in the year-over-year decrease.

Without the tax item, our third quarter income tax rate would have been just over 37% compared with 36% rate in 2004.

We also expect a 37% tax rate in the fourth quarter.

This all adds up to net income of $369 million or quarterly earnings per share of $1.38.

That includes the $0.44 per share related to the one time reduction.

Excluding the income tax item earnings would have been $0.94 per share versus $0.77 per share a year ago.

A 22% increase.

We experienced solid quarterly earnings growth despite the challenges of hurricanes and high fuel prices.

Looking ahead to the end of the year, I would like to give you a quick update on our outlook for cash capital spending and free cash flow after dividends.

From a capital standpoint, we are tracking slightly ahead of our $2.1 billion cash capital guidance.

We would now anticipate spending in the 2.15 to $2.2 billion range.

Through the course of the year we encountered several challenges that have pressured our capital budget, events such as the hurricanes, wash outs and added southern Powder River Basin joint line maintenance have each required extra capital work that was not originally anticipated.

We could have cut spending in other areas but we decided not to delay critical capital programs that we have under way.

You'll recall from earlier this year there will be some insurance dollars coming in related to the January west coast storm, but the timing of any recovery is uncertain and may not occur until next year.

Higher cash capital spending obviously impacts cash flows.

In addition to the cash capital spending, the impact of weather events and higher diesel fuel prices has reduced our earnings somewhat.

Therefore, free cash flow after dividends will likely be in the 200 million to $250 million range.

There is still two months left in the year and our performance over that time will ultimately determine where these numbers actually come out.

Finally, just a quick look at our balance sheet.

Through the end of the third quarter our least adjusted debt to cap ratio is showing slight improvement.

Looking ahead to the December we expect to maintain and perhaps improve somewhat our balance sheet strength despite some of the challenges we faced in 2005.

With that, I will turn it over to Jim.

Thanks, Rob, and good morning, everyone.

Let's start out today with a look at our quarterly revenue by business group.

Ag products recorded its best ever quarterly revenue converting a 7% volume increase into 27% revenue growth.

In addition to strong yield improvement, growth was driven by a 50% increase in revenues to and from Mexico.

Ethanol revenues were also up 54% on a 22% increase in car loads.

In addition, shipments of wheat and food grains through the Gulf were up 7% year-over-year.

Looking to the fourth quarter we're in the midst of the grain harvest and and we see strong demand continuing in this category.

Industrial products also had its best ever quarterly revenue up 16% on 2% fewer car loads.

Impacted somewhat by the hurricanes, this group had solid demand which enabled double digit yield improvement.

Car loads of aggregates grew 11% in the quarter due to strong demand in Texas, Arkansas and Louisiana.

In addition, we saw strong demand for construction materials such as lumber and steel which is expected to continue in the fourth quarter.

Along with best ever quarterly revenue, our intermodal group also had record quarterly loadings.

In fact, August was our best month for intermodal loads in the quarter international volume continued its trend of double digit volume increases for the year while domestic units were basically flat.

Yields improved 6% in the quarter in part due to increased fuel surcharges but clearly we have future upside in this area as contracts expire.

For the fourth quarter we would expect a strong finish to peak season.

Although this segment was mostly impacted by Gulf Coast hurricanes, our chemicals business recorded its best ever quarterly revenue up 9% on 4% fewer car loads.

To give you a feel for how Hurricane Rita impacted us, our September car loads had been tracking up 1%, but finished the month down 8%.

As it did in the first half of the year, demand for fertilizer continued strong in the quarter and our chemical yields benefited from fewer shorter haul loads.

Solid demand is expected to continue in the fourth quarter but production is still impacted by the lingering effects of Hurricane Rita.

As of today we still have roughly 20 or so plants that have not resumed full production.

Despite continued issues in the southern Powder River Basin energy posted its best third quarter revenue.

Demand clearly exceeded supply as car loads were down 3% in the quarter but higher yields drove a 4% revenue increase similar to intermodal, we have a number of long-term energy contracts that are not priced to market today and have good opportunity next year.

In addition to strong demand for Wyoming coal, demand is also very strong for coal out of our Colorado and Utah franchise.

Revenue grew 12% to $167 million for the third quarter.

Before I move onto autos, let me talk in a little more detail about the southern Powder River Basin.

We moved an average of 32.7 trains per day out of the basin in the third quarter meeting roughly 87% of our customers demand.

This is down from a year ago, but up a train and a half from the second quarter.

We have been able to meet 100% of demand in this quarter we have have loaded about 340 additional coal trains.

A variety of factors caused loadings opportunities to be miss and had when you look at the supply chain, mines, railroads and utilities, all of us share some part of the responsibility for the misses, so we must all work together to be part of the solution as well.

Starting out the fourth quarter, coal loadings have impacted -- have been impacted by the Kansas wash outs.

In October we likely will average about 30 trains per day, the fewest loadings since the May joint line derailment.

For the balance of the quarter we look to average between 32 and 33 trains per day with some potential upside.

Our overriding goal is to do everything we can to sea the demands of our customers and in 2005 alone we invested more than 50 million to increase the capacity of our coal franchise.

We also continue to work with the BNSF to minimize the joint line maintenance impact on loadings.

In fact, the joint line maintenance plan has been revised recently to provide additional loadings through the balance of the year.

At this point with this means for 2006 maintenance and loadings is somewhat unclear, but we will continue to work with all members of the supply chain to optimized loadings in a safe, efficient manner.

To wrap up the commodity groups, we had a 4% revenue growth and 5% fewer car loadings in our auto group, third quarter best.

Both finished vehicles and auto parts shipments were down in the quarter due to lower vehicle production.

In addition, shipments of auto parts to and from Mexico declined as productions south of the border was also lower.

Yield and fuel surcharge increases produced revenue growth.

Overtime, this group also has a we will see a better yield as long-term contracts expire.

Our fourth quarter expectation is for continued softness in this category due to lower finished vehicle production.

Turning now to operations, the slide lays out network velocity against the background -- backdrop of our seven day car loadings.

Our network management initiatives are having a positive affect on operations we moved our highest seven-day car load volume, just under 198,000 cars a week, in the second week of September.

What I am pleased with is this was the same week the velocity hit its highest point in nearly a year.

A week later however, we had to shut down operations in Texas in preparation for Hurricane Rita.

Just as we were recovering from that set back, our four main lines around the Topeka, Kansas area were washed out by a very severe storm that dumped between 10 and 12" of rain over several hours.

These are major corridors for UP serving as the primary correction to the east and south from the western part of our system.

As you seen in the weekly metrics and volumes the operating chal lengths resulted in a slower start to the fourth quarter.

We did however, see nearly a half a mile per hour velocity gain and a 3% increase in car loadings last week.

Importantly, we still expect to see year-over-year operating improvements in the fourth quarter.

In July I mentioned that improvements in our Houston and Los Angeles terminals were critical to increasing our overall network velocity.

We had been making progress in Houston prior to Hurricane Rita, but that obviously set us back some.

This slide shows the progress we made in the Los Angeles area.

During the quarter we increased velocity by more than 30%, reduced terminal dwell at west Colton by 30% and completed the cutover of our Unified Plan intermodal changes significantly increasing our ICTF facility volumes.

With peak season intermodal volumes running at record levels, we still have work ahead of us.

This demonstrates we are focused on the right things to improve railroad operations.

We talked in the past about productivity and the need to produce revenue growth from existing assets.

With freight cars, car utilization measures the loaded cycle time of a car.

Lower utilization times equate to more revenue per car loads per car.

Car utilization is also a measure very visible to our customers.

In the face of record volumes and hurricanes, we improve freight car utilization by 6% year-over-year.

Again, we believe this is a positive sign of our operating progress.

Beyond our own methods for measuring operational efficiency the ultimate measure is in the eyes of our customers.

To assess how our customers view our performance, we conduct monthly surveys of 200 customers pulling the same group of customers in the same month each year.

Beginning this summer, we started to see some improvement clearly our mark of 70 in September is well above last year's rating but still a long way off our best year of 78.

We're certainly not declaring victory here, but it is encouraging since one of the questions asked on the survey is about the value paid for the service received.

Although we have been -- have seen improvement from the Unified Plan and other network management initiatives, we clearly have more work in front of us.

The final piece of Phase I of the Unified Plan Chicago Intermodal Changes was completed in August.

Phase II which focuses more on terminals and gateways is now under way.

The goal of Phase II is to create capacity through further network simplification, reduce car and train handlings and more point-to-point trains.

Phase II also focuses on improving the process of matching our transportation plan to our marketing forecast and allocating assets to maximize network velocity.

We will also continue to implement lean initiatives in the terminals, lean processes can help us create capacity as we remove process bottlenecks and improve terminal fluidity.

The roll out of our new customer inventory management systems is ongoing.

As we discussed at our May analyst meetings, SIMS is a critical tool that we're using with our customers to pro actively manage inventory.

The process is cut over in Phoenix, Los Angeles, Las Vegas, and San Antonio with roll outs in Houston and Roseville currently scheduled by year end.

Although it is early yet and we're still finalizing our plan for next year, I thought I would share some of our assumptions as we look ahead.

First, we see demand continue to go out strip supply creating continued yield opportunities.

In fact, next year we have a substantial number of long-term contracts available to reprice to market rates as well as add a full fuel surcharge recovery.

We also believe fuel prices are likely to remain high next year, but again we have an opportunity here to further expand our surcharge coverage as contracts renew.

The biggest opportunity we have is to improve productivity and therefore improve our profitability by taking more of our strong revenue growth to the bottom line.

A key part of our focus here is in work force productivity.

We caught up on the hiring over the past couple of years and the future we're only hire as needed for attrition and growth.

We will continue to only make capital investments supported by returns that significantly exceed our cost to capital.

These investments provide an opportunity for us as we target productivity gains in business growth, particularly in our intermodal and energy groups.

At the end of the day, all the actions will result in a more satisfied customer base.

We believe we are taking the right steps to improve our operations, improve our financial returns and provide a valuable service for our customers.

With that, I will turn it back over to Dick.

Thank you.

Looking to 2006 we clearly have some great opportunities in front of us especially the opportunity to improve our returns and deliver better service for our customers.

As Jim mentioned earlier, our operating folks took a 1-2 punch a couple of weeks ago when the storm in Kansas dumped 10 to 12" of rain in a short period of time which was just after the Hurricane Rita hit the Gulf Coast.

I have often said that operating a railroad with 33,000 miles is like long factory with no roof on it.

With all of the attention that we've gotten from mother nature this year, it has really been brought home how true that is.

Wash outs in Kansas have clearly impacted our business levels in October.

During the first two weeks of the month, car loads have averaged about 5% below forecast due to the directly due to the wash outs.

At this point we estimate that the Kansas wash outs could cost us a nickel or so in the fourth quarter.

Because that storm occurred at the very beginning of the quarter, we may have an opportunity to make up some of the missed loadings, though this will clearly be a challenge in the face of peak season.

Additional fourth quarter drivers will include the amount of time it takes for some of our Gulf Coast customers to reopen their production facilities following Hurricane Rita, and the direction of fuel prices which are likely to be a challenge again this quarter.

One clear positive is the continuing strong demand for our service.

Our customers want to do more business with us and we're working hard to profitably accommodate their needs.

With all of that in mind, we are expecting to see fourth quarter revenue growth in the 11 to 12% range.

At that level, our full year revenue growth would also be about 11 or 12%.

Fourth quarter diesel fuel prices are expected to range between 210 and 2.15 per gallon.

As Rob showed you earlier, we're currently paying closer to 2.30 per gallon for our fuel.

The fourth quarter guidance has some risk if diesel fuel prices don't moderate the way that gasoline prices have.

At the 2.10 to 2.15 per gallon level, our full year average fuel price for '05 would be about $1.80.

That's 50% more than last year's record prices.

Despite the fuel surcharge programs high diesel fuel prices remain a huge cost inflate or.

We won't rest until we have full coverage in place.

Taken together, we currently expect our fourth quarter earnings to be in the $0.95 to $1 per share range.

This would bring full year earnings excluding the tax item to the 3.25 to 3.30 per share range.

On a full year basis as Rob said, we're bumping up our cash capital estimate and adjusting our free cash flow projections.

Looking at the overall state of the railroad today, we believe we should see both financial and operational improvements in the fourth quarter despite the slow start in October.

As Jim showed you, we're already seeing gradual improvement.

Importantly, we believe our network is more resilient than it was a year ago.

Today our railroad is better resourced in terms of crews and locomotives forming a solid foundation upon which we have been implementing the Unified Plan.

Although record volumes will challenge our improvement efforts this quarter, we're dedicated to the task and truly believe we're making progress.

Our goal is to be a company where three stake holders, customers, employees and shareholders, are all benefiting from efficient operations, a safe working environment and rates of return that exceed our cost of capital.

With that, let's open it up for any questions that you might have.

[OPERATOR INSTRUCTIONS] Our first question is from Scott Flower of Citigroup.

Please proceed with your question.

Good morning all.

I wonder and I know you talked about it but I want to get some numbers around it.

The fuel surcharge coverage issue, where are you, what proportion are you covered now and I know that may be in different forms, RCAF versus different fuel surcharge, and given some of the opportunities, what is realistic as a percentage of your book-to-business that you think may be covered by next year?

I am trying to get a sense of where you are now and where you think that can move to as we look at '06.

Scott, this is Rob.

The coverage ratio if you include as you asked RCAF, is close to 90% of our revenue is touched with some sort of fuel surcharge recovery or another.

As we indicated in the numbers here, we're recovering only 70% above the benchmark rate.

What it implies is not only do we have 10% of the revenue uncovered, but the 90% that's covered isn't doing its job of covering 100% of the costs.

We will make progress on that.

I can't give you an absolute number.

As each contract becomes available for us to re look at, we are either putting a surcharge in if it doesn't have one or strengthening it if it doesn't have a good enough one that gets full recovery.

The potential improvement going to be from upgrade in fuel surcharges in terms of what may already be covered but having a better fuller coverage versus actually increasing the number of contracts that have some mechanism?

Scott, this is Jim.

It is really a combination of both.

You heard me mention that we've got next year about 15% of revenue, 10 to 15% rolls over on the contract side, you know, both of those include we're going a lot of our contracts have fuel recovery mechanisms but we need to upgrade those.

Our goal is 100% when you get long-term here.

We made good progress every year.

We will continue to make progress going forward.

And then just a couple other ones.

I know that it is hard to look at your data particularly because of the hurricane impact, but if I look at industrial and there may have been some impact, and this is true across the industry, everybody's manifest business is down this quarter and I keep hearing everyone saying how good demand it is.

And I guess one of the questions I got is, where are we in terms of balancing price versus volume growth or the manifest business just a business that needs to shrink relative to getting yields up to adequate levels because every railroad is talking about how demand is good yet everybody's manifest or industrial business is down and I'm just wondering where are we in terms of balancing pricing versus where you want volume growth?

I assume as one point you want a balance between the two.

Jim?

Scott, we take a hard look at our total manifest network.

And as you know, we're the largest manifest railroad.

We believe absolutely it is a great franchise for us.

We are looking at what makes sense in our network, pricing is a big component of getting the returns up in this business.

Look willing at fluidity.

How it impacts network is important.

The reinvestability in the business.

We have lost some business in terms of pricing, but the demand is still there.

When we sit with our customers, so right now overall the economy still seems to be holding when we're talking with our customers in the industrial sector.

If the returns don't get to the point we need them, we're not going to handle the business.

What we are really working on here is what makes most sense for us going forward.

I think, though, too, Jim, to address the third quarter specifically with what happened with industrial products in hurricane Rita had a huge negative impact on our aggregate business in Texas as an example, because it essentially shut it down for the last week and that's a business that runs about 1,000 cars a day, so it just had an enormous impact.

As Jim said, our demand is just couldn't be stronger.

Then just a couple of other quick ones.

One is is there any potential insurance recovery from Rita?

I know you talked about the west coast storms earlier this year.

Some level of insurance coverage that at some juncture, whether in '06 or otherwise, may come to you.

Scott, probably not at this level.

That's something we keep a very close eye on.

Okay.

Last quick question was on CapEx you noted that you're spending the money despite some of the short-term impacts.

What do you think the shorter term weather impacts or otherwise, whether it's PRB or the west coast storms or Rita, have added to the CapEx budget this year versus what you would've assumed baseline would have been this year?

Scott, that's the it's in the range of that additional guidance that we gave.

Just refresh me.

I looked at the chart and was it 100 to 150 million.

No, 50 to 100.

Thanks.

I will let someone else have at it.

Okay.

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

Please proceed with your question.

Great.

Thanks.

Good morning.

Good morning, Jim.

It may be a little early in the process here.

How do you know if the Unified Plan is working or not?

Did anything come during the quarter that where you could look at tangible savings and are you at a point now you can start to feel like you can see the trajectory, the slope of the line going forward on the cost benefits?

Jim, do you want to?

I will take a shot at that one, Jim.

There are a lot of different measures you look at.

There is no home run here.

It is good steady progress.

I will give you an example.

The chart I had there on record loadings where we also hit our highest velocity level in a year.

I would attribute that to the things we've been doing on Unified Plan, particularly intermodal network and a lot of the lean initiatives.

You look at things like the car cycle time, utilization time, again, with record volumes, with the weather issues we've dealt with, we still improved that.

Not where we need to be.

If you look at the cost area when I sit back and look at it in year, we can point to things like training.

We know our training numbers are in terms of number of employees a year ago we were -- about 2300 TNY folks in training this quarter we had about 1500.

Our training costs have moved down.

Part that is catch up, part of that is being healthier.

Your velocity numbers when we look at things like our terminal dwell times that come into play there, you can see that in again car cycle time was one and car hire and also things like our limos that are reoccur rates, equipment utilization, part of the progress obviously is masked with what's happened with the network.

When we sort through it, it is definitely there.

And our ability to even recover quicker.

When you're healthier with crews and power, we do get hit externally.

It is going to snow this winter.

We see our ability to recover as much better.

Okay.

Great.

I asked two questions on coal.

The first one that Burlington Northern beliefs there is about 50 to 75 million tons of incremental demands in the PRB for '06 and they expect to get about 25 million tons of this.

I think they're being a bit conservative or realistic given all that's going on out there with both the railroads and the mines.

Is UP prepared to pick up 25 million tons?

Do you think you could do above or below that number?

Jim, I'm not going to give you any specific numbers here.

I will tell you the demand is very strong going forward here.

We are working with -- on our network in terms of what do we need to do to handle it, a wild card is what will happen on the maintenance up here in the joint line.

Again we're working with Burlington Northern and our customers.

We've got some great opportunities for next year.

Okay.

Good.

Last question is also on coal.

It is our understanding the Kansas City Power and Light right now they're in dispute with UP and I wouldn't expect you to get into the details of that.

I understand it is sensitive for the Montrose plant.

They're suggesting the rate will go up almost 40% for their coal transportation.

I am asking the question more to say is a 40% increase for a plant, that indicative of the types of increases you see are necessary out there to get transportation rates up to market levels for some of your contracts?

I don't think it would be appropriate to discuss what we're doing with our customers, Jim.

Jim, do you see that?

We're not going to comment on the rate.

What's important here in my mind we've got to get the return up in the coal business.

If we're going to look at capacity and investment going forward and the kind of capital that's needed, they absolutely have to go up and they have to go up in my mind pretty substantially.

Okay.

Great.

Thanks, guys.

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

Please proceed with your question.

Good morning, gentlemen.

Good morning, Jason.

A couple quick ones here if we can.

What I am looking at the quarter, when I am looking at the arc here on chemicals, that was up about 14%, a lot hire than we expected.

Anything specific going on there?

Well, there is a couple of things.

We are start to go get some fuel recovery in net fuel charge recovery, internet business.

We do have contracts that have rolled off so core pricing is starting to move up.

You did have a little bit of positive because of less business going into STS this quarter, that's short-term storage, and more of it going direct to producers.

You know, it is the market, the demand has been pretty strong there.

I think that's an indication of what the potential is here pricing wise as we you test the market.

So as we model out going forward we should expect double digit gains in the ark.

It all depends on market demand.

There are a lot of factors that come into play.

If the demand stays very strong we've got good upside.

And I understand you guys have been hit by mother nature pretty hard with a couple of body blows but if we can look at 2006, should we expect pretty much everything to be back up and running and maybe get a little recovery freight?

I think that's a fair statement depending once again, winter comes every year and you have hurricanes and unusual events, but this year we've had more than we've ever experienced before in history in a compressed period of time, but we do look for the railroad to recover here in the fourth quarter, and you know, if all things being equal, we ought to look for continuous improvement next year.

Okay.

One more and I will let somebody else have at it.

You mention that about 10 to 15% business is going to roll over in '06 but it sounds like there is a disproportional amount in intermodal and coal as well.

Could you give us sort of a break down what percent of rolls over in each?

You know, I don't have the specific numbers.

My point when you look at it, you have energy is obviously where you have your greatest concentration of coal contracts, but it's also I look at the yields.

You have intermodal, energy and auto, auto is also 90+% of that is in contracts.

Those are the three areas that will have good opportunities next year.

Okay.

Fair enough.

Thanks, gentlemen.

Thank you.

Our next question is coming from Tom Wadewitz of J.P. Morgan.

Please proceed with your question.

Good morning.

Two questions for you.

On the track capacity side, it seems to me like that's probably still the area where the biggest constraint and I am wondering whether you think that's going to be a constraint looking to 2006 or whether you think that if you get modest improvement in velocity that will no longer be an issue for you and you will be able to grow whatever a couple of percent on the unit side?

Jim, do you want.

I will take that one.

I don't see the capacity challenge going away in the near term because demand is so strong.

What's important for us is to look at how you manage the capacity which is a combination of putting capital in the right places if the returns are there, the network initiatives we have going on operationally and managing flows.

The last two are not capital solutions.

They're process solutions.

I don't see again if you assume the economy is going to stay relatively strong next year, the whole industry has challenges here as we're going forward.

I think that's exactly right.

This is Davidson.

I couldn't agree with more with what Jim said.

We'll still be facing real challenges.

So with that in mind, what Duke is a realistic number if the demand was there?

I know you have quite a bit of pent up coal demand, intermodal secular growth trend provides support.

Is there track capacity available to grow total units in the mid-single digits or is that really not possible given some of the constraints you have, should is be more like a 1 to 2% number all in given where you're at on track capacity?

Tom, I think it is early for us to give you a number on volume here.

The commodities are substantial and I want to focus on the financial returns and yield necklace terms of moving forward, and productivity in terms of the network here.

Okay.

And then just I think two kind of technical ones for Rob.

On the other income that's coming in a bit stronger than you expected, did I understand it right 49 million of other income on fourth quarter and then on fuel surcharges, I don't know if you gave us the actual surcharge collection this quarter or not?

The other income, yes, we gave guidance of 140 for the year and that implies a strong fourth quarter in that 40 plus range for the fourth quarter, Tom.

On the fuel recovery, I didn't give a number.

I gave the 70% above the benchmark rate.

Had we recovered 100% it would have added another 110 million or so to our earnings.

There is a lag.

We're continuing to chase that fuel as we go up, so it potentially still is a negative if it keeps running up.

Is that, can you give us a sense of what that number might have been year-over-year?

No.

I really can't, Tom.

Okay.

Fair enough.

Thank you for the time.

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

Please proceed with your question.

Good morning, guys.

As you look out into 2006, you indicated work force is up 2% or so, what is your expectation for hiring into '06 and do you foresee being a bit over staffed early in the year just to -- or are you trying to get a bit over staffed in order to make sure you don't run into a shortage of labor if demand stays this strong?

John, I don't think we said next year that we're going to be up 2%.

This year.

This year, '05 versus '04.

You know, John, when we look ahead to next year, again, as I had mentioned, the number of people we have in training that rate and our hiring is going to be less than what you've seen in the last couple of years.

In fact, you go back '04 we hired in total in the company 7700 new employees, '05 we're going to be about 5400 and that rate will drop next year.

We've got opportunities in the productivity side to get healthier here.

Also we have good volume opportunities.

What we're sorting through right now is what is the right mix.

As you add coal, you think about coal demand, those are pure train starts, so any time you put coal in the network you're going to do a little more hiring.

I think we've got good opportunity to offset some of the volume with product activity.

You have to be a little careful too about the hiring numbers.

That's Social Security numbers we're talking about and when we look at our people we're talking for the full year we're talking full time equivalents as you know, so it gets confusing if the raw numbers don't equate to the full time equivalents.

So you see just trained employees beginning to ebb down in terms of hiring numbers and training ebb down a little bit versus what we've seen in the last couple of years?

On the hiring that's true.

You had one other question about surge capacity and having -- we committed two and a half years ago when we were short here, we are going to keep some surge capacity in here to deal with issues like major storms, floods, to get healthier here.

We're doing -- fourth quarter hiring obviously people we have in training is getting ready for next year's volume.

Minimum it takes you about six months to hire an employee and get them on the ground to where they're starting to become productive.

Okay.

All right.

And then on the fuel surcharge, given your desire to increase obviously the level of recovery, are you looking at modifying your surcharge program at all being they're going to go more of a mileage based surcharge mechanism to look more truck-like and help on the recovery some?

Anything you intend to do to be more aggressive in modifying that program?

Right now we believe our approach makes most sense.

We're always taking a hard look at it, the real goal here is to get to 100% recovery on our fuel.

We'll keep watching.

I am in front of a lot of our customers, and I think you have a real mixed view about how they see that fuel surcharge recovery, but we're going to do what's best for Union Pacific.

We just want to take it off the table as a variable.

Right.

Period.

Very good.

Thanks for your time.

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

Please proceed with your question.

You mentioned demand still running greater than supply or train capacity and that would produce continued favorable upward bias to yields going into next year.

You mention a couple times demand's importance which makes sense.

My question is sort of what level of economic growth does that balance start to go the other way and you have less upward ability to push higher on yields?

Fuel prices have a lot to do with that.

Truck capacity and the fact we're so much more efficient than trucks so it is a pretty complicated question, Jim, do you want to take a shot at it?

You can look at general economic demand next year right now it is relatively strong, but there are other factors that Dick said.

What's happening on the truck sector in terms of costs, a lot of customers that want to put more business on the railroad.

High natural gas prices drive it.

Import business coming in, we've got a long ways to go here to in terms of our financial returns.

We've got I think a lot of our business here we're going to get to cost capital or higher we have to change substantially in terms of the returns.

Okay.

How important is the service component as a long-term driver of price?

We have to get service up, no question in our mind and we're making progress.

We again when we're in front of our customers we are seeing some positive trends as I had shown in our customer surveys, and it is all about the value proposition, but none of us are satisfied where we're at, but we have a good plan to improve it.

Thank you.

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

Please proceed with your question.

Good morning.

Can you talk a little bit about the Kansas floods for a minute.

How much are you completely rebounded from that at this point or still working through the track issues?

And when you think about CapEx for next year, you've had a lot of shocks to the system this year which have impacted whether it is the derailments or the hurricanes.

Can you think in general terms whether we should see some of that pull back or is based on your Unified Plan and kind of your track builds should we see that maintain these levels or even increase them?

The Kansas wash outs, as we speak we are redriving or reconstructing the last two bridges right now.

We've been operating on a temporary infrastructure there for the last couple of weeks, and by sometime tomorrow we should have the -- we're working twenty four hours a day obviously.

We should have the last two bridges completed on Friday.

The biggest impact actually, our guys reopened the track on a temporary basis in about 72 hours or a little over.

They did a great job of doing it, but what really happened at one time we had about 350 trains standing still.

Which was consuming locomotive hours and reducing freight car utilization and it takes awhile in a big network operation like ours to get the those flows smoothed back out, and that's just happening as we speak that we're starting to get our flows leveled back out and get our locomotives being utilized appropriately again.

So the answer to your question is we're just about to get the impact to Kansas behind us.

As far as our capital spending for next year, you know we're not done with the planning effort yet, and as you well know the final decision is up to our Board of Directors.

I would look for spending to certainly not exceed what we're investing this year.

Great.

Second question.

Jim or Rob, can you talk about the break out of the yields, break it into what was price, fuel, surcharge and mix of the 11% gain?

Yes, the yield was about 5% of that.

Fuel surcharge was 6%.

The balance was mix and volume.

Great.

Last question quick one is you talked about the Unified Plan.

I guess you said you launched the second phase of it.

Does that mean the first one is kind of the first phase is done, everything has been implemented and we're on the fine tuning phase?

Can you talk in more detail about what you ran over earlier.

I will.

I think the first thing to keep in mind here, this is going to be an ongoing process.

You know, we've broken this thing up into phases here, because you're making some major changing in your network, but even Phase I, you've got now Phase II which I said is going to focus on the gateway, Mexico, the terminal, but we're going back and even looking at Phase I what's happening with the network, what's happening with business demand, if you're not careful here you can look up a year from now and figure out the products you put into the market didn't support the network, so it is going to be ever green process here in managing the network and again, I expect we'll continue to see improvement.

Great.

Thanks a lot for your help.

Our next question is from John Larkin of Legg Mason.

Please proceed with your question.

Good morning, gentlemen, thanks for taking my call.

I had a question on the grain business which was stronger than we thought it might be.

How much of that was a function of grain being pulled off the river in the month of September and put on the rail?

We think very little right now.

Okay.

So that is sustainable going forward, you think.

We see a strong fourth quarter.

A lot of other factors come into play when you think of next year.

Jim, I think I heard you say you were growing that from a volume point of view about 1% year-over-year up until the hurricane hit and then it dropped to minus 8%.

Was that the correct interpretation of your comments.

In September before we were hit with the hurricane, we were up about 1%.

If you look backwards is not too far off where we have been, and then into the month of September down 8%, so it really hit us pretty hard.

The hurricane hit early in the month of September, so does that also reflect what was going on in July and August?

It was really the second hurricane that hit us the most, Rita.

I understand.

Rita is the one at that impacted Union Pacific so much.

Thank you.

And one final question.

With all of the visits from mother nature that you've had this year and all of the trials and tribulations that have been created, is there anything you can do to change your maintenance program to perhaps in the future become less vulnerable to these sorts of disruptions?

We try to pay real attention to where we had track wash outs and that sort of thing, you know, in years gone by in some cases people tended to fill bridges and put pipes in and maybe not consider what's happened like with the construction of new roads and shopping centers, so we look at the run offs, the drainage and that sort of thing and in most cases mother nature is telling you something that you need to increase your opening through the track and that sort of thing to handle the flows, so we always try to learn from the bitter experiences.

Thank you very much.

Thank you.

One thing I want to mention about grain, you asked that question and you know that you asked that.

It is huge carry over stock pile generally speak the yields have turned out to be far stronger than with a were anticipated particularly in the soybean area.

There is a lot of grain in this country so the opportunity is there to move it.

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

Please proceed with your question.

I have two questions.

One sort of customer related and the other operational.

With reference to the customers you guys have gotten fairly decent in improvements in the arc for your automotive business.

Obviously the domestic automotive industry is it struggling quite badly right now.

I wonder if you can speak to the prospects for your automotive business looking to 2006 at your ability to improve returns in the automotive business.

And what's your position with the transplants and the imported product that's coming into the United States?

Jim.

Randy, as you know we have the majority of the market share in the west, the domestic producers, the international producers coming in.

It is -- they've got tough times, but it really varies among the individual customers here.

You know, at the end of the day, when we look at the investment required that we have made in this network that could be required to maintain it in the future, we have to get the returns up on this business.

When you look at the growth opportunities, right now I think so production will be pretty much flat this year, vehicle sales compared to last year.

It is real wild card for next year in terms of where it will end up.

We're working with our customers in terms of how do we improve utilization, load on load capabilities, back hauls, but we do need to get the returns up in the business.

Is there an opportunity to sort of raise rates but give the customer more value so you don't get a squeeze issue in the auto side?

Clearly the auto companies with talking about getting concessions from their suppliers, major rationalization.

I wonder how it will impact your auto business in 2006.

I think again I said our service numbers need to improve.

At the end of day for autos, we're doing better when you look at where we have come from here.

I still come back to when you have demand across your other five business groups then strategically you have to decide what businesses are going to put your limited resources, and I tell you, if we can't get the returns up in some of these businesses we're not going to handle it.

Okay.

Somewhat related fashion, a lot of the U.S. chemical industry is natural gas based. $14 in MCF is putting pressure on those guys.

When you talk to your sales force in terms of talking to the chemical industry, what's the outlook for 2006?

Have you got any concerns about volumes coming off?

Well, I think the volume opportunities limited in that Wisconsin when you look at it.

It is a function of where they are capacity-wise.

There is not much if any new capacity going in other than maybe plastics, but I think the volume upside is going to be very slow as we said in our strategic plan going forward here.

One thing that could change is that I think in the chemical companies have been saying this, could be more import business at some point as opposed to domestic production.

You guys think you will win on a shift from import to domestic or lose in a domestic import shift?

I think the experience we've had thus far is kind of a break even.

We have been witnessing that as you well know chemicals used to be a huge export item for the U.S. and last year or two that's been the balance has been changing.

That implies in some ways when you think about your import you have lower margins there and again what we look particularly when you look at intermodal business, we have very good upside in the margins on that business.

Okay.

My final question has to do with the Sunset Corridor.

That's kind of you identified that as kind of your critical strength.

I think you've been adding sidings into it.

What is the status on the Sunset Corridor?

House it running?

What is the capacity situation there?

Have you been please with the headway that you've made on that route.

It has been a good news story for us.

We will add almost 70 miles of double track this year kind of our base plan is add somewhere around 50 miles a year even though we have done better this year.

You know that the Sunset is really running pretty well, and although it may not have quite as much capacity as we'd like, we also had the prerogative of shifting some business coming out of southern California over our central corridor that runs on from L.A. to Salt Lake City, we had some unused or additional capacity we could take advantage of there, so we tried to balance our business between the two lines and we're adding double track at a pretty healthy pace out there.

And in terms of sort of the performance speeds are up on the Sunset, volumes are up on the Sunset.

Yes, yes.

Both.

Service is also a lot better there in the Phoenix and Tucson area.

In fact, Phoenix has been kind of a poster child for us.

We put the inventory management system in and some capital spending along with it and it really, really has improved things.

Our next question is coming from David Broughton of AG Edwards.

Please proceed with your question.

Donald, David, just don't call me late for dinner.

Dick, Richard, maybe you guys can give me maybe a minor pointed but I am missing something here.

The gain on sales from real estate in the fourth quarter will be how much more than they were last year?

Our guidance for the full year, Don, is in the 140 million range and year-to-date we are in the other income line which is primarily real estate.

In the year-to-date in the 90 million range, so that implies 45 to 50 million number.

And what was the gain on sale last year in.

Last year was for the quarter fourth quarter last year was more than 25 range.

It is a stronger market for us as we see at this point in time for the fourth quarter.

And your guidance $0.95 to the $1 includes that gain; right.

That's correct.

So where am I going to stray by suggesting that you're really guiding us to 87 to 92?

I think, Don, this is Jim.

I think there are other factors you have to look at.

You do have the real estate side as we said though we're chasing the fuel numbers.

We just don't -- you can't keep up as quickly as they've gone going forward here.

I think what's important if you remember Rob's slide, is we're going to show improvement in our operating ratio where you take fuel out of it which and that excludes real estate.

Real estate will be what it is going to be here.

I really look at are we making core improvement in the operations, and we will see that again in the fourth quarter.

But your guidance includes $0.06, $0.07 of real estate that is not core improvement?

Don, just a couple comments.

This is Rob.

We always have real estate sales in our numbers as you know.

Year in and year out it ebbs and flows.

In years are stronger than others.

This isn't unusual in that sense.

Additionally you may recall we said that we anticipate this time that the fourth quarter will be negatively impacted as a result of the Kansas wash outs by about a nickel or so, so you may not be factoring that in either.

In your guidance there is a $0.06 more of real estate sales than there were last year?

Yes, Yes.

Good enough.

Just wanted to make sure I got my math right.

Our last question today will be coming from Edward Wolfe of Bear Stearns.

Please proceed with your question.

A couple of follow ups and then a question or two.

Don't want to pile in on that, but in the third quarter the 42 million of other, how much of that was real estate gains versus year ago and the third quarter?

Last year's third quarter was comparable to last year's fourth quarter, about 25 million, so we were, rough numbers Ed, about 15 million stronger third quarter than the previous year.

Okay, and, Rob, the guidance you gave, I just want to clarify that I heard it right, was for an OR that was flat at around 86 of the that was including fuel; correct.

That's correct.

Just wanted to make sure I heard it right.

Including a higher priced fuel of course than in that 2.10 to 2.15 per gallon range.

Of course.

When you look out at the issues you're having the mother nature issues in Kansas, in Houston, the PRB, and you look at what's impacted the network a little bit in the short-term, how would you rank those issues in terms of the overall fluidity of the network and where do you think you're going to be through those issues completely if you look at those three?

I think the answer is we don't know exactly because we haven't nailed down the maintenance plan on the PRB for 2006.

We are still clearly going to be carrying over some work to be done in '06.

As far as putting the impact of the two hurricanes and the Kansas floods behind us, that's going to pretty well be taken care of.

Although as you probably know, the CSX will not have their railroad totally restored until sometime in '06 as well.

We still are detouring some traffic through Memphis rather than the New Orleans, so there will be some impact there that will go on for I don't exactly know how long it is going to take the CSX to restore their bridges.

As you know they got really, really creamed with Katrina, but all things being equal, we look for good improvement in our operation in the months ahead.

We look for continuous improvement and Unified Plan and the lean initiatives kick in, they are kicking in and we see it every day, we're looking for good improvement.

I thought I had heard Jim say that some percentage of the chemical customers were not yet back online.

That's true.

Can you talk about what percentage of that business is not back online in the timing for that?

Of course we can't actually predict what when they're going to get back up it full production.

They would have to tell you that.

They're coming back every week.

Ramping up production.

I don't know.

Does anybody have a feel when we might be the 100%?

I don't.

We'd be guessing.

We had 100 -- over 100 customers impacted.

We're down to around 20 or so still not at full production.

I think it is going to -- they're picking up and expanding but it is going to be through the fourth quarter until the end here until you get them back to full production.

One last quick one.

You talked about 10 to 15% customers rolling over in '06.

What was the number like in '05 for some reference?

You know, single digits, maybe around 8 or 9.

Thanks, guy's, for the time.

I appreciate it.

Thank you.

I think that wraps it up, so we'll look forward to visiting with you again in three months.

Ladies and gentlemen, this is it conclude today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.