聯合太平洋集團 (UNP) 2007 Q1 法說會逐字稿

April 19, 2007 in Omaha, Nebraska.

This presentation may accompany materials, contain statements about future expectations, or results of the Corporation that are not statements of historical fact.

These statements are or will be forward-looking statements as defined by the Federal Securities Laws and generally include, without limitation expectations, projections, estimates, and similar statements regarding the Corporation and its operations of financial performance, customer demand, and economic conditions.

Forward-looking statements should not be read as a guarantee of future performance and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in the statements.

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

More detailed information regarding the forward-looking information, such risks and uncertainties are contained in the materials accompanying this presentation and the filings made by the Corporation with the Securities and Exchange Commission which are available from the SEC, at www.sec.gov and on the Corporation's website.

In addition, during the course of the presentation the Corporation will refer to certain non-GAAP measures.

Management believes these measures provide an alternate presentation of results that more accurately reflect ongoing operations.

These measures should be considered in addition to and not a substitute for the reported GAAP results.

Please refer to our website for any reconciliation to these measures.

[OPERATOR INSTRUCTIONS] Greetings ladies and gentlemen and welcome to the Union Pacific first quarter 2007 earnings release conference call.

[OPERATOR INSTRUCTIONS] A brief question and answer session will follow the formal presentation.

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr.

Jim Young, President and CEO for Union Pacific.

Thank you.

Mr.

Young, you may begin.

Good morning, everyone, welcome to our first quarter earnings conference call.

With me today are Rob Knight our CFO; Jack Koraleski, Executive Vice President of Marketing and Sales; and Dennis Duffy, Executive Vice President of Operations.

Our first quarter earnings total was $1.41 per share, it's up 23% versus last year's $1.15 per share.

Our quarterly operating income also grew to a record $719 million, a 19% increase.

We produced record first quarter revenue of $3.8 billion, despite a 2% carloading decrease.

As you'll hear from Jack in a minute, the primary driver of the carload decline was continued economic weakness as reflected in our autos, industrial products and domestic intermodal business.

However, EP's franchise diversity helped mitigate some of the impact of lower carloadings, as strengths in other groups, particularly chemicals, helped drive our year-over-year revenue growth.

Although winter weather affected our entire network, coal volumes were especially impacted by winter storms across our central corridor during January and February, followed up by a blizzard in the Southern Powder River Basin at the end of March.

The March storm in particular had a major impact in mine production for over a week.

Our operating ratio improved 2.4 points to 81.3%, that's a first quarter best.

And we're making good progress in improving profitability and increasing operating efficiency and safety.

I'm particularly pleased that our customers are also showing their confidence in Union Pacific with satisfaction survey results that have reached a four-year high.

UP customers are realizing a greater value for their transportation dollar today and we're committed to enhancing that value going forward.

Overall our first quarter results marked a solid start to the year.

So with that, let me turn it over to Jack to talk about a revenue performance and outlook.

Thanks, Jim and good morning.

On the strength of a 6% increase in average revenue per car to a record $1,565 we set a first quarter revenue record of over $3.6 billion, even as the winter storms and some soft markets held volume 2% below last year.

Yield gains were strong across the board, with four of our commodity groups posting best ever average revenue per car while the other two set first quarter records.

With the yield gains, chemicals set an all-time revenue records and ag products, energy, and intermodal established new first quarter bests.

In addition to our improving yield, customer satisfaction, as Jim said, reached a four-year high as customers are acknowledging the improved service, the reliability, and the velocity of our many product offerings.

Let me take you through the volume growth drivers for the quarter.

Start with chemicals.

Chemicals showed surprising strength with volume up 3%.

All segments of our chemical business saw volume growth with the largest gains coming from an 80% increase in potash exports and strong domestic demand for fertilizer in anticipation of the spring corn planting.

Export soda ash movements were also strong with volume up through the Gulf, the PNW, and also to Mexico.

Tariff and contract pricing increases produced a 6% increase in average revenue per car, that improvement in yield combined with the volume growth to produce revenue growth of 9%.

With continued growth in our international business, intermodal posted a 1% increase in volume, although the pace of growth has moderated in a slower economy our international business posted a solid 3% gain, offsetting declines in our domestic and premium segments.

Average revenue per unit increased in both the international and domestic business segments, resulting in a 3% improvement in yield.

Put the volume and yield gains together and revenue grew 4%.

Looking ahead, we're counting on improved service and some strengthening of our economy to help drive growth in intermodal volumes.

Our new truck competitive Sunset corridor service offerings with the NS will also help as we bring more highway business the railroads.

Our energy business in the first quarter was a real roller coaster right.

We started the quarter with a crippling ice storm across central Nebraska that knocked out commercial power and slowed train operations and ended with a late March storm that forced all the coal producers to cease mining operations on the joint line for almost two days.

Even after mining operations resumed, production remained hampered by the after effects of the storm.

In between were other storms and mine production interruptions that impacted UPs coal train operations as well as the operations of our utility customers.

Despite the impact of the winter weather, energy car loadings posted a slight gain while revenue grew 4%.

The decline in the southern Powder River Basin tonnage was mitigated by the progress we've made increasing productivity.

Cars per train and tons per train both established best ever records in the quarter.

The other good news for the quarter was our ability to lift the SPRB embargo.

The progress in renewing the joint line track and roadbed is such that we can again consider growth opportunities with new customers.

Colorado/Utah tonnage was up 5%, a comparison made somewhat easier by the mine productions that we experienced at two mines last year.

Due to the impact of the winter storms we're off to somewhat of a slower start in our energy business than we had anticipated but with solid demand for Western coal and ongoing capacity expansion projects we continue to expect that coal is going to be a key driver of our growth here in 2007.

Assuming mine production can keep pace, we expect SPRB growth of 5 to 6% for the rest of the year which would put full year volume up around 4% when you consider the flat first quarter performance.

Now let me touch briefly on the other three business groups, each of which saw softer volumes in the quarter.

Start with ag products.

Our ag products revenue grew 8% on a 6% volume decline.

Our ethanol volume grew 50% and DDGs were up 58%, we saw a decline in whole grains business, particularly wheat and Gulf exports of feed grains.

Soft wheat production in UP served origins, weaker export market and lower barge rates all took their toll in the first quarter.

Our Mexico franchise was a plus for us with an overall 11% gain year-over-year driven by a 36% increase in feed grains to Mexico.

Our new produce unit train grew as the operating teams at UP and CFX continued to provide outstanding service.

We were 92% on time or early for first quarter which is pretty great performance when you consider that those trains went right through the heart of storm central.

Record average revenue per car helped to hold automotive revenue to a 2% decline as volume dropped by 4% from last year's record levels.

Hard shipments increased year-over-year, but that growth was not enough to offset a 9% decline in finished vehicles.

Last but not least, industrial products.

We had a weak housing market and winter weather that slowed construction and poor reactivity in the Texas, Oklahoma area.

Those were the biggest drivers of a 13% decline in industrial products volume.

But even with the market softness, industrial products helped lead the way in yield improvement with an average revenue per car up 11%, holding the fall off in revenue to only 3%.

Our customer satisfaction index climbed to 79 in the first quarter, it's up 9 points from last year and the best quarterly results since 2003.

The improvement reflects customers's requisition of our improving service, perhaps best highlighted by the ability of the network to recover from that series of winter storms that the operating team battled throughout the quarter.

With some continued economic softness and the carry-over impact of the late March storm on our energy business where we missed 28 trains here in April, we expect to see second quarter volume range from flat with last year's record volumes to down 2%.

Continued yield improvement will drive revenue growth of 3 to 5%.

Still our expectation that the economy will strengthen as we move through year, but based on the way the first half is playing out we've lowered our full year volume outlook to now range from flat to up 2% with revenue growth in the 4 to 6% range.

As we go forward the diversity of our traffic mix, our commitment to yield improvement and a stronger network are all going to give us the ability to drive top line growth and give us the opportunity as well to capitalize on some additional volume as the economy strengthens.

With that I'll turn it over to Dennis.

Thank you Jack and good morning.

As Jim mentioned the operating team faced several challenges during the first quarter, but we made solid progress in safety, service performance, and productivity.

Let me begin today with safety where we have achieved solid improvement to start the year.

This chart shows our three year safety trend for employees and rail equipment and the progress we're making in both incident rates, the blue bars as well as the FRA reportables, the yellow lines.

With employee safety, the incident rate is down 16%.

And the reportable rate is down 12% year-over-year, nearing best ever levels.

We're also making good progress in the rail equipment area where the incident rate declined 29% and the reportable rate improved 17% year-over-year, both best levels ever achieved.

A safer railroad is a more fluid run as evidenced by our service metrics where we made consistent progress across the board, despite the difficult winter you heard about, our network proved its resiliency as we quickly recovered velocity after each interruption.

Average velocity for the quarter increased nearly 2% to 21.7 miles per hour.

Our terminal dwell dropped nearly four hours or almost 13%.

We also took 14,000 cars out of inventory, freeing up 140 miles of track across our system.

Although some of this can be attributed to the softer volume, it is clear that we are improving our asset turns.

Freight car utilization which measures the number of days between originated carloads improved by nearly a day to a new first quarter best.

Our initiatives in the unified plan, terminal processing, lean projects, and our customer inventory management system, which we call CIMS continued to make positive contributions to these gains.

These improvements are equally evident in our service offerings.

In our manifest network, we continued to deliver a more reliable service product.

The manifest network starts and ends at the customer.

In the upper left, industry spot and pull, which measures the first and last customer interface, improved to 92% within the scheduled service window, up 6 points year-over-year and 15 points since 2005.

Car connection performance which measures connections at the terminals improved 6 points to 85% in the first quarter, '07.

We improved our train plan compliance substantially, up 12 points year-over-year to 91%.

This despite significantly tightening our performance standard.

Reducing variability in our operation improves asset productivity and cost and we will continue to make progress against this tighter standard.

Finally, the working unit rate is a key measure of our network complexity and efficiency.

Part of the unified plan effort has been to reduce train stops or work events across our network.

Since we initiated the plan in 2005 we reduced the work event nearly 25%.

All of these improvements are the direct result of our network management initiatives, greater accountability, and consistent execution of an achievable transportation plan.

We're driving the same kinds of efficiency gains in other areas of our network.

Although coal and intermodal are already very efficient unit train services we are improving productivity further by increasing train sizes in these networks and there's huge leverage here.

I've talked to you previously about our innovative in train wheel repair process that allows us to keep coal train sets intact, decreasing dwell, saving days on repaired cars, and increasing cars per train.

This is helping us increase average Powder River train coal size by more than two cars to a best ever 129.1 in the first quarter.

We see more upside here.

But just those two extra cars translates to 225 additional Powder River coal trains over the course of a year.

With intermodal, we're achieving more boxes, that is containers or trailers per train.

We're driving this through plan design, agressive equipment management, and by working with our customers and interchange partners.

The increase of 10 boxes per train, more than 7%, gets us the equivalent of another 1900 intermodal trains in 2007 without adding additional crew starts.

We see upside in all three service networks, premium, bulk, manifest in this productivity area.

Improving returns is a key part of our ability to support our 2007 capital program which totals 3.2 billion all in.

We made capital improvements for four fundamental reasons.

Safety, throughput, growth, and maintainability.

Nearly 50% of the total is capital maintenance aimed directly at safety and throughput.

Our '07 capital maintenance plan includes 4.4 million ties, 870 million miles -- excuse me, 870 miles of rail, 8.5 miles of bridges, and over 100 million on yard and industry track rehabilitation.

We are on target with this year's program and in fact we have nearly completed the largest 2007 maintenance projects in our Sunset corridor between L.A.

and El Paso.

The next biggest category, locomotives, supports both growth and productivity.

This year's program includes 300 locomotives, compliant with Tier 2 emission standards and nearly 150 environmentally friendly switch locomotives for service in California and Texas.

Both the 550 million of capacity spending and the 195 million commercial facility investments are aimed at removing bottlenecks and for future growth across our network.

Over 90% of the total spend is concentrated in U.P.'s franchise strengths in high growth corridors, the Sunset route, the southern Powder River Basin, the Central Corridor to Chicago and St.

Louis, and the Texas Gulf routes.

Let me close out today by reiterating our 2007 operating focus areas that I outlined for you in January.

In safety, our improving results reflect our commitment to a total safety culture at Union Pacific.

We expect ongoing service improvements over the remainder of 2007 which will translate into greater resource productivity and lower failure cost.

Finally, our network initiatives and process improvements are aimed at all levels of the organization with the intent of driving shareholder returns.

With that, let me turn it over to Rob.

Thanks, Dennis and good morning.

Before I get into the details, I'd like to let everyone know that our 2006 fact book will be available on our website on April 23, that's next Monday, on the U.P.

website, under the Investor Relations page.

I'll start this morning with a look at our income statement where we are reporting record first quarter operating revenue of $3.8 billion, up nearly $140 million or 4%.

Quarterly operating expenses increased only $25 million in the quarter or 1%.

The net result was a 19% increase in operating income to $719 million, a first quarter best.

Strong pricing, better operating efficiency, and improved safety drove higher quarterly earnings.

We did lose some of our operating income upside in the quarter, maybe as much as $15 million or so, as a result of the winter storms.

So all in, the first quarter was a solid start to 2007.

If we break down the components of our quarter, starting with the top line, we achieved 3% commodity revenue growth to a record $3.7 billion.

This slide provides a walk across of the first quarter growth drivers and it's a much different picture than what we've shown you in prior quarters.

First quarter volume was down over 2% and our business mix was also negative in the quarter.

Fuel surcharge revenue decreased year-over-year due to the lag effect of our fuel surcharge mechanisms.

You might recall that first quarter 2006 revenue benefited from higher fuel prices at the end of 2005.

In contrast, fuel prices were lower coming into 2007 which resulted in lower first quarter surcharges.

Fuel was actually a double whammy for us in the quarter.

On top of lower year-over-year fuel surcharge revenue, we also paid more per gallon of fuel in the quarter.

I'll talk a little bit more about that here in a couple of minutes.

Turning back to commodity revenue, our strong price improvement was able to offset the headwinds of lower volume, although only three of six marketing groups experienced year-over-year car loading growth, all six achieved record first quarter average revenue per car.

On the expense side, starting with salary and benefits, this category grew about 4.5% in the quarter, or $51 million.

Wage inflation and a larger workforce accounted for the majority of the year-over-year increase.

The increase was offset somewhat by lower volume costs and greater train crew productivity.

Coming into 2007 we had more employees in training than we did a year ago in anticipation of attrition and volume growth later in the year, so we had a bit of a timing difference that should begin to resolve itself in the second quarter.

As our productivity initiatives continue to take hold through the year, we would expect year-over-year salary and benefit expense increases to be more moderate.

The next expense category is fuel and utilities, down 1% in the quarter to $683 million.

Our quarterly fuel price increased only $0.03 per gallon from $1.87 in '06 to $1.90 per gallon this year but we completely offset the higher price with lower consumption.

We burned 13 million fewer gallons of diesel in the first quarter of 2007, saving us roughly $26 million.

Lower business volumes drove the majority of the decreased usage, the other factor was our improved fuel consumption rate which was a first quarter best.

As required by the Surface Transportation Board, we will converts or regulated tariff business to a mileage based fuel surcharge program effective April 26.

This change impacts roughly 15% of our revenue base but we do not anticipate it will impact our ability to offset the effect of rising fuel prices.

For the second quarter we are assuming our diesel fuel costs will be about $2.20 per gallon, up about $0.05 per gallon from last year.

The next expense line, equipment and other rents, also declined year-over-year to $353 million, a 4% reduction.

The drivers of the decline were lower volumes and improved operational fluidity.

As Dennis showed you earlier, online freight car inventory improved by 5% and freight car utilization increased 8%, both driving improvement.

In the second quarter, we would expect to see moderate growth in this category, up 2% or so driven by increased locomotives leases.

Materials and supplies expense totaled $176 million from the quarter, a 7% increase from 2006.

Higher material prices and increased maintenance activity are the primary drivers of the year-over-year expense change.

For the second quarter, this expense line should increase 4 to 5% as a result of inflation and higher maintenance activities.

Finally, we have purchased services and other which declined $37 million in the quarter or 8%.

This category came in better than expected for a couple of reasons.

Casualty expenses were about $30 million less than anticipated, following our semi annual actuarial study.

The improvements in our safety experience as well as our expected claim payments drove this reduction.

In addition, lower volume and increased operating efficiency resulted in better cost control.

Looking out to the second quarter, we would expect year-over-year growth of roughly 6% or so.

Turning to our operating ratio, we reported an 81.3% ratio in the first quarter.

That's 2.4 points of improvement versus a year ago.

Lower casualty costs were certainly a positive contributor, but we also overcame the negative impact of weather and fuel in the quarter.

Overall, we are making progress with more potential ahead of us.

The next slide illustrates our first quarter income statement.

Other income totaled $15 million in the first quarter, up $5 million from a year ago and in line with expectations for a full year other income of 75 to $100 million.

Our first quarter income tax expense increased 51 million in the quarter, primarily as a result of higher earnings.

Our effective tax rate was also slightly higher in 2007 at 37.8%, versus 37.2% last year.

And that tax rate of 37.8% is probably a good assumption for your full year '07 planning.

First quarter net income totaled $386 million, or $1.41 per share, a 23% increase over 2006 earnings of $1.15 per share.

All things considered, a good start to the year.

As you know, back in January we announced our share repurchase program and dividend increase.

We paid the quarterly dividend of $0.35 per share, a 17% increase on April 2.

And in the first quarter, we begin implementation of our share buy-back, purchasing just over 2 million shares of common stock or roughly 10% of the program through open market purchases.

Our average purchase price in the quarter was $98.68 per share.

Turning now to capital, we have firmed up our plans for an all in capital program of roughly $3.2 billion in 2007.

Our spending will be allocated at roughly $2.7 billion in cash capital spending and the remainder will be equipment lease financing.

This chart illustrates the growth trend in our cash generation.

From 2004 to 2006, cash from operations increased by over $600 million, a 13% compound annual growth rate and for 2007, we clearly expect another double-digit gain.

This cash generation gives us confidence in our ability to build the strong growth capital program and return cash to our shareholders.

In terms of our outlook for the second quarter, we anticipate earnings growth of 10 to 15% off of 2006 earnings of $1.44 per share.

Similar to the first quarter, we'll rely on pricing gains and productivity to generate positive results.

We're also keeping an eye on fuel prices, especially if we see a summer price spike that we can't recover until the third quarter.

As Jack discussed earlier, we are moderating our full year volume outlook to a range of flat volumes year-over-year to possibly up 2%.

Along with that change we are revising our full year revenue target to 4 to 6% growth.

Our full year operating ratio earnings and return targets are unchanged.

Although we may not have as much volume leverage as we anticipated coming into the year, we are increasingly confident in our ability to improve profitability through greater efficiency.

With that, let me turn it back over to Jim for some closing comments.

Thanks, Rob.

When we talked with you back in January our outlook for the year took into consideration a soft first quarter economy with volumes picking up in the second quarter and strengthening even more in the second half.

As Jack mentioned, however, April is starting out slow in part due to weather but also continued economic weakness.

Although this economic uncertainty is reflected in our new volume and revenue outlook, UP financial goals for r 2007 are unchanged.

We're focused on improving yields, service reliability, and enhancing shareholder value.

Substantially improving or our operating efficiency is the key to achieving each of these items and our first quarter results are a good start to the year.

With that, let's open it up for your questions.

Thank you.

[OPERATOR INSTRUCTIONS].

Our first question is from Thomas Wadewitz with JPMorgan.

Please state your question.

Good morning.

Good morning, Tom.

Strong results.

Impressive in the softer volume period.

I've got two questions I wanted to ask you.

The first one is just in the nature of the yield growth that you produced.

Very strong in the ag and industrial products lines.

A little bit less so in some of the others.

Do you think it's fair to look at that and say well, those are two lines where you can access the business and price up and perhaps it's an indication of future yield growth in some of the other line items, because those are more -- you have more business under contract in the other line items?

Well, Tom, I think it's tough to jump from those to kind of reflect the market in all of those.

It's obviously going to be a function of the mix, competition in terms of when you look at the business and where it's moving.

We haven't really seen other than maybe in the domestic intermodal, any softening in terms of the price market today.

But it really does vary based on the markets we're serving.

I guess maybe if I could restate, reask it a little bit differently.

It's probably those two lines because they're more tariff business, are more representative of the current market, whereas some of the other lines like auto and say, energy wouldn't necessarily represent the current market because a lot of it is still under long-term contract.

Is that a fair way to look at it?

Jack, do you want to take a shot?

Tom, when you look at it, you're going to -- we've been pretty open about the fact that our auto business, our intermodal business, and our energy business is where we held the preponderance of the old legacy deals.

So that is true.

And when you look at right now in the industrial products ag products, chemicals does have some legacy deals as well, although not nearly as much as those as those other three.

And we do have places in the market today that still very strong demand where we can continue to take pricing up and that's basically what's reflected in those numbers.

You are right that ag and industrial products has the preponderance of tariff business.

Great.

And then one more question.

Just with respect to the guidance, trying to kind of resolve some of the specific things that you said.

It sounds like cost, opportunity, and comp, and benefits, you'll maybe see that improve somewhat.

It sounds like on a fuel you had that Rob mentioned the double whammy in first quarter so I'm wondering if fuel could actually be less of a headwind in second quarter?

And then it also would appear that volumes maybe you have some pent up coal demand.

So even though you're cautious, volumes could be a little better in second quarter.

So that seems to be the backdrop.

And your guidance would appear conservative, given some of those factors, because you're implying a little slower pace of earnings growth in second quarter versus first.

I'm wondering if I'm missing something in the way I'm looking at that or if perhaps there's just a little bit of conservatism in the second quarter guidance you've provided.

Well, Tom, I think the visibility of volume right now is pretty cloudy.

We're seeing a little bit of strength in some of these areas the last couple weeks, but it's tough to tell whether that's inventory rebuild or really a strengthening in the economy.

We're going to be cautious here on the volume outlook going forward.

On the salary and wages, honestly I'm not happy with what happened in first quarter.

Part of that is carry-over when we -- we have about a six to nine month lead time on our hiring and training cost.

We have slowed down our hiring here.

We started that in the fourth quarter and we'll see that get back in-line.

But we're -- it's hard to see the visibility in the economy right now.

Okay.

But perhaps there would be some conservative approach in some of the underlying assumptions.

Do you think that that's maybe fair?

We'll see, Tom.

Okay.

Great, thank you for the time.

Our next question is from Ed Wolfe with Bear, Stearns.

Please state your question.

Thanks.

Good morning guys.

Just a follow-up to some of the comments on guidance in the quarter.

You made the comment about the casualty insurance which was down, total insurance was down year-over-year, being up again year-over-year in second quarter.

Is the implication that that $30 million was kind of a one-time benefit or is some of that ongoing?

How do we think about that?

Ed, the preponderance of the first quarter reduction was one-time in nature, a result of our semi-annual actuarial study on the personal injury line which is part of the casualty.

Going forward, I wouldn't anticipate a big change.

We create a little bit of savings on the PI line but there are other items as you know that are part of that casualty line like, as you mentioned, insurance which clearly insurance costs are going up on us.

Net, net, going forward costs will be basically flattish going forward.

Let me add something here, though.

While we can look at it and say it's one-time in the quarter, really it results from progress we're making on our safety, in terms of reduced estimates and average sum of value and a reduced number of injuries.

So I know it's a big number in the quarter that comes through here but it's very real in terms of the trends and our safety results.

That's fair.

Rick Paterson asked a question I want to footnote him on it, yesterday, that I thought was interesting.

When you look at what you're getting in terms of new contracts when they come up, multi-year contracts, what is kind of the annual increase on those contracts after the first increase?

In other words, what's the annual year increase looking like on those?

Jack, you want to take that?

There's a combination.

It really depends on each one we negotiate.

Bottom line, kind of our starting point on contracts is we would use the RCAF minus fuel or in the industry we call it the [ALIF] and then a full fuel surcharge on top of that and that's kind of our standard fare for a contract that we're negligent at market rates.

Is that different with a longer term contract or a shorter term contract?

Is there some negotiation around the RCAF?

There certainly is.

Some customers would prefer just a fixed price increase over -- to know what that is and lock it in.

And we are amenable to having those discussions with customers as well.

I don't know that it necessarily is short versus longer term.

The majority of our contracts right now are three years and there's an occasional five year deal.

So we're not going out a real long time.

But we are very much interested in ensuring that we have a solid escalation and good fuel cost recovery.

Where is RCAF right now?

We're all kind of looking at each other.

I don't know where it is.

Roughly 2, 3%, something like that.

Yes.

In that zone.

Thanks.

I'll get back online.

Thanks for the time.

Our next question is from Jordan Alliger with Deutsche Bank.

You had just mentioned I think intermodal, auto, and energy I think had the preponderance of legacy deals.

So can you just be a little more specific in terms of visiting sort of the pace of the contracts in those buckets that may be coming up over the next year or two, so to get a handle on some of the potential yield trends in those areas?

Well, Jordan, about as we have said, around 32% of our total book we have not touched yet.

And the three areas you said are where it's highly concentrated, Jack, I don't know if we've got--?

5% this year.

Is probably what we're going to touch.

I think next year it's about 7%.

7 or 8%?

Right.

In all of those, we've got some kind of tracks that are multi-year, quite a few years out.

I don't -- it's going to be a while in those three categories that we're going to be able to touch 100%.

Okay.

That was it for me.

Thanks.

Thanks, Jordan.

Our next question is from Ken Hoexter with Merrill Lynch.

Please state your question.

Good morning.

Good morning, Ken.

Pretty solid costs despite some of these weather impacts.

I know you talked a little bit about the slowing economy, Jim.

Can you maybe break down what if in your volume outlook, at least for the second quarter right now is kind of due to these leftover weather impacts and the snow from the CRP versus what you're looking at as far as economic growth going on right now?

Well, when you look at our second quarter numbers, the coal demand is there.

Again, let's start with weather.

Weather primarily hit coal.

The demand is there, the real question in my mind is whether the mines are going to be able to produce.

We have put a lot of capacity in and we're ready to handle that coal coming through.

So again, the question is, the capability to produce at the mine source.

The real wild card to me are in the construction related areas.

Your lumber, cement, stone, which were down double-digit first quarter, are still running down double-digit.

But we are seeing a little bit of strengthening in those categories.

And then domestic intermodal is one that, in fact you're going to see a little bit of a shift here in second quarter.

Actually, our international volume in second quarter is a little bit softer but domestic is picking up.

Jack, you want to add anything on that?

No, I think that's a good summary of where we are.

And then on that domestic picking up, when do you start up or have you already with Norfolk Southern on that southeast corridor and can you update us on how that's progressing?

We are having good results right now.

We made a change on our Blue Streak service with the Norfolk Southern in February.

Since that time we're now running a fourth evening service, it's been 100% on time since we made conversion and we're looking forward to the opportunity to shift to the Shreveport Gateway at some point in time which would given us another improvement in terms of transit time and also reduce mileage.

Customer receptivity to the product has been very good.

We would like to see the economy strengthen some more so we could get more.

But we're having lots of discussions with customers that are currently moving freight on the highway system because the business very much is truck competitive.

And we're starting to see see a lot of activity that way.

Great.

And if I could just get one technical follow-up with Dennis.

On those manifest network performance charts, when you talk about industry spot pull and you've improved say 77% to 92%.

And you said within the tightened window.

Can you tell us what kind of windows you talk about when you talk about being on time.

Is that within a day?

Within a half a day?

Hours?

Absolutely, Ken.

Historically, Ken, that had been 24 hours and we reduced it to 8 hours.

Great.

Thanks a lot.

Our next question is from Jason Seidl with Credit Suisse.

Please state your question.

Good morning, everybody.

Let me just drill down a little bit on what you guys are talking about with domestic intermodal.

Did hear you right in saying there has been no softness in pricing for domestic intermodal.

The market pricing on domestic intermodal has softened.

Again, there's a lot of excess truck capacity out there.

We are not chasing that market.

In terms of our first quarter results.

And that's good to see.

And yet you believe that your domestic business is picking up then so that's--?

I'm seeing a trend, right.

We've seen it start to pick up here the last three or four weeks.

Perfect.

Let me switch to PRB and the embargo.

How should we look at that, beyond 2007 in terms of your ability to recoup the business?

Should we think of it as an extra percent per year that you might be able to acquire or could it be above that?

I think the way you look at it is it to me reflects the health of our network and our ability to handle coal, whether it's East or whether it's for the current customers we have.

I would say it's probably more in '08 and really it will be a function of where the demand comes from.

Okay.

Fair enough.

Can you guys give us an update on your double tracking initiatives of the Sunset route?

Have they stayed the same or have they changed?

We're basically on target.

We're going to do about the 56 miles of construction this year, 90 miles of grading, and we continue to work on our terminals and bring their capability up into the same time frame and we're on about a four year time track.

Perfect.

Thanks, gentlemen.

Our next question is from John Larkin with Stifel Nicolaus.

Please state your question.

Good morning, everyone.

With respect to the first quarter operating ratio, you mentioned, I think it was a $30 million benefit from reduced casualty expense which is tied to your safety program.

Was that more or less offset by adverse expenses related to the weather and fuel?

Was that pretty much a push?

Or would the operating ratio potentially have been quite a bit lower without the weather and the fuel headwinds?

There is no question in my mind when you look at the weather issues, including mine production up there, that it basically washed the good news from the safety accrual.

Okay.

Another question, there's been a lot of talk about perhaps some increased transloading activity on the West Coast because of some of the rate increases that the steam ship companies are having to deal with.

Have you seen that so far to date and is that a good thing from a profitability point of view with respect to your intermodal business?

John, we started to see some of that happen last year where basically the international containers were just coming through straight away as opposed to transloading to domestic.

It has not really been a big issue for us overall.

We're, again, some of those international steam ship contracts are part of the legacy deals but some of them are also coming up for renewal and those kinds of things.

So the differential of shifting has resulted in a shift of business between domestic and international but it really has not had much of a financial impact on us.

Okay.

And just maybe one last question related to the start-up of the U.P.

direct product and what your intentions are there, vis-a-vis perhaps a similar product that is offered by one of your larger customers?

Jack?

UP direct you're talking about streamline?

I guess that's what we call it.

Wholesale, intermodal product.

It's a door-to-door product that customer demand has been very strong, particularly in the IMC community.

And we think it's an opportunity for us to take advantage of our technology and our ability to produce in the market.

We don't intend to take it to a retail strategy at this time.

We're looking primarily as an opportunity to work with IMCs.

And other partners in the transportation marketplace today.

So we're in the mode right now of doing some test shipments.

The tests are running well.

The technology is coming together very nicely and we're pretty optimistic about the market receptivity.

All right.

Thank you very much.

Thank you.

The next question is from [Darren Curtis] with [Austin Friars Capital].

Please state your question.

Good morning.

Good morning.

Just a quick question.

Having listened to CSX yesterday they were very bullish about the yield environment, actually out until the end of 2008 and you guys have had a great quarter in terms of yield despite difficult volumes.

I'm still confused.

Despite that, why you're happy to run a balance sheet on circa 1.5 times debt to EBITDA.

What does it take for you guys to feel more comfortable being more aggressive with the balance sheet structure, given this new environment, if you like?

Well, Darren, our -- again, I think it's one of those if you want to take a short term versus long-term view and when we look at our balance sheet, it's been in good shape.

Our strategy here was to, in 2007 start to accelerate our returns to our shareholders.

That's why we made the nice bump in the dividend.

We announced the share repurchase program.

I think it's important in our industry, because we're capital intensive, there are business cycles that come out here, that we want to maintain flexibility here.

So we're right at kind of the bottom of that investment grade point and I think that's what makes most sense for us right now.

How does that investment grade point impact your daily operations?

Well, I think it's more flexibility long-term.

Day-to-day operations it's not going to have a huge impact on us.

I mean, what's important for us to generate cash from the business day-to-day.

But again, thinking long-term and the potential issues you can wrestle with, that's more of the focus when you think about the investment grade.

Okay.

Okay thank you.

The next question is from Scott Flower with Banc of America Securities.

Good morning, all.

Good morning, Scott.

Yes.

Just a couple of things.

One was -- and I know Rob mentioned that salaries and you also talked about, Jim, salaries should moderate into Q2 and the hiring cycle and the lag effect.

But could you give us maybe some parameters or a ballpark in terms of what kind of rate of change or how much deceleration?

I know it's not precise, and I know it's not a pinpoint estimate, but a range of what you should think about in the salary and wage line as we look prospectively to the latter part of this year or second quarter?

I'll let Rob answer that.

Depending on what volumes do, a range going forward would be more -- we would expect to see more of like a 2 to 3% on the salary and benefit line.

And as we mentioned we kind of had the, if you will, another double whammy in the first quarter with the timing of some of the training activities that were going on and carryover from last year, and training ahead of plans for this year.

I would say going forward, it's more in a 2 to 3.

That's great.

Thank you.

And then I know that Jack gave us a little bit of color in terms of order of magnitude of the legacy deals in '07 and '08 that you all will be able to approach to the marketplace.

Are those predominantly in the coal business with the automotive and intermodal being more in the out years or is there also some componentry of Automotive and intermodal in '07 and '08 in terms of the legacy contracts that come to market.

There's some of everything, Scott.

We'll have some intermodal.

We'll have some chemical.

We'll have autos and energy.

Okay.

But it's not skewed toward one of those categories at all?

No, not in the calendar years of '07, '08, probably not.

Okay.

And then maybe a couple other quick marketing questions.

How much of the industrial and ag business are tariff-based, in terms of a split?

In other words, are those 50% tariff?

Are they 20% tariff?

Order of magnitude.

I'm just trying to get a sense in those two categories, how much is tariff oriented versus contract--.

It's around 90%.

It's much higher than 50%.

90%?

Yes.

It's depending on the individual commodity line group, it's anywhere from 70 to 90%.

For both industrial and ag?

Yes.

Then the last question I had was just to get maybe some sense -- and I don't know how I want to frame this, but to get some order of magnitude sense of what's the difference in terms of art performance on the international side of intermodal versus the domestic?

I know that very specifically you all are not chasing volumes versus giving up price, but is it dampening the rate of improvement in price domestic versus what you're able to get in international?

I'm just trying to get a sense between those two different sides of intermodal.

Any sense of a difference in the spread of arc?

Or however you might want to help me frame that.

If you step back and look at it, let me just give you the historical perspective on domestic intermodal would say in the first quarter your prices would go down because you come off peak season of those issues that drive both the international and domestic markets.

So typically that's what would happen.

In the first quarter we saw a 6% increase in our international business and we saw between a 2 and 3% increase in our domestic business.

That's arc or price?

That's price.

Okay.

Thank you.

The next question is from Kevin Maczka with BB&T Capital Markets.

Thanks.

Good morning.

Good morning, Kevin.

You have a slide in here about increasing the train side both on the coal and the intermodal side and it seems to me that adding a couple of cars to a coal train or a couple of intermodal box to an intermodal train is -- you could characterize that maybe as low hanging fruit.

I'm just wondering if there are still a lot of opportunities like that in your unified plan or at what point do you get into something that is maybe not so easy as just adding a few extra cars to a train?

Well, I wouldn't characterize it as low hanging fruit because of the -- what's required to actually get the train size up and the network.

I'll let Duff give you a little more technicolor.

Well, it's a combination obviously of process because you have to have all three vested parties involved.

Have you to have the mines involved, the utilities, and certainly us.

So as I said in my words and comments, we think there is upside here for the long-term.

There's immediate opportunities and there's certainly long-term opportunities.

Some of the longer term opportunities would deal with some of the infrastructure issues but we tend to look at this as an immediate concern as well as intermediate and long-term.

So train size productivity, while it may sound like low hanging fruit, the leverage in terms of the opportunities there, based on the number of trains we operate on a daily basis are huge and we're aggressive.

We're all over it.

One of our focus points here with our capacity expansion also looking at the network is what we can do in train size.

Because you're obviously moving between point A and B can be limited by siding length and that's something we take into account where we're putting our capacity.

Okay.

My other questions have been addressed.

Thank you.

The next question is from Randy Cousins with BMO Capital Markets.

Please state your question.

Good morning, everyone.

Good morning, Randy.

You guys have done just an absolutely spectacular job driving asset productivity.

What is confusing me a little here is normally when I think of asset productivity improving I would think that the labor productivity would actually improve with it.

Your labor productivity is down about 4% measures on a GTMs per average employee.

How long does it take you to get this kind of thing back on-track because the old rule used to use was that your labor productivity basically had to match your unit cost growth and so is this like a one quarter phenomenon?

A two quarter phenomenon?

How should we think about labor productivity?

Randy, as we said earlier, there's a lag factor here.

Again, we've had -- we have more people in training than we did a year ago.

Part of that was in anticipation of a stronger economy, that still could happen here, second half.

As you may remember, it takes a minimum six to seven months to get someone trained and on the ground.

Weather also came into play here.

Instead of folks working on capital, some of them were working on keeping the railroad open on OE this year.

So I don't -- there's really a lag here in terms of what we see.

We also have introduced a new program in the Company this year where we -- when we have furloughs, in order to avoid losing people, we have a program that guarantees their healthcare cost and a minimum wage, in order to try to bridge our attrition.

Historically we would have cut them off and unfortunately you lose sometimes up to half and it's $60,000 to hire and train.

We thought we could have a better model here.

So we got caught a little bit here with the volume numbers in second quarter.

But I I will tell you the labor piece is going to catch up here.

So Q2 is going to be sort of not great labor productivity, obviously.

Is it kind of Q3, Q4?

Fully to interest people out of the system to get the labor productivity up?

It will get continue to improve.

Okay.

One other thing, and just in terms of sort of mix so I can understand better.

Your carloads were down 2 but your RTMs and GTMs were off 3%.

What exactly went on there?

It's primarily coal.

Okay.

And then just with reference to this casualty issue, I looked at my notes for the third quarter of last year and I think there was a $30 million benefit -- excuse me, a $23 million benefit when you went through that again, that semi annual trueing up.

Given the trend that you're seeing here, is this something that when you go through the second trueing up, because you do it twice a year, that we're going to see another sort of benefit?

Or are you guys kind of comfortable with what the accrual is for casualty?

It's going to be a function of our safety experience, the types of incidents you have, the severity, all of that plays into the equation here.

Our safety, as Dennis talked about is off to a good start, first three months of the year, and again, it will be a function of how those trends move.

Okay.

And then finally, lastly, if you permit me, [Mersk] is changing the number of drop points that they've got in North America.

Suggesting again that they're going to move more stuff through the Suez.

How do you see what Mersk is doing impacting your intermodal business?

At this point in time, we don't see that as having a major impact on us.

Okay.

Great.

Thank you.

The next question is from [Salvatore Vitali] with Calyon Securities.

Please state your question.

Good morning.

Good morning.

Just a quick question.

One, a clarification on something said earlier.

Did I get that right that there was a 2 to 3% differential between domestic and international yields in the quarter?

Yes.

I assume that the international yield is higher there, right.

Yes.

And then just a little bit more color, if I may, on the average revenue per car in agricultural and industrial.

Is there any, like, for example, for agricultural is there any particular commodity within agricultural that was stronger than any other?

Yes, if you looked at things like ethanol and DDGs, those kinds of markets, you'll see stronger pricing than what we'll see in some of the others right at the moment because that's just what the market is.

On industrial, is there any particular segment there?

Right at the moment, probably our steel market is probably one of the hottest markets that we have right at the moment.

Okay.

And then going forward into the rest of the quarters of the year, can you provide any color as to how sustainable that type of yield growth in either agricultural or industrial is?

That's pretty hard to -- because what I would have to tell you is what's going to happen with the economy.

Our plan right now, we expect to see some solid price growth.

As we look at the economy, we're seeing improving trends in our lumber carloadings, our steel carloadings, rock, sand, and cement.

We would like it to be even stronger than what it is.

The trends are headed in the right direction.

We have a solid plan and we really aren't seeing anything right now that would persuade us that it won't come to fruition.

Thank you.

Our last question comes from Gary Chase with Lehman Brothers.

Please state your question.

Good morning, guys.

Good morning, Gary.

Just a quick question for Jack to kind of revisit this topic of ag and industrial and looking at the pricing there as leading indicators.

You were just addressing a mix question.

I'm curious if that is having a significant impact?

In other words, as the volume comes out is there a mix impact here that we ought to be looking at or is most of what we see real price gain year on year?

Most of what you see is primarily price gain.

There is some mix effect to it but we have had some great market opportunities in those two businesses to take prices up.

Going forward there's all those questions about what does the wheat crop look like, what does the corn crop look like, and what will be the demand for transportation services.

Jack, can I ask you, this one is -- let me see if I can phrase this the right way.

I mean, pricing would appear to be accelerating right now at a time when volumes are weak which is kind of opposite what a lot of people thought they were going to get.

Are these two linked in some way that we ought to be thinking about?

In other words, does the volume decline mean there is more ability to price because you're more selective.

I guess really what I'm after is as we look forward and think about volumes that might potentially be increasing into a stronger economy, is it a consistent thought to believe we can have both volume growth again and pricing gains of the magnitude we're seeing right now?

Gary, I don't think if again you're trying to project out economic demand, in the long-term if we head into a serious recession, things could be a challenge here for us.

One of the things we are seeing here is our service numbers are improving, we're turning assets well, customers are willing to pay for that value.

I see it consistently when we're sitting in front of our customers here.

Again, I -- I've got 15,000 freight cars in storage right now.

I've got 200 locomotives surplus right now.

We're hoping for an economic recovery here and we're going to focus on our service numbers.

So again, you're asking a longer term question on demand that I think is pretty tough to predict right now.

Okay.

And just one last knit for you, Rob.

You referenced a $15 million number in lost profit for the quarter on weather.

Was that lost volume?

Increased expense?

A combination.

A combination of things as a result of the, primarily two winter storms on the front end of the quarter and the tail end of the quarter.

Primarily in coal.

We lost what was it, about 150, 200 or so the first quarter.

Yes.

Okay.

Thanks a lot, guys.

Thank you.

I would now like to turn it back over to Jim Young for closing comments.

Well, thank you, everyone for attending the conference here this morning.

We again -- the only uncertainty is the economy right now but we feel good about our operating efficiencies this quarter and we'll see you again in three months.

Thank you.

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

You may disconnect your lines at this time and thank you for your par participation.