聯合太平洋集團 (UNP) 2008 Q1 法說會逐字稿

These statements are or will be forward-looking statements as defined by the federal securities laws and generally include without limitations, expectations, projections, estimates and similar statements regarding the Corporation and its operational and 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 statement.

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More detailed information regarding forward-looking information and such risks and uncertainties are contained in the materials accompanying this presentation and in 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 alternative presentation of results that more accurately reflect ongoing operations.

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

Please refer to our website for reconciliation of these measure to GAAP.

Greetings, ladies and gentlemen.

Welcome to the Union Pacific first quarter 2008 earnings release conference call.

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

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

(OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded.

Slides for this webcast will be user-controlled.

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

Jim Young, Chairman and CEO for Union Pacific.

Thank you Mr.

Young, you may begin.

Good morning, everyone.

Welcome to Union Pacific's first quarter earnings conference call.

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

I'm happy to are report a strong start for the quarter here.

We're reporting record first quarter earnings.

Union Pacific Corporation earned a $1.70 per share in the quarter, the 21% increase over 2007.

The key factor in this game was a 10% increase in operating income, the first quarter best, $788 million.

Despite a variety of challenges in the quarter from continued economic weakness, ongoing turmoil in the financial markets, the endless climb in fuel prices, and weather challenges, we remain focused on improving profitability.

If you look at what drove our performance in the first quarter, it was really the strong if fundamentals of our company.

Despite a soft economic environment UP's franchise diversity provided a solid demand base.

Record shipments of coal and strong grain movements allowed us to offset double-digit volume declines in products such as lumber, finished vehicles, and cement.

Our continued focus on price produced record first quarter operating revenue of $4.3 billion.

That's up 11% to a year ago.

Offsetting a portion of our strong revenue growth was another quarter of record diesel fuel prices.

Although we can't do much to influence commodity markets, we are working to minimize the impact to our fuel surcharge programs as well as improve our fuel efficiency.

The benefits of ongoing operating initiatives were evident as we improved employee productivity, asset utilization, and overall network fluidity.

In addition, the railroad's operating resiliency enabled us to improve customer service despite the tough operating environment.

We are delivering a more valuable service product to our customers, in turn they are rewarding us with profitable business.

Overall, it was a good quarter for us as we converted record revenue and reliable efficient service into strong bottom line growth.

These results are a testament to the hard working men and women of Union Pacific.

As many of you know, a stretch of our mainline was out of service for the majority of the first quarter.

Thanks to the commitment and dedication of our operating team, we literally moved a mountain.

We resumed limited operations on that line a few weeks ago.

We also appreciate our customer's patience during this time.

With that let me turn it over to Jack now for a breakdown of first quarter revenue.

Jack?

Thanks, Jim.

Good morning.

By way of overview, all six of our businesses posted best-ever records for average revenue per car in the first quarter, driving an 11% growth in freight revenue to $4.1 billion, even as the economic softness held our volume flat.

Our ag products team, chemicals, and energy set the best-ever revenue marks while the other three groups had record first quarters.

At the same time, customer satisfaction again showed year-over-year improvement.

Turn the chart to page six, chart makes it pretty easy to see which markets were impacted by the economic softness.

Our automotive business declined 6% with growth in parts partially offsetting the effect of the sluggish vehicle sales.

Of course in addition to the economic softness, the American axle strike which began in late February has also lowered volume and reduces revenue by about $15 million every month that that strike continues.

Bumpy construction markets continue to impact industrial products.

But the good news in our industrial products business was a 17% increase in steel shipments.

Low inventories creating a strong domestic market and high prices for foreign steel are limiting imports.

Intermodal volumes also continue to be impacted by the economy.

Ag products revenue drew 10% with strength in grain shipments, especially in the export market.

Demand for coal remains strong and 34% increase in export potash allowed chemicals to even post a slight gain.

I'm going to take you through a look at three of the businesses a little more closely.

That will be ag products, energy, and intermodal.

Let's start with ag products.

That business posted the largest revenue gain as a 10% growth in volume combined with a 13% improvement in average revenue per car to drive revenue up 24%.

Wheat shipments increased over 50% with favorable commodity prices, above average production, and a weak U.S.

dollar, all combining to nearly double exports.

A weak dollar also helped drive feed grain exports up 32%, and much of the growth coming in Milo destined to European markets.

Both wheat and feed benefited from improved shuttle train productivity.

We expect that the export markets are going to stay strong and be a key driver of ag products growth throughout 2008.

Ethanol and DDGs continued their growth as well with volumes up about 19%.

About the only area of softness that did see in our ag products business was import beer where high inventory levels were still being worked off in the first quarter.

Our energy revenue was up 17%, with volume up 6%, an 11% increase in average revenue per car.

Continued strong demand along with a more normal coal production and improved network efficiency, drove the southern Powder River Basin volume up 7%, setting new records for trains, tons, and car loads.

Colorado/Utah volumes were up 4% for the quarter and were also aided by better production and improved service performance.

Now in January, we talked about the fact although demand in the Colorado/Utah market looked flat, the emerging export opportunity could drive a more favorable outlook.

So with the shortfall of coal to meet demand in the global market and the weak dollar, we now expect that business will be about a 4% increase.

The SPRB outlook remains unchanged at about 5% with strong demand from existing customers.

With an 8% improvement in average revenue per unit intermodal revenue grew 5%, even though volume ran 3% below year-ago levels.

Overall West Coast port volumes were down, due to the continued softness of the U.S.

economy.

We saw that impact in our international segment where volumes declined 5%.

Volume in our domestic business was flat year-over-year as growth in the legacy contract business offset other business losses.

We expect intermodal to gain some strength here in the second half, and to be flat versus last year when 2008 wraps up.

Continued service improvement supports yield gain and helps us capitalize on business opportunities, but most importantly, it leads to higher levels of customer satisfaction.

Our customer satisfaction index climbed to 81 in the first quarter which was up 2 points from last year.

Our outlook calls for the second quarter that it's going to look a lot like it did in the first.

Ag products and energy should continue strong, offsetting continued weaknesses in the automotive and industrial product segments.

It looks like chemical volumes will stay pretty solid, and intermodal should run closer to year-ago levels.

Put it all together, and we expect overall volume in the second quarter to be down 1% to flat versus a year ago.

Our full year outlook remains unchanged in the range of down one to plus one by year-end.

The primary driver of revenue growth is going to be our continued focus on yield.

We expect our core price increase to stay in the 5 to 6%-range throughout the year.

With that, I'm going to turn it over to Dennis for the operating review.

Thank you, Jack, and good morning.

The operating team continued its efforts in the first quarter to drive better service to our customers and bring efficiency gains to the bottom line.

The starting point for operations is safety where we continue to drive improvements in the employee, public, and derailment prevention areas.

The main impetus here is our total safety culture and zero tolerance mentality.

From a train operations and service delivery standpoint, we had another quarter of strong improvement.

We are running a more resilient network today as a result of our capital programs, unified plan efforts, and continuous process innovation.

We are also using our resources more efficiently, reducing train starts, increasing train length, and speeding asset turns.

In the first quarter, we hauled 1% more gross ton miles with 4% fewer first crew starts, and 7% less yard and local starts.

In the Powder River Basin, train length grew to nearly 131 cars per train in the first quarter which will move more than a hundred additional loaded coal trains of coal in '08 versus '07 without any additional crews or locomotives.

We achieved these results despite a challenging winter environment.

As Jim mentioned, we were without the use of our mainline between Klamath Falls and Eugene, Oregon for the majority of the quarter.

While our engineering team was dedicated to the task of reopening this line, the rest of the operating group focused on maintaining service to our customers in the most be efficient expeditious manner.

The results of those efforts can be seen in our overall network performance metrics.

As you can see by the bars in the upper left corner, we had a significant increase in the level of network disruption, up 22%.

Despite that, we made a nice pickup in system velocity, gaining a half mile per hour during the quarter.

We also managed a slight improvement in our terminal dwell and reduced our inventory levels by 1%.

As Jack just showed you, we continued to improve the service product we are delivering to our customers.

Two measures that are very visible from a customer perspective are industry [spot full] and freight car utilization.

Spot full metric measures our first and last interface with the customer, did we pull the car from the customer's facility and did we deliver the car to the customer within the designated time period.

Freight car utilization which measures the days between originated car loads, was a first quarter best, 9.9 days.

Union Pacific and our customers benefit from this in the form of lower costs, with both reduced daily equipment rents, as well as long-term capital expenditures.

We are also managing our unit cost with greater employee productivity and fuel efficiency.

Other efforts to reduce train starts and increase train length are reflected in a 4% increase in gross and miles hauled per employee.

We talk with you quarterly about fuel efficiency and our efforts to move more freight with less diesel fuel.

Given the huge step up in fuel prices, those efforts have never been more important.

In the quarter, we achieved a first-quarter-best level at 1.28 gallons per thousand gross ton miles.

Again, this is something that benefits both UP and our customers.

Rails are roughly three times more fuel efficient than trucks, so we have a natural cost advantage.

Through a combination of our conservation efforts and technology improvements, we have the ability to further enhance fuel efficiency and related bottom line results.

As demonstrated in our network efficiency and customer service performance, we are achieving greater asset productivity, which in turns gives us flexibility in our resource planning.

Although we want to insure the railroad is resourced to handle whatever the economy, our customers, or mother nature brings our way, we plan for this in the most productive and cost-efficient manner.

From a crew standpoint, we currently plan to hire about 2,000 new conductors.

Although this hiring level would be backfill for the preponderance of this, we expect attrition to take somewhere more than 2,000.

We have the ability to scale that hiring up or down, depending on demand.

Because we still have a couple hundred employees furloughed today.

We have some volume variability with our current employee base.

On the locomotive side, we also have a good plan in place to update the fleet, bringing on 175 fuel efficient, environmentally friendly new road locomotives.

At the same time, we are also turning back more than 200 older leased units and parking up to 400 in our surge fleet.

If we look further at where we plan to spend our capital dollars in 2008, the plan is somewhat similar to what we did last year.

Our maintenance way budget is $1.6 billion.

Those dollars allow us to improve safety, increase service reliability, provide for growth, and enhance productivity.

On the locomotive side and freight car side, I've already discussed 175 locomotive ads for the year.

This is 125 fewer locomotives than we bought in '07.

So the total locomotive spend is less versus last year.

For freight cars, we are going to add 300 covered hoppers to support our agriculture business which is clearly in strong demand.

Capital spending, both in terms of new track and terminals, is expected to total about $840 million, that's capacity spending.

Approximately 85% of the spending is devoted to adding capacity in the Sunset Corridor and the red-ex areas of the Central Corridor.

As we move forward in second quarter of '08, our operating priorities are unchanged, operate a safer railroad, provide an enhanced service product to our customers, and continue to drive productivity and throughput to create value for all of our stakeholders.

With that I'll turn it over to Rob.

Thanks, Dennis, and good morning.

Before I get into the details on the first quarter, I'd like to call your attention to a couple changes in our income statement.

As a result of system enhancements and to improve the clarity of our financial statements, we have reclassified the components of operating revenue into freight revenue and other.

We have also revamped our expense categories to give everyone a better view into our business.

We are reporting fuel as a stand alone category, and have combined purchase services and materials into one line.

In addition, certain other expenses were reclassified among the operating expense categories.

Of course, none of these changes impact previously reported earnings.

On the investor relations page of our website, we have provided reclassified quarterly numbers for 2007, 2006 and 2005 as well as a brief description of the account changes.

This information should be helpful for you in updating your models.

Turning to the income statement summary, first quarter operating revenue grew 11% to $4.3 billion.

Quarterly operating expenses increased $352 million to just under $3.5 billion.

The primary driver of the higher expense was a 45% increase in fuel expense.

We also experienced higher costs associated with the Oregon mudslide which added around $20 million of operating expense to the quarter.

The mudslide will also have a capital impact.

Although there's still work being done, we currently are estimating between 60 and $70 million of capital to repair that line.

We do have some insurance that should help offset a portion of this, so we will be pursuing that over the next several months.

The net result of our operations was 10% growth in operating income to a first quarter best, $788 million.

The primary driver of operating revenue growth was a $404-million increase in freight revenue to $4.1 billion.

Our continued focus on price, as well as increased fuel surcharge revenue associated with rising diesel fuel prices, drove the year-over-year gain.

Splitting up the 11% increase in freight revenue, we would say about half was core price and half was from our fuel cost recovery.

Today, roughly 25% of our total book of business is still under legacy contracts.

In the near term, as we experience strong volume growth under those old legacy deals, it holds back our overall yields.

As you know, legacy contracts do not reflect current market prices and lack adequate fuel surcharge mechanisms.

Our quarterly business mix was better than originally anticipated.

Greater than expected movements of long haul export grain, as well as increased Colorado/Utah coal moves, added to our first quarter growth.

First quarter other revenue increased 9% or $17 million to $211 million.

The primary driver of this increase was higher revenue from subsidiaries.

First quarter compensation and benefits expense declined 3% in the quarter to $1.1 billion.

Greater employee productivity allowed us to lower workforce levels by 3%, primarily through attrition.

Fewer train starts and lower training costs contributed to greater efficiency across our company.

Looking ahead at the year, we will continue to align our hiring plans and workforce levels with anticipated volume and productivity.

Turning now to fuel expense, this category increased $295 million to $957 million.

Despite moving 1% more gross ton miles, we consumed 2 million fewer gallons of diesel fuel as we continue our focused efforts on conservation.

Unfortunately, this improved consumption was more than offset by a 47% increase in prices during the quarter.

Average first quarter diesel fuel prices increased nearly $1 year-over-year from a $1.93 per gallon in 2007 to $2.84 a gallon this year.

Of course as you all know, prices have increased dramatically in the last month and remain at historically high levels.

In fact, we're currently paying around $3.40 per gallon and could average close to that price in the second quarter.

This would be more than a 50% increase from last year's quarterly price of $2.20 per gallon.

And as we have said, we are focused on obtaining 100% fuel surcharge recovery, but until we reprice all of our legacy contracts, we are not fully protected from rising fuel prices.

As a result, fuel costs will be a challenge to earnings throughout the year.

Purchase services and materials expense were up 6% in the quarter to $469 million.

We would attribute roughly one third of the increased cost to the Oregon mudslide, as third party contractors were employed to help us reopen that line.

In addition, we experienced increased facility expenses as well as higher crude transportation and lodging expenses.

Equipment and other rents expense totaled $342 million in the first quarter, up only 1%.

Although we continue to improve our equipment utilization during the quarter, those gains were offset by higher locomotive lease expense related to our 2007 acquisitions and car hire reclaims.

Other expense increased 23% or $46 million in the first quarter to $242 million.

The majority of the increase relates to last year's acquisition actuarial study which resulted in a $30-million casualty expense reduction.

Although we continue to benefit from our improved safety performance in the form of lower quarterly accrual rate, the year-over-year comparison is unfavorable.

We also experienced cost inflation related to increased utility cost, and higher state and local taxes.

Moving now to slide 28, we illustrate the drivers of our first quarter operating ratio.

Our first quarter 2008 operating ratio was 81.5%.

The effective increased fuel expenses, net of fuel surcharges, added 3 points in the quarter.

We also had the impact of last year's casualty accrual, and the Oregon mudslide.

Against these combined headwinds, we have made great progress.

Strong operating revenue growth and overall efficiency gains took over four points off the operating ratio, nearly offsetting the cost challenges.

Importantly, if you set aside these costs, we basically held our quarterly unit costs flat versus last year.

Turning now to the full income statement.

First quarter other income totaled $25 million, up $10 million year-over-year as a result of increased gains from real estate sales and higher lease income.

For the full year, we now expect other income to be in the range of 75 to $100 million dollars.

Interest expense increased $13 million or 12% to $126 million, driven by higher debt levels.

Income taxes grew 4% to $244 million as a result of higher pretax income.

The effective income tax rate of 35.5% was 2.3 points lower than last year's rate as a result of a state tax law change.

For the balance of 2008, we expect our effective tax rates to be around 37%.

Net income grew 15% to $443 million, a first quarter best.

Our diluted shares outstanding declined 4% year-over-year, contributing to the 21% increase in first quarter earnings per share of $1.70.

We continue to produce solid earnings growth in a challenging business environment.

During the first quarter, we continue to purchase shares, buying back 3.3 million shares of UP common stock for a total cost of around $400 million.

Since inception, we have repurchased roughly 15.9 million of our 20-million share program, returning nearly $1.9 billion in cash to our shareholders.

Turning now to slide 31 and our balance sheet.

We remain comfortable with our current balance sheet strategy.

Over the last 12 months, our total debt increased nearly $1.7 billion and add over three points to our debt-to-capital ratio.

We continue to generate capacity on our balance sheet through improved profitability.

We are using that capacity in a balanced approach to invest in our business, pay dividends, and return cash through our share repurchase program.

As we look out at the second quarter and the remainder of the year, the two biggest variables are carload volumes and fuel prices.

As Jack discussed earlier, we expect second quarter volumes to be in the range of down 1% to flat versus last year.

Combining that volume outlook with diesel fuel prices around $3.40 per gallon, we expect second quarter earnings to be between $1.80 and $1.95 per share or 9 to 18% growth.

The impact of fuel alone in the second quarter could increase locomotive fuel costs by $180 million or more from the first quarter levels.

Although we will recover a portion of that through our surcharge programs, the two-month lag will push some of that recovery to the third quarter.

Setting aside the impact of higher diesel fuel prices, pricing gains and productivity will continue in the second quarter and increase overall profitability for our company.

For the full year 2008, we had originally expected annual fuel prices to increase 15 to 20%.

Today, it seems likely that annual diesel costs will be substantially higher than that.

Despite that headwind however, we are not changing our full-year earnings guidance of $7.75 to $8.25 per share.

Clearly, higher fuel prices will impact our earnings, but fuel generally has a greater impact on a quarterly basis than it does over the course of the full year.

As I just mentioned, this is because of our two-month lag in our surcharge programs.

High fuel prices will also affect our ability to show operating ratio improvement in 2008.

As we consume over 1 billion gallons of diesel fuel annually, rising diesel prices make fuel expense a bigger and bigger part of total operating expense, over 27% for us in the first quarter.

And just the math of rising fuel surcharge revenue and fuel expense, results in a higher operating ratio, even if we had a 100% percent recovery which we do not.

Although 2008 is shaping up to be a challenging year, we are confident that our ongoing initiatives to improve profitability and drive efficiency will result in solid earnings growth.

With that, turn it back over to Jim.

Thanks, Rob.

When we laid out our 2008 plan for you back in January, our message was pretty simple.

Although we expected external factors, such as the economy, high diesel fuel prices to challenge us, we're committed to deliver a record year for our shareholders.

Our opportunities are clearly within our control and we have initiatives underway that will help us achieve our objectives.

Union Pacific will continue to improve safety, drive greater productivity across the organization, and increase customer value.

With that, we've got some time here to take a few of your questions.

Thank you.

Ladies and gentlemen, at this time we will be conducting a question-and-answer session.

(OPERATOR INSTRUCTIONS) Our first question comes from Ken Hoexter with Merrill Lynch.

Please go ahead with your question.

Great.

Good morning.

Just to start off, a great job in covering despite the network downside in the upper West.

But just looking at the coal side, you talked about how the continued growth you're expecting from the shippings.

Can you talk a bit about how if we're seeing any of the PRB volumes make up what is now moving export from the east coast?

Are you seeing more and more of that PR B shipments go east?

Ken, I'll let Jack take this.

But overall, the export impact really has indirect influence on PRB.

We're not seeing a surge in terms of requests that it would displace eastern coal.

We have got enough demand here just domestically, that out of PRB now we're talking about, that we see --- pretty strong here going forward here.

Colorado/Utah has been a little bit of a surprise to us, as you know.

I think Jack mentioned, we were expecting flat volume.

We're about 4% up.

Some of that could have some impact, particularly a little bit going west.

Jack, is there anything I missed?

You know Ken, actually what we're seeing is the more likely impact is in Colorado/Utah.

We're moving probably in the neighborhood of 3 million tons now export, heading primarily to the river and then beyond.

But we are getting more phone calls, as Europe gets tight and the coal imports come off of East Coast mines moving to Europe, there's a lot more interest being generated.

But right now, the interest is more for the higher BTU, Colorado/Utah coal than it is PRB.

Is there capacity to handle that increase demand?

I think we're in fairly good shape.

Actually the mines have held up.

We from time to time, we've have had problems with some of the Colorado/Utah mines in terms of their geology and things like that, but tell you right at the moment, mines are doing well.

We're doing well.

The market's pretty hot, so we're feeling pretty good about it.

PRB has the capacity.

Colorado/Utah will be stretched.

When you look at, I mean the potential to see any kind of a major surge coming out of there, there's a little bit of upside, but not significant.

The network interruption days, that was an interesting one on the side.

I don't think I've seen that before on your slides.

How do you measure that?

Do you want to take that.

We look at any time we incur 50 or more greater train hours in one particular day from an incident, then we characterize that as a service interruption day.

That's great.

It's a significant event usually.

Now, the exposure on the insurance from the problems in Upper West, are you still exposed about $25 million of that total amount that you had given?

Well, Ken, again, I think you have to be careful on the timing of the insurance recovery.

We're not assuming anything in our financials right now.

That will be a long, drawn-out process out there going forward.

Most of it will hit capital.

The pressure we will see from this thing for the year will be the 60, $70 million capital hit we're going to take.

Rob, do you want to -- ?

No, that's right.

Generally, the deductible is at 25.

But Jim's right, it will be a long, drawn-out process.

As I mentioned, a majority of that cost that we incurred is on the capital side.

Great.

One last question, if I may.

On the amount of locomotives, it sounds like you're turning back in a lot of older locomotives, the 222 you mentioned.

You're only adding 175.

Should we see --- can we see a sizable decrease in rents going forward because of that?

Well, you will see a lower -- by the end of the year, we will have fewer locomotives operating on our property.

You should see some reduction going forward on the other hand.

I hope volume picks up, in terms of the need to maybe go back into the short-term lease market.

Okay.

Great.

Thanks for the time.

Okay.

Our next question comes from the line of Tom Wadewitz with J.P.

Morgan.

Please go ahead with your question.

Hey.

Good morning.

Morning, Tom.

Wanted to drill down a little bit on fuel and try to understand the impact in the quarter and then going forward.

In fourth quarter, clear you had the timing impact with maybe a greater effect.

In first quarter, if you look at surcharge and increase in expense, do you think that it was kind of neutral or headwind or tail wind?

How would you look at that?

Then I guess second quarter, does it look like it's a much greater headwind?

Rob, do you want to take that?

Yes.

It was clearly a headwind for us in the first quarter, Tom.

Rough numbers, our expense was up roughly $300 million on the plus side, and we recovered roughly $200 million more if you look at it in terms of the yield.

Clearly, it was a headwind for us.

The second quarter, we will see what fuel prices do.

But as I mentioned, we're looking at currently high spot levels or prices that we're paying around $3.40.

That's going to create a headwind for us, but which we're always --- with that two-month lag, we're always behind when it's in a rising price environment.

Now, it goes both ways when the prices soften, we will see the benefit, but in a rising price environment, it creates a headwind.

Tom, with our legacy contracts as we have talked about, there's just no question we are challenged to recover fuel.

It's just going to take time and focus to, as these things come up, get the right fuel recovery mechanism in there.

But as long as prices continue to go up, we're going to have a problem with each quarter.

As Rob said, who knows, I mean it's anybody's guess where at some point, things do move a little bit in cycles and you get the reverse effect.

But our goal is to get a hundred percent fuel recovery and make it a neutral in our business going forward.

Right.

Okay.

In terms of the 11% yield, was there any mix?

Or was it purely 5.5 from price and 5.5 from year-over-year increase in fuel surcharge?

There's some mix in there when you look at it.

If you recall, Rob was talking a little bit about our legacy contracts that we saw some, some pretty decent growth on those legacy contracts which quite honestly, there's not much in there in terms of price or what reflects in the market.

It did hold down -- it actually negatively impacted our overall yields.

But I will tell you, 5 to 6% is what we had said earlier for the year on our core price.

We're sticking to that.

There's some markets today that are hotter than that.

You look at some of these commodity markets like coal, egg, that are out here.

The market's pretty hot.

On the other side, domestic intermodal, pretty weak.

International intermodal, pretty weak.

We're --- in some of the markets, the pricing opportunity is a little bit stronger than others, but we're sticking to our 5 to 6%.

Okay.

Do you care to quantify on the legacy contracts?

If you look at your volume growth for business under those contracts versus what total volumes were.

What was the volume growth on the legacy contracts?

Do you have a sense of it?

You know what, I really don't.

I haven't broken it out that way.

We aren't looking at it that way.

Right.

But we do know the legacy growth was on the higher than average side, but we haven't given that number precisely.

Right.

Right.

Okay.

Then on the opportunity that comes from high fuel prices, I guess your franchise isn't tremendously leveraged to things like domestic intermodal, but it would seem that truckers are extremely challenged with the high fuel prices.

I'm wondering where do you see potential opportunity for some business to come to the railroad versus truck, just as the fuel prices are really hurting truckers a lot.

Well, Tom, there's no question the pressure's there.

We are seeing more interest.

I think you have to be careful.

On the one side there's a lot of pressure, but I will tell you, there's also --- a lot of these truckers are just basically trying to get some positive cash flow.

That can put some presser on pricing in the short-term which we see.

But long-term, I'll tell you again, we look at intermodal and coal as our higher growth potentials.

I don't see the cost pressure changing on the truck side, and that in my mind really bodes well for us in terms of our intermodal network.

Jack, do you want to add anything?

No, I think that's right.

I think as we move into peak season, you will see things perk up again.

Obviously, we could put a lot more business on the railroad if we wanted to change our pricing strategy which we don't, so that's it.

Okay.

Great.

Good quarter, and thanks for the time.

Thanks Tom.

Our next question comes from the line of Ed Wolfe with Wolfe Research.

Please go ahead with your question.

Good morning.

Morning, Ed.

Could we get an update Dennis, on the Oregon outage?

What exactly is going on in terms of --- I get the sense you're mostly through it, but there's still a little bit of digging out?

Yes.

That's a fair characterization, Ed.

What we did was, we restored the service on a nighttime basis.

We take about a ten-hour window at night to run trains through there.

What we are in the process of doing now, is cleaning up the unsuitable material that poses risk to be able to come down on us in future operations.

We think we're gaining on that.

We should get that behind us here, hopefully within the next 30 days and be back to a full regular operation.

So assuming another 30 days, so it's two thirds of your quarter, something like that.

What's the impact, the drag that we should think about from Oregon this quarter?

Well, it costs us about a nickle in the first quarter.

I would --- my gut says maybe half that.

You think about for second quarter?

There's several components of it, lost revenue.

We had some business, intermodal moved down the highway.

You had out-of-route miles that came through, in terms of running it where we could, around through the Salt Lake/Ogden, and back up.

Then you again, lost asset utilization.

There's both an operating cost and revenue component on there.

Again, my gut says maybe half of what we saw in the second quarter.

On the auto side, if I look at the strike which seems to have gotten worse not better recently, what's the impact as you think about that if it were to last the whole quarter?

It costs us $14 million the first quarter.

It's costing us $14 million a month.

It's anybody's guess where that will come back.

$14 million if we did that times three.

That's kind of a worst case scenario?

That's right.

That's revenue.

What's the earnings impact to that?

In the short-term, in the short-term Ed, a lot of that falls to the bottom line.

Why are you laughing at me?

I'm not going to give you the margins in the auto business.

Fair enough.

Labor, headcount down 3.3, and you made some comments about hiring, but also attrition.

How should we think about that moving forward?

Right now, it looks like we will hire in total, 4,000 employees for the year.

We're going to lose about 4200, 4500 employees.

Net-net, you will see that differential there.

Again, part of this is really a function of how we look for volume going forward.

I expect our productivity numbers to --- they need to continue to improve and -- but again it's a wild card.

What we have to be careful of here, is you can take a lot of costs out pretty quick in an organization.

But when that business comes back, we're very focused on maintaining our surge capability.

We have go --- what do we have, 300, 400 locomotives sitting in storage right now.

I've got about 15,000 freight cars in storage.

We have on our train and engine crew side, the furrows today are about 300.

Now, that's down from the peak where we were about 8 to 900.

But we want to make certain we have the right balance between surge recovery and efficiency.

Jack had mentioned intermodal strength a couple times expected --- for at least, it to improve in the second half.

Also said, that it's not going to be based on going to get it on price.

What's the confidence?

Is it just easier comps?

Is it fuel being at these prices?

Why are you so confident in intermodal?

Jack?

I think when we just look at the supply demand situation that's out there, Ed, I think it's going to be okay.

I think you will actually see volume levels pick up during kind of the peak season kind of thing, although it probably won't be as robust as we have seen in the past.

But I think it will be there for us.

I also think that you will see some --- there are some pressures in the trucking industry and I do think you will see some of those guys starting to fold up.

You will see some of that take pressure off, and put more opportunity for us in the domestic world for the rail side.

Just everything that we look at, kind of tells us it's going to perk up here a little bit.

It's not going to be an outstanding season.

But the domestic side of the business, it is going to help.

There's another fact here we didn't really talk about which is our really very good service.

As we put new service products into the market, we show the consistency.

Customers don't automatically switch.

We're proven we can provide a good consistent service in the market, and that's what we're also seeing more calls.

not only the truck --- the cost from the trucking center pressure, but good service products we're putting in the markets.

We're also expanding some service out of northern California and other places, and taking advantage of the new train service with the MS and things like that.

We have some growth opportunities there that are pretty attractive from a --- .

That was my follow up.

Is the Meridian speedway starting to open up a little bit for you?

Actually it is.

We lost a little business there that we talked about I think in the last quarter with the contract shift, but we're rebuilding it fine.

Customers like the service.

It's great performance.

It's very reliable and I think that's going to be one of our growth features for the rest of the year.

Thank you.

Last question, then I'll pass it off.

Just could you give an update on the Sunset Corridor and the timing for when you think the double-track will be done from here?

We're sticking to our original timeframe on that, Ed.

We're doing what we said we would do this year.

That is about 30, 36 miles additional construction.

We're going to do somewhere about 140 miles of additional grading and we're on target to get all that accomplished.

We're working with Arizona to get our permitting issues behind us there, as well as the local communities in Arizona.

We're staying with the original timeframe.

We like it to be maybe somewhere in the first part of 2011, have it behind us.

Thanks a lot for the time everybody.

Thanks Ed.

Our next question comes from the line of William Green with Morgan Stanley.

Please go ahead with your question.

Just quickly to follow up on intermodal there.

There's been some press reports about container shortages.

Has that limited your ability to grow intermodal at all?

Not substantially at all.

No

Okay.

Then when we think about the repricing story, you said you had --- you got 6% of the revenue that's repricing this year.

How does the timing of that work?

Did you have 6% reprice in the first quarter or does it kind of layer in?

Most of it is back-end loaded into the year.

What are we really seeing in the first quarter?

Is it really what you were able to reprice in 2006 then, and then you will get the kicker in the fourth quarter?

Yes.

There's some of that in there.

'07 you mean?

Sorry.

Yes, '07.

Right.

Right.

And then can I ask on fuel, do you see any sort of demand elasticity as these fuel surcharges keep rising?

Recognizing that trucks should lose more than you do, but also, obviously, it's hard to change with a two-week move in oil at $17 per barrel.

You're not going to change your whole supply chain.

Do you see shippers reacting from a volume standpoint?

Or do they just accept it?

I think in some cases, we are again, at the end of the day for our customers, it's the total cost.

No core price, plus fuel surcharge.

They will make their decisions in terms of where there might be an alternative move that gives more economics.

In some cases, you can find some pretty low costs in the market.

What we're trying to work with our customers on is long-term.

In some cases, there's some business that quite honestly, probably shouldn't be moving on the railroad.

Again, you look at the efficiency, you look at the density, you look at length of haul that's out here.

We are losing and have lost some business that's out here.

But nothing in terms of --- that I'm overly concerned with.

Again, rationalizing the network and what business moves on here is a long-term process.

Okay.

Two quick detailed questions.

Leverage ratios, where do you see those going?

Do you expect the mudslide do you have any impact on second quarter cost?

Rob?

Leverage ratios, you saw the debt-to-cap ratio was up.

We think as we improve our profitability, we have capacity on the balance sheet.

We haven't given a target in terms of what we're aiming for, other than being a solid, triple-B, flat-rated kind of metrics is how we look at it.

As we mentioned earlier on the mudslide for the second quarter, I think Jim said about half the impact would be a reasonable assumption for the second quarter which call that about $0.02.

Okay.

Great.

Thanks for your help.

Okay, Bill.

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

Please go head with your question.

Two questions.

One, have you seen, given how lean truck freight has been the last couple quarters, have you seen the competitive environment spill over into any other commodity types other than intermodal, in terms of more aggressive truck pricing for other types of commodities?

Jack?

Yes, we have.

We have seen it in our industrial products.

Actually John, the way you would look at it is, any business that is susceptible to truck which covers a widespread group of things.

Our industrial products business would be one in particular.

Some of the nonspecialty chemicals, a little bit of impact there.

But it really kind of boils down to Jim's comment of the total price, when you add fuel surcharge and the freight rate together.

What you find is the business that we tend to lose, is the business where we were stretching it to keep it on the railroad to begin with.

That's what starts to fall off.

Okay.

And then Jim, to your comment about their being some freight currently on the rails that maybe shouldn't be.

Is that causing you any issues, in terms of operational performance?

Could your operational performance be a stair-step function better if some of that freight that maybe should be on the highway or elsewhere wasn't in your system?

No, John.

I don't see a major stair-step function there.

We just have to keep at it, in terms of processes, capacity that's out here.

I will tell you, we had --- you know, we always remind, we have winter every year, so we don't want to make it a big issue.

But I'll tell you, our network with the issues we had, we really showed a great capability to recover.

And I don't, I just don't see that on the --- taking a huge chunk of business off, there would be this step function.

You know, John, Dennis and I, when we came into the 2003-2004 and the problems we had there, our teams kind of sat down as we did the unified plan and really looked at places where there were operational issues associated with business.

I think we have pretty well cleaned the franchise up on those kind of things.

Okay, very good.

The barge companies are really struggling right now I guess.

Again winter did show up in the first quarter, I think it was some of the worst winter conditions they had seen on the rivers in a couple years.

One of the companies was talking about second quarter, is going to be negatively impacted by high river conditions on the Mississippi.

Is your bulk franchise doing a little bit better than you would have expected because of some market share gains from the barges right now?

Or would you classify that as some of the business that maybe should, shouldn't be on the rail?

Do you want to handle that one, Jack?

I don't see the market share shift from barges being as significant as I do the export market demand that's out there today, and the cheap U.S.

dollar.

We're just really not seeing a significant shift from barge.

Actually, I think there was some impact on our coal business, because the high waters on the river where we ended up backing up some trains.

Got you.

Okay.

Then lastly, in terms of fuel, I guess a year ago when oil was, I don't know 75 bucks a barrel or whatever it was, I can't even keep up with it any more.

But the comments were made at the time that forward curve on hedging and that type of thing wasn't that attractive.

Obviously nobody had the crystal ball to think that oil was going to $120 a barrel or whatever we may get to.

I'm just curious.

Given the rapid spike and how fast it keeps going up and the fact it just never seems to want to give any back.

Have you guys started rethinking your strategy in terms of how you approach your fuel costs?

Yes, you're doing a great job, a better job at the recovery and the surcharge programs.

But is there another mechanism out there that you need to start exploring again?

You know, John.

at the ends of the day here, our best strategy is on the fuel surcharge.

It really is.

We have talked about it.

We don't ignore it.

But I'll tell you, I'd hate to get in the situation that I have locked in a future price and it falls,and then I've got the worst of both world's.

I'm refunding --- you're cutting your revenue side and you lock the high price, and then, it can work both ways.

I just don't see that going forward here.

As you said, I'm not certain anybody saw $118 crude, at least the experts I've followed.

Very few of them had that on the agenda.

Again, our focus is on the fuel recovery, the fuel surcharge going forward.

Is there a price level that does become attractive from the standpoint of doing something on a hedge basis?

If oil was back into the mid-70s, would you look to hedge at that point?

Or --- is it hedges are kind of off limits and you're going to do this all through the surcharge mechanisms?

The only time we might look at it is where you get down to where we have the base coverage.

You look at where these things could kick in which is probably in more of the 50, $60-range that's out here.

But even then, I'll tell you, I'd be hard pressed to say let's lock it up.

Okay.

All right, very good.

Nice quarter.

Thanks for your time, guys.

Thanks John.

Our next question comes from the line of John Larkin with Stifel Nicklaus> Please go head with your question.

Morning, gentlemen.

Morning, John.

I had a question, probably best aimed towards Jack, regarding the downturn in international volume.

How much of that do you think is a function of the slowdown of consumer consumption?

And how much of that is a function of the fact of some of the retailers and the steamship companies running through the canals to the East Coast directly?

Which presumably, will now bounce back to the West Coast if the consumer starts to purchase again.

John, I think primarily right now, you're seeing the economic softness, high inventory levels, and things like that.

You're not seeing the retailers really buying a lot or stocking a lot.

We are still seeing some impact from the shift from the West Coast, from the previous ILWU negotiation problems that were there.

You saw the big retailers shift distribution centers and things like that.

We are seeing some of that, but that's working itself through the supply pipeline.

I think what you're seeing right now is more a function of the economy than you are that.

That I guess increases the likelihood that we will bounce back here eventually.

For Rob perhaps, I was a little surprised with your locomotive order in particular, that you didn't talk at all about drawing maybe some of the '09 orders into '08 to take advantage of the bonus appreciation.

Any thought along those lines?

John, we will take a look at it, but at this point in time, we don't have plans to pull ahead any capital spending as a result of bonus appreciation.

But we will continue to look at it.

It's really just a timing issue, as you know.

Right.

We will look at that, but we don't have plans to do that at this time.

Is it possible to perhaps take advantage of that savings with some of the work that perhaps you plan to do in the second half of the year that isn't under contract yet?

Is that something that is possible?

We have heard some of the other railroads are contemplating that.

We will definitely take advantage of the bonus depreciation, but the question would be whether or not it causes us to pull something ahead, is what we haven't determined to do yet.

John, we have got a pretty healthy capital spend.

I'm not --- $3.1 billion, I'm not --- I mean we're not going to ignore the economics, bonus depreciation.

Rob says timing.

But that's a pretty healthy spread, particularly given where the demand is right now.

Got it.

I understand the caution.

Maybe just one question on the regulatory front.

We have heard sometime during the second quarter, the railroad industry perhaps with the AAR taking the lead, is going to make a proposal to the STB to factor in replacement costs into the calculation of ROIC.

Which presumably would take the ROIC down quite a bit below the new weighted average cost of capital that is generated with the capitalized pricing model.

Is that a fair assessment of where we are?

It sounds to me like the STB is going to seriously consider those.

Do you think there's a strong likelihood that this could be adopted?

What sort of opposition might you get from some of the shipper groups?

Well, John, as you know when I testified, I guess it was about a year ago now, I made a point of replacement costs and used several examples in terms of what it cost to replace bridges today.

What I'm pleased with is that the STB is considering it.

Rob and his team have been working very hard with the other railroads in terms of methodologies.

We'll see what happens.

Again, my comments when I'm on the hill, is what we have to keep in mind here is whatever methodology is picked, will determine how much capital goes in the business, because it's going to be a function of returns.

And without considering replacement costs in the equation, you get to this point where you may say returns are capped.

You're going to see capital pretty flat going forward.

Again, I think there will be a nice debate.

Rob?

I agree with that.

We believe in it very strongly.

We're going to put forth our view on it.

We believe the STB as Jim said, has certainly opened the door and is receptive to reviewing, evaluating it.

We will go from there.

I think right now, when you consider what's happened in this country with train station infrastructure, the time is absolutely right to have this kind of discussion.

Sounds very helpful.

Nice quarter.

Thank you.

Thanks John.

Our next question comes from the line of Randy Cousins with BMO Capital.

Please go ahead with your question.

Morning.

Morning Randy.

Just in reference to your ag business, I wonder if you guys could comment on the relative advantages of shipping under the PNW versus the Gulf?

And whether more attractive shipping rates out of the PNW play to the strength of the Union Pacific versus shipping out of the Gulf?

Do you want to handle that, Jack?

I think, Randy, the determinant is really the freight factors as we look at it today.

We did see a significant increase in the PNW.

That works out fairly well for us.

But what we're really looking at right now, is the balance between the Gulf and the PNW.

The markets will shift, depending on ocean freight rates and things like that.

We can play in either of those markets and play pretty darn effectively.

You don't have a preference one way or the other?

I guess if --- it really depends on rate levels.

I think intrinsically, you would say that our franchise would probably favor the Gulf a little bit.

But, we're ideally suited to handle it either way.

Okay.

One other question, just on the revenue side.

Your industrial products division was up about 9%, which is relatively on the low end.

I wondered what was going on there.

Was it a mix issue in terms of arc increase or just competition from the trucks?

You're looking at the average revenue per car?

Exactly.

I think, Randy, when you look at the marketplace right now in the industrial products world, the price increases that we're getting, that's a big book of business for us.

It's heavily dominated by lumber and some of those.

And they're just not moving much product, so we're seeing a mix shift there, number one.

Number two, in some of those markets, you're probably seeing more like 2 to 3% price increases, instead of the opportunities that we have in export wheat and steel, and some of the other things.

I think it's more a reflection of the market and what's happening there, than it is anything else.

The economic recovery will benefit us enormously.

Okay.

And then last question here for Dennis, 4% productivity growth in the first quarter.

I'm always impressed when that occurs in a winter.

Was that just an easy year-over-year comp?

Or is that kind of a sustainable rate in terms of labor productivity?

Well, we did have a nice year-over- year comp, but we stressed that we want to have at least a minimum of 3 to 5% productivity, Randy.

That's our internal, external target.

We try and drive our whole organization that way.

Now last Rob, the guidance you've given, is that now including a $3.40 fuel price?

Yes.

It does.

Okay.

If the $3.40 is obviously a drag, relative to what you're originally looking for, where is the offset to some extent?

Can you give us some sense as to where you're getting positive variance relative to --- the drag that's been created by this much higher fuel cost?

Yes.

Same thing you saw in the first quarter, that is continued improvement on the price side and productivity.

It's really wrapped up in those two items.

Okay.

Great.

Thanks.

Our next question comes from the line of Jason Seidl with Independent Transport Research.

Please go ahead with your question.

Thank you.

Morning everybody.

Morning, Jason.

What kind of impact is the China Olympics going to have with some of the factories shutting down?

Is it possible that we're going to see a little bit of a double peak or maybe two small hills?

Jason, are you talking about auto?

What?

Just in general.

I mean --- I know auto going to be some of it, but even some on the intermodal side?

Are we going to see sort of a spike in June, and then maybe a spike towards the later, September, October timeframe?

I wish I knew the answer to that.

We're suspecting that it's going to get a little stronger here than normal in the second quarter, that you're going to see a break.

Then it will resume after the Olympics.

The key question, probably the speculative question is, whether or not they will come back from the Olympics as strong as they went into it.

Have you guys done any research into the factories that are shutting down in some of the smog areas, and how much of your business is exposed to it?

Jason, a lot of those factories are heavy industrial around the area up there.

We haven't --- I'll tell you, it's a wild card here.

At the end of the day, we're going to have to manage whatever happens here going forward on demand.

That's why it's important for us to have some surge capacity if there's some fluctuations here.

But I just don't see it at this point as a major, major issue for us.

Okay, fair enough.

And switching to intermodal really quick.

Given where fuel is at, have you had any thoughts to pushing out some more intermodal initiatives?

Maybe some new services to try to capture market share?

We actually have looked at expanding some of the Bluestreak lines and opening up again some of this northern California business, heading to Texas and other places.

We are evaluating opportunities where we can expand the product offering.

Okay, fair enough.

It was good.

Impressive quarter.

Thanks.

Thank you.

Our next question comes from the line of Gary Chase with Lehman brothers.

Please go ahead with your question.

Good morning everybody.

Morning, Gary.

Just a couple quick ones, and then maybe one for Jack or Jim.

Dennis or Rob, when you talk about these network interruption days rising, is there a way you can generalize as to what the expense impact of that is?

Or is it kind of all over the place?

What does it mean that you had 12 more network interruption days this quarter than you did last year?

It depends on what the interruption is.

Kind of short answer would be, it's kind of all over the place in terms of what the dollar impact would be.

I said though, this mudslide cost us $20 million in the quarter.

But you can't necessarily extrapolate every incident being exactly the same, so it does kind of depend upon what the incident is.

Okay.

And can you -- you noted the $180 million which I took to mean the variance in fuel price from the first to second quarter laid on top of the second quarter consumption is going to cost you $180 million right, assuming 2Q is $3.40.

What's a good assumption for the incremental surcharge recovery that you would get from that given the lag, of 120 or so?

Do you want to try and answer that one?

Again, if they're running up, it's going to put pressure on us again.

Again, as this keeps moving up.

Rob?

I mean $180 million, it's obviously not zero, that would be an enormous number.

There has to be some significant portion.

No.

We haven't given a number on that.

But again, it's a similar dynamic.

It depends on exactly what the price is.

What --- how --- what's you're chasing and where it is.

But generally speaking, we've got that two-month lag, so a two-thirds kind of number is a rough estimate in a rising price environment.

Okay.

Thanks for that.

And then, Jack and/or Jim, you guys have talked in answer to a couple of prior questions about elasticity between modes as a result of some of the surcharges.

Just curious if you have heard any color about, or any instances of, just elasticity overall --- reaction to the total cost change and people saying well, we have decided to ship less as a result of the transportation cost.

It really varies by commodity group.

It's obvious when you look at the coal, ag, and the ores that are out of here, it's pretty hot.

In terms of their pricing, what we see on demand.

On the other side, where they have the capability to maybe consider moving business on the highway, there's some places again that we have found that price elasticity point.

But you have to --- to me it's important to understand the market, the competition in terms of what's driving this, and whether it's a short-term, long-term deal.

We could chase a lot of business by cutting prices right now.

There's just no question in my mind, when we look at where we are seeing some of this business flow.

But I'll tell you, and honestly, I just don't think that's the right thing to do for us long-term.

Jack, you -- ?

Gary, I have not seen any indication that a customer stops producing product because of freight rates.

It's really the market.

It's really the demand for their product.

It's their own productivity and ability to manufacture and produce a product more efficiently or effectively than their competition.

It's not freight rates that differentiate whether or not the product gets made or not.

Okay.

Thanks guys.

Gentlemen, there are no further questions in the queue.

Would you like to make some closing comments?

I would.

Well, thank you everyone for attending our call this morning.

I'd like to remind all of you that we do have our analyst meeting on May 15 in Chicago which we will give you an update on our next five-year outlook.

I'm pretty excited about the opportunities I see, but we will talk to you about both opportunities and challenges.

Hopefully, we will see all of you there.

So again, thank you for attending this morning.

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

Thank you for your participation.

You may disconnect your lines at this time.