聯合太平洋集團 (UNP) 2009 Q3 法說會逐字稿

Greetings, and welcome to the Union Pacific third quarter 2009 earnings call.

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

A brief presentation will follow the formal presentation.

(Operator Instructions).

As a reminder, this conference is being recorded and the slides for today's presentation are user-controlled.

It's 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 third quarter earnings conference call.

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

Union Pacific's third quarter 2009 earnings totaled $1.02 per share.

That compares to earnings of $1.38 per share in 2008, a 26% decrease.

These results are clearly driven by the global recession and our related 15% volume reduction.

Although we'll never be satisfied reporting lower earnings, there are some positives in our results.

The Union Pacific team achieved a third quarter best operating ratio by concentrating on our business fundamentals of safety, service, value, and productivity.

Our safety performance was better in all areas as we continue to gain traction with our safety initiatives.

Our customer service reached all-time highs.

Excellent service reports Union Pacific's value proposition, enabling us to achieve pricing gains that support our capital investments and drive financial returns.

We're also generating better margins through improved efficiency.

Although the benefits of project operating ratio were evident before the economic downturn, we're taking advantage of the lighter volumes to accelerate productivity effort.

In addition to running a very solid operation in the third quarter, we're encouraged to see seven day carloadings increase from second-quarter levels.

We view this as a sign the economy has at least stabilized and might be improving slightly.

Within this environment, however, there is still a great deal of uncertainty.

Because of that, we continue to hold a larger-than-usual cash balance and remain fully committed to maintaining a strong balance sheet.

With that, let me turn it over to Jack to talk about our business [volume].

Thanks, Jim, and good morning.

The impact of the economic downturn continued to be felt in each of our six businesses during the third quarter, leading to the 15% falloff in volume.

Average revenue for car was down 12% as core price gains of 4% were more than offset by a decrease in fuel charge revenue and a little negative mix.

That being said, we're not shifting our pricing strategy in any way.

We're absolutely focused on reinvestability, even though the soft economy is making things more challenging for us.

So with both volume and average revenue per car down from last year, freight revenue declined 25% to $3.5 billion.

Although volumes were down year-over-year during the quarter, they were improved from the first half of the year with the run rate up about 10% from last quarter.

That strengthening was driven by several factors.

Seasonality played a role, as coal, wheat and intermodal all picked up over the past few months.

We have seen inventory replenishment ebb and flow, so it's starting to look like sales rates and inventories are aligning, which is a good sign we bottomed out.

Cash For Clunkers has given a boost to our automotive volumes.

Supply chain issues ranging from mine production in Colorado/Utah to bankruptcies in the ethanol market have all improved.

Stronger value proposition is attracting new business to the railroad.

And last but certainly not least, some of the improvement is what our customers are calling stronger demand, which offers some hope we will see more signs of recovery next year.

Let me take you through what is happening in each of our six businesses, start with ag.

A 12% decline in ag products car loadings combined with a 13% decline in average revenue per car to lower revenue, 23% for the quarter.

Whole grains down 18% as both exports and domestic shipments declined.

Reduced animal inventories and fewer shipments to [forward] ethanol plants led a 7% decline in domestic rate, and the lower animal counts were also a significant driver of a 13% decline in meals and oil shipment.

DDGs and ethanol both posted a slight improvement, with ethanol getting a boost from the resumed production of the former VeraSun plants.

Import beer and volume on our produce rail service also posted year-over-year gains in the quarter.

Auto revenues declined 30%, as a 19% drop in volume combined with a 14% reduction in average revenue per car, spurred by Cash For Clunkers and the resolution of the bankruptcy-related plant shutdowns.

The 19% volume decline represents significant strengthening from earlier this year, with volume up 30% over the second quarter.

Finished vehicles declined 28% year-over-year, but parts were only down 6% as we saw a nearly 50% increase in parts volume over the prior quarter as manufacturers started to ramp-up production in response to the higher sales volumes.

In chemicals, a 16% revenue decline was the result of a 7% reduction in average revenue per car and a 10% drop in volume from 2008 levels that were negatively impacted by last year's hurricane.

Our plastic shipments grew slightly as export moves offset the 5% decline in the domestic market.

Continued weakness in the construction, autos, and industrial sectors of the economy was reflected in the decline in liquid and dry shipments.

Caustic soda was the one counter to the trend, growing 2% as commodity pricing favored domestic producers versus the imports.

Economic conditions also drove declines in petroleum and soda ash down 17% and 11%, and continued weak domestic demand and a weak export potash market resulted in a 24% drop in the fertilizer shipments.

Against last year's best-ever quarter, energy volume dropped 14%, which combined with an 8% decline in average revenue per car, reduced revenue of 21%.

[Both] stockpiles remain high as a result of the recession's impact on industrial production, utility outages, relatively mild summer weather in our served territories, and to a limited degree lower natural gas prices.

Soft demand on our contract losses from the first quarter drove a 14% decline in trains out of the Powder River Basin, and although improved from second quarters, Colorado/Utah shipments continue to be hampered by coal quality problems and production issues, resulting in 210 fewer trains than a year ago.

Those economic doldrums are still prevalent in our industrial products business, where volumes were down 29%.

Add to that a 14% drop in average revenue per car and the result is a 39% reduction in revenue.

The softness and housing and construction again drove declines in steel, rock, lumber, and cement.

The steel mill capacity utilization strengthened through the year, but is still significantly below last year's level, driving a 50% reduction in steel and scrap shipments for the quarter.

Rock inventories remain high, with stimulus spending having only minor effects so far, and the one bright spot has been our new short haul uranium tailings move in Utah that drove a 6,500 unit increase in hazardous waste loadings for the quarter.

Intermodal revenue down 22%, volume was off 13%, and average revenue per unit declined 11%.

The weakness of the overall economy continues to be reflected in low west course import volumes, which resulted in a 25% decline in our international and intermodal segment.

Our domestic intermodal was again a good news story with volume up 9%, largely driven by the new Hub business.

So it looks like the economy has bottomed out.

Unfortunately, we're not seeing an upturn yet.

We expect volume will stay below last year, but given the steep falloff in 2008, that shortfall should narrow as we move towards year end.

With winter approaching, we don't see a pick up in the cards for lumber, stone, cement, asphalt, or steel.

We have seen some stimulus-related projects, but they really appear to be replacing other funding sources rather than generating incrementability at this time.

Stockpiles are high and demand is soft, and we think Powder River Basin tonnage is going to trail last year's record fourth quarter by 10%, and while the chemical business should hold the current run rate, wet weather and weak exports could produce another disappointing fall fertilizer market.

Against the challenges, we do have some bright spots.

The fall harvest is looking great.

Exports are picking up.

Ethanol should hold its run rate, and with the VeraSun ethanol plants back on line, we should continue to post year-over-year growth in ethanols and DDGs.

With auto inventories having gone from unprecedented highs earlier in the year to relatively low following Cash For Clunkers, that inventory replenishment should keep volume at least as strong as the third quarter.

And with the peak international peak behind us, such as it was, the international intermodal volumes will soften through year-end.

At the same time, domestic should continue to outpace last year with added Hub business and the continued strength of our new service offerings.

We're staying focused on reinvestability, new business development, and capitalizing on the opportunities created by a strong value proposition that our service is creating.

One of the best proofs of that value proposition is what our customers are saying.

So I will wrap up with a look at customer satisfaction, which came in at 88 for the third quarter.

That is a 5 point improvement from last year and our new best-ever quarterly mark since we started measuring customer satisfaction back in 1987.

During the quarter, we also set our best-ever monthly record with the satisfaction index closing in August with 90.

With that, I will turn it over to Dennis to talk about our operation.

Thank you, Jack, and god morning.

In the third quarter, the operating team continued to make significant enhancements to both our operating efficiency and service delivery.

In fact, the performance of our rail network has never been better.

Third quarter velocity increased nearly 16% versus 2008 to a best-ever 27.4 miles an hour.

Freight car utilization, which is cycle time between loaded [moves], set a record at 8.4 days.

The lower cycle time means fewer assets are needed, reducing capital and lease expenses.

Terminal dwell times held steady at 24.5 hours, and as we discussed in July, we have shut down our significantly curtailed operations at several locations to reduce cost and reflect current demand.

We gained these efficiencies while also improving our service performance, as shown by our service delivery index in the lower right and by the record customer satisfaction that Jack told you about.

We achieved this performance while also improving the number one priority -- safety, making double-digit gains year-to-date for all three categories in public employee, public, and customer.

Our productivity efforts are also paying off in capital activities.

Roughly two-thirds of our capital spending this year goes to replacing and improving the infrastructure.

A diligent focus on process improvement, using lean principles, has driven steady productivity gains.

This stretches our capital dollars with a payoff in lower, slower miles.

Fewer speed restrictions means better fluidity and service and reduced operating costs.

On the operating expense side, we set another best-ever fuel efficiency rate in the third quarter, 2% better than the same quarter last year, saving about $20 million in fuel costs.

We're reducing our freight car lease expenses by $4 million and also reduced overtime and guaranteed costs significantly.

All of these productivity gains improve our agility in the uncertain economy.

In fact, year-over-year we were volume variable with our working resources.

Gross ton miles were down 17% year-over-year, but we were able to reduce train starts and our working resources even more.

As you heard from Jack, volumes have improved from the April trough.

Sequentially, gross ton miles actually increased by 9% from the second quarter to third quarter.

We put a few more resources back into service, but these remember tempered by permanent reductions from attrition, equipment retirements, and lease returns.

The work we did over the last few years to efficiently handle volume across the network, such as the unified plan, various inventory management systems, and the operating income statements we installed in our field work units, also helped us be more agile in sizing the network in the current environment.

The best part of this story, however, is still in front of us, when volumes increase further.

We see strong upside leverage in the operation as a result of long-term structural changes made in our network operations.

For example, the Evergreen process of the Unified Plant, which has created room to grow in the existing training network without adding additional starts; changing our locomotive utilization, including expanded use of distributed power; and developing better assignment practices to take greater advantage of technology.

These structural changes also create room to grow in the existing train network and improve fuel efficiency.

We maintain search capacity to quickly handle changes in demand, thus creating resiliency and the strategic investments in our infrastructure over the last several years provide with capacity to grow.

The combination of these activities as well as many others have enabled us to be volume variable and will give us good upside leverage as volumes return.

With that, let me turn it over to Rob.

Thanks, Dennis.

Good morning.

We'll start the review of the financial results with a look at our income statement summary.

Third quarter operating revenue totaled $3.7 billion, 24% lower than 2008.

The primary drivers were a 15% decrease in car loadings as well as a $590 million reduction in fuel surcharges.

Quarterly operating expenses declined 26% to $2.7 billion.

A 49% decrease in third quarter diesel fuel prices contributed to the lower expense.

In addition, UP's ongoing efforts to operate with a high degree of volume variability while increasing organizational efficiency helped reduce quarterly costs.

Lower third quarter operating revenue and expense combined to produce quarterly operating income of $967 million, a 20% reduction versus 2008.

Third quarter freight revenue totaled $3.5 billion, down 25% from 2008.

Similar to operating revenue, lower volumes and reduced fuel surcharge revenue drove the decline.

In the chart on the left, the blue bars illustrate the year-over-year change in our rate-based fuel surcharge program.

Of course, this program is only one of a number of fuel surcharge programs that the company uses.

But it demonstrates the significant decrease in fuel surcharges between 2008 and 2009.

The yellow bars illustrate the year-over-year change in average revenue per car.

As diesel fuel prices and the related fuel surcharges declined, our customers benefited from lower freight bills.

In fact, after seeing a 1% increase in the first quarter average revenue per car, the third quarter average revenue per car was 12% lower versus 2008.

The mix of our business was negative in the quarter by a couple of points.

Over 60% of third quarter carloads were energy and intermodal shipment, groups with the lowest average revenue per car.

This more than offset the impact of higher average revenue per car move like ag products and chemicals.

As Jack discussed, third quarter core pricing totaled roughly 4%, still strong but reflective of the very difficult economic environment that we face today.

And given current pricing levels, we now expect full-year core price to be closer to the 5% mark.

Although clearly pressured by the economy, we remain firmly committed to pricing our business to improve returns, which will be evident in our overall profitability.

Turning now to expenses, we'll start with compensation and benefits, which totaled nearly $1 billion in the quarter, an 11% decline.

During the quarter, Union Pacific continued to take actions to better align workforce levels with demand.

Through a combination of furloughs, attrition, and management actions, third quarter employment levels were 11% lower than in 2008.

In fact, we have seen a sequential decrease in our workforce over the past six quarters.

In addition to our employment actions, greater overall labor productivity kept average compensation per employee pretty flat in the quarter.

This is especially significant when you consider about 85% of our workforce received a 4.5% wage increase on July 1.

For the remainder of 2009, we will continue to manage workforce levels with demand.

Slide 23 shows the year-over-year impact of diesel fuel prices, volumes, and fuel surcharges on the quarterly earnings.

Third quarter fuel expense declined $669 million in the quarter or 59%.

The biggest contributor was a falloff in quarterly diesel fuel prices that went from $3.70 per gallon last year to $1.87 per gallon in 2009, saving $442 million.

In addition, third quarter gross ton miles were off 17% year-over-year, driving down consumption and saving $180 million.

The red and green bars on the slide demonstrate the quarterly impact from our fuel surcharge lag.

As we discussed in July, earnings in the the first half of 2009 benefited roughly $0.40 per share.

That earnings tailwind was created as diesel fuel prices declined and the associated fuel surcharge revenue lagged the lower prices by roughly two months.

In the third quarter, however, the relatively stable fuel price environment allowed our fuel surcharge programs to nearly match the price we were paying for fuel.

As a result, the combined impact of fuel prices and the related surcharge lag was basically zero in the quarter.

At current diesel fuel prices of around $2.05 per gallon, we would expect to lap a very favorable comparison in the fourth quarter.

You recall last year's fourth quarter benefited from roughly $0.30 per share earnings tailwind associated with the fuel surcharge lag, and we clearly don't expect to see a similar benefit this year.

Purchase services and materials expense declined 16% in the third quarter to $403 million.

Lower volumes and increased operating efficiency contributed to lower contract services expense, reduced crew transportation and lodging, as well as fewer joint facility costs.

We also used less locomotive and freight car materials in the quarter as we performed fewer repairs as a result of lower volumes and having portions of these [sleep] in storage.

In addition, this expense line has a favorable year over year variance associated with last year's hurricanes of about $11 million.

Turning to equipment and other rents, this expense category declined $36 million year-over-year or 11%.

Reduced volumes, particularly for shipments of industrial products and intermodal containers, reduced short-term car rents by about $14 million in the quarter.

Better asset utilization as well as fewer leased assets also contributed to the quarterly expense decline.

In addition, locomotive lease expense declined as a result of restructuring certain locomotive leases from operating through capital in the second quarter.

This transaction reduced equipment and other rents expense by $22 million, while increasing depreciation expense $15 million and interest expense $14 million.

Other expense totaled $179 million in the quarter, a decrease of $39 million or 18%.

Reduced freight and property damages, employee travel, and utilities expense contributed to this decline.

We also recorded less expense for bad debts in the quarter.

An improved receivables collection rate and our ongoing efficiency focus help drive expenses lower.

Increased property taxes offset a portion of this decline.

Turning now to slide 27, we look at our expense variability for the quarter.

Union Pacific has taken action throughout 2009 to adjust our cost structure as business volumes remain low.

That work continued in the third quarter in the form of reduced workforce levels, stored assets, greater operating productivity, and a companywide focus on efficiency.

If you normalize for the year-over-year change in diesel fuel prices, we achieved an expense variability rate in the third quarter in excess of 80%.

The organization responded very well to the challenging business environment, which positions us to bring volumes back on to the network and in a cost-efficient matter.

In fact, we expect that we will add volumes to our network at higher margins when the business volumes rebound.

The final proof statement of our quarterly results can be seen in a record third quarter operating ratio of 73.7%.

In the face of significant lower volumes, we achieved 1.2 points of year-over-year improvement.

Operating efficiency, focused cost reductions, lower fuel prices, and pricing gains all contributed to quarterly progression.

Since 2006, the work of project operating ratio helped us take nearly 7.5 points off of our operating ratio, despite seeing car loading declines of almost 19%.

Taking a look at the full income statement, other income totaled $14 million in the third quarter, down $9 million versus 2008.

Less rental and interest income as well as lower gains from real estate sales contributed to this decline.

Third quarter interest expense increased $26 million to $156 million.

Higher year-over-year debt levels and a slightly higher effective interest rate drove the increased expense.

Income tax expense was 24% lower in the quarter, to $308 million.

Lower pretax income was the primary driver of the decline, offset somewhat by a lower effective tax rate last year.

Our third quarter 2009 effective tax rate was 37.3%, 0.7 points above the 2008 rate.

On a full-year basis, we expect the effective tax rate to be close to 37%.

Third quarter net income totaled $517 million, a 26% decline or earnings of $1.02 per share.

Slide 30 shows our quarter-end cash position and all-in debt levels.

We continue to maintain above-average cash balances as warranted by the economic environment.

Adjusted debt levels increased to $14.5 billion, reflecting new debt issuance over the past year.

For the fourth quarter, our expectations continue to be driven by the economy.

As Jack mentioned, the volume comparisons become increasingly favorable as we move toward the end of the year.

In particular, we experienced a 10% decline in seven-day car loadings between November and December last year.

Although we don't expect to see declines of that magnitude in 2009, weekly volumes will likely slow between Thanksgiving and New Year's.

We also face a significant headwind from fuel in the fourth quarter.

As I discussed earlier, the fuel surcharge lag contributed roughly $0.30 per share to quarterly earnings in 2008, adding significant pressure to year-over-year comparisons this year.

Regardless, we will stay focused on controlling the parts of the business within our control, which will position us for strong upside and increasing returns when the economy does improve.

With that, let me turn it back to Jim.

Thanks, Rob.

As we close out the final months of 2009, we would like to share our early thinking in what is ahead in 2010.

We don't expect a quick rebound and are positioning ourselves for a slow recovery.

In that environment, we remain dedicated to running our railroad as efficiently as possible and providing customers with a strong service product.

Excellent service creates market opportunities, attracts new customers, and supports future pricing gains.

We're still developing our capital plan for 2010, but our spending level will be balanced between current low demand levels and our commitments to long-term strategic growth.

Although we're not -- we won't be taking any new locomotives next year, we will have the additional burden of implementing positive train control.

The Safety Bill requires complete installation by year end 2015.

We'll aggressively pursue meeting the deadline.

Looking beyond today's economic challenges, we believe UP's accelerated productivity efforts will drive significant upside leverage when volumes start to improve, enabling UP to deliver increasing financial returns and growing cash flow.

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

(Operator Instructions).

Our first question is coming from the line of Thomas Wadewitz with JPMorgan Chase.

Please proceed with your question, sir.

Good morning.

Good morning, Tom.

Let's see, I wanted to get a sense of your operating leverage, which you might see through expanded train size, assuming you see pickup in industrial volumes looking out over a couple of quarters.

I guess to get at that, can you give a sense of what your average train length is at the present time, setting aside coal and ag?

If you look at the scheduled network, average train lengths and perhaps what you could get to given sidings or other constraints if you see improvement in volumes?

Tom, that is a difficult question because the ability to absorb volume in the near-term as it comes back to function by corridor, by yard, and by types of business.

We are managing our train length pretty efficiently.

We're running pretty decent-sized trains right now when you look at it.

Again, if you look at the dropoff in volume and the reduction in train starts, you will see we have done a pretty good job of matching that.

The real upside in my mind comes into the context of think about -- we have 1,700 locomotives that are stored and were depreciating.

So if you see some of that increased volume, we won't see an incremental cost in terms of locomotive ownership.

There is room in certain corridors in terms of absorption of train size.

We do have our train crews that were running what we call a low mile strategy, which says that they have opportunity to move up.

To put a specific number on it is pretty tough now.

There is significant leverage as the volume comes back in terms of our ability to convert that into bottom lines income.

Dennis, you want to add anything to that?

No, across the board whatever the train type is.

We have room to go.

I will tell you this our train lengths on the intermodal side, the auto side, and manifest -- other than the auto side and manifest side are largest that they have been.

As Jim said, since we added DPU to two-thirds of our gross ton miles, we have significant growth opportunities in every one of the train class categories.

Okay.

Good.

That is helpful.

What my other question would be, with respect to coal, and I apologize if I missed this in your prepared remarks.

But you can give us a sense of the magnitude of stockpiles in your specific region?

And does that imply that the negative case will be a stepdown in volumes next year in coal, or is it more realistic to say you're running at a low rate and maybe the negative case for coal volumes next year is flat with this year?

Jack.

You think about what could drive coal next year.

There are so many variables, including is it going to be a cold winter or warm winter, hot summer.

what is going to happen with the export markets, all of those things.

I can tell you our stockpile situation is relatively high.

Probably higher -- there was a report out recently that said on average, somewhere in the neighborhood of 20% higher than a year ago.

So there is a significant coal stockpile out there, but there are a lot of conditions that would determine whether or not we're going to be down flat or potentially up volumes from next year.

Okay.

So you -- all right.

Good.

Fair enough.

Thank you for your time.

Thanks, Tom.

Thank you.

Our next question come is from the line of Chris Ceraso with Credit Suisse.

Good morning, this is Allison Landry in for Chris.

I was wondering if you can give some color on percentage of your contracts that have been locked in for 2010?

Jack.

Allison, if you look right now, it's difficult to say.

We're in the process of renegotiating right now and looking at those contracts, and it's too early to say what percent has been done or what.

There are still a lot of things that will have to be decided here before we get to year-end.

Okay, some of the other railroads have been talking about maintaining their expectation of above rail inflation?

Would you say that that is true for you guys as well?

Allison, I'm not going to give you specific guidance, other than to tell you if you think about Union Pacific, we have the biggest book of legacy deals still in front of us.

And I do see positive upside in pricing.

Okay.

That is great.

And then maybe turning to fuel.

Seems like the gallons consumed are trending better or lower than the volume declines.

Can you talk about maybe some fuel efficiency measures that you guys are gaining on?

You bet, Allison.

We have a comprehensive fuel conservation program.

Obviously our DPU program, where we're using the distributed power, we think that generates about 4% to 6% fuel savings versus conventional power configurations.

We put in a fuel conservation speed where we use the maximum speed of 50 at the most efficient fuel throttle positions.

Our trains, tons per powered axle, the way we distribute power, we have been able to take advantage of our AC technology.

That has lowered the number of units required by over 100, and it's generated fuel conservation savings for us.

And then for the last thing I'd mention side our is Fuel Master's Program, which is our engineers, our operating craft engineers, practicing good operating practices and teaching others and there is a reward recognition program in there.

That has been a significant contributor to our fuel conservation efforts.

It's a multifaceted approach.

Okay.

Great.

Thank you for the time.

Thanks, Allison.

The next question is coming from the line of Walter Spracklin of RBC Capital Markets.

Please proceed with your question.

Good morning, guys.

Good morning.

Just back on pricing.

You're indicating the quarter was 4%, down from where you had been up until recently, I know you're guiding toward the 5%.

I wanted a better sense -- you mentioned there is a mix effect in there and there is also the general economic pressure.

Is there any way you can break out what is pushing that down?

Is it the pressure from customers given the economic environment, or the mix effect during that quarter?

Jack, you can take that?

Walter, there are a number of things that impacted pricing in this quarter.

We said in the past that our legacy deals are not evenly distributed throughout the year, nor are they even distributed evenly year-to-year.

We had a situation in the second half of 2009 here where we have lapped legacy renegotiations from last year.

Last year, we had a very nice price increase as we stepped up the rates to market this year, and now from the rest of the year, and it's replaced by a more normal escalation.

That is one factor.

And the second factor for us, I had 4.5% increase in price in my international intermodal business that was completely offset by contract provisions in my legacy intermodal business that required price decrease.

That was a fairly large hit for us.

And the third factor I would say is the escalation contract and the escalation vehicles themselves, for instance, [ALIF] was only up 2.5% in the quarter, and last year it was up close to 5%.

Those are kind of the three swing factors that were out there.

Okay, that is great color.

Appreciate that.

The second question -- this is for Jim.

Washington, still no word from them.

Can you give us an update on -- we had been hearing rumblings that a bill has surfaced, that you had a look at.

You might be all right with it.

Is there anything you can provides us, understanding there is confidentiality there?

Any update you can provide us on what is coming out of Washington?

Walter, we're still waiting to see an actual bill or language about every other week.

I would say this, though.

We have been in discussion with Chairman Rockefeller and Chairman Oberstar for years in terms of our concerns, what is required in terms of ensuring this industry can still afford to invest -- discussions and replacement costs.

I am confident they're listening.

Most members who have an influence want to see more business movement on the railroads.

So we'll so what comes out and get a chance to look at it and take it from there.

Nothing on timing, though?

There is a lot of issues going on in Washington today that I'm not certain that new regulations in the railroad industry are a priority, although I am concerned and I have said this to members that uncertainty is a problem in our industry and we have to have some certainty when we start thinking about long-term investment decisions.

They realize that.

But we have a great story.

We have made a lot of investment.

You have to be careful about choosing [this] any new regulations too far because investment will dry up and that has been our message for the members.

That is great.

Thanks for the color.

Okay.

Our next question is coming from the line of Matt Troy of Citigroup.

Please proceed with your question, sir.

Thanks.

I was wondering if you could talk about, Jack, what you're hearing from customers.

If I look at the fourth quarter, we only have six weeks left.

You get the dropoff into Thanksgiving week and get the dropoff in the last two weeks of December.

First quarter is shaping up to be a black hole.

I wonder if you can talk about what you're hearing from customers in terms of their shipping intentions and capacity requirements beyond what is the end of the peak season that didn't materialize?

It's a mixed bag.

I just think through, for instance -- I think coal is going to just stay where it is.

As I said in my remarks, it's going to be down 10% from a year ago, and we're going to get down to the contract minimum with ourselves and also the utilities.

So, that is not going go up.

The ag world is going to being strong for us and the export market is picking up, both soybeans and then once the corn harvest is completed, I think we will see strength.

And that should take us into the first quarter easily and we should be decent there.

And chemical run-rate is about where it's going to be, plastics faring better because of exports.

I think the fertilizer is going to be disappointing.

I think that is going to be seasonally appropriate from the levels it is.

We'll see a downturn through the holidays, and then it will show some uptick in the first quarter.

Intermodal, it's going to follow a seasonal pattern, although our domestic I think is going to outperform year-ago levels, and -- both because of Hub and also because of new international lanes with Norfolk Southern and the reefer service we started up this year.

Automotive guys tell me they're expecting it to stay strong here, the inventory replenishment cycle.

They're not going gangbusters in terms of overtime and everything else to fill the inventory levels back up.

So, we have talked to several of them recently and sounds like we should be okay through the first quarter.

And that would leave the IP guys, and I think construction season, for all intents and purposes, shut down.

And I think the IP world is going to stay where it is.

I think it's going to be a tough first quarter and the hope appears to be second quarter of 2010.

They're all saying that they hoping to see at least some minor rebound in the construction industry.

The one exception might be steel.

The steel capacity utilization crossed 62%, I think, was the most recent number I saw.

And if that were to continue, we could see a bit of an upstick in our steel car loadings and buck the seasonal trend there.

Thanks for that comprehensive answer.

I would take those comments and ask Dennis in terms of operation if we do see that seasonal sequential decline from mid-December to January, is it reasonable to assume you'll be taking actions on the headcount front or the network productivity perspective to scale back for reduced traffic levels with the normal seasonality?

What are the one or two levers you can pull in the near-term for 1Q?

Absolutely, Matt, we would do that and have been doing that.

I think you saw that demonstrated here in the numbers this quarter.

One of the first things we do is obviously go in there and adjust our Unified Plant, and we've been doing on that on a daily, weekly, monthly basis commensurate with demand, and would adjust our training starts and the other one that you heard was the initial question series about train size.

With that, we have been consistently taking up train size and would adjust obviously our yard operations, which we have been driving more towards our efficient yards, downsizing and shutting down our smaller yards.

Those are just three classic things we start with in immediately and those are an ongoing process for us.

All right.

Thanks for the time.

Thank you.

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

Please proceed with your question, sir.

Morning.

Good morning.

Jim, you talked about accelerating productivity effort, building accelerated productivity effort.

If we have a half-speed or volume recovery that is on the weaker side of the equation, how much of an opportunity is there to take additional cost out of this system?

Or have we taken the cost structure down to as good as we're going get?

Is there another point of OR that can come out by running the railroad better?

I won't give you the number in terms of the OR.

The biggest challenge we have now, we're all struggling with right now, is when you have picked that point of the uptick, and our assumption here the next year is we're not going to see anything significant.

Many of the issues -- Rob mentioned the project OR initiative we have had underway for a couple of years now.

There are short-term, there are mid-term and long-term types of opportunities that have come out of that.

So, we're going to continue to be aggressive in our efficiency in this environment.

And, on the other hand, we have to be prepared for when the thing picks up.

I expect us to continue to show good cost performance.

Is that a case of offsetting inflation or the situation where you can actually do better than just be consistent with inflation?

If you work for me, your minimum target is offsetting inflation.

I think there are cases we have done better.

You have to be smart about -- listen, the other caveat here, we have to be careful -- we're not going to jeopardize service.

And it gets so important for us right now with our service metrics.

We have customers that have not considered rail before that are starting to look at rail.

Customers are seeing the value proposition, which -- that value proposition helps in the pricing initiatives that we take a look at.

So there is a whole spectrum of things we look at and consider.

Again, it doesn't end in one year and it's going to be a tough year next year and we're going to respond with our efficiency.

Jack, I wonder if you could comment on the growth and domestic business ex-Hub.

We know we have the Hub business.

Are you getting growth quarter-to-quarter in your domestic business or from Q2 to Q3, taking out the Hub factor in terms of the numbers?

Randy, I would say in a down economy, our domestic business without Hub would be flat to maybe slightly up with a variety of things happening within that mix, and Hub pushes us over the top in terms of growth.

And just to sneak in, could you comment on the pricing in the intermodal business?

Are you still seeing pressure on the price front from the trucking competition, particularly in the domestic front?

On the domestic front, my bigger issue is my legacy contract.

Okay, thank you.

Thanks, Randy.

Thank you.

The next question is from the line of Bill Greene with Morgan Stanley.

Please proceed with your question.

Hi, good morning.

I wanted to follow up on a couple of comments.

Jack, you mentioned it was too soon to talk about what is repriced for 2010.

I think last year at this time, you mentioned the at the start of the year for 2009, you expected roughly 70% of the business locked in on price.

Would there be any reason it would be different this year when we look to 2010?

Bill, yes.

This is a different economic scenario than where we were last year.

Even at this point last year, we still hadn't really realized the full extent of how bad things were going to get.

I think there is a lot more moving pieces, it's a lot more difficult economic scenario and there is -- it could turn out to be the same.

I'm not prepared to say that yet.

Okay.

And then, Jim, as you think about managing the volume rebound over time, and UP's done a phenomenal job taking out costs to the downside, you haven't shown much negative operating leveraging.

There is some skepticism that you can show positive operating leverage when volume comes back.

Are you willing to [veer] this in through price or something?

Can we expect lower-than-expected recovery because you're only going to take volumes back at an incrementally higher margin?

How do you believe that?

I have to believe some of the costs will come back.

You will have some come back.

The obvious one -- fuel is about 100% variable with volume when you look at it.

Our first criteria when we look at it is where does it fit on the reinvestability?

That is your first test in terms of taking any business back in.

The second one, every group in this company has taken costs [out].

Sometimes there is, I guess, we look at things when you have the challenges we have.

I have seen our team really put on the table some things in terms of accelerating cost reductions that, you ask the question -- is it absolutely mission critical?

And in the environment we're in, it's not.

And we're going to be very, very cautious about adding costs in as we move forward.

Obviously, you're going to have some cost increase there that is clear.

But we do have good leverage and many of the costs that came out of here, at least as I see the next two or three years, are not coming back.

You mentioned the locomotive being able to leverage that -- does this mean we wouldn't have to take any locomotives going forward so we can actually see a reduction in gross CapEx, too?

I said in my comments we wouldn't take new deliveries next year.

We are sitting on, I think, 1,700 right now.

So we have got quite a bit of room in terms of taking volumes before we're back in the locomotive market.

All right, great.

Thanks for the time.

Okay, Bill.

Our next question is from the line of Jon Langenfeld with Robert W.

Baird & Company.

Please proceed with your question.

Thank you.

Good morning, on the coal side, is there any evidence that as you bump up into some of these minimum contract agreements with the mines and the utilities -- any evidence that that is taking away in a meaningful way from the first half 2010 demand?

I don't see, that Jon.

This is Jack.

I don't see that at the moment.

It's not a widespread hitting up against the minimums?

No.

Although at the end of the day here with higher inventories, clearly coal volumes in the first half -- I want to make sure this is the question -- they will have pressure in first half in coal simply because the inventories are high.

I understand that.

I guess I am wondering, are you bumping into your minimums widespread, which to me would indicate that there is additional weakness, even above and beyond the inventory stockpile that may occur in the first half of 2010?

No, we don't see anything in there.

Okay.

Nothing significant.

On a domestic intermodal side, I can imagine that is probably one of the more price aggressive places given what is happening in the trucking world.

Can you talk a little bit about when truck pricing turns, how you are positioned to benefit from that and how quickly you can see the benefit from that?

I think there are a couple of perspectives there.

You have to show the service product first.

You can have -- jumping back and forth between truck and intermodal, it's -- customers don't do that routinely.

We have had great service products in place, new offerings we're putting in place -- and you have to ask the question, the impact of both demand and fuel.

You have fuel, crude over $80 a barrel, that will start to come through the market and obviously that should help us on the railside.

We're more fuel efficient.

I don't know if you can say there is a magical point here.

If anything, we probably have seen if there is any shift going on, it's been the last -- right now with whatever -- calling it a peak.

There is pickup and demand there.

I don't think there is a magic number saying you automatically see a swing.

Okay, thank you.

Okay, Jon.

Thank you, the next question is from the line of Edward Wolfe with Wolfe Research.

Please proceed with your question.

Good morning, guys it's Scott Group in for Ed.

A quick one on pricing.

Can you give color -- on the 4% pricing for the fourth quarter, can you give a sense of where you started the quarter and where you finished, if it was different than 4% throughout?

Scott, I haven't thought about it that way.

No, I don't see much different between the beginning and the end of the quarter, other than just the way the escalations played out in terms of formulas.

But no real substantive change in activity, thought, or strategy.

Okay, and as you look at 2010, for the legacy contracts that come up, are they more front-end or back-end loaded for next year?

And can you tell us if you have any big international intermodal contracts coming up next year?

I have some front and I have some mid-years, and I don't have any major international modals.

Okay, great.

Just housekeeping now.

For headcount, you can give color where you finished the quarter and where we should see headcount going from here?

I know it was down from second quarter to third quarter.

Are you planning on keeping it flat into fourth or should it be up or down from here?

Total number's down 11%, I believe, to a year ago.

We're taking a look, a hard look.

And keep in mind, we're still experiencing attrition.

While the rate of attrition slowed down a bit, we'll still probably in total lose about 3,000 or so, 2,500 employees this year and we're managing that.

We have a, pretty much a hiring freeze in, other than a few pockets in the company.

We're going to continue to manage it in terms of lining up as much as we can with volumes.

So fair to say headcount is not up from where we saw it in third quarter?

Right.

Sequentially.

That is right.

Okay, great.

Okay.

Lastly on the coal side, can you give an update on Colorado/Utah and when you're expecting the mines to come back, and refresh us on when the contract losses for PRB coal [laps]?

The contract losses, this is Jack, Scott.

The contract losses will lap January 1.

And Colorado/Utah, I would love to tell you, but I really don't know.

They're dealing with geology issues, they're dealing with coal quality issues.

I have no way of knowing how that is going to fare next year.

We have seen this happen before and all of a sudden, they hit a solid seam of coal productions very well, and they get back into the problem.

It's hard for us to determine that.

Okay.

Thanks for the time, guys.

Thanks, Scott.

Our next question is from the line of Ken Hoexter with Banc of America Merrill Lynch.

Please proceed with your question, sir.

Good morning.

Nice job on the results, guys.

A quick question on the intermodal legacy contract that you mentioned that was bringing down rates, you can delve into that a little bit?

I'm unfamiliar with why you have built-in price reductions into the contract.

They're legacy deals, Ken.

So this is -- how long is that contract?

Okay.

Forget it.

I just -- sorry about that.

I get it now.

And then the rates on this contract, still confused by the comment on why you can't talk about the percentage that is locked in for year ahead.

What would -- wouldn't the contracts be locked in today?

Or next year already?

A certain percentage of them?

Or -- I just don't understand how much could be in flux at this point.

Jack?

When you stop and you look at the contracts, there are some that are in place.

There are some that have contract provisions that are still variable as to where the price is going to play itself out.

Even in some of the contracts as we negotiate, the escalation terms will vary with respect to our caps or paylift and those kind of things, and they all variable.

It's difficult in this environment to give you any assurance that I have locked in 65% of my price in the marketplace, and there are too many variables to let me tell you that and have you count on us.

We have to be careful a little bit.

The fact is a pretty major bulk of our business is locked in the contract base.

What is the total percent of the total book that's contract?

44% long-term and about 30% one-year deal.

I would be careful coming away from here that there is a major shift in the terms of the percent of our books that's contract or not.

We're still in negotiations.

We're not getting into the details here, but I'm not -- there is not a major trend change from what we have seen in the past.

Jim, to wrap up, you talked about the regulatory picture earlier to one of the questions.

I just want to understand Are you seeing any activity pick up right now as health care seems to slow down?

Or is this, we hear so many different things about the rails have seen something or something is coming.

It's imminent.

I want to understand what your perspective is, if you're hearing chatter picking up at all or is it slow and consistent?

I think it's been consistent in terms of where we're at.

I don't see healthcare diminishing in terms of the focus in DC today.

We'll see what happens, and we're waiting to get a first look here and everyone will see that.

I would just be cautious about overreacting to anything that comes out.

Okay.

Thanks.

Thanks, Ken.

Thank you, the next question is from the line of Gary Chase of Barclays Capital.

Please proceed with your question.

Good morning.

Good morning, Gary.

Could I ask you to clarify on the legacy domestic business, that is RCAF, right?

That is going to presumably change going forward -- that is just a temporary issue?

Or is that a more, a longer-term priced reduction?

Gary, there are RCAF issues and other contract provisions that I'm not at liberty to talk about.

When you think about the intermodal business and look at what is going on, is there a transloading phenomenon that is effecting the domestic versus international mix when you look at how the volumes are playing out versus what we're seeing elsewhere?

In the past, it's always been -- we cycled back and forth here.

Used to be you had a lot of international business -- ocean carriers would like to transload into domestic boxes for movement into the US to get their boxes back to the Far East.

And then that went away, and now it's cycling back again where we are doing transloading on the West Coast into domestic boxes and returning to the international.

Is there any way to get a read on how much impact that is having or is that too tough to tell?

It's tough to tell.

Okay.

And then, I don't know, I guess for everybody, when you think about where that leverage point is, where that volume will really matter and have the biggest incremental impact, is there a way to think about generically where that is, which [economy] grouping?

I would think intermodal.

Is that a fair assessment?

Gary, I think it falls -- if you're, I'm not sure if I understand your question, but --

If you think about the opportunity to add one incremental car to a train opposed to --

Well, it's going to be your manifest network, it will be your intermodal network, autos, you think about coal, you don't add coal to car loads.

You add coat at train starts.

But even in areas -- or [grain] shuttle.

Even in those areas, you still will have leverage again.

My example is the locomotive.

We're depreciating the cost of locomotives in the books, and not earning $1 revenue.

It varies by group and each one clearly will show good leverage.

Go ahead.

We need to get a another question.

You want to go to the back of the line?

I will let it go.

Okay, thank you.

Our next question is from the line of Justin Yagerman with Deutsche Bank.

Please proceed with your question.

Good morning.

Good morning.

I wanted to get a sense, you talked about the fuel and performance is good.

As you bring back potentially locomotives, hopefully as the economy improves, what is the MPG impact to that and how much of an offset you can create in things like improving distributed power across your network and that kind of thing?

Jack.

Well, Justin, we don't expect to see a significant increase here.

First off, we still have some of our more fuel-efficient locomotive stored.

In terms of if we have to bring locomotives back, they're not going to be at a degraded consumption rate at this point, and we think we have room to grow on.

I showed you that about two-thirds of our gross ton miles are in DPU.

We can still have incremental growth there.

And we've got room to grow on our TDA -- that's our new tons per powered axle that allocating [power] with.

And our fuel conservation speeds and our fuel master.

So we expect to continue this improvement yet -- even if gross ton miles do go up, which as you saw here in the third quarter, we have 9% 3Q versus 2Q, and we still took the fuel utilization down 2%.

We expect more of the same.

That is great and great to hear.

I know you guys have mentioned and there have been a couple of questions on what is going in the domestic intermodal side, and that you do have a legacy contract that that at least one that is weighing on profitability and in that piece.

And I guess -- there has been a lot of talk in the marketplace about there being conversations around that contract.

Can you at least give us some color as to whether or not you're in those conversations, and if so, do you think any kind of resolution, if there is one, brings things toward a market rate on that piece of business?

I'm not going to get into the details.

Other than to tell you, we're always in discussion with our good customers.

More to come on that.

Okay.

That is fair enough.

And then, any more color than what you guys already said on PTC and the costs or potentially timing on any rollout there?

No.

Okay.

I appreciate the time, gentlemen.

Thanks, Justin.

Thank you.

Ladies and gentlemen, there are no further questions at this time.

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

Well, thanks, everyone, for joining us in the call.

I hope you heard from our team here.

We see nice opportunity next year and let's hope the economy starts to turn.

We'll see you in about three months.

Thank you.

This concludes today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.